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OTCQB And OTCQX Rule Changes

Posted by Securities Attorney Laura Anthony | December 18, 2020 Tags: OTCQB And OTCQX Rule Changes

Effective October 1, 2020, the OTCQB and OTCQX tiers of OTC Markets have instituted amendments to their rules, including an increase in fees.

The OTC Markets divide issuers into three (3) levels of quotation marketplaces: OTCQX, OTCQB and OTC Pink Open Market. The OTC Pink Open Market, which involves the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information. Companies trading on the OTCQX, OTCQB and OTC Pink Current Information tiers of OTC Markets have the option of reporting directly to OTC Markets under its Alternative Reporting Standards. The Alternative Reporting Standards are more robust for the OTCQB and OTCQX in that they require audited financial statements prepared in accordance with U.S. GAAP and audited by a PCAOB qualified auditor in the same format as would be included in SEC registration statements and reports.

As an aside, companies that report to the SEC under Regulation A and foreign companies that qualify for the SEC reporting exemption under Exchange Act Rule 12g3-2(b) may also qualify for the OTCQX, OTCQB and OTC Pink Current Information tiers of OTC Markets if they otherwise meet the listing qualifications. For more information on OTCQB and OTCQX listing requirements, see HERE, HERE, and HERE.

OTCQB Amendments

Effective October 1, 2020, the OTCQB Standards, Version 3.4, went into effect. To review the last amendments adopted in February 2020, see HERE. The new Version 3.4 modified the prior rules as follows:

Fees. Effective January 1, 2021, the OTCQB annual fee will increase from $12,000 to $14,000 and the application fee will increase from $2,500 to $5,000.

Corporate Governance Requirements. Companies that alternatively report to OTC Markets must meet certain corporate governance requirements to be eligible to trade on the OTCQB. In particular, such companies must have a board of directors that includes at least two independent directors and must have an audit committee the majority of which are independent directors. The new rules provide that trusts, funds, and other similar companies may be exempted from these corporate governance standards. A company wishing to be exempted must apply to OTC Markets in writing and such exemption will be granted in the sole and absolute discretion of OTC Markets.

Application Review/Reasons for Denial. Although OTC Markets has always had broad discretion to deny an application to trade on the OTCQB, the new rules specifically provide that OTC Markets may “[R]efuse the application for any reason, including but not limited to stock promotion, dilution risk, and use of “toxic” financiers if it determines, in its sole and absolute discretion, that the admission of the Company’s securities for trading on OTCQB, would be likely to impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors.”

OTCQX Amendments

Effective October 1, 2020, the OTCQX Standards, Version 8.6, went into effect. To review the last amendments adopted in December 2019, see HERE. The new Version 8.6 modified the prior rules as follows:

Fees. Effective January 1, 2021, the OTCQX annual fee will increase from $20,000 to $23,000. The application fee remains unchanged at $5,000.

International Company Upgrade to OTCQX. A Company with a class of securities currently quoted on the OTCQB market that chooses to upgrade to OTCQX may now be exempt from the requirement to select an OTCQX Sponsor or submit a Letter of Introduction.

Sponsor for International Companies. An OTCQX Sponsor who is an attorney or law firm is no longer required to be headquartered in the U.S. or Canada. Instead, each attorney who provides services as an OTCQX Sponsor must be licensed to practice law and in good standing in the U.S. As a reminder, I am a qualified OTCQX Sponsor.

« SEC Adopts Amendments To Management Discussion And Analysis Intellectual Property And Technology Risks – International Business Operations »

NYSE, Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19

Posted by Securities Attorney Laura Anthony | April 24, 2020 Tags: NYSE Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19

In addition to the SEC, the various trading markets, including the Nasdaq, NYSE and OTC Markets are providing relief to trading companies that are facing unprecedented challenges as a result of the worldwide COVID-19 crisis.

NYSE

The NYSE has taken a more formal approach to relief for listed companies. On March 20, 2020 and again on April 6, 2020 the NYSE filed a notice and immediate effectiveness of proposed rule changes to provide relief from the continued listing market cap requirements and certain shareholder approval requirements.

Recognizing the extremely high level of market volatility as a result of the COVID-19 crisis, the NYSE has temporarily suspended until June 30, 2020 its continued listing requirement that companies must maintain an average global market capitalization over a consecutive 30-trading-day period of at least $15 million. Likewise, the NYSE is suspending the requirement that a listed company maintain a minimum trading price of $1.00 or more over a consecutive 30-trading-day period, through June 30, 2020.

The NYSE intends to waive certain shareholder approval requirements for continued listing on the NYSE through June 30, 2020. In particular, in light of the fact that many listed companies will have urgent liquidity needs in the coming months due to lost revenues and maturing debt obligations, the NYSE is proposing to ease shareholder approval requirements to allow capital raises. The big board amendments align the requirements more closely with the NYSE American requirements.

The NYSE big board rules prohibit issuances to related parties if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance subject to a limited exception if the issuances are above a minimum price and no more than 5% of the outstanding common stock. For a review of the NYSE American rule for affiliate issuances, see HERE. The NYSE also requires shareholder approval for private issuances below the minimum price for any transactions relating to 20% or more the outstanding common stock or voting power. For a review of the 20% rule for the NYSE American, see HERE.

Realizing that existing large shareholders and affiliates are often the only willing providers of capital when a company is undergoing difficult times, the rule change allows for the issuance of securities to affiliates that exceed the 1% or 5% limits if completed prior to June 30, 3030 where the securities are sold for cash that meets the minimum price and if the transaction is reviewed and approved by the company’s audit committee or a comparable committee comprised solely of independent directors. The waiver cannot be relied upon if the proceeds would be used for an acquisition of stock or assets of another company in which the affiliate has a direct or indirect interest. Furthermore, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule. The substantially similar NYSE American rules can be reviewed HERE – equity compensation, and HERE – change of control.

The NYSE has also waived the 20% rule for private placements completed through and including June 30, 2020 where a bona fide financing is made to a single purchaser for cash meeting the minimum price requirement. Again, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule.

Nasdaq

The Nasdaq has taken a less formal approach on some of its requirements and a formal rule amendment on others. Although Nasdaq has not suspended its listing requirements, it will give due weight to the realities surrounding the worldwide crisis in both considering listing standards compliance and requests for financial viability waivers, such as under Rule 5635.

Generally, companies newly deficient with the bid price, market value of listed securities, or market value of public float requirements have at least 180 days to regain compliance and may be eligible for additional time. Nasdaq has enacted a temporary rule change such that companies that fall out of compliance with these listing standards related to price through and including June 30, 2020 will have additional time to regain compliance. That is, the non-compliance period will be tolled through June 30, 2020 and not counted in the 180 day period. Companies will still receive notification of non-compliance and will still need to file the appropriate Form 8-K. Companies that no longer satisfy the applicable equity requirement can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months plus the tolling period, to come back into compliance with the requirement.

The information memorandum confirms that listed companies that avail themselves of the 45-day extension for Exchange Act filings (see HERE) will not be considered deficient under Nasdaq Rule 5250(c) which requires all listed companies to timely file all required SEC periodic financial reports. Companies that are unable to file a periodic report by the relevant due date, but that are not eligible for the relief granted by the SEC, can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months to file.

As discussed in my blog related to SEC COVID-19 relief (see HERE), the SEC has granted relief where a company is required to comply with Exchange Act Sections 14(a) or 14(c) requiring the furnishing of proxy or information statements to shareholders, and mail delivery is not possible due to the coronavirus and the company has made a good-faith effort to deliver such materials. Nasdaq likewise will not consider a company in non-compliance with Rule 5250(d) requiring companies to make available their annual, quarterly and interim reports to shareholders or Rule 5620(b) requiring companies to solicit proxies and provide proxy statements for all meetings of shareholders when relying on the SEC relief. Nasdaq confirms that it permits virtual shareholder meetings as long as it is permissible under the relevant state law and shareholders have the opportunity to ask questions of management.

The Nasdaq shareholder approval rules generally require companies to obtain approval from shareholders prior to issuing securities in connection with: (i) certain acquisitions of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants (see HERE); (iii) a change of control (see HERE); and (iv) certain private placements at a price less than the minimum price as defined in Listing Rule 5635(d) (see HERE.

An exception is available for companies in financial distress where the delay in securing stockholder approval would seriously jeopardize the financial viability of the company. To request a financial viability exception, the company must complete a written request including a letter addressing how a delay resulting from seeking shareholder approval would seriously jeopardize its financial viability and how the proposed transaction would benefit the company. The standard is usually difficult to meet; however, Nasdaq has indicated that it will consider the consider the impact of disruptions caused by COVID-19 in its review of any pending or new requests for a financial viability exception. In addition, reliance by the company on a financial viability exception must expressly be approved by the company’s audit committee and the company must obtain Nasdaq’s approval to rely upon the financial viability exception prior to proceeding with the transaction. Under the rule, companies must also provide notice to shareholders at least ten days prior to issuing securities in the exempted transaction.

OTC Markets

OTC Markets Group has provided blanket relief for OTCQB and OTCQX companies with certain deficiencies until June 30, 2020. Until that date, no new compliance deficiency notices will be sent related to bid price, market cap, or market value of public float. Also, any OTCQX or OTCQB company that has already received a compliance notice related to bid price, market cap, or market value of public float with a cure period expiring between March and June will automatically receive an extension until June 30, 2020 to cure their deficiency.

OTC Markets has also extended the implementation date for compliance with the OTCQB rules requiring at least 50 beneficial shareholders and minimum float of 10% or $2 million in market value of public float, respectively, until June 30, 2020. The extension applies only to companies already traded on OTCQB as of May 20, 2018. All other companies were subject to these requirements effective May 20, 2018.

« Disclosures Related To COVID-19 SEC Proposed Rule Changes for Exempt Offerings – Part 2 »

OTCQB And OTC Pink Rule Changes

Posted by Securities Attorney Laura Anthony | February 21, 2020 Tags: OTCQB And OTC Pink Rule Changes

In December 2019 the OTC Markets updated its Pink Disclosure Guidelines and Attorney Letter Agreement and Guidelines. The Pink disclosure guidelines and attorney letter apply to companies that elect to report directly to OTC Markets pursuant to its Alternative Reporting Standard. Furthermore, in January 2020 OTC Markets amended the OTCQB standards related to the disclosure of convertible debt and notification procedures for companies undergoing a change in control. The OTCQB also updated its criteria for determining independence of directors, and added additional transfer agent requirements for Canadian Companies.

