Senators Charles Schumer (D-N.Y.) and Pat Toomey (R-Pa.) have introduced groundbreaking legislation, S 1933, making it easier for small and medium-sized companies to access capital through public markets so they can expand and create jobs. The legislation, co-sponsored by Senators Mark Warner (D-Va.) and Mike Crapo (R-Idaho), would create an on-ramp to public markets for a new category of issuers, called emerging growth companies that have less than $1 billion in annual revenues at the time they register with the SEC and less than $700 million in publicly-traded shares after the IPO. The legislation creates a transitional on-ramp status for these companies to encourage them to go public. The on-ramp period would last as many as five years, or until a company reaches $1 billion in annual revenue or $700 million in publicly-traded shares. Full compliance with certain obligations would be phased in during that period. On-ramp status is designed to be temporary and transitional, encouraging small and medium-sized companies to go public but ensuring they transition to full compliance over time or as they grow.
The scaled regulations are limited to those areas of compliance that are high cost and which do not compromise core investor protections or disclosures, and all of them build on existing scaled regulations. For example, the legislation would only require emerging growth companies to provide audited financial statements to the SEC for the two years before registration, rather than three years. Full compliance would be phased in each year so a full five years of audited financials are required after three years.
The legislation would also exempt emerging growth companies from the requirement to hold a shareholder advisory vote on executive compensation arrangements, including golden parachutes. The SEC already recognized the additional burden these requirements impose on small issuers by giving them an additional year to comply with the new rules. Because the shareholder advisory vote is required once every three years, the measure effectively only exempts companies from a maximum of two such votes. Furthermore, shareholders in venture-backed companies are likely to be well-protected as a result of the terms negotiated by venture capital investors and the fact that founders and senior executives are often large shareholders themselves, ensuring interests are aligned.
To increase visibility for emerging growth companies while maintaining transparency and consistency for investors, the measure would improve the flow of information about emerging growth companies to investors before and after an IPO. The bill would update restrictions on communications to account for advances in modes of communication and the information available to investors. In particular, the bill would close the information gap for smaller companies and allow emerging growth companies to test the waters before filing a registration statement.
Existing rules allow research on large companies to be provided continuously, but prohibit investment banks participating in the underwriting process from publishing research on emerging growth companies. The legislation would allow investors to have access to research reports about emerging growth companies prior to the IPO. However, the measure would maintain other extensive protections in this area, such as Sarbanes Oxley Section 501, which addresses potential conflicts of interest that can arise when analysts recommend equity securities, SEC Regulation AC, the Global Research Analyst Settlement and disclosure requirements regarding potential conflicts of interest. These changes would address the current information shortfall by providing a way for investors to obtain research about IPO candidates in a manner consistent with investor protection.
The legislation would permit emerging growth companies to gauge preliminary interest in a potential offering by expanding the range of permissible pre-filing communications to institutional investors, and filing a registration statement with the SEC on a confidential basis, which non-U.S. companies are currently permitted to do. This would help emerging growth companies determine the likelihood of a successful IPO, but general solicitation would still be prohibited, as would any expanded communications to retail investors. Anti-fraud provisions of the securities laws would still apply, and a prospectus would still be required prior to any sale.