Securities Regulation Daily SEC’s Small Business Forum report includes 14 recommendations for securities policy
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Friday, December 6, 2019

SEC’s Small Business Forum report includes 14 recommendations for securities policy

By John Filar Atwood

Staff responds to each of the suggestions in a report that summarizes the August meeting of SEC Commissioners, staff, and members of the public and private sectors.

The SEC released its report on the 2019 Government-Business Forum on Small Business Capital Formation in which it addresses suggestions for recalibrating the securities laws to better assist small businesses and their investors. The policy recommendations were made by participants at the August meeting and address issues facing emerging businesses, mature and later-stage private companies, and small reporting companies.

Emerging businesses. Participants discussed issues facing these entities, which the report notes generally raise capital through some combination of bootstrapping, self-financing, bank debt, friends and family, crowdfunding, angel investors, and seed rounds. The funding is typically used to get companies off the ground and through early prototypes.

The first recommendation in this area was to revise the definition of accredited investor. Specifically, participants suggested that for natural persons, in addition to the income and net worth thresholds in the definition, there should be a sophistication test as an additional way to qualify. Tribal governments should be provided parity with state governments, and the dollar amounts to scale for geography should be revised to lower the thresholds in states/regions with a lower cost of living.

The Commission responded that the Division of Corporation Finance is currently considering recommending propose amendments to expand the definition of accredited investor under Securities Act Regulation D. Part of the SEC’s concept release on the harmonization of the exempt offering framework seeks public comment on whether current rules that limit who can invest in certain offerings should be expanded to focus on criteria other than wealth of the investor. The concept release also seeks feedback on whether the Commission should consider rule changes to expand the types of entities that may qualify as accredited investors.

A second suggestion for emerging business concerned finders. Participants recommended that the SEC, and possibly FINRA, look into who finders are, and what the different categories might be for participation in transactions. They said that rules should be explicit and clear for purposes of determining the categories of finders and what constitutes "engaging in the business of effecting transactions in securities" that triggers classification as a broker.

The Commission noted that the Division of Trading and Markets is considering recommending proposed rules concerning the status of finders for purposes of Exchange Act Section 15(a). According to the report, the staff will consider the forum participants’ recommendation in connection with the initiative.

Participants also recommended that Regulation Crowdfunding rules be revised to allow accredited investors to make unlimited investments and raise the maximum limit on the overall deal. The Commission said that the staff will consider this suggestion in connection with the initiative on ways to harmonize and improve the exempt offering framework. The concept release specifically seeks comment on the overall offering limit and individual investment limits contained in Regulation Crowdfunding, the Commission noted.

Later-stage private companies. The report states that later-stage private companies generally are those that are growing and looking for larger amounts of capital that can fund operations of scale, ventures into new verticals, and preparation for public markets. The report notes that most often these investors are institutional, whether syndicate groups, venture capital, private equity, or public funds.

For these types of companies, the participants suggested a federal preemption for all resales of securities sold in a Regulation A Tier 2 offering, provided that the issuer is current in its Tier 2 reporting. They also suggested that there be an unconditional exemption from Exchange Act Section 12(g) for all Regulation A Tier 2 reporting companies, provided that the issuer is current in its Tier 2 reporting.

The Commission replied that in its 2015 final release adopting amendments to Regulation A, the staff undertook to study and submit a report to the Commission no later than five years following the adoption of the amendments on the impact of both the Tier 1 and Tier 2 offerings on capital formation and investor protection. The final release indicated that the report will include, but not be limited to, a review of: (1) the amount of capital raised under the amendments; (2) the number of issuances and amount raised by both Tier 1 and Tier 2 offerings; (3) the number of placement agents and brokers facilitating the Regulation A offerings; (4) the number of federal, state, or any other actions taken against issuers, placement agents, or brokers with respect to both Tier 1 and Tier 2 offerings; and (5) whether any additional investor protections are necessary for either Tier 1 or Tier 2.

The Commission stated that the Division of Corporation Finance will consider the forum recommendations, and the findings from the staff’s report on Regulation A, in connection with the exempt offering harmonization project. The Commission noted that the concept release specifically seeks comment on whether the Commission should extend federal preemption to additional offers and sales of securities and whether the conditional Section 12(g) exemption for Regulation A Tier 2 securities should be modified.

The forum participants also suggested that the Commission provide a series of Investment Company Act exemptions for diversified funds selling securities under Regulation A, Regulation Crowdfunding, and Regulation D. The Commission said that although it did not request public comment on providing potential exemptions under the Investment Company Act for offerings by pooled investment vehicles under Regulation A, Regulation Crowdfunding, and Regulation D in the harmonization concept release, staff in the Division of Investment Management will consider this forum recommendation in connection with that initiative.

Small reporting companies. The report states that these companies are those that can access broad pools of investors when they conduct public offerings, allowing companies to raise large amounts of money to fund activities such as research and development, capital expenditures, or debt service. The public offerings also provide liquidity to early-stage investors and publicity for the company.

The major forum recommendation for these entities was that the Commission reform the rules governing the proxy process by, among other things, providing for effective oversight of proxy advisory firms under Rule 14a-2(b), with a focus on conflicts of interest, accuracy, transparency, and issuer-specific decision making. They also suggested amending the submission and resubmission thresholds for shareholder proposals under Rule 14a-8.

The Commission noted that in November it proposed amendments to its rules governing proxy solicitations to, among other things, condition the availability of certain existing exemptions from the information and filing requirements of the federal proxy rules for proxy voting advice businesses upon additional disclosure and procedural requirements. At the same time, the Commission proposed amendments to certain procedural requirements and the provision relating to resubmitted proposals under the shareholder-proposal rule.

The proposed amendments would, among other things, replace the current ownership requirements with a tiered approach that would provide three options for demonstrating an ownership stake through a combination of amount of securities owned and length of time held. The Commission said that the Divisions of Corporation Finance and Investment Management considered and will continue to consider the forum recommendation in connection with those initiatives.

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