The OTC Markets divide issuers into three (3) levels of quotation marketplaces: OTCQX, OTCQB and OTC Pink Open Market. The OTC Pink Open Market, which involves the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information. Companies trading on the OTCQX, OTCQB and OTC Pink Current Information tiers of OTC Markets have the option of reporting directly to OTC Markets under its Alternative Reporting Standards. The Alternative Reporting Standards are somewhat more robust for the OTCQB and OTCQX in that they require audited financial statements prepared in accordance with U.S. GAAP and audited by a PCAOB qualified auditor in the same format as would be included in SEC registration statements and reports.

OTCQB Amendments

Effective February 22, 2020, the OTCQB Standards, Version 8, will go into effect. Some of the rule changes were previously adopted and others have been added to or modified. In particular, the new Version 8 includes:

Debt Securities, Including Promissory and Convertible Notes – Companies will be required to provide prompt disclosure of the issuance of any promissory notes, convertible notes, convertible debentures, or any other debt instruments that may be converted into a class of the company’s equity securities. Such disclosure must include copies of the securities purchase agreement(s) or similar agreement(s) setting forth the terms of such arrangement, any related promissory notes or similar evidence of indebtedness, and any irrevocable transfer agent instructions. Companies must make such disclosure either through the SEC’s EDGAR system or the OTC Disclosure & News Service, as applicable. Effective December 12, 2019, OTC Markets made a similar rule change for OTCQX listed companies.

OTCQB Certifications – Companies will be required to list and describe any outstanding promissory notes, convertible notes, convertible debentures, or any other debt instruments that may be converted into a class of the issuer’s equity securities when completing OTCQB certifications. OTC Market has been vocal about concerns with convertible instruments and, in particular, the potential for extreme dilution to existing shareholders and stock promotion campaigns by certain convertible investors. For more on OTC Markets stock promotion guidelines and policies, see HERE. As I have written about many times, there are quality investors and others that are not quality in the micro-cap 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. The requirement to disclose these investments, and the investment documents, is a smart change for OTC Markets, adding a level of transparency to the marketplace as a whole.

Change of Control – The new rule release reiterates the requirements related to a change of control. In particular, effective July 31, 2017, OTC Markets amended the OTCQB rules to set standards related to the processing and reporting of change in control events (see HERE). Subsequently, effective April 16, 2019, OTC Markets updated the definition of a “change of control” to include any events resulting in:

(i) Any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becoming the “beneficial owner” (as defined in Rule 13d-3 of the Exchange Act), directly or indirectly, of securities of the company representing fifty percent (50%) or more of the total voting power represented by the company’s then outstanding voting securities;

(ii) The consummation of the sale or disposition by the company of all or substantially all of the company’s assets;

(iii) A change in the composition of the board occurring within a two (2)-year period, as a result of which fewer than a majority of the directors are directors immediately prior to such change; or

(iv) The consummation of a merger or consolidation of the company with any other corporation, other than a merger or consolidation which would result in the voting securities of the company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or its parent) at least fifty percent (50%) of the total voting power represented by the voting securities of the company or such surviving entity or its parent outstanding immediately after such merger or consolidation.

Under the change of control rule, a company is responsible for notifying OTC Markets upon the completion of a transaction resulting in a change of control and must submit a new OTCQB application and application fee ($2,500) within 20 calendar days. OTC Markets will review the notice and application and may request additional information. The failure to respond or fully comply with such requests may result in removal from the OTCQB. Furthermore, immediately following a change in control event, a company is required to file a new OTCQB certification and updated company profile page. Regardless of notification, OTC Markets may also make a discretionary determination that a change of control event has occurred.

The newest rule release clarifies that the failure to submit the new application and documentation within the 20 days is grounds for the suspension or removal from the OTCQB at OTC Markets’ sole and absolute discretion.

Independent Directors – The new rules amend the definition of an independent director to conform to the earlier amendment in the OTCQX rules. The definition of an independent director has been updated to mean “a person other than an executive officer or employee of the company or any other person having a relationship which, in the opinion of the company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The following persons shall not be considered independent: (A) a director who is, or at any time during the past three years was, employed by the company; (B) a director who accepted or has a family member who accepted any compensation from the company in excess of $120,000 during any fiscal year within the three years preceding the determination of independence, other than compensation for board or board committee service; compensation paid to a family member who is an employee (other than an executive officer) of the company; or benefits under a tax-qualified retirement plan, or non-discretionary compensation; or (C) a director who is the family member of a person who is, or at any time during the past three years was, employed by the company as an executive officer.”

Canadian Companies – Canadian companies must retain a transfer agent that participates in the Transfer Agent Verified Shares Program as of April 1, 2020 (rule change was adopted December 12, 2019).

Pink Disclosure Guidelines Amendments

OTC Markets updated the Pink Disclosure Guidelines in anticipation of changes to the SEC’s Rule 15c2-11 (see HERE). The Pink Disclosure Guidelines are designed to track the information requirements in Rule 15c2-11. The amended rules have updated the Pink Disclosure Guidelines to require:

(i) Corporate History – the name of the company and predecessors since inception (previously a company only had to provide prior names for the last five years);

(ii) Debt Securities, Including Promissory and Convertible Notes – a company must now disclose all outstanding convertible, promissory or similar debt instruments as of the period end date of the report (previously only had to disclose such obligations issued in the previous two fiscal years);

(iii) Financial Statements – must now include a statement of changes in shareholders’ equity. In addition, all financial statements for a particular period must be uploaded in one document.

(iv) Officers, Directors, and Control Persons – the rules have been amended to clarify that all 5%-or-greater shareholders of any class of outstanding securities must be disclosed; and

(v) Verified Profile – a company must verify the company profile through OTCIQ to qualify for Pink Current or Limited Information.

Attorney letters are required for a company to qualify for OTC Pink Current Information if that company does not submit audited financial statements prepared in accordance with U.S. GAAP and audited by a PCAOB qualified auditor. In order to submit an attorney letter on behalf of a company, the attorney must submit an Attorney Letter Agreement to OTC Markets and be approved by OTC Markets. The rules related to an attorney letter agreement have been updated to allow for submittal of the agreement through Docusign.

Furthermore, the attorney letter agreement has updated required disclosures that must be included in a company’s attorney letter related to regulatory proceedings. In particular, an attorney letter submitted on behalf of a company must state that the attorney is permitted to practice before the SEC (i.e., has not been prohibited from such practice) and whether the attorney is currently or has in the past five years been the subject of any investigation, hearing or proceeding by the SEC, CFTC, FINRA or any federal, state or foreign regulatory agency, including a description of any investigation, hearing or proceeding.

« SEC Proposes Amendments To MD&A Disclosures SEC Proposes Additional Disclosures For Resource Extraction Companies »

The OTCQB Has Added Additional Quantitative Listing Standards

Posted by Securities Attorney Laura Anthony | August 14, 2018 Tags: OTC Markets, OTCQB, The OTCQB Has Added Additional Quantitative Listing Standards

On May 20, 2018, the OTC Markets Group published the OTCQB Standards version 3.0 incorporating amendments to the OTCQB initial and ongoing listing standards to add further quantitative shareholder and public float requirements. The new standards went into effect on May 20, 2018 for new listing applications. Existing OTCQB traded companies have until May 20, 2020 to comply with the new requirements.

The amended listing standards now require that an applicant company:

Have at least 50 beneficial shareholders holding at least one round lot (100 shares) each;
Have a freely tradeable public float of at least 10% of the total issued and outstanding shares of the tradeable class of securities. OTC Markets may allow an exemption from this requirement for companies with a public float above 5% of total issued and outstanding and whose market value of public float is above $2 million or for a company that has a separate class of securities trading on a national exchange. Any exemption must be applied for in writing and will be granted at OTC Markets Group’s sole and absolute discretion.

Previously in October 2017, OTC Markets amended its OTCQB rules to increase the annual listing fee from $10,000 to $12,000. Prior to that on July 31, 2017, the OTC Markets Group enacted amendments to the OTCQB standards related to the processing and reporting of change in control events. For a review of the change of control standards, see HERE.

A review of OTCQB Listing Standards

The OTC Markets divide issuers into three (3) levels of quotation marketplaces: OTCQX, OTCQB and OTC Pink Open Market. The OTC Pink Open Market, which involves the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information. The OTCQB is considered the venture-market tier designed for entrepreneurial and development-stage U.S. and international companies. To apply to the OTCQB, a company must submit a completed application and quotation agreement and pay the application fee.

Eligibility Requirements

To be eligible to be quoted on the OTCQB, all companies will be required to:

Meet a minimum closing bid price on OTC Markets of $0.01 for each of the last 30 calendar days and as of the day the OTCQB application is approved;
In the event that there is no prior public market and a 15c2-11 application has recently been approved by FINRA allowing a quotation at $0.01 or greater, or if the company is traded on a Qualified Foreign Exchange at a price greater than $0.01, OTC Markets can waive the bid requirement at its sole discretion. In this case, the company’s stock must trade above the $0.01 for each of the 30 calendar days immediately subsequent to the company first being quoted on the OTCQB;
Have at least 50 beneficial shareholders, each owning at least 100 shares;
Have a freely tradeable public float of at least 10% of the total shares issued and outstanding of the class of security to be traded on the OTCQB. OTC Markets may allow an exemption from this requirement for companies with a public float above 5% of total issued and outstanding and whose market value of public float is above $2 million or for a company that has a separate class of securities trading on a national exchange. Any exemption must be applied for in writing and will be granted at OTC Markets Group’s sole and absolute discretion;
Have current disclosure by meeting one of the following: (a) being subject to the reporting requirements of the Securities Exchange Act of 1934 and be current in such reporting obligations; (b) being a Regulation A reporting company and be current in such reporting obligations; (c) if an international issuer, be eligible to rely on the registration exemption found in Exchange Act Rule 12g-2(b) and be current and compliant in such requirements; (d) be a bank current in its reporting obligations to its bank regulator; or (e) be current in the OTC Markets Alternative Reporting Standards;
Have U.S. GAAP audited financials prepared by a PCAOB qualified auditor, including an audit opinion that is not adverse, disclaimed or qualified. International reporting companies or companies trading on a qualified foreign exchange may have audited financial statements prepared in accordance with IFRS. Regulation A reporting companies are exempt from the requirement that the initial audits be prepared by a PCAOB auditor; however, subsequent financial statements are required to have a PCAOPB audit;
Be duly organized, validly existing and in good standing under the laws of each jurisdiction in which it is organized and does business;
Not be subject to any bankruptcy or reorganization proceedings;
Submit an application and pay an application and annual fee;
Maintain a current and accurate company profile on the OTC Markets website;
Use an SEC registered transfer agent and authorize the transfer agent to provide information to OTC Markets about the company’s securities, including but not limited to shares authorized, shares issued and outstanding, and share issuance history; and
Submit an OTCQB Annual Certification confirming the accuracy of the current company profile and providing information on officers, directors and controlling shareholders.
For companies that are relying on the Alternative Reporting Standard (i.e., not reporting to the SEC), meet minimum corporate governance requirements, including (i) have a board of directors that includes at least two independent directors; and (ii) have an audit committee comprised of a majority of independent directors. A company may request the ability to phase in compliance with this requirement if: (a) at least one member of the board of directors and audit committee are independent at the time of the application; and (b) at least two members of the board and a majority of the audit committee are independent within the later of 90 days after the company begins trading on the OTCQB or by the time of the company’s next annual meeting and in no event later than one year from joining the OTCQB.

