Introduction

On May 7, 2024, the Securities and Exchange Commission (SEC) published a draft of new rules to regulate private companies' issuance and allotment of debt securities. While publicly listed companies can issue securities to the general public, private companies typically raise capital through equity or debt investments from private investors. The proposed Rules seek to allow private companies to issue and allot debt securities to the public.

Scope of the Proposed Rules

The proposed rules specifically apply to debt securities issued by private companies, whether through a public offering, private placement, or any other method sanctioned by the Securities and Exchange Commission (SEC). Additionally, these rules encompass registered exchanges, platforms, and capital market operators that enable the issuance and allocation of debt securities for private companies. 

This article will explain some key terms to better understand the scope of the proposed Rules.

1. Debt securities. A debt security is an investment asset that represents a debt owed by an issuer (such as a government or company) to an investor who acts as a lender. This type of investment involves debt rather than ownership in a company. On the other hand, equity security is a financial instrument representing a company’s ownership share. It gives the holder the right to a proportion of the earnings of the issuing 
2. Public offering and private placement. A public offering is the sale of financial instruments, such as bonds, to the public to raise capital. Private placement, on the other hand, refers to the process of selling stocks and securities to a select group of investors and institutions rather than offering them to the general public on the open market. This method allows companies to raise capital without the need for a public offering, and it often involves negotiating directly with potential investors.

The proposed Rules will only apply to the issuance of debt security by private companies through a public offering or private placement. Private companies are not allowed to issue equity securities.

Legal Justification for the Rules

It is important to consider whether the SEC has the legal bandwidth to make these Rules. In establishing these Rules, the SEC has relied on the provisions of the Business Facilitation  Act (the “Act”) as its basis for developing rules enabling private companies to issue and allot debt securities. According to the Act, a company can only issue or allot securities to the public where;

1. It is a public company, and the amount has been stated in its prospectus, which is required to be raised by the issue of share capital; or
2. The Commission has, by prescription in a lawful regulation, approved the issuance and allotment of securities by private companies.

Based on the provision of the Act, the Commission is seeking to issue this rule to enable private companies to allot debt securities to investors.

Requirements for Eligibility

While these rules apply to private companies, not every private company will be qualified to allot its debt securities to the public.

Based on the proposed Rules, a private company will be eligible to allot its debt securities where it satisfies the following criteria:

1. It is a duly registered company under the Companies and Allied Matters Act (CAMA), 2020, or other enabling laws;
2. It has been operational for at least three (3) years;
3. It is not in default of payment of interest or repayment of principal in respect of previous debt issuance(s) for more than 6 (six) months;
4. Ensure the bonds are rated by a rating agency (this is not a requirement for private placements); 
5. Ensure that all necessary approvals are obtained from relevant regulatory authorities other than the SEC and that such approvals are duly filed with the SEC.

Procedure for allotment

Once a private company is certified as eligible to offer its debt securities to the public in accordance with sections 9-14 of the proposed Rules, the following steps must be taken:

1. Registration with the SEC. the company offering the debt securities is required to submit certain documents, which include, the memorandum and article of association, a copy of the board and shareholders’ resolution authorising the issue of debt securities, current CAC report on the statutory information of the company (evidence of registration, statement of share capital, particulars of directors and secretary), draft prospectus, copy of the company’s latest account for 3 preceding years, draft agreement between the company and the issuing house, Form SEC 6, for registration purposes.
2. Execute the offer documents and file them with the SEC for review and clearance.
3. Allotment and listing on the registered securities exchange within 30 days of the completion of the allotment.
4. The Issuing House will be required to file a report with the Commission within 21 working days after allotment. This report shall contain a summary of the applications received, the list of allottees of 50,000 units of securities, a statement of issue proceeds account, 

The Rules also set out additional responsibilities for issuing companies and issuing houses. These include filing periodic reports and complying with the Code of Conduct for Capital Market Operators.

Restrictions
Despite the innovation that the proposed Rules tend to bring to raising capital by private companies, it also introduce restrictions on what cannot be done and who can take part in the allotment and issuance of debt securities by private companies. The proposed Rules set the following restrictions on the activities of private companies in the capital market. 

1. Debt securities issued under these rules can only be sold to "Qualified investors." This protects less sophisticated investors from potentially risky private debt offerings.
2. Only registered capital market operators can participate in debt issuances governed by these rules. This promotes the involvement of qualified professionals and upholds best practices.
3. Private companies cannot offer, sell, or allot securities to the public without prior approval from the securities exchange and registration with the SEC. This prevents unauthorised public offerings and protects investors.
4. Securities purchased through a public offer under these rules can only be traded on a registered securities exchange. This ensures transparency and oversight in the secondary market for these debt instruments.

Sanctions and Penalties for Non-Compliance

The draft rules specify penalties for issuing companies that allocate securities without obtaining SEC approval. These penalties may include fines, suspension, rescission of the transaction, withdrawal of registration, or any other penalty deemed appropriate by the Commission.

Implications of the Proposed Rules

The implementation of the Rules on private companies is anticipated to have far-reaching and substantial implications across various aspects of business operations, governance, and compliance within the private sector.

1. Market development. The Rules could increase private companies' capital bases by providing a framework for raising business capital by issuing debt securities to the public. They also have the potential to contribute to the development of the capital market, which would facilitate increased investment opportunities, capital raising, and economic growth.
2. Additional compliance obligations. Private companies will be required to adhere to rules set out by the Commission, such as obtaining regulatory approvals and filing necessary documents regarding the allotment of debt securities. While this would promote regulatory compliance, transparency, market integrity, and accountability, it would also increase their compliance obligations. 
3. Investor protection. By limiting the offering of debt securities to only qualified investors, the Rules would reduce investor harm as it would ensure that only investors with the necessary knowledge and risk tolerance participate in the offerings.

Conclusion

The recent introduction by the Nigerian SEC of rules for debt issuance and allotment by private companies is an encouraging step that will expand private companies' ability to raise capital, thus improving their financial stability. This also brings Nigeria in line with developed nations where the protection of investors is the focus for both private and public companies. These provisions will create an avenue for the protection of investors in private debt offerings, as is currently the case with public companies; ensure a fair and orderly market for debt issuances, thus efficiency and transparency in private capital formation; and a structured process, these regulations might ease the process for private companies to access raising capital through debt issuance.

A good example is the United States' SEC. All securities offerings, including those by private companies, are subject to registration. This is an all-inclusive approach aimed at providing protection to all investors, regardless of the size of the company or the type of investor.

It will be interesting to see the finalised structures and the clarity the rules will provide after the Commission has considered comments from industry stakeholders and the public. We expect that these rules will promote the growth and stability of private companies, ultimately leading to positive economic outcomes for Nigeria.

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Section 43(1)(a),(b)

These are registered individuals or firms with license to perform specific functions within the capital market. Capital Market Operators perform different roles within the market, such as, trading, investing, underwriting, advising, etc.

A Qualified investor is an institutional investor or high net worth individual as defined in the Commission’s rules.

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