©2012 CCH. All Rights Reserved.

Highlights

March 2012

Special ReportWolters Kluwer Law & Business Briefing

✔ Facilitates raising of capital through the Internet

✔ Eases ban on general solicitation in private offerings

✔ Provides a reduced-regulation “on ramp” for small IPOs

✔ Increases threshold for exempt private offerings to $50m

✔ Raises 500-shareholder trigger for SEC reporting

House Passes JOBS Act with IPO “On Ramp” and Crowdfunding

On March 8, the U.S. House of Representatives passed legislation by an overwhelming, bipartisan vote (390-23) creating an “on ramp” for companies to go public, authorizing crowdfunding, reforming SEC Regulations D and A, and raising the 500-shareholder threshold for private companies and community banks. The Jumpstart Our Business Startups (JOBS) Act, H.R. 3606, would reduce the costs of going public by providing companies with a temporary reprieve from SEC regulations by phasing in certain regulations over a five‐year period, thus enabling smaller companies to go public sooner. H.R. 3606 would also remove an SEC regulatory ban preventing small businesses from using adver-tisements to solicit investors. Further, the measure would remove SEC restrictions that prevent crowdfunding so entrepreneurs can raise equity capital from a large pool of small investors.

In addition, the legislation would amend Regulation A, increasing the offering threshold for companies exempted from SEC registration from $5 million to $50 million. The Act also removes barriers to capital formation for small companies by raising the shareholder registration requirement threshold from 500 to 2,000 shareholders, with 1500 of those shareholders required to be accredited investors. Similarly, the legislation would increase the number of shareholders permitted to invest in a community bank from 500 to 2,000 without triggering SEC filing duties.

Meanwhile, Senate Majority Leader Harry Reid (D-NV) said that the Senate will move forward with its own package of legislation to create jobs and streamline how companies sell stock through IPOs. There are a number of companion Senate bills that parallel discrete titles of H.R. 3606, as noted below.

The Obama Administration issued a formal Statement of Policy supporting the JOBS Act. As noted in the policy statement, the President outlined a number of ways to help small businesses grow and become more competitive in his September 8, 2011, address to a Joint Session of Congress on jobs and the economy, as well as in the Startup America Legislative Agenda he sent to the Congress last month. In both the speech and the agenda, the President called for cutting the red tape that prevents many rapidly growing startup companies from raising needed capital. Noting commonalities between the President’s approach and some of the proposals in H.R. 3060, the Administration looks forward to working with Congress to craft legislation that facilitates capital formation and job growth for small businesses and provides appropriate investor protections.

Inside

Title I: Emerging Growth Companies ......................2

Title II: Regulation D ...............................................6

Title III: Crowdfunding ...........................................8State Preemption................................................10Inflation Adjustments ........................................10Rejected Amendments .......................................11Obama Administration Support ........................11

Title IV: Small Company Formation ......................12

Titles V and VI: 500-Shareholder Threshold ....................................13

Title VII: Outreach on Law Changes ......................15

About the Author ...................................................15

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Title I: Emerging Growth Companies

Title I of the JOBS Act is the “Reopening American Capital Markets to Emerging Growth Companies Act.” The title is designed to promote job creation and further economic growth by reducing the cost of going public for small and medium size companies. Co-authored by Rep. Stephen Fincher (R-TN) and Rep. John Carney (D-DE), the measure would create a new category of issuer, the “emerging growth company,” which would retain that status for five years or until it exceeds $1 billion in annual gross revenue or becomes a large ac-celerated filer. H.R 3606 ensures investors are protected by requiring emerging growth companies to provide audited financial statements as well as establishing and maintaining internal controls over financial reporting.

The measure is intended to address the decline in the number of companies entering the U.S. capital markets through initial public offerings [H. Rep. No. 112-406]. In October 2011, the IPO Task Force issued a report that found that 791 companies went public in 1996, and that the U.S. averaged 530 IPOs per year from 1991 to 2000. By contrast, the U.S. averaged fewer than 157 IPOs per year from 2001 to 2008. In 2009, the U.S. had only 61 IPOs; in 2010, it had 153 IPOs. The IPO Task Force found that the number of IPOs remains well below historic levels and is far below the number needed to replace the number of listed companies lost to mergers, acquisitions, de-listings and bankruptcy.

The measure would amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to establish a new category of issuers known as emerging growth companies. These are issuers that have total annual gross revenues of less than $1 billion. An issuer that is an emerging growth company as of the first day of a fiscal year must continue to be deemed as such until: (1) the last day of the fiscal year during which the issuer had $1 billion in annual gross revenues or more; (2) the last day of the fiscal year following the fifth anniversary of the issuer’s initial public offering date; or (3) the date in which the issuer is deemed to be a “large accelerated filer,” defined by the SEC as an issuer with more than $700 million in public float.

The House approved a floor amendment offered by Rep. Sheila  Jackson-Lee (D-TX) adding a requirement that a company would not be considered an emerging growth company if it has issued more than $1 billion in non-convertible debt over the prior three years. In addition, the House approved a floor amendment of-

fered by Rep. Mike McIntyre (R-NC) that would adjust the emerging growth company definition for inflation, resulting in providing more flexibility for businesses.

The legislation would provide temporary regulatory relief to small companies, yet ensure their eventual compliance with regulatory requirements as they grow larger. The measure also would define the initial public offering date as the date of the first sale of common equity securities of an issuer pursuant to an effective registration statement under the Securities Act.

Under H.R. 3606, SEC regulations for emerging growth companies would 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 would allow emerging growth companies to defer compliance with Sarbanes-Oxley Act Section 404(b) until the company is no longer considered an emerging growth company. The exemp-tion from Section 404(b) would delay the hiring of an additional outside auditor to verify the company’s internal controls for the five year “on-ramp” period. Section 404(b) requires the company’s auditor to report on and attest to management’s assessment of the company’s internal controls.

Emerging growth companies would still have to comply with SEC-mandated quarterly and annual disclosures, but would be exempted from Section 404(b) for a longer transition period of up to five years. To ensure investor protections, the management of an emerging growth company would still have to establish and maintain internal controls over financial reporting, as mandated by Section 404(a), and its chief executive officer and chief financial officer would still have to certify the company’s financial statements. Section 404(a) requires that annual reports filed with the SEC must be accompanied by a statement by company management that management is responsible for creating and maintaining adequate internal controls. In the report, management must also present its assessment of the effectiveness of those controls.

In addition, the JOBS Act would only require emerging growth companies to provide audited financial statements for the two years prior to registration rather than three years, thereby saving the companies millions. This two-year period already applies to companies with

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a public float under $75 million, which are known as non-accelerated filers. Within a year of its initial public offering, an emerging growth company would report three years’ worth of financial statements, as larger companies must do.

