Congress should work to restore the preeminence of the U.S. public securities markets and enact reforms to enhance regulatory oversight of the private markets.
The U.S. public markets remain the gold standard among the world’s capital markets in large part due to the high standards for companies in reporting material information. In recent years, the private securities markets have eclipsed the public markets in the capital raised for new and emerging companies. Congress should ensure the preeminence of the U.S. public markets, including resisting measures to water-down current regulatory standards while also enacting measures to provide greater transparency of the private markets. As private markets expand as the result of regulatory policies pursued by the SEC, Congress has an obligation to review the rules under which these markets operate and the protections in place for investors.
Reinforce the Primacy of the Public Securities Markets.
Over the course of the last decade, there has been an unprecedented expansion of the private markets, which has reduced the number of initial public offerings (IPOs) and thereby concentrated retail investors in larger companies.[i] Additionally, there has been a significant increase in the number of so-called “Unicorns” or privately held companies with a valuation of a billion dollars or more.
The investing public has a strong interest in robust public securities markets, which continue to be comparatively vibrant and healthy. If these markets are to remain so in the coming years, however, Congress must ensure that large and rapidly growing companies have appropriate incentives to raise capital via the public securities markets.
Companies, investors, and the public more broadly, all benefit when companies operate in the public securities markets. Investors receive transparency and equitable access to the markets, while companies gain greater access to capital, with more accountability and more robust corporate governance. Regulators and policymakers, in turn, are provided real-time market information to guide their decision-making.
As Congress considers how best to promote growth in the number of companies in the U.S. public markets, its first step should be to reform Section 12(g) of the Exchange Act, [ii] which specifies financial reporting thresholds. Congress raised the initial reporting threshold from 500 shareholders to 2000 shareholders in 2012,[iii] which now encourages large, privately-held companies to remain private for extended periods, or even indefinitely.[iv] Congress should revise and reform this rule to align its incentives with the goal of vibrant public markets.
Reform the Private Securities Markets.
Congress should enact long-overdue improvements to promote greater transparency for investors and regulators in the marketplace for private offerings under Rule 506 of Regulation D under the Securities Act of 1933 (Securities Act). Specifically, Congress should require the SEC to gather important data regarding the private placement markets through enhancements to the “Form D,” and require the filing of the form as a condition of relying on the relevant exemption. This and similar protective revisions to the rule would benefit not only investors, but legitimate issuers and promoters who use private offerings to raise capital.[v] Indeed, the Commission itself has recognized the acute problem surrounding the lack of reliable data regarding Regulation D offerings[vi] – the largest segment of the exempt offerings markets – but has nevertheless not taken steps to gather more relevant data, such as requiring prefiling and post-closing Form D filings from issuers to obtain more complete data.
Revise the Accredited Investor Definition.
Congress and the SEC should be focused on promoting and expanding the public markets rather than incentivizing issuers to raise capital in the private markets. In 2020, the SEC missed an opportunity to realign incentives toward public offerings and thereby failed to fulfill its mandate to protect investors, by neglecting to address long-overdue changes to the wealth and income standards defining accredited investors. Instead, the Commission adopted sweeping new rules aimed at expanding the number of natural persons who qualify as accredited investors. After nearly four decades of inaction by the SEC, the 117th Congress should enact legislation to update the existing income and net-worth standards used to determine accredited status,[vii] while prohibiting the SEC staff from further expanding the accredited investor definition pursuant to authority established in its 2020 rule adoption.
Standardize Environmental, Social, and Corporate Governance (ESG) Disclosures.
Securities laws currently require the disclosure of information material to investors in their decision-making process. Increasingly, investors view a company’s environmental impact as a material metric for determining whether to invest.[viii] To date, however, there are no uniform standards for reporting on environmental impact. In the absence of such standards, companies may make selective or misleading disclosures about the environmental benefits of their products or services to make the company appear to its investors to be more environmentally friendly than it really is, a phenomenon also known as “greenwashing.” The result is investor confusion.
The time has come to provide investors that are seeking to understand factors such as a company’s environmental impact with the ability to accurately understand and weigh ESG risks in their investment decisions, and Congress can play an important role in this regard.[ix] Congress should direct the SEC to promptly develop a uniform standard for all reporting by public companies regarding climate risks so that investors can understand companies’ real environmental impact record, and make “head-to-head” comparisons between competing investments.[x] Congress should also consider passing legislation that would direct the SEC to establish a task force to consolidate, to the extent possible, themes from existing reporting frameworks and standards in order to catalyze faster progress toward standardization. Such an approach has proven constructive in other nations, and there is reason to believe it could play an important role in “moving the ball forward” in the U.S. as well.[xi]
Enhance Cybersecurity Risk Disclosures.
