SEC Proposes Shortening Trade Settlement
Posted by Securities Attorney Laura Anthony | December 27, 2016 Tags: , , ,

On September 28, 2016, the SEC proposed a rule amendment to shorten the standard broker-initiated trade settlement cycle from three business days from the trade date (T+3) to two business days (T+2). The change is designed to help reduce risks, including credit, market and liquidity risks, associated with unsettled transactions in the marketplace. Outgoing SEC Chair, Mary Jo White was quoted as saying that the change “is an important step to the SEC’s ongoing efforts to enhance the resiliency and efficiency of the U.S. clearance and settlement system.” I have previously written about the clearance and settlement process for U.S. capital markets, which can be reviewed HERE.

Background

DTC provides the depository and book entry settlement services for substantially all equity trading in the US. Over $600 billion in transactions are completed at DTC each day. Although all similar, the exact clearance and settlement process depends on the type of security being traded (stock, bond, etc.), the form the security takes (paper or electronic), how the security is owned (registered or beneficial), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved.

All securities trades involve a legally binding contract. In general, the “clearing” of those trades involves implementing the terms of the contract, including ensuring processing to the correct buyer and seller in the correct security and correct amount and at the correct price and date. This process is effectuated electronically.

“Settlement” refers to the fulfillment of the contract through the exchanging of funds and delivery of the securities. In 1993, Exchange Act Rule 15c6-1 was adopted requiring that settlement occur three business days after the trade date, commonly referred to as “T+3.” Delivery occurs electronically by making an adjusting book entry as to entitlement. One brokerage account is debited and another is credited at the DTC level and a corresponding entry is made at each brokerage firm involved in the transaction. DTC only tracks the securities entitlement of its participating members, while the individual brokerage firms track the holdings in their customer accounts. Technology, of course, plays an important role in the process and ability to efficiently manage settlements.

There may be two brokerage firms between DTC and the customer account holder. Brokerage firms that are direct members with DTC are referred to as “clearing brokers.” Many brokerage firms make arrangements with these DTC members (clearing brokers) to clear the securities on their behalf. Those firms are referred to as “introducing brokers.” A clearing broker will directly route an order through the national exchange or OTC Market, whereas an introducing broker will route the order to a clearing broker, who then routes the order through the exchange or OTC Market.

The Dodd-Frank Act added a definition of, and responsibilities associated with, a “financial market utility” or FMU. Clearing brokers are FMU’s. FMU’s provide the actual functions associated with clearing trades through the DTC system. As part of that process, a division of DTC, the National Securities Clearing Corporation (“NSCC”), becomes the buyer and seller of each contract, netting out and settling all brokerage transactions each day, making one adjusting entry per day. The net entry debits or credits the brokerage firm’s account as necessary. When one of the counterparties in the process does not fulfill its settlement obligations by delivering the securities, there is a “failure to deliver.” Overall, failures to deliver are less than 1% of all transactions.

Likewise, a cash account is maintained for each brokerage firm, which is netted and debited and/or credited each day. These accounts can be in the billions. Clearing firms can either settle each day or carry their open account forward until the next business day. Because all transactions are netted out, 99% of all trade obligations do not require the exchange of money, which helps reduce some risk. NSCC’s role in this process is referred to as a central counterparty or CCP. This process is continuous.

Looking at the process from the top down, the CCP carries the risk that the clearing firm (or FMU) will not have the financial resources to perform its obligations. In turn, the clearing firms have risks from their customers, including introducing brokers, who in turn ultimately have risks from the individual account holders. The risks are compounded by changing values of the securities being traded, during the settlement process. The faster a trade settles, the lower the cumulative risk at each level of the process.

This is a very simplified high-level description of the process. Technically, the roles of DTC and its subsidiaries, CEDE and NSCC, as well as clearing agencies and introducing brokers involve a complex set of regulations, with different definitions, obligations and roles for the different hats the entities wear depending on the type of security being traded (stock, bond, etc.), how the security is owned (registered or beneficial), the form the security takes (paper or electronic), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved (retail or institutional). For those interested, the SEC rule release provides an excellent in-depth review of the settlement and clearing process.

Exchange Act Rule 15c6-1

Exchange Act Rule 15c6-1 prohibits a broker-dealer from effecting or entering into a contract for the purchase or sale of a security, subject to certain exemptions, that provides for the payment of the funds or delivery of the securities later than the third business day after the contract (i.e., trade) date unless expressly agreed upon by both parties at the time of the transaction. Exempted securities include government and municipal securities, commercial paper, limited partnership units that are not listed on an exchange or automated quotations system (OTC Markets), and sales in a firm commitment underwritten offering that are priced after market close.

