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

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

Highlights of Changes

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

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

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

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

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

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

Comprehensive Refresher on OTCQB, Including the New Amendments

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

Eligibility Requirements

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

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

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

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

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

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

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

Requirements for Bank Reporting Companies

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

International Companies

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

Application Review Process

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

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

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

Ongoing Requirements

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

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

Fees

Newly applying entities must pay an initial application fee of $2,500, which fee is waived for existing OTCQB entities. All OTCQB companies will be required to pay an annual fee of $10,000. Fees are nonrefundable.

Removal/Suspension from OTCQB

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

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

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

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

The Author

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

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

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

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SEC Issues White Paper On Penny Stock Risks
Posted by Securities Attorney Laura Anthony | February 21, 2017 Tags: , , , , , ,

On December 16, 2016, the SEC announced several new settled enforcement proceedings against market participants including issuers, attorneys and a transfer agent, related to penny stock fraud. On the same day the SEC issued a new white paper detailing the risks associated with investing in penny stocks. This blog summarizes the SEC white paper.

As I have written about on numerous occasions, the prevention of micro-cap fraud is and will always be a primary focus of the SEC and other securities regulators. In fact, the SEC will go to great lengths to investigate and ultimately prosecute micro-cap fraud. See my blog HERE regarding the recent somewhat scandalous case involving Guy Gentile.

Introduction

The SEC Division of Economic and Risk Analysis published a white paper on the risks and consequences of investing in stocks quoted in the micro-cap markets versus those listed on a national securities exchange. The paper reviewed 1.8 million trades by more than 200,000 investors and concludes that returns on investment in the micro-cap markets tend to be negative with the returns and risk worsening for less transparent companies or those involved in improper promotional campaigns.

The white paper notes that the incidence of and amount of negative returns, as well as alleged market manipulation increase with the fewer disclosure-related requirements associated with the company. The white paper, on the whole, is very negative towards OTC Markets securities. However, off the top, I think the white paper is skewed unfairly against OTC Markets securities when it should target those lower-tier securities that do not provide disclosures to the public.

This blog will summarize the white paper, including many of its facts and figures, but will find issue with its framework. The white paper does not give fair distinction to the higher OTCQX tier of OTC Markets. In fact, “OTCQX” only appears twice in the entire white paper, both in a footnote that purports to list the OTCQX requirements, but fails to mention the quantitative requirements, including that the security not be a penny stock as defined by the federal securities laws. The shortened “QX” does appear 13 times in the white paper, providing some factual and statistical information such as market size and trading patterns, but again, ignores the meaningful distinction related to the penny stock definition. For a review of the OTCQX tier of OTC Markets and its listing requirements, see my blog HERE.

It is axiomatic that the vast majority of new jobs are created by small and emerging companies and that these companies are critical to the economic well being of the United States. See, for example, my blog on the SEC report on the definition of accredited investor HERE and its study on private placements HERE.

According to both Bloomberg and Forbes, 8 out of 10 new businesses fail within 18 months and that number jumps to 96% in the first 10 years. However, despite that failure rate, it is indisputable that we need entrepreneurs to continue forming new businesses and access supportive capital, to have a healthy economy.

Likewise, it is axiomatic to all micro-cap market participants that those companies that fail to provide meaningful disclosure to the public, are more likely to result in investment losses. Those companies are also more likely to engage in market manipulation and other securities law violations. However, those companies that do provide meaningful disclosure to the public, whether through SEC reporting or alternatively to the OTC Markets, and especially those companies that trade on the OTCQX, are the very small and emerging companies that are necessary and vital to our healthy economy. They may be the 8 out of 10 or the 96%, but some will also be the 2 out of 10 and 4% ­­– and all are necessary.

Also, the fact is that bank financing is not readily available for these companies, and they have no choice but to try to access capital through the public. That public wants an exit strategy and that exit strategy tends to be the public markets. Where the companies are small and immature in their business life cycle, the OTC Markets provide that secondary trading market. In discussing this aspect of the economies of these small public companies, they are more positively referred to by the SEC as “venture” companies and the trading market as a “venture exchange” (see my blog HERE).

