A congressionally mandated budget report may ring the death knell for proposed legislation that would increase the leverage limit for business development companies (BDCs).
The April 10, 2014 report by the Congressional Budget Office (CBO) estimates that the Small Business Credit Availability Act, H.R. 1800, if enacted, would cost taxpayers $354 million over the next 10 years.
H.R. 1800, introduced in April 2013, would
- Reduce from 200 percent to 150 percent the asset coverage requirements that apply to BDCs;
- Allow BDCs to invest in shares of investment advisers to BDCs;
- Eliminate certain protections for holders of preferred stock issued by BDCs; and
- Amend certain SEC rules and forms to allow BDCs to use streamlined securities offerings provisions that are available to other public companies.
Click here for our summary of H.R. 1800 and the prospects for its enactment.
The loss of federal tax revenues would result from the differences in taxation of income to individuals. BDCs pass through income to their shareholders, so the income they generate typically is subject only to individual income tax. In contrast, taxable income from “C” corporations is subject to taxation at the corporate level and at the individual tax level. The report estimates that by shifting income from C corporations to BDCs, enacting the legislation would reduce federal tax revenues by $350 million between 2014 and 2024.
The Statutory Pay-As-You-Go Act of 2010 established budget reporting and enforcement procedures for legislation affecting direct federal spending or federal tax revenues. The CBO report could block the legislation, unless its sponsors propose alternatives that would make the bill revenue neutral.
In various speeches recently, SEC representatives have addressed the need for disclosure reform following the December 2013 release of the JOBS Act-mandated Regulation S-K study. The disclosure review will begin by considering the disclosures that flow into periodic reports. In addition, the Staff also will evaluate whether Industry Guides and form specific disclosures should be updated. In its analysis, the Staff will consider whether disclosure requirements should be scaled for smaller reporting companies and EGCs. Keith Higgins, director of the Division of Corporation Finance, outlined the process that would be undertaken by various teams across the Division to assess whether certain requirements are outdated, whether certain requirements result in redundant or duplicative disclosures, and whether the disclosure requirements might benefit from a principles-based approach. Regulation S-X will also be reviewed as part of this effort.
Higgins also commented on the Staff’s plan to consider how information is disclosed and whether documents could be made simpler and more user friendly through the introduction of hyperlinks or topical indices. The Staff also intends to consider whether to recommend a “company disclosure” or “core disclosure” approach by which a an issuer’s basic business description and other company information would be disclosed in a “core” document and supplemented through periodic filings.
In the absence of rule changes, Higgins noted that practitioners could improve disclosures by avoiding repetition, producing more tailored, less generic risk factors and other disclosures, and eliminating outdated information. In another series of public remarks, Higgins identified a number of areas that often lead to duplicative disclosures. For example, discussion of share-based compensation, verbatim repetition from the notes to the financial statements in the MD&A section of an issuer’s critical accounting policies, and the “follow the leader” phenomenon whereby issuers include disclosures made by other comparable companies in their own filings even if those disclosures may not be appropriate or as relevant.
See more at: http://www.sec.gov/News/Speech/Detail/Speech/1370541479332#.U1fIKVTD_zY and http://www.sec.gov/News/Speech/Detail/Speech/1370541190424#.U1fIRFTD_zY.
On April 10, 2014, the Investor Advisory Committee (the “IAC”) of the Securities and Exchange Commission (the “SEC”) held a meeting during which it recommended that the SEC adopt crowdfunding rules that are both consistent with the Dodd-Frank Act and commensurate with the risks inherent in allowing early stage start-up companies to sell securities based on limited information to unsophisticated, low net worth investors. The IAC specifically made six recommendations to strengthen the SEC’s proposed crowdfunding rules, addressing the following: (1) the amounts of money an investor can invest in crowdfunding offerings; (2) the enforcement mechanisms for investment limits; (3) the obligations of intermediaries and the ability to curate; (4) educational materials; (5) the definition of electronic delivery; and (6) offering integration.