All companies are required to post their initial disclosure on the OTC Markets website and make an initial certification. The initial disclosure includes:

Confirmation that the company is current in its SEC reporting obligations, whether subject to the Exchange Act reporting requirements or Regulation A reporting requirements, and has filed all reports with the SEC on the EDGAR system that all financial statements have been prepared in accordance with U.S. GAAP, and that the auditor opinion is not adverse, disclaimed or qualified;
Bank Reporting Companies must have filed all financial reports required to be filed with their banking regulator for the prior two years, including audited financial statements;
International Companies – (i) Companies subject to the Exchange Act reporting requirements must be current in such reports; (ii) A company that is not an SEC Reporting company must be current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and shall have posted in English through the OTC Disclosure & News Service or an Integrated Newswire, the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b) for the preceding 24 months (or from inception if less than 24 months); and all financial statements have been prepared in accordance with U.S. GAAP and that the auditor opinion is not adverse, disclaimed or qualified;
Alternative Reporting Companies must have filed, through the OTC Disclosure and News Services, an information and disclosure statement meeting the requirements of the OTCQX and OTCQB disclosure guidelines. If the company was an SEC Reporting Company immediately prior to joining OTCQB and has a current 10-K or 20-F on file with the SEC, or was a Regulation A Reporting Company immediately prior to joining OTCQB and has a current 1-K on file with the SEC, the company is not required to file an information statement through the OTC Disclosure & News Service, but subsequent to joining OTCQB must file all annual, quarterly, interim and current reports required pursuant to the OTCQX and OTCQB Disclosure Guidelines; and
Verified Company Profile – verification that the company profile is current, complete and accurate.

In addition, all companies will be required to file an initial and annual certification on the OTC Markets website, signed by the CEO and/or CFO, stating:

The company’s reporting standing (i.e., whether SEC reporting, Regulation A reporting, Alternative Standards Reporting, bank reporting or international reporting) and briefly describing the registration status or the applicable exemption from SEC registration of the company;
If the company is an international company and relying on 12g3-2(b), that it is current in such obligations;
That the company is current in its reporting obligations as of the most recent fiscal year end and any subsequent reporting periods and that such information has been filed either on EDGAR or the OTC Disclosure & News Service, as applicable;
That the company profile on the OTC Markets website is current and complete and includes the total shares outstanding, authorized and in the public float as of that date;
The number of beneficial shareholders holding at least 100 shares and the number of shares in the public float as of the least practicable date;
That the company is duly organized, validly existing and in good standing under the laws of each state or jurisdiction in which the company is organized and conducts business;
Identifies the law firm and/or attorneys that assist the company in preparing its annual report or 10-K. Include the firm and attorney name if outside counsel, or name and title if internal counsel. If no attorney assisted in putting together the disclosure, the company must identify the person or persons who prepared the disclosure and their relationship to the company;
Identifies any third-party providers engaged by the company, its officers, directors or controlling shareholders, during the prior fiscal year and up to the date of the certification, to provide investor relations services, public relations services, stock promotion services or related services;
Names and shareholdings of all officers and directors and shareholders that beneficially own 5% or more of the total outstanding shares, including beneficial ownership of entity shareholders.

An application to OTCQB can be delayed or denied at OTC Markets’ sole discretion if they determine that admission would be likely to impair the reputation or integrity of OTC Markets group or be detrimental to the interests of investors.

Requirements for Bank Reporting Companies

Bank reporting companies must meet all the same requirements as all other OTCQB companies except for the SEC reporting requirements. Instead, bank reporting companies are required to post their previous two years’ and ongoing yearly disclosures that were and are filed with the company’s bank regulator, on the OTC Markets website.

International Companies

In addition to the same requirements for all issuers as set forth above, foreign issuers must be listed on a Qualified Foreign Exchange and be compliant with SEC Rule 12g3-2(b). Moreover, a foreign entity must submit a letter of introduction from a qualified OTCQB Sponsor which states that the OTCQB Sponsor has a reasonable belief that the company is in compliance with SEC Rule 12g3-2(b), is listed on a Qualified Foreign Exchange, and has posted required disclosure on the OTC Markets website. A foreign entity must post two years’ historical and ongoing quarterly and annual reports, in English, on the OTC Markets website which comply with SEC Rule 12g3-2(b). I am a qualified OTCQB Sponsor and assist multiple international companies with this process.

Application Review Process

OTC Markets will review all applications and may request additional information on any of the information submitted. In addition, OTC Markets can require that a company provide a further undertaking, such as submission of personal information forms for any executive officer, director or 5%-or-greater beneficial owner. OTC Markets can request that third parties provide confirmations or information as well. OTC Markets can, and likely will, conduct independent due diligence including through the review of publicly available information.

OTC Markets can deny an application if it determines, upon its sole and absolute discretion, that the admission of the company would be likely to impair the reputation or integrity of OTC Markets or be detrimental to the interests of investors.

Upon approval of an application, the company’s securities will be designated as OTCQB on the OTC Markets websites, market data products and broker-dealer platforms.

Ongoing Requirements

All companies are required to remain in compliance with the OTCQB standards, including the ongoing disclosure obligations;
S. OTCQB companies will be required to remain current and timely in their SEC reporting obligations, including either Exchange Act reports, Regulation A+ reports or Alternative Reporting Standard and including all audited financial statement requirements;
A foreign company that is not an SEC Reporting Company must remain current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and in any event shall, on an ongoing basis, post in English through the OTC Disclosure & News Service or an Integrated Newswire the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b);
Audited financial statements must be prepared in accordance with U.S. GAAP or, for international reporting companies or alternative reporting companies listed on a qualified foreign exchange, IFRS and all must contain an audit opinion that is not adverse, disclaimed or qualified. Audits must be completed by a PCAOB qualified auditor.
Banks must remain current in their banking reporting requirements and file copies of their reports on the OTC Markets website no later than 45 days following the end of a quarter or 90 days following the end of the fiscal year;
All OTC Markets postings and reports must be filed within 45 days following the end of a quarter or 90 days following the end of the fiscal year for US Exchange Act issuers and Alternative Reporting Standard filers, as required by Regulation A+ for Regulation A+ reporting issuers, and immediately after their submission to their primary regulator for international companies; where applicable, file a notice of late filing allowing for 5 extra days on a quarterly report and 15 extra days on an annual or semiannual report;
All OTCQB companies will be required to post annual certifications on the OTC Markets website signed by either the CEO or CFO no later than 30 days following the company’s annual report due date;
All companies are required to comply with all federal, state, and international securities laws and must cooperate with all securities regulatory agencies;
Must pay the annual fee within 30 days of prior to the beginning of each new annual service period;
All companies must respond to OTC Markets inquiries and requests;
All companies must maintain an updated verified company profile on the OTC Markets website and must submit a Company Update Form at least once every six months;
OTCQB is a recognized securities manual for purposes of blue sky secondary market exceptions. A precondition to relying upon the manual’s exemption is the maintenance of current updated disclosure information as required by OTC Markets;
All companies must make a press release and possibly other public disclosure (such as a Form 8-K) to inform the public of any news or information which might be reasonably expected to materially affect the market of its securities;
An OTCQB company must act promptly to dispel unfounded rumors which result in unusual market activity or price variations;
All companies must file interim disclosures in the event the company undergoes a reverse merger or change of control and make new updated certifications and disclosure related to the new business and control persons;
All OTCQB companies are subject to the OTC Markets Stock Promotion Policy, as such policy may be amended from time to time. In the event that OTC Markets determines, upon its sole discretion, that a company is the subject of promotional activities that encourage trading, OTC Markets may require the company to provide additional public information related to shareholdings of officers, directors and control persons and confirmation of shares outstanding, and any share issuance in the prior two years. OTC Markets may also require submission of a Personal Information Form for any executive officer, director or 5%-or-greater shareholder;
OTCQB companies must quickly issue press releases to the public to disclose any news or information which might reasonably be expected to materially affect the market for its securities.
Not be subject to bankruptcy or reorganization proceedings;
Be duly organized and in good standing under the laws of each jurisdiction in which the company is organized or does business;
Have at least 50 beneficial shareholders, each owning at least 100 shares;
Have a freely tradeable public float of at least 10% of the total shares issued and outstanding of the class of security to be traded on the OTCQB. OTC Markets may allow an exemption from this requirement for companies with a public float above 5% of total issued and outstanding and whose market value of public float is above $2 million or for a company that has a separate class of securities trading on a national exchange. Any exemption must be applied for in writing and will be granted at OTC Markets Group’s sole and absolute discretion;
Companies relying on the Alternative Reporting Standard must comply with the ongoing corporate governance requirements subject to a notice and one-year grace period if the company falls into noncompliance;
All OTCQB companies must meet the minimum bid price of $.01 per share at the close of business of at least one of the previous thirty (30) consecutive calendar days; in the event that the price falls below $.01, the company will begin a grace period of 90 calendar days to maintain a closing bid price of $.01 for ten consecutive trading days; and
Use an SEC registered transfer agent and authorize the transfer agent to provide information to OTC Markets about the company’s securities, including but not limited to shares authorized, shares issued and outstanding, and share issuance history.

Officers and directors of the company are responsible for compliance with the ongoing requirements and the content of all information. Entities that do not meet the requirements of either OTCQX or OTCQB will be quoted on the OTC Pink.

Procedures for Change in Control Events

A “change in control event” is defined to mean a transaction resulting in: (i) a change in the majority ownership or effective control of a company; (ii) material changes to the company’s management team or board of directors; or (iii) in conjunction with either of the above, a material change in the nature of the company’s business operations.

Under Section 2.4, a company will be responsible for notifying OTC Markets upon the completion of a transaction resulting in a change of control. Regardless of notification, OTC Markets may also make a discretionary determination that a change of control event has occurred.

Upon a change of control event, a company will be required to submit a OTCQB Change in Control Notification together with a new OTCQB Application and application fee ($2,500) within 20 calendar days. OTC Markets will review the notice and application and may request additional information. The failure to respond or fully comply with such requests may result in removal from the OTCQB.

Furthermore, immediately following a change in control event, a company would be required to file a new OTCQB Certification and updated company profile page.

