Recent rule-making activity by the Securities and Exchange Commission ("SEC" or "Commission") to benefit capital formation by smaller businesses has eased the resale restrictions on non-registered securities, expanded the availability of the "short form" registration process and "scaled" disclosure requirements and proposed a widening of the safe harbor for private placements of securities.
Most of the reforms had their genesis in recommendations made in the April 23, 2006 Final Report of the Advisory Committee on Smaller Public Companies (available at http://www.sec/gov/info/ smallbus/acspc.shtml ), chartered by the SEC in 2004 to examine the impact of Sarbanes-Oxley and other aspects of the federal securities laws on smaller companies and assigned a mission of striking a balance between the dual objectives of making the United States public capital markets more accessible to small business and assuring the protection of investors.
Amendments To Rules 144
Amendments effective February 15, 2008 to Rule 144 under the Securities Act of 1933, as amended ("Securities Act") should help companies raise capital more easily and less expensively by improving liquidity for investors who purchase "restricted securities" through shortening the holding periods and reducing the conditions for public resales, especially for persons who are not affiliated with the issuer of the securities.
Section 4(1) of the Securities Act provides an exemption from the registration requirements of Section 5 for offers and sales by any person who is not an issuer, underwriter or dealer. Section 2(a)(11) of the Securities Act defines an underwriter as "any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking." Rule 144 was adopted by the Commission in 1972 to set forth conditions under which a selling security holder would be deemed not to be engaged in a distribution of securities and therefore not an underwriter with respect to such securities, thus making available the Section 4(1) exemption. These conditions included (i) a requirement that adequate current public information about the issuer be available; (ii) a holding period of a minimum of one year; (iii) volume limitations on resales; (iv) compliance with manner of sale requirements; and (v) the required filing of Form 144 if the amount of securities sold exceeded certain thresholds.
Previously, Rule 144(k) permitted a non-affiliate to resell restricted securities publicly without being subject to the above limitations if the securities had been held for two years or more, provided that the security holder was not, and, for the three months prior to the sale, had not been an affiliate of the issuer.
In its adopting release, (Release No. 33-8869, December 6, 2007), the Commission stated that the purpose of Rule 144 is to provide objective criteria for determining that the person selling securities to the public has not acquired the securities from the issuer for distribution: "After observing the operation of Rule 144 since the 1997 amendments [the last shortening of the holding period], we believe that a six-month holding period for securities of reporting issuers provides a reasonable indication that an investor has assumed the economic risk of investment in the securities to be resold under Rule 144."
The amendments provide the following relief:
• Shorten the holding period for restricted securities of reporting companies to six months.
• Simplify Rule 144 compliance for non-affiliates of reporting companies by allowing such non-affiliates to resell freely, restricted securities after a six-month holding period (subject only to the Rule 144(c) public information requirement until the securities have been held for one year) and after a 12 month holding period with no restrictions.
• Allow affiliates to resell restricted securities after a six-month holding period in accordance with the current public information, volume limitation and manner of sale requirements.
• For affiliates' sales, raise the thresholds that trigger Form 144 filing requirements from 500 shares or $10,000 to 5,000 shares or $50,000.
Expanded Availability Of "Short Form" Registration And "Scaled Disclosure"
The "Short Form" Facilitates Raising Capital. Form S-3 is the "short form" registration statement under the Securities Act that allows incorporation by reference to information previously filed with the SEC pursuant to the periodic reporting system. Amendments to the eligibility requirements of Form S-3, effective January 28, 2008, expand the number of companies able to conduct primary offerings of securities on this form regardless of the size of the companies' public float. See , Release No. 33-8878 (December 19, 2007). Previously, the form was available for primary offerings only by issuers with over $75 million in public float.
Under the new rules:
• Issuers are eligible to use Form S-3 if they have a class of common equity listed and registered on a national securities exchange and have timely filed Exchange Act reports for a period of 12 months prior to filing the registration statement;
• No more than the equivalent of one-third of the issuer's public float may be sold in primary offerings over any period of 12 months; and
• Shell companies are not eligible to use S-3 until they have ceased being a shell company for at least 12 months.
Form S-3 eligibility for primary offerings enables companies to conduct such offerings "off the shelf" under Rule 415 of the Securities Act which, the Commission observed in its adopting release, provides considerable flexibility in accessing the public securities markets from time to time in response to changes in the markets and other factors. Shelf registration eligibility and the ability to forward incorporate information allow companies to avoid delays in the offering process and serve to reduce costs associated with preparing and filing post-effective amendments to registration statements.
