December 2017 - Reverse-Merger.com

The Investment Adviser Advertising Rule

Posted by Securities Attorney Laura Anthony | December 27, 2017 Tags: Advertising Rule, C Office of Compliance Inspections and Examinations, Investment Adviser Advertising Rule, Rule 206(4)-1, The Investment Adviser Advertising Rule, the SEC Office of Compliance Inspections and Examinations

On September 14, 2017, the SEC Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert identifying the most frequent compliance violations to the investment adviser’s advertising rule.

The Advertising Rule

The “Advertising Rule” found in Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advisers Act”) prohibits an adviser from directly or indirectly publishing, circulating or distributing any advertisement that contains any untrue statement of material fact, or that is otherwise false or misleading. “Advertising” includes any “notice, circular, letter or other written communicated addressed to one or more persons or any notice or other announcement published or made by radio or television which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.”

The Advertising Rule specifically prohibits: (i) any advertisement that directly or indirectly refers to any testimonial concerning the adviser or any report or service rendered by the adviser; (ii) an adviser from advertising past specific recommendations that were profitable to any person; (iii) any advertisements claiming that any graph, chart or formula can by itself determine whether to buy or sell a security; and (iv) advertisements that offer purportedly free reports, analysis or services.

In addition to the Advertising Rule itself, guidance on adviser advertising can be found in SEC-issued guidance updates, opinions and no-action letters, and settled or adjudicated court and administrative proceedings.

Most Frequent Advertising Rule Violations

The OCIE risk alert identified the following most frequent violations of the Advertising Rule:

Misleading Performance Results. The OCIE often observed advertisements with misleading performance results. As an example, any advertisement of results that do not deduct the advisory fee from the presented performance, is deemed misleading. As another example, advertisements that compared results from a particular benchmark were often misleading as the parameters or strategies involved in the two comparisons were often materially different. Finally, hypothetical and back-tested performance results could be misleading where information on how returns were derived or other material information was not included.

Misleading One-on-One Presentations. An example of a misleading one-on-one presentation would be where the adviser advertised performance results gross of fees without necessarily additional material disclosures. Again, the mere failure to disclose that advisory fees had not been deducted from an advertisement would also be misleading.

Misleading Claim of Compliance with Voluntary Performance Standards. The OCIE staff observes cases in which an adviser claims compliance with voluntary performance standards, when in fact, they were not compliant.

Cherry-Picked Profitable Stock Selections. An advertisement that cherry-picks profitable stock selections without a balanced presentation, including disclosure related to unprofitable selections, is misleading.

Misleading Selection of Recommendations. The OCIE staff often finds adviser advertisements that include past specific investment recommendations in a misleading way. In the TCW Group no-action letter, the SEC specifically found that it was not misleading to include five or more best-performing holdings or stock picks, as long as an equal number of worst performers were also disclosed. Moreover, an adviser would have to also include other materially relevant information about its strategy. In the Franklin no-action letter, the SEC staff allowed advertisements including past specific performance results that used consistently applied, objective, non-performance based selection criteria, as long as the adviser included certain disclosures such as that the included results were not all results or all securities purchased or sold, and did not include profits related to specific recommendations. Many advisers fail to follow the guidance in these no-action letters.

Compliance Policies and Procedures. Many advisers do not have adequate compliance policies and procedures to prevent deficient advertising practices. Adequate procedures would include a process for reviewing and approving advertisement materials prior to publication or dissemination; determining parameters for inclusion in performance calculations; and confirming the accuracy of performance results.

OCIE Touting Initiative

In 2016 the OCIE launched a Touting Initiative to examine adviser advertisements that touted awards, ranking lists or professional designations and accolades in their marketing materials. Where an adviser includes third-party rankings or awards in their advertisements, they must include material facts related to the award or ranking, so as not to be misleading, including the date of the award, selection criteria, who created or gave the award or ranking, and whether the adviser paid to be included. Furthermore, the OCIE found that advisers sometimes obtained a ranking or award by providing false information in their application or nomination for the award in the first place. Finally, another commonly found touting violation involved improper client testimonials.

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.

