Financial Reform Fallout
The Dodd-Frank Act Holds Hidden Traps for Companies
Michael L. Monson
January 1, 2011
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) into law. While most of the Dodd-Frank Act focuses on banking reforms, a few inconspicuous provisions have the potential to significantly impact two important business segments in the state of Utah—startup companies and mining companies.
Historically, Utah has ranked as one of the top states for entrepreneurial activity. In fact, Forbes magazine just recognized Utah as the No. 1 state in the nation for fostering business growth. Business growth in the Beehive State has resulted to a large extent from startup companies that are able to find the necessary capital and market niche to become profitable.
The Dodd-Frank Act includes a provision that may make the availability of capital for cash-strapped startups harder to find. In order for a company to obtain equity financing through the sale of securities such as stocks or membership interests, the company must either register with the Securities and Exchange Commission (SEC) or find an applicable exemption from registration. Registration with the SEC is not practical for startup companies. Therefore, startup companies need an exemption
One of the most popular exemptions from registration is Rule 506 under Regulation D. Companies using the Rule 506 exemption can raise an unlimited amount of money. Companies may also sell their securities to an unlimited number of investors under Rule 506, provided the investors qualify as “accredited investors.”
Accredited investors are large institutions such as banks, insurance companies and registered investment companies; business entities and trusts with assets exceeding $5 million; and wealthy individuals. Prior to the passage of the Dodd-Frank Act, an individual could qualify as an accredited investor if such person either had individual net worth, or joint net worth with the person’s spouse, that exceeded $1 million or income exceeding $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
The Dodd-Frank Act has changed the definition of accredited investor as it applies to individuals. Effective as of July 21, 2010, the value of a primary residence can no longer be included when determining the net worth of an individual for purposes of the $1-million-net-worth standard for accreditation.
The Dodd-Frank Act also provides that the SEC may “undertake a review of the definition of the term ‘accredited investor,’ as such term applies to natural persons, to determine whether the requirements of the definition…should be adjusted or modified.” The SEC is to apply three factors in determining whether to modify the definition of accredited investor for individuals. These factors are the protection of investors, the public interest and the state of the economy.
During the four-year period beginning on July 21, 2010, the net worth standard must remain at $1 million (excluding the value of the primary residence as described above). However, the $200,000-of-income-or-$300,000-with-spouse standard for accreditation is subject to change at any time after completion of the SEC’s review and subject to notice and comment rulemaking. After July 21, 2014, and not less frequently than once every four years thereafter, the SEC is required to undertake a review of the definition of “accredited investor” in its entirety as it applies to natural persons.
While changes to the definition of accredited investor as it applies to individuals will likely protect some investors from making bad investments, it will also reduce the pool of individuals who qualify as accredited investors and who have historically been one of the primary sources of capital for startup companies. Limited access to capital for startup companies could negatively impact many young Utah companies.
Two sections near the end of the Dodd-Frank Act increase the securities reporting requirements for mining companies. Each periodic securities report filed by mining companies must now include the total number of citations received from the Mine Safety and Health Administration (MSHA) which MSHA deems to be “significant and substantial.”
Given the spate of recent mine disasters and near disasters, most people would likely agree that requiring mine operators to be accountable for mine safety is a good thing. However, requiring disclosure of all citations which are deemed “significant and substantial” by MSHA has the potential to unnecessarily affect the value of mining companies’ stock.
The phrase “significant and substantial” is a term of art in the mining industry. Violations are deemed “significant and substantial” if they meet a two-part test: first, the violation must be “reasonably likely” to result in an accident; and second, that accident must be reasonably expected to result in a serious injury. The problem is that recently, MSHA has become very liberal, and many in the mining industry would say unreasonable, in determining which violations are “significant and substantial.” For example, in a related mining regulation, mine operators are required to immediately report any accident that has the “reasonable potential” to cause death. In a recent case (Newmont USA Limited v. Secretary of Labor), MSHA argued that a broken leg had the “reasonable potential” to cause death because surgery was required. MSHA’s argument was that complications, such as fat embolisms and deep vein thrombosis, can result from surgery and thus surgery in general has the “reasonable potential” to cause death.
Industry insiders are reporting that MSHA is increasingly using similar strained arguments to impose “significant and substantial” classifications on mining violations. Now that the Dodd-Frank Act is in effect, even the most trivial violations will have to be disclosed to the securities markets if MSHA labels them as “significant and substantial.” This reporting requirement has the potential to negatively impact an industry that, according to the Utah Department of Natural Resources, contributes more than $3 billion each year to Utah’s economy.
Michael L. Monson is an attorney at Rinehart Fetzer Simonsen & Booth, PC. He can be reached at email@example.com