Tuesday, January 13, 2015

House to Bring Up Dodd-Frank Corrections Bill Under a Rule

The House, having failed to pass bipartisan legislation containing a number of Dodd-Frank corrections and job creation measures on a fast track, is bringing the Promoting Job Creation and Reducing Small Business Burdens Act, H.R. 37, under a rule this week. The measure contains a number of Dodd-Frank Act corrections, as well as corrections and enhancements to the JOBS Act. The bill was brought up under a suspension of the rules last week, which meant that it had to pass by a 2/3 super majority. While 35 Democrats did vote for the bill, the final vote of 276 to 146 came up short of the two-thirds needed to pass it,

Registration of Thrifts. Title III of the Act is the Holding Company Registration Threshold Equalization Act, which amends the JOBS Act to extend shareholder thresholds for SEC registration and deregistration to savings and loan institutions. The measure corrects the inadvertent omission of thrifts from the new shareholder thresholds contained in the JOBS Act and thereby effects congressional intent.

Currently, JOBS Act Sec. 601 raises the number of shareholders permitted to invest in a community bank before triggering SEC reporting and registration from 499 to 1999. It also requires termination of a security registration in the case of a bank or bank holding company if the number of holders of a class of security drops below 1200. The bill would extend these shareholder thresholds to savings and loan associations.

Representative Ann Wagner (R-Mo.), a co-sponsor of the legislation, noted that these JOBS Act provisions lift outdated burdens off small lenders and help increase capital raising. She noted that many community banks have already taken advantage of the new shareholder threshold provisions. Thrifts were intended to be included in the new thresholds, Rep. Wagner said, because they are regulated like banks and are subject to the same reporting requirements.

Brokers in Mergers. Title IV of the Act is the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, which amends the Exchange Act to reform and to scale the regulation of M&A brokers. Representative Bill Huizenga (R-Mich.), sponsor of the measure, noted that current federal law treats the sale of a small, privately held business as if it were a Wall Street investment firm selling securities of a public company. The legislation establishes a streamlined and commonsense approach that allows for the sale of small- and mid-size businesses while maintaining the necessary safeguards.

The legislation provides for a notice-filing registration procedure for brokers performing services in connection with the transfer of ownership of smaller privately held companies and provides for regulation appropriate to the limited scope of the activities of such brokers. H.R. 2274 is designed to scale federal regulation of securities broker-dealers with respect to privately negotiated business sales, mergers, and acquisitions.

At a hearing last year on capital formation conducted by the House Capital Markets Subcommittee, Rep. Huizenga noted that an SEC working group studied this issue, but the SEC has not moved with recommendations. Thus, Rep. Huizenga concluded that a legislative tool is needed.

Specifically, the measure would add a new subsection to Exchange Act Sec. 15, which governs broker-dealer registration, to reduce the regulatory costs incurred by sellers and buyers of small- and mid-sized privately held companies for professional business brokerage services, while enhancing their protection through well defined, appropriately scaled, and cost-effective federal securities regulation. The legislation would direct the SEC to create a simplified system of registration through a public notice filing, publicly available on the SEC’s website, and would require appropriate client disclosures pertaining to M&A brokers and their associates. The legislation would also direct the SEC to tailor its rules governing M&A brokers in light of the limited scope of their activities, the nature of privately negotiated M&A transactions, and the active involvement of buyers and sellers in those transactions.

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 an associated person were subject to suspension or revocation of registration, a statutory disqualification, or a disqualification under SEC rules pursuant to the Dodd-Frank Act.

Remove international barrier to swap data reporting. Title V of the Act is the Swap Data Repository and Clearinghouse Indemnification Correction Act. As a condition of obtaining access to swap data repositories, Dodd-Frank required foreign regulators to indemnify repositories and the CFTC and SEC for any litigation expenses that may arise from sharing information. This requirement would be removed by this provision.

