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Small business initiatives under the securities acts.

The SEC has established a new reporting system that simplifies filing and ongoing reporting requirements for smaller businesses. It also has liberalized its rules for exempt transactions including raising the threshold for such exemptions.

In 1992 the Securities and Exchange Commission (SEC) established new policies and procedures permitting small businesses to enter U.S. capital markets with reduced disclosure for registration and reporting. Despite minimum publicity, through April 1994, small businesses of all types have filed almost 600 registration state using the new Forms SB-1 and SB-2.

Capital Sources Are Changing

Because the nature of banking has changed radically over the last several years, banks are lending less to corporations than in the past. The traditional bank strategy of accepting deposits to make loans will continue to change as individuals save through mutual funds or invest in debt and equity markets. Lending to small business will continue to decline as banks become involved in more profitable activities, such as foreign currency trading, underwriting activities, multi-national corporation cash management services, and the development of derivative financial products. Moreover, the expectation that the considerable difference between short and long term interest rates will narrow encourages corporations to look for other sources to support their operating and investing activities. Capital markets fulfill these needs.

The SEC quickly recognized recent changes in banking practices and moved to ease entry into the public marketing and trading of securities by adopting several changes to earlier regulations under the securities acts.

In July 1992 (expanded in April 1993), the Commission adopted final rules and new forms for its small business initiatives (SBI). These rules extended existing registration requirements under the Securities Act of 1933 (the Act) with the introduction of Forms SB-1 and SB-2. Likewise, the Commission lessened the periodic reporting burden of the Securities Exchange Act of 1934 (the Exchange Act) with new Forms 10-SB, 10-QSB, and 10-KSB and modified the proxy rules for small issuers. Issued at the same time, new Regulation S-B contains rules to simplify the registration and reporting requirements of the securities acts for small business.

The Securities Act of 1933

The Act contains legislation of enduring importance. Its purpose is to provide full and fair disclosure to investors concerning securities offered in interstate commerce, leaving intact intrastate jurisdiction under the various state "blue sky" laws.

To achieve this objective, Congress empowered the SEC with rule-making authority to implement the provisions of the Act. The law requires Federal registration as a means of selling securities in interstate commerce.

However, Section 4 of the Act includes an important provision that addresses transactions exempt from registration. Regulations A and D contain rules that apply to exempt offerings. The small business initiatives, although focused on new registration forms, include modifications to liberalize selected rules under the aegis of exempt transactions.

The Securities Exchange Act of 1934

The stated rationale for the Exchange Act is that a national public interest is affected by transactions conducted on securities exchanges and over-the-counter markets. Thus, an imperative exists for Federal regulation over public markets as well as transactions by officers, directors and principal security holders (insiders). Moreover, to remove impediments to perfecting the mechanisms for a national market system, the law requires certain reports, some on a continuing basis.

Integrated Disclosure System

After over 40 years of rules and regulations, SEC registration and reporting requirements became so cumbersome and expansive that during the late 1970's Congress considered replacing the Act and the Exchange Act with a new statute, the Federal Securities Code. Its purpose would have been to integrate registration and reporting requirements into one law. After much debate, the idea was shelved. However, the SEC staff, using its historical legislative mandate, was able to achieve many of the objectives of the moribund Federal Securities Code by adopting Regulation S-K and revising existing Regulation S-X.

Regulation S-K contains standard instructions for nonfinancial data fried under the securities acts. Factual information related to the business and its property, a management discussion and analysis of financial condition and results of operations (MD&A), a description of the securities of the issuer, and information concerning certain security holders are examples of data requirements from Regulation S-K.

Regulation S-X, together with Financial Reporting Releases, sets forth the form and content of financial statements to be filed with the Commission. Financial statements submitted under the securities acts contain prescribed financial data addressed under Regulation S-X. This regulation contains instructions as to financial statements and the presentation of consolidated and combined financial statements. Form requirements for most filings require two years of audited balance sheets and three years of audited statements of income, cash flows, and changes in stockholders' equity.

The Small Business Disclosure System

Regulation S-B has an almost identical list of items to those found in Regulation S-K, but the two documents differ markedly in the detail required. Regulation S-B reduces the burden for registration and reporting and contains detailed instructions for small business issuers. A small business issuer is defined as a U.S. or Canadian firm with annual revenue of less than $25 million in its latest fiscal year and with a float of voting securities held by non-affiliates of less than $25 million. The SBI provides registrants with Forms SB-1 and SB-2, and the regional filing system is available to such small business registrants.

