The SEC Small Business Capital Formation Advisory Committee (SBCFAC) was created by Congress in recognition that smaller firms too frequently did not garner the support they need. The Committee formally provides feedback to the Commission and, ostensibly, the SEC should be reviewing and pursuing the recommendations. Since SEC Chair Gary Gensler was sworn into office in April 2021, the SEC has pursued none of the Committee’s recommendations.
So what are these recommendations the Committee has sent to the Commission?
In May 2021, the SBCAF told the Commission to improve access to capital for “underrepresented founders and investors, including women, minorities, and founders outside of prominent tech hubs.” The Committee told the Commission to incorporate the following changes:
- “With respect to the “qualifying venture capital fund” exemption in Section 3(c)(1) of the Investment Company Act of 1940:
- a. increase the current $10 million limit on the aggregate amount of capital contributions and uncalled committed capital to $150 million; and
- b. increase the number of permitted beneficial owners from 250 to 600.
- Amend the “venture capital fund” definition under Rule 203(l)-1 of the Investment Advisers Act of 1940 to permit venture capital “fund of funds” investments by treating an investment in another venture capital fund, which itself meets the requirements of Rule 203(l)-1, as a “qualifying investment.”
During a meeting of the Committee in February 2022, SBCFAC noted that accredited investors are a “critical source of early-stage capital for small businesses in communities across the country, and changes that would shrink the pool of currently accredited investors would have a detrimental effect on small business capital formation. The ripple effects of limiting access to early-stage capital would negatively impact access to future rounds of financing from funds and other later-stage investors, rippling further into the companies that will one day go public.”
Currently, broadly the definition of an accredited investor adheres to a wealth metric – an individual must earn over $200,000 a year ($300,000 if married) or be worth more than $1 million (beyond a primary residence). Yet everyone acknowledges that a sizable bank account does not denote financial acumen. The Committee worried that making the hurdle more difficult for being deemed an accredited investor would exacerbate the “racial wealth gap,” making the definition less inclusive and impacting underserved communities. The Committee recommended that the Commission should:
- “… not increase the current financial thresholds for individual investors to qualify as accredited.
- Going forward, consider indexing the financial thresholds for inflation on a periodic basis.
- Given the imperfect proxy that financial thresholds provide for measuring investor sophistication, provide alternative methods for investors to qualify as sophisticated, which could include investment experience, knowledge gained through work experience or membership in associations, education credentials, additional professional certifications, or tests to demonstrate sophistication.”
The Committee also recommended that the Commission “consider creating a new exemption for local and/or micro-investments that would not be limited to accredited investors.”
Following a meeting in May of 2022, the SBCFAC addressed the SEC’s push into ESG – or, more specifically, climate disclosure.
The Committee acknowledged that climate is an important topic but questioned the Commission’s move that may “deter private companies from going public.” The Committee also worried about the rule’s impact on small companies that may provide services or products for public companies, thus suffering from collateral compliance.
“To the extent public companies are required to track and provide downstream greenhouse gas emissions, smaller suppliers and vendors that are unable or delayed in providing their greenhouse gas emissions may lose business to larger companies that can provide such metrics.”
In aggregate, the Committee told the Commission that climate disclosure rules will make it more difficult for both smaller and public firms to raise capital as well as undermine a firm’s ability to generate the revenue needed to sustain their businesses.
At the same meeting, the Committee addressed the issue of SPACs or special purpose acquisition companies – blank check firms that boomed in 2021 but continue to be utilized today. The Committee agreed, in general, that disclosure could be improved but told the Commission that it is in the best interest of all to keep SPACs as a viable path for going public. The Committee expressed their concern that the Commission’s proposed rules “might render SPACs unusable as an alternative to IPOs.”
The meeting in August of 2022 addressed secondary liquidity for securities issued under Regulation A (Reg A+). This exemption was effectively created under the JOBS Act of 2012. It pre-empted state Blue Sky review for a primary offering while allowing issuers to trade securities immediately following a funding round – if they decided to float their shares. But what was absent in the new Rule was pre-emption for secondary trading of these securities, creating an unnecessary hurdle to provide liquidity for investors. The Committee advised the Commission to run a pilot program for secondary trading for shares issued under Tier 2 of Reg A for firms current in their reporting. One would assume if the pilot was successful, the Commission would write rules to codify secondary trading for Reg A+ issued securities.
A meeting in October of 2022 saw the Committee telling the Commission to promote strong and effective U.S. public markets. Broadly, the SBCFAC advised the Commission to harmonize rules for becoming a public company; provide greater clarity in the application of securities laws; while reiterating their previous recommendations on SPACs.
A second letter emerging from the same meeting called on the Commission to provide better support for entrepreneurial ecosystems. This included leaving Reg D as it is, reiterating its support of broadening the definition of an accredited investor while recommending a micro-exemption – that would not be limited to accredited investors.
Additionally, Finders – a longstanding policy request that has oddly defied common sense rulemaking – was revisited with Committee members telling the Commission to provide a “simple playbook for finders.”
Another recommendation was that the Commission should take action to allow exempt offerings via pooled investment funds. These funds should be made accessible to retail investors thus providing access to investment opportunity for broader population.
A meeting took place earlier this month (February), so more recommendations are on the way.
What all of these issues have in common is that the Commission has ignored the advice from people with boots-on-the-ground experience. The Committee has done a very good job of highlighting issues that impact smaller firms while providing salient advice as to what the Commission should do to help these firms improve their ability to access capital – especially for underserved segments of society. The SEC periodically publishes its regulatory agenda, and not one of the items advocated by SBCFAC is on the list, but several, like Reg D changes – or climate disclosure, are poised to take things in the wrong direction.
The Committee was established as bipartisan legislation under the Small Business Advocate Act of 2016, signed into law by President Obama. According to the law, the Commission is required to:
“… review the findings and recommendations of the Committee; and (2) each time the Committee submits a finding or recommendation to the Commission, promptly issue a public statement— (A) assessing the finding or recommendation of the Committee; and (B) disclosing the action, if any, the Commission intends to take with respect to the finding or recommendation.”
It is not clear if the SEC has ever issued a response to the recommendations of the SBCFAC, even though it is mandated by law. Perhaps the Commission has a different definition for the word promptly.
The Gensler Commission has been known for churning out rules at a pace that outstrips the ability of SEC officials to manage the demands. The rule-making mission is to the point that the SEC has lost many top executives, according to a report issued last October by the Inspector General. The report stated that in the “first 8 months of 2022, the SEC proposed 26 new rules, which was more than twice as many new rules as proposed the preceding year and more than it had proposed in each of the previous 5 years.”
When it comes to the SEC supporting capital formation – a key component of the SEC’s mission statement, small businesses, and underserved communities appear to be losing out. When it comes to policy emanating from the SEC, actions speak louder than words.