Open Capital Markets For Local Economies. William E. Scholz
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passed or implemented in a bi-partisan nature. Each policy can unlock capital investment, but like all activity in capital markets, must be implemented in an equitable, responsible way and with appropriate oversight.
Tax Cuts and Jobs Act (TCJA) and Opportunity Zones.
A recent push toward local capital markets occurred as bi-partisan legislation in the 2017 Tax Cuts and Jobs Act (TCJA). Opportunity Zones offer a tax incentive for investors in distressed communities. The tax incentive introduces patient capital and a local focus to tax policy. Qualified Opportunity Zones were identified by Governors, an example of decentralized policymaking.
Opportunity Zones draw the most partisan scrutiny as the legislation is ultimately a tax cut. Opportunity Zones do provide anecdotal evidence of reinvestment. In Detroit, several projects will utilize the incentive supporting residential and commercial development [1]. Multi-million-dollar development projects can expand the tax base significantly, especially in distressed communities.
Many regions are also creating economic development positions that support capital formation. The Rockefeller Foundation, for example, will support Chief Opportunity Zone Officers in select municipalities with total awards of over 5 million USD [2]. The Chief Opportunity Zone Officer acts to prepare projects and organize capital stacks for qualifying projects.
The Opportunity Zone Officer fills an important need for local capital markets by offering dedicated support to catalyze deal flow. Distressed markets often have a ‘chicken-or-egg’ problem as it relates to deal flow. As the market declines, less private sector resources go toward packaging or preparing deals for investment. Public markets have a much more robust industry of investment bankers and analysts that connect investors with deal flow.
Opportunity Zones have been quite successful in many regions in raising awareness of the need for a structured process to support capital reinvestment. Support includes nurturing and promoting deal flow as well as building relationships with potential investors at home and abroad. My hometown of Erie, Pennsylvania completed a successful Homecoming event to attract significant investment back to the region.
The Jumpstart Our Business Startups (JOBS) Act and Equity Crowdfunding.
Another initiative called the Jumpstart Our Business Startups Act (Jobs) reevaluates securities law to lower barriers for startups and investors in the Internet era. Securities Law remained largely unchained since being established in 1933 and 1934 with the passing of the Securities Act and Securities Exchange Acts. The legislation established the framework to regulate secondary markets and created the Securities and Exchange Commission (SEC) to protect investors.
In today’s world, some protections require revaluation. For example, prior to the JOBS Act, rules prevented companies from soliciting investment online. Investors can review enough information and disclosures to verify the quality of the investment.
The core of JOBS legislation lowers the barrier to investment in specific deals. Until the JOBS Act, only accredited investors could make equity investments into startup firms. The SEC’s definition for an accredited investor is an annual income of 300,000 USD for an individual for two years in a row, 200,000 USD for each family member in a household, or the ownership of 1 Million USD or more in assets [3].
These regulations made sense decades ago. For example, in the age of industrial manufacturing, starting a business required significant capital expenditure or a relationship with a higher tier manufacturer who might serve as an early client. Equipment was expensive and the return from that equipment aligned more directly with its capacity and material costs. Today’s digital technology, on the other hand, is replicated exponentially and distributed limitlessly to customers across the globe. A business can go viral and offer a 10x or 100x return to investors. That return is unlikely for manufacturers.
Also, prior to the Internet, investors had few resources to verify the legitimacy of an investment let alone conduct complicated due diligence. Many simply did not have experience in evaluating new investments and they could not obtain access to verified investment disclosures. Travel was more limited so visiting an investment opportunity might be out of the question.
Consider a hypothetical investment in real estate. A bad actor could lie about a property or sell a fake property deed. At least individuals with a high net worth and investor accreditation would understand complicated investment deals and would not go personally bankrupt should an investment go South [4].
The JOBS Act allows non-accredited investors to make equity investment through registered equity crowdfunding portals, who operate as broker-dealers. Firms raising money through equity crowdfunding utilize the Regulation CF exemption, which is different from other exemptions utilized by issuers. The first equity crowdfunding portals launched in 2016 focusing on specific niches and verticals.
Blockchain, JOBS 3.0, and SEC Harmonization.
Blockchain is forcing the hand of national Governments throughout the world. Blockchain is the underlying technology behind cryptocurrency. Cryptocurrency trading established the trading platforms and technology that could facilitate trading equity into firms.
Since the technology exists, some firms are simply moving forward with raising securities on the Blockchain. If one nation fails to act, they risk falling behind other nations who allow this type of trading.
Blockchain is not cryptocurrency, however, similar technology that facilitates cryptocurrency trading are applied to trading equity or stock on primary and secondary Blockchain exchanges.
In April of 2019, FINRA approved the first Blockchain enabled secondary trading platform [5]. In September of 2019, after working with the SEC, Blockstack raised $23 Million in a Regulation A+ token offering [6]. In short, FINRA and the SEC are approving secondary trading platforms for private capital markets. However, specific approvals from FINRA and SEC are bolstered by codified congressional and regulatory rules that govern future trading platforms.
In 2018, JOBS 3.0 passed the U.S. House of Representatives by a vote of 406-4 [7]. JOBS 3.0 continues to lower barriers for private capital markets by allowing more “testing-the-waters” activities, facilitating the creation of venture exchanges, and lowering barriers to reporting.
In September of 2019, the SEC completed a request for comment under the ‘Concept Release On Harmonization of Securities Offering [8].’ The SEC solicited comment and will review key areas related to securities offerings including accredited investor status, secondary trading platforms, and integrating the legal framework for securities exemption into a more streamlined framework. Harmonization again seeks to lower barriers to investing and establishing primary and secondary trading for private capital markets.
The Federal Government is mobilizing quickly to adapt securities law to Internet technology and provide incentives that build the foundation for local capital markets. From 2012, to 2019, the Federal Government has mobilized transformative legislation with care and caution and spearheaded new local infrastructure to identify, vet, and promote quality deal flow.
Between Opportunity Zones and Equity Crowdfunding, Billions of USD have been invested across countless deals with some capital finding its way to distressed communities. In a relatively short period of time, The American Government and local leaders are building open capital markets for local economies, an example of Government efficiency and economic growth.
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