Ask any banker, and he will tell you: “It’s hard to say, ‘I’m sorry, but you don’t qualify.’”
It is especially difficult when the loan applicant is a local business person with great instincts and a promising plan. It’s even harder to hear that news and know that the meetings, the applications and the due diligence leading up to that moment turned out to be a waste of time and resources. Unfortunately, both applying for and approving credit has become so difficult that, for some small-business owners, closing a loan to fund expansion is nothing short of miraculous. This is primarily due to regulatory strangulation on banks. Congress has been facing increasing pressures from small business owners to do something to help them get credit to expand and create jobs to improve the flailing economy. So far, no one in either government or the private sector has found “big” solutions, but Congress has attempted to make changes in a bipartisan bill named the JOBS Act (Jumpstart Our Business Startups), which was signed into law on April 5, 2012.
The JOBS Act was enacted to reach the lofty goal of changing the way small businesses develop. The primary focus of the JOBS Act is to boost small businesses, termed “emerging growth companies,” in their formation by loosening the restrictions on raising capital. The JOBS Act addresses traditional methods of capitalization as well as crowd-sourcing capital by harnessing social media for micro-investments. Additionally, the JOBS Act outlines a gradual plan for new companies seeking to qualify for public trading by allowing them to ease into the cumbersome disclosure obligations required of publicly traded companies.
In addition to seeking ways for entrepreneurs and small business owners to get the funding they need to help their businesses grow, the JOBS Act included changes that will impact the community banks that are often on the front lines with those fledgling businesses and are struggling under the weight of regulation. Under the JOBS Act, banks can have up to 2,000 shareholders before having to register with the SEC. Previously, just 500 shareholders created the need to secure and maintain designation as a public company. Also, a bank can deregister from publicly traded status if its number of shareholders slips below 1,200 through consolidation or buy-backs, rather than 300 shareholders under previous rules.
The changes in designation requirements give smaller banks a lot more flexibility in how they operate. Prior to the enactment, bank officers had to keep a watchful eye on how many shareholders they had, remaining vigilant to death or divorce, which could lead to distribution of shares to new shareholders and push the number of shareholders past the allowed threshold.
Passing that threshold can be costly. Registration with the SEC as a publicly traded bank comes with the expense associated with preparing disclosures and complying with multiple layers of red tape spawned by the reporting requirements of the Exchange Act of 1934 and the Sarbanes-Oxley Act, among others. Now, banks can raise capital by taking on additional shareholders without concern that the additional investors would launch it into an expensive SEC registration, which in turn would eat away at the very capital raised through the addition of new shareholders.
Many banking leaders see their bank’s publicly traded designation and registration with the SEC as an important benefit for the image of the bank. Certainly, though costly, these disclosure requirements provide their shareholders with unprecedented transparency into a bank’s bottom line. Moreover, many shareholders have become accustomed to the additional disclosures provided to them and don’t want to see the bank forgo that reporting process. For a bank that is growing into new markets, the effort of the additional reporting is definitely worth it.
Of course for smaller banks, secure in their market with no immediate needs to raise capital, it is likely a blessing to have more breathing room to expand and contract their shareholder ranks. Even more of a benefit is their ability to avoid the significant costs of jumping through the hoops required by the SEC and other regulatory agencies.
There has been some criticism of the JOBS Act in allowing smaller banks this expansiveness, or ability to opt out of SEC requirements until they reach 500 shareholders. Those criticisms by consumer protection groups about larger banks staying private and denying their shareholders critical data, normally disclosed if the bank was publicly traded, are largely overblown. After all, banks have to file balance sheets quarterly with the FDIC and are subject to reporting requirements and audits of other federal and state agencies. No bank, whether publicly traded or private, can operate without significant and frequent disclosure of its balance sheets and business practices.
The JOBS Act is a good start in allowing some flexibility for small businesses and banks to reach success. However, there is still a long way to go in striking that balance between loosening regulations to allow businesses and banks to grow through creative business solutions and continuing to keep their shareholders and the public informed as to how they are operating.
Ellen Kennedy is a partner in the Lexington office of Dinsmore (www.dinsmore.com), focusing her practice on bankruptcy and corporate law.