Dodd Bill: Potential Impact on Private Capital Formation
The massive financial reform legislation that cleared the Senate Banking Committee on March 22, 2010, Restoring American Financial Stability Act of 2010 (the “Dodd Bill”), is pending for action on the Senate floor this week. While Senate Republicans blocked a move by Democrats for a floor debate on Monday, April 26th, there continues to be speculation that some form of the Dodd Bill will likely pass the Senate.
Much of the public discussion of the Dodd Bill has been focused on the impact to large financial institutions, private equity firms and hedge funds. While Wall Street has garnered most of the attention, the Dodd Bill’s impact on Main Street will be equally, if not more, significant. One of the more pernicious features of the Dodd Bill would have a rather marked and, in our view, negative impact upon private capital raises. The Dodd Bill contains a provision that will limit private placements relying on Regulation D, which is one of the primary means used by issuers for private securities offerings without registration with the SEC. This can have a chilling effect on private capital formation, particularly smaller issuers with time-sensitive capital needs that rely upon individual investors.
One critical piece of Regulation D is the ability for issuers to make offers to “accredited investors.” Currently, individual investors who are the life blood of many different types of private placements must either have “net worth” of $1,000,000 or meet income thresholds of $200,000 a year (for the prior two years) or $300,000 a year (with their spouse for the prior two years) in order to be considered as “accredited investors.” The Dodd Bill would require that both the net worth test and the income test be adjusted to reflect the effect of inflation since the standards were originally adopted. The Wall Street Journal reports that the Dodd Bill would raise the net worth test to $2,300,000 and the income threshold to $450,000 and that such a change would disqualify approximately 77% of current accredited investors. One of the principal market impacts of these changes would be to hamper the “angel” investor market that is critical to the development of early stage businesses.
The Dodd Bill would also require issuers seeking to utilize Regulation D to submit offering materials to the SEC for a 120-day review. This is in effect a registration requirement, which would make it very difficult for many businesses to raise equity capital in a timely fashion. Currently, there is no SEC review of filings made pursuant to Regulation D.
The Dodd Bill also contains provisions that would make it more difficult for private placements to qualify as “covered securities.” The Dodd Bill would alter the provisions of Section 18 of the Securities Act of 1933, as amended, which was designed to provide uniformity for private offerings involving multiple state regulations by providing an exemption for “covered securities.” Securities offered in a transaction exempt from registration under the Securities Act is one of the “covered securities.” The amendment proposed by the Dodd Bill changes that provision in connection with a “covered security” and provides that the SEC, by rule or regulation, may designate the class of securities that it deems to be covered or not covered, in connection with offerings exempt from the registration requirements, based upon the size of the offering, the number of states in which the securities will be offered and the nature of the persons to whom the securities is being offered.
Whether these provisions will remain in the Dodd Bill should it be enacted by the Senate is unclear and there is no companion provision in the House bill. As a result should the Dodd Bill pass the Senate, the two bills would be subject to a conference committee.
We will continue to monitor the progress of the Dodd Bill and will provide updates as appropriate.
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