Carta Policy: Weekly Brief for July 15

The Topline

• Sen. Manchin stops modified BBB, leaving only the possibility of narrow prescription drug bill…QSBS likely preserved

• National Defense Authorization Act advances in the House with amendments that could lead to changes in private capital formation rules and access to banking services for cannabis companies  

• Gensler shows openness to using the SEC’s exemptive authority for digital assets but does not signal broader rulemaking to provide regulatory clarity 

• SEC rolls back proxy reforms adopted under previous administration along partisan lines

Macro matters

Congressional agenda

Lawmakers returned to DC for a busy July work period with limited legislative days and November elections looming. 

Declining consumer confidence, market volatility, and rising inflation continue to dominate the conversation with the Consumer Price Index (CPI) rising 1.3% in June, representing a 9.1% increase over last year—the largest year-over-year change since 1981. The CPI report makes it all but certain the Fed will raise rates by at least 75 bps when the FOMC meets later this month, with some speculation there could be a full percentage point rate hike in an attempt to tamp down inflation.

Build Back Better Act (BBB)…construction stopped and blueprint changed

Sen. Joe Manchin has declared he will not support climate and tax portions of a modified Build Back Better proposal.  The remaining option is a narrow bill focused on prescription drug prices and extending Affordable Care Act subsidies. Lucy got her football out once again…Leader Chuck Schumer (and many in DC) lined up thinking this was not a drill…and at the last-minute Sen. Manchin grabbed the ball from Lucy and spiked it. 

Qualified Small Business Stock likely preserved

Qualified small business stock (QSBS) will likely be preserved in its current form, as Sen. Manchin has swept the tax portion off the table. A number of factors led to this outcome. Although curtailing QSBS may have been a relatively small tax change, its impact would have been outsized, as it would have hampered the innovation economy. When this process began one year ago, Carta organized a coalition and engaged to prevent policymakers from curtailing the current QSBS treatment. This work gained traction with lawmakers—along with similar efforts on the range of tax issues in other industries—and helped illustrate the tradeoffs that likely contributed to the fall of the broader tax portion of the bill. Preserving QSBS is critical to the ecosystem, and Carta plans to stay engaged to ensure proposals that would diminish QSBS do not reemerge on any legislative vehicles this year.

Bipartisan Innovation Act (BIA) 

The fate of the BIA remains uncertain. Leader McConnell and Senate Republicans held firm in ending negotiations on the Bipartisan Innovation Act—legislation to bolster U.S. competitiveness—if Senate Democrats pursued a BBB legislation, which they did in earnest until, well, last night. Essentially, Senate Republicans said, pick one, but you can’t have both. The question will be whether a narrow and partisan prescription drug bill counts as BBB. 

Our read: a broad BIA is not coming together by August recess. Senate Democrats may try to cobble together a legislative path forward, but the closer to the November election, the less likely bipartisanship wins. An increasingly likely path is passing legislation that only provides funding for the U.S. semiconductor industry, largely contained in the so-called CHIPS Act. This approach, if adopted, would jettison provisions to establish export controls around private investment into certain areas, as well as direct the SEC to revamp private capital formation process.

National Defense Authorization Act (NDAA)

Congress is also working on the FY 23 NDAA—an annual must-past defense policy bill supporting military and national defense functions. The House approved an amendment to the NDAA that would require the SEC to revamp capital formation rules for Chinese-based issuers. Although more narrow than previous efforts, the industry has concerns the SEC may use this directive to revamp private market capital formation more broadly. The policy team will continue to monitor through Senate consideration and the conference process, which will likely begin in September.   

The House-passed NDAA also contained a provision, the SAFE Banking Act, to allow cannabis businesses to access the banking system. While this provision has bipartisan support, Leader Schumer has focused instead on passing a broader decriminalization bill. With comprehensive reform looking less likely, the NDAA may be the best chance for the SAFE Banking Act to become law. 

Carta releases automated 83(b) submission

Carta has modernized how 83(b) elections are filed by taking a manual and uncertain process—printing, signing, and sending multiple copies to the IRS—and automating it. Users who choose to early exercise on our platform will now be able to automatically submit an 83(b) election to the IRS by reviewing their document, digitally signing, and submitting. We take it from there by sending the election form to the IRS, so that you don’t have to. 

This new feature is made possible because a coalition of startups, investors, law firms, and other stakeholders came together to urge the IRS and policymakers to make the process easier, and the IRS responded. Thanks to our coalition partners for your leadership.

Capital markets

SEC considers reforms around proxy voting advice and shareholder proposals

The SEC held an open meeting this week with its full five-member Commission seated, as Mark Uyeda was officially sworn in on June 30. The Commission also bade farewell to Commissioner Allison Lee. 

On a party-line vote (3-2), the SEC approved a rule that would roll back reforms on proxy voting advice adopted in 2020 under former Chairman Jay Clayton to address concerns the reforms restrained the provision of independent proxy voting advice. Proxy advisory firms provide recommendations on how to vote on the corporate proxy. Policymakers on both sides have increased scrutiny and pressure as the proxy advisory firms have become more involved and influential on issues around environmental, social, and governance. While the SEC stopped short of repealing the 2020 rule in its entirety, it rescinded provisions that required proxy advisers to engage the company prior to giving recommendations to investors, and provide the company with a mechanism to respond to voting recommendations.

The Commission also proposed amendments in a 3-2 vote to the shareholder proposal process that would make it more difficult for public companies to exclude shareholder proposals from proxy statements. Notably, the SEC’s proposed and adopted proxy reforms are likely to add to the burden and cost of being a public company and further incentivizing companies to stay private.

