Laura Anthony

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    • Title:Founding Partner
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    The Financial Choice Act 2.0

    Tuesday, March 28, 2017, 9:34 AM [General]
    0 (0 Ratings)

    On February 9, 2017, the Chair of the House Financial Services Committee issued a memo outlining changes to the Financial Choice Act, dubbing the newest version the Financial Choice Act 2.0. The memo was not intended for public distribution but found its way in any event, causing a great deal of anticipation as to the amended Act itself. The actual amended Act has not been released as of the date of this blog.

    Introduction

    As a reminder, the Financial Choice Act, which was passed by the House Financial Services Committee on September 13, 2016, is an extensive, extreme piece of legislation that would dismantle a large amount of the power of the SEC and strip the Dodd-Frank Act of many of its key provisions. As first written, it would not be feasible for the Act to pass into law, but it certainly illustrates the extreme views of members of the House on the state of current over-regulation.

    Moreover, the new administration continues that view and it is possible that the newer version will be in a form that could gain traction. It is also possible that parts of the lengthy Act could be bifurcated out and included in other Acts that ultimately are passed into law.

    Summary of Original Financial Choice Act

    The Executive Summary for the original Financial Choice Act lists the following seven key principles of the Act:

    1. Economic growth must be revitalized through competitive, transparent, and innovative capital markets;
    2. Every American, regardless of their circumstances, must have the opportunity to achieve financial independence;
    3. Consumers must be vigorously protected from fraud and deception as well as the loss of economic liberty;
    4. Taxpayer bailouts of financial institutions must end and no company can remain too big to fail;
    5. Systemic risk must be managed in a market with profit and loss;
    6. Simplicity must replace complexity, because complexity can be gamed by the well-connected and abused by the Washington powerful; and
    7. Both Wall Street and Washington must be held accountable.

    The Act focuses on dismantling Dodd-Frank. Many of the changes would repeal provisions related to executive compensation (I note that the leaked memo on version 2.0 does not indicate any changes to these original provisions). Related to executive compensation, the Financial Choice Act would include:

    1. Pay Ratio. The Act would repeal the section of Dodd-Frank which requires companies to disclose the pay ratio between CEO’s and the median employees.  For a summary of the pay ratio rule, see my blog HERE.  This rule is under scrutiny and attack separate and apart of the Financial Choice Act as well.  On February 6, 2017, acting SEC Chair Michael Piwowar called for the SEC to conduct an expedited review of the rule for the purpose of reconsidering its implementation.  It is highly likely that this rule will not be implemented as written, if at all.
    2. Incentive-based Compensation. The Act would repeal provisions of Dodd-Frank that require enhanced disclosure related to incentive-based compensation by certain institutions.
    3. Hedging. Proposal to repeal the section of Dodd-Frank which requires companies to disclose whether employees or directors can offset any increase in market value of the company’s equity grants as compensation.
    4. Say on Pay. The Act will amend the Say on Pay rules such that the current advisory vote would only be necessary in years when there has been a material change to compensation arrangements, as opposed to the current requirement that a vote be held at least once every 3 years.  For more information on the Say on Pay rules, see my blog HERE.
    5. Clawback Rules. The Clawback rules would prohibit companies from listing on an exchange unless such company has policies allowing for the clawback of executive compensation under certain circumstances.  This would be in the form of additional corporate governance requirements.  For more information on the clawback rules, see my blog HERE.  The Act will amend the clawback rules such that they will only apply to current and former executives that had “control or authority” over the company’s financial statements.

    On the bank-specific side, the Act would eliminate bank prohibitions on capital distributions and limitations on mergers, consolidations, or acquisitions of assets or control to the extent that these limitations relate to capital or liquidity standards or concentrations of deposits or assets.

    Related to bailouts, the Act would, in summary:

    1. Repeal the authority of the Financial Stability Oversight Council to designate firms as systematically important financial institutions (i.e., too big to fail);
    2. Repeal Title II of Dodd-Frank and replace it with new bankruptcy code provisions specifically designed to accommodate large, complex financial institutions. Title II of Dodd-Frank is the orderly liquidation authority, granting authority to the federal government to obtain receivership control over large financial institutions; and
    3. Repeal Title VIII of Dodd-Frank, which gives the Financial Stability Oversight Council access to the Federal Reserve discount window for systematically important financial institutions (i.e., gives the federal government the money to bail out financial institutions) as well as the authority to conduct examinations and enforcement related to risk management;

    Related to accountability from financial regulators, the Act would:

    1. Make all financial regulatory agencies subject to the REINS Act related to appropriations and place all such agencies on an appropriations process subject to bipartisan control;
    2. Require all financial regulators to conduct a detailed cost-benefit analysis for all proposed regulations (provisions analogous to this are already required, but this would be more extreme);
    3. Reauthorize the SEC for a period of 5 years with funding, structural and enforcement reforms (i.e., dismantle the current SEC and replace it with a watered-down version);
    4. “Institute significant due-process reforms for every American who feels that they have been the victim of a government shakedown”;
    5. Repeal the Chevron Deference doctrine.  Under this doctrine, a court must defer to an agency’s interpretation of statues and rules;
    6. Demand greater accountability and transparency from the Federal Reserve; and
    7. Abolish the Office of Financial Research.

    Under the heading “[U]leash opportunities for small businesses, innovators, and job creators by facilitating capital formation,” the Act would:

    1. Repeal multiple sections of Dodd-Frank, including the Volker Rule (which restricts U.S. banks from making speculative investments, including proprietary trading, venture capital and merchant bank activities);
    2. Repeal the SEC’s authority to either prospectively or retroactively eliminate or restrict securities arbitration;
    3. Repeal non-material specialized disclosure; and
    4. Incorporate more than two dozen committee- or House-passed capital formation bills, including H.R. 1090 – Retail Investor Protection Act (prohibiting certain restrictions on investment advisors), H.R. 4168 – Small Business Capital Formation Enhancement Act (requiring prompt SEC action on finding of the annual SEC government business forum), H.R. 4498 – Helping Angels Lead Our Startups Act (directing the SEC to amend Regulation D, expanding the allowable use of solicitation and advertising), and H.R. 5019 – Fair Access to Investment Research Act (expanding exclusion of research reports from the definition of an offer for or to sell securities under the Securities Act).

    Financial Choice Act 2.0

    As mentioned, the described changes come from a leaked memo from the Chair of the House Financial Services Committee. The actual changes have not been made public as of yet. The vast majority of changes in the memo are related to banking provisions and the Consumer Financial Protection Bureau; however, below is a summary of those directly impacting the federal securities laws and potentially my client base.

    Key provisions of the newer version of the Financial Choice Act include:

    1. An increase in the Sarbanes-Oxley Act (“SOX”) Rule 404(b) compliance threshold from $250 million public float to $500 million. Currently smaller reporting companies and emerging-growth companies are exempted from compliance with Rule 404(b).  A “smaller reporting company” is currently defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter; or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

    Interestingly, when the SEC proposed an increase in the threshold definition of “smaller reporting company” in June of last year, from $75 million to $250 million, it specifically chose to concurrently amend the definition of an “accelerated filer” to eliminate the benefit of an exclusion from the SOX 404(b) requirements for companies with a float over $75 million. In particular, the SEC proposed to amend the definition of “accelerated filer” to eliminate an exclusion for smaller reporting companies such that a company could be a smaller reporting company but also an accelerated filer. The SEC noted in its rule release that it intended to be sure that companies with a float over $75 million, whether a smaller reporting company or not, would have to comply with SOX 404(b) and the accelerated filing schedule for quarterly and annual reports. See my blog HERE.  If passed, the Financial Choice Act 2.0 would override the SEC’s current proposal on this point.

    1. The Financial Choice Act 2.0 would increase the registration threshold requirements under Section 12(g) of the Securities Exchange Act for smaller companies. The Act 2.0 would also index the thresholds for inflation moving forward.  In addition, the Act would eliminate the requirement to obtain ongoing accredited investor verifications for determining the Section 12(g) registration requirements.  On May 1, 2016, the SEC amended Exchange Act Rules 12g-1 through 12g-4 and 12h-3 related to the procedures for termination of registration under Section 12(g) through the filing of a Form 15 and for suspension of reporting obligations under Section 15(d), to reflect the higher thresholds set by the JOBS Act.  The SEC also made clarifying amendments to: (i) cross-reference the definition of “accredited investor” found in rule 501 of Regulation D, with the Section 12(g) registration requirements; (ii) add the date for making the registration determination (last day of fiscal year-end); and (iii) amend the definition of “held of record” to exclude persons who received shares under certain employee compensation plans.  Under the rules, a company that is not a bank, bank holding company or savings-and-loan holding company is required to register under Section 12(g) of the Exchange Act if, as of the last day of its most recent fiscal year-end, it has more than $10 million in assets and securities that are held of record by more than 2,000 persons, or 500 persons that are not accredited.  As I discussed in this blog on the subject HERE identifying accredited investors for purposes of the registration, and deregistration, requirements could be problematic.  Investors are not necessarily responsive to inquiries from a company and may balk at providing personal information, especially those that have purchased in the open market but then subsequently, for whatever reason, converted such ownership to certificate/book entry or otherwise “record ownership.”
    2. The Financial Choice Act 2.0 would expand the coverage under Title 1 of the JOBS Act to allow all companies to engage in certain test-the-waters communications in an IPO process and to file registration statements on a confidential basis. Title 1 of the JOBS Act specifically only applies to emerging-growth companies (EGC’s).  In particular, Section 105(c) of the JOBS Act provides an EGC with the flexibility to “test the waters” by engaging in oral or written communications with qualified institutional buyers (“QIB’s”) and institutional accredited investors (“IAI’s”) in order to gauge their interest in a proposed offering, whether prior to (irrespective of the 30-day safe harbor) or following the first filing of any registration statement, subject to the requirement that no security may be sold unless accompanied or preceded by a Section 10(a) prospectus.  Generally, in order to be considered a QIB, you must own and invest $100 million of securities, and in order to be considered an IAI, you must have a minimum of $5 million in assets.  For more information on test-the-waters communications by EGC’s, see my blog HERE.

    The Financial Choice Act 2.0 will also expand the ability to file a registration statement on a confidential basis to all companies and not just EGC’s. Currently, an EGC may initiate the “initial public offering” (“IPO”) process by submitting its IPO registration statements confidentially to the SEC for nonpublic review by the SEC staff. A confidentially submitted registration statement is not deemed filed under the Securities Act and accordingly is not required to be signed by an officer or director of the issuer or include auditor consent. Signatures and auditor consent are required no later than 15 days prior to commencing a “road show.” If the EGC does not conduct a traditional road show, then the registration statements and confidential submissions must be publicly filed no later than 15 days prior to the anticipated effectiveness date of the registration statement. I note that the JOBS Act had originally set the number of days for submission of all information at 21 days and the FAST Act shortened that time period to 15 days.

    1. A requirement that the SEC Chair conduct a study and issue a report on self-regulatory organizations, including recommendations to eliminate duplications and inefficiencies amongst the various organizations.
    2. The Financial Choice Act 2.0 would increase the allowable offering amount for Tier 2 of Regulation A (i.e., Regulation A+) from $50 million to $75 million in any 12-month period. I often write about Regulation A/A+.  For the most recent comprehensive article on the subject, see my blog HERE.
    3. The Financial Choice Act 2.0 would prohibit the SEC from requiring the use of “universal proxies” in contested elections of directors. Pre-change in administration, on October 16, 2016, the SEC proposed a rule requiring the use of the use of universal proxy cards in connection with contested elections of directors.  The proposed card would include the names of both the company and opposed nominees.  The SEC also proposed amendments to the rules related to the disclosure of voting options and standards for the election of directors.  My blog on the proposed rule can be read HERE.
    4. An inflation update to the minimum thresholds for shareholders to be able to submit proposals for annual meetings. Currently Rule 14a-8 permits qualifying shareholders to submit matters for inclusion in the company’s proxy statement for consideration by the shareholders at the company’s annual meetings.  Procedurally to submit a matter, among other qualifications, a shareholder must have continuously held a minimum of $2,000 in market value or 1% of the company’s securities entitled to vote on the subject proposal, for at least one year prior to the date the proposal is submitted and through the date of the annual meeting.  For further reading on this rule, see HERE.  The Financial Choice Act 2.0 would update the ownership requirement thresholds for inflation.
    5. Delay the repeal of the Chevron doctrine for two years. Under the Chevron doctrine, a court must defer to an agency’s interpretation of statutes and rules.  The Financial Choice Act called for the immediate repeal of this doctrine.  The Act 2.0 would delay such repeal for two years.
    6. Increase the limits on disclosure requirements for employee-issued securities under Rule 701 from $10 Million as set forth in version 1.0 to $20 million with an inflation adjustment. Rule 701 of the Securities Act provides an exemption from the registration requirements for the issuance of securities under written compensatory benefit plans. Rule 701 is a specialized exemption for private or non-reporting entities and may not be relied upon by companies that are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (“Exchange Act”). The Rule 701 exemption is only available to the issuing company and may not be relied upon for the resale of securities, whether by an affiliate or non-affiliate.  Currently, additional disclosures are required for issuance valued at $5 million or more in any 12-month period.  For more information on Rule 701, see my blog HERE.

    Thoughts

    In recent years we have seen the most dramatic changes in capital formation regulations and technological developments in the past 30 years, if not longer. Significant capital-formation changes include: (i) the creation of Rule 506(c), which came into effect on September 23, 2013, and allows for general solicitation and advertising in private offerings where the purchasers are limited to accredited investors; (ii) the overhaul of Regulation A, creating two tiers of offerings which came into effect on June 19, 2015, and allows for both pre-filing and post-filing marketing of an offering, called “testing the waters”; (iii) the addition of Section 5(d) of the Securities Act, which came into effect in April 2012, permitting emerging-growth companies to test the waters by engaging in pre- and post-filing communications with qualified institutional buyers or institutions that are accredited investors; and (iv) Title III crowdfunding, which came into effect on May 19, 2016, and allows for the use of Internet-based marketing and sales of securities offerings.

    At the same time, we have faced economic stagnation since the recession, a 7-year period of near-zero U.S. interest rates and negative interest rates in some foreign nations, nominal inflation and a near elimination of traditional bank financing for start-ups and emerging companies. If bank credit was available for small and emerging-growth companies, it would be inexpensive financing, but it is not and I do believe that Dodd-Frank and over-regulation are directly responsible for this particular problem.

    I am extremely optimistic that this trend is changing. According to an article published by CNN on March 10, 2017, the U.S. economy added 235,000 jobs in Trump’s first full month in office. In the year prior, the average was about 190,000 jobs per month.  In the same time period, the unemployment rate dropped from 4.8% to 4.7%. The same article reports that consumer and business confidence is high and as we all know, the stock market is at a record high. Wage growth continued to show signs of progress after persisting at a sluggish pace for years. Wages grew a solid 2.8% in February compared with a year ago.

    In my practice, optimism and growth are the buzzwords.  My clients are universally enthusiastic about the state of the economy and business prospects as a whole. The consistent mantra of decreasing regulations is universally welcomed with a sense of relief.  The SEC will not be immune to these changes, and we are just beginning to see what I believe will be an avalanche of positive change for small businesses and capital formation.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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    SEC Completes Inflation Adjustment To Civil Penalties

    Tuesday, March 21, 2017, 9:20 AM [General]
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    The SEC has completed the first annual adjustment for inflation of the maximum civil monetary penalties administered under the SEC. The inflation adjustment was mandated by the Federal Civil Penalties Inflation Adjustment Improvements Act of 2015, which requires all federal agencies to make an annual adjustment to civil penalties.

    The SEC adjusted civil penalties that can be imposed under the Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1040, Investment Advisors Act of 1940 and Sarbanes-Oxley Act of 2002. Under the Sarbanes-Oxley Act of 2002 civil penalties are those imposed by the PCAOB in disciplinary proceedings against its accountant members.

    The penalty increase applies to civil monetary penalties (“CMP”). A CMP is defined as “any penalty, fine, or other sanction that: (1) is for a specific amount, or has the maximum amount, as provided by federal law; and (2) is assessed or enforced by an agency in an administrative proceeding or by a federal court pursuant to federal law.”

    The following is a table of the new CMP’s.

    U.S. Code citation Civil monetary penalty description New Adjusted penalty amounts
    15 U.S.C. 77h-1(g)

    (Securities Act Sec. 8A(g))

    For natural person $8,289
    For any other person 82,893
    For natural person / fraud 82,893
    For any other person / fraud 414,466
    For natural person / fraud / substantial losses or risk of losses to others or gains to self  

    165,787

    For any other person / fraud / substantial losses or risk of losses to others or gain to self  

    801,299

    15 U.S.C. 77t(d)

    (Securities Act Sec. 20(d))

    For natural person 9,054
    For any other person 90,535
    For natural person / fraud 90,535
    For any other person / fraud 452,677
    For natural person / fraud / substantial losses or risk of losses to others  

    181,071

    For any other person / fraud / substantial losses or risk of losses to others  

    905,353

    15 U.S.C. 78u(d)(3)

    (Exchange Act Sec. 21(d)(3))

    For natural person 9,054
    For any other person 90,535
    For natural person / fraud 90,535
    For any other person / fraud 452,677
    For natural person / fraud / substantial losses or risk of losses to others or gains to self  

    181,071

    For any other person / fraud / substantial losses or risk of losses to others or gain to self  

    905,353

    15 U.S.C. 78u-1(a)(3) (Exchange Act Sec. 21A(a)(3)) Insider trading – controlling person 2,011,061
    15 U.S.C. 78u-2

    (Exchange Act Sec. 21B)

    For natural person 9,054
    For any other person 90,535
    For natural person / fraud 90,535
    For any other person / fraud 452,677
    For natural person / fraud / substantial losses or risk of losses to others  

    181,071

    For any other person / fraud / substantial losses or risk of losses to others  

    905,353

    15 U.S.C. 78ff(b)

    (Exchange Act Sec. 32(b))

    Exchange Act / failure to file information documents, reports  

    534

    15 U.S.C.

    78ff(c)(1)(B)

    (Exchange Act Sec. 32(c)(1)(B))

     

    Foreign Corrupt Practices – any issuer

     

    20,111

    15 U.S.C.

    78ff(c)(2)(B)

    (Exchange Act Sec. 32(c)(2)(B))

    Foreign Corrupt Practices – any agent or stockholder acting on behalf of issuer  

    20,111

    15 U.S.C. 80a-9(d)

    (Investment Company Act Sec. 9(d))

    For natural person 9,054
    For any other person 90,535
    For natural person / fraud 90,535
    For any other person / fraud 452,677
    For natural person / fraud / substantial losses or risk of losses to others or gains to self  

    181,071

    For any other person / fraud / substantial losses or risk of losses to others or gain to self  

    905,353

    15 U.S.C. 80a-41(e)

    (Investment Company Act Sec. 42(e))

    For natural person 9,054
    For any other person 90,535
    For natural person / fraud 90,535
    For any other person / fraud 452,677
    For natural person / fraud / substantial losses or risk of losses to others  

    181,071

    For any other person / fraud / substantial losses or risk of losses to others  

    905,353

    15 U.S.C. 80b-3(i) For natural person 9,054

    Further Reading

    Background:  A Trend Towards Increased Enforcement

    The SEC has demonstrated a trend to deter securities law violations through regulations and stronger enforcement including the SEC Broken Windows policy, increased Dodd-Frank whistleblower activity and reward payments, and increased bad-actor prohibitions.