Firm commitment offerings can rely on an extended T+4 settlement cycle. It is unclear what impact the proposed rule change will have on this exception. The SEC rule release has sought comment on the question.

One of the SEC’s roles is to enhance the resilience and efficiency of the clearance and settlement process such that the system itself does not add to, but rather subtracts from, the risks associated with trading in securities. The SEC is proposing to amend Rule 15a6-1(a) to shorten the settlement cycle to T+2. The SEC believes this change will reduce various risks in the marketplace, including: (i) the credit risk that one party will be unable to fulfill its delivery obligations (of either cash or the securities) on the settlement date; and (ii) the market risk that the value of the securities will change between the trade and settlement such as to result in a loss to one of the parties.

To drill down further on the summary of the settlement and clearing process described in the background section of this blog, the following is a high-level description of what happens following the execution of a trade. First, when the trade is submitted to an exchange or alternative trading system (such as OTC Markets), it is matched with a counterparty. That is, a buy order is electronically matched to a sell order. As long as there is a match, the trade is locked in and sent to NSCC.

On the trade date (T), NSCC validates the trade data and communicates receipt of the transaction. At that moment the parties are legally committed to complete the trade. At midnight on the first day (T+1), NSCC substitutes itself as the legal buyer and legal seller. Technically, the first buy/sell contract is replaced by two new contracts, one between NSCC and the buyer and the other between NSCC and the seller. On the second day (T+2), NSCC issues a trade summary report to its members which summarizes all securities and cash to be settled that day, and shows the net positions for each. NSCC also sends an electronic instruction to DTC to process the net security and cash settlements. Finally, on the third day (T+3), DTC process the electronic settlement by transferring cash and securities between the broker-dealer accounts and the broker-dealers, in turn, put the securities and/or cash in their customer accounts.

Although institutional trading is similar, there are unique aspects and there can be additional participants. For example, an institution may have a custodian of its securities in addition to its broker, may use a matching provider and may avail itself of different netting and settling processes within the brokerage and DTC systems. Although the detailed process may differ, ultimately both retail and institutional trades currently fully settle in the T+3 timeline.

As mentioned, the length of the settlement cycle impacts the exposure to credit, market and liquidity risks for the participants. The participants, including NSCC, take measures to reduce these risks, including by requiring funds to be kept on deposit by clearing and brokerage firms effecting such participants’ liquidity. Even then, however, all participants are exposed to market risk during the settlement process, including a decline in value of the traded securities and the risk that such decline could exceed the broker’s capital deposit or result in a failure to deliver.

A reduction in risks would reduce the necessity to mitigate such risk, including reducing the funds that must be kept on deposit by participants. It is undisputed that reducing the settlement cycle reduces these risks.

Also, obviously if funds are tied up for three days pending a settlement of a transaction, whether you are the retail investor or clearing agency, there is a lack of available liquidity to participate in other transactions during that time.

The reduction of the settlement cycle to T+2 will also assist in aligning global clearing of securities as many markets including the United Kingdom and many European countries are already on the T+2 schedule.

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 Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Download our mobile app at iTunes.

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 2016

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SEC Eliminates The “Tandy Letter”
Posted by Securities Attorney Laura Anthony | December 20, 2016 Tags: , , , , , , , ,

ABA Journal’s 10th Annual Blawg 100

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On October 5, 2016, the SEC Division of Corporation Finance (CorpFin) announced that, effective immediately, it would no longer require companies to include “Tandy” letter representations in comment letter response or registration acceleration requests addressed to the SEC.

Background

Beginning in the 1970s the SEC began to require an affirmative statement from the company acknowledging that the company cannot use the SEC’s comment process as a defense in any securities-related litigation.  Named after the first company required to provide the affirmations, this language is referred to as a “Tandy” letter.  By 2004 the “Tandy” letter was required in all comment letter responses to the SEC as well as registration acceleration requests.  The “Tandy” portion of a response was required to be agreed to by the company itself, so if the response letter was on attorney letterhead, a signature line was required to be included for the company or the company could submit a separate letter.  The Tandy language for an Exchange Act filing was as follows:

The company acknowledges that:

the company is responsible for the adequacy and accuracy of the disclosure in the filing;

staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and

the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

Tandy language for a Securities Act registration statement was as follows:

The company acknowledges the following:

Should the commission or the staff, acting pursuant to delegated authority, declare the filing effective, it does not preclude the commission from taking any action with respect to the filing;

the action of the Commission or the staff, acting pursuant to the delegated authority, in declaring the filing effective does not relieve the company from its full responsibility for adequacy and accuracy of the disclosure in the filing; and

the company may not assert staff comments and the declaration of effectiveness as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

The End of Tandy Letters

On October 5, 2016, CorpFin announced that it would no longer require companies to include “Tandy” letter representations in comment letter response or registration acceleration requests addressed to the SEC.  In its release the SEC notes that “while it remains true that companies are responsible for the accuracy and adequacy of the disclosure in their filings, the staff does not believe that it is necessary for them to make the affirmative representations in their filing review correspondence.”

