Yixin Huang

The Securities and Exchange Commission’s (“SEC”) regulatory reforms in recent years feature its attempts to enlarge the public markets and reverse a two decade decline in IPOs.[1] In mid-2017, the SEC announced that an emerging growth company (“EGC”) can initially file its registration statement confidentially with the commission.[2] In September 2019, the Commission expanded “test-the-waters” to allow any issuer to engage in communications with potential investors before filing a registration statement.[3] These regulatory reforms were meant to encourage more firms to enter the public market which has seen the annual average of 310 IPOs from 1980–2000 decline to 132 IPOs from 2006–2016.[4] A recent proposal by the SEC, however, seems to suggest that the agency may be diverging from this line of policy and moving to empower raising capital in the private market instead. Or is it?

On March 4, 2020, the SEC announced that it has voted to propose amending current rules on exempt offerings to “harmonize, simplify, and improve the exempt offering framework.”[5] The issuance of securities requires either registration with the SEC under Section 5 of the Securities Exchange Act of 1933 or satisfying a statutory exemption such as Regulation A, Regulation D, and Regulation Crowdfunding. If an issuance satisfies one of these exemptions, the firm does not need to fulfill similarly stringent disclosure requirements under SEC oversight, but may only be able to sell specific amounts or to accredited investors who have business sophistication or sufficient net wealth.[6] By lowering the eligibility criteria of exempted offerings, the proposed amendment, if implemented, would effectively enable more firms to raise higher amounts of capital in private markets without registering with the SEC. Specifically, the amendment primarily attempts to address the following:

  • “raise the offering limits for three different exempt offerings;
  • remove statutorily imposed investment limitations for certain investors;
  • shorten the integration safe harbor period from six months to 30 days, thus effectively collapsing different exemptions to the lowest common denominator for investor protection;
  • reduce the disclosure required for non-accredited investors under Regulation D;
  • expand the use of test-the-waters communications across all exempt offerings and for all types of investors;
  • expand the use of general solicitation overall; and,
  • weaken requirements for establishing whether an investor is accredited to little more than self-certification.”[7]

On its face, the proposed rule seems to encourage private fundraising at a detriment to public fundraising. After voting for the proposal, in his public comment, Commissioner Elad L. Roisman suggested that “[his] vote is not intended to expand the private markets, but to simplify and adjust [the] exempt offering framework with the hope that the proposed changes will make it easier for private companies to transition to public companies.”[8] The goal of the proposed amendment is to “promote capital formation and expand investment opportunities while preserving and enhancing important investor protections.”[9] In particular, the proposed amendment would lessen the barriers due to the complexity of rules and the resulted costs for small and medium-sized enterprises (“SME”) to enter the capital market. The rationale is that enabling SMEs to have freer access to the private markets would induce growth and may lead to them raising money in the public markets.[10]

The proposal has attracted welcome from the entrepreneur community, which seems to confirm Commissioner Roisman’s suggestion that the proposal would spur growth. The Association of Online Investment Platforms (“AOIP”), an advocacy group endorsing entrepreneurial small businesses, expressed strong supports for the proposed amendment.[11] Youngro Lee, Chairman of AOIP and CEO of Nextseed, suggested that “the exempt offering framework will be extremely helpful to main street entrepreneurs and investors.”[12] Tyler Gray, Chief Operating Officer of Microventures, a crowdfunding platform for early stage companies, said “[t]hese proposed changes are something we’ve wanted to see for a while, and they are better aligned with the reality of the crowdfunding investment space . . . we’re optimistic that the new rules will be a huge win for investors, issuers, and platforms.”[13] 

