October 2017 - Reverse-Merger.com

SEC Proposes Rules to Modernize and Simplify Disclosures

Posted by Securities Attorney Laura Anthony | October 31, 2017 Tags: Fast Act, Fixing America’s Surface Transportation Act, Regulation S-K, Regulation S-X, SEC Disclosure Effectiveness Initiative, SEC Proposes Rules to Modernize and Simplify Disclosures

On October 11, 2017, as part of the ongoing SEC Disclosure Effectiveness Initiative, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”).

The FAST Act, passed in December 2015, contains two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 requires the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.” In accordance with that requirement, On July 13, 2016, the SEC issued proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded. See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in the report issued on November 23, 2016. Section 72003 specifically required that the report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information. The proposed amendments seek to implement the various findings and recommendations in the November report.

As further discussed in this blog, the proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks.

Proposed Amendments

A. Description of Property (Item 102)

Item 102 requires disclosure of the location and general character of the principal plants, mines, and other materially important physical properties of the company and its subsidiaries.The instructions to Item 102 require the company to disclose information reasonable to inform investors as to the suitability, adequacy, productive capacity and utilization of facilities. The proposed amendment will emphasize materiality and require a company to disclose physical properties only to the extent that such properties are material to the company.

B. Management’s Discussion and Analysis (MD&A) (Item 303)

Item 303(a) requires a company to discuss their financial condition, changes in financial condition, and results of operations using year-to-year comparisons. The discussion is required to cover the period of the financial statements in the report (i.e., 2 years for smaller reporting companies and emerging growth companies and 3 years for others). Where trend information is relevant, the discussion may include 5 years with a disclosure of selected financial data.

The proposed amendment would allow the company to eliminate the earliest year in its discussion as long as (1) the discussion is not material to an understanding of the current financial condition; and (ii) the company has filed a prior Form 10-K with an MD&A discussion of the omitted year. The proposed amendment will also eliminate the reference to a five-year look-back in the instructions, but rather a company will be able to use any presentation or information that it believes will enhance a reader’s understanding. The amendments will flow through to foreign private issuers as well with conforming changes to the instructions for Item 5 of Form 20-F.

C. Directors, Executive Officers, Promoters and Control Persons (Item 401)

Item 401 requires disclosure of identifying and background information about a company’s directors, executive officers, and significant employees. The proposed amendments will clarify the instructions to Item 401 to clarify that the information is not required to be duplicated in various parts of a Form 10-K and/or proxy statement, but need only appear once and may be incorporated by reference in other parts of the documents.

D. Compliance with Section 16(a) (Item 405)

Section 16(a) of the Exchange Act requires officers, directors, and specified types of security holders to report their beneficial ownership of a company’s equity securities using forms prescribed by the SEC, such as an initial Form 3, amendments on Form 4 and annual Form 5. Item 405 requires the company to disclose each person who failed to timely file a Section 16 report during the most recent fiscal year or prior years. Section 16 reporting persons are required to deliver a copy of their reports to the company, though in practice, this is rarely done. The proposed amendments remove this requirement and allow the company to review EDGAR filings for compliance with Section 16(a).

In addition, the proposed amendment would eliminate the need to include the heading at all if there are no delinquencies to report, rather than include the heading with a statement such as “none” and remove the checkbox on the cover page of Form 10-K related to the disclosure. The proposed amendment includes several changes to make the instructions and title of this section conform to the SEC’s “plain English” requirements.

E. Corporate Governance (Item 407)

The proposed amendment will update the instructions and information required under Item 407 to remove reference to an obsolete audit standard and rather just refer broadly to applicable PCAOB and SEC requirements. EGC’s and smaller reporting companies are both exempted from the Item 407 requirements, and the proposed amendment clarifies the instruction language accordingly.

F. Outside Front Cover Page of the Prospectus (Item 501(b))

The proposed amendments are designed to streamline the front cover page of a prospectus and give a company flexibility in designing the page to tailor to their business and particular offering. The proposed changes include (i) eliminating instructions related to changing or clarifying a name that may be confused with a well-known company; (ii) allowing for a statement that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus with a cross-reference to the page number; (iii) requiring the disclosure of the principal trading market and company symbol, even if such trading market is not a national exchange; and (iv) streamlining the “subject to completion” legend.

G. Risk Factors (Item 503(c))

A company is required to disclose the most significant factors that make an offering speculative or risky. Although the disclosure is intended to be principals-based, many examples are included in the instructions. The proposed amendments would move Item 503(c) to Subpart 100 to clarify that risk factors are also required in a Form 10 and Exchange Act periodic reports and not just offering-related disclosures. The proposed amendment would also eliminate the risk factor examples from the instructions.

H. Plan of Distribution (Item 508)

Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about underwriters. The term “sub-underwriter” is referred to in the rule; however, it is not defined. The proposed rules will define a “sub-underwriter” as “a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities but is not itself in privity of contract with the issuer of the securities.”

I. Undertakings (Item 512)

Item 512 provides undertakings that a company must include in Part II of its registration statement, depending on the type of offering. The proposed amendments simplify the undertakings requirements and eliminate provisions that are duplicative because the requirement already exists, or that are obsolete due to changes in the law. For example, Items 512(d), 512(e) and 512(f) are all obsolete and should be eliminated. Item 512(c) related to unsold rights offerings that are then offered to the public, can be eliminated as other provisions of the law would require the company to update the (or complete a new) registration statement regardless.

J. Exhibits (Item 601)

The proposed amendment makes several changes to the exhibit filing requirements to streamline and reduce the volume of documents, many of which may not be material, which are required to be filed. The proposed amendments also make at least one addition to the exhibit requirements and in particular, a company must disclose a subsidiaries LEI number if one has been issued. For information on a LEI, see HERE.

The proposed amendment add exhibits related to Item 202 disclosures (registered capital stock, debt securities, warrants, rights, American Depository Receipts, and other securities) to Exchange Act periodic reports on Form 10-K and 10-Q. Such exhibits are currently only required in registration statements, Form 8-K and Schedule 14A.

The proposed amendment also clarifies that schedules and exhibits to exhibits need not be filed unless they are, in and of themselves, material to an investment decision. Although historically the SEC did not object to the omission of schedules and exhibits to exhibits with personally identifiable information, the rules generally require the filing of a confidential treatment request for most omissions. The proposed amendments allow a company to omit schedules and exhibits to exhibits as long as a brief description of the omitted documents is included. In addition, a copy of the omitted items must be provided if requested by the SEC, though a confidential treatment request could also be made at that time. Likewise the proposed amendments will allow a company to redact information that is both (i) not material, and (ii) competitively harmful if disclosed.

K. Incorporation by Reference

Currently rules related to incorporation by reference are spread among a variety of regulations, including Regulation S-K, Regulation C, Regulation 12B and numerous forms. The proposed amendments would revise Item 10(d), Rule 411, and a number of SEC forms to simplify and modernize these rules while still providing all material information. Rule 12b-23 is proposed to be rescinded. The amendments streamline the rules and further allow for incorporation by reference to eliminate duplicative disclosure. The proposed rules will require a hyperlink to information that is incorporated by reference if the information is available on EDGAR.

The proposed rules specifically do not add or change the rules related to cross-references or other incorporation within the financial statements to other disclosure items. There is a concern as to the impact on auditor review requirements if such links or changes are added.

