On November 15, the House Financial Services Committee approved 23 bills, which included various bills that facilitate capital formation and reduce certain regulatory requirements.‎  Chairman of the Committee, Jeb Hensarling, stated that these bills “…will provide smaller businesses with greater access to the capital markets so those businesses can grow and create jobs.”  The following were included among the approved bills:

  • H.R. 4263‎, the Regulation A+ Improvement Act, which proposes to increase ‎the amount that companies can offer and sell under SEC Regulation A, Tier II, from $50 million to $75 million. The bill passed 37-23.
  • H.R. 4015, the Corporate Governance Reform and Transparency Act of 2017, which provides for the registration of proxy advisory firms with the SEC, disclosure of proxy firms’ potential conflicts of interest and codes of ethics, and the disclosure of proxy firms’ methodologies for formulating proxy recommendations and analyses.  The bill passed 40-20.
  • H.R. 4248, which proposes to repeal Section 1502 of the Dodd-Frank Act, and would require public companies to disclose in annual reports filed with the SEC whether the company sources “conflict minerals” from the Democratic Republic of Congo and its nine neighboring countries. The bill passed 32-27.
  • H.R. 4267, the Small Business Credit Availability Act, which proposes to amend the Investment Company Act of 1940 in order to require the SEC to streamline the offering, filing, and registration processes for BDCs.  The bill also increases a BDCs’ ability to deploy capital to businesses by reducing its asset coverage ratio—or required ratio of assets to debt—from 200% to 150% if certain requirements are met. The bill passed 58-2.
  • H.R. 4279, the ‎Expanding Investment Opportunities Act, which directs the SEC to amend its rules to enable closed-end funds that meet certain requirements to be considered “well-known seasoned issuers” (WKSIs) and to conform the filing and offering regulations for closed-end funds to those of traditional operating companies. The bill passed 58-2.
  • H.R. 4281, the Expanding Access to Capital for Rural Job Creators Act, which proposes to amend the Securities Exchange Act of 1934 to have the SEC’s Advocate for Small Business Capital Formation identify any unique challenges to rural area small businesses when identifying problems that small businesses have with securing access to capital. H.R. 4281 also requires that the annual report made by the SEC’s Small Business Advocate include a summary of any unique issues encountered by rural area small businesses. The bill passed 60-0.

The U.S. Department of the Treasury issued its second report (of four reports), titled “A Financial System that Creates Economic Opportunities, Capital Markets.”  The Report was issued in response to Presidential Order 137772 setting forth the Core Principles that should guide regulation of the U.S. financial system. The Report addresses various elements of the capital markets, from the equity and debt markets, to the U.S. Treasury securities market, and to derivatives and securitization.  The recommendations relating to the U.S. IPO market and reducing the regulatory burdens for companies seeking to undertake an IPO as well as for smaller public companies may be very familiar to readers of this blog, since many of the measures are included in the Financial CHOICE Act or otherwise addressed in proposed legislation or in rule proposals from the SEC.

See our alert, which may be accessed here.

On June 8, 2017, the U.S. House of Representatives, by a vote mostly along party lines, approved a bill that would repeal many of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) requirements and significantly reduce the regulatory burden for financial institutions. If enacted in its current form, the Financial CHOICE Act of 2017 (the “CHOICE Act”) would also alter the regulatory landscape for business development companies (“BDCs”), investment companies and investment advisers. Among other things, the CHOICE Act would:

  • Loosen some restrictions on BDCs concerning leverage, preferred stock, proxy procedures and investments;
  • Tighten the burden of proof for plaintiffs suing investment advisers for breach of fiduciary duty;
  • Broaden the exemption from the definition of an “investment company” available to venture capital funds; and
  • Streamline the process for investment companies and investment advisers to obtain exemptive orders.

The CHOICE Act, which passed 233-186, was sent to the Senate for consideration on June 12, 2017. Here is a summary of key provisions of the CHOICE Act that affect BDCs, investment companies and investment advisers.

Read our client alert.

On June 1, 2017, the Public Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, which the PCAOB believes will increase the relevance and utility of auditors’ reports by including additional information regarding the audit process, and other disclosures. Most significantly, the new standard requires inclusion in the audit report of a discussion of critical audit matters (CAMs) identified in the course of the audit. The new standard also contains an auditor tenure disclosure requirement and standardizes the format of the report, among other changes. The new standard retains the pass/fail opinion of the existing auditor’s report.

