rules they should use standard english in order to facilitate compliance and crowd funding iss issuers. if the regulations are dense and legally complex, those businesses will need sophisticated securities counsel to guide them through the regulations. that would significantly increase the cost of the offering, and for these small offerings, cost is all important. that leaves issuers with two alternatives. either they try to navigate the complex rules on their own in, which case violations are likely, or they would simply not use the exemption in which case the promise of crowd funding won't be realized. the best way to deal with the issue is to write the rules so that small business entrepreneurs can understand them without hiring expensive attorneys. fourth and finally, the s.e.c. should adopt a substantial compliance rule to protect issuers and crowd funding

intermediaries who inadvertently violate some of the requirement. the exemption contains a lot of detail and as i said the issuers using it will not be particularly sophisticated. because of that, the possibility of a inadvertent violation is high and the consequences of even a minor immaterial technical violation are drastic. loss of the exception, violation of the securities act and liability to return all of the money to every single purchaser. other securities act exemptions protect issuers who substantially comply with the requirements of the exception or who reasonably believe the requirements of the exemption are met, even if it turns out they are not, and the s.e.c. should contain similar rules in the crowd funding regulation. my written statement includes a number of other specific recommendations, but my time is just about up so let me thank you again for the opportunity to talk to you today. >> all right. i certainly appreciate it, and we'll now recognize mr. coffee. >> thank you, chairman mchenry,

ranking member quigley and members of the subcommittee. my name is john cove, an i've been working in the field of initial public offerings for over 30 years. let me make three basic points briefly. first, i believe the greatest enemy of the job creation today is not overregulation but the loss of investor confidence. today american investors have lost confidence in the april ipo marketplace, facebook disaster, the drying up of the ipo pipeline and the initial public offerings all trading below their offering price. this erosion confidence goes all the way back to the burst of the internet bubl in 2001 and confidence has not been restored, but more recently there's been a new focus. investors are again and again complaining about the prevalence ever selective disclosure in ipos. as issuers, underwriters and

analysts seem to be tipping, as seems to have occurred in facebook, projections and forecasts to preferred institutional investors. i think there were a number of problems with the ipo mark placed today, and i agree with many of the comments made by oversight chairman issa in his letter to the s.e.c. particularly list view that there should be recognition given to the role of auctions in this process. i would point you particularly to the problem of selective disclosure. there is no efficiency in selective disclosure. this is an issue of fairness shs and i think there are ways in which the jobs act actually compounds this problem as i set forth in my written testimony. let me move now to my second point. the jobs act on virtually every page requires the s.e.c. to adopt new rules, to implement the jobs act and it imposes fairly tight timetables and the first of those deadlines expires on july 4th with respect to crowd funding.

under recent decisions of the dc circuit court of appeals, the proposed rules that the s.e.c. must adopt shortly, are vulnerable to judicial second guessing. either the dc circuit might find some costs to be overstated, or it might find some benefit to be understated or it might even say that the empirical studies done by others that the s.e.c. is relying on are just not reliable. all this has happened recently in recent decisions. as a result the s.e.c. stands the risk that its rules could be found arbitrary and capricious as this happened on three or four occasions. as a result, virtually everyone affected by s.e.c. rules today under the jobs act has an incentive to sue if they are not happy. they are going to find an attorney, and many are going to go to court this. will result in continuing uncertainty, confusion and delay in the implementation process. even if the s.e.c. makes a super human effort, litigation is

still predictable because someone who is not happy with the rule now has a fair option of going to court and suing. third point which relates to the second, i reviewed the commission's most recent policy statement, including the statement dated march 16th, 2012, setting forth its, quote, current guidelines on economic analysis and s.e.c. rule-making. i believe these new guidelines properly integrate economic analysis with the rule-making process. they do require the commission to consider economically reasonable alternatives to the rule being proposed, and they do require the careful matching of costs and benefits. of course, i cannot tell you that the commission will always follow these principles in rules that have not yet been proposed or formulated, but i can tell you whatever the commission does, whatever heroic effort may make, there is still a real prospect this the dc circuit could disagree and substitute its judgment for the commission's judgment. if that happens, can i not tell

