Thursday, February 11, 2021

Statutory vs. Regulatory Exemptions

Nevada legislators recently introduced legislation to create a statutory exemption from licensure for the investment advisers for certain qualifying private funds.  The language appears nearly identical to the model regulation released by the North American Securities Administrators Association (NASAA). Notably, NASSA explained that its regulatory approach would be "contingent in many respects on how the SEC moves forward on implementation in this area. Consequently, if the SEC makes significant alterations to its proposals NASAA may be required to reevaluate the provisions in any proposed model rule or rules."  Nevada's own Securities Division also recently released a proposed regulatory update which includes NASAA's model regulatory exemption.

There are really two questions here.  The first is whether an appropriately tailored exemption from licensing requirements should exist for certain private funds.  Nevada’s own securities regulators support the exemption and included it in their draft regulations. As it stands, putting the exemption into place does not require the Nevada Legislature to do anything.  The exemption appears highly likely to be embodied in the final regulatory code at the conclusion of the ordinary regulatory process.  I filed a comment letter on this with the Nevada legislature and have reviewed the letters filed by supporters of the legislation.  Although they all seem like well-intentioned people who are enthusiastic about the exemption, none appear to be securities lawyers.

There isn't any real debate over whether the exemption should exist.  The real question is whether to situate the exemption within the statute or regulatory code.  Enacting this legislation would calcify the exemption in statutory language and require additional legislative acts to address any later-discovered flaws with it or to modify it to conform to changing circumstances. In contrast, allowing state regulators to situate the exemption within their regulatory code will avoid these problems.  Indeed, most states who provide for such an exemption do so through their regulations and not through a statute.

Situating the exemption in the statute instead of the regulations presents real problems.  Nevada’s legislature does not meet on an annual basis.  It will not be well-positioned to respond to changing circumstances.  Moreover, the proposed legislation references federal regulations which may be changed by the SEC.  Will the content and meaning of Nevada’s statutes change when federal securities regulations change (as they often do) or become recodified with slightly different language or different citations?  How readily will people be able to understand Nevada's statute if federal regulations change and Nevada’s unchanging statute refers to an outdated regulatory code?  I don't know the answer to this but can see that it will create questions and likely require private funds to obtain expensive opinions from securities lawyers about what the statutory exemption means and whether they qualify for it. When other states update their regulatory code, Nevada’s statute will likely sit unchanged.

Putting the exemption in the statute seems likely to generate problems over time because statutes cannot be changed as readily as regulations.  In effect, this approach could raise the cost of capital formation and frustrate the goal of facilitating capital formation in Nevada.  These issues could avoided entirely by allowing state regulators to update their own exemptions to conform to the constantly-changing federal securities laws. To be sure, the variance between statute and regulations might not be great in the the first year.  Yet with each additional year, the probability that the statute will become outdated and diverge from model state securities regulations will increase.  

There is a real danger here that seeking positive economic development by passing legislation will, over time, make economic development more difficult.  If legislators want to support the exemption and also ensure that access to capital remains robust, they should take a different approach which would preserve regulation’s essential flexibility in the face of changing circumstances. The legislation might be amended to direct the Nevada Securities Division to periodically consider whether to amend its regulations to keep them up to date.  For example, the Legislature might direct the Securities Division to solicit public comments and review existing exemptions every three years and determine whether to initiate rulemaking to appropriately rebalance capital formation and investor protection.  The Legislature could also specify criteria for the Securities Division to consider, such as: (i) the cost and burden of existing regulation; (ii) the amount of capital raised under existing exemptions; (iii) the Securities Division’s experience overseeing particular exemptions; and (iv) any public comments received about the existing exemptions.  A structured prod to update could accomplish the same goal and avoid the problems which will likely flow from cluttering up the statute with something that belongs in regulations.

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