    The SEC Broken Windows policy is one in which the SEC is committed to pursue infractions big and small; where they are committed to investigate, review and monitor all activities and not just wait for someone to call and complain or just wait for the big cases.  The idea is that small infractions lead to bigger infractions, and the securities markets have had the reputation that minor violations are overlooked, creating a culture where laws are treated as meaningless guidelines.  So the SEC thinks it is important to pursue all types of wrongdoings—not just big frauds, but negligence-based cases and the enforcement of prophylactic measures as well.

    In a speech by Mary Jo White back in October 2013, she announced the policy and the SEC’s enforcement initiative.  The policy is modeled after one pursued by the NYPD back in the nineties under Mayor Rudy Giuliani, which resulted in helping to clean up the streets of New York.  The analogy is that if a window is broken and someone fixes it, it is a sign that disorder will not be tolerated, but if no one fixes it, the thought is that no one cares and no one is watching so why not break more windows.

    Although I believe that the new chairman, commissioners and division chiefs at the SEC will be more business-friendly than their predecessors, I also think enforcement of legal infractions will always remain a priority.

    SEC Civil Penalties

    Under the law, penalties differ depending on whether the SEC pursues and resolves an action in an SEC administrative proceeding or through a federal court action. In SEC administrative proceedings, there are three tiers of maximum penalties. For most civil violations, the SEC can impose a first-tier money penalty for “each act or omission” violating the securities laws.  Second-tier violations involve at least reckless misconduct. Third-tier violations involve fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement that resulted in substantial losses to victims or substantial pecuniary gain to the wrongdoer.

    The tiers are the same when a proceeding is heard in federal court, except that the SEC also has the option of seeking, instead, a penalty equal to the wrongdoers’ “ill-gotten gain” from the violation.

    According to a Yale Law Journal article published in October 2014, since 2000 penalties have grown 30% year-over-year, compared to only a 3% growth in cases filed. The article points out that Xerox’s 2002 $10 million civil penalty was then “the largest ever levied in a Commission action against a public company for financial fraud,” and that since that time, corporate penalties have skyrocketed. As I’ve noted in several prior blogs, the SEC is very vocal about its use of penalties as a deterrent and its commitment to increase that trend.

    Proposed SEC Penalties Act

    In July 2015 Congress passed the SEC Penalties Act to increase the per-violation caps. The Act did not move past its initial congressional passage. The Act proposed to increase penalties for first-tier violations to the greater of $10,000 for individuals or $100,000 for entities, or the gross pecuniary gain by the wrongdoer. Second-tier penalties are increased to the greater of $100,000 for individuals or $500,000 for entities, or the gross pecuniary gain by the wrongdoer. Third-tier penalties are increased to the greater of (i) $1 million per violation for individuals or $10 million per violation for entities, (ii) three times the gross pecuniary gain, or (iii) the losses incurred by victims as a result of the violation. The SEC Penalties Act also triples the penalty cap for recidivists who have been held criminally or civilly liable for securities fraud in the last five years.

    The Act also provides authority to seek civil penalties for violations of previously imposed injunctions or bars with each violation and each day of continuing violation being considered a separate offense. The penalties under the proposed Act would apply in both administrative and federal court proceedings.

    Particular Considerations Related to Administrative Proceedings

    The SEC Penalties Act, as written in its beginning form, treats administrative court and federal court proceedings equally.  However, the administrative court process is not an equal forum, and based on a barrage of negative attacks, including lawsuits, appeals and media coverage, requires review and attention. An analysis by the Wall Street Journal in 2015 indicated that in the last five years, the SEC has won 90% of cases brought in its own administrative courts but only 69% of cases brought in federal court. Part of the disparity could be that the SEC chooses to settle or drop “losing” claims, but that still leaves a large discrepancy.

    Moreover, the Dodd-Frank Act, enacted in 2010, for the first time granted the SEC the authority to impose civil penalties in administrative proceedings against any person the SEC claims violated the securities laws, regardless of whether that person or firm is in the securities business. In other words, Dodd-Frank opened the doors for the SEC’s own administrative proceedings to be just another forum for the pursuit of any securities law violations.  Common sense tells us that this change, seven years ago, directly relates to the uproar in the defensive bar.

    Over the past years a slew of cases have been filed challenging the SEC’s power in administrative actions and the administrative process. In June 2015 in the case Hill vs. SEC, a federal district court in Atlanta granted injunctive relief preventing the SEC from proceeding with an administrative proceeding on the grounds that the proceeding was unconstitutional. Without getting overly complex, Hill argued that the SEC administrative process (i) violated Article I of the constitution by letting the SEC pick the forum in which to pursue claims (administrative court or federal court) and that power is limited to Congress; (ii) violated the Seventh Amendment right to a jury trial (administrative court proceedings are heard by an administrative court judge); and (iii) violated the Article II Appointments Clause.

    The federal court rejected the first two arguments but found that the there was enough evidence and support of a violation of the Appointments Clause to support the granting of a temporary injunction. In particular, the SEC administrative law judge was an inferior officer that, under Article II, must be appointed by either the president, a court of law, or a department head. In fact, the judge had not been appointed by the SEC commissioner (department head), the president or a court.

    In August 2016 the U.S. Court of Appeals for the D.C. Circuit ruled that the administrative law judge’s appointment was proper.  However, in December 2016 the 10th U.S. Circuit Court of Appeals ruled that SEC administrative law judges are not constitutionally appointed. The matter may next be heard by the Supreme Court.

    Liability for Signing SEC Report, Including CEO and CFO Certifications

    I am often asked about potential liability for signing SEC reports and, in particular, the CEO and CFO certifications.  An officer providing a false certification potentially could be subject to SEC action for violating Section 13(a) or 15(d) of the Exchange Act and to both the SEC and private actions for violating Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5. Each of these violations could be a first-, second- or third-tier violation depending upon the level of scienter by the signing officer or director and the damage resulting from the false report. In practice, courts consider the actual facts, including the signer’s involvement or scope of knowledge of the information in the reports, and do not consider the signing of the report itself dispositive. The SEC advocates the view that officers and directors have a proactive responsibility to ensure the accuracy of the reports they sign and have concurrent liability.

    As a reminder, a public company with a class of securities registered under Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC. The underlying basis of the reporting requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner.  Reports filed with the SEC can be viewed by the public on the SEC EDGAR website. The required reports include an annual Form 10-K, quarterly Form 10Q’s, and current periodic Form 8-K, as well as proxy reports and certain shareholder and affiliate reporting requirements.

    These reports are signed by company officers and directors. A company officer signs a Form 10-Q and all company directors sign a Form 10-K. Moreover, the Sarbanes-Oxley Act of 2002 (“SOX”) implemented a requirement that the company’s principal executive officer or officers and principal financial officer or officers execute certain personal certifications included with each Form 10-Q and 10-K. Certifications are not required on a periodic Form 8-K.

    Although it is the function of the officer that determines the requirement to execute the certifications, for purposes of this blog, I will refer to the principal executive officer as the “CEO” and the principal financial officer as the “CFO.” All companies that file reports under the Exchange Act, whether domestic or foreign, small business issuers or well-known seasoned issuers, are required to include the sw. Under the CEO/CFO certification requirement, the CEO and CFO must personally certify the accuracy of the information contained in reports filed with the SEC and the procedures established by the company to report disclosures and prepare financial statements.

    A company’s CEO and CFO must each provide two certifications as part of the company’s quarterly Form 10-Q and annual Form 10-K. The certifications are required under Sections 302 and 906 of the SOX. The certifications are executed individually and filed as exhibits to the applicable quarterly and annual filings. Although certifications are not included in reports other than Forms 10-Q and 10-K, the disclosure controls and procedures to which the CEO and CFO certify must ensure full and timely disclosure in all current reports, as well as definitive proxy materials and definitive information statements.

    Section 302 Certification

    Under Section 302, the CEO and CFO make statements related to the accuracy of the reports filed with the SEC and the controls and procedures established by the company to ensure the accuracy of such reports. The certification must be in the exact form set forth in the rule, and the wording may not be changed in any respect whatsoever. The CEO and CFO must each certify that:

    • He or she has reviewed the report;
    • Based on his or her knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances, not misleading;
    • Based on his or her knowledge, the financial statements and financial information fairly present, in all material respects, the company’s financial condition, results of operations and cash flows of the company;
    • The certifying officer(s) is/are responsible for:
      • establishing and maintaining disclosure controls and procedures;
      • having designed such disclosure controls and procedures to ensure that they are informed of all material information;
      • having each evaluated the effectiveness of the disclosure and financial controls and procedures as of the end of each period in which they are making the certification; and
      • having disclosed their conclusions regarding the effectiveness of the controls and procedures in the subject Form 10-Q or 10-K;
    • He or she has disclosed to the company auditors and to the audit committee any significant deficiencies or material weaknesses in the design or operation of internal controls over financial reporting which could adversely affect the company’s ability to record, process, summarize and report financial data;
    • He or she has disclosed to the company auditors and to the audit committee any fraud, material or not, that involves employees who have a significant role in internal controls over financial reporting; and
    • Any changes in the internal controls or financial reporting have been disclosed in the subject Form 10-Q or 10-K, including changes designed to correct deficiencies or material weaknesses.

    If a material weakness is uncovered, it must be disclosed in a Form 10-K and, as a result, management cannot conclude that its controls and procedures are effective. The SEC defines a material weakness to be a deficiency, or a combination of deficiencies, in internal control over financial reporting that creates a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. The disclosure of a material weakness should include the nature of the weakness, its impact on financial reports and plans or steps and changes made to correct the disclosed material weakness.

    Section 906 Certification

    Under Section 906, the CEO and CFO must attest that the subject periodic report with financial statements fully complies with the Exchange Act and that information in the report fairly presents, in all material respects, the company’s financial condition and results of operations. Like the Section 302 certification, the Section 906 certification must be in the exact form set forth in the rule and the wording may not be changed in any respect whatsoever.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    The SEC Has Issued New Guidance Related To Foreign Private Issuers

    Tuesday, March 14, 2017, 9:12 AM [General]
    0 (0 Ratings)

    On December 8, 2016, the SEC issued 35 new compliance and disclosure interpretations (C&DI) including five related to the use of Form 20-F by foreign private issuers and seven related to the definition of a foreign private issuer.

    C&DI Related to use of Form 20-F

    In the first of the five new C&DI, the SEC confirms that under certain circumstances the subsidiary of a foreign private issuer may use an F-series registration statement to register securities that are guaranteed by the parent company, even if the subsidiary itself does not qualify as a foreign private issuer. In addition, the subsidiary may use Form 20-F for its annual report. To qualify, the parent and subsidiary must file consolidated financial statements or be eligible to present narrative disclosure under Rule 3-10 of Regulation S-X.

    Likewise in the second of the new C&DI, the SEC confirms that an F-series registration statement may be used to register securities to be issued by the parent and guaranteed by the subsidiary. When a parent foreign private issuer issues securities guaranteed or co-issued by one or more subsidiaries that do not themselves qualify as a foreign private issuer, the parent and subsidiary may use an F-series registration statement when they are eligible to present condensed consolidating financial information or narrative disclosure.

    In the third C&DI the SEC clarifies the deadline for filing a Form 20-F annual report. In particular, the Form 20-F is due 4 months to the day from the end of a company’s fiscal year-end. For example, if a company’s fiscal year-end is February 20, the Form 20-F due date would be June 20.

    In the fourth C&DI, the SEC confirms that a wholly owned subsidiary can omit certain information from its Form 20-F annual report in the same manner that a wholly owned subsidiary of a U.S. company can omit information in its Form 10-K. The subsidiary would need to include a prominent statement on its cover page that it meets the requirements to and is providing reduced disclosure.

    The requirements to be able to provide reduced disclosure, for both 20-F and 10-K filers, include: (i) all of the company’s equity securities are owned, either directly or indirectly, by a single entity which is subject to the reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”); (ii) such parent entity is current in its reporting requirements; (iii) the parent company specifically names the subsidiary in its description of its business; (iv) during the preceding 36 calendar months and any subsequent period of days, there has not been any material default in the payment of principal, interest or any other material default with respect to any indebtedness of the parent or its subsidiaries; and (v) there has not been any material default in the payment of rentals under material long-term leases.

    The disclosure that may be omitted by a qualifying subsidiary includes: (i) selected financial data; (ii) operating and financial review prospects; (iii) the list of subsidiaries exhibit; (iv) information required by Item 6.A, Directors and Senior Management, Item 6.B, Compensation, 6.D, Employees, Item 6.E, Share Ownership, Item 7, Major Shareholders and Related Party Transactions, Item 16A, Audit Committee Financial Expert, and Item 16B, Code of Ethics; and (v) Item 4 Information on the company as long as such information is included in the parent company’s filings.

    In the final new C&DI, the SEC confirms that a foreign private issuer may incorporate by reference into a Form 20-F annual report information that had previously been filed with the SEC in another report, such as a Form 6-K.

    C&DI Related to Definition of Foreign Private Issuer

    The first of the new guidance on the definition of a foreign private issuer relates to determining whether 50% or more of a company’s outstanding securities are directly or indirectly owned by U.S. residents when a company has multiple classes of voting stock with different voting rights. In such a case a company may either (i) calculate voting power on a combined basis; or (ii) make a determination based on the number of voting securities. A company must apply its methodology on a consistent basis.

    The second C&DI provides guidance on determining whether an individual is a U.S. resident. In particular, the SEC confirms that a permanent residence with a green card would be considered a U.S. resident. A company may also consider any relevant facts including tax residency, nationality, mailing address, physical presence, the location of a significant portion of their financial and legal relationships and immigration status. The application of facts must be consistently applied to all shareholders.

    The third C&DI clarifies the determination of citizenship and residency of directors and officers. A company must consider the citizenship and residency of all individual directors and officers separately and not count them as a single group. In the fourth C&DI, the SEC addresses the determination where a company has two boards of directors. In that case, the company should examine the board that most closely undertakes functions that U.S.-style boards of directors would. Where such determination cannot be made or where both boards provide these functions, both boards should be aggregated and citizenship and residency examined for both.

    In the fifth C&DI the SEC confirms that a company can use the geographic segment information in its balance sheet to determine if more than 50% of its assets are located outside the U.S. A company may also use any other reasonable methodology as long as it is used consistently.

    In the sixth C&DI the SEC provides guidance for determining whether a business is principally administered in the U.S. As with the theme of the other guidance, the SEC gives the company guidance to exercise reasonable discretion consistently. A company must assess the location from which its officers, partners, or managers primarily direct, control and coordinate the company business and activities.

    In the seventh new C&DI the SEC confirms that holding meetings of shareholders or the board of directors on occasion, will not necessarily result in a conclusion that the company is principally administered in the U.S.

    In another new C&DI the SEC confirms that all securities-trading markets in countries that are part of the European Union may be considered a single foreign jurisdiction for purposes of applying the trading market definition for purposes of determining the trading of foreign securities.

    Refresher Overview for Foreign Private Issuers

                    Definition of Foreign Private Issuer

    Both the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934, as amended (“Exchange Act”) contain definitions of a “foreign private issuer.” Generally, if a company does not meet the definition of a foreign private issuer, it is subject to the same registration and reporting requirements as any U.S. company.

    The determination of foreign private issuer status is not just dependent on the country of domicile, though a U.S. company can never qualify regardless of the location of its operations, assets, management and subsidiaries. There are generally two tests of qualification as a foreign private issuer, as follows: (i) relative degree of U.S. share ownership; and (ii) level of U.S. business contacts.

    As with many securities law definitions, the overall definition of foreign private issuer starts with an all-encompassing “any foreign issuer” and then carves out exceptions from there. In particular, a foreign private issuer is any foreign issuer, except one that meets the following as of the last day of its second fiscal quarter:

    (i) a foreign government;

    (ii) more than 50% of its voting securities are directly or indirectly held by U.S. residents; and any of the following: (a) the majority of the executive officers or directors are U.S. citizens or residents; (b) more than 50% of the assets are in the U.S.; or (c) the principal business is in the U.S.  Principal business location is determined by considering the company’s principal business segments or operations, its board and shareholder meetings, its headquarters, and its most influential key executives.

    That is, if less than 50% of a foreign company’s shareholders are located in the U.S., it qualifies as a foreign private issuer.  If more than 50% of the record shareholders are in the U.S., the company must further consider the location of its officers and directors, assets and business operations.

