At a House Financial Services Subcommittee hearing, representatives considered testimony on the impact of the growth of the private securities markets.

The Subcommittee on Investor Protection, Entrepreneurship and Capital Markets examined private market exemptions as a barrier to IPOs and retail investment. According to a majority staff memorandum, the hearing was based in part, on a June, 2019, SEC concept release on ways to harmonize the current exempt offering framework. The majority staff outlined several of the most common exempt offerings, including those under Securities Act Rule 506 and Rule 144A.

Several bills were considered at the meeting including:

  • H.R. ____, the "Private Securities Transparency and Reform Act," which would establish additional requirements for issuers' sales of securities in reliance on Regulation D;
  • H.R. ____, which would require the SEC to submit a report to Congress regarding private securities offerings;
  • H.R. ____, the "Fair Investment Opportunities for Professional Experts Act," which would codify the specific qualifications of individuals as accredited investors;
  • H.R. ____, the "Crowdfunding Amendments Act," which would subject crowdfunding to SEC jurisdiction;
  • H.R. 2899, the "Main Street Growth Act," which would allow the registration of venture exchanges;
  • H.R. ____, the "Rare Disease Fund Act," which would encourage the development of high-risk, high-return therapies for rare diseases;
  • H.R. ____, the "Family Office Technical Correction Act," which would allow family offices to qualify as accredited investors; and
  • H.R. 609, the "Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act," which would exempt broker-dealers from registration when engaging in transfers of ownership of smaller privately held companies.

Highlighted Testimony

Commissioner of the Vermont Department of Financial Regulation and the Immediate Past-President of the North American Securities Administrators Association ("NASAA") Mike Pieciak urged Congress to remove incentives for companies to stay private. Mr. Pieciak stated that this could be achieved by amending SEA Section 12(g) to reduce the number of holders of record from 2,000, thus triggering earlier the requirement for issuers to register with the SEC.

Boston College Law School Associate Dean for Academic Affairs and Professor of Law Renee Jones urged Congress to (i) consider the impact of dual class capitalization and (ii) revisit the JOBS Act Amendments and Section 12(g) in order to address the many shortcomings in "unicorn governance structures."

Ellenoff, Grossman & Schole LLP Partner Douglas Ellenoff stated that he was not a proponent of imposing pre- and post-filing requirements on private placements.


Steven Lofchie

The testimony given on behalf of NASAA is significant as it reflects the views, generally, of state securities regulators. Mr. Pieciak tells us that information about private companies is limited, the price of trading in private companies is high, and the markets are fundamentally unfair. At the same time, he recognizes that the private markets are where the gains are to be made and he wants retail investors to have a chance to get in. He also concedes that startup offerings often "do not go according to plan. Such offerings are inherently speculative, and highly risky." From a policy perspective, these statements contain important and fundamental inconsistencies.

Just the other day, a number of state securities regulators sued the SEC alleging that the obligations imposed on broker-dealers to look out for their customers under the SEC's newly adopted Regulation Best Interest were insufficiently demanding. These state securities regulators are eager to bring lawsuits against broker-dealers that recommend risky investments to their customers. Against that background, why would a broker-dealer risk recommending that a retail investor put money in a startup, even if it were a public company? In short, the regulators want a world where retails investors may reap substantial rewards by investing in startups, but are protected against meaningful risk. That is generally not the way things work.

Mr. Pieciak laments that "entrepreneurs located in the American heartland" have trouble raising capital because they are far from the venture investors on the West Coast and the East. But the midwestern issuers are not prevented from registering with the SEC and accessing the public markets that the NASAA representative believes are more attractive in any regard. So why don't the midwestern issuers go public? A reasonable guess is that the cost of going public, and the burdens of being public, are just too high.

If these questions are to be seriously addressed, regulators have to be willing to recognize that their goals are fundamentally inconsistent, and that they need to emphasize one or the other. If they want more companies to go public, they must lower the associated burdens. If they want retail investors to put their money in risky startups, they must rely on those investors to evaluate brokers' recommendations, and not put all the risk of failure on the brokers. If they want to make it easier for very small firms to raise capital, then they may need to make it even easier for firms to raise money in the private markets and to stay private. Like economics, financial regulation is about trade-offs.

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