Remarks before The North American Securities Administrators Association 2014 Public Policy Conference
Commissioner Kara M. Stein
April 8, 2014
Thank you Andrea, for that kind introduction. And my thanks to NASAA for inviting me to be here with you today. Before I begin, I need to remind you that the views I am expressing today are my own and do not necessarily reflect the views of the Commission, my fellow Commissioners, or the staff of the Commission.
It is a pleasure to be here with such a dedicated group of public servants. I’m very glad to be talking with you today and offering my thoughts. But, let me be clear, I am also very interested in hearing your thoughts on a number of matters. Each of you works every day, to encourage capital formation, create jobs for Americans, and help protect investors. It is hard to imagine a more ambitious goal. And one that you have delivered on time and time again.
States have a proud tradition in regulating capital markets, recognizing early on the need to protect honest businesses from dishonest competition, and everyday investors from fraud. It has been over 150 years since the states first began to recognize the compelling need to protect and nurture these markets.
In 1852, the Commonwealth of Massachusetts was among the first to jump into the fray when it adopted a law requiring railroad companies to certify that their stock had been “subscribed for by responsible parties” who paid at least 20% of the par value into the company treasury. By 1879, the State of California had gone so far as to adopt a constitutional ban against selling stock on margin.
Ultimately, each state took its own approach. But perhaps the most transformative was Kansas’s adoption of the “blue sky law” in 1911. The brainchild of Kansas blacksmith turned banker, Joseph Dolley, the law was the first of its kind in our country. Its name, as we all know, has become synonymous with state securities regulation.
Interestingly, there have been many theories about the origin of the name — most suggesting that promoters were selling stock of companies with assets backed by nothing but “the blue skies of Kansas.” This makes for a good legend, but in this case, the truth may be even more powerful than the legend.
Dolley himself wrote in The Topeka State Journal in 1935 that he named the Kansas law after his own experience with fraud. A so-called “Chicago slicker” had promised some of Dolley’s farmer neighbors that his company had a contraption that could make rain. After four days of spraying chemicals into the clear blue sky, the hucksters abandoned both the equipment and the town, leaving them with nothing but “blue sky.”
As Dolley said, “the name stuck.” So did the concept. The basic and simple framework of this landmark law survives today in both state and federal regulation. One of the most critical components of that framework is the requirement to tell the truth. It’s a remarkably simple, but important concept. Why? Because truth telling is the underpinning of investor confidence, which is the foundation of capital formation, jobs, and prosperity.
If investors don’t trust the markets, they won’t invest their capital. And without capital, our businesses will not survive, thrive and create jobs. You see this every day. Each of you receives calls from harmed investors and local businesses. You have a significant stake in how well investors are protected, and whether businesses in your states can get the capital they need, when they need it.
The Securities and Exchange Commission has long relied upon and benefited from your work. We are partners, and we must continue to be. Particularly now as the Commission is engaged in implementing some of the most dramatic revisions to our securities laws in decades. Some of them are in response to the financial crisis and the subsequent Dodd-Frank Wall Street Reform and Consumer Protection Act. Others are in response to Congressional directives in the Jumpstart Our Business Startups Act (JOBS Act) to make it easier for businesses to raise capital.
As the Commission considers these changes, we must also revisit our partnership at every step. We must assess how we can leverage our scarce resources to effectively encourage businesses, while also protecting college savings and family retirement. In the months ahead, the Commission will continue its efforts to finalize rules called for by the JOBS Act. In that regard, I would be particularly interested in hearing from all of you regarding three specific areas: general solicitation, crowdfunding, and Regulation A.
So let me tell you what I am thinking about as I approach these three opportunities. Over the past several decades, private offerings have gone from a tiny portion of the US capital market, to now comprising more than half of it. In 2012, $1.2 trillion in capital was raised through registered offerings. That same year, half a trillion more, or $1.7 trillion, in capital was raised through private offerings.
