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Final Report of the SEC Government-Business Forum on Small Business Capital Formation
June 1998
This report has been compiled by the staff of the Division of Corporation Finance, U.S. Securities and Exchange Commission. The views and recommendations in this report, however, are those of the Forum participants and not the Securities and Exchange Commission, the Commissioners or any of the Commission's staff members.
PrefaceIn September 1997, the Government Business Forum on Small Business Capital Formation met in San Francisco, California. The recommendations from the 1997 Forum follow. We believe that many worthwhile proposals are evidenced. The participants gave careful consideration to a wide variety of issues, including, once again the recommendations of the 1995 White House Conference on Small Business. One purpose of the Forum is to give the capital-raising needs of small business greater attention, with the hope that these needs may be accommodated, in balance with appropriate, and necessary governmental regulations to safeguard the public interest. It is apparent from the following recommendations of the Forum participants, that this purpose has been well-served. We thank them for their efforts and are pleased to present this report.
Opening Panel"Using Technology To Finance Small Business into the Next Century"
Core PresentersTaxation Roundtable
Credit Roundtable
Securities Roundtable – September 18
Securities Roundtable – September 19
1997 Forum Staff
Table of Contents
I. Summary of Forum RecommendationsA. Taxation
PreambleSmall business recognizes the rationale for taxes and understands the need to pay tax to support government. However, we are opposed to taxes that have the result of diminishing capital that provides growth needs of small business to generate GDP and jobs. Simplified, fair, understandable taxes are necessary. Any administrative actions that burdens small business is counterproductive to profitability of business needed for continuance. We also believe it is vitally important that a cooperative rather than a confrontational enforcement regime be established that will help businesses find the most efficient ways to comply with the law. Simplicity, cooperation, and understanding are the best ways to establish appropriate goals and resolve existing problems.
Primary Recommendations (ranked)
Particular attention should also be paid to the surviving spouse when the estate contains small business assets. The Forum recommends that Congress establish that it is not necessary to create a complex by-pass trust or similar instrument in order to get the full advantage of the unified credit to pass a small business to heirs. Secondary Recommendations (ranked)
B. CreditThe Forum endorses the White House Conference recommendation #63, which pertains to environmental liability rulings and regulations on sites prior to 1987. The Forum supports the goals and objectives of the SBREFA, which relates to rules and regulations for all federal agencies. The top 60 recommendations of the White House Conference should be re-endorsed. In particular, emphasis should be on recommendation #5A, #25, and #286. Congress should provide additional appropriations to allow the SBA to comply with Congressionally-mandated oversight. The SBA should re-examine the paperwork requirements for the 7(a) program. The CDFI Fund should increase its efforts to encourage small business/economic development entities to obtain CDFI certification. The CDFI Fund should seek opportunities where market investment returns can be achieved. In designating future sites for cleanup, the Brownfields/Superfund programs of the EPA should give specific consideration to the following:
The SBA should develop credit programs to assist small businesses participating in welfare-to-work programs. The SEC and the SBA should create relational links via websites and SBA Business Information Centers (BICs) to provide entrepreneur training necessary to facilitate business development and access to credit for small businesses. The SBA should increase the number of non-bank, small business lenders (SBLCs) eligible to process SBA loans. International sales continue to provide a significant growth opportunity to small businesses. Banks, especially those lending with an asset-based orientation, effectively exclude financings of international sales and/or resulting receivables. Efforts should be made to encourage or even mandate to some degree that banks avail themselves of the guarantee/insurance programs already in place by the Department of Commerce, the SBA, the Export-Import Bank, and many states. Such programs generally provide financing for export contracts/sales while leaving the bank's collateral and security intact.
C. Securities Regulation
1. Securities Act of 1933The mere posting of the names and addresses of potential buyers and sellers by a company should not be deemed to be in connection with the purchase and sale of securities for purposes of the anti-fraud provisions of the federal securities laws. The disclosure requirements of Regulation S-K (and S-B) should be amended to provide that any small business equity offering prospectus submitted to the Commission or state securities regulatory agencies disclose the valuation methodology implicit in the terms of the offerings. The Commission should clarify by rule or interpretive release that materiality is not equivalent to Regulation S-K or S-B disclosure. The Commission is encouraged to use the exemptive authority conferred to it by the National Securities Markets Improvement Act of 1996 (Section 28 of the Securities Act) to exempt from federal registration offerings of up to $10 million, provided that the issuer has filed a registration statement that has been declared effective in at least one state. The Commission should preserve state authority with respect to Section 3(a)(10) of the Securities Act so that states can, at their discretion, continue to conduct "fairness" hearings in connection with securities offered and sold in reliance of Section 3(a)(10), irrespective of whether the securities that are the subject of any fairness hearing are "covered securities" under Section 18(b) of the Securities Act. The Commission should amend Regulation A to require audited financial statements in the offering circular. Regulation A filings reviewed by the Commission or listed Regulation A securities should be exempt from state review. The Commission should require Regulation A filings to be filed via EDGAR. The Commission and Congress should take appropriate measures to enforce the letter and spirit of Section 18(b)(4)(D) of the Securities Act, which preempted state registration authority over securities offered or sold in reliance upon Rule 506. The Commission should permit general solicitation for all private placements, provided the Commission enacts some suitability standard for purchasers who should be accredited investors based upon NASAA's model definition of accredited investor. The Commission should not require issuers to have pre-existing relationships with accredited investors in order to avoid the ban on general solicitation in Rule 505 and 506 offerings. The Commission should eliminate the ban on general solicitation in Rule 505 and 506 offerings, but retain the ban on general advertising. The Commission should not require start-up companies to provide audited financial statements to non-accredited investors in Rule 505 or 506 offerings. The Commission should consider an alternative test/definition for determining an accredited investor based upon a percentage of an investor's net worth. The Commission should simplify Form D. The threshold of Rule 701 should be increased from $5 million to $10 million. States should be encouraged to adopt an uniform exemption to coordinate with Rule 701 as amended. The Commission should recognize Rule 1001 as an exemption from federal registration for issuers relying on the NASAA Model Accredited Investor exemption. In the alternative, the Commission is encouraged to issue a release proposing a federal exemption for all states that have adopted the NASAA Model Accredited Investor Exemption.
