“Legislative Proposals to Enhance Capital Formation and Reduce Regulatory Burdens”

APRIL 29, 2015


Download Annotated Testimony (pdf)


Good Afternoon, Chairman Garrett, Ranking Member Maloney, and Members of this Subcommittee, on behalf of the North American Securities Administrators Association, Inc. (NASAA), I am pleased to submit this statement to the House Committee on Financial Services for inclusion in the record of the hearing entitled “Legislative Proposals to Enhance Capital Formation and Reduce Regulatory Burdens,” held on April 29, 2015 by the Subcommittee on Capital Markets and Government Sponsored Enterprises.

NASAA was organized in 1919, and is the oldest international organization devoted to investor protection. Its membership consists of the securities administrators in the 50 states, the District of Columbia, Canada, Mexico, Puerto Rico and the U.S. Virgin Islands, and its mission is to serve as the voice of securities agencies responsible for grassroots investor protection and efficient capital formation.

State securities regulators have protected Main Street investors for the past 100 years, longer than any other securities regulator. Ten state securities regulators are appointed by Secretaries of State, five are under the jurisdiction of their states’ Attorney General, several are appointed by their Governors and cabinet officials and others work for independent commissions or boards. State securities regulators closely interact with the business community and investors in their state, fostering a collaborative relationship with compliant registrants through accessibility and communication.

Collectively and individually, state securities regulators enforce state securities laws by investigating suspected investment fraud, and, where warranted, pursuing enforcement actions that may result in fines, restitution to investors and jail time. State securities regulators ensure honest financial markets by licensing registrants – both firms and investment professionals – and conducting ongoing compliance inspections and examinations. They work with issuers to ensure that securities offerings include legally required disclosures, thus resulting in a transparent and fluid securities market.

State Securities Regulators and Capital Formation

NASAA members are at the forefront of fostering capital formation for small businesses, entrepreneurs and investors in their state. We share Congress’ desire to improve the U.S. economy through improved access to capital for small and emerging businesses. The reality of new technologies, new modes of investing, and a global, interconnected marketplace, requires new ideas and creative solutions. Toward this shared goal, state securities regulators and NASAA have been involved in numerous efforts to facilitate capital formation, promote U.S. job growth and protect investors.

State regulators provide a level of accessibility to local, small business issuers and investors that is unavailable from any federal regulator. In Washington, for example, the Securities Division conducts sustained outreach to entrepreneurs, small business development centers, and other local groups regarding vital information that businesses need to know if they are contemplating raising capital. We provide assistance through all stages of a growing company’s business operations, from formation through the issuance of securities, and help to ensure that small businesses have access to the capital needed to start or grow their business in a manner consistent with both state and federal regulations.

State securities regulators also are accountable to residents of their states, including both investors and local businesses that seek to raise capital. We must answer questions from investors, businesses, local legislators, and the local media regarding offerings that have been registered, as well as those that have not been granted registration. This accountability factors into the way state securities regulators review applications for registration, including the adequacy of disclosures to prospective investors.

Before commenting on the specific proposals before the Subcommittee today, I would like to take an opportunity to update the Subcommittee on some recent and exciting steps NASAA and its members have undertaken to promote responsible capital formation in your districts and communities.

Establishment of Electronic Filing Depository System
Last fall, NASAA implemented an electronic filing system called the Electronic Filing Depository (EFD) to allow private company issuers to electronically file a Form D for Regulation D, Rule 506 securities offerings in one or more states. This system interfaces with the SEC’s EDGAR system and enhances the efficiency of the regulatory filing process for certain exempt securities offerings. It also allows the public to search and view, free of charge, state Form D filings.

Coordinated Review for Regulation A Offerings
NASAA successfully designed a modernized and simplified review process for Regulation A offerings. NASAA’s “Multi-State Coordinated Review Program,” which was first implemented in April 2014, allows for filings to be made in one place and distributed electronically to all states. Coordinated Review also sets up a streamlined and coordinated review process among all the states in which an issuer has filed.

Intrastate “Crowdfunding” and Related State Exemptions
As of today, 23 states and the District of Columbia have enacted state-based “equity” crowdfunding laws, or other limited offering exemptions, and more than a dozen other states are working on similar laws. While equity crowdfunding on a federal level is not yet legal, states have found creative ways to work within existing federal exemptions to enable local businesses to reach potential customers.

