The House of Representatives overwhelmingly passed two bills designed to improve capital formation, one addressing the 500-shareholder threshold for SEC registration and one addressing offerings under Regulation A.
500-Shareholder SEC Registration Threshold
Sections 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) generally requires companies with at least $10 million dollars in total assets and 500 shareholders to file reports with the SEC. While the $10 million asset threshold has increased from $1 million over the years, the 500 shareholder threshold has not moved. House of Representative bill H.R. 1965 would increase the shareholder threshold for SEC registration from 500 to 2,000 as to banks and bank holding companies. The bill was approved in the House of Representative by a vote of 420 to 2.
The overwhelming approval of H.R. 1965 seems to imply that a similar bill, H.R. 2167, the Private Company Flexibility and Growth Act, is also likely to receive broad support in the House. H.R. 2167 would increase from 500 to 1,000 the shareholder threshold for any company (not just for banks and bank holding companies). Employees would not count toward the 1,000 shareholder threshold. The original version of H.R. 2167 also would not have counted “accredited investors” toward the 1,000 shareholder threshold, but that exception was removed during committee deliberations. The House of Representative’s Financial Services Committee was recently approved the bill, which will proceed to the full House of Representatives.
Regulation A Small Offering Reforms
Section 3(b) of the Securities Act of 1933, as amended (the “Securities Act”) authorizes the SEC to exempt from SEC registration certain small offerings of securities. Adopted pursuant to Section 3(b), Regulation A is an exemption for public offerings not exceeding $5 million in any 12-month period, which requires disseminating to investors a detailed disclosure document, called an offering circular, that is subject to SEC review. Conducting a Regulation A offering is similar to going through the SEC registration process, with some notable simplifications:
- Financial statements are relaxed and do not need to be audited;
- There are no Exchange Act reporting obligations after the offering unless the company has more than $10 million in total assets and more than 500 shareholders;
- The offering circular has a simplified formats the issuer can select, including a question-and-answer approach; and
- Companies may “test the waters” to determine if there is adequate interest in their securities before incurring the legal, accounting, and other business costs of filing the offering circular and related materials with the SEC.
House of Representative bill H.R. 1070, the Small Company Capital Formation Act of 2011, would codify in Section 3(b) an expanded Regulation A framework. Here is a summary of those terms and conditions:
- Aggregate offering amount – $50 million annual aggregate offering amount. This essentially replaces the current $5 million limitation.
- Public offerings – would be expressly OK.
- Restricted securities – securities issued would not be “restricted” securities (e.g., they would be freely re-saleable).
- Issuer liability – would expressly include liability under Securities Act Section 12(a)(2) for material misstatements or omissions (generally limited to public offerings).
- Testing the waters – would be OK to solicit indications of interest, but SEC rulemaking would be required to implement how this works. (Presumably, .this would be similar to current Regulation A rules).
- Audited financials – would be required annually, which is a notable difference from current Regulation A.
- Other terms the SEC may determine – the SEC could impose additional requirements, such as:
- An offering statement with prescribed disclosures
- Bad actor disqualifications
- Periodic disclosures regarding the issuer
- Types of securities – the exemption would be available for equity securities, debt securities, and debt securities convertible or exchangeable to equity interests, including any guarantees of such securities.
- Preemption – state “blue sky” laws would be preempted as to any offering pursuant to this exemption if the offering is:
- offered or sold on a national securities exchange (which is only useful for already public companies), or
- sold to a “qualified purchaser” (which is not yet defined, so this has no current effect).
The bill was approved in the House of Representative by a vote of 421 to 1.
Small company reforms to facilitate capital formation seems to be a popular mantra this election year, regardless of political party. As we all hope this results in clear public policy that fairly balances the challenging, sometimes divergent policy goals of capital formation, investor protection and market integrity, we will continue to actively monitor and summarize significant developments as they unfold.