The bill was necessary because according to a joint CFTC-SEC report, international entities objected to the indemnification requirement and were unwilling to register or recognize swap data repositories without access to data.

According to Rep. Gwen Moore (D-Wis), the bill was non-controversial and the SEC has said outright that it supports the bill. In addition, three of five CFTC commissioners support the bill, she said.

Exempt interaffiliate swaps. Title II of the bill would exempt interaffiliate swap transactions from the Dodd-Frank Act’s margin, clearing, and reporting requirements. Interaffiliate swaps are swaps executed between entities under common corporate ownership.

According to Rep. Steve Stivers (R-Ohio), the federal government shouldn’t penalize businesses for how they choose to do business. Rules on interaffiliate swaps don’t consider increased costs on business. Interaffiliate swaps are simply an accounting method used to assign transactions and centralize and aggregate risk. They don’t create systemic risk, he said.

Emerging Growth Companies. Title VI of the Act is the Improving Access to Capital for Emerging Growth Companies Act. This was a bi-partisan piece of legislation introduced by Rep. Stephen Fincher (R-Tenn.) and Rep. John Delaney (D-Md.) in the 113th Congress that would build on and expand the JOBS Act of 2012 by making improvements to the IPO process for emerging growth companies. It would reduce the number of days that emerging growth companies must have a confidential registration statement on file with the SEC from 21 days to 15 days before they can conduct a road show. It would also allow a one-year grace period for an issuer that began the IPO process as an emerging growth company to complete its IPO as an emerging growth company.

Representative Fincher described the reforms as simple, technical improvements to the JOBS Act that improve the IPO process and allow emerging growth companies to continue growing and providing jobs. He noted that more than 200 companies have registered with the SEC as emerging growth companies since the passage of the JOBS Act in April 2012. The JOBS Act established the emerging growth company category in Title I. At the one-year anniversary of the JOBS Act, he noted, a study by Ernst & Young showed that approximately 78 percent of all publicly filed IPO registration statements and approximately 83 percent of the IPOs that went effective since April 2012 were filed by emerging growth companies (see Cong. Record, November 22, 2013, p. E1756).

During the mark-up, Rep. Delaney said that the bill creates a more streamlined IPO process without sacrificing investor protection. He added that for an emerging growth company doing an IPO is a difficult moment, which can be costly, time consuming, and cumbersome. But, at the same time, said Rep. Delaney, investor protection is at its highest during the IPO process. The SEC does a full review of the filing, he noted, and this is when the audit firms establish all the important accounting policies for the company and the underwriters conduct due diligence. In addition, most of the offerings are usually sold to institutional investors, who engage in significant diligence.

With respect to an emerging growth company, the measure directs that within 30 days of enactment, the SEC must revise its general instructions on Form S-1 to indicate that a registration statement filed or submitted for confidential review by an issuer prior to an initial public offering may omit financial information for historical periods otherwise required by Reg. S-X as of the time of filing or confidential submission of the registration statement, provided that the omitted financial information relates to a historical period that the issuer reasonably believes will not be required to be included in the Form S-1 at the time of the contemplated offering. Another proviso is that prior to the issuer distributing a preliminary prospectus to investors, the registration statement is amended to include all financial information required by Regulation S-X at the date of the amendment.

XBRL relief. Title VII of the Act is the Small Company Disclosure Simplification Act, which would exempt smaller public companies from requirements relating to the use of Extensible Business Reporting Language (XBRL) for periodic reporting to the SEC. The measure was introduced by Rep. Robert Hurt (R-Va.), who believes that the legislation would streamline regulations for small public companies and remove a disincentive for companies to access capital in the public markets.

Public companies are required to provide their financial statements in an interactive data format using XBRL. XBRL tags certain data points in issuers’ reports and exports them in a standardized format. XBRL is reported in a unique computing language, one that requires specific expertise outside the bounds of traditional financial or accounting training.