Rather than require “Tandy” representations, the SEC will now include the following statement in all comment letters:

We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff.

The end of the “Tandy” letter requirements was effective on October 5, 2016.  As the requirement was a staff policy and not a rule, no rule release or other formal publication from the SEC was required.

Although the written “Tandy” letter is no longer required, the meaning of the words has not changed.  That is, regardless of the writing, a company may still not assert staff comments, the clearing of such comments, or the fact of an SEC review of any filing, as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

As a securities attorney it is important to educate clients on what the comment and review process means, and does not mean.  The purpose of a review by CorpFin is to ensure compliance with the disclosure requirements under the federal securities laws, including Regulation S-K and Regulation S-X, and to enhance such disclosures as to each particular issuer.  CorpFin will also be cognizant of the antifraud provisions of the federal securities laws and may refer a matter to the Division of Enforcement where material concerns arise over the adequacy and accuracy of reported information or other securities law violations, including violations of the Section 5 registration requirements.  CorpFin has an Office of Enforcement Liason in that regard.

However, neither the SEC nor CorpFin evaluates the merits of any transaction or makes an assessment or determination as to whether a transaction or company is appropriate for any particular investor or the marketplace as a whole.  The purpose of a review is to ensure compliance with the disclosure requirements of the securities laws.  In that regard, CorpFin may ask for increased risk factors and clear disclosure related to the merits or lack thereof of a particular transaction, but they do not assess or comment upon those merits beyond the disclosure.

As the “Tandy” Letter made clear to companies, they are still responsible for the contents of their filings, and both private litigation and enforcement proceedings may be brought regardless of an SEC review.  With the end of the “Tandy” Letter, it is incumbent upon SEC counsel to remind clients of their obligations and the role of the SEC.

Further Reading

For further reading on the comment and review process, see my blog HERE .

Also, I have been keeping on ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative.  The following is a recap of such initiative and proposed and actual changes.

On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC.  The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list.  In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format.  See my blog HERE on the Item 601 proposed changes.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K.  Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance.  See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments).  See my blog on the proposed rule change HERE.

That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016.  See my two-part blog on the S-K Concept Release HERE and HERE.

As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE).  The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates.  See my blog HERE.

As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies.  For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K.  For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law.  The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K.  The current Regulation S-K and S-X Amendments are part of this initiative.  In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information.  See my blog 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 Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Download our mobile app at iTunes.

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 2016

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SEC Cracks Down On Failure To File 8-K For Financing Activities; An Overview Of Form 8-K
Posted by Securities Attorney Laura Anthony | December 13, 2016

Introduction and Background

On September 26, 2016, and again on the 27th, the SEC brought enforcement actions against issuers for the failure to file 8-K’s associated with corporate finance transactions and in particular PIPE transactions involving the issuance of convertible debt, preferred equity, warrants and similar instruments. Prior to the release of these two actions, I have been hearing rumors in the industry that the SEC has issued “hundreds” of subpoenas (likely an exaggeration) to issuers related to PIPE transactions and in particular to determine 8-K filing deficiencies. Using this as a backdrop, this blog will also address Form 8-K filing requirements in general.

Back in August 2014, the SEC did a similar sweep related to 8-K filing failures associated with 3(a)(10) transactions. See my blog HERE for a discussion of those actions and 3(a)(10) proceedings in general. The 8-K filing deficiency actions were a precursor to a larger SEC investigation on 3(a)(10) transactions themselves which culminated in two well-known enforcement actions against active 3(a)(10) participants (the Ironridge companies and IBC Funds) and resulted in a chill on the 3(a)(10) activity in the industry as a whole. 3(a)(10) actions continue today but the volume of transactions has dramatically reduced and the attention to due diligence, detail and reporting requirements has likewise increased.

The SEC rarely takes enforcement action or expends time or resources on investigating the failure to file an 8-K.  When such issues arise, it is usually in connection with a routine review of a company’s SEC reports or as part of the comment and review process associated with the filing of a registration statement.  All reports filed with the SEC are subject to SEC review and comment and the Sarbanes-Oxley Act requires that the SEC undertake some level of review of every reporting company at least once every three years.

