In a letter to Senate Banking Committee Chair Tim Johnson (D-SD)and Ranking Member Richard Shelby (R-AL), Sec Chair Mary Schapiro said that the Jumpstart Our Business Startups (JOBS) Act, HR 3606, passed by the House would weaken investor protections by, for example, exempting emerging growth companies from the internal control auditor attestation provisions of Section 404(b) of Sarbanes-Oxley. The SEC Chair firmly believes in the protections of 404(b) and that the provision has significantly improved the quality of financial reporting and, thus, believes this change is unwarranted. She asked that the Senate add this and a number of other investor protections to the legislation. The House passed HR 3606 by a vote of 390-23
In the letter, she also noted that SEC rulemaking mandated by HR 3606 is simply not achievable within the indicated time limits. For example, the rulemaking implementing the crowdfunding provisions must be completed 180 days. Chairman Schapiro suggested that a deadline of 18 months would be more appropriate for regulations of this magnitude.
The crowdfunding piece of HR 3606 needs additional safeguards to protect investors from those who seek to engage in fraudulent activities. Without adequate protection of investors, posited the Chair, confidence in crowdfunding would be significantly undermined. The SEC Chair urged the Senate to better protect crowdfunding investors by providing oversight of the industry professionals that intermediate and facilitate these offerings.
With SEC oversight, she noted, the intermediaries could be critical gatekeepers, running background checks and facilitating adequate disclosure by small businesses. In her view, SEC oversight would enhance investor protections by requiring intermediaries to protect investors and issuers and by requiring funds and securities to be held at an independent bank or brokerage firm.
H.R. 3606 exempts emerging growth companies from any regulations promulgated by the Public Company Accounting Oversight Board that would require mandatory audit firm rotation, thereby allowing them to avoid the unnecessary costs of changing from an auditor familiar with the company to one that is not. Currently, the PCAOB has set out a concept release on mandatory auditor rotation as a means of enhancing the independence of outside auditors. The PCAOB has not proposed any regulations on mandatory auditor rotation. In addition, the JOBS Act would provide that any auditing standards adopted by the PCAOB after enactment would not apply to emerging growth companies unless the SEC finds that the application of such rules to emerging growth companies is necessary or appropriate after it considers investor protection, efficiency, competition, and capital formation.
The Act also would provide emerging growth companies with the same extended compliance period for new or revised accounting standards issued by the Financial Accounting Standards Board (FASB) that are currently available to private companies, if such new or revised standards apply to companies that are not issuers.
According to Chairman Schapiro, these provisions would restrict the independence of accounting and auditing standard setting by the FASB and the PCAOB and undermine independent standard setting by these expert Boards. Moreover, both the FASB and PCAOB are already authorized to consider different approaches for different classes of issuers if they find that this is appropriate.
The Chair asks that the $1 billion annual threshold for status as an emerging growth company under HR 3606 be lowered so as to pose less risk to investors and more appropriately focus the benefits provided by the IPO on ramp provisions on smaller businesses that are engines of growth. In addition, HR 3606 would weaken investor protections around the relationship between research analysts and investment bankers working at the same firm, said the Chair, as well as the treatment of research reports prepared by underwriters of IPOs.
HR 3606 would also overturn SRO rules establishing mandatory quiet periods designed to prevent banks from using conflicted research to reward insiders for selecting the bank as an underwriter. Also, for the first time, the legislation would allow research reports in connection with an IPO by an emerging growth company to be published before, during and after the IPO by the underwriter without any such reports being subject to the protections or accountability that currently apply to offering prospectuses. Essentially, reasoned Chairman Schapiro, research reports prepared by underwriters in emerging growth company IPOs would compete with prospectuses for investor attention; and investors would not have the full protections of the securities laws if misled by the research reports.
The SEC Chair also said that a provision in HR 3606 allowing emerging growth companies to submit their confidential statements in draft form for SEC staff review would reduce transparency and also hamper the staff’s ability to provide effective reviews. The staff benefits from the insight the public provides on IPO filings. It could also require significant resources for the staff review of offerings that companies are not willing to make public and then abandon before making a public filing. She noted that the SEC staff recently limited the general practice of allowing foreign issuers to submit IPO registrations in nonpublic draft form because of these concerns. Expanding that program to all IPOs could adversely impact the IPO review program.
The Chair said that the test the waters provisions of HR 3606 could bring real value by allowing offering materials to be provided to accredited investors and qualified institutional buyers before the availability of a prospectus, adding that the SEC already allows some test the waters activities. But unlike the existing test the waters provisions, she continued, HR 3606 would not require companies to file with the SEC and take responsibility for the materials they used to solicit investor interest, even after they file for their IPOs.
This would result in uneven information for investors who see both the test the waters materials and the prospectus compared to those who only see the prospectus. Also, it could result in investors focusing their attention on the test the waters materials instead of on the prospectus, without important investor protections being applied to those materials.
Currently, HR 3606 requires only limited disclosure about the business that the investors are funding. The Chair urges the Senate to mandate the disclosure of additional information, such as a description of the business or the business plan, financial information, a summary of risks facing the business, a discussion of the voting rights of the stock being offered, and ongoing updates on the status of the business.