Representative Hurt noted that a glaring example of a regulation where costs currently outweigh potential benefits is related to the use of XBRL. The bill offers a commonsense solution to this problem, ensuring that regulations are not hampering the success of smaller companies. Currently, he continued, in order to comply with the XBRL regulation, small companies must expend tens of thousands of dollars on average. However, evidence suggests that less than 10 percent of investors actually use XBRL.

In line with the JOBS Act, the measure would remove duplicative regulations for small companies from submitting interactive data filings with XBRL. Public companies would still be required to file mandatory information with the SEC.

The legislation would create a two-tier exemption from reporting in XBRL for smaller public companies. First, emerging-growth companies would be exempt from using XBRL for financial statements and other periodic reporting required by the SEC, although such companies can elect to use XBRL. Second, an exemption from reporting in XBRL is provided for other smaller companies, specifically those with total gross revenue under $250 million. These companies can also elect to use XBRL. But, the bill provides that the exemption for companies with revenue below $250 million must continue in effect for five years after enactment or two years after an SEC determination that the benefits of using XBRL reporting outweigh the costs to the company.

In making this determination, the SEC must use an analysis spelled out in the legislation. The analysis must include an assessment by the Commission of how such costs and benefits may differ from the costs and benefits identified by the SEC in the order relating to interactive data to improve financial reporting of January 30, 2009, 74 F.R. 6776, because of the size of such companies. The analysis must also assess the effects on efficiency, competition, capital formation, and financing, as well as on analyst coverage of such issuers, including any such effects resulting from the use of XBRL by investors.

The analysis must further include the cost to the company of submitting data to the SEC in XBRL, posting it on the company’s website in XBRL, as well as the cost of the software to do all this. The analysis must then assess the benefits of XBRL to the SEC in terms of the improved ability to monitor the securities markets and to assess the potential outcomes of regulatory alternatives. Importantly, the SEC analysis must also assess the effectiveness of U.S. standards for interactive filing data relative to the standards of international counterparts.

The legislation requires the SEC to submit a report to Congress, within one year, on the progress in implementing XBRL reporting and the use of XBRL data by SEC officials and by investors.

Volcker Rule relief. Title VIII of the Act is the Restoring Proven Financing for American Employers Act, which would clarify that nothing in the Volcker Rule should be construed to require the divestiture, prior to July 21, 2017, of any debt securities of collateralized loan obligations (CLOs), if such debt securities were issued before January 31, 2014. Introduced by Rep. Andy Barr (R-Ky.), the measure amend the Volcker Rule to exclude certain debt securities of CLOs from the prohibition against acquiring or retaining an ownership interest in a hedge fund or private equity fund.

Rep. Barr said that the legacy debt securities of CLOs must be protected from the medicine that the Volcker Rule prescribes. In his view, this medicine would be far more damaging to the credit markets than the perceived illness of suffering losses from CLO paper. Congress must grandfather existing CLO investments.

The legislation would also clarify that a financial institution would not be considered to have an ownership interest in a CLO if there is no indicia of ownership other than the right of the firm to fire or remove for cause, or to participate in the selection or removal of, a general partner, managing member, member of the board of directors, investment manager, investment adviser, or commodity trading advisor of the fund provided that the CLO is predominantly backed by loans.

The measure also provides that an investment manager or investment adviser must be deemed to be removed for cause if the manager or adviser is removed as a result of a breach of a material term of the management or advisory agreement or the agreement governing the CLO; the inability of the investment manager or adviser to continue to perform its contractual obligations; or any other action or inaction by the investment manager or investment adviser that has, or could reasonably be expected to have, a materially adverse effect on the CLO if the manager or adviser fails to cure or take reasonable steps to cure such effect within a reasonable time.

The legislation represents a bipartisan compromise that balances the goal of preserving a proven financing mechanism with concerns against watering down the Volcker Rule.

