How Many Investors Is Too Many?

The SEC is reconsidering the 500-shareholder threshold for when private companies must publicly disclose financial information.

Last January, following a $1.5 billion Goldman Sachs private placement, Facebook announced that it would start publicly disclosing its financials in 2012. The reason: the company expected to trigger the Securities and Exchange Commission’s long-standing requirement that private companies with 500 or more shareholders and over $10 million in total assets must file financial reports with the SEC.

Now, regulators are evaluating whether the 500-shareholder threshold is a deterrent to companies’ ability to access capital. At a hearing last week before the House Committee on Oversight and Government Reform on the dearth of initial public offerings, chairman Darrell Issa (R-Calif.) said his concern isn’t with the Facebooks of the world but with the smaller, privately held companies on track for an eventual IPO that need significant funding to grow in the meantime. SEC chairman Mary Schapiro acknowledged that 500 may be an “arbitrary number” and said her agency is considering whether the investor cap, instituted nearly 50 years ago, should be revisited.

Possible changes include redefining which investors fall into the calculation. At present, those shareholders include employees, accredited investors, and institutional investors. Some factors do keep the number down: options issued to employees do not count, and brokers who act on behalf of many investors count as one stockholder.

So while the rules may force not-ready-for-prime-time companies to expose their financials, they also let some publicly traded companies to suddenly stop making public disclosures and “go dark” when the number of shareholders drops below 500, Schapiro noted. A Senate bill introduced in March would change the threshold to 2,000 holders for banks and bank holding companies.

In another possible change that could become reality sooner, the SEC may loosen the restrictions put on companies in promoting private securities offerings. Meredith Cross, director of the SEC’s division of corporation finance, said she will likely suggest the regulator issue a concept release on the subject of general solicitation in the coming months to see how the public feels on the topic.

At the Tuesday hearing, lawmakers questioned whether the SEC’s general solicitation ban violates free speech. But other factors may outweigh any tendency to loosen existing rules. “If you’re going to be conditioning the market without issuing a prospectus, investors might be harmed,” James Hamilton, principal securities law analyst for Wolters Kluwer Law & Business, tells CFO. “With a lot of information floating out there, some people may get it and some people might not.”

Schapiro did not give a timeline for issuing any proposed changes but said she considers the topics “front and center on our agenda.” She added, “Getting the balance right between protecting investors and making access to capital efficient [for companies] is job one.”

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