Fees

Newly applying entities must pay an initial application fee of $2,500, which fee is waived for existing OTCQB entities. All OTCQB companies will be required to pay an annual fee of $12,000. Companies may opt to make two semiannual installments of $6,500. Fees are nonrefundable.

Removal/Suspension from OTCQB

A company may be removed from the OTCQB if, at any time, it fails to meet the eligibility and continued quotation requirements subject to a notice and opportunity to cure. Companies that are delinquent in filing and reporting requirements are subject to a 45-day cure period. Companies with a bid price deficiency shall have a 90-day cure period. However, in the event the company’s bid price falls below $0.001 at any time for five consecutive trading days, the company will be immediately removed from the OTCQB. All other deficiencies are subject to a 30-day cure period. OTC Markets may provide additional cure periods, but in no event may audited financial statements be older than 18 months.

Companies are granted a cure period of 30 calendar days for failure to maintain the minimum ongoing beneficial shareholder amount and public float requirements. A company may apply in writing to OTC Markets Group for an extension of the 30-day cure period by submitting a plan to cure the deficiency, which extension may be granted by OTC Markets Group in its sole and absolute discretion.

In addition, OTC Markets Group may remove the company’s securities from trading on OTCQB immediately and at any time, without notice, if OTC Markets Group, upon its sole and absolute discretion, believes the continued inclusion of the company’s securities would impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors.

In addition, OTC Markets can temporarily suspend trading on the OTCQB pending investigation or further due diligence review.

A company may voluntarily withdraw from the OTCQB with 24 hours’ notice.

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

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

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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

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

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OTC Markets Amends Listing Standards For OTCQB To Allow Non-Reporting Issuers

Posted by Securities Attorney Laura Anthony | June 27, 2017 Tags: Non-Reporting Issuers, OTC Markets, OTC Markets Amends Listing Standards For OTCQB, OTC Markets Amends Listing Standards For OTCQB To Allow Non-Reporting Issuers, OTCQB

Effective May 18, 2017, the OTC Markets has amended its qualification rules for the OTCQB to allow quotation by companies that follow its alternative reporting standard (“Alternative Reporting Standard”). OTC Markets aligned the new requirements with the existing OTCQX Alternative Reporting Standard requirements. In addition, the OTC Markets made clarifying amendments to its rules, amended the rules related to the timing of removal for delinquent filers, and revised the rules for international reporting companies.

Highlights of Changes

To qualify for the OTCQB using the Alternative Reporting Standard, a company must file audited financial statements prepared in accordance with U.S. GAAP by a PCAOB qualified auditor, have a minimum bid price of $0.01, not be subject to bankruptcy or reorganization proceedings, and maintain corporate governance including (i) have a board of directors that includes a minimum of two independent directors, and (ii) have an audit committee comprised of a majority of independent directors.

The cure period for delinquent filings has been extended to 45 days from the prior 30-day period. However, the cure period for a bid price deficiency has been reduced in half to 90 days from the prior 180 days. Moreover, if a company’s closing bid price falls below $0.001 at any time for five consecutive days, the company will automatically be removed from the OTCQB.

The new rules clarify that a U.S. transfer agent is only required for U.S. and Canadian incorporated companies. However, international reporting companies must now file their reports with OTC Markets immediately after such filing with their primary international market.

The new rules clarify that the OTCQB annual fee is due 30 days prior to the beginning of each new annual service period. An OTCQB company must remain registered and in good standing in its state of incorporation.

The OTCQB has been recognized by most U.S. states as a “securities manual” for the purpose of the blue sky manual’s exemption. In order to qualify, companies must file reports with OTC Markets that meet the information requirements for the manual’s exemption in the state. The OTC Markets filings requirements are designed to ensure satisfaction of these requirements.

Finally, the new rules clarify that an OTCQB company is required to make timely disclosures of news releases and developments whether through an SEC form 8-K or press release with OTC Markets. A company must also act promptly to dispel unfounded rumors which result in unusual market activity or price variations.

Comprehensive Refresher on OTCQB, Including the New Amendments

The OTC Markets divide issuers into three (3) levels of quotation marketplaces: OTCQX, OTCQB and OTC Pink. The OTC Pink, which involves the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information. The OTCQB is considered the venture market tier designed for entrepreneurial and development-stage U.S. and international companies. To apply to the OTCQB, a company must submit a completed application and quotation agreement and pay the application fee.

Eligibility Requirements

To be eligible to be quoted on the OTCQB, all companies will be required to:

Meet a minimum closing bid price on OTC Markets of $.01 for each of the last 30 calendar days and as of the day the OTCQB application is approved;
In the event that there is no prior public market and a 15c2-11 application has been submitted to FINRA by a market maker, OTC Markets can waive the bid requirement at its sole discretion;
In the event that a company is a seasoned public issuer that completed a reverse stock split within 6 months prior to applying to the OTCQB, the company must have a post-reverse-split minimum bid price of $.01 at the close of business on each of the 5 consecutive trading days immediately before applying to the OTCQB;
In the event the company is moving to the OTCQB from the OTCQX, it must have a minimum closing bid price of $.01 for at least one (1) of the 30 calendar days immediately preceding;
Companies may not be subject to bankruptcy or reorganization proceedings the company’s application;
Either be subject to the reporting requirements of the Securities Exchange Act of 1934 and be current in such reporting obligations, be a Tier 2 Regulation A reporting company and be current in such reporting obligations, or, if an international issuer, be eligible to rely on the registration exemption found in Exchange Act Rule 12g-2(b) and be current and compliant in such requirements or be a bank current in its reporting obligations to its bank regulator, or be current in the OTC Markets Alternative Reporting Standards;
Have U.S. GAAP audited financials prepared by a PCAOB qualified auditor, including an audit opinion that is not adverse, disclaimed or qualified. International reporting companies may have audited financial statements prepared in accordance with IFRS;
Be duly organized, validly existing and in good standing under the laws of each jurisdiction in which it is organized and does business;
Submit an application and pay an application and annual fee;
Maintain a current and accurate company profile on the OTC Markets website;
Use an SEC registered transfer agent and authorize the transfer agent to provide information to OTC Markets about the company’s securities, including but not limited to shares authorized, shares issued and outstanding, and share issuance history; and
Submit an OTCQB Annual Certification confirming the accuracy of the current company profile and providing information on officers, directors and controlling shareholders.
For companies that are relying on the Alternative Reporting Standard (i.e., not reporting to the SEC), meet minimum corporate governance requirements, including (i) have a board of directors that includes at least two independent directors; and (ii) have an audit committee comprised of a majority of independent directors. A company may request the ability to phase in compliance with this requirement if: (a) at least one member of the board of directors and audit committee are independent at the time of the application; and (b) at least two members of the board and a majority of the audit committee are independent within the later of 90 days after the company begins trading on the OTCQB or by the time of the company’s next annual meeting and in no event later than one year from joining the OTCQB.

All companies are required to post their initial disclosure on the OTC Markets website and make an initial certification. The initial disclosure includes:

Confirmation that the company is current in its SEC reporting obligations, whether subject to the Exchange Act reporting requirements or Regulation A+ reporting requirements, and has filed all reports with the SEC, that all financial statements have been prepared in accordance with U.S. GAAP, and that the auditor opinion is not adverse, disclaimed or qualified;
Bank Reporting Companies must have filed all financial reported required to be filed with their banking regulator for the prior two years, including audited financial statements;
International Companies – (i) Companies subject to the Exchange Act reporting requirements must be current in such reports; (ii) A company that is not an SEC Reporting company must be current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and shall have posted in English through the OTC Disclosure & News Service or an Integrated Newswire, the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b) for the preceding 24 months (or from inception if less than 24 months); and all financial statements have been prepared in accordance with U.S. GAAP and that the auditor opinion is not adverse, disclaimed or qualified;
Alternative Reporting Companies must have filed, through the OTC Disclosure and News Services, an information and disclosure statement meeting the requirements of the OTCQX and OTCQB disclosure guidelines; and
Verification that the company profile is current, complete and accurate.

In addition, all companies will be required to file an initial and annual certification on the OTC Markets website, signed by the CEO and/or CFO, stating:

The company’s reporting standing (i.e., whether SEC reporting, Regulation A+ reporting, Alternative Standards Reporting, bank reporting or international reporting) and briefly describing the registration status of the company;
If the company is an international company and relying on 12g3-2(b), that it is current in such obligations;
That the company is current in its reporting obligations to its regulator and that such information is available either on EDGAR or the OTC Markets website;
That the company profile on the OTC Markets website is current and complete and includes the total shares outstanding, authorized and in the public float as of that date;
That the company is duly organized, validly existing and in good standing under the laws of each state or jurisdiction in which the company is organized and conducts business;
States the law firm and/or attorneys that assist the company in preparing its annual report or 10-K;
Identifies any third-party providers engaged by the company, its officers, directors or controlling shareholders, during the prior fiscal year and up to the date of the certification, to provide investor relations services, public relations services, stock promotion services or related services;
Confirms the total shares authorized, outstanding and in the public float as of that date; and
Names and shareholdings of all officers and directors and shareholders that beneficially own 5% or more of the total outstanding shares, including beneficial ownership of entity shareholders.

Requirements for Bank Reporting Companies

International Companies

Application Review Process

OTC Markets will review all applications and may request additional information on any of the information submitted. In addition, OTC Markets can require that a company provide a further undertaking, such as submission of personal information forms for any executive officer, director or 5% or greater beneficial owner. OTC Markets can request that third parties provide confirmations or information as well. OTC Markets can, and likely will, conduct independent due diligence including through the review of publicly available information.

Upon approval of an application, the company’s securities will be designated as OTCQB on the OTC Markets websites, market data products and broker-dealer platforms.