The legislation also would provide emerging growth companies with the same extended compliance period for new or revised accounting standards issued by the Financial Accounting Standards Board (FASB) that are currently available to private companies, if the new or revised standards apply to companies that are not issuers. An emerging growth company would also have to present selected financial data in its periodic reports only for the earliest audited period presented in connection with its first registration statement.

H.R. 3606 exempts emerging growth companies from any regulations promulgated by the Public Company Accounting Oversight Board that would require mandatory audit firm rotation, thereby allowing them to avoid the unnecessary costs of changing from an auditor familiar with the company to one that is not. Currently, the PCAOB has set out a concept release on mandatory auditor rotation as a means of enhancing the independence of outside auditors. The PCAOB has not proposed any regulations on mandatory auditor rotation. In addition, the JOBS Act would provide that any auditing standards adopted by the PCAOB after enactment would not apply to emerging growth companies unless the SEC finds that the application of the rules to emerging growth companies is necessary or appropriate after it considers investor protection, efficiency, competition and capital formation.

H.R. 3606 also gives emerging growth companies the opportunity to opt in to certain regulations by comply-ing with them before they lose their status as emerging growth companies. However, if the FASB adopts new accounting standards while a company is an emerging growth company, the company must comply with either all or none of the new FASB standards while it remains an emerging growth company.

The Act also exempts emerging growth companies from two new corporate governance requirements that were established by the Dodd-Frank Wall Street Reform and Consumer Protection Act. First, emerging growth companies would be exempted from the requirement of Section 951 that public companies hold a non-binding stockholder advisory vote at least once every three years on executive compensation and a shareholder vote on executive severance payments known as golden parachutes.. Second, the bill exempts emerging growth companies from Section 953(b)’s requirement that

public companies calculate and disclose the median compensation of all employees compared to the CEO. But note that emerging growth companies would still have to comply with all stock exchange corporate governance and listing requirements, including board member independence rules.

The legislation would require an issuer that loses its status as an emerging growth company before its second anniversary as a public company to comply with the Dodd-Frank Act’s executive compensation shareholder advisory vote requirements starting in its third year of being a public company. Further, an issuer that loses its emerging growth company status after its second anniversary as a public company must comply with the executive compensation shareholder advisory vote requirements beginning in the fiscal year after losing its status. These provisions are by way of an amendment offered by Rep. Keith Ellison (D-MN), and approved during the Financial Services Committee mark up of H.R. 3606, requiring 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 emerg-ing 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 that date. The Amendment deals with Rep. Ellison’s concern that, under the original bill, an emerging growth company could conceivably have gone eight years before conducting its first shareholder advisory vote on executive compensation.

H.R. 3606 also improves the flow of information about emerging growth companies to investors by removing burdensome and outdated restrictions on communications between companies, research analysts and investors. Existing SEC rules prohibit investment banks that underwrite a company’s IPO from publish-ing research on companies that would be classified as emerging growth companies under the legislation. H.R. 3606 allows investors to obtain research reports about an emerging growth company before or at the same time as its IPO. The legislation, however, maintains other investor protections, such as those set forth in Sarbanes-Oxley Section 501, which address potential conflicts of interest that can arise when analysts recom-mend equity securities.

The bill would amend the Securities Act to permit the publication or distribution by a broker or dealer of a research report about an emerging growth company that

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is the subject of a proposed public offering, even if the broker or dealer is participating or will participate in the offering. This section also would amend the Securities Act to expand the range of permissible pre-filing com-munications to sophisticated institutional investors to allow emerging growth companies to determine whether qualified institutional or accredited investors might have an interest in a contemplated securities offering.

H.R. 3606 also permits emerging growth companies to gauge the interest in potential IPOs by permitting greater pre-filing communications to institutional and qualified investors to determine whether an IPO is likely to be successful. All of the antifraud provisions of the securities laws still apply, however, and the delivery of a statutory prospectus before securities are sold in an IPO would still be required.

Thus, the Securities Exchange Act is amended to permit members of the investment banking team for a broker or dealer participating in an offering to arrange for communications between securities analysts and potential investors in emerging growth companies, and to permit research analysts to participate in com-munications with management of the issuer that are also attended by other members of the broker or dealer. This section would also permit the publication and distribution of research reports about emerging growth companies during post-IPO quiet periods and lock-up periods established by the SEC or national securities associations under the Exchange Act.

The House rejected an amendment offered by Rep. Maxine Waters (D-CA) providing that if a broker or dealer is underwriting an initial public offering for an emerging growth company and providing research to the public about the IPO, those research reports must be filed with the SEC, and the broker or dealer must be held to stricter liability for its comments. Rep. John Carney (D-DE), co-author of the on-ramp provisions, assured that the Waters Amendment was unnecessary because several investor protections already exist in this area, citing Sarbanes-Oxley Section 501, SEC Regula-tion AC and the global Wall Street settlement, all of which would apply.

Section 501 contains provisions ensuring the objectiv-ity of analyst research reports and requires disclosure of the extent to which the analyst holds securities in the company discussed in the research report. Regulation AC requires that research reports provided or circulated by a brokerage firm contain a statement attesting that the views expressed in the report accurately reflect the analyst’s personal views and whether or not the analyst will receive compensation in connection with the views

or recommendations expressed in the report. The global settlement effected structural changes in the way busi-ness is done on Wall Street. For example, pursuant to the settlement, firms agreed to create firewalls between research and investment banking designed to prohibit improper communications.

H.R. 3606 would permit emerging growth companies to pre-file confidential registration statements, thereby allowing them to begin the SEC review process without publicly revealing sensitive commercial and financial information to their competitors. Currently, only foreign companies are permitted to file confidential registration statements with the SEC. The legislation would require an emerging growth company to publicly file its initial confidential submission at least 21 days before it begins a pre-IPO road show for potential investors. A road show is 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.

Under the bill, U.S. companies would be allowed to submit draft registration statements to the SEC on a confidential basis, as is currently permitted for non-U.S. companies. Final registration materials, including all amendments resulting from the SEC review process, would still have to be made publicly available to inves-tors with adequate time for review prior to an emerging growth company’s initial public offering.

The Act would require the SEC to study the effects of the transition from fraction trading to penny trading for securities, including the effect of the transition on initial public offerings and liquidity for small and mid-cap companies. The SEC would report to Congress about the impact of penny trading 90 days after enact-ment. The Act also would authorize the SEC to increase the trading increment for emerging growth companies to greater than $.01 but less than $.10 within 180 days of enactment.

This provision in H.R. 3606 came by way of an amendment offered by Rep. David Schweikert (R-AZ), and approved by the Financial Services Committee, which directs 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 imple-mentation. 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

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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 Com-mission 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.