L. Forms

The proposed amendments include several amendments to forms to conform with and implement all the changes in the rules.

M. XBRL

The proposed amendments would require all of the information on the cover pages of Form 10-K, Form 10-Q, Form 8-K, Form 20-F, and Form 40-F to be tagged in Inline XBRL in accordance with the EDGAR Filer Manual.

Further Reading on the FAST Act

I’ve blogged several times on the FAST Act since its initial passing on December 15, 2015. An initial discussion and summary of the FAST Act can be read HERE. A summary of the SEC guidance on the FAST Act as relates to savings and loan companies can be read HERE.

On January 13, 2016, the SEC issued interim final rules memorializing two provisions of the FAST Act. In particular, the SEC revised the instructions to Forms S-1 and F-1 to allow the omission of historical financial information and to allow smaller reporting companies to use forward incorporation by reference to update an effective S-1. A summary can be read HERE. On May 3, 2016, the SEC issued final amendments to revise the rules related to the thresholds for registrations, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934. The amendments mark the final rule making and implementation of all provisions under the JOBS Act, and implement further provisions under the FAST Act. A summary can be read HERE.

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. The request for comment was required by Section 72003 of the FAST Act. For a summary see HERE.

On August 17, 2017, the SEC issued guidance on financial statement requirements for confidential and public registration statement filings by both emerging growth companies (EGC) and non-emerging growth companies. The new Compliance and Disclosure Interpretations (C&DI’s) follow the SEC’s decision to permit all companies to submit draft registration statements, on a confidential basis. For a summary see HERE and HERE.

As required by Section 72003 of the Fixing America’s Surface Transportation Act (the “FAST Act”), on November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K including detailed recommendations for changes. For a summary see HERE.

Further Background on SEC Disclosure Effectiveness Initiative

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.

On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments 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 amendment also requires that all exhibits be filed in HTML format. The new Rule goes into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018. See my blog HERE on the Item 601 rule changes.

On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read 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. This proposal is slated for action in this year’s SEC regulatory agenda.

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. Both of these items are slated for action in this year’s SEC regulatory agenda.

As part of the ongoing disclosure effectiveness intiiactive, 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. These items are all included in this year’s SEC regulatory agenda.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.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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« NASDAQ Issues Report Advocating for The U.S. Public Markets Emerging Growth Companies Will Start To Grow Up »

NASDAQ Issues Report Advocating for The U.S. Public Markets

Posted by Securities Attorney Laura Anthony | October 24, 2017 Tags: NASDAQ Issues Report Advocating for The U.S. Public Markets, SEC Disclosure Effectiveness Initiative, The NASDAQ Paper, The Promise of Market Reform: Reigniting American’s Economic Engine

Before SEC Commissioner Michael Piwowar’s May 16, 2017, speech at the SEC-NYU Dialogue on Securities Market Regulation regarding the U.S. IPO Market (see summary HERE), and SEC Chair Jay Clayton’s July 12, 2017, speech to the Economic Club of New York (see summary HERE), the topic of the U.S. IPO market had already gained significant market attention. Earlier this year, NASDAQ issued a paper titled “The Promise of Market Reform: Reigniting American’s Economic Engine” with its views and position on how to revitalize the U.S. equities and IPO market (the “NASDAQ Paper”). This blog summarizes the NASDAQ Paper.

The NASDAQ Paper begins with a statement by Adena Friedman, President and CEO of NASDAQ. The statement begins with a decidedly positive outlook, noting that “The U.S. equities markets exist to facilitate job creation and wealth creation for millions of people, ultimately driving economic growth for our country.” Ms. Friedman adds that “[E]xceptional market returns in recent years reflect the growing strength of the U.S. and global economy and continued confidence in the health of U.S. markets.”

However, on the other side she points out that there are structural issues that need to be addressed, noting that markets have become more complex and costly for companies that are already public or considering going public. The problem runs deep. Again quoting Ms. Friedman: “[I]f the volume of IPOs continues to fall and more companies choose to stay or go private, job creation and economic growth could suffer, and income inequality could worsen as average investors become increasingly shut out of the most attractive offerings.” In that regard, NASDAQ has issued its Paper setting out reforms that it advocates for to improve interest in the U.S. public markets.

The NASDAQ Paper

Following an Executive Summary, the NASDAQ Paper is broken down into three sections: (i) Reconstructing the Regulatory Framework; (ii) Modernizing Market Structure; and (iii) Promoting Long-Termism.

Executive Summary

Like Ms. Friedman’s statement, the executive summary at the beginning of the NASDAQ Paper touts the importance of robust U.S. public markets to our economy, a message I have reiterated in many blogs over the years. Citing the SEC’s own statistics, the NASDAQ Paper points out that since 1970, 92% of job creation has come from public companies and that the vast majority of Americans are invested in public companies either directly or indirectly through pension funds, mutual funds and other retirement accounts. Furthermore, index funds have gained in popularity, but for an index strategy to work, there needs to be a healthy selection of public companies to comprise these indexes and provide diversification and profitability.

Although many pension funds invest in private equity firms that in turn invest in private companies, these private investments are illiquid and hard to value. Accordingly, public markets remain and will continue to remain the investment of choice for U.S. retirement accounts.

However, with the necessary transparency of public companies comes greater obligations and compliance costs. Over the years the U.S. has continued to add layers of regulation such that the burdens of being public can outweigh the benefits. I note this is more so for larger companies that do not qualify as emerging growth or smaller public companies and are required to comply with even greater levels of disclosure, including compliance with Sarbanes-Oxley Act Section 404. For more on public company disclosure requirements, see HERE and HERE. A summary of the ongoing SEC Disclosure Effectiveness Initiative is at the end of this blog.

The NASDAQ Paper cites many reasons for the slowdown in the U.S. IPO market, including: (i) shareholder activists; (ii) frivolous shareholder lawsuits; (iii) pressure to prioritize short-term returns over long-term strategic growth; (iv) burdensome costs and headaches of the proxy process; and (v) irrelevant disclosure obligations. Moreover, the better companies have no problem finding private equity and often choose that route.

In addition to the direct causes for the slowdown, NASDAQ has three main concerns over the U.S. public markets, including: (i) complex regulations disincentivize market participation; (ii) a one-size-fits-all market structure does not work for small and emerging growth companies; and (iii) a culture in the investment community and media that prioritizes short-term return over long-term growth. NASDAQ offers its view and suggested solutions for each of these issues.

Reconstructing the Regulatory Framework

Although regulations and oversight are obviously a necessity, regulations which were put into place as a result of the financial crisis now need to be reviewed and particularly in relation to the burdens they impose on public companies and those considering entering the public markets. Moreover, years of layering of regulations, without a top-down view, has created unnecessary complexities for companies.

NASDAQ points to the proxy process as an area needing crucial regulatory reform. Although shareholders should have an ability to raise legitimate concerns, the proxy process is being used for nuisance value at a significant cost to companies. NASDAQ suggests that the SEC:

(i) Raise the minimum ownership amount and holding period to ensure that proposals have meaningful shareholder backing. Currently, the SEC rules allow a shareholder holding $2,000 or more of company stock for a period of one year or longer, to include issues in a company proxy statement, regardless of materiality, subject to the company’s ability to seek SEC no-action letter redress, which of course requires time and expense. For more on this process, see HERE. NASDAQ suggests increasing the minimum ownership to at least 1% of the company’s outstanding stock and increasing the minimum holding period to 3 years.

