Public Company Status, 500 Shareholders of Record, and SEC Efforts at Reform (Part 3)

So what needs to be done?  Section 12(g) needs to be administratively updated.  The Section should be rewritten to take into account street name owners.  In that way, large companies cannot hide behind the record ownership standard when they have a substantial number of actual owners.  At the same time, smaller companies would get greater latitude to avoid the trap for the unwary.

This needs to be done but it means abandoning a system (“of record”) that, while disconnected from reality, has had the advantage of being relatively objective and easy to administer.  Companies could get a list of shareholders, count the number of owners and quickly determine (as of the first day of the fiscal year) whether they were public (assuming they met the asset threshold).  Moving to a system of counting beneficial owners is far more complicated and required information that companies may not have. 

Because street name owners have accounts with brokers, companies do not know the number of beneficial owners unless the brokers tell them.  While public companies are required annually to ask brokers for the number of street name accounts (companies have to provide enough copies of the proxy materials distributed to beneficial owners), see Rules 14a-13 & 14b-1, 17 CFR 240.14a-13 & 14b-1, that only occurs after the company has already become public.  Until then, companies are not required to ask, and brokers are not required to tell, the number of street name accounts. 

Moreover, a rule not carefully drafted could still be circumvented.  To the extent that the rules only counted beneficial owners one layer deep, it would be easy to adopt a structure that allowed for many owners but avoided triggering public company status.  Thus, for example, such a system might count Goldman's special purpose vehicle as a single shareholder but miss all of the investors with an interest in the SPV.  Yet once companies are obligated to count the number of investors in the SPV, they once again must confront the problem of acquiring the information.

The counting rules are long overdue for reconsideration.  But doing so will open up a hornets nest of issues and be more difficult to apply.