For more information, see our client alert, “Recommendations of the SEC’s Investment Advisory Committee Regarding Crowdfunding Rules,” available at http://www.mofo.com/files/Uploads/Images/140422-SEC-Regarding-Crowdfunding-Rules.pdf.
On June 4, 2014, Morrison & Foerster partner David Lynn will chair a PLI conference entitled Global Capital Markets & the U.S. Securities Laws 2014: Raising Capital in an Evolving Regulatory Environment. This program will provide updates on domestic and international regulatory and market developments. Morrison & Foerster partner Marty Dunn is also participating in the conference and will be speaking on the panel titled “Hot Topics in Capital Markets.” For more information about the event, and to register, please click here.
The Jumpstart Our Business Startups Act (the “JOBS Act”), designed to stimulate IPO activity in the U.S. is celebrating its second anniversary this month at a time when U.S. IPO activity is at a high since 2000. While adoption of several of the JOBS Act accommodations are increasing, confidential submissions of IPO registration statements has had the most significant impact on how IPOs are being conducted, and perhaps even on the number of IPOs.
For more, see http://www.mofo.com/files/Uploads/Images/140422-A-Look-at-the-JOBS-Act-at-Its-Second-Anniversary.pdf
The SEC recently provided some data on registered offerings by foreign issuers, noting that
- In 2013, there were approximately 50 new foreign registrants;
- Since the passage of the JOBS Act, there have been over 100 foreign private issuers making confidential submissions to the SEC;
- Over half of these submissions resulted in public filings of registration statements;
- Approximately 50% of the draft submissions since the JOBS Act was adopted include financial statements prepared in accordance with IFRS.
Recently, Craig Lewis, the Chief Economist and Director of the SEC’s Division of Economic and Risk Analysis, commented (see speech at: http://www.sec.gov/News/Speech/Detail/Speech/1370541497283#.U08MNVTD_zY ) on the economic impact of various JOBS Act reforms, or the effects on “efficiency, competition, and capital formation” (ECCF).
In his remarks, Lewis notes that smaller companies may face informational frictions that may affect negatively their ability to raise capital. Of course, smaller companies now reach investors beyond those with whom they have a pre-existing relationship through use of general solicitation in certain Rule 506 offerings or by using matchmaking services that may rely on general solicitation to reach investors. In the future, smaller companies might be able to rely on Regulation A+ offerings to cast a wider net and conduct offerings that use general solicitation. Presumably, these approaches lessen the informational frictions. However, in practice, at conferences, presenters frequently note that companies that “need” to use general solicitation may be companies that are not appealing to venture or private equity funds. This would make it sound like using general solicitation is a last resort rather than a desired approach and suggests that there is some stigma, at least within certain communities, associated with communicating more broadly. It would be an unfortunate result to assume that companies are relegated to using general solicitation when they have run out of options or are unable to attract experienced investors. These perceptions in fact may counter all the rational conclusions that may be reached regarding lower search costs and lessened informational frictions.
Many companies may engage a placement agent or financial intermediary that has close relationships with institutional investors, but the companies may still find it appealing to engage in communications that may be construed as “general solicitation” in order to raise awareness about their businesses. Funds may choose to engage in a broader range of communications even if they continue to seek investments principally from high net worth individuals, family offices and institutional investors.
On April 10, 2014, the Division of Corporation Finance of the Securities and Exchange Commission (the “SEC”) issued one revised and two new compliance and disclosure interpretations (“C&DIs”) regarding crowdfunding and Rule 147 under the Securities Act of 1933, as amended (the “Securities Act”), which are summarized below. Section 3(a)(11) of the Securities Act (“Section 3(a)(11)”) provides an exemption from the registration requirements of the Securities Act for any security which is a part of an issue offered and sold only to persons who reside in a single state or territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such state or territory. Rule 147 under the Securities Act (“Rule 147”) provides a safe harbor for offerings conducted pursuant to Section 3(a)(11), which requires that the issuer must be a resident of, and doing business in, the same state in which all offers and sales are made, and the offering may not be offered or sold to non-residents.
