The SEC yesterday announced a series of sweeping proposals that would significantly streamline the capital formation process for smaller public companies.
In doing so, the SEC adopted many of the recommendations made in 2005 by the SEC’s Small Business Advisory Committee. While the text of the proposals are not yet public, we believe these proposals, if adopted, will significantly reduce the cost of capital for smaller public companies and lessen the reporting burdens faced by such issuers. At the same time, the proposals will radically alter the landscape for investors who purchase privately placed securities of reporting companies by greatly reducing the liquidity risk of such investments.
As described in the SEC’s press release, the key proposals are:
• Significant Reduction of Rule 144 Holding Periods.
The proposals would reduce the existing one-year holding period under Rule 144 to six months for holders of restricted securities of reporting companies that have been reporting for at least the prior 90 days and would allow non-affiliates to freely resell such restricted securities after that sixmonth period without any volume or manner of sale restrictions. The reduced holding period would be tolled for any period during which the holder had a short position or put equivalent position in the issuer’s securities.
• Form S-3 and Shelf Registration Available to Smaller Public Companies.
The proposals would make Form S-3 (the short-form registration statement) available to nearly all public companies to effect primary sales of equity securities by eliminating the $75 million public float requirement contained in existing Form S-3. Companies with a public float of less than $75 million would be able to sell no more than the equivalent of 20% of its public float in primary offerings on Form S-3 over any one-year period. To use Form S- 3, the issuer must meet the other eligibility criteria of the Form (e.g., current in Exchange Act reports for last twelve months). The Form would not be available for any issuer that has been a “shell company” during the last twelve months.
• Expansion of Lower Disclosure Requirements for Smaller Reporting Companies.
The proposals would increase from $25 million to $75 million the market capitalization threshold for public companies to take advantage of disclosure requirements currently applicable to small business issuers. These “smaller reporting companies” would have the ability to choose on an item-by-item basis, the disclosure requirements that would govern their filings. In connection with this proposal, the existing small business issuer forms and regulations would be rescinded and consolidated with the existing forms and regulations applicable to larger public companies.
• Regulation D Integration Safe Harbor Reduced to 90 Days.
Under the proposals, offerings that are separated by at least 90 days would not be integrated for Section 5 purposes, versus the six month period currently in effect.
• Limited Marketing Allowed for Private Placements to “Rule 507 Qualified Purchasers.”
Under this new exemption, an issuer would be permitted to conduct a private placement with limited, tombstone-like advertising, so long as the issuer only sells its securities to a new, higher category of accredited investor called “Rule 507 Qualified Purchasers.” Under the proposal, a Rule 507 Qualified Purchaser would include an individual with $2.5 million of investments or $400,000 of annual income or $600,000 of aggregate annual income with their spouse. Institutions would qualify if they own $10 million in investments. Directors, executive officers and general partners of the issuer would also qualify.
• Expansion of Accredited Investor Definitions.
The definition would be expanded to include a new “investments- owned” standard, which would allow individuals and institutions who own investments of $750,000 and $5 million, respectively, to be accredited investors. These dollar thresholds, and the Rule 507 Qualified Purchasers thresholds, would be inflation-adjusted annually starting in 2012.
• Elimination of Underwriter Status in Business Combination Transactions.
Current restrictions in Rule 145 that require affiliates to comply with Rule 144 with respect to registered securities acquired in a business combination transaction would be eliminated under the new proposals, except for shell companies.
• Registration Exemption for Companies with Widespread Option Holders.
The proposals would allow private non-reporting issuers to avoid registering with the SEC solely as a result of the number of holders of compensatory employee stock options issued under employee stock option plans.
We intend to submit comments to the Staff on the rule proposals once they are published in the Federal Register. We welcome any input from our clients and friends on these proposals, as we develop our own comments. Once the comments are received and processed by the Staff, the SEC will publish final rules, which should thereafter become effective. This process may take from six to twelve months to run its course.
We asked an author of the Staff’s recommendations to the SEC whether they intend to implement transition rules to allow compliance with these proposals prior to their formal adoption.
He indicated that they may consider doing so for some of the proposals after publication of the final rules.