Events & Announcements

Emerging Scholar Award Recipient: Goldburn P. Maynard, Jr.

The Denver University Law Review is pleased to announce that it has selected the recipient of the Emerging Scholar Award.  Click here for details!


Emerging Scholar Award: Exclusive Spring Opportunity for Publication in Volume 92

The Denver University Law Review is pleased to announce the Emerging Scholar Award. This exclusive opportunity is for all scholars who have received their J.D. as of March 1, 2014 and have not yet accepted a tenure-track teaching position nor held a full-time teaching position for more than three years. The selected recipient will receive an award of $500 and publication in Issue 1, Volume 92, scheduled for early 2015.

We will accept submissions for the Emerging Scholar Award from March 24, 2014, until March 31, 2014. Our Articles Committee will review all submitted articles and respond to authors by April 14, 2014. Please click here to view submission details.

Volume 92 Board of Editors Announced

Denver University Law Review is excited to announce the Volume 92 Board of Editors.  Please join us in congratulating them in this accomplishment and supporting them in continuing the fine tradition of the Denver University Law Review. Please click here to view the masthead.


Revisiting Sex: Gender & Sex Discrimination Fifty Years After the Civil Rights Act

On January 31 and February 1, 2014,  the Denver University Law Review will present its annual symposium: “Revisiting Sex: Gender & Sex Discrimination Fifty Years After the Civil Rights Act.” The Civil Rights Act of 1964 represents one of the most significant milestones of the twentieth century. Title VII of the Civil Rights Act protects individuals against employment discrimination on the bases of race, color, national origin, sex, and religion.

The Symposium will explore the meaning of “sex” under Title VII, present the role gender plays in the workplace, and review the shortcomings of the fifty-year-old Title VII framework. Panel topics include Caregiving in 2014; Intersectionalities; Access to Work, Pay Inequality, and Discrimination; Sexuality and Gender Issues; and Biases in Litigation and Amongst the Judiciary.

All are welcome, and CLE credit will be available.

For more information about the Symposium, please visit our Revisiting Sex page.

The final agenda for the Symposium is available for download here.

For any other questions, please contact LaLonnie Villa-Martinez.


DULR Online Presents the JOBS Act Issue

DULR Online is proud to present its JOBS Act Issue. This issue features eight student articles covering different aspects of the Jumpstart Our Business Startups Act, the landmark legislation passed by Congress in 2012 "[t]o increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies." The JOBS Act Issue represents a unique collaboration between the Denver University Law Review, DULR Online, and Professor J. Robert Brown, Jr. Please explore the full issue here.

DU Community Outreach: Student Leaders Develop Program to Connect Diverse High School Students to the Law

On April 20, 2013, the University of Denver Sturm College of Law will host forty-five high school students to participate in Spring Training for Youth and Legal Education (STYLE). STYLE was developed by student leaders of diversity programs at DU Law to connect high school students with the legal profession. The program targets high school students who would not normally have access to the legal community because of their socioeconomic background. The students were nominated by a teacher, counselor, or other community member based on level of motivation and promise. STYLE will introduce the nominated high school students to diverse legal professionals and law students. Students will engage in seminar discussions and participate in a mock trial. The DU Law Review will post select STYLE articles in April.
Subscriptions and Submissions

For information on how to subscribe to the Denver University Law Review, please click here.

For the guidelines on how to submit an article to Denver University Law Review, please click here. If you would like to submit a shorter piece to DULR Online, please contact the Online Editor, Jonathan Coppom, at jcoppom15@law.du.edu.

Emerging Scholar Award
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Saturday
Apr272013

JOBS Act Title V: Raising the Threshold for Registration

[PDF]

Susan Beblavi*

I. Introduction

Congress adopted the Jumpstart Our Business Startups Act (the “JOBS Act”) on April 5, 2012.[1] According to the preamble, the JOBS Act will “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.”[2] The Act sought to accomplish this goal by alleviating the regulatory burdens surrounding capital raising. 

Title V of the JOBS Act amends Section 12(g) of the Securities Exchange Act of 1934 Act (the “Exchange Act”).[3] The amendments raise the threshold number of shareholders required to trigger securities registration requirements with the Securities and Exchange Commission (“SEC”).[4] Registration has significant consequences. Registered companies must file periodic reports, adhere to the proxy rules, prohibit short swing profits, and comply with other requirements of the federal securities laws.[5] These provisions protect investors but also add significant cost to a company’s operations. 

