Class matters: He the SEC’s new tier system favors

It’s a basic fact of capitalism that repeat customers get better treatment than one-timers and walk-ins.

It’s a basic fact of capitalism that repeat customers get better treatment than one-timers and walk-ins. Just ask any frequent flier, diner or gambler about the perks of being a steady patron. Now the Securities and Exchange Commission is trying to apply that principle to the nation’s stock and bond markets.

On June 29 the commission approved a set of rules designed to make it easier for big companies to raise capital by selling their securities to the public. The rules create a new class of corporate registrant, the “well-known seasoned issuer,” which the SEC defines as a company that has a market capitalization of more than $700 million and that has been public for more than a year. Such issuers will be able to commence offerings immediately upon filing a shelf registration, rather than having to wait for SEC staff to review and approve that document.

Additionally, these issuers can omit much of the information normally required in offering prospectuses, because it is included in their quarterly and annual reports. That will speed their time to market. The idea of such “company registration” (as opposed to deal-by-deal registration) dates back as far as 1966, when exSEC staffer Milton Cohen suggested the idea in a Harvard Law Review article.

Companies that don’t meet the $700 million threshold can still qualify for well-known seasoned issuer status -- for bond offerings only -- if they issued more than $1 billion in bonds during the preceding year. Eligibility will be determined annually.

Issuers that obtain seasoned status will also enjoy more leeway to communicate with the public around the time of their offerings. Currently, so-called quiet period rules prevent companies from advertising, giving interviews or even releasing certain data to investors while a deal is pending.

The rationale behind the proposal is a good one: A reputable company that regularly reports financial results to shareholders shouldn’t have to file massive documents disclosing its financial condition and the nature of its business every time it conducts an equity or debt offering. That’s especially true in today’s highly volatile markets, because opportunities for cheap financing can emerge quickly -- and disappear even faster.

“This is going to let companies begin to take advantage of fast-moving market situations,” says Michael McCoy, a former SEC corporation finance division attorney who now represents corporate clients at St. Louis law firm Bryan Cave.

Companies meeting the well-known-seasoned-issuer requirements accounted for 92 percent of all proceeds from securities offerings (78 percent of equity and 97 percent of debt) from 1997 to 2003, according to an SEC study done in conjunction with the rulemaking.

But like many regulations, this one may have unintended consequences. By creating a privileged cohort of issuers, the new rules by definition also create a corporate underclass of sorts. If one company is worth $690 million and a competitor is valued at $710 million, the second firm will enjoy all the aforementioned benefits of being a well-known seasoned issuer -- and can exploit those advantages to gain an edge on its rival.

As of the close of trading on July 25, there were 5,141 publicly owned companies with less than $700 million in market capitalization, according to Yahoo! Finance. Although some of these are risky penny stocks, hundreds of others, such as cosmetics maker Elizabeth Arden, semiconductor manufacturer Exar Corp. and clothing retailer Kenneth Cole Productions, are vibrant, well-known concerns (see table).

“There’s a basic fairness issue here,” says an investor relations consultant to small- and midcap companies, who declined to be identified for fear of rousing regulators’ ire. “But it does also raise the possibility that a CEO or CFO will use whatever wiggle room they have with the numbers to try and get the stock up so they make the cutoff.”

That’s something regular customers of the capital markets -- and their shareholders -- won’t have to worry about much. For everyone else, the true impact will be known sometime after the rules take effect on December 1.

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