Statement on Amendments to the Exempt Offering Framework
Nov. 2, 2020
For decades, private offerings were the exception to the rule in our securities regime. The registration and reporting provisions in the federal securities laws are designed to level the playing field by requiring issuers to provide all investors with reliable, timely, and material information about investments. The public markets are designed to, and to a remarkable degree succeed at, offering a fair shake to the so-called mom-and-pop investor vis-à-vis a wealthy hedge fund. What’s more, the discipline imposed by public markets drives more efficient capital allocation, which in turn drives our economy.
Exempt private offerings have traditionally served an important role in providing capital for smaller and medium-sized companies, often along their path to the public markets. It is well understood that retail investors operate at a severe disadvantage in the private market because of information asymmetries and other power imbalances. Historically, the primary protection against this power imbalance was to limit private companies to capital raised from investors that are large or sophisticated enough to compete, or wealthy enough to bear the cost if they lose out. In recent years, however, the exception (or exemptions from registration) have swallowed the rule, with statutory and regulatory changes steadily chipping away at restrictions on private offerings and exposing more and more retail investors to their risks.
Today’s final rules exemplify this trend, permitting larger and more frequent private offerings to be more widely offered to the general public with the purported goal of enhancing investor opportunity. Enhancing investor opportunity might be a persuasive rationale if this rule arose out of a groundswell of support from investors, or if there were evidence that retail investors would find better opportunities in the private market. However, the evidence suggests that retail investors would actually do worse in the private markets. And, as with so many of our rulemakings in the last few years, investors – the supposed beneficiaries of the rule – largely oppose it.
They are not alone. This rule is in large part also opposed by state securities regulators – those on the front lines fighting fraud in private markets. They have made clear that these changes will make it harder to police the private market and will therefore leave more vulnerable investors at risk.
Finally, the rule lacks meaningful analysis of how our policymaking has affected the dramatic shift of capital to the private market in recent years, and fails to account for how public and private markets do or should interrelate. This is due, at least in part, to the fact we have so little data on how the largest segment of the private market – offerings under Regulation D – actually operates. Thus, once again we make significant changes to a market that is already awash in capital, but into which we have little visibility.
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My concerns with the individual provisions of the final rule are numerous. I question, for example, the wisdom of increasing capital raising limits in offerings such as Regulation A, Crowdfunding, and Rule 504 when investors have demonstrated no interest, and issuers no need, for such increases. But my larger concern is the sweeping effect of these changes taken together and in the broader regulatory context, including the Commission’s failure to address the effects of inflation on the nearly 40-year-old wealth thresholds in the accredited investor definition. Because of the Commission’s failure to modernize these wealth thresholds, the pool of accredited investors is getting steadily bigger and the investors in that pool steadily less wealthy.
And while ever more investors are considered accredited, we also expand access to non-accredited investors through expansions of the Regulation Crowdfunding, Regulation A, and Rule 504 exemptions, and other changes. So, issuers in non-public markets have more and more access to investors that would not previously have been considered accredited, and greater access to investors who do not meet even the weakened wealth thresholds in the accredited investor definition.
At the same time, we steadily strip away investor protections in this market, reducing disclosure requirements and relaxing accredited investor verification standards. Our rulemaking, including today’s release, takes an insistently narrow view of the changes we make, failing to consider them as a whole and how they interact with other regulatory efforts. These changes are cast as mere adjustments to the framework to make it easier to navigate, but their effects on investor protection loom large.
Take, for example, the drastic changes to the integration framework, which threaten to effectively nullify the doctrine. The integration doctrine has long been an important mechanism to prevent companies from evading registration and disclosure requirements by disguising what is really a large, continuous, widely offered issuance as separate exempt offerings. Today’s rule eliminates any real analysis of whether separate offerings should be considered functionally the same.
The rule sets forth a new “general principle of integration” which states that “offers and sales will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the [Securities] Act, or that an exemption from registration is available for the particular offering.” Register or comply with an exemption. This is the basic requirement of the federal securities laws. As a principle of integration, it adds nothing, and illustrates that we have effectively rendered the doctrine hollow but for a requirement to wait 30 days between offerings.
