In October 2017, the US Department of the Treasury (Treasury) published a report titled "A Financial System That Creates Economic Opportunities" (Treasury Report).1 Treasury, under the direction of Secretary Steven T. Mnuchin, prepared the Treasury Report in response to Executive Order 13772 (Executive Order).2 The Executive Order established a set of Core Principles consistent with which the financial markets should be regulated.3
The recommendations in the Treasury Report are organized in the following categories:
- Promoting access to capital for all types of companies, including small and growing businesses, through reduction of regulatory burden and improved access to investment opportunities;
- Fostering robust secondary markets in equity and debt;
- Appropriately tailoring regulations on securitized products to encourage lending and risk transfer;
- Recalibrating derivatives regulation to promote market efficiency and effective risk mitigation;
- Rationalizing and modernizing the US capital markets regulatory structure and processes; and
- Advancing US interests by promoting a level playing field internationally.4
This alert summarizes Treasury's recommendations related to the following sections of the Treasury Report: Access to Capital, Equity Market Structure, the Treasury Market, Corporate Bond Liquidity, Securitization, Derivatives, and Regulatory Structure and Process. As described herein, most of Treasury's recommendations can be accomplished through administrative action by the Securities and Exchange Commission (SEC) or other regulators, rather than through congressional action.
Access to Capital
Treasury begins the Access to Capital section of the Treasury Report with a familiar discussion of the decline of initial public offerings (IPOs) and the number of public companies over the past two decades. This report, like the SEC's new leadership, is focused on practical and feasible ways to increase companies' access to public capital and to make it more attractive for companies to engage in the public markets. Treasury has identified a handful of concerns related to, among other things, compliance costs, limitations on access to investment opportunities, disclosure burdens, shareholder litigation risk and the role of proxy advisory firms, and has offered a series of related recommendations to attempt to alleviate the regulatory burden of those concerns. The recommendations include the following.
- Remove Non-Material Disclosure Requirements. In connection with concerns that certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)5 create immaterial disclosure requirements, Treasury recommends repealing the sections of the Dodd-Frank Act that require disclosure related to conflict minerals, mine safety, resource extraction and chief executive officer (CEO) pay ratios. This recommendation is consistent with the Financial CHOICE Act of 2017 (CHOICE Act)6 and would require congressional action. Should Congress decide these disclosure obligations are appropriate, or fail to act with respect to the CHOICE Act, Treasury recommends that the SEC act to exempt smaller reporting companies and emerging growth companies from these requirements.7
- Eliminate Duplicative Requirements. Consistent with the Fixing America's Surface Transportation Act (FAST Act),8 Treasury recommends that the SEC amend Regulation S-K9 to remove provisions that are duplicative. The FAST Act addresses various items of Regulation S-K, including incorporation by reference, Management's Discussion & Analysis, undertakings, and extensible business reporting language requirements.10
- Permit Additional Pre-IPO Communications. Emerging growth companies are currently permitted to communicate with certain institutional investors prior to the filing of a registration statement for a securities offering in order to gauge the level of interest in the offering.11 Treasury recommends expanding this ability to "test the waters" for a potential securities offering to all companies instead of limiting this ability only to emerging growth companies.12
- Address Concerns on Shareholder Proposals. The Securities Exchange Act of 1934 (Exchange Act) Rule 14a-813 provides a mechanism for shareholders to submit proposals to companies in which they hold shares for inclusion in a company's proxy materials, subject to certain procedural and substantive requirements.14 Such requirements include that the shareholder has held at least $2,000 or 1% of the company's shares for at least one year.15 Treasury views certain of these parameters as outdated and recommends that the $2,000 holding requirement be revised (presumably increased). Treasury suggests that the SEC consider looking to a shareholder's ownership interest in a company as a percentage of such shareholder's net liquid assets to determine eligibility to submit a shareholder proposal, and also recommends revising resubmission thresholds to "promote accountability, better manage costs, and reduce unnecessary burden."16
- Concerns on Class Action Litigation. In order to shield public companies from the liability concerns associated with Section 10(b)17 of the Exchange Act and Rule 10b-518 thereunder, Treasury recommends that the states and the SEC explore ways to alleviate the costs associated with securities litigation.19
- Allow Business Development Companies to Use Securities Offering Reform. Certain of the securities offering rules that provide additional flexibility in accessing the capital markets to most public reporting companies do not apply to business development companies (BDCs), even though BDCs are Exchange Act reporting companies. Treasury recommends that the SEC revise these rules to apply to BDCs.20
