Regulation S-K - Reverse-Merger.com

Updated Disclosures for Mining Companies

Posted by Securities Attorney Laura Anthony | February 5, 2019

In the 4th quarter of 2018, the SEC finalized amendments to the disclosure requirements for mining companies under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The proposed rule amendments were originally published in June 2016. In addition to providing better information to investors about a company’s mining properties, the amendments are intended to more closely align the SEC rules with current industry and global regulatory practices and standards as set out in by the Committee for Reserves International Reporting Standards (CRIRSCO). In addition, the amendments rescind Industry Guide 7 and consolidate the disclosure requirements for registrants with material mining operations in a new subpart of Regulation S-K.

The final amendments require companies with mining operations to disclose information concerning their mineral resources and mineral reserves. Disclosures on mineral resource estimates were previously only allowed in limited circumstances. The rule amendments provide for a two-year transition period with compliance beginning in the first fiscal year on or after January 1, 2021.

Summary of the Final Rules

In amending the disclosure rules for mining companies, the SEC considered that many companies are already subject to one or more of the s and that by aligning the SEC reporting requirements to these rules, the compliance burden and costs for these companies could be reduced while still providing the necessary investor protections.

Under the final rules, a company with material mining operations must disclose specific information related to its mineral resources and mineral reserves on one or more of its properties. The rules define “mineral reserve” to include diluting materials and allowances for losses that may occur when the material is mined or extracted. The rules also amend the definition of “mineral resource” to exclude geothermal energy. Consistent with CRIRSCO standards, a company must disclose exploration results, mineral resources, or mineral reserves in SEC filings based on information and supporting documentation prepared by a mining expert referred to as a “qualified person.”

A company must obtain a dated and signed technical report summary from the qualified person related to mineral resources and reserves determined to be on each material property. The report must be signed either directly by the qualified person or the firm that employs them. Moreover, multiple qualified persons may take part in preparing the final technical report summary. The qualified person may conduct either a pre-feasibility or final feasibility study to support a determination of mineral reserves even in high-risk situations. The report must be filed as an exhibit to the company’s SEC report when first disclosed and subsequent changes or amendments to the report must also be filed as exhibits. A technical report on exploration results may also be voluntarily filed as an exhibit.

The final rules require the qualified person to use a price for each commodity that provides a reasonable basis for establishing estimates of mineral resources or reserves. The price may be either historical or forward-looking, but the report must disclose and explain the reasons for using the selected price, including any material underlying assumptions. Similarly, instead of requiring a specific point of reference, the qualified person may choose any point of reference subject to disclosure and explanations. The technical report summary may disclose mineral resources as mineral reserves as long as it also discloses mineral resources excluding mineral reserves.

A qualified person is not subject to expert liability under Section 11 of the Securities Act of 1933 (“Securities Act”) for information and factors that are outside that person’s expertise, even if discussed in the technical report.

Although the proposed rule amendment provided for quantitative presumptions as to when mineral resources or reserves will be deemed material, the final rule did not include this provision, instead allowing management to rely on a principles-based approach in determining materiality. Likewise, management can determine when a change in previously reported estimates of mineral resources or reserves is material. Also, the proposed rule would have required a table with certain information on a company’s top 20 properties, but the final rule instead also uses a principles-based approach, again leaving it to the company to determine material disclosures of its properties and mining operations.

Materiality relating to mineral resources and reserves has been modified to consistently rely on a principles-based approach. A principles-based approach requires the company to “rely on a registrant’s management to evaluate the significance of information in the context of the registrant’s overall business and financial circumstances” and to “exercise judgment” in determining whether disclosure is required. The SEC has shown a trend towards this principles-based approach for determining materiality for purposes of disclosure in its recent reviews and amendments to Regulation S-K and Regulation S-X (see, for example, HERE and HERE). Practitioners, including the American Bar Association (“ABA”), have advocated for principles-based disclosure over quantitative or bright line tests (see HERE) believing that a quantitative guideline results in lengthy, and often immaterial, information. Congressional lawmakers have also supported this approach requiring the SEC to conduct a study on shifting even more disclosure requirements to principles based, as part of the FAST Act (see HERE).

The number of summaries and tables that are currently required has been reduced from seven to two and the company may now choose to make its disclosures using either tables or a narrative format. A company is permitted to voluntarily disclose exploration targets in its SEC reports as long as they are accompanied by certain specified cautionary and explanatory statements. Disclosure of exploration activity and results is mandatory once the company determines the information is material to investors. Also, the qualified person may include inferred resources in their economic analysis as long as certain conditions are met.

A company may now use historical estimates of mineral resources or reserves in SEC filings pertaining to mergers, acquisitions, or business combinations if they are unable to update the estimate prior to the completion of the relevant transaction, provided that the company discloses the source and date of the estimate, and does not treat the estimate as a current estimate.

Finally, the amended rules allow a company holding a royalty or similar interest to omit any information required under the summary and individual property disclosure provisions to which it lacks access and which it cannot obtain without incurring an unreasonable burden or expense.

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SEC Issues Additional Guidance on Regulation A+

Posted by Securities Attorney Laura Anthony | June 20, 2017 Tags: CD&I Guidance, EGC, Form 1-A, Form 1-A Filings, Form 1-A Qualified, Regulation A Offering Circular, Regulation A+ Rules, Rule 506(c) Offering, Section 71003 of the FAST Act, test the waters” Rules, Tier 2 Regulation A Offering

On March 31, 2017, the SEC Division of Corporation Finance issued six new Compliance and Disclosure Interpretations (C&DI) to provide guidance related to Regulation A/A+. Since the new Regulation A+ came into effect on June 19, 2015, its use has continued to steadily increase. In my practice it is the most popular method for a public offering under $50 million.

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

New CD&I Guidance

In the first of the new CD&I, the SEC clarifies the timing of the filing of a Form 8-A to register a class of securities under Section 12(b) or (g) of the Exchange Act. In particular, in order to be able to file a Form 8-A as part of the Regulation A+ process, in addition to utilizing Form S-1 format in the Regulation A+ offering circular, a company must file the Form 8-A concurrent with qualification of the offering circular. Registration under 12(g) occurs automatically; however, Registration under 12(b) requires that the applicable national securities exchange certify the registration within five calendar days. As with any SEC filings based on calendar days, where the fifth day falls on a Saturday, Sunday or federal holiday, the certification may be received on the next business day.

