The SEC Office of the Advocate for Small Business Capital Formation ("OASB") highlighted initiatives and provided recommendations to support small businesses and investors.

In its 2019 Annual Report, the OASB provided updates on small business capital formation for (i) small, emerging businesses, (ii) mature businesses and (ii) small public companies. The OASB outlined:

  • the regulatory pathways companies use to raise capital;

  • the primary types of offerings and the types of companies taking advantage of them; and

  • how and where companies utilize these offering types in industries raising the most capital.

The OASB recommended:

  • modifying the exempt offering framework to take account of modern communications technology (e.g., the internet);

  • expanding the scope of the definition of "accredited investor" to include persons who can demonstrate financial sophistication;

  • expanding the ability of registered investment companies to invest in private funds and companies;

  • allowing finders, not fully regulated as broker-dealers, to assist in raising capital;

  • facilitating crowdfunding; and

  • reducing regulatory reporting requirements for smaller, less complex companies.

The Advocate's report provides a good amount of data as to the various provisions under the securities laws by which issuers raise capital; i.e., Rule 506 private placements vs. registered offerings. The report both emphasizes the importance to the economy of facilitating the ability of small businesses to raise capital and the increasing difficulties of doing so; e.g., the diminution in the number of community banks and the reduced amount of research that broker-dealers produce in regard to small firms. The report also notes that small investors may complain that they are not afforded access to growing companies.

The imposition of increased sales regulations on broker-dealers, during the past year (particularly Regulation Best Interest and various fiduciary obligations imposed at the state law level), would seem likely to exacerbate the difficulties faced by small businesses in raising capital. That is, broker-dealers that sell securities of small private companies to individual investors may face a greater likelihood of liability if the investments go badly; logically, broker-dealers that wish to avoid legal liability are safer directing investors to large companies and to diversified public funds. This may not be a bad thing, all in all, but it is inconsistent with any policy of funding startups.

If the SEC and Congress wish to encourage investments by individuals in startups, they should consider how to modify the securities (and perhaps the banking) regulations to do so. This would require acknowledging that allowing small investors to invest in small business exposes those investors to greater risks of loss. One solution proposed in the report, which seems quite feasible, is to modify the laws or regulations governing SEC-registered investment companies so that they can more readily invest in startups. While the Advocate concedes that channeling small investors through an investment fund subjects these investors to an additional level of ongoing fees, the recommendation does have the potential to provide additional investor protections. Broker-dealers will not be subject to the same level of suitability liability if they can direct investors to regulated funds that invest in startups, as opposed to marketing the startups directly.

Although the Advocate does not make any recommendations as to the regulations governing investment research, she does note that most exchange-traded companies with less than $100 million in market capitalization have no research coverage (at page 25). This is a problem that requires a significant SEC study, as the current rules provide no reasonable way for a broker-dealer that would devote significant resources to research on small companies to make money on that research. The SEC needs to think outside of its box on this.

Finally, Congress should consider allowing community banks to act as securities brokers in selling the securities of small businesses. The community banks need a way to generate more revenue and the small businesses need to find agents willing to raise money for them: who better than the community banks that make loans to them?

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