Recommendations Of SEC Government-Business Forum On Small Business Capital Formation
Posted by Securities Attorney Laura Anthony | May 23, 2017 Tags: , , , , , , , , , , , , , , , , , , , , , ,

In early April, the SEC Office of Small Business Policy published the 2016 Final Report on the SEC Government-Business Forum on Small Business Capital Formation, a forum I had the honor of attending and participating in. As required by the Small Business Investment Incentive Act of 1980, each year the SEC holds a forum focused on small business capital formation. The goal of the forum is to develop recommendations for government and private action to eliminate or reduce impediments to small business capital formation.

The forum is taken seriously by the SEC and its participants, including the NASAA, and leading small business and professional organizations. The forum began with short speeches by each of the SEC commissioners and a panel discussion, following which attendees, including myself, worked in breakout sessions to drill down on specific issues and suggest changes to rules and regulations to help support small business capital formation, as well as the related, secondary trading markets. In particular, the three breakout groups were on exempt securities offerings; smaller reporting companies; and the secondary market for securities of small businesses.

Each breakout group is given the opportunity to make recommendations. The recommendations were refined and voted upon by the forum participants in the few months following the forum and have now been released by the SEC in a report containing all 15 final recommendations. In the process, the participants ranked the recommendations by whether it is likely the SEC will give high, medium, low or no priority to each recommendation.

Recommendations often gain traction. For example, the forum first recommended reducing the Rule 144 holding period for Exchange Act reporting companies to six months, a rule which was passed in 2008. Last year the forum recommended increasing the financial thresholds for the smaller reporting company definition, and the SEC did indeed propose a change following that recommendation. See my blog HERE for more information on the proposed change. Also last year the forum recommended changes to Rule 147 and 504, which recommendations were considered in the SEC’s rule changes that followed. See my blog HERE for information on the new Rule 147A and Rule 147 and 504 changes.

Forum Recommendations

The following is a list of the recommendations listed in order or priority. The priority was determined by a poll of all participants and is intended to provide guidance to the SEC as to the importance and urgency assigned to each recommendation. I have included my comments and commentary with the recommendations.

  1. As recommended by the SEC Advisory Committee on Small and Emerging Companies, the SEC should (a) maintain the monetary thresholds for accredited investors; and (b) expand the categories of qualification for accredited investor status based on various types of sophistication, such as education, experience or training, including, but not limited to, persons with FINRA licenses, CPA or CFA designations, or management positions with issuers. My blog on the Advisory Committee on Small and Emerging Companies’ recommendations can be read HERE. Also, to read on the SEC’s report on the accredited investor definition, see HERE.
  2. The definition of smaller reporting company and non-accelerated filer should be revised to include an issuer with a public float of less than $250 million or with annual revenues of less than $100 million, excluding large accelerated filers; and to extend the period of exemption from Sarbanes 404(b) for an additional five years for pre- or low-revenue companies after they cease to be emerging-growth companies. See my blog HERE for more information on the current proposed change to the definition of smaller reporting company and HERE related to the distinctions between a smaller reporting company and an emerging-growth company.
  3. Lead a joint effort with NASAA and FINRA to implement a private placement broker category including developing a workable timeline and plan to regulate and allow for “finders” and limited intermediary registration, regulation and exemptions. I think this topic is vitally important. The issue of finders has been at the forefront of small business capital formation during the 20+ years I have been practicing securities law. The topic is often explored by regulators; see, for example, the SEC Advisory Committee on Small and Emerging Companies recommendations HERE and a more comprehensive review of the topic HERE which includes a summary of the American Bar Association’s recommendations.

Despite all these efforts, it has been very hard to gain any traction in this area. Part of the reason is that it would take a joint effort by FINRA, the NASAA and both the Divisions of Corporation Finance and Trading and Markets within the SEC. This area needs attention. The fact is that thousands of people act as unlicensed finders—an activity that, although it remains illegal, is commonplace in the industry. In other words, by failing to address and regulate finders in a workable and meaningful fashion, the SEC and regulators perpetuate an unregulated fringe industry that attracts bad actors equally with the good and results in improper activity such as misrepresentations in the fundraising process equally with the honest efforts. However, practitioners, including myself, remain committed to affecting changes, including by providing regulators with reasoned recommendations.

  1. The SEC should adopt rules that pre-empt state registration for all primary and secondary trading of securities qualified under Regulation A/Tier 2, and all other securities registered with the SEC. I have been a vocal proponent of state blue sky pre-emption, including related to the secondary trading of securities. Currently, such secondary trading is usually achieved through the Manual’s Exemption, which is not recognized by all states. There is a lack of uniformity in the secondary trading market that continues to negatively impact small business issuers. For more on this topic, see my two-part blog HERE and HERE.
  2. Regulation A should be amended to: (i) pre-empt state blue sky regulation for all secondary sales of Tier 2 securities (included in the 4th recommendation above); (ii) allow companies registered under the Exchange Act, including at least business development companies, emerging-growth companies and smaller reporting companies, to utilize Regulation A (see my blog on this topic, including a discussion of a proposed rule change submitted by OTC Markets, HERE ); and (iii) provide a clearer definition of what constitutes “testing-the-waters materials” and permissible media activities.
  3. Simplify disclosure requirements and costs for smaller reporting companies and emerging-growth companies with a principles-based approach to Regulation S-K, eliminating information that is not material, reducing or eliminating non-securities-related disclosures with a political or social purpose (such as pay ratio, conflict minerals, etc.), making XBRL compliance optional and harmonizing rules for emerging-growth companies with smaller reporting companies. For more on the ongoing efforts to revise Regulation S-K, including in manners addressed in this recommendation, see HERE and for more information on the differences between emerging-growth companies and smaller reporting companies, see HERE.
  4. Mandate comparable disclosure by short sellers or market makers holding short positions that apply to long investors, such as through the use of a short selling report on Schedule 13D.
  5. The SEC should provide scaled public disclosure requirements, including the use of non-GAAP accounting standards that would constitute adequate current information for entities whose securities will be traded on secondary markets. This recommendation came from the secondary market for securities of small businesses breakout group. I was part of the smaller reporting companies breakout group, so I did not hear the specific discussion on this recommendation.  However, I do note that Rule 144 does provide for a definition of adequate current public information for companies that are not subject to the Exchange Act reporting requirements.  In particular, Rule 144 provides that adequate current public information would include the information required by SEC Rule 15c2-11 and OTC Markets specifically models its alternative reporting disclosure requirements to satisfy the disclosures required by Rule 15c2-11.
  6. The eligibility requirements for the use of Form S-3 should be revised to include all reporting companies. For more on the use of Form S-3, see my blog HERE
  7. The SEC should clarify the relationship of exempt offerings in which general solicitation is not permitted, such as in Section 4(a)(2) and Rule 506(b) offerings, with Rule 506(c) offerings involving general solicitation in the following ways: (i) the facts and circumstances analysis regarding whether general solicitation is attributable to purchasers in an exempt offering should apply equally to offerings that allow general solicitation as to those that do not (such that even if an offering is labeled 506(c), if in fact no general solicitation is used, it can be treated as a 506(b); and (ii) to clarify that Rule 152 applies to Rule 506(c) so that an issuer using Rule 506(c) may subsequently engage in a registered public offering without adversely affecting the Rule 506(c) exemption. I note that within days of the forum, the SEC did indeed issue guidance on the use of Rule 152 as applies to Rule 506(c) offerings, at least as relates to an lternative trading systemintegration analysis between 506(b) and 506(c) offerings. See my blog HERE.
  8. The SEC should amend Regulation ATS to allow for the resale of unregistered securities including those traded pursuant to Rule 144 and 144A and issued pursuant to Sections 4(a)(2), 4(a)(6) and 4(a)(7) and Rules 504 and 506.
  9. The SEC should permit an ATS to file a 15c2-11 with FINRA and review the FINRA process to make sure that there is no undue burden on applicants and issuers. An ATS is an “alternative trading system.” The OTC Markets’ trading platform is an ATS. This recommendation would allow OTC Markets to directly file 15c2-11 applications on behalf of companies. A 15c2-11 application is the application submitted to FINRA to obtain a trading symbol and allow market makers to quote the securities of companies that trade on an ATS, such as the OTC Markets. Today, only market makers seeking to quote the trading in securities can submit the application. Also today, the application process can be difficult and lack clear guidance or timelines for the market makers and companies involved. This process definitely needs attention and this recommendation would be an excellent start.
  10. Regulation CF should be amended to (i) permit the usage of special-purpose vehicles so that many small investors may be grouped together into one entity which then makes a single investment in a company raising capital under Regulation CF; and (ii) harmonize the Regulation CF advertising rules to avoid traps in situations where an issuer advertises or engages in general solicitations under Regulation A or Rule 506(c) and then converts to or from a Regulation CF offering.
  11. The SEC should provide greater clarity on when trading activities require ATS registration, and when an entity or technology platform needs to a funding portal, broker-dealer, ATS and/or exchange in order to “be engaged in the business” of secondary trading transactions.
  12. Reduce the Rule 144 holding period to 3 months for reporting companies. I fully support this recommendation.

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.

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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Road Shows
Posted by Securities Attorney Laura Anthony | May 16, 2017 Tags: , , , , , , , , , , , , , , , , , , , , , , ,

Introduction; Definitions

We often hear the words “road show” associated with a securities offering. A road show is simply a series of presentations made by company management to key members of buy-side market participants such as broker-dealers that may participate in the syndication of an offering, and institutional investor groups and money managers that may invest into an offering. A road show is designed to provide these market participants with more information about the issuer and the offering and a chance to meet and assess management, including their presentation skills and competence in a Q&A setting. Investors often place a high level of importance on road show meetings and as such, a well-run road show can make the difference as to the level of success of an offering.

A road show usually involves an intensive period of multiple meetings and presentations in a number of different cities over a one-to-two-week period. Although road shows are generally live, they can be by teleconference, or electronic using prepared written presentation materials. In today’s Internet world, road shows are often recorded from a live presentation and made available publicly for a period of time. The meetings and presentations can vary in length and depth depending on the size and importance of the particular audience. During the road show, the underwriters are building a book of interest which will help determine the pricing for the offering.

A company can also conduct a “non-deal road show” for the purpose of driving interest in the company and its stock, where no particular offering is planned.

Unless it is a non-deal road show, the road show involves an offer of securities. “Offers” of securities are very broadly defined.  Section 2(a)(3) of the Securities Act defines “offer to sell,” “offer for sale,” or “offer” to include “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.”

The timing and manner of all offers of securities are regulated, and especially so in registered offerings. All issuers that have filed a registration statement are permitted to make oral offers of their securities, but only certain types of written offers are allowed. Written offers must comply with Section 10 of the Securities Act, including a requirement that a prospectus meeting the information requirements in Section 10(a) be delivered at the time of or prior to the offer.  In addition, certain eligible issuers may provide supplemental written information and graphic communications not otherwise included in the prospectus filed with the SEC (i.e., a free writing prospectus) as part of an offer of securities.  All of these oral and written communication rules are implicated in the road show process and must be considered when planning and completing the road show.

