June 21, 2011

Why House Bills on June 22 Would Weaken Investor Protection: NASAA's Concerns

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On Wednesday, June 22, the House Financial Services Committee is scheduled to mark up two bills that have the potential to weakenvital investor protections.

The first bill, H.R. 1082, the Small Business Capital Access and Job Preservation Act, would exempt private equity fund advisers from SEC registration requirements.

The second bill, H.R. 1070, the Small Company Capital Formation Act, would expand the Regulation A exemption by raising the dollar limit for that exemption from $5 million to $50 million and would preempt state authority to review Regulation A offerings.

State securities regulators have a number of concerns with both bills. On June 15, I wrote to the full committee to spotlight these concerns. (Read the NASAA letter here.)

At least two fundamental components of H.R. 1082 are so vague that they undermine any benefits the bill purports to confer on small business.

For example, the legislation does not define “private equity fund” but rather delegates this task to the SEC. It seems unwise to establish an exemption before defining what is covered by the exemption. The bill also gives the SEC six months to promulgate rules necessary to establish the record keeping and reporting obligations of these advisers.

The bill also is unclear as to what, if any, reporting requirements are required for private equity fund advisers. An exemption from all registration and reporting requirements would likely have the unintended consequence of depriving the SEC of important regulatory information critical for assessing risk and protecting investors.

Furthermore, unlike the exemption for advisers contained in Dodd-Frank, the language in H.R. 1082 is not limited to advisers who solely advise private equity funds.

Turning to H.R. 1070, we strongly object to the language in Section 6, which would preempt state authority over certain securities offerings. This language, if improperly construed, could seriously jeopardize the states’ ability to protect investors.

william galvinAs my colleague, Massachusetts Secretary of the Commonwealth William Galvin (left), wrote in his comment letter to the committee, the language of Section 6 states that Regulation A offerings that are not sold through a broker-dealer shall not be “covered securities” under Section 18 of the Securities Act of 1933. “By implication,” Galvin wrote, “under Section 6, Regulation A offerings that are sold through a broker-dealer would be considered covered securities, and state review would therefore be preempted.”

In order to avoid any unintended limitations on the states’ ability to protect investors, NASAA has strongly urged the Committee to remove or clarify this language.

While we appreciate Congressional efforts to reduce burdensome regulation on small business, NASAA continues to believe that these efforts will not be effective if they eliminate necessary disclosure requirements or otherwise limit the states’ ability to protect investors.

While filing a registration statement and “going public” involves some expenses, much of this cost results from requirements that are necessary to ensure adequate disclosure of material information and provide sufficient investor protection. This system of disclosure ensures investor faith in the integrity of the public markets.

Currently, Regulation A blends certain elements of a registered offering and an exempt offering. It is, to some degree, a mini-public offering on a private-offering scale. It does not have all of the investor protection provisions of a typical registered offering. But as currently utilized, Regulation A does retain the investor protections contemplated by Section 3(b) of the Securities Act because of the small amount involved.

Raising the dollar limit for Regulation A exemption from $5 million to $50 million would result in the broad marketing and sale of the riskiest, most speculative securities to the least sophisticated investors.

The changes proposed by H.R. 1070 would afford small, untested companies all of the benefits of a public offering, but would strip the Regulation A exempt offerings of all investor protections. As currently drafted, this bill focuses entirely on the desires of the small business issuer and ignores the need for reasonable investor protections that are currently contained in existing law.

While NASAA understands the desire to facilitate job creation, we respectfully point out that creating exemptions from important investor protection statutes may not be the best option.

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