Many times when a company ceases to provide disclosure or information to the public and remains dark for a period of time, its business operations have failed, it has gone private, or otherwise has been abandoned. These companies continue to trade, and sometimes with high volume with no public information. The SEC makes an effort to eliminate these companies through its Operation Shell-Expel (see HERE), but unfortunately many remain and new ones are added all the time as the 8-out-of-10 cycle continues.

Although all penny stocks are risky, and are undeniably the highest-risk investments, grouping all OTC Markets into the white paper, in the fashion that the SEC has done, strikes me as fundamentally unfair. Throughout my summary of the SEC White Paper, I provide thoughts and commentary.

SEC White Paper

The SEC White Paper begins with an introduction on some high-level differences between an exchange traded security and one on the OTC Markets. One of the biggest distinctions is that the majority of ownership and trading of an exchange listed security is by institutional investors, whereas the majority of ownership and trading on the OTC Markets is by individuals. The SEC points out that institutions tend to be more proactive in research and shareholder activism, creating a check on corporate governance.  As an aside, these institutions are also more sophisticated and able to assert greater influence and power over a company than an individual small shareholder.

The SEC quickly highlights the negative literature on OTC Markets securities, including that they have poor liquidity, generate negative and volatile returns and are often subject to market manipulation, including by the dissemination of false and misleading information. Although OTC securities offer the opportunity to invest in early-stage companies that may grow to be larger successful ones, the number that do exceed is small (such as the 2 out of 10 in my summary above).

One portion of the white paper’s information I find interesting is that despite the risks, OTC Markets continue to grow and investor demands for these stocks continues to rise. The SEC offers two hypotheses for this. The first is that OTC investors are simply gambling for the big return, just as they do with the lottery.  The second is that OTC Markets investors simply make bad investment decisions. However, the report does admit that little is known about the characteristics of OTC investors and that this is likely the first comprehensive study trying to determine those demographics. Personally, I also think that many OTC Markets investors are day traders and that although a particular stock may go down over time, those day traders are taking advantage of the small intraday price changes to make a profit.

The SEC reviewed 1.8 million trades by more than 200,000 investors and concludes that returns on investment in the micro-cap markets tend to be negative, with the returns and risk worsening for less transparent companies or those involved in improper promotional campaigns, and are also worse for elderly and retired investors and those with lower levels of income and education.  The SEC white paper purports to be the first study of its kind that examines investor outcomes around stock promotions and level of disclosure.

I would suggest that the exact same results (i.e., lower returns on less transparent investments and those engaged in improper promotional campaigns and lower returns for the elderly and lower income and education demographic) would be found for any investments in any studied market and are not unique to OTC Markets securities. To be clear, I don’t think the correlation is necessarily improper activity, though that could be the case especially when looking at some stock promotions. Companies that provide less disclosure may have less capital and financial resources to further their business plan and, as such, are far riskier investments. Also, companies that provide less disclosure may be less interested in furthering the public aspect of their business.  Even if the underlying business is sound, if they are not providing public disclosure, the stock price and liquidity are unlikely to reflect the underlying business, which could result in poor investor returns.

The SEC white paper continues with a three-part discussion: (i) OTC Market structure and size; (ii) review of academic literature; and (iii) analysis of OTC investor demographics and outcomes.

OTC Market Structure and Size

The SEC white paper describes the basic makeup of OTC Markets including its three tiers of OTC Pink, OTCQB and OTCQX. I’ve written about these market tiers many times. For a review of the three tiers, see my blog HERE, though I note that both the OTCQB and OTCQX have updated their listing standards since that blog was written. The OTC Pink remains unchanged. For the most current listing standards on the OTCQX see HERE and for the OTCQB see HERE.

The SEC white paper also references the OTCBB, which technically still exists, but has fewer than 400 listed securities and does not have a readily accessible quote page.

The SEC white paper has a lot of information on the market size and its growth over the years. Without getting into a lot of facts and figures, I note that the OTC Markets grew by 47% from 2012 through 2015, with $238 billion of trading in 2015. There are approximately 10,000 securities quoted on OTC Markets, as compared to approximately 2,700 on NASDAQ, of which only approximately 675 are micro-cap companies.

