Notice: Undefined variable: indexpage in /home/wfe/public_html/focus/2011-12/header.php on line 49
WFE Focus December 2011
Alternative capital financing for the 99% (of business)
John Katovich
Cutting Edge Capital

We stand at a unique moment in history. The capital markets have suffered a severe blow to their reputations from the 2008 financial crisis. The rise of high frequency trading and the “financialization” of economies have called into question whether the markets still deliver on their original purpose of efficiently facilitating the transfer of savings into investments for companies to develop products, services, research and development. Unemployment is now at levels rarely seen before in over a century, with well over 7.5 million “officially” unemployed in the U.S., and likely many more unaccounted for. Add to that the heightened awareness of the stress on the planet combined with the super-charged connectivity of peoples across the globe, we are witnessing an unprecedented demand for change. Economists and politicians are rethinking the status quo, while communities are working to take back their local economies.

Here in the U.S., we are experiencing some interesting dynamics. New listings via the IPO market have significantly dwindled in the last decade due in great part to increased costs and decreased interests by banks to underwrite versus trade for their own accounts. The Occupy and Tea Party movements, while still in their infancy, are signaling that a demand for alternatives is on the rise. And other changes are underway and growing. Local movements are rapidly growing, from the “Buy Local” campaigns to green chambers of commerce to complementary currencies; individuals want to feel connected to something place-based again. The “Move Your Money” campaign may not have caused Bank of America and Citigroup to report significant losses last quarter, but not heeding this signal of a demand for change will only exacerbate their problems in the future. And authors have begun to codify these issues; Journalist Amy Cortese’s Locavesting, and Michael Shuman’s soon-to-be-released Local Dollars – Local Sense, are excellent books covering what is now happening in terms of alternative local investments, and Marjorie Kelly’s upcoming book, Owning Our Future: The Emerging Ownership Revolution, on new generative ownership designs, provides answers to questions she raised previously in her provocative work The Divine Right of Capital.

But for all the talk about “local” movements today, there is still very little that can be done in the U.S. in terms of “local investments” in small to medium sized companies. This is especially true if you are not lucky or smart enough to be one of the 1 to 2 percent who qualifies as an “accredited investor” under U.S. laws. Interestingly, the bar was raised even higher with new laws created out of the financial crisis that eliminated the value of one’s personal residency from this qualification. This is a curious and interesting restriction, given that there is a growing body of work to show that it is quite possible to beat Wall Street’s estimates of 5% long-term performance by investing in local community businesses.

The problem is not the lack of funds available by the non-accredited population. In my county of Alameda, east of San Francisco, California, there are enough investable funds held by individuals in savings, securities and retirement accounts to fund small business needs three times over in a given year. Standing in the way of this potential pool of money are those restrictions that prevent most individuals from investing in private enterprises. As Michael Shuman has pointed out, an individual can fly to Las Vegas and lose his or her entire savings without filling out a single form, but to invest in a private enterprise is more restrictive and difficult today than it has ever been, and for most of the population, extremely difficult unless you know exactly where to look. These restrictions end up costing private companies needed capital to grow and prosper. If national or state governments were to implement simple, zero-cost reforms, the number and variety of local investment opportunities would expand dramatically, and they would be in a position to hire.

Consider this: Small business accounts for 99% of all U.S. companies and the U.S. Department of Commerce reported that it is the fastest growing segment of the U.S. economy. 27.5 million small businesses employ half of all private sector employees and contribute half of private GDP, about $5.5 Trillion annually. They include high growth startups that have the potential to become corporate powerhouses and they produce 16 times more patents than large companies. They are responsible for more than 2 out of every 3 jobs created over the past 30 years, while large corporations have been net job destroyers. There is overwhelming evidence that local small businesses are the untapped resource, and quite likely the only way out of the current economic malaise.

Small and medium size businesses are the backbone of the global economy. But today’s capital markets fail the needs of community economies at the risk of snuffing out innovation. The inability to raise capital is the reason half of new businesses don’t last more than five years. The core mission of a bank used to be to support local economies, yet bank loans to small businesses have mostly dried up. No mutual fund specializes in local small businesses, yet most Americans are forced to invest their pensions or choose to direct their long-term savings in mutual funds that have restrictions on where the funds can be invested. We are inundated daily by statistics about the Fortune 500 economy and the performance of the major indices as if they were accurate proxies for the economy, when in fact they represent a wholly different economy from anything remotely close to what individuals see and touch every day. The real economy is in our backyards, but supporting it is quite difficult for most.

Regions that have traditionally been underserved are now discovering advantages by exploring complimentary currencies and new alternative investment vehicles. By supporting this movement we ensure that we will continue to produce a strong stable of listing candidates for the larger exchange markets. Developing and supporting local markets alongside existing markets is neither mutually exclusive nor contrary to the larger market’s competitive advantages. A local exchange could act as an incubator for larger exchanges to tap growing companies, while simultaneously supporting functional economic redundancy, which in turn can help communities to grow, stabilize and invest more in small to large markets. These local systems will continue to be connected to the whole, but they can and will need to become more self-sufficient and self-reliant, especially with regard to necessities such as food, water, and energy systems that will need to work when global infrastructures suffer.

