Growth Strategies

SEC’s Small Biz Proposals Criticized

Changes to a rule intended to help small private companies with financing could result in discouraged businesses, according to attorneys.
Sarah JohnsonSeptember 24, 2007

Participants in a Securities and Exchange Commission roundtable criticized proposed rule changes that the SEC claims would make it easier for small companies to raise capital.

Earlier this year, the SEC proposed adjustments to several rules under Regulation D, a 25-year-old guideline used to determine whether private offerings are exempt from SEC registration. Under the proposed changes, private issuers would be able to solicit sales of securities through limited advertising to so-called “large accredited investors,” who are considered sophisticated or wealthy enough not to need the SEC’s protection. Currently, all private offerings made through a general solicitation or widespread advertising are not eligible to receive the registration exemption.

The SEC has also cut in half a safe-harbor timeline that excludes concurrently offered securities from receiving the Regulation D exemption. According to the SEC, this rule was put in place so that companies could not split one offering that would not be entitled to the exemption into multiple offerings that would. The SEC has reduced the safe harbor from six months to 90 days. In addition, the commission has proposed making the form for these filings electronic and requiring additional disclosures from the companies that use it.

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While praising the ideas raised in the proposed changes, the participants in Monday’s annual SEC small-business forum took issue with how companies would be able to comply. For example, Marc Morgenstern, managing partner at Blue Mesa Partners, said similar terms in the rules could be easily misinterpreted and could have “very mischievous consequences.” In particular, he felt wording could be misconstrued by non-lawyers and went against the commission’s drive for using plain English in regulations and company disclosures. “I think the SEC is straying from its own mission,” he said.

Gregory Yadley, a partner at Shumaker Loop & Kendrick LLP, also wondered if the allowance for some written advertising for sophisticated investors was even feasible. Could it work for companies that are not well-established? And what would happen if it didn’t work? “In 30 to 40 days [of advertising], you could burn through a lot of cash and then would you go back to the humdrum, the accredited investors? Maybe not,” he said. “That’s a huge problem we need to deal with.”

Still, panelist Steven Bochner, a partner at Wilson Sonsini Goodrich & Rosati, praised the proposed exemption for securities sold to “large accredited investors” as a modest yet positive step. “Hopefully what it does is improve capital formation, improve efficiency, and allow the right kind of investors to more effectively get in contact with one another without impeding investor protection,” he said.

The SEC defines large accredited investors as individuals who own at least $2.5 million in investments or earn $400,000 in annual income. Organizations with assets equal to $10 million would fit in this category. Those considered simply “accredited investors” basically have half of those amounts.

The American Bar Association also voiced its opposition to portions of a related SEC proposal that makes changes to the form companies fill out to receive the Regulation D exemption. The commission has proposed making the form electronic and requiring companies to include their revenue range. However, according to the ABA, small, private companies will likely decide to opt out of including their revenue number, which could result in a “negative implication” against the issuer and hurt the integrity of the commission’s information-gathering.

Indeed, William Venema, an attorney for Epstein Becker Green Wickliff & Hall, told he predicts the changes to the form could deter small companies from using Regulation D altogether. He fears that by making it electronic, the forms could be made more accessible for the general public and the companies’ competitors. Currently, the paper forms are only available at the SEC’s headquarters. “A lot of private issuers could end up saying, ‘Whoa, I’m not going to let some competitor know how much money I’m raising,’” and decide to forgo getting the exemptions, he said. That result, he notes, would be the opposite of the regulation’s intent, which is to help smaller businesses with capital formation.

The SEC is collecting public comment on the Regulation D proposal until October 9 and stopped taking feedback for the corresponding form changes earlier this month. The SEC Advisory Committee on Smaller Public Companies had proposed similar changes in its report released last year.

Taking another suggestion from the committee, the SEC has also proposed exempting private companies from registering their compensatory employee stock options with the commission. During Monday’s roundtable, participants generally supported this proposal. Under current rules, companies with 500 or more employees, directors, and consultants who receive compensatory stock options have to register if they have more than $10 million in assets — even if they are a private company. To meet repeated requests by private issuers to update this rule, since 1992 the SEC has been sending no-action letters to those companies that met certain conditions and did not register the securities.

In its comment letter to the SEC, the ABA is asking the commission to pull back on some of the requirements in its proposal. “The extensive list of conditions . . . makes the proposed relief burdensome and, in some cases, unattainable as a practical matter,” wrote Keith Higgins, chairman of ABA’s Committee on Federal Regulation of Securities.