(ii) Update the SEC process for removing repetitive, unsuccessful proposals from proxies. NASDAQ backs the Financial Choice Act proposal, which would significantly increase the level of shareholder support a rejected proposal would need to have to be reintroduced at a future meeting. Moreover, the topics of shareholder proposals should be better identified to ensure that only matters that are meaningful to the shareholders are considered at annual meetings.

(iii) Create transparency and fairness in the proxy advisory industry. Due to the large number of proxies to consider each year, institutional investors rely on proxy advisory firms, which are unregulated and “rife with opacity, lack of accountability and conflicts of interest.” NASDAQ suggests that voting is often at the whim of these advisory firms, with no obligation to provide information related to their analysis, financial interests, or stock ownership (including long or short positions).

NASDAQ also advocates changes in corporate disclosure requirements. Although transparency is critically important, companies should have the flexibility to provide full disclosure that is shareholder-friendly (readable) and less burdensome on companies. I’ve included more information on the SEC’s Disclosure Effectiveness Initiative at the end of this blog. NASDAQ has strong views in this regard, and suggests the following changes:

(i) Offer flexibility on quarterly reporting. NASDAQ suggests allowing companies to file semiannual reports with material interim updates via press releases and Form 8-K’s.

(ii) Streamline quarterly reporting obligations for small and medium growth companies. NASDAQ suggests that “if companies report all key financial and business details in quarterly press releases, we should consider eliminating the archaic 10-Q form, which is duplicative and bureaucratic. We should also study options that allow for greater flexibility in reporting schedules, so that as long as companies are transparent with shareholders, they have the flexibility to report on a less-rigid structure. This would also promote our third goal of promoting long-termism.” In addition, NASDAQ questions the usefulness of XBRL, noting that many analysts use their own technology in any event.

(iii) Expand classifications for disclosure relief. In particular, NASDAQ suggests expanding the class of companies that will qualify as a “smaller reporting company” and “emerging growth company” to take advantage of the scaled-down disclosure requirements available to these companies.

(iv) Expand the ability to “test the waters” for emerging growth companies. For more information on test-the-waters provisions, see HERE and HERE.

(v) Allow all companies to file confidential draft registration statements. Since the time that NASDAQ issued its Paper, the SEC has, in fact, implemented this change. See HERE for more information.

(vi) Increase the definition of emerging growth company from the current $1,070,000,000 to $1.5 billion and eliminate the five-year phase-out period,

(vii) Harmonize the definitions and obligations of smaller reporting company with non-accelerated filer and emerging growth company. For more on the distinctions between these categories, see HERE. Also, for a summary of the current proposed changes to the definition of a smaller reporting company, see HERE.

(viii) Allow all companies to use shelf registrations regardless of size.

(ix) Roll back politically motivated disclosure requirements such that disclosures are only required that help investors evaluate a company’s financial performance and economic prospects. Examples of politically motivated disclosures include the conflict mineral disclosures and executive pay ratio.

(x) The SEC should complete its Disclosure Effectiveness Initiative to strip out unnecessary requirements and simplify the process all around.

NASDAQ suggests the need for comprehensive litigation reform. There has been a record rate of securities class actions, many of which are dismissed and are clearly filed for nuisance value. In fact, NASDAQ suggests, and I agree, that class actions have become a method of negotiation and ordinary standard business practice. However, the cost to companies to defend frivolous lawsuits is huge, as is the deterrent to entering the public arena. NASDAQ has several suggestions in this regard, including, for example: (i) ease the standards for imposing sanction on lawyers for bringing frivolous lawsuits; (ii) tighten the requirements for granting class certification; (iii) allow interlocutory appeals of decisions; (iv) require disclosure of third-party financing of the litigation; (v) limit plaintiffs’ legal fees; (vi) allow a plaintiff to amend its complaint only once; (vii) further codify the standards for pleading with respect to scienter and loss causation, and clarify the exclusive nature of federal jurisdiction over securities claims; (viii) increase the burden of proof; (ix) require the loser to pay the legal fees of the winner and require plaintiffs to post a bond to ensure this right; and (x) allow enforceable arbitration provisions for shareholder matters.

NASDAQ also supports tax reform and, in particular, is supportive of the current administration’s efforts to reduce corporate tax rates for U.S. companies as well as territorial taxation for foreign corporate earnings. The exchange also advocates for lower individual taxes specifically related to gains from investments in public companies. In particular, NASDAQ suggests:

(i) Exploring a system that would create a tax structure for individual investors that ties a low level of taxes on investments to the overall value of the account, rather than a higher dividends and capital gains tax on earnings within the account. Sweden introduced such a system in 2012, and since that time approximately 16% of the total Swedish population has taken advantage of this system and the number of Swedish IPO’s has doubled.

(ii) Expand the tax exemption on the sale of small business stock in the secondary market. The tax code currently has a narrow exemption that only benefits venture capitalists and private equity investors.

(iii) Enact a 100% dividends received deduction for holders of corporate stock, avoiding double taxation of corporate profits.

(iv) Eliminate the net investment income tax, which was enacted in 2013 and invokes a 3.8% surcharge on dividends and capital gains.

(v) Exclude dividends and capital gains from income for purposes of determining the phase-out of itemized deductions.

Modernizing Market Structure

The NASDAQ Paper states the obvious: the current market structure needs to be updated for technological advances. A particular problem is the illiquidity faced by small public companies, a problem which NASDAQ believes can be addressed through market reforms leveraging new technology. NASDAQ is particularly critical of Regulation NMS. NASDAQ specifically recommends:

(i) Strengthen markets for smaller companies. Small and medium companies face liquidity issues that also result in market volatility. When a buy or sell order is placed on a stock with low trading volume, it can create dramatic price movements which do not reflect underlying value. NASDSAQ suggests that the problem stems from fragmentation with trading spread among too many trading venues. Interestingly, 15 years ago, 90% of trading was on a single exchange, but today there are 12 exchanges and 50 or more trading venues. Although most OTC Market securities would not qualify for an exchange listing, even if they wanted to, NASDAQ cites the existence of this and other alternative trading systems as also causing a spread-out of liquidity. NASDAQ believes concentrating that disaggregated liquidity onto a single exchange, with limited exceptions, will allow investors to better source liquidity.

I can’t say I agree with NASDAQ on this one. The OTC Markets provides a much-needed source of capital raising and secondary market trading for small and emerging growth companies, where no other option exists. I am, and continue to be, an avid supporter of the OTC Markets and advocate for its recognition as a venture exchange. A legislatively supported venture market would improve the system dramatically. See my article HERE. I also note that the OTC Markets has a platform in place and a desire to be such a venture market. However, as of today, it has failed to receive the legislative support necessary to make the effective changes needed to the system.

(ii) Give issuers a choice to consolidate liquidity and improve trading quality. NASDAQ advocates reducing Unlisted Trading Privileges (UTP) but at the same time creating an exchange that small and medium companies can trade on. However, from my viewpoint such a route would reduce the number of publicly traded securities, which of course would increase supply and demand for traded securities, but would leave many small and emerging growth companies with no access to public capital or secondary markets.