A confluence of climate change, famine, state failure, uncontrolled migration, and disease may likely add unprecedented and unpredictable stresses on all of the world’s resources and systems. Given the likelihood of many if not all of these events in the near future, now is the time to insulate and redesign our social and economic systems to withstand disruption and change, essentially shock-proofing the system for a sustainable 21st century, while at the same time taking advantage of the unique opportunities that these changes create. And these prudent protections can also flow toward greater benefits for the larger capital market system, as mentioned above.

As world exchanges are now advancing their own sustainability practices and agendas, I made the decision to leave my position at NASDAQ to work toward the development of alternative and local investment opportunities, directly, through Cutting Edge Capital, a consulting firm co-founded with my partner, Jenny Kassan, devoted to helping small to medium size businesses find alternative capital financing, and indirectly, by supporting the work of others in this arena.

Examples of some Cutting Edge Capital’s financing alternative work include:

Direct Public Offerings (DPO) that raise capital by selling shares to the public. These work like an IPO in that a company can offer securities or loans directly to the public through a general solicitation, typically relying on an “Intrastate Exemption.” There are dollar limitations depending on the type of DPO, and a company does not receive blanket exemptions from filing in the 50 states. And shares from DPOs are not typically traded on a secondary market, as they would be from listing on a national exchange. With a DPO, the company raising the money handles the marketing of the offering itself, eliminating the middleman. A major advantage is that investors can support a local, place-based company, and also get in on early stage investments typically reserved for angels and accredited investors. Cutting Edge Capital is currently working on DPOs for clients in multiple states including California, Washington and New York where companies either have a ready client base of interested investors, or know that they can spread the word easily to raise their targeted funds.

Local Exchanges that eventually could and should be created to handle all the functions of a stock market for a specific region and provide a way to reinvigorate capital investment in small, innovative firms and regional economies. Until then, the U.S. markets may have to rely on work-around exemptions, such as what CEC is helping companies like Mission Markets plan for, by combining the structures of a broker-dealer with an Alternative Trading System.

Investing in Community Development Finance Institutions (CDFI) that assist underserved and low income communities in a specific geographic region. These can be banks, credit unions, venture capital funds or loan funds, and in at least one state, non-accredited investors can own shares in the CDFIs or in funds that support them.

Crowd Funding helps individuals, start ups and even ongoing businesses to raise money by aggregating small sums from many individuals via the Internet. Person to person finance (P2P) was popularized by sites such as, a micro lender, and Kickstarter, which lets people donate to creative projects. And a proposal originally drafted by our nonprofit affiliate Sustainable Economies Law Center, has now resulted in pending legislation in the U.S. Congress that may allow companies to raise as much as $1m from individuals investing up to $10,000 while bypassing the costly federal and state registration processes.

Cutting Edge Capital also works with many Cooperatives - associations that run for the mutual benefit of their member owners. They can be worker owned, consumer owned, producer owned, buyer owned, or a combination, and they can bring in outside investors up to a limit, while still honoring the principles of remaining member-owned and managed.

Naturally, there are risks investing in small businesses that also need to be addressed. Today the U.S. approach requires publicly traded companies to file financial reports, and some form of a lighter, less costly approach must be developed for small companies that offer securities to the public. But there is not, as of yet, an SEC requirement for publicly traded companies to file reports on non-financial risks, even if it is later found to be “material” in nature. Logically, an investor should be just as interested in knowing all material aspects of a business, whether financial or otherwise, and this would be true whether large, medium or small, and whether listed on a large national exchange or locally. Transparency is a strong motivator for good behavior, whether applied to the environment, society, or how you govern, and this would hold true for any size of business.

And as with the reporting of financial information, cost will be a factor when considering how a small company will report on ESG factors. The key here will be the development of clear, concise and practical indicators. Knowing these will be critical in discerning the quality of any local stock or portfolio.

Efforts are underway to provide additional non-financial information that any potential investor can rely on. B-Lab’s GIIRs, for instance, assess the social and environmental impact (but not the financial performance) of companies and funds using a ratings approach analogous to Morningstar investment rankings or S&P credit risk ratings. But even more than ratings are needed before we can be comfortable that investors will have the information they need. In order to confidently rate a company, we must know that a company is transparent in terms of reporting on what it does.

Luckily, a new industry standard is under development by Dr. Jean Rogers that will provide a complete view of risks and opportunities of issuers (publicly listed at first), which will also be able to weight portfolios according to sustainability risks. Investors will finally be able to compare peer performances using key performance indicators on material environmental, social, and governance issues, and understand the relative positioning of companies with respect to future challenges. This Sustainability Accounting Standards Board (SASB) was developed out of Dr. Rogers’ particular expertise in developing metrics for measurement of sustainability performance, having worked with the Global Reporting Initiative on development of the G3 corporate sustainability reporting guidelines, and partnering with the Initiative for Responsible Investment at Harvard University to develop a method for assessing the materiality of sustainability issues by sector, as a basis for identifying opportunities for improved competitiveness.

