Speech by SEC Commissioner:
Remarks at the Twenty-First Annual Government-Business Forum on Small Business Capital Formation
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
September 26, 2002
Thank you, Mauri. It's a pleasure to be here this morning. I appreciate your pointing out my experience as a businessman. That's one of the important chapters in my life that helps shape my perspective as a Commissioner. As a small business person, you understand the importance of accountability and integrity. You learn that you need to be brave enough to stand up for what you believe in and take risks. Perhaps most importantly, you learn the value of innovation and creativity. If you're going to make money particularly as a small businessperson you've got to provide something more, something different that distinguishes your product or your service, something of value. That sort of creativity, that drive to find solutions where one isn't always apparent will, I hope, prove to be good training for my tenure on the Commission. Before I go any further, I do need to point out that I'll be expressing my own views and these are not necessarily the views of any other Commissioners or the Commission as a whole.
Of course, we are all very much focused on the events of the last year, from the fall of Enron, WorldCom and others, to the landmark Sarbanes-Oxley legislation. I know there will be a lot of discussion in the next two days about the Sarbanes-Oxley Act and the effect it will have on small businesses. This is critically important legislation and I'm sure the discussion will be very interesting and very useful.
I'd like to jump ahead a bit past the implementation of the Sarbanes-Oxley Act and talk for just a few minutes about innovations that I think we need to consider in the capital raising process. In some ways, it isn't quite accurate to say this is jumping past Sarbanes-Oxley because I strongly believe that any reforms that we consider to the capital-raising process will build on, and really be a continuation of, the Sarbanes-Oxley reforms. The Sarbanes-Oxley Act promises to enhance the timeliness, quality, accuracy and completeness of the information available in the markets about publicly traded companies. I think this will be a critical springboard from which to address any future reforms to the offering process.
So why should we address offering process reform? I would argue that we need to take steps to bring the offering process into the 21st century. That's not to say that the offering process under the Securities Act is broken. Rather, there are aspects that I think are inefficient, that cause issuers unnecessary delay and aggravation. There also are aspects of the process that simply don't work very well in light of current electronic technologies and in light of the globalization of the securities markets.
Let me give you a few examples of areas that I think deserve careful attention.
- Private to public offerings Issuers often face real tensions when trying to raise capital within the current 33 Act offering regime. These tensions are illustrated very well by the integration questions that arise when successive private offerings or successive private and public offerings are attempted in close proximity to each other.
The Commission adopted Rule 155 in the beginning of 2001 to address some of the troubling integration problems that issuers face. Specifically, Rule 155 provides a safe harbor that gives issuers certainty when they want to start a private offering after abandoning a registered public offering, or if they want to start a registered public offering after abandoning a private placement. This certainty is important, especially in these volatile markets. Issuers need the flexibility to find alternate financing if their initial financing plans do not work out.
One question I think we need to consider is whether Rule 155 goes far enough to address the integration concerns companies face. In my opinion, this is an area that deserves close attention. Rule 155 does not address the integration concerns companies face when they do successive private placements. It also doesn't provide any relief if securities have already been sold in the first offering. In those cases, the issuer is left to try to find another safe harbor that might apply such as Rule 152 (for registered offerings following completed private offerings). Alternatively, the issuer can apply old principles such as the "five factor test" to determine if the offerings are part of one offering. This creates significant uncertainty. In my opinion, we should think creatively about how to help issuers more efficiently access the capital markets while still ensuring investor protection.
Similar questions arise when issuers need to access capital quickly which pushes them to conduct private offerings, but when the purchasers of their securities want to be able to resell the securities to gain liquidity. Our offering process provides some mechanisms for the issuer and the purchaser to meet their needs such as the filing of resale registration statements or reselling under Rule 144. However, the emergence of alternative forms of financing such as PIPEs (which stands for private investments in public equity) and equity lines of credit have blurred the lines between public and private forms of financing. Is this a problem? Not necessarily. It does create complications as evidenced by the careful steps companies need to take to make sure they comply with Section 5 when navigating the fine line between the private and public offering in these deals. But more importantly, I do think it indicates that this area deserves scrutiny to determine if our offering system is adequately suited to the needs of companies today. At a minimum, it is fair to ask whether there are inefficiencies that impede capital formation and raise the cost of capital, which can be addressed in a manner that does not compromise investor protection.
