Policy Newsletter

Policy weekly: HFSC considers removing barriers to capital access

10 February 2023
The Carta Policy Team

The Topline

  • Biden delivers SOTU: “Every time somebody starts a small business, it’s an act of hope.”

  • HFSC capital formation agenda kicks into gear

  • SEC capital formation advisory committee raises concerns with private fund adviser rule

  • A stake through the heart of crypto (staking)

  • FTC plans rulemaking workshop mid-comment period on noncompetes ban

Biden delivers SOTU: “Every time somebody starts a small business, it’s an act of hope.”

President Biden was at the Capitol for his second State of the Union address, delivering a wide-ranging speech that drew predictably mixed reviews and occasionally elicited disagreement from Republicans in attendance. He was very optimistic on the path of the economy, a view somewhat tempered by Fed Chair Jay Powell’s predictions of a lengthy battle against inflation. 

Other topics covered include:

  • Small businesses on the rise:The president highlighted that a record-setting 10 million Americans applied to start a new business in the first two years of his administration. He tasked Vice President Kamala Harris with continuing to ensure more small businesses can access capital, a timely request given the week’s activities.

  • A flyby on China: Despite the intense attention on U.S.-China relations, China received little airtime during the address, and the now-popped balloon was not mentioned. 

  • Tax priorities in limbo: Biden re-proposed his “billionaire minimum tax,” which would subject taxpayers with over $100 million in net assets to a minimum tax rate of 20%; he also called for an increase from the current 1% stock buyback excise tax to 4%. Neither will be achieved this session.

  • Privacy and antitrust: Biden made three asks in this space: (1) ban online platforms from collecting personal data on children, (2) prohibit targeted advertising online to children, and (3) strengthen personal data collection restrictions. He also reflected the administration’s continued interest in addressing anticompetitive practices at big tech platforms.

Why it matters: The State of the Union is expensive political “real estate,” and President Biden used it to advocate on items that will affect the private markets. Carta will continue to highlight bipartisan support for small businesses, pushing for policies that drive capital to startups and growth-stage companies (see below). We need to ensure policies around data privacy and competition reflect the input of the innovation ecosystem. We are heading into a presidential campaign year, but regulators and Congress will be moving forward on policy, and now is the time to engage. 

HFSC capital formation agenda kicks into gear

To kick off Chairman Patrick McHenry’s capital formation-focused agenda, the HFSC held two hearings centered on expanding the accredited investor definition and increasing access to capital for small businesses. The committee considered over a dozen legislative proposals that are expected to be marked up at the end of March. Members of both parties are interested in expanding the accredited investor definition, as both sides acknowledged financial wealth does not equate sophistication and can often impede access to capital and investment opportunities for diverse communities. Republicans criticized anticipated efforts from the SEC that would raise wealth and income thresholds for the disproportionate impact it would have on diverse and lower-income communities. Many Democrats, however, used the hearings to echo concerns pointed out by SEC Commissioners around the need for more disclosure in the private markets to protect investors and the broader economy as the size of the private markets has grown. Such concerns could help bolster SEC efforts that may increase disclosures under Regulation D and push large private companies into the public markets.

Why it matters: Capital formation will be a key focus for McHenry and is likely an area where we will see bipartisan action. Many of the proposals, including around expanding venture capital fund parameters and the ability to make fund-of-fund investments, are supported by the SEC’s Small Business Advocate as policies that could help drive capital formation outside of traditional funding hubs and benefit underrepresented founders—a message that will resonate with both slides of the aisle. Engagement will be key, and Carta will be working with others in the ecosystem to build bipartisan consensus to move these priorities forward. Building congressional support to bolster capital formation will also help push back on expected actions out of the SEC—notably changes to Regulation D and the private fund adviser proposal—which are expected to impose barriers to capital access, particularly for smaller and emerging fund managers.

Other HFSC activity this week:

  • Privacy legislation:Chair Patrick McHenry unveiled a financial services-focused privacy draft bill, which would preempt state privacy laws, but does not yet contain an enforcement component. Privacy debate continues to struggle on policy issues and jurisdictional issues, so expect changes and a long road ahead.

  • China investment: HFSC considered legislative proposals on investment in and from China and related entities. No concrete consensus emerged, but expect drive towards  transparency and possibly investment filters  around such holdings. 

 SEC capital formation advisory committee raises concerns with private fund adviser rule

The SEC’s Small Business Capital Formation Advisory Committee (SBCFAC) scrutinized the Commission’s Private Fund Adviser proposal, its sweeping effort to more intensely regulate the private equity and venture capital industries. Meeting participants highlighted expected compliance burdens from the rule, which would impose new disclosure obligations for SEC-registered private fund advisers and prohibit all advisers from participating in certain activities, some of which are common industry practice such as side letters. Notably, the proposal would prohibit adviser indemnification provisions for even simple negligence, which could impact investment decisions and an adviser’s decision to support and engage with their portfolio companies. Under this standard, investors could arguably sue anytime a deal goes south. Committee members also raised the question of SEC overreach and sought to understand the problems the agency is attempting to solve.

