SEC Proposes New Capital-Raising Rules

In a move meant to sweeten the capital markets for small companies soured on going public thanks to the Sarbanes-Oxley Act, the Securities and Exchange Commission wants feedback on two proposals to make it easier and cheaper for companies to raise capital.

The SEC has published separate proposing releases which would, among other things, expand the use of Forms S-3 and F-3 to allow more companies to take advantage of shelf registration of securities and to shorten the holding periods under Rule 144 for restricted securities.

Black

Both measures “are important changes for the business community,” says Barbara Black, director of the Corporate Law Center at University of Cincinnati College of Law. “Both these changes should have a significant impact on the ability of businesses to raise capital.”

The proposals, largely based on recommendations by the SEC Advisory Committee on Smaller Public Companies, are part of a series of measures unveiled by the SEC in May to modernize the capital raising and reporting requirements for smaller companies. They were proposed the same day the Commission approved its final management guidance to comply with Section 404 of SOX and confirmed that non-accelerated filers will need to start complying with Section 404 at the end of the year.

Whether these gestures to non-accelerated filers will be enough to placate demands for yet another extension on SOX compliance remains unclear. Late last week, the House of Representatives approved an amendment to a budget bill that required another year’s extension. The amendment passed handily, and is attached to a funding bill for the SEC, the White House and other executive branch agencies to pressure the Bush Administration on the bill. Its fate in the Senate, and whether it would survive the backroom dealing common in House-Senate conference committees, remains unclear.

Nevertheless, Black says the proposals are also a significant step by the SEC toward registering companies as a whole, rather than the specific securities offerings they want to bring to market.

Allowing more public companies to use Form S-3 would allow them to raise funds more quickly and at a lower cost via “shelf registrations,” where companies register securities with the SEC in advance and wait for a good opportunity to sell them, Black says.

Easing restrictions on the resale of securities that were issued in private offerings should also reduce the cost of raising capital for all companies, she says. While companies save on SEC registration costs in private offerings, the price is discounted because the securities cannot be sold publicly for some period of time. “Reducing the holding period and the other relaxations make the securities more liquid, so the discount should be less,” Black explains.

Patel

Nimish Patel, a partner in the law firm of Richardson & Patel, says the changes could drive more financing transactions. “For companies thinking of going public to attract capital, the proposed rules will continue to point them in that direction,” he says. In addition to cutting the cost of capital, he continues, the changes could reduce legal and accounting costs and the time management spends to attract financing. “That goes right to companies’ bottom lines,” he says.

Others, however, say by continuing to impose thresholds and size tests, even broader ones, the proposed measures won’t provide enough relief to the smallest companies that need it the most.

Morgenstern

“Too mechanistic” is how Marc Morgenstern, a partner in the law firm Sonnenschein Nath & Rosenthal, describes the proposals. “They’re well intentioned, but don’t challenge the basic premise that people somehow need to be more protected from smaller companies than big ones,” he says, adding that a regulatory bias against smaller companies “remains through the entire set of rules.”

Proposed Changes To 144 And 145

The proposals would amend Rule 144 of the Securities Exchange Act, trimming the holding period for restricted securities to six months, if the security holder hasn’t engaged in certain hedging transactions. Security holders would have to “toll,” or suspend, the holding period during the time they enter into certain hedging transactions, by as long as one year.

Patel expects the tolling period to draw “a lot of comments,” particularly from funds that conduct “PIPE” (private investment in public equity) deals, and which can legally short stocks. One issue, he says, is how to disclose a short position and how that disclosure will be viewed by companies.

Still, he notes that the additional time isn’t more restrictive than the current rule. “If people want the benefit of the six-month holding period, then they shouldn’t short during that six month period,” he says.

The SEC also proposed eliminating the presumptive underwriter provision in Rule 145 except for transactions involving shell companies and harmonizing the resale requirements in Rule 145 with the resale provisions for the securities of shell companies in Rule 144.

Comments On 144 And 145

Instructions For Commenting On The Proposals

Comments on 144/145 proposals:

Comments should be received on or before [60 days after publication in the Federal Register] and may be submitted by any of the following methods:

Electronic comments:

Use the Commission’s Internet comment formwww.sec.gov/rules/proposed.shtml

; or

Send an E-mail to rule-comments@sec.gov. Please include File Number S7-11-07 on the subject line; or

Use the Federal eRulemaking Portal www.regulations.gov. Follow the instructions for submitting comments.

