In a panel of the Investor Advisory Committee, speakers spiritedly discussed a recent Concept Release on securities offering reform that raises issues for capital formation, investor protection and market integrity.
Concept Release. In June 2019, the SEC issued a Concept Release on Harmonization of Securities Offering Exemptions. Jennifer Zepralka, Chief of the SEC Office of Small Business Policy, explained that the release broadly reviewed the available exemptions to the registration requirements and examined the state of registered versus deregistered offerings.
According to the release, significantly larger amounts of new capital have been raised in deregistered offerings in recent years. An estimated $2.9 trillion has been raised in exempt offerings in 2018, compared to $1.4 trillion raised in registered offerings. In 138 specific requests for comment, the release explores whether overlapping exemptions are confusing for issuers trying to navigate the most efficient path to raise capital; whether there are any gaps in the framework that may make it difficult for companies to find the right exception from registration at key stages of their business cycle, and looking whether integration could help issuers to transition from one exempt offering to another and ultimately to a registered public offering.
The comment period closed on September 24, and the SEC has received more than 150 letters so far. The most popular topic for comment has been the definition of "accredited investor."
Risks of easing restrictions. Several speakers explored risks to investors and the markets that may arise from relaxing restrictions in securities offerings.
According to Renee Jones, associate dean of academics and professor at Boston College Law School, new transaction exemptions created by Congress and the SEC and the past 15 years have strayed dramatically from their statutory and traditional bases. This trend towards increasingly relaxed conditions for exemption has created new risks for investors. Further, the expansion of these exemptions has also created unfortunate spillover effects that have spread to all corners of the economy, and have impacted the welfare of corporate employees, consumers and even broader society.
Jones also took issue with several "flawed" premises. In her view, it has not been adequately shown that retail investors would likely gain superior returns if allowed to invest more easily and privately offered securities. Jones also believes it a "strange" assumption that there is an inherent conflict between the objectives of investor protection and capital formation, when comprehensive disclosure is the hallmark of efficient capital markets and transparent security markets have served as the engine of the U.S. economy and are the envy of the world. Moreover, the lack of information transparency has been associated with serious economic problems, including poor investment decisions, even by sophisticated investors, misallocation of capital and increased opportunities for misconduct and fraud.
According to Andrea Seidt, Ohio Securities Commissioner, private offerings have been and remain the most common source of state enforcement action, and a recent paper showed that this was the case not just in Ohio but across the nation. Companies take advantage of the relaxed filing reporting requirements to perpetrate fraud, with minimal pre or post sale disclosure. Exemptions have become so attractive that most companies to very little or no upside to going public at all, and retail investors have not been all that interested in the private or quasi private deals that the JOBS Act has made available to them—possibly in part due to financial capacity, as half of American households have less than $10,000 in savings.
Yet proposals are being discussed to make these exemptions even more attractive. Seidt believes this would cause public markets to shrink even further, since companies will be able to stay private and gain the same access to capital as public companies with none of the cost. Further, Seidt believes that "Mom and Pop investors might get fleeced," though this is not definite, due to the lack of data as to how investors on the whole actually fare in private markets.
According to Tyler Gellasch, Executive Director, Healthy Markets Association the concept release is a continuation of a decades long trend where Congress and the commission have created exemptions and exceptions from a regulatory framework, and these changes have siphoned off trillions of dollars from capital from the public markets and the private ones. Two thirds of offerings are outside of the public realm, and there are 500 companies in the private markets valued at more than a billion dollars.
Without basic information on securities, it's impossible to make for even the most sophisticated investors in the world to make informed decisions about where and how much to invest, said Gellasch. The consequence of reduced disclosure requirements has led to many IPOs significantly underperforming. This has ramifications for investors and the economy. For example, this year, one company went from a predicted valuation of $120 billion dollars to an IPO of $80 something, and yesterday was trading under $45 billion. That's a $75 billion range for one company in what it's worth, over the course of a few months. This was because the company had to make more disclosure following the IPO, and as investors started asking questions and learning things, the valuation dropped. There were similar valuation issues with WeWork and Peloton.
"If you're an investor and you can choose anywhere in the world to invest, do you really want to invest in IPOs when they've got that track record over the last 10 years?" Gellasch asked.
Gellasch also noted that the securities laws were adopted not just for investor protection, but so the government can gain basic information about companies, such as whether they are paying their taxes or violating laws.
Promoting capital formation. In the view of Sara Hanks, CEO, Crowd Check, Inc., it is just too hard for small companies to go public, given information and filing requirements. Hanks believes that more companies might go public if were an entry level reporting tier, possibly based on regulation, that they could comply with until they could move to a higher level of reporting at the time of their choosing. She recommends to shift regulation from the time of offer to the time of sale, and that there should be no prohibitions on general solicitation anywhere in the exempt offering framework.
As to the accredited investor definition, Hanks recommends:
- Keep the existing financial qualification, but index it to inflation from now on;
- Add accreditation by means of a securities specific educational qualification, such as holding CFA designation or certain FINRA licenses;
- Add accreditation by reference to a specific test developed for private investors; and
- Add accreditation by chaperone.
Mott believes that offerings policy should not be driven by "unicorns" which are outliers that don’t reflect the majority of angel and VC funding. In particular, she believes that the general solicitation rules need to be modernized and demo days should be carved out. Further, the Angel Capital Association recommends creating a definition of qualified private sale that covers sales of minority positions in private companies with limited trading volume.