Skip to main content

The Importance of Small Business Capital Formation

Commissioner Luis A. Aguilar

Nov. 20, 2014

Thank you and good morning.  Let me start by extending a warm welcome to the panel members and other participants, including those viewing by webcast, to today’s Forum on Small Business Capital Formation.  I look forward to your discussions.  Before I begin, let me note that these remarks are my own, and do not necessarily reflect the views of the U.S. Securities and Exchange Commission (“SEC” or “Commission”), my fellow Commissioners, or members of the Commission’s staff.

Small businesses[1] are the engine that drives the U.S. economy.  The statistics show that small businesses make up 99.7% of U.S. employer firms, 48.5% of private-sector employment, and 37% of high-tech employment.[2]  Small firms were responsible for 63% of net new jobs created between 1993 and mid-2013, or more than 14 million of the nearly 23 million net new jobs created during this period.[3]  There is no debate that the success of small businesses is essential to the sustained growth of our greater economy.

The SEC has long recognized the importance of small businesses.  For example, since 1979, the SEC has had an Office of Small Business Policy.  In addition to annually organizing today’s Forum, this Office is available to answer questions and, importantly, participate in rulemakings and other activities that affect smaller reporting companies.  Moreover, in 2011, the Commission established an Advisory Committee on Small and Emerging Companies to provide the Commission with advice and recommendations specifically related to privately-held small businesses and publicly traded companies with less than $250 million in public market capitalization.[4]  And, of course, the Commission has also, over the years, promulgated a number of regulations that were geared towards smaller firms, such as Regulation A, first adopted in 1936, and Regulation D in 1982.[5]      

More recently, following the passage of the Jumpstart Our Business Startups Act (“JOBS Act”), the SEC has focused on rulemakings intended to facilitate the ability of small businesses to access the capital markets.  For example, within the past 18 months, the Commission has pressed forward with a number of important initiatives in this area, including:

  • proposed rules on crowdfunding, which would exempt qualifying transactions from the registration and prospectus delivery requirements of the Securities Act;[6]
  • proposed rule amendments to Regulation A of the Securities Act (known as “Regulation A-plus”), which would permit companies to raise up to $50 million in any 12-month period without requiring registration under the Securities Act, provided certain  requirements are met;[7]
  • final rules amending Rule 506 of Regulation D, to remove the prohibition against general solicitation and advertising, provided that all purchasers are accredited investors;[8] and
  • proposed various rules to further amend Rule 506 to address concerns about the impact of general solicitation that were raised by numerous commenters.[9]

In looking at the Commission’s role in facilitating capital formation for small businesses, it is important to note that the Commission’s mission is to do so in a manner consistent with the protection of investors and maintaining the integrity of the capital markets. 

There is no doubt that a successful investment environment requires a system that works for both issuers and investors.  The challenge is to develop a process that enables businesses to raise capital in a cost effective way while also, importantly, providing for ways to benefit and protect investors and the markets generally.

As we all know, investments in companies—both small and large—inherently have risks.  It is also understood that investments in small or emerging businesses carry unique investment risks.[10]  While it is hoped that many small businesses will grow and flourish and make money for both entrepreneurs and investors, we should not lose sight of the heightened risks these riskier enterprises pose for investors—through the higher risk of small business failure,[11] the lower liquidity of these securities, and, regretfully, the higher incidence of outright fraud in the small business security markets.[12]    

Given these heightened risks, Congress and the Commission historically have sought to protect investors by requiring that certain conditions be met in exempt offerings geared towards small businesses.  Examples of this include:

  • limiting general solicitation in Rule 506 offerings to “accredited investors” that presumably are better situated to understand the risks of the investments and absorb any losses; 
  • imposing limits on the capital that may be raised in offerings under Regulation A and the proposed Regulation A-plus and crowdfunding exemptions; and
  • imposing individual and aggregate investment limits in crowdfunding transactions.   

In addition, many exemptions require that issuers make specific disclosures to investors.[13]       

I note that today the Forum will consider one important issue that underpins the capital formation for small businesses—and that is the definition of “accredited investors.”

