October 29, 2020

Coffee & Conversation: Insights from the SEC's Small Business Advocate

In this episode of Coffee & Conversation, Partners Jessica Magee, James Brown and Doug Lionberger are joined by Jennifer Riegel, a policy manager at the Office of the Advocate for Small Business Capital Formation (OASB) at the U.S. Securities and Exchange Commission (SEC), for a discussion on the challenges of connecting small businesses to capital and how the OASB helps companies in this area. They talk about how COVID-19 has affected businesses and what relief the SEC has offered as well as explain why small businesses have difficulty connecting to investors and raising capital. The conversation also highlights new and proposed rules covering the definition of an accredited investor, classification of finders and disclosures, and it concludes with the speakers' expectations for Fiscal Year 2021.


Podcast Transcript

Jessica Magee: Hi, everybody. James, Doug, Jenny, it's nice to see you. Thank you guys for getting together today. Thanks especially to you, Jenny Riegel, for joining us for Coffee & Conversation with the Office of the Advocate for Small Business Capital Formation at the United States Securities and Exchange Commission. That's a bit of a mouthful, but I just want to say I'm so glad you're here today. Thank you for joining Doug and James and myself for some conversation. I'll do a quick bio, if you don't mind. I know you do a lot of outreach, so a lot of people already know you by reputation and interaction, but Jenny joined the office in July of 2019, and there she leads the Legal and Policy Team on regulatory matters, rulemaking commentary and capital raising issues, both internally and externally. Before Jenny joined the office, you were in the Division of Corporation Finance in the Small Business Policy Group and a senior special counsel to Director of Corp Fin, as we lovingly refer to it. And then before that the Disclosure Operations Division. So you've been around and done a lot around the agency. I think you've been there since 2007, which means you and I overlapped. I was in, I was in enforcement, so we were doing sometimes different work, going in different directions, of course. But it's always nice to get to connect back with an agency that does such important work. So thank you so much for being here today, Jenny. I'm really glad to have you.

Jennifer Riegel: Thank you so much for having me and for Doug and James for joining me in this conversation. I've been really looking forward to it. Again, as Jessica mentioned, I'm Jenny Riegel, and we have like the longest title known to man, the Office of the Advocate for Small Business Capital Formation. But we feel that long title is commiserate with our big mission and what we're here to do to help small businesses and their investors. But we not only get a long title, we also get a really lawyerly government disclaimer that the views I express today are my own and they do not necessarily reflect the views of the commission or any other staff on the commission. And with that, I'll turn it back to Jessica to introduce Doug and James.

Jessica Magee: Oh, good. Well, appreciate that. Doug and James, I'm so glad you're here today really to lead this discussion. I mean, I cannot think of two finer, more qualified lawyers to do so. So really appreciate you taking time out of your schedules. For those watching today that haven't had a chance to meet or work with you, I'll let them know that both of you really have just extensive experience representing issuers and underwriters and IPOs, public and private equity and debt offerings, and you regularly advise PE investors, portfolio companies, other public and private companies on just a wide array of transactions, whether it's mergers, acquisitions, dispositions, strategic investments. In addition to all of that, I know that you represent entrepreneurs, VC investors and others in formation, financing and operation of emerging companies. So really thrilled to put the three of you together today and to try to not mess up the conversation really with my own views and experiences as the sort of trial and defense lawyer on the call. And before I turn it over to the three of you, Jenny, I think, I'm glad that you talk about the big mandate and the big mission of your office. I think one thing that we should do before we just dive in is really have you level set for everybody, what is the Office of the Advocate? What do you do? Why do you do it?

What Is the Office of the Advocate for Small Business Capital Formation?

Jennifer Riegel: Thank you so much for asking, and we could think of our office as a startup within the government. We started in January 2019, and we were created by Congress with almost unanimous, bipartisan support. And any time you hear that widespread bipartisan support, you know that there must have been a real need. And I think it's policymakers recognize that there is this gap between the role we as a society have come to expect of small businesses in creating jobs, innovation and wealth, and the accessibility of capital, on the other hand, to meet those expectations, and we believe that creates the need for advocates. And in particular, we have a focus on addressing the unique challenges faced by women- and minority-owned investors, as well as rural businesses and businesses impacted by natural disasters and their investors. And we're taking a proactive approach to engage with a variety of voices from small businesses and investors and try and take all that feedback that we hear, and we bring it back to the commission and the rule writers who are working on the policy matters and try to incorporate that feedback as early as possible as policies are being developed. The one other important aspect I wanted to mention today is we really kind of think of our office as an educational resource and an entry point for question. And as many of you are aware, the SEC has lots of rules and regulations and interpretations and guidance, and it's hard for businesses, and yes, very sophisticated counsel, to know where is the exact entry point within the Division of Trading and Markets or Division of Corporation Finance that I should be talking to about this particular issue and what each of them are really delving this down into. And I guess this aspect of our office, I think it as we're cruise directors. We go around and we help direct to the appropriate people. And so we're happy to serve and provide that education and to provide that kind of entry point for a lot of these questions that often come up.

James Brown: Thanks for that, Jenny. I think one thing that's important to note in your crew's direct role, I think one thing that's important to note is that a lot of times people think of small businesses and they don't really understand what that means. In reality, the OASB works with a really broad array of American companies, so can you touch on that a little bit?

