Part III: Principles, Regulations, & Better Government
Part I explains why an organization focused on principles outperforms a rules-based one. Rules stifle judgment, while intuition enables better decision-making. Part II explores how Wefunder could design an intuition-building machine so we can make better decisions based on our principles. Part III discusses the challenges of this approach for regulated companies that interface with the government.
Wefunder is from Mars; FINRA is from Venus
Wefunder is regulated by two government agencies: the SEC & FINRA1.
In 2016, when our industry was legalized, I was naive and idealistic. I remember thinking: “We’re the good guys - we have nothing to worry about! I can’t wait to work with our regulators! Let’s share all of our data in real-time and be super transparent! We’re all going to create this industry together to make sure it works really well! ”
I still retain some of this idealism with the SEC2. Over a decade, we’ve interacted with top-tier staffers with excellent judgment, all working as best they can within the mandates of their political masters. In all of our conversations, and hundreds of pages of letters, we’ve seen the SEC staff listen carefully and wrestle with complex issues.
On the flip side, dealing with FINRA has felt like getting repeatedly punched in the nuts, with no referee who will put a stop to it. Each time FINRA takes a swing, I’m forced to spend between $50,000 to $500,0000 on lawyers. Like a rat undergoing electro-shock therapy, I’ve been conditioned to avoid my torturer.
It felt like we were dealing with incomprehensible aliens (the Borg?). Until recently, I didn’t put much thought into why. The individual members of FINRA are decent people, so why is the collective output of the organization so bad?
I now believe that it’s because Wefunder and FINRA have polar opposite cultures. FINRA is rules-based; Wefunder is principles-based.
Wefunder’s culture is Do The Right Thing for the Investor. When the law is ambiguous, as it most often is in our new industry, we default to the spirit of the law - the underlying principle. How would our wise, common-sense grandmothers judge us?
FINRA, in contrast, has lost touch with the underlying principles. This has led FINRA to absurd outcomes, like demanding we do things that are unequivocally worse for investors (more on that in a future post).
How could this be?
I don’t have an inside look at FINRA’s culture, but I can make an educated hypothesis: the bureaucracy has collapsed under the weight of complexity, the incentives are wrong, and the well-intentioned employees within FINRA don’t have enough power to change course. We’re all trapped by the system.
How can government agencies perform better?
Instead of directly targeting FINRA, let’s go up a level: how could we improve government so it performs better? Different government agencies have varying levels of effectiveness - what separates the good ones from the bad ones?
I believe in regulation and a better, more effective government. That said, when the government is ransacking a private home to kill a pet squirrel3, I think we can agree something is wrong. The output of our bureaucracy is leading to results that many of the officials in the system know is kafkaesque. Yet, no one has the power to stop it.
There is much talk these days around limiting the power of the administrative state. Whether you support that or not, the Supreme Court has already started to roll back administrative power4 and will continue to do so through the 2020s.
Here is my controversial belief: With whatever power remains after the Supreme Court is done with them, the employees within these agencies must be given more power to be able to use common sense judgment. But in turn, government officials must be held directly accountable. That’s the path for better government.
Isn’t that a paradox? We want the government itself to have less power, but the employees within the agencies more power? If we want a better-run government, yes! What’s holding society back is not enough officials are authorized to use common sense!
Let’s talk about the squirrel. Peanut the Squirrel was rescued as a baby by Mark Longo after his mother was killed. He couldn’t survive in the wild, so for the next seven years, Peanut lived happily with Mark in an animal sanctuary in New York.
When Mark learned that New York requires a permit to keep a pet squirrel, he filled out the paperwork… but alas, before the permit was approved, someone complained to the New York State Department of Environmental Conservation (DEC).
Officials from four separate New York State agencies conferred. An investigation was launched. A judge signed a search warrant. Over 10 police offers, investigators, and wildlife officials conducted a 5 hour raid, ransacking Mark’s home until they found Peanut, who bit one of the wildlife officials trying to kidnap him. A wildlife official then decided to kill Peanut to test for rabies. No more cute squirrel: problem solved.
Everyone was “just following orders”. No one had the power to stop the juggernaut and say, “Hey, maybe justice is best served if we help Mark get his permit faster?”
In Everyday Freedom: Designing the Framework for a Flourishing Society, Phillip Howard writes:
American government is missing the critical component of accomplishment: human choice on the spot. America is suffering from a vacuum of authority. Public officials have lots of power, but it’s largely negative. Officials can say no (and many seem to relish doing so), but they can’t say yes. American government is failing not because officials have too much power, but because they have too little…. But restoring judgment to official decisions does require trusting a system of government rooted in human responsibility.
The recipe for a high-performing organization is simple:
Raise the hiring bar to seek out only the best;
Hire fewer, more talented people, but pay them more;
Continually train them on underlying principles;
Design their incentives to lead to just outcomes;
Give them the freedom and personal agency to use their best judgement;
Most importantly, hold them accountable, and when serious mistakes are made, fire those with continual bad judgement.
This is not how our government currently works. The biggest problem is lack of accountability. The Supreme Court is addressing separation of powers, to ensure the agencies are accountable to the voters. But within the agencies themselves, it is nearly impossible to fire poor performers. In fact, over 99.5% of all federal government employees received a rating of at least “fully successful” on their performance evaluations. That’s quite unlikely to be true in reality.
