Industry Research Report Regulatory Changes: The JOBS Act

The passing of the JOBS Act in April 2012 and the resulting changes in both general solicitation and the definition of accredited investors will have a significant impact on how emerging growth companies are able to finance their business. Previously, companies were prohibited from generally soliciting investors with whom they did not already have an existing relationship under Regulation D. This significant change will broaden the opportunities for companies to reach investors. Moreover, the children of the Baby Boomer generation, known as Millenials, have an appetite to investment directly in emerging growth companies rather than through traditional financial instruments such as the outright purchase of listed stocks. OneMedResearch reports on the Regulatory Changes in The JOBS Act through an interview with Jeff Feldman who has worked on Wall Street as a banker and economist since 1967 and discusses the history of Regulation D and how the SECs arbitrary ruling on the definition of accredited investor. These regulations have had a lasting impact in depriving many potential investors from otherwise participating in emerging growth companies and is a major contributing factor to the wealth gap in this country. The regulatory changes in the JOBS Act will change this significantly and perhaps be on the most significant changes to securities laws in the last 40 years.

OneMedRadio Interview w/ Jeff Feldman November 30th, 2012

Brett Johnson: Welcome, this is Brett Johnson. OneMedRadio New York. Today I'm with Jeffrey Feldman. Jeff has been on Wall Street since 1967 and seen its evolution in its role in shaping America. As an economist and wall street banker, he's been in the trenches for over 40 years. He's seen demographic and financial trends. He's watched the evolution of regulation of financial markets. Jeff joins us today to offer perspective on what he thinks is a tremendous change occurring that will create significant investment opportunities related to demographic trends and technology. He is founder of Polywog which he hopes will capitalize on the JOBS Act in its capacity to help investors outside the traditional connected lead benefit by participating in innovative companies. Thanks for joining us today Jeff.

Jeff Feldman: Thanks for having me Brett.

Brett Johnson: So Jeff, you've been on wall street for some time. The whole term "accredited investor" is a major, sort of debating point for securities offerings and private placements in general. Can you talk a little bit about your background and what you know about this term "accredited investor" and why thats relevant and how it came to be?

Jeff Feldman: Yup. I started my career in 1967 at Goldman Sachs. 1967 was an important year in the history of private investment. 10 years earlier, 1957, George DeRote, a famous venture capitalist at Harvard University, in a company called American Research & Development Corporation, invested $70,000 in Digital Equipment Corporation. A startup at that time. In 1967, Digital Equipment went public and George's $70,000 investment was worth $355 million. As you might imagine, this caused quite a furor on Wall Street when we all started scurrying around trying to figure out how

we can invest in companies like that. And that was really the genesis of what is the modern private placement business. The modern venture capital and private equity business. In 1967, there were no rules for who could participate in such partnerships because there had never really been any demand for them before. So as these partnerships started to get put together, the Securities and Exchange Commission became concerned that people who are unsophisticated or perhaps lacking in sufficient assets would start to put too much of their money into things they really didn't understand. And so the SEC proposed sometime in the late '60s, that there should be a standard and they came up with the phrase "accredited investor." And then they set out to a series of hearings to try to define what is an accredited investor. There were actually more than one proposal. Of course, one proposal was that it should be a matter of income and wealth, which is the one that they ultimately chose and the other was that it was a matter of sophistication. Perhaps, give people a test. Or perhaps look and see if they have been managing their own money for a period of time and they've done pretty well with it. There were a number of standards considered but in 1972, the SEC decided that an accredited investor was someone who earned $200,000 a year at the time or had a net worth of $300,000 and at the time that included their house and their automobile. So it was a pretty modest standard, but still in 1972, most people did not qualify for that standard. The standard actually went into effect in 1974. 1974 is significant because 1974 is the year that the Employee Retirement Income Security Act was passed (ERISA). That created retirement accounts. Retirement accounts are important because later on in the decade, the department of labor said retirement accounts could own stock, the famous prudent man rule and the mutual fund industry blossomed. Now mutual funds own public companies. Private equity firms and venture capital firms invest in private companies. So here we have the genesis of the ability to invest in private companies at the same time a market was created to take out those private companies in the public markets by accumulating the retirement assets of most of the population. Now a cynic might say that was done on purpose but I don't think anybody was that smart back then. So we started to see a division take place between the more elite investors who were defined arbitrarily and the people who could not invest in private placements. Compounding that problem, or that issue, is the fact that the banks in the early '70's figured out how to mass distribute credit card debt and create credit cards rather and create installment debt. Up until 1973, if you had a credit card, you had to pay it

