House Financial Services Hearing on Legislative Proposals to Enhance Capital Formation for Small and Emerging Growth Companies
On May 1, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing entitled “Legislative Proposals to Enhance Capital Formation for Small and Emerging Growth Companies, Part II.” The hearing examined the discussion drafts for the Equity Crowdfunding Improvement Act of 2014, the Startup Capital Modernization Act of 2014, and “To direct the Securities and Exchange Commission to revise the proposed amendments to Regulation D, Form D, and Rule 156.”
Witness Testimony
Benjamin Miller, Co-Founder of Fundrise, shared his experience using Regulation A to crowdfund the development of local real estate in the District of Columbia. Miller explained that since the Jumpstart Our Business Startups (JOBS) Act of 2012 did not exist when Fundrise started its endeavor, it had to work within the existing regulatory framework, and with a legal team it found a way through using Regulation A. According to Miller, over the past two years, they were the only firm to have successfully qualified more than one Regulation A offering, having climbed the “regulatory mountain” associated with Regulation A no less than three times.
Miller continued to say that Fundrise supports any proposal that lessens the regulatory burdens of Regulation A offerings while simultaneously increasing the regulatory certainty faced by small businesses to raise capital. In addition, Miller supported the exclusion of investors in Regulation A+ offerings from the number of holders of record counted under Section 12(g) of the Exchange Act. Miller found that the wording contained in the draft bill is slightly confusing and he asked that the Subcommittee consider whether there are clearer and simpler ways to accomplish this goal.
Annemarie Tierney, Executive Vice President and General Counsel of SecondMarket, testified that she strongly supports Section (5) of the proposed legislation referred to as “A bill to amend the securities laws to improve the small company capital formation provisions, and for other purposes” to adopt Section 4(a)(7) of the Securities Act of 1933 and to make securities sold pursuant to that exemption covered securities for purposes of Section 18 of the Securities Act of 1933. In her view, this legislation merely codified a long-standing legal framework applicable to resales of private securities by shareholders who cannot meet the requirements of Rule 144.
Tierney explained that based in part on a provision of the JOBS Act, a private company now has the ability to defer an IPO and Securities Exchange Act of 1934 reporting and remain private longer than it might have done in the past. She continued that now only the very largest companies are undertaking IPOs and receiving the sales and equity research support needed to succeed as public companies.
Furthermore, Tierney discussed the challenges presented under the current legal framework for private company shareholder liquidity. Tierney continued that challenges come into play when the shareholder cannot rely on Rule 144 because he is an affiliate of the company, as is the case for officers, directors, and control persons, or where the shareholder has not held the shares to be sold for the requisite 12-month period, as in the case of a private company employee who holds options, but not the common stock underlying the options. She said that on the federal level no specific statutory safe harbor exists for these types of resale transactions.
Tierney also commented on the draft legislation referred to as “To direct the Securities and Exchange Commission to revise its proposed amendments to Regulation D, Form D and Rule 156” regarding the SEC’s proposed amendments to Regulation D. While Tierney said she supports the underlying goals of minimizing investor fraud and enabling the SEC to evaluate market practices in Rule 506 offerings, she strongly believes that many of the SEC’s proposed changes are unworkable for startups raising capital in today’s electronic world.
Next, Tierney told the subcommittee that the SEC’s proposed rules would require that an “Advance Form D” be filed by the issuer with the SEC no later than 15 days before the commencement of general solicitation. In her view, an advance filing would effectively impose a 15-day cooling off period for offerings by startups seeking capital on a continuous basis and is “quite simply” inconsistent with the intent of the original JOBS Act.
Tierney also argued that the proposed amendment to Rule 507 to disqualify an issuer who failed to comply with the Form D filing requirements within the past five years from relying on Rule 506 for any new offering for a one-year period is clearly contrary to the intent of the JOBS Act and punitively disproportionate to the impact that such failure would have on investors and the market.
In addition, Tierney told the Subcommittee that Rule 510 T of Regulation D would require that an issuer conducting a 506(c) offering submit to the SEC general solicitation materials prepared and used in connection with the offerings in advance of the use of such materials, imposing a significant expense and burden on issuers. As a result, Tierney said she supports Section (6) to require the submission of materials to provide workable, rational guidance on what types of materials in a single filing after the closing of an offering but would also request that the SEC be directed to provide workable, rational guidance on what types of materials would be considered “general solicitation materials.”
