In February 2016, Congress passed the bipartisan SEC Small Business Advocate Act of 2016 (the “Act”). The Act amended the Securities Exchange Act of 1934 to establish an independent Office of the Advocate for Small Business Capital Formation (the “Office”) within the Securities and Exchange Commission (“SEC”). (H.R. 3784). Officially established in 2019, the Office aims to assist and advance the interests of small businesses and their investors in securing access to capital and complying with SEC regulations. (SEC). Recently, the Office pushed for regulators to consider how current costs and regulatory regimes restrict small businesses’ ability to access and raise capital, arguing that small businesses face significant disadvantages when fundraising compared to larger companies. (Tom Zanki, Law 360). However, questions arise as to how the Office’s proposed policy adjustments to current capital raising rules will affect existing SEC regulations.

Advocating for small businesses at various stages in their life cycle, the Office supports emerging, privately held companies raising initial capital, later-stage private companies seeking liquidity in the public market, as well as small public companies seeking to raise additional capital by accessing broader pools of investors. (SEC). Specifically, the Office takes a proactive stance to identify and address the unique challenges minority-owned, women-owned, rural, and natural disaster area small businesses and their investors continue to face when attempting to secure access to capital. Id.

Each year, the Office hosts an event known as the Small Business Forum (the “Forum”). (SEC). At the Forum, individuals from the public and private sector convene to issue feedback regarding the current capital raising framework and analyze the areas where small businesses and investors would benefit from changes to SEC rules and regulations. Id.  From those discussions, participants draft recommendations aimed at mitigating the problems identified to make the capital formation framework more applicable and more conducive to small businesses. Id. The SEC then responds to those recommendations and delivers a summary of the policy recommendations to Congress. (SEC). On December 16, 2022, the Office issued its Annual Report (the “Report”) for the 2022 fiscal year that reflects the proposed policy recommendations resulting from the Forum and details the specific measures the Office would like to see the SEC implement. (Anna Pinedo, JD Supra).

Highlighting the complexity of existing capital raising rules, the Office first requests that the SEC further develop and improve the accessibility of current tools and educational resources aimed at helping entrepreneurs and investors understand how to comply with securities laws. (SEC). The Office believes expanding informative resources that break down fundamental securities law concepts into plain language will give small businesses a more equal opportunity to properly navigate securities laws and access funding networks. Id. Further, the Office hopes that this policy recommendation will mitigate the distinctive challenges women and minority entrepreneurs face in navigating this complexity as they do not have access to the same capital markets, experienced mentors and advisors, and supportive entrepreneurial communities as their counterparts. (Id.; Tom Zanki, Law 360).

To further address the uneven playing field within the capital raising process between small and large businesses, the Office proposes a series of targeted SEC regulatory changes. (SEC). Because many small businesses experience a hurdle to capital raising from not having pre-existing accredited investor networks, the Office recommends that the SEC expand the definition of accredited investor. (Id.; Tom Zanki, Law 360). As an alternative to net worth and income thresholds, the Office proposes the SEC include additional qualitative professional criteria to showcase financial sophistication. Id. Since women, minority, and rural owned enterprises often start out with a smaller network of potential investors, the Office cautions the SEC from increasing existing accredited investor wealth thresholds to avoid intensifying barriers to entry for women, minority, and rural owned enterprises by further limiting these small businesses’ potential investor pool. (SEC). The Office is further recommending that the SEC or Congress amend Regulation Crowdfunding (“Reg CF”) to make the SEC’s COVID-19 extension of regulatory relief permanent. (SEC; Tom Zanki, Law 360). This would allow small businesses offering $250,000 or less within a twelve-month period to be able to continue to meet financial statement requirements by providing their own financial statements and certain income tax returns certified by a principal executive officer of the company instead of an independent public accountant. Id. The Office argues the permanent ability to meet financial disclosure requirements this way will help small businesses meet urgent funding needs through a Reg CF offering. (SEC). The Office also wants Congress to amend Section 4A(f)(3) of the Securities Act, the provision that prohibits investment companies from using Reg CF, to allow investment companies to finance crowdfund companies to further expand a small business’s potential access to capital. Id.

The SEC’s recent rulemaking agenda indicates potential revisions to the current Form D notice and disclosure requirements. (SEC). These potential reforms would require a Form D to be filed prior to the time any solicitation is made under Regulation D (“Reg D”) and to include additional material information about the company such as its management, size, and financial condition. (SEC). In response to these potential Reg D amendments, the Office urges the SEC to avoid making any changes that would make raising capital through a Reg D offering more burdensome. (Tom Zanki, Law 360). The Office emphasizes how additional disclosure obligations would disproportionately affect small businesses since they do not have the same ability as large companies to absorb higher costs associated with providing additional disclosures.Id. Thus, the Office cautions the SEC from making any changes that may deter businesses from relying on a Rule 506(b) safe harbor, what the Office argues would have a pronounced effect on small businesses, especially women and minority owned enterprises, who already face the most significant barriers to accessing capital. (SEC).

In regard to the public offering space, the Office urges the SEC to evaluate any new disclosure requirements they consider and specifically tailor them for small public companies. Id. Because the vibrancy of capital markets depends on having dynamic companies of varying sizes, the Office recommends that the SEC scale its disclosure and reporting framework for public companies to be specifically reflective of the size and operational differences that exist between small and large public companies. Id. In addition to scaling back any new disclosure and reporting obligations for small public companies, the Office further recommends that small businesses be given the option to delay compliance to any new disclosure or reporting requirements in order to help stay public. Id.

The Office’s 2022 Report presents a series of targeted improvements to the existing regulatory scheme that the Office argues unnecessarily hinders capital formation for small businesses. While I believe an uneven playing field between small and large businesses should not exist within the capital raising process, I question the viability of these proposed policy recommendations since the Office’s Report calls for direct adjustments to existing SEC regulations. I agree with Commissioner Crenshaw that easing the existing SEC disclosure requirements and capital raising rules to help small businesses runs the risk of depriving investors of meaningful protection and information necessary for informed decision making. (SEC). In expanding the definition of accredited investors, market access becomes expanded to a pool of investors with varying levels of risk tolerance, investment experience, and bargaining power who may not have the same capacity to receive the necessary information to make an informed investment decision from internally produced financial statements. Id. Because of these potential risks, I think the implications of these rule and regulatory changes for investors should be analyzed further to ensure a balance is struck between improving small businesses’ access to capital and continuing to protect investors. At this stage, I think adopting the Office’s proposals advocating for additional regulatory clarity and educational resources is a practical choice to begin improving small businesses’ ability to raise capital on a more even playing field.