off every month. Human beings are pretty much homogeneous in terms of our desires. We all want nicer homes, better lifestyles, better opportunities, better education for our kids. But starting in the early 70's, some people got to get there by investing and others got to get there by borrowing. Fast forward to today, the investors, who we now refer to as the 1%, have accumulated $30 trillion of wealth and the borrowers who are really going after the same assets have accumulated $15 trillion of debt. And it really all stems from a very arbitrary decision that didn't have to be made. If they had used a sophistication test then there are many people who did not have the net worth who could have become investors. You can't tell me that 10 Harvard University Law students who each put $15,000 into a partnership and collected enough money to be an investor doesn't have the same sophistication as someone who just inherited $2 million and has never worked in their lives. But the law said the latter person is sophisticated and the Harvard University Law students are not. It simply is ludicrous. But that is the system we have lived under. If you said to yourself "I want to be a tech stock investor." And 10 years ago, you invested in some of the right stocks and investments. Some of those that had been successful. The NASDAQ index, the tech index, is up about 47% over the last 10 years, which is a return of about 4.5-5% a year. And there's nothing wrong with that. But anybody listening to this can tick off the names of lots and lots of people who have become billionaires in tech stocks. Now what's the difference between billionaires and the people who have made 4-5% a year? The people who make 4-5% a year invested in stocks or in mutual funds that are buying stocks and they bought it either on the IPO or after the IPO. The people who invested early in those companies' history were sellers on the IPO. So the sellers became billionaires and the buyers are making a decent return. Now there's nothing wrong with a decent return but the fact of the matter is for those who like to be more ambitious with their investing, even if they wanted to be, the law prohibited it. The beauty of the JOBS act is that it now opens up that type of investing to anybody who wants to do it. Look at this another way. Over the past 20 years, Americans have bought $1.5 trillion of lottery tickets. In a survey, that was done by McKinsey, 30% of lottery buyers said that they bought those tickets for wealth creation purposes. Now you can smirk at that, but if we take them at their word, that's almost half a trillion dollars that people were putting into lottery tickets in order to try to create wealth. Now the fact of the matter is, they were precluded from trying to make a lot of money any other way. This was the only one that was available to them.

So if the law had been different and some of that half a trillion dollars, lets say $200 billion, had been invested in either venture deals or small businesses in communities all across the country, think of how different this country would be today. Sure several of them would have failed but some of them would have become very large businesses. And the people would have $200 billion and it takes $50,000 to start a little business and each of those businesses can create 6 or 8 or 10 jobs. There's 4-5 million jobs that we could have created by simply allowing people to do whatever they wanted to do. And by the way, the return for almost all of those people on their lottery tickets was zero. So they certainly would have been better off if they had been afforded the opportunity that the JOBS Act now affords them.

Brett Johnson: So did you think that the, obviously the regulators back then had any idea that the decision to just essentially block investment opportunities just to the rich and sort of deny the less wealthy the ability to make a lot of money. I mean that sort of led to the 1% vs 99% division.

Jeff Feldman: That is true, but I believe that is a totally unintended consequence. I don't think anybody could have had the vision to see that. You know, it was a very different world. Just to give you a little perspective, when I first joined Goldman Sachs, which was a very fine firm even back then, I got a handwritten paycheck. We didn't have any technology at all. We didn't get technology until the early 70s. So, it would be very hard pressed to have that kind of perspective. I was a research analyst and we got all of our data, our macroeconomic data, from the Bureau of Labor Statistics. They were the keeper of all the government data in those days and we got all of that data six months in a year. What was going to happen next was impossible because we had been looking back trying to figure out what had happened. And because it was all paper, it took a long time to figure that out. So no, I don't think that this was a conspiracy, I just think this was an unfortunate consequence, the good news if there is any, is that now 40 years later, empirically anybody can sit down and do this analysis and say well it didn't have to be this way. And once again, I don't believe that anybody who had a hand in creating the JOBS Act was thinking this

