If the SEC expands to private company debt, how would it affect startups?
SEC Rule 15c2-11 has been restricted in regulatory usage to private company stocks. The rule prohibits broker-dealers from publishing quotes on private issues beyond national securities exchanges unless current financials have been made public.1 The SEC generally has applied it to Over-The-Counter, small stocks. Now the SEC wants to apply it also to debt securities.
Pushback starts with the fact that the rule was never intended for debt. Debt securities are a popular instrument for startups and other non-public companies. Debt doesn’t dilute ownership shares for founders, management, and early investors. The SEC wants to enforce the rule through another rule – 144A. This rule enables purchasers of private placement securities to resell their investments to qualified institutional buyers, under certain conditions. The rule change has been postponed to January 4, 2025.2
Why the SEC cares about private debt
The SEC may be showing interest because private market investments have increased substantially over the last decade or so. According to Preqin, the total in 2010 was US$2 trillion while November of 2021 showed US$6 trillion in private markets. The SEC may be concerned that retail investors who can’t reasonably afford to lose their investments may be included and at risk.
There is no precedent for the SEC rule change, but “securities” in the rule can generally include debt. The SEC usually asks for public comment on a change but no comment period was given.
Why it matters to startups
The cost of issuing debt securities in compliance with the rule would increase from current requirements. Fewer bonds would likely be issued and dealer quotes on non-compliant bonds would be mostly unavailable, making that part of the bond market even more opaque.3
This change is more worrisome for small, private companies – often startups – whereas larger companies could likely absorb the increase. Also, a larger company would usually have more access to bank loans.
Finally, private companies rarely want to make their financials public. A change in the 15c2-11 rule seems to require any company, whether public or private and issuing debt securities, to disclose their financials. Publicly available financials are more costly and often require more staff. Startups also might lose some competitive advantages if forced to report publicly on their financial progress.
1 SEC Delays by Two Years Implementation of Rule 15c2-11 for Private Issuers of Rule 144A Debt Securities, December 12, 2022, https://www.skadden.com/insights/publications/2022/12/sec-delays-by-two-years-implementation, Skadden, Arps, Slate, Meagher & Flom LLP
2 ibid
3 The Detriment of Rule 15c2-11’s Application to Fixed Income Markets (The Consequences of Unilateral Rulemaking Without Public Comment) by Joe Corcoran, Managing Director, and Associate General Counsel for SIFMA and Chris Killian, Managing Director for SIFMA. https://www.sifma.org/resources/news/the-detriment-of-rule-15c2-11s-application-to-fixed-income-markets-the-consequences-of-unilateral-rulemaking-without-public-comment/