A road show is generally timed to be completed in the last few weeks before a registration statement goes effective or a Regulation A offering circular becomes qualified.  In a registered offering, Section 5(c) prohibits offers prior to the filing of the registration statement and as such, the road show would never commence pre-filing.  Regulation A is not a registered offering for purposes of Section 5(c), but for practical purposes, a Regulation A road show also commences right before SEC qualification.  Rule 163 provides an exception to the pre-filing offer rules only available to well-known seasoned issuers (very big companies), which is not discussed in this blog.

For a private offering, the road show occurs once the offering documents are completed. An Emerging Growth Company (EGC) that has filed its registration statement on a confidential basis must make the initial filing and all confidentially submitted amendments public a minimum of 15 days prior to starting the road show.

A road show is subject to the test-the-waters and pre-effective communication rules.  For a review of testing the waters in a registered offering, see HERE and for Regulation A offerings, see HERE.

A road show is specifically regulated under Rule 433 of the Securities Act and the free writing prospectus rules.  Securities Act Rule 433(h)(4) defines a road show as an offer, other than a statutory prospectus, that “contains a presentation regarding an offering by one or more of the members of the issuer’s management ….. and includes discussion of one or more of the issuer, such management, and the securities being offered.”

The SEC definition of road show includes the language “other than a statutory prospectus.”  The statutory prospectus is one that meets the requirements of Section 10(a) of the Securities Act and is generally the filed final prospectus that contains the disclosures outlined in the particular offering form being used (for example, Form S-1 or 1-A) and including disclosures delineated in Regulations S-K and S-X.

In general, if the information being presented in a road show is nothing more than what is already included in the prospectus filed with the SEC, there are no particular SEC filing requirements.  On the other hand, if the information is written and goes beyond the statutory prospectus, it may be considered a “free writing prospectus” and be subject to specific eligibility requirements for use, form and content and SEC filing requirements all as set forth in Rule 433 and discussed herein.

Rule 405 of the Securities Act defines a free writing prospectus (“FWP”) as “any written communication as defined in this section that constitutes an offer to sell or a solicitation of an offer to buy the securities relating to a registered offering that is used after the registration statement in respect of the offering is filed… and is made by means other than (i) a prospectus satisfying the requirements of Section 10(a) of the Act…; (2) a written communication used in reliance on Rule 167 and Rule 426 (note that both rules relate to offerings by asset backed issuers); or (3) a written communication that constitutes an offer to sell or solicitation of an offer to buy such securities that falls within the exception from the definition of prospectus in clause (a) of Section 2(a)(10) of the Act.”  Section 2(a)(10)(a) in turn exempts written communications that are provided after a registration statement goes effective with the SEC as long as the effective registration statement is provided to the recipient prior to or at the same time.

Types of Road Shows; Oral/Live vs. Written; Free Writing Prospectus (FWP) Requirements

The rules distinguish between a “live” vs. a “written” road show communication, with one being an “oral offer” and more freely allowed and the other being a “written offer” and more strictly regulated.  In addition, the rules differentiate requirements based on whether a road show is for a registered or private offering and, if a registered offering, whether such offering is an initial public offering (IPO) involving common or convertible equity.

Where a road show communication is purely oral, it is not an FWP and thus there are no specific SEC filing requirements (though see the discussion on Regulation FD below).  Where an oral communication implicates Regulation FD, a Form 8-K would need to be filed regardless of whether the communication is during a road show or in any other forum.

Although road shows are generally live and specifically designed to constitute oral offers, they can also be electronic using prepared written presentation materials.  Both live and electronic road shows may be available for replay electronically over the Internet.

Live road shows include: (i) a live, in-person presentation to a live, in-person audience; (ii) a live, real-time presentation to a live audience or simultaneous multiple audiences transmitted electronically; (iii) a concurrent live presentation and real-time electronic transmittal of such presentation; (iv) a webcast or video conference that originates live and is transmitted in real time; (v) a live telephone conversation, even if it is recorded; and (vi) the slide deck or other presentation materials used during the road show unless investors are allowed to print or take copies of the information.

The explanatory note to Rule 433(d)(8) states: “A communication that is provided or transmitted simultaneously with a road show and is provided or transmitted in a manner designed to make the communication available only as part of the road show and not separately is deemed to be part of the road show. Therefore, if the road show is not a written communication, such a simultaneous communication (even if it would otherwise be a graphic communication or other written communication) is also deemed not to be written.”

Accordingly, road show slides and video clips are not considered to be written offers as long as copies are not left behind. Even handouts are not written offers so long as they are collected at the end of the presentation. If they are left behind, however, they become a free writing prospectus (FWP) and are subject to Securities Act Rules 164 and 433, including a requirement that the materials be filed with the SEC.

A video recording of the road show meeting will not need to be filed as an FWP so long as it is available on the Internet to everyone and covers the same ground as the live road show.  Such video road shows are considered a “bona fide electronic road show.”  Rule 433(h)(5) defines a “bona fide electronic road show” as a road show “that is a written communication transmitted by graphic means that contains a presentation by one or more officers of an issuer or other persons in an issuer’s management….”  It is permissible to have multiple versions of a bona fide electronic road show as long as all versions are available to an unrestricted audience.  For example, different members of management may record different presentations and, although access must be unrestricted, management may record versions that are more retail investor facing or institutional investor facing.

On the other hand, a FWP would include any written communication that could constitute an offer to sell or a solicitation of an offer to buy securities subject to a registration statement that is used after the filing of a registration statement and before its effectiveness.  A FWP is a supplemental writing that is not part of the filed registration statement.  If the writing is simply a repetition of information contained in the filed registration statement, it may be used without regard to the separate FWP rule.

Rule 405 of the Securities Act defines a written communication as any communication that is “written, printed, a radio or television broadcast or a graphic communication.”  A graphic communication includes “all forms of electronic media, including but not limited to, audiotapes, videotapes, facsimiles, CD Rom, electronic mail, internet websites, substantially similar messages widely distributed (rather than individually distributed) on telephone answering or voice mail systems, computers, computer networks and other forms of computer data compilation.”  Basically, for purposes of rules related to FWP’s, all communications that can be reduced to writing are considered a written communication.  Accordingly, radio and TV interviews, other than those published by unaffiliated and uncompensated media, would be considered a FWP and subject to the SEC use and filing rules.

Electronic road shows that do not originate live and in real time are considered written communications and FWP’s.   Once it is determined that a road show includes a FWP, unless an exemption applies, an SEC filing is required.  As mentioned, bona fide electronic road shows, although technically a FWP, are not required to be filed with the SEC.  In addition, Rule 433 only requires the filing of a FWP for an IPO of common or convertible equity.

A non-exempted FWP must be filed with the SEC, using Form 8-K, no later than the date of first use.  An after-hours filing will satisfy this requirement as long as it is on the same calendar day.  Moreover, all FWP’s must be filed with the SEC, whether distributed by the registrant or another offering participant and whether such distribution was intentional or unintentional.

The use of a FWP has specific eligibility requirements.  A FWP may not be used by any issuer that is “ineligible” for such use.  The following entities are ineligible to use a free writing prospectus: (i) companies that are or were in the past three years a blank-check company; (ii) companies that are or were in the past three years a shell company; (iii) penny-stock issuers; (iv) companies that conducted a penny-stock offering within the past three years; (v) business development companies; (vi) companies that are delinquent in their Exchange Act reporting requirements; (vii) limited partnerships that are engaged in an offering that is not a firm commitment offering; and (viii) companies that have filed or have been forced into bankruptcy in the last three years.

Small- and micro-cap issuers will rarely be eligible to use a free writing prospectus. Accordingly, small and micro-cap companies generally are limited to live road shows involving oral offers not constituting a FWP.

Moreover, underwriters generally require specific representations and warranties and indemnification related to FWP’s regardless of whether they are required to be filed with the SEC.

Content

The road show presentation usually covers key aspects of the offering itself, including the reasons for the offering and use of proceeds.  In addition, management will also cover important aspects of their business and growth plans, industry trends, competition and the market for their products or services.  An important aspect of the road show is the question-and-answer period or Q&A, though obviously this is only included in live interactive road shows.  It is common for materials to include drilled-down information that is provided on a higher level in the prospectus as well as theory and thoughts behind business plans and management goals.

The preparation of the road show content is usually a collaborative effort between the company, underwriters and legal counsel.  Although the road show begins much later in the process, since its content is derived from the registration statement, ideally the planning begins at the same time as the registration statement drafting.  Also, slides, PowerPoint presentations and other presentation materials should be carefully prepared to get the most out of their effectiveness.

The lawyer generally reviews all materials for compliance with the rules related to offering communications as well as potential liability for the representations themselves.  Part of the compliance review is ensuring that no statements conflict with or provide a material change to the information in the filed offering prospectus; that could be deemed materially misleading by content or omission; and compliance with Regulation FD if applicable.

Also from a technical legal perspective, all road show materials should contain a disclaimer for forward-looking statements, and that disclaimer should be read in live or prerecorded road show presentations.  Where the road show content includes a FWP, it is required to contain a legend indicating that a prospectus has been filed, where it can be read (a hyperlink can satisfy this requirement), and advising prospectus investors to read the prospectus.

Under Rule 433(b)(2), the FWP for a non-reporting or unseasoned company must be accompanied with or preceded by the prospectus filed with the SEC.  The delivery requirement can be satisfied by providing a hyperlink to the filed prospectus on the EDGAR database.

Road show materials, even those that are also a FWP, generally are not subject to liability under Section 11 of the Securities Act.  Section 11 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.  Road-show materials, including FWPs, are not a part of the registration statement, but rather are supplemental materials.   Section 12 liability, however, does apply to road-show materials.  Section 12 provides liability against the seller of securities for material misstatements or omissions in connection with that sale, whether oral or in writing.

Follow-on Offerings and Regulation FD

Regulation FD requires that companies subject to the SEC reporting requirements take steps to ensure that material information is disclosed to the general public in a fair and fully accessible manner such that the public as a whole has simultaneous access to the information.  Consequently, Regulation FD would be implicated in connection with communications in a road show for a follow-on offering by a company already subject to the Exchange Act reporting requirements.  Regulation FD excludes communications (i) to a person who owes the issuer a duty of trust or confidence, such as legal counsel and financial advisors; (ii) communications to any person who expressly agrees to maintain the information in confidence; and (iii) communications in connection with certain offerings of securities registered under the Securities Act of 1933 (this exemption does not include registered shelf offerings).

Where a road show is being conducted by a company subject to the Exchange Act reporting requirements, counsel should ensure that that the presentation either does not include material non-public information or that the information is simultaneously disclosed to the public in a Form 8-K.  As a backstop where Regulation FD applies, the company should also consider having all road-show attendees sign a confidentiality agreement.

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.

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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The SEC Has Issued New Guidance Related To Foreign Private Issuers
Posted by Securities Attorney Laura Anthony | March 14, 2017 Tags: , , , , , , , , , , , ,

On December 8, 2016, the SEC issued 35 new compliance and disclosure interpretations (C&DI) including five related to the use of Form 20-F by foreign private issuers and seven related to the definition of a foreign private issuer.