Title V changed the requirements for registration but in a complicated fashion. The amendment increased the threshold for registration from 500 holders of record to 2,000. The provision, however, provided that companies with 500 unaccredited investors must register.[6]  The Jobs Act also excluded from the total those employees who acquired shares through certain compensation plans.

This paper will explore the amendments to Section 12(g). Part II addresses the state of the law prior to the adoption of the JOBS Act. Part III discusses how Congress determined the new threshold for registration. Part IV considers the likely consequences of Title V.

II. The Law Prior to the Adoption of the JOBS Act

As originally enacted, the Exchange Act did not obligate companies in the over-the-counter market to register. Only issuers listed on a national securities exchange were subject to the requirements of the Exchange Act.[7] The disparity in treatment resulted in proposals for reform throughout the 1940s and 1950s.[8] Only in 1964 did Congress finally extend the registration requirements to non-exchange traded companies with the adoption of Section 12(g) of the Exchange Act.[9]

Under the provision, issuers were required to register with the SEC if they had “total assets exceeding $1 million” and a class of securities “held of record by 500 persons or more.”[10] The asset test ensured that the issuers could afford the requirements that came with registration.[11]  The minimum number of shareholders ensured that there would be sufficient trading activity to justify the imposition of the reporting requirements.[12] The amendments extended the registration requirements to an “estimated 3,500 issuers of over-the-counter securities.”[13]

The SEC gradually raised the asset threshold for registration. Rule amendments in 1982 increased the amount to $3 million.[14] The threshold was again raised to $5 million in 1986 and $10 million in 1996.[15] Although the number of shareholders of record never changed, [16] the SEC did clarify that the requirement applied to participants in depositories[17] and to foreign shareholders.[18]

With experience, the shareholder threshold raised concerns. Companies could inadvertently trigger registration by accidentally amassing more than 500 shareholders of record.[19]  This risk increased with the growth in the use of stock as compensation for employees.[20]  The low threshold, therefore, acted as a disincentive to use equity as a form of worker compensation.[21]

In addition, the market shifted from an emphasis on “holders of record” to beneficial or street name owners.[22] Record ownership ceased to have any relationship to actual number of shareholders.[23] At the same time, however, companies could not always control the number of shares held in record name. The arbitrary or random decision by some investors to rely on record ownership could trigger registration requirements.[24]

The “held of record” standard also to some degree applied the reporting requirements in an arbitrary fashion.[25] In In the Matter of Bacardi Corporation, Bacardi sought to deregister by undertaking a reverse stock split that would decrease the number of shareholders of record to less than 300.[26] In counting the number of shareholders of record, Bacardi did not take into account count 238 revocable trusts, each with one share.  Bacardi argued that these trusts had been created only for the “express purpose of attempting to prevent . . . deregistration” and constituted a “circumvention” of §12(g). The Commission held that this section is “directed at issuers who seek to evade registration . . . not a tool to help issuers deregister.”[27] Accordingly, the trusts were to be counted as holders of record.

III. Legislative History and Impetus Behind Title V

Representative David Schweikert introduced what would later become Title V of the JOBS Act on June 14, 2011[28] as part of the “Private Company Flexibility and Growth Act.”[29]  The original legislation sought to raise the shareholder threshold in Section 12(g) from 500 shareholders of record to 1000.[30] The original bill also excluded from the definition of “held of record” accredited investors or employees who obtained their shares through certain types of compensation plans.[31]

The exclusion of employees was intended to encourage the use of equity as compensation, allowing companies to pay lower salaries and save cash for operations.[32] The change in the number of shareholders of record was viewed as necessary because the existing threshold had “become an impediment to capital formation for small startup companies that are innovative and create jobs.”[33]  By avoiding registration and the accompanying expenses associated with public status, companies could use the saved funds to create jobs.[34]  The requirement also facilitated capital raising. Companies no longer had to stop selling shares once they approached the 500 threshold.[35] Finally, the change took into account the fact that the “ability [of investors] to gain information [today is] dramatically different than even a decade ago.”[36] 