Ongoing Requirements

All companies are required to remain in compliance with the OTCQB standards, including the ongoing disclosure obligations;
S. OTCQB companies will be required to remain current and timely in their SEC reporting obligations, including either Exchange Act reports, Regulation A+ reports or Alternative Reporting Standard and including all audited financial statement requirements;
A foreign company that is not an SEC Reporting Company must remain current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and in any event shall, on an ongoing basis, post in English through the OTC Disclosure & News Service or an Integrated Newswire the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b);
Banks must remain current in their banking reporting requirements and file copies of their reports on the OTC Markets website no later than 45 days following the end of a quarter or 90 days following the end of the fiscal year;
All OTC Markets postings and reports must be filed within 45 days following the end of a quarter or 90 days following the end of the fiscal year for US Exchange Act issuers and Alternative Reporting Standard filers, as required by Regulation A+ for Regulation A+ reporting issuers, and immediately after their submission to their primary regulator for international companies; where applicable, file a notice of late filing allowing for 5 extra days on a quarterly report and 15 extra days on an annual or semiannual report;
All OTCQB companies will be required to post annual certifications on the OTC Markets website signed by either the CEO or CFO no later than 30 days following the company’s annual report due date;
All companies are required to comply with all federal, state, and international securities laws and must cooperate with all securities regulatory agencies;
Must pay the annual fee within 30 days of prior to the beginning of each new annual service period;
All companies must respond to OTC Markets inquiries and requests;
All companies must maintain an updated verified company profile on the OTC Markets website and must submit a Company Update Form at least once every six months;
OTCQB is a recognized securities manual for purposes of blue sky secondary market exceptions. A precondition to relying upon the manuals exemption is the maintenance of current updated disclosure information as required by OTC Markets;
All companies must make a press release and possibly other public disclosure (such as a Form 8-K) to inform the public of any news or information which might be reasonably expected to materially affect the market of its securities;
All companies must file interim disclosures in the event the company undergoes a reverse merger or change of control and make new updated certifications and disclosure related to the new business and control persons;
In the event that OTC Markets determines, upon its sole discretion, that a company is the subject of promotional activities that encourage trading, OTC Markets may require the company to provide additional public information related to shareholdings of officers, directors and control persons and confirmation of shares outstanding, and any share issuance in the prior two years. OTC Markets may also require submission of a Personal Information Form for any executive officer, director or 5%-or-greater shareholder.
Not be subject to bankruptcy or reorganization proceedings;
Be duly organized and in good standing under the laws of each jurisdiction in which the company is organized or does business;
Companies relying on the Alternative Reporting Standard must comply with the ongoing corporate governance requirements subject to a notice and one-year grace period if the company falls into noncompliance;
All OTCQB companies must meet the minimum bid price of $.01 per share at the close of business of at least one of the previous thirty (30) consecutive calendar days; in the event that the price falls below $.01, the company will begin a grace period of 90 calendar days to maintain a closing bid price of $.01 for ten consecutive trading days; and
Use an SEC registered transfer agent and authorize the transfer agent to provide information to OTC Markets about the company’s securities, including but not limited to shares authorized, shares issued and outstanding, and share issuance history.

Fees

Removal/Suspension from OTCQB

In addition, OTC Markets can temporarily suspend trading on the OTCQB pending investigation or further due diligence review.

A company may voluntarily withdraw from the OTCQB with 24 hours’ notice.

The Author

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

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Confidentially Marketed Public Offerings (CMPO)

Posted by Securities Attorney Laura Anthony | July 5, 2016 Tags: CMPO, Confidentially Marketed Public Offering, Confidentially Marketed Public Offerings, Form 8-K, NASDAQ Considerations, NASDAQ Rules, Regulation FD, S-3 Eligibility, S-3 Registration Statement, S-3 Shelf Registration

Not surprisingly, I read the trades including all the basics, the Wall Street Journal, Bloomberg, The Street,The PIPEs Report, etc. A few years ago I started seeing the term “confidentially marketed public offerings” or “CMPO” on a regular basis. The weekly PIPEs Report breaks down offerings using a variety of metrics and in the past few years, the weekly number of completed CMPOs has grown in significance. CMPOs count for billions of dollars in capital raised each year.

CMPO Defined

A CMPO is a type of shelf offering registered on a Form S-3 that involves speedy takedowns when market opportunities present themselves (for example, on heavy volume). A CMPO is very flexible as each takedown is on negotiated terms with the particular investor or investor group. In particular, an effective S-3 shelf registration statement allows for takedowns at a discount to market price and other flexibility in the parameters of the offering such as the inclusion of warrants and terms of such warrants. A CMPO is sometimes referred to as “wall-crossed,” “pre-marketed” or “overnight” offerings.

In a typical CMPO, an underwriter confidentially markets takedowns of an effective S-3 shelf registration statement to a small number of institutional investors. The underwriter will not disclose the name of the issuing company until the institutional investor agrees that they have a firm interest in receiving confidential information and agrees not to trade in such company’s securities until the offering is either completed or abandoned.

When an investor confirms their interest, the company and its banker will negotiate the terms of the offering with the investor(s), including amount, price (generally a discount to market price), warrant coverage and terms of such warrant coverage. The disclosure of the name of the issuer and confidential information related to the offering is referred to as bringing the investor “over the wall.” Once brought over the wall, the potential investor(s) will complete due diligence. This process is completed on a confidential basis.

Once the terms have been agreed upon, the offering is “flipped” from confidential to public and a prospectus supplement, free writing prospectus, if any, a Rule 134 press release and a Form 8-K are prepared and filed informing the market of the offering. These public documents are almost always filed after the market closes and the offering itself generally closes that night as well, though sometimes the closing occurs the next trading day. The closing is the same as a firm commitment underwritten offering, such that there is a single closing of the entire takedown. The closing process and documents are also the same as a firm commitment underwritten offering including an underwriting agreement, opinion of counsel and a comfort letter. As the public disclosure and closing of the offering generally occurs overnight, a CMPO earned the name an “overnight” offering.

Generally the necessary closing documents and public filings have been prepared and are on standby ready to be utilized when a deal is agreed upon. Both the company and investors will wait for a favorable market window, such as an increase in the price and volume of the company’s stock, to close the offering.

S-3 Eligibility; NASDAQ Considerations; FINRA

A CMPO requires an effective S-3 shelf registration statement and accordingly is only available to companies that qualify to use an S-3. Among other requirements, to qualify to use an S-3 registration statement a company must have timely filed all Exchange Act reports, including Form 8-K, within the prior 12 months. An S-3 also contains certain limitations on the value of securities that can be offered. Companies that have an aggregate market value of voting and non-voting common stock held by non-affiliates of $75 million or more, may offer the full amount of securities under an S-3 registration. For companies that have an aggregate market value of voting and non-voting common stock held by non-affiliates of less than $75 million, the company can offer up to one-third of that market value in any trailing 12-month period. This one-third limitation is referred to as the “baby shelf rule.”

To calculate the non-affiliate float for purposes of S-3 eligibility, a company may look back 60 days and select the highest of the last sales prices or the average of the bid and ask prices on the principal exchange. The registration capacity for a baby shelf is measured immediately prior to the offering and re-measured on a rolling basis in connection with subsequent takedowns. The availability for a particular takedown is measured as the current allowable offering amount less any amounts actually sold under the same S-3 in prior takedowns. Accordingly, the available offering amount will increase as a company’s stock price increases, and decrease as a stock price decreases.

A company should be careful that a CMPO is structured to comply with the NASDAQ definition of “public offering,” thereby avoiding NASDAQ’s rules requiring shareholder approval for private placements where the issuance will or could equal 20% or more of the pre-transaction outstanding shares. In particular, NASDAQ requires advance shareholder approval when a company sells 20% or more of its outstanding common stock (or securities convertible into common stock) in a private offering, at a discount to the greater of the market price or book value per share of the common stock. A separate NASDAQ rule also requires shareholder approval where officers, directors, employees, consultants or affiliates are issued common stock in a private placement at a discount to market price. CMPO’s have been stopped in their tracks by NASDAQ requiring pre-closing shareholder approval.

A CMPO differs from a standard public offering as it is confidentially marketed and is completed with little or no advance market notice. Accordingly, in determining whether a CMPO qualifies as a public offering, NASDAQ will consider: (i) the type of offering including whether it is being completed by an underwriter on a firm commitment or best-efforts basis (firm commitment being favorable); (ii) the manner of offering and marketing, including number of investors marketed to and how such investors were chosen (the more broad the marketing, the better); (iii) the prior relationship between the investors and the company or underwriter (again, the more broadly marketed, the better, as public offerings are generally widely marketed); (iv) offering terms including price (a deeper discount is unfavorable); and (v) the extent to which the company controls the offering and its distribution (insider participation is unfavorable).

NASDAQ also has rules requiring an advance application for the listing of additional shares resulting from follow-on offerings. Generally NASDAQ requires 15 days advance notice, but will often waive this advance notice upon request.

A CMPO will need to comply with FINRA rule 5110, the corporate finance rule. Generally FINRA will process a 5110 clearance on the same day. Moreover, there are several exemptions to issuer 5110 compliance, including based on the size of the company’s public float. For a brief overview of Rule 5110, see my blogHERE.

Confidentiality; Regulation FD; Insider Trading

By nature a CMPO involves the disclosure of confidential information to potential investors, including, but not limited to, that the company is considering a public offering takedown, the pricing terms of the offering, warrant coverage, and the disclosure of potentially confidential information during the due diligence phase. To ensure compliance with Regulation FD and avoid insider trading, the company and its underwriters will obtain a confidentiality agreement from the potential investors. The agreement will include a trading blackout for a specific period of time, generally until the offering either closes or is abandoned.

Although the confidential portion of the CMPO usually occurs very quickly (a week or two), many institutional investors require that the company issue a public “cleansing” statement if the offering does not proceed within a specified period of time. The cleansing statement would need to disclose any material non-public information disclosed to the potential investor as part of the negotiation and due diligence related to the offering. In the event the offering proceeds to a close, the offering documents (including potential free writing prospectus or prospectus supplement, Rule 134 press release and 8-K) will include all material non-public information previously disclosed to potential investors during the confidential phase. Both the company and the investor need to be careful that the filed offering materials and/or cleansing statement contain all necessary information to avoid potential insider trading issues.

The company must be sure to also file with the SEC all written marketing offering materials associated with a registered offering either as part of the prospectus or as a free writing prospectus. Generally with a CMPO, the written materials provided to investors are limited to public filings and investor presentation materials such as a PowerPoint already in the public domain that do not, in and of themselves, contain any material non-public information and therefore do not need to be filed with the SEC as offering materials.

As a reminder, Regulation FD excludes communications (i) to a person who owes the issuer a duty of trust or confidence such as legal counsel and financial advisors; (ii) communications to any person who expressly agrees to maintain the information in confidence (such as potential investors in a CMPO); and (iii) communications in connection with certain offerings of securities registered under the Securities Act of 1933 (this exemption does not include registered shelf offerings and, accordingly, generally does not include a CMPO).

Benefits of a CMPO

A CMPO offers a great deal of flexibility to a company and its bankers. Utilized correctly, a CMPO can have minimal market impact. It is widely believed that announcements of public offerings, and impending dilution and selling pressure, invite short selling and speculative short-term market activity. Since a CMPO is confidential by nature and the time between the public awareness and completion of a particular takedown is very short (oftentimes the same day), the opportunity for speculating and short sellers is minimized. Moreover, as a result of the confidential nature of a CMPO, if a particular offering or takedown is abandoned, the market is unaware, relieving the company of the typical downward pricing pressure associated with an abandoned offering. Likewise, this confidential process allows the company to test the waters and only proceed when investor appetite is confirmed.