C&DI Related to use of Form 20-F

In the first of the five new C&DI, the SEC confirms that under certain circumstances the subsidiary of a foreign private issuer may use an F-series registration statement to register securities that are guaranteed by the parent company, even if the subsidiary itself does not qualify as a foreign private issuer. In addition, the subsidiary may use Form 20-F for its annual report. To qualify, the parent and subsidiary must file consolidated financial statements or be eligible to present narrative disclosure under Rule 3-10 of Regulation S-X.

Likewise in the second of the new C&DI, the SEC confirms that an F-series registration statement may be used to register securities to be issued by the parent and guaranteed by the subsidiary. When a parent foreign private issuer issues securities guaranteed or co-issued by one or more subsidiaries that do not themselves qualify as a foreign private issuer, the parent and subsidiary may use an F-series registration statement when they are eligible to present condensed consolidating financial information or narrative disclosure.

In the third C&DI the SEC clarifies the deadline for filing a Form 20-F annual report. In particular, the Form 20-F is due 4 months to the day from the end of a company’s fiscal year-end. For example, if a company’s fiscal year-end is February 20, the Form 20-F due date would be June 20.

In the fourth C&DI, the SEC confirms that a wholly owned subsidiary can omit certain information from its Form 20-F annual report in the same manner that a wholly owned subsidiary of a U.S. company can omit information in its Form 10-K. The subsidiary would need to include a prominent statement on its cover page that it meets the requirements to and is providing reduced disclosure.

The requirements to be able to provide reduced disclosure, for both 20-F and 10-K filers, include: (i) all of the company’s equity securities are owned, either directly or indirectly, by a single entity which is subject to the reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”); (ii) such parent entity is current in its reporting requirements; (iii) the parent company specifically names the subsidiary in its description of its business; (iv) during the preceding 36 calendar months and any subsequent period of days, there has not been any material default in the payment of principal, interest or any other material default with respect to any indebtedness of the parent or its subsidiaries; and (v) there has not been any material default in the payment of rentals under material long-term leases.

The disclosure that may be omitted by a qualifying subsidiary includes: (i) selected financial data; (ii) operating and financial review prospects; (iii) the list of subsidiaries exhibit; (iv) information required by Item 6.A, Directors and Senior Management, Item 6.B, Compensation, 6.D, Employees, Item 6.E, Share Ownership, Item 7, Major Shareholders and Related Party Transactions, Item 16A, Audit Committee Financial Expert, and Item 16B, Code of Ethics; and (v) Item 4 Information on the company as long as such information is included in the parent company’s filings.

In the final new C&DI, the SEC confirms that a foreign private issuer may incorporate by reference into a Form 20-F annual report information that had previously been filed with the SEC in another report, such as a Form 6-K.

C&DI Related to Definition of Foreign Private Issuer

The first of the new guidance on the definition of a foreign private issuer relates to determining whether 50% or more of a company’s outstanding securities are directly or indirectly owned by U.S. residents when a company has multiple classes of voting stock with different voting rights. In such a case a company may either (i) calculate voting power on a combined basis; or (ii) make a determination based on the number of voting securities. A company must apply its methodology on a consistent basis.

The second C&DI provides guidance on determining whether an individual is a U.S. resident. In particular, the SEC confirms that a permanent residence with a green card would be considered a U.S. resident. A company may also consider any relevant facts including tax residency, nationality, mailing address, physical presence, the location of a significant portion of their financial and legal relationships and immigration status. The application of facts must be consistently applied to all shareholders.

The third C&DI clarifies the determination of citizenship and residency of directors and officers. A company must consider the citizenship and residency of all individual directors and officers separately and not count them as a single group. In the fourth C&DI, the SEC addresses the determination where a company has two boards of directors. In that case, the company should examine the board that most closely undertakes functions that U.S.-style boards of directors would. Where such determination cannot be made or where both boards provide these functions, both boards should be aggregated and citizenship and residency examined for both.

In the fifth C&DI the SEC confirms that a company can use the geographic segment information in its balance sheet to determine if more than 50% of its assets are located outside the U.S. A company may also use any other reasonable methodology as long as it is used consistently.

In the sixth C&DI the SEC provides guidance for determining whether a business is principally administered in the U.S. As with the theme of the other guidance, the SEC gives the company guidance to exercise reasonable discretion consistently. A company must assess the location from which its officers, partners, or managers primarily direct, control and coordinate the company business and activities.

In the seventh new C&DI the SEC confirms that holding meetings of shareholders or the board of directors on occasion, will not necessarily result in a conclusion that the company is principally administered in the U.S.

In another new C&DI the SEC confirms that all securities-trading markets in countries that are part of the European Union may be considered a single foreign jurisdiction for purposes of applying the trading market definition for purposes of determining the trading of foreign securities.

Refresher Overview for Foreign Private Issuers

                Definition of Foreign Private Issuer

Both the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934, as amended (“Exchange Act”) contain definitions of a “foreign private issuer.” Generally, if a company does not meet the definition of a foreign private issuer, it is subject to the same registration and reporting requirements as any U.S. company.

The determination of foreign private issuer status is not just dependent on the country of domicile, though a U.S. company can never qualify regardless of the location of its operations, assets, management and subsidiaries. There are generally two tests of qualification as a foreign private issuer, as follows: (i) relative degree of U.S. share ownership; and (ii) level of U.S. business contacts.

As with many securities law definitions, the overall definition of foreign private issuer starts with an all-encompassing “any foreign issuer” and then carves out exceptions from there. In particular, a foreign private issuer is any foreign issuer, except one that meets the following as of the last day of its second fiscal quarter:

(i) a foreign government;

(ii) more than 50% of its voting securities are directly or indirectly held by U.S. residents; and any of the following: (a) the majority of the executive officers or directors are U.S. citizens or residents; (b) more than 50% of the assets are in the U.S.; or (c) the principal business is in the U.S.  Principal business location is determined by considering the company’s principal business segments or operations, its board and shareholder meetings, its headquarters, and its most influential key executives.

That is, if less than 50% of a foreign company’s shareholders are located in the U.S., it qualifies as a foreign private issuer.  If more than 50% of the record shareholders are in the U.S., the company must further consider the location of its officers and directors, assets and business operations.

Registration and Ongoing Reporting Obligations

Like U.S. companies, when a foreign company desires to sell securities to U.S. investors, such offers and sales must either be registered or there must be an available Securities Act exemption from registration. The registration and exemption rules available to foreign private issuers are the same as those for U.S. domestic companies, including, for example, Regulation D (with the primarily used Rules 506(b) and 506(c)) and Regulation S) and resale restrictions and exemptions such as under Section 4(a)(1) and Rule 144.

When offers and sales are registered, the foreign company becomes subject to ongoing reporting requirements. Subject to the exemption under Exchange Act Rule 12g3-2(b) discussed at the end of this blog, when a foreign company desires to trade on a U.S. exchange or the OTC Markets, it must register a class of securities under either Section 12(b) or 12(g) of the Exchange Act.  Likewise, when a foreign company’s worldwide assets and worldwide/U.S. shareholder base reaches a certain level ($10 million in assets; total shareholders of 2,000 or greater or 500 unaccredited with U.S. shareholders being 300 or more), it is required to register with the SEC under Section 12(g) of the Exchange Act.

The SEC has adopted several rules applicable only to foreign private issuers and maintains an Office of International Corporate Finance to review filings and assist in registration and reporting questions. Of particular significance:

(i) Foreign private issuers may prepare financial statements using either US GAAP; International Financial Reporting Standards (“IFRS”); or home country accounting standards with a reconciliation to US GAAP;

(ii) Foreign private issuers are exempt from the Section 14 proxy rules;

(iii) Insiders of foreign private issuers are exempt from the Section 16 reporting requirements and short swing trading prohibitions; however, they must comply with Section 13 (for a review of Sections 13 and 16, see my blog HERE);

(iv) Foreign private issuers are exempt from Regulation FD;

(v) Foreign private issuers may use separate registration and reporting forms and are not required to file quarterly reports (for example, Form F-1 registration statement and Forms 20-F and 6-K for annual and periodic reports); and

(vi) Foreign private issuers have a separate exemption from the Section 12(g) registration requirements (Rule 12g3-2(b)) allowing the trading of securities on the OTC Markets without being subject to the SEC reporting requirement.

Although a foreign private issuer may voluntarily register and report using the same forms and rules applicable to U.S. issuers, they may also opt to use special forms and rules specifically designed for and only available to foreign companies. Form 20-F is the primary disclosure document and Exchange Act registration form for foreign private issuers and is analogous to both an annual report on Form 10-K and an Exchange Act registration statement on Form 10. A Form F-1 is the general registration form for the offer and sale of securities under the Securities Act and, like Form S-1, is the form to be used when the company does not qualify for the use of any other registration form.

A Form F-3 is analogous to a Form S-3.  A Form F-3 allows incorporation by reference of an annual and other SEC reports. To qualify to use a Form F-3, the foreign company must, among other requirements that are substantially similar to S-3, have been subject to the Exchange Act reporting requirements for at least 12 months and have filed all reports in a timely manner during that time. The company must have filed at least one annual report on Form 20-F. A Form F-4 is used for business combinations and exchange offers, and a Form F-6 is used for American Depository Receipts (ADR).  Also, under certain circumstances, a foreign private issuer can submit a registration statement on a confidential basis.

Once registered, a foreign private issuer must file periodic reports. A Form 20-F is used for an annual report and is due within four months of fiscal year-end. Quarterly reports are not required. A Form 6-K is used for periodic reports and captures: (i) the information that would be required to be filed in a Form 8-K; (ii) information the company makes or is required to make public under the laws of its country of domicile; and (iii) information it files or is required to file with a U.S. and foreign stock exchange.

As noted above, a foreign private issuer may elect to use either U.S. GAAP; International Financial Reporting Standards (“IFRS”); or home country accounting standards with a reconciliation to U.S. GAAP in the preparation and presentation of its financial statements. Regardless of the accounting standard used, the audit firm must be registered with the PCAOB.

All filings with the SEC must be made in English. Where a document or contract is being translated from a different language, the SEC has rules to ensure that the translation is fair and accurate.

The SEC rules do not have scaled disclosure requirements for foreign private issuers. That is, all companies, regardless of size, must report the same information. A foreign private issuer that would qualify as a smaller reporting company or emerging growth company should consider whether it should use and be subject to the regular U.S. reporting requirements and registration and reporting forms. The company should also consider that no foreign private issuer is required to provide a Compensation Discussion & Analysis (CD&I).  If the foreign company opts to be subject to the regular U.S. reporting requirements, it must also use U.S. GAAP for its financial statements. For further discussions on general reporting requirements and rules related to smaller reporting and emerging growth companies, see my blogs HERE and HERE and related to ongoing proposed changes HERE, which includes multiple related links under the “further background” subsection.

                Deregistration

The deregistration rules for a foreign private issuer are different from those for domestic companies. A foreign private issuer may deregister if: (i) the average daily volume of trading of its securities in the U.S. for a recent 12-month period is less than 5% of the worldwide average daily trading volume; or (ii) the company has fewer than 300 shareholders worldwide. In addition, the company must: (i) have been reporting for at least one year and have filed at least one annual report and be current in all reports; (ii) must not have registered securities for sale in the last 12 months; and (iii) must have maintained a listing of securities in its primary trading markets for at least 12 months prior to deregistration.

