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Trump's Nominee for SEC Chief: Implications for Startups and Fintech

RegulatorySECTrumpFintechStartup

Shriram Bhashyam   January 19, 2017


On January 4, 2017, President-Elect Donald Trump nominated Jay Clayton, a private sector Wall Street lawyer, to serve as the next Chairman of the SEC. While the confirmation hearings will tell us a lot about Mr. Clayton’s background, qualifications, and leanings, I can’t wait that long and preview here what the SEC’s agenda may look like in his tenure.
Source: Sullivan & Cromwell LLP

Who is Jay Clayton?

Jay Clayton is a well-respected and veteran Wall Street lawyer, who’s a partner at the white shoe firm Sullivan & Cromwell LLP. His areas of expertise are M&A and capital markets. Some highlights from his deal sheet include representing Barclays in its purchase of assets of Lehman Brothers out of bankruptcy, and working on the Alibaba IPO, the largest IPO of all time. He has represented a slew of banks, hedge funds, and other financial institutions in transactions and before regulators, which I’m sure will receive scrutiny during his confirmation hearings (cough — Sen. Warren — cough).


The Deal Maker and the Prosecutor

I think we’ll see the SEC diverge rather sharply from the course it has taken under outgoing Chair Mary Jo White. Under Chair White, the SEC emphasized enforcement and investor protection, fining and penalizing wrong-doers in record amounts. To be sure, the SEC agenda under Chair White was also informed by the political climate at the time, where Wall Street was vilified and absorbed a lot of the blame for the Great Recession. Additionally, a change in direction at the SEC is informed by the tendencies of the leaders making the nominations, with President-Elect Trump decidedly more laissez-faire than President Obama when it comes to regulation.
Peering under the hood further, Jay Clayton is a deal lawyer through and through. He’s worked at one of the top Wall Street law firms since graduating law school in 1993 and is regarded as a preeminent deal maker. Chair White, by contrast, has a background in litigation and prosecution. Chair White was the U.S. Attorney for the Southern District of New York (which many in the legal community regard as the most desirable prosecutorial position in the country), where she notably led the prosecutions of John Gotti and the terrorists responsible for the 1993 World Trade Center bombing. Following her run as a U.S. Attorney, she was the chair of the litigation department at Debevoise & Plimpton, another venerable Wall Street law firm.

A Lighter Touch

That Mr. Clayton is a deal maker rather than a prosecutor is a strong signal that the SEC’s agenda will lean more towards facilitating capital formation and further away from enforcement. For the fintech and startup communities, there are a few specific ramifications I’ll highlight.
The SEC will likely soften the stance enunciated by Chair White in her “Silicon Valley Initiative” speech on March 31, 2016. In that speech, she put the Valley on notice that the SEC was paying attention to what was going on there, given the “eye-popping” valuations, greater breadth of investor participation, and sheer amounts of capital being deployed. It’s reasonable to think that Mr. Clayton would not focus as much on possible securities fraud in the Valley, and be more deferential to a world where investors are sophisticated and can fend for themselves. I think we’ll also see a slowdown in the momentum of SEC investigations of startups. The SEC is reportedly investigating Theranos and Hampton Creek, for false or misleading statements in their pitch decks and other offering documents related to their fundraising. These types of investigations by the SEC will more likely slow down under Mr. Clayton’s regime.
We’ll probably see an acceleration of rulemakings that ease capital formation. One initiative, currently percolating in the halls of Congress, is the Fix Crowdfunding Act (“FCA”), which is meant to improve upon the JOBS Act. The FCA seeks to, among other things, increase the cap on what an issuer can raise in a crowdfunded transaction from $1 million to $5 million, ease investor caps, and reduce liability to crowdfunding portals. The SEC may throw its weight behind this bill, and if passed, could act swiftly to implement it via rulemaking. I wouldn’t be surprised if there were further initiatives that expand upon the premise of the JOBS Act.

We may also see rules revisiting who qualifies as an accredited investor, an issue which has been debated at the SEC for a few years now. A revised definition of accredited investor may be could broaden its scope, by for example, allowing those with certain financial credentials (e.g., CFA) to qualify as an accredited investor, regardless of income level or net worth.

This post was originally published on Medium (available here).

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With RAISE Act, Congress Paves Way for Private Secondary Markets

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Shriram Bhashyam   December 23, 2015

I recently wrote a guest article for TechCrunch on a legal development which will impact the growth of secondary markets for private shares. It's shared below.

On December 4, 2015 President Obama signed into law the FAST Act, which is mainly about transportation funding. Included within the FAST Act is a section, the Reforming Access for Investments in Startup Enterprises (“RAISE”) Act, which codifies a previously unwritten means through which startup employees, ex-employees, early investors, and other shareholders have been legally allowed to sell their shares.

The passing of the RAISE Act is a major step towards the development of orderly and deep secondary markets for private shares, as it will create more transparency around the process and its legality, and it will lend legitimacy to these markets.  How this develops will impact all stakeholders—sellers of the shares, investors, the companies who issue the securities being bought and sold, and the service providers (full disclosure, I am a co-founder of EquityZen, a platform that conducts secondary transactions in pre-IPO shares).

Background

A quick—I promise—background on the securities laws and how they apply to sales of startup shares by employees, ex-employees, and early investors. Generally, the securities laws require registration of securities to be offered or sold, unless an exemption applies. The sale of startup shares by an employee, to, say, pay off school debt, is a sale of securities that must comply with the securities laws. The relevant exemption here is what is colloquially known among securities lawyers (admittedly, I am one of them) as the “4(a)(1-½)” exemption, which applies to resales of privately held shares.

Developed through interpretive guidance from the Securities and Exchange Commission (“SEC”) and from case law, the “4(a)(1-½)” exemption provides that a resale of privately held shares is exempt from registration requirements if the resale is to a limited number of purchasers and completed without public advertising or general solicitation, the seller provides the purchaser with certain information regarding the issuer (the company whose stock is being sold), although the seller may be limited in what she can provide, the purchaser is sufficiently sophisticated to evaluate the risks of investment and to bear economic loss resulting from the investment, and the purchaser is acquiring the shares for investment and not for resale.

RAISE Act

The RAISE Act codifies the “4(a)(1-½)” exemption by writing it into the securities laws as an explicit exemption. In order for a resale of private shares to qualify for the RAISE Act exemption, among other things the purchaser is an Accredited Investor, there is no general advertising or general solicitation of the transaction, and the seller is not a “bad actor” as specified in SEC rules. Additionally, the new RAISE Act exemption would require that the purchaser is provided with certain information, including basic information about the issuer, the securities being sold, as well as the issuer’s balance sheet and similar financial statements for the last two years (in accordance with GAAP).

 Additionally, if the seller is a control person with respect to the issuer (I note that “control person” is not defined but one can think of this as senior management, a director, or material shareholder), the affiliation must be disclosed (to address possible conflicts of interest).

Analysis

As one can see, the RAISE Act exemption generally corresponds with what the “4(a)(1-½)” exemption has required. Notably, there is not a limit on offers or the number of purchasers, a signal of legislative intent to foster the development of robust private secondary markets.

The RAISE Act also specifies disclosure requirements for these transactions. This is a welcome step towards standardization and transparency in admittedly bespoke and opaque markets. However, it should be acknowledged that the disclosure requirements are not easy asks of the companies. A founding principle of EquityZen is that the company whose shares are being sold is a key stakeholder in the process, whose interests should be accounted for. A balance needs to be struck between a private issuer’s interest in guarding sensitive information and the investor’s interest in having sufficient information to make an investment decision.

It’s important to note that...

Continue reading at TechCrunch.

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