2. Securities Exchange Act of 1934In order to foster competition among accounting firms, the Commission should exempt smaller companies from any Commission accounting regulations relating to 1934 Act reports that are imposed over and above AICPA/FASB requirements until these smaller companies reach a certain size. The NASD should eliminate, or substantially relax, underwriting compensation limitations of offerings that cannot satisfy the quantifiable listing standards of the exchanges or NASDAQ. Liquidity for small companies should be encouraged by amending the registration provisions of the Exchange Act to facilitate limited trading of securities of small businesses through Internet matching services. To enhance liquidity of smaller issuers, the Commission should grant approval to a passive, Internet-based electronic "bulletin board" in which individuals that own securities of smaller issuers would post offers to buy and sell directly on the Internet web site. The participants would contract with a single transfer agent to facilitate clearance and settlement of all securities offered to purchase or sell on the web site. Selling shareholders would be required to place the securities offered for sale on deposit with the transfer agent. There would be no listing or maintenance standards other than a requirement that issuers would provide a "hyperlink" to its Form U-7, which the issuer would be required to update continuously as a condition of approval for investors to post offers with respect to that issuer's securities on the web site. As part of this information requirement, issuers also would be required to post reviewed quarterly financial statements and audited year-end financial statements on the web site. Broker-dealer telephone solicitation would be prohibited in connection with any offer posted on the web site: investors themselves would place offers to buy and sell directly on the web site. It is recommended that this "bulletin board" be implemented on a pilot basis with a specified number (e.g., initially permit shareholders of between 100 to 500 issuers to post offers to buy or sell on the "bulletin board"). The Commission is encouraged to review the regulations promulgated under the Penny Stock Reform Act of 1992 and to consider changes to those rules to facilitate secondary trading in the securities of smaller issuers. Any new penny stock rules that are adopted by the Commission should concentrate on the sales practices of brokers; they should not have the effect of excluding small businesses from capital formation. Rule 3a4-1 of the Exchange Act should be amended to create a presumption that would clarify that officers and directors of small businesses would be free to engage in sales of the securities of their company under all circumstances. Conforming changes to state broker-dealer registration provisions should be encouraged. The Commission should study the issuer market for dislocation caused by trading practices and self-regulatory organization rules, such as the NASD "hot issue" rule. Some periodic mandatory reporting obligations should be applied to all electronic bulletin board quoted stock. The NASD should modify its computer system to enable the NASD to identify whether a security is an electronic bulletin board quoted security. To encourage use of the electronic bulletin board market, the NASD should implement constructive improvements to the electronic bulletin board to improve liquidity and stock tradeability of small companies by considering the imposition of new listing standards to include: a special symbol, special limited information standards, the escrow of insiders' stock and the requirement of a promotional shares escrow agreement and options and warrants agreements, and an "evergreen" Form U-7. To discourage "bear raids," the Commission should establish rules prohibiting short selling in the over-the-counter market after a security has crossed a certain downward trigger; this would be analogous to current rules for listed securities. The same "uptick" rules should apply to all stocks (Bulletin Board, SmallCap) as a requirement to make a short sale. Broker-dealers should be strictly required to meet the same coverage requirements for naked shorts as applied to customers and a 100% haircut on such shorts should be strictly enforced against violators. A system should be implemented to determine accurately through reporting requirements the number of shares that have been shorted and vigorously enforce the rule. As applied to broker-dealers and the general public, shorting of Bulletin Board stocks quoted below $2.50 and NASDAQ SmallCap and NMS stocks below $3.50 should be prohibited. The shorting of all stock within ten business days after effectiveness of an initial public offering should be prohibited.
3. Investment Company Act of 1940/Investment Advisers Act of 1940The Investment Company Act should be amended to permit closed-end mutual funds that will provide "pooled capital" for small business venture capital investments. Such closed-end funds should be:
D. Federal/State RegulationAll states and the Commission should be encouraged to accept the Form U-7 for any offering under $10 million, provided the issuer is not prohibited from using the Form U-7. Form U-7 should be amended to include a question permitting and encouraging the inclusion of forward-looking statements to mirror Commission guidelines. All the states should adopt coordinated equity review for Small Company Offering Registrations (SCORs) and Regulation A offerings. All states are encouraged to adopt coordinated equity review for Forms S-1, SB-1 and SB-2 filings, with appropriate guidelines, and to participate in regional review programs for SCOR and Regulation A filings. States should be encouraged by rule and statute, including preemption where appropriate, to coordinate all review efforts and substantive guidelines and standards for each filing level (whether SCOR, Regulation A, SB-1, SB-2 or S-1) so that an issuer need file only once, receive only one comment letter on behalf of all states, conform to only one set of standards for all states and negotiate with only one agency on behalf of all states. The SEC and all states should adopt a national coordinated standard of review for the purpose of eliminating duplicative review. The states (through NASAA) should be encouraged to create uniform reporting requirements for private offerings conducted pursuant to Rule 506. The Commission should use its rulemaking authority to ensure that NASDAQ SmallCap listed securities be exempt from blue sky regulations to the extent that the NASDAQ SmallCap listing requirements are similar to the listing requirements of the NYSE or AMEX. The Commission and the states should create/provide an exemption for finders who are not registered broker-dealers. A finder would be defined as a person who occasionally arranges for investors to acquire securities of a business. Non broker-dealer finders would not be subject to any qualifications criteria, including, but not limited to, testing, bonding or financial reporting. The activities of a non broker-dealer may be circumscribed by the amount of compensation received or involvement with a specified number of transactions. Congress is encouraged to preempt state licensing authority over issuer-agents for those agents that receive no compensation, commissions, or other remuneration in connection with the placement of securities offered and sold in reliance upon Rule 506. Stronger state enforcement action, both criminal and civil, should be taken against fraudulent activity involving electronic bulletin board quoted securities.