The OTC Markets monthly newsletter gives a complete review and breakdown of the size of OTC Markets. For the one month of December 31, 2016, the following is the number of traded securities and volume:

Monthly Trade Summary – December 2016
Market Designations Number
of Securities*
Monthly
$ Volume
Monthly $ Volume
per Security
2016 $ Volume*
OTCQX 461 $3,844,835,942 $8,340,208 $36,847,879,435
OTCQB 933 $3,249,939,872 $3,483,322 $13,638,584,206
Pink 8,234 $14,648,939,577 $1,779,079 $142,411,521,245
Total 9,628 $21,743,715,392 $2,258,383 $192,897,984,887

Literature Review

The SEC white paper continues with a summary of recent academic research and analysis including on OTC Markets securities’ liquidity, returns, market manipulation, transition to an exchange and investor participation.

Liquidity refers to the ability of shareholders to quickly buy and sell securities near the market price without substantial price impact. Where there is a lack of liquidity, it is difficult to sell.  Also, low-volume stocks tend to have wider price fluctuations and bid-ask spreads, and are more expensive for dealers to hold in inventory. OTC Markets securities are less liquid than those listed on a national exchange such as the NYSE MKT or NASDAQ. Research also shows that there tends to be lower liquidity with less transparency and disclosure. None of this is surprising, though many of us that work in the OTC Markets space have seen the anomaly of a company with no information, and likely no underlying business or management, trading on heavy volume.

The returns on OTC Markets securities are also very different than exchange traded securities. Returns on OTC Markets are often negative, volatile and skewed (the lottery factor). Where the majority of trades have negative returns, there is the incidence of extremely high, lottery-like returns on some of the securities. This, again, is not surprising. OTC Markets-traded companies tend to be smaller companies and thus would naturally have a smaller market capitalization and smaller returns as well as the potential for larger upside.

Again, returns on companies that provide less transparency and public information tend to be lower.  Interestingly, another hypothesis as to why returns are lower is the short-sale constraints on OTC Market securities. Many OTC Market securities are ineligible for margin (and thus short sales), and locating shares for borrow can be challenging. Those that are margin-eligible usually have a very high carry interest and per-share transaction cost for short sales. The argument is that short sales create an equilibrium and thus help reflect a truer stock price such that the stock will be less vulnerable to negative price adjustments. However, unfortunately, sophisticated traders can open offshore accounts that will allow for short selling of OTC Market securities, opening those same securities up to manipulation by those investors.

OTC Markets securities are relatively often the target of market manipulation, including outright fraudulent disclosures and pump-and-dump schemes. Generally these schemes are conducted in the trading of those companies that are less transparent in disclosures. A market manipulation scheme can involve the dissemination of false information followed by taking advantage of the price changes that result. The scheme can be perpetrated by the company and its insiders, or by unaffiliated investors.  Examples include spam and email campaigns, rumors and false information in Internet chat rooms or forums, and false “analyst reports.” Research shows these schemes are effective – that is, the price increases while the stock is being touted and falls when the campaign is over.

Obviously not all increases in stock prices are a result of improper behavior. OTC Markets stocks react to legitimate news and growth as well.  In fact, the majority of extreme increases in trading price and volume are the result of changes in company fundamentals and not market manipulation. Moreover, not investor relations and stock promotion is perfectly legal and can be completely legitimate. It is when false or misleading information is being disseminated, or targeted marketing aimed at vulnerable investor groups is used, that it is problematic. The key is recognizing the difference, which generally involves transparency from companies that provide steady, consistent disclosure with apparent credible information.

Many OTC investors are hoping to “bet” on the company that will grow and move to an exchange where it is likely the stock price will increase substantially, as will liquidity. The SEC white paper gives dismal statistics on the rates of graduation. However, it does note that the rate of movement to an exchange is much higher for OTCQX or OTCQB (9%) than OTC Pink companies (less than 1%). The SEC white paper also suggests that companies that graduate to an exchange from the OTC Markets underperform those companies that go public onto an exchange in the first instance.

The last area that the SEC white paper discusses in this section is investor participation and, in particular, why that investor participation continues to grow year over year. The SEC white paper gives two hypotheses, the first being that investors are drawn by the opportunity for lottery-like payoff and the second is that investors are “duped about the stock return probabilities.”  Although this sounds harsh, the white paper is not actually referring to market manipulation, but rather suggests that all OTC investors, including the most sophisticated, make poor estimates on return probabilities. No reason for this is offered.

