The US Department of Treasury has published a report on ways the government may streamline and reduce burdens of capital markets regulation. The report is an interesting compendium of the pressing need to reduce regulatory hurdles while pointing to policy initiatives that can improve access to capital and thus boost the US economy. The document was drafted in response to Executive Order 13772 issued by President Trump which calls on Treasury to identify laws and regulations that are inconsistent with a set of Core Principles of financial regulation.
Treasury notes that during the past 20 years, the US has seen a nearly 50% decline in the number of publicly-traded companies. This is a troubling trend as more public companies can be used as a barometer of economic health. Simultaneously, when companies use the private markets to raise money, the majority of the population is denied the opportunity to participate in the potential growth of these companies along with diversification provided to one’s portfolio.
Treasury Secretary Steven T. Mnuchin says the US has experienced slow economic growth for too long;
“By streamlining the regulatory system, we can make the U.S. capital markets a true source of economic growth which will harness American ingenuity and allow small businesses to grow.”
Many people believe that economic growth can be boosted beyond the current tepid rate. But improving growth will take a plethora of legislative improvements including regulatory reduction, tax reform and policy improvements. Broadly speaking the Treasury recommendations include expanding the range of eligible investors, empowering investor due diligence efforts, and modifying rules for private funds investing in private offerings.
Regarding the JOBS Act of 2012, Treasury states that after a few years of experience it is time to take a look at how these tools can be improved. There should be no argument from any member of Congress with this statement. While the JOBS Act created many powerful tools that have helped the economy, anything can be improved. All industry observers are aware there exist challenges within the original JOBS Act legislation, but perfect did not get in the way of good and the bipartisan bill has now been fully enacted for more than a year.
Some interesting points of note included in the Treasury report:
- Nearly 87% of the rms ling for an IPO after April 2012 have identified themselves as EGCs under the IPO on-ramp.
- After the JOBS Act, smaller IPOs, those seeking proceeds up to $30 million, constituted approximately 22% of all IPOs from 2012-2016 as compared to 17% from 2007-2011.
- IPOs with an initial market capitalization of $75 million or below constituted 38% of IPOs in 1996, but had declined to only 6% of IPOs by 2012. During this same time period, large IPOs – those with an initial market capitalization of $700 million and more – grew from 3% of IPOs in 1996 to 33% in 2012.
- Regulation A+ and crowdfunding [Reg CF] represent innovative capital raising frameworks that are targeted to support pre-IPO companies. e JOBS Act also sought to make matching investors with companies seeking to raise capital easier by removing the prohibitions on general solicitation and advertising under certain conditions.
- In the year after implementation, 147 Regulation A+ offerings were led by companies seeking to raise $2.6 billion in financing. Approximately 81 offerings totaling $1.5 billion were qualified under Reg A+ by the SEC, 60% of which were Tier 2. By comparison, there were 27 qualified Reg A+ offerings in the preceding four years. The average size of a Reg A+ offering was approximately $18 million.
- Reg CF crowdfunding rules implementing Title III of the JOBS Act became effective in May 2016. In the 12-month period following effectiveness, 335 companies led crowdfunding offerings with the SEC and there were 26 portals registered with FINRA for unaccredited investors. Of the filed crowdfunding offerings, 43% were funded, 30% of campaigns ended unsuccessfully, and the others ongoing. Total capital committed was in excess of $40 million. On average, each funded offering raised $282,000 and included participation from 312 investors.
- Market participants have expressed concerns about the cost and complexity of using Reg CF crowdfunding compared to private placement offerings. Due to the complexity and cost adverse selection may occur where only less-attractive companies pursue funding from less sophisticated investors.
So what should policymakers do to improve the environment?
Regarding Reg A+, Treasury believes usage has been “modest” in contrast to Reg D. Expanding the exemption to reporting companies is an easy first step. Additionally, Treasury recommends steps to increase liquidity in the secondary market for Tier 2 securities. Treasury recommends that state securities regulators update their regulations to exempt secondary trading of Tier 2 securities from Blue Sky rules or alternatively the SEC preempts state registration requirements for these transactions.
Treasury also recommends that the Tier 2 offering limit be increased to $75 million.
Regarding Reg CF, Treasury hits the list of needed reforms that industry participants and certain members of Congress have been talking about for some time.
Allowing single-purpose crowdfunding vehicles (SPVs) advised by a registered investment adviser, which may mitigate issuers’ concerns about vehicles having an unwieldy number of shareholders. The SEC registration thresholds trap (2,000 total shareholders, or over 500 unaccredited shareholders) needs to be addressed.
Treasury recommends that current limitations on investments in crowdfunding offerings be waived for accredited investors as defined by Reg D. Reg CF may become more attractive if a company can more easily reach its funding goals. For non-accreds, Treasury recommends that the crowdfunding rules be amended to have investment limits based on the greater of annual income or net worth for the 5% and 10% tests, rather than the lesser.
The funding cap under Reg CF needs to be increased from the current $ 1.07, million to at least $5 million per year. This will allow companies to lower the offering costs per dollar raised while empowering a broader group of emerging companies to participate in this exemption.
The conditional exemption from Section 12(g) needs to be modified by raising the max revenue requirement from $25 million to $100 million. This means Reg CF crowdfunded companies can stay private longer and should not be forced to register as public companies until reaching higher revenues.
As for the definition of an Accredited Investor, this needs to be updated to reflect the current rule that disenfranchises much of the country to the benefit of the very rich. Treasury says amendments to the accredited investor definition should be undertaken to expand the eligible pool of sophisticated investors.
There is plenty more in this common-sense report that can boost economic growth and innovation, while creating more jobs.
The authors of the Treasury report have taken a balanced and thoughtful approach in outlining ways to improve capital markets while not undermining investor protection that benefits the entire population. Much could be accomplished if policymakers, both elected and appointed, pursue these recommendations. Even with a highly polarized Congress, there is much in this report that should easily garner bipartisan support, except by members on the extreme fringes of the policy spectrum.
The report is embedded below.