American Depository Receipts (ADRs)

An ADR is a certificate that evidences ownership of American Depository Shares (ADS) which, in turn, reflect a specified interest in a foreign company’s shares. Technically the ADR is a certificate reflecting ownership of an ADS, but in practice market participants just use the term ADR to reflect both.  An ADR trades in U.S. dollars and clears through the U.S. DTC, thus avoiding foreign currency issuers. ADR’s are issued by a U.S. bank which, in turn, either directly or indirectly through a relationship with a foreign custodian bank, holds a deposit of the underlying foreign company’s shares. ADR securities must either be subject to the Exchange Act reporting requirements or be exempt under Rule 12g3-2(b).  ADR’s are always registered on Form F-6.

OTC Markets

OTC Markets allows for the listing and trading of foreign entities on the OTCQX and OTCQB that do not meet the definition of a foreign private issuer as long as such company has its securities listed on a Qualifying Foreign Stock Exchange for a minimum of the preceding 40 calendar days subject to OTC Markets’ ability to waive such requirement upon application. If the company does not meet the definition of foreign private issuer, it still must fully comply with Exchange Act Rule 12g3-2(b). For details on the OTCQX listing requirements for international companies, see my blog HERE and for listing requirements for OTCQB companies, including international issuers, see HERE.

India as an Emerging Market

India is widely considered the world’s fastest-growing major economy. The small- and micro-cap industry has been eyeing India as an emerging market for the U.S. public marketplace for several years now. In my practice alone, I have been approached by several groups that see the U.S. public markets as offering incredible potential to the exploding Indian start-up and emerging growth sector. Taking advantage of this opportunity, however, was stifled by strict Indian laws prohibiting or limiting foreign investment into Indian companies. In June 2016, the Indian government announced new rules allowing for foreign direct investments into Indian-owned and -domiciled companies, opening up the country to foreign investment, including by U.S. shareholders.

The new rules allow for up to 100% foreign investment in certain sectors. U.S. investors who already invest heavily in Indian-based defense, aviation, pharmaceutical and technology companies will see even greater opportunity in these sectors, which will now allow up to 100% foreign investment.  Although certain sectors, including defense, will still require advance government approval for foreign investment, most sectors will receive automatic approval. U.S. public companies will now be free to invest in and acquire Indian-based subsidiaries. Likewise, more India-based companies will be able to trade on U.S. public markets, attracting U.S. shareholders and the benefits of market liquidity and public company valuations.

Indian companies are slowly starting to take advantage of reverse-merger transactions with U.S. public companies. In July 2016, online travel agency Yatra Online, Inc., entered into a reverse-merger agreement with Terrapin 3 Acquisition Corp, a U.S. SPAC.  The transaction is expected to close in October 2016. Yatra is structured under a U.S. holding company with operations in India though an India-domiciled subsidiary.

Last year Vidocon d2h became the first India-based company to go public via reverse merger when it completed a reverse merger with a U.S. NASDAQ SPAC. In January, 2016 Bangalore-based Strand Life Sciences Pvt. Ltd. became the second India-based reverse merger when it went public in the U.S. in a transaction with a NASDAQ company.

In addition, U.S.-based public companies, venture capital and private equity firms, and hedge funds and family offices have been investing heavily in the Indian start-up and emerging growth boom. Yatra and Strand Life had both received several rounds of U.S. private funding before entering into their reverse merger agreements. NASDAQ-listed firm Ctrip.com International recently invested $180 million into another India-based online travel company, MakeMyTrip.

India’s Mumbai/Bombay Stock Exchange is already a Qualified Foreign Exchange for purposes of meeting the standards to trade on the U.S. OTCQX International.  For details on all OTCQX listing requirements, including for international companies, see my blog HERE and related directly to international companies including Rule 12g3-2(b), see HERE.  At least 5 companies currently trade on the OTCQX, with their principal market being in India.

Exchange Act Rule 12g3-2(b)

Exchange Act Rule 12g3-2(b) permits foreign private issuers to have their equity securities traded on the U.S. over-the-counter market without registration under Section 12 of the Exchange Act (and therefore without being subject to the Exchange Act reporting requirements). The rule is automatic for foreign issuers that meet its requirements. A foreign issuer may not rely on the rule if it is otherwise subject to the Exchange Act reporting requirements.

The rule provides that an issuer is not required to be subject to the Exchange Act reporting requirements if:

  1. the issuer currently maintains a listing of its securities on one or more exchanges in a foreign jurisdiction which is the primary trading market for such securities; and
  2. the issuer has published, in English, on its website or through an electronic information delivery system generally available to the public in its primary trading market (such as the OTC Market Group website), information that, since the first day of its most recently completed fiscal year, it (a) has made public or been required to make public pursuant to the laws of its country of domicile; (b) has filed or been required to file with the principal stock exchange in its primary trading market and which has been made public by that exchange; and (c) has distributed or been required to distribute to its security holders.

 Primary Trading Market means that at least 55 percent of the trading in the subject class of securities on a worldwide basis took place in, on or through the facilities of a securities market or markets in a single foreign jurisdiction or in no more than two foreign jurisdictions during the issuer’s most recently completed fiscal year.

In order to maintain the Rule 12g3-2(b) exemption, the issuer must continue to publish the required information on an ongoing basis and for each fiscal year. The information required to be published electronically is information that is material to an investment decision regarding the subject securities, such as information concerning:

(i) Results of operations or financial condition;

(ii) Changes in business;

(iii) Acquisitions or dispositions of assets;

(iv) The issuance, redemption or acquisition of securities;

(v) Changes in management or control;

(vi) The granting of options or the payment of other remuneration to directors or officers; and

(vii) Transactions with directors, officers or principal security holders.

At a minimum, a foreign private issuer shall electronically publish English translations of the following documents:

(i) Its annual report, including or accompanied by annual financial statements;

(ii) Interim reports that include financial statements;

(iii) Press releases; and

(iv) All other communications and documents distributed directly to security holders of each class of securities to which the exemption relates.

Click Here To Print- PDF Printout The SEC Has Issued New Guidance Related To Foreign Private Issuers

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.

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The SEC Has Proposed The Use Of Universal Proxy Cards
Posted by Securities Attorney Laura Anthony | February 28, 2017 Tags: , , , , , ,

The SEC has seen a huge exodus of key officials and employees since the recent change in administration, and the ultimate effect of these changes on pending or proposed rule making remains to be seen. However, some proposed rules, whether published or still in drafting process, will remain largely unaffected by the political changes. This could be one of them. In particular, on October 16, 2016, the SEC proposed amendments to the federal proxy rules to require the use of universal proxy cards in connection with contested elections of directors. The proposed card would include the names of both the company and opposed nominees. The SEC also proposed amendments to the rules related to the disclosure of voting options and standards for the election of directors.

Currently where there is a contested election of directors, shareholders likely receive two separate and competing proxy cards from the company and the opposition. Each card generally only contains the directors supported by the sender of the proxy – i.e. all the company’s director picks on one card and all the opposition’s director picks on the other card. A shareholder that wants to vote for some directors on each of the cards, cannot currently do so using a proxy card. The voting process would only allow the shareholder to return one of the cards as valid.  If both were returned the second would cancel out and replace the first under state corporate law.

Shareholders can always appear in person and vote for any directors, whether company or opposition supported, but such appearance is rare and adds an unfair expense to those shareholders. In an effort to provide the same voting rights to shareholders utilizing a proxy card instead of in person appearance, the proposed new rule would require the use of a universal proxy card with all nominees listed on a single card.

Opposition to the proposed rule is concerned that it will give more power to shareholder activists groups and encourage additional proxy contests ultimately damaging the corporation that pays the price, both directly and indirectly, by such adversarial processes.

In an era of strong shareholder activism, the regulation of a company’s obligation in the face of a shareholder proposal has been complex, populated with a slew of no-action letters, SEC guidance through C&DI, and court rulings. In October 2015, the SEC issued its first updated Staff Legal Bulletin on shareholder proposals in years (see my blog HERE) and on the same day the SEC issued specific guidance related to merger and acquisition transactions (see my blog HERE).

SEC Proposed Rule

Introduction and Background

Each state’s corporate law provides for the election of directors by shareholders and the holding of an annual meeting for such purpose.  Company’s subject to the reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”), must comply with Section 14 of the Exchange Act, which sets forth the federal proxy rules and regulations. Private companies, and companies that voluntarily file reports with the SEC (called ’33 Act companies) are not subject to the Section 14 proxy requirements. The SEC views its regulatory authority over the proxy process as “preventing the recurrence of abuses which have frustrated the free exercise of the voting right of stockholders.”

Currently shareholders that appear in person for a meeting, can vote from any of the choices for a director. However, shareholders voting by proxy, which is the vast majority (as high as 99.9%) can only choose from the candidates on the proxy card provided by the party soliciting such vote. In a contested election a shareholder will receive two separate proxy cards and solicitations, one from the company and one from the opposition. Under state law, a shareholder cannot submit two separate proxy cards as the second cancels out and replaces the first.

Although the current proxy rules do allow for all candidates to be listed on a single card, such candidate must agree. Generally in a contested election the opposing candidates will not agree presuming it will impede the process for the opposition or have the appearance of an affiliation or support that does not exist. Moreover, neither party is required to include the other’s nominees, and accordingly, even if the director nominees would consent, they are not included for strategic purposes.

As mentioned, shareholders appearing in person can vote for any duly nominated directors, regardless of whether supported by a company or the opposition. However, in today’s world shareholders rarely appear in person. Besides the time and expense of traveling to and appearing at a meeting, where shares are held in a brokerage account in street name, a shareholder desiring to appear in person needs to go through an added process of having a proxy changed from the brokerage firm to their individual name before they will be on the list and allowed to appear and vote in person. Over the years some large shareholders have taken to sending a representative to meetings so that they could split a vote among directors nominated by a company and those nominated by opposition.

In 1992 the SEC adopted Rule 14a-4(d)(4), called the “short slate rule,” which allows an opposing group that is only seeking to nominate a minority of the board, to use their returned proxy card, and proxy power, to also vote for the company nominees. The short slate rule has limitations. First it is granting voting authority to the opposition group who can then use that authority to vote for some or all of company nominees, at their discretion. Second, although a shareholder can give specific instruction on the short slate card as to who of the company nominees they will not vote for, they will still need to review a second set of proxies (i.e. those prepared by the company) to get those names.

In 2013 the SEC Investor Advisory Committee recommended the use of a universal proxy card and in 2014 the SEC received a rulemaking petition from the Council of Institutional Investors making the same request. As a response, the SEC issued the new rule proposal which would require the use of a “universal proxy” card that includes the names of all nominated director candidates.

In its rule release the SEC discusses the rule oppositions fear that a universal proxy card will give strength to an already bold shareholder activist sector, but notes that “a universal proxy card would better enable shareholders to have their shares voted by proxy for their preferred candidates and eliminate the need for special accommodations to be made for shareholders outside the federal proxy process in order to be able to make such selections.”

Companies have a concern that dissident board representation can be counter-productive and lead to a less effective board of directors due to dissension, loss of collegiality and fewer qualified persons willing to serve. The SEC rule release solicits comments on this point.

