BILL ANALYSIS                                                                                                                                                                                                    






                        SENATE COMMITTEE ON BANKING, FINANCE,
                                    AND INSURANCE
                           Senator Ronald Calderon, Chair


          SB 1155 (Dutton)         Hearing Date:  April 7, 2010  

          As Amended: March 22, 2010
          Fiscal:             Yes
          Urgency:       No
          

           SUMMARY    Would amend the Capital Access Company Law, by  
          changing the definition of a small business and adding a  
          definition for a smaller business; exempting Capital Access  
          Companies from the Corporate Securities Law of 1968; exempting  
          businesses from the Capital Access Company Law, if they are  
          approved as Small Business Investment Companies by the federal  
          Small Business Administration; replacing existing law conflict  
          of interest provisions with conflict of interest provisions  
          utilized by the federal Small Business Administration for its  
          licensees; and making related changes, as specified.  
           
          DIGEST
            
          Existing federal law
           
            1.  Provides for Investment Company Act of 1940, which  
              requires investment companies with more than 100  
              shareholders to register with, and be regulated by, the  
              Securities and Exchange Commission (SEC);

            2.  Authorizes exemptions from the Investment Company Act of  
              1940, pursuant to changes added to that law by the National  
              Securities Markets Improvement Act of 1996.  Under Section  
              6(a)(5)(A) of the Investment Company Act, an exemption is  
              provided for "any company that is not engaged in the  
              business of issuing redeemable securities, the operations of  
              which are subject to regulation by the State in which the  
              company is organized under a statute governing entities that  
              provide financial or managerial assistance to enterprises  
              doing business, or proposing to do business, in that State."  
               To be eligible for an exemption, the company must also meet  
              the following requirements:  

                  a.        The organizational documents must state that  




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                    the activities of the company are limited to the  
                    promotion of economic, business, or industrial  
                    development in the state through the provision of  
                    financial or managerial assistance to enterprises  
                    doing business or proposing to do business in that  
                    state;

                  b.        Immediately following each sale of securities  
                    of the company, at least 80% of the securities must be  
                    held by persons who reside in or who have a  
                    substantial business presence in that state;

                  c.        The securities must be sold only to accredited  
                    investors, as that term is defined under the  
                    Securities Act of 1933, or to other persons approved  
                    by the SEC;

                  d.        The company must comply with specified  
                    criteria intended to ensure that it invests its funds  
                    in a relatively safe manner. 

           Existing law  

           1.  Provides for the Capital Access Company (CAC) Law, which is  
              administered by the Department of Corporations (DOC), and was  
              formed for the express purpose of allowing companies to operate  
              in California under the exemption described in Existing federal  
              law number 2 above.  Under the CAC Law (Corporations Code  
              Section 28000 et seq.): 

               a.     A company seeking to become a CAC must submit an  
                 application to DOC, and must be approved by DOC before it may  
                 sell securities under the exemption granted to specified  
                 companies under the Investment Company Act of 1940;  

               b.     A small business firm is defined as one that proposes to  
                 transact, or transacts business on a regular and continuous  
                 basis in California, has fewer than 500 employees, and meets  
                 other conditions, as specified;

               c.     A CAC is required to use its best efforts to provide  
                 financing assistance to small business firms doing business  
                 or proposing to do business wholly or substantially in this  
                 state;

               d.     CACs must comply with the Corporate Securities Law of  




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                 1968, which authorizes the Commissioner of Corporations to  
                 regulate securities offerings in California;

               e.     CACs may not transfer or assign their licenses to other  
                 entities;

               f.     CACs must comply with specified conflict of interest  
                 provisions;
                
            2.  Exempts CACs from the requirement to obtain a permit from DOC  
              before selling non-redeemable securities (Corporations Code  
              Section 25102(p)), as long as the securities are sold to  
              accredited investors, as specified.    

          This bill

            1.  Would amend the CAC Law, as follows:

               a.     Would redefine a "small business firm" as one that  
                 proposes to transact, or transacts, business on a regular  
                 and continuous basis in California and which, together  
                 with its affiliates, has a net worth of not more than $18  
                 million and average net income after federal income  
                 taxes, and excluding any carryover losses, of no greater  
                 than $6 million during the preceding two years;

               b.     Would add a definition for a "smaller business  
                 firm," defined as one that proposes to transact, or  
                 transacts, business on a regular and continuous basis in  
                 California and, together with its affiliates, has a net  
                 worth of not more than $6 million and average net income,  
                 after federal income taxes, and excluding any carryover  
                 losses, of no greater than $2 million during the  
                 preceding two years;

               c.     Would exempt a business licensed under the CAC Law  
                 from the Corporate Securities Law of 1968;

               d.     Would provide that any person licensed under the CAC  
                 Law is exempt from specified portions of that law, if it  
                 becomes licensed as a Small Business Investment Company  
                 subject to regulation by the Small Business  
                 Administration.  Generally speaking, businesses that  
                 qualify for this exemption would still be subject to the  
                 portions of the CAC Law that relate to acquisition of  
                 control and to enforcement;