As was the case with the SEC’s investigation into 3(a)(10) transactions, it is my belief that the SEC is reviewing the PIPE industry as a whole and in particular the process, procedure and effects associated with convertible instruments.  The majority of these transactions involve the issuance of convertible notes which then convert into common stock following a holding period in reliance on Rule 144 and Section 3(a)(9) of the Securities Act of 1933 (“Securities Act”).  For a review of the use of Section 3(a)(9) related to convertible notes, see my blog HERE.  Any convertible instrument can be used in the same manner, such as preferred stock and warrants.

The use of convertible instruments in PIPE transactions is perfectly legal and acceptable.  However, like any other aspect of the securities marketplace, it can be abused.  My belief is that the SEC is using the investigation into the failure to file 8-K’s in association with these transactions to assist in a larger investigation into related fraud and other violations.  If a company is failing to file an initial 8-K for the transaction and subsequent 8-K’s to report the issuance of securities upon a conversion, there may also be other issues and violations.  Examples of abusive or improper activity could include: (i) backdating of notes or failure to provide the funding associated with the note; (ii) improper undisclosed affiliations between investors and the company or its officers and directors; (iii) manipulative trading practices; (iv) improper stock promotion (although a topic for another blog, stock promotion itself is not illegal as long as, among other things, the information disseminated is true and accurate, there is no pump-and-dump activity, and Securities Act Section 17(b) disclosures are used); or (v) trading on insider information.

During a conversion process, the number of issued and outstanding shares of common stock can increase dramatically, causing dilution to existing shareholders and a decrease in stock price from large selling pressure.  In an action against Connexus Corporation, the SEC noted that the unreported issuances of securities increased the amount of common stock by more than 600% from the last reported number.

The ability of an investor to convert and trade responsibly makes the difference between a successful financing relationship with the investment community and one that can cause long-term damage to a company.

To be clear, I do not think there is anything inherently wrong, illegal or improper with these corporate finance transactions. The exact same structure is used for PIPE investments in companies big and small, whether traded on the OTC Markets, NASDAQ or NYSE. However, smaller companies often do not have the volume and liquidity to bear the effect of sudden enormous selling pressure. Larger companies are not immune to issues, though. Nuanced provisions negotiated in these convertible derivative instruments can be problematic as well, such as the recent use of the Black-Scholes put option in warrants (see Vapor Corp. as a prime example).

When considering a PIPE transaction, companies are often presented with numerous term sheets and investors to choose from. The terms will only vary slightly and many investors will match terms from a competitor. In choosing a transaction it is incumbent upon the company to conduct due diligence on the investor, including their reputation in the industry and trading history associated with other investments and conversions.

Form 8-K Filing Requirements Related to PIPE Transactions

A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) must file reports with the SEC. For an overview of these reporting requirements, see my blog HERE. For a running update on the state of proposed changes to the specific reporting requirements in Regulations S-K and S-X, see my summary at the end of this blog.

Exchange Act Rule 13a-11 requires the filing of current reports on Form 8-K. Subject to certain exceptions, a Form 8-K must be filed within four (4) business days after the occurrence of the event being disclosed. No extension is available for an 8-K. Companies file this report with the SEC to announce major or extraordinary events that shareholders should know about, including entry into material agreements and the issuance of unregistered securities. It is these two specific events that are implicated with the entry into corporate financing transactions, and subsequent conversions of convertible instruments such as convertible debt or preferred stock.

In particular, Item 1.01 of Form 8-K requires that a company report if it has entered into “a material definitive agreement not made in the ordinary course of business…” Under Item 1.01, the company must report: (a) the date of the agreement; (b) the parties to the agreement; (c) a description of any material relationship between the parties, other than the reported agreement; and (d) a brief description of the terms and conditions of the agreement.

Item 3.02 of Form 8-K requires that a company report the unregistered sale of securities. Under Item 3.02, the company must report the unregistered sale of securities if the aggregate sales/issuances of securities constitutes 5% or more of the outstanding securities since the last reported number filed with the SEC. The report must disclose: (a) the date, title and amount of securities sold; (b) the nature and amount of consideration paid; (c) the Securities Act exemption being relied upon and a brief explanation of the facts relied upon to support the exemption; and (d) where applicable, the terms of conversion or exercise.

The Item 3.02 filing requirement is triggered if the volume threshold of the underlying equity securities issuable upon conversion is exceeded, even if those issuances are structured as takedowns over time, such as where a convertible note is partially converted in multiple tranches. That is, if it is foreseeable that the total number of securities issued in a corporate finance transaction will exceed 5% of the current outstanding securities, an Item 3.02 8-K must be filed. Likewise, where the actual conversions and issuances of common stock exceed the 5% threshold in aggregate, an 8-K is required.

