On May 10, 2011, Securities and Exchange Commission (the "Commission") Chairman Mary Schapiro testified before the U.S. House of Representatives Committee on Oversight and Government Reform (the "Committee") on the future of capital formation. The testimony followed a recent exchange of letters between Chairman Schapiro and Representative Darrell Issa, Chairman of the Committee, on capital-raising reform, particularly for small businesses. Chairman Schapiro stated that the Commission is comprehensively reviewing its offering rules in light of changes in the operation of the markets, advances in technology and the acceleration in the pace of communications.
Chairman Schapiro testified she had asked the Commission's staff to "take a fresh look at some of [its] offering rules to develop ideas for the Commission to consider that would reduce the regulatory burdens on small business capital formation in a manner consistent with investor protection." She noted that specific areas of focus in the staff's review will include:
- the threshold number of shareholders that trigger public reporting (currently 500) for otherwise private companies, including questions surrounding the use of special purpose vehicles that hold securities of a private company for groups of investors;
- whether the general solicitation ban in private offerings should be revisited in light of current technologies, capital-raising trends and the Commission's mandates to protect investors and facilitate capital formation;
- regulatory questions posed by new capital-raising strategies; and
- the restrictions on communications in initial public offerings (better known as "gun-jumping").
Number of Shareholders that Trigger Public Reporting
One of the current rules under review is the limit on the number of shareholders a private company can have before it is required to register its securities with the Commission and become subject to its reporting requirements. Currently, the rules provide that once a private company issues shares to 500 or more persons and has total assets exceeding $10 million, it must register its securities with the Commission and comply with the Commission's reporting requirement, within 120 days of the end of the fiscal year in which the 500 shareholder threshold is reached. The Commission is considering whether the threshold number of holders that trigger registration should be raised, as well as how the number of holders is counted. The Commission has the rulemaking authority to revise the shareholder threshold without approval from Congress.
The Commission staff is also reviewing the use of special purpose vehicles ("SPVs") to allow one or more pools of investors to invest in companies that have not completed an initial public offering and how the SPV is counted for purposes of counting the number of holders in a company in determining whether registration is required. Under the current rules, the SPV is counted as one holder. The Commission will consider whether new rules should require each of the holders in the SPV to be counted individually, whether such proposed counting rule should apply only if the issuer is involved in forming the SPV, or whether the formation of the SVPs and investors' interest in them suggest underlying problems with the Commission's current rules that should be addressed.
Chairman Schapiro emphasized that the Commission will subject any recommendation or proposed change to the reporting thresholds to rigorous analysis as to the impact on investor protection and capital formation and the other costs and benefits of any proposed change.
In addition, the Commission is monitoring secondary trading on online trading platforms, many of which facilitate the trading of securities of private companies. Chairman Schapiro recognized the benefits these platforms bring in providing liquidity to and attracting investors in smaller private companies, but expressed concern with secondary trading in private companies, in which there is lack of information available to investors.
This raises the question of whether it is desirable public policy to have private companies with a great deal of shareholders that do not register with the Commission and issue conventional public disclosure where trading occurs only in new platforms like SecondMarket. This issue is likely to be hotly debated.
General Solicitation Ban in Private Offerings
Under current Commission rules, private offerings that are exempt from registration with the Commission are generally subject to a ban on the use of general solicitation or advertising to attract investors. The recent withdrawal of an offer of shares of Facebook, a private company, by Goldman Sachs Group Inc. from its U.S. clients due to the level of media attention has particularly brought these rules into the spotlight. Chairman Schapiro confirmed in her letter to Representative Issa that the Commission did not intervene with the Facebook offering to limit it to foreigners.
