SEC Commissioner Caroline Crenshaw, during a recent speech, floated the idea of requiring big private companies that raise funds using Rule 506 exemption in Regulation D to provide audited financial statements to investors.
It would be modeled after Regulation A, which has a tiered system. Larger private companies that raise capital using Reg A exemption are subject to more stringent reporting requirements, including audited financials performed by an independent accountant following GAAS set by the AICPA.
Her proposed reforms come as the SEC staff is currently working on a draft proposal that would be presented to commissioners on Reg D, which allows private companies to raise an unlimited amount of capital from an unlimited number of “accredited investors.”
The commission is planning to issue a proposal sometime in the spring of this year, according to the SEC’s rulemaking agenda.
Unlike public offerings, companies that use exempt offerings such as Reg A or Reg D do not have to follow a full set of SEC regulations intended to protect investors that buy and sell stocks of publicly listed companies. They are exempt from securities registration.
The accredited investor definition in Reg D under the Securities Act of 1933 allow individuals who hold a Series 7, 65, or 82 license in good standing to qualify. Individuals also qualify if they had at least an income of $200,000, joint income of $300,000, or at least $1 million in net worth, excluding a primary residence. The threshold is intended to allow those who can withstand financial losses or are financially savvy.
However, Crenshaw said that private offerings have grown at a faster pace than public offerings over the past decade. Moreover, Reg D today does not really help smaller private companies as intended, and accredited investors are not that sophisticated, it turns out, as shown most recently with the implosion of FTX Trading Ltd..
And her proposals “are among the critical reforms that we can make to ensure that our private markets operate as originally intended,” she said at the 50th Annual Securities Regulation Institute on Jan. 30, 2023. “Let’s ensure the exemption operates as designed.”
Crenshaw’s Proposed Reforms to Reg D
In Crenshaw’s opinion, Reg D could have scaled requirements like Reg A. Tier 1 under Reg A is for offerings of up to $20 million in a 12-month period. Tier 2 is for offerings of up to $75 million in a 12-month period.
Both Tier 1 and 2 have to comply with basic requirements, such as offering circular, subject to review and qualification by the SEC staff and must file two years of financial statements. Along with audited financial statements, companies using Tier 2 offerings must file annual, semiannual, current and special financial reports with the SEC.
In making a case for a tiered framework for Reg D, she borrowed from a catch phrase of one-size-does-not-fit all used by business groups who argue that rules must be tailored for smaller companies that have less resource for regulatory compliance.
Thus, a tiered framework “recognizes that not all offerings are created equally,” Crenshaw said. “I envision that, like Reg A, different sizes of offerings would trigger different disclosure obligations. But unlike Reg A, additional obligations would be triggered by the size of the company, in terms of market cap, value or the size of the investor base. In other words, large private issuers – and not the small businesses at the heart of Reg D – would have additional obligations.”
She believes that large private issuers can afford to comply with heightened disclosure obligations. And she said, for example, they could hire independent auditors who would opine on the fairness of the financial statements and confirm that the company’s internal controls over financial reporting (ICFR) is sufficient.
Crenshaw also proposed reforms to Form D.
She said that the SEC could require companies to file Form D before any solicitation under Reg D is made.
“Failure to file a Form D could have actual consequences, such as the inability to rely on Reg D in future offerings,” she said. “And the Form itself could have useful, substantive information about a private company.”
For example, she said the form could give information about the company’s size by assets, investors and employees; its operations; its management; its financial condition and revenues; and the volume and nature of the securities offerings.
In addition, she said that the SEC could require an executive officer to sign and certify Form D to enhance accountability.
This article originally appeared in the Feb. 3, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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