Moreover, there is a concern that shareholders could be confused as to which candidates are endorsed by who, and the effect of the voting process itself. In order to avoid any confusion as to which candidates are endorsed by the company and which by opposition, the SEC is also including amendments that would require a clear distinguishing disclosure on the proxy card. Additional amendments require clear disclosure on the voting options and standards for the election of directors.

Proposed Amendments

In order to provide for the use of universal proxy cards, the SEC has proposed amendments to the proxy rules related to the solicitation of proxies, the preparation and use of proxy cards and the dissemination of information about all director nominees in a contested election. In particular the proposed rules:

  • Revise the consent required of a bona fide nominee such that a consent for nomination with include the consent to be included in all proxy statements and proxy cards. Clear disclosure distinguishing company and dissident nominees will be required in all proxy statements;
  • Eliminates the short slate rule for companies other than funds and BDC’s as the rule would no longer have an effect or be necessary;
  • Requires the use of universal proxy cards in all non-exempt solicitations in connection with contested elections. The universal proxy card would not be required where the election of directors is uncontested.  There may be cases where shareholder proposals are contested by a company in which case a shareholder would still receive two proxy cards, however, in such case, all director nominees must be included in each groups proxy cards.
  • Requires dissidents to provide companies with notice of intent to solicit proxies in support of nominees other than the company’s nominees, and to provide the names of those nominees. The rule changes specify timing and notice requirements;
  • Requires companies to provide dissidents with notice of the names of the company’s nominees;
  • Provides for a filing deadline for the dissidents’ definitive proxy statement;
  • Requires dissidents to solicit the holders of shares representing at least a majority of the voting power of shares entitled to vote on the election of directors;
  • Prescribes requirements for the universal proxy cards, including form, content and disclosures;
  • Makes changes to the form of proxy including requiring an “against” and “abstain” voting option; and
  • Makes changes to the proxy statement disclosure to require a better explanation of the effect of a “withhold” vote in an election.

The SEC rule release has a useful chart on the timing of soliciting universal proxy cards:

Due Date Action Required
 

No later than 60 calendar days before the anniversary of the previous year’s annual meeting date or, if the registrant did not hold an annual meeting during the previous year, or if the date of the meeting has changed by more than 30 calendar days from the previous year, by the later of 60 calendar days prior to the date of the annual meeting or the tenth calendar day following the day on which public announcement of the date of the annual meeting is first made by the registrant. [proposed Rule 14a-19(b)(1)]

 

Dissident must provide notice to the registrant of its intent to solicit the holders of at least a majority of the voting power of shares entitled to vote on the election of directors in support of director nominees other than the registrant’s nominees and include the names of those nominees.

No later than 50 calendar days before the anniversary of the previous year’s annual meeting date or, if the registrant did not hold an annual meeting during the previous year, or if the date of the meeting has changed by more than 30 calendar days from the previous year, no later than 50 calendar days prior to the date of the annual meeting. [proposed Rule 14a- 19(d)] Registrant must notify the dissident of the names of the registrant’s nominees.
No later than 20 business days before the record date for the meeting.  [current Rule 14a-13] Registrant must conduct broker searches to determine the number of copies of proxy materials necessary to supply such material to beneficial owners.
By the later of 25 calendar days before the meeting date or five calendar days after the registrant files its definitive proxy statement. [proposed Rule 14a-19(a)(2)] Dissident must file its definitive proxy statement with the Commission.

The proposed new rules will not apply to companies registered under the Investment Company Act of 1940 or BDC’s but would apply to all other entities subject to the Exchange Act proxy rules, including smaller reporting companies and emerging growth companies.

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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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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What Does The SEC Do And What Is Its Purpose?
Posted by Securities Attorney Laura Anthony | February 14, 2017 Tags: , , , , ,

As I write about the myriad of constantly changing and progressing securities law-related policies, rules, regulations, guidance and issues, I am reminded that sometimes it is important to go back and explain certain key facts to lay a proper foundation for an understanding of the topics which layer on this foundation. In this blog, I am doing just that by explaining what the Securities and Exchange Commission (SEC) is and its purpose. Most of information in this blog comes from the SEC website, which is an extremely useful resource for practitioners, issuers, investors and all market participants.

Introduction

The mission of the SEC is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.  Although each mission should be a priority, the reality is that the focus of the SEC changes based on its Chair and Commissioners and political pressure. Outgoing Chair Mary Jo White viewed the SEC enforcement division and task of investor protection as her top priority. Jay Clayton will likely shift the top priority to capital formation.

In addition to regulating and overseeing the processes involved in capital formation (registration and exemptions), the SEC regulates the market participants themselves, including securities exchanges, brokers and dealers, investment advisors, investment companies, issuers and investors, and civilly enforces the law as to each of these participants.  Related to securities exchanges, brokers and dealers and investment advisors, the SEC is primarily concerned with disclosure, fair dealing and protecting against fraud. The SEC brings hundreds of enforcement proceedings each year. For a review of the SEC 2016 enforcement results, see my blog HERE.

The federal securities laws are based on the premise that all investors, whether large institutions or private individuals, should have access to disclosure and information about an investment both before they buy it and during the time they hold the investment. The public company reporting requirements are designed to provide meaningful, comparable information and data about public companies so that investors can conduct due diligence and make an analysis as to whether to buy, sell or hold a particular security.

In order to be effective in its mission in an ever-changing global economy, the SEC must stay connected with market participants and their needs, and be abreast of, and utilize, technological advances. Moreover, the SEC considers the education of investors as a key component to its mission. Educated investors make better decisions. The majority of leads and ultimate evidence on wrongdoing come from investors themselves and, as such, better educated investors provide a more useful resource for enforcement.

History

The SEC was formed as a response to the stock market crash of October 1929 and the following period of the Great Depression. First, Congress passed the Securities Act of 1933, which was designed to regulate disclosure and truth in the purchase and sale of securities. Second, Congress passed the Securities Exchange Act of 1934, which created the SEC and was designed to regulate the people who sell and trade securities, including public companies, brokers, dealers and exchanges. Joseph Kennedy, John F. Kennedy’s father, was the first Chairman of the SEC.

Organization

The SEC is controlled by five commissioners appointed by the president. Each commissioner serves a five-year term and the terms are staggered as to the individual commissioners. One of the commissioners is designated as the chairman by the president. By law, and in an effort to ensure bipartisan policies, no more than three of the commissioners can belong to the same political party.

The SEC is divided into five divisions and 23 offices, all of which are headquartered in Washington, D.C., although there are 11 regional offices throughout the country. A brief summary of each division follows.

Divisions

Division of Corporation Finance

The Division of Corporation Finance (CorpFin) oversees disclosure documents filed by companies with the SEC, including, for example, registration statements on Form S-1, 1-A or Form 10, SEC reports on Forms 10-Q, 10-K and 8-K, and proxy materials related to annual and special shareholder meetings. CorpFin routinely reviews the documents filed with the SEC and may provide comments on the filings. For information on responding to SEC comments, see my blog HERE.

CorpFin provides administrative interpretations and guidance on the federal securities laws for the public and makes specific recommendations to the SEC for rule implementation and changes. In addition to the more formal written no-action letter process, CorpFin maintains staff that is available to answer calls by potential issuers and investors to provide guidance and interpretations on the federal securities laws, including related to whether a particular offering would qualify for an exemption from the registration requirements. CorpFin also works with the Office of Chief Accountant to monitor accounting activities, including the Financial Accounting Standards Board (FASB), which formulates generally accepted accounting principles (GAAP).

Division of Enforcement

The Division of Enforcement conducts investigations and brings civil and administrative proceedings on behalf of the SEC to enforce the federal securities laws. The Division of Enforcement is not itself a criminal prosecutory authority but does work with law enforcement agencies such as the Department of Justice and Attorney General offices around the U.S. to recommend and assist with criminal cases.

All SEC investigations are private. Once an investigation is completed, the SEC will decide to take no action, pursue a civil complaint or pursue an administrative proceeding. Matters that may result in civil or administrative proceedings are often settled first. Although this firm does not represent clients in enforcement proceedings, I have written about the topic in general on numerous occasions. For further reading on enforcement penalties, see HERE. Related to the SEC Whistleblower program, see HERE. For reading related to the SEC’s efforts to prevent microcap fraud, see HERE.

Division of Trading and Markets

The Division of Trading and Markets is responsible for the SEC’s role of maintaining fair, orderly and efficient markets.  In executing its duties, the Division provides daily oversight of major market participants, including the securities exchanges, broker-dealers, self-regulatory organizations including FINRA and the MSRB, clearing agencies, transfer agents, securities information processors and credit rating agencies. This Division also oversees the Securities Investor Protection Corporation (SIPC), which provides insurance against loss in customer accounts due to the bankruptcy or other overall failure of brokerage firms. SIPC does not ensure against individual losses from market declines or negligent or fraudulent broker conduct.

The Division of Trading and Markets also assists with financial integrity programs for broker-dealers, reviewing rules proposed by self-regulatory organizations, drafting and proposing rules and interpretations related to market operations and surveilling the markets.

Division of Investment Management

The Division of Investment Management helps oversee the investment management industry, including mutual funds, fund managers, analysts and investment advisors. The Division of Investment Management is responsible for both investor protection and promoting capital formation in the industry balancing between disclosure by funds and limiting regulatory costs that ultimately reduce gains.

The Division of Investment Management assists the SEC in promulgating and interpreting laws and regulations in the investment management industry, responds to no-action letter and exemptive relief requests, reviews investment company and investment advisor filings with the SEC, and assists in enforcement proceedings.

Division of Economic and Risk Analysis

The Division of Economic and Risk Analysis helps with all aspects of the SEC’s mission through its economic analysis and data analytics. This Division interacts with all other divisions and offices of the SEC, providing economic and risk analyses related to policymaking, rulemaking, enforcement and examinations. The Division also provides advance risk assessments as to litigation, examinations, registrants reviews and general economic support.

Offices of the SEC

The SEC has several offices that perform functions related to the SEC’s overall mission, including, but not limited to, the Office of General Counsel, the Office of the Chief Accountant, the Office of Compliance Inspections and Examinations, the Office of Investor Education and Advocacy, the Office of Credit Ratings, the Office of International Affairs, the Office of Municipal Securities, the Office of Ethics Counsel, the Office of the Investor Advocate, the Office of Women and Minority Inclusion, the Office of the Chief Operating Officer, the Office of Legislative and Intergovernmental Affairs, the Office of Public Affairs, the Office of the Secretary, the Office of Equal Employment Opportunity, the Office of the Inspector General and the Office of Administrative Law Judges, a few of which deserve explanation.

The General Counsel, as part of the Office of the General Counsel, is appointed by the Chairman, is the chief legal officer of the SEC and provides legal advice and counsel to all divisions, other offices, commissioners and the Chairman on all matters within the SEC’s jurisdiction. The General Counsel office also represents the SEC in all civil and administrative litigation matters.

The Chief Accountant, as part of the Office of the Chief Accountant, is also appointed by the Chairman and advises the SEC on all accounting and auditing matters, including approving PCAOB auditing rules. In addition, the Office of the Chief Accountant assists the SEC in establishing accounting principles and overseeing the private sector accounting standards-setting process. The Chief Accountant liaises with FASB, which in turn establishes GAAP. It also liaises with the PCAOB, the International Accounting Standards Board and the American Institute of Certified Public Accountants.