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

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SEC Advisory Committee On Small And Emerging Companies Holds Final Meeting

Posted by Securities Attorney Laura Anthony | December 19, 2017 Tags: SEC Advisory Committee On Small And Emerging Companies Holds Final Meeting

On September 13, 2017, the SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) held its final meeting and issued its final report. The Committee was organized by the SEC for a two-year term to provide advice on SEC rules, regulations and policies regarding “its mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation” as related to “(i) capital raising by emerging privately held small businesses and publicly traded companies with less than $250 million in public market capitalization; (ii) trading in the securities of such businesses and companies; and (iii) public reporting and corporate governance requirements to which such businesses and companies are subject.”

As the two-year term is expiring, Congress has determined to establish an Exchange Act-mandated, perpetual committee to be named the Small Business Capital Formation Advisory Committee. The SEC is also setting up a new Office of Advocate for Small Business Capital Formation and is actively seeking to fill both the advocate and Committee positions.

The September 13, 2017 Advisory Committee meeting discussed: (i) the auditor attestation report under Section 404(b) of the Sarbanes Oxley Act (“SOX”); (ii) the proposed amendments to the definition of a “smaller reporting company”; (iii) amendments to the definition of an “accredited investor”; (iv) potential updates to modernize Securities Act Rule 701 of the Securities Act related to employee stock compensation from private companies; (v) finders in private placement transaction; (vi) disclosure of board diversity; and (vii) the creation of a new secondary market for accredited investors to trade small-cap equities.

Amendment to Smaller Reporting Company Definition

The Advisory Committee believes that public company disclosure requirements disproportionately burden smaller reporting companies. In July 2015 the Advisory Committee made specific recommendations to the SEC for changes to the definition of a “smaller reporting company” (see HERE). Under the current rules a “smaller reporting company” is defined as one that, among other things, has a public float of less than $75 million in common equity, or if unable to calculate the public float, has less than $50 million in annual revenues. Similarly, a company is considered a non-accelerated filer if it has a public float of less than $75 million as of the last day of the most recently completely second fiscal quarter. The Advisory Committee has made the following recommendations:

The SEC should revise the definition of “smaller reporting company” to include companies with a public float of up to $250 million. This will increase the class of companies benefiting from a broad range of benefits to smaller reporting companies, including (i) exemption from the pay ratio rule; (ii) exemption from the auditor attestation requirements; and (iii) exemption from providing a compensation discussion and analysis. I note that the SEC proposed rules conforming to this recommendation and in the most recent meeting urged the SEC to finalize the rule. For more on the SEC proposed rule change, see HERE.

The SEC should revise its rules to align disclosure requirements for smaller reporting companies with those for emerging-growth companies. These include (i) exemption from the requirement to conduct shareholder advisory votes on executive compensation and on the frequency of such votes; (ii) exemption from rules requiring mandatory audit firm rotation; (iii) exemption from pay versus performance disclosure; and (iv) allow compliance with new accounting standards on the date that private companies are required to comply. For more information on the differences between a smaller reporting company and an EGC, please see HERE.

The SEC should revise the definition of “accelerated filer” to include companies with a public float of $250 million or more but less than $700 million. As a result, the auditor attestation report under Section 404(b) of the Sarbanes-Oxley Act would no longer apply to companies with a public float between $75 million and $250 million.

As an aside, one of the recommendations flowing from the 2016 SEC Government-Business Forum on Small Business Capital Formation is that the definition of smaller reporting company and non-accelerated filer should be revised to include an issuer with a public float of less than $250 million or with annual revenues of less than $100 million, excluding large accelerated filers; and to extend the period of exemption from Sarbanes 404(b) for an additional five years for pre- or low-revenue companies after they cease to be emerging-growth companies.

Amendment to Definition of an Accredited Investor

Previously on June 19, 2016, and in early 2015, the Advisory Committee made specific recommendations for changes to the definition of an “accredited investor.” See here for my prior blog on the subject HERE. The Advisory Committee has reiterated its prior recommendations, including:

The core of prior recommendations remain the same with the added statement that “the overarching goal of any changes the Commission might consider should be to ‘do no harm’ to the private offering ecosystem.”

The SEC should not change the current financial thresholds in the definition except to adjust for inflation on a going-forward basis.

