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SEC Requests Comments on Securities Offering Exemptions

Steven.Lofchie@cwt.com's picture
Commentary by Steven Lofchie

The SEC issued a concept release reviewing the framework for exempt offerings (largely focused on private placements, but also covering other topics, such as intrastate offerings and Regulation Crowdfunding). The agency is requesting public comment on ways to simplify, harmonize and improve the agency's framework. The SEC staff also published a report on market experience with Regulation Crowdfunding.

In the concept release, the SEC noted that, because several exemptions from registration have been introduced, expanded or otherwise revised, U.S. capital markets would benefit from a comprehensive review of the design and scope of the framework. The SEC is intending, through revisions to the exempt offering framework, to expand investment opportunities and promote capital formation while maintaining appropriate investor protections.

The concept release seeks input on, among other things, whether:

  • the SEC's exempt offering framework is "consistent, accessible, and effective" for companies and investors;

  • the SEC should consider changes to "simplify, improve, or harmonize" the exempt offering framework;

  • there should be any changes to streamline the capital-raising exemptions within the framework;

  • there are gaps in the framework that make it difficult to rely on an exemption from registration to raise capital at key stages of the business cycle;

  • the limitations on "who can invest in certain exempt offerings, or the amount they can invest, provide an appropriate level of investor protection" or "pose an undue obstacle to capital formation or investor access to investment opportunities";

  • the SEC should do more to allow companies to transition from one exempt offering to another and, eventually, to a registered public offering without undue friction or delay;

  • the SEC should take steps to facilitate capital formation in exempt offerings through pooled investment funds;

  • retail investors should be allowed greater exposure to growth-stage companies through pooled investment funds; and

  • the SEC should revise its rules governing exemptions for "resales of securities to facilitate capital formation and to promote investor protection by improving secondary market liquidity."

Separately, the SEC released a staff report on the "impact of Regulation Crowdfunding on capital formation and investor protection." The findings of the report that are relevant are assessed in the concept release. Notably, while the staff report is quite comprehensive, it does not provide information as to whether investors in crowdfunding transactions made or lost money.

The comment period will remain open for 90 days from the publication of the release in the Federal Register.

Commentary

Almost immediately after Congress adopted Dodd-Frank (purporting to protect sophisticated investors against the complexities of interest rate swaps), it also adopted the JOBS Act (freeing up retail investors to invest at least small amounts in pretty much anything). It is hard to comprehend how Congress could adopt both of these statutes effectively simultaneously and not be bothered by the inconsistency.

The SEC now shows itself to be as broad-minded as Congress. One day it adopts Regulation Best Interest, which will severely discourage any broker-dealer from making recommendations of other than plain-vanilla products to natural persons. Virtually the next day the SEC asks for comment as to how it can loosen up its rules so smaller investors can access a broader range of private securities offerings. To make this point more specifically, (i) Regulation Best Interest requires that Warren Buffett be treated no differently for suitability than a tenth grader with $2,000 and prohibits Warren from attesting to his ability to act independently, but (ii) in this release, the SEC asks for comment as to whether individuals with little money should be able to "opt into being accredited investors." If there is a common intellectual or policy thread to these two SEC releases, it is not one that is obvious.

Notwithstanding the disconnect between Regulation Best Interest and the SEC's concept release, this concept release is important. The burdens of SEC registration and regulation, among many other factors, have made the private securities markets steadily more important as compared to the market for initial public offerings. Accordingly, the possibility of a significant remake of the private offering market is a very big deal. Every issuer, investment bank, investment fund, and service provider should consider how a transformed private market could effect the ability to raise capital, the protections afforded and the opportunities provided for small investors, and the impact on the U.S. economy.

Recommendation: To improve retail investor access to growth-stage companies: eliminate the distinction between Investment Company Act Section 3(c)(1) funds (which can accept only 100 investors) and Section 3(c)(7) funds (which can take any number of investors, but the investors must meet much higher standards of wealth. This distinction not only makes no sense; it is harmful to smaller accredited investors who can invest in 3(c)(1) funds, but don't meet the higher "QEP" standard for 3(c)(7) funds. This is because the largest funds which are capable of attracting more sophisticated investors (who are also the investors most capable of monitoring the behavior of a fund's manager) are not open to accredited investors who can't meet the higher "QEP" standard. As a result, these accredited investors are limited to investing in private funds with other investors like themselves, who do not really have the resources to oversee the fund's conduct. Further, these funds that are limited to investment from 100 relatively small investors are unlikely to be able to negotiate the most attractive terms from issuers or to get in on the most attractive deals because they lack real size. 

(The discussion of the treatment of investment funds starts on page 172. The changes in law that seem to me most likely to result in retail investors being able to access meaningful opportunities to invest in attractive start-ups are those that expand their opportunities to do so through a collective investment vehicle.)

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