Wednesday, March 23, 2011

House Legislation Raising the Regulation A Exemption Threshold Gains Favor Conditioned on Audited Financial Statements

Support is growing for House legislation designed to encourage small companies to access the capital markets by increasing the offering threshold for companies exempted from SEC registration under Regulation A from $5 million to $50 million. The SEC has the authority to raise this threshold but has not done so for almost two decades. The Small Company Capital Formation Act, sponsored by Rep. David Schweikert (R-AZ), would also require the SEC to re-examine the threshold every two years and report to Congress on decisions regarding the adjustment to the threshold.

Financial Services Committee Chairman Spencer Bachus (R-ALA) said that amending Regulation A to make it a viable channel for small business to access capital will result in economic growth and more jobs. Small business creates most of the new jobs in the country, he added, and also new and better products that are so necessary to keep a mature economy vibrant and competitive. Rep. Schweikert emphasized that taking a small company public is an important, but expensive process that requires millions in underwriting costs. Raising the Regulation A threshold to $50 million is one way to lower those costs and promote economic growth and job creation.

In testimony before the Committee, Grant Thornton applauded the Small Company Capital Formation Act as the beginning of a campaign to bring back the small IPO market. The bill does three things that are enormously beneficial for small companies, said GT. First, it will drive down costs for issuers by permitting the use of a simpler Offering Circular for the SEC’s review. Second, it opens up the Regulation A exemption to a size that will allow companies to list on the NYSE and NASDAQ and to avail themselves of the so-called Blue Sky exemption, thus avoiding very costly state-by-state filings. The current Reg A limit of $5 million is below NYSE and NASDAQ listing minimums.

Third, the legislation will allow issuers to gauge the viability of an offering by meeting with investors before incurring the significant costs of an offering. This testing-the-waters provision is important, said GT, because there has been a steady increase in IPOs that are postponed, withdrawn, priced below the low end of the IPO filing range or that have broken the IPO price within 30 days of the completion of the offering. These busted deals can be ruinous to small companies:

Currently, companies relying on the Regulation A exemption do not have to submit audited financial statements. GT endorsed enactment of the legislation conditioned on issuers filing audited financial statements with the SEC and distributing such statements to prospective investors and submitting their offering statements to the SEC electronically. GT’s support was also conditioned on periodic disclosures determined by the SEC mimicing those required of registered companies and the inclusion of so called “bad boy” provisions to disqualify from participation in this market those individuals or entities with a disciplinary or criminal history.

GT also suggested that Regulation A financings be done through a FINRA-registered firm out of a concern that a minority of unscrupulous investors will pitch adverse deal structures and that issuers may not understand the implications to the company or its shareholders. While this may be controlled for at the listed-company level by exchange rulemaking, it would not be controlled for in the over-the-counter market and requiring the use of a FINRA-registered firm might minimize abuse.

The draft legislation would permit, but not require, the SEC to impose additional conditions on such Regulation A offerings, including authorizing the Commission to: require the issuer to file audited financial statements, to require the issuer to submit the offering statement and related filings electronically, and to establish disqualification provisions based on the disciplinary history of the issuer or related parties. The legislation would also permit the SEC to impose additional unspecified periodic reporting requirements on companies which make use of the exemption.

While noting that the bill’s sponsor has attempted to include provisions designed to enhance investor protections associated with Regulation A offerings, Damon Silvers, Policy Director of the AFL-CIO, was concerned that the bill does not guarantee that these added protections would be imposed even as it requires that the exemption be expanded. Moreover, he does not believe that the advocates of this approach have provided sufficient evidence that the change is warranted or given adequate thought to the potential harm to investors that could result.