The definition should be expanded to take into account measure of non-financial sophistication, regardless of income or net worth, thereby expanding rather than contracting the pool of accredited investors.

“Simplicity and certainty are vital to the utility of any expanded definition of accredited investor. Accordingly, any non-financial criteria should be able to be ascertained with certainty”; and

The SEC should continue to gather data on this subject and, in particular, what “attributes best encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”

Amendment to Rule 701

The Advisory Committee heard presentations and made recommendations to the SEC to amend Rule 701. Rule 701 of the Securities Act provides an exemption from the registration requirements for the issuance of securities under written compensatory benefit plans. Rule 701 is a specialized exemption for private or non-reporting entities and may not be relied upon by companies that are subject to the reporting requirements of the Exchange Act. The Rule 701 exemption is only available to the issuing company and may not be relied upon for the resale of securities, whether by an affiliate or non-affiliate.

Rule 701 exempts the offers and sales of securities under a written compensatory plan. The plan can provide for issuances to employees, directors, officers, general partners, trustees, or consultants and advisors. However, under the rule consultants and advisors may only receive securities under the exemption if: (i) they are a natural person (i.e., no entities); (ii) they provide bona fide services to the issuer, its parent or subsidiaries; and (iii) the services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market in the company’s securities.

Securities issued under Rule 701 are restricted securities for purposes of Rule 144; however, 90 days after a company becomes subject to the Exchange Act reporting requirements, securities issued under a 701 plan become available for resale. In addition, non-affiliates may sell Rule 701 securities after the 90-day period without regard to the current public information or holding period requirements of Rule 144.

The amount of securities sold in reliance on Rule 701 may not exceed, in any 12-month period, the greater of: (i) $1,000,000; (ii) 15% of the total assets of the issuer; or (iii) 15% of the outstanding amount of the class of securities being offered and sold in reliance on the exemption. Rule 701 issuances do not integrate with the offer and sales of any other securities under the Securities Act, whether registered or exempt.

Rule 701(e) contains specific disclosure obligations scaled to the amount of securities sold. In particular, for all issuances under Rule 701 a company must provide a copy of the plan itself to the share recipient. Where the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $5 million, the company must provide the following disclosures to investors within a reasonable period of time before the date of the sale: (i) a copy of the plan itself (ii) risk factors; (iii) financial statement as required under Regulation A; (iv) if the award is an option or warrant, the company must deliver disclosure before exercise or conversion; and (v) for deferred compensation, the company must deliver the disclosure to investors within a reasonable time before the date of the irrevocable election to defer is made.

The Advisory Committee made the following recommendations related to Rule 701:

Eliminate the Requirement that consultants be natural persons. The original limitation was intended to prevent Rule 701 from being used for capital-raising transactions; however, many smaller companies use outside employees or employee rental services that are run through entities. The Advisory Committee believes that this change will bring Rule 701 more in line with the realities of today’s business operations and that other provisions of the rule adequately address the prohibition against improper use of the Rule, such as for capital-raising transactions.

Remove the Rule 701 limits of the greater of: (i) $1,000,000; (ii) 15% of the total assets of the issuer; or (iii) 15% of the outstanding amount of the class of securities being offered and sold in reliance on the exemption. The Advisory Committee believes that the analysis required by these limits outweigh any benefits.

Increase the $5 million disclosure requirement cap to at least $10 million. Note that bills have now passed both the House and Senate that would increase the cap to $10 million and are expected to be signed by the President in the near future.

Exclude “material amendments” from the calculation of the limits in the Rule. Currently SEC CD&I on the Rule require repriced options to be counted as new grants or sales. However, it is argued that repricing merely keeps options within the intended use of the Rule, i.e., as compensation. Moreover, it is thought that companies avoid repricing when it would be beneficial, to avoid reaching the Rule limits.

Clarify the application of the Rule to Restricted Stock Units (RSU’s). RSU’s are not currently addressed in the Rule. It is recommended that they be treated the same as options. In addition, it is recommended that any disclosure obligations be triggered by exercise or settlement and not the grant itself. Note, however, that a CD&I does include RSU’s under Rule 701 and requires disclosure, and limit analysis, as of the date of grant.