According to Rep. Murphy, the Volcker Rule is not intended to capture debt. Debt is an everyday tool of plain vanilla financial institutions. The Volcker Rule is about equity ownership. Congress does not want banks owning hedge funds and private equity funds, but still wants lending. The legislation would provide narrow relief to existing CLO securities as long as they qualify as debt under the bill. For CLOs that are not debt securities under the bill, banks will get an additional two years to divest, which will prevent a disruptive fire sale of these securities.

Rep. Murphy added that the legislation also clarifies that the right to vote to remove a CLO manager in traditional, creditor-protective circumstances, such as a material breach of contract, does not, by itself, convert a debt security into an equity security under the Volcker Rule. (Cong. Record, Apr 29, 2013, pH3258).

Relief for advisers to venture capital funds. Title IX of the Act is the SBIC Advisers Relief Act, H.R. 4200, introduced by Rep. Blaine Luetkemeyer (R-Mo), would would amend the Investment Advisers Act to reduce unnecessary regulatory costs and eliminate duplicative regulation of investment advisers to small business investment companies. Specifically, the measure would allow advisers to venture capital funds to continue to be exempt reporting advisers if they also advise a small business investment company fund. The measure would also prevent the inclusion of the assets of a small business investment company fund in the SEC registration calculation of assets under management for those advisers that advise private funds in addition to small business investment company funds.

Currently, an adviser to a venture capital fund is exempt from SEC registration and an adviser to a small business investment company is exempt from registration. But, an adviser to both a venture capital fund and a small business investment company is not exempt. The legislation would exempt from SEC registration an investment adviser that advises both a venture capital fund and a small business investment company. A co-sponsor of the measure, Rep. Carolyn Maloney (D-NY), said that the measure restores the access of small businesses to broad investment advice and capital without compromising investor protection.

Simplifying Form 10-K. Title X of the Act is the Disclosure Modernization and Simplification Act, introduced by Rep. Scott Garrett (R-NJ), chair of the Capital Markets Subcommittee, which would direct the SEC to permit issuers to submit, on Form 10-K annual reports, a summary page to make annual disclosures easier to understand for current and prospective investors. Chairman Garrett noted that the summary page would have cross-references to the annual report to aid investors in navigating what can be lengthy annual reports. The bill would also direct the SEC, within 180 days of enactment, to tailor Regulation S-K’s disclosure rules as they apply to emerging growth companies and smaller issuers and to eliminate other duplicative, outdated, or unnecessary disclosure rules as they apply to these smaller issuers. It would also direct the SEC to identify and implement additional reforms to Reg. S-K to simplify and modernize SEC disclosure rules. The measure would require the SEC to consult with the Investor Advisory Committee when studying Regulation S-K.

Encouraging employee stock ownership. Title XI of the Act is the Encouraging Employee Ownership Act, introduced by Rep. Randy Hultgren (R-Ill.), which would amend SEC Rule 701, originally adopted in 1988 under Sec. 3(b) of the Securities Act and last updated in 1998. Under current law, if an issuer sells, in the aggregate, more than $5 million of securities in any consecutive 12-month period, the issuer is required to provide additional disclosures to investors, such as risk factors, the plans under which offerings are made, and certain financial statements. The legislation would require the SEC to increase that threshold to $20 million. Rep. Hultgren noted that support for this effort to expand the utility of Rule 701 can be found in the SEC’s Government-Business Forum on Small Business Capital Formation Final Reports for 2001, 2004-2005 and 2013.

The legislation aims to encourage the idea of letting employees own a stake in company they are part of. Ownership is a great incentive, noted the sponsor. Rule 701 mandates disclosure. The SEC arbitrarily set the threshold at $5 million, noted Rep. Hultgren. It is costly to prepare disclosures just so a company can offer stock to employees, said Rep. Hultgren. The bill, in addition to raising the threshold from 5 to 20 years, would also adjust it for inflation every five years.

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