Jun. 04, 2020
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Jay Clayton, Chairman
SEC Headquarters
100 F Street, NE
Washington, DC 20549
(202) 551-2100
chairmanoffice@sec.gov
Vanessa A. Countryman
Secretary, Securities and Exchange Commission
100 F Street NE
Washington, DC 20549-1090
rule-comments@sec.gov
Re: Facilitating Capital Formation and Expanding Investment
Opportunities by Improving Access to Capital in Private Markets [Release
Nos. 33–10763; 34–88321; File No. S7–05–20 RIN 3235–AM27]
Dear Chairman and Secretary:
Commenting on the above referenced proposed rule (the “Proposal”) by the
Securities and Exchange Commission (the “SEC” or the “Commission”)
concerning rules for fundraising in private markets.
In September, 2019, AFREF and the AFL-CIO commented on the Commission’s
concept release concerning securities offering exemptions. At that time,
they pointed out the many dangers posed to investors and the public by
the rapid expansion in the size of opaque private markets as compared to
public markets that require disclosure and transparency and foster
liquidity. They also pointed out that the rapid and unprecedented
expansion in private capital markets and the reduction in the number of
public companies over the past two decades poses fundamental risks to
the New Deal framework of securities laws that the SEC was created to
implement. They urged the Commission to undertake a full and careful
study of private markets, including the costs and risks of private
market expansion, which was not properly examined in the Concept Release.
The concerns were shared by many other commenters who also urged the
Commission to better and more carefully examine the costs of private
market expansion before moving ahead with rulemakings. These commenters
included the North American Association of Securities Administrators
(NAASA), the Consumer Federation of America, the Healthy Markets
Association, Better Markets, the California Attorney General, the
Council of Institutional Investors, numerous highly qualified academics
in the field of securities law, and others.
Unfortunately, the Commission has not heeded this advice. Instead, it
has chosen to move forward with this Proposal, which contains numerous
ill-considered measures to further deregulate markets for private
fundraising. These measures are not supported by a careful and fully
researched analysis of the potential costs of expanding the private
markets, but instead by an inadequate cost-benefit analysis in which SEC
staff freely admit that they lack reliable data on such critical
elements as the true returns of private market investments and the
impact of deregulating private market investments on the use of public
markets.
This Proposal includes a long list of measures that would dramatically
expand the ability of companies to raise large amounts of money from the
public without a registered offering and the associated disclosures and
governance requirements. These include:
Greatly weakening the integration doctrine by permitting issuers to
conduct multiple exempt offerings regardless of whether such offerings
are part of a single plan of financing, so long as each offering
qualifies for an exemption from 1933 Act registration requirements and
is separated by at least 30 days. Rather than preventing evasion of
registration requirements as is done under the current facts and
circumstances enforcement of the integration doctrine with a six months
waiting period, this new version of integration doctrine defines a
mechanism by which issuers could easily avoid registration requirements
by dividing large financings into multiple smaller exempt offerings
separated by only a brief period of time.
Expanding the ways in which issuers can communicate with the public
to effectively market potential “private” offerings, for example by
permitting communication around so-called “demo days” to be exempted
from general solicitation limits and allowing or greatly expanding
permissible “testing the waters” communications for all exempt
offerings. In cases where general solicitation is currently allowed for
accredited investors, such as 506(c) offerings, this Proposal weakens
verification requirements for accredited investor status, expanding
issuers effective ability to incorporate retail investors into
solicitations. These changes effectively allow general solicitation even
to relatively unsophisticated retail investors for a far broader range
of offerings.
Rendering Section 12(g) of the Exchange Act, one of the only
remaining mechanisms to push private companies into public markets, even
less relevant by weakening its applicability in cases of crowdfunding.
This is in addition to the previous statutory weakening of 12(g)
requirements in the JOBS Act, which have clearly contributed to the
expanding number of very large “unicorn” private companies.
Directly expanding the offering and investment limits for a number
of existing exemptions from ’33 Act registration requirements, including
Reg A, Reg CF (crowdfunding), and Rule 504. Especially combined with
other forms of deregulation listed above, this will lead to private
companies raising more money both collectively and individually from
investors. It has been well documented that exemptions which would be
expanded by this Proposal have been used to facilitate scams and other
rip-offs of retail investors.
