Today marked the first meeting of the SEC’s Advisory Committee on Small and Emerging Companies. The Committee’s is chartered to provide the Commission with advice on its rules, regulations, and policies, with regard to:
- capital raising by emerging privately held small businesses (“emerging companies”) and publicly traded companies with less than $250 million in public market capitalization (“smaller public companies”);
- trading in the securities of emerging companies and smaller public companies; and
- public reporting and corporate governance requirements of emerging companies and smaller public companies.
You can find more information about the Committee here. You can see the slides from the meeting here. You can also view the meeting Agenda here. The hearing will be posted online for viewing at a later date.
First let me admit that my lunch schedule was slightly different than the committee’s so I did miss a portion of the hearing but below is a short summary of the comments I heard as they relate to each of the key issues addressed at today’s hearing.
Issue #1: 12(g) Reporting Trigger. The first issue addressed was the 12(g) trigger that requires reporting from companies that have securities held of record by 500 or more persons and 10 million in total assets. There was a limited discussion of the numbers in the current rule and bills currently up for a vote in the House that would modify those numbers.
The committee focused on the “held of record” definition and its effect on how the 500 number is counted. Often non-reporting companies have more than 500 beneficial holders but less than 500 “held of record.” The securities are often held of record by institutions that then organize and moderate a secondary market with many more beneficial holders. A primary concern is protecting those beneficial investors and ensuring they receive accurate information related to their investment in the company.
A topic of significant discussion regarding this issue concerned Employee Stock Option Plans and the effect this Rule has on companies considering implementing such plans. ESOPS can easily lead a company to hit the 500 held of record number and this regulation has forced many companies to move to RSU’s which can create tax issues. More importantly, while options are generally not considered in the count until they vest, those options do vest if the company decides to terminate the plan.
Community banks were also considered on an individual basis given currently pending legislation that would provide a limited exemption for these entities. Access to capital is particularly important in this context because banks operate based on leveraging each dollar invested.
Another concern that seems highly likely to be addressed in the Committee’s recommendations is that of companies who hit the 12(g) trigger then go dark. A company forced to report under 12(g) can cease filing reports if its number of holders of record drops below 300. This leads to the situation of an investor investing in a reporting company and then finding his investment tied up in a company that no longer reports.
Issue #2: Scaling of Regulations. The second issue focused on the regulations for smaller companies going public and whether those regulations served as a deterrent that prevented companies from actually going public.
The committee provided some interesting numbers regarding this issue. First, many smaller companies spend 3-4 million per year in attorney, accountant, and audit fees for compliance. One example provided was that of a 50 million dollar company with 3 million in EBITDA that needs additional capital to grow but could not afford to go public due to compliance costs.
The committee spent some time discussing the sharp decline in IPO’s and corresponding increase in M&A activity among smaller companies as an alternative. There were varying viewpoints offered on this subject. One argument was that the M&A process offered a more efficient alternative for VC’s to exit the company. Another argument was the burden of regulation limited emerging companies’ ability to go public which allowed larger companies to sit back and wait until they could acquire the company on favorable terms.
A view shared by many of the participants on this issue was that while the goal used to be to grow a company to the point of a successful IPO, now most companies could find no benefit to going public due to the burden of regulation. As one participant put it, those that could afford to go public won’t and those that need to go public can’t.
Issue #3: Capital Raising Strategies. The discussion on this issue focused on two specific topics, Regulation A and Crowd Funding.
Regarding Reg A, the general consensus was that this method of raising capital had earned a largely negative connotation. Additional complaints were that the 5 million dollar limit was much too low to make it of much use. Most of the participants favored revamping the regulation with a new name, higher offering limit, and minimizing the disclosure and verification requirements.
Regarding Crowd Funding, the participants spent a significant amount of time discussing an issue they viewed as largely beneath the SEC. The point is that the amounts involved are so low that there is likely to be high participation among the public that will invariably lead to abuse. The participants expressed the view that regulating this level of funding was not worth dragging the SEC’s name through the mud when that inevitable abuse occurs.
An interesting note on this topic was the idea of regulating the websites and groups putting together the Crowd Funding as opposed to the company actually receiving the funding. This would effectively shift the research and investigative function outside of the company much like a mini investment bank underwriting an IPO.
Issue #4: General Solicitation. This topic was designed to discuss whether the Commission should relax the prohibition against General Solicitation under Rule 502. The common refrain was that so long as the recipient was an accredited investor there seemed to be no logical reason to distinguish how that recipient received the solicitation.
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