Inbound: SEC Proposal on Regulation D Reforms

Given the steady and continued volume and breadth of U.S. Securities and Exchange Commission (SEC) rulemaking and enforcement actions, it’s unsurprising that private market participants have yet to focus their attention on an impending (and likely contentious) SEC proposal on improvements to Regulation D and its related Form D requirements. Yet, the gist of the currently constituted SEC’s improvement plans has been clear for a while and should come as no surprise when eventually proposed.

Earlier this year, in keynote remarks at the Northwestern/Pritzker 50th Annual Securities Regulation Institute, titled "Big ‘Issues’ in the Small Business Safe Harbor,” SEC Commissioner Caroline Crenshaw made the case for “incremental, but essential” reforms to Regulation D of the Securities Act of 1933, contending that “unfettered access to capital through Rule 506 has had a bloating effect on private issuers,” while expressing concern about inadequate investor protections.[1] Regulation D is by far the predominant method by which issuers raise capital in the private markets. In fact, in terms of USD raised, Regulation D is basically twice the size of the U.S. public market for securities offerings.[2] Cmr. Crenshaw’s comments likely foreshadow the SEC’s formal rulemaking proposal to amend Regulation D.

Commissioner Crenshaw:

“Where we are today is a long way from where we began…”

In her remarks, Cmr. Crenshaw warned that “there are consequences to allowing issuers to grow so large without any requirements of registration,” outlining adverse impacts to investor protection, valuations impacting overall market integrity, corporate governance, and small businesses. Cmr. Crenshaw used the examples of FTX, Theranos, and WeWork, in which accredited investors all lost significant amounts of capital to so-called Unicorns, to underscore her point that “the de facto presumption that accredited investors need no disclosure isn’t panning out.”

As a potential solution, Cmr. Crenshaw made some suggestions for “modest reforms,” including:

Form D Reforms. The Commissioner suggests requiring that Form Ds be required to be filed before any solicitation is made pursuant to Regulation D. Further, the Commissioner would impose consequences on issuers for any failure to timely file a Form D, such as elimination of the availability of Regulation D for future offerings. In addition, Cmr. Crenshaw suggests that that Form D no longer be just a notice filing and instead include substantive disclosure about the issuer, such as 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.” Additionally, Form Ds would be required to be signed and certified by an executive officer, who would be accountable for the content.  In the Commissioner’s view, these suggested changes would bring material information to investors, mitigate existing information asymmetries, and provide systemic information for further study, including some insight into potential fraud.

Heightened Obligations on Larger Issuers and Issuances.  The Commissioner advocates for the adoption of a two-tier disclosure system that would impose greater obligations on the larger private issuers and issuances, similar to the structure and requirements of Regulation A,[3] in the exempt space, and Smaller Reporting Companies,[4] in the registered space. Her conception of these tiers is 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…. I believe that, at a minimum, large private issuers could bear heightened disclosure obligations, over and above what would be required of Form D, at offering and on an ongoing basis. For example, they could be required to engage independent auditors and would have to provide prospective and committed investors with financial statements audited in accordance with GAAS, along with auditor opinion letters, confirming the adequacy of the company’s internal controls over financial reporting.”

In its Spring 2023 RegFlex Agenda,[5] the SEC noted that its Division of Corporation Finance is considering recommending that the SEC propose amendments to Reg D, including updates to the accredited investor definition and to Form D, “to improve protections for investors.” That this rulemaking was added to the RegFlex Agenda so close in time after Cmr. Crenshaw’s speech was likely no accident. Further, given the size of private markets and their importance to the health of U.S. capital markets generally, the fact that the rulemaking has been delayed to a now-contemplated October 2023 date should not be shocking. Any proposed reform to Regulation D and the private markets is likely to be contentious and closely scrutinized both inside and out of the SEC. And, with the recent discussion of Regulation D reforms and potential changes to the SEC’s accredited investor definition by the SEC’s Investor Advisory Committee, it seems as though the SEC is looking for support for positions likely to be taken in the eventual proposal.[6]

Stay tuned for more activity this Fall 2023, as the SEC promises to continue the its recent and continued active rulemaking trend.

[1] SEC Cmr. Caroline Crenshaw, Big “Issues” in the Small Business Safe Harbor: Remarks at the 50th Annual Securities Regulation Institute, January 30, 2023, available at: https://www.sec.gov/news/speech/crenshaw-remarks-securities-regulation-institute-013023.

[2] SEC, Office of the Advocate for Small Business Capital Formation, 2022 Annual Report to the U.S. Congress, available at: https://www.sec.gov/files/2022-oasb-annual-report.pdf.

[3] See 17 CFR 230.251 et seq; and Amendments for Small and Additional Issues Exemptions under the Securities Act (Regulation A), Rel. Nos. 33-9741; 34-74578; 39-2501 (Mar. 25, 2015).

[4] See Guide to Smaller Reporting Companies, available at: https://www.sec.gov/education/smallbusiness/goingpublic/SRC.

[5] See SEC RegFlex Agenda (Fall 2023), available at: https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202304&RIN=3235-AN04.

[6] See SEC Investor Advisory Committee, Meeting on September 21, 2023, available at: https://www.sec.gov/about/advisory-committees/investor-advisory-committee.