The Securities & Exchange Commission (SEC) is seeking to regulate debt issuances by private companies and has recently published a draft of the new rules for comments. The Draft is the legal framework under which private companies can raise capital publicly without converting to a public company. The Draft requires private companies to register their existing and new debt securities with the SEC if the debt securities are fixed income securities, “including bonds, debentures and alternative asset classes such as Sukuk” and if such debt securities are issued using the private placement route or through a public offer. If the Draft becomes effective, private companies will also be required to file quarterly reports on the quarterly utilisation of the funds raised and submit quarterly unaudited financial statements and annual audited financial statements to the SEC. Additionally, private companies can only raise a maximum of N15bn within 1 year, must have operated for three years and can only sell such securities to qualified investors.
Implications for Private Companies
The Draft will bring private companies within the SEC’s regulatory remit because it essentially establishes a statutory right of action that empowers the SEC to take regulatory action against erring private companies. Where found in breach, private companies can become the subject of an SEC investigation, a regulatory fine, or litigation by the SEC.
Additionally, private companies looking to issue debt securities must carefully consider the implications of disclosing their financial information publicly during registration with the SEC and every quarter as required in the Draft. Private companies also need to think about the increased market and media scrutiny, compliance and offering costs, as well as competitive pressures that may result from public disclosure of otherwise sensitive financial information.
Is the SEC Overstepping its Legislative Authority by Seeking to Regulate the Private Placement of Debt Securities Directly?
The SEC cites section 43(1)(b) of the extant Business Facilitation Act as the legal basis for its decision to mandate the registration of the debt securities of private companies. Section 43(1)(a) &(b) provides as follows:
- No allotment shall be made of any securities of a company offered to the public for subscription unless, in the case of a —
a. public company, the amount stated in the prospectus as the minimum amount, which, in the opinion of the directors, is required to be raised by the issue of share capital to provide for the matters specified in paragraph 2 of the Third Schedule to this Act, has been subscribed and the sum payable on application for the amount so stated has been paid to and received by the company; or
b. private company, through any lawful means, as the Commission may by regulation prescribe.
In contrast to the mandate outlined in section 2(a) of the Draft, section 43 does not grant the SEC authority to oversee the private placement of debt securities issued by private companies. Rather, section 43 seems to confine the SEC’s jurisdiction to regulating the public offering of securities by such private entities while granting the SEC the discretion to establish lawful methods for private companies to make their securities available to the public. This distinction is important, especially in view of section 4 of the Draft, which requires private companies to register existing/privately issued debt securities issued before the effective date of the Draft. Within this context, the legality of the section is questionable and warrants a review.
It is useful to note that this section does not amend section 54 of the ISA, which mandates the compulsory registration of the securities of public companies and collective investment schemes. This raises the question of whether the SEC may, by subsidiary legislation, mandate the registration of the debt securities issued by private companies.
Final Comments
Given the pivotal role of the provisions of the Draft in shaping the capital market, it may be prudent for the SEC to provide some justification and rationale (not just the legal basis in section 43) for its decision to (x) allow private companies issue debt securities publicly (y) register the debt securities of private companies, notwithstanding that the potential buyers of the securities will be sophisticated investors; (z) mandate the registration of privately-issued debt securities in view of the legitimate expectation already created by the existing private placement regime under which those securities were issued.
For the SEC, it helps to remember that, in the realm of administrative law, irrationality, illegality, improper purpose, irrelevant considerations, and legitimate expectation are all substantive legal grounds upon which an administrative decision or policy can be legitimately challenged. Thus, without further review and clarification from the SEC, the Draft may be subject to avoidable litigation.
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