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

The third new CD&I addresses the age of financial statements to be included in a Tier 2 offering circular. In particular, financial statements generally do not go stale for nine months, as opposed to 135 days for other filings under Regulation S-X. Interim financial statements should be for a period of six months following the date of the fiscal year-end.

In the fourth new CD&I, the SEC confirmed that a tax opinion is not required to be filed as an exhibit to Form 1-A, but a company may do so voluntarily.

In the fifth new CD&I, the SEC confirmed that it will not object if an auditor’s consent is not included as an exhibit to an annual report on Form 1-K, even if though the report contains audited financial statements. The report would still need to contain the auditor’s report, but a separate consent is not required.

Finally in the last of the new CD&I, the SEC confirms that the requirement under Industry Guide 5 that sales material be submitted to the SEC before use, does not apply to Regulation A offerings. Industry Guide 5 relates to registration statements relating to interests in real estate limited partnerships.

Refresher on CD&I Issued November 2016

In November 2016, the SEC issued three CD&I providing guidance on Regulation A. In the first, the SEC has clarified that where a company seeks to qualify an additional class of securities via post-qualification amendment to a previously qualified Form 1-A, Item 4 of Part I, which requires “Summary Information Regarding the Offering and Other Current or Proposed Offerings,” need only include information related to the new class of securities seeking qualification.

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

Question 182.13 clarified the calculation of a 20% change in the price of the offering to determine the necessity of filing a post-qualification amendment which would be subject to SEC comment and review, versus a post-qualification supplement which would be effective immediately upon filing. In particular, Rule 253(b) provides that a change in price of no more than 20% of the qualified offering price, may be made by supplement and not require an amendment. An amendment is subject to a whole new review and comment period and must be declared qualified by the SEC. A supplement, on the other hand, is simply added to the already qualified Form 1-A, becoming qualified itself upon filing. The 20% variance can be either an increase or decrease in the offering price, but if it is an increase, it cannot result in an offering above the respective thresholds for Tier 1 ($20 million) or Tier 2 ($50 million).

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

In addition, on June 23, 2015, the SEC updated its Division of Corporation Finance C&DI to provide guidance related to Regulation A/A+ by publishing 11 new questions and answers and deleting 2 from its forms C&DI which are no longer applicable under the new rules. The summary below includes that guidance.

Regulation A/A+ – Private or Public Offering?

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

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

When considering integration, in addition to the discussion in the summary below, the SEC has now confirmed that a Regulation A/A+ offering can rely on Rule 152 such that a completed exempt offering, such as under Rule 506(b), will not integrate with a subsequent Regulation A filing. Under Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the issuer subsequently makes a public offering. The SEC has also issued guidance that Rule 152 applies to prevent integration between a completed 506(b) offering and a subsequent 506(c) offering, indicating that the important factor in the Rule 152 analysis is the ability to publicly solicit regardless of the filing of a registration statement.

Along the same lines, as Rule 506(c) is considered a public offering for this analysis, there would be nothing preventing a company from completing a Rule 506(c) offering either before, concurrently or after a Regulation A/A+ offering.

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

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

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

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

Practice Tip on Registration Rights Contracts

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

Refresher: The Final Rules – Summary of Regulation A+

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

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

However, as I will discuss below, this does not include preemption of state law related to broker-dealer registration. Five states do not have “issuer exemptions” for public offerings such as a Regulation A offering.

Specifics of Regulation A+ – How Does it Work?

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

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

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

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

Eligibility Requirements

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

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

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

A company that was once subject to the Exchange Act reporting obligations but suspended such reporting obligations by filing a Form 15 is eligible to utilize Regulation A/A+. 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/A+. A wholly owned subsidiary of an Exchange Act reporting company parent is eligible to complete a Regulation A/A+ offering as long as the parent reporting company is not a guarantor or co-issuer of the securities being issued.

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

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

Eligible Securities

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

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

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

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

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

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

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

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

All solicitation material must be submitted to the SEC as an Exhibit under Part III of Form 1-A. This is a significant difference from S-1 filers, who are not required to file “test the waters” communications with the SEC.

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

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

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

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

Continuous or Delayed Offerings

Continuous or delayed offerings (a form of a shelf offering) will be allowed only if the offering statement pertains to: (i) securities to be offered or sold solely by persons other than the issuer (however, note that under the rules this is limited to 30% of any offering); (ii) securities that are offered pursuant to a dividend or interest reinvestment plan or employee benefit plan; (iii) securities that are to be issued upon the exercise of outstanding options, warrants or rights; (iv) securities that are to be issued upon conversion of other outstanding securities; (v) securities that are pledged as collateral; or (vi) securities for which the offering will commence within two days of the offering statement qualification date, will be made on a continuous basis, will continue for a period of in excess of thirty days following the offering statement qualification date, and at the time of qualification are reasonably expected to be completed within two years of the qualification date. Under this last continuous offering section, issuers that are current in their Tier 2 reporting requirements may make continuous or delayed offerings for up to three years following qualification of the offering statement. Moreover, in the event a new qualification statement is filed for a new Regulation A offering, unsold securities from a prior qualification may be included, thus carrying those unsold securities forward for an additional three-year period.

Additional Tier 2 Requirements; Ability to List on an Exchange

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

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

An issuer may file a Form 8-A concurrently with the qualification of the Form 1-A, to register under the Exchange Act, and may make immediate application to a national securities exchange. A Form 8-A is a simple (generally 2-page) registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC (generally through an S-1). The Form 8-A will only be allowed if it is filed concurrently with the Form 1-A. That is, an issuer could not qualify a Form 1-A, wait a year or two, then file a Form 8-A. In that case, they would need to use the longer Form 10.

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

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

An issuer that reports under Regulation A is not considered to be subject to the Exchange Act reporting requirements and therefore its shareholders will be subject to the longer one-year holding period under Rule 144.

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

Integration

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

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

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

Offering Statement – General

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

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

Issuers may file offering circular updates after qualification in lieu of post-qualification amendments similar to the filing of a post-effective prospectus for an S-1. To qualify additional securities, a post-qualification amendment must be used.

Offering Statement – Non-Public (Confidential) Submission

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

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

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

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

Offering Statement – Form and Content

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

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

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

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

Form 1-A requires two years of financial information. All financial statements for Regulation A offerings must be prepared in accordance with GAAP. Financial statements of a Tier 1 issuer are not required to be audited unless the issuer has obtained an audit for other purposes. Audited financial statements are required for Tier 2 issuers. Audit firms for Tier 2 issuers must be independent and PCAOB-registered. An offering statement cannot be qualified if the date of the balance sheet is more than nine months prior to the date of qualification. Interim periods are only required for six-month intervals.