E. MiscellaneousThe Commission should modify EDGAR to reduce the costs to filers, while paying particular attention to small registrants who are required to file via EDGAR. The Commission and the SBA should work together to educate small businesses on capital formation. The White House Conference has been a positive force in bringing important small business issues to the attention of the President and Congress and therefore, the Forum recommends that Congress require that the President convene a White House Conference on Small Business in the second year of each Administration. II. IntroductionThe U.S. Securities and Exchange Commission hosts an annual forum that focuses on the capital formation concerns of small business as provided in the Small Business Investment Incentive Act of 1980. Thus, in each of the past sixteen years, the SEC Government-Business Forum on Small Business Capital Formation has been convened. A major purpose of the Forum is to provide a platform for small business to highlight perceived unnecessary impediments to the capital-raising process. Numerous recommendations have been developed at these Forums seeking legislative and regulatory change in the areas of taxation, securities regulation, financial services and state and federal assistance. Participants at the Forum typically are small business owners, venture capitalists, government officials, trade association representatives, academicians and advocates of small business. While a number of different formats have been tried over the years, a very effective one for purposes of the development of recommendations for governmental action has included the use of small interactive participant groups; and in recent years, the Forum has typically included this feature. The Sixteenth Annual Forum was held in San Francisco on September 18 and 19, 1997. The Forum is governed by an Executive Committee comprised of senior government officials and representatives of small business who have a strong interest and expertise with the issues and capital-raising problems of small business. The Executive Committee organizes, plans and implements the Forum. The topic areas of taxation, credit and securities again were selected as the focus of the Forum. The Executive Committee had determined that the format of the morning sessions would present a variety of roundtable discussions, each devoted to one of the three targeted disciplines. Each roundtable would highlight current issues in its targeted topic area, and be moderated by a member of the Forum's Executive Committee, with a core staff of presenters and commentators comprised of several experts in the particular discipline. Because all of the round tables would be offered concurrently, Forum participants had to select the roundtable discussion in which they wished to participate. As in prior years, time would be devoted to discussion in small interactive break-out groups in order to permit Forum participants sufficient opportunity to develop thoughtful recommendations. These groups were to be comprised only of participants who had attended a particular topic roundtable. Welcoming remarks were offered by Albert S. Dandridge, Associate Director for Small Business of the Corporation Finance Division of the U.S. Securities and Exchange Commission. Greg Dean, Assistant Chief Counsel for Advocacy, then moderated a opening panel discussion entitled, "Using Technology To Finance Small Business Into The Next Century." The panel was followed by the scheduled roundtable discussions. The luncheon address was presented by the Honorable Keith Paul Bishop, Commissioner of the California Department of Corporations. Break-out sessions among the Forum participants were conducted throughout the afternoon. The second day's session followed the same basic format. Ginger Ehn Lew, Deputy Administrator of the U.S. Small Business Administration, and Jere W. Glover, the Chief Counsel for Advocacy of the U.S. Small Business Administration then presented a report regarding various initiatives at the Small Business Administration. The luncheon address was offered by Lionel Allan of Allan Advisors, Inc. Break-out sessions followed in the afternoon. The Forum participant break-out sessions produced 75 recommendations, all of which were finally endorsed and are highlighted in the following section of this report. While the U.S. Securities and Exchange Commission hosts this annual convocation of small business friends and advocates, and is pleased to serve as such, it in no way seeks to sponsor or influence any of the Forum's recommendations. While a number of these matters are of substantial interest to the Commission as an institution, it takes no position on any of the recommendations. The views in this report are those of the Forum participants. III. Taxation
A. Statement of Issues Tax policy can impose a heavy burden upon smaller businesses. Uncertainty as well as frequent changes in the rules further complicate the area for most small businesses that are already overburdened with demands upon time and resources. Tax policy also can be used in ways that encourage certain activities that could foster the successful operations of the smaller entrepreneur.
B. Recommendations
PreambleSmall business recognizes the rationale for taxes and understands the need to pay tax to support government. However, we are opposed to taxes that have the result of diminishing capital that provides growth needs of small business to generate GDP and jobs. Simplified, fair, understandable taxes are necessary. Any administrative actions that burdens small business is counterproductive to profitability of business needed for continuance. We also believe it is vitally important that a cooperative rather than a confrontational enforcement regime be established that will help businesses find the most efficient ways to comply with the law. Simplicity, cooperation, and understanding are the best ways to establish appropriate goals and resolve existing problems.
Primary Recommendations (ranked)
Simplifying the federal tax structure will work many benefits to all parties involved. Small businesses would reap its share of the benefits, if such a system could be implemented.
Any uncertainty to the soundness of the nation's Social Security system has a negative impact upon economic matters, which hurts small businesses' ability to raise capital. The current system, which bases its effectiveness on the contributions of currently working persons, is inherently unstable and needs to be replaced.