    Registration and Ongoing Reporting Obligations

    Like U.S. companies, when a foreign company desires to sell securities to U.S. investors, such offers and sales must either be registered or there must be an available Securities Act exemption from registration. The registration and exemption rules available to foreign private issuers are the same as those for U.S. domestic companies, including, for example, Regulation D (with the primarily used Rules 506(b) and 506(c)) and Regulation S) and resale restrictions and exemptions such as under Section 4(a)(1) and Rule 144.

    When offers and sales are registered, the foreign company becomes subject to ongoing reporting requirements. Subject to the exemption under Exchange Act Rule 12g3-2(b) discussed at the end of this blog, when a foreign company desires to trade on a U.S. exchange or the OTC Markets, it must register a class of securities under either Section 12(b) or 12(g) of the Exchange Act.  Likewise, when a foreign company’s worldwide assets and worldwide/U.S. shareholder base reaches a certain level ($10 million in assets; total shareholders of 2,000 or greater or 500 unaccredited with U.S. shareholders being 300 or more), it is required to register with the SEC under Section 12(g) of the Exchange Act.

    The SEC has adopted several rules applicable only to foreign private issuers and maintains an Office of International Corporate Finance to review filings and assist in registration and reporting questions. Of particular significance:

    (i) Foreign private issuers may prepare financial statements using either US GAAP; International Financial Reporting Standards (“IFRS”); or home country accounting standards with a reconciliation to US GAAP;

    (ii) Foreign private issuers are exempt from the Section 14 proxy rules;

    (iii) Insiders of foreign private issuers are exempt from the Section 16 reporting requirements and short swing trading prohibitions; however, they must comply with Section 13 (for a review of Sections 13 and 16, see my blog HERE);

    (iv) Foreign private issuers are exempt from Regulation FD;

    (v) Foreign private issuers may use separate registration and reporting forms and are not required to file quarterly reports (for example, Form F-1 registration statement and Forms 20-F and 6-K for annual and periodic reports); and

    (vi) Foreign private issuers have a separate exemption from the Section 12(g) registration requirements (Rule 12g3-2(b)) allowing the trading of securities on the OTC Markets without being subject to the SEC reporting requirement.

    Although a foreign private issuer may voluntarily register and report using the same forms and rules applicable to U.S. issuers, they may also opt to use special forms and rules specifically designed for and only available to foreign companies. Form 20-F is the primary disclosure document and Exchange Act registration form for foreign private issuers and is analogous to both an annual report on Form 10-K and an Exchange Act registration statement on Form 10. A Form F-1 is the general registration form for the offer and sale of securities under the Securities Act and, like Form S-1, is the form to be used when the company does not qualify for the use of any other registration form.

    A Form F-3 is analogous to a Form S-3.  A Form F-3 allows incorporation by reference of an annual and other SEC reports. To qualify to use a Form F-3, the foreign company must, among other requirements that are substantially similar to S-3, have been subject to the Exchange Act reporting requirements for at least 12 months and have filed all reports in a timely manner during that time. The company must have filed at least one annual report on Form 20-F. A Form F-4 is used for business combinations and exchange offers, and a Form F-6 is used for American Depository Receipts (ADR).  Also, under certain circumstances, a foreign private issuer can submit a registration statement on a confidential basis.

    Once registered, a foreign private issuer must file periodic reports. A Form 20-F is used for an annual report and is due within four months of fiscal year-end. Quarterly reports are not required. A Form 6-K is used for periodic reports and captures: (i) the information that would be required to be filed in a Form 8-K; (ii) information the company makes or is required to make public under the laws of its country of domicile; and (iii) information it files or is required to file with a U.S. and foreign stock exchange.

    As noted above, a foreign private issuer may elect to use either U.S. GAAP; International Financial Reporting Standards (“IFRS”); or home country accounting standards with a reconciliation to U.S. GAAP in the preparation and presentation of its financial statements. Regardless of the accounting standard used, the audit firm must be registered with the PCAOB.

    All filings with the SEC must be made in English. Where a document or contract is being translated from a different language, the SEC has rules to ensure that the translation is fair and accurate.

    The SEC rules do not have scaled disclosure requirements for foreign private issuers. That is, all companies, regardless of size, must report the same information. A foreign private issuer that would qualify as a smaller reporting company or emerging growth company should consider whether it should use and be subject to the regular U.S. reporting requirements and registration and reporting forms. The company should also consider that no foreign private issuer is required to provide a Compensation Discussion & Analysis (CD&I).  If the foreign company opts to be subject to the regular U.S. reporting requirements, it must also use U.S. GAAP for its financial statements. For further discussions on general reporting requirements and rules related to smaller reporting and emerging growth companies, see my blogs HERE and HERE and related to ongoing proposed changes HERE, which includes multiple related links under the “further background” subsection.

                    Deregistration

    The deregistration rules for a foreign private issuer are different from those for domestic companies. A foreign private issuer may deregister if: (i) the average daily volume of trading of its securities in the U.S. for a recent 12-month period is less than 5% of the worldwide average daily trading volume; or (ii) the company has fewer than 300 shareholders worldwide. In addition, the company must: (i) have been reporting for at least one year and have filed at least one annual report and be current in all reports; (ii) must not have registered securities for sale in the last 12 months; and (iii) must have maintained a listing of securities in its primary trading markets for at least 12 months prior to deregistration.

    American Depository Receipts (ADRs)

    An ADR is a certificate that evidences ownership of American Depository Shares (ADS) which, in turn, reflect a specified interest in a foreign company’s shares. Technically the ADR is a certificate reflecting ownership of an ADS, but in practice market participants just use the term ADR to reflect both.  An ADR trades in U.S. dollars and clears through the U.S. DTC, thus avoiding foreign currency issuers. ADR’s are issued by a U.S. bank which, in turn, either directly or indirectly through a relationship with a foreign custodian bank, holds a deposit of the underlying foreign company’s shares. ADR securities must either be subject to the Exchange Act reporting requirements or be exempt under Rule 12g3-2(b).  ADR’s are always registered on Form F-6.

    OTC Markets

    OTC Markets allows for the listing and trading of foreign entities on the OTCQX and OTCQB that do not meet the definition of a foreign private issuer as long as such company has its securities listed on a Qualifying Foreign Stock Exchange for a minimum of the preceding 40 calendar days subject to OTC Markets’ ability to waive such requirement upon application. If the company does not meet the definition of foreign private issuer, it still must fully comply with Exchange Act Rule 12g3-2(b). For details on the OTCQX listing requirements for international companies, see my blog HERE and for listing requirements for OTCQB companies, including international issuers, see HERE.

    India as an Emerging Market

    India is widely considered the world’s fastest-growing major economy. The small- and micro-cap industry has been eyeing India as an emerging market for the U.S. public marketplace for several years now. In my practice alone, I have been approached by several groups that see the U.S. public markets as offering incredible potential to the exploding Indian start-up and emerging growth sector. Taking advantage of this opportunity, however, was stifled by strict Indian laws prohibiting or limiting foreign investment into Indian companies. In June 2016, the Indian government announced new rules allowing for foreign direct investments into Indian-owned and -domiciled companies, opening up the country to foreign investment, including by U.S. shareholders.

    The new rules allow for up to 100% foreign investment in certain sectors. U.S. investors who already invest heavily in Indian-based defense, aviation, pharmaceutical and technology companies will see even greater opportunity in these sectors, which will now allow up to 100% foreign investment.  Although certain sectors, including defense, will still require advance government approval for foreign investment, most sectors will receive automatic approval. U.S. public companies will now be free to invest in and acquire Indian-based subsidiaries. Likewise, more India-based companies will be able to trade on U.S. public markets, attracting U.S. shareholders and the benefits of market liquidity and public company valuations.

    Indian companies are slowly starting to take advantage of reverse-merger transactions with U.S. public companies. In July 2016, online travel agency Yatra Online, Inc., entered into a reverse-merger agreement with Terrapin 3 Acquisition Corp, a U.S. SPAC.  The transaction is expected to close in October 2016. Yatra is structured under a U.S. holding company with operations in India though an India-domiciled subsidiary.

    Last year Vidocon d2h became the first India-based company to go public via reverse merger when it completed a reverse merger with a U.S. NASDAQ SPAC. In January, 2016 Bangalore-based Strand Life Sciences Pvt. Ltd. became the second India-based reverse merger when it went public in the U.S. in a transaction with a NASDAQ company.

    In addition, U.S.-based public companies, venture capital and private equity firms, and hedge funds and family offices have been investing heavily in the Indian start-up and emerging growth boom. Yatra and Strand Life had both received several rounds of U.S. private funding before entering into their reverse merger agreements. NASDAQ-listed firm Ctrip.com International recently invested $180 million into another India-based online travel company, MakeMyTrip.

    India’s Mumbai/Bombay Stock Exchange is already a Qualified Foreign Exchange for purposes of meeting the standards to trade on the U.S. OTCQX International.  For details on all OTCQX listing requirements, including for international companies, see my blog HERE and related directly to international companies including Rule 12g3-2(b), see HERE.  At least 5 companies currently trade on the OTCQX, with their principal market being in India.

    Exchange Act Rule 12g3-2(b)

    Exchange Act Rule 12g3-2(b) permits foreign private issuers to have their equity securities traded on the U.S. over-the-counter market without registration under Section 12 of the Exchange Act (and therefore without being subject to the Exchange Act reporting requirements). The rule is automatic for foreign issuers that meet its requirements. A foreign issuer may not rely on the rule if it is otherwise subject to the Exchange Act reporting requirements.

    The rule provides that an issuer is not required to be subject to the Exchange Act reporting requirements if:

    1. the issuer currently maintains a listing of its securities on one or more exchanges in a foreign jurisdiction which is the primary trading market for such securities; and
    2. the issuer has published, in English, on its website or through an electronic information delivery system generally available to the public in its primary trading market (such as the OTC Market Group website), information that, since the first day of its most recently completed fiscal year, it (a) has made public or been required to make public pursuant to the laws of its country of domicile; (b) has filed or been required to file with the principal stock exchange in its primary trading market and which has been made public by that exchange; and (c) has distributed or been required to distribute to its security holders.

     Primary Trading Market means that at least 55 percent of the trading in the subject class of securities on a worldwide basis took place in, on or through the facilities of a securities market or markets in a single foreign jurisdiction or in no more than two foreign jurisdictions during the issuer’s most recently completed fiscal year.

    In order to maintain the Rule 12g3-2(b) exemption, the issuer must continue to publish the required information on an ongoing basis and for each fiscal year. The information required to be published electronically is information that is material to an investment decision regarding the subject securities, such as information concerning:

    (i) Results of operations or financial condition;

    (ii) Changes in business;

    (iii) Acquisitions or dispositions of assets;

    (iv) The issuance, redemption or acquisition of securities;

    (v) Changes in management or control;

    (vi) The granting of options or the payment of other remuneration to directors or officers; and

    (vii) Transactions with directors, officers or principal security holders.

    At a minimum, a foreign private issuer shall electronically publish English translations of the following documents:

    (i) Its annual report, including or accompanied by annual financial statements;

    (ii) Interim reports that include financial statements;

    (iii) Press releases; and

    (iv) All other communications and documents distributed directly to security holders of each class of securities to which the exemption relates.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    SEC Announces Examination Priorities For 2017

    Tuesday, March 7, 2017, 8:55 AM [General]
    0 (0 Ratings)

    On January 12, 2017, the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for 2017. The OCIE examines and reviews a wide variety of financial institutions, including investment advisors, investment companies, broker-dealers, transfer agents, clearing agencies and national securities exchanges. The OCIE examination goals are to promote compliance, prevent fraud, identify risk and inform policy.

    The priorities this year have a primary focus on (i) protecting retail investors, especially those saving for retirement; (ii) assessing market-wide risks; and (iii) new forms of technology, including automated investments advice.

    The SEC shares its annual examination priorities as a heads-up and to encourage industry participants to conduct independent reviews and make efforts for increased compliance, prior to an SEC examination, investigation or potential enforcement proceeding. Moreover, the SEC chooses its priority list in conjunction with discussions with all divisions of the SEC and other market regulators and identifies what it believes are the areas that present heightened risk to investors and market integrity.

    A. Retail Investors

    Retail investors are being offered products and services that were formally only available to institutional investors.  A wide range of products that have traditionally been alternative or institutional products, such as private funds, illiquid investments and structured products, are now available to the retail investor. In addition, as investors are more dependent than ever on their own investments for retirement, financial services firms have increased their services in the area of planning for retirement and the SEC intends to examine this area of service. The SEC will examine whether information, advice, products and services are being offered in a manner consistent with laws, rules and regulations.

    The focus of examinations in this area will be on:

    Electronic Investment Advice – Investors are increasingly able to obtain investment advice through automated or digital platforms. The SEC will examine registered investment advisors (RIA’s) and broker-dealers that offer these services, including “robo-advisors” that offer advice online or through other electronic platforms. The SEC will focus on the firms’ compliance programs, marketing, formulation of investment recommendations, data protection, and conflict of interest disclosures.

    Wrap Fee Programs – The SEC will expand its review of RIA’s and broker-dealers that offer a single bundled fee for advisory and brokerage services, usually referred to as a “wrap fee program.” In particular, the SEC will review whether the RIA’s are meeting their fiduciary duties and contractual obligations to the clients. Areas of concern are wrap account suitability, effectiveness of disclosures, conflicts of interest, and brokerage practices, including best execution and trading away.

    Exchange Traded Funds (“ETFs”) – The SEC will examine ETF’s for compliance with securities laws, including exemptions under the Exchange Act of 1934 and Investment Company Act of 1940. The SEC will also focus on unit creation, redemption process, sales practices and disclosures and the suitability of broker-dealers’ recommendations to purchase ETF’s with a niche strategy.

    Never-before-examined Investment Advisors – The SEC will expand its review of never-before-examined investment advisors and will, in particular, try to examine more newly registered advisors and advisors that have been registered for a long period of time without examination.

    Recidivist Representatives and their Employers – The SEC will use analytics to track individuals with a history of misconduct and will also examine the firms that employ these people.

    Multi-branch Advisors – The use of a multi-branch model provides unique challenges in fashioning compliance programs and oversight procedures.

    Share Class Selection – The SEC will examine factors affecting recommendations to invest in or remain invested in a particular share class of a mutual fund, including conflict-of-interest issues. The SEC will examine whether recommendations are being improperly made for share classes with higher loads or distribution fees.

    B.Focusing on Senior Investors and Retirement Investments

    The SEC continues to focus on retirement accounts and senior investors.  Specific areas of priority include:

    ReTIRE – The SEC will continue to focus on its ReTIRE initiative, which focuses on investment advisors and broker-dealers that offer services to retirement accounts. The priority this year is on recommendations and sales of variable insurance products and the sales and management of target date funds.

    Public Pension Advisors – The OCIE will examine investment advisors to state pension plans, municipalities and other government entities, including particular risks to these advisors such as pay to play and undisclosed gifts and entertainment practices.

    Senior Investors – The OCIE will evaluate how firms manage interactions with senior investors, including the ability to identify financial exploitation. Examinations will focus on supervisory programs and controls related to products and services directed at senior investors.

    C.Assessing Market-wide Risks

    The SEC continues to review structural risks and trends that involve multiple firms and industries, including:

    Money Market Funds – The SEC will review money market funds to ensure compliance with the new redemption rules and changes to Form PF which came into effect in October 2016.

    Payment for Order Flow – The SEC will examine broker-dealers with a retail client base to ensure compliance with the duty of best execution when routing customer orders.

    Clearing Agencies – The SEC will continue annual clearing agency reviews.

    FINRA – The SEC intends to enhance its oversight of FINRA with respect to its goal of protecting investors and market integrity. The SEC will also review the quality of FINRA’s examination of broker-dealers.

    Regulation Systems Compliance and Integrity (SCI) – The SEC will continue to review compliance with Regulation SCI. See my blog HERE.

    Cybersecurity – The SEC will review cybersecurity compliance procedures and controls. See my blog HERE.

    Anti-Money Laundering (“AML”) – The SEC will examine clearing and introducing firms’ AML programs and specifically those of firms that have not filed suspicious activity reports or have filed such reports late. The SEC will also examine programs that allow customers to deposit and withdraw cash and/or provide non-U.S. customers with direct access to the markets.

    D.Other Areas of Examination

    In addition to the primary focus discussed above, the SEC will prioritize the following additional areas for examination:

    Transfer Agents – The SEC views transfer agents as an important gatekeeper to prevent Section 5 and other violations as well as preventing fraud. The SEC intends to allocate more resources to examine transfer agents and particularly those involved with microcap securities and private offerings.

    Municipal Advisors – The SEC will conduct examinations of newly registered municipal advisors.

    Private Fund Advisors – The SEC will examine private fund advisors, focusing on conflicts of interest and disclosure of conflicts.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    The SEC Has Proposed The Use Of Universal Proxy Cards

    Tuesday, February 28, 2017, 8:23 AM [General]
    0 (0 Ratings)

    The SEC has seen a huge exodus of key officials and employees since the recent change in administration, and the ultimate effect of these changes on pending or proposed rule making remains to be seen. However, some proposed rules, whether published or still in drafting process, will remain largely unaffected by the political changes. This could be one of them. In particular, on October 16, 2016, the SEC proposed amendments to the federal proxy rules to require the use of universal proxy cards in connection with contested elections of directors. The proposed card would include the names of both the company and opposed nominees. The SEC also proposed amendments to the rules related to the disclosure of voting options and standards for the election of directors.

    Currently where there is a contested election of directors, shareholders likely receive two separate and competing proxy cards from the company and the opposition. Each card generally only contains the directors supported by the sender of the proxy – i.e. all the company’s director picks on one card and all the opposition’s director picks on the other card. A shareholder that wants to vote for some directors on each of the cards, cannot currently do so using a proxy card. The voting process would only allow the shareholder to return one of the cards as valid.  If both were returned the second would cancel out and replace the first under state corporate law.

