SEC Proposes Broad Capital Formation and Reporting Reforms

The Securities and Exchange Commission recently voted to propose a series of reforms to its rules governing capital formation and reporting. These proposals will significantly benefit smaller companies, although larger public companies will also benefit from some of the proposals. The principal changes include the following, among others:

• reduced disclosure and reporting requirements for companies with a common equity public float of less than $75 million;
• access to “short form” registration on Forms S-3 and F-3 by the same companies for public offerings that do not exceed 20% of their public float in a one-year period;
• expansion and revision of existing registration exemptions for private offerings under Regulation D, including a new exemption for sales with limited public advertising to specified wealthy individuals and institutions;
• enhanced access to the Rule 144 and Rule 145 safe harbors for public resales of restricted securities, including shortened holding periods for resales of securities of reporting companies; and
• exemptions that will reduce the circumstances under which non-reporting companies can become subject to SEC reporting requirements as a result of issuances of compensatory stock options.

Many of these proposed amendments reflect recommendations of the SEC’s Advisory Committee on Smaller Public Companies. The summary that follows is based on oral statements made by members of the staff of the SEC at an open meeting on May 23, 2007 and written statements published on the SEC website. In addition to the proposed rulemaking summarized above, the SEC also approved interpretive guidance and new rules relating to evaluation of internal control over financial reporting, and proposed a new rule defining “significant deficiency,” under Section 404 of the Sarbanes-Oxley Act of 2002. The SEC did not take any action at the meeting to extend the current dates for compliance with Section 404 and related SEC rules by non-accelerated filers. The full text of the proposals, and the action with respect to Section 404, was not available at the time this Alert was published. The proposals will be subject to public comment for 60 days after publication in the Federal Register, and the effective dates of the proposals, if adopted, is uncertain.

Disclosure and Reporting Requirements

The first proposal would amend existing disclosure and reporting requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934 to combine the current “small business issuer” and “non-accelerated filer” categories of smaller companies into a new category of “smaller reporting companies” for most purposes. This would increase the number of companies eligible for the reduced disclosure and reporting requirements for smaller public companies under SEC rules and significantly reduce the cost of reporting for these companies. Under the proposals, eligibility for the reduced reporting and disclosure requirements would be based on common equity public float of less than $75 million, rather than the existing standards of common equity public float and revenue of less than $25 million. The amendments would also integrate the new disclosure requirements into the generally applicable requirements of Regulation S-K and eliminate the current SEC “SB” rules and forms. Eligible companies could choose, on an item-by-item basis, whether to take advantage of the reduced disclosure requirements for smaller companies or to provide the same disclosure as larger companies.

Access to “Short Form” Registration (Forms S-3 and F-3) for Public Offerings

The next proposal would make the “short form” registration statements (Forms S-3 and F-3) available for specified public offerings by companies that do not meet the existing common equity public float requirement of $75 million. The ability to use Forms S-3 and F-3 for public offerings would make the significant timing and cost savings benefits of these forms available to smaller public companies for the first time. The amendments would allow public companies with less than $75 million in public float to register primary offerings of their securities on these forms, provided these companies:

• have filed their Securities Exchange Act reports on a timely basis for at least one year and satisfy the other applicable eligibility conditions for the use of Form S-3 or Form F-3;
• are not “shell companies” and have not been shell companies for at least one year before filing the registration statement; and
• do not sell more than the equivalent of 20% of their public float in primary offerings registered on Form S-3 or Form F-3, as applicable, over any one-year period.

Expansion and Revision of Regulation D for Private Offerings

The SEC has proposed several changes that will amend the exemption for unregistered offerings provided by Regulation D. These amendments will reduce current regulatory burdens on smaller companies and others that rely on Regulation D to raise capital in private offerings.

New Rule 507 “Qualified Purchaser” Exemption. The first of the proposed Regulation D amendments would create a new exemption under Regulation D for unregistered sales of securities to “Rule 507 qualified purchasers” – and allow companies to engage in limited, tombstone-like advertising as part of the offering process – as long as they sell the securities only to a new category of investors called “Rule 507 qualified purchasers.” The proposed definition of “Rule 507 qualified purchaser” would include the following:

• individuals who own at least $2.5 million in investments or have annual income of at least $400,000 individually or $600,000 with their spouses; 
• institutional investors that qualify as “accredited investors,” as currently defined, without having to satisfy monetary thresholds; and
• directors, executive officers and general partners of the issuer.

Revised Definition of “Accredited Investor.” The proposed amendments would also revise the existing “accredited investor” definition under Regulation D by adding an alternative way for individuals to qualify for accredited investor status. The proposals would create a new “investments-owned” category of accredited investors who own at least $750,000 of investments (for individuals) or $5 million (for institutions). The new test for accredited investor status would be in addition to the current standards based on total assets, net worth and income levels. The proposals would also add several new categories of entities to the list of accredited investors. In addition, the proposals would add an adjustment for inflation to the monetary thresholds for accredited investors and Rule 507 qualified purchasers, starting in 2012.

