March 25, 1992
TO: BOARD OF GOVERNORS NO. 20-92
SEC RULES COMMITTEE NO. 15-92
RE: SEC REGULATORY AND LEGISLATIVE PROPOSALS CONCERNING SMALL
BUSINESS INITIATIVES
__________________________________________________________
The Securities Exchange Commission has developed a package
of legislative and regulatory proposals designed to promote
capital formation of small businesses. The significant aspects
of these proposals are outlined below.
I. Legislative Proposals
The SEC has submitted to Congress a legislative proposal
entitled the "Small Business Incentive Act of 1992." The
proposal recommends the following amendments to the Investment
Company Act of 1940 and the Securities Act of 1933.
A. Investment Company Act
1. Section 3(c)(7) - The bill would create a new
"qualified purchaser" exception from regulation under the 1940
Act for investment pools whose securities are held by certain
highly sophisticated investors. The SEC would be given
rulemaking authority to define who constitutes a "qualified
purchaser." The SEC's memorandum in support of the proposed
legislation states that it anticipates that, "at least initially,
the definition of 'qualified institutional buyer' in Rule 144A
under the Securities Act of 1933 [i.e., certain institutional
investors that own or invest on a discretionary basis at least
$100 million in securities] would represent an appropriate
standard for determining the level of sophistication for those
institutions investing in proposed section 3(c)(7) issuers." The
memorandum also states that it would be appropriate to allow
natural persons that possess a high degree of sophistication to
invest in the new Section 3(c)(7) pools.
2. Section 3(c)(1) - Section 3(c)(1) of the Act,
the private investment company exception, currently includes a
two-part attribution rule designed to prevent circumvention of
the 100 investor limit included in that provision. The
attribution rules provide that beneficial ownership by a
companyis deemed to be ownership by one person, except that if
such company owns 10% or more of the outstanding voting
securities of the issuer, the issuer must "look through" to the
underlying investors. However, the second part of the test
states that it may not be necessary
The Commission believes that the current attribution test
is unnecessarily broad. The proposed legislation would amend
Section 3(c)(1) by exempting all entities other than investment
companies from the "look through" provisions for purposes of
applying the 100 investor limit under Section 3(c)(1).
3. Section 12(d)(1) - The bill would amend Section
12(d)(1) so that the limitations thereunder would no longer apply
to the purchase of private investment company securities by
registered investment companies. Therefore, the limit on
investment company purchases of securities of Section 3(c)(1)
issuers would be raised from 3% to 10% (which is the limit
imposed under Section 3(c)(1), as discussed above). The current
Section 12(d)(1) limitations would still apply to the purchase of
registered investment company shares by Section 3(c)(1)
companies.
4. Section 6(a)(5)(A) - The bill would create a
statutory exemption for companies (a) that are not engaged in the
business of issuing redeemable securities, (b) the operations of
which are subject to the business and industrial development laws
of the state in which it is organized, (c) of which not less than
80% of its securities being offered are held by persons who
reside or have a substantial business presence in that state, (4)
the securities of which are offered solely to accredited
investors, as defined in Section 2(15) of the Securities Act, and
(5) that do not purchase any securities issued by investment
companies, except in certain limited instances set forth in the
proposal.
5. Section 6(d)(1) - The bill would amend Section
6(d)(1), which provides an exemption for certain small intrastate
closed-end funds, by increasing the aggregate amount of proceeds
that may be raised by such funds from $100,000 to $10 million or
such other amount as the Commission may set by rule or order.
6. Business Development Companies - The bill would
amend certain provisions applicable to business development
companies ("BDCs"), which are closed-end funds that are permitted
to invest only in certain specified types of securities and are
exempt form several of the provisions of the Investment Company
Act. Currently, a BDC must have at least 70% of its assets in
certain specified securities. In satisfying the 70% test, BDCs
are expected to acquire primarily securities of "eligible
portfolio companies." In general, an eligible portfolio company
must fall into one of three categories: (a) entities which do not
have any class of securities with respect to which credit may be
extended pursuant to the margin rules of the Federal Reserve
Board, (b) certain companies which are controlled by the BDC, and
(c) companies which meet such other criteria as the SEC may
establish by rule. In addition, BDCs are permitted to purchase
other specified securities, cash items and government securities
in satisfying the 70% test. An important element included in the
definition of a BDC is that it is required to "make available
significant managerial assistance" with respect to the companies
that are treated by it as satisfying the 70% test described
above.