The Act would allow an emerging growth company to forgo the regulatory exemptions afforded to emerging growth companies and instead opt-in to certain regula-tory requirements as they see fit. However, emerging growth companies cannot selectively opt-in to comply with new or revised accounting standards. Instead, an emerging growth company must declare in its SEC-filed registration statement whether it will or will not use the extension of time for all new or revised accounting standards applicable to emerging growth companies.

The legislation would also make it easier for potential investors to get access to research and company informa-tion 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. Cur-rently, 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.

An amendment offered by Rep Scott Garrett (R-NJ), and approved by the Financial Services Committee, directs the SEC to analyze the registration requirements of Regulation S-K and determine how they can be up-dated 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 Financial Services 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.

Senate Companion Bill S 1933: Senators Charles Schumer (D-NY) and Pat Toomey (R-PA) have intro-duced legislation, S. 1933, making it easier for small and medium-sized companies to access capital through public markets so they can expand and create jobs. The legislation, co-sponsored by Senators Mark Warner (D-VA) and Mike Crapo (R-ID), would create an on-ramp to public markets for a new category of issuers, called emerging growth companies that have less than $1 bil-lion in annual revenues at the time they register with the SEC and less than $700 million in publicly-traded shares after the IPO.

The Senate legislation creates a transitional on-ramp status for these companies to encourage them to go public. The on-ramp period would last as many as five years, or until a company reaches $1 billion in annual revenue or $700 million in publicly-traded shares. Full compliance with certain obligations would be phased in during that period. The legislation would only re-quire emerging growth companies to provide audited financial statements to the SEC for the two years be-fore registration, rather than three years. Similar, to the House legislation, S 1933 would exempt emerging growth companies from compliance with Sarbanes-Oxley Act Section 404(b). Again similar to the H.R. 3606, the Senate bill provides any PCAOB rules re-quiring mandatory audit firm rotation would not ap-ply to an emerging growth company.

The bill would also exempt emerging growth companies from the requirement to hold a shareholder advisory vote on executive compensation arrangements, includ-ing golden parachutes. It would also permit emerging growth companies to gauge preliminary interest in a potential offering by expanding the range of permissible pre-filing communications to institutional investors, and filing a registration statement with the SEC on a confidential basis, which non-U.S. companies are cur-rently permitted to do.

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6 Special Report—Capital Formation

The Senate legislation would allow investors to have access to research reports about emerging growth companies prior to the IPO. However, the measure would maintain other extensive protections in this area, such as Sarbanes-Oxley Section 501, which addresses potential conflicts of interest that can arise when analysts recom-mend equity securities, SEC Regulation AC, the Global Research Analyst Settlement and disclo-sure requirements regarding potential conflicts of interest. These changes would address the current information shortfall by providing a way for in-vestors to obtain research about IPO candidates in a manner consistent with investor protection.

Title II: Regulation D

Title II of H.R. 3606 is the Access to Capital for Job Creators Act, authored by Rep. Kevin McCarthy, (R-CA), which would remove the prohibition against general solicitation or advertising on sales of non-pub-licly traded securities, provided that all purchasers of the securities are accredited investors. This measure would allow small companies offering securities under Regula-tion D to utilize advertisements or solicitation to reach investors and obtain capital. The SEC’s ban on solicita-tion, first adopted in 1982, limits the pool of potential investors and hampers the ability of small companies to raise capital.

The Securities Act requires that any offer to sell securities either be registered with the SEC or meet an exemption. Rule 506 of Regulation D is an exemption that allows companies to raise capital as long as they do not market their securities through general solicitations or advertising. This prohibition on general solicitation and advertising has been interpreted to mean that poten-tial investors must have an existing relationship with the company before they can be notified that unregistered securities are available for purchase. Congress believes that requiring potential investors to have an existing relationship with the company significantly limits the pool of pool of potential investors and severely hampers the ability of small companies to raise capital and create jobs [H. Rep. No. 112-263].

Title II directs the SEC to adopt regulations on how an issuer would verify that the purchasers of securities are accredited investors. The legislation is designed to encourage companies to advertise in order to attract additional capital, which will allow them to invest and hire additional employees.

Essentially, the measure amends Securities Act Section 4(2) to permit use of public solicitation in connection with private securities offerings. At present, SEC rules, including Rule 506 of Regulation D, create a safe harbor for companies that want to issue private securities to raise an unlimited amount of money from an unlimited number of accredited investors. However, the safe harbor does not permit the use of general solicitation or advertising to market these securities. The legislation requires the SEC to revise Rule 506 to provide that companies can use general solicitation or advertising to market these private securities, provided that all purchas-ers of the securities are accredited investors.

In addition, Title II directs the SEC to adopt regula-tions requiring issuers using general solicitation to verify that investors are accredited, rather than rely on investor self-certification, as is currently permitted. The legisla-tion is designed to allow companies to more easily raise capital by removing restrictions on general solicitation and advertising for certain private securities. It fairly balances the need to ease capital formation to spur job creation with a provision to better protect investors by putting greater responsibility on the issuer.

In addition to eliminating the ban on solicitations and advertisements by issuers and broker-dealers, H.R. 3606 would also enable offline and online forums that bring together investors with companies that need funding to play an increasingly important role in facili-tating capital investment in small companies. To ensure the continued viability of these forums, Congress believes that it is important that the SEC not treat these forums as broker-dealers simply because they are engaged in bringing investors and issuers together. Rather, the SEC should only treat these forums as broker-dealers if they receive transaction-based fees for their activities [H. Rep. No. 112-263].

The House approved a floor amendment offered by Rep. Patrick McHenry (R-NC) that 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 McHenry Amendment is designed to enable the marketing of private shares to accredited investors through platforms.

The House also approved a floor amendment offered by Rep. Kevin McCarthy (R-CA) clarifying that general advertising under the provisions should only apply to Rule 506 offerings, and allowing for general solicitation in the secondary sale of these securities so long as only

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qualified institutional buyers purchase the securities. The amendment also provides consistency in interpretation that general advertising should not cause these private offerings to be considered public offerings. According to Rep. McCarthy, the amendment ensures that more small businesses can find investors, while providing investor protection. It is designed to ensure that Rule 506 meets its original intent.

According to Rep. Pete Sessions (R-TX), the measure allows for general solicitation and advertising that would attract private investment. Small, privately held compa-nies will no longer be constrained in soliciting new ac-credited investors. In Rep. Sessions’ view, the uncertainty created by burdensome regulations and outdated rules hinders investment in small businesses. The legislation will foster job creation by simply allowing the private sector to participate in this endeavor [Cong. Rec. (Nov. 3, 2011), p. H7280].

In the view of Rep. Jared Polis (D-CO), the JOBS Act deals with a flaw in how private equity is raised. Currently, you have to know the right people to get into a private equity deal. In fact, a company that is offering private equity is not even allowed to, under SEC regulations, post a prospectus and information on its website in an open environment. The Act creates a safe harbor allowing companies simply providing information about an offering on their website to allow people who are not part of their personal network of friends to participate [Cong. Rec. (Nov. 3, 2011), pp. H7286-7287].

