In the second part of our interview with Congressman David Schweikert (R) of Arizona’s 6th District, we talk about the potential for securitization, why access to information being the greatest regulator, and what he sees for the future. Read Part I here.
EQ: One of the big next steps in the crowdfinance space, particularly in the peer-to-peer arena, could be the securitization of crowdfinance offerings and the creation of derivatives based on those securities. What role, if any, would you envision the federal government playing in regulating that segment of the industry?
Schweikert: We’ve actually had a number of conversation on that and creating a sort of a futures market. You could actually do some of the derivatives space rationally if it’s the sort of crowd-sourced lending platforms that are very popular right now.
Equity crowdfunding, that’s gonna be a little harder to design. I actually think, from a regulatory standpoint, we need to see what some of the design proposals are.
My instinct, though, is that this is the crowdfunding phase, and the financial instruments accompanying it are still several years away.
EQ: What part of the new crowd financing rules excites you the most? Are you more interested in the new potential provided to start-ups or small businesses?
Schweikert: The answer is very simple. It’s, “Yes.”
I’ve not found an elegant way to communicate this yet, but I want to evaluate the mindset of those who are elected and challenge their belief that they think they know how it’s going to look like a year or two years from now.
You and I may wake up tomorrow and find out that this is how ongoing concerns do their next tranche of capital. Or, this is how concerns start a new business to test this idea and it is used more as a market test than as a capital raise.
Is this how the person in the garage has an idea and puts it out? Is it a more of an elegant way of raising money from friends and family through a formal platform as opposed to over a kitchen table?
I have guesses, but I just don’t see enough of the future to be able to absolutely know. And that’s what I love about this. There’s lots and lots of optionality, lots and lots of possibilities. I think there’s actually a lot of need in the market from a particular internal community, ethnic communities, folks who want to do funding in underserved areas, to people who want to test proof of concept.
There’s so many options here, and who knows what this is going to look like in a few years.
EQ: So you’re excited about the market ultimately defining and deciding a lot of these things for us?
Schweikert: As it should! Those of us that were involved in creating it, we have a vision and the more we learn, the more that vision changes.
When it actually starts from the marketplace, we may find out that there’s uses of this type of capital raise that we never thought of, and that’s what makes this exciting. But that goes hand in hand with the new internet and technology world. We don’t know what will be presented to us tomorrow.
Think of the flexibility that comes from this type of platform. Its ability to reflect tomorrow’s idea, in many ways, is a great power.
EQ: Opening up rules regarding equity could have a democratizing effect on our economy, but the rules it’s changing and relaxing were born out of a time when fraud and exploitative practices were quite common. What do you think is different today that makes this less of a concern? How concerned are you that this relaxation could lead to more investors becoming the victims of fraud or unscrupulous financiers?
Schweikert: What is so different today than anytime in human history is you have access to the world’s information in the palm of your hand. If you’re carrying a smart device, you have the ability right now to say “that’s an interesting idea,” then type it into your smartphone and within seconds, you can see people’s histories, filings, and even blog posts. The access to information is, in many ways, the greatest regulator and greatest force in exposing bad actors.
My great hope is that so many of us now have grown comfortable using review websites, digging into comments on blogs and reviewers. We are becoming much better at using information to make purchasing decisions, travel decisions, and now hopefully we’re using it to make investment decisions.
There’s also the positive aspects of this issue that need to be addressed. We have an incredible bifurcation in our society. The number of folks that meet the SEC’s definition of qualified investors is tiny. Out of 318 million people, there’s only about 6 percent of our population that fall under that category.
The beauty of this is the democratization of being an investor. It allows a lot of people who may have a talent in understanding a relationship with an investment, and now they have a path to get there while not necessarily having the money in the bank to meet qualified investor standards.
If you care about income and wealth equality in a society, much of it comes because those in the investment class take risks. How do we get the opportunity to take risks, and therefore get greater returns, and make that available to every American.
EQ: To your point of increased information available to investors, part of that is communicating these kinds of opportunities directly. The lifting of the ban on general solicitation addresses that to a degree. Can you discuss the significance of that? What are some potential concerns with lifting that ban?
Schweikert: Even when the ban was on, there was often misinformation and misunderstanding in the marketplace. I will make the argument that post ban on general solicitation—which is still very new—there will be someone out there that does something stupid, because there always is. Even in the most regulated environment there’s someone that finds a way to game it.
Knowing there’s an investment out there, does that get the intellectual juices flowing to get you to look into it? To investigate and learn more to decide if it’s for you or not for you? I am from the view of the world that the more information and the more access to information—the more sunlight, if you will—the less fraud-prone society is.
One of the great secrets of the pink sheets 30 or 40 years ago was that they could put out a little bit of information and there was almost nowhere to go to prove it or disprove it. Today, you can prove it or disprove it in the palm of your hand.
EQ: For investors, whether they’re accredited or not, they need to be educated that investments do involve risk. Some of the regulations that are in place almost seem to be an attempt to remove risk from the market. Whose role is it to inform investors that these opportunities, or any other opportunities for that matter, do come with risks and that’s just something they need to factor into their personal decisions?
Schweikert: That’s actually hitting on something that we can spend hours talking about because it delves into a much bigger societal discussion. If you’re concerned about wealth inequality, rate of return is often based on risk. What does the United States do better than anyone else in the world? We take risks.
We’re a society of many, many risk takers and entrepreneurs and that has made us a very wealthy country. If you try to build a country that is absolutely safe and risk-free, you’ve now taken the growth out of a society. You’ve taken away innovation and made the ability to create those savings for your retirement and much more difficult.
So how do you deal with both the left’s concern that somebody might lose money on investments and the right’s concern that there be velocity in the marketplace? I think the access of information is the ultimate solution, because I think information is the ultimate regulator.
EQ: Any closing comments?
Schweikert: There’s so many folks that refer to this as, “Well, this is going to by Mary’s bakery down the corner and she needs to raise $90,000.” It might be, and I hope it is. I really hope it is. But I actually think that there’s a lot more options from larger concerns to concerns that have ideas and want to spin-off and create another affiliated organization. I think we’re going to find Crowdfunding—and other aspects of the JOBS Act—is a lot more dynamic than any of us have ever thought of.
In the hearing, we had one of the gentlemen talking about their experience in Europe, and it really is worth doing some reflection. I know a lot of what’s going on in Europe is on the debt side, but that makes great sense. How many of us are frustrated buying debt instruments and getting no yield on them? Yet, are you willing to loan some money to a concern that’s in your own neighborhood or in a business area in which you’re an expert in, and be able to get a rate of return that’s more worthy of your investment?
So in many ways, we’re maybe not that cutting edge here because this is going on in other places around the world and has been for decades. So we are trying to learn from those experiences.