Studies show that although investors frequently lose small investments in OTC stocks, they also occasionally receive an extremely large return. As such, the SEC white paper suggests that these investors are really just gamblers. I’m sure that oftentimes is correct.

Data Analysis and Investor Demographics

The Division of Economic and Risk Analysis studied a sampling of trades for specific securities and time periods which included information on the issuer, trade and investor. The purpose of the review was to determine a relationship between investor returns on the one hand and stock promotions, company transparency and investor demographics on the other hand. However, the information used for the analysis is admittedly biased in that such information was taken from the SEC enforcement files for the year 2014. Since one or more parties to the trades were the subject of enforcement proceedings, this information would not be indicative of the usual OTC company.

The SEC white paper comes to the conclusion that there is a positive correlation between losses and market manipulation and lack of transparency. As discussed above, this is not surprising and is actually quite logical. The white paper also found a positive correlation between losses and elderly, lower-income and poorly educated investors.

The Author

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

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

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

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

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

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

© Legal & Compliance, LLC 2017


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OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies
Posted by Securities Attorney Laura Anthony | June 28, 2016 Tags: , , , , , , , ,

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

Background

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

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

Whether trading on the OTCQX or OTCQB, keep in mind that unless the issuer has filed a Form 8-A or Form 10, they will not be considered “subject to the Exchange Act reporting requirements” for purposes of benefiting from the shorter 6-month Rule 144 holding period.   For a short overview of Rule 144, see HERE.

Regulation A Eligibility – Reporting Issuers

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

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

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

The SEC specifically provided that a company that was once subject to the Exchange Act reporting obligations but suspended such reporting obligations by filing a Form 15 is eligible to utilize Regulation A.  The determination of eligibility is made at the time of the offering.  Moreover, a company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to rely on Regulation A.  In addition, a wholly owned subsidiary of an Exchange Act reporting company parent is eligible to complete a Regulation A+ offering as long as the parent reporting company is not a guarantor or co-issuer of the securities being issued.

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

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

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

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

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

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

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

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

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

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

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

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

Further Thoughts

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

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

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

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

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

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

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

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

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

The Author

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

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.

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

Download our mobile app at iTunes.

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

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

© Legal & Compliance, LLC 2016


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Management’s Discussion and Analysis of Financial Condition and Results of Operation (MD&A)
Posted by Securities Attorney Laura Anthony | July 28, 2011 Tags: , , , , , , , ,

Management’s discussion and analysis of financial condition and results of operation, commonly referred to as MD&A is an integral parts of annual (Form 10-K) and quarterly (Form 10-Q) reports filed with the Securities and Exchange Commission (SEC). MD&A is also included in registration statements filed under both the Securities Exchange Act of 1934 (Form 10) and Securities Act of 1933 (Form S-1). MD&A requires the most input and effort from officers and directors of a company and due to the many components of required information, often generates SEC review and comments. Item 303 of Regulation S-K sets forth the required content for MD&A.

A MD&A discussion for quarterly reports on Form 10-Q is abbreviated from the requirements for annual reports on Form 10-K and registration statements. Although quarterly reports must discuss each item enumerated below the discussion is expected to be more focused concentrating on the most relevant and material items. In addition, as with my other blogs, this discussion will be limited to the requirements for small public companies (i.e. those with revenues of less than $75 million).

The SEC has issued guidance and interpretation on MD&A, which is helpful in understanding its required content. Pursuant to the SEC, MD&A has three primary purposes. These are:

• to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;

• to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and

• to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

Management, and company counsel, should keep these purposes in mind in drafting and finalizing MD&A. The content should not be overly technical, but neither should it be a forum for marketing content. Now, onto the specific MD&A requirements as set forth in Item 303 of Regulation S-K.

