The U.S. Department of the Treasury released a report this month outlining issues and recommendations in U.S. Capital Markets that the Treasury hopes will promote economic growth while maintaining investor protection. The Treasury report discussed measures that may facilitate the public offering and IPO process, as well as steps that could potentially facilitate capital raising for private placements (Regulation D) and other exempt offerings (Regulation CF and Regulation A+) associated with the JOBS Act. The following is a summary of the Treasury’s discussion on private placements and exempt offerings.
The Treasury report focused its discussion of Regulation A+ on Tier II, which allows issuers to raise up to $50 million in what some may consider a “mini IPO” due to reduced disclosure and ongoing reporting requirements (we have a more in depth discussion of Regulation A+ here and here). The Treasury report provided three recommendations to Tier II of Regulation A+.
First, the Treasury recommended expanding Regulation A+ to Exchange Act reporting companies. Current, publicly traded companies are prohibited from utilizing Regulation A+ and must utilize other exemptions such as Regulation D to raise capital outside of traditional public offerings. The Treasury stated expanding Regulation A+ to Exchange Act reporting companies could provide public companies with lower-cost means of raising capital as well as increase awareness of Regulation A+ availability.
Second, in an effort to increase liquidity in the secondary market, the Treasury recommended that state securities regulators update regulations to facilitate secondary market trading of Tier 2 securities, or, alternatively, that the SEC use its authority to preempt state registration requirements for Tier II offerings. Currently, federal securities laws do not impose trading restrictions for Tier 2 securities. State securities laws, however, may prohibit secondary market transactions that do not comply with state-level registration requirements. Tier II offerings are already exempt from state blue sky registration requirements, and it is the Treasury’s position that eliminating state-specific secondary market requirements would increase the marketability and liquidity of Regulation A+ offerings.
Finally, the Treasury recommended the Tier II offering limit be increased to $75 million. The Treasury cited the Financial Choice Act that passed in the House for policy rationale. The Treasury stated and increase in the Tier II amount to $75 million would reduce costs associated with raising capital for private companies.
The Treasury outlined concerns with the relative complexity and costs associated with using Regulation CF (discussed here and here) as opposed to simply conducting a private placement. The Treasury stated that the overall difficulty and cost associated with a Regulation CF offering may result in less-attractive companies pursuing funding from less sophisticated investors, who may not have the expertise to evaluate the investments. The Treasury recommended five primary changes to Regulation CF.
1. Allow single-purpose crowdfunding vehicles advised by a RIA that could potentially have a lead investor conduct due diligence, pool assets of other investors, and receive carried interest compensation;
2. Allow accredited investors to invest an unlimited amount of capital;
3. Change investment limits to the greater of 5% or 10% annual income or net worth from the lesser test currently imposed;
4. Raise the maximum revenue requirement for Regulation CF issuers to $100 million to $25 million; and
5. Raise the limit on offering amount to $5 million (currently $1 million) to lower offering costs per dollar raised.
The Treasury allocated a significant portion of its report to maintaining the efficacy of private capital markets, but only provided two recommendations for Regulation D. The Treasury’s recommendations focused on expanded access to private placements.
First, the Treasury recommended expanding the definition of an accredited investor. It is the Treasury’s position that an accredited investor could be broadened to include any investor who is advised on the merits of making a Regulation D investment by a fiduciary (such as a federal or state RIA). The Treasury also proposed including financial professionals, such as investment adviser and broker-dealer representatives, in the definition of an accredited investor.
Second, the Treasury recommended reviewing the provisions in the Securities Act and Investment Company Act that restrict unaccredited investors from investing in private funds containing Rule 506 offerings. The Treasury bolstered its position by stating unaccredited investors could further diversify investment portfolios through access to a well-diversified portfolio of private placements.
Finders Regulatory Structure
The Treasury also included a recommendation regarding finders. Currently, firms and individuals are generally required to register with the SEC, FINRA, and any relevant states in order to receive transaction-based compensation in connection with effecting a securities transaction. Thus, finders that are unaffiliated with a broker-dealer are likely operating in an unlicensed capacity. The Treasury recommended the SEC, FINRA, and states propose a new “broker-dealer lite” regulatory scheme for finders and other intermediaries that assist small companies with capital formation.
The Treasury’s report emphasized removing regulations imposed by federal and state securities regulatory authorities and SROs. Practically speaking, many of the Treasury’s proposals have a very small likelihood of fully coming to fruition (such as recommending all states ease Regulation A+ secondary market requirements and/or offer broker-dealer lite). However, some of the Treasury’s recommendations may be able to gain traction or have already been explored by federal regulators (i.e. expanding the definition of accredited investors to financial professionals was original the SEC’s idea).
Given the Treasury’s lack of jurisdiction over securities-related policy and rules, it will be up to federal and state regulators and legislative bodies to enact the Treasury’s recommended policies. The Treasury’s report does, however, provide us some insight into the current administration’s priorities in capital market regulation.