The Rule 415 Conundrum- We Await the SEC...

In recent interpretations, staff members of the Securities and Exchange Commission’s Division of Corporation Finance for the first time have been advising small public issuers (the almost 10,000 companies with less than $75 million in public trading stock) that they must limit the percentage of their company that may be registered to increase their float.

These “resale registrations,” typically permitting stock of former private equity investors to become tradable, according to the staff are really indirect public offerings by the company if the percentage is too high. Therefore, they say, the registration must be transformed into a “direct” public offering, which in almost all circumstances for these small companies is unachievable. While I respectfully disagree with the legal interpretation, that analysis can be saved for the legal journals.

I do need, however, to discuss what this will bring about. This interpretation (of Rule 415 under the Securities Act of 1933) likely will have the impact of effectively shutting down all financing opportunities for these small companies, any one of which could be the next Microsoft, Yahoo or Amgen. If private equity or so-called PIPE (private investment in public equity) investors are unable to achieve liquidity soon after their investment, most will simply not invest, or at best will substantially increase their price to do so to account for the additional risk.

There are those within the SEC who contend that these smaller companies should not be public. I could not disagree more strongly. One example: Advanced Cell Therapeutics, which managed to raise funds in a PIPE to support its research on extracting stem cells from fetuses without damaging the fetus. There is no other potential source of financing for a company like this other than a PIPE investor.

In biotechnology in particular, the question should not be whether the company is big enough to be public, but rather whether it can benefit from being publicly held. Easier access to large pools of capital is a major benefit to being public. If a small public company can raise money through PIPEs, the next cancer cure or Alzheimer’s treatment could be the result.

Reverse mergers also will be significantly impacted. After a merger, most shares in the company are “restricted” and cannot be sold unless the holder waits at least a year or registration is possible. And investors in what was the shell must have their shares registered – they cannot even sell after holding a year or two or even more. By limiting the amount to be registered to a very small amount (recently we have heard the desire of the staff to limit registration to 30% of shares held by nonaffiliates, a very small amount following most reverse mergers), the ability of these companies to benefit from going public through this popular and legitimate technique would decrease dramatically.

I implore the SEC’s Commissioners and Division of Corporation Finance, as well as the Congressional committees providing oversight, to show their support of entrepreneurs and small businesses when they seek to access public markets, and provide clear and unequivocal guidance as to how to provide liquidity for investors in these companies in a manner that is realistic, meaningful and balancing all interests, rather than overreacting to those few who abuse the system.

Allowing continued growth in the $25 billion a year PIPE market, the only source of capital for very small companies to support their efforts to achieve their goals, can provide the opportunity for inventors, entrepreneurs and visionaries to achieve their version of the American dream. We hope the SEC will recognize the value of these companies and not cause thousands of companies to stop in their tracks and fail simply because their regulations made capital unavailable.