    Shareholders can always appear in person and vote for any directors, whether company or opposition supported, but such appearance is rare and adds an unfair expense to those shareholders. In an effort to provide the same voting rights to shareholders utilizing a proxy card instead of in person appearance, the proposed new rule would require the use of a universal proxy card with all nominees listed on a single card.

    Opposition to the proposed rule is concerned that it will give more power to shareholder activists groups and encourage additional proxy contests ultimately damaging the corporation that pays the price, both directly and indirectly, by such adversarial processes.

    In an era of strong shareholder activism, the regulation of a company’s obligation in the face of a shareholder proposal has been complex, populated with a slew of no-action letters, SEC guidance through C&DI, and court rulings. In October 2015, the SEC issued its first updated Staff Legal Bulletin on shareholder proposals in years (see my blog HERE) and on the same day the SEC issued specific guidance related to merger and acquisition transactions (see my blog HERE).

    SEC Proposed Rule

    Introduction and Background

    Each state’s corporate law provides for the election of directors by shareholders and the holding of an annual meeting for such purpose.  Company’s subject to the reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”), must comply with Section 14 of the Exchange Act, which sets forth the federal proxy rules and regulations. Private companies, and companies that voluntarily file reports with the SEC (called ’33 Act companies) are not subject to the Section 14 proxy requirements. The SEC views its regulatory authority over the proxy process as “preventing the recurrence of abuses which have frustrated the free exercise of the voting right of stockholders.”

    Currently shareholders that appear in person for a meeting, can vote from any of the choices for a director. However, shareholders voting by proxy, which is the vast majority (as high as 99.9%) can only choose from the candidates on the proxy card provided by the party soliciting such vote. In a contested election a shareholder will receive two separate proxy cards and solicitations, one from the company and one from the opposition. Under state law, a shareholder cannot submit two separate proxy cards as the second cancels out and replaces the first.

    Although the current proxy rules do allow for all candidates to be listed on a single card, such candidate must agree. Generally in a contested election the opposing candidates will not agree presuming it will impede the process for the opposition or have the appearance of an affiliation or support that does not exist. Moreover, neither party is required to include the other’s nominees, and accordingly, even if the director nominees would consent, they are not included for strategic purposes.

    As mentioned, shareholders appearing in person can vote for any duly nominated directors, regardless of whether supported by a company or the opposition. However, in today’s world shareholders rarely appear in person. Besides the time and expense of traveling to and appearing at a meeting, where shares are held in a brokerage account in street name, a shareholder desiring to appear in person needs to go through an added process of having a proxy changed from the brokerage firm to their individual name before they will be on the list and allowed to appear and vote in person. Over the years some large shareholders have taken to sending a representative to meetings so that they could split a vote among directors nominated by a company and those nominated by opposition.

    In 1992 the SEC adopted Rule 14a-4(d)(4), called the “short slate rule,” which allows an opposing group that is only seeking to nominate a minority of the board, to use their returned proxy card, and proxy power, to also vote for the company nominees. The short slate rule has limitations. First it is granting voting authority to the opposition group who can then use that authority to vote for some or all of company nominees, at their discretion. Second, although a shareholder can give specific instruction on the short slate card as to who of the company nominees they will not vote for, they will still need to review a second set of proxies (i.e. those prepared by the company) to get those names.

    In 2013 the SEC Investor Advisory Committee recommended the use of a universal proxy card and in 2014 the SEC received a rulemaking petition from the Council of Institutional Investors making the same request. As a response, the SEC issued the new rule proposal which would require the use of a “universal proxy” card that includes the names of all nominated director candidates.

    In its rule release the SEC discusses the rule oppositions fear that a universal proxy card will give strength to an already bold shareholder activist sector, but notes that “a universal proxy card would better enable shareholders to have their shares voted by proxy for their preferred candidates and eliminate the need for special accommodations to be made for shareholders outside the federal proxy process in order to be able to make such selections.”

    Companies have a concern that dissident board representation can be counter-productive and lead to a less effective board of directors due to dissension, loss of collegiality and fewer qualified persons willing to serve. The SEC rule release solicits comments on this point.

    Moreover, there is a concern that shareholders could be confused as to which candidates are endorsed by who, and the effect of the voting process itself. In order to avoid any confusion as to which candidates are endorsed by the company and which by opposition, the SEC is also including amendments that would require a clear distinguishing disclosure on the proxy card. Additional amendments require clear disclosure on the voting options and standards for the election of directors.

    Proposed Amendments

    In order to provide for the use of universal proxy cards, the SEC has proposed amendments to the proxy rules related to the solicitation of proxies, the preparation and use of proxy cards and the dissemination of information about all director nominees in a contested election. In particular the proposed rules:

    • Revise the consent required of a bona fide nominee such that a consent for nomination with include the consent to be included in all proxy statements and proxy cards. Clear disclosure distinguishing company and dissident nominees will be required in all proxy statements;
    • Eliminates the short slate rule for companies other than funds and BDC’s as the rule would no longer have an effect or be necessary;
    • Requires the use of universal proxy cards in all non-exempt solicitations in connection with contested elections. The universal proxy card would not be required where the election of directors is uncontested.  There may be cases where shareholder proposals are contested by a company in which case a shareholder would still receive two proxy cards, however, in such case, all director nominees must be included in each groups proxy cards.
    • Requires dissidents to provide companies with notice of intent to solicit proxies in support of nominees other than the company’s nominees, and to provide the names of those nominees. The rule changes specify timing and notice requirements;
    • Requires companies to provide dissidents with notice of the names of the company’s nominees;
    • Provides for a filing deadline for the dissidents’ definitive proxy statement;
    • Requires dissidents to solicit the holders of shares representing at least a majority of the voting power of shares entitled to vote on the election of directors;
    • Prescribes requirements for the universal proxy cards, including form, content and disclosures;
    • Makes changes to the form of proxy including requiring an “against” and “abstain” voting option; and
    • Makes changes to the proxy statement disclosure to require a better explanation of the effect of a “withhold” vote in an election.

    The SEC rule release has a useful chart on the timing of soliciting universal proxy cards:

    Due Date Action Required
     

    No later than 60 calendar days before the anniversary of the previous year’s annual meeting date or, if the registrant did not hold an annual meeting during the previous year, or if the date of the meeting has changed by more than 30 calendar days from the previous year, by the later of 60 calendar days prior to the date of the annual meeting or the tenth calendar day following the day on which public announcement of the date of the annual meeting is first made by the registrant. [proposed Rule 14a-19(b)(1)]

     

    Dissident must provide notice to the registrant of its intent to solicit the holders of at least a majority of the voting power of shares entitled to vote on the election of directors in support of director nominees other than the registrant’s nominees and include the names of those nominees.

    No later than 50 calendar days before the anniversary of the previous year’s annual meeting date or, if the registrant did not hold an annual meeting during the previous year, or if the date of the meeting has changed by more than 30 calendar days from the previous year, no later than 50 calendar days prior to the date of the annual meeting. [proposed Rule 14a- 19(d)] Registrant must notify the dissident of the names of the registrant’s nominees.
    No later than 20 business days before the record date for the meeting.  [current Rule 14a-13] Registrant must conduct broker searches to determine the number of copies of proxy materials necessary to supply such material to beneficial owners.
    By the later of 25 calendar days before the meeting date or five calendar days after the registrant files its definitive proxy statement. [proposed Rule 14a-19(a)(2)] Dissident must file its definitive proxy statement with the Commission.

    The proposed new rules will not apply to companies registered under the Investment Company Act of 1940 or BDC’s but would apply to all other entities subject to the Exchange Act proxy rules, including smaller reporting companies and emerging growth companies.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    SEC Issues White Paper On Penny Stock Risks

    Tuesday, February 21, 2017, 8:03 AM [General]
    0 (0 Ratings)

    On December 16, 2016, the SEC announced several new settled enforcement proceedings against market participants including issuers, attorneys and a transfer agent, related to penny stock fraud. On the same day the SEC issued a new white paper detailing the risks associated with investing in penny stocks. This blog summarizes the SEC white paper.

    As I have written about on numerous occasions, the prevention of micro-cap fraud is and will always be a primary focus of the SEC and other securities regulators. In fact, the SEC will go to great lengths to investigate and ultimately prosecute micro-cap fraud. See my blog HERE regarding the recent somewhat scandalous case involving Guy Gentile.

    Introduction

    The SEC Division of Economic and Risk Analysis published a white paper on the risks and consequences of investing in stocks quoted in the micro-cap markets versus those listed on a national securities exchange. The paper reviewed 1.8 million trades by more than 200,000 investors and concludes that returns on investment in the micro-cap markets tend to be negative with the returns and risk worsening for less transparent companies or those involved in improper promotional campaigns.

    The white paper notes that the incidence of and amount of negative returns, as well as alleged market manipulation increase with the fewer disclosure-related requirements associated with the company. The white paper, on the whole, is very negative towards OTC Markets securities. However, off the top, I think the white paper is skewed unfairly against OTC Markets securities when it should target those lower-tier securities that do not provide disclosures to the public.

    This blog will summarize the white paper, including many of its facts and figures, but will find issue with its framework. The white paper does not give fair distinction to the higher OTCQX tier of OTC Markets. In fact, “OTCQX” only appears twice in the entire white paper, both in a footnote that purports to list the OTCQX requirements, but fails to mention the quantitative requirements, including that the security not be a penny stock as defined by the federal securities laws. The shortened “QX” does appear 13 times in the white paper, providing some factual and statistical information such as market size and trading patterns, but again, ignores the meaningful distinction related to the penny stock definition. For a review of the OTCQX tier of OTC Markets and its listing requirements, see my blog HERE.

    It is axiomatic that the vast majority of new jobs are created by small and emerging companies and that these companies are critical to the economic well being of the United States. See, for example, my blog on the SEC report on the definition of accredited investor HERE and its study on private placements HERE.

    According to both Bloomberg and Forbes, 8 out of 10 new businesses fail within 18 months and that number jumps to 96% in the first 10 years. However, despite that failure rate, it is indisputable that we need entrepreneurs to continue forming new businesses and access supportive capital, to have a healthy economy.

    Likewise, it is axiomatic to all micro-cap market participants that those companies that fail to provide meaningful disclosure to the public, are more likely to result in investment losses. Those companies are also more likely to engage in market manipulation and other securities law violations. However, those companies that do provide meaningful disclosure to the public, whether through SEC reporting or alternatively to the OTC Markets, and especially those companies that trade on the OTCQX, are the very small and emerging companies that are necessary and vital to our healthy economy. They may be the 8 out of 10 or the 96%, but some will also be the 2 out of 10 and 4% ­­– and all are necessary.

    Also, the fact is that bank financing is not readily available for these companies, and they have no choice but to try to access capital through the public. That public wants an exit strategy and that exit strategy tends to be the public markets. Where the companies are small and immature in their business life cycle, the OTC Markets provide that secondary trading market. In discussing this aspect of the economies of these small public companies, they are more positively referred to by the SEC as “venture” companies and the trading market as a “venture exchange” (see my blog HERE).

    Many times when a company ceases to provide disclosure or information to the public and remains dark for a period of time, its business operations have failed, it has gone private, or otherwise has been abandoned. These companies continue to trade, and sometimes with high volume with no public information. The SEC makes an effort to eliminate these companies through its Operation Shell-Expel (see HERE), but unfortunately many remain and new ones are added all the time as the 8-out-of-10 cycle continues.

    Although all penny stocks are risky, and are undeniably the highest-risk investments, grouping all OTC Markets into the white paper, in the fashion that the SEC has done, strikes me as fundamentally unfair. Throughout my summary of the SEC White Paper, I provide thoughts and commentary.

    SEC White Paper

    The SEC White Paper begins with an introduction on some high-level differences between an exchange traded security and one on the OTC Markets. One of the biggest distinctions is that the majority of ownership and trading of an exchange listed security is by institutional investors, whereas the majority of ownership and trading on the OTC Markets is by individuals. The SEC points out that institutions tend to be more proactive in research and shareholder activism, creating a check on corporate governance.  As an aside, these institutions are also more sophisticated and able to assert greater influence and power over a company than an individual small shareholder.

    The SEC quickly highlights the negative literature on OTC Markets securities, including that they have poor liquidity, generate negative and volatile returns and are often subject to market manipulation, including by the dissemination of false and misleading information. Although OTC securities offer the opportunity to invest in early-stage companies that may grow to be larger successful ones, the number that do exceed is small (such as the 2 out of 10 in my summary above).

    One portion of the white paper’s information I find interesting is that despite the risks, OTC Markets continue to grow and investor demands for these stocks continues to rise. The SEC offers two hypotheses for this. The first is that OTC investors are simply gambling for the big return, just as they do with the lottery.  The second is that OTC Markets investors simply make bad investment decisions. However, the report does admit that little is known about the characteristics of OTC investors and that this is likely the first comprehensive study trying to determine those demographics. Personally, I also think that many OTC Markets investors are day traders and that although a particular stock may go down over time, those day traders are taking advantage of the small intraday price changes to make a profit.

    The SEC reviewed 1.8 million trades by more than 200,000 investors and concludes that returns on investment in the micro-cap markets tend to be negative, with the returns and risk worsening for less transparent companies or those involved in improper promotional campaigns, and are also worse for elderly and retired investors and those with lower levels of income and education.  The SEC white paper purports to be the first study of its kind that examines investor outcomes around stock promotions and level of disclosure.

    I would suggest that the exact same results (i.e., lower returns on less transparent investments and those engaged in improper promotional campaigns and lower returns for the elderly and lower income and education demographic) would be found for any investments in any studied market and are not unique to OTC Markets securities. To be clear, I don’t think the correlation is necessarily improper activity, though that could be the case especially when looking at some stock promotions. Companies that provide less disclosure may have less capital and financial resources to further their business plan and, as such, are far riskier investments. Also, companies that provide less disclosure may be less interested in furthering the public aspect of their business.  Even if the underlying business is sound, if they are not providing public disclosure, the stock price and liquidity are unlikely to reflect the underlying business, which could result in poor investor returns.

    The SEC white paper continues with a three-part discussion: (i) OTC Market structure and size; (ii) review of academic literature; and (iii) analysis of OTC investor demographics and outcomes.

    OTC Market Structure and Size

    The SEC white paper describes the basic makeup of OTC Markets including its three tiers of OTC Pink, OTCQB and OTCQX. I’ve written about these market tiers many times. For a review of the three tiers, see my blog HERE, though I note that both the OTCQB and OTCQX have updated their listing standards since that blog was written. The OTC Pink remains unchanged. For the most current listing standards on the OTCQX see HERE and for the OTCQB see HERE.

    The SEC white paper also references the OTCBB, which technically still exists, but has fewer than 400 listed securities and does not have a readily accessible quote page.

    The SEC white paper has a lot of information on the market size and its growth over the years. Without getting into a lot of facts and figures, I note that the OTC Markets grew by 47% from 2012 through 2015, with $238 billion of trading in 2015. There are approximately 10,000 securities quoted on OTC Markets, as compared to approximately 2,700 on NASDAQ, of which only approximately 675 are micro-cap companies.

    The OTC Markets monthly newsletter gives a complete review and breakdown of the size of OTC Markets. For the one month of December 31, 2016, the following is the number of traded securities and volume:

    Monthly Trade Summary – December 2016
    Market
    Designations
    Number
    of Securities*
    Monthly
    $ Volume
    Monthly $
    Volume
    per Security
    2016
    $ Volume*
    OTCQX 461 $3,844,835,942 $8,340,208 $36,847,879,435
    OTCQB 933 $3,249,939,872 $3,483,322 $13,638,584,206
    Pink 8,234 $14,648,939,577 $1,779,079 $142,411,521,245
    Total 9,628 $21,743,715,392 $2,258,383 $192,897,984,887

    Literature Review

    The SEC white paper continues with a summary of recent academic research and analysis including on OTC Markets securities’ liquidity, returns, market manipulation, transition to an exchange and investor participation.

    Liquidity refers to the ability of shareholders to quickly buy and sell securities near the market price without substantial price impact. Where there is a lack of liquidity, it is difficult to sell.  Also, low-volume stocks tend to have wider price fluctuations and bid-ask spreads, and are more expensive for dealers to hold in inventory. OTC Markets securities are less liquid than those listed on a national exchange such as the NYSE MKT or NASDAQ. Research also shows that there tends to be lower liquidity with less transparency and disclosure. None of this is surprising, though many of us that work in the OTC Markets space have seen the anomaly of a company with no information, and likely no underlying business or management, trading on heavy volume.

    The returns on OTC Markets securities are also very different than exchange traded securities. Returns on OTC Markets are often negative, volatile and skewed (the lottery factor). Where the majority of trades have negative returns, there is the incidence of extremely high, lottery-like returns on some of the securities. This, again, is not surprising. OTC Markets-traded companies tend to be smaller companies and thus would naturally have a smaller market capitalization and smaller returns as well as the potential for larger upside.

    Again, returns on companies that provide less transparency and public information tend to be lower.  Interestingly, another hypothesis as to why returns are lower is the short-sale constraints on OTC Market securities. Many OTC Market securities are ineligible for margin (and thus short sales), and locating shares for borrow can be challenging. Those that are margin-eligible usually have a very high carry interest and per-share transaction cost for short sales. The argument is that short sales create an equilibrium and thus help reflect a truer stock price such that the stock will be less vulnerable to negative price adjustments. However, unfortunately, sophisticated traders can open offshore accounts that will allow for short selling of OTC Market securities, opening those same securities up to manipulation by those investors.

    OTC Markets securities are relatively often the target of market manipulation, including outright fraudulent disclosures and pump-and-dump schemes. Generally these schemes are conducted in the trading of those companies that are less transparent in disclosures. A market manipulation scheme can involve the dissemination of false information followed by taking advantage of the price changes that result. The scheme can be perpetrated by the company and its insiders, or by unaffiliated investors.  Examples include spam and email campaigns, rumors and false information in Internet chat rooms or forums, and false “analyst reports.” Research shows these schemes are effective – that is, the price increases while the stock is being touted and falls when the campaign is over.