In each annual report on Form 10-K, and registration statements on either Forms 10 or S-1, a company must discuss its financial condition, changes in financial condition and results of operations. In addition to the four areas of discussion listed below, a company must include any other relevant information within its knowledge, which information provides a better or more complete understanding of their finances and financial condition. The four areas of financial discussion include:

1. Liquidity

A company must identify any known trends or known demands, commitments, events or uncertainties that will result in or reasonably could result in an increase or decrease in liquidity. In addition, a company must identify sources and uses of liquidity and any known changes thereto. Explanations of the information provided is required. In layman terms, liquidity is a discussion of sources of cash and uses of cash, and factors that could change or impact either, both as reflected in the financial period covered by the subject report, and for the future. Although not all inclusive, the discussion, at a minimum, should address all items included in the statement of cash flows provided as part of the financial statements. This item, together with the second area of discussion, capital resources, are considered so important the SEC has issued an interpretive release addressing these two areas separately from the rest of MD&A.

2. Capital Resources

A discussion of capital resources includes all material commitments for capital expenditures, the purpose and the source of funds for these commitments. This would include outstanding debts and obligations and simply put, where the money will come from to pay them. In addition, capital resources include a discussion of trends, favorable and unfavorable, that could impact capital resources. An obvious example would be a change in government regulation directly related to the company’s business.

3. Results of Operations

Results of operations include four areas of discussion: (i) unusual or infrequent events that have impacted on a company’s financial condition. An example would be a discontinuance of a specific product line, or sale of company subsidiary. (ii) trends that could have an impact on sales or revenues or income in general, including trends impacting costs and expenses; (iii) a narrative discussion of increases or decreases in sale or revenues; and (iv)impact of inflation and other external financial conditions.

4. Off Balance Sheet Arrangements

Off balance sheet arrangements have gained notoriety as a result of the recent economic turmoil caused by the mortgage scandal. An off balance sheet arrangement is any arrangement that could have an impact on a balance sheet, the most obvious example being a guarantee of a third party’s obligation. Accordingly, if a company has such an arrangement to report, they are required to provide a detailed analysis including the potential impact and relative importance of the arrangement.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.


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OTCQB and OTCQX Compared and Contrasted
Posted by Securities Attorney Laura Anthony | April 6, 2011 Tags: , , , , , , , ,

Over the past few years, the historical PinkSheets has undergone some considerable changes, starting with the creation of certain tiers of Issuers and culminating in its refurbished website and new URL “OTCMarkets.com”.

The new OTCMarkets.com divides Issuers into three (3) levels: OTCQX; OTCQB and PinkSheets. From a fundamental perspective, Issuers on the OTCQX must be fully reporting and current in their reporting obligations with the SEC and also undergo a quality review by industry professionals. Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC but do not undergo additional quality review.

OTCQB vs OTCBB

Issuers on the OTCQB are analogous to previous OTCBB listed entities. Although the OTCBB technically still exists, it is losing company quotations daily, mainly as market makers choose the full service, one stop shopping of the OTC Markets, to quote the stock of over the counter trading Issuers. OTCQB Issuers are current with their reporting requirements to the SEC pursuant to the Exchange Act of 1934. Market Makers quoting the stock of OTCQB Issuers either have a current 15c2-11 or are relying on the piggy back qualification.

OTCQX Issuers

Issuers with stock quoted on the OTCQX are not only current with their reporting obligations, but have undergone industry professional review. That is, in addition to meeting the requirements of the securities laws and SEC, these entities have opted to undergo greater scrutiny from the industry. The benefits to Investors in being able to rely on this quality review are enormous.

OTC Markets has established standardized methods for professionals to review the quality of Issuer information. In addition, OTC Markets has set forth standards for the qualifications of those responsible for undertaking the quality review. Lastly, OTC Markets maintains a strict accountability policy for securities attorneys, PCAOB auditors and other professionals who do not perform their review obligations properly and/or who do not adhere to OTC Markets standards. Issuer service providers that report false information to OTC Markets may ultimately find themselves blacklisted from the website. Consequently, it is essential that attorneys, auditors and any other professionals who submit Issuer data to OTC Markets confirm with absolute certainty that they their information is correct and complete.

OTCQX – A Valuable Resource for Investors

Prior to the enactment of the OTCQX tier by the OTC Markets, for quality of disclosure review, Investors had to rely on either the SEC review process or analyst reports. However, these sources are not consistent and as for the later, not necessarily reliable. The SEC does not review all documents filed by all Issuers, not even close. They simply do not have the resources nor personnel to do so. Accordingly, the quality of disclosure of any given Issuer may not meet even basic legal requirements and an Investor would have no easy way of determining which filings have been reviewed and which have not.