                                               SB 1155 (Dutton), Page 4





               e.     Would require at least 20% of the financing  
                 assistance provided by each licensee under the CAC Law to  
                 be provided through the purchase of securities of  
                 "smaller business firms," as defined;

               f.     Would authorize the transfer or assignment of a CAC  
                 license, subject to approval by the Commissioner;

               g.     Would replace the provisions of existing law  
                 intended to prohibit conflicts of interest by CACs with  
                 conflict of interest rules applied by the Small Business  
                 Administration to its licensees; and,

               h.     Would repeal code sections believed to be  
                 duplicative and/or unnecessary.  

           COMMENTS

          1.  Purpose of the bill   To streamline and simplify the CAC Law,  
              and encourage the formation of CACs, with the intent of  
              increasing the availability of early-stage funding to small  
              businesses.

           2.  Background   The logic behind the existing CAC Law is that  
              small businesses can better attract seed capital, if they  
              can approach a large number of investors.  If a small  
              business is reliant on 100 or fewer investors for its  
              capital needs, it is likely to be harder to raise needed  
              capital than if that same business could seek out 1,000  
              investors.  The more investors a business can solicit, the  
              smaller amount the business needs to request from each  
              investor.  Yet, under existing law, a business that seeks  
              out more than 100 investors must register with the SEC, a  
              process that is prohibitively expensive for most start-ups,  
              especially for small firms.  Exemptions from the Investment  
              Company Act of 1940 were created out of recognition that SEC  
              registration requirements could pose an insurmountable  
              barrier to small businesses.  

          The CAC Law was enacted in 1999, in an effort to utilize one of  
              the exemptions from the Investment Company Act of 1940, and  
              provide a source of capital to small businesses.  However,  
              to date, only one company has applied for permission to  
              become a CAC, and that company ultimately withdrew its  
              application.  This bill is an attempt to take a law that has  




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              been unused since its enactment and encourage its usage.  

          No other states offer models that can be used by California when  
              considering amendments to our law; according to the primary  
              proponent of this bill, no other states have enacted laws  
              similar to the CAC law.
           
          3.  Accredited Investors   Both existing law and this bill limit  
              CACs to soliciting investments from accredited investors, a  
              term which is defined in federal regulations.  Under Rule  
              501 of federal SEC Regulation D, the definition of an  
              accredited investor encompasses a number of entities,  
              including large, sophisticated firms, such as depository  
              institutions, trusts with assets in excess of $5 million,  
              certain large pension funds, and other large entities.  

          However, the definition also includes two classes of individuals  
              who may be less sophisticated.  For example, an accredited  
              investor is also:  1) any natural person whose individual  
              net worth, or joint net worth with that person's spouse, at  
              the time of his securities purchase, exceeds $1 million  
              (inclusive of homes, home furnishings, and automobiles); and  
              2) any natural person with an individual income in excess of  
              $200,000 in each of the two most recent years, or joint  
              income with that person's spouse in excess of $300,000 in  
              each of those years, together with a reasonable expectation  
              of reaching the same income level in the current year.  

          Because these two latter classes of individuals can include  
              senior citizens whose homes have appreciated in value since  
              their purchase, as well as small business owners who may  
              lack investment savvy, California has traditionally been  
              cautious in granting businesses broad flexibility to market  
              and sell securities to accredited investors.  Many of the  
              amendments being offered by the author in Committee today  
              reflect an effort to ensure that CACs do not engage in  
              predatory marketing or other anti-consumer behavior.
           
          4.  Support    According to the author, "The lack of access to  
              early-stage capital for start-up companies, and small,  
              women, and minority-owned businesses in particular, has been  
              well documented.  With national credit markets reeling and  
              California's economy mired in a recession, capital  
              investments are even harder to secure.  Capital Access  
              Companies would help ease this credit crunch by drawing in  
              accredited investors through the establishment of  




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              publicly-held venture funds aimed at filling the gap between  
              seed capital from friends and family (<$500,000) and venture  
              capital funding (>$5 million)."

