Brad Smith, President
December 24, 2002
Jonathan G. Katz, Secretary
Re: File No. S7-40-02
Proposed Rule Regarding Disclosure Required by Section 407 of the Sarbannes-Oxley Act of 2002
Dear Mr. Katz:
Thank you for the opportunity to comment on the recently enacted Sarbannes-Oxley Act. My perspective is that of a consultant to entry-level, development-stage companies that are small business issuers. Typically these small business issuers file small SB-2 offerings and depend upon the OTCBB electronic quotation system to provide a secondary market for their investors. The officers, directors and investors in these companies reflect Main Street America. These small business issuers personify the best attributes of free enterprise and entrepreneurship. These small business issuers risk substantial portions of their personal, family and friends capital in the course of developing their companies into viable enterprises. Typically this class of small business issuer is not served by the venture capital industry or upper tier capital market service providers. Most situations require many years of incremental gain for these companies to evolve ! to levels where they can access upper tier capital market capabilities and qualify to list on an exchange.
The purpose of this comment letter is to recommend that the Commission develop a different plan to regulate entry-level, development-stage small business issuers by creating a coherent and right sized regulatory scheme for these issuers. At minimum it must enable a lower threshold entry point that encourages small business issuers to improve to the next level of regulatory compliance. Assuming that small business issuers can immediately achieve full Sarbanes Oxley compliance is short sighted because this approach will have the effect of driving many issuers in this class out of public reporting status. Unfortunately this will have long term repercussions for the SEC, state securities regulators, current investors in small public companies and it will impact the ability of small issuers to raise new capital.
The Sarbanes Oxley rules are a one size fits all approach to regulation. This was not a practical approach for the small business issuer class in the past as is evidenced by the Commission developing unique rules and regulations that enable SB-2 registration, 10KSB and 10QSB filings, 15c2-11 to enable secondary market trading, etc.
I intend that my comment letter strongly recommend that the Commission put the small business issuer aspect of complying with Sarbanes Oxley on hold until the rules and regulations are sorted out by upper tier market participants. And, that as the upper tier market develops its knowledge base about how to implement Sarbanes Oxley the Commission can apply this knowledge to develop a coherent regulatory scheme for the small business issuer segment.
I caution the Commission to note that upper tier market participants are voicing concern in their comment letters about how the upper tier segment of the market can actually make Sarbanes Oxley rules and regulations work in practice. I recommend that until this new regulatory scheme is sorted out by upper tier participants that the small business issuer class be removed from this round of applying Sarbanes Oxley rules and regulations. I believe that when the upper tier knowledge base and practices are developed the Commission will be in a much better position to focus on creating a coherent and workable set of small business issuer rules and regulations and can do so in the context and spirit of developing a properly scaled regulatory scheme.
Specific concerns expressed by numerous comment letters express that the proposed requirements to qualify as an "audit committee financial expert" precludes too many individuals who would seem to be fully capable of exercising appropriate judgment on matters that come before a fund's audit committee is one indicator that upper tier market participants will have difficulty complying with Sarbanes Oxley rules and regulations. Determining who is a financial expert and how many financial experts will be available to serve as directors and head of independent audit committees are problems that must be solved by the upper tier before it is reasonable to apply this requirement to the development-stage, entry-level, small business issuer class. Comment letters have also raised a host of issues and concerns about increased liability for financial experts, if the role as articulated by the Commission is in fact a proper governance role for a director and how financial expe! rt capabilities will be measured and reported.
I recommend that the commission wait to apply the financial expert requirement to the small business issuer class until these financial expert issues are resolved.
As a good faith starting point I recommend that the Commission facilitate forming an ad hoc group of securities and investor associations, educators, issuers, and capital market practitioners to develop a Financial Expert certification program for small business issuers. Until there is a recognized source to create a supply of financial experts I believe that it is unrealistic for the Commission to expect that small business issuers can add these people to their boards when the upper tier is voicing concern about their ability to do so.
