SEC Chairman Mary L. Schapiro testified on the future of capital formation before the U.S. House of Representatives Committee on Oversight and Government Reform in a visit to Capitol Hill on May 10, 2011. Committee Chairman Darrell Issa (R-Cal.) had previously raised concerns to Chairman Schapiro about rules that he believes are restricting capital formation in the United States.
In her testimony, Chairman Schapiro recognized the need to facilitate access to investment capital, but at the same time satisfy the SEC’s obligation to protect investors and U.S. public markets. She has instructed the SEC staff to “take a fresh look at some of our offering rules to develop ideas for the Commission to consider that would reduce the regulatory burdens on small business capital formation in a manner consistent with investor protection.” Schapiro focused on two of the rules that Representative Issa finds at fault: the ban on general solicitation in connection with most private offerings; and the 500-shareholder threshold for public reporting requirements.
Under Section 4(2) of the Securities Act of 1933 and Regulation D, general solicitation and advertising is prohibited except in connection with Rule 504 offerings, which are limited in size. According to a report by The Deal Pipeline on May 11, 2011, the general solicitation ban has been criticized for years. Some argue that the ban is unnecessary because those who do not purchase a security are not harmed by a general solicitation. On the other hand, the ban may make it more difficult for “fraudsters to attract investors.” According to Chairman Schapiro, the SEC has to balance these considerations. Representative Issa went so far as to raise the question whether the ban violates the First Amendment. However, there does not appear to be any real support for that position.
Section 12(g) of the Securities Exchange Act of 1934 requires a company to register its securities, and thereby become a public reporting company, if at the end of its fiscal year the securities are “held of record” by 500 or more persons. Chairman Schapiro believes that both the threshold number and how holders of record are determined needs to be reviewed. She acknowledged that the securities markets have changed significantly since the threshold was established. It is not clear that 500 is a relevant number today or whether certain types of shareholders should be excluded. Also, the way shares are held today may result in inequitable treatment between public and private companies. Most public shares are held in street name, so a public company may actually have thousands of beneficial shareholders, but only a relatively small number of holders of record. On the other hand, private company shareholders hold shares directly and are all deemed to be holders of record. The public company could go “dark” if it has less than 500 holders of record, while the private company that hits the 500 threshold must begin public reporting.
Chairman Schapiro did note that the SEC has addressed the 500-shareholder threshold with regulatory relief in the past, including providing an exemption to the threshold for compensatory stock options in Rule 12h-1(f). According to an AP report on May 10, 2011, Representative Issa has asked the SEC to consider additionally exempting company employees who own stock from counting toward the threshold.
OUR TAKE: Capital formation is key to the economy. It is critical that the SEC and Congress recognize the impact of changing markets and practices in determining what rules and restrictions should reasonably be in place to protect the investing public and the integrity of our public markets. The reality is that many very large and successful companies are postponing or foregoing IPOs. The ability to facilitate capital raising by private companies, therefore, takes on even greater importance. The SEC’s review should result in proposals to modernize the rules while maintaining its investor-protection mission.