To help restore confidence in the securities markets after the stock market crash of 1929, Congress passed the Securities Exchange Act of 1934, which authorized creation of the Securities and Exchange Commission (SEC). The SEC is an independent, nonpartisan regulatory agency responsible for administering federal securities laws. It has broad regulatory authority over significant parts of the securities industry, including stock exchanges, mutual funds, investment advisers, and brokerage firms.
Among the major federal securities statutes that the SEC enforces is the Investment Company Act of 1940 (ICA; P.L. 76-768). According to the SEC, the ICA applies to investment companies, and investment vehicles (such as mutual funds) that are "engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in 'securities,' or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities, and owns or proposes to acquire 'investment securities' having a value exceeding 40% of the value of its total assets." The SEC has described the ICA as
designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of…[the] Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations.
The ICA excludes certain investment pools, including hedge funds, from the definition of investment company, thus exempting them from the authority of its regulation when they have certain qualifying exceptions. One exception from the definition of an investment company and thus registration under the ICA is to a pooled investment entity whose outstanding stock is owned by 100 beneficial owners or fewer (a beneficial owner is a person who enjoys the benefits of ownership even when the title to a security is in another person's name such as a broker-dealer who is acting on behalf of an investor) and is not currently making nor intends to make a public securities offering. Under the ICA, once an entity takes on the 101st owner, it must register as an investment company and begin incurring the potentially significant time and money costs associated with registration.
Organized and run by their general partners, venture capital funds are investment pools that manage the funds of their wealthy investors interested in acquiring private equity stakes in emerging small- and medium-sized firms and startup firms with perceived growth potential. The funds often take an active role in the businesses, including providing managerial guidance and occupying corporate board seats. Venture capital funds with 100 or fewer beneficial owners are also not defined as investment companies, exempting them from the ICA registration requirement.
Currently, there are concerns within the business community over the perceived behavioral impact of the 100-investor limit on venture capital funds. Some observers have said that to avoid ICA registration and its potentially significant money and time costs, some venture capital funds appear to be reluctant to add additional investors, a potential loss of opportunities to expand the capital that they might use to invest in and help grow various businesses, which has historically included high-tech firms for some funds.
H.R. 1219, which has been marked up by the House Financial Services Committee, and S. 444, which has been marked up by the Senate Committee on Banking, Housing, and Urban Affairs (115th Congress), are legislative attempts to address such concerns. The bills would amend the ICA by creating a new subset of venture capital fund called a qualified venture capital fund (QVCF). QVCFs would be venture capital funds (as defined in federal securities law) with no more than $10 million in invested capital that could be owned by up to 250 beneficial investors before triggering the ICA registration requirement. In the 114th Congress, similar legislation, H.R. 4854, passed the House.
Some proponents of the bills have argued they would generally help to broaden access to capital for small businesses, thus boosting their prospects to thrive. The bills' sponsors, Representative Patrick McHenry and Senator Heidi Heitkamp, however, have emphasized more targeted additional benefits. They have asserted that the bills would be particularly helpful at expanding the number of venture capital funds in rural areas, helping to nurture more rural startups and small businesses.
By contrast, the North American Securities Administrators Association (NASAA), a group of state and provincial securities regulators, examined a similar bill, an early version of H.R. 4854 in the 114th Congress (which would have expanded the beneficial investor cap to 500 instead of 250, while the version that passed the House provided for a cap of 250) largely through an investor protection lens. The fundamental concern raised in its analysis was that by broadening existing regulatory exemptions, the legislation would expand the universe of investment vehicles devoid of regulatory oversight to the detriment of fund investors.
On March 22, 2017, the Congressional Budget Office issued comments on H.R. 1219: "Enacting H.R. 1219 would not affect direct spending or revenues; therefore, pay-as-you-go procedures do not apply. CBO estimates that enacting H.R. 1219 would not increase net direct spending or on-budget deficits in any of the four consecutive 10-year periods beginning in 2028."