Critics claim strict rules bar many from SCOR arena.

California offering picture differs from that of other states

Stiff requirements may disqualify many small California companies from being able to take advantage of a new stock offering method available in the state.

The intent of the state's new Small Corporate Offering Registration, or SCOR, law is to enable small companies wanting to make public offerings of up to $1 million to trim legal costs by filing a standard disclosure statement with the state Department of Corporations.

The SCOR law was passed by the state Legislature in September 1992 and became effective Jan. 1. Regulations to fine-tune the process were handed down by the Department of Corporations July 1.

The North American Securities Administrators Association in Washington, D.C., a body of securities regulators from various states, set up the original guidelines for SCOR offerings, and California is one of 30 states that has adopted its own variation of them.

But sources say some hurdles small companies have to overcome to make a SCOR offering in California are so stringent that few applicants will clear them. Among them are a merit review and a "blind pool" test.

A handful of states with SCOR laws are called merit states, while others are disclosure states. In disclosure states, as long as companies making offerings disclose all necessary information about their businesses, the offering can take place and it is up to the investor to decide whether or not to risk investing in the company.

But regulators in merit states not only require full company disclosure, they also set certain standards that small-business applicants must meet before offerings are approved.

In California, a small company that has been in operation for a number of years and makes a profit is more likely to pass the merit review test than one that hasn't been around as long and is not yet profitable, said Henry Lew, senior corporations counsel for the Department of Corporations.

SCOR applicants that have only been operational for a short time and are not yet profitable must demonstrate a reasonable likelihood they will be profitable in a reasonable period of time or it will be difficult for them to pass part of the merit review, Lew said.

SCOR applicant Robert Jones, president of Long Beach-based DemoNet Inc., and his consultant, Tori Geisler, said Lew commented at a recent meeting with them that, in general, probably very few companies applying for SCOR offerings will be able to pass the test. Lew would not comment on whether he made that claim or not.

But he told the Business Journal, "It's a tough standard. There's no question about it."

Putting firms through a strenuous merit review means "no start-up or emerging growth company is going to meet those standards, ever," said Geisler, a consultant with Newport Beach-based Amicus Group, small business consultants.

Companies that don't pass the merit review cannot make open offerings, which market shares to any investor. Instead, their offerings would be restricted to investors with a certain net worth or income, Lew said.

"In other states you don't have to go through that brain damage," said Luke McCarthy, an attorney with Pasadena-based Kaye Gyemant & McCarthy, a securities law firm.

McCarthy represents two of the three applicants that have thus far filed for SCOR offerings with the Department of Corporations. The three are DemoNet, Newport Beach-based Seaborn Beverages Co. and Irvine-based Genovation Inc.

Most other states with SCOR laws, if not all, don't place restrictions on the type of investors certain SCOR offerings may solicit, McCarthy noted.

"I am fairly confident many start-ups will not be able to get a truly open qualification (offering) in California," said Twila Foster, a member of the State Bar of California's business law section's corporations committee.

The California SCOR law also states "blind pool" companies may not make SCOR offerings, but left it up to the Department of Corporations to define what a blind pool company is, McCarthy said.

Part of the department's definition states that a blind pool company is a development company with no significant revenues. Sources say this clause could eliminate many SCOR applicants and other states don't use this definition for a blind pool company.

However, this clause "is not a blanket intention to exclude all start-up companies that have no revenue," Lew said.

"The department has the discretion to waive or deviate from the strict appliance of that provision," he added.

Indeed, the department has already done so. DemoNet, a company in the development stage with no significant revenue, applied in June for a SCOR offering.

The department waived the blind pool rule for that company, Lew said. DemoNet's application is still pending.

On top of the other restrictions, the $2,500 minimum filing fee for SCOR applicants is "significantly greater than in any other state," McCarthy said.

The application fee in other states averages $1,500, Geisler added.

In general, California regulators are more protective of investors than regulators in other states, Foster said.

Nevertheless, the application process for Seaborn is going smoothly so far, said a spokesman for the company who wished not to be identified.

Seaborn submitted a SCOR application June 9, has had some correspondence with the Department of Corporations, and is waiting for final approval, the spokesman said.