Additional Regulation D Proposals. Additional proposed changes to Regulation D include reducing the minimum safe harbor period for integration of offerings under Regulation D from six months to 90 days and providing uniform, updated “bad actor” disqualifications for all Regulation D offerings, rather than only Rule 505.

Form D Changes and Electronic Filing. The final proposal affecting Regulation D would revise the information required to be filed and require electronic filing of Form D, which is the notice filing by companies that have sold securities in a private offering under Regulation D. The SEC would develop an online filing system that would be accessible from any computer with Internet access. One result of electronic filing would be electronic access to the information in Form D filings by regulators and the public for the first time.

Enhanced Access to Rule 144 and Rule 145 Safe Harbor for Resales of Restricted Securities

The final series of proposals would amend Rule 144 and Rule 145 under the Securities Act, which provide safe harbors for resales of securities that satisfy certain conditions. These proposals will, if adopted, improve liquidity for investors who acquire “restricted securities” (generally, securities not acquired in a public offering) by shortening holding periods and reducing the conditions for public resales, especially for persons who are not affiliated with the issuer of the securities. Among the proposed changes are the following:

Shortened Holding Period. The SEC proposals will change the current Rule 144 holding period for restricted securities from one year to six months if the issuer of the securities is a reporting company and has been a reporting company for at least 90 days before the sale of the securities. The current one-year holding period would continue to apply to restricted securities issued by non-reporting companies. This new six-month holding period would be suspended during any period during which a security holder has a short position or has entered into a put equivalent position with respect to the securities. However, the tolling provision would not apply if the security holder has held the securities for one year or more, regardless of any hedging activity. As a result, the proposed tolling provision would not impose a holding period greater than the current one year holding period.

Simplified Conditions for Resales. The SEC proposals would simplify compliance with Rule 144 by both non-affiliates and affiliates of the company that issued the securities. In the case non-affiliates with restricted securities of a non-reporting company, the proposed amendments would allow resales without any additional conditions under Rule 144 after a one-year holding period, rather than the current two-year period. A non-affiliate with restricted securities of a reporting company could resell the securities without complying with any additional conditions of Rule 144 if current information concerning the company is publicly available after the new six-month holding period, subject to the tolling provision described above. The current public information requirement would not apply to resales more than one year after the non-affiliate acquired the securities.

For persons who are affiliates of the company that issued the securities, the SEC proposals would raise the thresholds for the Form 144 notice filing requirement and, for resales of debt securities, eliminate the existing manner of sale conditions. The proposals would also codify several unspecified staff interpretive positions relating to Rule 144.

The SEC proposals would also amend Rule 145, which imposes conditions on resales of securities received in business combination transactions. Under the proposed amendments, securities received by parties to specified business combination transactions and their affiliated persons would be transferable without restriction under Rule 145, although other restrictions on resales may continue to apply. Resales of securities received by these parties in transactions involving “blank check” companies, and shell companies not involved in a business combination transaction, would continue to be subject to the conditions of Rule 145, although these conditions would be harmonized with the previously described proposed changes to Rule 144.

Potential Coordination of Form 144 and Form 4 Filing Requirements. Finally, the SEC will solicit public comment on coordinating Form 144 notice filing requirements with the Form 4 requirement to report changes in beneficial ownership under Section 16 of the Securities Exchange Act. This would permit affiliates who are subject to Section 16 reporting requirements to satisfy the Form 144 notice filing requirement by filing a Form 4 reporting the sale of securities within two business days after the sale. The proposing release will also solicit comment on whether the SEC should revise Item 701 of Regulation S-K to require additional disclosure about the resale status of securities issued in unregistered transactions at the time the company first issues the securities.

Exemption from 1934 Act Registration for Compensatory Stock Options

Another proposal would create two new exemptions from the registration requirements applicable to employee stock options under Section 12(g) of the Securities Exchange Act. Section 12(g) currently requires a company with 500 or more holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year to register that class of equity security (and therefore become subject to the reporting requirements of the Securities Exchange Act if it is not so already) unless an exemption is available. Because stock options are a separate class of equity security from the underlying security under the Securities Exchange Act, a company that exceeds these tests must register that class of options, which can limit the use of equity compensation by private companies. The proposed exemptions would apply only to a company’s compensatory employee stock options and would not be available for the underlying class of securities.

Non-Reporting Companies. The first exemption would apply to compensatory employee stock options issued under a written plan by a non-reporting company under the following conditions:

• the plan limits eligible option holders to employees, directors and certain consultants and advisors;
• transfer of the shares received on exercise of the options and shares of the same class as those underlying the options is restricted; and
• the company provides financial and risk information to option holders and holders of shares received on exercise of the options similar to that required by Rule 701 if securities sold in reliance on Rule 701 exceeded $5 million in a 12-month period.

Reporting Companies. The second exemption would apply to compensatory employee stock options issued by companies that are subject to Securities Exchange Act reporting requirements. Among other conditions of the exemption, Securities Exchange Act Section 14 (proxy and information statement requirements) and Section 16 (beneficial ownership reporting, short-swing profits recapture and certain short sale prohibitions) would apply to both the options and the securities issuable on exercise of those options.