While the Securities and Exchange Commission’s package of proposals aimed at easing the financial reporting burden for small companies includes some welcome reforms, not all of the changes will be helpful, panelists at an SEC roundtable recently said.
Participants at last week’s annual SEC Government-Business Forum on Small Business Capital Formation praised some of the proposed ideas, such as easier rules to sell securities to a new category of large accredited investors. Other proposals, such as longer waiting periods for some transactions, were less popular.
Among those rule proposals, which total 623 pages combined, are initiatives to streamline Regulation D and Form D and make the form electronic; to provide an exemption that would keep private companies with stock options plans from unintentionally becoming public registrants; and to allow limited advertising by private issuers to solicit sales of securities to a new category of “large accredited investors.”
White
The comment period has closed on all the proposals except for the Regulation D reform, which is out for comment until Oct. 9. John White, director of the SEC’s Division of Corporation Finance, says he wants to complete rulemaking on all six proposals by the end of the year.
At the roundtable, Steven Bochner, a partner at the law firm Wilson Sonsini Goodrich & Rosati and a member of the SEC advisory committee on smaller public companies, praised the SEC proposal to exempt compensatory stock options for private companies, but cited “a few restrictions” he says will impair the effectiveness of the exemption from Securities Exchange Act registration. Specifically, he said, a transferability restriction and information requirements are more onerous than those that now exist under Rule 701.
Bochner
“I’d love to see this type of exemption with no additional transferability restrictions beyond that provided under Rule 144, and information requirements which parallel those that exist under [Rule] 701; nothing more onerous,” Bochner said.
He also praised a proposed exemption for securities sold to a new category of large accredited investors, proposed Rule 507, as “a pretty good first step.”
“If we get it right, it could improve capital formation, improve efficiency, and allow the right kind of investors and companies to more effectively get in contact with one another without impairing investor protection,” he said.
Greg Yadley, a partner at the law firm Shumaker, Loop & Kendrick, also praised proposed Rule 507 as “a wonderful thing, because it doesn’t have a monetary ceiling, you can have as many investors as you want, and it focuses on purchasers” as opposed to offerees. But he wondered what would happen if an issuer is unsuccessful in its use of limited advertising. “Can you go back to the hum-drum accredited investor?” he asked. “Maybe not … and that’s a huge problem we need to deal with.”
One question from the audience was why private pooled investment vehicles are excluded from the proposed Rule 507. Gerald Laporte, head of small business policy at the Division of Corporation Finance, said the issue was raised in many comment letters and will be reviewed by the SEC. “If there’s an adopting release on Reg D, they’ll be addressing that,” he said.
Marc Morgenstern, managing partner of Blue Mesa Partners, said updates to the definition of accredited investor should be examined “quite carefully,” since they’re largely based on definitions adopted in the 1980s and may not be relevant. He also said similar-sounding terms in the rules “will have very mischievous consequences,” citing a concern that the SEC “is straying from its own mission” of crafting rules in plainspoken English.
The SEC also proposed mandating the electronic filing of a streamlined, updated Form D, the form that must be filed by companies that rely on a registration exemption for private or limited offerings of securities provided under Regulation D after they first sell their securities. Laporte, noting that the SEC now only uses Form D data for enforcement purposes, said the Commission hopes the information “will become more valuable” once it enters the electronic era.
Rule 144, Reg S-B, and More
A second panel discussed revisions to Rule 144 of the Securities Act, changes to the eligibility requirements for Form S-3 and F-3, and merging Regulation S-B into Regulation S-K. And again, the mood was generally supportive with a few concerns.
Pinedo
Anna Pinedo, of the law firm Morris & Foerster, said a proposal to make Form S-3 more broadly available and eliminate the current public float requirement, combined with the other releases, will “make significant progress in terms of facilitating capital formation, and will really help smaller and mid-cap public companies.” She and other panel members did question the necessity of a provision that would limit the amount raised in a year to 20 percent of the company’s public float.
Gerard O’Connor of the law firm Foley Hoag said that if the SEC does use a “speed bump,” it should be higher than 20 percent public float. He also urged the SEC to reconsider making S-3 available for resale registration statements for public companies with market caps under $75 million.
While the panelists said the proposed changes to Rule 144 are helpful, they opposed the proposed reintroduction of tolling. The Rule 144 proposal re-introduces a provision that extends the holding period for up to six months while the security holder is engaged in certain hedging transactions.
Pinedo questioned whether reintroducing tolling is warranted, since the SEC “hasn’t pointed to any harms or abuses that have resulted as yet.”
Rule 507 “could improve capital formation, improve efficiency, and allow the right kind of investors and companies to more effectively get in contact.”
— Steve Bochner,
Partner,
Wilson Sonsini
Besides making the U.S. derivatives market “uncompetitive,” Pinedo said, if the SEC does reintroduce tolling, “There’s a plethora of issues the proposing release doesn’t begin to address.” The result will be so much confusion in the market that “it may outweigh the benefit of shortening the holding period to six months.”
Similarly, O’Connor urged the SEC to “wait on tolling.” Instead, the Commission should put the reduced holding period in place and observe the market before it decides tolling is necessary.
Most of the discussions centered on the rule proposals, but Section 404 of Sarbanes-Oxley did sneak into the conversation anyway. Phil Clough, managing general partner of ABS Capital Partners, stated that the major issue for small private companies “is still the 404 rules and cost.”
White reiterated that the SEC has “no plans or expectation” to extend the current year-end deadline for non-accelerated filers to comply with the management reporting requirements under Section 404. But he added that a final decision on whether to extend the deadline for the auditor assessment, which is set to take effect at the end of 2008, “needs to wait” until an SEC cost study on Auditing Standard No. 5 is completed.
“That [study] can’t occur until people have used AS5, which gets us to the end of March of next year,” White said.
Noting that some accounting firms and companies have indicated to the SEC that many non-accelerated filers are “going slowly” in getting ready for the management assessment, White said: “I’d urge all of you advising smaller companies … You should be getting to work on the task at hand for the end of the year.”
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