Is the SEC Doing Enough to Promote Capital Formation?

If you believe Commissioner Daniel M. Gallagher, the answer is an emphatic “no”, at least with respect to small businesses. On September 17, 2014, at a Heritage Foundation event, Commission Gallagher gave a speech criticizing the Securities and Exchange Commission’s failure to adequately promote capital formation by small businesses:

[S]adly, we at the SEC are not doing nearly enough to ensure that small businesses have the access to capital that they need to grow. We layer on rule after rule until it becomes prohibitively expensive to access the public capital markets.

After noting that not all of the regulatory burden is the SEC’s fault as “much of the ever-growing rulebook is a direct result of congressional mandates,” Commissioner Gallagher makes a number of recommendations for the SEC. Highlights include recommendations to:

  • Withdraw the proposed amendments to Regulation D. (Commission Gallagher did not support the proposed amendments as he stated in the SEC’s July 10, 2013 open meeting.)
  • Consider more deeply Regulation D, including considering broadening the blue sky exemption to help make the choice between the various exemptions available under Regulation D more meaningful.  According to Commissioner Gallagher, nearly all Regulation D offerings are conducted under Rule 506, even though 2/3 of the offerings are small enough that they could have been conducted pursuant to Rule 504 or 505, because Rule 506 offerings are exempt from blue sky regulations.
  • Analyze the secondary market for private company shares, where innovation has slowed. “We need more facilities to improve trading among accredited investors in the private secondary market.”
  • Finish implementing the JOBS Act’s reforms to Regulation A and couple the reforms with the formation of venture exchanges (national exchanges with listing rules tailored for smaller companies, including those issuing shares issued pursuant to Regulation A). Commission Gallagher noted that the SEC had proposed a robust set of rules, including blue sky preemption in certain larger Regulation A Offerings. (Commissioner Gallagher also noted, with respect to the proposal for blue sky exemption, that an “outpouring of anger from state regulators . . . wasn’t unexpected. After all, state regulators have been “protecting” investors from investment opportunities that are too risky for decades – I’m sure the Massachusetts residents who missed out on the offering of Apple Computer in 1980 because of their regulator’s concerns about the risk know this all too well.”)
  • Reconsider the current thresholds for scaled disclosure and the amount of disclosure that is required at each level – including having two tiers of scaling: significant scaling of disclosure for “nanocap” companies (i.e., companies with market capitalizations of up to $50 million) and moderate scaling for “microcap” companies with market capitalizations of $50 million to $300 million.

Coincidently, the SEC released its 2014 – 2018 Strategic Plan on September 19, 2014, two days after Commissioner Gallagher’s speech. Featured on the cover of the Strategic Plan is the SEC’s mission statement – “Protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation” (emphasis added).

But, judging by the SEC’s own Strategic Plan and its current rulemaking agenda, it is unlikely that the SEC will be vigorously addressing many of Commissioner Gallagher’s concerns regarding capital formation for small businesses in the near future.

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