In addition, while adjustments to the framework could make sense for harmonization purposes, we should be mindful that different exempt offerings have different features for good reason. It does not make sense in all instances for their requirements to be the same. For example, today’s rules remove the audit requirement for financial statements provided to non-accredited investors in Rule 506(b) offerings up to $20 million in order to harmonize these disclosure requirements with Regulation A. But Regulation A and 506(b) offerings are different in important respects, including that Regulation A financial statements are subject to staff review and qualification, and 506(b) financial statements are not. The new rule does not account for the sensible differences in their disclosure requirements.
Similarly, the adopting release weakens the accredited investor verification standard for Rule 506(c) and suggests that the standard is not meaningfully different than the verification standard under 506(b), which has been understood to require less of issuers and potentially permit them to rely on no more than self-certification by investors. In fact there is good reason for the 506(c) standard to be more robust than the 506(b) standard, namely the ability to engage in general solicitation under 506(c). The suggestion that they are or should be the same standard misconstrues the history of the requirement and fails to take into account important differences between the two exemptions.
Why does this matter? Are these just philosophical concerns? No, these changes will have concrete effects. In addition to the continued blurring of lines between public and private markets, they will make it harder for regulators to police the private market and to stop improper or fraudulent offerings before it’s too late. The interplay among the new integration, test the waters, demo days, and other provisions will effectively permit a wholesale importation of general solicitation into the private market, vastly increasing the potential for offers to non-accredited investors, and without a reliable method for regulators to quickly determine if an exemption is properly available. State securities regulators have identified these and other investor protections concerns. But instead of addressing those concerns, we exacerbate them.
And finally, I want to highlight one last example of the ways in which this rule reduces investor protections. At the onset of the COVID-19 crisis, the Commission implemented temporary relief for affected small businesses by loosening certain disclosure requirements under Regulation Crowdfunding. I voted for that temporary relief because it included certain heightened protections and was directly related to the needs of small businesses in a time of great economic stress.
One aspect of that temporary relief (relaxing requirements for accountant review of financial statements) is now being codified into this rule for what appears to be an arbitrary 18-month period. It is no longer tied to or justified by the economic conditions associated with COVID. Even more concerning, we are taking this action despite evidence that some issuers are not complying with the conditions that the Commission set for taking advantage of the temporary relief. So, not only are we extending the relief without tying it to COVID, but we are apparently overlooking existing non-compliance. It’s one thing to lack data, but it’s another entirely to disregard the data we have.
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In sum, the best opportunities for retail investors continue to be in the public market and we should give thoughtful consideration to increasing opportunities in that market. Instead, these rules continue the steady erosion of traditional and important boundaries between the public and private markets, which further disincentivizes public offerings and threatens investor protection in both markets. I respectfully dissent.
 See Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment: Hearing Before the H. Comm. on Fin. Servs., 116th Cong. (Sept. 11, 2019) (written testimony of Elisabeth de Fontenay, Professor, Duke University School of Law at 2-3), https://financialservices.house.gov/uploadedfiles/hhrg-116-ba16-wstate-defontenaye-20190911.pdf (providing that the “public markets were specifically designed to create an even playing field for retail investors relative to corporate insiders and sophisticated investors”).
 See Erik Gerding, The Cost to Retail Investors and Public Markets of “Harmonizing” Securities Offering Exemptions, The CLS Blue Sky Blog (Oct. 1, 2019), https://clsbluesky.law.columbia.edu/2019/10/01/the-cost-to-retail-investors-and-public-markets-of-harmonizing-securities-offering-exemptions/ (explaining that retail investors would be unlikely to gain access to the same issuers and investments in private offerings as institutional investors and, if they did, would likely earn lesser returns due to information asymmetries, liquidity risk, dilution risk, and other issues).
 This rulemaking has involved a tremendous amount of work, in a very compressed time period, under extremely difficult working conditions. I’m grateful for the staff’s efforts, and keenly aware that a lot has been asked of them over the last year or so in terms of workload. Unfortunately I cannot support the final rule today because of the majority’s policy choices, but I have long observed and benefitted from the expertise and dedication of the staff in the Division of Corporation Finance, the Division of Economic and Risk Analysis, and the Office of the General Counsel. My sincere thanks to them all.
 See Gerding, supra note 2 (“Investing in private securities would pose considerable additional risks for retail investors, relative to investing in public securities, and existing research suggests that these additional risks would not be sufficiently offset by higher expected returns. In fact, if retail investors are given more direct access to the private markets, they are likely to earn lower risk-adjusted returns overall than they do in the public markets, for several reasons.”). See also SEC, Report to Congress on Regulation A / Regulation D Performance (Aug. 2020), https://www.sec.gov/files/report-congress-regulation-a-d.pdf (“Based on an analysis of a small subset of public companies with Regulation D offerings, in line with prior studies, we find such companies tend to be smaller, less profitable, and more financially constrained than public companies conducting registered offerings. The small subset of public companies relying on Regulation D grew faster one year after the offering but had lower profitability and stock returns, compared to public companies undertaking registered offerings.”).