In debating the legislation, members of the House Committee on Financial Services generally agreed that a threshold of 500 shareholders of record was too low [37] but did not entirely agree on the “right” threshold for triggering registration.[38] Some wanted to raise the threshold to 2,000, bringing it in conformity with other proposals applicable to banks and bank holding companies.[39] The Committee also considered but rejected an amendment to look to beneficial rather than record owners.[40]

The Committee ultimately agreed on an “appropriate compromise” and increased the threshold to 2,000 shareholders of record.[41] The change, however, was accompanied by a separate threshold for unaccredited investors. Recognizing that these investors had a greater need for the protections of the securities laws, particularly the periodic reporting requirements,[42] the provision required registration whenever a company had more than 500 unaccredited shareholders of record.[43]

The legislation, therefore, essentially exempted companies that were, for the most part, owned by accredited investors. At the same time, companies could have a modest number of unaccredited shareholders. As Congressman Schweikert noted, “we’ve made the decision that this somewhat more sophisticated population gets to participate but they have to opt in.  And yet, we still do not lock out those who are, shall we say, working their way to becoming that next sophisticated population.”[44] The final provision also retained the exclusion for employees who owned shares as a result of certain compensation plans. 

In the Senate, concerns were raised by the continued reliance on record ownership.[45] Senator Dick Durbin introduced into the record a statement by SEC Commissioner Luis A. Aguilar addressing the subject.[46]  The letter cautioned that, under the standard, the actual number of owners would not be counted because most shares were owned beneficially through “street name” accounts.[47]  Commissioner Aguilar also argued that the definition of “accredited investor” was potentially insufficient to protect those investors who need it most.[48]  An amendment in the Senate to change the standard from record to beneficial ownership failed.[49]

IV. Implementation

Section 501[50] of the JOBS Act increased the threshold for registration in Section 12(g) to 2,000 persons of record or 500 persons “who are not accredited investors.”[51] In addition, the provision excluded from the definition of “holder of record” those persons who received securities through employee compensation plans.[52] The legislation instructed the SEC to adopt a safe harbor implementing the provision and to examine whether it needed additional enforcement authority to prevent evasion of the requirement.[53]

The provision was intended to reduce regulatory costs by decreasing the number of companies required to register under Section 12(g).  The provision, however, may not accomplish this goal.  First, the provision did not provide any immediate benefit.  The amendment left the number of shareholders needed to deregister at 300.  Thus, the sizable number of registered companies with fewer than 2,000 shareholders of record was unable to deregister. [54]

Second, although raising the threshold, many public companies will still confront the risk of registration once they have 500 shareholders of record. Most privately held companies raise capital through private placements.[55] In general, sales pursuant to Rule 506 are sold only to accredited investors.[56] As a result, companies selling to fewer than 2,000 accredited investors will initially avoid any requirement to register.

That status, however, will change. Even if accredited at the time of the purchase, an investor’s status may not remain static. [57] A shareholder’s income or net worth could fall as a result of the loss of a job or other financial reversal.[58] Thus, over time, shareholders may shift from accredited to unaccredited.  Companies will, therefore, need to monitor accredited investor status.[59] 

More importantly, accredited investors can, after a brief holding period, sell the shares to unaccredited investors. Rule 144 provides an exemption for the resale of securities purchased in a private placement.[60] The Rule provides that shares can be sold by non-affiliates after a one year holding period.  Moreover, the shares are unrestricted and can therefore be sold to anyone, including unaccredited investors.

Once sales begin to take place, therefore, companies will not know if shareholders are accredited or unaccredited.  Companies could attempt to monitor the accredited status of subsequent purchasers.[61]  Continuously inquiring into the investor’s status would, however, increase costs.[62] Issuers could try to control the number of unaccredited investors through contractual limitations. Doing so, however, would impose significant restrictions on transferability, interfere with secondary trading, and presumably reduce the value of the shares. 

Often, the company will not know a subsequent shareholder’s status.  Where this is the case, the company presumably will need to assume that they are unaccredited. Accordingly, a company will have to register once it has more than 500 shareholders of unknown status.

