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From Securities Regulation Daily, May 7, 2014

House panel marks up and approves legislation expanding capital formation and giving relief to SBIC investment advisers

By Jim Hamilton, J.D., LL.M

The House Financial Services has marked up and approved a number of pieces of securities legislation, most of which are designed to enhance capital formation and some of which appear to have strong bi-partisan support. Rep. Jeb Hensarling (R-Tex.), the chairman of the full Financial Services Committee, said that many of the bills are a follow up on the JOBS Act and are aimed at job creation. It is not a question of regulation or de-regulation, said Chairman Hensarling, it is a question of doing smart regulation. All of the measures were approved by voice vote. However, a recorded vote was requested on every bill and such was ordered by Chairman Hensarling. It was unclear when the recorded votes will be conducted.

SBIC Advisers Relief Act. One of the most strongly bi-partisan pieces of legislation approved by the Committee is the SBIC Advisers Relief Act, H.R. 4200, introduced by Rep. Blaine Luetkemeyer (R-Mo.), which would amend the Investment Advisers Act to reduce unnecessary regulatory costs and eliminate duplicative regulation of investment advisers to small business investment companies. Specifically H.R. 4200 would allow advisers to venture capital funds to continue to be exempt reporting advisers if they also advise a small business investment company fund. The measure would also prevent the inclusion of the assets of a small business investment company fund in the SEC registration calculation of assets under management for those advisers that advise private funds in addition to small business investment company funds.

Currently, an adviser to a venture capital fund is exempt from SEC registration and an adviser to a small business investment company is exempt from registration. But, an adviser to both a venture capital fund and a small business investment company is not exempt. The legislation would exempt from SEC registration an investment adviser that advises both a venture capital fund and a small business investment company. H.R. 4200, which would fix an unintended consequence of the Dodd-Frank Act, has strong bi-partisan support. It is backed by Rep. Maxine Waters (D-Cal.), the committee’s ranking member. A co-sponsor of H.R. 4200, Rep. Carolyn Maloney (D-N.Y.), said that the measure restores the access of small businesses to broad investment advice and capital without compromising investor protection.

Restricted Securities Relief Act. The committee also approved the Restricted Securities Relief Act, H.R. 4554, introduced by Rep. Mick Mulvaney (R-S.C.), which would amend SEC Rule 144 to reduce from six months to three months the mandatory holding period before which restricted securities issued by an SEC reporting company may be resold to the public. H.R. 4554 would also amend Rule 144 to allow the public resale of restricted securities originally issued by a shell company starting two years after the date on which the company files a Form 8-K with the SEC disclosing that it is no longer a shell company. Finally, H.R. 4554 would amend Sec. 18(b) of the Securities Act to include in the definition of “covered securities” exempt from state regulation any security offered or sold in compliance with Rule 144A. Rep. Mulvaney noted that the provisions in the measure reducing the holding period from six months to three months and providing for shell company relief are based on recommendations in the SEC’s Government-Business Forum on Small Business Capital Formation Final Report for 2012.

Rep. Mulvaney noted that it is appropriate to reduce the Rule 144 holding period in light of the need to increase liquidity and the increasing speed of information being disseminated into the markets. He also noted that Canada has made the change to a three-month holding period.

The ranking member opposes H.R. 4554, noting that the SEC reduced the holding period from two years to six months, which is proper. The bill would also encourage PIPE transactions.

Small Business Freedom to Grow Act. This measure, H.R. 4568, introduced by Rep. Ann Wagner (R-Mo.), was also approved by the committee. H.R. 4568 would amend the SEC Form S-1 registration statement to allow a smaller reporting company to incorporate by reference any documents the company files with the SEC after the effective date of the Form S-1. The bill would also amend the SEC’s Form S-3 registration statement to allow a smaller reporting company with a class of common equity securities listed and registered on a national securities exchange to register a primary securities offering exceeding one-third of the company’s public float. Finally, the legislation would further amend the Form S-3 registration statement to allow a smaller reporting company without a class of common equity securities listed and registered on a national securities exchange to register a primary securities offering not exceeding one-third of the company’s public float.

Encouraging Employee Ownership Act. The committee also approved the Encouraging Employee Ownership Act, H.R. 4571, introduced by Rep. Randy Hultgren (R-Ill.), which would amend SEC Rule 701, originally adopted in 1988 under Sec. 3(b) of the Securities Act and last updated in 1998. Under current law, if an issuer sells, in the aggregate, more than $5 million of securities in any consecutive 12-month period, the issuer is required to provide additional disclosures to investors, such as risk factors, the plans under which offerings are made, and certain financial statements. The legislation would require the SEC to increase that threshold to $20 million. Rep. Hultgren noted that support for this effort to expand the utility of Rule 701 can be found in the SEC’s Government-Business Forum on Small Business Capital Formation Final Reports for 2001, 2004-2005 and 2013.

