Recent days have seen a good deal of commentary regarding a proposed easing of the SEC's rules governing so-called "private placements" of securities. The rules would among other things, increase the number of shareholders a company could have and remain private for securities law purposes -- i.e. not required to make burdensome public filings of financial and other material, and also expedite Internet capital raising in very small amounts.
"The Securities and Exchange Commission is looking at adapting its rules to encourage Internet-age techniques for small companies raising capital. The issue is part of a wider review by the agency into whether to ease decades-old constraints on share issues by closely held companies."
These rules address capital raising by non-public companies, which are typically the small but growing firms that drive so much job creation in the U.S. To this observer, a long-time corporate attorney who serves both large and small firms, the commentary, both pro and con, largely misses the mark. While there is little to find objectionable about the proposed easing, it is unlikely to have a major macroeconomic effect.
Proponents such as Rep. Darrell Issa in the previously cited article argue that this easing should improve economic conditions by facilitating business start-ups and expansion. "Lifting or refining this rule could significantly improve the ability of companies to raise capital without creating risks that the SEC should be concerned with."
If so, this would expand employment as well. Opponents, such as Jason Zweig of the Wall Street Journal referring to the changes as possibly "The Next Debacle" argue that the easing may lead to a rash of securities fraud as unscrupulous issuing companies prey on naïve investors who were being protected from themselves by the more stringent rules. However, what is being missed by both are two things: (i) ease of capital raising is but a minor factor in companies' expansion plans, and (ii) the current -- supposedly stringent -- securities law regimen is hardly preventing fraud.
It is true that our current private placement framework dates back in large part to the early '80's and does not reflect today's price levels or communication methods, let alone market structures. An overhaul is definitely overdue and is likely to have at least some benefit in terms of removing needless impediments to business expansion.
However, as one who works with quite a number of small businesspeople, I can confidently say that I have never heard anyone express frustration with current securities law -- private or public -- as a reason for refraining from pursuing expansion plans. Concerns over the tax and regulatory environments, especially the impact of Obamacare and its dedicated taxes and tax increases and the expiration of Bush tax cuts pushed back to the end of 2012 with herculean efforts in Congress last year, implications of our national debt level and a general unease with a perceived anti-business bias of the current administration are frequently cited. Similarly, the suppression of aggregate demand resulting from the financial meltdown and the other factors noted above also constrains expansion and hiring. Until these matters are meaningfully addressed, technical changes in securities law are unlikely to do much good.
By the same token, it is an alarmist position to fret about a vast increase in fraud resulting from such changes. Over the last decade, whether it is overreaching by issuers and originators in the market for mortgage-backed securities and related aggressive accounting, too many public company managements aggressively pursuing their own compensation and in some cases -- e.g. WorldCom, Enron, Adelphia -- resorting to outright fraud to do so or investment advisor Ponzi schemes, there has been no shortage of securities fraud. Notably, none of this prominent fraud had anything to do with private placements. While it can of course be argued that the stringent rules may have prevented fraud in that arena, I would argue that the rules were no less stringent in the areas where the fraud did occur. For example, no one would argue that Madoff's activity was within the law; witness his guilty plea. Much of the fraud we have seen involved intentional wrongdoing and not aggressive application of technical rules.
In any event, I strongly believe that regulators best serve the investing public by promoting knowledge dissemination and healthy skepticism on the part of investors, as opposed to implementing more technical rules intended to protect people from their own exuberance. It is hard to see how allowing private companies more flexibility in their investor bases and communication methods will lead to an avalanche of fraud. Commentators fail to note that none of the liberalization initiatives would impact the so-called "anti-fraud" standards which require companies in all types of securities activity to tell investors the truth and the whole truth. This is more pertinent to fighting fraud than numerical standards and restricting internet use.
Commentators on both sides of this issue would better serve the public by addressing the broader factors impacting macroeconomic activity than these arcane matters. Our economy needs better fundamentals far more than technical tweaking. The most cogent recent analysis of this topic which I have seen was found in Mr. Zweig's column and was voiced by a senior investment banker at a leading originator of private deals, (John Borer of Rodman and Renshaw) and should be heeded by all concerned, irrespective of the applicable rules:
"If the person trying to sell you an offering is somebody you just met through a phone call after dinner, then that should send all kinds of shivers up your spine."