Until recently, the principal limiting factors on private offerings were, first, that they could not generally be offered or advertised to the public, and second, they could be sold only to accredited investors. Things have changed. Congress directed the Commission to remove the ban on general solicitation in Rule 506 offerings. For the first time, a so-called private offering can be advertised publicly — on a billboard or in a television commercial during the Superbowl. This is a sea change. We must wade carefully and thoughtfully into these waters, with investor protection serving as a beacon, so we ensure that the law facilitates capital formation, and not fraud.
We also must learn from our past mistakes. In 1992, the Commission tried a similar experiment when we changed another Reg D provision, Rule 504. The Commission lifted the ban on general solicitation hoping to help smaller issuers acquire “seed capital.” Instead, fraudsters cheated a lot of investors out of their hard earned savings. After several years of abuses, the Commission reversed course and ended the use of unrestricted general solicitation. What did we learn? Among other things, we learned that when we permit unrestricted general solicitation, fraud increases. It’s been said that those who do not learn from history are doomed to repeat it. We must not allow that to happen. We must be prepared to meet the same types of fraud and manipulation we encountered 15 years ago courtesy of the Rule 504 changes.
How do we do it? I think we can best do it by establishing some simple and basic requirements and providing vigorous enforcement. Basic filing obligations that are simple to fill out, and easy for issuers to complete, can help weed out the honest from the dishonest. Form D filings should be of little moment to the legitimate issuer, while giving serious pause to those intending fraud. While firms are required to file Forms D now, that obligation is rarely enforced. If an issuer, attempting to raise millions of dollars, cannot even meet the most basic of requirements to complete and submit its Form D filings, should that issuer be allowed to rely on the Rule 506 exemption for that offering? Honest mistakes by issuers can be quickly and easily cured, or even, when appropriate, waived by the Commission.
We must also ensure that investors get the information they need to understand what they are being sold. Shouldn’t each piece of advertising clearly and plainly alert the investor to the risks of the investment? Or is it okay to have cautions buried in fine print or relegated to an afterthought? When private funds advertise performance statistics - to ensure they are fairly and accurately presented, shouldn’t the limitations of these statistics be clearly disclosed?
Finally, shouldn’t we gather, and permit public analysis of the general solicitation materials? These advertising materials could be used to find problems in particular offerings, better understand our markets, look for trends and best practices, and inform our policy choices.
Let’s try to get it right now, but let’s also make sure we collect enough information and data to continue to evaluate how it’s going, and improve it over time. Investors, issuers, regulators, and others will be watching closely as we put in place simple, basic protections under Rule 506. We must not let them down. I look forward to hearing your thoughts on all of these issues.
The Commission has another great opportunity in its rulemaking for crowdfunding. Crowdfunding holds the promise of harnessing the power of the internet to provide capital for start-ups and small businesses that otherwise lack access to such capital. But with that opportunity also comes risk. Ordinary people, like a teacher in Iowa, or a retiree in Tampa, may not be equipped to assess the risks of an investment offer coming via the internet. We all need to make sure that crowdfunding isn’t turned into a new, cyber-version of boiler rooms. Investing in start-ups is a risky business. And potential crowdfunding investors should know that the risks include not just whether the company is successful, but also whether the company will dilute or otherwise devalue their investment as the company moves forward.
Reasonable investor caps, based on an investor’s ability to bear the risk, are also critical. We must carefully consider how to calculate these caps and how to ensure that they are enforced. We also must carefully consider the role of crowdfunding portals and our ability to properly oversee them. They can provide a critically important gatekeeping function. Finally, we must ensure that these small issuers have the information and tools they need to cost effectively meet their recordkeeping and disclosure obligations. If we are mindful of the needs, costs and burdens amongst these three groups -- investors, portals and issuers -- and balance them carefully, we will have a better chance of making this new capital raising vehicle a success.
We also are poised to improve capital raising under Regulation A, with our new proposal known as “Reg A+.” I have made no secret of my views that we need to work with you, our state partners here, and can benefit greatly from your unique expertise and ability. I want to take a moment to commend and congratulate NASAA and the states for voting to implement your new Coordinated Review Program. It’s my understanding that it is essentially ready to go. Well done. I have said this before, and it bears repeating, I remain concerned that the proposed Reg A+ does not provide workable options for smaller issuers, and that it unwisely precludes the states from their critical oversight function. I look forward to a continued dialogue with NASAA and others to find a better way to continue our partnership in the new Reg A+ framework. We have an opportunity here to provide a nuanced and thoughtful capital raising model that works, both for businesses and those seeking to fund them. Let’s not squander the opportunity.