Why it matters: If implemented, the SEC’s private fund adviser proposal would significantly expand the SEC’s regulatory reach into the venture capital industry and likely have a disproportionate impact on small and emerging fund managers and the founders they support. Despite the concerns raised from the SBCFAC members, Congress, and a number of commenters (including Carta), Gensler’s remarks suggest he plans to stay the course, doubling down on the need for transparency in an industry that impacts such a large swath of the economy. Any final rule would certainly face legal challenges that could delay implementation. However, as evidenced by the SEC’s latest exam agenda, the agency will continue to scrutinize private funds and their advisers.

Other SEC news:

  • 2023 Exam Priorities: The SEC released its 2023 Exam Priorities highlighting a number of focus areas, including private fund advisers, emerging technologies and crypto assets, ESG investing, and compliance with the SEC’s new Marketing Rule and standards of conduct for investment professionals.

  • SEC open meeting: Next week, the SEC is expected to adopt rules to shorten the securities settlement cycle from two business days (T+2) to one business day (T+1) after the trade date, which is intended to reduce settlement risk and clearing costs during times of high market volatility and trading volume. The Commission is also expected to propose reforms to the custody rules for investment advisers.

A stake through the heart of crypto

The SEC announced a $30 million settlement with Kraken, alleging its crypto asset staking program constituted a securities offering that should have been registered with the SEC. As part of the settlement, Kraken agreed to discontinue its staking program and would be permanently enjoined from operating another in the future. Crypto staking enables holders to earn income on their asset without selling it by locking it up to support and maintain the blockchain. At a basic level, imagine putting an asset into a high-yield deposit account. 

This is the first action the agency has taken against a staking program, though Gensler had previously suggested the crypto staking model looked very similar to crypto lending, which has been a focus for SEC enforcement actions. Commissioner Hester Peirce, who has long been critical of the SEC’s approach to crypto regulation, blasted the move to regulate a nascent industry through one-off enforcement actions instead of issuing guidance as not a “fair way of regulating.” Her bigger concern, however, was shuttering a program that “served people well” instead of developing a workable registration process, a move she described as “paternalistic and lazy.”

Why it matters:Without congressional or court intervention, there seems to be no slowing Gensler’s aggressive pursuit of the crypto industry through enforcement. Following the FTX collapse and fallout, there has been a bipartisan push for Congress to step in and develop a regulatory framework for the crypto industry. Continued one-off enforcement actions by regulators will intensify this desire among Republicans. Leaders of the House Agriculture Committee and Financial Services Committee—the primary committees of crypto jurisdiction—expressed an interest in coordinating efforts around digital asset regulation, and collaboration early in the legislative process can help smooth over jurisdictional tensions and make a comprehensive effort more feasible, though hurdles remain on everything from investor protection to the climate impact of crypto mining.

Elsewhere on crypto:

  • OFR highlights DeFi risk: Treasury’s Office of Financial Research identified three specific threats the continued growth of decentralized finance (DeFi) could pose to financial stability, all of which hinge on oversight and volatility.

  • Democrats continue cryptominer disclosure campaign: In a letter to Energy Secretary Jennifer Granholm and EPA Administrator Michael Regan, lawmakers called for the agencies to require emissions and energy use disclosures from cryptominers; rulemakings to that effect were not included in the agencies’ latest regulatory agendas.

  • England eyes digital currency: Britain’s Treasury and the Bank of England (BOE) are collaborating on the possibility of a BOE-backed digital pound, setting up a decision on the path forward “around the middle of the decade.” 

FTC plans rulemaking workshop mid-comment period on noncompetes ban

The Federal Trade Commission (FTC) proposed a rule to ban in large part non-compete agreements. President Biden further made the case in the State of the Union. And now the FTC will host a public forum on Thursday, Feb. 16 to examine its proposed rule. It’s an unusual move, as the agency is weeks into the 60-day public comment period on the proposal. The comment window is set to conclude on Mar. 20. The FTC argues noncompetes restrict employee mobility, suppress worker wages, and ultimately diminish innovation and undermine competition. 

Although we expect a range of reactions, many in industry have supported the general direction of the proposal. The details of implementation, however, will matter. One such detail is how the sale of a business is treated. Under the proposal, the ban on noncompetes would not apply to individuals who own 25% of the company. That is a substantial ownership stake, which may not be a typical holding. Industry will need to better understand how this would affect M&A

Why it matters: Banning noncompetes would be substantial deviation from current industry practices. The FTC is pushing hard and so is the president. Expect this to move forward, and understand how it will affect your current and future talent, as well as your growth path. 

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