In 2011, the SEC formed the Advisory Committee on Small and Emerging Companies (the “Committee”) to focus on interests and priorities of small business and smaller public companies. On September 13, 2017, the Committee met for the last time before the Committee’s charter expired on September 24, 2017 to discuss its Final Report, which was recently published in final form on September 21, 2017. While the SEC implemented a number of the Committee’s recommendations during the Committees tenure between 2011 and early 2017, others remain outstanding, and were addressed in the Final Report.
The Final Report emphasizes the need for the SEC to facilitate exempt offerings to help smaller businesses raise capital. In order to do so, the Committee set forth that the SEC can start by providing regulatory certainty for finders (private placement brokers and platforms that are not registered as broker-dealers) and by expanding the “accredited investor” definition to include measures of investor sophistication, regardless of income or net worth. In its recommendation to expand the “accredited investor” definition, the Committee set forth that “simplicity and certainty are vital to the utility of any expanded definition of accredited investor, so any non-numerical criteria should generally be ascertainable with certainty.”
Beyond the scope of raising private capital, the Committee stated that the SEC must also address disproportionate burdens faced by smaller reporting companies (“SRCs”). To encourage more companies to go public at earlier stages, the Committee recommended extending to SRCs the same accommodations made to emerging growth companies with respect to disclosure requirements, as well as increasing the financial thresholds in the SRC definition so that more companies could qualify.
Turning to its past efforts to increase diversity on reporting companies’ boards of directors, the Committee also recommended amending Item 407(c)(2) of Regulation S-K to require issuers to describe, in addition to their policy with respect to diversity, if any, the extent to which their boards are actually diverse. The Committee referred ti the importance of diversity, stating that “[b]oard diversity has been associated with improved competitiveness and talent management, greater access to capital, more sustainable profits, and better relations with stakeholders and therefore plays an important role in capital formation for small and emerging companies.”
The report’s final recommendations addressed improving secondary market liquidity. The Committee believes the SEC can improve secondary market liquidity by (1) creating a separate U.S. equity market for trading by accredited investors in the securities of smaller companies and (2) preempting state regulation of secondary trading in securities of certain Tier 2 Regulation A issuers. The Committee further recommended providing more trading support for small and mid-cap companies by allowing trading increments (tick-sizes) greater than one penny.
In addition to the Committee’s above recommendations, members of the meeting also discussed the auditor attestation requirement under Section 404(b) of the Sarbanes-Oxley Act (“SOX”) and proposed changes to Securities Act Rule 701.
Section 404(b) of Sox requires all public companies to include a report from management on the effectiveness of the company’s internal control over financial reporting in their annual reports on Form 10-K. In its discussion of the SOX auditor attestation requirement, the Committee considered the associated compliance costs and a proposal to change the SRC and “non-accelerated filer” definitions to a company with either a public float of less than $250 million or annual revenues of less than $100 million. The main argument set forth by the presenters was that many of the companies currently forced to comply with SOX’s auditor attestation requirement have low revenues and few employees, and the high cost of the controls audit diverts necessary funds from “more important” areas such as research and development.
The Committee’s final discussion turned to various proposed changes to Securities Act Rule 701, which is an exemption from registration for securities issued by non-reporting companies pursuant to certain compensatory arrangements – “in essence, a rule that makes it less burdensome to compensate employees with equity.” The proposed changes include, among others, removing the requirement that consultants be “natural persons,” removing the $5 million aggregate limitation, and clarifying the timing and delivery requirements for expanded disclosure. A detailed report of the Committee’s recommendations regarding Rule 701 was released on September 21, 2017 and is available here.
Though the Committee’s charter ended on September 24, 2017, SEC Chair Jay Clayton recognized the important work done by the Committee and announced during his opening remarks, that Congress is establishing a permanent successor to the Committee – named the Small Business Capital Formation Advisory Committee.