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

Part III requires an exhibits index and a description of exhibits required to be filed as part of the offering statement.

Offering Price

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

Ongoing Reporting

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

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

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

The ongoing reporting for Tier 2 companies is less demanding than the reporting requirements under the Securities Exchange Act. In particular, there are fewer 1-K items and only the semiannual 1-SA (rather than the quarterly 10-Q) and fewer events triggering Form 1-U (compared to Form 8-K). Companies may also incorporate text by reference from previous filings.

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

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

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

Freely Tradable Securities

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

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

Treatment under Section 12(g)

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

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

The issuer utilizes an SEC-registered transfer agent. Such transfer agent must be engaged at the time the company is relying on the exemption from Exchange Act registration;
The issuer remains subject to the Tier 2 reporting obligations;
The issuer is current in its Tier 2 reporting obligations, including the filing of an annual and semiannual report; and
The issuer has a public float of less than $75 million as of the last business day of its most recently completed semiannual period or, if no public float, had annual revenues of less than $50 million as of its most recently completed fiscal year-end.

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

State Law Preemption

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

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

State securities registration and exemption requirements are only preempted as to the Tier 2 offering and securities purchased pursuant to the qualified Tier 2 for 1-A offering circular. Subsequent resales of such securities are not preempted.

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

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

Broker-Dealer Placement

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

Further Thoughts

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

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

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

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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

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SEC Issues Report On Regulation S-K

Posted by Securities Attorney Laura Anthony | January 3, 2017 Tags: SEC Issues Report On Regulation S-K

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

The Report continues the ongoing review and proposed revisions to Regulations S-K and S-X as related to reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”). Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.

The Disclosure Effectiveness Initiative began in December 2013, when the SEC, as required by the JOBS Act, issued its first report on the Regulation S-K disclosure requirements. The Disclosure Effectiveness Initiative is intended to evaluate the rules related to disclosure, how information is presented and disclosed and how technology can be utilized in the process and to implement changes to improve the current disclosure-related rules and regulations.

Since the initiative began, the SEC has been issuing reports, an in-depth concept release, and proposed rule changes as part of the Disclosure Effectiveness Initiative. However, as of the date of this blog, none of the proposed changes have been implemented. I have included a summary of the various proposals and SEC publications at the end of this blog. I suspect that following the change in administration, and re-staffing of the SEC, including the as of yet to be announced replacements for SEC Chair Mary Jo White, Division of Corporation Finance Director Keith Higgins, and Trading and Markets Director Stephen Luparello, there will be significant progress in many of the outstanding proposals as well as new and different proposals on the subject. It is my belief that the new leadership will take a pro-business viewpoint and that we will see that flow through to the disclosure requirements, especially as it impacts smaller reporting companies and emerging-growth companies.

The Report

The FAST Act, passed in December 2015, contains two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 requires the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.” In accordance with that requirement, On July 13, 2016, the SEC issued proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded. The S-K and S-X Amendments also seek comment on certain disclosure requirements that overlap with U.S. GAAP and possible recommendations to FASB, the regulatory body that drafts and implements GAAP, for conforming changes. See my blog on the proposed rule change HERE. The proposal remains pending.

Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in the Report issued on November 23, 2016. As required, the SEC consulted with the IAC and ACSEC as part of the process.

Section 72003 specifically requires that the Report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information.

The SEC Report includes a high level review of the rule proposals issued by the SEC specifically in response to their mandate under the FAST Act. In particular, the proposed rule changes related to mining companies, proposed amendment to the definition of a smaller reporting company, the July 13, 2016 proposed amendments to Regulation S-K and the August 31, 2016 proposed amendment to Item 601 were all required by the FAST Act. In the Further Reading section below, I have included links to my blogs on these proposals.

Specific SEC Staff Recommendations

A. Item 10(d) Related to Incorporation by Reference

The SEC staff recommends revising Item 10(d) to permit incorporation by reference to documents that have been filed with the SEC for at least 5 years, but require a detailed description of and hyperlink to such documents. Currently the rule specifically prohibits incorporation of documents that have been filed more than five years prior.

The SEC staff recommends allowing incorporation by reference to financial statement footnotes where such disclosures satisfy other Regulation S-K item requirements. For example, disclosures related to related party transactions (Item 404), selected financial data (Item 301) and off-balance-sheet arrangements (Item 303) are all repeated in financial statement footnotes. The SEC staff notes that allowing incorporation by reference from financial statements to other documents would increase audit costs and burdens and accordingly specifically recommends disallowing outside incorporation from the financial statements.

In addition, currently incorporation-by-reference rules are not consistent. For example, Rule 411 related to Securities Act registration statements has different requirements than Rule 12b-23 related to Exchange Act registration statements. Different forms also have different rules and requirements. The SEC recommends consolidating all the incorporation-by-reference rules into Item 10(d) and that such rules apply to all filings under the both the Securities Act and Exchange Act.

B. Business Information

The SEC staff recommends revising Item 102 to clarify that a description of property is only required to the extent that physical properties are material to the company’s business. Currently, Item 102 requires companies to “state briefly the location and general character of the principal plants, mines and other materially important physical properties of the registrant and its subsidiaries.” The SEC could also streamline the disclosure requirement by adding a description of material property to the Item 101 business description as opposed to leaving it as a stand-alone item.

C. Management Discussion and Analysis

The SEC staff recommends revising Item 303 to clarify that a company need only provide a period-to-period comparison for the two most recent years and that it may hyperlink to the prior year’s annual report for prior comparisons. The SEC staff also recommends considering requiring a discussion of material changes and known trends and uncertainties that impacted those changes, as opposed to the current granular line-item comparisons. In that regard, the MD&A focus would shift to longer-term trends and how those trends impacted the reported financial statements and may impact future results.

The SEC staff also recommends eliminating the requirement to provide a tabular disclosure of contractual obligations. I note that smaller reporting companies are not required to provide this disclosure. The staff recommends that instead of the table, a company should provide a hyperlink to financial statement footnotes and a liquidity discussion that describes material changes to contractual obligations and the ability to pay and perform such obligations.