Jennifer Riegel: Yeah, James, that's a great point, and we really do. And I think there's a lot of different ways that people define small business, and whether it's based on employee count or another metric, we look at it kind of on your capital structure. So we kind of define them in three different groups: the early stage company, the mature, later-stage businesses and smaller public companies up to a $250 million public float. And we've really found that there's a difference issue set for each of those groups of companies. And with that full spectrum of needs and challenges and interests and goals across this small business, one commonality that we've seen is that many of these companies, they don't have a dedicated government relations office. So when small businesses encounter a problem, they put their heads down and they work through it and they move on.

Our office is here to try to work with those small businesses and their investors, identify those pressing challenges and work collaboratively with the staff of the commission to resolve those concerns.

Doug Lionberger: That's great, I think that's a much better foundation of what the OASB does and the kind of businesses it supports and works with. Can you bring us up to speed on the current events in your office and how that relates in the 2020 landscape and about changing economic climate as well as COVID, etc.?

COVID-19 Updates: How the OASB Adapted, How COVID Affected the Market and What Relief the SEC Offered

Jennifer Riegel: Yeah, happy to. I mean, to put it mildly, COVID-19 and its ripple effects have been decimated, decimating businesses across the country, many of whom have run out of cash and are closing their doors permanently. Here in our office, COVID forced us to get creative and leverage technology to pivot from in-person engagement to virtual events like we're doing here today. At the commission level, in early March the commission provided conditional regulatory relief for certain filing deadlines and annual meeting accommodations. Our office sought feedback to provide information to the market on what additional steps, or to seek feedback from the market, I apologize, on what additional steps the commission could take to assist companies. And so one of the things we did is we did an online investment crowdfunding, capital-raising virtual coffee, and we really sought to provide information to the market on what was happening in this new space that a lot of companies hadn't heard about. Then in April, our advisory committee, the Small Business Capital Formation Advisory Committee, convened to discuss the challenges that each of these respective committee members had seen in their areas of expertise. As we turned around and we brought that feedback to the commission and the rule writers in the agency, leading to the temporary crowdfunding release. James, did you want to highlight the commission's release?

James Brown: Sure. Yeah. So, on this COVID front, as a result of the outreach that the Jenny is talking about, in early May of this year, the SEC announced temporary conditional relief for companies seeking to raise capital in direct crowdfunding. And it's meant to kind of expedite the offering process for certain investors and also ease the reporting burden. So just kind of in broad strokes, it's available for companies that have a six-month operating history. And if the companies have done a crowdfunding offer before, they must have complied with the rules for that. And generally, it's a conditional relief that provides flexibility for certain eligible issuers, the issuers we just talked about, to assess interest in the crowdfunding offering before actually finalizing documents. And then once launched, the offering can close a little bit quicker as soon as, basically as soon as commitments become binding, so generally 48 hours after the commitment is made, instead of requiring the offering to be held open for 21 days. And it also eases some of the financial statement review requirements for certain offerings. So, and then that was met with, I don't know, was met with success or welcomed changes, and the commission extended the relief for offerings initiated through February of 2021. So Jenny, I imagine you're seeing a lot of activity there. Can you tell us a little bit about what you're seeing?

Jennifer Riegel: Yeah. Let me run that a little bit. I'll definitely touch on kind of what we've seen specific to crowdfunding, but I think I would love to take a step back and kind of look at market dynamics in general. So, the market dynamics, at least as far as we're seeing and hearing, are changing in ways that we really haven't seen before. And we're trying to monitor in the market to not only see the impact of COVID-19, but also hear the feedback and make sure that you are lining up and trying to best equip our office with the tools to be able to make policy decisions. Last year, in our inaugural annual report we set forth not only, we set forth not only recommendations for policy changes, but we have lots of great data. And you can see there are different graphics and illustrations trying to walk through the impacts in a very visual way. And so if you have not checked it out, I really encourage you to take a look. And it will come as no surprise that we are in the process of preparing this year's annual report. We're going to have an expanded data section covering the impact of COVID 19, as well as data by lifecycle, founder demographics, rural and natural disasters. And while I'll give a few teasers here today on some of the high-level data points that our office is seeing, I did want to put a caveat. And that is that many experts believe the data is not showing the full effects due to data latency issues, due to difficulties in separating post-crisis closing from those that were planned and papered pre-crisis, as well as any, like any market, they're difficult to attribute pathology — I'm sorry, I can't say the word — in an even more predictable market. It's hard in this market. So with those caveats, the startup ecosystem has traditionally ebbed and flowed. With previous cycles, they have weathered these economic storms, and some of the most innovative and notable companies were born during these downturns. In fact, most of the Fortune 500 companies were founded in times of economic stress. However, the sheer force and speed of the COVID-19 crisis, and its uncertain impact and duration, is not comparable to past downturns.

About 72 percent of startup saw their revenues drop significantly since the beginning of the crisis, with the average startup experiencing a decline of 32 percent. Shockingly, almost 40 percent of the companies saw their revenues drop by 40 percent or more.