The SEC was unwilling to expand the availability of the short form to OTCBB and "pink sheet" companies, limiting short form registration only to companies having a class of common equity listed on a national exchange. The Commission stated that the exchanges' listing rules, including both quantitative and qualitative standards, serve to assure that the market for an issuer's security has the depth and liquidity necessary to maintain fair and orderly markets. Moreover, the Commission noted that the exchanges' corporate governance requirements provide an added measure of investor protection.
More Companies May Use Modified Scaled Disclosure Requirements. Prior to the recent reforms, "small business issuers," companies with both revenues and a public float of less than $25 million, were eligible to use Regulation S-B's set of abbreviated disclosure rules in periodic reports and proxy statements under the Securities Exchange Act of 1934, as amended ("Exchange Act") and registration statements. Amendments which became effective on February 4, 2008, abolish Regulation S-B, make scaled disclosure regulations available to approximately 1,500 additional smaller companies, and do the following:
• Eliminate the "small business issuer" category with a new category of "smaller reporting companies" eligible to use the scaled disclosure requirements, the primary determinant for eligibility being that the company have less than $75 million in public float. If a company is unable to calculate public float, such as if it has no common equity outstanding or no market price for its outstanding common equity exists, the standard will be less than $50 million in revenue in the last year;
• Move 12 non-financial scaled disclosure item requirements from Regulation S-B into Regulation S-K, available only for smaller reporting companies;
• Move the scaled financial statement requirements in Item 310 of Regulation S-B into new Article 8 of Regulation S-X, and amend these requirements to provide a scaled disclosure option for smaller reporting companies, requiring two years of balance sheet data instead of one year;
• Permit smaller reporting companies to elect to comply with scaled financial and non-financial disclosure on an item-by-item "a la carte" basis;
• Eliminate the current SB forms, with a phase-out period for small business issuers transitioning to smaller reporting company status;
• Permit all foreign companies to qualify as smaller reporting companies if they otherwise qualify and choose to file on domestic company forms and provide financial statements prepared in accordance with United States generally accepted accounting principles.
See , SEC Release No. 33-8876 (December 19, 2007). Essentially, under the revised rules, the new category of "smaller reporting companies" replaces the old categories of "small business issuers" under Regulation S-B and "non-accelerated reporting companies" created by SOX.
The scaled reporting available under amended Regulation S-K permit smaller reporting companies, among other loosened standards, to (i) provide less historic financial statement information and the accompanying discussion and analysis and less detail on executive compensation and (iii) omit the Compensation Discussion and Analysis required of larger companies.
Proposed Widening Of Regulation D Private Placement Safe Harbor
Regulation D, originally adopted in 1982, was designed to facilitate small business capital formation by providing guidelines as to the availability of the private placement exemptions from the registration requirements of Section 5 of the Securities Act. However, it has come to be relied upon by both non-reporting and reporting issuers of securities.
The Commission has proposed amendments, not yet the subject of final rule-making at the time this article was being written, that would, among other things:
• Establish an additional exemption from the Securities Act registration provisions in new Rule 507 for sales of securities to a new category of qualified purchasers, called "large accredited investors" with respect to which the issuer could engage in limited advertising;
• Provide for adjustments to the definition of "accredited investor" to account for inflation; and
• Shorten the integration safe harbor in Regulation D from six months to 90 days.
See , SEC Release No. 33-8828 (August 3, 2007).
The Regulation D proposals have generated substantial commentary, particularly with respect to the Commission's unwillingness to eliminate the prohibition against general solicitation under Regulation D in its entirety, or at least in the case of offerings where purchasers are limited to "accredited investors," who are deemed to be able to fend for themselves. See, for example, Comments of the Committees on Federal Regulation of Securities, Middle Market and Small Business and State Regulation of Securities of the ABA, Business Law Section, at http://www.sec.gov/comments/s71807.shtml.
While the SEC has taken some important steps toward addressing the capital formation needs of smaller businesses, it has not loosened the restrictions nearly to the extent recommended by its Advisory Committee. Non exchange-listed smaller issuers will have to continue relying upon the long-form registration process, or private placements and PIPES as means of accessing capital. The number of companies eligible for the scaled disclosure requirements will begin to erode over time, unless the $75 million in public equity float cap for qualifying as a "smaller reporting company" is indexed to inflation. After an intensive and long-delayed focus on smaller companies, it will be disappointing if the Commission shelves the detailed analysis undertaken by the Advisory Committee and moves on to other issues.
Lawrence A. Goldman is a Director in the Corporate Practice Group of Gibbons P.C.He is the current Chair of the Middle Market and Small Business Committee of the American Bar Association Business Law Section.