February 8, 2012
Practice Group(s):
Corporate
Capital Markets Relief Coming from
Congress? House Approves Bills that Could
Provide Alternative Ways for Companies to
Raise Capital in Securities Offerings
By Phillip J. Kardis II, Robert K. Smith, and Barry J. Spatzer
To spur the capital markets in light of high unemployment and diminishing traditional IPOs, the
House of Representatives passed the Small Company Capital Formation Act of 2011 (H.R. 1070) and
the Access to Capital for Job Creators Act (H.R. 2940). If enacted, these bills may create attractive
alternatives to traditional smaller IPOs and make it easier to solicit large numbers of investors in
private offerings. Companies and their legal and financial advisors who are considering various
financing alternatives should consider the benefits of these bills should they become law.
Background
High unemployment has pushed Congress to ease the regulatory barriers faced by small businesses
attempting to raise capital. In particular, reform advocates cite the declining number of small
domestic IPOs in recent years as a significant cause of the growing unemployment rate.1 In response,
the House passed H.R. 1070 and H.R. 2940 in November 2011. The bills are currently on the Senate’s
legislative calendar. While this alert contemplates enactment of the legislation as passed by the
House, the bills may change as they migrate through the legislative process and, in certain respects,
require SEC rulemaking to implement.
Limitations of Regulation A and Regulation D
Regulation A provides an exemption from registration under the Securities Act (generally meaning
that the issuer is not required to file a full registration statement with the SEC covering the offering)
for offerings by certain non-public companies limited to $5 million in any 12-month period.
Regulation A offerings currently are not exempted from state registration requirements. Due
principally to the offering size limit and state law issues, Regulation A is rarely used.
Section 4(2) under the Securities Act provides an exemption from registration for certain non-public
offerings. Rule 506 of Regulation D provides a safe harbor under Section 4(2) for offerings to
“accredited investors” and up to 35 other “sophisticated investors.” While there is no offering size
limit under Section 4(2) or Rule 506, both prohibit the use of “general solicitation” or “general
advertising” (including, for example, using articles, notices or other advertisements in newspapers,
magazines, television, radio or similar media). Thus, in the absence of a pre-existing relationship
between a company or its agents and a potential investor, it can be challenging for smaller private
companies to reach a large number of investors.
1
Between 1991 and 1997, approximately 80% of domestic IPOs raised under $50 million, while in 2009 and 2010, IPOs
under $50 million constituted only 17-18% of domestic IPOs. See Testimony of John C. Coffee, Jr. Before the Securities
and Exchange Commission Hearing on “Government-Business Forum on Small Business Capital Formation” (November
17, 2011), available at www.sec.gov/info/smallbus/sbforum111711-materials-coffee.pdf.
Capital Markets Relief Coming from Congress? House
Approves Bills that Could Provide Alternative Ways for
Companies to Raise Capital in Securities Offerings
Regulation A Reform – Alternative to Smaller IPOs and Private Placements
H.R. 1070 seeks to eliminate the major obstacles to widespread use of Regulation A by raising the
offering limit from $5 million to $50 million. The new exemption created by H.R. 1070, which we
call “New Regulation A,” would also require the issuer to file annual audited financial statements with
the SEC and permits the SEC, in its discretion, to subject issuers to ongoing disclosure requirements
following the offering. Other than these changes, New Regulation A resembles the existing law in
many ways, including permitting general solicitation and advertising, “testing the waters” for investor
interest in advance of filing an offering document, offers, and sales to retail investors (allowing a
broad pool of potential purchasers) and the issuance of securities without resale restrictions.
While H.R. 1070 exempts offerings under New Regulation A from state Blue Sky requirements
(provided the security is listed on a national securities exchange or offered or sold to “qualified
purchasers”), issuers would still be required to comply with Blue Sky laws to the extent they wish to
remain private or offer securities to retail (non-qualified) purchasers. However, Blue Sky preemption
was a debated issue in New Regulation A, and the possibility of more broad preemption remains a
possibility as the legislation continues to evolve (we note that an earlier version of the legislation
called for Blue Sky preemption for offers and sales through a broker or dealer, and the final bill
requires the Comptroller General to conduct a study on the impact of state Blue Sky laws on New
Regulation A and report back to Congress on the results within three months).