And only about 12 percent are experiencing significant growth on the other hand. The pandemic and economic crisis have disproportionately impacted founders in historically underrepresented groups. Patterns across gender and race are particularly alarming. For example, it's an older fact, but it shows from the beginning of the crisis, from February to April, there was about a 22 percent overall decrease in small businesses, with a greater impact on women and minority groups. But when you look at black-owned businesses that had closed, it was at 41 percent. On the other hand, there are optimistic data points. On crowdfunding, specifically, reports are indicating that during July and August, there was an uptick in crowdfunding offering, delivering in those two months the same amount of capital, which is $48 million, as the full first year, so from 2016 to 2017 of online crowdfunding. And while the seed market continues to be still a little sluggish, angel investors have remained rather resilient. So I think I always try to compare those facts with the overall what is happening in the startup market and registered market because you can't just look at one small piece without understanding the bigger picture. And so consistent with prior years, the vast majority of capital that was being raised in the 12 months ended, and we're looking at June 30, 2020, was done either in a registered offering or in a 506(b) private placement. In aggregate, each of these offering types raised well over $1 trillion dollars. So to compare that to some of the other exemptions that I mentioned, $70 billion was raised under 506(c) (some people call that accredited investor crowdfunding), over $1 billion was raised under Regulation A, $170 million was raised under Rule 504 Reg D, and over $85 million was raised under regulation crowdfunding. So enough with that, although I do love my stats, I'd love to hear Doug and James, what are you seeing in the market? What are you observing? Kind of, what are you hearing?

Doug Lionberger: Sure. This is Doug. So I think that's really interesting, I think it's interesting when you mentioned 506(b). That's one where I think the general solicitation requirement there gets people intrigued, but in my practice, I've always found that one very hard to comply with. So I've actually never had a client actually successfully rely on 506(c) because of how onerous those restrictions are. We always advise them to go back and do 506(b) just to prevent kind of a technical foot fault. So that's kind of my experience there. I think, personally, I wish 506(c) was loosened up a little bit to make it a little bit easier to comply with, especially in today's age where a lot of these startup companies have a really strong media platform, etc., and it's part of their business philosophy where educating others on ways and capital, etc., could be a benefit. But it's hard to get that and comply with 506(c) the way it's drafted. It's been my experience there. I also think it's an interesting time, at least — and this could be a little colored by the market we operate in, which is predominantly energy — I think there's been a ton of expansion in the startup founders base, at least here in Houston where I where I live. So that's kind of exciting to see as to how that unplays and folds out. So that's really taken off, really since COVID hit. I think people are starting companies, etc., so I think there's actually a lot of excitement in that space.

James Brown: Yeah, I would, I would echo that and kind of the points he's talking about, about some of the rules or there's, there's some foot faults and pitfalls for the unwary in there. I think it's great what your group is doing. It's reaching out to investors and really thinking about how you can better serve investors and work with investors. I think that's one of the biggest barriers to entry, honestly, is that there's this great menu of capital-raising options, but unless you're a very sophisticated party, you don't know where to start. You don't know who to talk to. You don't even really know how to read the rules in all cases. And so I think for small businesses in particular, it's absolutely critical for the businesses and their investors to have navigable and functional tools to raise capital and vice versa, to invest in small companies in early stages. And you know, I just think it's, if you, if you have sophisticated counsel or you are a very sophisticated party, I think you are at an inherent advantage over parties that don't have that. And I think it's great that, whether it's the example that Doug's talking about or things that you've mentioned here, I think it's great that you're really trying to kind of fit those together and make that navigable for small businesses. And I know there's some ongoing discussion about other ways to do that and simplifying some of those exemptions and making more exemptions available for small businesses, and I wondered if you could expand on that a little bit.

Jessica Magee: Can I chime in just real quick? Jenny, I'm going to interrupt for a second just to say, you know, sort of a theme of what we're talking about is your office tries to translate and make more accessible the capital markets, right? And what we're talking about today is really connecting small business to capital and navigating what can be murky waters. And we talk a lot about, well, this rule exemption, or maybe this exemption is going to be broadened or softened, but even that can be hard to access. And so you held up an annual report. I really want people that are watching today to know one of the things that you all do is actively and regularly populate your own website on sec.gov, your reporting, other conversations, virtual events you're having there, are available for people to go find in really, I think, plain English accessible terms, what is the state of the law? What is the potential future in terms of proposed rulemaking, proposed relief? What can, what do companies need to know in terms of COVID relief that maybe they didn't know existed or has been extended? And so I just really want to encourage people to know that that resource is there and that James and Doug exists to translate those things. I mean, that's what, what we lawyers do is translate those, but also that's a large part of what your office is doing. And so anyone that has questions about the exempted relief or rulemaking things we're talking about today, at the end of this presentation, of course, our names, numbers will be available. I know a lot of what your office does is receive and triage those inbound requests. I just want to encourage people toward that action because it really is an opportunity to distill and simplify what can be very challenging obstacles to entry. And you can put a pin in it for later, if you like, but you said something a few minutes ago about your office's focus also on minority-owned, women-owned, weather-affected, rurally located businesses, which I wager are maybe taking, not necessarily a bigger hit, though maybe that's the case, but certainly their share of the hit right now. And so I really want viewers to understand that that is a focus area for your office and why that is such a priority.

The Complexities of Capital Raising

Jennifer Riegel: Absolutely, and thank you for chiming in. Before we, that is a really important point, and let me jump to one point before that, which is kind of on, on the complexity point. There are a number of different exemptions, and each of the different exemptions have different terms. And there is, as the commission acknowledged in the capital formation proposal that it put out this spring, there is a lot of complexity in the system. And I kind of joke sometimes, we have a chart that walks through all of this, and I'm sure Jessica can send it around after this, with a video. But it is something that we created. It's about six point font, and it has small, narrow margins.