Form SB-1

Small businesses now may use newly created Form SB-1 to register offerings up to $10 million during any continuous 12-month period. Selected rules from Regulations A and S-B apply to Form SB-1 offerings.

Although some Regulation A disclosure is used, Form SB-1 offerings are not exempt transactions as defined under Regulation A but merely a means for companies to make public offerings of registered securities with fewer disclosure requirements.

The SEC refers to registrants using Form SB-1 as transitional small business issuers. For periodic reporting, they are permitted to use the Regulation A model of disclosure until such time as they 1) register more than $10 million of securities in a continuous 12-month period (with certain exceptions); 2) elect to graduate to a non-transitional disclosure system; or 3) are no longer small business issuers.

Form SB-2

Form SB-2 provides the most flexible method of registration and is the moot commonly used registration by small business issuers. The most important provisions follow:

* There axe no dollar limits for SB-2 offerings;

* Audited financial statements for two fiscal years are required;

* Registrants file Forms 10-SB (registration), 10-KSB (annual), and 10-QSB (quarterly) to fulfill periodic reporting requirements under the 1934 Act instead of more complex Forms 10, 10-Q, and 10-K used by larger companies;

* For at least two years, small business registrants may fulfill their periodic reporting requirements under Regulation S-B; and

* Form SB-2 fliers may use the optional disclosure formats added to Schedule 14A--information required in the proxy statement.

Regulation S-B permits small companies to issue securities well in excess of their existing float. For example, a company with a float just under $25 million could issue securities for $60 million or more to non-affiliates and not trigger the upper limit provisions of Regulation S-B. Thus it could avoid, for at least two years, the more stringent periodic reporting requirements of the Exchange Act that would otherwise require compliance with Regulations S-K and S-X.

Forms S-2 and S-3

The adoption of the small business initiatives added instructions for Forms S-2 and S-3 that enable small business issuers to use those forms while maintaining the less demanding SB level of disclosure. The inclusion of small business issuers for offerings which do not meet the $75 million public float specified by Form S-3 is intended to recognize the potential use of this form not only for primary offerings of debt and non-convertible preferred stock but also for secondary offerings such as rights and warrants, dividend reinvestment plans, convertible instruments, and asset-backed securities.

Regulation A--Exempt Transaction--Small Offerings

Regulation A focuses on the small dollar amount of publicly offered securities of up to $5 million. Concurrently, with the adoption of Regulation S-B, Forms SB-1 and SB-2, the SEC amended Regulation A by raising the ceiling from $1.5 to $5 million. Regulation A requires an offering circular for investors and the filing of Form 1-A in Washington, D.C. or with an SEC Regional Office where the company conducts its principal business activities. The Regulation A exemption is now more attractive to both domestic and Canadian issuers.

Another new provision under Regulation A permits a company to "test the waters." This rule allows a potential issuer without an established market for its securities to determine whether there is sufficient interest in an offering for it to move forward. A company can achieve this goal by publishing identifying information concerning itself and its business so it can assess investor interest before undertaking the accounting, underwriting and legal costs for a "short form" Regulation A offering. Under its final rules, the SEC has stated that a written "test the water" document is not a prospectus, thus limiting liability claims under the Act.

The principal advantages of a Regulation A offering are:

* Form 1-A, a "short form" registration is used;

* Up to $5 million may be sold in a 12-month period;

* Only the latest year's balance sheet and two years of statements of income, cash flows and stockholders' equity, prepared according to generally accepted accounting principles, are required;

* Financial statements need not be audited unless they are already available;

* Three offering circular formats are permitted under Regulation A:

1. Model A--50 questions and answers;

2. Model B--12 items in narrative and tabular format;

3. Information required by Part I of Form SB-2, except for financial statements. Form 1-A, Part F/S, specifies financial statement requirements for all offering circulars; and

* Periodic reporting is unnecessary.

Regulation D--Exempt Transactions--Limited Offerings

Regulation D generally addresses non-public offerings that, with certain exceptions, limit the number of investors. Rule 504 is an exception to both the non-public and the limited number criteria. The small business initiatives modified the amount of the exemption under Rule 504. Now, non-Exchange reporting companies may publicly offer up to $1 million (raised from $500,000) of securities subject only to the anti-fraud and other civil liability provisions of the Federal securities laws. Issuers use Form D to notify the SEC when they use this exemption rule. Before the revisions, the SEC required "blue-skying" (state registration) of offerings between $500,000 and $1 million.