Industrial civilization has famously raised living standards all over the world, but at the same time compromised much of the adaptability necessary for these changing times. Maintaining the complex structures we have developed to keep the status quo generates growing instability and vulnerability. The transformation of regional markets into a single global system has helped to lower costs and increase productivity, but it may have also ironically and unintentionally led to greater threats to our own security by weakening local community stability and redundancy, and creating outcomes that deplete locally produced goods and services. This is a risky strategy.

Diversity is essential to resilience (and employment), and we must together support every effort to maintain and grow this base. The Morris Theorem, coined by Stanford professor of history and archaeology Ian Morris, states that “change is caused by lazy, greedy, frightened people looking for easier, more profitable and safer ways to do things. And they rarely know what they’re doing.” We might be lazy, greedy, frightened people looking only for profit, but this time we will have to know what we’re doing in order to survive and thrive.

About John Katovich

John Katovich was recently Executive Vice President and General Counsel at the Boston Stock Exchange, then Chief Regulatory Officer at BOXR, a subsidiary of NASDAQ. John founded Katovich and Kassan Law Group in 2002, representing corporations, LLCs, non-profits and other entities in areas of general business, financings, licensing, and regulation. Mr. Katovich also recently co-founded Cutting Edge Capital, developing innovative strategies for communities and business. John is also a Professor at Presidio Graduate School, teaching Capital Markets and Law, and consults with emerging countries in the area of markets and regulation. John was Sr. V.P. & General Counsel at the Pacific Stock Exchange, following his role as an Assistant Specialist an enforcement attorney. John was also Sr. VP and General Counsel for two software companies, OptiMark and ePIT, both developers of software for various trading applications. John is a graduate of Southern Illinois University School of Law (1979), and University of Illinois - Urbana-Champaign (1976). He completed the Executive Program on Negotiation at the Harvard Business School and the NASD Series 7. He is licensed to practice law in the state and federal district courts in both California and Illinois.


See UMIR 6.3 Exposure of Client Orders at
UMIR 1.1 Definitions: "standard trading unit" means, in respect of any equity or similar security: (i) 1,000 units of a security trading at less than $0.10 per unit, (ii) 500 units of a security trading at $0.10 or more per unit and less than $1.00 per unit, and (iii) 100 units of a security trading at $1.00 or more per unit.
UMIR 6.3(1)(b).
Other relevant exceptions include UMIR 6.3(1)(a): the client has specifically instructed the participant to deal otherwise with the particular order; and 6.3(1)(f): the order has a value of more than $100,000.
National Instrument 21-101 Marketplace Operation and National Instrument 23-101 Trading Rules were published for comment in July 1999. The July 2, 1999 publication is available at: The current legislation and its evolution are available at:
Toronto Stock Exchange Regulatory Notice 97-036 dated November 7, 1997, page 3.
Toronto Stock Exchange By-law 11.09(5) became effective on August 24, 1998: "A member that receives a client order to buy or sell 1200 shares or less of a listed security shall immediately enter the order in the Book or on another stock exchange on which the security is listed unless…(a) the client has specifically instructed otherwise with respect to that order;…or (c) the member executes the order against a client or non-client order at a better price than the client could have received on any Canadian stock exchange on which the security is listed."
UMIR 6.1 Entry of Orders to a Marketplace. (1) No order to purchase or sell a security shall be entered to trade on a marketplace at a price that includes a fraction or a part of a cent other than an increment of one-half of one cent in respect of an order with a price of less than $0.50.
Proposed amendments to NI 21-101 include revised disclosure requirements aimed at leveling the playing field among ATSs and exchanges, and enhancing disclosure generally. These proposed amendments are available at
Consultation Paper 23-404 Dark Pools, Dark Orders, and Other Developments in Market Structure in Canada was published in the Ontario Securities Commission Bulletin (2009) 32 OSCB 7877 and is available at
See CSA/IIROC Staff Notice 23-308 Update on Forum to Discuss CSA/IIROC Joint Consultation Paper 23-404 "Dark Pools, Dark Order and Other Developments in Market Structure in Canada" and Next Steps, available at
Joint CSA/IIROC - Position Paper 23-405 Dark Liquidity in the Canadian Market is available at
IIROC's Request for Comments "Provisions Respecting Dark Liquidity" published July 29, 2011 is available at
Letter dated October 27, 2011 from Mr. Kevan Cowan, TMX Group to Mr. Jim Twiss, IIROC is available at
Notice: Undefined variable: indexpage in /home/wfe/public_html/focus/2011-12/footer.php on line 2
Designed by Tayburn Kurumsal