 See, e.g., Letters from CFA Institute (June 12, 2020), Consumer Federation of America (June 4, 2020), Council of Institutional Investors (May 28, 2020), Healthy Markets (Mar. 16, 2020), and Better Markets (June 2, 2020), available at https://www.sec.gov/comments/s7-05-20/s70520.htm.
 See Letter from North American Securities Administrators Association, Inc. (NASAA) (June 1, 2020), https://www.sec.gov/comments/s7-05-20/s70520-7258827-217615.pdf.
 In 2019, exempt offerings accounted for approximately $2.7 trillion of new capital, compared to $1.2 trillion in registered offerings. See Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Proposed Rule, Rel. No. 33-10763, 8 (Mar. 4, 2020) (Proposing Release).
 SEC staff analysis has acknowledged the limitations of data provided by Form D under the current framework. See Scott Bauguess, Rachita Gullapalli, and Vladimir Ivanov, Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009-2017, SEC White Paper (Aug. 2018) (“Separate analysis by DERA staff of Form D filings by funds advised by registered investment advisers and broker-dealer members of FINRA suggests that Form D filings are not made for as much as 10% of unregistered offerings eligible for relief under Regulation D.”); Vlad Ivanov and Scott Baugess, Capital Raising in the U.S. The Significance of Unregistered Offerings Using the Regulation D Exemption, SEC White Paper (Feb. 2012) (“Further underestimation may occur to the extent that issuers do not report at all. Rule 503 requires the filing of a notice on Form D for all offerings under Regulation D. However, filing Form D is not a condition to claiming a Regulation D safe harbor or exemption. We understand that some issuers do not file Form Ds for offerings intended to be eligible for relief under Regulation D.”). Commenters have also observed the lack of visibility into the Regulation D market and urged us to take steps to remedy this data deficit before proceeding with further rulemaking affecting this market. See, e.g., Letter from NASAA (June 1, 2020) (“[A]s NASAA and other commenters have stated repeatedly, the Commission should not pursue its current slate of deregulatory proposals especially in the absence of hard data about the exempt offering marketplace.); see also Letter from NASAA (Oct. 21, 2020) (including specific recommendations for improving the collection of data related to the Regulation D market). Likewise I have repeatedly advocated for re-visiting the 2013 proposed amendments designed to improve our visibility into the Regulation D market, which the Commission never adopted. See, e.g., Commissioner Allison Herren Lee, Statement on Proposed Amendments to the Exempt Offering Framework (Mar. 4, 2020).
 As the SEC’s Investor Advocate has explained, the SEC’s own analysis shows that issuers in Regulation A and Regulation Crowdfunding offerings are not meeting current offering limits. See Letter From Rick A. Fleming (July 11, 2019), https://www.sec.gov/comments/s7-08-19/s70819-5800855-187067.pdf (providing that “only 132 issuers have reported proceeds from a Regulation A offering, and those issuers have raised less than half of the amount sought” and “[o]f the completed offerings under Regulation Crowdfunding, the average amount raised was $208,300, well below the $577,385 maximum that was sought in the average offering.”). See also Proposing Release at 124 (showing flat or declining interest in Rule 504 offerings and concluding that “data suggests that the higher threshold limits have not encouraged more issuers to conduct new offerings under the Rule 504 exemption”). I am also disappointed that we are dropping from the final rule an important investor protection proposal to prohibit Simple Agreements for Future Equity, or SAFEs, from Regulation Crowdfunding despite indications that such securities may result in harm to investors, confusion on the part of investors, and ultimately jeopardize the reputation of the Regulation Crowdfunding market. See Proposing Release at 157.
 See Amending the Accredited Investor Definition, Final Rule, Rel. No. 33-10824, 143 (Aug. 26, 2020) (showing a 550% increase in households qualifying as accredited since 1983).
