SEC gearing up for major private market rulemakings

Author:
The Carta Policy Team
Read time:
9 minutes
Published date:
June 15, 2023

Topline

• SEC’s regulatory agenda has private market reforms in focus
• Courts side with CFTC in landmark crypto case
• Economic package heads for the House floor with QSBS expansion
• Republicans grill CFPB director on junk fees, small business lending

SEC’s regulatory agenda has private market reforms in focus

The SEC’s latest regulatory agenda was released this week, and private market reforms will remain an area of focus for rulemaking activity over the coming year. Here are a few highlights and potential implications for the ecosystem:

• Private fund advisers: The SEC is expected to finalize its private fund adviser proposal, which would impose a number of new obligations on SEC-registered private fund advisers, including disclosure and audit requirements. The rule would also prohibit all private fund advisers— including VC fund advisers—from engaging in certain activities, such as the use of side letters or indemnification for simple negligence. Additionally, the Commission is expected to finalize a number of other proposals that would impose a host of new compliance obligations on SEC-registered private fund advisers, including with respect to cybersecurity risk management, vendor due diligence, custody, ESG disclosures, and enhanced Form PF reporting.

• Regulation D: The SEC is expected to propose Regulation D reforms, which could include requiring more disclosures from private issuers on Form D, requiring pre-filing or closing amendments, and conditioning the use of the exemption on a Form D filing.

• Accredited investors: The SEC is expected to consider raising the financial thresholds for individuals to qualify as accredited investors, which would limit private market investment opportunities and reduce an important source of capital for founders and fund managers, particularly in lower-cost regions that may lack access to traditional capital-raising networks.

• 12(g) holders of record: The SEC is expected to propose changing the way “holders of record” are counted under Section 12(g), which could push more private companies into the public markets before they are ready, reduce competition, and constrain investor access if the use of SPVs and other fund structures are constrained.

Why it matters: These actions, if implemented, would represent a sea change in how the agency regulates private fund advisers and would have a widespread impact on the entire private market ecosystem, in terms of both access to capital and investment opportunities. With a 3-2 majority, Chair Gensler will most likely have the support necessary to advance his policy priorities, though he will face aggressive oversight from House Republicans. While Congress is not likely to stop the SEC from moving forward, it could slow down the process, and bipartisan pushback could help moderate some of the proposals. For example, the House recently passed legislation that would codify existing accredited investor thresholds and expand sophistication onramps, increasing the pool of accredited investors rather than reducing it.

The SEC’s Small Business Capital Formation Advisory Committee, which met this week to discuss issues impacting funding gaps for underrepresented founders and startups, has also raised concerns with items on the SEC’s private market agenda and cautioned underrepresented founders and fund managers outside traditional venture hubs would be disproportionately affected.

Carta will continue to push back on policies that we believe will negatively impact the venture ecosystem and ultimately stifle innovation, job creation, and economic opportunity.

Courts side with CFTC in landmark crypto case, while Congress debates crypto framework

A U.S. District judge sided with the CFTC in a ruling against Ooki DAO, a decentralized cryptocurrency collective, finding them liable for violating commodities exchange rules. The ruling was one of the first cases concerning decentralized autonomous organizations (DAOs), and constituted a big win for the CFTC. The outcome confirmed that regulators will have the ability to sue decentralized finance (DeFi) actors moving forward. The judge ordered Ooki to pay a $643,542 fine, but it’s unclear how the Commission will collect the fine, as members of DAOs are often anonymous and informally organized. This ruling follows a series of crypto-related lawsuits, and comes on the heels of the SEC’s announcement last week that it will be suing both Binance and Coinbase.

House continues to debate crypto framework

The House held a hearing this week on the future of digital assets. Democrats criticized the draft crypto regulatory framework released by the Republican leaders of the House Financial Services and Agriculture Committees last week, arguing that the proposal puts power into the wrong hands by redirecting authority that was previously held by the SEC and giving it to the CFTC. Democrats and Republicans appear to be at an impasse in terms of the role of the SEC in crypto regulation: While the Democrats have largely continued to support the SEC and Chair Gensler, some Republicans are calling for Gensler’s removal.

Why it matters: There does not seem to be a clear path forward for a comprehensive crypto regulatory framework in the United States, from either a legislative or regulatory perspective. While the House continues to debate draft regulatory frameworks, the regulatory agencies (namely the CFTC and SEC) have sharpened their enforcement tools. As we speculated last week, it may ultimately be the court decisions that dictate the crypto regulatory regime in the medium-term—not an SEC rulemaking or a congressional bill. The CFTC ruling also highlights important questions surrounding enforcement for decentralized actors in the crypto industry—particularly the often anonymous actors in the DeFi space.