- Modify Eligibility Requirements for Scaled Regulation. The Treasury Report identifies a variety of reporting obligation exceptions or modifications provided to smaller reporting companies, non-accelerated filers and emerging growth companies. The limited requirements include extended time to file periodic reports, and exemptions from compliance with the auditor attestation requirement in Section 404(b) of the Sarbanes-Oxley Act.21 Treasury recommends expanding eligibility to qualify as a smaller reporting company and non-accelerated filer to include entities with up to $250 million in public float (currently it applies only to entities with $75 million in public float), and expanding the time frame in which an emerging growth company can retain its status to up to 10 years (currently emerging growth companies lose such status after five years).22
- Review Rules for Interval Funds. To encourage investment in lower-cap public companies, as well as private companies, Treasury recommends that the SEC review rules related to interval funds in order to evaluate whether greater flexibility would encourage investment in such smaller public and private companies.23
- Review and Consolidate Research Analyst Rules. To improve access to capital for small and young companies, including by increasing sell-side research coverage for smaller public companies through the reduction of the costs of regulation and compliance, Treasury recommends a holistic review of the Global Research Settlement,24 currently applicable to 12 major broker-dealer firms, and of the research analyst rules promulgated by the SEC and the Financial Industry Regulatory Authority (FINRA).25 In particular, Treasury suggests harmonizing the Global Research Settlement and research analyst rules to identify a single set of rules applicable to all financial institutions.
- Increase Flexibility for Regulation A Tier 2. Regulation A+26 provides an exemption from registration for certain companies offering up to $50 million in securities in a year.27 Regulation A issuers are permitted to use a scaled offering document and are subject to ongoing reporting requirements, and securities sold in certain Regulation A offerings are not subject to state "blue sky" requirements, among other benefits.28 Under current SEC rules, Exchange Act reporting companies may not rely on the Regulation A exemption.29 Treasury recommends that (1) the SEC expand Regulation A to permit Exchange Act reporting companies to participate in such offerings; (2) state securities laws be revised (or over-ridden by the SEC) to exempt secondary trading of such securities from registration under state law; and (3) the SEC increase the maximum Regulation A offering size from $50 million to $75 million per year.30
- Crowdfunding. The SEC's crowdfunding rules, which were required by the Jumpstart Our Business Startups Act (JOBS Act),31 provide for an exemption from registration for offerings up to $1 million per year, provided certain requirements of the rules are met.32 To address concerns about cost, complexity and alignment of investor incentives under the crowdfunding rules, Treasury recommends allowing single-purpose crowdfunding vehicles advised by a registered investment adviser, which could facilitate a type of syndicate investing model for crowdfunding offerings. In addition, to facilitate greater participation in such offerings, Treasury recommends that the rules' limits on investment be waived for accredited investors and that the rules be amended to base investment limits on the greater of annual income or net worth, rather than the lesser of the two. Finally, Treasury recommends increasing the maximum revenue requirement from $25 million to $100 million, and the one-year crowdfunding limit from $1 million to $5 million.33
- Create Appropriate Regulatory Structure for Finders. To facilitate access to capital for smaller companies with fewer resources that may have trouble identifying and locating potential investors, Treasury recommends that the SEC, FINRA, and the states propose a new regulatory regime for finders and other intermediaries to increase the resources available to smaller companies seeking capital.34
- Allow Additional Categories of Sophisticated Investors to Participate in Regulation D Offerings. Treasury recommends that the definition of "accredited investor" under Regulation D35 be expanded in order to increase access to exempt offerings to a greater number of investors. One of Treasury's suggestions is that the definition include any investor who is advised on the merits of making a Regulation D investment by a fiduciary, and similarly, that it include those who are considered to be qualified to make such a recommendation.36
- Review Rules for Private Funds Investing in Private Offerings. To promote diversification, Treasury recommends a review of the provisions of the Securities Act of 1933 (Securities Act)37 and Investment Company Act of 1940 (Investment Company Act)38 that restrict unaccredited investors from investing in a private fund containing Rule 506 offerings.39
- Empower Investor Due Diligence Efforts. With the goal of streamlining reporting and empowering investors, Treasury recommends that federal and state financial regulators, along with self-regulatory organizations (SROs), create a system of centralized reporting of individuals and firms that have been subject to adjudicated disciplinary proceedings or criminal convictions.40
1 US DEPARTMENT OF THE TREASURY REPORT, A Financial System That Creates Economic Opportunities: Capital Markets (2017) (hereinafter TREASURY REPORT).