Third, the changes implemented under Title V also make more complicated the determination of the number of record owners.[63] The number of record owners excludes employees but only if their shares were acquired from certain compensation plans. Thus, the exemption does not apply to employees who obtain shares in other ways. Moreover, once the employee sells the shares, the new owner is not exempt. [64]

Crowdfunding offerings can also complicate the determination of the number of record owners.  The JOBS Act contemplates an exemption from Section 12(g) for shares issued in this type of  offering.[65]  Companies, therefore, will need to maintain records indicating the source of the shares. To the extent investors hold shares issued in a crowdfunding offering, therefore, they may not be counted in determining the number of shareholders of record. 

Finally, the provision makes the decision to register voluntarily under Section 12(g) more complicated.  Companies trading in the OTC Bulletin Board must register.[66] For companies close to 500 shareholders of record, early registration merely advanced the date when they would become subject to the periodic reporting requirements and provided an immediate benefit of a liquid trading market.  With the threshold increased to 2,000, companies not confronting the risk of mandatory registration may decide not to voluntarily subject themselves to the periodic reporting requirements. As a result, investors will be denied access to the OTC Bulletin Board.  

V. Conclusion

Title V increased the threshold for registration from 500 holders of record to 2,000; however, it also provided that companies with 500 unaccredited investors must register. Additionally, the provision excluded from the total those employees who acquired shares through certain compensation plans and those who received shares through crowdfunding. Although these changes were proposed to reduce regulatory costs, they may well generate expensive record-keeping responsibilities. Accordingly, Title V may not exempt many additional companies from registration but could impose additional costs through the need for complex record-keeping systems.

 

 

 


       *.     J.D. Candidate 2013, University of Denver Sturm College of Law.

       [1].     Jumpstart Our Business Startups Act Frequently Asked Questions, U.S. Sec. & Exch. Comm’n, http://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htm (Apr. 11, 2012).

       [2].     Jumpstart Our Business Startups Act, H.R. 3606, 112th Cong., 2d. Sess. (2012), available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf.  

       [3].     U.S. Sec. & Exch. Comm’n, supra note 1.

       [4].     Testimony Concerning the “JOBS Act in Action Part II: Overseeing Effective Implementation of the JOBS Act at the SEC”, U.S. Sec. & Exch. Comm’n (June 28, 2012), http://www.sec.gov/news/testimony/2012/ts062812mls.htm.

       [5].     See Securities Exchange Act of 1934 § 13(a), 15 U.S.C § 78m(a) (requiring the filing of periodic and annual reports with the SEC); Securities Exchange Act of 1934 § 14(a), 15 U.S.C. § 78n(a)(1) (mandating  certain disclosures when soliciting proxies); Securities Exchange Act of 1934 § 16(a), 15 U.S.C. § 78p(a) (prohibiting short-swing profits by directors, officers, and principal stockholders); Williams Act § 14(d), 15 U.S.C. §78n(d) (prohibiting tender offers of registered securities).

       [6].     Title V made permanent the asset test adopted by the SEC. Section 12(g) originally set the threshold at $1 million. Relief from Reporting by Small Issuers, Exchange Act Release No. 37,157, 61 FR 21354 (May 1, 1996), available at http://sec.gov/rules/final/34-37157.txt. Through rulemaking, the SEC gradually raised this threshold to $10 million. See infra note 30.  The JOBS Act made the $10 million threshold permanent. 

       [7].     The Act applied to certain over-the-counter issuers only in very limited circumstances, such as required compliance with certain reporting requirements if an issuer filed a registration statement. Richard M. Phillips & Morgan Shipman, An Analysis of the Securities Acts Amendments of 1964, 1964 Duke L.J. 706, 712–13 (1964).

       [8].     Phillips & Shipman, supra note 7, at 714.

       [9].     Pub. L. No. 467, 88th Cong., 2d Sess. (Aug. 20, 1964). In 1963, the SEC issued a report acting as the catalyst for reform, and the SEC subsequently worked with industry groups to provide legislative proposals. Phillips, supra Note 7, at 707, 713; see Report of Special Study of Securities Market, U.S. Sec. & Exch. Comm’n,  H.R. Doc. No. 95, 88th Cong., 1st Sess. (1963). 

     [10].     Report on Authority to Enforce Exchange Act Rule 12g5-1 and Subsection (b)(3), U.S. Sec. & Exch. Comm’n, 6 (Oct. 15, 2012), available at http://www.sec.gov/news/studies/2012/authority-to-enforce-rule-12g5-1.pdf.

