The full House Financial Services Committee has approved by voice vote and sent to the House floor two pieces of legislation increasing the number of investors permitted to hold shares in either a company or a community bank before the organization is required to register with the SEC or “go public.” Currently, both banks and private companies are subject to a 500 investor threshold, which limits the amount of capital they can raise before they must comply with the reporting requirements associated with SEC registration. Both pieces of legislation would modify Section 12(g) of the Securities Exchange Act.
The Private Company Flexibility and Growth Act (H.R. 2167), sponsored by Rep. David Schweikert (R-AZ), increases the number of shareholders that can invest in a private company from 500 to 1,000. It also exempts employees from that count. H.R. 1965, sponsored by Rep. Jim Himes (D-Conn), increases the number of shareholders permitted to invest in a community bank from 500 to 2,000. HR 1965 updates the federal securities laws to ensure that smaller community banks are not required to register with the SEC and comply with burdensome reporting requirements that are intended for larger corporations.
HR 2167 would amend Section 12(g) of the Exchange Act to trigger SEC reporting at 1000 shareholders held of record and the definition of held of record would not include securities 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.
As introduced, the Private Company Flexibility and Growth Act would have exempted accredited investors from the held of record shareholder count as well as employees. But accredited investors were stripped from the legislation during an earlier subcommittee markup pursuant to an amendment introduced by Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee. The amendment was approved by voice vote and left undisturbed by the full Committee.
An amendment offered by Rep. Schweikert raising the trigger from 1000 to 2000 shareholders was withdrawn at the request of Committee Chair Spencer Bachus (R-ALA), who said that passage of the amendment could destroy the carefully constructed bi-partisan support that HR 2167 currently enjoys. Rep. Himes noted that the threshold could be set at 2000 shareholders in his legislation because HR 1965 deals with heavily regulated financial institutions.
HR 2167 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 received the securities pursuant to employee compensation plans in exempt transactions. Rep. Melvin Watt (D-NC) questioned whether the ``can’’ should be changed to ``must’’ in the legislative language, meaning an issuer qualifying for the safe harbor would be required to use it, and there seemed to be general agreement in the Committee that it should be changed to ``must’’ before HR 2967 reaches the House floor
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 recent 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.
But Chairman Schapiro observed that the securities markets have changed significantly since the enactment of Section 12(g). Also, since the definition of “held of record” was put into place, a fundamental shift has occurred in how securities are held in the United States. Today, the vast majority of securities of public companies are held in nominee or street name. This means that brokers that purchase securities on behalf of investors typically are listed as the holders of record. One broker may own a large position in a company on behalf of thousands of beneficial owners, she noted, but since the shares are all held in street name they are counted as being owned by one holder of record.
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.