    Obviously not all increases in stock prices are a result of improper behavior. OTC Markets stocks react to legitimate news and growth as well.  In fact, the majority of extreme increases in trading price and volume are the result of changes in company fundamentals and not market manipulation. Moreover, not investor relations and stock promotion is perfectly legal and can be completely legitimate. It is when false or misleading information is being disseminated, or targeted marketing aimed at vulnerable investor groups is used, that it is problematic. The key is recognizing the difference, which generally involves transparency from companies that provide steady, consistent disclosure with apparent credible information.

    Many OTC investors are hoping to “bet” on the company that will grow and move to an exchange where it is likely the stock price will increase substantially, as will liquidity. The SEC white paper gives dismal statistics on the rates of graduation. However, it does note that the rate of movement to an exchange is much higher for OTCQX or OTCQB (9%) than OTC Pink companies (less than 1%). The SEC white paper also suggests that companies that graduate to an exchange from the OTC Markets underperform those companies that go public onto an exchange in the first instance.

    The last area that the SEC white paper discusses in this section is investor participation and, in particular, why that investor participation continues to grow year over year. The SEC white paper gives two hypotheses, the first being that investors are drawn by the opportunity for lottery-like payoff and the second is that investors are “duped about the stock return probabilities.”  Although this sounds harsh, the white paper is not actually referring to market manipulation, but rather suggests that all OTC investors, including the most sophisticated, make poor estimates on return probabilities. No reason for this is offered.

    Studies show that although investors frequently lose small investments in OTC stocks, they also occasionally receive an extremely large return. As such, the SEC white paper suggests that these investors are really just gamblers. I’m sure that oftentimes is correct.

    Data Analysis and Investor Demographics

    The Division of Economic and Risk Analysis studied a sampling of trades for specific securities and time periods which included information on the issuer, trade and investor. The purpose of the review was to determine a relationship between investor returns on the one hand and stock promotions, company transparency and investor demographics on the other hand. However, the information used for the analysis is admittedly biased in that such information was taken from the SEC enforcement files for the year 2014. Since one or more parties to the trades were the subject of enforcement proceedings, this information would not be indicative of the usual OTC company.

    The SEC white paper comes to the conclusion that there is a positive correlation between losses and market manipulation and lack of transparency. As discussed above, this is not surprising and is actually quite logical. The white paper also found a positive correlation between losses and elderly, lower-income and poorly educated investors.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    What Does The SEC Do And What Is Its Purpose?

    Tuesday, February 14, 2017, 8:02 AM [General]
    0 (0 Ratings)

    As I write about the myriad of constantly changing and progressing securities law-related policies, rules, regulations, guidance and issues, I am reminded that sometimes it is important to go back and explain certain key facts to lay a proper foundation for an understanding of the topics which layer on this foundation. In this blog, I am doing just that by explaining what the Securities and Exchange Commission (SEC) is and its purpose. Most of information in this blog comes from the SEC website, which is an extremely useful resource for practitioners, issuers, investors and all market participants.

    Introduction

    The mission of the SEC is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.  Although each mission should be a priority, the reality is that the focus of the SEC changes based on its Chair and Commissioners and political pressure. Outgoing Chair Mary Jo White viewed the SEC enforcement division and task of investor protection as her top priority. Jay Clayton will likely shift the top priority to capital formation.

    In addition to regulating and overseeing the processes involved in capital formation (registration and exemptions), the SEC regulates the market participants themselves, including securities exchanges, brokers and dealers, investment advisors, investment companies, issuers and investors, and civilly enforces the law as to each of these participants.  Related to securities exchanges, brokers and dealers and investment advisors, the SEC is primarily concerned with disclosure, fair dealing and protecting against fraud. The SEC brings hundreds of enforcement proceedings each year. For a review of the SEC 2016 enforcement results, see my blog HERE.

    The federal securities laws are based on the premise that all investors, whether large institutions or private individuals, should have access to disclosure and information about an investment both before they buy it and during the time they hold the investment. The public company reporting requirements are designed to provide meaningful, comparable information and data about public companies so that investors can conduct due diligence and make an analysis as to whether to buy, sell or hold a particular security.

    In order to be effective in its mission in an ever-changing global economy, the SEC must stay connected with market participants and their needs, and be abreast of, and utilize, technological advances. Moreover, the SEC considers the education of investors as a key component to its mission. Educated investors make better decisions. The majority of leads and ultimate evidence on wrongdoing come from investors themselves and, as such, better educated investors provide a more useful resource for enforcement.

    History

    The SEC was formed as a response to the stock market crash of October 1929 and the following period of the Great Depression.  First, Congress passed the Securities Act of 1933, which was designed to regulate disclosure and truth in the purchase and sale of securities. Second, Congress passed the Securities Exchange Act of 1934, which created the SEC and was designed to regulate the people who sell and trade securities, including public companies, brokers, dealers and exchanges. Joseph Kennedy, John F. Kennedy’s father, was the first Chairman of the SEC.

    Organization

    The SEC is controlled by five commissioners appointed by the president. Each commissioner serves a five-year term and the terms are staggered as to the individual commissioners. One of the commissioners is designated as the chairman by the president. By law, and in an effort to ensure bipartisan policies, no more than three of the commissioners can belong to the same political party.

    The SEC is divided into five divisions and 23 offices, all of which are headquartered in Washington, D.C., although there are 11 regional offices throughout the country. A brief summary of each division follows.

    Divisions

    Division of Corporation Finance

    The Division of Corporation Finance (CorpFin) oversees disclosure documents filed by companies with the SEC, including, for example, registration statements on Form S-1, 1-A or Form 10, SEC reports on Forms 10-Q, 10-K and 8-K, and proxy materials related to annual and special shareholder meetings. CorpFin routinely reviews the documents filed with the SEC and may provide comments on the filings. For information on responding to SEC comments, see my blog HERE.

    CorpFin provides administrative interpretations and guidance on the federal securities laws for the public and makes specific recommendations to the SEC for rule implementation and changes. In addition to the more formal written no-action letter process, CorpFin maintains staff that is available to answer calls by potential issuers and investors to provide guidance and interpretations on the federal securities laws, including related to whether a particular offering would qualify for an exemption from the registration requirements. CorpFin also works with the Office of Chief Accountant to monitor accounting activities, including the Financial Accounting Standards Board (FASB), which formulates generally accepted accounting principles (GAAP).

    Division of Enforcement

    The Division of Enforcement conducts investigations and brings civil and administrative proceedings on behalf of the SEC to enforce the federal securities laws. The Division of Enforcement is not itself a criminal prosecutory authority but does work with law enforcement agencies such as the Department of Justice and Attorney General offices around the U.S. to recommend and assist with criminal cases.

    All SEC investigations are private. Once an investigation is completed, the SEC will decide to take no action, pursue a civil complaint or pursue an administrative proceeding. Matters that may result in civil or administrative proceedings are often settled first. Although this firm does not represent clients in enforcement proceedings, I have written about the topic in general on numerous occasions. For further reading on enforcement penalties, see HERE. Related to the SEC Whistleblower program, see HERE. For reading related to the SEC’s efforts to prevent microcap fraud, see HERE.

    Division of Trading and Markets

    The Division of Trading and Markets is responsible for the SEC’s role of maintaining fair, orderly and efficient markets.  In executing its duties, the Division provides daily oversight of major market participants, including the securities exchanges, broker-dealers, self-regulatory organizations including FINRA and the MSRB, clearing agencies, transfer agents, securities information processors and credit rating agencies. This Division also oversees the Securities Investor Protection Corporation (SIPC), which provides insurance against loss in customer accounts due to the bankruptcy or other overall failure of brokerage firms. SIPC does not ensure against individual losses from market declines or negligent or fraudulent broker conduct.

    The Division of Trading and Markets also assists with financial integrity programs for broker-dealers, reviewing rules proposed by self-regulatory organizations, drafting and proposing rules and interpretations related to market operations and surveilling the markets.

    Division of Investment Management

    The Division of Investment Management helps oversee the investment management industry, including mutual funds, fund managers, analysts and investment advisors. The Division of Investment Management is responsible for both investor protection and promoting capital formation in the industry balancing between disclosure by funds and limiting regulatory costs that ultimately reduce gains.

    The Division of Investment Management assists the SEC in promulgating and interpreting laws and regulations in the investment management industry, responds to no-action letter and exemptive relief requests, reviews investment company and investment advisor filings with the SEC, and assists in enforcement proceedings.

    Division of Economic and Risk Analysis

    The Division of Economic and Risk Analysis helps with all aspects of the SEC’s mission through its economic analysis and data analytics. This Division interacts with all other divisions and offices of the SEC, providing economic and risk analyses related to policymaking, rulemaking, enforcement and examinations. The Division also provides advance risk assessments as to litigation, examinations, registrants reviews and general economic support.

    Offices of the SEC

    The SEC has several offices that perform functions related to the SEC’s overall mission, including, but not limited to, the Office of General Counsel, the Office of the Chief Accountant, the Office of Compliance Inspections and Examinations, the Office of Investor Education and Advocacy, the Office of Credit Ratings, the Office of International Affairs, the Office of Municipal Securities, the Office of Ethics Counsel, the Office of the Investor Advocate, the Office of Women and Minority Inclusion, the Office of the Chief Operating Officer, the Office of Legislative and Intergovernmental Affairs, the Office of Public Affairs, the Office of the Secretary, the Office of Equal Employment Opportunity, the Office of the Inspector General and the Office of Administrative Law Judges, a few of which deserve explanation.

    The General Counsel, as part of the Office of the General Counsel, is appointed by the Chairman, is the chief legal officer of the SEC and provides legal advice and counsel to all divisions, other offices, commissioners and the Chairman on all matters within the SEC’s jurisdiction. The General Counsel office also represents the SEC in all civil and administrative litigation matters.

    The Chief Accountant, as part of the Office of the Chief Accountant, is also appointed by the Chairman and advises the SEC on all accounting and auditing matters, including approving PCAOB auditing rules. In addition, the Office of the Chief Accountant assists the SEC in establishing accounting principles and overseeing the private sector accounting standards-setting process. The Chief Accountant liaises with FASB, which in turn establishes GAAP. It also liaises with the PCAOB, the International Accounting Standards Board and the American Institute of Certified Public Accountants.

    The Office of Investor Education and Advocacy responds to questions, complaints and suggestions from the public. The Office also publishes information and holds seminars and other outreach educational programs to educate the public on the securities laws and their rights.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    House Passes Creating Financial Prosperity For Business And Investors Act

    Tuesday, February 7, 2017, 8:07 AM [General]
    3.7 (1 Ratings)

    On December 5, 2016, the U.S. House of Representatives passed the Creating Financial Prosperity for Businesses and Investors Act (H.R. 6427) (the “Act”), continuing the House’s pro-business legislation spree. The Act is actually comprised of six smaller acts, all of which have previously been considered and passed by the House in 2016. The Act is comprised of: (i) Title I: The Small Business Capital Formation Enhancement Act (H.R. 4168); (ii) Title II: The SEC Small Business Advocate Act (H.R. 3784); (iii) Title III: The Supporting American’s Innovators Act (H.R. 4854); (iv) Title IV: The Fix Crowdfunding Act (H.R. 4855); (v) Title V: The Fair Investment Opportunities for Professionals Experts Act (H.R. 2187); and (vi) Title VI: The U.S. Territories Investor Protection Act (H.R. 5322).

    Title I: The Small Business Capital Formation Enhancement Act (H.R. 4168)

    This Act requires the SEC to respond to the findings and recommendations of the SEC’s annual Government-Business Forum on Small Business Capital Formation, which forum I attended in 2016 and found very interesting and productive. The Act would require the SEC to respond to recommendations by issuing a public statement evaluating the finding or recommendation and indicating what action the SEC intends to take as a result. Currently, the SEC is required to hold the annual Government-Business Forum to review the current status of problems and programs related to small business capital formation. The SEC is also required to prepare summaries of the Forum and any findings made by the Forum but is not required to comment or take a position on same.

    The SEC is already legally required to review and respond to findings of the Investor Advisory Committee but currently is not required to take this additional step related to the small business forum. As with the Investor Advisory Committee, the SEC’s action on recommendations could be simply to review the matter further, conduct a study, consider or propose a rule change, or the SEC could state that it is taking no action at all. The Act does not limit, direct or require any particular response, just that a response be made. This Act was originally passed as part of the Financial Choice Act.

    Title II: The SEC Small Business Advocate Act (H.R. 3784)

    This legislation establishes the Office for Small Business Capital Formation within the SEC to assist small businesses and their investors in resolving problems and to provide a forum to identify issues and propose changes to statutes, regulations and rules to benefit small businesses and their investors and generally facilitate capital formation. The SEC would be required to review and respond to any recommendations by the committee. However, like similar rules, including the proposed H.R. 4168, the SEC’s response could be to review the matter further, conduct a study, consider or propose a rule change, or the SEC could state that it is taking no action at all.

    The new Office for Small Business Capital Formation would be responsible for planning and holding the annual Government-Business Forum on Small Business Capital Formation. The new office would also analyze the effects of new and proposed rules on small businesses. The purpose would be to create an office in the SEC that would advocate for rule and policy changes on behalf of small businesses and their investors.  In order to give the office independence in its role, the office would provide its reports directly to various committees of Congress without review or oversight by the SEC itself.

    The legislation also establishes the SEC Small Business Advisory Committee to provide the SEC with advice on rules, regulations and policies related to capital formation, securities trading, public reporting and corporate governance for emerging, privately held and smaller reporting companies with less than $250 million in public float. This new SEC Small Business Advisory Committee would essentially replace the voluntarily created SEC Advisory Committee on Small and Emerging Companies. The Advisory Committee on Small and Emerging Companies was last renewed by the SEC Chair and Commissioners on September 24, 2015 for a period of two years and accordingly, unless renewed again, will dissolve later this year.

    As a reminder, the Advisory Committee on Small and Emerging Companies was organized by the SEC to provide advice on SEC rules, regulations and policies regarding “its mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation” as related to “(i) capital raising by emerging privately held small businesses and publicly traded companies with less than $250 million in public market capitalization; (ii) trading in the securities of such businesses and companies; and (iii) public reporting and corporate governance requirements to which such businesses and companies are subject.”

    The SEC would have the same mandate to review and respond to recommendations by the new committee. My prior blog discussing this act is HERE.

    Title III: The Supporting America’s Innovators Act (H.R. 4854)

    This legislation creates a new small “qualifying venture capital fund” under the Investment Company Act of 1940 and increases the current registration exemption under Section 3(c)(1) of the Investment Company Act to allow for up to 250 investors in such qualifying venture capital fund. Currently Section 3(c)(1) of the Investment Company Act exempts pooled funds, such as hedge funds, from registering under the Act as long as they have fewer than 100 equity holders. There is no limit on the amount of invested capital in a fund to qualify for the 3(c)(1) exemption. H.R. 4854 would create a new class of pooled fund, called a “qualifying venture capital fund,” which would be defined as any venture fund with $10 million or less of invested capital and allow up to 250 investors in such fund.

    Title IV: The Fix Crowdfunding Act (H.R. 4855)

    From the time the SEC published the final Regulation Crowdfunding rules and regulations on October 30, 2015, the regulatory framework has met with wide criticism, including that the process is too costly considering the $1 million raise limitation. The most commonly repeated issues with the current structure include: (i) the $1 million annual minimum is too low to adequately meet small business funding needs; (ii) companies cannot “test the waters” in advance of or at the initial stages of an offering; and (iii) companies cannot currently use a Special Purchase Vehicle (SPV) in a crowdfunding offering. The Fix Crowdfunding Act only addresses one of these three complaints.

    The Fix Crowdfunding Act would also allow for the use of special purpose vehicles (SPV’s) in the fundraising process. The Act would allow for SPV’s by amending the Investment Company Act of 1940 to add a newly defined “crowdfunding vehicle” which is limited by its organizational and charter documents to one that acquires, holds and disposes of securities of a single issuing company in one or more crowdfunding transactions conducted under Section 4(a)(6) and Regulation Crowdfunding.

    In addition, the newly defined “crowdfunding vehicle” would need to meet the following requirements: (i) have only one class of securities; (ii) neither the vehicle nor any person associated with the vehicle can receive any compensation in connection with the purchase, holding or sale of securities of the investment target; (iii) the vehicle can only purchase securities issued in a transaction under Section 4(a)(6) and Regulation Crowdfunding; (iv) both the crowdfunding vehicle and investment target must remain current in their respective disclosure obligations under Regulation Crowdfunding; and (v) the crowdfunding vehicle must be advised by either a state or federally registered investment advisor (RIA).

    crowdfunding SPV will be exempt from the current per-investor investment limits under Regulation Crowdfunding (i.e., (a) if either annual income or net worth is less than $100,000, the investment limitation is the greater of $2,000 or 5% of the lesser of annual income or net worth; or (b) if both annual income and net worth are equal to or greater than $100,000, the investment limitation is 10% of the lesser of annual income or net worth). However, investments into the crowdfunding SPV would remain subject to the per-investor limitations.

    It is thought that an SPV structure helps protect the smaller investors by allowing them to pool funds together with larger investors in an entity that offers separate protections than the offering company itself. The SPV structure has become prevalent in Rule 506(c) offerings where the company is utilizing a platform to advertise and attract investors. However, under Rule 506(c), which is limited to accredited investors, it has not been problematic for SPV’s to stay within the current exemptions to registration under the Investment Company Act of 1940 by having fewer than 100 investors.

