In the Alan B. Levenson Keynote speech this week at the 50th anniversary Securities Regulation Institute (“SRI”), SEC Commissioner Caroline A. Crenshaw suggested a number of potential reforms to Regulation D (“Reg. D”) of the Securities Act of 1933 (the “Securities Act”). Reg. D. is intended to facilitate capital formation for small- and medium-sized businesses by creating certain exemptions for private securities offerings from the registration requirements of the Securities Act. A crucial benefit of Reg. D is that issuers file a Form D, which imposes limited disclosure obligations, with the SEC instead of a registration statement. Commissioner Crenshaw’s suggested reforms would significantly increase the regulatory disclosure obligations of private companies seeking to raise capital through exempt securities offerings under Reg. D.
Citing the recent explosive growth of the private markets and the number of “unicorn” private companies with a valuation of $1 billion or more, Commissioner Crenshaw expressed misgivings about the size and significance of such unicorns to the broader economy without the concomitant regulatory safeguards built into the public markets. Although the views expressed by Commissioner Crenshaw at SRI do not necessarily reflect those of her fellow Commissioners, the integrity of the private markets has also been a topic of significant interest to other Commissioners in recent years. Notably, former SEC Commissioner Allison Herren Lee also addressed the risks inherent in the dramatic growth and opacity of the private markets in an October 2021 speech, and former SEC Commissioner Robert Jackson echoed these sentiments in an April 2022 discussion at The Berkeley Spring Forum on M&A and the Boardroom co-hosted by Freshfields.
At SRI, Commissioner Crenshaw outlined certain perceived consequences of allowing private issuers to grow very large without additional regulatory oversight and disclosure:
- Investor Protection – Citing recent corporate failures at FTX, Theranos and WeWork, Commissioner Crenshaw called into question the premise underlying Reg. D that sophisticated investors can make informed investment decisions without a baseline level of disclosure.
- Inflated Valuations – The relative lack of price transparency in the private markets may incentivize companies to report positive news and results, which may cause inflated valuations.
- Healthy Corporate Governance – Private companies may be able to use market power to insulate themselves from public company governance standards or to create lax or deficient internal control environments.
- Impact on Small Businesses – Although the intent of Reg. D is to facilitate capital formation for small- and medium-sized businesses, the data has shown that Reg. D offerings have facilitated significant capital allocation to unicorns and other large issuers.
Proposed Framework for Amending Reg. D
Under Commissioner Crenshaw’s proposed two-tiered framework, issuers conducting securities offerings under Reg. D would be obligated to make certain basic disclosures, and larger private companies (in terms of market cap, value or the size of the investor base), would be subject to heightened disclosure requirements, such as filing both current and ongoing audited financial statements, along with auditor opinion letters confirming the adequacy of internal controls over financial reporting.
Commissioner Crenshaw also outlined the following suggested amendments to Form D:
- Require issuers to file a Form D prior to any solicitation under Reg. D, instead of 15 days after initial sale.
- Require executive officers to sign and certify Form D (rather than authorized representatives) so that executive officers bear accountability for the statements made on the form.
- Create consequences for failure to file Form D, such as inability to rely on Reg. D for future offerings.
- Require additional substantive disclosures about issuers:
- size (by assets, investors and employees),
- operations,
- management,
- financial condition and revenues, and
- the volume and nature of the securities offerings.
Potential Implications for Emerging Companies
The adoption of such proposals would significantly increase the regulatory burden and costs of conducting an exempt offering under Reg. D., especially for larger private companies. The heightened disclosure obligations described above would also allow larger competitors to access operational and financial information at an earlier, more vulnerable stage of the emerging company lifecycle.
While it is too early to tell what, if any, reforms will be implemented to Reg. D., statements made by Commissioner Crenshaw and others suggest that increased regulatory scrutiny of the private markets is on the horizon. If the Commission pursues a rule proposal it would then be presented to the public through publication in the Federal Register and on the SEC’s website for a specified period of time, typically between 30 and 60 days, for review and comment before the SEC drafts and publicizes the final rule. It would not be surprising to see the Commission prioritize rulemaking in this area given the “spillover effects” on the broader market that can result from the failure of a large private company.