     [11].     The SEC defined “total assets” as “the total assets as shown on the issuer's balance sheet or the balance sheet of the issuer and its subsidiaries consolidated, whichever is larger.” SEC General Rules and Regulations, Securities Exchange Act of 1934, 17 C.F.R. § 240.12g5-2 (1965). The assets test was designed to ensure that companies were big enough to afford to file periodic reports. Order Granting an Application of BF Enterprises, Inc. under Section 12(h) of the Securities Exchange Act of 1934, Exchange Act Release No. 66541, 77 Fed. Reg. 15148 (Mar. 8, 2012), available at http://www.sec.gov/rules/other/2012/34-66541.pdf.

     [12].     U.S. Sec. & Exch. Comm’n, supra note 10, at 5–6. “Held of record” meant those investors “identified as the owner of such securities on records of security holders maintained by or on behalf of the issuer.” 17 C.F.R. §240.12g5-1. The definition also included participants in depositories. See U.S. Sec. & Exch. Comm’n, supra note 11, at 9.

     [13].     This expansion of regulation “serve[d] another high important function; by subjecting corporate management to the glare of publicity, [it] provide[d] significant controls over, and inevitably reduce[d], conflicts of interest and undesirable management practices.” Phillips & Shipman, supra note 7, at 712.

     [14].     The Commission viewed the change as an adjustment designed to account for inflation. The Commission also reasoned that the 500-shareholder limit “criterion is an appropriate indicator of investor interest, one which balances the concerns of cost of compliance with adequate investor protection.” U.S. Sec. & Exch. Comm’n, supra note 17 at 17047–48.

     [15].     U.S. Sec. & Exch. Comm’n, supra note 6.

     [16].     System of Classification for Purposes of Exempting Smaller Issuers From Certain Reporting and Other Requirements, Exchange Act Release No. 18647, 47 Fed. Reg. 17046 (Apr. 13, 1982). The Commission brought a number of cases designed to enforce or clarify the threshold. 

     [17].     See U.S. Sec. & Exch. Comm’n, supra note 11 at 9.

     [18].     In In the Matter of The National Dollar Stores, Ltd., the issuer applied for an exemption from registration under §12(g) because it had only 456 shareholders living in the United States, in addition to 143 shareholders living abroad, and there was “a very nominal amount of trading interest in the stock.” 1968 SEC LEXIS 2728, *8 (U.S. Sec. & Exch. Comm’n Feb. 1, 1968). The SEC held that the fact some shareholders lived abroad was irrelevant and “entirely unconvincing,” accordingly the issuer was required to register. Id. at *12.

     [19].     More recently, there was speculation that Section 12(g) “forced” Google and Facebook to go public because they acquired more than 500 shareholders in 2003 and 2011, respectively. William K. Sjostrom Jr., Questioning The 500 Equity Holders Trigger, 1 Harv. Bus. L. Rev. Online 43, (2011), available at http://www.hblr.org/2011/03/questioning-the-500-equity-holders-trigger/.

     [20].     In 2010, it was estimated that “nine million employees held stock options, plus probably several hundred thousand employees who have other forms of individual equity. That is down from its peak in 2001, however, when the number was about 30% higher.” Employee Stock Options Fact Sheet, The Nat’l Ctr. for Emp. Ownership,  available at http://www.nceo.org/articles/employee-stock-options-factsheet (last visited Jan. 2, 2013).

     [21].     Tyler Adam, The JOBS Act: Unintended Consequences of the “Facebook Bill,” 9 Hastings Bus. L.J. 99, 113 (2012) (“to stay within the 500 record holder threshold, companies are faced with the choice of limiting the number of employees they hire, the number of new investors they take on, or their ability to acquire other businesses for stock”).

     [22].     Beneficial shares are held through an intermediary and securities in certificate form are deposited, or “immobilize[d],” with a registered clearing agency acting as a securities depository, with securities transactions reflected as changes in beneficial interest in the immobilized securities rather than changes in record ownership. J. Robert Brown, The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?, 13 J. Corp. L. 683, 715 (1988). 

     [23].     Id. at 683.