The rapid advances in technology have created many jurisdictional issues of law and this is true in the area of taxation policy. The recommended guidelines would establish some baseline for decision making and certainty were none or inadequate guidance currently exists.
Federal estate taxes are graduated and run up to a maximum rate of 55 percent. The current estate tax exemption still may be insufficient to cover the value of many family businesses. The overhang of this taxing system, and the gift tax system as well, has a particularly harmful and negative effect upon the valuation of small businesses. Repeal of the estate and gift tax could have an overall beneficial impact on the general economy by virtue of this beneficial change for small businesses. Particular attention should also be paid to the surviving spouse when the estate contains small business assets. The Forum recommends that Congress establish that it is not necessary to create a complex by-pass trust or similar instrument in order to get the full advantage of the unified credit to pass a small business to heirs. The use of this standard contrivance in order to avoid this tax should be recognized by providing for its utilization by all persons subject to the tax through simply eliminating tax where a surviving spouse succeeds to such small business assets.
Secondary Recommendations (ranked)
The uncertainty that surrounds the classification of "employee" versus independent contractor needs to be eliminated. From the perspective of small business operators, this determination impacts the decision whether tax withholding is necessary and if improperly decided by the employer can lead to significant tax penalties to the business.
Tax policy should be used to encourage investments in small businesses. The tax differential for capital gains encourages the investment of risk capital, especially in small and development stage companies. The listed recommendations will improve the recently revised provisions to help small businesses even more as well as to make the investment more attractive to the nation's investors.
Providing the recommended tax credit will benefit both small business and economically disadvantaged locations. Encouraging long-term investments in these communities will produce far reaching, long-term benefits to our overall economy.
While the entire tax scheme needs to be simplified, the area relating to the permissible deductible business expenses is particularly difficult and confusing. Should one area be selected as an experiment for simplification, it is this one that needs revision and would result in immediate significant benefits for small business.
Public notification and adequate time to consider proposed changes in public policy is essential to the well being of the nation in the guise of an informed electorate. In view of the particular complexity of tax policy, some meaningful, minimal period of time to consider proposed changes must be allowed for examination by the affected public.
In addition to cost and benefit analyses, the impact of proposed legislation upon affected persons needs to be assessed from the vantage of the difficulty an ordinary prudent person may have in complying with such provisions. IV. CreditA. Statement of the IssuesAccess to capital is a critical concern for small business. Regardless of its location in the development cycle, a Small Business is need of funds for its continuing operation. Typically, debt financing plays a central role in their recurring struggle to stay competitive.
B. RecommendationsThe Forum endorses the White House Conference recommendation #63, which pertains to environmental liability rulings and regulations on sites prior to 1987.White House Conference Recommendation #63 concerns the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) also known as Superfund. With respect to capital formation, the White House Conference delegates recommended that Congress should enact reformation of Superfund to "eliminate liability of fiduciaries and lending institutions that hold indicia of ownership primarily to protect a security interest in property that is subject to the act." This recommendation is in response to financial institutions refusal to lend to some small businesses due to environmental liability. In some instances, courts have found financial institutions liable for environmental cleanup even though the financial institution was not "managing or controlling" the underlying real estate. The Forum supports the goals and objectives of the SBREFA, which relates to rules and regulations for all federal agencies. The Small Business Enforcement Fairness Act (Public Law 104-121) was enacted by Congress in 1996. This law requires federal agencies to outreach to the small business community in the rulemaking process, to provide compliance guides for regulations that may burden small businesses and to offer informal assistance to the small business community. In addition, the law amended the Regulatory Flexibility Act by permitting small businesses to seek judicial review of regulatory small business analyses of federal regulations and established a Small Business and Agricultural Regulatory Enforcement Ombudsman. The top 60 recommendations of the White House Conference should be re-endorsed. In particular, emphasis should be on recommendation #5A, #25, and #286. White House Conference Recommendation #5A seeks regulatory streamlining or the development of investment vehicles for pension funds so that public and private pension funds can more readily invest in small businesses. White House Conference Recommendation #25 makes specific recommendations with respect to SBA's loan guarantee programs including, but not limited to: increasing the number of non-bank Small Business Lending Companies, increasing the loan amount from $750,000 to $1 million, and prohibiting over-collateralization of guaranteed loans. White House Conference Recommendation #286 concerns the future of the SBA. It recommends that the Guaranteed Loan Program, the 504 Loan Program and the Small Business Development Center Program should be maintained, increased and enhanced and that the Office of Advocacy should maintain its "independent role" within the federal government. Congress should provide additional appropriations to allow the SBA to comply with Congressionally-mandated oversight. The SBA should re-examine the paperwork requirements for the 7(a) program. With the success of the SBA's Low Documentation Program under the 7(a) Guaranteed Loan Program, the SBA should re-examine its paperwork requirements for the rest of the 7(a) Program. Initiatives like the SBA's Fastrack Pilot Program – where financial institutions use their own loan documents – should be encouraged. The CDFI Fund should increase its efforts to encourage small business/economic development entities to obtain CDFI certification. The CDFI Fund should seek opportunities where market investment returns can be achieved The Community Development Financial Institution Fund (CDFI) was created by Congress in 1994 to encourage financial institutions, their subsidiaries and regional third party lenders to lend in economically distressed areas. Financial institutions and others can petition the fund to match funds that the financial institutions have designated for community development lending and investment. In designating future sites for cleanup, the Brownfields/Superfund programs of the EPA should give specific consideration to the following:
