Securities Deregulation Coming in a Trojan Horse

Proposed Securities Laws Easing Will Make it Easier to Commit and Get Away With Fraud

Proposed legislation in house subcommittees suggests that Republicans and Democrats may try to sell securities deregulation as a jobs-creation mechanism. What it will more likely do is make it easier to commit fraud, and if coupled with other proposed legislation, make policing fraud more difficult than ever before.

On Wednesday, April 9th, the House Subcommittees on Capital Markets and Government Sponsored Entities and Financial Services held hearings on a range of bills addressing various securities regulations and rules–namely why those rules should be relaxed. What is going to happen if these pass?

The first and perhaps most jarring bill will reduce the threshold for “well-known, seasoned issuers” from a “public float” of $700 million to $250 million. As Columbia Law School Professor John Coffee intimated, “The intent was probably to allow most issuers to escape the ‘quiet period’ and ‘gun jumping’ restrictions of Section 5(c) of the Securities Act of 1933 in order to be able to ‘test the waters.'” The insidious effect is that Well Known Seasoned Issuers also qualify for “automatic shelf registration,” issuers. Thus, the majority of issuers would no longer be subject to prior SEC review of their registration statements.

Another bill would affect Rule 144 registration exemptions and holding periods for reporting companies. One of the key components of 144 and 144A registrations is the holding period of 6 months. The main thrust of that holding period is that it makes investing in the business using 144 unattractive except to the most committed investors, and therefore, forces companies who seek to attract capital go through the IPO and public offering and registration processes. The bill would reduce the holding period to just three months. This would in effect allow reporting companies to bypass IPOs altogether by issued post-IPO restricted securities that can be hedged on a short-run basis. While that may be the point, it is detrimental to the process.

One of the bills seeks to preempt state securities laws altogether for reporting companies. This would have the effect of federal encroachment into state sovereignty for states like Texas or New York that have more robust local securities and anti-fraud protections.

Yet another bill would allow mid-cap companies, e.g., those with a float of $250 million and annual revenues of $100 million to evade the reporting and requirements that were imposed by Sarbanes Oxley Section 404(b), and to do so indefinitely.

These should be juxtaposed to several bills circulating and the pending Supreme Court decision in Halliburton regarding securities class action proof and certification of classes in certain circumstances. These together will make it imminently easy to commit fraud, while making it way more difficult to prosecute or police fraud.

Investors will have to up their degrees of vigilance when making investments. Hopefully, this will spurn a new private watchdog industry that will help investors decide which companies are safe to invest in, and which are dangerous.