Section 201(c) of the JOBS Act provides that in connection with securities offered and sold in compliance with Rule 506 of Regulation D certain intermediary parties will not be subject to broker-dealer registration.  Parties that do not receive compensation in connection with the purchase/sale of the security, take possession of the customer funds in connection with such security, and are not subject to statutory disqualification, may now engage in a broad range of conduct previously unavailable to non-broker-dealer registered entities.  Such parties may now maintain a platform or mechanism allowing for the offer, sale, purchase, or negotiation of securities and engage in general solicitation, advertisements, or related activity whether online or in person.

Section 304 of the JOBS Act also creates a new crowdfunding exemption.  Section 304 amends the Exchange Act to allow issuers to raise no more than $1 million in a 12-month period via registered funding platforms provided that the offering is conducted via a funding portal that complies with certain requirements, the amount raised meets certain investor based limits, and the issuer meets certain requirements.  Notably, unlike the Rule 506 Exemption, section 304 requires that such institutions must register with the SEC and FINRA as “funding portals” and not engage in investment advisement or management of investor funds or the solicitation of the purchase/sale/offer of securities.

The SEC has taken a lenient view towards the use of these JOBS Act Exemptions based on the notion that such firms receive carried interest as compensation in lieu of transaction-based compensation.  On March 26, 2013, the SEC’s Division of Trading and Markets granted no-action relief to FundersClub Inc., an operator of an accredited investor online portal and its affiliate FundersClub Management, LLC, a manager of investment funds, marking the first successful use of the new JOBS Act Exemptions.  Shortly thereafter, no-action relief was also granted to AngelList LLC and AngelList Advisors LLC permitting a registered investment adviser to operate a similar internet-based investment platform.

These new permissible activities mark a high watermark in the venture capital space and will be sure to lead to the funding of new innovative companies.

Mr. Parker offered career advice to students throughout the breakfast.  For those seeking a job in-house, Mr. Parker recommends three to four years at a law firm to get training and experience.  He noted that job opportunities come in a variety of ways—from the “traditional” route of sending applications in response to job postings to recommendations and referrals from networking.  He explained that compliance is a growing area which students may want to consider.  Finally, Mr. Parker urged attendees to keep an open mind with their career.  Given the current market and the changing dynamics of the industry, one may have to take a step back professionally or move laterally in order to start on a new path that can lead to growth.

Our thanks to Professor Kent Bernard for moderating and Mr. Parker for taking the time to speak at Fordham.  We wish Mr. Parker good luck as he begins his new position with the New York City Bar.

This year’s lecture was given by Mr. Benjamin M. Lawsky, the Superintendent of the New York State Department of Financial Services (“DFS”). DFS is a relatively new regulatory body which was created in October of 2011 after Governor Andrew Cuomo decided to merge the New York State Insurance Department and New York State Bank Department.  Mr. Lawsky’s talk, titled “Regulating in an Evolving Financial Landscape”, first outlined the mission of the DFS and then provided examples of how the DFS was enforcing “a new regulatory architecture of a reformed Wall Street.”

Mr. Lawsky began by describing the characteristics of a good regulatory body, emphasizing that while a regulatory agency must be “nimble,” regulation must “not stifle innovation.”  Mr. Lawsky explained how there will be a constant “push and pull” between regulators and the financial industry, and that regulators need to remain “vigilant” even in the wake of the expanded regulatory authority provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  Mr. Lawsky expressed concern that in the wake of financial reform risk may simply be “pushed into darker corners” of the financial market.  Regulators need to approach life after Dodd-Frank with humility, and be cognizant of the fact that no one set of laws will keep the financial system safe forever.

Mr. Lawsky emphasized that one of the strengths of the newly created DFS was the fact that it had no “institutional inertia.”  In outlining how Mr. Lawsky envisioned DFS fitting in with the other state and federal regulators, he mentioned how he saw the old system of regulation as a race to the bottom, a “competition” between regulators to see who could have the lightest touch.  Now, given the mandate from Governor Cuomo to keep New York the financial capital of the world while keeping consumers safe, Mr. Lawsky wants the DFS to be vigilant in ferreting out frauds and also in preventing developments which could prompt future crises.  In doing so, he hopes DFS can help create a spirit of healthy competition among regulators.

Mr. Lawsky walked through  five areas in which the DFS has been active since its inception.

First, the DFS was a regulatory leader in examining force-placed insurance. When homeowners default on insurance they are also likely to default on their insurance payments. In most cases a clause in the mortgage documents allows the mortgagor, in the event of the homeowner’s failure to pay insurance an premium, to purchase insurance and add it to the mortgage. Many times the forced place insurance cost homeowners 2-10x the cost of normal insurance.  Part of this higher cost was the result of insurance premiums being channeled back to the mortgagor. Through DFS investigations, two insurers (QBE and Assurant) who make up over 90% of the New York market for force-placed insurance were forced to pay millions of dollars in settlements and restitution.  Mr. Lawsky has indicated that he has urged state regulators outside of New York to follow the model set up by DFS and protect consumers from this predatory practice.

Next, DFS has been compelling banks to take anti-money laundering statutes more seriously.  Mr. Lawsky analogized the regulatory regime to a menu where entities could choose their money laundering activity from a list with an associated fine.  So long as the entities paid the fine, they were able to engage in the money laundering activity.  The DFS began to take stronger regulatory actions and as a result other regulatory agencies have followed suit.  This was one example where money laundering led to “healthy competition” between regulators.

