Middle-Market Public Policy Roundup

Congress is back in session, and it isn’t wasting any time getting to work. This week, the House Financial Services Subcommittee on Investor Protection held a hearing to discuss the growth of private markets and bills currently under consideration that would expand the accredited investor definition and clarify other securities regulations.

Subcommittee Reviews Proposed Legislation for Private Markets 

The House Financial Services Committee is evaluating several pieces of potential legislation that would affect the definition of accredited investors, crowdfunding, family offices and small business M&A.

On Sept. 11, the Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets held a hearing entitled “Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment” to address the eclipse of private markets over public exchanges.

Several of the eight bipartisan legislative proposals up for consideration in connection with the hearing came from the so-called “JOBS 3.0” Act, a bipartisan package of legislation which passed the House of Representatives last Congress (you can see MMG’s coverage here). The JOBS 3.0 Act did not receive a vote in the Senate.

The Exempt Offering Framework

Driven by “exempt offerings,” the SEC estimates private issuers raised roughly $2.9 trillion of capital through exempt offerings, compared with only $1.4 trillion through public offerings. The changes to securities law over the years have made it easier for companies to remain private longer and raise capital through the private markets rather than pursue an IPO.

In June, the Securities and Exchange Commission issued a concept release to solicit comments on ways to harmonize the current exempt offering framework, which we discussed in a previous edition of the Public Policy Roundup. Specifically, the SEC is seeking comments on ways to make it easier for smaller issuers to raise capital in the private markets. ACG plans to submit comments to the SEC to advocate for much-needed changes to the current patchwork of exemptions on behalf of the middle market. .

Causes of the Decrease in IPOs

Throughout the hearing, many of the witnesses—and some Democratic lawmakers—contended that a decrease in IPOs and the simultaneous increase in capital flowing through the private market has occurred due to deregulation of exempt offerings. Renee Jones, associate dean for academic affairs and professor of law at Boston College Law School, stated throughout her testimony that private markets have seen their rapid rise due to eased standards on private security resales, elimination of the ban on general solicitations, and an increase in the number of shareholders that triggers issuer registration requirements.

Based on conversations with CEOs and others involved in the facilitation of capital flow, Rep. Jim Himes, D-Conn., said the real issue contributing to the decline of IPOs seems to lie in so-called “short-termism.” Whereas private companies can pursue long-term projects, public companies are under pressure from shareholders to grow their quarterly earnings at the expense of large capital investments. Many CEOs and company owners may not want to pursue an IPO for this reason.

Other lawmakers contended the rise in the private markets is the result of increased burdens on publicly traded companies. Rep. Patrick McHenry, R-N.C., the ranking member of the House Financial Services Committee, said that the SEC’s regulation of crowdfunding investments has made it so the cost to smaller businesses is higher than the benefits. McHenry said he wants to fix this issue with the Crowdfunding Amendments Act, which would amend the SEC’s Regulation Crowdfunding to allow investors to pool their money into a “crowdfunding vehicle” and raise the public reporting threshold to a level consistent with other exempt offerings.

According to a summary of the bill, this law would benefit both investors and businesses; investors would get to work with a registered crowdfunding vehicle adviser with a fiduciary responsibility for the fund, and companies would only have to work with one fund, instead of thousands of small, individual donors.

Opportunities for Increased Investor Access

A point discussed throughout the hearing was the elevated risk for investors in private securities and the need to strike a balance between risk and access.

One bill, the Fair Investment Opportunities for Professional Experts Act, would expand the definition of accredited investor, with similar qualifiers to what the SEC’s concept release proposed. Under the current framework, unaccredited investors are generally not able to pursue investment opportunities such as those presented by private equity, venture capital and hedge funds.

Under the proposed legislation, registered brokers and investment advisers, as well as those who have the appropriate education or experience, as determined by the SEC and verified by the Financial Industry Regulatory Authority, would qualify as accredited investors.

Currently, a person is considered an accredited investor only if their income exceeds $200,000 or their net worth exceeds $1 million. These individuals are not considered to need the protections of the securities laws, according to the SEC, because they have a cushion to withstand a loss.

Rep. McHenry criticized this “wealth standard,” saying that it equates personal wealth with intelligence. “There’s a societal decision that if you’re not a high net worth individual, you’re dumb,” he said. “There’s a decision by Congress and policymakers that net worth equals intelligence and therefore we’re cutting off people that maybe don’t have high net worth but are deeply versed.”

He pointed out that under the current regime, Ben Bernanke, former chairman of the Federal Reserve, could not qualify as an accredited investor because he didn’t meet its wealth standard. “He was chairman of the largest bank on the planet—and this is just one of the great limitations [of the standard].”

Rep. French Hill, R-Ark., the bill’s sponsor, and Rep. Steve Stivers, R-Ohio, also spent a significant portion of their allotted time extolling the benefits of the legislation.

Other Items of Interest

The committee also discussed the Family Office Technical Correction Act, which would deem any person who is a family office or a family client to be an accredited investor.

Under current law, if a client of a family office is not an accredited investor, then the entire family office might not be considered an accredited investor and therefore would be prohibited from investing in private securities, according to the SEC.

Also among the bills was the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act. This proposed legislation would exempt certain merger and acquisition brokers from registering as broker-dealers.

Under the bill, M&A brokers are defined as brokers that facilitate the transfer of ownership of privately held companies with earnings of less than $25 million or revenues of less than $250 million annually.