SEC Commissioner calls for review of complex products ahead of single-stock ETF launch

SEC Commissioner Caroline Crenshaw warned investors of the risks associated with leveraged single-stock ETFs and called for the Commission to update its regulatory framework around complex exchange-traded products with respect to self-directed trading. Crenshaw’s statements are consistent with a FINRA regulatory notice that requested comment on several methods for addressing the risk of complex products, including whether investors should be required to pass a “knowledge check” before accessing complex products. The SEC has generally relied on compliance with applicable regulatory requirements and disclosure to inform and protect investors rather than weighing in on the merits of a particular investment product. Potential actions to limit access to publicly available products for self-directed retail investors could create a slippery slope for merit-based regulation of investment products and further limit retail investment opportunities.

Crypto & digital assets

European Commission reaches deal on crypto-asset regulatory framework

The global push to regulate crypto and digital assets continues, with the European Commission reaching a provisional agreement on digital asset regulation. Markets in Crypto-Assets (MiCA)—which covers crypto assets and stablecoins, as well as the exchanges they trade on and the wallets in which they are housed—would require digital asset issuers to publish and provide regulators a “white paper” with details of the project prior to operations. Further, crypto-asset service providers will need authorization to operate within the EU. Oversight and enforcement will largely rest with national regulators, though European bodies will have investigative authority. This agreement would be subject to approval by the Council and the European Parliament before going through the formal adoption process. 

U.S. regulatory posture

The direction of the U.S. regulation is at an inflection point: Congress is unlikely to act in the near term, but agencies are working through the Administration’s Executive Order on digital asset regulation framework. The Federal Reserve’s Lael Brainard asserts regulation does not stifle innovation, but rather creates the guardrails to enable investors and developers to build a resilient infrastructure. The Fed’s point person on regulation, Michael Barr, is about to take office. Although Barr has worked in the space, serving as an advisor to Ripple labs, expect a more aggressive approach around investor protection and the possible systemic risk issues Governor Brainard flagged. 

Gensler expresses openness to using exemptive authority 

SEC Chair Gary Gensler believes the majority of digital assets are securities and that many of the platforms should be registered. He again asserted that many crypto companies are non-compliant. To encourage such companies to engage the SEC, he hinted that the SEC does have robust authorities to use exemptive authorities—which Commissioner Peirce has been encouraging the agency to use. To date, the SEC has not provided a clear regulatory path for the industry, so although he is showing flexibility, this bespoke exemptive approach may continue to leave operators with little certainty.

Treasury requests comments on digital assets and develops framework for international crypto 

In response to President Biden’s Executive Order on “Ensuring Responsible Development of Digital Assets,” the Treasury Department issued a request for comments on equitable economic growth, on the implications of the adoption of digital assets and changes in financial market and payment infrastructures for U.S. consumers, investors, businesses, and for equitable economic growth. Suggested areas for discussion include opportunities for consumers and businesses, general risks in digital asset financial markets, and impact on the most vulnerable. Comments must be received by August 8, 2022. 

Treasury has also consulted with the departments to develop a framework for interagency engagement with foreign counterparts around foreign assistance, capacity-building, and the coordination of global compliance to promote international principles, standards, and best practices. 

Banking and financial products

Joint statement on a risk-based approach to customer due diligence

The federal banking regulators issued a joint statement clarifying that banks and non-banks should use a risk-based approach that evaluates each specific customer when creating customer profiles as part of customer due diligence, rather than a blanket approach to all customers from a region or industry. The statement also encourages financial institutions to implement enhanced monitoring rather than outright ending customer relationships as a risk mitigation strategy.

Taxation

Taxation of the digital economy

Initial versions of the BBB proposed modifications to the current international tax rules that were intended to align the U.S. more closely with OECD pillar 2 rules, which would establish a 15% global minimum tax on the earnings of multinational enterprises. Pillar 2 rules create a tax that is applied on profits in any jurisdiction whenever a taxpayer’s effective tax rate (ETR) falls below the minimum 15% rate. Some U.S. multinationals have raised concerns that the tax will deprive them of various U.S. business tax credits (R&D, clean energy, and low-income housing tax credits) by allowing a non-U.S. jurisdiction to impose the global minimum tax if the U.S. tax credits push a group’s U.S. ETR below the 15% rate. 

The plan was for Congress to leverage BBB to approve changes to the U.S. tax code and bring us in line with the international accord. That path appears closed, so supportive policymakers will need to find another avenue. The repercussions of the U.S. failing to act in time would increase the risk that other countries walk away from the effort altogether, or alternatively, allow foreign nations to forge ahead with the plan without us and punish U.S. companies with higher taxes in their jurisdictions.

Antitrust, privacy, and technology

California privacy standard process moving

The state of California initiated the formal rulemaking process to implement the California Privacy Rights Act (CPRA), which amends and expands the underlying California Consumer Privacy Act with a focus on consumer opt-out rights and disclosures. The proposed regulations seek to provide guidance to consumers, businesses, service providers, and third parties on how to operationalize new rights and concepts introduced by the CPRA. The mandatory public comment period on the proposed regulations will close on Aug. 23, 2022, and the Agency will hold a public hearing on the proposed regulations on Aug. 24 and 25.

Upcoming events

• House Financial Services Committee hearing, “ Oversight of the SEC’s Division of Enforcement” – July 19 at 10:00 am (ET)

• Senate Banking Committee hearing, “ Fairness in Financial Services: Racism and Discrimination in Banking” – July 19 at 10:00 am (ET)

• Federal Open Market Committee meeting – July 26 and 27

Notable SEC proposed rules and comment deadlines

*60-days after publication in the Federal Register, which has not occurred

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