NASAA Capital Formation Roundtable
Next month, NASAA will host a Capital Formation Roundtable in Washington, DC that will bring together state securities regulators and stakeholders from private industry, the public sector, and academia. The Roundtable will be attended by small business owners, entrepreneurs, practitioners, representatives of venture capital, representatives of several major exchanges, and others. One goal of the Roundtable is to create a forum within which NASAA members can learn more about the priorities of these stakeholders, and work with them to help shape the future of capital formation at the state level. NASAA is very excited about the new initiative.

NASAA Comments on Legislation Now Before the Subcommittee

Today’s hearing involves 12 legislative proposals that address different aspects of securities and banking law. Several of the proposals are new, or significantly amended versions of legislation introduced and discussed in previous years. I will address each proposal as it relates to the securities laws and investor protection.

In addition, a number of bills before the Subcommittee closely resemble legislation that was considered but not enacted during the 113th Congress. Although NASAA previously testified regarding certain of these proposals, including at hearings held by this Subcommittee, I will address these proposals in my statement today as some members of the Subcommittee have expressed continued interest in NASAA’s views.

Finally, there are several bills before the Subcommittee about which NASAA has no position. I will not address the merits of those bills in my statement.

1. The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act of 2015 (H.R. 686)

Over the past five years, state securities regulators have worked closely with the American Bar Association, M&A practitioners, and other stakeholders, to fashion a streamlined registration framework for persons acting as M&A brokers. These collaborations served as the basis for the development of a state model rule which exempts M&A brokers from state securities registration pursuant to certain conditions, as well as for legislation introduced in the 113th Congress, H.R. 2274.

As originally proposed in the 113th Congress, H.R. 2274 would have established a statutory exemption for M&A brokers, subject to key features, including: (1) the establishment of a streamlined electronic registration requirement with the Securities and Exchange Commission (“SEC”); (2) the disqualification of any broker or an associated person who is subject to suspension or revocation of registration; (3) the inapplicability of the exemption to any M&A transaction where one party or more is a shell company; and (4) the inapplicability of the exemption to M&A transactions involving a company with earnings in excess of $25 million, and gross revenue in excess of $250 million.

NASAA was pleased to support H.R. 2274 when it was introduced in the 113th Congress as it struck a good balance between the legitimate interests of all stakeholders while maintaining vital protections for investors and businesses. Unfortunately, when that bill was considered by the Financial Services Committee on November 14, 2013, the Committee adopted an amendment that removed key investor protections, including the bill’s statutory “bad actor” disqualification provision, prohibitions on “shell” transactions, and a requirement for electronic registration by notice filing with the SEC. These changes prevented NASAA from supporting the legislation when it was considered by the full House on January 14, 2014.

The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act of 2015, H.R. 686, is identical to the amended version of H.R. 2274 that passed the House in the 113th Congress. Therefore, NASAA does not support the bill. In its current form, the legislation lacks the key investor protection features discussed above, including a basic and critical provision disqualifying “bad actors” from the registration exemption established by the bill.

Although state securities administrators are disappointed that we cannot support H.R. 686 as presently constituted, we continue to recognize a valid basis for a responsible statutory exemption from registration for persons acting as a broker in many M&A transactions. Moreover, we note that there appears to be consensus among many stakeholders that there could be bipartisan support in Congress for legislation that restores the investor protections noted above, and which NASAA could also support. In the event that the House were to amend H.R. 686 to restore the bad-actor disqualification and prohibition on “shell transactions,” consistent with the earlier House bill, and recently introduced Senate legislation, NASAA would be pleased to revisit its position.

2. The Reforming Access for Investments in Startup Enterprises Act of 2015 (H.R. 1839)

H.R. 1839 would add a new transactional exemption in Section 4 of the Securities Act of 1933 (“Securities Act”) for secondary market sales by any person other than an issuer, underwriter, or dealer. It would also require that if securities are “offered” through the use of any general solicitation or advertising under this new exemption, all such sales “are made through a platform available only to accredited investors.” Finally, it would preempt state authority to review and/or exempt these secondary sales.

NASAA commented on a discussion draft in the 113th Congress—the Startup Capital Modernization Act of 2014, which contained one provision with language nearly identical to H.R. 1839. State securities regulators are very sensitive to the desire for increased liquidity for holders of unlisted securities and understand the interest in this type of an exemption, but after a close review of H.R. 1839, we continue to have concerns regarding important investor protections.