Congress should incentivize publicly traded companies to consider whether they have appropriate cybersecurity expertise on their governing body.[xii] Doing so is a common-sense way to promote greater attention to cybersecurity risk by public corporations. Investors and customers are well-served by policies that encourage companies to consider such risks proactively, as opposed to reacting to a data breach that has already occurred and harmed investors and customers.[xiii]
[i] Incredibly, private offerings once comprised just a small fraction of the overall market for securities, but today they serve as the primary source of investment capital for many businesses and have vastly exceeded the capital raised in public markets. According to the SEC, in 2018, public offerings accounted for $1.4 trillion of new capital, compared to the approximately $2.9 trillion that the SEC has estimated was raised through exempt offering channels.
[ii] Section 12(g) of the Securities Exchange Act of 1934 establishes the thresholds at which an issuer is required to register a class of securities with the SEC.
[iii] 15 U.S.C. §78l(g).
[iv] See Written Testimony of Renee M. Jones, Associate Dean for Academic Affairs and Professor of Law at the Boston College Law School, at the HFSC Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets hearing on Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment (Sept. 11, 2019), available at https://financialservices.house.gov/uploadedfiles/hhrg-116-ba16-wstate-jonesr-20190911.pdf.
[v] See Letter from NASAA President Christopher Gerold to Vanessa Countryman, Re: File No. S7-08-19: Concept Release on Harmonization of Securities Offering Exemptions (Oct. 11, 2019) at 5, available at https://www.nasaa.org/wp-content/uploads/2019/10/NASAA-Comment-Letter-re-SEC-Exempt-Offerings-Concept-Release-10-11-19-1.pdf.
[vi] See Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, SEC Rel. Nos. 33-10884; 34-90300 (Nov. 2, 2020), available at https://www.sec.gov/rules/final/2020/33-10844.pdf.
[vii] For the past 38 years, the Commission’s failure to index these standards to account for inflation has eroded the investor protections they were designed to provide. Each year the Commission fails to address these standards only expands the pool of accredited investors, including investors who only meet the wealth standard based on their accumulated retirement savings.
[viii] For example, “BlackRock, the world’s largest asset manager, with assets under management of $7.4 trillion as of December 31, 2019, announced recently that it would be asking the companies that it invests in on behalf of its clients to (1) publish disclosure in line with industry-specific Sustainability Accounting Standards Board (SASB) guidelines, or disclose a similar set of data in a way that is relevant to the particular business, and (2) disclose climate-related risks in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). State Street, with assets under management of $3.1 trillion as of December 31, 2019, announced the launch of a system for evaluating the performance of a company’s business operations and governance vis-à-vis what State Street had identified as financially material and sector-specific ESG issues, based on the SASB materiality framework and data from third-party providers. State Street explained that it uses this system to help clients understand their portfolio exposures, as well as inform its own investment and voting decisions.” See Rick A. Fleming and Alexandra M. Ledbetter, Making Mandatory Sustainability Disclosure a Reality, SEC Office of the Investor Advocate White Paper (2020) at 2, available at https://www.sec.gov/files/making-mandatory-sustainability-disclosure-a-reality-white-paper.pdf.
[ix] As SEC Investor Advocate Rick Fleming recently observed “the case for ESG disclosure has become only stronger [in 2020],” however “adoption and implementation of prescriptive ESG-related disclosure requirements is extremely challenging when there is so much variation among the private-sector frameworks because the SEC may be reluctant to choose one model over the others in the absence of a clear consensus surrounding any particular framework. Without a critical mass of support for a particular model, it may require an act of the U.S. Congress to determine which standards should become the official metrics for ESG disclosure in the United States.” Id.
[x] See SEC Chairman Jay Clayton discussion with Sen. Elizabeth Warren during the Senate Banking Committee Hearing (Nov. 17, 2020).
[xi] See Toward Common Metrics and Consistent Reporting of Sustainable Value Creation, World Economic Forum Consultation Draft (Jan. 2020), available at https://www.weforum.org/whitepapers/toward-common-metrics-and-consistent-reporting-of-sustainable-value-creation.
[xii] Deloitte’s 11th Global risk management survey of financial institutions found that “sixty-seven percent of respondents named cybersecurity as one of the three risks that would increase the most in importance for their business over the next two years, far more than for any other risk. Yet, only about one-half of the respondents felt their institutions were extremely or very effective in managing this risk.” See https://www2.deloitte.com/content/dam/insights/us/articles/4222_Global-risk-management-survey/DI_global-risk-management-survey.pdf.
[xiii] NASAA supports the bipartisan Cybersecurity Disclosure Act (S.592), which would require publicly traded companies to include in their SEC disclosures to investors information on whether any member of the company’s Board of Directors possesses “cybersecurity expertise,” as that term is defined, and if not, why having such expertise on the Board of Directors is not necessary because of other cybersecurity steps taken by the company. A copy of NASAA’s letter expressing support for the legislation is available at https://www.nasaa.org/wp-content/uploads/2019/06/NASAA-Letter-Re-Cybersecurity-Disclosure-Act-of-2019-Final-in-PDF-June-18-2019.pdf.