way at all. I think they what they were thinking was the economy is stagnating, the usual tools of capital formation are busy dealing with problems. The investment banks have gone away, they've gone into proprietary trading and other activities. There's nobody who's trying to put together the capital to allow us to create businesses to drive innovation and employment. And so, almost out of desperation, the law said lets give everybody the chance to do that and of course there are problems with that because they are having difficulty in enacting this legislation because there are a number of things to consider and unfortunately it occurs at a time post-Madoff, post the subprime crisis, post a whole series of unfortunate fraud that makes everybody focus on the downside and lose sight of the upside. The analogy I always use is in the Medicare system, which was a $600 billion system, it was estimated that there is $85 billion of fraud. So a similar analysis in Medicare would be, well we should eliminate the Medicare program because it would eliminate $85 billion of fraud. Thats true. But the other $515 billion keeps tens of millions of people healthy and alive and productive and participating in the US economy. So on balance, its a very very good thing. So we try to control the fraud but we recognize the benefits of the system. The JOBS Act offers tremendous benefit in terms of allowing people to have more control over their lives in terms of where they put their money. The intermediating system, the venture capital/private equity people, they have their own agenda. They worry about rates of return. They worry about getting money back to the investors in a certain period of time. They don't think in terms of how do I want to live my life in the United States. What kinds of things do I want to see built for my family, for my children. What kind of a society do I want to live in? They think in terms of internal rate of return. The individual investor may think that way, but collectively they will probably are going to think in terms of what benefits society. Because at the end of the day we are a fairly homogeneous society in terms of our aspirations.

Brett Johnson: Interesting. So who do you see? What's your outlook on the JOBS Act and the passage of it? And who are the proponents of it? And what are the opposing forces?

Jeff Feldman: I had an interesting experience yesterday. I attended an investment conference and I met an operative from the White House who had a significant role in the creation of the legislation. And I explained to him the perspective that I shared with you and his eyes got wide and he said well you need to come down to the White House next week and we didn't really see how great a job we've done. So I think that there is a big learning curve in Washington even though the President kind of urged this legislation. He really hasn't talked about it much since he's signed it because I think they are still getting their arms around it. I don't think they that really understand the esoteric nature of regulation, the significance the change to regulation D, which deals with general solicitation but somebody like me who's been in this business for you know, almost half a century. I understand that things are very very profound changes and as they come to understand them, I hope they become very excited about it. I was at the SEC a couple of weeks ago, and I saw a little evidence that theres any sense of urgency about this. The various provisions will get enacted over time. I'm hopeful they'll be enacted sooner rather than later. Whenever it happens, it will happen and when it does it happen it will materially change much about the US economy and I think that buy and large, those changes will be very very positive.

Brett Johnson: So lets talk a little bit about demographic trends and the baby boomers who became investors that led to a big boom in share ownership in the United States, now you have the millienials. Can you give us your perspective on just demographics and who invests?

Jeff Feldman: Sure, let me put that in context for you. After World War II, we had a very homogeneous generation. The veterans came home, they were in their 20s and 30s, they started families, bought homes in the suburbs. I think everybody that knows that story, they went to work, they worked hard, but they remembered World War II and they remembered the depression. So they were reasonably cautious with their money. That was a generation of savers. Everybody had a passbook. In fact, in the early 60s, the United States had the highest savings rate in the world. In 1960, 4 million people, 4 million individuals in the United States owned stocks.

Only 5% of those 4 million people owned what we used to call the "nifty fifty." The great manufacturing and retail names of the time like Bethleham Steel and Sears and Woolworth's. Owning stocks was not a big deal. The average daily volume in 1967 of the New York Stock Exchange, my first year in the business, was less than one million shares a day. So stock ownership was just not park of who we were. We were cautious, we were capital preservation oriented. 5% or 5.25% in a passbook, was 3% real. We have low inflation, low interest rates. Everybody was happy. In 1973, the Iranians closed the Strait of Formouz, we had what we called the Oil Shock where we had gas lines, prices shot up, the economy suffered from the lack of energy and stagnated. We invented the word "stagflation." We had recessionary growth and high interest rates. From '73-'79 we suffered *MUTE*. During that time, getting *MUTE* and experiencing price inflation of 7, 8, 9, or 10% was not fun. And investors came to understand *MUTE*. Harry Brown and Ruth Bent who invented the reserve fund. A money market fund that would allow people to take money out of their passbooks and put it into a fund that could invest in the higher yielding CDs that were available from banks. And of course, they became very popular. So we broke that very strong trend to be savers. People were still saving money, but they weren't necessarily getting the government guarantee. They were willing to buy what was called junk paper in order to get higher yield and so for the first time we each produced a modicum of risk into that equation. As I said earlier, in 1974, ERISA passed and in 1978, it became clear that those retirement funds could be invested in the stock market. Now that World War II generation really didn't care that much. By this time they were in their 50s or 60s, but the WWII generation spawned the baby boomer generation which was born between 1936 and 1964. In 1981, the first boomers turned 35 years of age. Most stocks are owned by people between the ages of 35-55. Until you're 35, you don't have any discretionary capital. After you're 55, you start to become more conservative so that 70% of stocks are owned by people between 35 and 55. So think about that. From 1981 to 1999, we added 78 million people to the investor demographic in this country. 20 million people owned stocks in 1980 and MUTE. The Dow was 1000 in 1980 and 10,722 at its peak in 2000. And it was driven in part, in large part, by all of that liquidity. But back in 1980, on Wall Street, we were looking at a transition as well. Two companies went public in 1980 that really got my attention. One was FedEx and the other was Apple. In a society that was clearly manufacturing *MUTE*. I didn't get the idea of the value of a company that