Rep. Maxine Waters (D-CA) said that measure would amend the Securities Act to remove the prohibition on general solicitation or general advertising for offers of securities made under Rule 506 of Regulation D if those securities are only sold to accredited investors. The current ban on general advertising has been interpreted to mean that companies can only raise capital from investors with whom they have had a preexisting relationship. This requirement would hamper their ability to obtain capital and it is therefore appropriate to modernize this provision through legislation [Cong. Rec. (Nov. 3, 2011), p. H7290].

According to Rep. Carolyn Maloney (D-NY), the measure would remove a contradiction in federal securi-ties regulation. Under the current system, companies seeking to raise capital by selling shares are barred from many types of advertising and solicitations. In effect, the current system tells businesses to go out and create jobs, but prevents them from telling potential investors about the idea. The Act would end this contradiction

by removing the restrictions on general solicitation and advertising for certain private securities offerings and help companies attract potential investors and raise the capital that they need to succeed [Cong. Rec. (Nov. 3, 2011), p. H7921].

Rep. Don Manzullo (R-IL) added that requiring potential investors to have an existing relationship with a particular company limits the pool of potential investors and hampers the efforts of small companies who have a great idea to raise much-needed capital to expand and hire workers. By making an exemption in the advertising ban for accredited investors, he said, the Act will make it easier for companies to raise capital without putting less sophisticated investors at risk [Cong. Rec. (Nov. 3, 2011), p. H7293].

An amendment offered by Rep. Brad Miller (D-NC) requiring disclosure of any compensation agreement with the executives or a golden parachute severance package was rejected. Opposing the amendment, Rep. McCarthy said that the Miller Amendment goes against the legislation’s very purpose by imposing stiffer regula-tions on private companies raising capital than on public companies. The SEC does not require public companies selling to retail investors to put compensation disclosure in their advertising, emphasized the sponsor, and even the Dodd-Frank Act did not go this far. Moreover, the Waters Amendment ensures that H.R. 2940 specifically targets only accredited investors. The SEC has no authority to regulate the compensation of executives at private companies, noted the sponsor. At a time when the costs and benefits of regulations are so important, said Rep. McCarthy, the Miller Amendment would fail anyone’s cost-benefit analysis [Cong. Rec. (Nov. 3, 2011), pp. H7294-7295].

Senate Companion Bill S 1831: The Access to Capital for Job Creators Act (S. 1831), sponsored by Senator John Thune (R-SD), would direct the SEC to revise Regulation D governing an exemption from public offering requirements for limited offers and sales without regard to the dollar amount of the offering. The bill would require changes providing that a speci-fied prohibition against general solicitation or general advertising does not apply to offers and sales of securities made pursuant to Regulation D if all purchasers of the securities are accredited investors. The legislation would also require rule amendments requiring that the issuer take reasonable steps to verify that purchasers are ac-credited investors, using such methods as are determined by the SEC.

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Title III: CrowdfundingTitle III of H.R. 3606 is the Entrepreneur Access to Capital Act. Authored by Rep. Patrick McHenry (R-NC), the measure would allow crowdfunding to finance new businesses by allowing companies to accept and pool donations of up to $1 million, or $2 million in some cases if the company provides investors with audited financial statements, without registering with the SEC.

Individual contributions are limited to $10,000 or 10 percent of the investor’s annual income, whichever is less. In addition, the measure would create substantial intermediary requirements or issuer requirements if there is no intermediary. This key mandate for investor protection is one reason the bill has received broad, bipartisan congressional support, as well as backing from the Obama Administration. Crowdfunding describes a form of capital raising where, according to SEC Chair Mary Schapiro, groups of people pool money, typically composed of very small individual contributions, to support an effort by others to accomplish a specific goal. The concept of crowdfunding focuses on collective cooperation where investors try to get funding publicly instead of from personal contacts. The network is large, and many investors are often found.

The committee report accompanying the measure finds that current SEC regulations impede this innova-tive and lower-risk form of financing by prohibiting gen-eral solicitation and advertisements for non-registered offerings and by capping the number of shareholders for nonregistered companies at 500 [H. Rep. No. 112-262]. The legislation provides that persons who hold securities issued pursuant to the crowdfunding exemption will not count against the shareholder threshold cap in Exchange Act Section 12(g). By exempting these offerings from SEC registration, and by preempting state registration laws, the measure would enable entrepreneurs to access capital from potential investors across the United States more easily, resulting in business expansion and job growth [H. Rep. No. 112-262].

The JOBS Act would require issuers and intermediar-ies to fulfill a number of requirements in order to avail themselves of this new exemption. These requirements, which include notices to the SEC about the offerings and parties to the offerings that will be shared with the states, are designed to reduce the risk of fraud in these offerings and thereby protect investors. The legislation would also allow for an unlimited number of investors to invest via a crowdfunding offering and preempts state securities registration laws. However, the legislation

would not restrict the states’ ability to discover, stop and prosecute fraudulent offerings [H. Rep. No. 112-262].

Representative Jared Polis (D-CO) noted that the crowdfunding legislation would allow a business to raise money from small investors across the country. There is no legal way to do that until the legislation is enacted. Currently, entrepreneurs without access to capital cannot raise funds in small tranches without incurring SEC oversight, said Rep. Polis, adding that the legislation “effectively allows working American families to raise money for their ideas by crowdsourc-ing, or raising money over the Internet” [Cong. Rec. (Nov. 3, 2011 p. H7286].

Moreover, said Rep. Polis, the legislation limits any loss an investor may incur to 10 percent of his or her income. Thus, a person who makes $80,000 can only invest, and thus potentially lose, $8,000 per year under the legislative framework [Cong. Rec. (Nov. 3, 2011), p. H7284].

The legislation provides that an issuer or intermediary may rely on certifications provided by the investor to verify the investor’s annual income. Representative McHenry, who is chairman of the House TARP and Financial Services Subcommittee, added several investor protections to the original bill. These are extensive investor protections demanded of the intermediary and, if there is no intermediary, the issuer. Under H.R. 3606, the issuer must warn investors on its website of the speculative nature of investments in startups, emerging businesses and small issuers, and risks in the secondary market related to illiquidity. Investors must also be warned that they are subject to restrictions on sale.

Also, the issuer must require each potential investor to answer questions demonstrating competency in the recognition of the level of risk applicable to investments in startups, emerging businesses and small issuers, including the risk of illiquidity and other areas that the SEC may deem appropriate. The issuer must also maintain any books and records that the Commission determines appropriate.