The SBA programs providing technical assistance for small businesses - including minority-and women-owned businesses, start-ups and businesses located in special impact areas should be improved and expanded. The SBA has had considerable success with its Microloan Program. Such lending and technical assistance programs should be expanded. The SBA has recently established pilot Pre-qualification Loan Programs for women-and minority-owned businesses under the 7(a) Loan Program. With respect to Empowerment Zones/Enterprise Communities, the SBA has established 15 "One-Stop-Capital Shops" throughout the country. In addition to the nearly 1000 Small Business Development Centers, the SBA also has expanded its Business Information Centers throughout the country. The SBA should build upon these initiatives. The SBA should develop credit programs to assist small businesses participating in welfare-to-work programs. The SBA has taken a lead government role in connecting small business employers to local welfare to work efforts and job-ready workers. In addition, the SBA has established the goal of providing entrepreneurial training and counseling to those currently or formerly on welfare who are interested in starting a business as a means to self-sufficiency. The SBA also will improve access to credit for former welfare individuals through the SBA's Microloan Program and its other capital-access programs. The SEC and the SBA should create relational links via websites and SBA Business Information Centers (BICs) to provide entrepreneur training necessary to facilitate business development and access to credit for small businesses. The SEC and the SBA should continue their efforts at creating information and electronic documents to provide information to entrepreneurs on debt and equity capital such as "Q&A: Small Business and the SEC" and the SEC's and the SBA's respective Internet sites. On the SEC's Internet site, the "Q&A" booklet has links to the SBA's loan and equity programs. The SBA should increase the number of non-bank, small business lenders (SBLCs) eligible to process SBA loans. Currently, the SBA has 14 Small Business Lending Companies that participate in the SBA's 7(a) Guaranteed Program. These non-bank lending institutions, like their bank counterparts, are partnered with the SBA in making loans to the small business community. Unlike banks, Small Business Lending Companies are solely regulated by the SBA. International sales continue to provide a significant growth opportunity to small businesses. Banks, especially those lending with an asset-based orientation, effectively exclude financings of international sales and/or resulting receivables. Efforts should be made to encourage or even mandate to some degree that banks avail themselves of the guarantee/insurance programs already in place by the Department of Commerce, the SBA, the Export-Import Bank, and many states. Such programs generally provide financing for export contracts/sales while leaving the bank's collateral and security intact. In order to compete effectively, small businesses must be able to obtain debt funding in the most expeditious and favorable manner. Banks could assist small businesses by availing themselves of existing government programs. V. Securities RegulationA. Statement of the IssuesCompliance with securities regulations may impose substantial costs upon issuers of securities. There is a geometric progression in the impact of such costs relative to the smallness of the issuer. Coordination of federal and state regulation continues to be needed and substantial relief from costs would flow from a more unified system of regulation.
B. Recommendations1. Securities Act of 1933The mere posting of the names and addresses of potential buyers and sellers by a company should not be deemed to be in connection with the purchase and sale of securities for purposes of the anti-fraud provisions of the federal securities laws. Given the critical role that liquidity plays in an investor's decision, the Commission should permit companies to post the names and addresses of potential buyers and sellers. The disclosure requirements of Regulation S-K (and S-B) should be amended to provide that any small business equity offering prospectus submitted to the Commission or state securities regulatory agencies disclose the valuation methodology implicit in the terms of the offerings. Item 505 of Regulations S-K and S-B require that an issuer give the factors that were considered in determining the offering price where there is no established public market for the common equity being registered or if there is a significant difference between the offering price and the market price of the stock. Typically, a registration statement discloses that the public offering price was determined by negotiation between the issuer and the underwriter and it is not necessarily related to the issuer's asset value, net worth or other established criteria of value. The Commission should clarify by rule or interpretive release that materiality is not equivalent to Regulation S-K or S-B disclosure. The Commission should publicly indicate that materiality standards may be satisfied with less information than required in Regulations S-K and S-B. The Commission is encouraged to use the exemptive authority conferred to it by the National Securities Markets Improvements Act of 1996 (Section 28 of the Securities Act) to exempt from federal registration offerings of up to $10 million, provided that the issuer has filed a registration statement that has been declared effective in at least one state. In October 1996, the National Securities Markets Improvements Act of 1996 (NSMIA) was enacted into law. NSMIA added Section 28 to the Securities Act, which grants the Commission broad authority to create new exemptions from registration. This exemptive authority is not subject to any dollar limit. To date, the Commission has not exercised this authority. The Commission should preserve state authority with respect to Section 3(a)(10) of the Securities Act so that states can, at their discretion, continue to conduct "fairness" hearings in connection with securities offered and sold in reliance of Section 3(a)(10), irrespective of whether the securities that are the subject of any fairness hearing are "covered securities" under Section 18(b) of the Securities Act. Section 3(a)(10) of the Securities Act provides an exemption for securities issued in exchange for outstanding securities of an issuer pursuant to a fairness hearing. Section 18(b)(4)(C) of the Securities Act, which was added by NSMIA, preempts any state from registering securities that were "covered securities" before such a hearing and therefore preempts the state law authorizing that hearing. In Staff Legal Bulletin No. 3 (CF), the staff stated: "When a state fairness hearing relates to the registration, or exemption from registration, of securities that are covered securities before the hearing, Section 18 preempts the state law authorizing that hearing. An issuer, therefore, cannot use that hearing as a basis