NASDAQ is careful not to suggest eliminating off-exchange (OTC Markets) trading, noting that “[O]ff-exchange trading represents 38.4% of small and medium growth company trading volume today. While there are great benefits to consolidating on-exchange trading, there is also important value provided by off-exchange trading that merit consideration, especially block trades and price-improved trades. The network of off-exchange brokers also supports systemic resiliency for the trading of these securities.We want to work with the industry towards constructive solutions that balance on- and off- exchange activities.” However, it continues arguing in favor of consolidation. In reading the Paper, I wonder if NASDAQ is ultimately suggesting that OTC Markets be turned into a national exchange and run by NASDAQ itself.

(iii) Deploy intelligent tick sizes for small and medium growth companies. NASDAQ cites research that a one-size-fits-all approach to tick size is suboptimal for many (particularly small and medium growth) companies, which should trade in a suitable tick regime determined by their listing exchange. NASDAQ believes trading could be on sub-penny, penny, nickel or dime increments. For information on the SEC tick size pilot program, see HERE.

(iv) Cultivate innovative market-level solutions that improve the trading of small and medium growth companies. NASDAQ advocates eliminating or greatly reducing Regulation NMS. Regulation NMS (National Market System) is a set of rules and regulations governing fairness in price execution, quote displays and access to market data. NASDAQ believes that these rules are restrictive to the market as a whole and negatively impact the liquidity of lower-priced securities.

(v) Implement an intelligent rebate/fee structure that promotes liquidity and avoids market distortion. In this recommendation, NASDAQ is suggesting plans for incentivizing market making in less liquid stocks.

(vi) Ensure fair and reasonable pricing for participants in the context of limiting exchange competition. Of course, if competition is eliminated, there must be rules in place to ensure that “the house” doesn’t win all! (My words, not NASDAQ’s.)

Promoting Long-termism

Companies are under increasing pressure to realize short-term profits for shareholders to the detriment of sustainable long-term growth. NASDAQ particularly points the blame finger at activist investors. Furthermore, unlike many investor groups, NASDAQ supports dual class structures which allow the entrepreneurs and internal management to invest in a motivating fashion along with external investors. NASDAQ’s specific recommendations include:

(i) Address concerns regarding activist investors. As shareholder activism has grown, its definition and purpose have become more muddled. Activism is a term used as an investment strategy that may or may not have any benefit to the company and its other shareholders. In addition to a need for dialogue and research in this area, NASDAQ advocates for further transparency and disclosure around arrangements and motivations by activists, including conflicts of interest.

(ii) Equalize short interest transparency. Short interest disclosures should tie in with Section 13 long position disclosure requirements. The NASDAQ Paper hits the nail on the head: “the asymmetry of information between long investors and those with short positions deprives companies of insights into trading activity and limits their ability to engage with investors and it deprives investors of information necessary to make meaningful investment decisions.”

(iii) Continue to support a dual class structure. Each public company, and their entrepreneurs and innovators, should have the flexibility to determine the best class structure for that company.

(iv) Encourage, rather than mandate, ESG disclosure. ESG stands for environmental, social and governance disclosures.

Further Reading on the SEC Disclosure Effectiveness Initiative

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. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flexibility Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only includes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

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. These items are all included in this year’s SEC regulatory agenda.

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« SEC Chief Accountant Speaks On Initial Coin Offerings ( ICO’s) SEC Proposes Rules to Modernize and Simplify Disclosures »

SEC Chief Accountant Speaks On Initial Coin Offerings ( ICO’s)

Posted by Securities Attorney Laura Anthony | October 17, 2017 Tags: blockchain, cryptocurrencies, digital coins, Distributed Ledger Technology, DLT, ICO by the DAO, ICOs, SEC Chief Accountant Speaks On Initial Coin Offerings, secondary token trading

On September 11, 2017, the SEC Chief Accountant, Wesley R. Bricker, gave a speech before the AICPA National Conference on Banks & Savings Institutions. The bulk of the speech was similar to Mr. Bricker’s June 2017 speech before the 36th Annual SEC and Financial Reporting Institute Conference, summarized HERE. However, one topic that was new, and interesting enough to spark this blog, was related to initial coin offerings (ICO’s). Note that offers and sales of digital coins, cryptocurrencies or tokens using distributed ledger technology (DLT) or blockchain have become widely known as ICO’s.

As the capital markets become more and more focused on all things blockchain, including ICO’s, secondary token trading, and disruptive changes made possible by distributed ledger technology (DLT), which is inevitably transforming capital market processes, the SEC is fronting a wave of questions and concerns on the subject. On July 25, 2017, the SEC issued a report on an investigation related to an ICO by the DAO and statements by the Divisions of Corporation Finance and Enforcement related to the investigative report. On the same day, the SEC issued an Investor Bulletin related to ICO’s. (See summary of the report, statement and investor bulletin HERE).

Almost all divisions and committees of the SEC are and will be impacted by DLT and ICO’s and are working diligently to address the technology and the public markets’ wave of interest. In August 2017 the SEC suspended the trading in a slew of bitcoin-based companies questioning the accuracy of publicly reported information and press releases. On September 20, 2017, the SEC’s Investor Advisory Committee announced the agenda for its next meeting to be held on October 12, the first item on which is blockchain and other distributed ledger technology and its implications for securities markets.

FINRA is likewise as attentive to DLT and its far-reaching implications. On July 13, 2017, FINRA held a Blockchain Symposium including participation by the Office of the Comptroller of Currency, the US Commodity Futures Trading Commission (CFTC), the Federal Reserve Board and the SEC. Earlier in the year, FINRA published a report on the technology and its potential impacts on broker-dealers and the markets in general. See HERE for a summary.

Although outside of my practice area, the Internal Revenue Service is stepping up efforts to make sure taxes are reported and paid for trading profits and other taxable income related to cryptocurrencies. In that regard, the IRS has contracted with a company that provides software that analyzes and tracks bitcoin transactions.

Mr. Bricker’s Remarks on ICO’s

Mr. Bricker begins by talking about the SEC report on the DAO investigation, stating that “[T]he report makes clear that the federal securities laws apply to those who offer and sell securities in the U.S., regardless of whether the issuing entity is a traditional company or a decentralized autonomous organization, whether those securities are purchased using U.S. dollars or virtual currencies, or whether they are distributed in certificated form or through distributed ledger technology.”

All offers and sales of securities in the U.S. must either be registered with the SEC or must qualify for an exemption. The SEC’s registration requirements include the filing of audited financial statements. In addition, I note that many exemptions likewise require the disclosure of either audited or unaudited financial statements. Furthermore, the basic antifraud principles encompassed in Rule 10b-5 of the Securities Exchange Act of 1934 and Section 17(a) of the Securities Act of 1933, require full and fair disclosure, which includes financial information about the issuer.

Mr. Bricker confirms the basics that U.S. accounting principles apply to ICO’s as they do with any other offerings. Issuing companies should review guidance related to the presentation and disclosure of financial statements, consolidation, translation, assets, liabilities, revenue, expenses and ownership.

Mr. Bricker lists questions that both issuers and holders should consider:

Issuers:

What are the necessary financial statement filing requirements?

Are there liabilities requiring recognition or disclosure?

Are there previously recognized assets that require de-recognition?