Require disclosure only after the threshold has been exceeded. Currently, expanded disclosure must be provided to any person who receives securities under Rule 701 during the 12-month period in which the company sells securities under Rule 701 with a value over $5 million. As disclosure is required prior to a grant, a company could inadvertently fail to comply with the Rule when it did not properly predict it would reach the cap, or future amendments result in reaching the cap. This is another reason that amendments should be excluded from the cap calculation. Moreover, it was recommended that the disclosure requirements be simplified to require only a current balance sheet and income statement, and only requiring updates upon a material change or once a year.

Clarify timing and delivery requirements for disclosure documents. Currently disclosure is required to be delivered “a reasonable period of time prior to the sale.” It is recommended that disclosure be clearly allowed to be delivered at any time prior to the sale and that “access equals delivery” satisfy deliver requirements. Since Rule 701 only applies to private companies, companies sometimes do, and could be formally allowed to set up data rooms accessible to equity recipients. Note that on November 6, 2017, the SEC issued a new CD&I on the subject which specifically allows a company to implement cyber security safeguards when electronically transmitting or providing disclosure in accordance with Rule 701.

For more on Rule 701, see my blog HERE.

Private Placement Finders

In a repeated and ongoing theme, the Advisory Committee once again recommended that the SEC take action to provide regulatory certainty to finders in private placement transactions. The Advisory Committee has previously made recommendations to the SEC and sought regulatory action on May 15, 2017 and on September 23, 2015. In addition to a plea for any guidance and support, in 2015 the Advisory Committee had made the following specific recommendations:

The SEC take steps to clarify the current ambiguity in broker-dealer regulation by determining that persons that receive transaction-based compensation solely for providing names of or introductions to prospective investors are not subject to registration as a broker under the Exchange Act;

The SEC exempt intermediaries on a federal level that are actively involved in the discussions, negotiations and structuring, and solicitation of prospective investors for private financings as long as such intermediaries are registered on the state level;

The SEC spearhead a joint effort with the North American Securities Administrators Association (NASAA) and FINRA to ensure coordinated state regulation and adoption of measured regulation that is transparent, responsive to the needs of small businesses for capital, proportional to the risks to which investors in such offerings are exposed, and capable of early implementation and ongoing enforcement; and

The SEC should take immediate steps to begin to address this set of issues incrementally instead of waiting for the development of a comprehensive solution.

For a review of my ongoing discussion on finder’s fees, see my blog HERE.

Board Diversity

The Advisory Committee believes that board diversity improves competitiveness and creates greater access to capital, more sustainable profits and better shareholder relationships. As such, the Advisory Committee recommends that the SEC amend its current very broad rule on board diversity disclosure to require companies to describe their policies with respect to diversity and to disclose the extent to which their boards are diverse. As with the current rule, the definition of diversity can be left to the company; however, disclosure should include information regarding race, gender and ethnicity.

Market Structure – Secondary Trading

The Advisory Committee recognizes that liquidity is an issue for smaller companies. The Advisory Committee advocates for a new U.S. equity market for the trading by accredited investors in smaller company securities. The Advisory Committee also advocates for federal law preemption over the secondary trading of Tier 2 Regulation A securities. Moreover, the Advisory Committee recommends that the SEC allow for smaller exchange-listed companies to voluntarily choose larger trading increments or tick sizes. It is thought that widening spreads from the current one-penny increments could provide economic incentives that would encourage the provision of trading support to the equity securities of small and mid-cap companies. More flexibility and larger tick sizes could also encourage IPO’s for small companies. For more on the SEC tick size pilot program, see HERE.

Sarbanes-Oxley Section 404(b)

The Advisory Committee has heard presentations on the Sarbanes-Oxley Section 404(b) requirement for an auditor attestation and report on management’s assessment of internal control over financial reporting. Among other things, Section 404(b) of SOX requires companies to include in their annual reports filed with the SEC, an accompanying auditor’s attestation report on the effectiveness of the company’s internal control over financial reporting. In other words, reporting companies must employ their auditor to audit and attest upon their financial internal control process, in addition to the financial statements themselves.

