Regulation D (Reg D), the leading securities exemption for private offerings, is a huge market measured at over a trillion annually. Under the JOBS Act of 2012, Reg D received an update: old Reg D (506b) was joined by new Reg D (506c), an exemption that allowed for general solicitation or public marketing of the offering—mostly online.
The decision to allow issuers to promote offerings publicly recognized the growing importance of the Internet for financial services. Digital finance is becoming the norm, and marketing private securities beyond smoke-filled rooms and the golf course makes a lot of sense. Yet, uptake of Reg D 506c—or Accredited Crowdfunding—has been slow to take place.
During a presentation at the Securities and Exchange Commission (SEC), Small Business Capital Formation Advisory Committee (SBCFAC), Sabrina Howell, Professor of Finance at the New York University Stern School of Business, reviewed data on the Reg D market.
Howell shared that the take-up of Reg D 506c is relatively low and that only 8.4% of venture capital funds have leveraged the new exemption since 2013. She disclosed several reasons for the tepid use of 506c. First, there is an additional hurdle for investors under the new exemption, as they must be verified as Accredited (IE, an accredited investor). This incurs an additional cost to the process while also discouraging investors, as they must disclose personal information, like tax records, to be qualified as Accredited.
The second is that “strong networks matter.” The affluent value social circles of wealth – a natural filter for individuals able to participate in Reg D private offerings. Coming from the right school, living in the right neighborhood and being a member of the posh club matter. Powell explains:
“Public advertising on its own is only helpful to the small fraction of prospective issuers with a strong track record but weak personal networks.”
There has been a lot of discussion about venture capital and VC funds that cater to the wealthy few. Some want to see this elite realm of investing opened up to a far broader audience as opposed blocking participation from the masses. While Reg D 506c removes a geographic barrier, this quality has done little to improve participation from underrepresented communities.
Howell shares:
- Efforts to protect investors from fraud (e.g., capping investors or installing verification requirements) can come at the expense of higher barriers to entry for issuers
- Track record matters at arms’ length, and strong networks matter in relationship financing
• So public advertising on its own is only helpful to the small fraction of prospective issuers with a strong track record but weak personal networks
Howell claims that VCs are “overwhelmingly white, male, and graduates of elite schools,” impacting which firms get funded.
Almost all VC funds utilize Reg D. Since Reg D 506c was allowed about ten years ago, 7440 VCs have used old Reg D 506b, and just 685 VCs have used Reg D 506c, the exemption allowing public solicitation.
While the utilization of Reg D 506c has improved recently, the jury remains out on whether the trend will continue.
In general, Reg D 506(c) compared to old Reg D funds are:
- 49% smaller
- 47% more likely to be outside a top-10 city
- 36% more likely to be a VC firm’s first fund
- 3x more likely to use an intermediary
- 14% more non-pension LPs, 88% more individual LPs
Reg D 506c also sees a higher percentage of female or minority managers and more first-time managers.
Howell explains that the track record, investor verification costs, and regulatory barriers have undermined the utilization of the exemption that allows promotion—something regulators can address but have yet to pursue.
There is a movement within Congress to update the Accredited Investor rule. Currently, the definition of an Accredited Investor is based on wealth metrics of an income greater than $200,000 or net worth over $1 million (minus primary residence). Some policymakers would prefer a sophistication qualification – which makes more sense. This could transform private securities markets by allowing more individuals to participate in the booming market, which has grown while public markets have declined. Congressional legislation addressing the issue has seen bipartisan support, but the Democrat-controlled Senate has killed any modifications – due to extreme investor protection concerns and a belief that the government must save people from themselves. This changes when the Republicans take over in 2025.
Currently, the Commission, under the leadership of Chairman Gary Gensler, has long sought to make it more difficult to be deemed Accredited and less inclusive, harming underserved communities. Altering Reg D has been at the top of Gensler’s agenda for years. This is another factor that will soon change as the new Administration steps in and a new Chairman takes over the SEC. Perhaps 2025 will see the democratization of private placements issued under Reg D – good for the economy and empowering smaller investors.