The Regulation D (Rule 504) changes permit the following:

* An exemption from registration based upon a small dollar amount, as does Regulation A;

* General public solicitation of investors without requiring an offering circular;

* Unconditional use of the $1 million exemption; and

* Free transferability of securities.

In many cases the $1 million exemption may have little immediate impact. Most state securities regulators had adapted their laws to conform to existing Federal statutes. Thus, state registration would still be required for offerings between $500,000 and $1 million. However, the SEC continues to encourage state securities administrators to adjust their rules to the more liberal requirements under Rule 504 of Regulation D.

The Exhibit contains a list of forms discussed with a summary of registration and reporting requirements under the securities acts.

Current Developments

Speaking unofficially, a spokesperson at the SEC recently noted that since inception in 1992 through April of 1994, registrants filed 588 registration statements using Form SB-2. These filings totaled approximately $7 billion. With only $527 million in debt, the bulk of capital formation was in equity offerings.

A disappointing statistic for the same period showed that there have been only two SB-1 filings, both for raising equity capital. As noted above, many state securities laws are based upon Federal statutes: as state regulators modify their laws, these filings should increase.

Regulation A exempt offerings have increased markedly since the ceiling was raised from $1.5 million to $5 million. In the year prior to the increased limit (1991-92), there were 31 filings. After the revision, filings totaled 151 through April of 1994.

New Options

The SBI sponsored by the SEC provides small firms with various options to raise capital to finance their operating and investing activities. With various alternatives under the securities acts, it may be difficult to select the optimum means for an initial public offering (IPO) or a secondary offering. It seems obvious from the statistics, however, that Form SB-2 and Regulation A filings are the most popular routes to raise capital. Moreover, it can be concluded that Form SB-1, with a ceiling of $10 million, may be of limited use since companies may take advantage of the Regulation A exemption of $5 million every 12 months. Such a strategy eliminates the need for periodic reporting that would otherwise be required.

Also, filing with a regional office of the SEC rather than in Washington, D.C. has many advantages. The proximity of a regional staff aids in getting help and information related to registration requirements and available exemptions.


Form S-1. A full registration form under the Securities Act of 1933 It must be used by any company issuing securities for the first time unless the firm is entitled to an exemption under the Act or qualifies for an abbreviated form. Form S-1 requires detailed information contained in Regulation S-K and financial statements prepared according to Regulation S-X, with appropriate periodic reporting under the Exchange Act.

Form S-2. For registrants that have been filing timely periodic reports for at least 36 months and meet the tests as creditworthy. If eligible, small business issuers follow Regulation S-B disclosure rules.

Form S-3. For registration by entities fulfilling the requirements under Form S-2 and, in addition, meeting a stock float test by having an aggregate market value of voting stock held by non-affiliates of more than $75 million. If eligible, small business issuers follow Regulation S-B disclosure rules.

Form SB-1. The SEC adopted this new form in its small business initiative in April 1993, This is a transitional registration form that permits non-reporting registrants to offer securities up to $10 million. Registration requirements follow selected items from both Regulations A and S-B. Eligible companies comply with periodic reporting using Regulation A disclosure. Audited financial statements prepared under GAAP are required for two years.

Form SB-2. Public companies with revenues of less than $25 million and with a public float of securities of less than $25 million may use this form. Regulation S-B disclosure requirements for periodic reporting may be followed for at least two years before registrants come under Regulations S-K and S-X.

Form 1-A. A small exempt offering under Regulation A. Non-reporting companies may offer up to $5 million in a public distribution. An offering circular is required. Only the latest year's balance sheet and two years of statements of income, cash flows, and stockholders equity is required. GAAP statements are required but they may be unaudited. No periodic reports are required.

Form D. A limited exempt offering under Regulation D. An unlimited amount of securities may be offered privately to no more than 35 accredited "sophisticated" investors. Under Rule 504, up to $1 million can be publicly offered without registration under Federal statutes. Registration and periodic reporting are not required under a Regulation D exemption.

Proxy Statements. Under SBI rules, proxy materials have been simplified in order to align registration requirements with periodic reporting standards.

William J. Coffey, PhD, CPA, and Lewis Schier, PhD, are professors of accounting at Pace University.
COPYRIGHT 1995 New York State Society of Certified Public Accountants
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Author:Coffey, William J.; Schier, Lewis
Publication:The CPA Journal
Date:Jan 1, 1995
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