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Core Principle Two

Policies Intended to Spur Capital Formation Must Balance the Need to Maintain Investor Protection

  • Congress Must Strengthen Investor Protections that Were Weakened by the JOBS Act to Minimize the Act’s Enormous Potential for Abuse
  • Congress Should Mandate the Filing of Form D in Private Securities Offerings Exempt from Registration Under Rule 506
  • Congress Should Amend the Securities Exchange Act of 1934 to Allow for a Private Civil Action Against a Person that Provides Substantial Assistance in Violation of Such Act

The facilitation of access to capital for new and small businesses is a worthy goal. Small businesses, including startups with high growth potential, continue to have difficulty obtaining access to capital, and policymakers are justified in exploring new and innovative ways to help them. However, if Congress legislates in this area, it is imperative that it do so in a careful and deliberate fashion that balances the goals of capital formation with investor protection.

State securities regulators support the idea that the opportunity to invest in small businesses, including emerging businesses, should exist for all investors as long as they understand the risk involved and have the financial ability to absorb attendant losses. However, small and emerging businesses, by definition, carry extreme risk, and it is very difficult for most retail investors to evaluate or price this risk. Indeed, statistics show that roughly 50 percent of small businesses fail within the first five years. Moreover, within this risky sector of small business investment, start-up businesses without a track record are particularly speculative and subject to failure.

If efforts to promote access to investment capital for small businesses are to be successful, investors need to be confident that they are protected to the fullest extent possible from fraud and undisclosed risk. Such assurance encourages investment, and in turn, increases the availability of investment capital. Conversely, hasty and ill-considered deregulation of public securities offerings, even when undertaken with the best intentions, can have devastating consequences for investors and businesses alike. In the absence of adequate attention to investor protection, policies that are intended to aid small businesses by helping them attract capital are likely to have precisely the opposite effect.

Congress Must Strengthen Investor Protections that Were Weakened by the JOBS Act to Minimize the Act’s Enormous Potential for Abuse

The 112th Congress passed the JOBS Act in an effort to make it easier for small and emerging companies to raise capital and grow. In doing so, many Members of Congress expressed concern about the deterioration of long-standing investor protections. The 113th Congress should take steps to enhance investor protections; otherwise, investors will distrust the market, and the intent to increase capital for small businesses will be thwarted.

The removal of the ban on “general solicitation” in offerings conducted under Rule 506, as mandated in Title II of the JOBS Act, dismantles an important investor protection. NASAA believes that elimination of the ban warrants a corresponding increase in dollar thresholds in the accredited investor definition, and that Congress should mandate such a change. Congress also should ensure that clear guidance is given to issuers regarding the reasonable steps that are necessary to verify that purchasers are accredited investors. In addition, a Form D should be filed prior to the use of any general solicitation, and reasonable restrictions should be placed on advertising, including performance advertising for private funds.

SEC rulemaking on crowdfunding offerings, as authorized under Title III of the JOBS Act, should similarly reflect a uniform and balanced regulatory approach. For crowdfunding to be successful, regulations must create a framework that minimizes unnecessary burdens on small businesses while simultaneously insulating investors from fraud and abuse. Given the potential for huge numbers of unsophisticated investors to participate in crowdfunded offerings, and in view of the anticipated lack of regulatory oversight these public offerings will receive, NASAA believes that high standards must be in place for issuers and funding portals or intermediaries.

Congress Should Mandate the Filing of Form D in Private Securities Offerings Exempt from Registration Under Rule 506

In Section 926 of the Dodd-Frank Act, Congress set forth a process to disqualify “felons and other bad actors” from conducting private securities offerings under Rule 506 of Regulation D. The adoption of a disqualification provision would provide much needed investor protection and would not be detrimental to legitimate issuers. Recidivists rightfully should not be allowed to conduct private securities offerings under the safe harbor exemption provided by Rule 506.

NASAA welcomes this change, especially after state regulators were preempted under the National Securities Markets Improvement Act (NSMIA) in 1996 from weeding out recidivists from Rule 506 offerings. In the post-NSMIA era, small business issuers are using Rule 506 almost exclusively for Regulation D offerings. Although properly used by many legitimate issuers, the exemption has become an attractive option for individuals who would otherwise be prohibited from engaging in the securities business. Today, the exemption is being misused to steal millions of dollars from investors through false and misleading representations in offerings that provide the appearance of legitimacy without any meaningful scrutiny of regulators. NASAA believes that Congress should require similar disqualification provisions to all other offerings made under Regulation D. This will assist states in keeping recidivists from selling securities to residents of their states.

Congress also can protect investors by requiring the filing of a Form D for each Rule 506 offering. Under current federal securities law, filing a Form D with the SEC and state securities regulators is not a condition to the availability of the Rule 506 exemption. In fact, because filing a Form D currently is not a condition of any Regulation D exemptions, it is hard for regulators and the public to use the filing or non-filing of a Form D as an indicator of securities law compliance. The fact that filing is not currently a condition of the exemptions at the federal level also creates confusion as to the necessity of filing with the SEC as well as the states and serves as a roadblock to enforcement efforts.

Congress Should Amend the Securities Exchange Act of 1934 to Allow for a Private Civil Action Against a Person that Provides Substantial Assistance in Violation of Such Act

The 113th Congress should enact The Liability for Aiding and Abetting Securities Violations Act. This important legislation, first proposed in 2009 by former Senator Arlen Specter and reintroduced in 2010 by Representative Maxine Waters, would amend the 1934 Act to establish a private right of action for aiding and abetting violations of federal securities laws.

Congress always has recognized private actions as a means of achieving the investor protection goals underlying securities laws. Private actions afford victims of fraud the best and often only hope of recovering their losses, which governmental enforcement programs are ill equipped to do on a large scale. By exposing all parties responsible for fraud, including those who provide substantial assistance, such legislation will not only help deter future violations, but may afford some recovery to those who have lost their investments and often their life savings.

Court cases have recently severely restricted aiding and abetting liability in private actions. These restrictions resulted from an overly narrow interpretation of the anti-fraud provisions set out by Congress. Where claims of fraud lie within the statutory boundaries set by Congress, there is no justification for such a narrow interpretation that further limits the ability of investors to seek relief.

Allowing private litigants to bring fraud claims against those who have aided and abetted such fraud will ensure that investors have meaningful private remedies in federal court. Given the marked rise in the incidence of corporate fraud and securities law violations affecting large classes of investors, the need for a partial legislative response is apparent. The balance has been tipped too far in favor of preventing claims rather than protecting investors who have suffered losses. Legislative action allowing federal relief is even more important in light of restrictions placed upon state law to provide an alternative remedy. In view of the massive corporate fraud that has surfaced in recent years, and because alternate forums for aggrieved investors remain limited, it is especially important that Congress provide meaningful remedies to victims of securities fraud.


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