On Wednesday, March 7, 2012, the House is scheduled to begin consideration H.R. 3606, the Reopening American Capital Markets to Emerging Growth Companies Act of 2011, under a rule.  The rule would provide for one hour of debate equally divided and controlled by the chair and ranking minority member of the Committee on Financial Services.  Additionally, the rule makes in order and provides ten minutes of debate for each of the seventeen amendments (summarized below) printed in the Rules Committee report accompanying H.Res. 572, in addition to providing for one motion to recommit with or without instructions.  The bill was introduced by Rep. Steven Fincher (R-TN) on December 8, 2011, and referred to the Committee on Financial Services.  On February 16, 2012, a mark-up was held and the bill was ordered to be reported by a recorded vote of 54-1.

The bill is a legislative package of bipartisan measures that would increase capital formation, spur the growth of startups and small businesses and enable more small-scale businesses to enter public markets.  A section-by-section breakdown is as follows:

TITLE I—REOPENING AMERICAN CAPITAL MARKETS TO EMERGING GROWTH COMPANIES 

This section would amend the Securities Act of 1933 (SA) and the Securities Exchange Act of 1934 (SEA) to define "emerging growth company" (EGC) as an issuer with total annual gross revenues of less than $1 billion during its most recently completed fiscal year.

The bill would also amend SEA and the Dodd-Frank Act of 2010 to exempt EGCs from the requirement for separate shareholder approval of executive compensation, including golden parachute compensation.

Additionally, EGCs would be exempted from Section 404(b) of the Sarbanes-Oxley Act (P.L. 107-204) for a longer transition period—up to five years—instead of the current transition period of two years.  To ensure sufficient investor protections, management would be required to establish and maintain internal controls over financial reporting, as mandated by Sarbanes-Oxley Section 404(a), and comply with Sarbanes-Oxley’s requirement that the company’s chief executive officer and chief financial officer certify the company’s financial statements. 

The bill would also amend SA to state that an EGC need not present more than two years of audited financial statements in order for its registration statement, with respect to an initial public offering of its common equity securities, to be effective. 

The bill would also prohibit the mandatory rotation of an EGC’s audit firm to avoid the unnecessary costs of changing from an auditor familiar with the company to one that is not, and would amend the Sarbanes-Oxley Act to exempt a registered public accounting firm that prepares or issues a report on its audit of an emerging growth company from the requirement that it attest to, and report on, any assessment of internal controls the company's management has made.

H.R. 3606 would give EGCs the opportunity to “opt-in” to certain regulations by complying with them before they lose EGC status.  However, if the Financial Accounting Standards Board adopts new accounting standards while a company is an EGC, the EGC would be required to comply with either all or none of the new standards while it remains an EGC.

The bill would improve the flow of information about EGCs to investors by removing restrictions on communications between companies, research analysts, and investors.  (Existing Securities Exchange Commission (SEC) rules prohibit investment banks that underwrite a company’s IPO from publishing research on companies that would be classified as EGCs.)  The bill would allow investors to obtain research reports about an EGC before or at the same time as its IPO.  However, the bill would maintain other protections in this area, such as Sarbanes-Oxley Section 501, that address potential conflicts of interest that can arise when analysts recommend equity securities.

Lastly, the bill would amend SA to authorize an emerging growth company, before its initial public offering date, to submit to the SEC a draft registration statement for confidential nonpublic review by SEC staff before the public filing, provided that the initial confidential submission and all amendments to it are publicly filed with the SEC within 21 days before the issuer conducts a "road show."  However, the bill would declare that the SEC shall not be compelled to disclose such information.  (A "road show" is an industry term referring to an offer that contains a presentation regarding an offering by one or more members of the issuer's management and includes discussion of the issuer, its management, and/or the securities being offered.)

TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS

This section would amend the SA and direct the SEC to eliminate the restriction under Regulation D Section 506 prohibiting the solicitation or advertising of an equity offering by certain issuers.

The bill would require the SEC to establish rules to ensure that only “accredited” investors purchase such securities.

TITLE III—ENTREPRENEUR ACCESS TO CAPITAL 

This section would amend the SA to establish an exemption from the requirement that certain securities be registered with the SEC.  Specifically, the bill would exempt securities from registration requirements if:

• The aggregate amount raised through the issuance is $1 million or less each year ($2 million or less if the issuer provides investors with certain financial information); and
• Each individual who invests in the securities does not invest, in any year, more than the lesser of $10,000 or 10 percent of the investor’s annual income.