was going to deliver envelopes. I didn't understand yet that we were moving into an information age. Apple was a little different. We started to see the New York Stock Exchange having to close two days a week. Wednesdays and Fridays at noon in order to deal with the paperwork because they were still doing mostly paper back then. And so we understood that computer power and the ability to move information electronically was critically important to the growth of the country. In July of 1981, IBM introduced the PC. Further evidence that we were moving towards an information age. But even though it was only 25 years until Facebook, there was nobody in 1981 who understood what was about to happen from the point of view of the information age. But fortunately, the introduction of the information age economy, the introduction of the PC coincided precisely with a) the coming of age of the baby boomers and b) the advent of mutual funds that allowed people buy portfolios of companies. And these companies were providing the very services that were *MUTE* the investors. They were getting the PC, they were getting the information super highway, then called the internet. And all of the companies that participated in that, Dell, Cisco, Juniper, all the names that everybody knows were springing up to build this wonderful new infrastructure. So we had this wonderful coalescing of a demographic boom, a technology boom, and a wonderful new capital market tool that could bring the two of them together and we had an unprecedented bull market. And now the boomers are starting to retire. And their children, the so called millenials, were born between 1976 and 1995. 1976 + 35 is 2011. So the millennials are coming of age now. 80 million people. Young, bright, computer proficient, optimistic just like their parents were, smarter than their parents, many more of them college educated, and so we have this new demographic. We have all kinds of new technology. Everybody's aware of social media and people are aware of the human genome, robotics, everywhere you look. We'll probably be known as the molecular age, where we really are able to change very fundamentally the way we engage in science in so many areas. We have wonderful new technology, a bright fresh new demographic, and here's the JOBS act that creates the kinds of securities that will allow people to invest the way they want to in what they want to invest in far more flexibly than the mutual funds that their parents had to deal with. So we have set the stage for a prosperity that a few years ago would have been unimaginable.

Brett Johnson: So basically the JOBS act is intersecting with technology advances and demographics to create a very hopeful outlook of a very bright economic future?

Jeff Feldman: I was there in 1979 and 1980 when interest rates were, when the primary got to 21%. If you could get a mortgage in the early 80s, it was 16%. Inflation rate was 12% and unemployment rate was 13-15%. The numbers were dreadful. In many ways, worse than they are now. And everybody knew that we would never have a bull market in this country again. And oh by the way, we had an Asian power that was eating our lunch financially. Japan was far more powerful than us, growing very rapidly. If you go back and read the press at the time there was only going to be a matter of time before Japan became the dominant economic force in the world. And I think China is going to go through a very similar path that Japan went through. By the way, Japan had more money than China has now. Japan had more money, more assets than China has now. Even today, Japan has $12 trillion of citizen's money invested in less than 2%. They are sitting on tremendous amounts of cash but are very very conservative. And its very hard to build a modern economy. The United States economy which boomed after the industrial revolution was done in a country in which there were less than 20 million people and we had several recessions and several national bank failures between the Civil War and 1907. The most important legislation that we have in the United States today is the Sherman Antitrust Act of 1890 which maintains the competitive nature of capitalism. China hasn't even gotten to the Sherman Antitrust Act of 1890. They don't have antitrust legislation. So they've got to go through decades and decades of the pain and suffering that we went through to build our economy and they've got to do it with 1.2 billion people. I think they are going to have serious problems. Meantime, we, in the United States, have this wonderful mix that we had 30 years ago of an emerging demographic, wonderful emerging technology, and exactly the right types of securities to allow us to bring the two of them together.

Brett Johnson: That's tremendous but Jeff, thank you so much for your comments and insights. You offered trememnoud perspective on history

and lets hope that this JOBS Act pushes through and that these opportunities are going to be here. Thanks for joining us today.

Jeff Feldman: Thank you Brett. Brett Johnson: That was Jeff Feldman, chairman of Polywog, sharing his perspectives on the economy, the future, and the JOBS Act. This is Brett Johnson with OneMedRadio, New York City, signing off. Good day.