The Item 3.02 8-K must disclose all unregistered issuances that resulted in increasing the total outstanding securities by the 5% threshold.  As a simple example, if a company reports 10,000,000 shares of outstanding common stock in its 10-Q and then proceeds to issue 100,000 shares each in a series of conversions, as soon as the total outstanding reaches 10,500,000, the 8-K filing requirement would be triggered and each of the conversions would need to be reported.

Form 8-K Filing Requirements: A Broad Overview

As mentioned above, any U.S. reporting company must file periodic reports on Form 8-K. A foreign issuer uses a Form 6-K, which has different requirements. The following is a brief description of each of the events that trigger an 8-K filing requirement. Many transactions will require the filing under multiple Item numbers, in which case the company can set forth all the material information and cross-reference the disclosure under each Item. Also, a Form 8-K can serve double duty and satisfy certain other filing requirements, such as those related to proxy proceedings or business combination transactions. The front page of the form 8-K provides check boxes to disclose such double use.

  Section 1 – Registrant’s Business and Operations

                Item 1.01 Entry into a Material Definitive Agreement Material agreements are those that create material obligations that are enforceable by or against a company.  As a rule of thumb, if an agreement is material enough to require separate board or shareholder consent, it requires an 8-K filing. Non-binding term sheets or letters of intent generally do not trigger a filing requirement, though material binding provisions contained therein may, such as significant breakup fees. A company is not required to file a copy of the agreement itself with the 8-K, but if it does not, the agreement must be filed with the next periodic report on either Form 10-Q or 10-K. As is encouraged by the SEC, I usually recommend that the agreement be filed with the 8-K. The determination of an 8-K filing requirement that is made at the time the agreement is entered into such that if the agreement becomes material through the passage of time or events, an 8-K filing is not later triggered.

Item 1.02 Termination of a Material Definitive Agreement The termination of an agreement that is reported or reportable in Item 1.01, other than by its own terms, must be reported.

Item 1.03 Bankruptcy or Receivership An 8-K must be filed for bankruptcy or receivership actions involving either the company or its parent (majority shareholder).

Item 1.04 Mine Safety – Reporting of Shutdowns and Patters of Violations – The requirement for an 8-K is triggered by the receipt of a notice under the Federal Mine Safety and Health Act of 1977 or from the Mine Safety and Health Administration.

Section 2 – Financial Information

               Item 2.01 Completion of Acquisition or Disposition of Assets – In addition to reporting the particular acquisition or disposition transaction, this section triggers the requirement to provide financial statements and information under Regulation S-X, including historical and/or pro forma financial statements. If the report also involves a change of shell status, the financial statements must be included with the initial report under Item 2.01. If the company was not a shell, the financial statements may be filed by amendment within 71 days of the initial 8-K reporting the Item 2.01 event.

Item 2.02 Results of Operations and Financial Conditions – An Item 2.02 is triggered by the disclosure of any material non-public financial information about a completed quarter of fiscal year-end. An Item 2.02 disclosure is usually accompanied by a press release, which can be “furnished” and not “filed.” See below for a discussion on the difference. Also, an Item 2.02 filing must be made prior to any associated earnings call.

Item 2.03 Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant – An example of an off-balance sheet transaction would be one where the company guarantees or lease or other obligation of a third party.

Item 2.04 Triggering Events that Accelerate or Increase a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement – An example would be the default by the primary party to a guaranteed obligation.

Item 2.05 Costs Associated with Exit or Disposal Activities – An example would be the termination of a business division or manufacturing plant.  Another example would be material write-offs or restructuring costs.

Item 2.06 Material Impairments – An example would be a material impairment to the value of assets such as goodwill or investment securities.  Another example could be the loss of value to technology inventory due to obsolescence.

Section 3 – Securities and Trading Markets

               Item 3.01 Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing – An example would be a notice of delinquency with the listing requirements of an exchange such as the NASDAQ or NYSE MKT. If such notice culminates in an actual delisting, another 8-K would need to be filed under this item. Likewise, a company’s decision to delist and move to the OTC Markets would be reportable.

Item 3.02 Unregistered Sales of Equity Securities – For a smaller reporting company, this Item requires that a company report the unregistered sale of securities if the aggregate sales/issuances of securities constitutes 5% or more of the outstanding securities since the last reported number filed with the SEC.  For all other companies, the threshold is triggered at a 1% change.

Item 3.03 Material Modification to Rights of Security Holders – Examples would be amendments to preferred stock preferences or the issuance of senior securities.

Section 4 – Matters Related to Accountants and Financial Statements

               Item 4.01 Changes in Registrant’s Certifying Accountant – An 8-K filing under this Item will always be reviewed by the SEC and must meet the exact particular disclosure requirements.