And any time a securities lawyer needs to create a chart to explain a system in six point font with narrow margins, I think it's fair to say it's complex.

This is a very complex system. And then when you combine that with an entrepreneur who may more quickly associate the SEC with football on Saturdays than a capital raising offering, you really have a challenging situation. And so that is kind of what our office tries to translate. We try, you know, there is this complexity in the system. But while we hear, that's one piece of feedback we've heard, we also heard loud and clear don't mess with 506(b) private placement. Don't change that, I want to keep that structure. That is where over a trillion dollars is being raised on an annual basis. And people, that is a tried and true system that people have regularly used, and they want to have that access to capital in that manner. And so, we did hear, the commission heard that there should be efforts to kind of make changes around where there are pain points in the other exemptions, changing kind of offering levels between one to the next that may make sense, the flowing disclosures across offerings, what makes sense. We don't need to go into the weeds, but at a high level, the proposal kind of walks through what changes could be made for the exempt offering system to function better. And that is, that is a proposal that is before the commission. It is something that the commission or the chairman has said is a priority and that he would like to get done before the end of the year. So if you are interested in that, stay tuned. But I would love to pivot to, Jessica, what you also mentioned, which is a really important part about identifying the unique challenges faced by women- and minority-owned businesses, and also rural businesses and businesses impacted by natural disasters. And this is something that our office, specifically and with intentionality, our office has embraced the opportunity to go out and find groups and engage with underrepresented groups. We recognize in our office that our economy is hurt by systemic challenges, and by underestimating certain entrepreneurs, there's a lot of unrealized potential that's left sitting on the table. So we're dedicated to going out and elevating and talking about it and quantifying these gaps in data that we have in our annual report and our discussions and in our outreach, to try to bring essentially greater awareness of this issue so that entrepreneurs who face traditionally heightened challenges can have better access to capital. And we really tried to take this broader approach. And if we see a group that we are interested in or think we can help, we reach out to them. We don't wait for a company to come and talk to us, or a group to come talk to us. We try and go out and proactively seek that input and feedback and see how our office can help them. Last year, our office went to AfroTech. We also did an event in Atlanta with historically black colleges at Morehouse College. During our small, virtual small business forum this June, we were proud to showcase so many diverse speakers who were 50 percent racially and ethnically diverse, as well as 50 percent men and women. And we, and Jessica highlighted, we've done a ton of virtual coffee, and we try to have a wide variety of different diverse organizations and offices and audiences. And if you have an idea out there and you want to come talk to us, please reach out to us. It's smallbusiness@sec.gov, our email, our website is www.sec.gov. But we really try — and you'll see this in our small business forum. A bunch of our videos are up there, so you can even see different segments of the forum that you're interested in. We have lots of absolutely amazing speakers that have so much great information. We try to focus on the success story and building on these success stories rather than starting on what are undeniably really negative statistics. And for those that may not know the statistics, studies have reported that approximately 1 percent of venture capital goes to businesses with black founders. Less than 2 percent goes to businesses with Latino founders, and only about 10 percent goes to businesses with female founders. So our office is trying to think outside the box and meet entrepreneurs and investors where they are. For example, this summer, the head of our office, Martha Miller, did two podcasts, which are pretty unusual for a government employee to go out and do a podcast. But she wanted to make sure that we're trying to reach out to entrepreneurs and investors and letting them know that we're here and to come talk to us. One of those podcasts focused on women of color, and we're trying to continue that focus. It's certainly not something that's new to our office. It's just, it's something that has increased visibility given the important national conversation that we're having right now. And kind of on that note, I would love to hear from you all what, whether it's on support for diverse founders or rural businesses or businesses impacted by natural disasters, I'd love to see what you're observing, if it's an interesting trend or an impact on capital raisings. I'll say that one thing that we don't often get a lot of direct feedback on, and I'm really curious to see what Doug and James have to say on this, is how natural disasters are impacting capital raising. I think it goes back to that idea that when a small business encounters a problem, they put their head down and they work through it and they figure it out. They find the solution, and they don't come and talk to the government to relay the feedback on kind of how it impacted their capital raising. And so I'd love, Doug and James, I don't know if you have any insight and sorry to put you on the spot, but on. Unfortunately, Houston was impacted by Hurricane Harvey in 2017, and I'd love to hear if you were able to see anything in the market that I could take back and consider.

James Brown: I will say, and I'll let Doug talk in a second, but I will say what I've seen is that it's just the challenge that people deal with every single day, is just identifying and connecting investors with small businesses. And the problem is when there's something going on like a Hurricane Harvey or some other macroeconomic environment, it's kind of like you say, people just put their head down and they don't think about where solutions are coming from. They think about putting out fires, right? Hopefully, not literally. But, so I think that's the big problem, and I think that's why it's great, the outreach you're talking about. Because I think one of the big barriers for people, particularly at the startup or in the small business space, is you don't really know what you don't know yet. And you may think that there's this SEC and they do this black box government thing, and you put in, you put your inputs in and it spits out an answer. But that's not always the case. There's multiple avenues you can go down. Like you said, there's a huge chart with six point font with all the different options and choose your own adventure. And I think one of the big issues is, like I said, clients a lot of times just don't know what they don't know, and they don't know how to ask or where to even get started. And then specifically on the natural disaster front, I think the tendency, at least with my clients, is to kind of buckle down and put your head down and sort of focus internally rather than, rather than like you said, look for where resources can come from outside.