Improving the “Accredited Investor” Definition

The Forum’s input on the “accredited investor” definition is particularly timely because, under the Dodd-Frank Act, the Commission is required to undertake a review of the definition, as applied to natural persons, to determine whether it should be modified for the protection of investors, in the public interest, and in light of the economy.[14]  Indeed, the Dodd-Frank Act mandates that the Commission commence this review no earlier than this past July 2014, and at least once every four years thereafter.

In addition, the definition of “accredited investor” has taken on greater meaning now that issuers can engage, without registration, in unlimited advertising and solicitation, so long as the ultimate purchasers are accredited investors.[15]  Given the importance of this definition in helping to identify investors that are presumably sophisticated and financially able to invest in illiquid securities, the accredited investor definition is particularly important. 

Recently, the Commission’s Investor Advisory Committee (“IAC”) provided the Commission with its own recommendations regarding possible ways to amend the accredited investor definition.  The IAC’s recommendations would both limit and expand the pool of accredited investors—always with an eye to identifying individuals who should be able to fend for themselves.  In brief, the IAC recommended that the Commission revise the accredited investor definition to enable individuals to qualify as accredited investors based on various ways of assessing their financial sophistication, such as through specialized work experience, investment experience, licensing or other professional credentials, or perhaps even through a qualifying test developed by, or in collaboration with, securities regulators.[16]

The IAC, like many observers, is also concerned that the current definition of an “accredited investor” may assume too much.[17]  The criticism is that it is a crudely-designed method to distinguish between purchasers who are supposedly financially sophisticated and purchasers who are not.  Specifically, the definition assumes that individual accredited investors are knowledgeable and experienced about financial matters if they meet specific income or net worth thresholds.  Although one may argue that an individual with annual income of $200,000 or net worth of $1,000,000 is well-off,[18] those benchmarks do not necessarily correlate with a person’s financial sophistication.[19]

Indeed, the SEC’s Division of Economic and Risk Analysis estimated that only a small percentage of U.S. households meeting the definition of accredited investor have substantial direct holdings of individual securities, which suggest that their experience investing in securities might be limited.[20]  This point is important because a general solicitation, combined with an offering exempted under Rule 506, means that the issuer is not required to provide information statements or disclosures to investors.[21]  The IAC also addressed this issue, as it recommended that the Commission revise its accredited investor definition, as it pertains to natural persons, to take into consideration the loss of investor protections once provided by the ban on general solicitation and advertising.[22]  Thus, the fear is that investors may not truly be sophisticated, and may not be in a position to effectively negotiate to obtain the information they need.

I know that the Forum participants have a lot to contribute on the accredited investor definition, and I look forward to the discussion of this issue.

Enhancing Secondary Market Liquidity for Small Business Equity

I also note that today’s Forum will feature a panel to discuss secondary market liquidity for the securities of small businesses.  This topic also has increased importance in light of new, and expected, Commission rules that would enable a far wider range of small business securities to be sold in the secondary trading markets.  For example, the larger dollar amount of securities that could be issued under proposed Regulation A-plus will not be restricted securities, and could therefore be immediately traded by security holders who are not affiliates of the issuer.[23]  Separately, as currently proposed, shares issued in crowdfunding transactions would be freely tradable after a one-year holding period.  Similarly, securities issued in private placements under Regulation D are permitted to be resold after a one-year holding period.[24]

Unlike large, well established publicly-owned companies, one of the biggest problems long facing small companies is the lack of an actively-traded secondary market for their securities.[25]  In an attempt to generate more investor interest in small and mid-sized companies, commentators and market participants have periodically urged the Commission to consider special mechanisms to facilitate the trading of the shares in these companies.[26]

One idea that has been suggested is for the Commission to change the way shares are priced.[27]  The idea is to widen the spread on small cap stocks, so as to promote greater interest in these stocks, and thereby promote greater interest in the small cap stock market itself.[28]  To that end, the Commission is currently considering a 12-month “tick size” pilot program.  This pilot program proposes to study the effects of widening minimum quoting and trading increments—that is, tick sizes—for certain stocks with smaller capitalization.[29]   

