Chair Mary Schapiro, in
testimony before the House Oversight and Government Reform
Committee, advised that the Commission is committed to seeing if the
500-shareholder limit which triggers an issuer’s periodic filing
obligation still makes sense. The SEC intends to do a thorough and
rigorous analysis of the threshold, which she said will require the
gathering of economic data and analysis. The SEC needs to understand
the characteristics of these companies and whether their
shareholders hold their securities in record name or in the name of
the beneficial owner.
Schapiro said the staff review of the 500-shareholder
test is front and center on the Commission’s agenda. The staff is
also reviewing the general solicitation ban as part of its overall
review of capital formation regulations. Corporation Finance
Director Meredith Cross noted that the staff is likely to recommend
that the Commission issue a concept release on the general
solicitation ban.
Section 12(g) of the 1934 Act, which was enacted in
1964, requires companies with more than $10 million in assets whose
securities are held by more than 500 owners to file annual and other
periodic reports with the SEC. The reports are then available to the
public through the SEC's EDGAR database. While the $10 million
threshold has been increased incrementally over the years from the
$1 million level initially set in 1964, the 500 shareholder
requirement has never been updated.
In her written remarks, Schapiro noted that, shortly
after the enactment of Section 12(g), the Commission adopted rules
to define the terms “held of record” and “total assets.” The
definition of held of record counts only persons identified as
owners on records of security holders maintained by the company in
accordance with accepted practice. Schapiro explained that the
Commission used this definition to simplify the process of
determining the applicability of Section 12(g) by allowing a company
to look to the holders of its securities as shown on records
maintained that it maintains or that are maintained on its behalf,
such as records maintained by the company’s transfer agent.
Schapiro observed that the securities markets have
changed significantly since the enactment of Section 12(g). Since
the definition of held of record was put into place, a fundamental
shift has occurred in how securities are held in the U.S. Today, the
vast majority of securities of public companies are held in nominee
or street name. Brokers that purchase securities on behalf of
investors typically are listed as the holders of record. One broker
may own a large position in a company on behalf of thousands of
beneficial owners, but since the shares are all held in street name
they are counted as being owned by one holder of record.
In response to concerns from Rep. Pat Meehan (R-PA)
about carving sweat equity out of the 500-shareholder count, Cross
noted that, pursuant to an SEC rule adopted in 2007, options granted
to employees do not count towards the 500 shareholder number. In
addition, the staff has provided relief so that restricted stock
units provided to employees do not have to be counted towards the
500 shareholder trigger. Cross said the review of the Section 12(g)
limit will include the question of whether employees should be
counted at all. The SEC has heard that the 500 shareholder limit is
an impediment to capital raising. The review will consider whether
500 is the right number and whether the counting is being done
correctly to include the right people in the count.
Rep. Patrick McHenry (R-NC) asked why there is a class
of accredited investors. Cross explained that sometime in the early
1980s, a determination was made that investors with $1 million in
net worth can fend for themselves and do not need the protection of
the securities laws, which allows them to participate in
unregistered private offerings. Cross said the staff will consider
whether accredited investors should be eliminated from the count as
part of its review.
In response to a question from ranking member Elijah
Cummings (D-MD) about which principles would guide the staff review
of the general solicitation ban and the 500-shareholder rule, and
what factors would be considered, Cross said that, with regard to
the 500-shareholder limit, the staff would like to know the investor
makeup and the characteristics of these companies. For example, the
staff will look at whether they are trading in the dark market or
are engines of growth in need of capital. It may turn out that
different answers are needed for different companies, such as
companies bumping up against the 500 limit which cannot get
additional capital. There may have to be different tests for
different types of companies, according to Cross.
With regard to the general solicitation ban, Cross
said that the staff wants to be confident that, if the ban is
eliminated and private offerings are allowed through publicity and
advertising, the group to whom the securities are sold is the group
that does not need the protection of the federal securities laws and
that they are, in fact, accredited investors. If they do not need
protection, it may make sense to make it easier to reach them, she
said.
In offerings that are exempt from registration under
Section 5, the extent to which an issuer may communicate publicly
depends on the requirements of the exemption upon which the issuer
is relying. One of the most commonly used exemptions is Section 4(2)
of the 1933 Act, which exempts transactions by an issuer that do not
involve any public offering. Currently, an issuer that wishes to
rely on Section 4(2) or its safe harbor, Rule 506 of Regulation D,
is generally subject to a ban on the use of general solicitation or
advertising to attract investors for its offering. The ban was
designed to ensure that those who would benefit from the safeguards
of registration are not solicited in connection with a private
offering.
Rep. Trey Gowdy (R-SC) raised the question of whether
the general solicitation ban is constitutional. He noted that the
ban implicates a fundamental right. It must be under the strictest
level of constitutional scrutiny and must be as narrowly drawn as
possible. If the SEC concludes that the general solicitation ban
does not pass constitutional muster, Gowdy said there is precedent
for the SEC not to enforce the ban. Schapiro replied that, the SEC
would seek to change it rather than not enforce the ban. She
acknowledged that the ban limits speech to some extent and said the
staff study will examine that issue. A First Amendment analysis will
be part of the study. Schapiro said the issue is whether the
protection of investors is appropriately balanced with the need for
companies to effectively communicate in order to raise capital.