Are there revenues or expenses requiring recognition or deferral?

Is there a transaction with owners, resulting in debt or equity classification and possibly compensation expense?

Are there implications for the provision for income taxes?

Holders:

Does specialized accounting guidance (such as for investment companies) apply to the holder’s financial statement presentation?

What are the characteristics of the coin or token in considering whether, how, and at what value the transaction should affect the holder’s financial statements?

What is the nature of the holder’s involvement in considering whether the issuer’s activities should be consolidated or accounted for under the equity method?

A new wave of ICO’s

Since the SEC issued its report on the DAO, my office has been actively involved with clients and potential clients interested in structuring ICO’s which comply with the federal (and state) securities laws. Although I have yet to see a registered ICO, several are now utilizing 506(b) or 506(c) to complete their offerings. For instance, the recent $285 million Filecoin ICO was completed in reliance on Rule 506(c) and included such institutional investors as Sequoia Capital, Andreessen Horowitz and Union Square Ventures. Other similar offerings have been and continue to be launched on platforms such as CoinList (which is partnered with AngelList) and now more traditional securities offering platforms such as Start Engine. I am certain the number of securities ICO’s relying on traditional securities offering registration or exemption rules and regulations will continue to increase dramatically.

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« Updates On Regulation A+ NASDAQ Issues Report Advocating for The U.S. Public Markets »

Updates On Regulation A+

Posted by Securities Attorney Laura Anthony | October 10, 2017 Tags: Improving Access to Capital Act, Summary of Regulation A, Updates On Regulation A+

On September 14, 2017, the SEC issued three new Compliance and Disclosure Interpretations (C&DI) to provide guidance related to the filing of a Form 8-A in conjunction with a Tier 2 Regulation A offering. The new guidance addresses the timing of financial statements and subsequent reporting requirements under the Securities Exchange Act of 1934 (“Exchange Act”).

Furthermore, earlier in September, the House passed the Improving Access to Capital Act, which would allow companies subject to the reporting requirements under the Exchange Act to use Regulation A, a change the entire marketplace is advocating for.

As I do with each blog on Regulation A, I have included an ongoing commentary, practice tips, and thoughts on Regulation A+, and a summary of the Regulation A+ rules, including interpretations and guidance up to the date of this blog.

New CD&I Guidance

As a reminder, Tier 2 issuers that have used the S-1 format for their Form 1-A filing are permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements and to register with a national exchange. The Form 8-A must be filed within 5 days of qualification of the Form 1-A by the SEC. A Form 8-A is a simple Exchange Act registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC. Upon filing a Form 8-A, the issuer will become subject to the full Exchange Act reporting obligations, and the scaled-down Regulation A+ reporting will automatically be suspended. A form 8-A can also be used as a short-form registration to list on a national exchange under Section 12(b) of the Exchange Act.

On March 31, 2017, the SEC issued initial guidance on the timing of the filing of the Form 8-A for an exchange listing. In order to be able to file a Form 8-A as part of the Regulation A+ process, in addition to utilizing Form S-1 format in the Regulation A+ offering circular, a company must file the Form 8-A concurrent with qualification of the offering circular. Registration under 12(g) occurs automatically; however, Registration under 12(b) requires that the applicable national securities exchange certify the registration within five calendar days. As with any SEC filings based on calendar days, where the fifth day falls on a Saturday, Sunday or federal holiday, the certification may be received on the next business day.

In the new September 14, 2017 CD&I, the SEC confirmed that an issuer may also file a Form 8-A concurrently (i.e., within five days) with the qualification of a post-qualification amendment to a Form 1-A. Financial statements in any qualified Form 1-A must be current at the time of qualification, and the same holds true for a post-qualification amendment. The SEC also points out that the reason a Form 8-A may only be filed concurrently with qualification is to ensure that financial statements are current at the time a company becomes registered under the Exchange Act and subject to its reporting requirements.

The SEC has clarified the timing of an annual report on Form 10-K once an 8-A has been filed. In particular, in the event that a qualified Form 1-A did not contain an audit of the last full fiscal year, the SEC will allow the company to file its annual report within 90 days of effectiveness of a Form 8-A. A Form 8-A is usually effective as of its filing, but can be preconditioned on certain events, such as a certification of a national exchange as described above. For example, if a company with a calendar year-end qualifies a Form 1-A on March 30, 2018 and files an 8-A on April 4, 2018, it would be required to file a Form 10-K for fiscal year-end December 31, 2017 (with the 2016 comparable period) within 90 calendar days from the effectiveness of the Form 8-A.

Likewise, the SEC provided guidance on the timing of a quarterly report on Form 10-Q following effectiveness of a Form 8-A. Generally, a company must file its 10-Q within 45 days of the effectiveness of a registration statement, or on the due date of its regular 10-Q if the company was already subject to the Exchange Act reporting requirements. The SEC has confirmed that it will allow a 10-Q to be filed within 45 days of effectiveness of a Form 8-A filed in connection with a Form 1-A qualification. Moreover, a company may actually have to file two Form 10-Q’s in that time period. A Form 1-A does not require (or allow for) the filing of quarterly stub periods; rather, a stub period must be for a minimum of a six-month financial period. Accordingly, it is possible that a company would need to file two Form 10-Q’s for two stub periods, within 45 days of effectiveness of its Form 8-A.

For example, a company with a calendar year-end qualifies a Form 1-A on August 10, 2018 and files a Form 8-A, which goes effective on the same day. The qualified Form 1-A contains an audit for fiscal year-end December 31, 2016 and 2017, but does not contain any stub period financial statements for 2018 (note that the 2017 year-end audit would not go stale for purposes of Regulation A until September 30, 2018 in this example). In this case, the company would need to file its Form 10-Q’s for both quarters ended March 31, 2018 and June 30, 2018 by September 24, 2018.

Improving Access to Capital Act

The Improving Access to Capital Act is a short Act with only two sections. First the Act requires that companies subject to the Exchange Act reporting requirements not be ineligible to utilize Regulation A. As noted below, Regulation A is written to include a list of ineligible issuers. The Act would remove reporting companies from that list. Second the Act provides that Exchange Act reports will satisfy the Tier 2 reporting requirements.

The Act was passed with a 403-3 vote by the House and will next be presented to the Senate. I am hopeful that this much-needed change will come to fruition.

The Final Rules – Summary of Regulation A

I’ve written about Regulation A+ on numerous occasions, including detailing the history and intent of the rules. Title IV of the JOBS Act, which was signed into law on April 5, 2012, set out the framework for the new Regulation A and required the SEC to adopt specific rules to implement the new provisions. The new rules came into effect on June 19, 2015. For a refresher on such history and intent, see my blog HERE. Importantly, as I point out in that blog and others I have written on the subject, Tier 2 of Regulation A preempts state blue sky law.

In addition to the federal government, every state has its own set of securities laws and securities regulators. Unless the federal law specifically “preempts” or overrules state law, every offer and sale of securities must comply with both the federal and the state law. There are 54 U.S. jurisdictions, including all 50 states and 4 territories, each with separate and different securities laws. Even in states that have identical statutes, the states’ interpretations or focuses under the statutes differ greatly. On top of that, each state has a filing fee and a review process that takes time to deal with. It’s difficult, time-consuming and expensive.