- Communications. The next area that I think deserves attention is the issue of what communications are permissible in the offering process. In this regard, an issue that I imagine is of particular interest to small business issuers is whether we should rethink the ban on general solicitations in private placements. In light of current technologies such as the Internet, it seems that issuers lose a great deal of flexibility by not being able to go out to the world to find investors. If infact sales are made only to accredited investors, is the prohibition on using general solicitations to find investors truly necessary? Right now, there is a mechanism by which private placements can be conducted over the Internet but it has been criticized as restrictive and cumbersome. This mechanism was first articulated in staff no-action letters beginning with IPONet in July of 1996. The procedure described in IPONet requires the issuer to use a broker-dealer who establishes a website to find accredited investors. The website cannot identify any issuer or offering except in password-protected parts of the site. Rather, investors are able to gain access to specific offering information only after the broker-dealer has determined that they are accredited. At that point, the investors can access offering information through a password-protected portion of the website. Even then, they are restricted in the offerings in which they can participate and are prohibited from purchasing in any offerings that were pending at the time they initially were given access to the site. Now, I don't want to be critical of the IPONet line of letters. This was a creative and innovative step to help issuers make use of the Internet to conduct private placements. My question is whether there is more we can do to further this innovation without sacrificing our investor protection goals.
I do not mean to prejudge the issue. I don't know the answer to the question and I think it needs to be studied. I do, however, think this is an issue we should take on, evaluate carefully, and determine if there are costs and inefficiencies we can eliminate without compromise to our primary goal of investor protection.
- Use of the Internet in registered offerings. Along similar lines, I think it's fair to ask whether issuers should be given greater latitude to use the Internet to communicate with investors in registered offerings. Section 5 of the Securities Act was conceived when we lived in a "paper-based world." The Commission has taken important steps to help issuers and other market participants make use of the Internet. My question is whether there are further innovations that can and should be made.
For example, we base our registered offering process around the concept of the primacy of the prospectus. This is an important concept. The Section 10 prospectus is the document that contains the full, balanced disclosures on which we want investors to base their investment decisions. The question is whether there are ways in which we can encourage innovation, and encourage greater use of websites to supplement or act as a substitute for the traditional Section 10 prospectus. This is not an easy issue. If we take this issue on, we will have to face difficult questions of what information must be filed with the Commission or retained in archives on the issuer's website, how to treat third-party information such as hyperlinked information, what liability should attach to the offering information on the issuer's website, how to ensure the information is balanced and gives an accurate picture of the company, and many other questions. The Commission has already faced and begun to address some of these issues. For example, in April of 2000, the Commission took on some of these issues in its Electronic Media release. However, it also acknowledged that this is a dynamic and changing environment and we need to periodically reevaluate our regulatory system to ensure it keeps up with change, and does not impede progress. All of this, I should reiterate, cannot be to the detriment of investor protections. If we liberalize our rules as they apply to websites for example, if we allow issuers to use their websites as prospectuses or as adjuncts to their prospectuses, we will need to focus on how to ensure the information on the websites is accurate, current and balanced. Further, we will need to ensure that appropriate liability attaches I would submit at least Section 12(a)(2) liability to all offering communications that qualify as prospectuses.
I offer these ideas as matters to think about and matters that I believe the Commission should evaluate when we get beyond the immediate challenge of adopting rules under the Sarbanes-Oxley Act. As I said earlier, I believe the Sarbanes-Oxley legislation will give us a good platform from which to consider any possible reform proposals under the Securities Act. I also think the events of the last year are a strong reminder that any actions we take must be cast against the backdrop of our paramount mission investor protection. To accomplish these objectives, we'll need to think creatively and listen closely to you and the rest of our constituents.