Doug Lionberger: I echo that, and that's been my experience as well. I would say on the natural disaster front, I've seen clients go more towards bank financing as opposed to other types of raising equity, is what I've seen. And obviously there's a little bit larger companies who actually have the ability to tap bank financing. The one thing I did see a lot of was the PPP program, was you saw virtually any client who could qualify go after those funds. So that was really interesting to see. But again, on the natural disaster front, that's one where I would think you would see more than what we have seen, especially living in Houston. It was, it's just not something that I've seen a lot of from the investor side. And then we're talking a lot about the company side of the house, but I'd like to take a minute to talk about investors' and other individuals' participation in private placements by small businesses. Recently, the SEC amended the accredited investor definition. So historically, it's been based on two criteria: income or net worth. And I think this change has been long overdue. The new criteria include the ability to qualify based on certain financial sophistication metrics. So for example, if you present certain professional certifications or designations, you can meet the definition of an accredited investor. There's a way to qualify based on spousal qualifications, and four or five others that we don't really need to go into the specifics on. So I'd be interested in your take on the amended definition and how, your role in getting that taken care of.

Amended Accredited Investor Definition and Proposed Tiered Finders Classification

Jennifer Riegel: You know, that's a great point, and the accredited investor definition is so central to securities law. It has a significant role in the private offering framework, which ultimately impacts what offering investors have access to, as well as what offerings companies can do to raise capital. It really does have this central role in securities law, again, because it is a central component of that 506(b) private placement that is raising annually over $1 trillion. And so the broadening the definition to include this experience, and kind of experience and certifications that the commission allowed is definitely a huge first step, the fact that it's beyond net worth and income. The other kind of really interesting thing is it opens the door for future commission orders. So the commission defined it to include different series, holding a Series 65, Series 7, Series 65 and 82, and remaining in good standing. But it could be broadened. And when looking at this, we've already gotten a few questions of how can I weigh in, where can I weigh in? And for those who just can't wait, you can always use the comment file. So while the accredited investor definition was proposed and then adopted, that proposal common file, you can always still submit further thought and further comment, even though the rulemaking has already been adopted. So that is one place that people are ready to go. You can certainly put it there, put your feedback there, and someone will read it. When the rules, around the time the rules get adopted, there's going to be a small business compliance guide that will walk through the details of the tool, how to comply with it, name, the impact. And with that, or around the time of that is my understanding, the staff intends to provide more clarity on where these, where the feedback should go on kind of weighing in on if the commission should be considering new elements of the accredited investor definition. We also, part of our office, we try to highlight things in videos, which is kind of abnormal for the SEC, and so we have a quick little spotlight video that we put out. And we tweeted it and put it out on social media to try to get people aware of the fact that this definition is changing. And I saw the other week that it was recently published in the Federal Register, and so the rules will be effective on December 8, 2020. So for those who are curious when it's going to actually happen, it's December 8, 2020.

Doug Lionberger: Thanks, and kind of follow it up on that similar vein, kind of connecting investors to companies, the SEC recently held a meeting to discuss finders to consider whether to issue a notice proposing to grant a conditional exemption to allow people to engage in certain limited activities on behalf of issuers. Is this a matter that your office deals a lot with, and what are your thoughts on kind of the finder's fee?

Jennifer Riegel: This is definitely a challenge that we have heard small businesses face. When you're trying to raise capital at different levels, you need to make sure that the investors that you're seeking are a good fit for the company, both in terms of industry experience, as well as risk tolerance, as well as investment capacity. And being able to go out and find those investors that are appropriate for your company can be really challenging for a lot of companies. And we, like many issues, we hear that this challenge is felt more acutely among certain entrepreneurs, including those located far from the coastal hot spots of funding or those within certain demographic groups, like women- and minority-owned businesses, where there may be higher hurdles to connecting with funders based on their existing network of potential investors who may not be accredited or, and, a good fit for their investment. And this is, a number of different thought leaders have raised these challenges over the decades. This is not something new that our office just heard. But this is, this is something that is really important to be able to make that connection, and this is something that's come up again and again. Several speakers recently highlighted the hurdles of finding, developing and growing a network at our recent small business forum this summer. The proposal seeks feedback on the proposed exemption, which essentially outlines a proposed framework for finders. So it would be, at a high level, two classes of finders: Tier 1 Finders and Tier 2 Finders. They would be subject to conditions that are tailored to the scope of their respective activities. Essentially trying to establish clear lines for both registered broker activity and limited activity by finders that would be exempt from registration. It was recently published in the Federal Register, so comments are due on November 12, 2020, and to help encourage feedback, our office created two educational resources. So one is the chart that compared some of the permissible activities, requirements and limitations of the proposed exemptive order, and then a short video that provides a high-level overview of the proposal. And it actually animates some of the elements of the chart showing you how they all fit together and what does that mean for businesses, investors and potential finders. Enough about the details, I would absolutely love to hear your take on both kind of the challenges, as well as experience, in counseling clients in this area.

James Brown: I will say I will put in a plug for the video as well. I watched it and was deeply impressed with the animation of the charts. But I think the big issue here is people are asking for certainty, and without guidance, there just isn't any. You know, historically this has been, I know Jessica could probably speak to the enforcement angle on this, but this has been a question that people ask all the time. And like I said, the biggest challenge these companies face, and it's starting to sound like a broken record, I guess, is finding the right people with the right company. And oftentimes, an intermediary or a third party can be crucial to that. And the problem with that is you have very little guidance. You got a factors test and a line of no action letters and case law that kind of sets out some things that are clearly right and clearly wrong. But having some, some guidance and the way you guys broke it down into a chart of "This is what you can do if you're Tier 1, and this what you can do if you're Tier 2" is, I think that will be welcomed by the market. Jessica, I don't know if you want to weigh in on from an enforcement angle.