As you may have read, this potential pilot program has received significant criticism.  For example, some commenters have suggested that an unintended consequence of increasing spreads could be an increase in trading costs for such trades.[30]  Other commenters are concerned that the pilot program will benefit the national stock exchanges, to the detriment of other alternate trading venues, such as dark pools.[31]  The comment period for the pilot program is still open, and I look forward to your thoughts on the pilot program—as well as other ways to address the anemic secondary market liquidity in a manner that works for companies, investors, and the markets.

As you discuss the challenges facing small businesses, I also encourage you to consider the role that can be played by the brave men and women who have risked their lives to fight for our freedoms.  There is no doubt that veterans can help small companies grow.  Veterans have long demonstrated through their commitment to service and their capacity for adapting to various environments and situations, that they have the drive, experience, and skills to benefit any company smart enough and lucky enough to hire them.[32]  I encourage small businesses to make a special effort to recruit veterans.  We will all benefit.

Without doubt, veterans are no strangers to the world of small businesses.  In fact, nearly one out of every ten U.S. small businesses is owned and operated by veterans.   

In closing, I want to again thank today’s participants, and importantly, I want to thank the hard work of the SEC staff responsible for putting together today’s Forum.  Thank you.

[1] For these purposes, small businesses are defined as those independent businesses with fewer than 500 employees.  See U.S. Small Business Administration Office of Advocacy, Frequently Asked Questions, available at

[2] Id.

[3] Id.

[4] SEC Advisory Committee on Small and Emerging Companies,

[5] The original Regulation A was actually a collection of 11 separate exemptions from registration, most of which went up to $100,000 in offerings subject to various conditions.  These 11 exemptions were repealed and replaced by a single $100,000 Regulation A exemption adopted effective in 1941.  See Securities Act Release No. 2410, [1941-44 Transfer Binder] Fed. Sec. L. Rep. (CCII) 75,111 (Dec. 3, 1940).  Regulation A, in effect today, permits offerings of up to $5 million to be exempt from registration, provided that the issuer meets certain offering conditions, including, among others, filing an offering statement with the Commission, no sales are made until the offering statement is deemed “qualified,” and offering circulars are provided to the purchasers of securities.  See Securities Act Release No. 33-6949 (July 30, 1992).  Rules 504 and 505 of Regulation D were adopted pursuant to the SEC's authority in § 3(b) of the Securities Act of 1933 (the “Securities Act”) to exempt offerings with an aggregate offering price of not more than $5 million.  Rule 506 of Regulation D was adopted as a safe harbor provision pursuant to § 4(2) of the Securities Act for “transactions by an issuer not involving any public offerings.”  Under Rule 506 as originally adopted (prior to revisions enacted last year and discussed further below in footnote 9 and accompanying text), issuances that met certain conditions, such as that offers and sales could be to no more than 35 purchasers who were financially sophisticated and an unlimited number of accredited investors.  See Revision of Certain Exemptions From Registration for Transactions Involving Limited Offers and Sales, SEC Release No. 33-6389 (Mar. 8, 1982).

[6] See Crowdfunding, Release No. 33-9470 (Oct. 23, 2013), available at

[7] See Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, SEC Release No. 33-9497 (Dec. 18, 2013), available at take advantage of this new proposed offering exemption, called “Tier 2” offerings in the proposed rule, an issuer would be required to provide audited financial statements, to have ongoing reporting obligations, and to abide by certain limitations on sales.  See id.

[8] See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, SEC Release No. 33-9415 (July 10, 2013), available at

[9] See Amendments to Regulation D, Form D and Rule 156, SEC Release No. 33-9416 (July 10, 2013),  available at  Among other things, these amendments proposed (i) requiring the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation; (ii) requiring the filing of a closing amendment to Form D after the termination of any Rule 506 offering; (iii) requiring written general solicitation materials used in Rule 506(c) offerings to include certain legends and other disclosures; and (iv) requiring the submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the Commission. 