Section 404(b) has been a hot topic recently, with those already or soon to be required to comply almost unilaterally requesting relief, and those that benefit from its application, including accountants and auditors, almost unilaterally touting its benefits. The Financial Choice Act, which is not likely to pass in its complete form, includes a provision that would increase the Rule 404(b) compliance threshold from a $250 million public float to $500 million.

In one Advisory Committee presentation, a representative from a large accounting firm supported Section 404(b) and touted improvements in accounting quality. According to studies, companies that have control audits have fewer restatements, higher valuations and lower costs of debt.

However, in the second presentation by the CEO of a relatively small pre-revenue biotech company, the reality of the onerous cost and effort involved to comply with Section 404(b) was illustrated. The cost of 404(b) compliance took away from R&D, growth, and additional employees, and could add 1% or more to the company’s overall burn rate. That CEO advocated for an exemption from 404(b) for all companies with either a public float under $250 million or annual revenues under $100 million.

The Advisory Committee seems to agree that 404(b) is not necessary or helpful for smaller companies but did not make a specific recommendation as suggested by the biotech CEO. Rather, the Advisory Board has recommended a change in the definition of “accelerated filer” as noted above, which would include a higher threshold for Section 404(b) compliance.

The Author

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« SEC Publishes Report on Access to Capital and Market Liquidity The Investment Adviser Advertising Rule »

SEC Publishes Report on Access to Capital and Market Liquidity

Posted by Securities Attorney Laura Anthony | December 13, 2017 Tags: Access to Capital and Market Liquidity, Changes and Trends in Market Liquidity, Changes and Trends in Primary Issuance, SEC Publishes Report on Access to Capital and Market Liquidity

On August 8, 2017 the SEC Division of Economic and Risk Analysis (DERA) published a 315-page report describing trends in primary securities issuance and secondary market liquidity and assessing how those trends relate to impacts of the Dodd-Frank Act, including the Volcker Rule. The report examines the issuances of debt, equity and asset-backed securities and reviews liquidity in U.S. treasuries, corporate bonds, credit default swaps and bond funds. Included in the reports is a study of trends in unregistered offerings, including Regulation C and Regulation Crowdfunding.

This blog summarizes portions of the report that I think will be of interest to the small-cap marketplace.

Disclaimers and Considerations

The report begins with a level of disclaimers and the obvious issue of isolating the impact of particular rules, especially when multiple rules are being implemented in the same time period. Even without the DERA notes that noted trends and behaviors could have occurred absent rule changes or reforms. The financial crisis that resulted in the implementation of Dodd-Frank, necessarily resulted in changes in market trends in and of itself, as did post crisis changes other than Dodd-Frank such as much lower interest rates. Furthermore, observed changes could be a result of numerous other factors such as various regulations (besides the studies Dodd-Frank and JOBS Act), non-regulatory market structure changes and technological advances.

Moreover, five broad economic considerations shaped the DERA analysis. First, capital raising in primary markets and liquidity in secondary markets are inextricably intertwined. There is a direct correlation between the ability to exit investments on the secondary market and the inflow of new investments for primary issuances. Second, alternative credit risk products impact activity and liquidity in bond markets. Third, liquidity is an important characteristic of capital markets, impacting the ability of investors to execute trades of different sizes, quickly and at a low cost. Fourth, although large sample analysis is used to study the markets, this information may not reflect the behaviors of smaller market segments. For example, since the sample size and offering size for companies relying on the JOBS Act provisions is relatively small, and its time of use is relatively short, the DERA declines to reach conclusions regarding future trends related to these offerings. Fifth, regulations that affect one group over another, affect the ability to observe overall changes in market indicators and links to such regulations.

Changes and Trends in Primary Issuance

As I reiterate in many of my blogs, all offers and sales of securities must be either registered with the SEC under the Securities Act of 1933 (the “Securities Act”) or conducted under an exemption from registration. All offerings require disclosure to potential investors with registered offerings requiring detailed disclosures and financial information delineated by regulations, including Regulations S-K and S-X. Companies completing registered offerings become subject to ongoing reporting requirements under the Securities Exchange Act of 1934 (the “Exchange Act”). For more information on Exchange Act reporting requirements, see HERE.