If enacted, the new exemption may result in advantages over existing capital raising alternatives. In
particular, the exemption may:
 Constitute an attractive alternative to traditional smaller IPOs for companies looking to raise up to
$50 million (as IPOs take a significantly longer time to close and require a more comprehensive S1 filing);
 Require reduced offering expenses as compared to a traditional IPO (including lower audit, legal,
regulatory and financial advisor costs);
 Require less burdensome ongoing disclosure requirements than for public companies under the
Exchange Act (other than audited financials)2;
 Permit an issuer to remain exempt from most provisions of Sarbanes-Oxley (provided the issuer is
not required to register under the Exchange Act);
 Allow an issuer desiring to go public to procure some of the benefits enjoyed by other public
companies, such as listing on a national securities exchange and liquidity and price transparency
for its shares; and/or;
 Allow an issuer desiring to stay private to list on a private securities exchange (e.g.,
SecondMarket) to enhance liquidity for purchasers and existing stockholders (including insiders).
2
If (i) the company determined to list the securities on a national securities exchange, or (ii) on the last day of the
company’s fiscal year, the class of securities issued by the company is held by 500 or more record holders and the
company’s total assets exceed $10 million, the company would become subject to the periodic reporting requirements
under the Exchange Act. Widespread sales to retail investors under New Regulation A could cause the company to
become subject to the reporting requirements under the Exchange Act by virtue of the 500 shareholder limit. We do note,
however, that a separate bill had been introduced in the House that would increase this limit from 500 to 1000
shareholders. The SEC has also stated that it is considering increasing the 500 shareholder threshold (which the SEC has
the power to do unilaterally).
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Capital Markets Relief Coming from Congress? House
Approves Bills that Could Provide Alternative Ways for
Companies to Raise Capital in Securities Offerings
Regulation D Reform – Reaching More Investors
H.R. 2940 amends Section 4(2) under the Securities Act to provide that the exemption thereunder is
available whether or not general solicitation or advertising is involved. The bill also requires the SEC
to promulgate rules providing that general solicitation restrictions do not apply to offerings conducted
pursuant to Rule 506 under Regulation D, provided that each ultimate purchaser is an accredited
investor.
If enacted, this legislation will perhaps allow companies and their agents to cast a wider net in private
placements without crossing into general solicitation or advertising. The ability to use general
solicitation and advertising in connection with large private placements may result in Rule 506
becoming a more desirable alternative than a registered offering in some cases.
Opportunities for Investment Banks and Other Capital Markets Participants
In addition to companies seeking to raise capital, the legislation may yield new opportunities for other
participants in the capital markets. Investment banks may find it attractive to re-enter the shrinking
market for small underwritten offerings, as the increased offering limit under New Regulation A may
generate enthusiasm from potential investors who were previously uninterested in such offerings due
to size and liquidity constraints. In addition, offerings nearing the $50 million cap may permit the
establishment of a more liquid trading market in the securities (including creating a more appealing
environment for market makers), further increasing the marketability of such offerings. The ability to
generally solicit investors may also allow banks and other participants to add value in other ways not
permitted under existing securities laws.
In particular, we note that the new rules may help supplant the disappearing market for small IPOs.
Offerings under the new exemptions are likely to be more attractive to some smaller companies when
compared to the lengthy, costly SEC review of an S-1 registration statement. Regional banks may
particularly be positioned to capitalize on these new opportunities, given their existing relationships
with smaller regional issuers and the potential for such deals to impact their bottom line.
Next Steps and How We Can Help
 Monitoring the development of the bills through the legislative process will be key. We are
following the bills, including any changes, and are available to speak with you about the
legislation’s path through Congress and its prospects to become law.
 If you are seeking alternatives to traditional IPOs or private placements, learning more about the
proposed legislation should be part of any menu of capital raising alternatives. We can assist you,
for example, with making presentations to boards of directors considering raising capital.
 Consider meeting with financial and legal advisors now regarding the legislation. These advisors
can help you become familiar with the rules and help you make a more informed decision
regarding capital raising alternatives. For example, we can help you determine the costs and
benefits of pursuing a larger Regulation A offering versus a traditional IPO and associated issues
(such as Sarbanes-Oxley compliance costs, timing considerations and liability matters).
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Capital Markets Relief Coming from Congress? House
Approves Bills that Could Provide Alternative Ways for
Companies to Raise Capital in Securities Offerings
 Now may be a time for financial advisors to revisit transactions that were previously shelved due
to concerns that the new legislation may ease, or to target additional companies that may be in a
position to take advantage of the new laws if, and when, they are enacted. We have significant
experience in advising underwriters in securities offerings.
Even though the proposed legislation discussed in this alert is not yet law, now is the time to
become familiar with the legislation as it evolves. In particular, if you have any questions
about the potential benefits of the proposed legislation, or any other matters related to raising
capital in the public and private securities markets, please contact the authors.
Authors:
Phillip J. Kardis II
phillip.kardis@klgates.com
+1.202.778.9401
Robert K. Smith
robert.smith@klgates.com
+1.202.778.9376
Barry J. Spatzer
barry.spatzer@klgates.com
+1.202.778.9261
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