Other comment letters raise concerns, issues and problems that must be resolved regarding the code of ethics disclosure and internal control reports. Upper tier market participants will be required to spend considerable resources resolving the concerns, issues and problems raised in these comment letters. Given this fact, it is not realistic to require development-stage, entry-level, small business issuers to expend precious scarce resources resolving these same issues until they can do so in the context of accessing knowledge and practices developed by the upper tier market participants.
The Commission requests comment on whether a transition period would be appropriate. Presumably the Commission is making this offer primarily to upper tier market participants. This offer indicates that the Commission is aware it will take resources and time for upper tier market participants to achieve full compliance with these new rules and regulations. Whatever the Commission's view of this need for a transition period for the upper tier, the situation is even more extreme for entry small business issuers. Therefore additional time and consideration must be given to the small business issuer class if the Commission wants them to succeed in their efforts to instill Sarbanes Oxley related rules and regulations into their business models.
I encourage the Commission to wait to impose Sarbanes Oxley rules and regulations on the small business issuer class until upper tier market participants have assimilated these rules and regulations into their segment. Under this approach the Commission can in good faith develop a better small business issuer regulatory scheme. Including small business class issuers in the current round of Sarbanes Oxley rules and regulations is short sighted because it is likely to create more problems than it solves.
I believe it is important to note that small business issuers did not generate the problems that caused Sarbanes Oxley legislation. These problems were caused by upper tier market participants. Therefore, the upper tier should be required to implement Sarbanes Oxley rules and regulations first. Small business issuers deserve the benefit of SEC decision makers developing right sized regulations for their segment.
I assume that the primary cause of Sarbanes Oxley affecting development-stage, entry-level, small business issuers is exchange reporting requirements. One must also assume that this is the beginning of a process that will continue raising the regulatory bar for exchange reporting requirements. Therefore, I recommend that securities policy makers, regulators and practitioners take this opportunity to step back and create a transition market category for the entry level small business issuer class. From my perspective the Commission will achieve a far better outcome by maintaining a large number of small public issuers being reporting entities than by raising the entry level thresholds so high that meaningful numbers in this issuer class stop being reporting entities.
I recommend that the Commission consider my comments in this letter in a context that considers the benefits of small business issuers currently using SB-2 registrations and OTCBB trading status to raise capital, provide a secondary market for their investors and maintain public reporting status because regulatory oversight requires it. This is a good entry point, base line or transition market from which an entry level small business issuer can develop their company into an exchange quality issuer.
I strongly recommend that the Commission envision how to instill the intent of Sarbanes Oxley into the OTCBB issuer segment of the market without terminating it as a logical entry point for small business issuers or designating the OTCBB an exchange.
Preserving the OTCBB as a transition market place and maintaining the SB-2 offering as a development-stage capitalization tool will enable the small business issuer class to more quickly become fully compliant with Sarbanes Oxley. Making it possible for more small business issuers to successfully work on achieving Sarbanes Oxley compliance will create a better long term outcome. Forcing small business issuers underground and away from registered offerings and reporting status will create ongoing regulatory problems.
I believe that the best way for the Commission to address this situation is to delay imposing Sarbanes Oxley on small business issuers and OTCBB traded companies. And, do so with an understanding that at the proper time the Commission will develop a complete set of Sarbanes Oxley lite small business issuer rules and regulations. And, do it in the context of designing a coherent entry-level, small business issuer regulatory scheme that enables something short of an exchange market place secondary market.
Imposing Sarbanes Oxley rules and regulations on the small business issuer class and its secondary market place when upper tier market participants have so many unresolved concerns, issues and problems fails to set up proper conditions for successful experiences or outcomes. The small business issuer class requires a unique set of right-sized regulations. I encourage the Commission to wait until it has the time and resources to properly focus on develop a coherent set of small business issuer regulations that will enable this class of issuer to raise capital, provide a secondary market for its investors and maintain reporting entity status at lower levels than what is and will be required by exchange reporting status.
I appreciate the opportunity to comment to the Commission on the proposed rules, and would be happy to discuss any questions the Commission may have with respect to this letter. Any questions about this letter may be directed to Brad Smith (512-261-5200 or email@example.com).