Rule 147 does not prohibit general advertising or general solicitation (Question 141.03)
While this revised CD&I did not change substantively, the SEC Staff reiterated that Rule 147 does not prohibit general advertising or general solicitation. However, any general advertising or general solicitation must be conducted in a manner consistent with the requirement that offers made in reliance on the intrastate exemption under Section 3(a)(11) and Rule 147 be made only to persons resident in the state or territory of which the issuer is a resident.
Use of a third-party internet portal to promote an intrastate offering does not preclude reliance on Rule 147 (Question 141.04)
This CD&I notes that an issuer claiming an exemption under Rule 147 may use a third-party internet portal to promote an offering to residents of a single state in accordance with a state statute or regulation intended to enable crowdfunding within that state if the portal implements measures to ensure that offers of securities are made only to persons resident in the relevant state or territory. These measures must include, at a minimum:
- disclaimers and restrictive legends which make clear that the offering is limited to residents of the relevant state under applicable law; and
- limiting access to information about specific investment opportunities to persons who confirm they are residents of the relevant state (examples of an acceptable confirmation are a representation as to residence or in-state residence information, such as a zip code or residence address).
An issuer’s use of its own website or social media presence to offer securities would likely involve offers to residents outside the state, making the offering inconsistent with Rule 147 (Question 141.05)
This C&DI notes that issuers generally use their websites and social media presence to communicate in a broad and indiscriminate manner. Therefore, although the specific facts and circumstances would determine whether a particular communication is an offer of securities, using an established internet presence to issue information about specific investment opportunities would likely involve offers to residents outside the state in which the issuer does business.
On April 8, Commissioner Aguilar and Commissioner Stein spoke at the North American Securities Administrators Association conference.
Commissioner Aguilar noted in his remarks that “Regulation A-plus remains a work in progress, and no one can say what the ultimate outcome will be.” The Commissioner went on to note that a workable exemption would “attract issuers that might otherwise choose more opaque exemptions for their capital-raising needs.” Indeed, in Rule 506 offerings to accredited investors, there are no disclosure requirements, no investment limit, and no ongoing reporting obligations. The proposed Reg A+ framework provides enhanced investor protections that should mitigate any concerns; however, the debate regarding pre-emption continues.
Even with coordinated review, an issuer faced with a range of capital-raising alternatives, will not choose a Tier 2 offering if state review is necessary. Tier 2 offerings are unlikely to be “local” in nature. Statements of Policy applied by state regulators have not been updated in a meaningful way and are inconsistent with practices in “public” offerings.
A Tier 2 Reg A+ offering will have more in common with a public offering than with a private placement. Many states require that each investor in their state sign a subscription agreement. Of course, in a registered offering that clears and settles through DTC and is sold by a broker-dealer, individual subscription agreements generally are not used. A recent state review triggered comments from examiners inquiring about the rules of DTC, and requested more information about Cede & Co, DTC’s nominee, as well as about the “officers, directors and purpose/role of Cede & Co.” Presumably, Tier 2 Reg A+ offerings will clear through DTC. These are the just examples of speed bumps that do little to add to investor protection.
Having just marked the second anniversary of the JOBS Act, it seems that more regulatory change may be under consideration. We previously reported on various bills that were introduced in the House of Representatives to address parts of the existing JOBS Act framework. This week, the House Financial Services Committee will hold a hearing on a group of proposed bills that would take things one step farther by:
- Amending the definition of “non-accelerated filer”;
- Simplify the annual report on Form 10-K through the addition of a “summary” page;
- Mandate that the SEC simplify and modernize Regulation S-K’s disclosure requirements;
- Increase the dollar threshold for issuances under Rule 701;
- Revise the definition of “WKSI” so that more issuers benefit from the flexibility permitted to these issuers;
- Shorten the Rule 144 holding period;
- Amend Form S-1 to permit smaller reporting companies to forward incorporate; and
- Amend Form S-3 for smaller reporting companies to eliminate the current one-third restriction on primary offerings.
More on these proposed bills is available here: http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=375104.