D. Management, Security Holders, Corporate Governance

The SEC staff recommends clarifying the rules as to when and where the business experience of executive officers is required in proxy statements. In particular, the rules should clarify that the information is not required in a proxy statement when it is otherwise contained in a Form 10-K.

The SEC staff recommends allowing a company to simply review EDGAR filings to determine compliance with Section 16. Currently a Section 16 filer is required to also furnish a company with their filings. Similarly, the staff recommends eliminating the Section 16 disclosure requirement altogether where there are no delinquencies to report.

The SEC staff makes multiple recommendations to clarify and clean up certain corporate governance reporting requirements including further aligning the smaller reporting company and emerging-growth company requirements.

E.Registration Statements

As related to registration statements, the SEC staff makes several recommendations to clean up redundancies, allow for hyperlinks, and add consistencies to the requirements related to registration statements. The following is a brief description of some of those recommendations.

The SEC staff recommends eliminating the provision of Item 501 related to the name of the company. In particular, the SEC rules have provisions related to the use of a name that is the same as a “well-known” company or could be misleading. The concept is already covered by intellectual property laws and it is not necessary for the SEC to have a specific regulation addressing same.

The staff recommends eliminating the requirement to provide an explanation of the method of determining the price of an offering in a registration statement from the cover page and allowing a hyperlink to the same disclosure elsewhere in the document.

The staff recommends adding a disclosure to specify if the company already trades on the OTC Markets and to provide the trading symbol. Currently the disclosure is only required for exchange-traded companies. In practice, OTC-traded companies already do this.

The staff recommends reducing the length of the “subject to completion” disclaimer on the front page by eliminating reference to state law where it is not applicable, such as when the offering pre-empts state law under the National Securities Market Improvement Act (NSMIA).

The staff recommends eliminating several of the Item 512 undertakings provisions as duplicative, redundant or obsolete.

F. Exhibits

The staff recommends adding a description of the company’s outstanding securities as an exhibit to Form 10-K. The staff also recommends adding the requirement that a subsidiaries legal entity identifier number (LEI) be included in the subsidiary list exhibit.

The staff recommends permitting the omission of attachments and schedules from exhibits unless the schedule or attachment has material information that is not disclosed elsewhere.

G. Manner of Delivery Requirements

The staff recommends adding XBRL tagging to the cover page of reports. The staff also recommends allowing the use of hyperlinks to websites when a disclosure of such website URL is required.

Further Reading

The following is a recap of the ongoing Disclosure Effectiveness Initiative-related reports and proposals. The Disclosure Effectiveness Initiative began in December 2013, when the SEC, as required by the JOBS Act, issued its first report on the Regulation S-K disclosure requirements. The Disclosure Effectiveness Initiative is intended to evaluate the rules related to disclosure, how information is presented and disclosed and how technology can be utilized in the process and to implement changes to improve the current disclosure-related rules and regulations.

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

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

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

On June 16, 2016, the SEC proposed revisions to Item 102 of Regulation S-K and Industry Guide 7 related to the property disclosure requirements for mining companies. The revisions are intended to modernize the disclosure obligations to be better aligned with current industry and global regulatory practices. The SEC also proposed rescinding Industry Guide 7 and including the substantive provisions in a new subpart in Regulation S-K.

On April 15, 2016, the SEC issued a concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements. See my two-part blog on the S-K Concept Release HERE and HERE.

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

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

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

The Author

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

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

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SEC Issues Proposed Amendments To Item 601 Of Regulation S-K Related To Exhibits

Posted by Securities Attorney Laura Anthony | September 20, 2016 Tags: Item 601 Of Regulation S-K, Regulation S-K, SEC

This newest proposed rule change to Regulation S-K is part of the SEC Division of Corporation Finance’s Disclosure Effectiveness Initiative. At the end of this blog, I include an up-to-date summary of the proposals and request for comment related to the ongoing Disclosure Effectiveness Initiative.

Background

On April 15, 2016, the SEC issued a 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements in Regulation S-K (“S-K Concept Release”). The S-K Concept Release contained a discussion and request for comment on exhibit filing requirements. Item 601 of Regulation S-K specifies the exhibits that must be filed with registration statements and SEC reports. Item 601 requires the filing of certain material contracts, corporate documents, and other information as exhibits to registration statements and reports.

A particular area of discussion recently has been the need to file schedules to contracts. These schedules can be lengthy and lack materiality. Likewise, a recent area of discussion has been the necessity of filing an immaterial amendment to a material exhibit. The S-K Concept Release contains a lengthy discussion on exhibits, including drilling down on specific filing requirements. Many of the exhibit filing requirements are principle-based, including, for example, quantitative thresholds for contracts. Consistent with the rest of the S-K Concept Release, the SEC discusses whether these standards should be changed to a straight materiality approach. The SEC also discusses eliminating some exhibit filing requirements altogether, such as where the information is otherwise fleshed out in financial statements or other disclosures (for example, a list of subsidiaries).

Companies are allowed to reference exhibits filed in prior filings as opposed to refiling the exhibit with the SEC. The current proposed rule amendment is limited to the presentation of such information and, in particular, including a hyperlink to the actual filed exhibit. I suspect the SEC shall issue further amendments related to exhibits as it continues its initiative and rule changes related to Regulation S-K.

Proposed Amendments

In addition to the filing of exhibits and schedules, Item 601 of Regulation S-K requires each company to include an exhibit index list that lists each exhibit included as part of the filing. Once an exhibit has been filed once, the company can incorporate by reference by including a footnote as to which filing the original exhibit can be found in. Unfortunately, I find that companies often will indicate that an exhibit has been previously filed, without giving a specific reference as to which filing or when, leaving an investor or reviewer to go fish. The SEC rightfully asserts that requiring companies to include hyperlinks from the exhibit index to the actual exhibits filed would allow much easier access to these filings.

The proposed rule change would require companies to include a hyperlink to each filed exhibit on the exhibit index for virtually all filings made with the SEC, including XBRL exhibits. An active hyperlink would be required in all filings made under the Securities Act or Exchange Act, provided however, that if the filing is a registration statement, the active hyperlinks need only be included in the version that becomes effective.

Currently exhibits may be filed in the EDGAR system in either ASCII or HTML format. HTML format allows for hyperlinks to another place within the same document or to a separate document. ASCII does not support such hyperlinks. Over the years HTML has become the standard used for EDGAR filings, with 99% of filings in 2015 using HTML. The current proposed rule would prohibit the use of ASCII for exhibits and require onlyHTML with the newly required hyperlinks.

