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Panel to urge SEC action on 'Facebook rule'

by Lisa Allen in Washington  |  Published February 1, 2012 at 9:15 AM
The Securities and Exchange Commission is moving forward with relaxing the "Facebook rule."

The SEC's Advisory Committee on Small and Emerging Companies is likely to recommend Wednesday, Feb. 1, that the commission take immediate steps to ease a rule requiring startup companies to register whenever they reach 500 shareholders, according to the advisory committee's chairman.

Suggesting the 40-year-old 500 shareholder rule is in need of thorough review because it leads to an "absurd set of circumstances," Stephen M. Graham, the managing partner of the Seattle office of Fenwick & West LLP, said he will recommend the advisory committee urge the SEC to undertake an interim easing of the rule while the more thorough examination takes place.

"Everyone understands that the 500 number was developed in the '60s, and a lot has happened since," said Graham. "I don't think anyone would disagree that [the number] doesn't work any more ... that it is the wrong the number. The question is, what is the right answer?"

The 500-shareholder rule requires a private company file extensive SEC information whenever its stockholder base exceeds 500. It defines a shareholder as someone who actually holds the share of stock.

In addition to making raising capital difficult for startups, the rule has had an impact in keeping some offerings from Americans.

Last year Goldman, Sachs & Co. and Facebook Inc. canceled a private $1.5 billion stock offering because of the SEC registration threshold. On Friday The Wall Street Journal reported that Facebook on Wednesday will file to carry out an initial public offering valuing the company at up to $100 billion.

Graham said the SEC did a lot of research in the 1960s when it developed the 500 number and needs to do similarly extensive research about a replacement, but also needs to act to offer some immediate assistance to startup companies trying to raise capital.

"My personal view is studies are fine, but often times it is important to crawl before you walk and at a minimum we need some sort of interim relief," he said.

He said he expected the panel on Wednesday would discuss various alternatives for interim relief, but make a recommendation to the SEC on one by the meeting's close.

Graham said one of the biggest problems with the current 500 rule is its definition of "shareholders" as being the people who actually hold the stock certificates.

Since the 500 number was adopted in the 1960s, it has become common for stock in public companies to be held in street names by investors' brokerages. The result is that big public companies with thousands of shareholders whose stock is held in street name can have less than 500 formal shareholders under the rule. Meanwhile startup private companies whose shareholders hold their own stock are getting forced to register even if the actual number of shareholders is far smaller.

"You have this absurd set of circumstances where a big public company whose shares are often held in street names can go dark if the number of [street names] drops below 300, while a private company has to start reporting when it reaches 500 investors," said Graham.

Both the SEC and Congress have been looking at alternatives to the 500 number. Some suggestions call for the SEC to rely on a measure of a company's outstanding public obligations rather than number of shareholders in deciding who has to file. Other proposals would replace the current threshold with a series of steps leading to full SEC registration.

At the same time, Congress has heard warnings that a simple increase in the 500 number could have unintended consequences -- and result in more big public companies whose shareholders hold stock in street names going "dark."

SEC Chairman Mary A. Schapiro formed the advisory committee in September, saying it would provide "advice and recommendations specifically related to privately held small businesses and publicly traded companies with less than $250 million in public market capitalization" with the goal being "to facilitate capital formation while at the same time protecting investors."

The advisory committee is also to discuss possible approaches the SEC could take in attempts to use Web-based "crowdsourcing" to raise capital for startups.
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Tags: Advisory Committee on Small and Emerging Companies | Congress | Facebook Inc. | Facebook rule | Fenwick & West LLP | Goldman Sachs & Co. | initial public offering | IPO | Mary A. Schapiro | SEC | Securities and Exchange Commission | Stephen M. Graham | The Wall Street Journal

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