In order to qualify for this exemption, the bill would also require issuers or intermediaries acting between issuers and investors to provide certain information and risk disclosures to investors, such as warnings of the speculative nature generally applicable to investments in startups, emerging businesses, and small issuers.  The bill would also require issuers or intermediaries to provide information about the issuer and offering to the SEC, in addition to providing continuous investor-level access to the intermediary's website and maintaining such books and records as the SEC deems appropriate.

Additionally, the bill would require the SEC to develop regulations to implement this new authority and to set out actions that would disqualify certain individuals from issuing securities under the exemption.

TITLE IV—SMALL COMPANY CAPITAL FORMATION 

This section would amend the SA to direct the SEC to exempt from its regulation a class of securities for which the aggregate offering amount is between $5 million and $50 million, subject to specified terms and conditions.

The bill would authorize the SEC to:

1. Require an issuer of such exempted class of securities to make periodic disclosures available to investors regarding the issuer, its business operations, its financial condition, and its use of investor funds; and
2. Provide for the suspension and termination of such a requirement with respect to that issuer.

Additionally, the bill would require the SEC to:

1. Review and increase biennially such offering amount limitation, as appropriate; and
2. Report to certain congressional committees on its reasons for not increasing the amount if it determines not to do so.

TITLE V—PRIVATE COMPANY FLEXIBILITY AND GROWTH

This section would raise the threshold for mandatory registration under the SEA to change the thresholds for total assets and for class of equity security holders of record which trigger the requirement for a securities issuer to register with the SEC.  Specifically, the bill would increase the total assets threshold from $1 million to $10 million, and the class of equity security holders of record threshold from 500 to 1,000 persons.

The bill would also exclude securities held by shareholders who received such securities under employee compensation plans from the 1,000 shareholder threshold.

TITLE VI—CAPITAL EXPANSION

This section would amend the SEA to increase the number of shareholders permitted to invest in a community bank from 500 to 2,000.

This package of legislation intended to improve small businesses’ access to capital.  Specifically, many pieces of the legislation would improve capital formation by expanding equity financing options.  The alternative method, debt financing, is prohibitively difficult in light of tightened lending standards following the financial crisis of 2008-09.  Equity financing can fill that void if we modernize outdated regulations that do not work in 21^st Century capital markets.  Capital formation is necessary for business expansion and therefore job creation and sustained economic growth. 

According to the Office of the Majority Leader, “The JOBS Act represents an opportunity for both parties to work together and deliver results on areas of common ground that boost small businesses, startups, and entrepreneurs. These measures have broad bipartisan support from Congress, President Obama, and successful entrepreneurs like Steve Case, the former Chair and Founder of AOL and a member of the President’s Council on Jobs and Economic Competitiveness.”

Background on Title I

This bill seeks to promote American job creation and further economic growth by making it easier for more companies to access capital markets through the creation of a new category of issuer known as an “Emerging Growth Company” (EGC).  An EGC would lose its status at the end of five years, or earlier, if it reaches $1 billion in annual gross revenue, or becomes a “large accelerated filer,” which is a company with over $700 million in public float.  The bill adapts the SEC’s scaled regulations for smaller companies by more slowly phasing in those regulations that impose high costs on issuers, without compromising core investor protections or disclosures.

Background on Title II

Under current law, securities may be sold through private offerings, that is, sales that are made to a limited number of eligible investors rather than to the general public, without being registered with the Securities and Exchange Commission (SEC).  Issuers of securities through such offerings are prohibited from using general solicitation or advertising to market the securities.  According to the Committee on Financial Services, this prohibition on general solicitation and advertising has been interpreted to mean that potential investors must have an existing relationship with the company before they can be notified that unregistered securities are available for purchase. Requiring potential investors to have an existing relationship with the company significantly limits the pool of potential investors and severely hampers the ability of small companies to raise capital and create jobs.

Thus, by eliminating the ban on solicitations and advertisements by issuers and broker-dealers, H.R. 2940 would also enable offline and online forums that bring together investors with companies that need funding to play an increasingly important role in facilitating capital investment in small companies.

