The Small Business Capital Formation Advisory Committee (SBCFAC) of the Securities and Exchange Commission (SEC) has thrown down the gauntlet. As explained on the SEC’s website, the SBCFAC was established by the SEC Small Business Advocate Act of 2016 and is intended to provide a formal mechanism for the Commission to receive advice and recommendations on rules, regulations, and policy issues related to small business, including smaller public companies. His latest meeting sent a clear message: It’s time to start providing liquidity to the private markets.
The onus is now on the entire Commission, along with two new members, Mark T. Uyeda and Jaime Lizaraga, to heed their advice. Ten years after President Obama signed the bipartisan Jumpstart Our Business Startups (JOBS Act of 2012), which invited ordinary Americans into the lucrative private capital markets, the job remains half-done at best. Two Title III of the JOBS Act—which became Regulation Crowdfunding (Reg CF)—and Title IV—which dramatically improved Regulation A (Reg A+)—demonstrated the success of deregulation. These two titles enabled a paradigm shift in private equity investing by allowing startups and small businesses to accept investment from retail investors. Reg CF caters to smaller and younger companies with a 12-month bid limit of $5 million. More mature companies use Reg A+, which combines higher SEC scrutiny with a 12-month offering limit of $75 million.
In March 2021, the Commission expanded provisions of the JOBS Act that freed up more capital. But challenges remain. Foremost among these is the lack of liquidity in the secondary market, where initial buyers resell shares. SBCFAC addressed this issue this month by revising the non-preferred secondary trading status for both Reg CF and Reg A+.
The meeting started with speeches by the Commissioner. Commissioner Hester Peirce spoke about how secondary market liquidity and investor protection complement rather than oppose:
Secondary market liquidity combines capital formation and investor protection. An issuer’s ability to raise capital depends in part on whether buyers of their securities will enjoy strong liquidity in the secondary market.
As the presentations began, Ryan Feit, CEO and co-founder of crowdfunding portal SeedInvest, conveyed the sense of frustration investors feel about their illiquid investments even as values rise due to following rounds of higher share prices:
[W]what’s happening is that many startup and small business investors are quickly exhausted. They make an investment or several and they’re excited about it, and then they actually realize that I might have to wait five to ten years to get any return on it.
This ultimately leads to less capital for newer projects and good ideas end up not getting funded.
Sarah Hanks, a prominent securities practitioner and SBCFAC member, spoke about the tedious nature of complying with state-by-state regimes that differ in fee structure, timing, notification requirements and other areas. She mentioned possible solutions in the JOBS 4.0 Act, which Congress is currently considering.
Indeed, CEI filed comments in June on the JOBS Act 4.0, focusing on the importance of preempting the secondary trading process for government securities among a range of other proposals to improve private equity.
Opposing any measure to provide liquidity to the private market was a representative of the North American Association of Securities Administrators (NASAA), a trade organization representing state-level securities agencies. NASSA generally opposes any access to private capital markets for retail investors and promotes additional burdens for accredited investors. She staunchly opposed the JOBS Act, filing numerous statements, comments and press releases, at one point describing it as an “investor protection disaster waiting to happen.” Two NASA members, Montana and Massachusetts, sued the SEC to stop enforcement of Reg A+ with NASA’s support as friend of the court. They lost.
But that didn’t stop the commission, at least for Reg A+. They voted 9-1 in favor of a Reg A+ pilot program to supersede state securities laws for secondary trading. The ball is now in the commissioners court. According to JD Alois on Crowdfunding Insider, the committee is to “submit a formal recommendation to the Commission in the coming weeks that outlines the need for preference for Reg A+ securities.” The time has come for the SEC to act in favor of small businesses. And Congress should complement this move by passing the Jobs 4.0 Act.