SEC Small Business Committee Throws Down the Gauntlet on State Trading Preemption

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The Securities and Exchange Commission’s (SEC) Small Business Capital Formation Advisory Committee (SBCFAC) has thrown down the gauntlet. As the SEC’s website explains, the SBCFAC was established by the SEC Small Business Advocate Act of 2016 and is designed to provide a formal mechanism for the Commission to receive advice and recommendations on rules, regulations and policy matters relating to small businesses, including smaller public companies. Its latest meeting produced a clear message: It’s time to start providing liquidity in the private markets.

The onus is now on the full Commission, flush with two new members, Mark T. Uyeda and Jaime Lizárraga, to heed their advice. Ten years after President Obama signed the bipartisan Jumpstart Our Business Startups (JOBS Act of 2012), which invited everyday Americans into the lucrative private capital markets, the work remains half done at best. Two JOBS Act Title III—which became Regulation Crowdfunding (Reg CF)—and Title IV—which drastically improved Regulation A (Reg A+)—have shown the success of deregulation. These two titles enabled a paradigm shift in private company investing by allowing startups and small businesses to accept investment from retail investors. Reg CF caters to smaller and younger companies with a 12-month offer limit of $5 million. More mature companies use Reg A+, which couples higher SEC scrutiny with a 12-month offer limit of $75 million.

In March 2021, the Commission expanded JOBS Act provisions that freed more capital. But challenges remain. First among them is the lack of liquidity in the secondary market, where initial purchasers resell shares. The SBCFAC tackled that problem this month by reviewing the lack of secondary trading state preemption for both Reg CF and Reg A+.

The meeting opened with commissioner remarks. Commissioner Hester Peirce spoke about how secondary market liquidity and investor protection complement, rather than oppose each other:

Secondary market liquidity marries capital formation and investor protection consideration. Issuer’s ability to raise capital turns in part on whether purchasers of their securities will enjoy strong secondary market liquidity.

When presentations began, Ryan Feit, CEO and co-founder of crowdfunding portal SeedInvest, relayed the frustration investors feel from their illiquid investments, even when values rise due to follow on rounds at higher per/share prices:

[W]hat happens is many startup and small business investors get burned out quickly. They make an investment or a few, and they’re excited about it, and then they actually realize that I might need to wait five to ten years to get any return out of this.

This ultimately leads to less capital for newer projects and ultimately good ideas not being funded.

Sara Hanks, a noted securities practitioner and SBCFAC member, spoke about the tedious nature of complying with state-by-state regimes, which differ in fee structure, timing, notice requirements, and other areas. She mentioned possible solutions in the JOBS Act 4.0 Congress is currently considering.

Indeed, CEI filed comments in June on the JOBS Act 4.0 focusing on the importance of preempting state securities processes for secondary trading among a bevy of other proposals to improve private capital.

Opposing any measure to provide private-market liquidity was a representative from the North American Securities Administrators Association (NASAA), a trade organization representing state-level securities agencies. The NASSA customarily opposes all access to private capital markets for retail investors and promotes additional burdens for accredited investors. It staunchly opposed the JOBS Act, filing numerous statements, comments, and press releases, at one point describing it as “an investor protection disaster waiting to happen.” Two NASSA members, Montana and Massachusetts, sued the SEC to stop implementation of Reg A+ with the NASSA in support as amicus curiae. They lost.

But this did not deter the committee, at least for Reg A+. They voted 9-1 in favor of a pilot program for Reg A+ to preempt state securities laws for secondary trading. The ball is now in the commissioners’ court. According to J.D. Alois of Crowdfund Insider, the committee should be “submitting a formal recommendation to the Commission in the coming weeks that outlines the need for preemption for Reg A+ securities.” The time has come for the SEC to act for small businesses. And Congress should complement this move by passing the JOBS Act 4.0.