you that a federal court has a better judgment or greater expertise than the securities and exchange commission. it is not more expert. it is not more sensitive to the market. thus, i do not think we'll come out with better rules through that process. my bottom line here is that the s.e.c. is today caught between the rock and the hard place. it has been asked to expedite rules and is trying to do so but it faces a somewhat unsympathetic bench that is quite skeptical of rule-making in general. could i give you some specific examples and might like to do so if we have questions. for example, the s.e.c. has to adopt rules both on the use of audited financial statements, on the use of follow-up periodic disclosure offer an offering, true under sections 3b and the new crowd funding exemption. in all those areas the commission is doing what congress has told it to do, but i think we're going to see a long battle because i predict those unhappy with these rules are going to try to exercise the judicial option. ultimately the danger here is

that we can be led back to the area of the 1930s when courts could substitute their analysis and their preferences for those of the agency by saying that it would interfere with day of the contract. today instead they will be saying it interferes with proper cost benefit analysis. there's a danger that looms here, and i'll stop at that point. >> all right. i thank the panel for their testimony, and your mitten testimony will be in the record. i'll now recognize myself for five minutes. now, securities regulation, you know, we -- we have a foundation of 1933, 1934 for the essence of our securities regulations. that's still the foundation of what we deal with today. and at the time we were -- congress was acting to deal with a challenge which was the folks standing on street corners hawking securities. times have changed. we now have the internet.

what we have found and what i have said multiple times before is that under the mentality of the s.e.c. the website ebay would not be able to exist because the s.e.c. would not be there to root out folks who have lower net worth from purchasing products. instead, we know that ebay sells, you know, billions of dollars on a yearly basis between people that don't know each other. two individuals of average means that don't know each other, but under the s.e.c. mentality that simply would not be able to take place without massive fraud, but then we have the s.e.c., and we've known the very large failures of the s.e.c. to root out fraud among regulated entities that they oversee, and that is unfortunate. we don't want that. we don't want any fraud in this.

in the crowd funding space or in securities at all. so there's a question of how we root this out. mr. hillel-tuch, you mentioned that you believe that fraud can be in essence rooted out through the power of the crowds. can you explain why you believe that? >> yeah, absolutely, not a problem. crowd funding is very transparent. as i mentioned earlier, there is a lot of feedback from community participants. in essence the crowd basically polices players. it keeps them honest. the beauty about crowd funding is you have a centralized location which is a portal, and it allows for communication by potential investors to analyze and share their views on offerings and web-based structure allows portals and regulation to provide risk disclosure and investor education. we -- we definitely expect

portals and their operators to undertake a gatekeeping role in authenticating issue identity and requirement standards, but what we've noticed historically, both in our platform and others, is the crowd is extremely wise in assessing potential risk. on top of that, looking at 1930, for example, you didn't have the access to information that you have now. i'm able to go on to google, for example, and research a company to see their track history, either online presence as well as offline. i'm able to pull up a credit score. i'm able to research individual all from the comfort of my home. something that every investor is able to do now that simply did not exist before computers, before the internet. the access to information to the individual now is at a level unheard it. we're not using it for our fraud prevention which is very unfortunate. >> fraud prevention, professor bradford, you mentioned in your writings and testimony today,

that placing additional layers of mandatory disclosure on the issuer rather than portal is not the best way to root out fraud. can you about flush that out for us. >> it's mostly because the entrepreneurs that are going to be using this, and these are relatively small offerings, really inexperienced entrepreneurs, simply can't bear the cost of that burden. if i'm making a $200,000 offering, it doesn't take much cost before i simply can't do it. every dollar that's paid for regulatory cost, every dollar that's paid to be the intermediary is a dollar that i don't get to use for my business, and, therefore, it makes more sense to try and do it structurally through the entrepreneurs and protect fraud that way than imposing a whole bunch of complicated disclosure requirements that these people probably aren't going to fully understand in any event without having to hire securities counsel which is another expense. >> so do the 50 states as it stands now have the ability to root out fraud?

