Securities and Exchange Commission Small Business Capital Formation Advisory Committee Meeting
Securities and Exchange Commission
Small Business Capital Formation Advisory Committee Meeting on Small and Emerging Companies
Monday, May 6, 2019
Jay Clayton, Chairman, Securities and Exchange Commission (SEC)
Clayton said the committee discussion identifying several key issues is extremely important and that going forward, the committee will be recognizing and identifying the various sizes and nominal values of companies. He said the rules for raising capital need to reflect their company variances, as well as provide simplicity for people to understand the rules. Clayton added that an area in need of improvement is cutting down on costs to allow for more capital flow while maintaining investor protections. He also stated his support for the overlap of the committee agenda with the SEC Division of Corporate Finance.
Commissioner Hester Peirce, SEC
Peirce said the committee can help address the difficulties of the SEC being a good regulator and understanding the industry it regulates, particular to securities and capital related market players. Peirce said capital markets can be used to level the playing field and benefit everyone, and this committee can work to improve and support many lives through its diverse geographical group.
Commissioner Elad Roisman, SEC
Roisman applauded the inaugural meeting of this committee and the devotion to the current state of small business communities. He said capital formation is a priority and expressed desire for improvement in the secondary markets. Roisman said the committee offering ideas from its diverse background would help support the SEC’s mission for small business moving forward.
Martha Miller, Office of the Advocate for Small Business Capital Formation
Miller said the creation of the Office of the Advocate for Small Business Capital Formation under Section 40 of the Securities and Exchange Act which created this committee, and expressed her support to dedicate the office and network to serve and amplify small business capital. She said the committee serves to advise on SEC rules, regulations, and policies for small emerging companies to small public companies earning $250 million or less, addressing many issues across a broad landscape, including the trade and sale of securities and corporate governance. Miller highlighted the appointment of Carla Garrett, Jeff Solomon, Greg Yadley, and Youngro Lee to the committee board as the chair, vice-chair, secretary and assistant secretary, respectively. She added the importance of the diverse backgrounds of committee members in helping address important future items to raise the profile of small businesses at the SEC.
Panel I: Discussion of SEC Capital Formation Initiatives
Miller said the Division of Corporate Finance has a broad array of responsibilities and makes recommendations to company rules or reporting applications for private exemptions, as well as the sale and buying of securities, including Regulation D. Miller pointed to other “germane” dealings of the division, such as the business development company (BDC) commission that deals with reporting reforms, provides clarity to the role of finders and whether they need to be registered as broker dealers under finders issue policies, and small fund outreach initiatives.
Bill Hinman, Director of the SEC Division of Corporation Finance, said this committee shows the need for broad capital formation, recommending looking over private placement exemptions and not focusing on government finders. He said rulemaking and committee input are “very, very” important, and to further look into Regulation A (Reg A) and Regulation Crowdfunding, as the division will be producing reports on both regulations soon. He said it is important to maximize the levels of crowdfunding, as there are only 1300 offerings counted under crowdfunding, with only half meeting determined capital amounts. He said there will be recommendations to look at raising limit amounts or investment limits. Hinman also spoke about tier one and two of Reg A, and reviewing preemptive activity under tier two for amounts raised under tier one requirements. He said size limits will need to be evaluated, as well as harmonization efforts for private place exemptions. Hinman recommended the committee work to help appropriately define accredited investor and assist in other scaling and exemption efforts in guiding the SEC rulemaking process. Hinman included a recommendation of the committee shaping Rule 701 for private company equity offerings to employees on an exemption basis, outside the traditional employee relationship definition. He also said the committee could help revise the SEC 10 Q filling forms for earnings definitions, as well as scale disclosure reporting efforts under 404-b requirements for financial size reporting. Hinman also said financial reporting requirements for private companies could be made easier through advising reform to Rule 305 or Reg X. He said reexamining significance tests and the period of time for financial statements without losing investor protection would be beneficial. Hinman recommended a long-term reform to Regulation S-K to modernize the repository of disclosure requirements. He said that some bright line dollar standards could be out of date, and added that transitioning to a principles-based approach and addressing attestation would help reform standards.
Question & Answer
Sara Hanks, CEO and Co-Founder, CrowdCheck, Inc., touched on testing the waters proposals being considered in Congress and the need to take incremental approaches before regulatory action. Hinman said proposals being considered in Congress set out to expand to non-agencies, but the division is looking at an approach to harmonization for a more comprehensive way forward. Jennifer Zepralka, Chief, Office of Small Business Policy (OSBP) said the need to find balance for investor protection is important. She also said she would like the committee to look into 506-c and address defrauding.
Youngro Lee, CEO and Co-Founder, NextSeed, expressed a desire for clarity of the role of entrepreneurs in capital formation and for the SEC to provide guidance in this area. Hinman said harmonization is in the works, rather than a patchwork approach for raising capital and trying to fit in private exemptions. He said the division is also looking at increasing the space for investor involvement.
