Policy Newsletter

Congress scrambles to finalize year-end legislation

December 1, 2023
The Carta Policy Team

Topline

  • Congress scrambles to finalize year-end legislation with potential impacts to private markets

  • SCOTUS decision could limit SEC authority 

  • SEC committee examines accredited investor definition

  • Major win for the IRS against fund managers

  • Carta and coalition submit letter to FinCEN ahead of CTA implementation date

Congress scrambles to finalize year-end legislation—how will this impact private markets?

Congress is negotiating its final must-pass bill of the year, the annual defense bill (the National Defense Authorization Act, or NDAA), which often serves as a vehicle for other miscellaneous legislative priorities. Policymakers are still negotiating two proposals that would affect the innovation ecosystem if they are included:  

  • Crypto: House Financial Services Committee Chairman McHenry is “objecting to everything else” under his jurisdiction unless his crypto legislation is included in the NDAA. As a result, the bill will likely move forward without the financial-services related provisions. Whether that is posturing or not, it is increasingly unlikely crypto legislation is included in the package but we expect the House to consider a crypto regulatory framework bill early next year.

  • Outbound investment: There is bipartisan support for the goal of screening outbound U.S. investment into China, but there is disagreement on how it is done. The Senate is proposing a more permanent and broad screening approach while HFSC Republicans are seeking a more tailored mechanism. This disagreement will likely keep the provision out of law this year, though the existing Executive Order and bipartisan support will keep the policy in play in 2024. 

While the NDAA is on track to be passed before year end, don’t hold your breath for an end of year tax package. House Republicans have continued to press Speaker Johnson for a year-end tax bill, but time is running out and the likelihood of a package coming together in 2023 seems to be near zero.

SCOTUS decision could limit SEC’s authority 

This week, the Supreme Court heard oral arguments in a case that could have major implications for SEC enforcement and the broader administrative state. In U.S. v Jarkesy, the Fifth Circuit found that the SEC’s use of administrative proceedings for securities fraud claims was unconstitutional on a number of grounds, including violations of the Seventh Amendment right to a jury trial and the nondelegation doctrine, which prevents Congress from delegating its lawmaking authority. During oral arguments, the Court’s conservative majority cast doubt on the constitutionality of these proceedings, particularly with respect to the right to a jury trial. It therefore seems likely the Court will limit the SEC’s use of in-house proceedings. 

Potential implications: A negative ruling for the SEC would not preclude the SEC from bringing fraud charges, but it would have to do so in federal court, which could delay and potentially reduce actions against bad actors. The bigger threat for the SEC is if the ruling in Jarkesy leads to a stronger nondelegation doctrine, which would limit the ability of Congress to delegate its lawmaking authority to the agency and put much of the SEC’s regulatory authority at stake. The bulk of the federal securities law is based on SEC rules derived from congressional authority as opposed to direct legislation. And some of this authority is very broad. For example, Congress gave the Commission the authority to make rules it deems “necessary or appropriate in the public interest or protection of investors.” Rules based on this premise would be ripe for challenge, as the SEC undoubtedly would have exercised policy discretion in deciding to promulgate such rules. 

Why it matters: As the administrative state has grown, the judiciary has been chipping away at its expanding authority in recent years. The SEC, in particular, has been dealt a number of losses recently (e.g. crypto, stock buyback rules), and it is facing a number of other challenges, including a recent lawsuit to invalidate the private fund adviser rules. In addition to upcoming litigation on Chevron deference, the Jarkesy decision’s approach to nondelegation could have major implications for the SEC and the broader regulatory state. Expect the pressure to continue, as Meta is suing the Federal Trade Commission on the constitutionality of its in-house courts, a similar claim to that of Jarkesy.

SEC committee examines accredited investor definition

Members of the SEC’s Small Business Capital Formation Advisory Committee (SBCFAC) recently debated options to update the accredited investor definition, including the development of education-based qualification criteria as well as potential updates to the existing asset and income thresholds. 

  • Education-based qualification. There is growing support on the committee—as well as in Congress—for education-based qualification standards based on professional credentials or through examination. Broadly, SBCFAC members agreed that a test should focus on the risks of investing, but some pushed for a component to assess whether investors can adequately analyze investment options for themselves. 

  • Asset and income thresholds. Retroactively indexing income thresholds to inflation would significantly reduce the eligible pool of angel investors, further restricting the flow of capital to new businesses particularly in lower cost-of-living regions. Indexing them going forward was discussed as an alternative, but some members raised concerns that shifting thresholds would complicate compliance when investors’ incomes fall back below a rising index. The Committee also discussed allowing investors to allocate a certain percentage of new wealth (5%) to private market investments without qualifying as accredited investors, or potentially reducing the qualifying asset/income thresholds for investors who meet certain education-based requirements. 

What’s next: The group is expected to develop recommendations to update the accredited investor definition, which will be considered and voted on when the Committee meets again in 2024. The Committee’s deliberations are paralleled by a bipartisan legislative effort to expand the education-based qualification options and preserve current asset/income thresholds, which will not force the SEC’s hand but could help moderate expected rulemaking efforts that could potentially narrow the pool of investors who qualify as accredited.

Major win for the IRS against fund managers 

The Tax Court sided with the IRS’s position on the application of self-employment tax rules to state law limited partnerships.

  • The Internal Revenue Code generally excludes a limited partner’s distributive share of partnership income or loss from self-employment tax. However, the rules do not define “limited partner,” an opening that has created legal ambiguity for taxpayers as various states introduced new types of business entities.

  • The Tax Court ruled this week that while fund managers may be considered “limited partners” under state laws, that does not automatically qualify them for the limited partner exemption for federal self-employment tax.

What’s next: The IRS has already added a new project to its FY24 Priority Guidance Plan to provide guidance on section 1402(a)(13)—aiming to clarify the limited partner definition and analyze the techniques used by partners to claim the self-employment tax exemption. And if the latest Tax Court opinion survives future legal battles, fund managers could face millions of dollars in additional self-employment taxes. 

Carta and coalition submit letter to FinCEN ahead of CTA implementation date

On January 1, the Corporate Transparency Act (CTA) will come into effect and create substantial new reporting requirements for millions of small businesses and startups. Carta and our coalition members have been hard at work finding solutions to make implementation easier. As a result of these efforts, the Financial Crimes Enforcement Network (FinCEN) has agreed to a number of our requests that will ease compliance, including allowing third-party service providers to assist with beneficial ownership information (BOI) reporting and batch uploading.

The coalition continues to find workable solutions for the required reporting. Last week, Carta and our coalition members submitted a comment letter asking Treasury/FinCEN to:

  • Prioritize providing API specifications that will allow intermediaries to assist reporting companies to submit BOI reports prior to January 1, 2024, the CTA implementation date

  • Provide guidance allowing third-party service providers to assist individuals to obtain, update, and correct a FinCEN identifier via API submission portal

  • Provide clarity on certification requirements and obligations when CTA reports are filed by third-party service providers on behalf of reporting companies.

The Carta team will continue to track closely and provide updates on CTA ahead of the January 1 implementation date.

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