In addition, the proposed rule changes would include conforming changes to Rule 105 of Regulation S-T. Rule 105 sets forth the limitations and liabilities for the use of hyperlinks. Rule 105 allows hyperlinks to other documents within the same filing or previously filed documents on EDGAR but prohibits hyperlinks to sites, locations, or documents outside the EDGAR system.

Further Background

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE. On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE.

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

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

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

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

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.

Download our mobile app at iTunes.

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SEC Requests Comment On Changes To Subpart 400 To Regulation S-K

Posted by Securities Attorney Laura Anthony | September 13, 2016 Tags: Fast Act, Regulation S-K, Regulation S-X, SEC, Smaller Reporting Company, Subpart 400, The Fast Act

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. The request for comment is part of the ongoing SEC Division of Corporation Finance’s Disclosure Effectiveness Initiative and as required by Section 72003 of the FAST Act.

Background

The topic of disclosure requirements under Regulations S-K and S-X as pertains to financial statements and disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) has come to the forefront over the past couple of years. The purpose of the Disclosure Effectiveness Initiative is to assess whether the business and financial disclosure requirements continue to provide the information investors need to make informed investment and voting decisions.

Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.

In addition to affecting companies filing registration statements (including on Form 1-A in a Regulation A/A+ offering) and those filing reports with the SEC, any changes to Regulations S-K or S-X will affect acquired entities, acquirees, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.

In accordance with its mandate under Section 72003 of the FAST Act, the SEC is studying and seeking comment to:

Determine how to modernize and simplify disclosure requirements to reduce the costs and burdens to the company while still providing all material and necessary information to investors;

Further a principles-based approach whereby companies and their management can determine the relevancy and materiality of information provided instead of just including boilerplate language or filling space to meet a static requirement. Of course, this needs to be balanced with the need to ensure completeness and comparability of information among different companies; and

Evaluate information delivery methods and explore ways to eliminate repetition and the disclosure of immaterial information.

Request for Comment

Subpart 400 of Regulation S-K, including Items 401 through 407, require disclosures on directors, executive officers, control persons and promoters; executive compensation; security ownership of certain beneficial owners and management; transactions with related persons, promoters and control persons; ethics and corporate governance.

The SEC’s request for comment does not provide any commentary about particular concerns, thoughts, or questions by the SEC, but is a short general request on “existing requirements in these rules as well as on potential disclosure issues that commenters believe the rules should address.”

Overview of Subpart 400

Item 401 – Directors, Executive Officers, Promoters and Control Persons

Item 401 of Regulation S-K requires the disclosure of the identity and ages of all directors and persons nominated to become a director. In addition, Item 401 requires disclosure of all positions held at the company by that director or nominee, their term of office, and any arrangement or understanding between that person and another person “pursuant to which he was or is to be selected as a director or nominee.” The instructions provide some clarity. Compensation for service as a director is not included in arrangements with other persons. A person must consent to being included as a nominee. No information need be provided on an outgoing director.

Item 401 requires the disclosure of the identity and ages of all executive officers. In addition, Item 401 requires disclosure of all positions held at the company by that executive officer, their term of office, and any arrangement or understanding between that person and another person pursuant to which he was or is to be selected as an officer. A person must consent to being included as an executive officer.

For a first-time registration statement or a registration statement by a company not subject to the reporting requirements under the Securities Exchange Act, Item 401 requires the identification of certain significant employees – in particular, where a person is not an executive officer but otherwise makes a significant contribution to the company’s business. The same information required for executive officers is required for significant employees. Similarly, for a first-time registration statement or registration statement by a company that has not been subject to the reporting requirements for at least 12 months, the same information must be provided for promoters and control persons.

In addition, family relationships, business experience for the past five years, and disclosures of certain legal proceedings must be made for each director and executive officer. The legal proceeding disclosure is a scaled-down version of the bad-actor requirements found elsewhere in the rules, such as Rule 506 and Regulation A. Also, Item 401 requires disclosure of bankruptcy proceedings involving the person or a company for which they were an executive officer during the past five years.

Item 402 – Executive Compensation

An entire treatise could be written on Item 402. From a high level, Item 402 requires disclosure of all compensation awarded to, earned by, or paid to a company’s executive officers and directors. Item 402 also requires disclosures related to pay ratio and require “say on pay” advisory votes. See my blog HERE.

Compensation must be disclosed in tabular form and is meant to encompass any and all benefits received by an executive officer or director, including salary, bonuses, stock awards (including under a plan or not, qualified or non-qualified), option awards, non-equity incentive plans, pension value, benefits, perquisites and all other forms of compensation. Moreover, Item 402 requires a compensation discussion and analysis explaining the presented information.

Item 402 requires details of outstanding stock awards and options, including exercise dates and prices, the market value of underlying securities and vesting schedules. Detailed information is also required regarding pension benefits.

Emerging-growth and smaller reporting companies provide a scaled-down disclosure under Item 402. For details on the Item 402 scaled-down requirements related to emerging growth and smaller reporting companies, see my blog HERE.

Item 403 – Security Ownership of Certain Beneficial Owners and Management

Item 403 requires disclosure of the security ownership of officers, directors and 5% or greater shareholders, including the beneficial owner or natural person behind any entity ownership. Ownership is disclosed in tabular form and includes name, address, number of securities owned and percentage owned of that class. Item 403 requires disclosure of all classes of outstanding equity regardless of whether such class is registered or publicly trades.

Item 404 – Transactions with Related Persons, Promoters, and Certain Control Persons

Item 404 requires the disclosure of material related party transactions. For purposes of Item 404, related parties include officers or officer nominees, directors or director nominees, a family member of a director or executive office, 5% or greater shareholders, or any person that has a direct or indirect material interest in the company. Companies other than emerging-growth or smaller reporting companies must also disclose the company’s policy for the review, approval or ratification of related party transactions. Item 404 also requires the disclosure of compensations, assets or benefits to be received by promoters where the company is filing an S-1 or Form 10 registration statement.

A “promoter” has a specific definition in the securities laws and is not tied to stock promotion in the sense that many may think. A “promoter” is defined in Rule 405 of the Securities Act as including:

(1) Any person who, acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer; or

(2) Any person who, in connection with the founding and organizing of the business or enterprise of an issuer, directly or indirectly receives in consideration of services or property, or both services and property, 10 percent or more of any class of securities of the issuer or 10 percent or more of the proceeds from the sale of any class of such securities. However, a person who receives such securities or proceeds either solely as underwriting commissions or solely in consideration of property shall not be deemed a promoter within the meaning of this paragraph if such person does not otherwise take part in founding and organizing the enterprise.