[10] See U.S. Small Business Administration, Starting and Managing a Business, Starting a Business, Explore Loans, Grants and Funding, Venture Capital, available at (“Investing in new or very early companies inherently carries a high degree of risk.”)  See also Washington State Department of Financial Institutions, A Consumer’s Guide to Small Business Investments, available at  (“A basic principle of investing in a small business is: Never make a small business investment that you cannot afford to lose entirely. …  Small business investments are generally highly illiquid even though the securities may technically [be] freely transferable. Thus, you will usually be unable to sell your securities if the company takes a turn for the worse.”).

[11] According to the U.S. Small Business Administration, over 50% of small businesses fail within the first five years.  See Robert Longley, Why Small Businesses Fail: SBA (2014), available at, according to a Bloomberg study cited by Forbes magazine, eight out of ten entrepreneurs who start businesses fail within the first 18 months.  See Eric T. Wagner, Five Reasons 8 Out Of 10 Businesses Fail (Sept. 12, 2013), available at

[12] See comment letter from Andrea L. Seidt, Commissioner, Ohio Division of Securities (Jan. 9, 2013), available at (noting that “[s]tatistics repeatedly demonstrate that most new businesses fail” crowdfunding provides investors with “almost no bargaining power and little information”); see also SEC Website, Microcap Stock: A Guide for Investors, available at (“accurate information about ‘microcap stocks’ – low-priced stocks issued by the smallest of companies – may be difficult to find . . . when publicly-available information is scarce, fraudsters can easily spread false information about microcap companies, making profits while creating losses for unsuspecting investors.”) (Website last visited November 9, 2014).

[13] For instance, offerings seeking to benefit from the registration exemptions of Regulation A (or proposed Regulation A-plus) or the crowdfunding proposed rules would be obligated to satisfy certain issuer disclosure and reporting requirements.  See Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, SEC Release No. 33-9497 (Dec. 18, 2013), available at; and Crowdfunding, SEC Release No. 33-9470 (Oct. 23, 2013), available at

[14] See Section 413(a) of Title IV of the Dodd-Frank Act, available at

[15] Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, SEC Release No. 33-9415 (July 10, 2013), available at

[16] In particular, the IAC suggested that individuals who have attained certain professional credentials, or who have relevant professional experience, such as individuals with Series 7 securities licenses or those with Chartered Financial Analyst designations, could qualify as accredited investors without regard to their income or net worth.  The IAC also suggested that the Commission could look to certain individuals with professional experience that qualifies them as financial experts, such as persons who have work experience in the private equity sector or have spent some period of time as a director of a large business.  The IAC also suggests that the Commission look to individuals with certain investment experience to qualify as accredited investors.  See Recommendation of the Investor as Purchaser Subcommittee and the Investor Education Subcommittee: Accredited Investor Definition, at p. 2, available at (last visited Oct. 7, 2014).

[17] See, e.g., id.; Doug Cornelius, The Confusing Analysis of Whether You Are An Accredited Investor, Compliance Building (Sept. 30, 2013), available at; Comment letter from Karen Tyler, NASAA President and Commissioner, North Dakota Securities Department, North American Securities Administrators Association, Inc. (dated Oct. 27, 2007), available at

[18] The definition of “accredited investor” applicable to Rule 506 is set forth in Rule 501(a) of Regulation D [17 CFR 230.501(a)] and includes any person who comes within one of the definition’s enumerated categories of persons, or whom the issuer “reasonably believes” comes within any of the enumerated categories, at the time of the sale of the securities to that person.  The categories include (A) any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000, excluding the person’s primary residence and any indebtedness secured thereby (up to the value of such residence), and (B) any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

[19] For example—and without limiting the concerns raised over the accredited investor definition—many households meeting the accredited investor threshold are likely to be elderly, with savings accumulated over the course of decades (which must, in turn, last the rest of a lifetime).  I am particularly concerned that seniors may be targeted by general solicitations, as many older Americans may lack the financial literacy necessary to understand the risks of an investment in restricted, unregistered securities.  See SEC,  Study Regarding Financial Literacy Among Investors As Required by Section 917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, at p. 15 (Aug. 2012), available at (“…surveys demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population.”) . This risk may be heightened by cold-calling and other forms of general solicitation.  To that end, seniors and other unsophisticated investors targeted for their relative wealth may not be protected by the definition of “accredited investor,” but in fact may be more vulnerable because of it.