Moreover, the issuer must take reasonable measures to reduce the risk of fraud with respect to the transactions. The issuer must also provide the SEC with its physical address, website address, and the names of its principals and employees and keep this information up-to-date, as well as provide the Commission with continuous investor-level access to the issuer’s website. The issuer must also provide the Commission with basic notice of the offering not later than the first day funds are solicited from potential investors. The notice must state the purpose and intended use of the capital formation

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funds sought by the issuer and the target offering amount. In turn, the SEC must make this information available to state authorities.

The issuer must state a target offering amount and withhold capital formation proceeds until the aggregate capital raised from investors other than the issuer is at least 60 percent of the target offering amount. Moreover, the issuer must outsource cash-management functions to a qualified third-party custodian, such as a traditional broker or dealer or insured depository institution. The issuer’s website must offer a method of communication with its investors, and the must disclose to potential investors that the issuer has an interest in the offering. In addition, the issuer cannot offer investment advice.

Representative Scott Garrett (R-NJ), Chairman of the Capital Markets Subcommittee, stressed the importance of the bill’s investor safeguards, notably the requirement that investors be warned of the speculative nature of investing in startups and of the restrictions on sale requirements that can affect the liquidity of their invest-ments on the secondary market. Furthermore, providing the SEC with continuous investor-level access to the issuer’s website is important, emphasized Chairman Gar-ret, because Congress wants to ensure that information being conveyed to investors is the same information that the SEC has [Cong. Rec. (Nov. 3, 2011), p.7289].

Chairman McHenry crafted a Managers’ Amendment to the underlying crowdfunding section of the legislation based on post-markup feedback from the SEC staff. While the Managers’ Amendment was primarily a technical amendment, it did contain some substantive changes to the legislation. It requires the issuer to state a target offering amount and a deadline to reach the target offering amount and to ensure that the third party custo-dian withholds offering proceeds until aggregate capital raised from investors other than the issuer is at least 60 percent of the target offering amount. The issuer must also provide the SEC with a notice upon completion of the offering, which must include the aggregate offering amount and the number of purchasers. Consistent with legislative history that the intermediary facilitating crowdfunding is not envisioned to be a broker-dealer (see discussion below), the Managers’ Amendment provides that with respect to a crowdfunding transaction involv-ing an intermediary, the intermediary will not have to register as a broker under Exchange Act Section 15(a)(1) solely by reason of participation in the transaction.

The Managers’ Amendment also clarifies that the disqualification provision ensures that both issuers and intermediaries, as well as their predecessors, affiliates, officers, directors, or persons fulfilling similar roles, are disqualified from the exemption established in the

legislation should they have a history of committing securities fraud. According to Chairman McHenry, the ramifications of not modernizing federal securities regulations have led to registration and reporting requirements so onerous and costly that small companies have great difficulty raising capital. For instance, if a startup company offers an equity stake to investors through a medium like Facebook or Twitter, it is presumably in violation of SEC regulations for that communication and offering. However, soliciting money for one’s favorite charity or even a political candidate through the same Internet medium is per-fectly legal. Furthermore, high-net-worth individuals can invest in businesses before the average family can. And a small business is limited in the amount of equity stakes it can provide investors and in the number of investors it can attain.

The Entrepreneur Access to Capital Act is all about opening these capital markets to the average investor, emphasized Chairman McHenry, by removing the SEC restrictions on crowdfunding to allow entrepreneurs and small businesses to raise capital from everyday investors. Already prevalent in Europe and Asia, he noted, crowdfunding has proven that broadening the communication and investment capabilities for investors and entrepreneurs can have a positive impact on capital formation [Cong. Rec. (Nov. 3, 2011), p. H7295].

In a colloquy with Chairman McHenry, Rep. Ed Perlmutter (D-CO), noting that the legislation creates a new exemption from registration under the Securities Act for what Congress calls “crowdfunding” securities but does not define that term, submitted a definition for the record that crowdfunding refers to a technique for raising money over the Internet in relatively small amounts from a large number of people. Chairman McHenry generally agreed with this assessment, adding that the intention is to have an Internet portal of sorts, but this could be done on any mass basis. He noted, however, that the legisla-tion specifies that disclosures must be clear, and the SEC has authority to require additional disclosures [Cong. Rec. (Nov. 3, 2011), p. H7297].

In colloquies with Rep. Perlmutter and Chairman Garrett, Chairman McHenry clarified that intermediar-ies are not intended to be broker-dealers but rather to act as a low-cost conduit for capital formation and provide a means by which to do that. He further noted that the investor protections outlined in the legislation with regard to the intermediaries, and on how they are to operate, are there to enable them to be low-cost but also preserve individuals’ capital and make sure their investments are appropriately handled. Chairman

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Garrett added that broker-dealers may not be interested in a $25,000 or $50,000 or $100,000 enterprise, and that is another reason broker-dealers are not envisioned to be intermediaries under the legislation.

Agreeing with that statement, Chairman McHenry added that traditional broker-dealers will not be in this market. The congressional intent with these low-dollar issuances is to carve out opportunities for small busi-nesses. Representative Perlmutter understands that the intermediary will be the conduit, and not the custodian, of the funds. However, one of the intermediary’s responsibilities is to outsource the cash-management responsibilities to qualified third-party custodians, such as broker-dealers or insured depository institutions, a concern that Congress had as the legislation moved through committee. The requirement that offering proceeds be withheld until at least 60 percent of the target is raised is intended to alleviate this concern [Cong. Rec. (Nov. 3, 2011), p. H7299].

State Preemption

A bipartisan agreement preserving state enforcement authority allowed the legislation to move forward but, according to some, did not go far enough in preserving the power of state authorities. The Perlmutter-McHenry Amendment ensures that state securities regulators have the means to police fraud, deceit, misrepresentation and other unlawful behavior to protect investors.

Because state securities regulators already have the resources and expertise to examine unlawful behavior at a micro level, said Chairman McHenry, it is essential that this legislation authorize them to continue to fight unlawful conduct. The powers of state securities regula-tors are no different with respect to crowdfunding than with respect to any covered security [Cong. Rec. (Nov. 3, 2011), p. H7306].

Explicating further on the amendment, Rep. Perlmutter said that the legislation’s structure is such that when an issuer solicits small investments, the SEC is notified. Once that notification is made, each state is notified of the solicitation. The Perlmutter-McHenry Amendment ensures that when the states get this notice, they can use their enforcement authority to stop fraud or other bad acts. This police power extends to both the issuer and the intermediaries [Cong. Rec. (Nov. 3, 2011), p. H7306].

According to Rep. Melvin Watt (D-NC), the Perlmut-ter-McHenry Amendment still preempts state law and fails to address the fundamental concern that states have had with the legislation since its introduction, which

is the preemption of state authority to review securities prior to their offering.

