Tuesday, October 29, 2013

House Panel Holds Hearings on Bills to Reduce Impediments to Capital Formation; Possible JOBS Act II

The House Capital Markets Subcommittee held a hearing to examine seven pieces of legislation designed to eliminate impediments to capital formation. H.R. 1800, the Small Business Credit Availability Act, would amend Section 60 of the Investment Company Act to allow business development companies (BDCs) to purchase, acquire, and hold securities of or other interests in an investment advisers or advisors to investment companies and allow BDCs to issue more than one class of senior security which is a stock. H.R. 1800 would also amend Section 61(a) of the Investment Company Act to reduce the ratio of assets to debt from 200% to 150%. Finally, H.R. 1800 would direct the SEC to revise its rules and forms to allow business development companies to use the streamlined securities offering provisions available to other registrants under the Securities Acts. Among these revisions, H.R. 1800 directs the SEC to revise Rules 418 and 14a-101 under the Securities Acts, and Rule 103 under Regulation FD, which are not explicitly included in H.R. 31, the Next Steps for Credit Availability Act, introduced by Rep. Nydia Velazquez (D-NY), is substantially similar to H.R. 1800 except that it does not direct the SEC to revise Rules 418 and 14a-101 and Regulation FD Rule 103.

Introduced by Rep. Mick Mulvaney (R-SC), H.R. 1973, the Business Development Company Modernization Act would amend Section 2(a)(46)(B) and Section 60 of the Investment Company Act to allow BDCs to purchase, acquire, or hold securities or other interests in the business of registered investment advisers, advisors to investment companies, and other “eligible portfolio companies” as defined in the Investment Company Act, including certain financial services companies. On June 12, 2013, Joseph Ferraro of Prospect Capital testified that by eliminating outdated limitations, H.R. 1973 would bring small- to medium-sized financial services businesses into the family of “eligible assets,” thus removing an obstacle to their growth and increasing the flow of BDC dollars into these new and expanding U.S. businesses.

Gary Wunderlich, CEO of Wunderlich Securities, testifying        on behalf of the Securities Industry and Financial Markets Association said supports efforts to modernize regulation of Business Development Companies as contemplated in the three bills under discussion. Since their creation, BDCs have been subject to regulation under the Investment Company Act subjecting them to certain statutory safeguards covering such areas as diversification, leverage, compliance and valuation. The BDC structure was created to promote public vehicles as a means to bring capital to small and medium sized businesses and by regulation, noted Mr. Wunderlich, adding that 70% of BDCs investments must be in private or small cap companies.

The JOBs Act provided for an onramp for Emerging Growth Companies to access the IPO market and has also created a framework for crowdfunding to bring capital to early stage entrepreneurs in much smaller increments. But SIFMA believes that more can be done to promote the flow of capital to private companies that are big enough to need larger amounts of capital to reach the next stage of their development but are still
years away from an IPO. BDCs offer one such critical source of capital to eligible companies, said SIFMA.. BDC's have been active issuers in the last few years as they see opportunity to bring funds to attractive companies that are struggling to find capital at a reasonable cost from other sources.

SIFMA also believes that some incremental flexibility in the asset coverage ratio should be provided to BDCs to allow them to better fulfill their mission while at the same time maintaining sufficient safeguards to protect investors such as enhanced disclosure requirements, capital structure limitations, corporate governance and compliance requirements, affiliate transaction limitations and restrictions on leverage, all of which are applicable to BDCs by virtue of their being subject to compliance with the 1940 Act and which are incremental to the safeguards applicable to other public companies.

Introduced by Rep. Bill Huizenga (R-MI), H.R. 2274, the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, would amend Section 15(b) of the Securities Exchange Act to create a simplified SEC registration system for M&A brokers. Specifically, H.R. 2274 would allow M&A brokers to register with the SEC by filing an electronic notice which would be made publicly available on the SEC’s website. A properly completed electronic notice of registration would become effective immediately upon receipt by the SEC, except that SEC approval of such notice would be required if the M&A broker, or a person associated with the M&A broker, is subject to suspension or revocation of registration, a statutory disqualification, or a disqualification under SEC rules pursuant to the Dodd-Frank Act. H.R. 2274 would also require M&A brokers to make certain disclosures to clients as may be required by the SEC including, but not limited to, a description of the M&A broker and its affiliates, associated persons, fees, and any conflicts of interest.