The new standard and other changes are subject to Securities and Exchange Commission (SEC) approval. Assuming that approval is obtained, the PCAOB expects the provisions, other than those related to CAMs, to take effect for audits for fiscal years ending on or after December 15, 2017. Provisions related to CAMs will take effect for (1) large accelerated filers, in connection with audits for fiscal years ending on or after June 30, 2019, and (2) all other filers, in connection with audits for fiscal years ending on or after December 15, 2020.

Read our client alert.

On June 1, 2017, the Public Company Accounting Oversight Board (PCAOB) adopted a new standard for auditor’s reports that requires a description of “critical audit matters,” for purposes of providing investors with information regarding the most challenging, subjective or complex aspects of the audit. Under the new standard, critical audit matters are defined as any matter arising from the current period’s audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex auditor judgment. If no critical audit matters arose from the audit, the auditor’s report must state that there were no critical audit matters. The communication of each critical audit matter in the auditor’s report must include: (a) the identification of the critical audit matter; (b) a description of the principal considerations that led the auditor to determine that the matter was a critical audit matter; (c) a description of how the critical audit matter was addressed in the audit; and (d) a reference to the relevant financial statement accounts or disclosures. Additional changes to the auditor’s report under the new standard include items that are intended to clarify the auditor’s role and responsibilities, provide additional information about the auditor and make the auditor’s report easier to read for investors. Under the new standard, the auditor’s report will still retain the pass/fail opinion of the existing auditor’s report.

The new standard will apply to audits conducted under PCAOB standards, but communication of critical audit matters will not be required for audits of: (1) broker-dealers reporting under Exchange Act Rule 17a-5; (2) investment companies other than business development companies (BDCs); (3) employee stock purchase, savings and similar plans; and (4) emerging growth companies (EGCs) as defined under Exchange Act Section 3(a)(80). The new standard is still subject to approval by the SEC. If approved, all provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after December 15, 2017. The provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019 for large accelerated filers and for fiscal years ending on or after December 15, 2020 for all other companies subject to such provisions.

A copy of the PCAOB’s fact sheet on the new standard is available at: https://pcaobus.org/News/Releases/Pages/fact-sheet-auditors-report-standard-adoption-6-1-17.aspx.

A copy of the PCAOB’s release on the new standard is available at: https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf.

Many groups have come forward in recent weeks with their lists of regulations that should be reviewed or amended, as well as their list of areas that merit close review in light of the potential burdens that may be imposed by current regulation.  As far as securities regulation is concerned, much of the focus, at least in the popular press, has been placed on measures that relate to IPOs; however, modest changes in other areas would have a positive impact on capital formation—here is our current list:

  • Adopting the proposed amendments relating to smaller reporting companies;
  • Continuing to advance the disclosure effectiveness initiative;
  • Continuing the review of the industry guides in order to modernize these requirements and eliminate outdated or repetitive requirements;
  • Revisiting the WKSI standard in order to see if similar accommodations and offering related flexibility should be made available to a broader universe of companies;
  • Reviewing existing communications safe harbors in order to modernize these and make communications safe harbors available to a broader array of companies, including business development companies;
  • Adopting the proposed amendment to Rule 163(c) that would allow underwriters or other financial intermediaries to engage in discussions on a WKSI’s behalf relating to a possible offering;
  • Assessing whether a policy rationale remains for including MLPs within the definition of “ineligible issuer” when MLPs undertake public offerings on a best efforts basis;
  • Assessing who suffers when ineligible issuers are prevented from using FWPs other than for term sheet purposes;
  • Removing the limitations that require certain issuers to conduct live only roadshows;
  • Eliminating the need for “market-maker” prospectuses;
  • Reviewing the one-third limit applicable to primary issuances off of a shelf registration statement for certain smaller companies;
  • Modernizing the filing requirements for BDCs, permitting access equals delivery for BDCs and modernizing the research safe harbors to include BDCs;
  • Adding knowledgeable employees to the definition of accredited investor;
  • Eliminating the IPO quiet period;
  • Working with the securities exchanges to review their “20% Rules” (requiring a shareholder vote for private placements completed at a discount that will result in an issuance or potential issuance of securities greater than 20% of the pre-transaction total shares outstanding);
  • Addressing the Rule 144 aggregation rules for private equity and venture capital fund related sales;
  • Shortening the Rule 144 holding period for reporting companies;
  • Including sovereign wealth funds and central banks within the definition of QIBs;
  • Shortening the 30-day period in Rule 155; and
  • Shortening the six-month integration safe harbor contained in Regulation D.