If there was more accountability, we could restructure government to give more freedom and power to officials to use their best judgment.
The SEC is one of the better run government agencies. The staff is more highly compensated and is stocked with top-tier talent. Their culture is more principles-based. And even the SEC union (yes, the SEC staff is unionized) has an entire cartoon series to make fun of the lack of freedom the Staff has within their own organization:
That is the irony of all this. The officials themselves feel the oppression within their own bureaucracies. We’re all slaves to the machine.
How can Wefunder best operate in this environment?
It’s fun to think about how government can be reformed to work better. But my job as CEO is less fun: I must operate Wefunder safely within the vast machinery of government power that could crush us, while always doing right by our customers.
I’ve always known intellectually that the law is not black and white. But running Wefunder for a decade has made me feel it more acutely: despite thousands of pages of rules, no one knows with 100% certainty what is legal. No matter how many rules are created, they can never cover the complexity of reality. A principles-based system is the only workable solution.
Our job is different than our regulators. We have customers that demand we solve their problems, now. Even if a regulator was willing to offer guidance, we can’t wait multiple years for them to decide what we should do. Our customers will be harmed if we don’t act: in their mind, the buck stops with us.
When we have to make a decision where the law is ambiguous, my guiding principle has always been, “What is the spirit of the law? What is the law trying to accomplish? What is best for our customers?” We decide accordingly.
This has worked well with the SEC, which is also more principles-based, and with the good judgment to interpret those principles correctly.
It has not worked at all with FINRA.
A specific example
This may all seem too abstract without specific examples. The problem is that the examples are all overly complex to be understandable in a short essay. But I'll give one issue (of dozens!) a go. Please bear with me:
* Wefunder helps companies raise money from their customers
* Companies raise money with two laws called "Reg CF" and "Reg D"
* FINRA regulates Wefunder only for the "Reg CF" portion
* When companies raise money from Reg D and Reg CF investors, we place the total amount raised on the same terms - across both laws - on their profile. We put how much they raise from each exemption in a tooltip.
* FINRA, judging only from a Reg CF prism, claims this is misleading. They want only the Reg CF number displayed. They threaten to fine us.
* We counter that is it misleading not to combine the two numbers. Obfuscating the "Reg D" raise harms investors. If it's equity, investors must know how much dilution the company is taking on. Or, if it's a loan, an investor needs to know how much debt the company will have to repay. These are critical numbers to an investing decision.
* We pay our law firm tens of thousands of dollars to respond to FINRA on this point. There is no resolution two years later.
There are dozens of similar disagreements much like the one above. So what are we to do when the law is unclear? We must do what our principles demand. We don’t harm our customers to “cover our ass”. We must have faith that the rule of law will ultimately treat us fairly, if we always focus on adding value to society.
And if FINRA disagrees? I’ve now come to the seemingly cynical conclusion that our system of justice is best described as power meets power. But it’s not cynical. It’s the best thing about America. If I was in China and disagreed with President Xi, I could be disappeared and have all my assets appropriated. In America, when we believe our government is in the wrong, we can fight for what is right. Power adapts to power, and citizens with constitutional rights are the most powerful force of all.
I was inspired by Over Ruled: The Human Toll of Too Much Law, written by Supreme Court Justice Neil Gorsuch. It tells the stories of normal people that are treated unfairly by our government. They stand up at great risk to themselves and change the system. The book concludes:
Democracy doesn’t depend just on a people equipped with the knowledge necessary to engage in the hard work of self-government… It depends on the courage of men and women willing to stand up, even at a high personal cost, to defend the right to democratic self rule, equal treatment, life, liberty, and the pursuit of happiness that belong to us all…. Nor is it necessary to reach back to great figures in history. The stories of the men and women whose stories fill chapter after chapter of this book inspire us, too. Often against high odds, they have struggled to realize a little more of the Declaration’s promise in their own times and places… We stand in awe of them. They are our real hope.
I didn’t set out to battle the government. I’d rather focus on building our business and creating value for society. But if fate calls on us to be the ones to spearhead the fight, we should be honored for the chance to stand beside the heroes in that book.
FINRA claims to be non-governmental. However, as Judge Justin Walker of the United States Court of Appeals for the D.C. Circuit says, FINRA “functions in a way similar to a government agency” in part because it acts in “‘an adjudicatory and prosecutorial capacity’ and ‘is required by statute to enforce the securities laws.’’
Much of the tech world is bitter at the SEC for their stance on crypto, but that was a political decision by the duly elected Biden administration. After the election, a new political decision will be made by the Trump administration. This is how democratic accountability is supposed to work. One can’t blame the SEC staff.
Just a few examples of recent Supreme Court decisions limiting the power of the administrative state:
Loper Bright Enterprises v. Raimondo. Requires courts to exercise their independent judgment in deciding whether an agency has acted within its statutory authority.
Securities and Exchange Commission v. Jarkesy. The Seventh Amendment entitles the defendant to a jury trial.
West Virginia v. Environmental Protection Agency. Limits ability to create new regulations with significant economic impact or political salience without clear statutory authorization.