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From Securities Regulation Daily, November 14, 2013

House panel marks up and approves three bipartisan bills to enhance capital formation

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

The House Financial Services Committee (Committee) has marked up and reported out three bipartisan bills that would purportedly ease the regulation of business development companies, create a tick size pilot program for emerging growth companies, and reform the regulation of M&A brokers. All three are part of an initiative to enhance capital formation. Committee Chair Jeb Hensarling (R-Tex.) said that these three bills, combined with other bills the Committee will soon consider in a subsequent mark-up, will be bundled together to comprise a JOBS Act 2.0.

Business development companies. Business development companies are closed-end investment companies that invest in and lend to small- and medium-sized private companies rather than large public companies; they fill a market niche that some commercial banks have abandoned. As a result, many small- and medium-sized businesses have been able to obtain financing, which has supported their growth and which might not otherwise have been available to them.

In 1980, Congress authorized the creation of business development companies by amending the Investment Company Act (ICA), but Congress has not updated the statute since 1980. In the intervening years, the regulatory framework has created challenges for business development companies seeking to raise and deploy capital, and thereby to satisfy their congressional mandate to lend to small- and medium-sized companies.

In an effort to reform the regulation of business development companies, the Committee approved the Small Business Credit Availability Act, H.R. 1800. Introduced by Rep. Michael Grimm (R-N.Y.), H.R. 1800 would amend Section 60 of the ICA to allow business development companies to purchase, acquire, or hold securities or other interests in investment advisers or advisers to investment companies, and allow them to issue more than one class of senior security, which is a stock. H.R. 1800 also amends Section 61(a) of the ICA to reduce the ratio of assets to debt that business development companies are required to maintain from 200 percent to 150 percent. Finally, H.R. 1800 directs the SEC to revise its rules and forms to allow business development companies to use the streamlined securities offering provisions available to other registrants under the Securities Act.

Much of the modernization of securities regulation that occurred in 2005 by way of Securities Offering Reform largely did not apply to business development companies. As a result, as SIFMA noted in recent testimony before the Committee, many unnecessary obstacles remain in place that prevent business development companies from efficiently accessing the markets and in turn, providing much needed capital to middle market companies. SIFMA supports efforts to align the regulation for business development companies more closely with that of other public companies.

Most business development companies are RICs (Regulated Investment Companies) under the federal tax code. As a result, RICs are required to dividend out substantially all of their net income for tax purposes. Thus, business development companies are required to come to the public markets more regularly to raise capital in order to grow. The inability to utilize some of the built-in efficiencies in securities regulation for frequent corporate issuers, such as incorporating previously filed information by reference, creates unnecessary burdens.

Tick size pilot program. The Committee also unanimously marked up and approved the Small Cap Liquidity Reform Act, H.R. 3448, which would allow small emerging growth companies to enter a five-year pilot program that would give them the ability to quote and trade stocks in 5- and 10-cent increments instead of just pennies. The increased tick size maximizes their liquidity, giving them access to capital that the penny tick size does not.

Introduced by Rep. Sean P. Duffy (R-Wis.), and co-sponsored by Rep. John Carney (D-Del.), H.R. 3448 would provide for an optional SEC-administered pilot program allowing certain JOBS Act emerging growth companies with a stock price above $1.00 to increase the tick size at which their stocks are quoted and traded. The tick size would increase from $0.01 to $0.05 or if the company’s board of directors so elects, $0.10. The bill allows covered emerging growth companies to change the tick size of their stock from $0.05 to $0.10 or from $0.10 to $0.05 once during the pilot program. It also allows companies to opt out of the program.

By providing flexibility in tick size for smaller issuers, the bill aims to improve market quality and increase liquidity in companies’ shares, thereby promoting capital formation.

An amendment offered by Rep. Duffy, and approved during the mark-up, provides that if an emerging growth company opts out of program, the SEC must notify all venues on which the company is traded. Another Duffy amendment approved in the mark-up would give the SEC discretion to determine where in the 5- and 10-cent increments the stock may be traded. An amendment offered by Rep. Carney would clarify that the intent is to apply the safe harbor provision in the bill solely to the decision to expand the tick size for the company. The intent is to ensure that the safe harbor is not too broad, while at the same time sufficient to protect the company from shareholder suits.

Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act. The Committee also approved by a unanimous 57 to 0 vote, H.R. 2274, the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act. Sponsored by Rep. Bill Huizenga (R-Mich.), the act would amend Section 15(b) of the Securities Exchange Act to reform the regulation of M&A brokers. Representative Huizenga noted that current federal law treats the sale of a small privately held business as if it were a Wall Street investment firm selling securities of a public company. The legislation establishes a streamlined and commonsense approach that allows for the sale of small- and mid-size businesses while maintaining the necessary safeguards, protecting jobs, and allowing for continued economic growth.

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