for relying on Section 3(a)(10) exemption for securities that are "covered securities" before the hearing.'' The Commission should amend Regulation A to require audited financial statements in the offering circular. Financial statements in Regulation A filings must be prepared in accordance with generally accepted accounting principles in the United States but need not be audited. However, if audited financial statements are available they must be provided. Requiring audited financial statements could result in the issuer's securities being more attractive to investors and thus more liquid. Regulation A filings reviewed by the Commission or listed Regulation A securities should be exempt from state review. Currently, securities issued under Regulation A are subject to state registration and review. They are not "covered securities" for purposes of Section 18 of the Securities Act. Preempting these transactions from state review could lower offering costs to small issuers. The Commission should require Regulation A filings to be filed via EDGAR. All exempt offerings, including Regulation A offerings, are exempt from filing via EDGAR pursuant to Rule 101(c) of Regulation S-T. Requiring Regulation A filings to be made on EDGAR would entail additional costs to the issuer, but the filing would be broadly disseminated, and thus, perhaps, generate additional investor interest. The Commission and Congress should take appropriate measures to enforce the letter and spirit of Section 18(b)(4)(D) of the Securities Act, which preempted state registration authority over securities offered or sold in reliance upon Rule 506. In offerings of "covered securities," Section 18(b) specifically preserves the right of a state to require an issuer to file certain notices and pay fees in connection with the offering. With respect to offerings that are exempt under Rule 506, states may impose "notice filing requirements that are substantially similar to those required by [Rule 506]. See Section 18(b)(4)(D) of the Securities Act. Because states may continue to regulate offerings made in reliance upon Section 4(2), some confusion may exist as to where the statutory preemption resides. The Commission should permit general solicitation for all private placements, provided the Commission enacts some suitability standard for purchasers who should be accredited investors based upon NASAA's model definition of accredited investor. Permitting general solicitation of accredited investors would constitute an intermediate step in revising the "offer" analysis in the Commission's exemptive regulatory system. It would open these offerings to those highly sophisticated investors who are characterized as "accredited." The Commission should not require issuers to have pre-existing relationships with accredited investors in order to avoid the ban on general solicitation in Rule 505 and 506 offerings. Rule 502(c) of Regulation D prohibits the use of general solicitation or general advertising in connection with Regulation D offerings, except in Rule 504. According to administrative positions of Rule 502(c), one way to determine whether a solicitation or advertisement is general or limited is the existence of a relationship between the issuer and the offerees. As noted above, permitting general solicitation of accredited investors would constitute an intermediate step in revising the "offer" analysis in the Commission's regulatory system. The Commission should eliminate the ban on general solicitation in Rule 505 and 506 offerings, but retain the ban on general advertising. Permitting general solicitation in the context of Rule 505 and 506 offerings would eliminate, for example, any need to examine for preexisting relationships. As such, issuers would not need to inquire into the nature of the offerees and the extent and quality of their prior relationships with the issuer and the utility of these rules to small businesses would increase. The Commission should not require start-up companies to provide audited financial statements to non-accredited investors in Rule 505 or 506 offerings. Audited financial statements represent a significant expense to start-up companies. While this cost, however, must be balanced with investor protection concerns, other protections in the exemption scheme should be sufficient. The Commission should consider an alternative test/definition for determining an accredited investor based upon a percentage of an investor's net worth. Rule 501(a) of Regulation D provides that a natural person may be deemed to be an accredited investor if he or she has individual net worth, or joint net worth with that person's spouse, at the time of the purchase exceeding $1,000,000 or individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same level in the current year. While these tests are objective, it excludes many persons with financial experience and sophistication who invest or earn less who should nevertheless be included in the definition. The Commission should simplify Form D. The Commission requires that a Form D be filed no later than 15 days after the first sale of securities in a Regulation D offering. Simplifying the form, including, perhaps, revising the language to be in "Plain English," would save an issuer both time and expense. The threshold of Rule 701 should be increased from $5 million to $10 million. States should be encouraged to adopt an uniform exemption to coordinate with Rule 701 as amended. Increasing the ceiling in Rule 701 to $10 million would be beneficial to small businesses. A co-extensive state exemption also would be desirable. On February 27, 1998, the Commission issued a release proposing that the $5 million ceiling of Rule 701 be removed under the statutory authority given to the Commission by NSMIA and instead set the maximum amount of securities that may be sold in a year at various thresholds. In addition, offers would not be counted for purposes of calculating the ceiling. The Commission should recognize Rule 1001 as an exemption from federal registration for issuers relying on the NASAA Model Accredited Investor exemption. In the alternative, the Commission is encouraged to issue a release proposing a federal exemption for all states that have adopted the NASAA Model Accredited Investor Exemption. In May 1996, the Commission adopted Rule 1001, which exempts from the registration requirements of the Securities Act offers and sales up to $5 million that are exempt from state qualification under paragraph (n) of Section 25102 of the California Corporations Code. The California law provides an exemption from state law registration for offerings made to specified classes of qualified purchasers that are similar, but not the same as, accredited investors under Regulation D. Certain methods of general solicitation are permitted under the California law. NASAA's Model Accredited Investor Exemption, which has been adopted by a number of states, permits solicitations similar to those permitted under the California provision. It also provides that securities may be sold only to persons who are, or are reasonably believed to be, accredited investors as defined in Rule 501 of Regulation D. The Commission should acknowledge the model exemption as an appropriate exemption under federal law as well.
