By: Pete Hoglund, RCM Business Solutions, Legal Support

In light of the myriad of political controversies and the upheaval of the financial regulatory system, the issue of over-regulation in the financial sector has become of great concern to corporations. The issue of over-regulation and its practical effect on businesses is an important one for RCM clients I wanted to take the time to delve a little deeper into this issue. I have found that our clients, particularly small and mid-sized entities, face several hurdles in capital raising and that the regulatory climate can prove particularly challenging. Specifically, I am interested in the question of whether capital raising requirements and the subsequent required disclosure is overly burdensome to small and mid-sized companies.

Presumably, the primary intent behind disclosure and government regulation of such businesses is consumer/investor protection and transparency. That is, the goal is to ensure that companies are what they purport to be. In this way, by relying on say, a financial statement of a company, investors, particularly public and non-institutional investors, can be assured that the company is being honest. Admittedly, the public needs some degree of protection. There are many material facts, which only insiders of companies are privy to and thus it seems only natural to ensure some degree of accuracy. This is especially true when smaller companies are looking to raise capital through equity. Moreover, smaller companies may not be able to look to institutional and savvy investors to extend funding in the same way that a larger, more established company may be able to.

Given that the public ought to be protected to some degree, the obvious question is: How much protection does the public need and how much should businesses have to sacrifice in order to afford this protection? On the one hand, smaller companies might seem to be especially likely to mislead the public. They are not inherently transparent by way of the internet’s immediate dissemination of information in the same way in which a publicly traded company might be. Without any regulatory protection, the average member of the public may not be able to Google a small company and come up with daily, material information. Aside from a Better Business Bureau report and perhaps a few consumer complaints, desired information might be tough to come by. This would suggest that these companies should be regulated significantly in order to deter small business owners from taking advantage of less experienced investors.

On the other hand, there are serious costs related to complying with all the meticulous requirements. Obviously, small businesses are less likely to be able to afford such costs. Thus in a somewhat indirect way, perhaps small businesses would be more likely to grow financially if they could eliminate the cost of compliance. Note that these are not simply financial costs. Indeed there are costs to hire an accountant or attorney to ensure compliance. Yet there is also an economic cost of time. Generally, complying with these specific guidelines requires careful review. It also might require some form of reliance upon the government, which can amount to a very painful waiting game. As anyone who has visited the DMV knows, the wheels of government spin especially slowly.

Balancing the need to protect the investor that is dealing with a small and relatively opaque company with the needs of business owners who have been inhibited from effectively operating their companies due to compliance burdens, is the key to effective regulation. Yet, from a legal perspective, we also should be analyzing the extent to which a public investor should be granted the right to act on their own volition. With the exception of fraud cases (which of course have their own, separate remedies), investors are not forced to give capital to companies. Given that most investments are inexorably risky, maybe the focus should shift away from the smaller companies to the investors themselves. Perhaps the government could donate more time towards educating inexperienced investors as to why they should be careful and how to assess risk.

Moreover, we reiterate the phrase caveat emptor (or “buyer beware”). While I certainly recognize that not every member of the American public is well educated, I look to casinos and the gaming industry for guidance. Anyone over 21 can gamble at their local casino. There are few, if any, limits on how much the average casino enthusiast can bet and spend. In fact, no prior gambling experience is required to sit down at the blackjack table. So long as the investor or gambler has funds sufficient to keep playing, his cards will keep being dealt. The point is- we recognize that all bets are risky and we place at least some faith in the public for knowing their own limits and assessing their own risks. I fail to see how, at its core, investing in a small company is much different from playing blackjack. While the stakes can be higher, the observable risk is not only apparent but obvious.

In closing, I posit that small businesses could benefit significantly from a reduction in government regulations concerning investment and capital raising. The current scheme of over-regulation has hindered the growth of small businesses and has put a huge emphasis on the protection of investors with very little empirical evidence that such protection is warranted or that it outweighs the associated costs. Without the overly burdensome compliance requirements, small and mid-market businesses could more readily raise capital and would be able to open their doors to a new and eager class of investors. Furthermore, business would be able to reduce a significant and, most importantly, an ongoing cost. This may just be a situation in which our practical, economic views should trump our ideological concerns.

Pete Hoglund is a third-year law student at the Depaul University College of Law and has always had an interest in the small business world. He also interns at Reliance Capital Markets in Chicago. Pete can be reached at petehoglund@gmail.com with any thoughts, questions, or concerns.