In combination, loosening all of these limits on private company
fundraising will permit companies to greatly expand the total amount of
capital they are able to raise without registering as a public company,
and engage mass marketing (general solicitation) to retail investors for
such fundraising. We agree with Commissioner Alison Herren Lee’s
statement that this Proposal would “erode significant distinctions
between public and private markets”, distinctions that are critically
important for the protection of investors and the efficient functioning
of the markets.
The SEC’s economic analysis refuses to come to grips with the potential
negative effects of these changes; instead they are simply denied. While
the economic analysis goes on for dozens of pages, the flavor of
repeated assertion can be seen in the “Broad Economic Analysis” that
introduces it. For example, the negative effects of the reduction in
public market registration is addressed on CFR 18003 as follows:
“For instance, some commenters expressed concern that facilitating
capital raising through exempt offerings might incrementally contribute
to the ongoing decline in U.S. registered offerings, which might limit
the overall set of investment opportunities available to nonaccredited
investors and decrease the aggregate amount of information available to
investors. Even if that were the case, expanded access to capital
allowing issuers to meet their financing needs at a lower cost would
enhance the efficiency of capital allocation to growth opportunities,
with the resulting benefits for economic growth, competition, and
capital markets as a whole.”
This initial claim about enhanced efficiency is unsupported. The
reduction in transparency in capital markets created by increased use of
private markets could lead to significant misallocation and misdirection
of capital, as investors will have less information available to make
capital allocation decisions. This could easily reduce the economic
growth benefits of capital markets.
The economic analysis continues by simply asserting that deregulating
private offerings will not lead to substitution from public to private
markets:
“Importantly, we do not expect the proposed amendments to deter a
significant proportion of the issuers that are large and mature enough
to be on the cusp of going public from pursuing a public offering. Such
issuers likely already have a developed network of angel investors
and/or backing from venture capitalists on which they can rely to raise
the necessary amount of financing today. Thus, such issuers’ decision to
go public is likely driven more by the benefits of being a public
reporting company (relative to the cost of being public). Rather, we
believe that the amendments might have the most significant effects on
smaller growth issuers that presently lack sufficient access to
financing that they require to develop their business model and gain scale.”
The entire concern with deregulating private offering mechanisms is that
it will increase the effective size at which companies reach “the cusp
of becoming public”. By lowering the costs of raising private funds
relative to going public, the deregulatory elements of this Proposal
will shift the supply curve for private fundraising downward, leading to
companies expanding to a larger size before it makes sense to go public
for fundraising purposes. It is unclear whether this analysis is
claiming that there is some fixed level of size that leads companies to
go public regardless of fundraising costs, or that companies go public
not due to any need to raise funds, but due to unspecified other
benefits of becoming a public firm. Both claims seem unlikely.
Such assertions are littered throughout the economic analysis. For
example, the risks to non-accredited investors of greater solicitation
for of opaque private offerings is simply dismissed because such
investors already have access to investments that “involve a high level
of risk or require extensive due diligence, both as part of the
securities market….and holdings of registered nontraded securities,
including REITs and structured notes)” (CFR 18006). In this way, the
SEC’s failure to provide effective regulatory protections in other parts
of the securities markets is turned into a justification for
deregulation in the private offering markets. The discussion of returns
in private markets admits that comprehensive information on private
market returns is lacking and simply lists a large number of academic
resources (e.g. in footnote 372), without summarizing and analyzing the
evidence in order to determine what it indicates about the costs or
benefits of private market investment accessibility for retail investors.
This Proposal would greatly weaken private offering rules in ways that
would discourage public market offerings and the associated disclosure
and governance protections. This would make overall capital markets more
opaque, less accountable, and less likely to lead to efficient capital
allocation decisions. Especially when combined with the liberalized
rules for general solicitation also included in the Proposal, it would
lead to significant additional risks for ordinary investors. These
changes are not properly justified through economic evidence. The
Commission should reject these changes. Any effort to rationalize
private offering rules should proceed in a way that is much more
measured, clearly supported by evidence on both the costs and benefits
of encouraging additional private offerings, and less likely to
contribute to the ongoing decline in public offerings.
Thank you for your attention to this comment.
Yours sincerely.
Robert E. Rutkowski
cc:
Representative Steny Hoyer
House Majority Leader
Legislative Correspondence Team