SEC Chair Instructs Staff to Revisit Regulations Regarding Small Business Capital Formation

By Cydney Posner

Friday's issue of The Wall Street Journal  has a report on the SEC's plans to take a fresh look at ways to reduce the regulatory burden on private companies and small business capital formation efforts.

The author reports that the SEC is " moving toward easing decades-old constraints on share issues by private companies, in a sweeping review that could remake the way American start-ups raise capital." The revisions contemplated are disclosed in a letter from SEC Chair Mary Schapiro to Rep. Darrell Issa, House Oversight Committee Chairman. Thanks to John McKenna, Partner, Cooley LLP, you too can read the letter. 

Among the areas being revisited are the following:

• Restrictions on communications in IPOs;
• Whether the ban on general solicitation should be revised in light of current technologies, recent trends in capital-raising and the SEC's mandate to protect investors;
• The 500-shareholder trigger for Exchange Act reporting, including the use of special purpose vehicles; and
• The regulatory questions implicated in new capital-raising strategies.

The WSJ speculates that the "move could potentially delay or derail IPOs by tech companies that want to grow but would rather avoid having to disclose vast amounts of information. It could also shut out many ordinary investors from one of the fastest-growing market sectors, since shares in private companies are generally available only to investors whose individual net worth is at least $1 million. And at a time when investors are seeking more market transparency, it would lessen the amount of publicly available data about those companies."

Many of the current rules date back to 1964, and Rep. Issa had expressed concerns that the current rules discourage private investment. The WSJ notes that, while the SEC is considering raising the 500-shareholder trigger, it's unclear by how much. According to the article, the American Bankers Association has lobbied for an increase in the limit to 2,000. The Schapiro letter also suggests that there may be changes in the use of "record ownership" as the means to calculate the number of holders. Her letter discusses the changes related to street name ownership since the 500-person trigger was initially adopted, noting that the manner of counting is a factor in the number of companies' "going dark." One possibility might be that the SEC would take another look at the 2006 recommendations of its Advisory Committee on Smaller Public Companies.  You might recall that that Committee recommended that the SEC amend its rules under the Exchange Act to interpret "held of record" to mean beneficial holders and, after completion of a study, that the SEC then determine whether the intent of Section 12(g) would be better served by changing the number of shareholders that trigger Exchange Act reporting from 500 to some other number. (Note that the preliminary recommendations had suggested raising the number to 1,000.) The Committee also recommended that the SEC exclude from the count of securityholders holders of unexercised options issued in compensatory transactions.

The Wall Street Journal notes the "review comes as the SEC investigates whether there are abuses in the electronic market for shares in companies such as Facebook. The concern is that technology-company insiders could be trading in the private market using information unavailable to outside investors. The SEC has sent subpoenas to a number of tech companies seeking information on how their shares are traded, people familiar with the matter say." In that regard, Schapiro notes that the staff is monitoring secondary trading of private company shares using various online trading platforms. She also indicates that the SEC will examine issues raised by the use of "special purpose vehicles" to allow a group of shareholders to buy a stake in a private company, while counting as only one shareholder for the purposes of the SEC rules. This practice has come under criticism recently as an effort at circumvention of the rules and raises a number of policy issues for the SEC, including how SPVs should be counted and issuer involvement. The staff is also looking at the use of "crowdfunding," the pooling of funds by small contributors to support a particular effort, such as a film. In looking at a possible exemption for this type of activity, she raises the potential fraud concerns that developed in connection with Rule 504.

The SEC also is contemplating loosening the prohibition on general solicitation. You might recall that Goldman Sachs withdrew its offer of shares in Facebook to its U.S. clients, citing concerns about whether the level of publicity could have violated the prohibition. Interestingly, the letter notes that "[a]t no point in time did the staff advise or instruct Facebook or Goldman Sachs that the offering could not be conducted in the United States." Instead, Schapiro points out that the staff has recently focused attention instead on whether participating investors were solicited through the general solicitation or whether they were otherwise previously known to the issuer. The Advisory Committee had also recommended that the SEC adopt a new private offering exemption from the registration requirements of the Securities Act that does not prohibit general solicitation and advertising for transactions with purchasers who do not need all the protections of the Securities Act's registration requirements. Additionally, it recommended that the SEC relax prohibitions against general solicitation and advertising found in Rule 502(c) under the Securities Act to parallel the "test the waters" model of Rule 254 under that Act.