One of the purposes of exempt offerings is to reduce the burden on companies during the capital-raising process and thereafter. Certainly not all companies can afford, nor should take on the expense of, a registered offering and ongoing SEC reporting requirements. Since exempt offerings require fewer disclosures and have far less regulatory oversight, they are subject to investor limitations, such as accreditation, and for some, offering limits. The investor protection provisions of the exemption claimed must be met to qualify for the exemption from registration.

The JOBS Act, enacted in 2012, was designed to promote registered and exempt offerings. The JOBS Act created emerging growth companies (EGC’s), expanded Rule 506 of Regulation D by creating Rule 506(c) allowing general solicitation and advertising in exempt offerings limited to accredited investors, amended Rule 144A to allow general solicitation and advertising, revamped Regulation A completely and created Regulation CF (Title III Crowdfunding). The DERA notes that these changes would be expected to have important effects on the amount of capital being raised and personally, I think that the changes have had a dramatic impact on primary issuances and especially for smaller companies.

As noted above, the DERA is reluctant to directly tie increases in primary market issuances to the JOBS Act because it involves relatively newer regulations (the provisions were enacted over time from 2012 through 2016), and smaller sample sizes for analysis, but the report can’t deny the uptick, noting the increase in activity around its implementation.

The DERA analyzed the primary issuance of debt, equity and asset-backed securities. The DERA reviewed changes in IPO’s, seasoned follow-on offerings, Regulation A and exempt offerings of debt and equity under Regulation D. Total capital formation from the signing of Dodd-Frank into law in 2010 through the end of 2016 was $20.20 trillion, of which $8.8 trillion was raised through registered offerings and the balance through private offerings. The DERA did not find a decrease in total primary market security issuances as a result of Dodd-Frank, though it did find that there was an increase around the implementation of the JOBS Act in 2012.

The DERA did note several trends, including that capital raised through initial public offerings (IPO’s) ebbs and flows over time, reaching highs in 1999, 2007 and 2014 and lows in 2003, 2008 and 2016. The number of small company IPO’s has increased in recent years. IPO’s of less than $30 million increased from 17% of total IPO’s to 22% following passage of the JOBS Act. Although I do not believe that emerging growth companies (EGC’s) are necessarily small companies, more than 75% of IPO’s were by EGC’s in 2016. The use of Regulation A also continues to increase.

In addition, private offerings have increased substantially over the years. The amount raised through private offerings in the period from 2012 through 2016 was more than 26% higher than the amount raised in registered offerings in the same time period.

Changes and Trends in Market Liquidity

The DERA found it more difficult to tie changes in market liquidity to regulatory reform, citing other factors such as the electronification of markets, changes in macroeconomic conditions, and post-crisis changes in dealer risk preferences as influencers.

The report focused on treasuries, corporate bonds, single-name credit default swaps and funds in its liquidity analysis, devoting 191 pages to these topics. A discussion of this areas is beyond the scope of this blog.

The DERA does state that it found no empirical evidence that U.S. Treasury market liquidity deteriorated after regulatory reforms. Trading activity in corporate bond markets has generally improved or remained flat. Furthermore, transaction costs have decreased over the years on whole. Dealers in corporate bond markets have reduced their capital commitment since 2007, which is consistent with the Volcker Rule.

The Author

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« OTC Markets Group Establishes A Stock Promotion Policy SEC Advisory Committee On Small And Emerging Companies Holds Final Meeting »

OTC Markets Group Establishes A Stock Promotion Policy

Posted by Securities Attorney Laura Anthony | December 5, 2017 Tags: OTC Markets, OTC Markets Group, OTC Markets Group Establishes A Stock Promotion Policy, Stock Promotion Policy

As OTC Markets Group continues to position itself as a respected venture trading platform, it has adopted a new stock promotion policy and best practices guidelines to improve investor transparency and address concerns over fraudulent or improper stock promotion campaigns. The stock promotion policy and best practices guidelines are designed to assist companies with responsible investor relations and to address problematic issues. Recognizing that fraudulent stock promotion is a systemic problem requiring an all-fronts effort by industry participants and regulators, the new policy focuses on transparency and disclosure of current information, and the correction of false statements or materially misleading information issued by third parties.

