Ostensibly in the name of investor protection, there is no shortage of new rules and enforcement actions coming from the Biden Administration’s Securities and Exchange Commission (SEC). The sheer volume and range of Chairman Gensler’s proposed regulatory agenda is dizzying and the negative impact it will have on our economy is difficult to quantify. In the first quarter of 2022, the SEC proposed only one less rule than it did during its most aggressive regulatory quarter ever, where it implemented portions of the ill-advised Dodd-Frank Act.
Though following the 2008 financial crisis, Congress and President Obama did get something right by enacting the bipartisan Jumpstart Our Business Startups (JOBS) Act, a bipartisan bill easing the regulatory burden of raising capital that helped arrest the then declining amount of small business formation. It is odd then that the Biden Administration’s SEC is pursuing an agenda that undercuts President Obama’s bipartisan achievement and that will devastate capital formation in the United States.
This harmful agenda is all the more unfathomable amid continued supply chain disruptions, acute labor shortages, an annual inflation rate that just reached a 40-year high, and a series of aggressive rate hikes from the Federal Reserve that will raise the cost of capital significantly and deter new businesses, that are already experiencing a credit shortfall, from obtaining the necessary financing to launch, grow, and scale. Since the COVID pandemic, the number of business startups skyrocketed to near 40-year highs, with many startups born of necessity from COVID lockdowns. Without more opportunities to access capital though, these numbers will likely prove temporary as many of these newfound businesses fail.
Undermining one of the reforms in the original JOBS Act that raised the thresholds for public company registration, the SEC has noticed its intent to alter its “held of record” rules, potentially changing the treatment of venture-capital and private-equity funds. This would effectively force companies into the expensive IPO process much earlier in their life cycle, which the SEC estimates to cost $2.5 million in the initial registration and $1.5 million in annual costs thereafter. Regrettably, the SEC’s new agenda is about to make public reporting even more expensive. By the SEC’s own estimates, it predicts that its recently proposed climate risk rule will result in an additional $6.5 billion of annual paperwork costs for public companies, nearly tripling the current expense incurred. The agenda contains several similar mandatory disclosures on cybersecurity, human capital management, corporate board diversity, and others that will raise the cost of public filings.
The SEC is also set to add more disclosure requirements to Regulation D securities offerings, one of the most important exemptions from public registration and a major avenue for young firms to raise capital. These offerings raised over $1.5 trillion in capital in 2019 alone according to the SEC, which is nearly 60% of all private capital raised that year. Additionally, the SEC is likely set to raise the thresholds for its accredited investor rules, further restricting investments in early-stage companies to only the wealthiest individuals in America and limiting the pool of possible investors. It is difficult to overstate the harm that these new regulatory changes to our private securities markets will cause to entrepreneurs seeking capital.
In order to ensure our economic recovery, Congress must not only oppose these proposals from the SEC, but must also steer the SEC toward its capital formation mission as was done nearly a decade ago under the JOBS Act. A particularly notable provision in that law allowed so called “emerging growth companies” (EGC) to take advantage of a less costly and burdensome disclosure regime in the early years following their IPO. Since 2014, nearly 90% of IPOs have come from businesses that qualify as EGCs and the benefit of this provision has been especially pronounced in the biotech industry which had 212 IPOs in the five years following the bill’s enactment compared to only 55 IPOs in the five years preceding it. Moderna was an EGC and its successful COVID vaccine, that was central to Biden’s pandemic response, might never have been developed if not for the IPO on-ramp. Indeed, with such pro-growth reforms, the unheard-of startup of today has the potential in less than ten years to become a leader in innovation and the next household name like Lyft, Carvana, or Instacart.
The new JOBS Act proposal released last month by Senate Banking Ranking Member Pat Toomey (R-PA) is a welcome path towards refocusing the SEC. In contrast to the SEC’s approach to accredited investors, Senator Toomey’s proposal would ensure that testing an investor’s knowledge is used as an alternative to the current income and wealth requirements, thus opening up investing opportunities for more individuals and expanding the number of individuals a startup can tap for capital. Another part of his proposal brings much needed regulatory certainty and relief to so called finders and private placement brokers who effectively connect entrepreneurs to accredited investors whom they would otherwise not have access. Crowdfunding introduced by the original JOBS Act would also be improved by preempting burdensome state securities law registration. A new “micro-offering” exemption would also enable businesses to raise small, but needed, amounts of capital without facing burdensome SEC filings. To be sure, these reforms will not solve all the challenges our startups currently face, but they will provide much needed relief for businesses looking to not just survive the pressures they’ve encountered but emerge stronger than ever.
At the signing of the original JOBS Act, President Obama stated that it represented an important step in the journey towards removing “a number of barriers preventing aspiring entrepreneurs from getting funding.” Given the significant challenges entrepreneurs now face, that journey needs to begin again. The JOBS Act and its several iterations have historically been bipartisan efforts. The new version likewise contains several bipartisan provisions and likely represents one of Congress’ last opportunities to make law before the midterm elections. Simply put, in order to secure a stronger economy tomorrow, Congress needs to pass another JOBS Act today.