On July 28, 2022, the SEC released its report from the 41st Annual Government-Business Forum on Small Business Capital Formation. The report provides a summary of the forum proceedings, including the recommendations developed by participants for changes needed to the capital raising framework and the SEC’s responses to the recommendations. The forum featured panelists and discussions on (i) empowering entrepreneurs with tools to navigate capital raising; (ii) hometown entrepreneurship, including how entrepreneurs can thrive outside of traditional capital raising hubs; (iii) how emerging fund managers are diversifying capital; and (iv) what to know and how to think ahead in the small cap world. The forum had a focus on diversity, including panel speakers and discussion topics. A clear message across the board is that women- and minority-owned businesses face the biggest challenges in the capital markets.
The SEC’s Office of the Advocate for Small Business Capital Formation launched in January 2019 after being created by Congress pursuant to the Small Business Advocate Act of 2016 (see HERE). One of the core tenants of the Office is recognizing that small businesses are job creators, generators of economic opportunity and fundamental to the growth of the country, a drum I often beat.
The Office has the following functions: (i) assist small businesses (privately held or public with a market cap of less than $250 million) and their investors in resolving problems with the SEC or self-regulatory organizations; (ii) identify and propose regulatory changes that would benefit small businesses and their investors; (iii) identify problems small businesses have in securing capital; (iv) analyze the potential impact of regulatory changes on small businesses and their investors; (v) conduct outreach programs; (vi) identify unique challenges for minority-owned businesses; and (vii) consult with the Investor Advocate on regulatory and legislative changes.
The SEC hosts the annual Government-Business Forum on Small Business Capital Formation pursuant to the Small Business Investment Incentive Act of 1980. The SEC delivers a report to Congress each year following the forum. Since its formation, the Office of the Advocate for Small Business Capital Formation has been responsible for the report’s preparation and dissemination.
Report on the 41st Annual Small Business Forum
Empowering Entrepreneurs with Tools to Navigate Capital Raising
The theme of empowering entrepreneurs centered around education and mentorship. Entrepreneurs lack proper resources to learn about and navigate capital raising options. In that regard, the forum made five recommendations to the SEC. Each recommendation and the SEC’s response is set forth below.
- Ensure capital raising rules provide equitable access to capital for underrepresented founds and investors.
SEC Response – The SEC’s response was noncommittal and vague, merely stating that it will consider the recommendation, including when proposing or implementing any changes to the exempt offering rules. The SEC notes that further changes to the exempt offering rules are on the latest regulatory Agenda (see HERE). The SEC last adopted final amendments updating the exempt offering rules and processes on November 2, 2020. I published a five-part blog on the series, including related to integration (HERE); offering communications (HERE); amendments to Rule 504, Rule 506(b) and 506(c) of Regulation D (HERE); Regulation A (HERE); and Regulation CF (HERE).
- Support entrepreneurs who lack the technical assistance to understand how to access traditional capital.
SEC Response – The SEC points to six online educational resources developed in partnership with the SEC, including (i) Capital Raising Hub – HERE; (ii) Cutting Through the Jargon – a glossary of terms – HERE; (iii) Navigate your options – HERE; (iv) Capital Trends Maps – HERE; (v) Building Blocks – HERE; and (vi) Emerging Fund Managers – HERE.
- Utilize technology and educational resources to help facilitate small business capital markets and decentralize and democratize capital markets.
SEC Response – As this recommendation is substantially similar to the one above, the SEC merely reiterated its response.
- In considering any changes to the private capital markets, ensure companies have viable pathways to access capital to allow growth and innovation.
SEC Response – The SEC ducks this recommendation by pointing out that investor protection and investor confidence in capital markets are of primary importance.
- Revise Regulation Crowdfunding to permit investment companies to conduct a Regulation CF offering.
SEC Response – The SEC lacks the authority to implement rules that contravene the Congressionally approved statutory language, which language, in turn, prohibits the use of Regulation Crowdfunding by investment companies.
Hometown Entrepreneurship Including how Entrepreneurs can Thrive Outside of Traditional Capital Raising Hubs
As a remote work environment has gained acceptance and popularity, both investors and entrepreneurs no longer look for opportunities that are geographically tied to traditional capital raising hubs such as Silicon Valley and New York City. Tech hubs have recently been successful in South Florida, the Midwest and Texas, for example, and local investing has gained traction. Native Americans face different challenges, including understanding their unique options and enticing investors for their businesses. The forum’s five recommendations and SEC responses include:
- Expand the accredited investor definition to achieve greater diversity among startup investors and entrepreneurs.
SEC Response – The SEC indicates it will consider it. I highly doubt any such changes will be made.
- Expand the accredited investor definition to include additional measures of sophistication.
SEC Response – In 2020, the SEC adopted amendments to the accredited investor definition, including allowing qualification based on certain professional certifications, designations, or credentials (see HERE). In a related order, the SEC designated holders in good standing of the Series 7 (Licensed General Securities Representative), Series 65 (Licensed Investment Adviser Representative), and Series 82 (Licensed Private Securities Offerings Representative) licenses as accredited investors. The SEC indicates it would consider adding additional certifications. Again, I highly doubt that will happen.
