Friday, June 3, 2011

Small Company Capital Formation Act of 2011 – Much Needed but At What Cost?

There is a new bill in the House that aims to facilitate capital raising by private companies (H.R. 1070). The bill was introduced in March 2011 by Representative David Schweiker and is currently being considered by the House Committee on Financial Services.

The bill proposes to amend Section 3(b) of the Securities Act of 1933. Section 3(b) of the Act authorized the Securities and Exchange Commission (the “SEC”) to create Regulation A, an exemption for private companies to conduct public offerings of their securities in the amount not exceeding $5 million in a 12-month period. Companies relying on Regulation A need to file an offering statement with the SEC and get it approved. The securities are offered publicly, are not “restricted” (i.e., freely tradable), and solicitation and advertising (“testing the waters”) is allowed. Advantages of Regulation A (as opposed to the full-blown registration) include the following: simplified financial statements, which need not be audited, there are no Exchange Act reporting obligations after the offering is concluded unless the company has more than $10 million in total assets and more than 500 shareholders, and companies may file a simplified version of the offering statement. Disadvantages are: that the Regulation A offering is still very expensive in terms of legal and accounting costs, and such offerings are not exempt from state “blue sky” laws.

The new bill H.R. 1070 proposes to introduce an additional exemption under Section 3(b), allowing companies to raise between $5 million and $50 million. Similarly to the existing exemption for offerings under $5 million, the securities could be offered and sold publicly and would not be considered “restricted”. “Testing the waters” would be permitted. Companies would need to file with the SEC an offering statement. However, companies raising up to $50 million would be required to file audited financial statements with the SEC. The SEC could also require the company issuing such securities to make periodic disclosures available to the investors. According to the May 2nd amendment of the bill, such securities would not be exempt from state regulation unless offered through brokers and dealers.

The requirements for audited financial statements and the possibility of ongoing periodic disclosures make the exemption look more like an initial public offering. Continued state regulation may render it unpopular due to high compliance costs, just like the Regulation A offerings. But it is too early to judge, as the bill may be amended substantially before being voted on by both the House and the Senate.

Generally, if a bill is reported favorably by a committee to the House, it will be considered by the full House and then move to being considered in the Senate. However, most bills are never considered by the committees, and thus never move forward. Since its introduction in March 2011, bill H.R. 1070 was already reviewed by a subcommittee of the Committee on Financial Services and on May 4 was forwarded to the full Committee for consideration. Although only at the initial step in the legislative process, it already has 17 cosponsors (2 Democrats and 15 Republicans). It appears to be on the “fast track”, as the lack of access to capital is seen by many as a major impediment to growth in the U.S. economy.

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