At a legislative hearing on H.R. 2940 held by the Subcommittee on Capital Markets and Government Sponsored Enterprises on September 21, 2011, Barry Silbert, Chief Executive Officer of SecondMarket, Inc., testified that "if only accredited investors are eligible to purchase unregistered securities, shouldn't we strive to maximize the pool of accredited investors that have access to the offering?”  Mr. Silbert also noted that the SEC and Congress "recognize that sophisticated, accredited individual and institutional investors have greater capacity for risk and do not require the enhanced protections provided to the average retail investor."

This bill, introduced by Rep. Kevin McCarthy (R-CA), was approved by the House on November 3, 2011, by a vote of 413-11.

Background on Title III

According to the Committee on Financial Services, “crowdfunding” is an increasingly popular method of capital formation, where, according to SEC Chairman Mary Schapiro, "groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal."  Current SEC regulations impede this innovative and lower-risk form of financing, by prohibiting general solicitation and advertisements for non-registered offerings and capping the number of shareholders for non-registered companies at 500.  This bill would remove SEC restrictions that prevent “crowdfunding” so entrepreneurs can raise equity capital from a large pool of small investors who may or may not be considered “accredited” by the SEC.

This bill, introduced by Rep. Patrick McHenry (R-NC), was approved by the House on November 3, 2011, by a vote of 407-17.

Background on Title IV

Under Section 3 of the Securities Act of 1933, the SEC is authorized to exempt small securities offerings from registration.  Pursuant to Section 3, the SEC promulgated Regulation A, which exempts public offerings of less than $5 million in any 12-month period.  Initially, Congress authorized the SEC to set the Section 3 threshold at $100,000.  The limit has been raised multiple times, and in 1992 the SEC set the threshold at $5 million.

According to the House Committee on Financial Services, “Since the SEC set the Regulation A threshold at $5 million in 1992, issuers and market participants have pointed out that the offering threshold has been too low to justify the costs of going public under Regulation A.”  Further, “inflation, which has risen approximately 165% since 1980, when Congress gave the SEC the authority to set the Regulation A offering threshold, has further exacerbated the imbalance between costs and benefits.”

Regulation A was used by companies only 78 times between 1995 and 2004.  It was used only 3 times in 2010.  As the Financial Services Committee notes, “The low number of Regulation A filings--each for the maximum amount of $5 million--demonstrates that a revision to Regulation A is necessary.”

H.R. 1070, the Small Company Capital Formation Act, is intended to increase the use of Regulation A offerings and help make capital available to small companies.  The bill would raise the offering threshold for companies exempted from registration with the SEC under Regulation A from $5 million – the threshold set in the early 1990s – to $50 million.  The bill also provides the SEC with the authority to increase the threshold and requires the SEC to re-examine the threshold every two years and report to Congress on its decisions regarding adjustment of the threshold.

Amending Regulation A would grant small companies access to capital and permit greater investment in these companies – which will foster economic growth and job creation.

This bill, introduced by Rep. Dave Schweikert (R-AZ), was approved by the House on November 2, 2011, by a vote of 421-1.

Background on Title V

Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires issuers to register equity securities with the SEC if those securities are held by 500 or more record holders and the company has total assets of more than $10 million.   SEC Chairman Schapiro has explained that Section 12(g) was enacted to improve investor protection by extending to the larger companies in the over-the-counter market the same requirements that apply to companies listed on an exchange.  After a company registers with the SEC under Section 12(g), it must comply with all of the Exchange Act’s reporting requirements

Section 12(g) has exacerbated the conditions small for small- and mid-cap companies to stay private longer either by choice or market reality—the inability to raise capital on public markets has led to a greater dependence on private equity financing.  Under the current 500 shareholder limitation, however, each new round of financing from private equity or other investors adds more shareholders, leaving fewer shares for employees, and ultimately prompting the decision of whether to go public. 

H.R. 2167 is premised on the idea that section 12(g) forces companies go public prematurely if they are facing SEC registration anyway, or to remain private and restrict shareholders, which ultimately can leave small- and mid-cap companies at a strategic disadvantage.

This bill, introduced by Rep. Dave Schweikert (R-AZ), was ordered to be reported by the Committee on Financial Services on October 26, 2011, by a voice vote.

Background on Title VI

This bill, introduced by Rep. Ben Quayle (R-AZ), would enable banks to better deploy their capital to make loans and create jobs rather than comply with burdensome SEC requirements.

