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
SB 1155 (Dutton), Page 2
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
SB 1155 (Dutton), Page 3
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
SB 1155 (Dutton), Page 8
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