The Office of Investor Education and Advocacy responds to questions, complaints and suggestions from the public. The Office also publishes information and holds seminars and other outreach educational programs to educate the public on the securities laws and their rights.

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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SEC Issues New C&DI On Abbreviated Debt Tender And Debt Exchange Offers
Posted by Securities Attorney Laura Anthony | January 31, 2017 Tags: , , , , , , , , , ,

ABA Journal’s 10th Annual Blawg 100

——————————————————————————————————

The SEC has been issuing a slew of new Compliance and Disclosure Interpretations (“C&DI”) on numerous topics in the past few months. On November 18, 2016, the SEC issued seven new C&DI providing guidance on tender offers in general as well as on abbreviated debt tender and debt exchange offers, known as the Five-Day Tender Offer. The guidance related to the Five-Day Tender Offer clarifies a previously issued January 2015 no-action letter on the subject. As I have not written on the subject of tender offers previously, I include a very high-level summary of tender offers in general and together with specific discussion on the new C&DI.

What Is a Tender Offer?

A tender offer is not statutorily defined, but from a high level is a broad solicitation made by a company or a third party to purchase a substantial portion of the outstanding debt or equity of a company. A tender offer is set for a specific period of time and at a specific price. The purchase offer can be for cash or for equity in either the same or another company (an exchange offer). Where a tender offer is an exchange offer, the offeror must either register the securities being offered for exchange or there must be an available exemption from registration such as under Section 4(a)(2) or Rule 506 of Regulation D.

A tender offer must be made at a fixed price and can include conditions to a closing, such as receiving a certain minimum percentage of accepted tenders. If the person making the tender may own more than 5% of the company’s securities after the tender offer is completed, they must file a Schedule TO with the SEC, including certain delineated disclosures.

Where a tender offer is being made by a company or its management, it is often in association with a going private transaction. Where it is being made by a third party, it is generally for the purpose of acquiring control over the target company and can be either a friendly or hostile takeover attempt.

As mentioned, a tender offer is not statutorily defined but rather can be applied to a broad array of transactions that include the change of ownership of securities. Over the years, a judicially established eight-factor test is used to determine whether the tender offer rules have been implicated and need to be complied with. In particular, in Wellman v. Dickinson, 475 F. Supp. 783 (S.D,N.Y. 1979) the court listed the following eight factors in determining whether a transaction is a tender offer:

  1. An active and widespread solicitation of public shareholders for the shares of a company is made;
  2. A solicitation is made for a substantial percentage of the company’s securities;
  3. The offer to purchase is made at a premium to prevailing market price;
  4. The terms of the offer are firm rather than negotiable;
  5. The offer is contingent on the tender of a fixed number of minimum shares and may be subject to a fixed maximum;
  6. The offer is open for a limited period of time;
  7. The offeree is subjected to pressure to sell their securities; and
  8. Public announcements are made regarding the offer.

Not all factors need be present for a transaction to be considered a tender offer, but rather all facts and circumstances must be considered. The SEC has historically focused on whether an investor is being asked to make an investment decision and whether there is pressure to sell. Once it is determined that a transaction involves a tender offer, the tender offer rules and regulations must be complied with.

Tender offers are governed by the Williams Act, which added Sections 13(d), 13(e), 14(d) and 14(e) to the Securities Exchange Act of 1934. The principle behind the regulatory framework is to ensure proper disclosures to, and equal treatment of, all offerees and to prevent unfair selling pressure. Section 14(d) and Regulation 14D govern tender offers by third parties. Section 14(d) and Regulation 14D set forth the SEC filing requirements and information that must be delivered to those being solicited in association with a tender offer, including the requirement to file a Schedule TO with the SEC.

As with any disclosure document relating to the solicitation or sale of securities, a Schedule TO is comprehensive and includes:

(i)  A summary term sheet;

(ii)  Information about the issuer;

(iii)  The identity and background of the filing persons;

(iv)  The terms of the transactions;

(v)  Any past contacts, transactions and negotiations involving the filing person and the target company and offerees;

(vi)  The purposes of the transactions and plans or proposals;

(vii)  The source and amount of funds or other consideration for the tender offer;

(viii)  Interests in the subject securities, including direct and indirect ownership;

(ix)  Persons/assets retained, employed, compensated or used in the tender process.  In its November 18, 2016 C&DI the SEC clarifies that the terms of employment and compensation to financial advisors engaged by an issuer’s board or independent committee to provide financial advice, would need to be disclosed in this section even if such financial advisor is not soliciting or making recommendations to shareholders.  In addition, another of the new C&DI clarifies the specificity needed related to compensatory disclosure for financial advisors that are active in soliciting or making recommendations to shareholders.  Such disclosure may not always need to include the exact dollar figure of the fees paid or payable to the financial advisor but must include a detailed discussion of the types of fees (such as independence fees, sale or success fees, advisory fees, discretionary fees, bonuses, etc.), when and how such fees will be paid, including any contingencies and any other information that would reasonably be material for a shareholder to judge the merits and objectivity of the financial advisor’s recommendations.

(x)  Financial Statements;

(xi)  Additional information as appropriate; and

(xii)  Exhibits.

Section 14(e) and Regulation 14E contain the antifraud provisions associated with tender offers and apply to all tender offers, whether by insiders or third parties, for cash or an exchange, and whether full or mini offers. Section 14(e) prohibits an offeror from making any untrue statement of a material fact, or omitting to state any material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. Section 14(e) also prohibits any fraudulent, deceptive or manipulative acts in connection with a tender offer.

Regulation 14E contains certain requirements designed to prevent fraudulent conduct and must be complied with in all tender offers. Regulation 14E requires:

(i) A tender offer must be open for at least 20 days;

(ii) The percentage of the class of securities being sought and the consideration offered cannot change unless the offer remains open for at least an additional 10 business days following notice of such change;

(iii) The offeror must promptly make full payment, or return the tendered securities, upon the termination, withdrawal or closing of the offering.  Prompt payment is generally considered to be within 3 days;

(iv)  Public notice must be made of any extension of an offer, and such notice must disclose the amount of any securities already tendered.  Public notice is usually made via a press release in a widely disseminated publication such as the Wall Street Journal;

(v)  The company subject to a tender offer must disclose its position on the tender offer (for, against, or expresses no opinion) to its shareholders. The disclosure must be made within 10 days of notice of the tender offer being provided to the target shareholders;

(vi)  All parties must be mindful of insider trading rules and avoid trading when in possession of information related to the launch of a tender offer.  Where the company is tendering for its own shares, it must be extra careful and cannot conduct a tender while in possession of insider information;

(vii)  Tendering persons must have a net long position in the subject security at the time of tendering and at the end of the proration period in connection with partial tender offers (and not engage in short-tendering and hedged tendering in connection with their tenders); and

(viii)  Subject to certain exceptions, no covered person can purchase or arrange to purchase any of the subject securities from the time of announcement of the tender until its completion through closing, termination or expiration.  A covered person is broadly defined to include the offeror and its affiliates, including its dealer-manager and advisors.

Section 13(e) governs the information delivery requirements for the repurchase of equity securities by an issuer company and its affiliates. Rule 13e-4 sets forth disclosure, filing and procedural requirements for a company tendering for its own equity securities, including the filing of a Schedule TO with the SEC. An equity security is broadly defined and includes securities convertible into equity securities such as options, warrants and convertible debt but does not include non-convertible debt. Companies often use the SEC no-action letter process for relief as to whether a particular security is an equity security invoking Rule 13e-4 or similar enough to debt as to not require compliance with the rule.

In addition to an initial Schedule TO, which must be filed with the SEC on the commencement date of the offer, under Rule 13e-4, a company must file any of its written communications related to the tender offer, an amendment to the Schedule TO reporting any material changes, and a final amendment to the Schedule TO reporting the results of the tender offer. Moreover, a company must further disseminate information through either mail or widely distributed newspaper publications or both.

Where a company or affiliate is the offeror, Rule 13e-4 requires that such offeror allow a tendering shareholder the right to withdraw their tender at any time while the tender offer remains open. The tender offer must be made to all holders of the subject class of securities and where an offer is oversubscribed, the company must accept tenders up to its disclosed limit on a pro rata basis.

There are several exemptions from the Section 13(e) and Rule 13e-4 requirements. Also, careful consideration should be given when a company embarks on a stock repurchase program under Rule 10b-18 to ensure that such program does not actually result in a tender offer necessitating compliance with the tender offer rules. For a summary of Rule 10b-18, see my blog HERE.

Where the target company remains public, upon acquiring 5% or more of the outstanding securities, Section 13(d) requires that a Schedule 13D must be filed by the acquirer. For more information on Schedule 13D disclosure requirements, see my blog HERE.

Mini-tenders

Many provisions of the Williams Act, including Sections 13(d), 13(e), 14(d) and Regulation 14D do not have to be complied with for a tender offer that will result in less than 5% ownership (“mini-tender”); however, the antifraud provisions still apply. Mini-tenders are really just a bid for the purchase of stock, usually through a purchase order with a broker, which bid must remain open for a minimum of 20 days. A mini-tender bidder must make payment in full promptly upon a closing. Bidders in a mini-tender do not have to file documents with the SEC or provide the delineated disclosures required by a full tender offer.

Key differences between a mini-tender and full tender offer include: (i) a mini-tender is not required to file a Schedule TO with the SEC, and thus a target company is not given the opportunity to file a responsive Schedule 14d-9; (ii) a mini-tender bidder is not required to treat all offerees equally; (iii) a mini-tender bidder is not required to carve back offerees on a pro rata basis if oversubscribed; (iv) a mini-tender is not required to allow investors to change their minds and withdraw shares prior to a full closing; (v) a mini-tender deadline can be extended indefinitely.

Mini-tenders tend to be at or below market price, whereas full tenders tend to be at a premium to market price, reflecting the increased value in obtaining a control position over the target company. As a result of the lack of investor protections, and that mini-tenders are generally below market price, they are considered predatory and have a high level of negative stigma. The primary criticism against a mini-tender is that target shareholders are likely confused about the distinctions between the mini and full tender and do not realize that the offer is below market, irrevocable, and does not require equal and fair treatment for all shareholders, although all of this information would be required to be disclosed under the still applicable tender offer antifraud provisions.

There does not appear to be a rational reason as to why an investor in a liquid market would choose to sell to a bidder below market price unless there is confusion as to the terms of the offer being presented. The SEC even has a warning page on mini-tenders urging investors to carefully review all terms and conditions. Where a market is not liquid, a mini-tender could be a viable exit strategy, though in practice, mini-tenders are largely launched for the purchase of larger, highly liquid securities.

Abbreviated Debt Tender Offers (Five Business Day Tender Offer)

As discussed above, Section 14(e) of the Exchange Act and Regulation 14E set forth certain requirements for all tender offers designed to prevent fraud and manipulative acts and practices. One of those requirements is that a tender offer be open for a minimum of 20 business days and remain open for at least an additional 10 business days after notice of any change in the consideration offered.