Chairman McHenry said that crowdfunding will not work without the exemption from individual state registration. When it costs $150 to register a security in Connecticut, explained the sponsor, and a person is only trying to raise $150 from Connecticut, the person nets zero. The legislation’s intent is to preserve state antifraud enforcement, said Chairman McHenry, which the states do well. According to Rep. Perlmutter, the purpose of the state exemptive provision is to create a national solicitation notification to the SEC followed by execution of the powers of the states, as opposed to individual notification state by state. The SEC has its police powers as well if there is any fraud, manipula-tion or misrepresentation [Cong. Rec. (Nov. 3, 2011), pp. H7307-7308].

A bipartisan amendment crafted by Rep. Al Green (D-TX) and Rep. Michael Grimm (R-NY) ensures that crowdfunding proceeds are not handled by persons who have been convicted of either state or federal securities fraud. The amendment would require that the SEC construct appropriate measures, by regulation or rule, to prevent these persons from handling the money. Thus, the SEC must adopt regulations under which an issuer or intermediary would not be eligible to use the crowdfunding exemption based on the disciplinary history of the issuer or intermediary or its predecessors, affiliates, officers, directors or persons fulfilling similar roles. The provisions must be substantially similar to the disqualification provisions contained in the regula-tions adopted in accordance with Section 926 of the Dodd-Frank Act. A provision added to the Act by an amendment offered by Rep. Carolyn Maloney (D-NY) requires issuers to provide notice to the SEC that they intend to engage in crowdfunding. The SEC must then make that notice available to the state securities regula-tors. With that knowledge, said Rep. Maloney, the states can better protect investors [Cong. Rec. (Nov. 3, 2011), p. H7299].

Inflation Adjustments

Two amendments would index portions of the legisla-tion to inflation. The Fincher-Sherman Amendment provides for adjustments for inflation the $1 million and $2 million caps in the underlying legislation. As the real value of money decreases over time, noted Rep. Stephen Fincher (R-TN), small-contribution investors may be discouraged from supporting start-up companies in the future due to the diminishing

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buying power of their original investments. By index-ing consumer price index, he emphasized, Congress “will continue to allow investment opportunities for Main Street Americans … to pool their money and support entrepreneurs in their communities.” [Cong. Rec. (Nov. 3. 2011), p. H7302].

Similarly the Quayle Amendment removes what Rep. Ben Quayle (R-AZ) calls “an unnecessary barrier to allow startups and small businesses to raise capital through individual investments of up to $10,000, or 10 percent of an investor’s income.” He explained that the amendment would simply index this individual investment cap to inflation [Cong. Rec. (Nov. 3, 2011), p. H7303].

In supporting the two inflation-adjusting amend-ments, Chairman McHenry noted that too often when legislation is not indexed for inflation, Congress must go back and amend current laws. Because the need for small businesses to have access to capital is constant, he observed, Congress should index the investment cap for inflation [Cong. Rec. (Nov. 3. 2011), p. H7303].

Rejected Amendments

An amendment offered by Rep. Nydia Velázquez (D-NY) requiring disclosure to potential investors of the intermediary’s compensation structure for participa-tion in the security offering was rejected. In opposing the amendment, Chairman McHenry mentioned the enormous amount of investor protection already in the legislation. He said that Congress wants crowdfunding intermediaries to compete with one another to offer the best platform and technology for both issuers and investors. Businesses are free to work with different intermediaries, and if they do not see an intermediary that fits with their cost structure, he reasoned, they can be their own intermediary. He said that forcing intermediaries to disclose the compensation structure to potential investors would have a chilling effect on compensation in the market and the participation of potential intermediaries in this mode [Cong. Rec. (Nov. 3, 2011), p. H7304].

An amendment offered by Rep. John Barrow (D-GA) requiring that the offering contain a link to a website maintained by the SEC where the SEC will post a comprehensive set of warnings and safety tips to public investors was also rejected. In opposing the Barrow Amendment, Chairman McHenry expressed discomfort with requiring intermediaries of what is an exempt offering under securities law to link to the SEC’s website. In his view, it gives the stamp of ap-

proval to the exempt offering and might create more confusion, not necessarily by Rep. Barrow’s intent, but by the design of the legislation and by the legisla-tive text in the amendment. Chairman McHenry added that he is hopeful that when the legislation is signed into law that the SEC would create an investor alert regarding crowdfunding investments like it did with microcap stock, a guide for investors available on the SEC’s existing website [Cong. Rec. (Nov. 3, 2011), p. H7306].

Obama Administration Support

In a policy statement, the Obama Administration said it supports passage of the Entrepreneurial Access to Capital Act to allow crowdfunding, with appropriate investor protections, to finance new businesses. In his September 8 address to a joint session of Congress on jobs and the economy, President Obama called for cutting away the red tape that prevents many rapidly growing startup companies from raising needed capital, including through a crowdfunding exemption from the require-ment to register public securities offerings with the SEC.

This proposal, which would enable greater flexibility in soliciting relatively small equity investments, grew out of the President’s Startup America initiative and has been endorsed by the President’s Council on Jobs and Competitiveness. The policy statement notes that the crowdfunding piece is broadly consistent with the President’s proposal. The legislation would make it easier for entrepreneurs to raise capital and create jobs. The Administration said that it looks forward to continuing to work with Congress to craft legislation that facilitates capital formation and job growth and provides appropri-ate investor protections.

Senate Companion Bill S 1791: The Democratizing Access to Capital Act (S. 1791), sponsored by Sen. Scott Brown (R-MA), would authorize crowdfunding of an aggregate annual amount raised through the issue of the securities during any 12-month period by an incorpo-rated entity formed under state law to $1 million or less, and individual investments in the securities would be limited to a maximum aggregate annual amount of $1,000. S 1791 would amend the Securities Act to preempt state law with respect to the regulation of crowdfunded securities. It would subject crowdfunding intermediaries to state authority to investigate and au-thorize enforcement actions with respect to fraud, deceit or unlawful conduct in connection with securities or securities transactions

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Title IV: Small Company Formation

Title IV of the legislation is the Small Company Formation Act. Authored by Rep. David Schweikert (R-AZ), the title would increase the offering threshold for companies exempted from SEC registration under Regulation A from $5 million to $50 million. The SEC has the authority to raise this threshold but has not done so for almost two decades. Congress believes that amending Regulation A to make it a viable chan-nel for small companies to access capital will permit greater investment in these companies, resulting in economic growth.

Securities Act Section 3 authorizes the SEC to exempt small securities offerings from registration. Under Section 3, the SEC promulgated Regulation A, which exempts public offerings of less than $5 million in any 12-month period. The SEC set the threshold at $5 million in 1992, where it has remained unchanged to the present day.

The exemption requires an offering document to be filed with the SEC, which is subject to SEC staff review. The exemption sets forth information requirements that are simpler than those required in registered offerings, including allowing companies to provide the disclosure in a question and answer format, and allows companies to test the waters for interest in their offerings before they incur the full expense of preparing the Regulation A offering document.

