The Securities and Exchange Commission (SEC) recently conducted its 31st daylong Government-Business Forum on Small Business Capital Formation. This forum and the new Advisory Committee on Small and Emerging Companies have become a spawning ground for initiatives like the Jumpstart Our Business Startups (JOBS) Act, which was enacted in April. Proponents of the Act argue that it dramatically expands opportunities for small business to gain access to capital and cut their compliance costs.
The SEC takes the Forum seriously, as demonstrated by the fact that all of the commissioners spoke before they all left for another meeting. This article will cover the first panel, which discussed the implantation of the JOBS Act, given that the regulations are still pending before the SEC.
SEC Chairwoman Mary Schapiro led off the speeches by recognizing that almost a hundred companies have submitted draft registrations in anticipation of the regulations, while 70 banks have taken the opportunity the Act provides to de-register. She concluded that the Commission needs to seek a “balance” between investor protection and capital formation.
Commissioner Elisse Walter stated that as technology changes, methods of communication must change, but she pointedly observed that the JOBS Act means, “We’re essentially permitting public offerings of private securities. People often frame this as balancing, but I see this as presenting a false choice. A vital prerequisite to capital formation is confidence.”
Commissioner Luis Aguilar said investors want “financial statements they can trust,” so that they can provide patient capital.
Commissioner Troy Paredes called for the Commission to make the promotion of small business a top priority, with implementation of the JOBS Act at the top of the agenda, since society benefits from entrepreneurship through advances in technology and medicine, as well as job creation and economic growth.
Commissioner Daniel Gallagher repeated remarks of the other commissioners regarding the need to protect investors and promote small business.
The first panel began with Sara Hanks, co-founder and CEO of CrowdCheck of Alexandria, Va., who explained that the JOBS Act provides for an exemption from registration under the Securities Act of 1933 for offerings of up to $1 million, which could increase if the SEC allows offerings to be made to non-accredited investors, a the Act authorizes the Commission to do.
It also provides an exemption from the Securities Act of 1934 for crowd-funding offerings. These offerings will be made through crowd-funding portals. She remarked that while Kickstarter and Circle Up may look similar, they are completely different models.
However, some things have not changed. Offerings of securities must either be registered or exempt. This may seem like a trivial point, but securities enforcers are concerned that they will discover that offerings have been made in advance of the rules being issued that are neither registered nor exempt. The failure to register confers upon the purchaser the power to rescind the subscription, and litigation and enforcement actions could follow.
The SEC is still concerned with enforcement, and disclosure is still important. Investment advisers still need to be registered, mutual funds need to be registered and exchanges also need to be registered. The SEC will have to figure out how to integrate offerings with later transactions to raise additional capital, as well as resolve such “other technical stuff” as the nature of liability for issuers and portals when rules are violated.
Senior SEC staffer Meredith Cross interjected that “if a lot of people are defrauded, crowd funding will not provide capital formation. It can do great things or be a terrible failure, and the right balance needs to be struck.”
Jean Peters, board member of Angel Capital Association and managing director at Golden Seeds Fund, presented the perspective of angel investors as providing adult leadership and 90 percent of the capital for startups, which in turn provide 10 percent of the jobs in any given year. She cautioned that crowd funding is not a panacea and that her firm screens a thousand deals to find 10 or 12 to invest in, while the industry only invests in 10,000 out of 75,000 screened. Peters also stressed the need for some sort of “safe harbor” to protect issuers and angels from litigation resulting from errors in qualifying investors as accredited and therefore suitable for solicitation.
Michael Lempres, Assistant General Counsel of Silicon Valley Bank, which provides banking services to half of all startups, said that for most startups, the main issue is access to capital, except that in the life sciences area, it is the stringency of regulation by the Food and Drug Administration.
Under the so-called “Super Reg A,” the size of startup offerings can increase from $5 million to $50 million. However, he advised that expectations are dampened due to the erosion of interest in this market, due in large part to the fixed costs entailed in going public because of the required disclosures.
Emerging-growth companies are given a five-year window to take advantage of relaxed accounting requirements and receive a nonpublic review by the SEC. However, Lempres explained that companies are reluctant to take advantage of these provisions, although they realize that investors want full disclosure. Therefore, the market is setting the standards, rather than Congress or the regulators.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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