For several years, OTC Markets Group has been delineating companies with a skull-and-crossbones sign where they have raised concerns such as improper or misleading disclosures, spam campaigns, questionable stock promotion, investigation of fraudulent or other criminal activity, regulatory suspensions or disruptive corporate actions. While labeled with a skull and crossbones, a company that does not have current information or is not on the OTCQB or OTCQX will have its quote blocked on the OTC Markets website.

The new policy addresses: (i) publicly identifying securities being promoted; (ii) identifying fraudulent promotional campaigns; (iii) responsibilities of companies with promoted securities; (iv) the impact on OTCQX or OTCQB designations; (v) caveat emptor policy and stock promotion; and (vi) regulatory referrals. This blog summarizes both the new stock promotion policy and best practices guidelines.

OTC Markets Group Policy on Stock Promotion

The basic premise behind OTC Markets Group policy on stock promotion is the timely disclosure of material information, which includes the duty to dispel unfounded rumors, misinformation or false statements. Technology has increased the ability for companies, insiders and third parties to engage in improper and manipulative activities, including through spam campaigns, and anonymous social networks and message groups.

A company that is the subject of an active campaign or has a history of stock promotion may be denied an application for trading on the OTCQB or OTCQX. A company may be removed from the OTCQB or OTCQX, upon the sole discretion of OTC Markets Group, if it is involved in an active campaign involving misleading information or manipulative promotion. Furthermore, promotional activity of a shell company will result in the immediate removal from OTCQB (shells are not permitted on OTCQX). OTC Markets Group will continue to use the caveat emptor skull-and-crossbones designations as well. Where appropriate, OTC Markets Group will refer a company to the SEC, FINRA or other regulatory agency for investigation.

Paid promotions are often associated with pump-and-dump activities where a third party is attempting to pump the stock price to liquidate at inflated prices, following which the stock will inevitably go down. Improper and misleading promotional materials, which can often be in the form of e-mails, newsletters, social media outlets (such as message boards), press releases, videos, telephone calls, or direct mail, generally share the following common characteristics.

Failure to identify the sponsor of the promotion or if the promotion is paid for an anonymous third party

Information focuses on a company’s stock rather that its business;

Speculative language, including but not limited to grandiose claims and numbers related to the company’s business, industry, financial results or business developments;

Touting of performance or profit potential from trading in a company’s stock with unsupported or exaggerated statements, including related to stock price;

Making unreasonable claims related to a company’s performance;

Directly or indirectly promising specific future performance;

Providing little or no factual information about the company;

Urging immediate action to avoid missing out;

Failing to provide disclosures related to risks of an investment.

Although not included in OTC Markets’ list of common characteristics, another red flag is when there is a comparison between the company being promoted and a well-known successful or respected company.

OTC Markets Group monitors for paid promotional activity and reviews for anonymous promotions, connections to bad actors, and impacts on trading. Beginning in first quarter 2018, stocks associated with such promotional activity will be identified with a “risk flag” next to its symbol on the OTC Markets website.

OTC Markets Group may also request that a company that is subject to promotional activity issue a press release to: (i) identify promotional activity; (ii) confirm information in the promotion or identify misinformation; (iii) and/or disclose recent securities transactions by insiders and affiliates. Furthermore, OTC Markets group may request information from a company and/or its transfer agent related to transactions and request additional disclosures from the company related to share issuances, financing agreements and the identity of people or advisors associated with the transactions.

OTC Markets Group Best Practices Guidelines for Stock Promotion

As in its separate stock promotion policy, the OTC Markets Group best practices on stock promotion guidelines reiterate the core principle that the timely disclosure of material information is key, which includes the duty to dispel unfounded rumors, misinformation or false statements.

OTC Markets Group suggests that companies perform due diligence on investor relations firms and their principals prior to engaging services. This is advice I am constantly giving to my clients. Basic due diligence includes reviewing other represented clients and doing basic searches for regulatory issues or negative news. Companies should also be very clear on what services an investor relations firm will perform and what compensation will be paid for those services.