(3) All persons coming within the definition of promoter in paragraph (1) of this definition may be referred to as founders or organizers or by another term provided that such term is reasonably descriptive of those persons’ activities with respect to the issuer.

Item 404 expands the definition of promoter to include “any person who acquired control of a registrant that is a shell company, or any person that is part of a group, consisting of two or more persons that agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of a registrant, that acquired control of a registrant that is a shell company.”

Item 405 – Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act requires the filing of Forms 3 and 4 by officers, directors or 10%-or-greater shareholders. For a review of the Section 16 filing requirements, see my blog HERE. Item 405 requires a company to disclose failures to meet these filing requirements.

Item 406 – Code of Ethics

Item 406 requires a company to disclose whether it has adopted a code of ethics for the executive officers and accounting controller. A copy of the code of ethics must also be filed with the SEC and included on the company’s website.

Item 407 – Corporate Governance

Item 407 requires disclosure of corporate governance standards, including those related to director independence; board committees, including audit compensation, and nominating committees; and annual meeting attendance. Item 407 requires detailed information for each category of corporate governance as well as the policies and procedures of each board committee.

Further Background

The request for comment follows the July 13, 2016 proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. That proposed rule change followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept ReleaseHERE and HERE.

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

Prior to the S-K Concept Release and current Regulation S-K and S-X proposed amendments, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

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

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.

Download our mobile app at iTunes.

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SEC Issues Proposed Regulation S-K and S-X Amendments

Posted by Securities Attorney Laura Anthony | August 9, 2016 Tags: Regulation S-K, Regulation S-K Amendments, Regulation S-X, Regulation S-X Amendments, S-K Amendments, S-X Amendments, SEC

On July 13, 2016, the SEC issued a 318-page proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). The proposed rule changes follow the 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

The proposed S-K and S-X Amendments are intended to facilitate the disclosure of information to investors while simplifying compliance efforts by companies. The proposed S-K and S-X Amendments come as a result of the Division of Corporation Finance’s Disclosure Effectiveness Initiative and as required by Section 72002 of the FAST Act. Prior to the issuance of these S-K and S-X Amendments, on June 27, 2016, as part of the same initiative, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The S-K and S-X Amendments also seek comment on certain disclosure requirements that overlap with U.S. GAAP and possible recommendations to FASB, the regulatory body that drafts and implements GAAP, for conforming changes.

Background

The topic of disclosure requirements under Regulations S-K and S-X as pertains to financial statements and disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) has come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.

In addition to affecting companies filing registration statements (including on Form 1-A in a Regulation A/A+ offering) and those filing reports with the SEC, the proposed S-K Amendments will affect acquired entities, acquirees, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.

The underlying basis of the disclosures required by Regulations S-K and S-X is to keep shareholders and the markets informed on a regular basis in a transparent manner. Reports and registration statements filed with the SEC can be viewed by the public on the SEC EDGAR website. A reporting company also has record-keeping requirements, must implement internal accounting controls and is subject to the Sarbanes-Oxley Act of 2002, including the CEO/CFO certification requirements. Under the CEO/CFO certification requirement, the CEO and CFO must personally certify the content of the reports filed with the SEC and the procedures established by the issuer to report disclosures and prepare financial statements. For more information on that topic, see my blog HERE.

The proposed S-K and S-X Amendments cover:

Duplicative requirements, including duplications between financial footnote requirements and disclosures in the body of a registration statement or report;

Overlapping requirements which may not be completely duplicative. The S-K Amendments consider whether to delete certain disclosure requirements that are covered in GAAP or other financial reporting or integrate such disclosures into a single rule source;

Outdated requirements which have become obsolete due to the passage of time or changes regulations, business or technology; and

Superseded requirements which are inconsistent with recent legislation or updated rules and regulations.

Redundant or Duplicative Reporting Requirements

The proposed S-K and S-X Amendments seek to eliminate a laundry list of 26 redundant and duplicative disclosures. Most of these proposed changes are technical and nuanced related to particular Regulation S-X GAAP and other financial statement disclosures—for example, foreign currency; financial statement consolidation, income tax disclosures, contingencies and interim accounting adjustments. As the proposed rule eliminations are duplicative, they will not change the financial reporting or disclosure requirements.

Overlapping Requirements

Similar to redundant and duplicative disclosures, the SEC has identified numerous disclosure requirements that are related to, but not exactly the same as, GAAP, IFRS and other SEC disclosure obligations. The Regulation S-K and S-X Amendments propose to delete, scale back or integrate the overlapping disclosures to eliminate the overlap.

The SEC category of overlapping disclosures, and related Regulation S-K and S-X Amendments, have added broad considerations for which the SEC is seeking public comment. In particular, some of the proposed changes would result in the relocation of disclosures in the filings. This raises considerations related to the prominence of information in a particular report and moving information from outside to inside financial statements.

When information is in a different location in a report, it may receive more or less attention and be thought of as more or less prominent. Moreover, information inside of financial statements is subjected to audit and interim review, internal control over financial reporting and XBRL tagging. In addition, information inside of financial statements is not subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995 related to forward-looking statements.

A complete detail of all the proposed Regulation S-K and S-X Amendment changes related to overlapping disclosures is beyond the scope of this blog; however, a few items deserve discussion.

In general, many of the changes proposed by the SEC relate to interim financial reporting. In some cases where items are fully required to be reported in a Form 8-K, annual report or management discussion and analysis (MD&A), the SEC proposes eliminating the same or similar requirement from interim financial statements.

For example, the SEC proposes eliminating significant business combination pro forma financial statement requirements from interim financial statements for smaller reporting companies and Regulation A filers. The pro forma financial statements are already sufficiently required by Item 9.01 of Form 8-K. Likewise, the SEC makes the same proposed elimination of financial reporting in interim reports for a significant business disposition or discontinued operation.

As another example, currently Regulation S-X requires disclosure of certain subsequent events in the footnotes to interim financial statements and Item 303 of Regulation S-K related to management discussion and analysis (MD&A) requires substantially the same disclosure. The SEC proposes to delete the Regulation S-X requirement and only require disclosure of these subsequent events in the MD&A. Likewise, the SEC proposes eliminating segment financial information from the footnotes and leaving it only in MD&A.