Third, DFS has been investigating the independence of consultants at banks.  Mr. Lawsky was concerned that these consultants may have lost their independence because banks pay their salaries and have much more contact with them than do regulatory agencies. He took the position that this compromised the ability of the consultants to work for the public interest and resulted in the consultants having their interests aligned with the banks.  There have even been instances of consultants willfully sweeping problems under the rug at banks.  This is another area where Mr. Lawsky hopes that attention from DFS will prompt attention from other state and federal regulatory agencies.

An emerging trend that the DFS is following is the acquisition of fixed and indexed annuity issuers by private equity companies.  Private equity controlled insurers account for 30% of the indexed, and 15% of the fixed annuity, income markets, up from 7% and 4% a year ago, respectively.  Philosophically, Mr. Lawsky wondered whether private equity firms should be acquiring insurers due to the conflict between the short term time horizon held by private equity companies and the long term time horizon that insurance issuers require.  Through aggressive risk-taking and high leverage, companies acquired by private equity firms could wind up in bankruptcy.  If a company which owes annuity obligations to a large number of retired Americans failed, the repercussions could be significant.

Finally, DFS has been examining the use of captive re-insurance.  Ostensibly, the practice of captive re-insurance is used to shift risk outside of the state or offshore to take advantage of looser reserve requirements.  This allows the insurance company to then divert reserves to other purposes, but no risk is actually transferred off of the parent’s books since they are usually the guarantor of the subsidiary.  This practice has put the stability of the entire insurance system at risk, and DFS has been examining what the appropriate response from regulators should be.

Through these five examples, Mr. Lawsky highlighted how the DFS has been involved in both the banking and insurance sectors since its creation in October 2011.  DFS under Mr. Lawsky’ stewardship should continue to remain proactive, aggressively meting out what it perceives to be risky or dangerous financial practices in an increasingly complex financial world.

Acclaimed as an “IPO On-Ramp,” Title I of the JOBS Act is championed by its supporters as a response to the problems identified by the task force by providing scaled regulations and exemptions from the securities laws. Central to Title I is the “emerging growth company” (“EGC”), a new class of issuer with total revenues of less than $1 billion, which benefits from the regulatory relief provided by Title I. However, in using $1 billion in annual gross revenues as a basis for qualifying as an EGC, Title I recklessly ensures that all but the very largest companies will be able to benefit from its provisions without making the usual kinds of important disclosures applicable to public reporting companies. Indeed, former SEC Chairman Mary Schapiro was critical of the $1 billion threshold, remarking that “[a] lower annual revenue threshold would pose less risk to investors and would more appropriately focus benefits provided by the new provisions on those smaller businesses that are the engine of growth for our economy….”  Indeed, while companies involved in IPOs of over $50 million have continued to enter the public capital markets successfully, smaller companies’ IPOs have “effectively disappeared.” Thus, on a fundamental level, Title I is ill-conceived.

Unfortunately, the so-called “IPO On-Ramp” has done little to stimulate the U.S. IPO market. In the year since its passing, IPOs have fallen 21%, from 80 last year to 63 this year. Instead, Title I has been a haven for misuse as companies like Goldman Sachs are exploiting the JOBS Act by creating shell, or “blank check”, companies for the purposes of skirting important restrictions on proprietary trading by commercial banks. Other shell companies have embarked on more fraudulent schemes to deceive investors under Title I of the JOBS Act, drawing the ire of the SEC. Industry experts like Columbia Law School Professor John Coffee predicted that Title I would create new opportunities for fraud and other financial crimes in the market. Perhaps unsurprisingly, he has affectionately dubbed the JOBS Act, the “boiler room legalization act” as an ode to the fraudulent practices that marked the 1980s.

Critics of the “IPO On-Ramp” claim its fundamental premise – that the costs of making an IPO are dissuading companies from entering the public markets – is flawed and that more structural changes are needed. Coffee suggests reducing underwriting costs may incentivize issuers to conduct more public offerings. However, the JOBS Act is silent on these issues. Instead, Title I is largely oriented around disclosure and regulatory costs, including elimination of the auditor-attestation requirement under § 404(b) of the Sarbanes-Oxley Act, because it ostensibly raises the costs of registration and, in so doing, dissuades small companies from going public. However, as Barbara Roper, Director of Investor Protection at the Consumer Federation of America, has noted, “[i]t is particularly troubling that [the JOBS Act] continues to scapegoat SOX 404(b) for a drop-off in small company IPOs that cannot in good conscience be laid at its door.” Thus, blaming § 404(b) is misplaced and should not be a guiding star as Congress tries to conjure up new ways to stimulate IPOs and job growth.

Ultimately, Title I of the JOBS Act has been a nearly unmitigated failure. It eliminated important investor protections ostensibly to encourage more companies to engage in IPOs and thus generate jobs. A year later, however, the total number of IPOs has decreased 20% and unemployment is still over 7%. Thus, while other aspects of the JOBS Act have yet to be implemented by the SEC, it is clear at this early juncture that the Act’s “IPO On-Ramp” desperately needs an off-ramp.

Rescheduled from Fall 2012:
13th Annual A.A. Sommer, Jr. Lecture on Corporate, Securities & Financial Law

Benjamin M. Lawsky, Esq.
Superintendent, New York State Department of Financial Services

"Regulating in an Evolving Financial Landscape"

There is a reception immediately following in the Platt Atrium.

The program and reception are free and open to all.

Registration: law.fordham.edu/sommer

The Sommer Lecture is made possible through the generosity of Morgan, Lewis & Bockius LLP.