The Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies (Committee) met on June 3 to discuss various topics including (1) SEC rules with respect to intrastate crowdfunding; (2) the effectiveness of the current public company disclosure regime; (3) rules and market structure matters relevant to venture exchanges; and (4) the SEC’s treatment of “finders” who facilitate capital raising for small companies. The Committee also provided a written recommendation to the SEC to formalize the so-called “Section 4(a)(1½)” exemption from registration under the Securities Act of 1933 (1933 Act).
Crowdfunding and Rule 147
In her opening remarks at the meeting, SEC Chair Mary Jo White emphasized her priority to complete the crowdfunding rulemaking required under the Jumpstart Our Business Startups Act (JOBS Act) this year. Chair White noted that more than 20 states have enacted some form of intrastate crowdfunding (i.e., crowdfunding solely within one state) legislation or rules. While there currently are safe harbors from 1933 Act registration applicable to intrastate crowdfunding, Chair White acknowledged that rules such as Rule 147 (which provides a safe harbor for offerings conducted solely within one state) and Rule 504 (which provides an exemption for sales of securities up to $1,000,000) could benefit from modernization. Indeed, with respect to Rule 147, Chair White remarked that “how an issuer might conduct an intrastate offering using the internet was not contemplated” at the time of adoption.
Regarding Rule 147 and the need for modernization, the Committee discussed the challenges issuers face in complying with Rule 147, including with respect to its “80 percent rule” (which requires that 80 percent of an issuer’s (1) gross revenues be derived from, (2) assets be located in, and (3) net proceeds of the offering be used within, the issuer’s state of operation). Michael Pieciak, who serves as the North American Securities Administrators Association observer on the Committee, noted that, with online based businesses and customers, it is increasingly difficult to abide by Rule 147, and even to make the necessary calculations. The Committee adopted a recommendation that the SEC modernize Rule 147.
Public Company Disclosure Effectiveness
The Committee discussed the SEC’s “Disclosure Effectiveness” agenda. Karen Garnett, associate director of the SEC’s Division of Corporation Finance (Division), noted that the Division is focused on three main areas of improvement: (1) Regulation S-K, (2) Regulation S-X and (3) the manner in which companies provide information, including EDGAR. Ms. Garnett highlighted a speech given by the Division’s director, Keith Higgins, that provides background on the SEC’s Disclosure Effectiveness agenda, which was previously discussed in the Corporate and Financial Weekly Digest edition of October 10, 2014.
The Committee heard from various industry members with respect to the disclosure regime. Common concerns of those present included the cost and volume (and value of certain disclosure requirements) of the current disclosure regime, particularly for smaller companies. Redundancy within the disclosure regime was also discussed. While Ms. Garnett expressed the SEC’s understanding and concern for the cost burdens of the disclosure regime on registrants, she emphasized the need to balance those concerns with the Division’s commitment to the continued improvement of information available to investors.
Rules and Market Structure Matters Relevant to Venture Exchanges
The Committee continued the discussion from its March 4, 2015 meeting on secondary market trading, particularly through venture exchanges (see the Corporate and Financial Weekly Digest edition of March 6, 2015). David Shillman, the associate director of the SEC’s Division of Trading & Markets, noted in his remarks that the real issue with venture exchanges is the difficulty in creating a viable market, largely because of the difficulty in attracting liquidity providers to the market. Shillman indicated the ongoing challenge for the SEC with respect to venture exchanges will be to create rules and trading venues that attract liquidity providers (e.g., by restricting competition among venues in order to promote and aggregate liquidity in small-cap securities) without reducing competition to the point that there is a risk for abuse by liquidity providers with monopoly power within the exchanges.
SEC’s Treatment of “Finders”
The Committee also discussed issues with respect to finders––those individuals who connect businesses with capital, for a fee, but do not register as broker-dealers. Gregory C. Yadley, a member of the Committee, noted that the underlying issue is that small and growing companies are in constant need of raising capital (and in need of assistance in being connected with sources of capital), but many fully registered broker-dealers are uninterested in assisting with micro and small offerings. Yadley noted that finders could fill that gap, but under the current disclosure regime, the finders would be operating in violation of federal and state securities laws. Yadley further noted that the SEC has taken meaningful action to address the issue of unregistered intermediaries in private company mergers and acquisitions transactions. Specifically, in a 2014 “No-Action” letter the SEC specified that it would not recommend enforcement action if an “M&A Broker” engages in certain activities in connection with the purchase or sale of privately held companies without registering as a broker-dealer (see the Corporate and Financial Weekly Digest edition of February 7, 2014). There appeared to be general agreement of the Committee members that the SEC should also take action to legitimize finders in the capital raising context, through some combination of exemptions and rules, but the Committee decided to table any formal recommendation until they could review the issue further.
Recommendation to Formalize Rule 4(a)(1½)
The Committee recommended that the SEC formalize the ‘Section 4(a)(1½)’ exemption to mimic existing opinion practice for resales of privately-issued securities by shareholders who are not able to rely on Securities Act Rule 144. In making its recommendation, the Committee noted that there are many situations in which selling shareholders are unable to rely on the Rule 144 safe harbor (which allows selling shareholders to sell privately-issued securities subject to the conditions of the rule). When the conditions of Rule 144 are not met, shareholders often rely on the so-called Section 4(a)(1½) exemption, which is not currently codified in law or formalized under SEC rules (but rather has developed through case law and legal opinion practice). The Section 4(a)(1½) exemption incorporates elements of the exemptions available under Securities Act Section 4(a)(1) for persons other than an issuer, underwriter or dealer, and Section 4(a)(2) for transactions by an issuer not involved in a public offering. The Committee recommended that the SEC formalize the Section 4(a)(1½) exemption under SEC rules.
The video of the meeting in its entirety can be found on the Committee’s website.