Jeff Solomon, CEO, Cowen, Inc., raised concerns regarding the small business funds initiative and Markets in Financial Instruments Directive II (MiFID II) research impact on small business. Miller said the small fund outreach initiative is helping to address and seek solutions for issues faced by smaller funds, such as angels and others, to fill a void for small business investment.
Panel II: Discussion of Capital Formation Advisory Committee Future Steps and Areas of Focus
Miller expressed a desire to address the “gray area” moving forward for innovation purposes, as well as collaboration across all state and federal government agencies.
Clayton said the compliance structure needs to be addressed to prevent barriers to entry for entrepreneurs. He also noted how important it is to investors to reform the accreditation process as well as lessen the risk for those who obtain it, as they currently run the risk of losing everything on one deal. Clayton discussed the need to align retail investment to management and institutional investment in order to provide more protection and lessen the “priming” of retail investment.
Roisman discussed the importance of improving areas that have evolved in the markets, as well as increasing liquidity flow in the secondary markets. He also said it would be beneficial to understand how stages of each cycle work, and utilizing debt raising as an important tool.
Robert Fox, National Managing Partner, Professional Standards Group, Grant Thornton LLP, said having consistent investor protection and harmonized requirement components would be beneficial, as several requirement changes can be costly for companies undergoing mergers. He recommended weighing the voice of both investors and entrepreneurs in discussions.
Carla Garrett, Corporate Partner, Potomac Law Group PLLC, said resources and programs for small businesses are limited, and the committee should help companies understand what vehicles are available. She said the patchwork of exemptions are difficult to understand and harmonization would “be nice.” Garrett added that liquidity for employees and others in private companies would be another area to educate in terms of exercising the options of utilizing secondary markets.
Youngro Lee, CEO and Co-Founder, NextSeed, said certain investor protection assumptions, like losing everything in one deal, are not true today. He said looking at the types of both investments and investors would benefit the rulemaking process. Lee said crowdfunding provides investment to cities and markets which would not otherwise have seen such investment. Lee said local investors need the opportunity to invest and see higher potential returns, and that crowdfunding is about investing in areas of interest and that the risk-reward analysis is not available. He noted two areas of potential concern for crowdfunding are the legal and secondary markets.
Terry McNew, President and CEO, MasterCraft Boat Holdings, said there is a choking pipeline of starting new companies through investment, and the cost for entry is costing great ideas. He recommended simplifying the path forward, and not overcomplicating the float requirements. McNew recommended wrangling out unnecessary regulation and balancing the risks.
Catherine Mott, Founder and CEO, BlueTree Capital Group, Allied Angels, and Venture Fund, expressed her support for angel investing, and referenced the Helping Angels Lead Our Startups Act (HALOS), in efforts to support angel investment and provide clarity to accredited investors. She said angel investment has “come out of the woodwork” in states with a tax credit, leading to job creation and company investment. Stephen Graham, Co-Chair, Fenwick & West LLP’s Life Sciences Practice, also said he would like to see clarity brought to the definition of accredited investor.
Jason Seats, Chief Investment Officer, Techstars, said investor protections should be focused on small business needs compared to the idea of investor experience in capital markets. He acknowledged that the committee is looking into private retail investment transitions, and recommended that the committee look at how much investor protection may adversely be causing harm to investors. Seats added that the average life cycle of investor funds is extending, leading to areas of the secondary market being utilized, and should be looked into further, especially regarding liquidity.
Jeffrey M. Solomon, CEO, Cowen, Inc, said that as markets have changed in the last 20 years, harmonization efforts should work to incentivize the individual investment to private access for retail investment. Solomon called for SEC guidance for individual investment alongside the sophisticated professional investors and said syndicates could help redefine how deals outside of exemptions look for investors. He also pointed to the decline in venture exchanges and said there is a need to create an attraction for them. Solomon said the decline in the number of public companies today compared to 1998, but mentioned specific markets opening up in the public process, like the biotech sector, and said there should be a right mix to utilizing the secondary markets.
Hank Torbert, President, AltaMax, LLC, expressed the importance of creating an environment for investors in specific markets, whether they are inside or outside the community being invested in. He also suggested providing incentivizes for banks and other local business investment. Torbert discussed the need to reign in those who are misleading companies, and for better management of this issue.
Gregory Yadley, Partner, Shumaker, Loop & Kendrick, LLP, said he supports companies’ ability to raise capital and the “wise” utilization of capital. He said companies should be able to breathe their ideas, and that there is a need for an intersection of what an offer is, noting that who companies can talk to in raising capital is important. Yadley expressed his desire to address the finders issues, the clarity of the definition of an accredited investor, and allowing entrepreneurs the ability to tell their story without worrying about violating the law.
The committee meeting concluded with the adoption of the committee By-Laws, with the exception of Sec (i), known as the Roberts Rules of Order.
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