Nevertheless, the suggested proposal to lower barriers and increase the offering limits to the private markets means that offerings that would previously have to be made in the public market and thus had to be registered with the SEC, could now happen in the private markets without strict SEC oversight. The diversion of activities from public markets to private markets is widely apparent. From 1980–2000, there was an annual average of 310 IPOs in the U.S.[14] From 2001–2012, that figure dropped to an average of ninety-nine.[15] As suggested by a member of the SEC Small and Emerging Companies Advisory Committee, the “large amounts of private capital” is a cause for this decline.[16]Professor John Coffee at Columbia Law School also noted a “decade long shift to private equity financing as a substitute for smaller public offerings.”[17] This observation is significant, because EGCs account for the majority of recent IPOs. In 2018, for example, ninety of ninety-six IPOs were attributed to EGCs.[18]

It remains to be seen whether the proposal is a move away from the SEC’s actions to expand the public markets with regulations like “test-the-waters”. In its official announcement, the SEC stated that the proposed amendment aims to promote capital formation.[19] Commissioner Roisman suggested that the public markets can grow when SMEs have expanded to a size with money raised in private markets and are ready to go public.[20] While the SEC did not acknowledge that the goal of the proposal is to further private markets at the cost of public markets, the many different economic factors at play here suggest that the far-reaching effects of the proposed amendment still remains to be seen.[21] It might be possible that the proposed amendment, if implemented, could reduce IPOs in the short term but result in a larger presence of strong companies in the IPO market in the long term. 

One concern associated with the decline of the public markets is the exclusion of the majority of Americans from potential investment opportunities.[22] The private markets are dominated by private equity firms, venture capitalists, and other private funds.[23] These private funds typically have high eligibility requirements for minimum investments.[24] Moreover, SEC rules on exempt offerings often only allow accredited investors who have sufficient net wealth or business sophistication to invest in the first place.[25] The proposed amendment would weaken the verification requirements for the accredited investor, but would not substantially alter the definition of the accredited investor.[26]As a result, “[o]nly the very wealthiest can afford the big sums demanded for direct access to private equity funds . . . which may require a minimum investment of $1 [million], $5 [million] or more[.]”[27] Gains from companies with large growth potential raising capital in the private markets hence would more likely go to wealthiest investors in the nation.

The outcome of the controversy remains clouded as the proposed amendment still awaits actual rulemaking after a comment period of 60 days. Whether the proposed amendment would signify a new era for the SEC in shaping a strategy to grow public or private markets has yet to be determined.



