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Originally published Saturday, September 28, 2013 at 8:05 PM

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Buyer beware of companies’ new way to gather capital

It should not be lost on anyone that deregulation, overheated speculation and high risk were major triggers of the Great Recession.

Special to The Seattle Times

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For 80 years, it has been illegal for a company to advertise for funding from the public, a ban that included newfangled social media such as Facebook and Twitter. That changed last week.

The Securities and Exchange Commission now allows startup companies, hedge funds and buyout firms to solicit the general public, with some restrictions. The biggest: Only accredited investors, people with more than $1 million in assets, can take part.

The new rule is the second phase of the JOBS Act (Jump-start Our Business Startups), which passed Congress with bipartisan support and was signed into law by President Obama last year.

The law also allows so-called crowdfunding, where average people can invest in small companies. This third phase, the most controversial part of the legislation, has yet to make it through the SEC rule-making process.

Even so, companies and even nonprofits can now buy billboards and bus ads to seek money. The Web has seen the rise of a number of outfits dedicated to helping gather the new capital. The most prominent include AngelList, Kickstarter and Crowdfunder.

For example, AngelList was promoting 669 companies in Seattle last week. Kickstarter was instrumental in raising donations for Detroit’s bronze statue of the movie hero RoboCop.

“This is the most significant piece of securities legislation since 1933,” said Joe Schocken, founder and president of the Seattle merchant bank Broadmark Capital. “This is a sea change. How it plays out is the story yet to be written. But it represents a huge change in how capital gets allocated in our economy.”

Schocken is a veteran investment banker and was an early supporter of the JOBS Act. He’s a friend of the president and has helped raise big money for the Democrats. He’s also not naive about the Wild West that the legislation has unleashed.

“On balance, it’s a very effective piece of legislation and it will be good for the economy,” he said.

With changes in the capital markets over recent decades, huge amounts of investments go to trading, commodity plays and other gambles. The JOBS Act is an attempt to lure more money into funding smaller, job-creating ventures by relaxing regulation.

Investors can still chase high yields, but they can also follow their passions and common interests, whether funding cures for diseases or building a new grocery in their neighborhood.

Yet Schocken said regulators were far behind the curve and the potential for mischief is high. Individuals will need to perform their own due diligence.

“Every Russian criminal and mafia member knows this is coming. There will be a large number of illegal deals. Very attractive investments will show up in your email box. Lots of good will come from it. And lots of bad. It’s the classic buyer beware.”

Reuters columnist Felix Salmon was even more blunt: The new funding platforms “offer a whole new world of opportunity when it comes to separating fools from their money.”

How the good plays out remains to be seen.

Seattle is already a hotbed for startups. An influential report last year by Startup Genome, compiled with Telefónica Digital, Stanford University and the University of California, Berkeley, ranked here No. 4 in the world as a “startup ecosystem,” and this was working under the old rules.

It should not be lost on anyone that deregulation, overheated speculation and high risk were major triggers of the Great Recession. The same was true in the lead-up to the Great Depression, which led to the tight regulation of securities eight decades ago.

I hope the good of the JOBS Act outweighs the bad, but it represents more deregulation. And let’s be clear: Without an effective federal watchdog, the market isn’t free. It is fixed by oligopolies and other powerful interests.

Too bad Democrats and Republicans couldn’t have come together for policies guaranteed to produce large numbers of jobs and more than repay their public investment: infrastructure, research and education.

Instead, this is the best we can do for Main Street. Buyer beware.

You may reach Jon Talton at jtalton@seattletimes.com

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About Jon Talton

Jon Talton comments on economic trends and turning points, putting them into context with people, place and the environment in the Pacific Northwest
jtalton@seattletimes.com

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