Thursday, February 16, 2012

House Panel Approves Bi-Partisan Legislation Creating On Ramp for Emerging Growth Companies

The House Financial Services Committee approved legislation seeking to promote job creation and further economic growth by making it easier for more companies to access capital markets by reducing the cost of going public for small and medium size companies. The Reopening American Capital Markets to Emerging Growth Companies Act, H.R. 3606, which passed by an overwhelming bi-partisan vote of 54-1 is sponsored by Rep. Stephen Fincher (R-TN) and John Carvey (D-DE). HR 3606 would create a new category of issuers, called emerging growth companies.

Under the Act, SEC regulations for emerging growth companies will be phased in over a period of five years or until the company becomes large enough to afford the regulatory costs traditionally associated with going public. This temporary reprieve from costly regulations will allow smaller companies to go public sooner in their life cycle. According to its sponsors, the legislation would apply scaled regulations for emerging growth companies without compromising core investor protections or disclosures.

The legislation creates a new category of issuers, called emerging growth companies, with annual revenues of less than $1 billion and following the initial public offering, less than $700 million in publicly traded shares. Exemptions for these on ramp status companies would end either after five years, or when the company reached $1 billion in revenue or $700 million in public float. The bill mirrors legislation introduced by a bipartisan group of U.S. Senators.

The measure also amends Section 404(b) of Sarbanes-Oxley to delay hiring an additional outside auditor to verify the company's internal controls for the five year on ramp period. In addition, the bill would only require emerging growth companies to provide audited financial statements for the two years prior to registration rather than three years, saving the companies millions.

The legislation would also make it easier for potential investors to get access to research and company information in advance of an IPO. This is critical for small and medium-sized companies trying to raise capital that have less visibility in the marketplace, said Rep. Fincher. Currently, there are regulations in place that make it difficult for investors to find the detailed research reports they need to make an informed decision about new companies.

Emerging growth companies would also be exempt from the requirement to hold a shareholder vote at least once every three years on executive compensation packages and golden parachutes. They are also exempt from the requirement to disclose the relationship between executive compensation and financial performance and the ratio of the CEO compensation to the median total compensation of all employees.

The Committee unanimously approved a Fincher-Carney Manager’s Amendment that made technical changes to the legislation and, in part, reflects discussions with the SEC and the FASB oversight body. Among other things, the amendment clarifies the definition of emerging growth company, makes the legislation prospective only, and makes accounting corrections.

An amendment offered by Rep. David Schweikert (R-AZ), and approved by the Committee, would direct the SEC to conduct a study examining the transition to trading and quoting securities in one penny increments, also known as decimalization. The study must examine the impact that decimalization has had on the number of initial public offerings since its implementation relative to the period before its implementation. The study must also examine the impact that this change has had on liquidity for small
and middle capitalization company securities and whether there is sufficient economic incentive to support trading operations in these securities in penny increments. Within 90 of enactment, the SEC must submit a report to Congress on the findings of the study.

The Schweikert Amendment also provides that if the Commission determines that the securities of emerging growth companies should be quoted and traded using a minimum increment of greater than $0.01, the Commission may by rule, not later than 180 days after the date of enactment, designate a minimum increment for the securities of emerging growth companies that is greater than $0.01 but less than $0.10 for use in all quoting and trading of securities in any exchange or other execution venue.

An amendment offered by Chairman Garrett, and approved by the Committee, directs the SEC to analyze the registration requirements of Regulation S-K and determine how they can be updated to modernize and simplify the registration process and reduce the costs for emerging growth companies. Within 180 days, the SEC must report on this review of Regulation S-K and recommend how the registration process can be streamlined to make it more efficient and less burdensome for emerging growth companies.

An amendment offered by Rep. Edward Royce (R-CA) raising the Section 404(b) exemption to companies with less than $1 billion market cap was withdrawn based on assurances from Committee leaders that there would be an opportunity to place the expanded exemption in another piece of legislation. Committee Vice Chairman Jeb Hensarling (R-TX) said that it is proper to reexamine the correct threshold for Section 404(b) compliance, but that this may not be the moment.

An amendment offered by Rep. Jim Himes (D-CT) that would have amended the definition of emerging growth company from a company with less than $1 billion in sales to one with $750 million or less was rejected. Another Himes amendment that would have directed the SEC to require disclosure of a symbol or some other kind of identifier so that investors could identify an emerging growth company was also rejected. Rep. Fincher said that such an identifier could serve to stigmatize an emerging growth company.

An amendment offered by Rep. Keith Ellison (D-MN) that would have deleted the emerging growth company exemption for shareholder advisory votes on executive compensation was also rejected. However, the Committee approved an Ellison Amendment that requires an emerging growth company that terminates its status as such to conduct a shareholder advisory vote on executive pay at the one year period beginning on the date the issuer is no longer an emerging growth company. In the case of an emerging growth company that had that status for less than two years after the first sale of common equity securities pursuant to a Securities Act registration statement, the shareholder advisory vote must be held on the three-year period beginning on such date. The Amendment deals with Rep. Ellison’s concern that, under the original bill, an emerging growth company could go eight years before conducting its first shareholder advisory vote on executive compensation.