Commissioner’s Release: 1- CACL: The Capital Access Company Law

GRAY DAVIS, Governor
Date: August 9, 1999

WILLIAM KENEFICK, Acting Commissioner

Senate Bill 2189 (Chapter 668, Statutes 1998) enacted the Capital Access Company Law (the “CACL”), which, among other things, provides for the licensure and regulation of capital access companies by the Commissioner of Corporations. This law, which is found at Corporations Code Section 28000 et seq., became operative on July 1, 1999, and is intended to facilitate California small businesses obtaining financing by enabling certain investment companies to rely on a recently-enacted exemption from registration under the federal Investment Company Act of 1940 (the “Investment Company Act”).

Under the Investment Company Act, investment companies are subject to registration and oversight by the Securities and Exchange Commission. At the federal level, investment companies must comply with various requirements (e.g., periodic reporting, disclosure of information, examination and audit) that are designed to protect the investing public. The National Securities Markets Improvement Act of 1996 (“NSMIA”) amended the Investment Company Act to exempt any investment company not engaged in the business of issuing redeemable securities if its operations are regulated by the state where it is formed pursuant to a statute regulating companies that provide financial or managerial assistance to businesses in the state, and if certain additional conditions are met. Section 6(a)(5) of the Investment Company Act. The CACL provides for the licensure and regulation of capital access companies that are exempt from the Investment Company Act by virtue of Section 6(a)(5). Capital access companies are defined under the CACL as providing financing or managerial assistance to small business firms in California. Corporations Code Sections 28047, 28200 and 28400-28404.

Also, under the existing California securities law, the Department of Corporations and the Commissioner of Corporations regulate the offer and sale of securities in this state, as well as License and regulate broker-dealers and investment advisers, under the Corporate Securities Law of 1968 (the “CSL”). The offer or sale of non-redeemable securities to accredited investors by a capital access company Licensed under the CACL is exempt from the qualification requirements of the CSL. Corporations Code Section 25102(p). A capital access company Licensed under the CACL is also exempt from the broker-dealer licensure requirements of the CSL. Corporations Code Section 25208.

The CACL provides that a capital access company is limited primarily to providing financial or managerial assistance to small businesses that meet specified requirements, including that the small businesses receiving the financial assistance have a significant connection to California. Corporations Code Section 28047. Although the CACL imposes obligations on the board of directors, executive committee, or other policy body of the capital access company in regard to the approval of the investment contract between the company and the person who will make recommendations with respect to the investment of funds, neither the CACL nor the rules adopted by the Commissioner under the CACL limit in any way what the organizers or fund managers can earn from their investment efforts on behalf of the capital access company. Corporations Code Sections 28152, 28153 and 28212.

Below are additional requirements of the CACL:

• The capital access company’s securities can be sold only to accredited investors. Corporations Code Sections 28031 and 28200(d).

• The capital access company may not issue redeemable securities. Corporations Code Section 28200(b).

• Not less than 80% of the capital access company’s securities must be held by California residents or investors with a substantial business presence California. Corporations Code Section 28200(c).

• The investment of funds by a capital access company will be limited by and subject to provisions of the Investment Company Act, the CSL, and the CACL. Corporations Code Section 28200(e).

• The CACL also requires that capital access companies have:

• A tangible net worth of at least $250,000, exclusive of the funds to invest in small businesses. Corporations Code Section 28152(a).

• At least $5 million in funds to invest before a License is issued. (This requirement will be satisfied by the Commissioner’s issuance of the License to the capital access company, subject to an escrow or impound of funds until the company raises the minimum amount during a specified period of the offering.) Corporations Code Section 28152(b).

• Financial resources to cover expenses for three years. Corporations Code Section 28152(c).

• The directors, officers, and controlling persons of the company must be of good character and sound financial standing, competent to perform their functions, and be collectively adequate to manage the business of the company. Corporations Code Section 28152(d).

• A person who makes investment recommendations to the management of the capital access company be an investment adviser. Corporations Code Section 28152(e). This person need not be registered or Licensed under federal or California law. However to protect investors, the law does require the investment adviser to have a clean disciplinary record in the investment business. Moreover, and importantly, upon a showing by the capital access company that it is not in the public interest, the requirement that management must rely on an investment adviser may be waived. Corporations Code Section 28951(b).

• The capital access company must comply with the provisions of the CACL, Section 6(a)(5) of the Investment Company Act, applicable provisions of the CSL, and any regulation or order adopted or issued under the CACL. Corporations Code Section 28152(f).

The Commissioner is authorized to administer and enforce provisions of the CACL, including the authority to issue Licenses, establish examination and compliance procedures, and establish audit requirements and procedures. In order to implement the provisions of the CACL, the Commissioner adopted Subchapter 2.3 to Chapter 3 of Title 10 of the California Code of Regulations (the “CACL Rules”). 10 C.C.R. Sec. 280.100 et seq. The CACL Rules, which also became operative on July 1, 1999, were drafted consistent with the provisions of the exemption under the Investment Company Act and pursuant to the guidelines provided to the Department by staff of the Securities and Exchange Commission.

The application forms and instructions are contained in the CACL Rules, and are available from any of the Department’s offices and through the Department’s Home Page (www.dfpi.ca.gov).

CACL applications are accepted only in the Department of Corporations’ Sacramento Office, however.

In addition, organizers of capital access companies are encouraged to contact the Department to schedule a pre-filing conference before organizing and filing an application. A prefiling conference will assist organizers in the application process.

Finally, the CACL is a new law and the Department recognizes the importance of adjusting the application process and the requirements of the CACL and the CACL Rules to accommodate legitimate business concerns consistent with the intent and purposes of the law.