Do Small Companies Get Short Shrift?

Friday, June 1, 2007 - 00:00

Editor: Please tell us about your background and practice.

Hogoboom: As a corporate lawyer, I have been practicing securities and mergers and acquisitions law for about 22 years, having trained in New York City with a major Wall Street law firm doing large institutional M&A transactions and securities offerings. I have been with Lowenstein Sandler for the past 17 years where my practice has continued to focus on SEC and M&A matters, mostly for smaller and mid-cap public companies.

Editor: How much of a problem to your clients is the use by the SEC of enforcement actions for ad hoc rule writing?

Hogoboom: While that is not a significant problem for most of the companies I deal with, it does occur from time to time. I do not view this practice as an illegal use of authority by the SEC. In my area of activity I think that the SEC does much more damage by altering interpretations of its rules and regulations without any notice or particular logical basis.

Editor: Why isn't there a comment period before new rules are adopted?

Hogoboom: The SEC will tell you that most of what they are doing is consistent with their existing rules and interpretations. They will vehemently deny in most instances that they are changing the rules of the game as they go along. However, for those of us who deal with them on a day-to-day basis that is not the case.

Editor: How important is it for the SEC to make clear that any new, significant policies that apply to the whole securities industry will be vetted through the Administrative Procedures Act ("APA") process?

Hogoboom: As a general matter the whole philosophy of the APA makes tremendous sense - that you should give notice to people that you are regulating if there is going to be a significant change in the way you are doing your regulation. I am not sure that everything that the regulators do needs to go through a process of publication and comment since the regulators need to have some flexibility to respond to extreme circumstances when they occur. As long as there is some opportunity for self-examination and correction in the wake of some of those actions, I am not that concerned if the SEC sometimes uses its enforcement or interpretative powers to affect changes in regulations. However, if the actions are unchecked and there is no ability to comment on them after the fact and affect changes, this is somewhat dangerous. The SEC should always be open to people questioning whether their rules make sense in the light of the circumstances.

A new significant policy should be vetted through the rule making process. The SEC can do a lot of damage through incremental changes as well.

Editor: Do you agree that the SEC should use a principles-based and/or prudential approach to regulation?

Hogoboom: I do, but I am not certain that I would adopt the principles-based system in the same way other nations have. The SEC has played a tremendous role in making the U.S. capital market the most robust and efficient market in the world. There is much to be said for the way that they approach their regulatory obligations. However, I do think that we are at a point where a lot of the rules are there for historical reasons and are no longer relevant in today's market reality. It makes sense to have a fairly substantial overhaul of the way in which the SEC does business so that it is more efficient, makes more sense in the light of modern reality, and addresses the concerns that exist now as opposed to what existed 100 years ago.

Editor: Would it be easier for smaller companies to comply with a principles-based system?

Hogoboom: That depends on what the principles are. Navigating through the rules is not the problem that smaller companies face so much as having to adhere to rules that treat them as second class citizens and are not in keeping with modern realities. For instance, under the new Reform Act rules the SEC allows a well seasoned issuer to issue securities without having to go through the process of a full blown registration process and a potential for SEC review. A smaller public company, even though its public filings are available on the SEC EDGAR filing system, cannot incorporate their reports by reference into a registration statement which results in their having to spend hundreds of thousands of dollars to recreate information that already exists. There does not appear to be any rationale for this.

Editor: Is there anyone on the Commission who has stepped up for the small companies?

Hogoboom: I am not aware of anyone who has particularly championed the cause of smaller public companies. Congress did pass a law requiring the SEC to focus on the concerns of small businesses, but the SEC has not taken this responsibility seriously. The SEC has a small business advisory committee set up to provide guidance to the Commission about issues that face smaller companies. It has been consistently the case that the smaller public companies have gotten short-changed by the SEC.

Editor: Is the size of the staff a factor contributing to this neglect?

Hogoboom: I believe the SEC is understaffed. I think that an agency that performs as vital a role as they do deserves to be fully funded at a level which is necessary for them to do their job well because the entire economy depends on a fair and transparent financial market. They should spend the money now so that the SEC can perform its regulatory role rather than deal with the potential loss of access to capital or a potential meltdown in the financial markets. If they had more staff, they could get things done in a way that would not result in the delays that issuers are experiencing. It is also odd to me that in a situation where they appear to be under a budget crunch, both Congress and the SEC continue to erode the SEC's ability to collect fees on public filings - a nominal amount for a company filing to effect a public offering. To me the SEC should operate like the Federal Reserve system in becoming a net contributor to the federal budget.