In addition, H.R. 2274 would direct the SEC to tailor its rules governing M&A brokers by taking into account the nature of the transactions in which M&A brokers are involved, the involvement of the parties to such transactions, and the limited scope of the activities of M&A brokers. Under H.R. 2274, an M&A broker would be prohibited from receiving, holding, transferring, or having custody of client funds or securities in connection with the transfer of an eligible privately held company and would not to be able to engage on behalf of an issuer in a public securities offering. H.R. 2274 would require the SEC to work with the states to establish uniform and consistent standards of training, experience, competence, and other qualifications for M&A brokers, as well as to develop the form and content of the electronic notice of registration.

Arkansas Securities Commissioner Heath Abshure, speaking for the NASAA, said that state securities administrators generally support the targeted, well-balanced provisions of H.R. 2274, the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act.  This legislation would establish a simplified and streamlined registration process for broker-dealers engaged solely in the business of effecting the transfer or sale of privately held companies. NASAA is optimistic that this legislation will encourage registration and regulatory compliance by M&A brokers. The M&A industry has worked with NASAA in developing the proposal that is contained in H.R. 2274. The group welcomes its introduction and look forward to supporting the legislation in the 113th Congress.

Tom Quaadman, testifying for the Center for Capital Markets Competitiveness described H.R. 2274 as a common sense reform that should help entrepreneurs avail themselves of expert assistance in selling their business and realizing the full value of their enterprise, thereby providing further incentives for aspiring entrepreneurs to push forward with their ideas. By facilitating M&A activity, it would provide another source of capital for smaller companies.

Rep. Sean Duffy (R-WI) has circulated a discussion draft of legislation to amend Section 11A(c)(6) of the Exchange Act to provide for an optional pilot program administered by the SEC allowing certain Emerging Growth Companies (EGCs), a category of issuers recently established in Title I of the Jumpstart Our Business Startups (JOBS) Act with a stock price above $1.00 to increase the tick size at which their stocks are quoted and traded from $.01 to $.05, or, if the EGC’s board of directors so elects, $.10. The discussion draft would allow covered EGCs to change the tick size of their stock from $.05 to $.10 or from $.10 to $.05 one time during the pilot program, as it would also allow EGCs to opt out of the program.

The Capital Markets Center believes that the draft legislation proposed by Representative Duffy would help ensure a market structure that supports capital formation for all public companies. However, the Center asked that a provision be added to the bill providing safe harbor to insulate management and directors from liability in exercising the option to choose a tick size. Without such a safe harbor, reasoned the Center, companies may not avail themselves of the opportunity to participate in the pilot program and an opening to help smaller public companies may be lost.

 Rep. Robert Hurt (R-VA) has circulated a discussion draft to provide an optional exemption for EGCs and non-accelerated filers from SEC rules requiring registrants to file their financial statements in an interactive data format known as eXtensible Business Reporting Language (XBRL). The discussion draft would direct the SEC to revise its rules in accordance with the XBRL exemption.

Rep. Stephen Fincher (R-TN) has circulated a discussion draft of legislation to change registration requirements for EGCs. The discussion draft reduces from 21 to five the number of days that an EGC must have a confidential registration statement on file with the SEC before the EGC may conduct a road show. The discussion draft also clarifies that an issuer that had been an EGC when it filed its confidential registration statement but ceased to be an EGC before its initial public offering will be treated as an EGC through the date of its IPO. The discussion draft requires the SEC to revise its general instructions on Form S-1 to indicate that a registration statement filed (or submitted for confidential review) by an issuer before its IPO may omit financial information for historical periods otherwise required by regulation S–X. Finally, the discussion draft allows EGCs to submit a confidential draft registration statement to the SEC for any follow-on securities offerings after its IPO.

Describing as laudable Congressman Fincher’s discussion draft which would modify existing regulation of EGCs, Gary Wunderlich, CEO of Wunderlich Securities, testifying on behalf of the Securities Industry and Financial Markets Association said SIFMA supports of  each of the four provisions in the draft. Section 1 amends the Securities Act to reduce the quiet period requirements from 21 days to 5 days for public filing prior to public offerings by EGC’s. Currently, an EGC must file its registration statement publicly and must refrain from marketing the securities through its underwriters or otherwise for 21 days. SIFMA supports a significant reduction in the quiet period as contemplated in the bill
Sections 2 and 3 of the Discussion Draft add clarity and efficiency to two areas of securities regulation without impairing investor protection, testified SIFMA.  Section 2 provides a grace period for a change in status of an EGC by allowing an issuer that qualifies as an EGC at the time of the filing of its confidential registration statement for review to continue to be treated as an EGC through the date on which it consummates its initial public offering. Section 3 is designed to simplify the financial statement disclosure requirements for EGC’s. Currently an EGC must include the previous two years of audited financials when it files its registration statement for review. The last provision in the Fincher bill extends the ability for EGC’s to file a confidential registration statement not only for their initial public offering but also for a follow-on offering.