Relying on analysts’ reports entails tremendous risk because not all of them are licensed. Many “analysts” are simply stock promoters being paid to write glowing recommendations about a particular stock. Even the most well-intentioned analysts do not always verify the information provided to them by the issuer. Many are seeking to line their own pockets by selling their shares in an inflated market after their favorable report is disseminated. Inversely, others have shorted the stock and will profit in the down market after their unfavorable report reaches the street. Ultimately, there is no easy way for an Investor to discern whether a given report is prepared by a licensed, unbiased, honest professional – until now.

OTCQX Benefits

In addition, OTCQX offers Investors and Issuers various perks usually associated with trading on an Exchange (a stock exchange, such as the NASDAQ is different than the Over the Counter Market in that they have listing standards, such as price of stock, and have ongoing governance and compliance standards, such as audit committee review). These perks include, but are not limited to, real time quotes and various computerized communication resources for investor relations.

The Author

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.


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The End Of An Era; The OTCBB Has Been Replaced By The OTCQB
Posted by Securities Attorney Laura Anthony | March 17, 2011 Tags: , , , , , , ,

A few months ago I wrote an article predicting that the new “OTC Markets,” formerly known as the Pink Sheets, and it’s OTCQX and OTCQB quotation tiers were replacing the antiquated, formerly FINRA-run OTCBB. Current events add further evidence to this view. Recently, more than 1000 Companies which were trading on both the OTCBB and OTCQB were delisted from the OTCBB and now trade exclusively on the OTCQB tier of the OTC Markets. These entities are quickly becoming known by their new moniker, OTCQB Companies.

The Investment Banking firm of Rodman & Renshaw acquired the OTCBB from FINRA last year.

An OTCBB By Any Other Name

For more than a year leading up to this large scale, mass delistment, it has been impossible to decipher between an OTCBB Company and a Reporting Pink Sheet Company when viewing the OTC Markets website. Both entities appeared under the heading of “OTCQB.” It was essential to reference other source material in order to make the distinction.

The now privately owned and operated OTCBB quietly delisted approximately 1,000 fully reporting and current, public companies from its quotation medium, initially citing “failure to comply with Rule 15c2-11”. Subsequent delistments cited “Ineligible for quotation on OTCBB due to quoting inactivity under SEC Rule 15c2-11.”

Delistments Means Little to Nothing

Most, if not all, of these companies did not receive notice of their “delisting”. Moreover, most, if not all, of these companies still do not know that they are no longer OTCBB quoted companies. In fact, the change has had little if no impact on these companies and will likely not have future impact. Each of these companies continue to be quoted on the OTCQB on the website for OTC Markets.

Issuer Reporting Obligations

Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC. Although the entire Over the Counter is regulated by the SEC and FINRA, the OTC Markets and the OTCBB are both now privately owned and merely serve as quotation mediums. However, and most importantly, the OTC Markets is more user friendly and factually up to date and accurate than the website for the OTCBB. So, if all Over the Counter quotes can be found at www.otcmarkets.com and companies trading on the OTCQB have the exact same standards as the OTCBB, and FINRA is no longer directly associated with the OTCBB, is there any reason for the OTCBB to even exist?

The fact sheet on www.otcmarkets.com has this to say regarding OTCQB quoted securities:

“With over 94% of all market maker quotes in OTC securities published on OTC Markets Group’s platform vs. 6% on the FINRA BB, it is important that OTC Markets Group provide a separate designation to identify OTC-traded companies that are U.S. registered and reporting. OTC Markets Group has launched the OTCQBtm marketplace to help investors easily identify SEC reporting companies and regulated banks that are current with their disclosure obligations.”

In summary, the curtains have closed on the OTCBB in name only and its business as usual for the new OTCQB.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14.  In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”).  Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance. LLC for a free initial consultation or second opinion on an existing matter.


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  • Contact Information

    Laura Anthony, Attorney
    Legal & Compliance, LLC
    330 Clematis Street, Ste. 217
    West Palm Beach, FL 33401

    Toll Free: 1.800.341.2684
    Phone: 561.514.0936
    Fax: 561.514.0832