Jessica Magee: I just completely agree. And you know, I could probably nerd out on this topic for an extended period of time, but when I think of the changed definition of an accredited investor, which, I think, if you had to sum up the why of that change, it's to be more intentional and expansive to include people that really can weigh the risk attendant to investing rather than just some arbitrary financial threshold litmus test that existed. And then on the potential finder exception, I think it's the same thing. It's, again, from my prior enforcement perspective, we would always argue, as the SEC I'm sure does still in the cases it brings, that there is no finder's exception. And James, as you touch on that there are factors and you have to look every time at your specific facts, and you might have some, some borders, and you can say, "How do I tack two around? How do my facts line up there?" But a lot of times companies that are doing the right thing the right way and exercising very good and robust business judgment, either after the fact or before the fact, in a way that's almost paralyzing to take action they need to take to connect to capital, think, "Is this person able to do this? Am I able to use this matchmaker to connect to capital? Can I receive capital from this interested party?" And so, I'm really excited to see where this goes because I think it is designed and driven to provide more clarity. And from a defense perspective, I think it gives companies more assurance and comfort to say, again, if we're trying to do it the right way, we will have new guidance to go by, and even if we aren't sure we can fit perfectly into this cubbyhole, whatever that may ultimately end up being in the tiers, they can ask, they can inquire. But if I were to step further back and really put that enforcement hat back on, I bet there are a lot of questions about how is this ultimately going to affect Mr. and Mrs. Main Street, right, John and Jane Doe retail investor. Which a company needs to be thinking about. How do I get appropriate disclosure to an investor? And if there's not appropriate disclosure or if people are doing something more than being a mere finder, that can move that needle in a scary direction. But again, I always think more clarity and more sort of practical understanding of the realities of how capital, how companies need to connect to capital and who the intermediaries always are going to be, is a good thing.

Jennifer Riegel: I, we've, definitely heard the same thing. So I think any, I feel like the unique thing about finders that we've heard is it's not, if people are just requesting lines on the road, where are the lines on the road so I can know where I can be over here or over here, whether to counsel my clients one way. And this is often the space where we've heard a lot of lawyers. We've heard a lot of lawyers who are saying, "I don't know what to counsel my client. I don't want them to have a potential Section 5 violation down the road or a concern arise on an investment that engages a finder and does that create a question mark when you have a more sophisticated investment down the road?" And we've heard that as well. So these are definitely big issues, but I do think it's unique in a space where people aren't calling for necessarily one change or another. They're more looking for where the line is on the road and so I know where I can operate around them.

Disclosure-Related Rulemaking

James Brown: I would echo that, I would say that's exactly what I've seen, is people just want an answer. And tell us what the answer is, then we can deal with it. And so I think if this gets finalized, I think that will be a big step in the right direction. If I can steer the conversation a little bit back towards a couple of things, disclosure's been mentioned a couple times. And this is probably more of an issue for the companies on the larger end of the companies that you deal with, but and I will, you will probably tell that I've read your annual report, but I will say that CEOs will say it costs $1-2 million a year for just being a public company. Not going public, but just being a public company. And that's when things like auditing fees, legal fees, regulatory disclosures, compliance, things like that. And that can be prohibitive, and kind of the hallmark here is we don't want regulation to steer people's economic behavior, right? We want it, we want it, we want the system to work for people. And I will say that the SEC has done what I think is a great job of in recent years kind of streamlining disclosure, eliminating repetitive disclosure, limiting things like that. And then for companies that are, that you see in your office, changing the definition of small reporting company, so any company, there's a number of tests, but basically $250 million market cap and below, you can be a small reporting company. And that allows you to do things like only have two years of executive comp disclosure and only disclose the CEO and the two highest paid people, which is burdensome. And people don't like having their information out, and it's burdensome and it's costly. And so limiting that, I think, is a good idea. Two years of MD&A, narrative disclosure, two years of financial statements, things like that, as opposed to the regular three for a mid-cap or large cap company. So I think that's great. Doug, if you've kind of seen the same thing.

Doug Lionberger: My experience has been really similar to what you've seen. The one thing I would add is that scale disclosure is not an all-or-nothing approach, which I think is really important to some clients in that they still want to show certain things the same way their public peer companies show it for marketing purposes, etc. So it's important to remember that it's not all or nothing. You can use scale disclosure in one area and still provide the full, robust disclosure in other areas. So that's the only thing I would add there. Jenny, what have you seen in this area?