>> well, the 50 states and the s.e.c., i mean, nobody is talking about taking away the anti-fraud rules. the states under the jobs act still have the ability to enforce their fraud restrictions. that's not preempted. the s.e.c. has the existing anti-fraud rules, plus be a additional fraud rule in the crowd funding provisions. and that's the best way to attack fraud because that only imposes costs on the fraudsters. the problem with expensive mandatory disclosure requirements is you're imposing costs on everyone that wants to raise money, and most of whom, at least i believe, are honest entrepreneurs and acting in good faith to raise money for their business, and everything that we impose on them in the name of fraud protection is going to be borne mostly by honest people. >> well, thank you for your testimony. we expect a second round of questions, so i'll now recognize mr. quigley for five minutes. >> well, the same two gentlemen,

just for the sake of argument. you recognize a little bit of the difference of most of the transactions that take place on ebay. most people know when they are buying a bike on ebay what a bike should be, right? but some of these investments, mr. hillel-tuch, you would acknowledge there's a little more sophistication involved here, and i supported this act, but just for the sake of argument, let's talk about how we implement it. at least some sense of protecting those because of the level of sophistication that's involved with this, and the concerns that -- that they can take place with people who aren't as practiced. you acknowledge, that they are not as practiced in investing in the first place? >> that's actually a great position we can discuss.

what is very critical what a portal provides over any other kind of real structure is standardization of a lot of the requirements and the education that absolutely is necessary to the different levels of sophisticated. granted, assuming a credit investment is sophisticated in itself, that said through a portal what you're able to provide is, and we completely agree with professor bradford, it's critical to make it as seamless and low friction as possible, and cost is the decisive factor. the s.e.c. can very easily make this cost prohibitive when that's completely unnecessary. fraud and investor education go very much hand in hand. one of the things we've noticed with crowd funding right now is a lot of the network comes from individuals within your neighborhood. i mean, we have an example right now of a tea shop in kentucky trying to raise funds. they did so last year, and they raised it from within their community and the community

knows that shop. the community raises funds together to help that shop succeed, and those are the kinds of businesses that are not venture backable right now, but they do have members in their community who believe in that business, want to support that business and are right now not permitted to do so, and the education level is different. they don't have the interest of getting a short-term return on their investment. they are looking at the long-term strategy. >> professor bratford? >> i'm perfectly willing to concede that what is sold on ebay from securities and that securities are without a doubt more sophisticated than most of the products that are sold on ebay, but i do think that what ebay has learned through their platform about preventing fraud is useful to crowd funding. for a fraudster, if i get money, it's money. it doesn't money whether i'm pretending to sell people securities or whether i'm pretending to sell them goods that i don't eventually deliver,

and i think the experience with ebay shows a couple of things. number one, it shows that we can use an internet platform to sell things. we can have fraud protection techniques in place to help protect fraud, but having said that, i'm not going so far as to say that securities crowd funding ought to be unregulated. i think some of the things we have in the exemption, a limit on how much people can invest that you don't see when people are buying goods on ebay, some disclosure about what's going on, what the entrepreneur is going to do, clearly there ought to be more regulation of crowd funding than there is of ebay. no dispute about that. >> mr. cartwright, if you want to wade in. >> yes, thank you. >> we're talking about fraud in small offerings, and i would like to start with the baseline of where we stand today because,

and i feel very passionate about this. if you spend most of your career in a large law firm where you're too expensive to work with small offerings, you don't really see much of this, but when you go to work at s.e.c., you discover that there is an alarming, shocking amount of low-level fraud, i call it securities street fraud. it's guys who make up completely fraudulent press releases in pump and dump schemes that claim that the company has achieved a major contract with some chinese company or a big technological breakthrough that has commercial advantage, totally made up. this is hard core securities fraud, hard core wire fraud. this is hard core criminal behavior, or they exploit an affinity group. the members of their house of worship, or if they are of an ethnic background, recent immigrants trying to make their way in america and struggling,