2 Executive Order 13772 was published on February 3, 2017. Treasury delivered four reports related to the Executive Order. The focus of the Treasury Report is capital markets, debt, equity, commodities and derivative markets, central clearing, and other operational functions. TREASURY REPORT, supra note 1, at 5.
3 The Core Principles are as follows: empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth; prevent taxpayer-funded bailouts; foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry; enable American companies to be competitive with foreign firms in domestic and foreign markets; advance American interests in international financial regulatory negotiations and meetings; make regulation efficient, effective and appropriately tailored; and restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework. TREASURY REPORT, supra note 1, at 3.
4 TREASURY REPORT, supra note 1, at 6. The Treasury Report also made recommendations relating to "[e]nsuring proper risk management for central counterparties (CCPs) and other financial market utilities (FMUs) because of the critical role they play in the financial system."
5 Pub. L. No. 111-203 (2010). The relevant provisions of the Dodd-Frank Act are conflict minerals (Section 1502), mine safety (Section 1503), resource extraction (Section 1504) and pay ratios (Section 953(b)).
6 Financial CHOICE Act of 2017, H.R. 10, 115th Cong. § 441 (2017).
7 TREASURY REPORT, supra note 1, at 29.
8 Pub. L. No. 114-94 (2015).
9 17 C.F.R. Part 229.
10 TREASURY REPORT, supra note 1, at 30. On October 11, 2017, the SEC proposed rule amendments to modernize and simplify certain disclosure requirements in Regulation S-K in accordance with the FAST Act. The SEC indicated that the proposed amendments are intended to modernize and simplify certain disclosure requirements in a manner that reduces the costs and burdens on registrants while continuing to provide all material information to investors, to improve the readability and navigability of disclosure documents, and to discourage repetition and disclosure of immaterial information.
11 TREASURY REPORT, supra note 1, at 30.
13 17 C.F.R. §240.14a-8.
14 TREASURY REPORT, supra note 1, at 31.
15 TREASURY REPORT, supra note 1, at 31–32.
16 TREASURY REPORT, supra note 1, at 31–32.
17 15 U.S.C. § 78j(b).
18 17 C.F.R. 240.10b-5.
19 TREASURY REPORT, supra note 1, at 33–34.
20 TREASURY REPORT, supra note 1, at 34–35.
21 Pub. L. 107–124, 116 Stat. 745, § 404(b) (2002).
22 TREASURY REPORT, supra note 1, at 36–37.
23 TREASURY REPORT, supra note 1, at 37.
24 See TREASURY REPORT, supra note 1, at 37 ("In 2003 and 2004, securities regulators settled with 12 major broker-dealer firms for conflicts of interest between their research analysts and investment bankers [Global Settlement]. Under the Global Settlement, broker-dealers were required to reform their structures and practices to insulate research analysts from investment banking pressures. The Global Settlement only applies to the firms that are parties to the settlement.") (footnote omitted).
25 See Regulation AC and FINRA Rules 2241 and 2242.
26 17 C.F.R. § 240.15c2–11.
27 TREASURY REPORT, supra note 1, at 39.
30 TREASURY REPORT, supra note 1, at 39–40.
31 17 C.F.R. § 230.251.
32 TREASURY REPORT, supra note 1, at 40.
33 TREASURY REPORT, supra note 1, at 40–41.
34 TREASURY REPORT, supra note 1, at 43–44.
35 The term "accredited investor" includes, among others, banks; savings and loan associations; broker-dealers; investment companies; private business development companies; organizations described in section 501(c)(3) of the Internal Revenue Code; natural persons whose individual net worth, or joint net worth with their spouse, exceeds $1 million; trusts with total assets in excess of $5 million; and entities in which all of the equity owners are accredited investors. 17 C.F.R. § 230.501(a).
36 TREASURY REPORT, supra note 1, at 44.
37 15 U.S.C. § 77(a).
38 15 U.S.C. § 80(b).
39 17 C.F.R. § 230.502(b); TREASURY REPORT, supra note 1, at 45.
40 TREASURY REPORT, supra note 1, at 45.
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