She also noted the Commission had previously acted to facilitate capital raising in private offerings by adopting safe harbor rules and providing guidance on the scope of the private offering exemption and ban on general solicitation and advertising. In addition, Chairman Schapiro advised that the Commission will analyze whether new changes should be made to the general solicitation ban, and in connection with such analysis, the Commission will consider the following differing viewpoints:
- the view that the ban is a significant impediment to capital raising for small businesses;
- the view that the ban may be unnecessary because those who do not purchase the offered security (usually only "accredited" investors) would not be harmed by the solicitation that occurs; and
- the view that the ban helps prevent securities fraud by making it more difficult for fraudsters to attract investors or unscrupulous issuers to condition the market.
This raises the issue of whether private placements directed only to "accredited" or sophisticated investors should be completely free of the historic private placement regime prohibiting broad solicitation.
Communications in Initial Public Offerings
The Securities Act of 1933, as amended (the "Securities Act"), provides that each offering of securities must be registered with the Commission unless an exemption from registration is available. Under current Commission rules for registered offerings, issuers may not offer securities in the period prior to the filing of a Securities Act registration statement. In the period between the filing of a registration statement and the effectiveness of such registration statement, often referred to as the "waiting period" or "quiet period," an issuer can make oral offers but cannot make written offers other than through a prospectus that complies with Section 10 of the Securities Act. The prospectus provides comprehensive, balanced information about the issuer and the offering which facilitates investment decisions.
Since the term "offer" is construed very broadly, issuers must be cautious to limit communications before and during offerings to prevent making illegal offers, or "gun-jumping." In his prior letter to Chairman Schapiro, Representative Issa questioned whether the quiet period rules should be further liberalized in light of today's marketplace and communications technology. Chairman Schapiro reviewed steps the Commission had taken in recent years to modernize the rules governing communications in the registration process and expand an issuer's ability to communicate publicly during registered offerings, including the following changes adopted as part of the Commission's 2005 Securities Offering Reform:
- a bright-line safe-harbor for communications made more than 30 days before the filing of a registration statement;
- new rules protecting ordinary course business communications, even if made less than 30 days before the filing of a registration statement;
- new rules permitting certain written offers, also known as free writing prospectuses, outside of the required statutory prospectus;
- new rules permitting certain media communications and publications around the time of a public offering that previously would have been considered gun-jumping;
- expanded safe harbors to allow issuers to communicate more details about contemplated offerings;
- expanded safe harbors for use of research reports during registered offerings; and
- new rules greatly relaxing the restrictions on offers for well-know seasoned issuers (issuers who have a worldwide market value of outstanding voting and non-voting common equity held by non-affiliates of $700 million or more).
The Commission will review these quiet period rules as part of its overall review of capital formation rules, although Chairman Schapiro did not elaborate on the considerations the Commission would take into account in such review.
New Capital Raising Strategies
The Commission staff has also been discussing possible regulatory approaches to new capital formation strategies with business owners, representatives of small business industry organizations and state regulators. In a previous letter to Representative Issa, Chairman Schapiro noted one such strategy the Commission is reviewing is "crowdfunding," where groups of people pool money, usually in very small individual contributions, to support an effort by others to accomplish a specific goal. Supporters of crowdfunding are seeking exemptions from the registration requirements of the Securities Act to allow for additional ways for early stage companies and small businesses to raise capital. Chairman Schapiro noted that the Commission will be mindful of its responsibilities of both facilitating capital formation and protecting investors in considering whether any such exemption is appropriate. In the example of crowdfunding, the limits on both individual investment and offering amounts may reduce the incentives for abuse, but the widespread use of the internet for crowdfunding present additional challenges to investor protection for the Commission to consider.
The Commission is comprehensively reviewing its offering rules in light of changes in the operation of the markets, advances in technology and the acceleration in the pace of communications. In conducting its review, the Commission intends to solicit input and data from multiple sources, including small businesses, investor groups, the public-at-large and a new Advisory Committee on Small and Emerging Companies that the Commission is in the process of forming. Any rules the Commission proposes as a result of this review will be subject to a public comment period in advance of any rule changes being adopted.