The Securities and Exchange Commission Considers Revising Some of the Rules on Private-Company Capital Formation in the United States

AP: SEC Weighs New Rules for Private Companies' Stock
FT: SEC to Examine Private Share Trading Rules
WSJ: U.S. Eyes New Stock Rules
NYT: S.E.C. to Study Easing Rules on Shares of Private Companies

Over the past 10 years, the number of initial public offerings (“IPOs”) in the United States has decreased sharply from an average of 530 per year during the 1990s to an average of 130 per year since 2001. During the same period, however, the value of the transactions involving private-company stock has consistently grown. In 2010 alone, their value was $4.6 billion, which is almost twice as much as the corresponding 2009 figure of $2.4 billion. The proliferation of transactions in private-company shares has caught the attention of the Securities and Exchange Commission (the “SEC”). For example, the agency recently launched investigations to determine if certain private-company insiders have traded their private-company shares on the private market by using information which was not available to outside investors.

In the midst of such developments, the SEC is considering relaxing the rules regarding the ways private companies raise capital. The goal of the likely revisions is to reduce the private companies’ cost of regulatory compliance associated with capital formation without sacrificing investor protection. Such an ambitious objective may prove to be a significant challenge for the SEC in light of its shrinking budget and heavy workload related to the enactment of the Dodd-Frank Act.

Some commentators have opined that the SEC is likely to make two changes to the current regulatory regime. First, the agency would probably increase the number of shareholders a private company can have without being forced to make financial disclosures. Currently, this number is 499. Google, Inc.’s recent history provides an example of how this particular rule affects private companies in the U.S. In 2004, the company decided to go public because it could not raise sufficient capital without exceeding 499 shareholders. Second, the SEC is considering relaxing the strict prohibition against publicizing private-company share issues, known as a “general solicitation ban.” This solicitation ban was designed as a tool for protecting ordinary investors because private companies, unlike public ones, are not required to disclose financial information. If private companies were allowed to contact ordinary investors for the purpose of selling them their stock, those investors could be taken advantage of because they would have little or no information to rely on before making their decision.

Critics of the current version of the rules under scrutiny highlight that these rules discourage private companies from issuing shares, which reduces investment and leads to fewer jobs. Other commentators, however, point out that the SEC’s decision to review the relevant regulations may lead to the cancellation of some pending IPOs. Also, if the SEC amends its regulations to allow private companies greater flexibility in raising capital, it will take away the incentive for private companies to go public. Thus, ordinary investors will in effect be denied access to private-company shares, which are usually reserved for wealthy individuals.