As a registered offering, CMPO securities are freely tradable and immediately transferable, incentivizing investment activity and reducing the negotiated discount to market associated with restricted securities. Offering expenses for a CMPO are also less than a fully marketed follow-on public offering. The CMPO is based on an existing S-3 shelf registration, thus reducing drafting costs. Also, the expense of marketing an offering itself, including a road show, is reduced or eliminated altogether.

Although the structure of a CMPO requires that the issuing company be S-3 shelf registration eligible, CMPOs are often used by small and development-stage companies (such as technology and biotech companies) that have smaller market capitalizations and need to tap into the capital of the public markets on a more frequent basis to fund ongoing research and development of products.

The Author

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

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

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« OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies SEC Proposes Amendments To Definition Of “Small Reporting Company” »

OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies

Posted by Securities Attorney Laura Anthony | June 28, 2016 Tags: OTC Markets, OTC Markets Listing Requirements, OTCQB, OTCQX, Regulation A, Regulation a SEC, SEC, SEC Regulation A, SEC Reporting Companies

On June 6, OTC Markets filed a petition for rulemaking with the SEC requesting that the SEC amend Regulation A to expand the eligibility criteria to include all small issuers, including those that are subject to the Securities Exchange Act of 1934 (“Exchange Act”) reporting requirements and to allow “at-the-market offerings.”

Background

On March 25, 2015, the SEC released final rules amending Regulation A. The new Regulation A creates two tiers of offerings. Tier I of Regulation A, which does not preempt state law, allows offerings of up to $20 million in a twelve-month period. Due to difficult blue sky compliance, Tier 1 is rarely used. Tier 2, which does preempt state law, allows a raise of up to $50 million. Issuers may elect to proceed under either Tier I or Tier 2 for offerings up to $20 million. The new rules went into effect on June 19, 2015 and have been gaining traction ever since. Since that time, the SEC Division of Corporation Finance has issued periodic Compliance and Disclosure Interpretations (C&DI) to provide guidance related to Regulation A. I have previously written several articles on Regulation A and the C&DI. For a good review and summary, please see my blog HERE.

From inception, a Regulation A company could apply for a listing on the OTC Markets OTCQX Tier assuming it meets the qualifications. Elio Motors trades on the OTCQX. For a review of such qualifications, see my blog HERE. Unlike the OTCQX, generally a company that is not subject to the Exchange Act reporting requirements did not qualify for the OTCQB; however, effective July 10, the OTCQB has amended their rules to allow a Tier 2 reporting entity to qualify to apply for and trade on the OTCQB. My blog on the OTCQB rules related to Regulation A can be read HERE.

Whether trading on the OTCQX or OTCQB, keep in mind that 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. For a short overview of Rule 144, see HERE.

Regulation A Eligibility – Reporting Issuers

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

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

Although companies subject to the reporting requirement have been disqualified from day one, the SEC quickly issued guidance clarifying that Regulation A may be used by many existing “reporting entities” either because they voluntarily report (generally because they never filed a Form 8-A or Form 10 after an S-1 registration statement and the initial required reporting period has passed) or through a wholly owned subsidiary resulting in a complete or partial spin-off.

The SEC specifically provided that 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. The determination of eligibility is made at the time of the offering. Moreover, a company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to rely on Regulation A. In addition, 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.

Related to small business issuers, the current rules create an unfair distinction. A company trading on the OTC Markets that voluntarily reports to the SEC would be eligible, whereas a company that may be substantially similar but is required to file reports would be ineligible to utilize Regulation A+.

On June 6, 2016, OTC Markets filed a petition for rulemaking with the SEC requesting that the SEC amend Regulation A+ to expand the eligibility criteria to include all small issuers, including those that are subject to the Exchange Act reporting requirements and to allow “at-the-market offerings.”

The OTC Markets petition is concise and to the point. When Congress passed the JOBS Act, it left the particulars of Regulation A+ rulemaking to the SEC with only the following mandates:

The aggregate offering amount of all securities sold within a 12-month period shall not exceed $50,000,000;
The securities may be offered and sold publicly;
The securities shall not be restricted securities within the meaning of the federal securities laws;
The civil liability provisions under Section 12(a)(2) of the Securities Act shall apply to any person offering or selling Regulation A securities;
The issuer may solicit interest in the offering prior to filing any offering statement, on such terms and condition as the SEC may prescribe in the public interest and protecting investors;
The SEC shall require the issuer to file annual audited financial statements; and
Such other terms and conditions as the SEC shall determine are necessary in the public interest and protecting investors.

The JOBS Act itself did not prohibit or limit the use of Regulation A+ for reporting companies, and accordingly, that decision is within the SEC rulemaking discretion. In fact, throughout the JOBS Act and in particular in Title IV related to Regulation A+, Congress refers to expanding capital formation for “small issues” under $50 million with the goal of increasing capital to all small companies.

The SEC reasoning for excluding reporting companies in the first place is weak at best. In particular, the SEC excluded reporting issuers because the prior Regulation A rules, which were admittedly rarely used and ineffective at assisting in small business capital formation, contained the exclusion. That is, when revamping Regulation A+ as mandated by the JOBS Act, the SEC just didn’t change that provision.

The OTC Markets points out that the Regulation A+ rules as enacted offer more protections for non-accredited investors than a fully registered S-1 or S-3 offering. In particular, there are no investor limitations for unaccredited purchasers in an S-1 or S-3 offering, whereas a Regulation A+ offering limits investments by unaccredited investors to no more than 10% of the greater of the investor’s annual income or net worth. In addition, a traditional S-1 or S-3 does not have any limitations or prohibitions related to bad actor disqualifications, whereas Regulation A+ does prohibit use by “bad actors.”

The OTC Markets petition also contains a good discussion on the costs associated with an S-1 or S-3 offering, including added costs of state blue sky law compliance. State blue sky preemption is one of the cornerstones of Tier 2 Regulation A+ offerings that benefit issuers. Moreover, generally only much larger issuers are S-3 eligible and thus S-3 is not considered a “small company” capital formation tool. Similarly, private offerings under Regulation D are not registered and so do not offer the same level of investor protections. These offerings also result in restricted securities and thus less investor incentive to participate.

In addition to the obvious benefit to small and emerging company capital formation of allowing small reporting companies to utilize Regulation A+, there is also an added potential benefit to the capital markets as a whole. OTC Markets opines that the flow of freely tradable securities into the marketplace for existing public companies could have a positive uptick on the liquidity and overall growth and vitality of venture markets. Regulation A+ could have the benefit of pushing forward the much needed venture market for the secondary trading of securities of early-stage, small and emerging growth companies. OTC Markets points out that it could and should be that venture market.

The OTC Markets petition contains a pointed discussion on the market benefits, including noting that “Regulation A+ allows smaller companies, traditionally lacking the backing of bulge bracket investment banks and the large base of institutional ownership needed to fund ongoing research coverage, to reach out to a broader pool of potential investors through ‘testing the waters’ provisions and the efficient economical reach of the Internet and social media. Emerging companies can use Regulation A+ online offerings to tap into large numbers of individual investors and efficiently target smaller institutions. Allowing fully SEC reporting companies the same ability to leverage technology and transparency to reach potential investors would be expected to provide a ready source of growth capital, and, equally important, an increase in liquidity in the secondary market.”

Interestingly, OTC argues that opening up Regulation A+ to small reporting companies may reduce or minimize the use of toxic financing options which carry substantial dilution and downward pricing pressure on company stock. Moreover, allowing small reporting companies to utilize Regulation A+ may raise the interest in these offerings for investment banks.

Finally, in order to make Regulation A+ the most useful for reporting companies, OTC Markets requests that the SEC also amend the rules to allow “at-the-market” offerings. Currently all Regulation A+ offerings must be priced. In the case of a security that is already trading, the ability to price accurately is difficult and the inability to adjust such pricing in response to fluctuating market conditions can impede the success of the offering.

Further Thoughts

From my perspective, Regulation A has become the most popular method of fundraising and private-to-public transactions for small business issuers. Although as of the date of this blog, only one issuer, Elio Motors, Inc., has received a trading symbol and actively trades, many others are in the works and I think we will see an opening of the floodgates. As Tier 2 requires audited financial statements, the preparation process can take months and the placement of an offering can also take months.

A traditional IPO is completed using an underwriter on a “firm commitment” basis where the underwriter buys all the company’s securities on the first day of the IPO and proceeds to resell them. No Regulation A offerings have yet been completed in a firm commitment underwritten offering. To the contrary, current Regulation A offerings are either self-placed by the issuing company, or completed with the assistance of a broker-dealer placement agent on a best efforts basis. This placement process can take several months to complete. Accordingly, many issuers have not closed out their offerings as of yet and therefore have not reached the point of eligibility to apply for a trade symbol. My office alone has over half a dozen Regulation A offerings in the works.

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

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

This marks a huge change and opportunity for companies that wish to go public directly and raise less than $50 million. An initial or direct public offering on Form S-1 does not preempt state law. By choosing a Tier 2 Regulation A+ offering followed by a Form 8-A, the issuer can achieve the same result – i.e., become a fully reporting trading public company, without the added time and expense of complying with state blue sky laws. The other consideration would be the added investor qualifications, but if the issuer meets the requirements for and lists on a national exchange, the added investor qualifications no longer apply.

The SEC has a well published mission of “protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation.” Regulation A+ offers significant investor protections in that a form of registration statement is filed with the SEC and subject to a review and comment process. In addition, Regulation A+ allows for pre- and post-filing marketing using the Internet, social media, presentations and the like, provided all such materials are filed with the SEC and subject to review and comment. This process provides significant investor protections, including a permanent record of disclosures made during the offering process. Regulation A+ also provides a streamlined, affordable registration process with access to an expanded pool of investors, thus facilitating capital formation.

To the contrary, private offering documents are not filed or reviewed with the SEC and the process and level of disclosure are far less regulated. Public offerings using Form S-1 limit offering communications, and those communications are not necessarily filed or reviewed by the SEC. The Form S-1 process does not allow for broad Internet, crowd or social media marketing. A Form S-1 process also does not preempt state law and accordingly has significant added costs for a company. A Form S-1 works best for larger issuers with strong underwriter and institutional support. Regulation A+ provides the best method of registered capital formation for small companies, including those that are already subject to the SEC reporting requirements.

As was understood in passing the JOBS Act in 2012, the transparent Regulation A+ process is a preferred method of capital raising for small businesses, especially companies already subject to the reporting requirements who have audited financial statements readily available and processes in place for meeting SEC reporting and review requirements.