The Congressional Budget Office (CBO) estimates that implementing Title I of H.R. 3606 would require 40 additional SEC staff positions to handle new review and enforcement activities that would result from changes under the bill, which would cost about $50 million over the 2012-2017 period, assuming appropriation of the necessary amounts.

CBO previously scored sections II-V (H.R. 2940, H.R. 2930, H.R. 1070, and H.R. 2167) of this legislation and notes that as “H.R. 3606 incorporates provisions similar to those bills, and the CBO cost estimates for similar provisions are the same.”

Amendment No. 1—Rep. Fincher (R-TN): (Manager’s amendment) This amendment would make technical and conforming changes to the underlying bill.

Amendment No. 2—Rep. McIntyre (D-NC): This amendment would adjust the “emerging growth company” definition for inflation.

Amendment No. 3—Reps. Himes (D-CT) and Capuano (D-MA): This amendment would lower the gross annual revenue cap from $1,000,000,000 to $750,000,000 for “emerging growth companies” to remain eligible for the regulatory on-ramp and strike the public float requirement for the on-ramp.

Amendment No. 4—Rep. Jackson-Lee (D-TX): This amendment would add a requirement that a company not be considered an “emerging growth company” if it has issued more than $1 billion in non-convertible debt over the prior three years.

Amendment No. 5—Reps. Ellison (D-MN) and Capuano (D-MA): This amendment would require “emerging growth companies” to fully comply with say-on-pay and golden parachute shareholder votes.

Amendment No. 6—Reps. Waters (D-CA) and Capuano (D-MA): This amendment would require that if a broker or dealer is underwriting an initial public offering (IPO) for an “emerging growth company” (EGC) and providing research to the public about such IPO, the reports shall be filed with the SEC.  The amendment would also require EGCs communicating with potential investors before or following an offering to file those communications with the SEC.

Amendment No. 7—Rep. Jackson-Lee (D-TX): This amendment would strike language that allows an emerging growth company or its underwriter to communicate with “institutions that are accredited investors.”

Amendment No. 8—Rep. Jackson-Lee (D-TX): This amendment would establish a new filing fee for Reg S-K forms.

Amendment No. 9—Rep. Connolly (D-VA): This amendment would require the SEC to perform a study, in consultation with the Commodities Futures Trading Commission, of the effects on emerging growth companies of financial speculation on domestic oil and gasoline prices.

Amendment No. 10—Rep. McCarthy (R-CA): This amendment would clarify that general advertising under this provision should only apply to Regulation D rule 506 offerings, allow for general solicitation in the secondary sale of these securities provided that qualified institutional buyers purchase the securities, and provide consistency in interpretation that general advertising should not cause these offerings to be considered public offerings.

Amendment No. 11—Rep. McHenry (R-NC): This amendment would, for Rule 506 of Regulation D, provide an exemption from registration as a broker or dealer for trading platforms that do not charge a fee in connection with the purchase or sale of the security or permit general solicitations, general advertisements, or similar or related activities by issuers of such securities.  The amendment would also enable the marketing of private shares to accredited investors through platforms.

Amendment No. 12—Reps. Miller (D-NC) and Schweikert (R-AZ): This amendment would increase the total number of investors and limit the number of non-accredited investors allowed to be holders of record before registration is required.

Amendment No. 13—Rep. Schweikert (R-AZ): This amendment would direct the SEC to study whether it has the authority to enforce anti-evasion provisions associated with the shareholder threshold.

Amendment No. 14—Rep. Capuano (D-MA): This amendment would require the SEC to conduct a study to address anti-evasion concerns and determine if the term "held of record" should mean beneficial owner of the security.

Amendment No. 15—Rep. Peters (D-MI): This amendment would require publicly traded companies to disclose on an annual basis the total number of employees they have in each country and the percentage increase or decrease in employment in each country.

Amendment No. 16—Rep. Capps (D-CA): This amendment would require the Securities and Exchange Commission to issue a report to the Congress one year after the date of enactment on the increase in initial public offerings resulting from the act, including specific increases in filings by manufacturing and high-technology companies.

Amendment No. 17—Rep. Loesback (D-IA): This amendment would require information to be made available online, and outreach to be conducted to small and medium-sized businesses, women-owned businesses, veteran-owned businesses, and minority-owned businesses to inform them about changes put in place by this legislation.