Easing Regulatory Burden for Small Companies

I had the privilege to be on a panel on June 8, at the Securities and Exchange Commission in Washington. My slot (really your slot) was part of the agenda at a meeting of the Advisory Committee on Small and Emerging Companies. This Committee was established last year to advise the SEC on ways to ease the regulatory burden on smaller companies, focusing on those with a public market capitalization of under $250 million. Its members include attorneys, public and private company CEOs and CFOs, asset managers, VCs, and bankers. All have a vested interest, like you and the NYSE, in the health of the small cap community.

The most rewarding part of this opportunity was that the NYSE Euronext was representing your interests on regulatory burdens for smaller companies. We have over 500 in our family, listed our NYSE/NYSE MKT platforms. As your partner in the capital markets we take seriously our obligation to serve your interests where we can, especially when it’s a matter this important.

Now, on to the SEC Committee meeting itself. The first part covered the recently enacted JOBS Act, and the second part was a discussion of the capital market environment for smaller companies. I’ll summarize JOBS (briefly here) since it’s so expansive and thought-provoking.

Seal of the U.S. Securities and Exchange Commi...

Seal of the U.S. Securities and Exchange Commission. (Photo credit: Wikipedia)

The Act, passed in April this year, has many features designed to facilitate capital formation and encourage companies to join the ranks of public companies. For example, Title I of the Act establishes a new category of issuer, the “Emerging Growth Company”. An EGC is a company that has less than $1 billion in revenue at the time it goes public; it can remain in this category, cruising the “IPO on Ramp” generally for five years. BUT NOTE:  Unfortunately for the vast majority of publicly-listed companies, this designation and the relief that goes with it is only available to newly public companies (those IPO’ing after December 7, 2011). The perks of being an EGC are impressive and include:

  • Only two years of audited financials are required in a registration statement and any other periodic reports
  • Compensation disclosures are the same as those for “smaller reporting companies” (companies with a public float of less than $75 million)
  • Confidential filing of draft registration statements to the SEC for nonpublic review
  • Communication to “test the waters” with institutional investors is allowed to gauge interest in a proposed IPO
  • Research by analysts can be published on an EGC in registration (i.e. no “quiet period”)
  • No say-on-pay or golden parachute vote required or other compensation disclosures
  • SOX 404(b) auditor attestation of internal controls is not required
  • And separately: The SEC to study the impact of increasing the minimum price or quote increment for EGCs, from $0.01 to $0.10 (to improve trading liquidity). The hypothesis is that wider spreads will bring more participants and liquidity to the market

The Committee considered how investment banking firms will respond to the provision of the Act that permits research on EGCs, not knowing how FINRA will treat this given that the “Global Settlement” is in place and that analysts are currently separated from bankers.  “Proceed with caution and seek SEC guidance”, was the way it seems banks will respond.

If the Act’s above incentives aren’t enough for some entrepreneurs to take the plunge, contrasting congress’s encouragement for companies to do just that and go public, congress also made it easier to remain “private” or unregistered. It used to be that at 500 holders a company had to register with the SEC; now, one can remain private with as many as 2,000 shareholders.

The JOBS Act also threw a bone to companies already public, by lifting the ban on General Solicitations (part of Rule 506 of Regulation D) in private placements -- as long as the investors are accredited. Before the Act, issuers were prohibited from offering or selling securities by any form of solicitation or advertising (e.g. articles, ads, broadcasts, seminars, meetings). Determining which investors are, in fact, accredited will be an issue to manage, and the SEC is considering various verification alternatives. An increase in fraud is a major concern of the SEC. At the most extreme, think late night infomercials and stock certificates with the legend, “As Seen on TV!”

In another bit of relief for registrants, Regulation A, which had been initially enacted to support fundraising by smaller companies (by permitting the sale of unregistering securities), was modified to permit capital raises of up to $50 million, up from $5 million per annum. Despite the significant increase in the amount that can be raised, these securities still do not have “blue sky” exemptions and, as such, need to comply with state securities laws, so Reg A’s appeal may still be limited.

Beyond permitting General Solicitations and expanding Regulation “A+”, the Committee also looked at another aspect of the JOBS Act, the one enabling “Crowdfunding”. Here the Committee did not make a recommendation to the Commission as they have in other areas. Crowdfunding, generally, is the raising of capital over the internet by taking in small investments from many investors (or donors). The maximum allowed raise using this exemption is $1 million per year, and each investor is limited to $10,000 in its investment amount. All capital raising must also go through an intermediary or “portal”. Work on rules still has to be done by regulators in this area.