Economic package heads for the House floor with QSBS expansion

The House Ways and Means Committee’s economic package, the American Families and Jobs Act, advanced out of committee along partisan lines. Notably, it includes modifications to expand the scope of businesses eligible for the QSBS, a change Carta and its coalition partners have been working to secure. The provision would make several updates, including:

• Expanding the section 1202 exclusion eligibility to include investments in S corps
• Allowing for partial gains exclusion if you hold the stock for more than three years but less than five years
• Creating a new “tacking rule” to alter the calculation of the holding period for the exclusion by changing the treatment of convertible debt in certain circumstances

Why it matters: While the markup did not feature many changes to the underlying package, there were attempts from Democrats (and industry) to limit the proposed QSBS expansion. These efforts will recur when the package passes through the Rules Committee and is taken up on the House floor. Carta and our coalition partners sent a letter to House leadership this week in support of the expansion, and will continue to advocate for these changes.Though the package is unlikely to become law this session, the proposed QSBS inclusion is an important building block for our ongoing efforts.

Senate begins AI hearings, seeks privacy framework

The Senate Judiciary Committee held a hearing on artificial intelligence this week, and Democrats quickly honed in on privacy concerns related to generative AI. There seemed to be consensus among Democrats and Republicans that the current patchwork of state and sector-specific privacy laws will not be enough to adequately govern the risks posed by AI, but the path forward on how exactly to legislate privacy at a federal level remained unclear. Lawmakers also introduced bipartisan legislation to clarify that Section 230 immunity will not apply to claims based on generative AI, thus aiming to learn from previous mistakes regarding Big Tech and Section 230. The legislation ensures AI companies will be held liable in civil claims or criminal prosecutions involving the use or provision of generative AI.

Why it matters: The U.S. is certainly playing catch-up in terms of regulating AI technology. While both Congress and the White House want to build a policy framework, they are realizing some foundational legislative pieces need to be put in place to regulate AI, namely provisions surrounding privacy. Bottom line: there is still a very long path forward to reach comprehensive regulation. For the time being, expect more hearings, scrutiny, and legislative proposals, but little legislative progress.

News to know

• The Federal Reserve’s policy committee decides to pause rate hike s. At the Federal Open Market Committee hearing this week, the Fed announced it would hold rates steady for the first time in more than a year, while also warning that as many as two more rate hikes could occur in 2023.
• McHenry sends a letter to Treasury on FSOC guidance. In the letter, Rep. McHenry requests that FSOC revisit its April decision to evaluate risks posed by non-bank financial entities based on size, rather than the activities they undertake.
• Tax regulations no longer reviewed by OMB under new administration plan. The White House budget office will no longer review major tax regulations under a new agreement within the Biden administration, a move Treasury Department veterans say should speed up the regulatory process.
• McHenry introduces legislation to protect small business data. Rep. McHenry introduced two pieces of legislation to reform the Financial Crimes Enforcement Network (FinCEN) that would ensure that small businesses’ sensitive information are protected in its beneficial ownership reporting regime.
• CFPB Director Rohit Chopra testifies on the Hill, grilled on proposed credit card fee limit. Chopra fielded heavy criticism from Republicans on the totality of his regulatory agenda, ranging from the proposed rule on junk fees to the small business lending data collection required under Section 1071 of the Dodd-Frank Act. Chopra also requested additional resources to expand its digital literacy tools and respond to the rise of generative AI.
• Fed, SEC probing Goldman Sachs’s role in SVB’s final days. The Justice Department announced on Thursday that they have subpoenaed Goldman Sachs as part of its investigation into SVB for their role as buyer of the securities portfolio and adviser on the capital raise for SVB.
• The outcome of a Washington state lawsuit could block Democrats’ proposals to tax wealthy Americans. The case, which centers around a 2017 Republican tax law, could result in much larger refunds for multinational corporations, as well as prevent Democrats from imposing wealth taxes.
• SEC issues risk alert around marketing rule compliance. Last week, the SEC’s Division of Examinations issued a risk alert reminding advisers to ensure their marketing practices were in line with the new rule’s requirements. The marketing rule applies to SEC-registered private fund advisers and is a key focus area for examinations, particularly around how fund performance is communicated to investors.

Upcoming events

• House Financial Services Committee hearing: The Federal Reserve’s Semi-Annual Monetary Policy Report – June 21 at 7:00 a.m. PT / 10:00 a.m. ET
• House Financial Services Committee Oversight & Investigations Subcommittee hearing: Oversight of the SEC – June 22 at 6:00 a.m. PT / 9:00 a.m. ET
• House Financial Services Committee Capital Markets Subcommittee hearing: Oversight of the SEC’s Division of Trading and Markets – June 22 at 7:30 a.m. PT / 10:30 a.m. ET
• SEC Investor Advisory Committee – June 22 at 7:00 a.m. PT / 10:00 a.m. ET
• House Committee on Small Business hearing: Reviewing the SBA’s Office of Advocacy Report on the Regulatory Flexibility Act – June 22 at 7:00 a.m. PT / 10:00 a.m. ET
• Senate Committee on Banking, Housing, and Urban Affairs hearing: The Semiannual Monetary Policy Report to the Congress – June 22 at 7:00 a.m. PT / 10:00 a.m. ET
• Carta QSBS Virtual Event: How To Save Up to $10M in Capital Gains: Qualified Small Business Tax Exemption – June 27 at 10:00 a.m. PT / 1:00 p.m. ET