2. Securities Exchange Act of 1934In order to foster competition among accounting firms, the Commission should exempt smaller companies from any Commission accounting regulations relating to 1934 Act reports that are imposed over and above AICPA/FASB requirements until these smaller companies reach a certain size. Smaller companies find it expensive to prepare annual and quarterly reports as well as proxy statements. Accounting costs represent a significant amount of these costs. By tying increased accounting requirements to an issuer's size, a small business issuer's costs should be reduced. The NASD should eliminate, or substantially relax, underwriting compensation limitations of offerings that cannot satisfy the quantifiable listing standards of the exchanges or NASDAQ. The NASD imposes its underwriting compensation limitations on any registered public offering that uses an underwriter regardless of whether the issuer's securities will be quoted on the NASDAQ Small Cap market, the OTC Bulletin Board or the "Pink Sheets." Eliminating or substantially relaxing the underwriting compensation limitations to companies whose securities will only be quoted on the OTC Bulletin Board or the "Pink Sheets" should encourage underwriters to be more interested in these smaller companies. Liquidity for small companies should be encouraged by amending the registration provisions of the Exchange Act to facilitate limited trading of securities of small businesses through Internet matching services. Liquidity is a crucial consideration of issuers and investors who use alternative offering vehicles. The Internet is one example of such a vehicle. To enhance liquidity of smaller issuers, the Commission should grant approval to a passive, Internet-based electronic "bulletin board" in which individuals that own securities of smaller issuers would post offers to buy and sell directly on the Internet web site. The participants would contract with a single transfer agent to facilitate clearance and settlement of all securities offered to purchase or sell on the web site. Selling shareholders would be required to place the securities offered for sale on deposit with the transfer agent. There would be no listing or maintenance standards other than a requirement that issuers would provide a "hyperlink" to its Form U-7, which the issuer would be required to update continuously as a condition of approval for investors to post offers with respect to that issuer's securities on the web site. As part of this information requirement, issuers also would be required to post reviewed quarterly financial statements and audited year-end financial statements on the web site. Broker-dealer telephone solicitation would be prohibited in connection with any offer posted on the web site: investors themselves would place offers to buy and sell directly on the web site. It is recommended that this "bulletin board" be implemented on a pilot basis with a specified number (e.g., initially permit shareholders of between 100 to 500 issuers to post offers to buy or sell on the "bulletin board"). Systems that enhance securities liquidity should be developed and encouraged. The proposal recognizes the need for certain protective mechanisms such as a continuous flow of issuer information that is built into the system. The Commission is encouraged to review the regulations promulgated under the Penny Stock Reform Act of 1992 and to consider changes to those rules to facilitate secondary trading in the securities of smaller issuers. The additional requirements imposed by the Commission on penny stocks as a result of this legislation impacts small companies disproportionately and hurts liquidity by discouraging brokers from handling these securities. The regulatory system needs to be reviewed with a view to relieving burdens on small companies. Any new penny stock rules that are adopted by the Commission should concentrate on the sales practices of brokers; they should not have the effect of excluding small businesses from capital formation. Improper broker practices should be addressed and regulated. Small companies should not bear the brunt of compliance requirements that really have little to do with their businesses, and only incidentally with their attempts to raise funds. Rule 3a4-1 of the Exchange Act should be amended to create a presumption that would clarify that officers and directors of small businesses would be free to engage in sales of the securities of their company under all circumstances. Conforming changes to state broker-dealer registration provisions should be encouraged. Officers and directors should be allowed to market the securities of their companies without restriction. In many cases, this is the only viable marketing method available to small companies. The Commission should study the issuer market for dislocation caused by trading practices and self-regulatory organization rules, such as the NASD "hot issue" rule. A Commission study should be undertaken to determine the extent of suspicious market movements attributable to current regulatory requirements in contrast to illegal actions by market professionals and others. Some periodic mandatory reporting obligations should be applied to all electronic bulletin board quoted stock. Liquidity mechanisms must be accompanied by current public information requirements in order to instill confidence in such systems. The NASD should modify its computer system to enable the NASD to identify whether a security is an electronic bulletin board quoted security. System markets should be developed and implemented so that universal identification can be quickly determined. Investors need to know whether a security is carried on Nasdaq in contrast to the OTC Bulletin Board. To encourage use of the electronic bulletin board market, the NASD should implement constructive improvements to the electronic bulletin board to improve liquidity and stock tradability of small companies by considering the imposition of new listing standards to include: a special symbol, special limited information standards, the escrow of insiders' stock and the requirement of a promotional shares escrow agreement and options and warrants agreements, and an "evergreen" Form U-7. The recommended requirements would make the market a better one and instill confidence in investors who decide to invest in the kinds of companies whose securities trade in such a market. In turn, liquidity will be enhanced because other investors may be more willing to purchase in secondary transactions because of the added protections built into the market. To discourage "bear raids," the Commission should establish rules prohibiting short selling in the over-the-counter market after a security has crossed a certain downward trigger; this would be analogous to current rules for listed securities. Speculative market activities are particularly harmful to fledgling markets in the securities of small companies. Regulatory action is needed to limit the use of short selling in these markets. The same "uptick" rules should apply to all stocks (Bulletin Board, SmallCap) as a requirement to make a short sale. Appropriate timing restrictions should be imposed to protect small as well as broader markets in securities. Whatever protective rules govern short selling should be applicable in the OTC Bulletin Board market. Broker-dealers should be strictly required to meet the same coverage requirements for naked shorts as applied to customers and a 100% haircut on such shorts should be strictly enforced against violators. Coverage requirements applicable to short selling transactions should be applied to any participant regardless of professional characteristics. A system should be implemented to determine accurately through reporting requirements the number of shares that have been shorted and vigorously enforce the rule. Mechanisms need to be implemented that will track short selling so that greater accountability with respect to improper activities may be introduced into the markets. As applied to broker-dealers and the general public, shorting of Bulletin Board stocks quoted below $2.50 and NASDAQ SmallCap and NMS stocks below $3.50 should be prohibited. An outright prohibition on short selling needs to be implemented with respect to lower-priced securities. This approach will benefit the little companies whose stocks can be ravaged by such an unregulated use of the short selling technique. The shorting of all stock within ten business days after effectiveness of an initial public offering should be prohibited. This prohibition would be particularly helpful for a small company just entering the public market. Speculative activity at this point can only harm the company and ultimately the investors as well.