and there's way too much of it, and it's disgusting, and they are doing that under the existing law, and they are using sometimes most of them don't even care about the exemption from section 5. i mean, if you're willing to blow through the most fundamental fraud provisions in the criminal law, you're not worried about would wl you have an exemption from the otherwise applicable provisions of section 569 securities act. but if they are, they are claiming 504, typically rule 504, typically erroneously. the way to address this, and it's a problem, because it's left to the s.e.c. to address, and the s.e.c. doesn't have the toombs. we talk about the s.e.c. being the cop on wall street, but it's not a cop. that's hype. it has a civil jurisdiction. it can't do search warrants. it can't do wiretaps. it can't do stings, and most importantly it can't go into

federal court and bring a case that ends up with a conviction that puts people in jail. that's under the department of justice, but the u.s. attorney's office is around the country who are responsible, they have got a lot on their plate, and this stuff is pretty small time. at the s.e.c. the enforcement attorneys used to refer to it it dismissively as little cases. they don't get much press, but small people who are innocent are harmed. i think the way to root out fraud as it exists under existing law and under crowd funding or any other change in the law is to direct resources in an efficient fashion to bring criminal cases against these people. it's very frustrating for s.e.c. enforcement, lawyers. they know these guys shrug off a civil case from the s.e.c. it's the cost of doing business. it's a risk. they don't mind when they are

taking the proceeds from an offering and spending it on sports cars and speed boats instead what have they claimed. we need something like, and maybe there's other ways to do this, but something like a national task force in justice, national so it has the scope and scale to develop the expertise and the efficiency to root these people out and the u.s. attorneys offices around the country can refer those small cases for criminal prosecution and the s.e.c. can refer the cases, if we started putting these people in jail the way we should, they would pretty soon -- there'd be a lot less of them. i think that's what we ought to do. >> thank you for your comments, and to that point we've retained state fraud prevention and prosecution within the laws that currently exist for crowd funding. that way you have, you know, your county prosecutors and state prosecutors, they can

actually go after these quote small fraudsters, and i appreciate it. >> as you say, mr. chairman, the state law enforcement is critical here because they do, at least in some jurisdictions, they are prepared to handle matters that are somewhat smaller than the federal authorities will, but frankly i still think we need more. >> absolutely. thank you. with that, we'll now recognize the vice chairman of the committee, mr. gitana of new hampshire for five minutes. >> thank you, mr. chairman. thank you all for testifying today. i wanted to address my first remarks to professor coffee. thank you for being here. you had mentioned in your testimony the arbitrary and capricious findings by the court. i'm assuming you're aware of the fact that the s.e.c. recently instituted new and stronger cost benefit analysis policy? >> if you'll put on your mike phono, it unon your microphone. >> i understand that and i was referring to their new guidelines as of march 19th,

2012. >> well, i guess -- okay. i appreciate that. my question would be just by the fact there's going to be a greater effort now put into cost benefit analysis, wouldn't that necessarily reduce the amount of risk of any arbitrary and capricious finding? >> well, i hope that we have a better understanding and that we have a workable accommodation between the s.e.c., one of our best federal agencies and the dc circuit court of appeals. only time will tell because right now the ease with which the prior findings were overturned creates a strong litigation incentive. someone will always feel injured by a new s.e.c. rule and there's a strong incentive to sue. i hope there's an understanding that's quickly reached though. >> would you say that the s.e.c. in the past has put a lot of effort and energy into performing legitimate and

serious economic analysis? >> i think that i would agree with maybe your subtext and say times it's been proforma, i think, however, the burden cannot be overstated. if you look at just the crowd funding provision in the jobs act. i count eight different sets of rules that congress has directed the s.e.c. to promulgate just under section 4a, so they have a burden and very short time limits. it's hard to do everything overnight. >> mr. cartwright, can you comment on that? i happen to think that cost benefit analysis should be performed. i think that the s.e.c. can peer form a valuable commodity here for just about everybody, but i wanted to hear your comment on that. >> the law requires it. the s.e.c. is required to consider efficiency, competition and capital formation in most of it rule-making activities, and it's been required to do that for quite some time. i think too often in the past,