Beginning in 1986, the SEC began issuing a series of no-action letters providing relief from the 20-day rule for certain non-convertible, investment-grade debt tender offers. The SEC recognized that tender offers in a straight debt transaction are often effectuated to refinance debt at a lower interest rate or to extend looming maturity dates. The tender is often at a small premium to the prevailing market or pay-off price and does not include any equity upside or kicker considerations. All parties to a debt tender offer are motivated to move quickly and without the equity considerations; the SEC recognized that the same investor protections are not necessary as in an equity tender offer.

The SEC relief generally required that the debt tender remain open for 7-10 days. In January 2015, in response to a request from numerous top industry law firms, the SEC granted further no-action relief establishing a Five Business Day Tender Offer for non-convertible debt securities, which meets certain delineated terms and conditions.

The conditions to a Five Business Day Tender Offer include:

(i)  Immediate Widespread Dissemination – the debt tender must begin with immediate (prior to 12:00 noon on the first day of the offer) widespread dissemination of the offer including by press release and Form 8-K containing certain disclosures and including a hyperlink to an Internet address where the offeree can effectuate the tender.  The November 18, 2016 C&DI clarifies that a foreign private issuer may satisfy this requirement by filing a Form 6-K instead of Form 8-K.

(ii) Be made for non-convertible debt securities only;

(iii) Only be initiated by the issuer of the debt securities or a direct or indirect wholly owned subsidiary or parent company;

(iv) Be made solely for cash consideration or an exchange for Qualified Debt Securities.  Qualified Debt Securities means non-convertible debt securities that are identical in all material respects (including issuer, guarantor, collateral, priority, and terms and covenants) to the debt securities that are the subject of the tender offer except for the maturity date, interest payment and record dates, redemption provisions and interest rate, and provided further that to be Qualified Debt Securities, all interest payments must be solely in cash (no equity) and the weighted average life to maturity must be longer than the debt that is subject to the offer.

(v) Be open to all record and beneficial holders of the debt securities, provided that in an exchange offer, the exchange offer can be limited to Qualified Institutional Buyers as defined in Rule 144A and/or non-U.S. persons as defined in Regulation S under the Securities Act, and as long as all other record and beneficial holders are offered cash with a value reasonably equal to the value of the exchange securities being offered to those qualified to receive such exchange.  The November 18, 2016 C&DI clarifies that although the offer has to be made equally to all holders, like other tender offers, it can have conditions to closing such as that a minimum number of debt holders accept the tender.

(vi) The November 18, 2016 C&DI clarifies that where the offer includes an exchange of Qualified Debt Securities to Qualified Institutional Buyers as defined in Rule 144A of the Securities Act, the cash consideration to the other record holders can be calculated by reference to a benchmark as long as it is the same benchmark used to calculate the value of the Qualified Debt Securities.

(vii) Not be made in connection with the solicitation of consents to amend the outstanding debt securities;

(viii) Not be made if a default exists with respect to the subject tender, or any other, material credit agreement to which the company is a party;

(ix) Not be made if at the time of the offer the company is in bankruptcy or insolvency proceedings;

(x) Not be financed with the proceeds of a Senior Indebtedness;

(xi) Permits tender procedures through a certificate as long as the actual debt security is delivered within 2 business days of closing;

(xii) Provide for certain withdrawal rights until the expiration of the offer or any extension;

(xiii) Provide that consideration will be promptly paid for the tendered debt securities; and

(xiv) Not be made in connection with a change of control, merger or other extraordinary transaction involving the company and not be commenced within ten business days of an announcement of the purchase, sale or transfer of a material subsidiary or amount of assets.  The November 18, 2016 C&DI clarifies that a company could announce a plan to conduct a Five Business Day Tender Offer but could not commence the offer until the ten-business-day period had passed.

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 2017


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SEC Issues Guidance On Integration With A 506(c) Offering
Posted by Securities Attorney Laura Anthony | January 10, 2017 Tags: , ,

ABA Journal’s 10th Annual Blawg 100

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On November 17, 2016, the SEC Division of Corporation Finance issued a new Compliance and Disclosure Interpretations (C&DI) related to the integration of a completed 506(b) offering with a new 506(c) offering. The new C&DI confirms that 506(c) offering will not integrate with a previously completed 506(b) offering.

Effective September, 2013, the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rules 506 and 144A offerings as required by Title II of the JOBS Act. The enactment of new 506(c) resulting in the elimination of the prohibition against general solicitation and advertising in private offerings to accredited investors has been a slow but sure success. Trailblazers such as startenging.com, realtymogul.com, circleup.com, wefunder.com and seedinvest.com proved that the model can work, and the rest of the capital marketplace has taken notice.  Recently, more established broker-dealers have begun their foray into the 506(c) marketplace with accredited investor-only crowdfunding websites accompanied by the use of marketing and solicitation to draw investors.

The historical Rule 506 was renumbered to Rule 506(b) and issuers have the option of completing offerings under either Rule 506(b) or 506(c). Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors, provided however that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, are provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering.

The new Rule 506(c) requires that all sales be strictly made to accredited investors and adds a burden of verifying such accredited status to the issuing company. In a 506(c) offering, it is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering. Accordingly the issue of integration, or when the 506(c) offering could be deemed to taint the previously completed 506(b) offering, is extremely important for companies utilizing these types of corporate finance transactions.

Integration and the New C&DI

In general the concept of integration is whether two offerings integrate such that either offering fails to comply with the exemption or registration rules being relied upon. The new C&DI effectively treats a 506(c) offering as a public offering and provides in total:

Question: An issuer has been conducting a private offering in which it has made offers and sales in reliance on Rule 506(b). Less than six months after the most recent sale in that offering, the issuer decides to generally solicit investors in reliance on Rule 506(c). Are the factors listed in the Note to Rule 502(a) the sole means by which the issuer determines whether all of the offers and sales constitute a single offering?

Answer: No. Under Securities Act Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the issuer subsequently decides to make a public offering. Therefore, we believe under these circumstances that offers and sales of securities made in reliance on Rule 506(b) prior to the general solicitation would not be integrated with subsequent offers and sales of securities pursuant to Rule 506(c). So long as all of the applicable requirements of Rule 506(b) were met for offers and sales that occurred prior to the general solicitation, they would be exempt from registration and the issuer would be able to make offers and sales pursuant to Rule 506(c). Of course, the issuer would have to then satisfy all of the applicable requirements of Rule 506(c) for the subsequent offers and sales, including that it take reasonable steps to verify the accredited investor status of all subsequent purchasers.

Rule 502(a) of Regulation D provides a five-factor test to determine whether separate offerings should be integrated (and thus whether an exemption is available for the private offering and there have been no violations of Section 5 for the registered offering). The five factors are: (1) whether the offerings are part of a single plan of financing; (2) whether the offerings involve issuance of the same class of security; (3) whether the offerings are made at or about the same time; (4) whether the same type of consideration is to be received; and (5) whether the offerings are for the same general purpose. The five-factor test is subjective, and the SEC staff has not provided definitive guidance as to what weight to give to the various factors or, indeed, how many of them have to be met.

Rule 502(a) also provides for a six-month safe harbor wherein multiple private offerings that are conducted at least six (6) months apart will not be integrated.  A private offering that is conducted at least six (6) months before or after a registered or exempt public offering will not be integrated with the public offering.

Rule 152 is a safe harbor for issuers undertaking a registered public offering after conducting a private offering. As interpreted by the SEC, a completed private offering will not be integrated with a subsequently commenced registered public offering. Clearly as a result of the ability to publicly solicit, the SEC is treating a Rule 506(c) offering as a public offering in making an integration analysis.

Brief Summary of 506(c)

Effective September 23, 2013, the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rules 506 and 144A offerings as required by Title II of the JOBS Act. For a complete discussion of the final rules, please see my blog HERE. For a discussion on the use of general solicitation and advertising, including when a solicitation may not be considered “general solicitation” for purposes of the 506 Rules, see my blog HERE.

Title II of the JOBS Act required the SEC to amend Rule 506 of Regulation D to permit general solicitation and advertising in offerings under Rule 506, provided that all purchasers of the securities are accredited investors. The JOBS Act required that the rules necessitate that the issuer take reasonable steps to verify that purchasers of the securities are accredited investors using such methods as determined by the SEC. Rule 506 is a safe harbor promulgated under Section 4(a)(2) (formerly Section 4(2)) of the Securities Act of 1933, exempting transactions by an issuer not involving a public offering. In a Rule 506 offering, an issuer can sell an unlimited amount of securities to accredited investors and up to 35 unaccredited sophisticated investors. The standard to determine whether an investor is accredited has historically been the reasonable belief of the issuer.

Rule 506(c) permits the use of general solicitation and advertising to offer and sell securities under Rule 506, provided that the following conditions are met:

  1. the issuer takes reasonable steps to verify that the purchasers are accredited;
  2. all purchasers of securities must be accredited investors, either because they come within one of the categories in the definition of accredited investor, or the issuer reasonably believes that they do, at the time of the sale; and
  3. all terms and conditions of Rule 501 and Rules 502(a) and (d) must be satisfied.

Rule 506(c) includes a non-exclusive list of methods that issuers may use to verify that investors are accredited. An issuer that does not wish to engage in general solicitation and advertising can rely on the old Rule 506 and offer and sell to up to 35 unaccredited sophisticated investors. An issuer opting to rely on the old Rule 506 does not have to take any additional steps to verify that a purchaser is accredited.

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 2017


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SEC Proposes Shortening Trade Settlement
Posted by Securities Attorney Laura Anthony | December 27, 2016 Tags: , , ,

On September 28, 2016, the SEC proposed a rule amendment to shorten the standard broker-initiated trade settlement cycle from three business days from the trade date (T+3) to two business days (T+2). The change is designed to help reduce risks, including credit, market and liquidity risks, associated with unsettled transactions in the marketplace. Outgoing SEC Chair, Mary Jo White was quoted as saying that the change “is an important step to the SEC’s ongoing efforts to enhance the resiliency and efficiency of the U.S. clearance and settlement system.” I have previously written about the clearance and settlement process for U.S. capital markets, which can be reviewed HERE.

Background

DTC provides the depository and book entry settlement services for substantially all equity trading in the US. Over $600 billion in transactions are completed at DTC each day. Although all similar, the exact clearance and settlement process depends on the type of security being traded (stock, bond, etc.), the form the security takes (paper or electronic), how the security is owned (registered or beneficial), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved.

All securities trades involve a legally binding contract. In general, the “clearing” of those trades involves implementing the terms of the contract, including ensuring processing to the correct buyer and seller in the correct security and correct amount and at the correct price and date. This process is effectuated electronically.

“Settlement” refers to the fulfillment of the contract through the exchanging of funds and delivery of the securities. In 1993, Exchange Act Rule 15c6-1 was adopted requiring that settlement occur three business days after the trade date, commonly referred to as “T+3.” Delivery occurs electronically by making an adjusting book entry as to entitlement. One brokerage account is debited and another is credited at the DTC level and a corresponding entry is made at each brokerage firm involved in the transaction. DTC only tracks the securities entitlement of its participating members, while the individual brokerage firms track the holdings in their customer accounts. Technology, of course, plays an important role in the process and ability to efficiently manage settlements.

There may be two brokerage firms between DTC and the customer account holder. Brokerage firms that are direct members with DTC are referred to as “clearing brokers.” Many brokerage firms make arrangements with these DTC members (clearing brokers) to clear the securities on their behalf. Those firms are referred to as “introducing brokers.” A clearing broker will directly route an order through the national exchange or OTC Market, whereas an introducing broker will route the order to a clearing broker, who then routes the order through the exchange or OTC Market.