3. Investment Company Act/Investment Advisers ActThe Investment Company Act should be amended to permit closed-end mutual funds that will provide "pooled capital" for small business venture capital investments. Such closed-end funds should be:
The Commission should reexamine Rule 275.205-3 with a view towards relaxing the limitations regarding the circumstances in which securities are permitted to accept performance-based fees. The Commission is encouraged to revise Rule 275.205-3 to permit advisers to provide advice to "pools" of investors that would otherwise not meet the asset or income tests of Rule 205-3 and to receive compensation based on the investment performance of the "pool" of securities. This proposal could help small business access greater pools of money for the development and operation of their businesses. Any countervailing impact upon investor protection appears to be small. 4. Federal/State RegulationAll states and the Commission should be encouraged to accept the Form U-7 for any offering under $10 million, provided the issuer is not prohibited from using the Form U-7. The specially designed form for small issuer offerings to raise a limited amount of capital should be universally accepted for registration purposes. Significant cost savings would result for the issuers that need this type of help the most. Form U-7 should be amended to include a question permitting and encouraging the inclusion of forward-looking statements to mirror Commission guidelines. Because the Commission encourages the use of projections, this form should acknowledge the importance and acceptability of such information. With respect to start-ups and other early stage companies this sort of information is helpful to investors in developing an appreciation for the issuer's business plan. All the states should adopt coordinated equity review for Small Company Offering Registrations (SCORs) and Regulation A offerings. Any and all methods of reducing the duplicative impact of multiple state reviews should be adopted and encouraged. All states are encouraged to adopt coordinated equity review for Forms S-1, SB-1 and SB-2 filings, with appropriate guidelines, and to participate in regional review programs for SCOR and Regulation A filings. These programs developed and coordinated by the North American Securities Administrators Association, Inc. are excellent examples of effective methods to avoid duplicative reviews. All the states should participate in these programs. States should be encouraged by rule and statute, including preemption where appropriate, to coordinate all review efforts and substantive guidelines and standards for each filing level (whether SCOR, Regulation A, SB-1, SB-2 or S-1) so that an issuer need file only once, receive only one comment letter on behalf of all states, conform to only one set of standards for all states and negotiate with only one agency on behalf of all states. While the NASAA model is a good one to further the elimination of duplicative reviews, all other efforts that can be devised to further that goal should be pursued and implemented by the state regulatory authorities. The SEC and all states should adopt a national coordinated standard of review for the purpose of eliminating duplicative review. Greater coordination of comments among the states as well as between the states and the Commission is desirable. Considerable savings would result if a single round of comments were generated on a filing. The states (through NASAA) should be encouraged to create uniform reporting requirements for private offerings conducted pursuant to Rule 506. While the states have been preempted from regulating offerings under Rule 506 they still have regulatory authority over offerings made in reliance upon Section 4(2), the non-public offering exemption. Coordination of these regulatory efforts among the states would be a help to small companies trying to raise capital in this way. The Commission should use its rulemaking authority to ensure that Nasdaq SmallCap listed securities be exempt from blue sky regulations to the extent that the Nasdaq SmallCap listing requirements are similar to the listing requirements of the NYSE or AMEX. If the listing standards for the Nasdaq Small Cap market ever become comparable to those for securities listed on the national exchanges that have been preempted from state review, the Commission should seek comparable treatment for these securities. The Commission and the states should create/provide an exemption for finders who are not registered broker-dealers. A finder would be defined as a person who occasionally arranges for investors to acquire securities of a business. Non broker-dealer finders would not be subject to any qualifications criteria, including, but not limited to, testing, bonding or financial reporting. The activities of a non broker-dealer may be circumscribed by the amount of compensation received or involvement with a specified number of transactions. The development of an authorized category for persons providing limited assistance to businesses by finding investors for their securities should be encouraged. A person providing very limited service should be subjected to a lower level of regulatory oversight, if any is deemed necessary. Congress is encouraged to preempt state licensing authority over issuer-agents for those agents that receive no compensation, commissions, or other remuneration in connection with the placement of securities offered and sold in reliance upon Rule 506. The states should not require the licensing of persons participating in the placement of non-public offerings if they are receiving no remuneration for the service. Stronger state enforcement action, both criminal and civil, should be taken against fraudulent activity involving electronic bulletin board quoted securities. Unlawful activities by unscrupulous persons may "poison" the markets for small companies. The regulatory authorities should direct their efforts toward maintaining fair and honest markets especially where such markets are specializing in the securities of small companies. VI. MiscellaneousThe Commission should modify EDGAR to reduce the costs to filers, while paying particular attention to small registrants who are required to file via EDGAR. The Commission's electronic filing system should be revised to reduce costs to participating registrants. With lower costs, more companies will be able to become voluntary filers, which will be beneficial for them and the investors as well. The Commission and the SBA should work together to educate small businesses on capital formation. More educational opportunities should be provided by federal regulators. The Commission's town hall meetings for small businesses are illustrative of an effective outreach approach of this nature. More instructive opportunities should be developed. The White House Conference has been a positive force in bringing important small business issues to the attention of the President and Congress and therefore, the Forum recommends that Congress require that the President convene a White House Conference on Small Business in the second year of each Administration. The national gathering of small business under the auspices of a Congressionally-mandated, but Administration-sponsored conference, has been most productive for the interests of small businesses. The lack of frequency is problematical. Requiring a biennial convocation following the start of a new Administration would provide the discipline necessary to keep small business interests in the limelight. VII. Forum Participants
http://www.sec.gov/info/smallbus/finrep16.htm
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