- Expand the accredited investor definition to include any person who invests not more than 10% of the greater of his/her annual income or net assets.
SEC Response – The SEC indicates it will consider it. I won’t hold my breath.
- In considering changes that raise the wealth thresholds in the accredited investor definition, consider the unintended consequences on access to capital in under-resourced and underrepresented communities.
SEC Response – The SEC indicates it will consider it. Although the recommendation will likely spark conversation in the anticipated rule changes that will most certainly raise the current financial thresholds in the accredited investor definition, that conversation will merely be an explanation as to why it is okay to disregard the recommendation.
- Finalize the Commission’s finder’s order.
SEC Response – In October 2020, the SEC proposed an exemptive order that would permit natural persons to engage in certain limited activities involving accredited investors without registering as a broker-dealer (see HERE.) The proposal did not materialize into a final rule and has since been dropped from the regulatory agenda. The SEC does not even try to give false hope on this one. The proposal is dead – at least for now.
How Emerging Fund Managers are Diversifying Capital
The success of fund managers depends on attracting institutional limited partners as investors. However, the total available institutional dollars for investment in these funds is limited and highly competitive with black, brown, Asian, indigenous and other minority founders have the most difficulty gaining access. The five forum recommendations and SEC responses are as follows:
- Create a new private fund exemption to allow states to foster intrastate and regional funds focused on community-based investing that is open to non-accredited investors.
SEC Response – The SEC will consider it.
- Increase the thresholds (number of investors and cap on fund size) allowed in 3(c)(1) funds to achieve greater diversity among startup investors and entrepreneurs.
SEC Response – A 3(c)(1) fund is a type of pooled investment vehicle that is excluded from the definition of “investment company” under the Investment Company Act of 1940 because it has no more than 100 beneficial owners. The SEC then notes that any amendments to the ’40 Act would require Congressional action.
- Support underrepresented emerging fund managers—specifically minorities and women—building funds that diversify capital allocators, engage sophisticated investors, and challenge pattern matching trends.
SEC Response – Since the recommendation is itself vague, it gave the SEC a lot of room to argue it already provides support. The SEC points to the six websites discussed above and talks about efforts to engage with diverse communities, including investors in the disability community, ethnic-based groups, veterans, and young adults.
- Increase the number of investors allowed in 3(c)(1) funds above 99 investors.
SEC Response – Any amendments to the ’40 Act would require Congressional action.
- Support underrepresented and emerging fund managers and their investors through targeted resources, in collaboration with other federal agencies.
SEC Response – Just like number 3 above, this recommendation was vague and elicited the same response from the SEC as above.
What to Know and How to Think Ahead in the Small Cap World
The theme of the forum in this area, like others, is diversity including through the composition of the board of directors. Moreover, the forum is looking for ways for small public companies to be included with institutional investors and indexes. The five recommendations and SEC responses include:
- Modernize Section 17(b) of the Securities Act to warn against pump-and-dump schemes by requiring additional disclosure about paid stock promotion.
SEC Response – Section 17(b) requires promoters to disclose information related to compensation. Any amendments to Section 17(b) would require congressional action.
- Consider the impact of the proposed environmental, social, or governance (ESG) regulations on small and medium-sized companies, including whether such requirements will discourage companies from going public.
SEC Response – The SEC believes it is doing so already by excluding smaller reporting companies from Scope 3 emissions disclosures in its proposed climate disclosure rules. On March 21, 2022, the SEC proposed rules that would require publicly reporting companies to include certain climate-related disclosures in their registration statements and periodic reports. The rules are extremely robust and resulted in my longest blog series to date – eight segments. The entire series can be read here – Part 1 – HERE; Part 2 – HERE; Part 3 – HERE; Part 4 – HERE; Part 5 – HERE; Part 6 – HERE; Part 7 – HERE; and Part 8 – HERE.
- Modernize regulation of transfer agents in response to technological and market advancements to increase disclosures made available to broker-dealers to facilitate liquidity for smaller public companies while continuing to protect investors.
SEC Response – In 2015 the SEC published an Advance Notice of Proposed Rulemaking and Concept Release related to transfer agents (see HERE). The SEC indicates it is still considering a rule change (though I note it is not on the regulatory Agenda).
- Increase transparency around short selling activities and improve short sale data.
SEC Response – On February 25, 2022, the SEC proposed a new rule and related form designed to provide greater transparency through the publication of short sale-related data to investors and other market participants. Under the rule, institutional investment managers that meet or exceed a specified reporting threshold would be required to report, on a monthly basis using the proposed form, specified short position data and short activity data for equity securities.
- Collaborate with NSCC, DTCC, clearing firms, and broker-dealers to improve the clearing and settlement process for small public companies.
SEC Response – The SEC is open to ideas.
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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