The legislation directs the GAO to conduct a study on the impact of state blue sky laws on offerings made under Regulation A and report to Congress on the results of the study within three months of enactment. The legislation encourages small companies to access the capital markets by creating a less burdensome process for raising capital. Congress believes that smaller companies considering raising capital could benefit from Regula-tion A because raising capital under a Regulation A exemption is less costly and time consuming than using a conventional IPO subject to reporting and registration requirements [H. Rep. No. 112-206].

Issuers and market participants have complained that the offering threshold is too low to justify the costs of going public under Regulation A. Moreover, inflation has risen approximately 165% since 1980, when Con-gress authorized the SEC to set the offering threshold, and this has exacerbated the imbalance between costs and benefits. Between 1995 and 2004, companies used Regulation A only 78 times; in 2010, only three times.

According to Congress, the low number of Regulation A filings, each for the maximum amount of $5 million, demonstrates that a revision to Regulation A is necessary. In order to increase the use of Regulation A offerings and help make capital available to small companies, the measure would increase the offering threshold to $50 million [H. Rep. No. 112-206].

Congress posits that small companies are critical to U.S. economic growth. By reducing the regulatory burden and expense of raising capital from the invest-ing public, the legislation would make it viable for small companies to access capital by permitting greater investment in these companies, resulting in economic growth and job creation. Regulation A offerings can also help entrepreneurial businesses attract private capital at lower costs than might be feasible in an initial public offering using full SEC registration procedures [H. Rep. No. 112-206].

Specifically, the legislation would amend Securities Act Section 3 and require the SEC to add a class of exempt securities with the following characteristics: (1) the aggregate offering amount of all securities sold within the prior 12-month period in reliance on the exemption cannot exceed $50 million; (2) the securities may be offered and sold publicly; (3) the securities cannot be restricted securities within the meaning of the federal securities laws; and (4) the securities must be equity securities, debt securities or debt securities convertible or exchangeable to equity interests [H. Rep. No. 112-206].

The legislation would allow the issuer to solicit interest in the offering prior to filing any offering statement, on terms and conditions that the SEC may prescribe in the public interest or for investor protec-tion. The Commission must require issuers to submit an audited financial statement annually. The legislation would also authorize the SEC to set forth other terms and conditions for these offerings, which may include a requirement that the issuer of the securities prepare and electronically file with the Commission, and distribute to investors, an offering statement and disqualification provisions under which the exemption must not be available. The disqualification provisions must be substantially similar to the disqualification provisions contained in the regulations adopted in accordance with Dodd-Frank Act Section 926.

The measure would also subject Regulation A pro-spectuses to liability under Securities Act Section 12(a)(2). The legislation would allow the SEC to require the issuer to make available to investors periodic disclosures regarding the issuer, its business operations, its financial condition, its corporate governance principles and its

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use of investor funds. The legislation also requires the SEC to review the offering amount every two years and to increase the amount as the Commission determines appropriate. If the SEC determines not to increase the amount, it must report to the House Committee on Financial Services and the Senate Banking Committee on its reasons for not increasing the amount [H. Rep. No. 112-206].

The legislation would exempt from state securities laws securities issued using Regulation A that are: (1) offered or sold through a broker or dealer; (2) offered or sold on a national securities exchange; or (3) sold to a qualified purchaser as defined by the SEC [H. Rep. No. 112-206].

Senate Companion Bill S 1544: Sponsored by Sen. John Tester (D-MT), S 1544 would amend the Securities Act to direct the SEC to exempt from regulation a class of securities for which the aggre-gate offering amount of all securities offered and sold within the prior 12-month period in reliance on the exemption is between $5 million and $50 million, subject to specified terms and conditions. It would limit such an exemption to equity securities, debt se-curities, and debt securities convertible or exchange-able to equity interests, including any guarantees of the securities. It would authorize the SEC to require an issuer of the exempted class of securities to make periodic disclosures available to investors regarding the issuer, its business operations, its financial condi-tion, and its use of investor funds and provide for the suspension and termination of such a requirement with respect to that issuer. S 1544 would also direct the Comptroller General to study the impact of state laws regulating securities offerings on offerings made under Regulation A.

Titles V and VI: 500-Shareholder ThresholdTitle V of the JOBS Act is the Private Company Flex-ibility and Growth Act, authored by Rep. David Sch-weikert (R-AZ). This measure increases the number of shareholders that can invest in a private company from 500 to 2,000, only 500 of which can be non-accredited investors, with 1500 having to be accredited investors as defined by the SEC. Originally, Title V raised the 500-shareholder threshold to 1,000. The threshold was raised to 2,000 pursuant an amendment offered by Rep. Brad Miller (D-NC).

Many small businesses are forced to file as a public company because of regulations that require companies with 500 shareholders and $10 million in assets to file with the SEC. This current shareholder threshold rule was originally adopted in 1964 and has not been mod-ernized since that time. This limitation causes undue pressure on the financial markets because it restricts the number of shareholders and assets that these companies can have, which severely limits the growth stages for companies in need of the time and flexibility to develop. Without regulatory relief, these small businesses will not grow or will be acquired by larger firms, leading to fewer jobs and less innovation.

The legislation would increase the number of share-holders that can invest in a private company from 500 to 2,000. It also would exempt employees from that count. The measure would amend Exchange Act Section 12(g) to trigger SEC reporting at 2,000 shareholders held of record, and the definition of “held of record” would not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration require-ments of Securities Act Section 5.

The legislation directs the SEC to revise the definition of “held of record” pursuant to Exchange Act Section 12(g)(5) to implement these changes. The Commission must also adopt safe harbor provisions that issuers can follow when determining whether holders of their securities received the securities pursuant to employee compensation plans in exempt transactions. Rep. Melvin Watt (D-NC) questioned whether the “can” should be changed to “must” in the legislative language, meaning an issuer qualifying for the safe harbor would have to use it, but the legislation retained the “can follow” language, allowing issuers discretion.

The House approved a floor amendment offered by Rep. Schweikert directing the SEC to examine its authority to enforce Rule 12g5-1 to determine if new enforcement tools are needed to enforce the anti-evasion provision contained in subsection (b)(3) of the rule, and must, within 120 days of enactment, transmit its recommendations to Congress.

Enacted in 1964, Exchange Act Section 12(g) requires companies with more than $10 million in assets whose securities are held by more than 500 owners to file annual and other periodic reports with the SEC, reports that become available to the public through the SEC’s EDGAR database. Although the $10 million threshold has been incrementally increased over the years from the $1 million level initially set in 1964, the 500-share-holder requirement has never been updated.