[20] Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, SEC Release No. 33-9415, at p. 75 (July 10, 2013), available at (stating that “evidence suggests that only a small fraction of the total accredited investor population has significant levels of direct stockholdings.”).

[21] Under Rule 506, no information statement or other disclosure is required to be provided if all the purchasers are accredited investors.  Form D, the Notice of Exempt Offering of Securities, does not currently require any substantive disclosure.  See Electronic Filing and Revision on Form D, SEC Release No. 33-8891 (Feb. 6, 2008), available at

[22] Recommendation of the Investor as Purchaser Subcommittee and the Investor Education Subcommittee: Accredited Investor Definition, at p. 2, available at (last visited Oct. 7, 2014) (stating that “this Committee earlier recommended that the Commission revise the accredited definition, as it pertains to natural persons, to reflect the loss of procedural protections once afforded by the general solicitation and advertising ban.”)  The SEC’s experience has shown that when stock promoters are allowed to advertise and solicit the public without the safeguards of the Commission’s registration or qualification requirements, it can open the door for fraudsters and scam artists. SEC Website, Microcap Stock: A Guide for Investors, available at  In 1992, in an effort to aid capital raising by small businesses, the Commission relaxed the ban on general solicitation under Rule 504, another provision of Regulation D, permitting unregistered offerings up to $1 million. Small Business Initiatives, SEC Release No. 33-6949 (July 30, 1992), available at  In addition to general solicitation, the 1992 amendments also permitted securities sold pursuant to Rule 504 to be freely-tradable in the secondary market.  These amendments to Rule 504 incited a wave of pump-and-dump schemes and other penny-stock frauds too devastating to ignore.  SEC Website, Microcap Fraud (June 24, 2003), available at  Accordingly, in 1999, the Commission reinstated the general solicitation ban under Rule 504, and restricted shares issues pursuant to the rule, for all offerings other than those that were registered under state law or made pursuant to certain state law exemptions.  Revision of Rule 504 of Regulation D, the “Seed Capital” Exemption, SEC Release No. 33-7644 (Feb. 25, 1999), available at  Although some of the microcap fraud schemes unleashed by the 1992 amendments, such as pump-and-dump frauds, relied on the freely-tradable nature of Rule 504 shares, other schemes were facilitated primarily by the ability of such issuers to spread fraudulent information about their business, assets, and results of operations without the scrutiny imposed by the registration process.  Supra, Microcap Fraud.  

[23] Securities Act §3(b)((2)(C), as added by JOBS Act §401(a).  See Rule 144 under the Securities Act.

[24] Id.  Securities Act Rule 144 allows public resale of restricted and controlled securities if a number of conditions are met, including, for example, meeting the holding period requirement of one year (assuming the seller is not an affiliate of the issuer).  See Rule 144 under the Securities Act.

[25] See, for example, Comment letter from John Perkins, Chairman, Small Business Capital Access Association (April 22, 1997), available at (“As the SBCAA stated last year, the biggest problem faced by small companies trying to raise capital is the lack of a secondary market for the investors who invest in these offerings.”).

