Post-JOBS Act, where do all the various transaction exemptions – Reg. D., Reg. A, the new crowdfunding exemption -- fit into the menu of options for issuers? Moreover, where do these exemptions fit into the still-shifting regulatory architecture of investor protection?
I’ve been thinking about these questions since the University of Colorado Law School hosted a roundtable on the JOBS Act on October 2. The roundtable brought together a wide swath of the startup community, including legal practitioners, entrepreneurs, investors (including from the venture capital community), startup incubators, and accountants. The roundtable, like previous roundtables at Harvard, NYU, and Stanford, aimed to provide feedback to officials from the SEC and the Department of Treasury on the impacts of the JOBS Act, as well as advice to the SEC as the Commission writes the rules to implement the statute.
Our roundtable (which was co-moderated by my dynamo colleague Brad Bernthal and me) focused on the so-called new so-called Regulation A+ exemption, as well as the new shareholder thresholds for registration under the ’34 Act.
For me, the roundtable offered an opportunity to look not only at individual transaction exemptions but to consider the whole constellation of exemptions together. From my perspective, Regulation D continues to look the most attractive to issuers, particularly in light of the SEC moving to relax general solicitation rules for 506 offerings.
But does the still-emerging architecture of transaction exemptions make sense from a policy perspective? Legal scholars have longed questioned the rationality of the existing structure of transaction exemptions. For example, are the income and net worth standards baked into the accredited investor standard good proxies for investor sophistication? Or do they function more as rough assurance that investors could better withstand a complete loss of investment?
If parts of the old rules were difficult to square, there is a large risk that the new rules will be completely under-theorized. Scholarship on transaction exemptions has struck me as having one of the highest ratios of value to quantity of scholarship. In other words, transaction exemptions impact a significant portion of capital-raising in the country, but seem to attract fewer scholars than IPOs and securities litigation. It would seem to be a good area for scholars to invest. Scholarship in this area seems to pay dividends for a long time. (E.g., Bradford’s 1996 economic analysis of transaction exemptions). As another example, consider the long history of work by Rutheford Campbell on Regulation A from the 1970s to the present.
There is a downside to an open field for scholars, namely that scholarship won’t adequately shape legislation and rulemaking, but instead will engage in post-hoc criticism and rationalization. This runs the risk of an even crazier tangle of rules forged in the cauldron of interest group politics rather than a well-thought-out regulatory scheme with a good “fit” between the exemption and the ability of investors to process information and bear risk. I’ve expressed concern that the rush to improve small business access to capital in the JOBS Act may be turning some of the economic logic of securities exemptions on its head: small issuers with the least amount of liquidity are less likely to enjoy information efficiencies in the trading of their stock. So granting various disclosure exemptions to “emerging growth companies” (a legislative euphemism for small companies that may be neither emerging nor have prospects for growth), means less public information for the companies on which market prices are least likely to impound information. This seems like an up-side-down Frank Gehry approach to re-designing the architecture of transaction exemptions.
Jeff Schwartz (Utah) has a radically different take, however, on transaction exemptions. His forthcoming Cardozo Law Review article, envisions a “life cycle” approach. Here is his abstract:
This Article argues that U.S. equity markets fail to offer a satisfactory listing venue for emerging firms. I contend that this lacuna is a manifestation of a flawed structure of equity-market regulation and that this void undermines entrepreneurship, jeopardizes the future of U.S. equity markets, and weakens the broader U.S. economy. To close this gap and respond to these concerns, I recommend a new theoretical structure for regulating equity markets. Under the “lifecycle model” I propose, regulations would adapt to firms as they age. The key change would be to establish a market specifically for newly-public young firms, where they would be subject to a regulatory regime that is strict enough to protect investors yet flexible enough to accommodate innovation and growth. As firms age, they would be moved to different markets, each set up to meet the unique regulatory challenges firms pose as they mature. This template is designed to offer entrepreneurial firms an attractive platform on which to list their shares while placing equity-market regulation on sound theoretical footing. In a brief Epilogue, I assess the implications of the recently-enacted JOBS Act on this argument and conclude that the case for reform based on the lifecycle model is undiminished.
Schwartz’s ideas are worthy of a long debate.
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