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Statement on Harmonization of Securities Offering Exemptions by Commissioner Caroline A. Crenshaw
Today’s rule significantly expands private market access to investors without first putting in place appropriate investor protections. As a result, issuers will be able to conduct larger and more frequent private offerings with fewer restrictions. These offerings will be made to a pool of investors with varying levels of risk tolerance, information access, investment experience and bargaining power. There are tradeoffs in that decision. Unfortunately, today’s release fails to engage in any substantive way with the crucial threshold question of whether those tradeoffs are – or even can be – balanced in a way that adequately protects retail investors. Not only that, the rule fails to address the fact that in the private markets, the rich and well-connected typically have better access to the most promising companies, while retail investors get the leftovers – too often, unfortunately, the losers. Instead of providing retail investors access to that elusive high return rate, the majority’s steady march of expanding the private markets will only further entrench the country’s increasing and concerning economic divide. I commend the staff for considering the utility of harmonizing the exempt offering framework. Entrepreneurs, particularly very small and traditionally underserved businesses, should have efficient access to capital. We should consider whether there is a fair way to broaden access for small, diverse companies while still fulfilling our duty to protect investors. Right now, high growth companies are increasingly deciding to remain private, benefitting groups of experienced and well-funded professional investors. It seems that “you have to start rich to get rich” in the private markets. Today, we do not fix that problem. Expanding access to the private markets as the Commission has done repeatedly recently not only fails to serve the majority’s stated goal of advancing the interests of small businesses and retail investors, it opens these markets to a class of investors who do not have the capital to survive one or two failed ventures. This approach will serve only to further widen the wealth and access gaps between investors who start rich and those who don’t. *** Presently, many companies in the private markets have a ready pool of investors, including accelerators, venture capital firms, angel investors, private equity funds, and many others, which I will collectively call venture capitalists. What these investors share are structural advantages that have led to their success. Venture capitalists employ trained professionals skilled at evaluating early stage companies. They have the market power to demand detailed information, which investors must negotiate because these issuers are not legally required to supply robust disclosures. This is because private offerings have historically been targeted, at least generally, at investors who can bear the risk of a total loss. Typical venture capital investors have diverse portfolios structured specifically to absorb the inevitable losses associated with early stage investing. They also understand how risk and reward profiles change as start-ups progress from seed funding through later funding rounds, and can adjust their risk exposure accordingly. Just as importantly, venture capitalists have professional advisors and lawyers to protect their interests by preserving voting rights, ensuring good governance, and protecting against dilution. The system is set up for their success. Not for anyone else’s. Estimates indicate that there is more than $1 trillion in private capital ready and waiting to be invested in existing private offerings. For this portion of the private markets, it does not appear that more money or further relaxed restrictions are necessary to build those companies. The exemptions are more than fulfilling their promise, as these companies and these investors are awash in money and opportunities. To be sure, not all viable companies readily attract this funding, even despite the surplus of capital clamoring to be invested. The solutions this rule presents are to allow private companies to raise capital by selling more risky offerings, in greater dollar amounts, with less information, and fewer rights, to unprepared and unprotected investors. Nowhere does the release examine whether this is a good idea. It could be that venture capital investors avoid these offerings because the potential payouts are too small to justify their time, or that they deem the investments too speculative. The release does not say. But as with most things, understanding the problem is key to crafting effective solutions. Without that analysis, I fear today’s response will make matters worse for those small businesses and those investors currently left out of these growth opportunities. Here’s why. At the core of this rule is the assumption that retail investors will successfully buy offerings that professional investors reject. We apparently believe that retail investors can better assess the risk adjusted returns and find value that venture capital overlooks. This is unlikely to be true. First, it is not supported by any data. Second, smaller investors do not have the same bargaining power to compel private issuers to provide robust information disclosures, and the offering exemptions do not require issuers to do so. Third, smaller investors often lack the money or the assets necessary to create the diverse portfolios of private companies needed to successfully withstand the inevitable losses. Retail investors face plenty more disadvantages, but you get the idea. Some might argue that although retail investors have been excluded from investing in the most promising private companies, they can make up the difference by investing in other exempt offerings. Unfortunately, because private markets are so opaque, we do not have the data to analyze this. This highlights a persistent problem with our approach to the private markets, in that issuers do not report the data needed to allow us to study them and their results, and thereby develop appropriate regulatory strategies. That won’t change under this rule, and without that information, I simply cannot conclude that these changes balance our mission imperatives of facilitating capital formation while also protecting investors. Based on the evidence we do have, these changes appear likely to offer only at best marginal benefits to the companies who need the most assistance, while increasing risks but not rewards for investors. I believe in the vital contributions offered by our country’s small businesses. In particular, I am committed to helping facilitate capital formation for minority, women, and veteran-owned businesses. That’s not just good policy; it’s good economics. There are real problems today with access and representation that leave promising companies and the entrepreneurs behind them on the outside looking in. Unfortunately, this proposal is not tailored toward solving those problems. Instead, it proposes a variety of changes to exemptions rarely used by these underserved businesses. In the end, we are expanding offerings we have not studied, to make it easier to sell to the investors who have the most to lose if a new venture fails. I’d like to believe that some of the small businesses that raise money because of this rulemaking will succeed. But others will fail entirely – or fail to pay retail investors the same high rate of return that venture capitalists demand to justify the risks of early venture investing. *** As always, my dissent today does not detract from my respect and appreciation for the efforts of staff. I am grateful for their hard work and dedication to advancing our agency’s mission. In particular, I recognize the fine work done by the members of the Division of Corporation Finance, the Office of the Advocate for Small Business Capital Formation, the Office of General Counsel, the Division of Investment Management, and the Division of Economic Risk Analysis. I look forward to working together to solve the problems faced by small businesses and investors, but today I respectfully dissent. "