Exemptions are subject to the antifraud provisions of the Securities Act, which generally make it unlawful to offer or sell a security without fully disclosing all material facts. Exemptions are based on the principal that securities registration is not necessary because of available and effective alternative oversight to ensure quality control, a pre-existing relationship between the company and potential investors (i.e., employees or current securities holders), or the offering is made to investors that meet minimum financial thresholds and are thus presumably capable to evaluate a private securities offering and do not need the full protection of the securities registration.

H.R. 1839 would create a new transactional exemption under the securities laws for certain secondary sales. With respect to nonpublic companies, it will be very difficult for a selling security holder (i.e., not the issuer) to obtain and provide to a subsequent purchaser the information necessary to fulfill the requirement that all material facts be disclosed, as sources of information such as the 10-K and 10-Q are unavailable. Further, the disclosures that the selling security holder received through a private placement memorandum or other disclosure document when he or she acquired the security may be significantly out-of-date. Moreover, an issuer may not have, or may not be willing to reveal, material information about the company to a purchaser with whom it is not familiar.

We note that this bill, unlike the discussion draft last year, proposes to allow securities holders to generally solicit and advertise to prospective purchasers, so long as the sale is made through a platform only available to accredited investors. We are concerned about allowing individual investors to resell their shares by generally soliciting the public when such selling security holders do not need to meet the protective standards for broker-dealers. We further note that the bill allows for general solicitation without any subsequent verification requirements that the persons being solicited also meet the income and net worth standards applicable to accredited investors. Issuers would be able to rely on self-made representations by purchasers concerning their status as accredited investors, which could be buried in user or subscription agreements, in contrast to the heightened verification standards under Rule 506(c).

We are concerned that the legislation lacks a definition or qualification standards for the “platform,” as compared to a registered broker-dealer. Similarly, there is neither a filing requirement nor qualification standards for the individual holder of securities to sell their shares through the platform. This is particularly troublesome when an investor sells their investment without providing the new purchaser with current, material information. As currently drafted this legislation appears to be focused on facilitating a business model built around secondary sales of privately issued securities while omitting significant investor protection. To be successful, capital formation measures must include investor protection provisions as such provisions foster confidence in companies and the markets. Moreover, because the bill deems these transactions as a “covered security” and thus preempts state review or applicable state exemptions, NASAA is concerned about the potential repercussions for investors who may be defrauded or subject to other unethical conduct. As with Regulation D, Rule 506 offerings, state securities regulators will only be able to take action after the fraud or unethical conduct has occurred, and in almost all such instances the investors’ funds will be unrecoverable.

We want to make the Subcommittee aware that under state law, there are at least 10 exemptions from securities registration for secondary transactions available to selling security holders. One popular exemption for selling securities holders is the “manual exemption.” This exemption has important investor protections that we strongly recommend as this Committee evaluates the bill. The manual exemption requires that (a) the transaction to be offered and sold through a broker-dealer; (b) the securities have been outstanding in the hands of the public for at least 90 days; (c) the issuer is in fact engaged in business (and is not in bankruptcy or receivership, and not a blank check, blind pool, or shell company with no specific business plan); (d) the security is sold at a price reasonably related to its current market price; (e) the security does not constitute whole or part of an unsold allotment; (f) a nationally recognized securities manual or a publicly available record filed with the SEC contain the following information: (i) description of business and operations, (ii) names of executive officers and directors, (iii) audited balance sheet dated within 18 months of the transaction, and (iv) audited income statements for two prior fiscal years (or shorter period since existence), and (g) the issuer must meet one of the following: (i) it has a class of equity securities listed on a national securities exchange or designated for trading on the NASDAQ, (ii) it has been engaged in continuous business for at least 3 years, or (iii) it has total assets of at least $2,000,000 based on audited balance sheet dated within 18 months of transaction. There are no state filing requirements under this exemption.

We continue to have concerns about the lack of transparency (i.e., platform qualifications standards, purchaser verification requirements and information disclosures) contained in this new exemption, and look forward to discussing with the Subcommittee those investor protections that we consider paramount to a workable exemption, even where the sale is made to an accredited investor. We also urge the Subcommittee to remove any state preemption so that states can tailor their own exemptions, with appropriate investor protections, to any new exemption enacted under federal law.

