Wednesday, June 15, 2011

House Legislation Would Raise 500-Shareholder Threshold to 1000 and Exclude Accredited Investors

Legislation introduced in the House would raise the 500-shareholder threshold for an SEC reporting company to 1000 and exclude accredited investors and employees. The Private Company Flexibility and Growth Act, HR 2167, is a bi-partisan measure would amend Section 12(g) of the Exchange Act to trigger SEC reporting on 1000 shareholders held of record and the definition of `held of record' would not include securities held by persons who qualify as accredited investors or securities that are held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of section 5 of the Securities Act.

The legislation directs the SEC to revise the definition of ``held of record’’ pursuant to section 12(g)(5) of the Exchange Act to implement these changes. The Commission must also adopt safe harbor provisions that issuers can follow when determining whether holders of their securities are accredited investors or that holders of their securities received the securities pursuant to employee compensation plans in exempt transactions.

Enacted in 1964, Section 12(g) of the Exchange Act requires companies with more than $10 million in assets whose securities are held by more than 500 owners to file annual and other periodic reports with the SEC, which reports are then available to the public through the SEC's EDGAR database. While the $10 million threshold has been incrementally increased over the years from the $1 million level initially set in 1964, the 500 shareholder requirement has never been updated.

In prepared testimony before the House Oversight and Government Reform Committee, SEC Chair Schapiro noted that, shortly after the enactment of Section 12(g), the Commission adopted rules defining the terms held of record and total assets. The definition of “held of record” counts as holders of record only persons identified as owners on records of security holders maintained by the company in accordance with accepted practice. The Chair explained that the Commission used this definition to simplify the process of determining the applicability of Section 12(g) by allowing a company to look to the holders of its securities as shown on records maintained by it or on its behalf, such as records maintained by the company’s transfer agent.

The SEC Chair added that a staff review of the 500-shareholder test is front and center on the Commission’s agenda. Chairman Schapiro emphasized that the Commission is absolutely committed to seeing if the 500-shareholder limit still makes sense and intends to do a thorough and rigorous analysis of this threshold. In testimony she noted that the review will require the gathering of economic data and analysis because the SEC needs to understand the characteristics of these companies and how their shareholders hold, whether in record name or in the name of the beneficial owner.

In response to concerns from Rep. Pat Meehan (R-PA) about carving sweat equity out of the 500-shareholer count, Corporation Finance Director Meredith Cross noted that, pursuant to an SEC rule adopted in 2007, options granted to employees don’t count towards the 500 shareholder number. In addition, Corp Fin staff have provided relief so that restricted stock units provided to employees do not have to be counted towards the 500 shareholder trigger. The Director said that the review of the Section 12(g) 500 limit will consider the question of whether employees should be counted at all. The staff’s review will consider if 500 is the right number and is the counting being done correctly, that is, are the right people being included in the count

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