Paper comments: Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-11-07. This file number should be included on the subject line if e-mail is used. Please use only one method. The Commission will post all comments on the Commission’s Web site www.sec.gov/rules/proposed.shtml.

Comments are also available for public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE, Washington, DC 20549. All comments received will be posted without change; the SEC does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

For further information contact: Katherine Hsu, Special Counsel, and Ray Be, Special Counsel, Office of Rulemaking, Division of Corporation Finance, at (202) 551-3430.

Comments on S-3 proposals:

Comments should be received on or before Aug. 27, 2007, and may be submitted by any of the following methods:

Electronic Comments:

Use the Commission’s Internet comment form www.sec.gov/rules/proposed.shtml.;

Send an E-mail to rule-comments@sec.gov. Please include File Number S7-10-07 on the subject line; or

Use the Federal Rulemaking Portal www.regulations.gov. Follow the instructions for submitting comments.

Paper Comments:

Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-10-07. This file number should be included on the subject line if e-mail is used. Please use only one method. The Commission will post all comments on the Commission’s Internet Web site www.sec.gov/rules/proposed.shtml. Comments are also available for public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE, Washington, DC 20549. All comments received will be posted without change; the SEC does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

For further information contact: Daniel Greenspan, at (202) 551-3430, in the Division of Corporation Finance.

Black calls the proposed elimination of the presumptive underwriter provision “long overdue.” Since the rule placed restrictions on the resale of registered shares, she says, it made little sense in the context of a stock merger.

The proposals would also eliminate the “manner of sale” limitations with respect to debt securities; increase the thresholds that would trigger a Form 144 filing requirement; and codify a number of SEC staff positions related to Rule 144.

Changes To Forms S-3 And F-3

In a separate release, the SEC proposed amending the eligibility requirements of Form S-3 and Form F-3 to allow domestic and foreign private issuers to conduct primary securities offerings on those forms regardless of the size of their public float or the rating of debt they’re offering. However, the issuers must satisfy the forms’ other eligibility conditions and can’t sell more than the equivalent of 20 percent of their public float (calculated in accordance with instructions in the rule) in primary offerings over any 12-month period. The proposal doesn’t extend to shell companies, which have to wait one year after they cease being shell companies to use Form S-3 and Form F-3 for primary offerings.

If adopted, the change would mark the first time in 15 years that the SEC has modified the public float eligibility requirements for primary offerings on Form S-3. Comments on the proposals are due Aug. 27.

Observers say the proposed change will be “welcome relief to smaller companies.”

Mittelman

“Combined with the proposed changes to Rule 144 and Regulation D, expansion of Form S-3 is the third leg of a tripod to support and elevate smaller-company access to the capital markets,” says David Mittelman, a partner in the law firm Reed Smith.

Currently, many smaller companies can only “gaze with envy” at the offering power Form S-3 provides, Mittelman says. Under the proposal, those small companies will be able to take advantage of favorable market conditions to pull shares “off a shelf” and sell them to investors. That would give small companies a means to tap capital markets other than “draconian” PIPE deals form private equity firms, he says.

In addition, the proposal clarifies some areas of securities law that have become muddled recently. Since last year, Mittelman says, the SEC staff has focused on where to draw lines between primary and secondary offerings when a smaller company registers a substantial amount of shares for resale. “This new proposal reflects a positive SEC effort helping smaller companies to clearly identify the nature of an offering and the number of shares eligible to be sold,” he says.

Mittelman says use of Form S-3 could prove “problematic” for companies with shares traded on the Pink Sheets, since the 20 percent public float is tied to market price and Pink Sheet stocks generally have less volume and more pricing volatility relative to exchange and the OTC Bulleting Board stocks.

Under the proposal, that 20 percent threshold is calculated at sale rather than the time of registration. While the 20 percent figure “is elastic in that more shares may be sold as the stock price increases,” which provides flexibility, Mittelman says, “it also creates risks of miscalculation.”

He says commenters are likely to question how the standard will be enforced and what the consequences of inadvertently exceeding it will be.

Black also believes that some commenters are likely to criticize the 20 percent cap as too low, but “as the SEC becomes more comfortable with the way the rule works, in a few years, they may expand it.”

Patel agrees that the SEC is likely to revise that threshold eventually. “It doesn’t harmonize with some of the other rules they have in place,” he says. Overall, however, he expects little in the way of changes to the proposals after the comment period.

The text of other proposed amendments related to amendments to Exchange Act Rule 12h-1 and Regulation D have not yet been posted to the SEC’s Web site.