3. The Small Business Investment Company Advisers Relief Act of 2015 (H.R. 432)

The Small Business Investment Company Advisers Relief Act of 2015 would amend the Investment Advisers Act of 1940 to expand the registration exemption under §203(l) so that it would exempt persons who are advisers to both venture capital funds and small business investment companies (“SBICs”). The bill would also exclude SBIC assets from the SEC registration threshold calculation for private funds under Section 203(m), and preempts state regulation of SBIC fund advisers.

As NASAA previously testified when the Subcommittee was considering similar legislation in the 113th Congress, state securities regulators appreciate that, on its face, H.R. 432 does not appear to directly impact retail investors. However, we are concerned that the contemplated preemption of state law would exempt advisers of SBICs from all state and federal registration focused on investor protection. Further, we remain concerned that removal of all forms of state and federal securities oversight of persons acting as the adviser of SBIC funds, as would be achieved under this bill, could have unforeseen downstream effects on the securities markets which might negatively impact retail investors. Therefore, should the Committee take action on H.R. 432, we recommend that the bill be amended to permit states the option of requiring the registration of any person acting solely as an adviser to an SBIC.

4. The Disclosure Modernization and Simplification Act of 2015 (H.R. 1525)

The Disclosure Modernization and Simplification Act would direct that the SEC permit issuers to submit a summary page as part of a Form 10-K filing in order to make annual disclosures easier to understand for current and prospective investors. It would also direct the SEC to reform Regulation S-K and tailor its disclosure rules as they apply to smaller issuers and Emerging Growth Companies.

In reviewing the SEC website, it does appear that Form 10-K cross-referencing by hyperlink is already widely used on the Electronic Data-Gathering, Analysis, and Retrieval (“EDGAR”) system. There has been bipartisan dialogue and scholarly debate about whether a one-size-fits-all reporting requirement makes sense for all issuers, especially for those reporting requirements that may be cost-prohibitive or inapplicable to issuers of smaller size (i.e. some environmental impact disclosures). We further note and appreciate that the sponsor has included provisions in H.R. 1525 that were recommended by NASAA last year, and adopted by the Committee during its consideration of similar legislation in the 113th Congress, which ensure that any revisions made to Regulation S-K by the SEC as a result of legislation shall continue to provide “all material information” to investors.

State securities regulators do not oppose the Disclosure Modernization and Simplification Act.

5. The Encouraging Employee Ownership Act of 2015 (H.R. 1317)

The Encouraging Employee Ownership Act directs the SEC to amend Rule 701 to increase the amount of securities that may be sold from $5 million to $10 million in a 12-month period, before the additional disclosures must be made. Rule 701, adopted pursuant to Section 3(b) of the Securities Act of 1933, provides an exemption from the registration requirements of the Securities Act for securities offered to employees or consultants pursuant to a written compensatory employee benefit plan or a written contract by an issuer that is a non-reporting company (i.e., a non-public issuer) under the Exchange Act. The purpose of Rule 701 is to facilitate the use of securities as compensation to employees for private companies, including start-ups.

Because NASAA commented extensively on similar legislation in testimony to this Subcommittee last year, I will not address it at length today. I would, however, respectfully refer interested members of the Subcommittee to pages 22-24 of my Written Testimony from that hearing on May 1, 2014.

6. The Small Business Freedom and Growth Act of 2015 (H.R. 1723)

The Small Business Freedom and Growth Act would require that the SEC revise Form S–1 to permit a smaller reporting company to incorporate by reference documents filed in a registration statement with the SEC. NASAA and state securities regulators participate in the SEC’s Advisory Committee on Small and Emerging Companies and the SEC’s Forum on Small Businesses Capital Formation. We understand that allowing incorporation by reference is a policy change that has been supported by many other participants. We also recall that last year Professor John C. Coffee advised the Subcommittee that such a reform, on its own, “could have real efficiency justifications and could help smaller issuers.” State securities regulators do not oppose H.R. 1723, although we strongly recommend that Congress consult the SEC prior to enacting legislation resulting in major changes to the use and application of Form S-1.