Very vague service descriptions often indicate an improper promotional campaign. OTC Markets Group also warns of red flags, including a request that payment be split among various individuals or groups.

A company that hires or sponsors investor relations is responsible for the content of communications made by that company and must ensure that all information is materially current and accurate. In addition, a company should retain editorial control and review all information before it is disseminated. Investor relations materials should not use language that makes assumptions, is speculative or misleading, or brazenly hypes the stock. Communications should not cover new material information that has not been previously disclosed, and should not extend beyond providing factual information to investors and shareholders.

The disclosures required by Section 17(b) must always be properly made, and OTC Markets Group specifically requires that any relationship between the investor relations individuals and entities and the company be fully disclosed.

Since third parties often engage in stock promotional activities without the knowledge or consent of a company, it is important for a company to know its investors, including the people behind any entities or investor groups. Investors that desire anonymity or utilize offshore entities raise a red flag. Furthermore, companies should be wary of shareholders that own significant control or investor groups that will qualify to remove restrictive legends on stock. Investor groups often change the name of their investment vehicle entity and, as such, due diligence should include prior entities.

OTC Markets Group warns against toxic or death spiral financing. Toxic or death spiral financing generally involves an investment in the form of a convertible promissory note or preferred stock that converts into common stock at a discount to market with no floor on the conversion price. As I have written about many times, there are quality investors and others that are not quality in the microcap space. The use of convertible instruments as a method to invest in public companies is perfectly legal and acceptable. However, like any other aspect of the securities marketplace, it can be abused. Further examples of abusive or improper activity could include: (i) backdating of notes or failure to provide the funding associated with the note; (ii) improper undisclosed affiliations between investors and the company or its officers and directors; (iii) manipulative trading practices; (iv) improper stock promotion; or (v) trading on insider information. Again, in choosing a transaction it is incumbent upon the company to conduct due diligence on the investor, including their reputation in the industry and trading history associated with other investments and conversions.

OTC Markets Group also warns of anonymous third-party promotions, noting that these promotions are a significant source of misleading and manipulative information. Any company-sponsored stock promotion must be disclosed, whether the company is involved directly or indirectly. The identity of a company’s investor relations firm must be disclosed on the company’s profile page on otcmarkets.com.

OTC Markets Group recommends that a company make a public announcement with the following information in the event it learns it is the subject of misleading or manipulative stock promotion.

A summary of the company’s understanding of the stock promotion, including how and when the company became aware of the campaign and a description of the promotion’s effect on the company’s trading activity;

Whether the content of the promotion is accurate or contains untrue or misleading information;

Conduct an inquiry of company management, officers and directors, to ascertain whether they are involved in the stock promotion and/or of have purchased or sold securities before, during or after the promotion;

Provide an up-to-date list of service providers who perform investor relations or similar services;

Disclose the issuance of convertible securities with variable rate or discount to market conversion rates. This disclosure should include details on the convertible instruments, including date, number of shares issued or issuable, price, conversion terms, and parties involved.

OTC Markets also suggests that all companies have insider trading policies, a policy which I support and suggest to my clients.

Section 17(b) of the Securities Act of 1933

The federal securities laws also govern stock promotion activity. Section 17(b) of the Securities Act of 1933 is an antifraud provision which requires that any communications which “publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service or communication” which describes a security, must disclose any consideration received or to be received either in the past, present or future, whether directly or indirectly by the issuer of such communication. Generally the disclosure must include: (i) the amount of consideration; (ii) from whom it is received, such as the company, a third-party shareholder or an underwriter and the individual persons behind any corporate entity involved; (iii) the nature of the consideration (for example, cash or stock, and if stock, whether restricted or unrestricted); and (iv) if consideration is paid by a third party other than the company whose securities are being promoted, the relationship between the company and the third party. Moreover, I recommend that companies ensure such communications include a disclosure as to whether the issuer of such communications owns stock which may be sold in any upmarket created by the communication.

The disclosure required by Section 17(b) must be included in each and every published document, including emails, message board postings and all other communications.

Further Reading on OTC Markets Group Rules

For a review of the OTCQB listing standards, see HERE . For a review of the OTCQX listing standards, see HERE. For a review of the OTC Pink standards, see HERE.

The Author

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