Jennifer Riegel: So this is an active area of lawmaking, right? The commission has been extraordinarily busy, and the chairman highlighted in a recent speech that in fiscal year 2020, Corp Fin took the lead on 19 different rulemaking related releases, including proposals, final rules, COVID relief and commission relief. So there is a lot going on, no shortage of different rulemaking, several of which included ways to streamline the rules for smaller public companies, some of which you guys have mentioned. The one, another is modernization of business, legal proceedings and risk factors disclosure. Those will be effective November 9. Accelerated filer definitions, which most people commonly associate with SOX, or Sarbanes-Oxley, 404(b) for those who like citations. And those are, those were effective in April of 2020, and they followed, of course, the small reporting company definition amendments, which happened in about June of 2018. Most recently, the commission adopted updates to the auditor independence role. And so those look, one of the big things for IPOs is they change kind of the look-back period for an IPO on auditor independence. It used to be three years. It's now one year. Those rules were just adopted last week, so we won't have the effective date until they're published in the Federal Register. There's also M&A accounting disclosure refinements, since we are talking about the accounting stuff, too. But these really do have an impact because the accounting rules definitely interplay with the legal rules, and there's a lot of crossover between the disclosures and the requirements. Another was the January 2020 proposal on MD&A and selected financial data. So certainly no shortage of things going on in the space, and we certainly hear feedback of all types on the rule. And if your clients are looking at these rules, whether it's an adopting rule or proposal, and they have feedback that they can give us relating to small business capital raising, we would love to hear it. So engage with us. Reach out, we will respond to emails. We call people back. We want to know that feedback. Don't just put your head down, and if you encounter a problem, we want to hear kind of how these rules are working because it really is important that our public markets remain dynamic and remain the disclosure opportunities that they currently are.

James Brown: That's great, and it sounds like you've got a lot on your plate and a lot of things here, you're working on here, which is great. So, you've mentioned this a couple of times on rulemakings and feedback and reaching out to clients. Can you talk a little bit about how specifically people actually get involved in kind of formal comment process and how you go about encouraging that and why you think they should do that? I mean, I think it's maybe a little obvious from what we've talked about, but.

How Do People Participate in the Comment Process, and Why Should They?

Jennifer Riegel: Absolutely, so I definitively believe in starting with the why. Why would you, your time is valuable and precious, so why would you take it to write a comment letter to us? And part of it is our office truly believes that our role should be based on practical, market-driven solutions that are designed to protect investors. And we need your perspective. Without your perspective and your experiences to understand what is working in the market and what aspects may need to be revised or tweaked to function more efficiently for the entire market. We need your voice. So reach out, engage with us, share your views and comment on proposed rulemaking. Now the second piece: how. We thought of that. We have a video on our video gallery. It's the at the top of the page, and it is the very first video that you see. And it's only about three minutes, and it walks you through literally how do you comment on a proposed rulemaking, where you find information, what information you need. It can be as simple as writing an email with a file number as your subject line, and it's rule-comments@sec.gov. You can also just go to an online submission form and just write a sentence. It does not need to be a formalized document that is reviewed by counsel. It can be something simple. It can be something straightforward. If you're experiencing an impact that impacts that rulemaking, we want to hear about it. I think the need to bring in that marketplace viewpoint is essential, and if we're not able to get it, then we can't truly highlight those voices and be able to take them into account as we're considering a final rule. So I encourage everyone to reach out. It can even be, we recently had a comment letter that used Twitter. So they did a Twitter feed and a conversation, and so they basically screenshotted parts of the Twitter feed into their comment letter, talking about feedback provided. And it doesn't have to be like what everyone else is doing. You can just submit your view and tell us what you're seeing and hearing in the market.

James Brown: And I think that's really the key, that if you hear anything from this, from this presentation or from this chat, it's trying to unwind some of the complexity and really get involved in the rulemaking process, really understand how to navigate some of these rules. And Jessica said before there'll be, we'll send around some links and phone numbers and all that. But the resources that Jenny's mentioned are really great. And I think, that's, like I said, if there's one takeaway, I hope that's it. That this isn't your typical SEC where everybody just needs to call their, they don't really know what's going on. Really want to get involved and make it work for small businesses, and I think that's a great development.

Wrapping up FY 2020 and Looking Ahead to FY 2021

Jessica Magee: So, as we're wrapping up, I'm going to put each of you on the spot, if you will bear with me, and I'm going to start with Jenny. You guys just finished your fiscal year. I remember it well, September 30, last day of the year for the SEC. Before that in June, I think you guys, was it your first time to do, I guess it would be, an all-virtual small business forum, right? And report it out to Congress on that. I think it was the 39th such forum. So I'm sure you've been doing a lot of taking stock of the year that was, fiscal year that was, and what's coming ahead in Fiscal 2021. I'm almost afraid to ask, now that time is just a construct man. But what can you tell us? What are your views, takeaways? What are the parts of the year for your office and the work you did, challenges you saw on the market and some of the success stories that I know you like to highlight? What are the big takeaways from your Fiscal 20, and what are you looking ahead to for Fiscal 21? And then after you go, I'm going to ask Doug and James from their perches of the world to sort of give us their views as well.