     [24].     In one case, the SEC took note of this possibility and exempted a company from registration under Section 12(g).  BF Enterprises had 85 shareholders. One of them created 500 identical trusts in an effort to force the company to register. U.S. Sec. & Exch. Comm’n, supra note 12. In exempting the company from registration, the Commission reasoned that this increase in the number of owners appearing on the company's books does not reflect a growth in public holders that requires the protections of Exchange Act reporting; nor is this increase “sufficiently significant from the point of view of the public interest to warrant the regulatory burden to be assumed by the Government and the compliance burden to be imposed on the [issuer] involved.” Id. at 15150.

     [25].     See Stephen J. Nelson, Petition for Commission Action to Require Exchange Act Registration of Over-the-Counter Equity Securities (July 3, 2003), available at http://www.sec.gov/rules/petitions/petn4-483.htm#P58_10328 (discussing twenty-four issuers allegedly using the definition of “held of record” to circumvent the reporting requirements and petitioning the SEC to define “held of record” in terms of beneficial ownership).

     [26].     In the Matter of Bacardi Corporation, Admin. Proc. File No. 3-7019, 5 (Feb. 15, 1990), available at http://www.sec.gov/litigation/aljdec/1990/id19900215mor.pdf;  see Securities Exchange Act of 1934 § 12(g)(4), 15 USC § 78l(g)(4) (permitting deregistration when company had less than 300 shareholders of record). 

     [27].     Id.

     [28].     Bill Summary & Status, H.R. 2167, 112th Cong., 1st Sess. (2011), available at http://thomas.loc.gov/cgi-bin/bdquery/z?d112:h.r.2167: (last visited Jan. 9, 2013).

     [29].     H.R. Rep. No. 112-327 (2011), available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr2167rh/pdf/BILLS-112hr2167rh.pdf.

     [30].     The proposal also raised the asset threshold to $10 million, the same amount imposed by the SEC in Rule 12g-1.   H.R. 2167, 112th Cong., 1st Sess. (2011), available at http://financialservices.house.gov/uploadedfiles/hr2167ai.pdf.

     [31].     Id. The SEC adopted Rule 12h-1(f) in 2007, allowing privates companies to furnish employees with compensatory stock options without registering such options. Legislative Proposals to Facilitate Small Business Capital Formation and Job Creation: Hearing before the Subcommittee on Capital Markets and Government Sponsored Enterprises of the Committee on Financial Services, 112th Cong. 77 (2011) [hereinafter Hearings] (statement of Meredith B. Cross, SEC Director Division of Corporation Finance), available at http://financialservices.house.gov/uploadedfiles/112-63.pdf.

     [32].     Hearings, supra note 31, at 128 (statement by Barry Silbert) (“[T]he 500 Shareholder Rule has created a disincentive for private companies to hire new employees, or acquire other business for stock, as these private companies are fearful of taking on too many shareholders. Application of the rule also discourages companies from providing equity-based compensation to employees, removing one of the great economic incentives attracting the country’s best and brightest employees to startups.”).  See also id. at 137 (statement by William Waddill) (“[B]iotechnology companies are particularly affected by this 500 shareholder rule due to our industry’s growth cycle trends and compensation practices . . . Exempting employees from any shareholder limit is a minimum necessary measure to ensure growing biotech companies are able to hire the best available employees and compensation them with equity interests, allowing them to realize the financial upside of a company’s success.”).

     [33].     H.R. Rep. No. 112-327, at 2.

     [34].     112 Cong. Rec. H1240 (daily ed. Mar. 7, 2012).

     [35].     Id. at H1244 (statement of Rep. David Schweikert).

     [36].     112th Cong., supra note 32. Representative Schweikert stated that this increase was, therefore, the “reality” of living in the modern world. Id. Additionally, one witness testifying before the House subcommittee stated, “[w]hen Section 12(g) was established in 1964, the Commission could not have anticipated the technological changes that have transpired since that time. These advances not only allow small companies to grow rapidly, but also bring more transparency and confidence to the financial markets.” Hearings, supra note 31, at 111.

     [37].     See 112 Cong. Rec. H1279 (Mar. 8, 2012).

     [38].     Hearings, supra note 31. 

     [39].     Id. Representative Schweikert further stated that he wanted to raise the threshold to 2,000 persons to make it in conformity with the proposed legislation sponsored by Representative Jim Himes. Id. Not everyone agreed with this approach.  Id. (statement by Rep. Barney Frank).