In other cases, the SEC supports elimination of a disclosure in the body of a document in favor of a financial statement disclosure. For example, the SEC proposes eliminating a discussion of warrants, rights and convertible instruments from the body of a Form 10 or S-1, noting that a complete disclosure including dilution is required in financial statements.

Outdated Requirements

The SEC has identified disclosure requirement that have become obsolete as a result of time, regulatory, business or technological changes. The Regulation S-K and S-X Amendments propose to amend and sometimes add, but not delete, disclosure as a result of outdated requirements.

Again, most of the outdated requirements are technical (for example, income tax disclosures) in nature and beyond the scope of this blog. Some are common sense; for example, a reference to information being available in the SEC public reference room would be amended to include only a reference to the SEC Internet address for EDGAR filings.

Another common-sense change is the proposal to eliminate the requirement to post the high and low bid or trading prices for each quarter for the prior two fiscal years in an annual 10-K. The SEC reasons that the daily market and trading prices of a security are readily available on a number of websites. Moreover, these websites allow for the download and collation of trading prices over periods of time and provide much more robust information than currently contained in a 10-K.

Superseded Requirements

The constant change in accounting and disclosure requirements and regulations have created inconsistencies in Regulation S-K and S-X. The SEC has gone through and proposed amendments to eliminate such inconsistencies. For example, certain provisions in Regulation S-X still refer to development-stage companies, a concept that was eliminated by FASB in June 2014.

The SEC also took this opportunity to clean up some nonexistent or incorrect references that resulted from regulatory changes over time.

Further Background

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

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.

Download our mobile app at iTunes.

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SEC Proposes Amendments To Definition Of “Small Reporting Company”

Posted by Securities Attorney Laura Anthony | July 12, 2016 Tags: Accelerated Filer, Large Accelerated Filer, Non-Accelerated Filer, Regulation S-K, Regulation S-X, Small Reporting Company, Smaller Reporting Company

On June 27, 2016, the SEC published proposed amendments to the definition of “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. The amendments would expand the number of companies that qualify as a smaller reporting company and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The rule change follows the SEC concept release and request for public comment on sweeping changes to the business and financial disclosure requirements in Regulation S-K. Throughout the SEC Concept Release, it referenced the scaled and different disclosure requirements for the different categories of company and affirmed that it was evaluating and considering changes to the eligibility criteria for each.

If the rule change is passed, the number of companies qualifying as a smaller reporting company will increase from 32% to 42% of all reporting companies.

The proposed rule change follows the SEC Advisory Committee on Small and Emerging Companies recommendations to the SEC on the point. In particular, the SEC proposes to amend the definition of a smaller reporting company to include companies with less than a $250 million public float as compared to the $75 million threshold in the current definition. In addition, if a company does not have an ascertainable public float, a smaller reporting company would be one with less than $100 million in annual revenues, as compared to the current threshold of less than $50 million. Once considered a smaller reporting company, a company would maintain that status unless its float drops below $200 million or its annual revenues below $80 million.

In addition, the SEC proposes to change the definition of “accelerated filer” and “large accelerated filer” to eliminate an exclusion from such definitions for smaller reporting companies. That is, the SEC specifically chose not to increase the $75 million threshold in the “accelerated filer” definition. Accordingly, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file its periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002.

In its press release accompanying the proposed rule changes, SEC Chair Mary Jo White was quoted as saying, “[R]aising the financial thresholds in the smaller reporting company definition is intended to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections. The Commission will benefit greatly from the public comments we receive from investors, issuers and other affected market participants on today’s proposal, as well as comments we receive on the Regulation S-K concept release, which will help inform any changes to the scaled disclosure system or other changes to our disclosure requirements.”

Background

The topic of disclosure requirements under Regulation S-K as pertains to disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) have come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC (“Reporting Requirements”). The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner.

The SEC disclosure requirements are scaled based on company size. The SEC established the smaller reporting company category in 2007 to provide general regulatory relief to these entities. A “smaller reporting company” is currently defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter; or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

The following table, copied from the SEC rule release, summarizes the scaled disclosure accommodations available to smaller reporting companies:

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.

Download our mobile app at iTunes.

« Confidentially Marketed Public Offerings (CMPO) Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 1 »

Risk Factor Disclosures For Reporting Public Companies

Posted by Securities Attorney Laura Anthony | March 11, 2015 Tags: Item 503, Regulation C, Regulation S-K, Risk Factor Disclosures, Risk Factors, Safe Harbor, Section 21E

A risk factor disclosure involves a discussion of circumstances, trends, or issues that may affect a company’s business, prospects, operating results, or financial condition. Risk factors must be disclosed in registration statements under the Securities Act and registration statements and reports under the Exchange Act. In addition, risk factors must be included in private offering documents where the exemption relied upon requires the delivery of a disclosure document, and is highly recommended even when such disclosure is not statutorily required.

The Importance of Risk Factors

Risk factors are one of the most often commented on sections of a registration statement. The careful crafting of pertinent risk factors can provide leeway for more robust discussion on business plans and future operations, and can satisfy a wide arrange of SEC concerns regarding existing financial and non-financial matters (such as potential default provisions in debt, dilution matters, inadvertent rule violations, etc.).

Although smaller reporting companies are not required to include risk factors in their annual Form 10-K and quarterly Form 10-Q, they may do so voluntarily and we recommend that such risk factors be included in their annual Form 10-K. As a reminder, a “smaller reporting company” is an issuer that is not an investment company or asset-backed issuer or majority-owned subsidiary and that (i) had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter; or (ii) in the case of an initial registration statement, had a public float of less than $75 million as of a date within days of the filing of the registration statement; or (iii) in the case of an issuer whose public float as calculated by (i) or (ii) is zero, had annual revenues of less than $75 million during the most recently completed fiscal year for which audited financial statements are available.

Risk factors, together with safe harbor language regarding forward-looking statements, can provide protection for forward-looking information contained in a document, such as plans and expectations, that do not pan out as expected or intended. Risk factors warn current and potential investors as to the risks of either purchasing or continuing to own the company’s stock. As the securities of smaller reporting companies are often high-risk penny stocks or thinly traded, and such companies tend to be in the business development and growth stage of their corporate life cycle, protections against failed or changed plans is fundamental.

By providing proper disclosure of the material risks associated with investing in a company’s securities, a company can mitigate the risk of liability to its shareholders should that risk come to pass. Risk factors act as an insurance policy and strong defense in the face of shareholder litigation.