William Beatty, Director of Securities in the Securities Division of the Washington State Department of Financial Institutions, testified on behalf of the North American Securities Administrators Association, Inc. Beatty argued that states are leaders in modernizing capital formation. In his opinion, the enactment of the JOBS Act unfortunately precluded the states from playing a leading role in crowdfunding, and following enactment of the law work on the NASAA model rule was deferred. Beatty added that with respect to the implementation of Regulation A+, the states are “ready-to-go,” provided that Congress and the SEC do not short-circuit their efforts by preempting them.
Next, the Beatty stated that the overall impact of the Startup Capital Modernization Act of 2014 would substantially and further weaken investor protections in several important ways. Beatty continued that NASAA continues to oppose Congress’s regulation of small investments in small companies because the federal government has neither the inclination nor the resources to regulate effectively in this area. In addition, he referred to the revisions specified by the draft legislation seeking to revise the SEC’s existing and proposed amendments to Regulation D and Rule 156 as an “assault on the authority” of the SEC to provide “basic, reasonable investor protection.”
Jeff Lynn, Chief Executive Officer of Seedrs Limited, testified that Title III of the JOBS Act provides the legislative framework for an equity crowdfunding regime in the United States and the SEC has not yet adopted rules to implement Title III. Lynn explained that Title III limits the amount an issuer can raise through equity crowdfunding to $1 million in any 12-month period. In addition, he contended that the financial statement requirements for issuers, in particular the audit requirement, are the most burdensome aspects of Title II and one of the main reasons it is unworkable. He believes that the principle of caps on the amount an investor can invest has an unnecessarily paternalistic element to it, especially when other safeguards are in place.
Lynn did say he believes that curation is an essential part of running an equity crowdfunding platform. The final problem that Lynn found with Title III relates to the use of special-purpose vehicles and nominee arrangements to aggregate investments. He feels the Improvement Act makes significant strides in addressing these failures of Title III, and believes that if the legislation is not enacted in the form proposed, there is substantially greater likelihood that equity crowdfunding will be able to flourish in the United States.
Questions
Chairman Scott Garrett (R-N.J.) asked Tierney to discuss Regulation D. Tierney said it was drafted for a Wall Street model and not for private companies such as a startup and the 15-day period is “just unworkable.” Tierney suggested a concept of filing one form for Regulation D rather than three forms, adding that this would be a massive relief because filing these forms is expensive.
Ranking Member Carolyn Maloney (D-N.Y.) asked Beatty what state securities regulators have done to streamline Regulation A since the JOBS Act was passed. Beatty said a fair amount of work has been done and recognized that with the GAO study regulations could be better.
Next, Ranking Member Maloney asked Tierney if investors claim to be accredited when they are not. Tierney said it does happen.
Vice Chairman Hurt asked Miller why issuers have avoided Regulation A. Miller said that it has become a question of what is the additional appeal to the process and how it benefits the investor or the fundraiser. Lynn said it also had to do with the offering amount and that there is a perception that good companies do not use regulation.
Representative David Scott (D-Ga.) said Congress needs to look at regulatory impediments and Regulation D is leading to issues with capital formation. He asked Tierney what the committee should actually do to act. Tierney asked for one Form D filing requirement that should be available across all 50 states. Tierney said that startups cannot rely on Regulation D for a 12-month period. Representative Scott replied that Tierney’s proposal was very reasonable.
Representative Kevin McCarthy (R-Calif.) asked what the view of crowdfunding is around the world related to sound liability. Lynn responded that it can be minimized by making the regulations very clear.
McCarthy asked Miller about Regulation A offerings. Miller said they were the only Regulation A offering in the United States.
Representative John Carney (D-Del.) asked if it is feasible to develop a one stop filing process on the state level. Beatty said that concerns about sending paper filings to all 50 states will soon be a thing of the past and Regulation D is only an eight-page form that is important for regulators to see early on.
Carney asked about how the IPO onramp has worked in practice and if there are problems. Beatty said how it will play out long term does give him some concern.
Representative Randy Neugebauer (R-Texas) asked Lynn about Title III and the negative impact on crowdfunding. Lynn said he has many concerns because the legislation was written with many burdens. Miller replied that the regulatory compliance is critical to your next round and the complexity is outside the knowledge base of the average entrepreneur so you have to rely on outside council.
Neugebauer asked if there is any reason to believe that regulatory burdens have increased in the last few years. Tierney replied that there are not a lot of good reasons to go public right now.
Representative Daniel Kildee (D-Mich.) said he is more interested in the areas of capital formation such as the mortgage market and making sure people have the ability to purchase a home. Beatty said a strong and healthy SEC is important but we cannot take regulators off the table in terms of providing services. Lynn responded that particularly for smaller growing businesses, smaller does not correlate with them being local because internet based companies are different.