     [40].     Amendment to H.R. 2167, 112th Cong., 1st Sess. (2011) (offered by Mr. Capuano) available at http://financialservices.house.gov/uploadedfiles/102611hr2167capuano.pdf.  According to some, the “held of record” standard provided a loophole whereby companies could have an unlimited number of investors without filing any disclosures. 112th Congress, supra note 32 (statement of Representative Capuano).

     [41].     Hearings, supra note 31. Representative Capuano stated, “We don’t know really whether it should be 500, 1,000, 2,000, 5,000, or some number, but there is no debate yet that I’ve heard that there should be no cap.” Id.

     [42].     “[G]overnment should not go to great lengths to protect people who really can fend for themselves, who are more sophisticated, and who really knowingly decide that they do not want protections.”112 Cong. Rec. H1279 (Mar. 8, 2012) (statement of Rep. Brad Miller).

     [43].     Id. (statement of  Rep. David Schweikert) ( “[W]e’ve made the decision that this somewhat more sophisticated population gets to participate, but they have to opt in. And yet, we still do not lock out those who are, shall we say, working their way to becoming the next sophisticated population.”).

     [44].     Discussing general solicitations, Representative Waters stated, “accredited investors are individuals, companies, or organizations that generally have the sophistication needed to make complex financial decisions. These folks are thought to need less protection than average retail investors.” 112 Cong. Rec. H7290 (Nov. 3, 2011).

     [45].     112 Cong. Rec. S1966-68 (Mar. 22, 2012) (statement of Sen. Jack Reed).

     [46].     112 Cong. Rec. S1970 (Mar. 22, 2012) (statement of Sen. Dick Durbin).

     [47].     Commissioner Aguilar wrote that “a company could have a virtually unlimited number of record stockholders, without being subject to the disclosure rules applicable to public companies.” 112 Cong. Rec. S1970 (Mar. 22, 2012).

     [48].     Id. Commissioner Aguilar used the example of a person worth $1 million and approaching retirement; this person is relying on this money to support them, so this person could not afford to lose large sums of money, unlike the accredited investor foreseen by the current definition. Id.

     [49].     112 Cong. Rec. S1977 (Mar. 22, 2012). The amendment was introduced by Senator Reed.  As he explained:  

But by counting shareholders of record instead of the beneficial shareholders—there is a legal owner on the books of the company, but that legal owner may represent thousands of actual owners . . . if we preserve this loophole going forward, this could potentially create a situation where an unlimited number of investors could be involved in a company and that company would still be able to remain private and not have to provide periodic reports under the Exchange Act . . . Our bill eliminates this loophole by clarifying that recordholders must be beneficial owners, while at the same time raising the shareholder cap from 500 to 750, to make it more contemporaneous. But we exempt employees from this recordholder trigger for public registration, and that will allow private companies that want to remain private, but want to reward their employees with shares to stock, the ability to do so without triggering the public reporting requirements.

112 Cong. Rec. S1823 (Mar. 20, 2012) (statement of Sen. Jack Reed).

     [50].     Title V addresses only those issuers who are not banks and bank holding companies; these types of issuers are addressed in Title VI.

     [51].     Jumpstart Our Business Startups Act § 501.

     [52].     Section 502 of the JOBS Act states in part, “the definition of ‘held of record’ shall not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of section 5 of the Securities Act of 1933.” Id. § 502. In an unrelated provision of the JOBS Act, shares issued through the crowdfunding exemption were also excluded from the threshold. Id. § 303.  Additionally, one Senator advised that “the definition of an ‘employee compensation plan’ should be interpreted broadly,” suggesting that current and former employees should be included within this definition as well as those who inherit securities from an employee. 112 Cong. Rec. S22301 (Mar. 29, 2012) (statement of Sen. Pat Toomey).

     [53].     “SEC, we believe you already have this authority. Please, for the first 120 days look into this, see if it causes any harm.” 112 Cong. Rec. H1279 (Mar. 8, 2012) (statement of Rep. David Schweikert).

     [54].     Based on 2011figures, the SEC estimated that, out of 2,524 reporting companies, only 318 had at least 2,000 shareholders of record. U.S. Sec. & Exch. Comm’n, supra note 11, at 26.

