March 26, 2012

The SEC Must Get On Board with Entrepreneurs

Hester Peirce

Former Senior Research Fellow
Summary

The JOBS Act would never have garnered such a bipartisan chorus of supporters if the SEC had taken the lead in modernizing its rules to make it easier for entrepreneurs and small businesses to raise capital.

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This article was originally published in Real Clear Markets

The JOBS Act, which passed the Senate on Thursday, is Congress's attempt to step into a void left by SEC inaction. It is an amalgamation of bills designed to make raising money easier for entrepreneurs and small, newly public companies. The bill passed both the House and the Senate by a large margin, and has already gotten a Presidential nod of approval. After the House approves the Senate's amendments, it is expected to be quickly signed by the President.

The JOBS Act would never have garnered such a bipartisan chorus of supporters if the SEC had taken the lead in modernizing its rules to make it easier for entrepreneurs and small businesses to raise capital. The SEC, though, has resisted changing its rules to accommodate the demands of entrepreneurs and would-be investors for new avenues of capital formation. The SEC's stubbornness is reminiscent of the actions of Massachusetts securities regulators three decades ago when they were confronted by the initial public offering of Apple.

Massachusetts regulators "protected" its residents from paying $22 a share for Apple stock (which is now trading at around $600 a share) by forcing Apple to withdraw its IPO from the state. Subsequent securities laws have taken away state regulators' ability to do what Massachusetts did, but the sentiment that drove the Massachusetts regulators is very much alive and well at the Securities and Exchange Commission.

Just as the Massachusetts regulators worried that Apple would harm investors, the SEC's inaction is motivated by a fear that it will be blamed for the abuses that will occur if access to capital is opened up. Indeed, the SEC is right to expect that there will be misconduct, because raising capital always attracts its share of bad apples. Regulatory inaction is less likely to draw criticism than regulatory flexibility, as the harm is hard to pinpoint. The businesses that cannot get capital as a result of unduly restrictive regulations do not survive to tell their stories. The would-be investors, who are prevented by SEC rules from even hearing about entrepreneurs' ideas, do not usually - the Apple story aside -- know what they are missing.

The need for SEC action is clear. Companies across the spectrum have run into oppressive regulatory barriers to accessing capital. Fresh-faced entrepreneurs are frustrated when they find out that they cannot use the Internet, which is central to everything else they do, to find investors to finance their ideas. Small, private companies that want to encourage and reward employees with stock are being told they cannot remain private if they do so. Companies that want to make their shares available to the public are scared off by the monetary cost, as well as the time required to comply with Sarbanes-Oxley and other regulatory requirements.

Yet, the SEC has refused to adopt reforms to ease the difficulties that small and growing companies face in obtaining financing. Many of these reforms, such as lifting constraints on entrepreneurs' communications with potential investors, are well within the SEC's authority. Despite studying small business capital formation for years, the SEC never seems to be able to bring itself to make meaningful changes in response to all that research. In a recent letter to the Senate Banking Committee, Chairman Schapiro told Congress that she had directed her staff to study many capital formation issues last spring. Nevertheless, she was not able to comment on the appropriate shareholder threshold for public reporting, one of the key pieces of the JOBS Act.

Balancing investor protection concerns with capital formation is a complex undertaking, the details of which would benefit from regulatory expertise. Such expertise has been lacking here precisely because the SEC has refused to apply itself in a productive manner. To make matters worse, the Senate bypassed its standard Committee process to vet legislative initiatives with experts. As a result, the JOBS Act, although it has many merits, is unlikely to bring entrepreneurs and investors together as effectively and safely as it could have.