Background: The lifeline of any business is access to capital. Without the necessary funds, entrepreneurs cannot turn their innovative ideas into startup companies, small businesses cannot grow their existing companies, and large companies cannot become Fortune 500 companies. The health of an economy is in large part determined by how dynamic or entrepreneurial it is. Business creation means economic growth, higher wages and better products at lower prices. Regrettably, the U.S. economy today is less entrepreneurial than it has been in the past three decades. In fact, the business failure rate exceeded the rate at which businesses were created from 2008-2011.
While many reasons exist for the decline in entrepreneurship, government regulation is a leading factor. Burdensome and complex federal securities regulation and banking regulation restrict the ability of small firms to raise the capital needed to start or grow businesses. This slows economic growth, reduces job creation, and raises costs for consumers.
Securities Regulation: In the early 1930s, Congress passed the Securities Exchange Act and gave the Securities and Exchange Commission (SEC) broad authority to regulate the securities industry. Originally tasked with preventing fraud and enforcing reasonable disclosure rules, the securities laws over-regulate, impose significant compliance cost, and undermine the ability of companies to raise the capital need to grow, innovate, and create jobs.
Small to medium size companies looking to access public capital markets or “go public” must comply with voluminous SEC rules and regulations. The SEC estimates the initial regulatory compliance cost for a company to go public at $2.5 million up front followed by $1.5 million per year. For many small businesses the cost is simply too great.
Many security regulatory barriers to capital exist. For example, regulation surrounding finders and business brokers – who connect small businesses with potential investors – raises the cost of finding capital. Regulation determining who is permitted to be an investor limits the number of potential investors for small businesses. Ambiguous rules for entrepreneurs raising private investment through family and friends impede startup companies. SEC regulation on peer-to-peer lending portals threatens to stop small businesses from crowdfunding. State registration and qualification rules harm small public and many private companies while large companies are exempt.
Banking Regulation: The Dodd-Frank Wall Street Reform and Consumer Protection Act has also contributed to the problem. Instead of reining in big banks and Wall Street, the regulatory burdens imposed by Dodd-Frank harm local community banks, raise lending costs, and restrict access to capital for businesses.
Prior to Dodd-Frank, the regulatory framework for banks was highly complex and imposed significant costs on financial intermediation and distorted capital markets. Dodd-Frank only worsened this problem. Research shows, for example, that after federal banking regulators imposed new capital requirements banks shifted away from non-mortgage lending and expanded mortgage lending. Depending on the banking activity, at least seven federal regulators can supervise, examine, or otherwise regulate a bank. These regulations have imposed enormous costs on banks leading to a decline in the number of banks and the concentration of the banking industry as a whole.
Section 413(a) of Dodd-Frank offers an example. Regulation D under the Securities Act allows small businesses to engage in public offerings without registering with the SEC, thus saving them high regulatory costs. Individuals who want to invest under Regulation D must be “accredited” meaning they have an income of more than $200,000 or have a net worth of at least $1 million. But under Section 413(a) of Dodd-Frank, accredited investors are now required to have a net worth of at least $1 million, excluding residential net worth. This drops the percent of households qualifying as an accredited investor from over 9 percent to 7.2 percent and reduces the number of potential investors for small businesses. Liberals are pushing to increase the income threshold to as high as $750,000 and the net worth threshold to as much as $2.5 million.
Banking regulations under the Federal Credit Union Act (FCUA) also impose problems for businesses attempting to gain access to capital. Section 107A of the FCUA prevents credit unions from offering business loans greater than 12.25 percent of the credit union’s assets.
Solution: Instead of assuming every entrepreneur or company is trying to defraud their investor and every investor is incapable of making wise investment decisions, Congress should return to the basic principles of securities regulation – preventing fraud and enforcing reasonable disclosure rules. Congress should eliminate laws and SEC rules that unnecessarily restrict access to capital for businesses and scale disclosure requirements to help small businesses grow. In addition, Congress should repeal Dodd-Frank and refocus banking regulation so that federal regulators no longer micro-manage banks. Reducing securities and banking regulation will empower businesses to gain access to capital necessary for innovation, growth, and job creation.