Getting past the highlights of the JOBS Act, the SEC Committee had work to do to support currently listed smaller companies. Towards that end, they heard some from a number of expert panelists with ideas on making things better.

David Weild, Chairman and CEO of Capital Markets Advisory Partners, commented that the SEC’s Regulation ATS in 1998, “decimalization” in 2001 and the resulting one-cent price increments for quotes and trades are harmful to the small-cap “ecosystem”. The less profitable nature of small-cap banking has led to fewer IPOs, less institutional research coverage, and fewer other aftermarket support structures. He says that the decline in small-cap IPOs, for example, began before Sarbanes-Oxley was enacted in 2002, so SOX is not the culprit. Weild posits that the challenges in the small-cap market – led by smaller tick sizes - “domino” back to the venture capital community, start-ups, and the ultimately to the overall level of U.S. employment. Along with some others in the industry, he suggests that issuers should be allowed to choose their own tick size. This Weild believes will improve the small cap company infrastructure.

Another panelist, Jeffrey Harris, The Dean’s Chair in Finance at Syracuse University’s Whitman School of Management places blame elsewhere like poor returns, the tech bubble pop, market distrust among retail investors, asset-class competition for investment dollars, and over-regulation for the poor health of the small cap market. Fixing this market would be best done by addressing costs of SOX, increasing market transparency to retail investors, and compensating market makers to provide liquidity – as opposed to increasing the minimum tick sizes.

James Angel, professor at the McDonough School of Business, Georgetown University, offered some provocative ideas to combat the “shrinking capital markets” (Jim highlighted that the Wilshire 5000 Index has only 3,639 member companies!) and lamented the lack of appropriate scaling of compliance costs for smaller companies. He said we need to explore the costs of fraud, cost of litigation, allow exchanges to “experiment”, companies to select their own tick sizes, compensate brokers for liquidity provision, have “12b-1 like” fees on each trade (to pay market makers and for research) and have more cost-benefit analysis from the SEC on their regulations.

After the well-known and widely-respected professor Angel, it was my chance to add to the dialog. I credit myself for not venturing and offering my own “pop-capitalist” ideas (perhaps at a later date), but rather to contribute by merely relaying the comments you offered us at the NYSE over the last few months. The themes I told the Committee were most important to you as leaders of our listed companies were

  • Disclosure: Too much strategic (competitive) detail must be revealed in filings; XBRL needs to be kept simple, examine its use and value on companies already employing XBRL tagging, offering more time to tag each quarter
  • Compliance costs: SOX 404 carve out should go up to $500 million from $75 million; the audit of internal controls is also redundant
  • Corporate governance: Simplify the definition of director independence
  • Capital raising: Expand the S-3 offering cap from $75 million of public equity and expand the one-third of float amount limit; new general solicitation rules will be helpful
  • Corporate visibility: Study new ways to foster research that is independent and valuable
  • PCAOB oversight: Audit firms are overly conservative and fearful of getting hit with “gotchas” and other criticisms by PCAOB; need for an audit firm advocate as balance
  • Litigation: Excessive lawsuits siphon resources from companies to law firms, SEC should review the merits of legal claims before companies have to settle or litigate; legal impact and costs are embedded in all professional service fees and passed onto shareholders
  • De-Sox: Permit companies to do this with two-thirds vote of shareholders and disclosure, the market will value this status
  • Empower this SEC Committee: To review and advise on any new regulation the SEC is considering for applicability and scalability to smaller companies

One thing I added to the conversation that should demonstrate the importance of a vital smaller company community to maintaining the fabric of our society is this comparison: The number of people employed by the approximately 1,900 listed companies under $250 million in public market capitalization is two million. Now compare this employment figure to a couple of public companies approximating the $152 billion total public value of these 1,900 companies. Global banking giant HSBC employs 288,000 people and technology leviathan Google, 35,000.  It’s very clear, smaller companies, as a group, provide a lot more jobs than very large companies.

Overall, the meeting was successful. Several top SEC officials participated actively and were fully engaged, asking many questions of the panelists and Committee members. It is clear that the SEC finds this initiative worthwhile as evidenced by this committee’s high standing within the Commission. They are keen to assist smaller companies through a smart analysis and balanced implementation of regulations so that these companies can devote their resources to the most rewarding returns for their investors.

I hope you found this review useful. We are committed to serving you on the NYSE Floor and as an advocate through our office and relationships in Washington, DC.

Please send me your thoughts on what else is important to you and your company. There will be more meetings!