However, as I will discuss below, this does not include preemption of state law related to broker-dealer registration. Five states (Florida, New York, Texas, Arizona and North Dakota) do not have “issuer exemptions” for public offerings such as a Regulation A offering. Companies completing a Regulation A offering without a broker-dealer will need to register as an “issuer dealer” in those states.

Two Tiers of Offerings

Regulation A is now divided into two offering paths, referred to as Tier 1 and Tier 2. Tier 1 remains substantially the same as the old pre-JOBS Act Regulation A but with a higher offering limit and allowing for more marketing and testing the waters. A Tier 1 offering allows for sales of up to $20 million in any 12-month period. Since Tier 1 does not preempt state law, it is really only useful for offerings that are limited to one but no more than a small handful of states. Tier 1 does not require the company to include audited financial statements and does not have any ongoing SEC reporting requirements. Tier 1 cannot be used for an initial going public transaction.

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

Tier 2 allows a company to file an offering circular with the SEC to raise up $50 million in a 12-month period. Tier 2 preempts state blue sky law. A company may elect to either provide the disclosure in the new Form 1-A or the disclosure in a traditional Form S-1 when conducting a Tier 2 offering. The Form S-1 format is a precondition to being able to file a Form 8-A to register under the Exchange Act. Either way, the SEC review process is a little shorter, and a company can market in a way that it cannot with a traditional IPO. Regulation A has specific company eligibility requirements, investor qualifications and associated per-investor investment limits.

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

Eligibility Requirements

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

The following issuers are not eligible for a Regulation A offering:

Companies currently subject to the reporting requirements of the Exchange Act;

Investment companies registered or required to be registered under the Investment Company Act of 1940, including BDC’s;

Blank check companies, which are companies that have no specific business plan or purpose or whose business plan and purpose is to engage in a merger or acquisition with an unidentified target; however, shell companies are not prohibited, unless such shell company is also a blank check company. A shell company is a company that has no or nominal operations; and either no or nominal assets, assets consisting of cash and cash equivalents; or assets consisting of any amount of cash and cash equivalents and nominal other assets. Accordingly, a start-up business or minimally operating business may utilize Regulation A;

Issuers seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights;

Issuers that have been subject to any order of the SEC under Exchange Act Section 12(j) denying, suspending or revoking registration, entered within the past five years;

Issuers that became subject to Regulation A reporting requirements, such as through a Tier 2 offering, and did not file required ongoing reports during the preceding two years; and

Issuers that are disqualified under the Rule 262 “bad actor” provisions

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

Unfortunately, in what is clearly a legislative miss, companies that are already publicly reporting – that is, are already required to file reports with the SEC – are not eligible. OTC Markets has petitioned the SEC to eliminate this eligibility criteria, and pretty well everyone in the industry supports a change here, but for now it remains. One of the top recommendations by the SEC Government-Business Forum on Small Business Capital Formation has also been to expand Regulation A to allow reporting issuers to utilize the process. For more information on the OTC Markets’ petition and discussion of the reasons that a change is needed in this regard, see my blog HERE. Also, as discussed at the beginning of this blog, the House has now passed the Improving Access to Capital Act, which would allow companies subject to the reporting requirements under the Exchange Act to use Regulation A.

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

Eligible Securities

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

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

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

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

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

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

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

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

All solicitation material must be submitted to the SEC as an Exhibit under Part III of Form 1-A. This is a significant difference from S-1 filers, who are not required to file “test the waters” communications with the SEC. There is no requirement that the materials be filed prior to use—only that they be included as an exhibit to the final qualified offering circular. In a CD&I the SEC has also confirmed that the requirement under Industry Guide 5 that sales material be submitted to the SEC before use, does not apply to Regulation A offerings. Industry Guide 5 relates to registration statements involving interests in real estate limited partnerships.

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

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

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

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

Continuous or Delayed Offerings

Continuous or delayed offerings (a form of a shelf offering) are allowed only if the offering statement pertains to: (i) securities to be offered or sold solely by persons other than the issuer (however, note that under the rules this is limited to 30% of any offering); (ii) securities that are offered pursuant to a dividend or interest reinvestment plan or employee benefit plan; (iii) securities that are to be issued upon the exercise of outstanding options, warrants or rights; (iv) securities that are to be issued upon conversion of other outstanding securities; (v) securities that are pledged as collateral; or (vi) securities for which the offering will commence within two days of the offering statement qualification date, will be made on a continuous basis, will continue for a period of in excess of thirty days following the offering statement qualification date, and at the time of qualification are reasonably expected to be completed within two years of the qualification date.

Under this last continuous offering section, issuers that are current in their Tier 2 reporting requirements may make continuous or delayed offerings for up to three years following qualification of the offering statement. Moreover, in the event a new qualification statement is filed for a new Regulation A offering, unsold securities from a prior qualification may be included, thus carrying those unsold securities forward for an additional three-year period. When continuously offering securities under an open Regulation A offering, a company must update its offering circular, via post-qualification amendment, to disclose material changes of fact and to keep the financial statements current.

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

Additional Tier 2 Requirements; Ability to List on an Exchange

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

The investment limitations for non-accredited investors resulted from a compromise with state regulators that opposed the state law preemption for Tier 2 offerings. It is the obligation of the issuer to notify investors of these limitations. Issuers may rely on the investors’ representations as to accreditation (no separate verification is required) and investment limits.

A company completing a Tier 2 offering may file a Form 8-A concurrently with the qualification of the Form 1-A (i.e., no later than 5 days following qualification), to register under the Exchange Act, and may make immediate application to a national securities exchange. A Form 8-A is a simple (generally 2-page) registration form used instead of a Form 10 for companies that have already filed the substantive Form 10 information with the SEC (generally through an S-1). The Form 8-A will only be allowed if it is filed within five (5) days of the qualification of the Form 1-A or a post-qualification amendment to the initial qualified Form 1-A. An issuer could not qualify a Form 1-A, wait a year or two, and then file a Form 8-A. In that case, they would need to use the longer Form 10.

Where the securities will be listed on a national exchange, the accredited investor limitations will not apply. When the Form 8-A is for registration with a national securities exchange under Section 12(b) of the Exchange Act, the national exchange must certify the Form 8-A within five (5) business days of its filing.

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

A company that reports under the scaled-down Regulation A requirements is not considered to be subject to the Exchange Act reporting requirements, and therefore its shareholders will need to satisfy the longer one-year holding period under Rule 144.

In a CD&I, the SEC confirmed that a company may withdraw a Tier 2 offering after qualification but prior to any sales or the filing of an annual report, by filing an exit report on Form 1-Z, and thereafter be relieved of any further filing requirements.

A company that reports under Regulation A may apply to trade on any of the three OTC Markets tiers of quotation (Pink, OTCQB or OTCQX).

Integration

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

The SEC has confirmed that a Regulation A offering can rely on Rule 152 such that a completed exempt offering, such as under Rule 506(b), will not integrate with a subsequent Regulation A offering. Under Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the company subsequently makes a public offering. The SEC has also issued guidance that Rule 152 applies to prevent integration between a completed 506(b) offering and a subsequent 506(c) offering, indicating that the important factor in the Rule 152 analysis is the ability to publicly solicit. As Rule 506(c) is considered a public offering for this analysis, there would be nothing preventing a company from completing a Rule 506(c) offering either before, concurrently or after a Regulation A offering.

