March 2017 - Reverse-Merger.com

The Financial Choice Act 2.0

Posted by Securities Attorney Laura Anthony | March 28, 2017 Tags: Dodd-Frank, EGC, Financial Choice Act 2.0, Say on Pay Rules, Summary of Original Financial Choice Act, The Financial Choice Act 2.0, Tier 2 of Regulation A

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:

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

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.
Incentive-based Compensation. The Act would repeal provisions of Dodd-Frank that require enhanced disclosure related to incentive-based compensation by certain institutions.
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.
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.
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:

Repeal the authority of the Financial Stability Oversight Council to designate firms as systematically important financial institutions (i.e., too big to fail);
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
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:

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;
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);
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);
“Institute significant due-process reforms for every American who feels that they have been the victim of a government shakedown”;
Repeal the Chevron Deference doctrine. Under this doctrine, a court must defer to an agency’s interpretation of statues and rules;
Demand greater accountability and transparency from the Federal Reserve; and
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:

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);
Repeal the SEC’s authority to either prospectively or retroactively eliminate or restrict securities arbitration;
Repeal non-material specialized disclosure; and
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:

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.

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.”
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.

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.
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.
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.
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.
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.
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.

Click Here To Print- PDF Printout The Financial Choice Act 2.0

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.

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« SEC Completes Inflation Adjustment To Civil Penalties The Acting SEC Chair Has Trimmed Enforcement’s Subpoena Power »

SEC Completes Inflation Adjustment To Civil Penalties

Posted by Securities Attorney Laura Anthony | March 21, 2017 Tags: CEO and CFO Certifications, Civil Monetary Penalties, CMP, Liability for Signing SEC Report, New Adjusted penalty amounts, PCAOB, Proposed SEC Penalties Act, SEC Civil Penalties, SEC Completes Inflation Adjustment To Civil Penalties, Section 302 Certification, Section 906 Certification

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 10^th 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.

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The Author

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

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

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« The SEC Has Issued New Guidance Related To Foreign Private Issuers The Financial Choice Act 2.0 »

The SEC Has Issued New Guidance Related To Foreign Private Issuers

Posted by Securities Attorney Laura Anthony | March 14, 2017 Tags: American Depository Receipts, American Depository Receipts (ADRs), C&DI Related to use of Form 20-F, Definition of Foreign Private Issuer, F-series registration statement, Foreign Private Issuers, Form 20-F annual report, Form 6-K, India as an Emerging Market, OTC Markets, Qualified Foreign Exchange, Refresher Overview for Foreign Private Issuers, SEC

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:

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
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.

Click Here To Print- PDF Printout The SEC Has Issued New Guidance Related To Foreign Private Issuers

The Author

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

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

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« SEC Announces Examination Priorities For 2017 SEC Completes Inflation Adjustment To Civil Penalties »

SEC Announces Examination Priorities For 2017

Posted by Securities Attorney Laura Anthony | March 7, 2017

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 (“ETF’s”) – 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

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

Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

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