[1] Patrick J. Gallagher, Going Public Secretly: The SEC’s Unavailing Effort to Increase Initial Public Offerings through Confidential Registration, 2019 Colum. Bus. L. Rev. 305, 305 (2019).
[2] Draft Registration Statement Processing Procedures Expanded, Sec. & Exch. Comm’n (Jun. 29, 2017), https://www.sec.gov/corpfin/announcement/draft-registration-statement-processing-procedures-expanded [https://perma.cc/WKZ4-ZGCT]. An emerging growth company has “total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year and, as of December 8, 2011, had not sold common equity securities under a registration statement.” Emerging Growth Companies, Sec. & Exch. Comm’n(Jul. 24, 2019), https://www.sec.gov/smallbusiness/goingpublic/EGC [https://perma.cc/K97Z-9FPG].
[3] SEC Adopts New Rule to Allow All Issuers to “Test-the-Waters,” Sec. & Exch. Comm’n (Sep. 26, 2019), https://www.sec.gov/news/press-release/2019-188 [https://perma.cc/P95U-CKDG].
[4] Id. (“The new rule is one of several SEC initiatives that build on JOBS Act provisions intended to encourage companies to access our public markets”); Gallagher, supra note 1, at 352; Lia Der Marderosian et al., 2017 IPO Report, Har. L. Sch. (May 25, 2017), https://corpgov.law.harvard.edu/2017/05/25/2017-ipo-report/ [https://perma.cc/S75G-WSXN] (Averaging the numbers of IPOs from 2006–2016 provided in the report gives an annual average of 132 IPOs in these ten years).
[5] SEC Proposes Rule Changes to Harmonize, Simplify and Improve the Exempt Offering Framework, Sec. & Exch. Comm’n (Mar. 4, 2020), https://www.sec.gov/news/press-release/2020-55 [https://perma.cc/Q8UM-A9GT].
[6] Accredited Investors, Sec. & Exch. Comm'n (Nov. 27, 2017), https://www.sec.gov/fast-answers/answers-accredhtm.html [https://perma.cc/8HTP-3DC7].
[7] Allison Herren Lee, Statement on Proposed Amendments to the Exempt Offering Framework, Sec. & Exch. Comm’n (Mar. 4, 2020), https://www.sec.gov/news/public-statement/lee-statement-proposed-amendments-exempt-offering-framework [https://perma.cc/J632-PHKW]. The proposed rule raises limits for Reg. A (Tier 1), Reg. A (Tier 2), Reg. Crowdfunding, and Rule 504 of Reg. D respectively to $20 million, $75 million, $5 million, and $10 million. It also proposed to remove the investment limits for accredited investors under Reg. Crowdfunding. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Sec. & Exch. Comm'm 116 (Mar. 4, 2020), https://www.sec.gov/rules/proposed/2020/33-10763.pdf [https://perma.cc/CRC5-53JD].
[8] Elad L. Roisman, Statement on the Harmonization Proposal, Sec. & Exch. Comm’n (Mar. 4, 2020), https://www.sec.gov/news/public-statement/statement-roisman-harmonization-2020-03-04 [https://perma.cc/MQ5R-EHUB].
[9] Sec. & Exch. Comm’n, supra note 5.
[10] Roisman, supra note 8.
[11] JD Alois, Huge Win: AOIP Members Comment on SEC Proposal to Improve Capital Formation, Crowdfund Insider (Mar. 6, 2020, 9:50 AM), https://www.crowdfundinsider.com/2020/03/158363-huge-win-aoip-members-comment-on-sec-proposal-improving-capital-formation/ [https://perma.cc/F59F-QQ9V].
[12] Id.
[13] Id.
[14] Gallagher, supra note 1, at 352.
[15] Id.
[16] Id.
[17] Before the Sec. & Exch.Comm’n Hearing on: “Government-Business Forum on Small Business Capital Formation” 1 (2011) (Testimony of John C. Coffee, Jr.), https://www.sec.gov/info/smallbus/sbforum111711-materials-coffee.pdf [https://perma.cc/6BP8-7VVY].
[18] Gallagher, supra note 1, at 349.
[19] Sec. & Exch. Comm’n, supra note 5.
[20] Roisman, supra note 8.
[21] Id. (the growth of small and mid-sized firms with private funding necessarily implicates complex economic factors).
[22] Gwynn Guilford, US Startups Don’t Want to go Public Anymore. That’s Bad News for Americans, Quartz (Feb. 1, 2018), https://qz.com/1192972/us-startups-are-shunning-ipos-thats-bad-news-for-americans/ [https://perma.cc/7GY7-2FRV].
[23] Peter Lee, Why Private Capital will Dominate Markets for the Decades to Come, EuroMoney, https://www.euromoney.com/article/b1dx148qjztwp3/why-private-capital-will-dominate-markets-for-the-decades-to-come [https://perma.cc/6UJ8-TTEP].
[24] Max Kasanda, Alternative Investments for a Wider Audience, Morgan Stanley (Jun. 2019),https://advisor.morganstanley.com/max.kasanda/articles/investing/alternative-investments.
[25] See, e.g., Investor Bulletin: Private Placements Under Regulation D, Sec. & Exch. Comm’n (Sep. 24, 2014), https://www.sec.gov/oiea/investor-alerts-bulletins/ib_privateplacements.html [https://perma.cc/MJ9R-9425].
[26] Roisman, supra note 8 (“The proposal contains new guidance on verification under Rule 506(c) . . . that the “reasonable steps” verification requirement of 506(c), may require no more than the “reasonable belief” standard.”).
[27] Gallagher, supra note 1, at 353; Stephen Foley, Private Equity Begins to Entice Ordinary Investors, Fin. Times (May 26, 2015), https://www.ft.com/content/e85240c4-b150-11e4-831b-00144feab7de [https://perma.cc/GNJ5-UH38].