Pending legislation in Congress, H.R. 3606, the `Reopening American Capital Markets to Emerging Growth Companies Act of 2012,’ offers hope for enhancing the ability of emerging business to tap America’s public capital markets. Passed on a bipartisan basis in the House of Representatives, the legislation is pending in the US Senate.
The bill amends the Securities Act of 1933 to establish a new category of issuers known as `Emerging Growth Companies’ (EGCs), which are issuers that have total annual gross revenues of less than $1 billion. H.R. The legislation exempts EGCs from certain regulatory requirements until the earliest of three dates: (1) five years from the date of the EGC’s initial public offering; (2) the date an EGC has $1 billion in annual gross revenue; or (3) the date an EGC becomes a `large accelerated filer,’ which is defined by the Securities and Exchange Commission (SEC) as a company that has a worldwide public float of
$700 million or more. H.R. 3606 thus provides temporary regulatory relief to small
companies, which encourages them to go public, yet ensures their eventual compliance with regulatory requirements as they grow larger.
H.R. 3606 adapts the SEC’s scaled regulations for smaller companies by more slowly phasing in regulations that impose high costs on issuers, without compromising core investor protections or disclosures. EGCs would still be required to comply with SEC-mandated quarterly and annual disclosures, but they would be exempted from Section 404(b) of the Sarbanes-Oxley Act (P.L. 107-204) of 2002 for a longer transition period–up to
five years–instead of the current transition period of two years. To ensure that investors are adequately protected, an EGC’s management would still be required to establish and maintain internal controls over financial reporting, as mandated by Section 404(a) of the Sarbanes-Oxley Act, and its chief executive officer and chief financial officer would still have to certify the company’s financial statements.
H.R. 3606 requires EGCs to provide audited financial statements for the two years prior to registration, rather than three years as is now required. This two-year period already applies to companies with a public float under $75 million, which are known as `non-accelerated filers.’ Within a year of its initial public offering (IPO), the EGC would report three years’ worth of financial statements, as larger companies are required to do.
H.R. 3606 exempts EGCs from any rules promulgated by the Public Company Accounting Oversight Board (PCAOB) that would require mandatory audit firm rotation, thereby allowing them to avoid the unnecessary costs of changing from an auditor familiar with the company to one that is not. H.R. 3606 gives EGCs the opportunity to `opt in’ to certain regulations by complying with them before they lose their EGC status. However, if the Financial Accounting Standards Board adopts new accounting standards while a company is an EGC, the EGC must comply with either all or none of the new standards while
it remains an EGC.
H.R. 3606 exempts EGCs from two new corporate governance requirements that were established by the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203). First, the bill exempts EGCs from Section 951′s requirement that public companies hold a non-binding stockholder vote on executive compensation arrangements. Second, the bill exempts EGCs from Section 953(b)’s requirement that public companies calculate and disclose the median compensation of all employees compared to the CEO. EGCs would still comply with all stock exchange corporate governance and listing requirements,
including board member independence rules.
H.R. 3606 also improves the flow of information about EGCs to investors by removing burdensome and outdated restrictions on communications between companies, research analysts, and investors. Existing SEC rules prohibit investment banks that underwrite a company’s IPO from publishing research on companies that would be classified as EGCs under the bill. The bill allows investors to obtain research reports about an EGC before or at the same time as its IPO. The bill, however, maintains other investor protections, such
as those set forth in Section 501 of the Sarbanes-Oxley Act, which address potential conflicts of interest that can arise when analysts recommend equity securities.
H.R. 3606 also permits EGCs to gauge the interest in potential IPOs by permitting greater pre-filing communications to institutional and qualified investors to determine whether an IPO is likely to be successful. All of the antifraud provisions of the securities laws still apply, however, and the delivery of a statutory prospectus before securities are sold in an IPO would still be required.
Finally, H.R. 3606 permits EGCs to pre-file confidential registration statements, thereby allowing them to begin the SEC review process without publicly revealing sensitive commercial and financial information to their competitors. Currently, only foreign companies are permitted to file confidential registration statements with the SEC. The bill requires an EGC to publicly file its initial confidential submission at least 21 days before it
begins a pre-IPO `road show’ for potential investors.