     [55].     Rule 506 of Regulation D permits companies to raise “an unlimited amount of money” and fall within a safe harbor if certain conditions are met. See Rule 506 of Regulation D, U.S. Sec. & Exch. Comm’n (Dec. 3, 2009) http://www.sec.gov/answers/rule506.htm (last visited Feb. 8, 2013). Rule 506 is the most common exemption. A Brief Rundown on Common Securities Exemptions, The California Securities Attorneys (last visited Jan. 14, 2013), http://thecaliforniasecuritiesattorneys.com/a-brief-rundown-on-common-securities-exemptions/.

     [56].     U.S. Sec & Exch. Comm’n, supra note 55. Rule 506 allows up to 35 unaccredited investors. Id. (stating most offerings do not sell to unaccredited investors).

     [57].     A safe harbor provision will likely be contemplated under Section 503 regarding the time at which an issuer determines accredited investor status (i.e. at the time of initial issuance or at some other date) and shares purchased through crowdfunding. When discussing a potential safe harbor provision, Senator Toomey stated, “absent actual knowledge of information to the contrary, to rely on information it has about a person at the time the securities are issued.”112 Cong. Rec. S22301 (Mar. 29, 2012).

         

        ..     [59] This concern may be addressed through rulemaking, with companies required to determine accredited status at the time the shareholder is most recently issued shares, or at the end of each fiscal year. See Letter from Steven R. Barth, Esq., Foley and Lardner LLP, to Elizabeth M. Murphy, Secretary of the Securities and Exchange Commission (May 24, 2012), available at http://www.sec.gov/comments/jobs-title-v/jobstitlev-5.pdf ; see also Letter from Keith Paul Bishop, Former California Commissioner of Corporation (June 13, 2012), available at http://www.sec.gov/comments/jobs-title-v/jobstitlev-7.pdf.

     [60].     Rule 144 specifies certain conditions, including a holding period, adequate current information, and compliance with a trading volume formula, that must be met in order to sell restricted and control securities. Rule 144: Selling Restricted and Control Securities, U.S. Sec. & Exch. Comm’n (Aug. 6, 2008), http://www.sec.gov/investor/pubs/rule144.htm.

     [61].     The SEC stated, “[i]t remains an open question as to how market participants will develop systems to address this issue and lower the possibility of error in their calculations of the number of holders or investor status.” U.S. Sec. & Exch. Comm’n, supra note 11, at 25.

     [62].     Steven R. Barth, Esq., supra note 59. (May 24, 2012); Letter from Robert E. Buckholz, Chair, Committee on Securities Regulation, New York City Bar, to Elizabeth M. Murphy, Secretary of the Securities and Exchange Commission (June 6, 2012), available at http://www.sec.gov/comments/jobs-title-v/jobstitlev-6.pdf. 

     [63].     U.S. Sec. & Exch. Comm’n, supra note 11, at 25. “Crowdfunding” alludes to the concept of companies raising certain amounts of money from a large number of investors. Id. at 24. The JOBS Act “exempt[s] offers and sales from the requirements of Section 5 of the Securities Act when the amount of securities offered is $1 million or less, provided that individual investments do not exceed certain thresholds and the issuer satisfies other conditions in the JOBS Act.” Id.

     [64].     In contrast, the crowdfunding exemption looks to the shares sold in the offering, not the identity of the holder.   See Jumpstart Our Business Startups Act § 303.

     [65].     The SEC must create the exemption through rulemaking. Section 303 of the JOBS Act states:

(a) EXEMPTION.—Section 12(g) of the Securities Exchange Act of 1934 (15 U.S.C. 78l(g)) is amended by adding at the end the following: ‘‘(6) EXCLUSION FOR PERSONS HOLDING CERTAIN SECURITIES.—The Commission shall, by rule, exempt, conditionally or unconditionally, securities acquired pursuant to an offering made under section 4(6) of the Securities Act of 1933 from the provisions of this subsection.’’ (b) RULEMAKING.—The Commission shall issue a rule to carry out section 12(g)(6) of the Securities Exchange Act of 1934 (15 U.S.C. 78c), as added by this section, not later than 270 days after the date of enactment of this Act.

Id.

     [66].     U.S. Sec. & Exch. Comm’n, supra note 11, at 5.

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