The “bespeaks caution” doctrine refers to a line of judicial case law holding that statements of future forecasts, projections and expectations in an offering or other disclosure document are not misleading as long as they contain adequate cautionary language disclosing specific risks. Section 21E of the Exchange Act, enacted as part of the Private Securities Litigation Reform Act of 1995, codifies this doctrine for qualifying issuers. Section 21E provides a public company with a safe harbor defense in securities litigation challenging forward-looking statements. Among other exclusions, companies that issue penny stocks may not rely on Section 21E, but may rely on the “bespeaks caution” line of case law.

To avail itself of the safe harbor protection, the forward-looking statements must be identified and be accompanied by meaningful, cautionary language that identifies important factors that could cause actual results to differ materially from those projected—i.e., risk factors. To provide protection, the risk disclosure must be specific, not just boilerplate.

SEC Rules and Guidance on Risk Factors

Regulation S-K sets forth the non-financial statement disclosure requirements for both the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) and is applicable to both registration statements and ongoing reporting requirements. In addition, Regulation S-K serves as a guide in the preparation of private placement disclosure documents. Items 501 and 503 of Regulation S-K include the requirements for the disclosure of risk factors.

Risk factors must be disclosed in registration statements under the Securities Act and registration statements and reports under the Exchange Act. Item 503 of Regulation S-K requires concise, logically organized statements of the particular risks involving either the company, industry or the offering being made by the company. The statements should be categorized and appear in order of importance under each category. Item 503 requires that the disclosure of risk factors in a registration statement be included in the beginning immediately following the summary section, or if there is no summary section, immediately following the cover page.

Item 501 requires that the risk factor section must be prominently cross-referenced by page number, on the cover page of a registration statement. Most companies comply with this rule by using bold, italics, larger font size or a combination thereof to comply with this rule.

Risk factor disclosures cannot contain countervailing or offsetting language. That is, a company cannot explain away the risk.

Like many areas of securities laws, the SEC gives broad guidance on disclosure, trying to avoid boilerplate language. The SEC requires the reporting company to make relevant risk factor disclosures that are germane, concise and written in plain English. The risk factors should be written as of the date of the report in which they are contained regardless of the period of the financial statements contained in such report. Each risk must have a heading that adequately describes the risk being disclosed and such heading should be bolded, italicized or both. Each risk must be concise and focused on a single material risk. The risks must be easy to read and written in such a way to highlight the most important information.

As mentioned above, the SEC requires that the risks be written in plain English. This requirement is codified in Rule 421(d) of Regulation C. Over the years, the SEC has published and updated plain English handbooks. The SEC plain English guidelines require that the risk factor section contain (i) short sentences; (ii) definitive, concrete, everyday words; (iii) active voice; (iv) tables or bullet point lists, whenever possible; (v) no legal jargon or highly technical business terms; and (vi) no multiple negatives.

Categories of Risk Factors

In general, risk factors pertain to the company, the industry, or the investment or offering. Company risks are those specific to the reporting company such as particular restrictive covenant documents, reliance or dependence on a concentrated source, or a history of losses. Industry risks are particular to the industry of the reporting company, such as technology, manufacturing, textile, or commonly in today’s market, cannabis. Investment or offering risks are those specifically tied to the security or trading market for the company’s securities, such as illiquidity. The risks included in each category should be organized in the order of materiality and importance.

The common broad areas of risk factor disclosure include:

Absence of an operating history;
Absence of revenues;
Absence of profits;
An accumulated deficit;
High degree of leverage (debt);
Dependence on a single or small number of products, suppliers, customers, manufacturers or markets;
Dependence on key personnel;
Dependence on particular financial resources or source of capital;
Early stage of product development;
Competition;
Adequacy of production and/or distribution;
Technological factors such as possible obsolescence;
Capital needs and the lack of adequate current or future funding;
A concentration of voting control in management or others;
The absence of a trading market or a thinly traded, low-priced market;
Litigation;
Governmental regulations;
Foreign operations and the effects of foreign regulations, export laws, and currency fluctuations;
Labor matters;
Intellectual property matters;
Restrictive covenants in contracts; and
Off-balance sheet arrangements

Risks that apply to any issuer or any offering should be avoided. For example, a general statement that an economic downturn would negatively impact a business should not be included; however, a concise statement that a particular economic change, such as a reduction or increase in the federal interest rate (or whatever change impacts the reporting business), and the particular risk associated with that change, could be included. Specific example are encouraged.

Typical SEC Comments on Risk Factors

Risk factors are one of the most often commented on sections of a registration statement or SEC report. These common SEC comments illustrate the SEC’s focus in reviewing risk factor disclosures.

We suggest that you revise your risk factor captions to make your disclosure more meaningful to your investors and shareholders. Some of your risk factors merely state a fact about your business. You should succinctly state in your captions the particular risk that results from the uncertainty.
Some of your risk factors are too vague and generic and do not adequately describe the risk that follows. Readers should be able to read the risk factor heading and come away with a strong understanding of what the risk is and the result of the risk as it specifically applies to you. Revise your subheadings accordingly.
In each risk factor, get to the risk as quickly as possible and provide only enough detail to place the risk in context. In some of your risk factors, the actual risk you are trying to convey does not stand out from the rest of the information.
Avoid presenting risks that could apply to any issuer in your industry, do not reflect your current operations, are not material, or are generic, boilerplate disclosures. Rather, tailor each risk factor to your specific facts and circumstances.
Revise each risk to remove mitigating information.
Consider including a risk factor that addresses XYZ.
Provide the information investors need to assess the magnitude of the risk.
Where possible, quantify the risk.
The introductory paragraph to your risk factors section is not complete, there may be risks that you do not consider material now but may become material, or there may be risks that you have not yet identified. You must disclose all risks that you believe are material at this time.
You include more than one risk under one subheading. Revise to include only one risk under each subheading.

As always, competent legal counsel should be utilized in crafting SEC reports and/or offering disclosure documents.

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.

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

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Mergers and Acquisitions; Merger Documents Outlined

Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: LOI, Merger Agreement, Regulation S-K, Reverse Merger

An Outline Of the Transaction

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

Next is the letter of intent (“LOI”). An 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 a “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 a 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.

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 of 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.

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. 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.

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.

1. 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.

2. 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.

3. 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, etc.

The Author

Attorney Laura Anthony

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

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.

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

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