The SEC Advisory Committee on Small and Emerging Companies (the “Committee”) met to review the Final Report of the Committee. The report included recommendations for future areas of focus including (i) capital raising by “emerging privately held small businesses and publicly traded companies with less than $250 million in public market capitalization,” (ii) trading securities of these companies, and (iii) public reporting and corporate governance requirements for them. The Committee also reviewed the auditor attestation report under Section 404(b) of the Sarbanes-Oxley Act and the registration exemption under Securities Act Rule 701.
The Committee recommended that the SEC focus on facilitating exempt offerings for privately held small companies, asserting that legal costs and associated risks have made such offerings less attractive to broker-dealers, which in turn makes it difficult for small companies to find investors.
Specifically, the Committee noted that (i) non-registered entities are hesitant to take part in exempt offerings because there is significant uncertainty in the market about what activities require broker-dealer registration under the current definition of “broker” and (ii) companies seeking to comply with the rules find it difficult to determine when they can engage a “finder” or online platform that is not registered as a broker-dealer. As a remedy, the Committee encouraged the SEC to provide regulatory clarity in this area and to create a less burdensome avenue for small businesses to engage potential investors.
The Committee also proposed that the SEC should revisit the definition of “accredited investor” under Rule 506 of Regulation D, and to avoid raising the threshold to qualify as an accredited investor. The Committee supported potential revisions that would take into account the “sophistication” of investors, but cautioned against revisions on the basis of net worth or income.
With respect to reporting and corporate governance requirements, the Committee urged the SEC to finalize a rule that would expand the number of small businesses that qualify for “scaled disclosure requirements.” The Committee explained that, since the implementation of the JOBS Act, 87% of initial public offerings (“IPOs”) have qualified as emerging growth companies (“EGCs”) (companies with less than $1,070,000,0000 in gross revenue during its most recently completed fiscal year), and that IPOs have declined significantly in recent years. This decline was described as being a result of the high costs of compliance and disclosure requirements that impose undue burdens on small companies. The Committee expressed support for the rule that would allow smaller reporting companies to qualify for the same disclosure and reporting requirements as EGCs. Furthermore, the Committee suggested amendments to the “accelerated filer” definition to exempt certain smaller companies from Section 404(b) auditor attestation requirements.
The meeting also included a presentation by executives from Orrick and Warby Parker regarding amendments to Securities Act Rule 701. The executives recommended (i) removal of the “hard cap limit” that restricts the value of securities sold in reliance on Rule 701, (ii) increase of the “soft cap limit” from $5 million to at least $10 million, and (iii) exclusion of material amendments from calculation of either limit. The executives asserted that equity compensation is a crucial aspect of facilitating success for small businesses, and said that it can be “critical to recruit talent” for companies that are not able to offer competitive cash compensation.
Finally, the Committee made recommendations for facilitating secondary market liquidity through preemption of certain state registration requirements, continued monitoring of the tick-size pilot program and less strict listing requirements for smaller companies.
This was the final meeting of the current Committee, as the two-year term expires on September 24, 2017.
Lofchie Comment: New SEC Chair Clayton has pledged to focus on improving the ability of companies to raise money in the public markets at a reasonable cost. This is an important change to the persistent governmental mindset of “ever more regulation.” After almost a decade of regulatory explosion that has shaped the norms and expectations of government behavior, any real reduction in regulation seems extraordinary.
One aspect of the recommendations was odd: the notion that it is not clear who must register as a “broker.” Under the law, it’s actually pretty clear: just about anyone who touches a securities transaction must register as a broker. Legal clarity isn’t really the issue; the issue is whether there should be a real exemption from registration for private placement brokers or else a form of much lighter registration/regulation that looks more like the regulatory scheme that applies to investment advisers (which may not be light, but it is much lighter than the broker-dealer scheme).