When the SEC issued the Regulation A+ rules on March 25, 2015, it issued a press release in which SEC Chair Mary Jo White was quoted as saying, “These new rules provide an effective, workable path to raising capital that also provides strong investor protections. It is important for the Commission to continue to look for ways that our rules can facilitate capital raising by smaller companies.” Allowing small reporting companies to partake in Regulation A+ meets all the mandates of the JOBS Act while concurrently satisfying the SEC goal of providing investor protections, and I am a strong advocate in support of a rule change in that regard.

The Author

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

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

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

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« A Comparison Of Nevada, Delaware And Florida Corporate Statutes Confidentially Marketed Public Offerings (CMPO) »

Mergers And Acquisitions – The Merger Transaction

Posted by Securities Attorney Laura Anthony | October 20, 2015 Tags: Mergers and Acquisitions, the merger transaction

Although I have written about document requirements in a merger transaction previously, with the recent booming M&A marketplace, it is worth revisiting. This blog only addresses friendly negotiated transactions achieved through share exchange or merger agreements. It does not address hostile takeovers.

A merger transaction can be structured as a straight acquisition with the acquiring company remaining in control, a reverse merger or a reverse triangular merger. In a reverse merger process, the target company shareholders exchange their shares for either new or existing shares of the public company so that at the end of the transaction, the shareholders of the target company own a majority of the acquiring public company and the target company has become a wholly owned subsidiary of the public company. The public company assumes the operations of the target company.

A reverse merger is often structured as a reverse triangular merger. In that case, the acquiring company forms a new subsidiary which merges with the target company. The primary benefits of the reverse triangular merger include the ease of shareholder consent and certain perceived tax benefits. The specific form of the transaction should be determined considering the relevant tax, accounting and business objectives of the overall transaction.

An Outline of the Transaction Documents

The Confidentiality Agreement

Generally the first step in an M&A deal is executing a confidentiality agreement and letter of intent. These documents can be combined or separate. If the parties are exchanging information prior to reaching the letter of intent stage of a potential transaction, a confidentiality agreement should be executed first.

In addition to requiring that both parties keep information confidential, a confidentiality agreement sets forth important parameters on the use of information. For instance, a reporting entity may have disclosure obligations in association with the initial negotiations for a transaction, which would need to be exempted from the confidentiality provisions. Moreover, a confidentiality agreement may contain other provisions unrelated to confidentiality, such as a prohibition against solicitation of customers or employees (non-competition) and other restrictive covenants. Standstill and exclusivity provisions may also be included, especially where the confidentiality agreement is separate from the letter of intent.

The Letter of Intent

A letter of intent (“LOI”) is generally non-binding and spells out the broad parameters of the transaction. The LOI helps identify and resolve key issues in the negotiation process and hopefully narrows down outstanding issues prior to spending the time and money associated with conducting due diligence and drafting the transaction contracts and supporting documents. Among other key points, the LOI may set the price or price range, the parameters of due diligence, necessary pre-deal recapitalizations, confidentiality, exclusivity, and time frames for completing each step in the process. Along with an LOI, the parties’ attorneys prepare a transaction checklist which includes a “to do” list along with the “who do” identification.

Many clients ask me how to protect their interests while trying to negotiate a merger or acquisition. During the negotiation period, both sides will incur time and expense, and will provide the other with confidential information. The way to protect confidential information is through a confidentiality agreement, but that does not protect against wasted time and expense. Many other protections can be used to avoid wasted time and expense.

Many, if not all, letters of intent contain some sort of exclusivity provision. In deal terminology, these exclusivity provisions are referred to as “no shop” or “window shop” provisions. A “no shop” provision prevents one or both parties from entering into any discussions or negotiations with a third party that could negatively affect the potential transaction, for a specific period of time. That period of time may be set in calendar time, such as sixty days, or based on conditions, such as completion of an environmental study, or a combination of both.

A “window shop” provision allows for some level of third-party negotiation or inquiry. An example of a window shop provision may be that a party cannot solicit other similar transactions but is not prohibited from hearing out an unsolicited proposal. A window shop provision may also allow the board of directors of a party to shop for a better deal, while giving a right of first refusal if such better deal is indeed received. Window shop provisions generally provide for notice and disclosure of potential “better deals” and either matching or topping rights.

Generally, both no shop and window shop provisions provide for a termination fee or other detriment for early termination. The size of the termination fee varies; however, drafters of a letter of intent should be cognizant that if the fee is substantial, it likely triggers an SEC reporting and disclosure requirement, which in and of itself could be detrimental to the deal.

Much different from a no shop or window shop provision is a “go shop” provision. To address a board of directors’ fiduciary duty and, in some instances, to maximize dollar value for its shareholders, a potential acquirer may request that the target “go shop” for a better deal up front to avoid wasted time and expense. A go shop provision is more controlled than an auction and allows both target and acquiring entities to test the market prior to expending resources. A go shop provision is common where it is evident that the board of directors’ “Revlon Duties” have been triggered.

Another common deal protection is a standstill agreement. A standstill agreement prevents a party from making business changes outside of the ordinary course, during the negotiation period. Examples include prohibitions against selling off major assets, incurring extraordinary debts or liabilities, spinning off subsidiaries, hiring or firing management teams and the like.

Finally, many companies protect their interests by requiring significant stockholders to agree to lock-ups pending a deal closure. Some lock-ups require that the stockholder agree that they will vote their shares in favor of the deal as well as not transfer or divest themselves of such shares.

The Merger Agreement

In a nutshell, the Merger Agreement sets out the financial terms of the transaction and legal rights and obligations of the parties with respect to the transaction. It provides the buyer with a detailed description of the business being purchased and provides for rights and remedies in the event that this description proves to be materially inaccurate. The Merger Agreement sets forth closing procedures, preconditions to closing and post-closing obligations, and sets out representations and warranties by all parties and the rights and remedies if these representations and warranties are inaccurate.

The main components of the Merger Agreement and a brief description of each are as follows:

Representations and Warranties – Representations and warranties generally provide the buyer and seller with a snapshot of facts as of the closing date. From the seller the facts are generally related to the business itself, such as that the seller has title to the assets, there are no undisclosed liabilities, there is no pending litigation or adversarial situation likely to result in litigation, taxes are paid and there are no issues with employees. From the buyer the facts are generally related to legal capacity, authority and ability to enter into a binding contract. The seller also represents and warrants its legal ability to enter into the agreement. Both parties represent as to the accuracy of public filings, financial statements, material contract, tax matters and organization and structure of the entity.

Covenants – Covenants generally govern the parties’ actions for a period prior to and following closing. An example of a covenant is that a seller must continue to operate the business in the ordinary course and maintain assets pending closing and, if there are post-closing payouts that the seller continues likewise. All covenants require good faith in completion.

Conditions – Conditions generally refer to pre-closing conditions such as shareholder and board of director approvals, that certain third-party consents are obtained and proper documents are signed. Generally for public companies these conditions include the filing of appropriate shareholder proxy or information statements under Section 14 of the Securities Exchange Act of 1934 and complying with shareholder appraisal rights provisions. Closing conditions usually include the payment of the compensation by the buyer. Generally, if all conditions precedent are not met, the parties can cancel the transaction.

Indemnification/remedies – Indemnification and remedies provide the rights and remedies of the parties in the event of a breach of the agreement, including a material inaccuracy in the representations and warranties or in the event of an unforeseen third-party claim related to either the agreement or the business.

Deal Protections – Like the LOI, the merger agreement itself will contain deal protection terms. These deal protection terms can include no shop or window shop provisions, requirements as to business operations by the parties prior to the closing; breakup fees; voting agreements and the like.

Schedules – Schedules generally provide the meat of what the seller is purchasing, such as a complete list of customers and contracts, all equity holders, individual creditors and terms of the obligations. The schedules provide the details.

In the event that the parties have not previously entered into a letter of intent or confidentiality agreement providing for due diligence review, the Merger Agreement may contain due diligence provisions. Likewise, the agreement may contain no shop provisions, breakup fees, non-compete and confidentiality provisions if not previously agreed to separately.

Disclosure Matters

In a merger or acquisition transaction, there are three basic steps that could invoke the disclosure requirements of the federal securities laws: (i) the negotiation period or pre-definitive agreement period; (ii) the definitive agreement; and (iii) closing.

(i) Negotiation Period (Pre-Definitive Agreement)

Generally speaking, the federal securities laws do not require the disclosure of a potential merger or acquisition until such time as the transaction has been reduced to a definitive agreement. Companies and individuals with information regarding non-public merger or acquisition transactions should be mindful of the rules and regulations preventing insider trading on such information. However, there are at least three cases where pre-definitive agreement disclosure may be necessary or mandated.

The first would be in the Management, Discussion and Analysis section of a company’s quarterly or annual report on Form 10-Q or 10-K, respectively. Item 303 of Regulation S-K, which governs the disclosure requirement for Management’s Discussion and Analysis of Financial Condition and Results of Operations, requires, as part of this disclosure, that the registrant identify any known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, the registrant’s liquidity increasing or decreasing in any material way. Furthermore, descriptions of known material trends in the registrant’s capital resources and expected changes in the mix and cost of such resources are required. Disclosure of known trends or uncertainties that the registrant reasonably expects will have a material impact on net sales, revenues, or income from continuing operations is also required. Finally, the Instructions to Item 303 state that MD&A “shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

It seems pretty clear that a potential merger or acquisition would fit firmly within the required MD&A discussion. However, realizing that disclosure of such negotiations and inclusion of such information could, and often would, jeopardize completing the transaction at all, the SEC has provided guidance. In SEC Release No. 33-6835 (1989), the SEC eliminated uncertainty regarding disclosure of preliminary merger negotiations by confirming that it did not intend for Item 303 to apply, and has not applied, and does not apply to preliminary merger negotiations. In general, the SEC’s recognition that companies have an interest in preserving the confidentiality of such negotiations is clearest in the context of a company’s continuous reporting obligations under the Exchange Act, where disclosure on Form 8-K of acquisitions or dispositions of assets not in the ordinary course of business is triggered by completion of the transaction (more on this below). Clearly, this is a perfect example and illustration of the importance of having competent legal counsel assist in interpreting and unraveling the numerous and complicated securities laws disclosure requirements.

In contrast, where a company registers securities for sale under the Securities Act, the SEC requires disclosure of material probable acquisitions and dispositions of businesses, including the financial statements of the business to be acquired or sold. Where the proceeds from the sale of the securities being registered are to be used to finance an acquisition of a business, the registration statement must disclose the intended use of proceeds. Again, accommodating the need for confidentiality of negotiations, registrants are specifically permitted not to disclose in registration statements the identity of the parties and the nature of the business sought if the acquisition is not yet probable and the board of directors determines that the acquisition would be jeopardized. Although beyond the scope of this blog, many merger and/or acquisition transactions require registration under Form S-4.