and i hope this is changing, too often in the past it was an afterthought. someone decided that there ought to be a rule, the chairman, division director or whatever. they get a rule-writing team going writing it. they write the rule, and then at the end of the process in the past at least someone would say, oh, my goodness. you know, there's that cost benefit analysis, the efficiency competition and capital formation we've got to do. it was kind of a compliance exercise, and it was done at the end. the s.e.c. is a lawyer-dominated agency, and the expertise that's really required here is more in the economics and economists regime, and those people were tipping off and not consulted at all, or if they were preemorally, so i think it's frankly wonderful here in america that if you believe that

an agency has exceeded its authority or acted arbitrary or capriciously you do have a chance to get into court and question the agency's exercise of its jurisdiction that. historically didn't happen at the s.e.c. very often, but other agencies have had this experience. the epa, almost every matter they do is litigated by one side or another, and you get better atity think as an agency if you have to respond to these legal requirements. i applaud the march statement. i think it's a very good statement, and i think that it's a huge step forward. the real question is whether this is going to be implemented in a way that gets the economists and people who are asking these questions in up front, at the very beginning, so the design of the rule is shaped in part by these argueses that the law requires rather than creating a rule and then trying to justify it basically a lawyer, do a brief at end to try

to justify what you've done in any event. >> quickly on a different subject matter. can you quickly describe the changes to the 500 shareholder act in the jobs act and what benefits you would foresee. >> are you asking me? >> yes. >> yeah, sure. as the law exists today, prior to the jobs act prior, prior to the jobs act, if a company had $10 million in assets which is a very small amount for a company of any size so almost always that test is satisfied, and 500 record holders, then it's required to basically become a company. a public company has to register with the s.e.c., and it -- it is an unfortunate development that today many of the most successful entrepreneurs no longer want to have their companies go public. when i started practice every entrepreneur, that was the holy grail. let's see if we can go public and do it fast, and the sooner

the better. now, some of the most successful companies, the most successful business leaders try to keep their companies private as long as possible because the disadvantages and burdens of being public are too great. so the jobs act in the title in question increases the threshold to 2,000 holders, provided that no more than 500 are accredited -- unaccredited. >> did you just say that you think people are keeping their companies private for a longer period of time because of the challenges of springing it public, correct? >> well, it's -- it's the challenges of -- in part the challenges -- there's two things. first -- >> i guess my question is it investor confidence, or is it overregulation? >> no, i think it is not a question of investor confidence. this is coming from the company side. it has two aspects to it. the first is companies that

lets say 15 or 20 years ago were of a scale where a public offering was feasible and the burdens of being public were not so costly, those companies would go public. today, there's a band of companies in size and scale that no longer can -- can swallow the overhead costs of operating as a public company and maybe becoming a public company so they have to wait longer until they grow bigger in order to become public, but what's really surprising is that even when they have gotten big enough so that they can meet the requirements, the most successful entrepreneurs today and if you hang out in silicon valley, lots and lots of people will tell you this. they want to keep their companies private as long as they can because they believe even once they are big enough to go public the burdens are greater than the benefits, and you can see that. google, for example, some years ago. 2004 i think, i got that right.

they hold on longer than they could have. i mean, they picked up an s.e.c. enforcement action against themselves and their general counsel for going too long. i think some of the recent ipos, just look what happened, you can see that they held out until the last possible moment, and that's one of the reasons why we have this -- there's an economist, i don't know if you saw it. q the economist" magazine thought the preeminent financial weekly had on its cover story a week ago the vanishing public company and it showed on the cover, the cover art was a paleoli,hic band rushing the mast adones over the cliff and we've got a problem here, and it is completely reversed since the early years of my career. >> thank you, mr. chairman, for the additional time. >> thank you so much. questions have been very good, and we'll start with a second round of questions, and