The legislation aims to encourage the idea of letting employees own a stake in company they are part of.. Ownership is a great incentive, noted the sponsor. Rule 701 mandates disclosure. The SEC arbitrarily set the threshold at $5 million, noted Rep. Hultgren. It is costly to prepare disclosures just so a company can offer stock to employees, said Rep. Hultgren. The bill, in addition to raising the threshold from 5 to 20 years, would also adjust it for inflation every five years.

Disclosure Modernization and Simplification Act. This measure, H.R. 4569, is a strongly bi-partisan measure that was approved by the committee and would direct the SEC to permit issuers to submit, on Form 10-K annual reports, a summary page to make annual disclosures easier to understand for current and prospective investors. The measure was introduced by Rep. Scott Garrett (R-N.J.), chair of the Capital Markets Subcommittee, who noted that the summary page would have cross-references to the annual report to aid investors in navigating what can be lengthy annual reports. The bill would also direct the SEC, within 180 days of enactment, to tailor Regulation S-K’s disclosure rules as they apply to emerging growth companies and smaller issuers and to eliminate other duplicative, outdated, or unnecessary disclosure rules as they apply to these smaller issuers. H.R. 4569 would also direct the SEC to identify and implement additional reforms to Reg. S-K to simplify and modernize SEC disclosure rules.

The committee approved an amendment offered by Rep. Maloney that would require the SEC to consult with the Investor Advisory Committee when studying Regulation S-K.

Private Placement Improvement Act. This piece of legislation, H.R. 4570, approved by the committee, is an effort to return the removal of the general solicitation in Rule 506 to the original intent of Congress when it passed the JOBS Act to eliminate the general solicitation requirement. In July 2013, the SEC implemented the JOBS Act by adopting a rule lifting the ban on general solicitation and advertising for certain private securities offerings under Rule 506 of Regulation D. According to Chairman Garrett, who introduced H.R. 4570, in addition to lifting the ban on general solicitation and advertising, the SEC issued a separate rule proposal not called for by Congress that would impose a number of new regulatory requirements on small companies seeking to utilize amended Rule 506 to raise capital, including proposals to submit additional Form D filings to the SEC in advance and at the conclusion of an offering, and to file written general solicitation materials with the SEC. Under the SEC’s rule proposal, an issuer could also be disqualified by the SEC from using Rule 506 for one year based on a failure to comply with the Form D filing requirements.

The comment period on these proposals closed on September 23, 2013. The SEC has received more than 200 comment letters, noted Chairman Garrett, but has not yet taken further action on the rule proposal. He noted that the Private Placement Improvement Act is designed to ensure that the amended Regulation D is consistent with the goals of Title II of the JOBS Act, and to ensure that small businesses do not face complicated and unnecessary regulatory burdens when attempting to raise capital through private securities offerings under Rule 506, while at the same time preserving important investor protections. He emphasized that the legislation would not remove the Form D filing requirement or imperil investor protection.

More broadly, Garrett observed that the SEC cannot alter a clear mandate from Congress in a way that would make Regulation D less attractive. Echoing this theme, Chairman Hensarling said that in the JOBS Act Congress spoke in a bi-partisan manner and that regulators should not overtly reverse the clear intent of Congress. Congress should not outsource its job to the SEC or other regulators, he emphasized. Rep. Robert Hurt (R-Va.), speaking in support of the bill, advised the SEC to stay in its own lane.

Startup Capital Modernization Act. The committee approved the Startup Capital Modernization Act, H.R. 4565, introduced by Rep. Patrick McHenry (R-N.C), chair of the Oversight Subcommittee, which is designed to allow small businesses to better use regulation A. The bill builds on the JOBS Act, which raised Tier 1 Regulation A offerings to 50 million. H.R. 4565 would reform and improve Regulation A securities offerings by increasing the maximum amount of a single public offering under Tier 2 Regulation A from $5 million to $10 million. The measure would also clarify the preservation of state enforcement authority with respect to an issuer, intermediary, or any other person or entity using the exemption from registration under Regulation A. Under the bill, the SEC is directed to exempt securities acquired under Tier 1 and Tier 2 Regulation A offerings from Sec. 12(g) of the Securities Exchange Act if the issuer provided potential investors with audited financial statements. The Securities Act would be amended to add the resale of any securities acquired in an exempted transaction to the list of exempted transactions as long as certain conditions are met.

Financial Regulatory Clarity Act. Finally, the committee approved the Financial Regulatory Clarity Act, H.R. 4466, co-sponsored by Rep. Shelley Moore Capito (R-W.Va.), chair of the Financial Institutions Subcommittee, and Rep. Gregory Meeks (D-N.Y.). The measure would require the SEC, CFTC, FDIC, OCC, and the Fed to assess whether any newly proposed regulation or order conflicts with, duplicates, or is inconsistent with existing federal regulations, and address any overlap or duplication before issuing the final rulemaking. The bill would also require the SEC, CFTC, and the other regulators to evaluate whether existing regulations are outdated, and to submit a report to Congress making recommendations for repealing or amending any conflicting, inconsistent, duplicative, or outdated laws or regulations within 60 days of a proposed rulemaking.

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