Accordingly, where disclosure is not otherwise required and has not otherwise been made, the MD&A need not contain a discussion of the impact of such negotiations where, in the company’s view, inclusion of such information would jeopardize completion of the transaction. Where disclosure is otherwise required or has otherwise been made by or on behalf of the company, the interests in avoiding premature disclosure no longer exist. In such case, the negotiations would be subject to the same disclosure standards under Item 303 as any other known trend, demand, commitment, event or uncertainty.

The second would be in Form 8-K, Item 1.01 Entry into A Material Definitive Agreement. Yes, this is in the correct category; the material definitive agreement referred to here is a letter of intent or confidentiality agreement. Item 1.01 of Form 8-K requires a company to disclose the entry into a material definitive agreement outside of the ordinary course of business. A “material definitive agreement” is defined as “an agreement that provides for obligations that are material to and enforceable against the registrant or rights that are material to the registrant and enforceable by the registrant against one or more other parties to the agreement, in each case whether or not subject to conditions.” Agreements relating to a merger or acquisition are outside the ordinary course of business. Moreover, although most letters of intent are non-binding by their terms, many include certain binding provisions such as confidentiality provisions, non-compete or non-circumvent provisions, no shop and exclusivity provisions, due diligence provisions, breakup fees and the like. On its face, it appears that a letter of intent would fall within the disclosure requirements in Item 1.01.

Once again, the SEC has offered interpretative guidance. In its final rule release no. 33-8400, the SEC, recognizing that disclosure of letters of intent could result in destroying the underlying transaction as well as create unnecessary market speculation, specifically eliminated the requirement that non-binding letters of intent be disclosed. Moreover, the SEC has taken the position that the binding provisions of the letter, such as non-disclosure and confidentiality, are not necessarily “material” and thus do not require disclosure. However, it is important that legal counsel assist the company in drafting the letter, or in interpreting an existing letter to determine if the binding provisions reach the “materiality” standard and thus become reportable. For example, generally large breakup fees or extraordinary exclusivity provisions are reportable.

The third would be in response to a Regulation FD issue. Regulation FD or fair disclosure prevents selective disclosure of non-public information. Originally Regulation FD was enacted to prevent companies from selectively providing information to fund managers, big brokerage firms and other “large players” in advance of providing the same information to the investment public at large. Regulation FD requires that in the event of an unintentional selective disclosure of insider information, the company take measures to immediately make the disclosure to the public at large through both a Form 8-K and press release.

(ii) The Definitive Agreement

The definitive agreement is disclosable in all aspects. In addition to inclusion in Form 10-Q and 10-K, a definitive agreement must be disclosed in Form 8-K within four (4) days of signing in accordance with Item 1.01 as described above. Moreover, following the entry of a definitive agreement, completion of conditions, such as a shareholder vote, will require in-depth disclosures regarding the potential target company, including their financial statements.

(iii) The Closing

The Closing is disclosable in all aspects, as is the definitive agreement. Moreover, in addition to item 1.01, the Closing may require disclosures under several or even most of the Items in Form 8-K, such as Item 2.01 – Completion of disposal or acquisition of Assets; Item 3.02 – Unregistered sale of securities; Item 4.01 – Changes in Certifying Accountant; Item 5.01 Change in Control; Item 5.06 – Change in Shell Status, etc.

Due Diligence in a Merger Transaction

Due diligence refers to the legal, business and financial investigation of a business prior to entering into a transaction. Although the due diligence process can vary depending on the nature of a transaction (a relatively small acquisition vs. a going public reverse merger), it is arguably the most important component of a transaction (or at least equal with documentation).

At the outset, in addition to requesting copies of corporate records and documents, all contracts, asset chains of title documents, financial statements and the like, due diligence includes becoming familiar with the target’s business, including an understanding of how they make money, what assets are important in revenues, who are their commercial partners and suppliers, and common off-balance-sheet and other hidden arrangements in that business. It is important to have a basic understanding of the business in order to effectively review the documents and information once supplied, to know what to ask for and to isolate potential future problems.

In addition to determining whether the transaction as a whole is worth pursuing, proper due diligence will help in structuring the transaction and preparing the proper documentation to prevent post-closing issues (such as making sure all assignments of contracts are complete, or where an assignment isn’t possible, new contracts are prepared).

In addition to creating due diligence lists of documents and information to be supplied, counsel for parties should perform separate checks for publicly available information. In today’s internet world, this part of the process has become dramatically easier. Counsel should be careful not to miss the basics, such as UCC lien searches, judgment searches, recorded property title and regulatory issues with any of the principals or players involved in the deal, including any bad actor issues that could be problematic going forward.

The Author

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

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. The firm’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. 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 producer and host of LawCast, 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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OTC Markets Comments on Proposed SEC Rules Regarding Amendments to Regulation D, Form D and Rule 156

Posted by Securities Attorney Laura Anthony | July 29, 2015 Tags: LawCast, OTC Law Firm, OTC Law Firms, OTC Lawyers, OTC Market Attorneys, OTC Markets Attorneys, OTC Securities Attorneys

On July 10, 2013, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156. On September 23, 2013 the OTC Markets Group published a letter responding to the SEC’s request for comments on the proposed rules. The entire OTC Markets comment letter is available on both the OTC Markets website and the SEC website. The OTC Markets Group, through OTC Link, owns and operates OTC Markets and its quotation platforms including OTCQX, OTCQB and pink sheets.

Summary of Proposed Rule Changes

The proposed amendments will (i) require the filing of a Form D to be made before the Issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an Issuer from relying on Rule 506 for one year for future offerings if the Issuer, or any predecessor or affiliate of the Issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”

On August 20, 2013, I published a blog detailing the proposed rule changes related to Form D and Rule 507, which can be viewed here. On August 27, 2013, I published a blog detailing the remainder of the proposed rule changes including the proposed amendments to general solicitation materials and the temporary requirement that all such materials be submitted to the SEC, which can be viewed here.

OTC Markets Comment Letter

OTC Markets has been vocal about its support of the lifting of the ban on general solicitation and advertising, and it continues to be so in its comment letter. However, OTC Markets is not supportive of the proposed new rules and, in fact, is concerned that the rules “would counteract the positive impact of the new general solicitation and advertising rules, contradict the intent of the JOBS Act, and ultimately harm small capital formation.” The OTC Market’s biggest concern is the proposed advance Form D filing requirement.

OTC Markets Comments Related to the Proposed Advance Form D Requirement

Currently, an Issuer must file a Form 15 within 15 days of the first sale of securities in a Regulation D offering. An Issuer must file an amendment if there is a material change to the information filed in the original Form D. The proposed rule would require the Issuer to file an advance Form D with the SEC at least 15 days prior to using advertising or general solicitation in conjunction with the new 506(c) offering exemption. OTC Markets has many issues with the proposed new filing requirement.

First, OTC Markets is concerned that the advance filing requirement will chill communications between Issuers and potential investors. It is unclear what constitutes general solicitation and advertising or non-confidential information. This lack of clarity will likely result in confusion by Issuers as to when or if an advance Form D is required. Moreover, the lack of clarity could cause Issuers to err on the cautious side and instead of providing more information to the public, maintain such information as confidential. One of the underlying intents of the JOBS Act was to increase the amount of publicly available information about Issuers.

OTC Markets points out that “[F]or many small companies, the fear of violating the Advance Form D requirement will cause them to keep information confidential. Investors, employees, the press and regulators would be deprived of valuable company information, leading to unreliable price discovery, a lack of market efficiency, reduced incentive to participate in private offerings, and less capital raising by small companies.” OTC Markets goes further to conclude that “the Advance Form D requirement may completely frustrate the Congressional intent behind the JOBS Act and make the end of the ban on general solicitation and advertising a non-event for small companies.”

In addition, OTC Markets takes issue with the SEC’s reasoning behind the proposed advance Form D requirement. In particular, the SEC has indicated that the requirement will help it analyze and better understand the market for Rule 506(c) private placements. The SEC does not offer a rationale as to how an advance Form D would provide information not already provided by the current Form D. Moreover, the SEC has access to documents submitted to FINRA by broker dealers acting as placement agent or participating in private placements. The current Form D filing requirement together with FINRA information already provides the SEC with enough data to analyze any market impact of 506(c) offerings without the negative effect of chilling small companies’ communications and capital raising efforts.

In a point very well taken, the OTC Markets states, “[T]he capital formation process would be much better served if the SEC engaged in thoughtful private placement rulemaking 12 months from now after conducting a thorough analysis of the impact of the new general solicitation rules on the private placement market. Implementing the Advance Form D requirement simultaneously with the end of the ban on general solicitation and advertising deprives the markets of the opportunity to properly evaluate the impact of the JOBS Act on small company capital formation.”

OTC Markets Comments – the Benefits of Adequate Current Public Information

OTC Markets advocates full public disclosure by all Issuers, especially those engaging in private placement offerings. The OTC Markets comment letter advocates “mandatory public disclosure of the information required under Securities Act Rule 144 in connection with any Rule 506(c) offering that utilizes general solicitation and advertising.” Rule 144 requires adequate current public information as a prerequisite to the sale of securities under the Rule. For a reporting company, the current public information requirement is met by being current in its reporting requirements with the SEC. For a non-reporting company, the current public information requirement is met by having all the information required by SEC Rule 15c2-11 made publicly available. Generally, this information is uploaded onto the OTC Markets website.

OTC Markets points out that prior to the new Rule 506(c), Regulation D required that information be kept confidential and not publicly available. OTC Markets sees the new rule as an opportunity for the SEC to increase and encourage public information by Issuers.

Although OTC Markets does not address this in its letter, one of the SEC’s reasons behind previously prohibiting public information was to ensure that only qualified investors had access to such information. However, in the proverbial “throw the bath water out with the baby,” the result was an influx of private secondary markets (such as pre-IPO Facebook) where everyone could see the trading of a security but only a qualified few could access information related to the Issuer. The new 506(c) is a tremendous shift whereby everyone can access the public information but only a qualified investor can make the actual investment.

OTC Markets rightfully points out that “[Public] availability of company information builds trust in our capital markets and provides vital protection against fraud.”

OTC Markets Comments on Proposed 506 Ban for Form D Noncompliance

The SEC has proposed a rule whereby Issuers would be banned from Rule 506 offerings for one year if that Issuer has failed to comply with the Form D filing requirements within the past 5 years. OTC Markets points out—and I couldn’t agree more—that the complexity of the Form D filing requirements, especially if the advance Form D is required, will lead to substantial technical noncompliance by well-intentioned Issuers. The one-year penalty is an overly severe punishment, especially in the environment of changing rules and regulations.

The Author

Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony 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 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 host of LawCast.com, the securities law network.

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

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