Crenshaw Goes on the Offensive Against Reg D

What do WeWork, Theranos and FTX have common? Aside from being some of the biggest corporate boondoggles in recent history, they all managed to raise substantial equity financing without going public. And if you think that defeats the purpose of regulating the securities markets through the Securities and Exchange Commission, at least one of the agency’s commissioners agrees with you.

Companies can work around the standard requirements for securities offerings courtesy of Regulation D. This measure lays out the rules for so-called private placements that are exempt from registration with the SEC, originating in the 1980s as a way to help small businesses raise capital. However, as SEC commissioner Caroline A. Crenshaw has pointed out, common use of Reg D has expanded beyond its initial intent of providing small businesses with a pathway to capital from “a limited type of investor who had access to baseline disclosures.”

Instead, access to capital has evolved to the point where there are an estimated 1,200 “unicorn” companies around the world – private companies with valuations of at least $1 billion. Conversely, data from S&P Global Market Intelligence indicates that proceeds from the 4,961 global equity offerings closed in 2022 totaled $421 billion – a 62% decline in total value and a 37% drop in deal volume from the prior year.

The boom in the private market has not come free of consequences, according to Crenshaw. First and foremost, private placements involve a theoretical risk trade-off: The accredited investors who are allowed to participate in the offerings possess enough expertise to render the benefits of mandatory disclosures moot. See the aforementioned meltdowns as evidence to the contrary. The SEC itself has warned that scam artists use the lack of investor protections involved in unregistered offerings to perpetrate fraud.

“As private companies have gained increasingly large[r] market power and as the pool of accredited investors has expanded – including venture capital, private equity funds, mutual funds, pension funds, and individuals that meet the requisite wealth thresholds – the de facto presumption that accredited investors need no disclosure isn’t panning out,” Crenshaw said in remarks delivered last month in support of modifying Reg D.

If facilitating fraud isn’t reason enough to reform Reg D, Crenshaw notes the growth of the private market has insidious spillover effects on the entire financial system. As more assets flow into illiquid private markets, for example, valuations tend to be inflated absent real-time price discovery.

Meanwhile, the growth of private companies means a declining share of the economy is subject to regulation and the associated costs dictated by adequate compliance programs. That arguably puts pressure on regulators and lawmakers to help publicly traded companies compete by watering down standards of corporate governance.

Lastly, if larger companies are dominating the market for private placements, how does that achieve the fundamental purpose of Reg D in the first place? Ironically, when it comes to Reg D, you could make the case that putting new guardrails on the measure designed to fuel the formation of small businesses might kickstart their growth.