Item 4.02 Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review – A filing on this Item is usually accompanied by or quickly followed by an amendment to the subject report and financial statements. Moreover, if the amended underlying report is not concurrently filed, an Item 4.02 filing in essence reports that the company is delinquent in its filing requirements, as an unreliable report is equivalent to no report. An Item 4.02 filing is due within 2 days of receipt of an auditor’s restatement letter.

Section 5 – Corporate Governance and Management

                Item 5.01 Changes in Control of Registrant – Control includes changes in the board of directors, officers or control shareholders.

Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers – This Item includes any and all changes in officers or directors, whether by resignation, termination, refusal to stand for re-election or completion of a change of control transaction.

Item 5.03 Amendments to Articles of Incorporation or Bylaws; Changes in Fiscal Year – When completing a corporate action that is processed by FINRA, this item filing requirement is triggered when the amended articles are filed with the state, regardless of the timing of FINRA’s review and processing of the change with the markets. A restatement that does not make material changes does not trigger an 8-K filing, such as where a company is combining multiple amendments for ease of reference or cleaning up otherwise ambiguous language.

Item 5.04 Temporary Suspension of Trading Under Registrant’s Employee Benefits Plans – This item filing requirement is triggered by the receipt of a notice under the Employment Retirement Income Security Act of 1974 (ERISA).

Item 5.05 Amendments to the Registrant’s Code of Ethics, or Waiver of a Provision of the Code of Ethics – In addition to filing an 8-K, the company must carry through the change to the documents posted on its website.

Item 5.06 Change in Shell Company Status – An Item 5.06 filing is usually accompanied by an Item 2.02 disclosure and triggers the filing of Form 10 information, including financial statements.

Item 5.07 Submission of Matters to a Vote of Security Holders – This Item requires the reporting of voting results and is thus a retrospective report of a vote as opposed to a prospective notice of a matter to be submitted for vote.  Item 5.07 also requires the disclosure of say-on-pay votes and the frequency on say-on-pay votes.

Item 5.08 Shareholder Director Nominations – This Item requires a company to inform shareholders of the date in which they must submit director nominations on Schedule 14N.

Section 6 – Asset-Backed Securities

               Item 6.01 ABS Informational and Computational Materials

Item 6.02 Change of Servicer or Trustee – Requires a report of any changes, whether through resignation or termination.

Item 6.03 Change in Credit Enhancement or Other External Support – Requires a report of any material changes, whether through the loss, addition or change in support.

Item 6.04 Failure to Make a Required Distribution – Only requires the report of material failures to distribute in a timely manner.

Item 6.05 Securities Act Updating Disclosure – Includes material changes in an offering of AB securities.

Item 6.06 Static Pool – Alternative to filing a prospectus supplement required by Item 1105 of Regulation AB.

Section 7 – Regulation FD

               Item 7.01 Regulation FD Disclosure – Information should be furnished and not filed. Where the information is material non-public information, such as in a press release, the filing must be made immediately prior to or simultaneously with the issuance of the release. Where information is accidentally released, the filing must be made immediately after the release and on the same calendar day.  Regulation FD disclosures are an exception to the usual four-day filing rule.

Section 8 – Other Events

Item 8.01 – Other Events – This is a catch-all voluntary filing by companies that wish to report information that does not otherwise fit within an 8-K category.  Because the information is voluntary and not otherwise required, there is no four-day filing rule.

Section 9 – Financial Statements and Exhibits

               Item 9.01 Financial Statements and Exhibits – Requires the filing of all financial statements and exhibits required by other Items on Form 8-K and specifies such financial statement requirements. In addition, Item 9.01 sets forth the timing of filing of the financial statements for both shell and non-shell companies.

Penalties for Failure to File

Late or missed filings carry severe consequences to companies. To qualify to use Form S-3, a company must have filed all SEC reports in a timely manner, including Form 8-K, for the prior 12 months. Moreover, filing failures can result in enforcement proceedings and the conclusion of and disclosure related to inadequate controls and procedures.

Difference Between Filed and Furnished

Section 18 of the Exchange Act imposes liability for material misstatements or omissions contained in reports and other information filed with the SEC. However, reports and other information that are “furnished” to the SEC do not impose liability under Section 18. The SEC allows certain information to be furnished as opposed to filed; however, it is incumbent upon the company to clearly disclose that it is avowing itself of the ability to furnish and not file. That is, unless otherwise specifically disclosed, information in a report made with the SEC will be deemed filed, not furnished.  Note, however, that other liability provisions under the Exchange Act may apply that are not dependent on the filing of documents, such as the anti-fraud provisions under Rule 10b-5.

Further Reading

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. However, I note that with the recent election, and the GOP sweeping control of both the House and Senate, it is unclear what the future of these initiatives holds.

On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format.  See my blog HERE on the Item 601 proposed changes.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE.

That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.