    The Fix Crowdfunding Act also modifies the current exemption from the Exchange Act Section 12(g) registration requirements under Regulation Crowdfunding. The Exchange Act and Regulation Crowdfunding currently provide that security holders who acquired their securities in a crowdfunded offering are not counted for purposes of the registration threshold, provided that the issuer is current in its required annual reports and has engaged a transfer agent for its securities. The Fix Crowdfunding Act would remove the annual report and transfer agent conditions if the issuer had a public float for the last semi-annual period of less than $75 million, or if the public float is zero for such period annual revenues of less than $50 million in the most recently completed fiscal year.

    One of my colleagues in the world of corporate finance, Dara Albright, wrote a great letter to Representative McHenry supporting the Fix Crowdfunding Act. Ms. Albright’s letter can be read HERE.

    Title V: The Fair Investment Opportunities for Professionals Experts Act (H.R. 2187)

    This legislation amends the definition of “accredited investor” under the Securities Act of 1933 to include: (i) persons whose individual net worth, together with their spouse, exceeds $1,000,000, adjusted for inflation, excluding the value of their primary residence; (ii) persons with an individual income greater than $200,000, or $300,000 for joint income, both adjusted for inflation; (iii) any person currently licensed or registered as a broker or investment adviser by the SEC, FINRA, an equivalent SRO, or state securities regulator; and (iv) persons whom the SEC determines have demonstrable education or job experience to qualify as having professional subject-matter knowledge related to a particular investment (FINRA or an equivalent self-regulatory organization must verify the person’s education or job experience).

    My prior blog discussing this act is HERE.

    Title VI: The U.S. Territories Investor Protection Act (H.R. 5322)

    This legislation amends the Investment Company Act to terminate an exemption for investment companies located in Puerto Rico, the Virgin Islands and other territories of the United States. Currently an exemption applies for entities located in these territories that limits sales of securities to residents of the particular territory in which they operate. The Act contains a three-year phase-in safe harbor.

    Other 2016 House Legislation

    Earlier in 2016 I wrote about: (i) H.R. 1675 – the Capital Markets Improvement Act of 2016, which has 5 smaller acts embedded therein; (ii) H.R. 3784, establishing the Advocate for Small Business Capital Formation and Small Business Capital Formation Advisory Committee within the SEC; and (iii) H.R. 2187, proposing an amendment to the definition of accredited investor. See my blog HERE.

    In early July, the House passed H.R. 2995, an appropriations bill for the federal budget for the fiscal year beginning October 1.  No further action has been taken. The 259-page bill, which is described as “making appropriations for financing services and general government for the fiscal year ending September 30, 2017, and for other purposes” (“House Appropriation Bill”), contains numerous provisions reducing or eliminating funding for key aspects of SEC enforcement and regulatory provisions. My discussion on this provision can be read as part of my blog on the Financial Choice Act, a link to which is below.

    On September 8, 2016, the House passed the Accelerating Access to Capital Act. Unlike many of the House bills that passed in 2016, this one gained national attention, including an article in the Wall Street Journal. The Accelerating Access to Capital Act is actually comprised of three bills: (i) H.R. 4850 – the Micro Offering Safe Harbor Act; (ii) H.R. 4852 – the Private Placement Improvement Act; and (iii) H.R. 2357 – the Accelerating Access to Capital Act. See my blog HERE.

    On September 13, 2016, the House passed the Financial Choice Act, which is an extreme anti-regulation act that would dramatically change the current SEC regime and dismantle a large portion of the Dodd-Frank Act. Read my blog on the Financial Choice Act HERE.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    SEC Issues New C&DI On Abbreviated Debt Tender And Debt Exchange Offers

    Tuesday, January 31, 2017, 8:21 AM [General]
    0 (0 Ratings)

    The SEC has been issuing a slew of new Compliance and Disclosure Interpretations (“C&DI”) on numerous topics in the past few months. On November 18, 2016, the SEC issued seven new C&DI providing guidance on tender offers in general as well as on abbreviated debt tender and debt exchange offers, known as the Five-Day Tender Offer. The guidance related to the Five-Day Tender Offer clarifies a previously issued January 2015 no-action letter on the subject. As I have not written on the subject of tender offers previously, I include a very high-level summary of tender offers in general and together with specific discussion on the new C&DI.

    What Is a Tender Offer?

    A tender offer is not statutorily defined, but from a high level is a broad solicitation made by a company or a third party to purchase a substantial portion of the outstanding debt or equity of a company. A tender offer is set for a specific period of time and at a specific price. The purchase offer can be for cash or for equity in either the same or another company (an exchange offer). Where a tender offer is an exchange offer, the offeror must either register the securities being offered for exchange or there must be an available exemption from registration such as under Section 4(a)(2) or Rule 506 of Regulation D.

    A tender offer must be made at a fixed price and can include conditions to a closing, such as receiving a certain minimum percentage of accepted tenders. If the person making the tender may own more than 5% of the company’s securities after the tender offer is completed, they must file a Schedule TO with the SEC, including certain delineated disclosures.

    Where a tender offer is being made by a company or its management, it is often in association with a going private transaction. Where it is being made by a third party, it is generally for the purpose of acquiring control over the target company and can be either a friendly or hostile takeover attempt.

    As mentioned, a tender offer is not statutorily defined but rather can be applied to a broad array of transactions that include the change of ownership of securities. Over the years, a judicially established eight-factor test is used to determine whether the tender offer rules have been implicated and need to be complied with. In particular, in Wellman v. Dickinson, 475 F. Supp. 783 (S.D,N.Y. 1979) the court listed the following eight factors in determining whether a transaction is a tender offer:

    1. An active and widespread solicitation of public shareholders for the shares of a company is made;
    2. A solicitation is made for a substantial percentage of the company’s securities;
    3. The offer to purchase is made at a premium to prevailing market price;
    4. The terms of the offer are firm rather than negotiable;
    5. The offer is contingent on the tender of a fixed number of minimum shares and may be subject to a fixed maximum;
    6. The offer is open for a limited period of time;
    7. The offeree is subjected to pressure to sell their securities; and
    8. Public announcements are made regarding the offer.

    Not all factors need be present for a transaction to be considered a tender offer, but rather all facts and circumstances must be considered. The SEC has historically focused on whether an investor is being asked to make an investment decision and whether there is pressure to sell. Once it is determined that a transaction involves a tender offer, the tender offer rules and regulations must be complied with.

    Tender offers are governed by the Williams Act, which added Sections 13(d), 13(e), 14(d) and 14(e) to the Securities Exchange Act of 1934. The principle behind the regulatory framework is to ensure proper disclosures to, and equal treatment of, all offerees and to prevent unfair selling pressure. Section 14(d) and Regulation 14D govern tender offers by third parties. Section 14(d) and Regulation 14D set forth the SEC filing requirements and information that must be delivered to those being solicited in association with a tender offer, including the requirement to file a Schedule TO with the SEC.

    As with any disclosure document relating to the solicitation or sale of securities, a Schedule TO is comprehensive and includes:

    (i)  A summary term sheet;

    (ii)  Information about the issuer;

    (iii)  The identity and background of the filing persons;

    (iv)  The terms of the transactions;

    (v)  Any past contacts, transactions and negotiations involving the filing person and the target company and offerees;

    (vi)  The purposes of the transactions and plans or proposals;

    (vii)  The source and amount of funds or other consideration for the tender offer;

    (viii)  Interests in the subject securities, including direct and indirect ownership;

    (ix)  Persons/assets retained, employed, compensated or used in the tender process.  In its November 18, 2016 C&DI the SEC clarifies that the terms of employment and compensation to financial advisors engaged by an issuer’s board or independent committee to provide financial advice, would need to be disclosed in this section even if such financial advisor is not soliciting or making recommendations to shareholders.  In addition, another of the new C&DI clarifies the specificity needed related to compensatory disclosure for financial advisors that are active in soliciting or making recommendations to shareholders.  Such disclosure may not always need to include the exact dollar figure of the fees paid or payable to the financial advisor but must include a detailed discussion of the types of fees (such as independence fees, sale or success fees, advisory fees, discretionary fees, bonuses, etc.), when and how such fees will be paid, including any contingencies and any other information that would reasonably be material for a shareholder to judge the merits and objectivity of the financial advisor’s recommendations.

    (x)  Financial Statements;

    (xi)  Additional information as appropriate; and

    (xii)  Exhibits.

    Section 14(e) and Regulation 14E contain the antifraud provisions associated with tender offers and apply to all tender offers, whether by insiders or third parties, for cash or an exchange, and whether full or mini offers. Section 14(e) prohibits an offeror from making any untrue statement of a material fact, or omitting to state any material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. Section 14(e) also prohibits any fraudulent, deceptive or manipulative acts in connection with a tender offer.

    Regulation 14E contains certain requirements designed to prevent fraudulent conduct and must be complied with in all tender offers. Regulation 14E requires:

    (i) A tender offer must be open for at least 20 days;

    (ii) The percentage of the class of securities being sought and the consideration offered cannot change unless the offer remains open for at least an additional 10 business days following notice of such change;

    (iii) The offeror must promptly make full payment, or return the tendered securities, upon the termination, withdrawal or closing of the offering.  Prompt payment is generally considered to be within 3 days;

    (iv)  Public notice must be made of any extension of an offer, and such notice must disclose the amount of any securities already tendered.  Public notice is usually made via a press release in a widely disseminated publication such as the Wall Street Journal;

    (v)  The company subject to a tender offer must disclose its position on the tender offer (for, against, or expresses no opinion) to its shareholders. The disclosure must be made within 10 days of notice of the tender offer being provided to the target shareholders;

    (vi)  All parties must be mindful of insider trading rules and avoid trading when in possession of information related to the launch of a tender offer.  Where the company is tendering for its own shares, it must be extra careful and cannot conduct a tender while in possession of insider information;

    (vii)  Tendering persons must have a net long position in the subject security at the time of tendering and at the end of the proration period in connection with partial tender offers (and not engage in short-tendering and hedged tendering in connection with their tenders); and

    (viii)  Subject to certain exceptions, no covered person can purchase or arrange to purchase any of the subject securities from the time of announcement of the tender until its completion through closing, termination or expiration.  A covered person is broadly defined to include the offeror and its affiliates, including its dealer-manager and advisors.

    Section 13(e) governs the information delivery requirements for the repurchase of equity securities by an issuer company and its affiliates. Rule 13e-4 sets forth disclosure, filing and procedural requirements for a company tendering for its own equity securities, including the filing of a Schedule TO with the SEC. An equity security is broadly defined and includes securities convertible into equity securities such as options, warrants and convertible debt but does not include non-convertible debt. Companies often use the SEC no-action letter process for relief as to whether a particular security is an equity security invoking Rule 13e-4 or similar enough to debt as to not require compliance with the rule.

    In addition to an initial Schedule TO, which must be filed with the SEC on the commencement date of the offer, under Rule 13e-4, a company must file any of its written communications related to the tender offer, an amendment to the Schedule TO reporting any material changes, and a final amendment to the Schedule TO reporting the results of the tender offer. Moreover, a company must further disseminate information through either mail or widely distributed newspaper publications or both.

    Where a company or affiliate is the offeror, Rule 13e-4 requires that such offeror allow a tendering shareholder the right to withdraw their tender at any time while the tender offer remains open. The tender offer must be made to all holders of the subject class of securities and where an offer is oversubscribed, the company must accept tenders up to its disclosed limit on a pro rata basis.

    There are several exemptions from the Section 13(e) and Rule 13e-4 requirements. Also, careful consideration should be given when a company embarks on a stock repurchase program under Rule 10b-18 to ensure that such program does not actually result in a tender offer necessitating compliance with the tender offer rules. For a summary of Rule 10b-18, see my blog HERE.

    Where the target company remains public, upon acquiring 5% or more of the outstanding securities, Section 13(d) requires that a Schedule 13D must be filed by the acquirer. For more information on Schedule 13D disclosure requirements, see my blog HERE.

    Mini-tenders

    Many provisions of the Williams Act, including Sections 13(d), 13(e), 14(d) and Regulation 14D do not have to be complied with for a tender offer that will result in less than 5% ownership (“mini-tender”); however, the antifraud provisions still apply. Mini-tenders are really just a bid for the purchase of stock, usually through a purchase order with a broker, which bid must remain open for a minimum of 20 days. A mini-tender bidder must make payment in full promptly upon a closing. Bidders in a mini-tender do not have to file documents with the SEC or provide the delineated disclosures required by a full tender offer.

    Key differences between a mini-tender and full tender offer include: (i) a mini-tender is not required to file a Schedule TO with the SEC, and thus a target company is not given the opportunity to file a responsive Schedule 14d-9; (ii) a mini-tender bidder is not required to treat all offerees equally; (iii) a mini-tender bidder is not required to carve back offerees on a pro rata basis if oversubscribed; (iv) a mini-tender is not required to allow investors to change their minds and withdraw shares prior to a full closing; (v) a mini-tender deadline can be extended indefinitely.

    Mini-tenders tend to be at or below market price, whereas full tenders tend to be at a premium to market price, reflecting the increased value in obtaining a control position over the target company. As a result of the lack of investor protections, and that mini-tenders are generally below market price, they are considered predatory and have a high level of negative stigma. The primary criticism against a mini-tender is that target shareholders are likely confused about the distinctions between the mini and full tender and do not realize that the offer is below market, irrevocable, and does not require equal and fair treatment for all shareholders, although all of this information would be required to be disclosed under the still applicable tender offer antifraud provisions.

    There does not appear to be a rational reason as to why an investor in a liquid market would choose to sell to a bidder below market price unless there is confusion as to the terms of the offer being presented. The SEC even has a warning page on mini-tenders urging investors to carefully review all terms and conditions. Where a market is not liquid, a mini-tender could be a viable exit strategy, though in practice, mini-tenders are largely launched for the purchase of larger, highly liquid securities.

    Abbreviated Debt Tender Offers (Five Business Day Tender Offer)

    As discussed above, Section 14(e) of the Exchange Act and Regulation 14E set forth certain requirements for all tender offers designed to prevent fraud and manipulative acts and practices. One of those requirements is that a tender offer be open for a minimum of 20 business days and remain open for at least an additional 10 business days after notice of any change in the consideration offered.

    Beginning in 1986, the SEC began issuing a series of no-action letters providing relief from the 20-day rule for certain non-convertible, investment-grade debt tender offers. The SEC recognized that tender offers in a straight debt transaction are often effectuated to refinance debt at a lower interest rate or to extend looming maturity dates. The tender is often at a small premium to the prevailing market or pay-off price and does not include any equity upside or kicker considerations. All parties to a debt tender offer are motivated to move quickly and without the equity considerations; the SEC recognized that the same investor protections are not necessary as in an equity tender offer.

    The SEC relief generally required that the debt tender remain open for 7-10 days. In January 2015, in response to a request from numerous top industry law firms, the SEC granted further no-action relief establishing a Five Business Day Tender Offer for non-convertible debt securities, which meets certain delineated terms and conditions.

    The conditions to a Five Business Day Tender Offer include:

    (i)  Immediate Widespread Dissemination – the debt tender must begin with immediate (prior to 12:00 noon on the first day of the offer) widespread dissemination of the offer including by press release and Form 8-K containing certain disclosures and including a hyperlink to an Internet address where the offeree can effectuate the tender.  The November 18, 2016 C&DI clarifies that a foreign private issuer may satisfy this requirement by filing a Form 6-K instead of Form 8-K.

    (ii) Be made for non-convertible debt securities only;

    (iii) Only be initiated by the issuer of the debt securities or a direct or indirect wholly owned subsidiary or parent company;

    (iv) Be made solely for cash consideration or an exchange for Qualified Debt Securities.  Qualified Debt Securities means non-convertible debt securities that are identical in all material respects (including issuer, guarantor, collateral, priority, and terms and covenants) to the debt securities that are the subject of the tender offer except for the maturity date, interest payment and record dates, redemption provisions and interest rate, and provided further that to be Qualified Debt Securities, all interest payments must be solely in cash (no equity) and the weighted average life to maturity must be longer than the debt that is subject to the offer.

    (v) Be open to all record and beneficial holders of the debt securities, provided that in an exchange offer, the exchange offer can be limited to Qualified Institutional Buyers as defined in Rule 144A and/or non-U.S. persons as defined in Regulation S under the Securities Act, and as long as all other record and beneficial holders are offered cash with a value reasonably equal to the value of the exchange securities being offered to those qualified to receive such exchange.  The November 18, 2016 C&DI clarifies that although the offer has to be made equally to all holders, like other tender offers, it can have conditions to closing such as that a minimum number of debt holders accept the tender.

    (vi) The November 18, 2016 C&DI clarifies that where the offer includes an exchange of Qualified Debt Securities to Qualified Institutional Buyers as defined in Rule 144A of the Securities Act, the cash consideration to the other record holders can be calculated by reference to a benchmark as long as it is the same benchmark used to calculate the value of the Qualified Debt Securities.

    (vii) Not be made in connection with the solicitation of consents to amend the outstanding debt securities;

    (viii) Not be made if a default exists with respect to the subject tender, or any other, material credit agreement to which the company is a party;

    (ix) Not be made if at the time of the offer the company is in bankruptcy or insolvency proceedings;

    (x) Not be financed with the proceeds of a Senior Indebtedness;

    (xi) Permits tender procedures through a certificate as long as the actual debt security is delivered within 2 business days of closing;

    (xii) Provide for certain withdrawal rights until the expiration of the offer or any extension;

    (xiii) Provide that consideration will be promptly paid for the tendered debt securities; and

    (xiv) Not be made in connection with a change of control, merger or other extraordinary transaction involving the company and not be commenced within ten business days of an announcement of the purchase, sale or transfer of a material subsidiary or amount of assets.  The November 18, 2016 C&DI clarifies that a company could announce a plan to conduct a Five Business Day Tender Offer but could not commence the offer until the ten-business-day period had passed.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

    Follow me on FacebookLinkedInYouTubeGoogle+Pinterest and Twitter.

    Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

    This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

    © Legal & Compliance, LLC 2017

    The SEC Has Issued New C&DI Guidance On Regulation A+

    Tuesday, January 24, 2017, 8:18 AM [General]
    0 (0 Ratings)

    On November 17, 2016, the SEC Division of Corporation Finance issued three new Compliance and Disclosure Interpretations (C&DI) to provide guidance related to Regulation A/A+. Since the new Regulation A+ came into effect on June 19, 2015, its use has continued to steadily increase.  In my practice alone I am noticing a large uptick in broker-dealer-placed Regulation A+ offerings, and recently, institutional investor interest.

    Following a discussion on the CD&I guidance, I have included some interesting statistics, practice tips, and thoughts on Regulation A+, and a refresher summary of the Regulation A+ rules.

    New CD&I Guidance

    In the first of the new CD&I, the SEC has clarified that where a company seeks to qualify an additional class of securities via post-qualification amendment to a previously qualified Form 1-A, Item 4 of Part I, which requires “Summary Information Regarding the Offering and Other Current or Proposed Offerings,” need only include information related to the new class of securities seeking qualification.

    In a reminder that Regulation A+ is technically an exemption from the registration requirements under Section 5 of the Securities Act, the SEC confirms that under Item 6 of Part I, requiring disclosure of unregistered securities issued or sold within the prior year, a company must disclose all securities issued or sold pursuant to Regulation A in the prior year.

    New question 182.13 clarifies the calculation of a 20% change in the price of the offering to determine the necessity of filing a post-qualification amendment which would be subject to SEC comment and review, versus a post-qualification supplement which would be effective immediately upon filing. In particular, Rule 253(b) provides that a change in price of no more than 20% of the qualified offering price, may be made by supplement and not require an amendment. An amendment is subject to a whole new review and comment period and must be declared qualified by the SEC. A supplement, on the other hand, is simply added to the already qualified Form 1-A, becoming qualified itself upon filing. The 20% variance can be either an increase or decrease in the offering price, but if an increase, cannot result in an offering above the respective thresholds for Tier 1 ($20 million) or Tier 2 ($50 million).

    In the third CD&I, the SEC confirms that companies using Form 1-A benefit from Section 71003 of the FAST Act.  In particular, the SEC interprets Section 71003 of the FAST Act to allow an emerging growth company (EGC) to omit financial information for historical periods if it reasonably believes that those financial statements will not be required at the time of the qualification of the Form 1-A, provided that the company file a pre-qualification amendment such that the Form 1-A qualified by the SEC contains all required up-to-date financial information. Interestingly, Section 71003 only refers to Forms S-1 and F-1 but the SEC has determined to allow an EGC the same benefit when filing a Form 1-A. Since financial statements for a new period would result in a material amendment to the Form 1-A, potential investors would need to be provided with a copy of such updated amendment prior to accepting funds and completing the sale of securities.

    Regulation A+ Statistics; Practice Tip; Further Thoughts

    Regulation A+ Statistics

    According to The Vintage Group, through November 30, 2016, there were a total of 165 Regulation A+ filings, 16 of which were subsequently withdrawn.  Of these, 130 have been qualified by the SEC, with the average time to receive qualification being 101 days.  Some companies have filed multiple Regulation A+ offerings. The 130 qualified offerings represent 94 different companies.  Thirty eight (38) of the 94 companies completed Tier 1 offerings and 56 completed Tier 2. The average offering size of Tier 1 offerings is $9.5 million and $28.9 million for Tier 2 offerings. As reported by The Vintage Group, the average cost of a Tier 1 offering has been $120,000 and of a Tier 2 offering has been $920,000.  I am assuming this includes marketing costs.

    Regulation A/A+ – Private or Public Offering?

    Although a complete discussion is beyond this blog, the legal nuance that Regulation A/A+ is an “exempt” offering under Section 5 has caused confusion and the need for careful thought by practitioners and the SEC staff alike. So far, it appears that Regulation A/A+ is treated as a public offering in all respects except as related to the applicability of Securities Act Section 11 liability.  Section 11 of the Securities Act provides a private cause of action in favor of purchasers of securities, against those involved in filing a false or misleading public offering registration statement. Any purchaser of securities, regardless of whether they bought directly from the company or secondarily in the aftermarket, can sue a company, its underwriters, and experts for damages where a false or misleading registration statement had been filed related to those securities.  Regulation A is not considered a public offering for purposes of Section 11 liability.

    Securities Act Section 12, which provides a private cause of action by a purchaser of securities directly against the seller of those securities, specifically imposes liability on any person offering or selling securities under Regulation A. The general antifraud provisions under Section 17 of the Securities Act, which apply to private and public offerings, of course apply to Regulation A/A+.

    When considering integration, in addition to the discussion in the summary below, the SEC has now confirmed that a Regulation A/A+ offering can rely on Rule 152 such that a completed exempt offering, such as under Rule 506(b), will not integrate with a subsequent Regulation A filing. Under Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the issuer subsequently makes a public offering. The SEC has also issued guidance that Rule 152 applies to prevent integration between a completed 506(b) offering and a subsequent 506(c) offering, indicating that the important factor in the Rule 152 analysis is the ability to publicly solicit regardless of the filing of a registration statement.

    However, Regulation A/A+ is definitely used as a going public transaction and, as such, is very much a public offering. Securities sold in a Regulation A+ offering are not restricted and therefore are available to be used to create a secondary market and trade such as on the OTC Markets or a national exchange.

    Tier 2 issuers that have used the S-1 format for their Form 1-A filing will be permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements. A Form 8-A is a simple registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC.  Upon filing a Form 8-A, the issuer will become subject to the full Exchange Act reporting obligations, and the scaled-down Regulation A+ reporting will automatically be suspended. With the filing of a Form 8-A, the issuer can apply to trade on a national exchange.

    This marks a huge change and opportunity for companies that wish to go public directly and raise less than $50 million. An initial or direct public offering on Form S-1 does not preempt state law. By choosing a Tier 2 Regulation A+ offering followed by a Form 8-A, the issuer can achieve the same result – i.e., become a fully reporting trading public company, without the added time and expense of complying with state blue sky laws.

    Also, effective July 10, 2016, the OTCQB amended their rules to allow a Tier 2 reporting entity to qualify to apply for and trade on the OTCQB; however, unless the issuer has filed a Form 8-A or Form 10, they will not be considered “subject to the Exchange Act reporting requirements” for purposes of benefiting from the shorter 6-month Rule 144 holding period.

    Practice Tip

    In light of the fact that Regulation A/A+ is technically an exemption from the Section 5 registration requirements, it might not be included in contractual provisions related to registration rights. In particular, the typical language in a piggyback or demand registration right provision creates the possibility that the company could do an offering under Regulation A/A+ and take the position that the shareholder is not entitled to participate under the registration rights provision because it did not do a “registration.” As an advocate of avoiding ambiguity, practitioners should carefully review these contractual provisions and add language to include a Form 1-A under Regulation A/A+ if the intent is to be sure that the shareholder is covered.  Likewise, if the intent is to exclude Regulation A/A+ offerings from the registration rights, that exclusion should be added to the language to avoid any dispute.

    Further Thoughts

    Tier 2 offerings in particular present a much-needed opportunity for smaller companies to go public without the added time and expense of state blue sky compliance but with added investor qualifications. Tier 2 offerings preempt state blue sky laws. To compromise with opponents to the state blue sky preemption, the SEC included investor qualifications for Tier 2 offerings. In particular, Tier 2 offerings have a limitation on the amount of securities non-accredited investors can purchase of no more than 10% of the greater of the investor’s annual income or net worth.

    However, as companies continue to learn about Regulation A+, many still do not understand that it is just a legal process with added benefits, such as active advertising and solicitation including through social media. There is no pool of funds to tap into; it is not a line of credit; it is just another process that companies can use to reach out to the investing public and try to convince them to buy stock in, or lend money to, their company.

    As such, companies seeking to complete a Regulation A/A+ offering must consider the economics and real-world aspects of the offering.  Key to a successful offering are a reasonable valuation and rational use of proceeds. A company should demonstrate value through its financial statements and disclosures and establish that the intended use of proceeds will result in moving the business plan ahead and hopefully create increased value for the shareholders. Investors want to know that their money is being put to the highest and best use to result in return on investment. Repayment of debt or cashing out of series A investors is generally not a saleable use of proceeds. Looking for $50 million for 30% of a pre-revenue start-up just isn’t going to do it!  The company has to be prepared to show you, the investor, that it has a plan, management, vision and ability to carry out the business proposition it is selling.

    From the investors’ perspective, these are risky investments by nature. Offering materials should be scrutinized. The SEC does not pass on the merits of an offering – only its disclosures. The fact that the registration statement has been qualified by the SEC has no bearing on the risk associated with or quality of the investment. That is for each investor to decide, either alone or with advisors, and requires really reviewing the offering materials and considering the viability of the business proposal. At the end of the day, the success of the business, and therefore the potential return on investment, requires the company to perform – to sell their widgets, keep ahead of the competition, and manage their business and growth successfully.

    Refresher:  The Final Rules – Summary of Regulation A+

                    History of Regulation A+; Goals and Purpose

    The original Regulation A was adopted in the 1960s as a sort of short-form registration process with the SEC. However, since Regulation A still required a lengthy and expensive state review and qualification process, known as “blue sky registration,” over the years it was used less and less until it was barely used at all. Literally years would go by with only a small handful, if any, Regulation A filings; however, the law remained on the books and the authors and advocates behind the JOBS Act saw potential to use Regulation A to democratize the IPO process by implementing some changes.

    Without going down a rabbit hole on “blue sky laws” from a high level, in addition to the federal government, every state has its own set of securities laws and securities regulators. Unless the federal law specifically “pre-empts” or overrules state law, every offer and sale of securities must comply with both the federal and the state law. There are 54 U.S. jurisdictions, including all 50 states and 4 territories, each with separate and different securities laws. Even in states that have identical statutes, the state’s interpretations or focus under the statutes differs greatly. On top of that, each state has a filing fee and a review process that takes time to deal with.  It’s difficult, time-consuming and expensive.

    Title IV of the JOBS Act that was signed into law on April 5, 2012, set out the framework for the new Regulation A and required the SEC to adopt specific rules to implement the new provisions, which it did. The new rules quickly became known as Regulation A+ and came into effect on June 19, 2015.  Regulation A+ has a path to pre-empt state law, and allows for unlimited marketing – as long as certain disclaimers are used, and of course, subject to antifraud laws – you have to be truthful.

    As with all of the provisions in the JOBS Act, Regulation A+ was created to provide a less expensive and easier method for smaller companies to access capital. One of the biggest impediments to reaching potential investors has always been strict prohibitions against marketing offerings – whether the offerings were registered with the SEC or under a private placement. Historically, companies wishing to sell securities could only contact people they know and have a business relationship with – which was a small group for anyone. Even the marketing of non-Regulation A registered offerings and IPO’s have been strictly limited. The use of a broker-dealer would be helpful because a company could then access that broker’s client base and contacts, but broker-dealers are not always interested in helping smaller companies raise money.

    The JOBS Act made the most dramatic changes to the landscape for the marketing and selling of both private and public offerings since the enactment of the Securities Act of 1933, one of which is the overhaul of Regulation A.

    In essence, Regulation A+ has given companies a mechanism and tools to empower them to reach out to the masses in completing an IPO and has concurrently put protections in place to prevent an abuse of the process.

    Specifics of Regulation A+ – How Does it Work?

    The new Regulation A+ actually divided Regulation A into two offering paths, referred to as Tier 1 and Tier 2. Tier 1 remains substantially the same as the old pre-JOBS Act Regulation A but with a higher offering limit and allowing more marketing. The old Regulation A was limited to offerings of $5 million or less in any 12-month period. The new Tier 1 has been increased to up to $20 million. Since Tier 1 does not pre-empt state law, it is really only useful for offerings that are limited to one but no more than a small handful of states.  Tier 1 does not require the company to include audited financial statements and does not have any ongoing SEC reporting requirements.  Tier 1 will likely not be used for a going public transaction.

    On June 23, 2015, the SEC updated its Division of Corporation Finance C&DI to provide guidance related to Regulation A/A+ by publishing 11 new questions and answers and deleting 2 from its forms C&DI which are no longer applicable under the new rules.  This summary includes that guidance.

    Both Tier I and Tier 2 offerings have minimum basic requirements, including issuer eligibility provisions and disclosure requirements.  In addition to the affiliate resale restrictions, resales of securities by selling security holders are limited to no more than 30% of a total particular offering for all Regulation A+ offerings. For offerings up to $20 million, an issuer can elect to proceed under either Tier 1 or Tier 2. Both tiers will allow companies to submit draft offering statements for non-public SEC staff review before a public filing, permit continued use of solicitation materials after the filing of the offering statement and use the EDGAR system for filings.

    Tier 2 allows a company to file a registration statement with the SEC to raise up $50 million in a 12-month period. Tier 2 pre-empts state blue sky law. The registration statement is a little less lengthy than a traditional IPO registration, the SEC review process is a little shorter, and a company can market in a way that it cannot with a traditional IPO. The trade-off is that Regulation A+ is limited in dollar amount to $50 million, there are specific company eligibility requirements, and there are investor qualifications and associated per-investor investment limits.

    Also, the process is not inexpensive. Attorneys’ fees, accounting and audit fees and, of course, marketing expenses all add up. A company needs to be organized and ready before engaging in any offering process, and especially so for a registered offering process. Even though a lot of attorneys, myself included, will provide a flat fee for the process, that flat fee is dependent on certain assumptions, including the level of organization of the company.

    Eligibility Requirements

    Regulation A+ will be available to companies organized and operating in the United States and Canada. The following issuers will not be eligible for a Regulation A+ offering:

    • Companies currently subject to the reporting requirements of the Exchange Act;
    • Investment companies registered or required to be registered under the Investment Company Act of 1940, including BDC’s;
    • Blank check companies, which are companies that have no specific business plan or purpose or whose business plan and purpose is to engage in a merger or acquisition with an unidentified target; however, shell companies are not prohibited, unless such shell company is also a blank check company. A shell company is a company that has no or nominal operations; and either no or nominal assets, assets consisting of cash and cash equivalents; or assets consisting of any amount of cash and cash equivalents and nominal other assets.  Accordingly, a start-up business or minimally operating business may utilize Regulation A+;
    • Issuers seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights;
    • Issuers that have been subject to any order of the SEC under Exchange Act Section 12(j) denying, suspending or revoking registration, entered within the past five years;
    • Issuers that became subject to Exchange Act reporting requirements, such as through a Tier 2 offering, and did not file required ongoing reports during the preceding two years; and
    • Issuers that are disqualified under the “bad actor” rules and, in particular, Rule 262 of Regulation A+.

    A company will be considered to have its “principal place of business” in the U.S. or Canada for purposes of determination of Regulation A/A+ eligibility if its officers, partners, or managers primarily direct, control and coordinate the company’s activities from the U.S. or Canada, even if the actual operations are located outside those countries.

    A company that was once subject to the Exchange Act reporting obligations but suspended such reporting obligations by filing a Form 15 is eligible to utilize Regulation A/A+. A company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to rely on Regulation A/A+. A wholly owned subsidiary of an Exchange Act reporting company parent is eligible to complete a Regulation A/A+ offering as long as the parent reporting company is not a guarantor or co-issuer of the securities being issued.

    Unfortunately, in what is clearly a legislative miss, companies that are already publicly reporting – that is, are already required to file reports with the SEC – are not eligible. OTC Markets has petitioned the SEC to eliminate this eligibility criteria, and pretty well everyone in the industry supports a change here, but for now it remains. For more information on the OTC Markets petition and discussion of the reasons that a change is needed in this regard, see my blog HERE.

    Regulation A/A+ can be used for business combination transactions, but is not available for shelf SPAC’s (special purpose acquisition companies).

    Eligible Securities

    The final rule limits securities that may be issued under Regulation A+ to equity securities, including common and preferred stock and options, warrants and other rights convertible into equity securities, debt securities and debt securities convertible or exchangeable into equity securities, including guarantees. If convertible securities or warrants are offered that may be exchanged or exercised within one year of the offering statement qualification (or at the option of the issuer), the underlying securities must also be qualified and the value of such securities must be included in the aggregate offering value.  Accordingly, the underlying securities will be included in determining the offering limits of $20 million and $50 million, respectively.

    Asset-backed securities are not allowed to be offered in a Regulation A+ offering. REIT’s and other real estate-based entities may use Regulation A+ and provide information similar to that required by a Form S-11 registration statement.

    General Solicitation and Advertising; Solicitation of Interest (“Testing the Waters”)

    Other than the investment limits, anyone can invest in a Regulation A+ offering, but of course, they have to know about it first – which brings us to marketing. All Regulation A+ offerings will be allowed to engage in general solicitation and advertising, at least according to the SEC. However, Tier 1 offerings will be required to review and comply with applicable state law related to such solicitation and advertising, including any prohibitions related to same.

    Regulation A+ allows for pre-qualification solicitations of interest in an offering, commonly referred to as “testing the waters.”  Issuers can use “test the waters” solicitation materials both before and after the initial filing of the offering statement and by any means. A company can use social media, internet websites, television and radio, print advertisements, and anything they can think of. Marketing can be oral or in writing, with the only limitations being certain disclaimers and truth. Although a company can and should be creative in its presentation of information, there are laws in place with serious ramifications requiring truth in the marketing process. Investors should watch for red flags such as clearly unprovable statements of grandeur, obvious hype or any statement that sounds too good to be true – as they are probably are just that.

    When using “test the waters” or pre-qualification marketing, a company must specifically state whether a registration statement has been filed and if one has been filed, provide a link to the filing. Also, the company must specifically state that no money is being solicited and that none will be accepted until after the registration statement is qualified with the SEC. Any investor indications of interest during this time are 100% non-binding – on both parties. That is, the potential investor has no obligation to make an investment when or if the offering is qualified with the SEC and the company has no obligation to file a registration statement or if one is already filed, to pursue its qualification. In fact, a company may decide that based on a poor response to its marketing efforts, it will abandon the offering until some future date or forever.