For more information on this hearing, please click here.
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On May 1, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing entitled “Legislative Proposals to Enhance Capital Formation for Small and Emerging Growth Companies, Part II.” The hearing examined the discussion drafts for the Equity Crowdfunding Improvement Act of 2014, the Startup Capital Modernization Act of 2014, and “To direct the Securities and Exchange Commission to revise the proposed amendments to Regulation D, Form D, and Rule 156.”
Witness Testimony
Benjamin Miller, Co-Founder of Fundrise, shared his experience using Regulation A to crowdfund the development of local real estate in the District of Columbia. Miller explained that since the Jumpstart Our Business Startups (JOBS) Act of 2012 did not exist when Fundrise started its endeavor, it had to work within the existing regulatory framework, and with a legal team it found a way through using Regulation A. According to Miller, over the past two years, they were the only firm to have successfully qualified more than one Regulation A offering, having climbed the “regulatory mountain” associated with Regulation A no less than three times.
Miller continued to say that Fundrise supports any proposal that lessens the regulatory burdens of Regulation A offerings while simultaneously increasing the regulatory certainty faced by small businesses to raise capital. In addition, Miller supported the exclusion of investors in Regulation A+ offerings from the number of holders of record counted under Section 12(g) of the Exchange Act. Miller found that the wording contained in the draft bill is slightly confusing and he asked that the Subcommittee consider whether there are clearer and simpler ways to accomplish this goal.
Annemarie Tierney, Executive Vice President and General Counsel of SecondMarket, testified that she strongly supports Section (5) of the proposed legislation referred to as “A bill to amend the securities laws to improve the small company capital formation provisions, and for other purposes” to adopt Section 4(a)(7) of the Securities Act of 1933 and to make securities sold pursuant to that exemption covered securities for purposes of Section 18 of the Securities Act of 1933. In her view, this legislation merely codified a long-standing legal framework applicable to resales of private securities by shareholders who cannot meet the requirements of Rule 144.
Tierney explained that based in part on a provision of the JOBS Act, a private company now has the ability to defer an IPO and Securities Exchange Act of 1934 reporting and remain private longer than it might have done in the past. She continued that now only the very largest companies are undertaking IPOs and receiving the sales and equity research support needed to succeed as public companies.
Furthermore, Tierney discussed the challenges presented under the current legal framework for private company shareholder liquidity. Tierney continued that challenges come into play when the shareholder cannot rely on Rule 144 because he is an affiliate of the company, as is the case for officers, directors, and control persons, or where the shareholder has not held the shares to be sold for the requisite 12-month period, as in the case of a private company employee who holds options, but not the common stock underlying the options. She said that on the federal level no specific statutory safe harbor exists for these types of resale transactions.
Tierney also commented on the draft legislation referred to as “To direct the Securities and Exchange Commission to revise its proposed amendments to Regulation D, Form D and Rule 156” regarding the SEC’s proposed amendments to Regulation D. While Tierney said she supports the underlying goals of minimizing investor fraud and enabling the SEC to evaluate market practices in Rule 506 offerings, she strongly believes that many of the SEC’s proposed changes are unworkable for startups raising capital in today’s electronic world.
Next, Tierney told the subcommittee that the SEC’s proposed rules would require that an “Advance Form D” be filed by the issuer with the SEC no later than 15 days before the commencement of general solicitation. In her view, an advance filing would effectively impose a 15-day cooling off period for offerings by startups seeking capital on a continuous basis and is “quite simply” inconsistent with the intent of the original JOBS Act.
Tierney also argued that the proposed amendment to Rule 507 to disqualify an issuer who failed to comply with the Form D filing requirements within the past five years from relying on Rule 506 for any new offering for a one-year period is clearly contrary to the intent of the JOBS Act and punitively disproportionate to the impact that such failure would have on investors and the market.
In addition, Tierney told the Subcommittee that Rule 510 T of Regulation D would require that an issuer conducting a 506(c) offering submit to the SEC general solicitation materials prepared and used in connection with the offerings in advance of the use of such materials, imposing a significant expense and burden on issuers. As a result, Tierney said she supports Section (6) to require the submission of materials to provide workable, rational guidance on what types of materials in a single filing after the closing of an offering but would also request that the SEC be directed to provide workable, rational guidance on what types of materials would be considered “general solicitation materials.”