 See, e.g., Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Final Rule, Release No. 33-10884, 209 (Nov. 2, 2020) (Adopting Release) (positing that the amendments will have only a marginal impact on the decline of public offerings because “[a]mendments to individual exemptions that have the greatest potential to result in the growth in capital raising pursuant to those exemptions relative to the baseline affect the market segments that are relatively small in absolute terms today” and “[w]hile changes to the disclosure requirements for sales to non-accredited investors under Rule 506(b) will reduce the cost to issuers of sales to such investors and may draw additional issuers to allow non-accredited investors in Rule 506(b) offerings, Rule 506(b) offerings with non-accredited investors currently comprise a relatively small portion of the market”).
 See Nonpublic Offering Exemption, Final Rule, Rel. No. 33-4552 (Nov. 6, 1962) (“What may appear to be a separate offering to a properly limited group will not be so considered if it is one of a related series of offerings. A person may not separate parts of a series of related transactions, the sum total of which is really one offering, and claim that a particular part is a nonpublic transaction.”).
 See Adopting Release at 360.
 See Adopting Release at 116-17 (“We are of the view that, in some circumstances, the reasonable steps determination may not be substantially different from an issuer’s development of a ‘reasonable belief’ for Rule 506(b) purposes. For example, an issuer’s receipt of a representation from an investor as to his or her accredited status could meet the ‘reasonable steps’ requirement if the issuer reasonably takes into consideration a prior substantive relationship with the investor or other facts that make apparent the accredited status of the investor.”).
 When the Commission proposed changes to Rule 506 to permit general solicitation for 506(c) offerings and to require issuers to take “reasonable steps” to verify accredited investor status, it emphasized that it was preserving the opportunity for issuers engage in offerings not involving general solicitation under Rule 506(b), recognizing that some issuers may not wish to “become subject to the new requirement to take reasonable steps to verify the accredited investor status of purchasers.” See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and 144A Offerings, Proposed Rule, Rel. No. 33-9354, 12 (Aug. 29, 2012). Thus the Commission characterized the “reasonable steps” verification requirement under 506(c) as a new requirement, not simply redundant to the existing “reasonable belief” standard for other offerings to accredited investors. The Commission was also clear at the time the “reasonable steps” verification standard was adopted that it would not be satisfied if an issuer “required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.” See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and 144A Offerings, Final Rules, Rel. No. 33-9415, 33-34 (July 10, 2013). The “reasonable belief” standard applicable to Rule 506(b) offerings, by contrast, has been viewed as requiring less of issuers and potentially permitting self-certification. See Peter Rasmussen, Rule 506(c)’s General Solicitation Remains Generally Disappointing, Bloomberg (May 26, 2017), https://www.bna.com/rule-506cs-general-b73014451604/ (Under the 506(b) reasonable belief standard, “[t]he issuer does not have to establish that its buyers meet the accredited investor standard. Rather, it is sufficient if the issuer reasonably believes that the buyers are eligible. Self-certification accomplished through the use of an investor questionnaire is common practice to reach this result. For 506(c) offerings, however, the bar has been raised. A reasonable belief is not sufficient.”); see also Solicitations of Interest Prior to a Registered Public Offering, Final Rule, Rel. No. 33-10699 (Sept. 25, 2019) (declining to reject “check the box” self-certification to satisfy the reasonable belief standard: “in response to this commenter’s concern regarding issuers relying on a ‘check-the-box’ or other self-certification method of determining investor status, we reiterate that the steps necessary to establish a reasonable belief as to investor status will be dependent on the facts and circumstances of the contemplated offering and each potential issuer”).
 See Letter from NASAA (June 1, 2020) (laying out concerns about the difficulty of policing and enforcing standards around the proposed treatment of integration, test the waters communications, and demo days); Letter from NASAA (Oct. 3, 2012), https://www.sec.gov/comments/s7-07-12/s70712-92.pdf (discussing the difficulty of policing offerings given the increased availability of general solicitation especially in light of the limitations of Form D, saying an “investigator who sees an advertised offering will have no simple way of knowing whether the issuer is engaged in a compliant Rule 506 offering or is merely advertising an unregistered, non-exempt public offering”).
 See Adopting Release at 286 (“While the existing temporary rule specifies that it applies to issuers affected by COVID-19, the extension of this relief under the final rules does not include this condition.”).
 A retrospective staff review of Regulation Crowdfunding issuances made in reliance on the temporary relief identified issuers that failed to comply with the requirement that such issuers have six months of operating history. See id. at 282 n.674 (identifying four issuers out of 57 that do not have the requisite operating history, a noncompliance rate of approximately seven percent).