In this piece, which was included in a recent compendium published by Practising Law Institute (PLI) titled “Looking Ahead:  The Impact of the 2016 Election on Key Legal Issues,” we offer our thoughts on the likely areas of focus for the Securities and Exchange Commission.

Access here:  https://media2.mofo.com/documents/170100-securities-law-crystal-ball.pdf.

 

Wednesday, November 30, 2016
11:00 a.m. – 12:30 p.m. EST

Traditionally, most public companies in the US were organized as C-corporations. However, tax developments in recent years have given corporate planners a wide range of new tools to structure a public company. For example, tax pass-through MLP and REIT structures are spreading into new asset classes. Also, traditional double taxed ‘C’ corporations are using tax pass-through entities, including partnerships, to reduce or eliminate entity-level taxes as well as optimize their internal structures with tax ‘disregarded entities’. These new tools lead to a variety of tax choices in deciding how to structure a public company.

During this briefing, which is intended for a general audience, the speakers will explain the structures, restrictions and pitfalls in this evolving hybrid world of C-corporations mixed with tax pass-throughs. Specifically, they will discuss:

  • Master limited partnerships;
  • REITs and alternative assets that may qualify as ‘real estate’;
  • Business development companies;
  • Consolidated groups of corporations and disregarded entities; and
  • Up-C structures.

Speakers:

CLE credit is pending for California and New York.

For more information, or to register, please click here.

Business development companies (“BDCs”) provide an important and growing alternative source of capital to small and middle market companies that may not otherwise have access to bank financing.  However, BDCs have been facing challenges raising money partly due to the recent decline of institutional ownership resulting from (1) the requirement of the SEC for registered open-end funds to disclose “acquired fund fees and expenses” (“AFFE”) of other funds they invest in (including BDCs) and (2) the limitation under Section 12(d)(1) of the Investment Company Act of 1940 (“Section 12(d)(1)”) of the ability of other registered investment companies (including exchange-traded funds) to acquire more than 3% of a BDC’s total outstanding stock.  In addition, the recent release of the U.S. Department of Labor’s final fiduciary rule (the “DOL final rule”) will likely result in ERISA plans avoiding investments in BDCs, whether directly or indirectly through an index.  The recent decline of institutional ownership in BDCs has negatively impacted the ability of BDCs to provide capital to small and middle market companies, although the increasing use of unitranche financing has created new financing opportunities for middle market companies.

For more information regarding the disclosure of AFFE, see our client alert:
Acquired Fund Fee Expenses and Business Development Companies.”

For more information regarding Section 12(d)(1), see our client alert:
Section 12(d)(1) and Business Development Companies.”

For more information regarding the DOL final rule, see our client alert:
Impact of DOL’s Final Rule on Business Development Companies.”

For more information regarding unitranche financing, see our article:
Developments in Unitranche Financing (2016).”

On June 28, 2016, Morrison & Foerster LLP, along with the Milken Institute, the U.S. Small Business Administration (SBA) and the Small Business Investment Alliance (SBIA), will be hosting the 2016 BDCs & Small Business Capital Formation Forum in Washington, DC.  The forum will focus on best practices and key issues for business development companies (“BDCs”) and small business investment companies (“SBICs”) and will include a CEO/investor roundtable discussion, a discussion of the role of BDCs and SBICs, a discussion of BDC regulatory items, and a discussion of small business capital formation.

BDCs were created in 1980 in order to enhance capital formation for small- and medium-sized companies.  BDCs also often establish wholly-owned subsidiaries which are licensed by the SBA to operate as SBICs and issue SBA-guaranteed debentures.  Since the early 1980s, the number of BDCs has grown significantly.  This growth was accelerated following the financial crisis of 2008, when BDCs were able to address the needs of small- and medium-sized businesses that did not have access to capital.  Currently, there are over 80 BDCs and BDC loan balances have more than tripled since 2008.  As of March 31, 2016, BDC aggregate loan commitments in the United States were over $82 billion and the top sectors included the following: (1) services ($24 billion), (2) manufacturing ($17 billion), (3) finance, insurance and real estate ($13 billion), (4) mining ($6 billion), and (5) transport, communication and electric/gas ($6 billion).  (Source: Testimony by Michael J. Arougheti, Co-Chairman of the Board of Directors, Ares Capital Corporation, on behalf of the SBIA, at Hearing on “Improving Communities and Business Access to Capital and Economic Development,” Senate Banking Committee, Subcommittee on Securities, Insurance and Investment, May 19, 2016)

The program agenda for the forum is available here.