[26] For example, the SEC Advisory Committee on Small and Emerging Companies recommended to the Commission that it create a separate specialized U.S. equity market that would facilitate trading in the securities of small and emerging companies.  See Comment letter from Stephen M. Graham and M. Christine Jacobs, Committee Co-Chairs, SEC Advisory Committee on Small and Emerging Companies (dated Mar. 21, 2013), available at  Some commentators have suggested that the SEC support a program, like the proposed “tick size” pilot, to test a change in the way shares are priced.  See Supriya Kurane, SEC asks exchanges, FINRA to submit "tick size" pilot plan, Reuters (June 25, 2014), available at

[27] See id., Supriya Kurane, In particular, these concerns echo those that have been raised since the introduction of a minimum price variation of one penny in 2005 for stocks of companies of all sizes (called “decimalization”), which is that decimalization itself may hurt the liquidity of small cap stocks.  See Order Directing the Exchanges and the Financial Industry Regulatory Authority To Submit a Tick Size Pilot Plan, SEC Release No. 34-72460 (June 24, 2014), available at  In a January 2010 Concept Release on Equity Market Structure, the Commission noted specifically that broker-dealers may have greater incentives to internalize low-priced stocks than higher priced stocks, given the relatively larger minimum spreads that could be earned by broker-dealers.  See Concept Release on Equity Market Structure, SEC Release No. 61358 (Jan. 14, 2010), available at

[28] See Supriya Kurane, SEC asks exchanges, FINRA to submit "tick size" pilot plan, Reuters (June 25, 2014), available at fact, Congress directed the Commission in the JOBS Act to conduct a study and report to Congress on how decimalization affected the number of initial public offerings (“IPOs”), and the liquidity and trading of smaller capitalization company securities.  The Commission submitted the staff’s study to Congress in the July 2012 Decimalization Report, which in part specifically suggested a public roundtable, where recommendations could be presented on a pilot program that would generate data to allow the Commission to further assess decimalization’s impact.  See Order Directing the Exchanges and the Financial Industry Regulatory Authority To Submit a Tick Size Pilot Plan, SEC Release No. 34-72460 (June 24, 2014), available at

[29] See SEC Announces Pilot Plan to Assess Stock Market Tick Size Impact for Smaller Companies, Press Release No. 2014-176 (Aug. 26, 2014), available at On November 3, 2014, the Commission provided notice of publication of a proposed “tick size” pilot program in the Federal Register to solicit public comments.  See Joint Industry Plan; BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Stock Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., Financial Industry Regulatory Authority, Inc., NASDAQ OMX BX, Inc., NASDAQ OMX PHLX LLC, The Nasdaq Stock Market LLC, New York Stock Exchange LLC, NYSE MKT LLC, and NYSE Arca, Inc.; Notice of Filing of Proposed National Market System Plan to Implement a Tick Size Pilot Program On a One-Year Pilot Basis, SEC Release No. 34-73511 (Nov. 3, 2014), available at; see also SEC Announces Pilot Plan to Assess Stock Market Tick Size Impact for Smaller Companies, SEC Press Release No. 2014-176 (Aug. 26, 2014), available at

[30] See Rick Baert, Critics strike back at tick-size pilot program, Pensions & Investments (Nov.10, 2014), available at (quoting Henry Yegerman, director of trading analytics and research at Markit Group Ltd, to say “[t]his test will mean better spreads but also more executions, with possibly higher cost,” and also pointing out that the exchange owners will benefit from the trade-at provision).

[31] See Dave Michaels and Sam Mamudi, Brokers Attack SEC’s Plan as Trojan Horse, Bloomberg (Nov. 11, 2014), available at (stating that the “one of [the tick size pilot’s] provisions -- called a trade-at rule -- is really a stealth attempt to hurt brokers that run private trading systems that compete with the likes of the New York Stock Exchange.”); see also Rick Baert, Critics strike back at tick-size pilot program, Pensions & Investments (Nov.10, 2014), available at (citing Henry Yegerman, director of trading analytics and research at Markit Group Ltd, to say that the exchange owners will benefit from the trade-at provision).

[32] Just two weeks ago, the President proclaimed the country’s first National Veterans Small Business Week to put a focus on how our military veteran entrepreneurs help our country prosper by creating new business opportunities, job growth, and economic progress that benefit us all.  See National Veterans Small Business Week (Nov. 3, 2014), available at; see also Letter from the President on National Veterans Small Business Week (Nov. 3, 2014), available at

Return to Top