Another topic that I would love to hear from you on is disclosure. As many of you know, the Commission is currently working on a review of our disclosure regime. This review strikes at the core of how we regulate our markets. Informed investors are the single most important factor in maintaining strong capital markets, and a robust economy. Informed investors can decide where and how to best allocate their capital. But misinformed investors may not only lose their money, they may also fail to assess and fund the best new ideas. Fair competition is key. And, for eighty years, that fairness has been largely achieved through disclosures.
It seems that as long as disclosure requirements have been around, so too have complaints about those requirements being overly burdensome. I have repeatedly heard this issue described as “disclosure overload.” I don’t think “disclosure overload” is the way we should be thinking about such a review. That is far too narrow of a goal. I do agree that our disclosure system needs some re-evaluation. What we need to be considering is how to improve the value of disclosures, and how do make them more meaningful. This may mean removing redundant requirements. But it should also include enhancing old requirements, or perhaps adding new ones, to reflect what investors and market participants care about in the 21st century.
And, importantly, it should include requiring the information to be in a format that is useable by investors, market participants and the Commission. Structured or “machine readable” data tremendously increases the power and value of disclosures. Meaningful disclosure should be driven by what investors and markets think. Some of us may not personally like one type of disclosure or another, but if investors think it is relevant and important, we should respect that. We should not be substituting our judgment for theirs. The Commission exists to facilitate capital formation and protect investors, and we should listen to them. We need everyone at the table for this debate, from businesses to investors to regulators. The Commission’s Investor Advisory Committee was created by Congress to “advise and consult” on, among other things, “the effectiveness of disclosure.” We should tap into this committee’s expertise, as we should with our Advisory Committee on Small and Emerging Companies. Improving the value of our disclosures is an important and monumental task, and I encourage all of you to give us your best thoughts and ideas as we move forward.
Finally, I want to briefly highlight yet another area where I think the states can provide significant value, and we can create effective enforcement partnerships. Both the States and the Federal Government are currently focused on high frequency trading and access to market moving information. We should be carefully considering whether there has been illegal conduct. But we also need to revise or create new rules to stop conduct that we think should be illegal. As the SEC continues to consider this and other market structure issues, we benefit greatly from both your ideas and your work on such issues.
The bottom line is we all need to be working in partnership to help businesses get the capital they need to survive, grow, and create jobs. And we all need to be working in partnership to ensure that investors know they aren’t going to lose their investments to schemes, scams or market manipulations. In this effort, you are a critical partner. So please, let us hear from you on issues that are vitally important to all of us. I want to thank all of you for the hard work you do every day to help businesses and families all over our nation, and I look forward to continue to work with you on our shared mission. Thank you.
 See, e.g., Merrick v. N. W. Halsey & Co., 242 U.S. 568; 587 (1917) (upholding a Michigan statute creating certain state securities regulations).
 See The Rise of the Massachusetts Uniform Securities Act, Brandon F. White and Andrew J. Palid, 94 Mass. L. Rev. 4; p. 118 (Jan 2013).
 See Willcox v. Edwards, 162 Cal. 455; 459 (Cal. Sup. Ct. 1912) (referring to section 26, article IV of the California Constitution of 1879).
 See generally, 100 Years of Securities Law: Examining a Foundation Laid in the Kansas Blue Sky; Rick A. Fleming, 50 Washburn L.J. 583 (Spring 2011).
 Id., p. 585-586.
 See Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 2009-2012, Vladmimir Ivanov and Scott Baugess, p. 8 (July 2013).
 See Revisions to Rule 504 of Regulation D, the “Seed Capital” Exemption; Rel. No. 33-7644 (“Investor protection concerns require that [the 1992 amendments permitting unrestricted general solicitation be reversed] to curb misuse of this exemption in the markets for ‘microcap’ companies.”)
 15 U.S.C. 78pp (2014).