7. The Small Company Disclosure Simplification Act of 2015 (H.R. 1965)

Extensible Business Reporting Language (“XBRL”) is an electronic reporting language that assigns unique electronic identifiers to individual items in an issuer’s financial reports, thereby making such data more interactive. This interactive financial data can allow investors, analysts and regulators to retrieve and use financial information in documents filed with the SEC. Any investor with a computer and an internet connection will have the ability to acquire and download interactive financial information that has generally been available only to large institutional users. In early 2009, the SEC published three final rules requiring XBRL tagging of certain disclosure information for operating companies, mutual funds, and credit rating agencies. The Small Company Disclosure Simplification Act would delay by five years from its enactment the date by which those rules would become effective, for companies with total annual revenues of less than $250 million. The bill would further require the SEC to analyze the costs and benefits of requiring companies of this size to file reports in XBRL format.

As a general matter, like the SEC’s Investor Advocate and the SEC’s Investor Advisory Committee, NASAA favors requirements regarding the use of XBRL and other protocols that maximize meaningful disclosure and improve its usefulness to investors. At the same time, as NASAA previously has testified, state securities regulators agree that the cost of XBRL reporting requirements should be reasonable, and that these costs should yield a justifiable benefit.

NASAA supports and encourages the SEC to provide sufficient regulatory analysis of the costs and benefits associated with XRBL reporting. However, we do not believe that Congress should enact legislation to unnecessarily further delay implementation of XBRL reporting for many companies that would be covered by H.R. 1965, the effect of which would be to exclude the XBRL filing requirements for more than 60 percent of all public companies. As SEC Investor Advocate Rick Fleming noted in discussing similar legislation considered in Congress earlier this year: “We should not expect the next generation of American investors to scroll through hundreds pages of disclosure to find the information they need to make investment decisions. Private companies would not display critical information to their customers in this manner, and American investors have a right to expect their government to do better.”

8. The Improving Access to Capital for Emerging Growth Companies Act (Discussion Draft)

Finally, NASAA would like to comment on the discussion draft legislation affecting emerging growth companies (“EGCs”). We commented on a similar draft in the 113th Congress, and noted that it would further relax reporting requirements for EGCs. In the draft proposed in the 113th Congress, EGCs would have benefited from a dramatic shortening of the window of time between the completion of a confidential filing with the SEC and the beginning of the “road show” marking its initial public offering (IPO). We noted that the shortening of the required waiting period from 21 days to five days may be beneficial for issuers, as it reduces the likelihood of external events impacting the offering; however, the 21-day period is already a relatively short window of time. Moreover, non-EGC companies seeking to go public do not even enjoy an opportunity for confidential review. Although we do not believe a shorter window is necessary, we were pleased to see it increased from five to 15 days in this new draft.

The JOBS Act authorized EGCs to submit registration documents to the SEC for review on a confidential basis prior to an IPO. The proposed legislation, however, would permit EGCs to enjoy this same “confidential review” privilege for follow-on offerings of securities issued after the IPO. It would also lengthen the grace period for changing a company’s status from an EGC to a non-EGC at the earlier of consummating an initial IPO or the end of the one-year period beginning on the date the company is no longer an EGC. When Congress established the mechanism for EGCs to obtain confidential SEC review of registration documents under the JOBS Act, its expressed purpose was to encourage companies to go public. It is not clear why the privilege should now be extended to companies that, by definition, have already successfully completed an IPO. Moreover, it is not clear why the privilege should be extended for a one-year period after disqualifying for EGC status and not completing an IPO. If a company no longer qualifies for EGC status (i.e., it has annual gross revenues of less than $1 billion in its most recent fiscal year and does not retain that status under four additional circumstances set forth in the JOBS Act), it should not be entitled to continued relief from important financial and risk disclosures applicable to public reporting companies.

The bill also requires that EGCs be permitted to file registration documents for confidential SEC review that “omit financial information for historical periods otherwise required by regulation S-X.” Accounting scandals have shaken public confidence in the markets and demonstrated the critical importance of complete and accurate financial reporting. Such an omission of historic financial information runs counter to the interests of investors, the public, and or our capital markets. We would also note that this draft requires reporting of historical financial information prior to the public filing of a Form S-1 rather than, as in the prior draft, prior to delivery of a preliminary prospectus. At a minimum, such information should be provided to investors reviewing the details of the business and the transaction in the preliminary prospectus. The success of our capital markets is based on full, complete and transparent information that is readily available and accessible for investors to digest prior to investing.


Thank you again, Chairman Garrett, and Ranking Member Maloney, for the opportunity to provide a Statement to the Subcommittee today.