Monday, January 6, 2014
Adi Osovsky, an S.J.D. candidate at Harvard Law School, has posted an interesting new article on SSRN, The Curious Case of the Secondary Market with Respect to Investor Protection.
Here's the abstract:
The primary mission of the U.S. Securities and Exchange Commission is to protect investors. However, current securities regulation clearly separates between public markets and private markets with respect to investor protection. While the federal securities laws impose strict and costly disclosure and anti-fraud requirements on issuers that offer their securities to the public, they exempt private offerings from such rigid regime. The liberal approach toward private offerings is based on the assumption that investors in private markets are sophisticated and thus can "fend for themselves".
This Article explores the validity of such traditional dichotomy between the public market and the private market in a relatively new, organized secondary market for ownership interests in private companies with retail investor access (the "Secondary Market"). The Secondary Market provides investors and employees with an opportunity to sell their holdings even before the first exit event. It also allows greater flexibility in capital formation, which may enhance productivity and job growth. However, the Secondary Market raises serious problems with regard to investor protection.
As this Article shows, the rise of the Secondary Market has revealed conspicuous cracks in the wall traditionally separating the public and the private markets and the two markets’ participants – the sophisticated investors versus the unsophisticated investors. This separation was undermined by the penetration of unsophisticated investors to the private market sphere and by the erosion of the assumptions regarding the ability of Secondary Market’s participants to fend for themselves.
The Article suggests that the erosion of the sophistication presumption deems the classic dichotomy between the heavily regulated public market and the lightly regulated private market artificial. It calls for a reexamination of the current regulatory regime with respect to investor protection. Such reexamination is of particular importance in light of the new Jumpstart Our Business Startup (JOBS) Act that would enable private companies to stay private longer, and the Secondary Market to thrive.
I haven't read the article yet, but the issue Osovsky addresses is an important one. Even if accredited investors are able to protect themselves in exempted private offerings, the Internet (in conjunction with the liberalization of Rule 144) now makes it much easier for them to resell those securities to unsophisticated investors.
Secondary purchasers will have access to at least some information about the issuer. Rule 144 protects those resales only if the issuer is a reporting company [Rule 144(b)(1)(i)] or if current public information is available about the issuer [Rule 144(b)(1)(ii) and (b)(2), in conjunction with 144(c)]. But is the information required by Rule 144(c)(2) for non-reporting companies sufficient?