As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law.  The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog 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 Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Download our mobile app at iTunes.

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 2016

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Yahoo Hacking Scandal And Obligations Related To Cybersecurity
Posted by Securities Attorney Laura Anthony | December 6, 2016 Tags: ,

On September 26, 2016, Senator Mark R. Warner (D-VA), a member of the Senate Intelligence and Banking Committees and cofounder of the bipartisan Senate Cybersecurity Caucus, wrote a letter to the SEC requesting that they investigate whether Yahoo, Inc., fulfilled its disclosure obligations under the federal securities laws related to a security breach that affected more than 500 million accounts. Senator Warner also requested that the SEC re-examine its guidance and requirements related to the disclosure of cybersecurity matters in general.

The letter was precipitated by a September 22, 2016, 8-K and press release issued by Yahoo disclosing the theft of certain user account information that occurred in late 2014. The press release referred to a “recent investigation” confirming the theft of user account information associated with at least 500 million accounts that was stolen in late 2014. Just 13 days prior to the 8-K and press release, on September 9, 2016, Yahoo filed a preliminary 14A filing with the SEC related to the sale of Yahoo’s operating business to Verizon Communications, Inc., in which it stated that it did not have any knowledge of “any incidents of, or third party claims alleging… unauthorized access” of personal data of its customers that could have a material effect on the Verizon-Yahoo transaction.

The September 22 filing was the first disclosure by Yahoo of the hack and has raised many questions as to when it knew about the 2014 cyberattack and what its duties were to make public disclosure of same. The hack has also raised questions related to the SEC’s current rules and thresholds for how and when companies need to report a material data breach.

This blog provides a summary of the current SEC guidelines related to disclosures of cybersecurity risks and incidents as well as a summary of current disclosure practices among reporting companies.

SEC Guidance on Disclosure of Cybersecurity Matters

Introduction

On October 13, 2011, the SEC issued a Disclosure Guidance related to cybersecurity risks and cyber incidents. The guidance attempts to find a balance between satisfying the disclosure mandates of providing material information related to risks to the investing community with a company’s need to refrain from providing disclosure that could, in and of itself, provide a road map to the very breaches a company attempts to prevent. In that regard, the SEC is clear that disclosure of actual detailed security measures is not required. As with the rules on disclosure in general, companies must consider their specific facts and circumstances in determining the required disclosure, if any.

Cyber-incidents can take many forms, both intentional and unintentional, and commonly include the unauthorized access of information, including personal information related to customers’ accounts or credit information, data corruption, misappropriating assets or sensitive information or causing operational disruption. A cyber-attack can be in the form of unauthorized access or a blocking of authorized access.

The purpose of a cyber-attack can vary as much as the methodology used, including for financial gain such as the theft of financial assets, intellectual property or sensitive personal information on the one hand, to a vengeful or terrorist motive through business disruption on the other hand. A primary example of the latter is the famous hacking of the Sony Pictures Entertainment email system in 2014.

When victim to a cyber-attack or incident, a company will have direct financial and indirect negative consequences, including but not limited to:

  • Remediation costs, including liability for stolen assets, costs of repairing system damage, and incentives or other costs associated with repairing customer and business relationships;
  • Increased cybersecurity protection costs to prevent both future attacks and the potential damage caused by same. These costs include organizational changes, employee training and engaging third-party experts and consultants;
  • Lost revenues from unauthorized use of proprietary information and lost customers;
  • Litigation; and
  • Reputational damage.

Disclosure Guidance

Consistent with all disclosure guidance, the SEC begins its guideline with the basic premise that the disclosure requirements are meant to “elicit disclosure of timely, comprehensive, and accurate information about risks and events that a reasonable investor would consider important to an investment decision.” With that said, as of the date of the guidance, and as of today, there is no specific disclosure requirement or rule under either Regulation S-K or S-X that addresses cybersecurity risks, attacks or other incidents.

However, as discussed further in this blog, many of the disclosure rules encompass these disclosures indirectly, such as risk factors, internal control assessments, management discussion and analysis, legal proceedings and financial statement loss contingencies. Moreover, as with all other disclosure requirements, an obligation to disclose cybersecurity risks, attacks or other incidents may be triggered to make other required disclosures not misleading considering the circumstances.

Risk Factors

Obviously, where appropriate, cybersecurity risks need to be included in risk factor disclosures. The SEC guidance in this regard is very common-sense. The SEC expects companies to “evaluate their cybersecurity risks and take into account all available relevant information, including prior cyber incidents and the severity and frequency of those incidents.” In addition, companies should consider the probability of an incident and the quantitative and qualitative magnitude of the risk, including potential costs and other consequences of an attack or other incident. Consideration should be given to the potential impact of the misappropriation of assets or sensitive information, corruption of data or operational disruptions. A company should also consider the adequacy of preventative processes and plans in place should an attack occur. Material actual threatened attacks may be material and require disclosure.