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In testimony before the House Oversight and Govern-ment Reform Committee, SEC Chair Mary Schapiro noted that, shortly after the enactment of Section 12(g), the Commission adopted rules defining the terms “held of record” and “total assets.” The definition of “held of re-cord” counts as holders of record only persons identified as owners on records of security holders maintained by the company in accordance with accepted practice. The chair explained that the Commission used this definition to simplify the process of determining the applicability of Section 12(g) by allowing a company to look to the holders of its securities as shown on records maintained by it or on its behalf, such as records maintained by the company’s transfer agent [Testimony of SEC Chair Mary Schapiro before the House Committee on Oversight and Government Reform (May 10, 2011)].

But Chairman Schapiro observed that the securities markets have changed significantly since the enactment of Section 12(g). Also, since the definition of “held of record” was put into place, a fundamental shift has occurred in how securities are held in the United States. Today, the vast majority of securities of public compa-nies are held in nominee or street name. This means that brokers that purchase securities on behalf of investors typically are listed as the holders of record. One broker may own a large position in a company on behalf of thousands of beneficial owners, she noted, but because the shares are all held in street name, they are counted as being owned by one holder of record.

Chairman Schapiro added that a staff review of the 500-shareholder test is front and center on the Commis-sion’s agenda. Chairman Schapiro emphasized that the Commission is absolutely committed to determining if the 500-shareholder limit still makes sense and intends to do a thorough and rigorous analysis of this threshold. In testimony, she noted that the review will require the gathering of economic data and analysis because the SEC needs to understand the characteristics of these compa-nies and how their shareholders hold positions, whether in record name or in the name of the beneficial owner.

Senate Companion Bill S 1824: The Private Com-pany Flexibility and Growth Act (S 1824), sponsored by Sen. Pat Toomey (R-PA), would amend the Securities Exchange Act to change the thresholds for total assets and for class of equity security holders of record that trig-ger the requirement for a securities issuer to register with the SEC from 500 to 2,000 persons. It would declare that, with respect to this registration requirement, the definition of “held of record” does not include securi-ties held by persons who received them pursuant to an

employee compensation plan in transactions exempted from specified registration requirements of the Securities Act. S 1824 would direct the SEC to revise the defini-tion of “held of record” in accordance with the Act and to adopt safe harbor provisions that issuers can follow to determine whether holders of securities have received securities pursuant to an employee compensation plan in an exempt transaction.

S 1824 would also exclude from the identity of municipal advisor (subject to registration requirements) any person appointed to or volunteering on a board, commission, committee or similar function of a municipal entity. It would exempt from these registration requirements any banks, including agencies or branches of a foreign bank.

Title VI of the Act, authored by Rep. Ben Quayle (R-AZ), would increase the number of shareholders permit-ted to invest in a community bank from 500 to 2,000. Thus, the legislation updates the federal securities laws to ensure that smaller community banks need not register with the SEC and comply with burdensome reporting requirements that are intended for larger corporations. This piece of the legislation is designed to enable banks to better deploy their capital to make loans and create jobs rather than comply with SEC requirements.

Currently, both banks and private companies are subject to a 500-investor threshold, which limits the amount of capital they can raise before they must com-ply with the reporting requirements associated with SEC registration. The legislation would modify Exchange Act Section 12(g). Title VI would also require termination of a security registration in the case of a bank or a bank holding company if the number of holders of record of the class of security drops to less than 1,200.

Title VI is similar to H.R. 1965, authored by Rep. Jim Himes (D-CT), who noted that the threshold could be set at 2,000 shareholders for banks, while the private-company threshold is raised to 1,000 sharehold-ers, because this piece of legislation deals with heavily regulated financial institutions. H.R. 1965 was approved by the House last year by a vote of 420-2.

Title VI dropped a provision in H.R. 1965 that would have directed the SEC Chief Economist and the Director of the Division of Corporation Finance to study and make a cost-benefit analysis of shareholder registration thresholds and report to Congress in two years. The cost-benefit analysis must take into account the incremental costs and benefits to investors of the increased disclosure that results from registration and the incremental costs and benefits to issuers associated with

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registration and reporting requirements, as well as the incremental administrative costs to the SEC associated with different thresholds. In addition, the cost-benefit analysis must evaluate the advisability of: (1) increasing the asset threshold; (2) indexing the asset threshold to a measure of inflation; (3) increasing the shareholder threshold; (4) changing the shareholder threshold to be based on the number of beneficial owners; and (5) creating new thresholds based on other criteria.

Senate Companion Bill S 1941: Bipartisan leg-islation introduced by Sen. Kay Bailey Hutchison (R-TX), S 1941, would raise the 500-shareholder threshold for SEC reporting to 2,000 for banks and bank holding companies. Co-sponsored by Sen. Mark Pryor (D-AK), the legislation would also raise the SEC decertification of registration thresh-old from 300 shareholders to 1,200 for banks and bank holding companies. In a 2008 letter to then-SEC Corporation Finance Director John White, the American Bankers Association explained that, for the banking industry, the shareholder number is the only meaningful Section 12(g) measure, as 99 percent of all banks have assets in excess of $10 million. The ABA noted that retaining the outdated shareholder threshold makes it difficult for banks to raise capital in their local communities for fear that they will trigger the 500-shareholder threshold.

Title VII: Outreach on Law ChangesTitle VII of the JOBS Act contains one provision requiring SEC outreach to certain businesses informing them about the law’s effect. The House approved a floor amendment offered by Rep. Dave Loebsack (D-Iowa), codified as Section 701 of the Act, directing the SEC to

provide online information and conduct outreach to in-form small and medium-sized businesses, women-owned businesses, veteran-owned businesses and minority-owned businesses of the changes made by the Act. The amendment is designed to ensure that small businesses that may face unique challenges are fully aware of the legislation’s benefits. r

About the AuthorJames Hamilton is a Principal Analyst at Wolters Kluwer Law & Business, a leading provider of corpo-rate and securities information and a prolific blogger (Jim Hamilton’s World of Securities Regulation, at http://jimhamiltonblog.blogspot.com). Hamilton has been tracking, analyzing and explaining securities law and regulation for over 30 years as an analyst for Wolters Kluwer Law & Business. He has written and spoken extensively on federal securities law and is cited as an authority in the Senate Banking Commit-tee Report (S. 111-176) of the Dodd-Frank Act. His analysis of that legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act: Law, Explanation and Analysis, is widely read. His earlier analysis of the Sarbanes-Oxley Act, the Sarbanes-Oxley Manual: A Handbook for the Act and SEC Rules, is considered a definitive explanation of the Act. His other works include the popular guidebook Responsibilities of Corporate Officers and Directors under Federal Securities Law, the Guide to Internal Controls, and the monthly newsletter Hedge Funds and Private Equity: Regula-tory and Risk Management Update. In addition to his many books and articles, Hamilton serves as a leading contributor to the industry-standard publication, the Federal Securities Law Reporter. Hamilton received an LL.M. from New York University School of Law.

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