Editor: Are you concerned that information you provide in response to SEC inquiries will trigger civil litigation?

Hogoboom: I worry that comment letters now become publicly available information, and companies can make disclosures to the SEC in the context of a comment response process that might be detrimental if it got into the hands of a litigious party. While I have yet to see that happen, it would not surprise me if it becomes a real problem when litigators become more adept at figuring out how to get their hands on these comment responses.

Editor: Would application to SEC inquiries of an examiner's privilege similar to the bank examiner's privilege be useful?

Hogoboom: I would not be in favor of that because we are not talking about a systemic risk to the entire financial system. It is one thing if people lose confidence in banks but a specific company should not have the right to operate in the dark when it comes to issues regarding public disclosure. It is not consistent with the model that the securities laws are based on which is that you use disclosure as an alternative to a merit review. I believe that many of those problems could be addressed if the SEC would take a less adversarial approach to the comment process and look at it as a cooperative endeavor. They should tell companies what they are looking for and provide them with guidance on how to satisfy their concerns.

The SEC is charged with making sure that the financial markets remain free of fraud - that is a policing activity. They are also in charge of the entire capital raising process for our economy. In that latter context there is a tremendous amount of collegiality between members of the commission's staff and professionals who are active in raising of money as opposed to litigators who are active in dealing with enforcement actions. Bank examiners can also bring enforcement actions against the institutions that they regulate. It is not all that different from the banking system we have now.

Editor: Do you believe that the confidentiality privilege should be taken seriously so that third party plaintiffs' lawyers do not have access to information given the SEC?

Hogoboom: I do not think that is different from the way that the SEC currently operates. They will not confirm that someone is the target of an investigation and they have procedures in place to ensure the confidentiality of most of their processes. Most of that information probably leaks from outside sources. It is difficult for us when representing a client in a potential enforcement action to get a lot of information from the SEC about what is really going on.

The Wells Notices are widely publicized because the issuers view that as a material development that needs to be disclosed in public filings. It is not completely unreasonable for the market to be informed about this. We are better off knowing all the details about what happened and how the scandals unfolded than for that to take place in a secret environment.

Editor: Would you advocate a policy urging corporations to take the self-assessment privilege much more to heart?

Hogoboom: I would favor asking the SEC to implement a safe harbor provision that would prevent an issuer from becoming liable for statements it makes in the area of self-assessment. There have been reforms carried out over the years to address similar cases with respect to forward-looking statements. I agree that anything we can do to encourage companies to be more open and forthcoming with information would be beneficial to the economy as a whole.

Editor: Have you found that the SEC has been mindful of reducing penalties in its enforcement actions against companies that are forthcoming during an investigation?

Hogoboom: Yes. Self-reporting goes a long way towards influencing the SEC's behavior.

I think that the SEC views this from the same perspective as that of a prosecutor - as a practical matter, whether someone's behavior is so egregious that it warrants use of SEC resources to bring an enforcement action.

Editor: Should the SEC apply a systemic cost-benefit analysis?

Hogoboom: The SEC should definitely engage in additional cost-benefit analysis of many of its functions. As it relates to smaller companies, some of the burdens that small businesses carry in their SEC reporting are not justified by any regulatory issue which could merit it. The inability of a small company to incorporate by reference in their filings other documents that they file with the SEC makes no sense to me. There is no cost-benefit there that would justify that process. If the SEC were able to take that kind of approach with respect to some of their regulations, they might change them to make the market more efficient without damaging their integrity.

Editor: Are there other reforms you believe are necessary to lessen the burdens faced by companies under the current regulatory regime?

Hogoboom: There are problems in the area of how small public companies can raise capital that need to be addressed, an area that has been thus far under-addressed. The SEC is somewhat suspicious about the ways that small public companies raise money. Much of that occurs because the SEC makes it hard for small public companies to raise money in traditional ways that are available to larger companies. If they would streamline the registration process in a way that makes sense in light of the availability of information, and make their forms and procedures available to smaller companies that have been around long enough, they would go a long way to reducing that burden.

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