The bill would amend the following provisions relating to
BDCs.
a. Section 2(a)(46) - The bill would
expand the definition of "eligible portfolio company", to allow
BDCs to invest in companies which do not have total assets in
excess of $4 million and capital and surplus in excess of $2
million.
b. Section 2(a)(48) - The bill would amend
Section 2(a)(48) to provide that a BDC is not required to make
available significant managerial assistance to any company that
falls within the new definition of "eligible portfolio company"
described above.
c. Section 55 - The bill would amend
Section 55 to clarify that a BDC's investment in the new
"eligible portfolio company" securities described above would
count toward the 70% of its assets that must be invested in
certain specified securities. In addition, Section 55 would be
amended to permit a BDC to acquire the securities of an eligible
portfolio company from persons other than the eligible portfolio
company or its affiliated persons, subject to such rules and
regulations as the Commission may prescribe as necessary or
appropriate int he public interest or for the protection of
investors.
d. Sections 61(a)(2) and (a)(3) - The bill
would amend Sections 61(a)(2) and (a)(3) to remove various
restrictions on the capital structures of BDCs.
B. Securities Act
1. Section 3(b) - The bill would increase the
offering limitation for exempted securities under Section 3(b)
from $5 million to $10 million.
II. Regulatory Proposals and Changes
A. Investment Company Act
1. Limit on Illiquid Assets - The SEC revised the
Guidelines to Form N-1A to increase the amount of illiquid assets
that a mutual fund may purchase from 10% to 15%. This change
became effective on March 20. (See Memorandum to SEC Rules
Members No. 13-92, dated March 23, 1992.)
B. Securities Act
1. Regulation E - The SEC proposed amendments to
Regulation E, which exempts from registration under the
Securities Act certain offerings by small business investment
companies ("SBICs") registered under the Investment Company Act
and by BDCs, to increase the aggregate offering price of
securities of SBICs that may be sold during a twelve month period
from $5 million to $15 million. The aggregate offering price of
securities issued by a BDC that is not a SBIC would remain
unchanged. The amount of SBIC or BDC securities that may be sold
annually by any person other than the issuer would increase from
$100,000 to $1,500,000.
2. Regulation A - The proposal would amend
Regulation A, which permits the unregistered public offering of
securities under specified conditions, to increase the dollar
amount on such offerings from $1.5 million to $5 million. In
addition, issuers would be allowed to solicit indications of
interest prior to filing an offering statement with the SEC
(i.e., "test the waters").
3. Regulation D - The proposal would amend Rule
504 of Regulation D, which exempts from registration annual
offerings of up to $1 million by non-Exchange Act reporting
issuers, to permit securities issued under Rule 504 to be freely
traded without registration and without the conditions regarding
state registration currently imposed by that Rule and to remove
limitations on the issuer's ability to engage in advertising or
other general offering activities.
4. Disclosure Requirements - New disclosure
requirements are proposed for "small business issuers", as
defined in the amendments to Rule 405 under the Securities Act
and Rule 12b-2 under the Exchange Act, which would be used for
both Securities Act registration and Exchange Act proxy and
reporting requirements.
III. Status of Legislative Proposals
The Senate Banking Securities Subcommittee is scheduled
to hold a hearing on the SEC's proposals on March 26. The
Institute plans to submit a written statement to the Subcommittee
by April 2. Therefore, please provide me with any comments you
have on the legislative proposals by March 30, 1992.
A copy of the SEC's legislative proposals and related
documents are attached as Attachment A.
IV. Comment Periods for Regulatory Proposals
A. Regulation E - Comments on the proposed amendments to
regulation E are due by May 19. Please provide me with your
comments on this proposal by April 30.
A copy of the SEC's release proposing amendments to
Regulation E under the Securities Act is attached as Attachment
B.
B. Regulations A and D - The comment period for these
proposed amendments expires on June 18. Please provide me with
any comments you may have on the proposed amendments by May 22.
A copy of the summary of the amendments to Regulations A
and D under the Securities Act is attached as Attachment C. If
you would like a copy of the entire release, please contact the
undersigned.
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We will keep you informed of developments relating to the
SEC's small business initiatives.
Amy B.R. Lancellotta
Associate General Counsel
Attachment