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

Offering Statement – General

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

There are no filing fees for the process. The offering statement is reviewed, commented upon and then declared “qualified” by the SEC with an issuance of a “notice of qualification.” The notice of qualification can be requested or will be issued by the SEC upon clearing comments. The SEC has been true to its word in that the review process has been substantially lighter than that normally associated with an S-1 or other Securities Act registration statement.

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

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

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

Offering Statement – Non-Public (Confidential) Submission

The rules permit a company to submit an offering statement to the SEC on a confidential basis. However, only companies that have not previously sold securities under a Regulation A or a Securities Act registration statement may submit the offering confidentially.

Confidential submissions will allow a Regulation A issuer to get the process under way while soliciting interest of investors using the “test the waters” provisions without negative publicity risk if it alters or withdraws the offering before qualification by the SEC. The confidential filing, SEC comments, and all amendments must be publicly filed at least 15 calendar days before qualification.

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

If a company wants to keep certain information confidential, even after the required time to make such information public, it will need to submit two confidential requests, one as part of the offering review process and one when prior confidential filings are made public. During the confidential Form 1-A review process, the company should submit a request under Rule 83 in the same manner it would during a typical review of a registered offering. Once the company is required to make the prior filings “public” (15 days prior to qualification), the company would make a new request for confidential treatment under Rule 406 in the same manner other confidential treatment requests are submitted. For a confidential treatment request under Rules 83 and 406, a company must submit a redacted version of the document via EDGAR with the appropriate legend indicating that confidential treatment has been requested. Concurrently, the company must submit a full, unredacted paper version of the document to the SEC using the ordinary confidential treatment procedure (such filings are submitted via a designated fax line to a designated person to maintain confidentiality).

Offering Statement – Form and Content

An offering statement is submitted on Form 1-A. Form 1-A consists of three parts: Part I – Notification, Part II – Offering Circular, and Part III – Exhibits. Part I calls for certain basic information about the company and the offering, and is primarily designed to confirm and determine eligibility for the use of the Form and a Regulation A offering in general. Part I includes issuer information; issuer eligibility; application of the bad-actor disqualifications and disclosures; jurisdictions in which securities are to be offered; and unregistered securities issued or sold within one year. As Regulation A is legally an unregistered offering, all Regulation A securities sold within the prior year must be included in this section.

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

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

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

Form 1-A requires two years of financial information. All financial statements for Regulation A offerings must be prepared in accordance with GAAP. Financial statements of a Tier 1 issuer are not required to be audited unless the issuer has obtained an audit for other purposes. Audited financial statements are required for Tier 2 issuers. Audit firms for Tier 2 issuers must be independent and PCAOB-registered. An offering statement cannot be qualified if the date of the balance sheet is more than nine months prior to the date of qualification. Financial statements do not go stale for nine months, as opposed to 135 days for other filings under Regulation S-X. Interim financial statements should be for a period of six months following the date of the fiscal year-end.

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

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

Part III requires an exhibits index and a description of exhibits required to be filed as part of the offering statement. A tax opinion is not required to be filed as an exhibit to Form 1-A, but a company may do so voluntarily.

Offering Price

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

Ongoing Reporting

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

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

A Tier 2 issuer may file an exit form 1-Z and relieve itself of any ongoing requirements if no securities have been sold under the Regulation A offering and the Form 1-Z is filed prior to the company’s first annual report on Form 1-K.

The ongoing reporting for Tier 2 companies is less demanding than the reporting requirements under the Securities Exchange Act. In particular, there are fewer 1-K items and only the semiannual 1-SA (rather than the quarterly 10-Q) and fewer events triggering Form 1-U (compared to Form 8-K). Companies may also incorporate text by reference from previous filings. In a CD&I, the SEC confirmed that it will not object if an auditor’s consent is not included as an exhibit to an annual report on Form 1-K, even if though the report contains audited financial statements. The report would still need to contain the auditor’s report, but a separate consent is not required.

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

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

The ongoing reports will qualify as the type of information a market maker would need to support the filing of a 15c2-11 application. Accordingly, an issuer that completes a Tier 2 offering could proceed to engage a market maker to file a 15c2-11 application and trade on the OTC Markets. The OTC Markets allows Regulation A reporting companies to apply for any of its tiers of listing, including the Pink, OTCQB or OTCQX, depending on which tier the company qualifies for.

A company that completes a Tier 2 offering and files a form 8-A may immediately apply for trading on a national exchange such as the NASDAQ or NYSE American. In 2017, several Regulation A issuers have begun trading on both exchanges.

Freely Tradable Securities

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

Since neither Tier 1 nor Tier 2 Regulation A issuers are subject to the Exchange Act reporting requirements (unless a Form 8-A is filed), the Rule 144 holding period for shareholders is the longer 12 months and such shareholders would not be able to rely on Rule 144 at all if the company has been a shell company at any time in its history. For more information on Rule 144 as relates to shell companies, see HERE.

Treatment under Section 12(g)

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

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

The issuer utilizes an SEC-registered transfer agent. Such transfer agent must be engaged at the time the company is relying on the exemption from Exchange Act registration;

The issuer remains subject to the Tier 2 reporting obligations;

The issuer is current in its Tier 2 reporting obligations, including the filing of an annual and semiannual report; and

The issuer has a public float of less than $75 million as of the last business day of its most recently completed semiannual period or, if no public float, had annual revenues of less than $50 million as of its most recently completed fiscal year-end.

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

State Law Preemption

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

Tier 2 offerings are not subject to state law review or qualification – i.e., state law is preempted. Securities sold in Tier 2 offerings were specifically added to the NSMIA as federally covered securities. Federally covered securities are exempt from state registration and overview. Regulation A provides that “(b) Treatment as covered securities for purposes of NSMIA… Section 18(b)(4) of the Securities Act of 1933… is further amended by inserting… (D) a rule or regulation adopted pursuant to section 3(b)(2) and such security is (i) offered or sold on a national securities exchange; or (ii) offered or sold to a qualified purchaser, as defined by the Commission pursuant to paragraph (3) with respect to that purchase or sale.” For a discussion on the NSMIA, see my blogs HERE and HERE.

State securities registration and exemption requirements are only preempted as to the Tier 2 offering and securities purchased pursuant to the qualified Tier 2 for 1-A offering circular. Subsequent resales of such securities are not preempted. However, securities traded on a national exchange are covered securities. Moreover, the OTCQB and OTCQX levels of OTC Markets are becoming widely recognized as satisfying the manual’s exemption for resale trading in most states.

State law preemption only applies to the securities offering itself and not to the person or persons who sell the securities. Unfortunately, not all states offer an issuer exemption for issuers that sell their own securities in public offerings such as a Regulation A offering. In particular, Arizona, Florida, Texas, New York and North Dakota require issuers to register with the state as issuer broker-dealers to qualify to sell securities directly. Each of these states has a short-form registration process in that regard. In addition, Alabama and Nevada require that the selling officers and directors of issuers register with the state.

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

Broker-Dealer Placement

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

Regulation A – Private or Public Offering?

