6 October 2020 Issue Brief

Small- and Medium-Size Enterprise Finance and Regulations

To achieve an effective balance between facilitating the delivery of needed capital to small- and medium-sized enterprises (SMEs) with the basic transparency and investor protection needs of small investors, effective regulation is imperative.

During the tech/telecom bubble of the 1990s (the so-called “tech bubble” represented a pronounced and unsustainable market rise attributed to increased speculation in technology stocks in the 1997- 2001 period) large numbers of small companies failed, leaving investors with hundreds of billions of dollars in financial losses. That, and high-profile governance and fraud cases at Enron and WorldCom, prompted new governance rules to prevent recurrence.

Small Business and SME Funding Regulations

The Sarbanes-Oxley Act of 2002 (SOX) imposed criminal penalties on senior management for fraudulent or misleading financial reporting, and required governance structures such as audits on company internal controls. Its internal controls section (Sec. 404b) was amended in 2007 to focus solely on financial reporting. Despite the changes, the Dodd-Frank Wall Street Reform and Consumer Protection Act specifically exempted companies with market capitalizations of less than $75 million from Sec. 404, and called on the Securities and Exchange Commission to study exempting companies with market capitalizations up to $250 million.

The US Jumpstart Our Business Startups Act (JOBS Act), which was enacted in 2012, granted further exemptions to transparency requirements, took Dodd-Frank up on increasing the Section 404 exemption to companies with market capitalizations of up to $250 million, and allowed smaller companies to raise capital via crowdfunding sources.

CFA Institute Viewpoint

CFA Institute supports efforts to provide venture funding for SMEs. At the same time, we believe that such efforts must be balanced with the transparency needs of investors. To achieve this balance, we believe companies should adhere to the following safeguards:

  • Undergo annual financial audits and include them in annual reports to shareowners and investors
  • Provide at least semi-annual updates on performance and financial condition
  • Disclose all important company news through normal public distribution channels
  • Hold principals liable for fraudulent representations made in offering documents, financial statements, or company announcements delivered through these channels
  • Trade shares only on special exchanges or trading platforms dedicated to such companies to ensure that investors are aware that the shares do not have to adhere to the same transparency and governance requirements as are required of traditionally listed companies.

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