William Beatty, Director of Securities in the Securities Division of the Washington State Department of Financial Institutions, testified on behalf of the North American Securities Administrators Association, Inc. Beatty argued that states are leaders in modernizing capital formation. In his opinion, the enactment of the JOBS Act unfortunately precluded the states from playing a leading role in crowdfunding, and following enactment of the law work on the NASAA model rule was deferred. Beatty added that with respect to the implementation of Regulation A+, the states are “ready-to-go,” provided that Congress and the SEC do not short-circuit their efforts by preempting them.
Next, the Beatty stated that the overall impact of the Startup Capital Modernization Act of 2014 would substantially and further weaken investor protections in several important ways. Beatty continued that NASAA continues to oppose Congress’s regulation of small investments in small companies because the federal government has neither the inclination nor the resources to regulate effectively in this area. In addition, he referred to the revisions specified by the draft legislation seeking to revise the SEC’s existing and proposed amendments to Regulation D and Rule 156 as an “assault on the authority” of the SEC to provide “basic, reasonable investor protection.”
Jeff Lynn, Chief Executive Officer of Seedrs Limited, testified that Title III of the JOBS Act provides the legislative framework for an equity crowdfunding regime in the United States and the SEC has not yet adopted rules to implement Title III. Lynn explained that Title III limits the amount an issuer can raise through equity crowdfunding to $1 million in any 12-month period. In addition, he contended that the financial statement requirements for issuers, in particular the audit requirement, are the most burdensome aspects of Title II and one of the main reasons it is unworkable. He believes that the principle of caps on the amount an investor can invest has an unnecessarily paternalistic element to it, especially when other safeguards are in place.
Lynn did say he believes that curation is an essential part of running an equity crowdfunding platform. The final problem that Lynn found with Title III relates to the use of special-purpose vehicles and nominee arrangements to aggregate investments. He feels the Improvement Act makes significant strides in addressing these failures of Title III, and believes that if the legislation is not enacted in the form proposed, there is substantially greater likelihood that equity crowdfunding will be able to flourish in the United States.
Questions
Chairman Scott Garrett (R-N.J.) asked Tierney to discuss Regulation D. Tierney said it was drafted for a Wall Street model and not for private companies such as a startup and the 15-day period is “just unworkable.” Tierney suggested a concept of filing one form for Regulation D rather than three forms, adding that this would be a massive relief because filing these forms is expensive.
Ranking Member Carolyn Maloney (D-N.Y.) asked Beatty what state securities regulators have done to streamline Regulation A since the JOBS Act was passed. Beatty said a fair amount of work has been done and recognized that with the GAO study regulations could be better.
Next, Ranking Member Maloney asked Tierney if investors claim to be accredited when they are not. Tierney said it does happen.
Vice Chairman Hurt asked Miller why issuers have avoided Regulation A. Miller said that it has become a question of what is the additional appeal to the process and how it benefits the investor or the fundraiser. Lynn said it also had to do with the offering amount and that there is a perception that good companies do not use regulation.
Representative David Scott (D-Ga.) said Congress needs to look at regulatory impediments and Regulation D is leading to issues with capital formation. He asked Tierney what the committee should actually do to act. Tierney asked for one Form D filing requirement that should be available across all 50 states. Tierney said that startups cannot rely on Regulation D for a 12-month period. Representative Scott replied that Tierney’s proposal was very reasonable.
Representative Kevin McCarthy (R-Calif.) asked what the view of crowdfunding is around the world related to sound liability. Lynn responded that it can be minimized by making the regulations very clear.
McCarthy asked Miller about Regulation A offerings. Miller said they were the only Regulation A offering in the United States.
Representative John Carney (D-Del.) asked if it is feasible to develop a one stop filing process on the state level. Beatty said that concerns about sending paper filings to all 50 states will soon be a thing of the past and Regulation D is only an eight-page form that is important for regulators to see early on.
Carney asked about how the IPO onramp has worked in practice and if there are problems. Beatty said how it will play out long term does give him some concern.
Representative Randy Neugebauer (R-Texas) asked Lynn about Title III and the negative impact on crowdfunding. Lynn said he has many concerns because the legislation was written with many burdens. Miller replied that the regulatory compliance is critical to your next round and the complexity is outside the knowledge base of the average entrepreneur so you have to rely on outside council.
Neugebauer asked if there is any reason to believe that regulatory burdens have increased in the last few years. Tierney replied that there are not a lot of good reasons to go public right now.
Representative Daniel Kildee (D-Mich.) said he is more interested in the areas of capital formation such as the mortgage market and making sure people have the ability to purchase a home. Beatty said a strong and healthy SEC is important but we cannot take regulators off the table in terms of providing services. Lynn responded that particularly for smaller growing businesses, smaller does not correlate with them being local because internet based companies are different.
For more information on this hearing, please click here.