Jennifer Riegel: That is an excellent question, and one we actually get fairly frequently, but I'm happy to kind of provide some information. So the head of our office recently gave a speech at SEC Speaks on "The Car Talk of Capital Raising." Her speech explained why our office is the car talk of capital raising, and while I certainly don't want to ruin the speech for you, I did want to share some of the highlights that she raised on the "capital raising engine." So some things, many of these things, are things that we've already talked about here today. And the first is complexity, and we hear that people are overwhelmed by the complexity of securities laws. And we have this need, as we've discussed, to connect people with educational resources and demystify compliance. The second is connecting founders with investors, also something we've discussed today, on finding that right fit. And kind of, as Jessica brought up before, it really brings up finders, the role of finders, but also who came back as an accredited investor. And then it also brings up the idea of how our company is connecting potential investors potentially outside their network through general solicitation. And this is something — I think I think it was, James discussed this before — on 506(c) and whether people are using the, using general solicitation to go out and solicit. Another topic that has come up a lot is smaller funds. So this isn't something we've discussed today, but we would be happy to have a discussion if anyone ever wants to reach out and talk about feedback on this point. But we hear from small and emerging fund sponsors that the current regulatory construct makes early stage investing more challenging, which pushes activity upstream into larger deals. They also report that the impacts are felt more strongly in certain geographies, industry sectors and demographic groups that are underrepresented by traditional venture capital. So savvy early stage investors do want, they appreciate the impact of that diversified portfolio, but they often lack the ability to do that with funds, so that is definitely a concern that we've heard. Another is public companies, and this is also something we've discussed here today. And we hear from larger private companies who are debating the future about liquidity and access to capital in the public market against the perceived challenges of that research coverage and the expenses of going public and staying public.

And it is important that becoming a public company remain an attractive goal for companies.

And lastly, and certainly not least, it is definitely something we are focused on, is the demographic inequity, demographic inequities, and COVID-19. Data is showing that capital raising is more challenging outside those traditional hubs, as we've discussed, as well as for women- and minority-owned investors, businesses, and even investors on other side, there aren't as many investors in those networks. And many are finding, many women and minority founders are finding themselves pitching to investors and fund managers that don't pattern match with those investors' notions of successful entrepreneurs. And so they're having, they're experiencing a challenge in raising over that hurdle. And COVID-19 is adding additional dimensions to these challenges. As we discussed, decimating small businesses, making those challenges far more acute, especially for women- and minority-owned businesses. So that, that is, that is a lot, but that is, those are kind of my highlight points.

Jessica Magee: Yeah. I mean, James is right, you have a lot on your plate. I hope it's a big plate. It's like a buffet-sized plate. James, what are your takeaways as we wind down from our own year, winding down and what you think is on the horizon?

James Brown: So I think, and I don't think this is going to surprise anyone, this is not exactly a novel thought, but it, 2020 has just been marked by uncertainty in my practice. It's companies, smaller companies, kind of trying, just trying to stay alive and find capital wherever they can. And just sort of kind of hoping to see where the light at the end of the tunnel is and hoping that light at the end of the tunnel isn't a train coming. But that's kind of what I've seen on the smaller companies. But then, and my experience is colored largely by energy because I am in Texas, but you've seen kind of some of the very large companies seemingly not very affected at all, and with some very, some of the largest merger transactions we've seen in several years. And so it's going to be interesting to see how 2021 plays out. Hopefully, there will be a little more, little more certainty. And I think some of that activity will filter down. I think, again, largely colored by energy, with the shutdowns and uncertainty and things like that, energy has really taken a big hit, on at least from a small to mid-cap size. But, so it's kind of hard to even put 2020 into a category from my perspective. Doug, what have you seen? I know you work a little bit more with the startups on the energy space.

Doug Lionberger: Yeah, so I think, like James said, 2020 has been an odd year, especially both of our practices are dominated by energy and the way energy got hammered by COVID, etc.

I think 2021 is really exciting on the energy startup side of things. I think there's a lot of people moving from what I would call it traditional energy companies to more energy technology, energy startup-type companies.

So I'm excited to see what 21 has in store in that area. I think there's a lot of expansion and a lot of growth in that space. Clean tech is another area that, it's exciting to see how all that plays out. I also think you're going to see the return — once COVID hit, it was hard to have actual valuations of certain companies. So the M&A dried up to a degree, and when M&A dries up, to a degree some of the capital raising is no longer necessary for some of the larger, mid-cap public companies. So I think that will return, fingers crossed. And also, I think there's actually been a decent amount of consolidation. So with that, I think that actually opens up a lot of those people to go out and start new companies, etc., kind of the lifecycle of, at least in the energy space, how that unfolds. So I'm excited to see what happens there in 21, but fingers crossed. I think it's safe to say 21 probably going to be a better year than 2020, or I hope so.

James Brown: Hopefully knocking on wood somewhere.

Jessica Magee: Exactly, throw some salt over your shoulder. I agree with all of that, and I think it's going to be an exciting year from my little perch in the world to see how the finder's exception issue develops and percolates, accredited investor definitions getting out into the bloodstream. And again, the work I do, and we haven't discussed this day, but smaller companies also looking to other divisions and offices of the SEC on lived experiences with Reg BI form, CRS, things of that nature. So, the lesson that I learn and learn and learn again every time I speak with fine folks from the SEC is that you all really do your best to be state of the art and tip of the spear, if I can mix my metaphors, sometimes with limited resources. Just doing a lot of work and especially the work that your office does to connect with small business, as broad a definition as that really is, and to be an advocate, an ear, a voice and a champion for small business and all the ways that it exists or should exist for future entrepreneurs. On behalf of our clients, we just appreciate that level of work and that level of access, and I want to remind people that watched us today to please reach out to us, reach out to your office. There are tools for translation, onroads to the highway of connecting small businesses to capital, and it's an exciting time for sure. And one in which we all must stay resilient and flexible to changing circumstances. So I just really want to thank you all again for joining me today for Coffee & Conversation. My mug is empty, which means our time must be up. Jenny Riegel, thank you so much. Doug and James, thanks for bringing your subject matter expertise to bear. I know I learned a lot today and those watching will be learning as well. So thank you guys so much.

Jennifer Riegel: Thank you so much for having me.

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