As with all risk-factor disclosures, the company must adequately describe the nature of the material risks and how such risks affect the company. Likewise, generic risk factors that could apply to all companies should not be included. Risk factor disclosure may include:

  • Discussion of the company’s business operations that give rise to material cybersecurity risks and the potential costs and consequences;
  • Discussion of any outsourcing of functions that give rise to risks or preventative measures;
  • Description of past incidents, including their costs and consequences;
  • Risks of cyber-incidents that could remain undetected for a period of time; and
  • Description of insurance coverage.

Management Discussion and Analysis (MD&A)

A company would need to include discussion of cybersecurity risks and incidents in its MD&A if the costs or other consequences associated with one or more known incidents or the risk of potential future incidents result in a material event, trend or uncertainty that is reasonably likely to have a material effect on the company’s results of operations, liquidity or financial condition, or could impact previously reported financial statements. The discussion should include any material realized or potential reduction in revenues, increase in cybersecurity protection costs, and related litigation. Furthermore, even if an attack did not result in direct losses, such as in the case of a failed attempted attack, but does result in other consequences, such as a material increase in cybersecurity expenses, disclosure would be appropriate.

Business Description; Legal Proceedings

Disclosure of cyber-related matters may be required in a company’s business description where they effect a company’s products, services, relationships with customers and suppliers or competitive conditions. Likewise, material litigation would need to be included in the “legal proceedings” section of a periodic report or registration statement.

Financial Statements

Cyber-matters may need to be included in a company’s financial statements prior to, during and/or after an incident. Costs to prevent cyber-incidents are generally capitalized and included on the balance sheet as an asset. GAAP provides for specific recognition, measurement and classification treatment for the payment of incentives to customers or business relations, including after a cyber-attack. Cyber-incidents can also result in direct losses or the necessity to account for loss contingencies, including those related to warranties, breach of contract, product recall and replacement, indemnification or remediation. Furthermore, incidents can result in loss of, and therefore accounting impairment to, goodwill, intangible assets, trademarks, patents, capitalized software and even inventory.

Controls and Procedures

To the extent that cyber-matters effect a company’s ability to record, process, summarize and report financial and other information in SEC filings, management will need to consider whether there is a reportable deficiency in disclosure controls and procedures.

Disclosure in Practice

The Yahoo hacking incident resulted in numerous media articles and blogs related to the disclosure of cyber-matters in SEC reports. One such blog was written by Kevin LaCroix and published in the D&O Diary. Mr. LaCroix’s blog points out that according to a September 19, 2016, Wall Street Journal article, cyber-attacks are occurring more frequently than ever but are rarely reported. The article cites a report that reviewed the filings of 9,000 public companies from 2010 to the present and found that only 95 of these companies had informed the SEC of a data breach.

As reported in a blog published by Debevoise and Plimpton, dated September 12, 2016, (thank you, thecorporatecounsel.net), a review of Fortune 100 cyber-reporting practices revealed that most disclosures are contained in the risk-factor section of regular periodic reports such as Forms 10-Q and 10-K as opposed to interim disclosures in a Form 8-K. Moreover, only 20 incidents were reported at all in the period from January 2013 through the third quarter of 2015.

My opinion (which was also Mr. LaCroix’s opinion and that of most of the industry) is that companies are relying on the materiality standard to avoid disclosure of cyber-incidents. Most public-company hacking involves large organizations that can reasonably make the judgment call that the incident and its effects are not material to investment decisions. See HERE for a discussion on materiality.

Additional Information

In 2011, at the time of the SEC release, there was a noticeable increase in reliance on technology by all businesses resulting in the issuance of the guidance. Today, the prevalence of technological reliance and cyber-incidents has increased dramatically and as such, it is my view that it is time for the SEC to review and update their guidance.

The SEC focuses time and financial resources on the use of technology by the SEC itself and market participants. In November 2015, the SEC adopted Regulation Systems Compliance and Integrity, which requires key market participants to have comprehensive written policies and procedures to ensure the security and resilience of their technological systems, to ensure that systems operate in compliance with federal securities laws and to provide for maintenance and testing of such systems. For more information see my blog HERE.

Recap on Disclosure Effectiveness Initiative

The disclosure of cybersecurity risks, attacks or other incidents is ultimately just a disclosure. As I’ve been writing about often recently, disclosure has been and continues to be a topic of examination and regulatory change.

On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format. See my blog HERE on the Item 601 proposed changes.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE.

That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.

As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog 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 Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Download our mobile app at iTunes.

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 2016

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