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

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

As mentioned above, the SEC has now confirmed that a Regulation A offering can rely on Rule 152 such that a completed exempt offering, such as under Rule 506(b), will not integrate with a subsequent Regulation A filing. Under Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the issuer subsequently makes a public offering. Along the same lines, as Rule 506(c) is considered a public offering for this analysis, there would be nothing preventing a company from completing a Rule 506(c) offering either before, concurrently or after a Regulation A offering.

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

Tier 2 issuers that have used the S-1 format for their Form 1-A filing are permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements and to register with a national exchange. The Form 8-A must be filed within 5 days of the qualification of the Form 1-A or any post-qualification amendments. A Form 8-A is a simple registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC. Upon filing a Form 8-A, the issuer will become subject to the full Exchange Act reporting obligations, and the scaled-down Regulation A+ reporting will automatically be suspended. A form 8-A can also be used as a short-form registration to list on a national exchange under Section 12(b) of the Exchange Act. Registration under 12(g) occurs automatically; however, Registration under 12(b) requires that the applicable national securities exchange certify the registration within five calendar days. As with any SEC filings based on calendar days, where the fifth day falls on a Saturday, Sunday or federal holiday, the certification may be received on the next business day.

A Regulation A process is clearly the best choice for a company that desires to go public and raise less than $50 million. An initial or direct public offering on Form S-1 does not preempt state law. By choosing a Tier 2 Regulation A offering followed by a Form 8-A, the issuer can achieve the same result – i.e., become a fully reporting trading public company, without the added time and expense of complying with state blue sky laws. In addition to the state law preemption benefit, Regulation A provides relief from the strictly regulated public communications that exist in an S-1 offering.

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

Practice Tip on Registration Rights Contracts

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

Further Thoughts

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

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

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

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SEC Provides Regulatory Relief To Hurricane Victims

Posted by Securities Attorney Laura Anthony | October 3, 2017 Tags: Form ADV Filing Deadline, Form ADV Filing Requirements, SEC Provides Regulatory Relief To Hurricane Victims

On September 28, 2017, the SEC announced interim final temporary rules (“Exemptive Order”) to provide relief to publicly trading companies, investment companies, accountants, transfer agents, municipal advisors and others affected the Hurricanes Harvey, Irma and Maria. In addition to the interim rules, the SEC urges others not covered by the relief but affected in their ability to provide information to the SEC or shareholders to contact the SEC to seek relief on a case-by-case basis.

Interim Final Temporary Rules

Generally the due date for Exchange Act reports for companies relying on the Exemptive Order shall be October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma, and November 2, 2017 for those affected by Hurricane Irma. As such, companies with such extended due dates may also file an additional extension on Form 12b-25 on those dates, and benefit from an additional five days for a Form 10-Q and 15 days for a Form 10-K. As long as the subject report is filed within the time specified in the 12b-25, such company will still be considered timely and current in its reporting requirements.

The filing extensions apply to all Exchange Act reports, including under Sections 13(a) such as Forms 10-Q, 10-K and 8-K; 13(d), (f) and (g) for reports of ownership in excess of 5%; Section 14 proxy, information, and tender offer filing; Section 15(d) filings, including Forms 10-Q, 10-K and 8-K; and 16(a), Regulations 13A, 13D-G, 14A, 14C and 15D, and Exchange Act Rules 13f-1, 14f-1 and 16a-3.

Where the company is seeking relief from a requirement to deliver a report or information to shareholders, such as proxy or tender offer information under Section 14 of the Exchange Act, in addition to the time periods, the company must show that the shareholders had a mailing address located in the zip codes affected by Hurricanes Harvey, Irma or Maria and that mail service was suspended.

For purposes of the eligibility to use Form S-3, a company relying on the Exemptive Order will be considered current and timely in its Exchange Act filing requirement during the relief period, if such company was current and timely prior to the first day of the period specified in the Order. As a reminder, among other requirements, to qualify to use an S-3 registration statement a company must have filed all Exchange Act reports in a timely manner, including Form 8-K, within the prior 12 months. Any delayed reports need to be filed by October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma and November 2, 2017 for those affected by Hurricane Irma.

For purposes of Form S-8 eligibility and the current information requirements under Rule 144(c), a company relying on the Exemptive Order will be considered current in its Exchange Act filing requirements if such company was current and timely prior to the first day of the period specified in the Order. Again, any delayed reports need to be filed by October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma and November 2, 2017 for those affected by Hurricane Irma.

Registered transfer agents either in areas affected by the Hurricanes, or unable to provide services to security holders in the affected areas, were also granted relief. Registered transfer agents unable to provide services under Sections 17A and 17(f) of the Exchange Act are granted temporary exemptive relief from compliance from August 25, 2017 through November 2, 2017 if: (i) they notify the SEC in writing by November 2, 2017 that they are relying on the Exemptive Order; (ii) the notification provides a statement of the reasons why, in good faith, the transfer agent was unable to comply with the rules; (iii) if the transfer agent knows or believes that the books and records it is required to maintain were lost, destroyed or materially damaged, the extent of such loss, the affected issuers, and steps taken to rectify the damage; (iv) if the transfer agent knows or believes that funds or securities belonging to either an issuer or security holder that were within its possession were lost, destroyed or materially damaged, the extent of such loss and steps taken to rectify the damage; and (v) the transfer agent must take steps to protect remaining books, records, funds and securities.

The Exemptive Order also allows independent auditors to provide books and records to issuer clients to assist in the reconstruction of accounting records, without infringing on such auditors’ independence. In particular, Exchange Act rules and Regulation S-X prohibit an independent auditor from “maintaining or preparing the audit client’s accounting records” or “preparing or originating source data underlying the audit client’s financial statements.” Relief under the Exemptive Order is conditioned upon limiting services by the independent auditor to reconstruction of previously existing accounting records that were lost or destroyed as a result of the hurricanes and that such services cease as soon as the audit client’s lost or destroyed records are reconstructed, its financial systems are fully operational and the client can effect an orderly and efficient transition to management or other service provider. In addition, the company’s audit committee must specifically approve the auditor’s services.

During the period from August 25, 2017 to November 1, 2017, a registered open-end investment company and a registered unit investment trust will be considered to have satisfied the requirements of Section 5(b)(2) of the Securities Act to deliver a summary or a statutory prospectus to an investor, provided that: (1) the sale of shares to the investor was not an initial purchase by the investor of shares of the company or unit investment trust; (2) the investor’s mailing address for delivery, as listed in the records of the company or unit investment trust, has a ZIP code for which the common carrier has suspended mail service, as a result of Hurricanes Harvey, Irma, Maria, of the type or class customarily used by the company or unit investment trust, to deliver summary or statutory prospectuses; and (3) the company, or unit investment trust, or other person promptly delivers the summary or statutory prospectus, either (a) if requested by the investor, or (b) by the earlier (i) of November 2, 2017 or (ii) the resumption of the applicable mail service. The same dates and parameters apply to registered investment advisers for the delivery of written disclosure statements to advisory clients.

A registered investment advisor affected by Hurricane Harvey will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between August 25, 2017 and October 6, 2017; and (ii) they filed by October, 10, 2017.

A registered investment advisor affected by Hurricane Irma will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between September 6, 2017 and October 18, 2017; and (ii) they filed by October, 19, 2017.

A registered investment advisor affected by Hurricane Maria will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between September 20, 2017 and November 1, 2017; and (ii) they filed by November 2, 2017.

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