The Dodd-Frank Act added a definition of, and responsibilities associated with, a “financial market utility” or FMU. Clearing brokers are FMU’s. FMU’s provide the actual functions associated with clearing trades through the DTC system. As part of that process, a division of DTC, the National Securities Clearing Corporation (“NSCC”), becomes the buyer and seller of each contract, netting out and settling all brokerage transactions each day, making one adjusting entry per day. The net entry debits or credits the brokerage firm’s account as necessary. When one of the counterparties in the process does not fulfill its settlement obligations by delivering the securities, there is a “failure to deliver.” Overall, failures to deliver are less than 1% of all transactions.

Likewise, a cash account is maintained for each brokerage firm, which is netted and debited and/or credited each day. These accounts can be in the billions. Clearing firms can either settle each day or carry their open account forward until the next business day. Because all transactions are netted out, 99% of all trade obligations do not require the exchange of money, which helps reduce some risk. NSCC’s role in this process is referred to as a central counterparty or CCP. This process is continuous.

Looking at the process from the top down, the CCP carries the risk that the clearing firm (or FMU) will not have the financial resources to perform its obligations. In turn, the clearing firms have risks from their customers, including introducing brokers, who in turn ultimately have risks from the individual account holders. The risks are compounded by changing values of the securities being traded, during the settlement process. The faster a trade settles, the lower the cumulative risk at each level of the process.

This is a very simplified high-level description of the process. Technically, the roles of DTC and its subsidiaries, CEDE and NSCC, as well as clearing agencies and introducing brokers involve a complex set of regulations, with different definitions, obligations and roles for the different hats the entities wear depending on the type of security being traded (stock, bond, etc.), how the security is owned (registered or beneficial), the form the security takes (paper or electronic), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved (retail or institutional). For those interested, the SEC rule release provides an excellent in-depth review of the settlement and clearing process.

Exchange Act Rule 15c6-1

Exchange Act Rule 15c6-1 prohibits a broker-dealer from effecting or entering into a contract for the purchase or sale of a security, subject to certain exemptions, that provides for the payment of the funds or delivery of the securities later than the third business day after the contract (i.e., trade) date unless expressly agreed upon by both parties at the time of the transaction. Exempted securities include government and municipal securities, commercial paper, limited partnership units that are not listed on an exchange or automated quotations system (OTC Markets), and sales in a firm commitment underwritten offering that are priced after market close.

Firm commitment offerings can rely on an extended T+4 settlement cycle. It is unclear what impact the proposed rule change will have on this exception. The SEC rule release has sought comment on the question.

One of the SEC’s roles is to enhance the resilience and efficiency of the clearance and settlement process such that the system itself does not add to, but rather subtracts from, the risks associated with trading in securities. The SEC is proposing to amend Rule 15a6-1(a) to shorten the settlement cycle to T+2. The SEC believes this change will reduce various risks in the marketplace, including: (i) the credit risk that one party will be unable to fulfill its delivery obligations (of either cash or the securities) on the settlement date; and (ii) the market risk that the value of the securities will change between the trade and settlement such as to result in a loss to one of the parties.

To drill down further on the summary of the settlement and clearing process described in the background section of this blog, the following is a high-level description of what happens following the execution of a trade. First, when the trade is submitted to an exchange or alternative trading system (such as OTC Markets), it is matched with a counterparty. That is, a buy order is electronically matched to a sell order. As long as there is a match, the trade is locked in and sent to NSCC.

On the trade date (T), NSCC validates the trade data and communicates receipt of the transaction. At that moment the parties are legally committed to complete the trade. At midnight on the first day (T+1), NSCC substitutes itself as the legal buyer and legal seller. Technically, the first buy/sell contract is replaced by two new contracts, one between NSCC and the buyer and the other between NSCC and the seller. On the second day (T+2), NSCC issues a trade summary report to its members which summarizes all securities and cash to be settled that day, and shows the net positions for each. NSCC also sends an electronic instruction to DTC to process the net security and cash settlements. Finally, on the third day (T+3), DTC process the electronic settlement by transferring cash and securities between the broker-dealer accounts and the broker-dealers, in turn, put the securities and/or cash in their customer accounts.

Although institutional trading is similar, there are unique aspects and there can be additional participants. For example, an institution may have a custodian of its securities in addition to its broker, may use a matching provider and may avail itself of different netting and settling processes within the brokerage and DTC systems. Although the detailed process may differ, ultimately both retail and institutional trades currently fully settle in the T+3 timeline.

As mentioned, the length of the settlement cycle impacts the exposure to credit, market and liquidity risks for the participants. The participants, including NSCC, take measures to reduce these risks, including by requiring funds to be kept on deposit by clearing and brokerage firms effecting such participants’ liquidity. Even then, however, all participants are exposed to market risk during the settlement process, including a decline in value of the traded securities and the risk that such decline could exceed the broker’s capital deposit or result in a failure to deliver.

A reduction in risks would reduce the necessity to mitigate such risk, including reducing the funds that must be kept on deposit by participants. It is undisputed that reducing the settlement cycle reduces these risks.

Also, obviously if funds are tied up for three days pending a settlement of a transaction, whether you are the retail investor or clearing agency, there is a lack of available liquidity to participate in other transactions during that time.

The reduction of the settlement cycle to T+2 will also assist in aligning global clearing of securities as many markets including the United Kingdom and many European countries are already on the T+2 schedule.

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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SEC Announces Enforcement Results For Fiscal Year-End 2016
Posted by Securities Attorney Laura Anthony | October 18, 2016 Tags: , ,

On October 11, 2016, the SEC announced its enforcement results for fiscal year-end September 30, 2016 (FYE 2016).  In FYE 2016 the SEC filed a record 868 enforcement actions, including against companies and executives for reporting violations, misconduct by companies and gatekeepers, fraud actions and more resulting in judgments and orders totaling more than $4 billion in disgorgement and penalties.

The actions also included a record number of enforcement proceedings against investment advisors and investment companies, a trend I expect to continue in the coming year as the SEC continues to crack down on the failure to adequately disclose all fees associated with investments into and operations of funds, as well as related party transactions.

Consistent with prior speeches and messaging, SEC Chair Mary Jo White made the following quote in the release announcing the enforcement results: “By every measure the enforcement program continues to be a resounding success holding executives, companies and market participants accountable for their illegal actions. Over the last three years, we have changed the way we do business on the enforcement front by using new data analytics to uncover fraud, enhancing our ability to litigate tough cases, and expanding the playbook bringing novel and significant actions to better protect investors and our markets.”

In a speech in February of this year, Chair White focused on enforcement, stating that the SEC “needs to go beyond disclosure” in carrying out its mission. That mission, as articulated by Chair White, is the protection of investors, maintaining fair, orderly and efficient markets, and facilitating capital formation. In 2015 the SEC brought a record number of enforcement proceedings and secured an all-time high for penalty and disgorgement orders, which record has been bested in FYE 2016. The primary areas of focus included cybersecurity, market structure requirements, dark pools, micro-cap fraud, financial reporting failures, insider trading, disclosure deficiencies in municipal offerings and protection of retail investors and retiree savings.

The SEC Division of Enforcement likewise is pleased with their results. Andrew J. Ceresney, Director of the Division of Enforcement, stated, “Through their hard work and steadfast dedication to our mission, the Division’s committed staff have helped protect investors and made our markets fairer and more reliable.”

Highlights of FYE 2016 SEC Enforcement

The SEC notes that in FYE 2016 it brought several first-of-its-kind actions, including: (i) against a firm solely for failing to file Suspicious Activity Reports (SARs) (see my blogs HERE and HERE for more on SARs); (ii) against an audit firm for auditor independence failures based on personal relationships with audit clients; (iii) municipal advisors for violations of fiduciary and antifraud provisions created by Dodd-Frank; (iv) against a private equity advisor for acting as an unlicensed broker-dealer; (v) against an issuer for misstatements and omissions related to the issuance of structured notes.

In addition, in FYE 2016 the SEC won a jury trial against a municipality and one of its officers for violations of the federal securities laws.  The SEC also continued its use of data and analytics to uncover market manipulation and insider trading violations. In FYE 2016, the SEC brought 78 insider trading cases.

Moreover, the SEC continues to crack down on attorneys, accountants and other gatekeepers. This is an extremely important aspect of the enforcement ecosystem, especially in the small- and micro-cap space. Attorneys, accountants, transfer agents, and broker-dealers that are active in the OTC Markets environment play an important role in improving and protecting the OTC Marketplace to the extent that they are reasonably capable in any given fact situation. In December 2015 the SEC issued an advance notice of proposed rulemaking and concept release on proposed new requirements for transfer agents. The proposal would add significant obligations on transfer agents, some of which I agreed with and others I did not. See my blogHERE on the subject. The SEC has not taken further action on this notice as of yet.

In its publication on FYE 2016 enforcement results, the SEC noted that it brought actions against gatekeepers for “failures to comply with professional standards.” A common theme in these actions is missing or ignoring clear indications of fraud or red flags. Examples of such actions include: (i) against auditors for ignoring red flags and fraud risks in conducting audits for annual reports to be filed with the SEC; (ii) violations of auditor independence rules; (iii) against a private fund administrator who missed or ignored clear indications of fraud in preparing and maintaining fund accounting records; (iv) against a consultant for improperly evaluating internal control deficiencies (this was a first-of-its-kind action as well); and (v) against EB-5 lawyers for acting as unregistered brokers.

In addition to enforcement matters I have written about such as HERE, micro-cap fraud and market manipulation continued to be a significant area of enforcement, as it always will. The SEC suspended tradingin 199 micro-cap issuers in FYE 2016. The SEC’s use of technology and data also helped uncover elaborate foreign market manipulation and trading schemes, including such as against a United Kingdom resident for intruding into online brokerage accounts of U.S. investors and making unauthorized trades.

Private offering fraud matters were also the target of multiple enforcement actions. Multiple private offering fraud actions were brought by the SEC in FYE 2016, including actions targeting certain population sectors such as seniors.

The SEC also brought action and collected record fines against market participants, including a $35 million penalty against Barclay’s and a $54 million penalty against Credit Suisse for violations in the operations of each of their alternative trading systems (ATSs). Merrill Lynch faced a $12.5 million fine for failure to have adequate risk controls in place before providing customers with access to the market, and Morgan Stanley was charged $1 million for inadequate written policies and procedures related to the protection of customer records and information.

Investment advisers and investment companies faced an unprecedented level of scrutiny in FYE 2016. In addition to many highly publicized cases related to hidden fees and undisclosed related party transactions, the SEC brought actions for fraud, such as against Aequitas Management for hiding its rapidly deteriorating financing condition after raising $350 million from investors. Thirteen investment advisory firms were charged with repeating false claims made by an investment manager firm highlighting the importance of independent due diligence and responsibilities. Investment funds also faced violations related to improper trading activity, including prearranged trades favoring certain clients.

Other areas that the SEC specifically continued to target for enforcement proceedings include Whistleblower protections (see HERE) and Foreign Corrupt Practices Act violations.

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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  • 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
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