    As such, solicitation material used before qualification of the offering circular must contain a legend stating that no money or consideration is being solicited and none will be accepted, no offer to buy securities can be accepted and any offer can be withdrawn before qualification, and a person’s indication of interest does not create a commitment to purchase securities.

    For a complete discussion of Regulation A/A+ “test the waters” rules and requirements, see my blog HERE.

    All solicitation material must be submitted to the SEC as an Exhibit under Part III of Form 1-A.  This is a significant difference from S-1 filers, who are not required to file “test the waters” communications with the SEC.

    A company can use Twitter and other social media that limit the number of characters in a communication, to test the waters as long as the company provides a hyperlink to the required disclaimers. In particular, a company can use a hyperlink to satisfy the disclosure and disclaimer requirements in Rule 255 as long as (i) the electronic communication is distributed through a platform that has technological limitations on the number of characters or amount of text that may be included in the communication; (ii) including the entire disclaimer and other required disclosures would exceed the character limit on that particular platform; and (iii) the communication has an active hyperlink to the required disclaimers and disclosures and, where possible, prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.

    Unlike the “testing of the waters” by emerging growth companies that are limited to QIB’s and accredited investors, a Regulation A+ company could reach out to retail and non-accredited investors. After the public filing but before SEC qualification, a company may use its preliminary offering circular to make written offers.

    Of course, all “test the waters” materials are subject to the antifraud provisions of federal securities laws.

    Like registered offerings, ongoing regularly released factual business communications, not including information related to the offering of securities, will be allowed and will not be considered solicitation materials.

    Continuous or Delayed Offerings

    Continuous or delayed offerings (a form of a shelf offering) will be allowed if (i) they commence within two days of the offering statement qualification date, (ii) are made on a continuous basis, (iii) will continue for a period of in excess of thirty days following the offering statement qualification date, and (iv) at the time of qualification are reasonably expected to be completed within two years of the qualification date.

    Issuers that are current in their Tier 2 reporting requirements may make continuous or delayed offerings for up to three years following qualification of the offering statement. Moreover, in the event a new qualification statement is filed for a new Regulation A+ offering, unsold securities from a prior qualification may be included, thus carrying those unsold securities forward for an additional three-year period.

    Continuous or delayed offerings are available for all securities qualified in the offering, including securities underlying convertible securities, securities offered by an affiliate or other selling security holder, and securities pledged as collateral.

    Additional Tier 2 Requirements; Ability to List on an Exchange

    In addition to the basic requirements that will apply to all Regulation A+ offerings, Tier 2 offerings will also require: (i) audited financial statements (though I note that state blue sky laws almost unilaterally require audited financial statements, so this federal distinction may not have a great deal of practical effect); (ii) ongoing reporting requirements including the filing of an annual and semiannual report and periodic reports for current information (new Forms 1-K, 1-SA and 1-U, respectively); and (iii) a limitation on the number of securities non-accredited investors can purchase to no more than 10% of the greater of the investor’s annual income or net worth.

    It is the obligation of the issuer to notify investors of these limitations. Issuers may rely on the investors’ representations as to accreditation (no separate verification is required) and investment limits.

    This third provision provides additional purchaser suitability standards and the Regulation A+ definition of “qualified purchaser” for purposes of allowing state law pre-emption. During the proposed rule comment process many groups, including certain U.S. senators, were very vocal about the lack of suitability standards of a “qualified purchaser.” Many pushed to align the definition of “qualified purchaser” to the current definition of “accredited investor.” The SEC’s final rules offer a compromise by adding suitability requirements to non-accredited investors to establish quantitative standards for non-accredited investors.

    The new rules allow Tier 2 issuers to file a Form 8-A to be filed concurrently with a Form 1-A, to register under the Exchange Act, and the immediate application to a national securities exchange. Where the securities will be listed on a national exchange, the accredited investor limitations will not apply.

    Although the ongoing reporting requirements will be substantially similar in form to a current annual report on Form 10-K, the issuer will not be considered to be subject to the Exchange Act reporting requirements. Accordingly, such issuer would not qualify for a listing on the OTCQB or national exchange, but would also not be disqualified from engaging in future Regulation A+ offerings.

    Tier 2 issuers that have used the S-1 format for their Form 1-A filing will be permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements. A Form 8-A is a simple (generally 2-page) registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC (generally through an S-1). The Form 8-A will only be allowed if it is filed concurrently with the Form 1-A. That is, an issuer could not qualify a Form 1-A, wait a year or two, then file a Form 8-A.  In that case, they would need to use the longer Form 10.

    Upon filing a Form 8-A, the issuer will become subject to the full Exchange Act reporting obligations, and the scaled-down Regulation A+ reporting will automatically be suspended.

    Integration

    The final rules include a limited-integration safe harbor such that offers and sales under Regulation A+ will not be integrated with prior or subsequent offers or sales that are (i) registered under the Securities Act; (ii) made under compensation plans relying on Rule 701; (iii) made under other employee benefit plans; (iv) made in reliance on Regulation S; (v) made more than six months following the completion of the Regulation A+ offering; or (vi) made in crowdfunding offerings exempt under Section 4(a)(6) of the Securities Act (Title III crowdfunding, which is not yet legal).

    In the absence of a clear exemption from integration, issuers would turn to the five-factor test. In particular, the determination of whether the Regulation A+ offering would integrate with one or more other offerings is a question of fact depending on the particular circumstances at hand. In particular, the following factors need to be considered in determining whether multiple offerings are integrated: (i) are the offerings part of a single plan of financing; (ii) do the offerings involve issuance of the same class of securities; (iii) are the offerings made at or about the same time; (iv) is the same type of consideration to be received; and (v) are the offerings made for the same general purpose.

    Offering Statement – General

    A company intending to conduct a Regulation A+ offering must file an offering statement with, and have it qualified by, the SEC.  The offering statement will be filed with the SEC using the EDGAR database filing system. Prospective investors must be provided with the filed pre-qualified offering statement 48 hours prior to a sale of securities. Once qualified, investors must be provided with the final qualified offering circular. Like current registration statements, Regulation A+ rules provide for an “access equals delivery” model, whereby access to the offering statement via the Internet and EDGAR database will satisfy the delivery requirements.

    There are no filing fees for the process. The offering statement will be reviewed much like an S-1 registration statement and declared “qualified” by the SEC with an issuance of a “notice of qualification.” The notice of qualification can be requested or will be issued by the SEC upon clearing comments. The SEC has indicated that reviewers will be assigned filings based on industry group.

    Issuers may file offering circular updates after qualification in lieu of post-qualification amendments similar to the filing of a post-effective prospectus for an S-1. To qualify additional securities, a post-qualification amendment must be used.

    Offering Statement – Non-Public (Confidential) Submission

    As is allowed for emerging growth companies, the rules permit an issuer to submit an offering statement to the SEC on a confidential basis. However, only companies that have not previously sold securities under a Regulation A or a Securities Act registration statement may submit the offering confidentially.

    Confidential submissions will allow a Regulation A+ issuer to get the process under way while soliciting interest of investors using the “test the waters” provisions without negative publicity risk if it alters or withdraws the offering before qualification by the SEC. However, the confidential filing, SEC comments, and all amendments must be publicly filed as exhibits to the offering statement at least 21 calendar days before qualification. When an S-1 is filed confidentially, the offering materials need be filed 21 calendar days before effectiveness, but the SEC comment letters and responses are not required to be filed.  This, together with the requirement to file “test the waters” communications, are significant increased pre-offering disclosure requirements for Regulation A+ offerings.

    Confidential submissions to the SEC are completed by choosing a “confidential” setting in the EDGAR system. To satisfy the requirement to publicly file the previous confidential information, the company can file all prior confidential information as an exhibit to its non-confidential filing, or change the setting in the EDGAR system on its prior filings, from “confidential” to “public.” In the event the company chooses to change its EDGAR setting to “public,” it would not have to re-file all prior confidential material as an exhibit to a new filing.

    If a company wants to keep certain information confidential, even after the required time to make such information public, it will need to submit two confidential requests, one as part of the registration review process and one when prior confidential filings are made public.  During the confidential Form 1-A review process, the company should submit a request under Rule 83 in the same manner it would during a typical review of a registered offering. Once the company is required to make the prior filings “public” (21 days prior to qualification), the company would make a new request for confidential treatment under Rule 406 in the same manner other confidential treatment requests are submitted. In particular, for a confidential treatment request under Rules 83 and 406, a company must submit a redacted version of the document via EDGAR with the appropriate legend indicating that confidential treatment has been requested.  Concurrently, the company must submit a full, unredacted paper version of the document to the SEC using the ordinary confidential treatment procedure (such filings are submitted via a designated fax line to a designated person to maintain confidentiality).

    Offering Statement – Form and Content

    The rules require use of new modified Form 1-A.  Form 1-A consists of three parts: Part I – Notification, Part II – Offering Circular, and Part III – Exhibits. Part I calls for certain basic information about the issuer and the offering, and is primarily designed to confirm and determine eligibility for the use of the Form and a Regulation A offering in general.  Part I will include issuer information; issuer eligibility; application of the bad actor disqualification and disclosure; jurisdictions in which securities are to be offered; and unregistered securities issued or sold within one year.

    Part II is the offering circular and is similar to the prospectus in a registration statement. Part II requires disclosure of basic information about the issuer and the offering; material risks; dilution; plan of distribution; use of proceeds; description of the business operations; description of physical properties; discussion of financial condition and results of operations (MD&A); identification of and disclosure about directors, executives and key employees; executive compensation; beneficial security ownership information; related party transactions; description of offered securities; and two years of financial information.

    The required information in Part 2 of Form 1-A is scaled down from the requirements in Regulation S-K applicable to Form S-1.  Issuers can complete Part 2 by either following the Form 1-A disclosure format or by including the information required by Part I of Form S-1 or Form S-11 as applicable. Note that only issuers that elect to use the S-1 or S-11 format will be able to subsequently file an 8-A to register and become subject to the Exchange Act reporting requirements.

    Moreover, issuers that had previously completed a Regulation A offering and had thereafter been subject to and filed reports with the SEC under Tier 2 could incorporate by reference from these reports in future Regulation A offering circulars.

    Form 1-A requires two years of financial information. All financial statements for Regulation A offerings must be prepared in accordance with GAAP. Financial statements of a Tier 1 issuer are not required to be audited unless the issuer has obtained an audit for other purposes. Audited financial statements are required for Tier 2 issuers. Audit firms for Tier 2 issuers must be independent and PCAOB-registered. An offering statement cannot be qualified if the date of the balance sheet is more than nine months prior to the date of qualification.

    A recently created entity may choose to provide a balance sheet as of its inception date as long as that inception date is within nine months before the date of filing or qualification and the date of filing or qualification is not more than three months after the entity reached its first annual balance sheet date. The date of the most recent balance sheet determines which fiscal years, or period since existence for recently created entities, the statements of comprehensive income, cash flows and changes in stockholders’ equity must cover. When the balance sheet is dated as of inception, the statements of comprehensive income, cash flows and changes in stockholders’ equity will not be applicable.

    Part III requires an exhibits index and a description of exhibits required to be filed as part of the offering statement.

    Offering Price

    All Regulation A+ offerings must be at a fixed price. That is, no offerings may be made “at the market” or for other than a fixed price.

    Ongoing Reporting

    Both Tier I and Tier 2 issuers must file summary information after the termination or completion of a Regulation A+ offering. A Tier I company will need to file certain information about the Regulation A offering, including information on sales and the termination of sales, on a new Form 1-Z exit report, no later than 30 calendar days after termination or completion of the offering. Tier I issuers will not have any ongoing reporting requirements.

    Tier 2 companies are also required to file certain offering termination information and would have the choice of using Form 1-Z or including the information in their first annual report on new Form 1-K.  In addition to the offering summary information, Tier 2 issuers are required to submit ongoing reports including: an annual report on Form 1-K, semiannual reports on Form 1-SA, current event reports on Form 1-U and notice of suspension of ongoing reporting obligations on Form 1-Z (all filed electronically on EDGAR).

    The ongoing reporting for Tier 2 companies is less demanding than the reporting requirements under the Securities Exchange Act. In particular, there are fewer 1-K items and only the semiannual 1-SA (rather than the quarterly 10-Q) and fewer events triggering Form 1-U (compared to Form 8-K). The SEC anticipates that companies would use their Regulation A+ offering circular as the groundwork for the ongoing reports, and they may incorporate by reference text from previous filings.

    The annual Form 1-K must be filed within 120 calendar days of fiscal year-end. The semiannual Form 1-SA must be filed within 90 calendar days after the end of the semiannual period. The current report on Form 1-U must be filed within 4 business days of the triggering event.  Successor issuers, such as following a merger, must continue to file the ongoing reports.

    The rules also provide for a suspension of reporting obligations for a Regulation A+ issuer that desires to suspend or terminate its reporting requirements. Termination is accomplished by filing a Form 1-Z and requires that a company be current over stated periods in its reporting, have fewer than 300 shareholders of record, and have no ongoing offers or sales in reliance on a Regulation A+ offering statement. Of course, a company may file a Form 10 to become subject to the full Exchange Act reporting requirements.

    The ongoing reports will qualify as the type of information a market maker would need to support the filing of a 15c2-11 application. Accordingly, an issuer that completes a Tier 2 offering could proceed to engage a market maker to file a 15c2-11 application and trade on the OTC Pink tier of the OTC Markets. Such issuer, however, would not be deemed to be “subject to the Exchange Act reporting requirements” to support a listing on the OTCQB or OTCQX levels of the OTC Markets.

    Freely Tradable Securities

    Securities issued to non-affiliates in a Regulation A+ offering will be freely tradable. Securities issued to affiliates in a Regulation A+ offering will be subject to the affiliate resale restrictions in Rule 144, except for a holding period. The same resale restrictions for affiliates and non-affiliates apply to securities registered in a Form S-1.

    However, since neither Tier 1 nor Tier 2 Regulation A+ issuers are subject to the SEC reporting requirements, the shareholders of issuers would not be able to rely on Rule 144 for prior shell companies. Moreover, the Tier 2 reports do not constitute reasonably current public information for the support of the use of Rule 144 for affiliates in the future.

    Treatment under Section 12(g)

    Exchange Act Section 12(g) requires that an issuer with total assets exceeding $10,000,000 and a class of equity securities held of record by either 2,000 persons or 500 persons who are not accredited register with the SEC, generally on Form 10, and thereafter be subject to the reporting requirements of the Exchange Act.

    The new Regulation A+ exempts securities in a Tier 2 offering from the Section 12(g) registration requirements if the issuer meets all of the following conditions:

    • The issuer utilizes an SEC-registered transfer agent. Such transfer agent must be engaged at the time the company is relying on the exemption from Exchange Act registration;
    • The issuer remains subject to the Tier 2 reporting obligations;
    • The issuer is current in its Tier 2 reporting obligations, including the filing of an annual and semiannual report; and
    • The issuer has a public float of less than $75 million as of the last business day of its most recently completed semiannual period or, if no public float, had annual revenues of less than $50 million as of its most recently completed fiscal year-end.

    Moreover, even if a Tier 2 issuer is not eligible for the Section 12(g) registration exemption as set forth above, that issuer will have a two-year transition period prior to being required to having to register under the Exchange Act, as long as during that two-year period, the issuer continues to file all of its ongoing Regulation A+ reports in a timely manner with the SEC.

    State Law Pre-emption

    Tier I offerings do not pre-empt state law and remain subject to state blue sky qualification. The SEC, in its press release, encouraged issuers to utilize the NASAA-coordinated review program for Tier I blue sky compliance. For a brief discussion on the NASAA-coordinated review program, see my blog HERE. However, in practice, I do not think this program is being utilized; rather, when Tier 1 is being used, it is limited to just one or a very small number of states and the company is completing the blue sky process independently.

    Tier 2 offerings are not subject to state law review or qualification – i.e., state law is pre-empted.  State securities registration and exemption requirements are only pre-empted as to the Tier 2 offering and securities purchased pursuant to the qualified Tier 2 for 1-A offering circular. Subsequent resales of such securities are not pre-empted.

    The text of Title IV of the JOBS Act provides, among other items, a provision that certain Regulation A securities should be treated as covered securities for purposes of the National Securities Markets Improvement Act (NSMIA). Federally covered securities are exempt from state registration and overview. Regulation A provides that “(b) Treatment as covered securities for purposes of NSMIA… Section 18(b)(4) of the Securities Act of 1933… is further amended by inserting… (D) a rule or regulation adopted pursuant to section 3(b)(2) and such security is (i) offered or sold on a national securities exchange; or (ii) offered or sold to a qualified purchaser, as defined by the Commission pursuant to paragraph (3) with respect to that purchase or sale.” For a discussion on the NSMIA, see my blogs HERE and HERE.

    The definition of “qualified purchaser” became the subject of debate and contention during the comment process associated with the initially issued Regulation A+ proposed rules. In a compromise, the SEC has imposed a limit on Tier 2 offerings such that the amount of securities non-accredited investors can purchase is to be no more than 10% of the greater of the investor’s annual income or net worth. In light of this investor suitability limitation, the SEC has then defined a “qualified purchaser” as any purchaser in a Tier 2 offering.

    Federally covered securities, including Tier 2 offered securities, are still subject to state antifraud provisions, and states may require certain notice filings. In addition, as with any covered securities, states maintain the authority to investigate and prosecute fraudulent securities transactions.

    Broker-dealer Placement

    Broker-dealers acting as placement or marketing agent will be required to comply with FINRA Rule 5110 regarding filing of underwriting compensation, for a Regulation A+ offering.

    The Author

    Laura Anthony, Esq.
    Founding Partner
    Legal & Compliance, LLC
    Corporate, Securities and Going Public Attorneys
    LAnthony@LegalAndCompliance.com

    Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

    Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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