          This bill, and an earlier version of the legislation that was  
              never heard by this committee (SB 491, Dutton) was drafted  
              by securities and corporate finance lawyer Lee Petillon.   
              Mr. Petillon specializes in helping pair companies seeking  
              capital with willing investors.  He believes that the  
              complexity of the existing CAC Law has discouraged companies  
              from applying to become CACs, and is hopeful that the  
              proposed amendments will remove the barriers that have kept  
              firms away.

          The Torrance Chamber of Commerce, and a small business owner who  
              provides management consulting and advisory services to  
              small business in California, support SB 1155, because they  
              believe that the bill will benefit small businesses and  
              result in more jobs.  

           5.  Opposition    None received.
           
          6.  Suggested Amendments   Committee staff has worked closely  
              with the author's office and interested parties, in an  
              attempt to ensure that this bill will achieve the author's  
              intent, without weakening the consumer protections in  
              existing law.  These discussions have resulted in the  
              amendments listed below, which will be proposed by the  
              author in Committee.  

          However, further review by DOC will be necessary, as this bill  
              moves.  Input from DOC is of particular importance regarding  
              this bill's proposal to exempt CACs from portions of the CAC  
              law, if they are approved as Small Business Investment  
              Companies by the Small Business Administration, and the  
              bill's proposal to replace existing law conflict of interest  
              provisions with ones contained in existing Small Business  
              Association regulations.  Further amendments may be  
              necessary to address one or more of these issues, as this  
              bill moves.  The author's office has committed to working  
              with DOC and other interested parties, to ensure that the  
              bill does not allow or encourage predatory marketing or  
              other fraudulent, anti-consumer behavior by CACs.  

          Amendments to be proposed by the author in Committee include the  
              following:




                                               SB 1155 (Dutton), Page 7





          Page 3, strike lines 1 and 2 and reinsert Section 28002 of the  
              Corporations Code, as it reads under existing law.

          Page 5, strike line 3 and insert:  (e) That none of the  
              following persons are subject to any

          Page 5, strike line 10 and insert:  25212:

          (1) A person who is or will be a controlling person of the  
              applicant;
          (2) A person who makes or will make recommendations with respect  
              to the investment of funds of the applicant;
          (3) A person who is or will be a partner, principal executive  
              officer, manager, or director of the appliance;
          (4) A person who occupies or will occupy a similar status or who  
              performs or will perform similar functions to those listed  
              above;
          (5) An employee who materially aids or assists or will  
              materially aid or assist in the applicant's  
              investment-related functions;
          (6) A broker-dealer or agent who materially aids or assists or  
              will materially aid or assist in the sale or distribution of  
              any securities of the applicant.

          Page 6, lines 24 to 26, return subdivision (f) of Section 28200  
              of the Corporations Code to the way it reads under existing  
              law.

          Add an amendment to Corporations Code Section 25102(p), as  
              follows:

          (p) An offer or sale of nonredeemable securities to accredited  
              investors (Section 28031) by a person licensed under the  
              Capital Access Company Law (Division 3 (commencing with  
              Section 28000) of Title 4), provided that all purchasers  
              either have a preexisting personal or business relationship  
              with the offeror or any of its partners, officers, directors  
              or controlling persons, or managers, (as appointed or  
              elected by the members) if the offeror is a limited  
              liability company, or by reason of their business or  
              financial experience or the business or financial experience  
              of their professional advisers who are unaffiliated with and  
              who are not compensated by the issuer or any affiliate or  
              selling agent of the issuer, directly or indirectly, could  
              be reasonably assumed to have the capacity to protect their  




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              own interests in connection with the transaction. All  
              nonredeemable securities shall be evidenced by certificates  
              that shall have stamped or printed prominently on their face  
              a legend in a form to be prescribed by rule or order of the  
              commissioner restricting transfer of the securities in the  
              manner as the rule or order provides.  The exemption under  
              this subdivision shall not be available for any offering  
              that is exempt or asserted to be exempt pursuant to Section  
              3(a)(11) under the Securities Act of 1933 (15 USC  
              77(c)(a)(11)) or Rule 147 (17 CFR 230.147) thereunder or  
              otherwise is conducted by means of any form of general  
              solicitation or general advertising.

           7.  Prior and Related Legislation  

                   a.        SB 491 (Dutton):  Would have deleted a  
                    significant portion of the CAC Law and directed the  
                    Commissioner of Corporations to promulgate regulations  
                    intended to further the intent of that law.  Never  
                    heard in the Senate Banking, Finance & Insurance  
                    Committee.  


          POSITIONS
          
          Support
           
          Lee Petillon, Petillon, Hiraide, Loomis, Zagzebski & Zagzebski,  
          LLP
          The Optimize Group
          Torrance Chamber of Commerce
           
          Oppose
               
          None received

          Consultant:  Eileen Newhall  (916) 651-4102