Small Cap Market - Reverse-Merger.com

A Comparison Of Nevada, Delaware And Florida Corporate Statutes

Posted by Securities Attorney Laura Anthony | June 21, 2016 Tags: Delaware Corporate Statutes, Delaware Corporations, Delaware General Corporation Law, Florida Corporate Statutes, Nevada Corporate Statutes

When forming a new entity, I am often asked the best state of domicile. Following a July 1, 2014 increase in Delaware franchise taxes, I am also often asked the best state to re-domicile or move to following an exit from Delaware. Delaware remains the gold standard; however, there has been a definite shift and Delaware is now not the “only standard.”

Part of the reason for the shift away from Delaware has been the increase in fees. Delaware calculates annual fees based on one of two methods: (i) the authorized share method; and (ii) the assume par value capital (asset value) method. For either method the annual fee is capped at $180,000.00. Even for small- and micro-cap business issuers, the annual fee often reaches the tens of thousands. For example, a company with 300,000,000 common shares authorized with a $.001 par value per share and 30,000,000 shares issued and outstanding and $20,000,000 in gross assets would pay $180,000.00 per year using the authorized share method and $70,350.00 per year using the assumed par value method. This is a very significant expense for a small company and, as you can see, the assumptions I have made reflect a very small business.

A second reason for the shift away has been that over the years, the Delaware General Corporation Law(DGCL) has become more aligned with the Model Business Corporation Act (MBCA), which in turn has become the standard followed by many states. In other words, the differences between, for example, Delaware and Nevada have narrowed.

Delaware originally established itself as the best state of incorporation for several reasons including that the Delaware Court of Chancery hears all matters in Delaware courts involving business and corporate disputes and has done so since its formation in 1792. Accordingly the judges are well informed on business matters and corporate law in general, and there is a large body of precedence from which corporate management and their advisors can garner and use when planning transactions and other corporate actions, and determining related risk management.

For instance, in today’s active merger and acquisition marketplace, Delaware courts have led the way in deciding cases involving appraisal and dissenters’ rights and directors’ duties and responsibilities. See my blog HERE for more information on appraisal rights and HERE on directors’ duties.

Moreover, oftentimes institutions prefer to invest in Delaware domiciled corporations in making their own risk assessments. The reason is not always because Delaware is better but rather the funds’ insiders or counsel may be familiar with Delaware law and, in making a relatively quick investment decision, do not want to expend the time or resources researching a different state’s body of law.

The two most popular states for incorporation by business entities remain Nevada and Delaware, both of which offer corporations a degree of flexibility from a menu of reasonable alternatives that can be tailored to the companies’ business sectors, markets and corporate culture. Other states have also gained popularity for various reasons. For example, Florida has gained popularity due to the rise in Florida businesses and Florida-based public companies. Wisconsin and Colorado have also become popular due to low fees and management-friendly provisions.

For my clients I am very comfortable recommending states outside of Delaware as a preferred choice for domicile or re-domicile. This blog provides a summary and comparison of the most relevant provisions of the Delaware, Nevada and Florida corporate laws…

Read More

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.

« NYSE MKT Listing Requirements OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies »

SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 2

Posted by Securities Attorney Laura Anthony | June 7, 2016 Tags: Non-GAAP, Non-GAAP Measures, Regulation G, SEC Issues New C&DI

On May 17, 2016, the SEC published 12 new Compliance & Disclosure Interpretations (C&DI) related to the use of non-GAAP financial measures by public companies. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.

This is the second part in a two-part blog series on the use of non-GAAP financial information. In the first blog I summarized the new C&DI, and in this blog I am reviewing Regulation G and Item 10(e) of Regulation S-K. The first blog in the series can be read HERE.

Background

In the last couple of months SEC Chair Mary Jo White, SEC Deputy Chief Accountant Wesley Bricker, Chief Accountant James Schnurr and Corp Fin Director Keith Higgins have all given speeches at various venues across the company admonishing public companies for their increased use of non-GAAP financial measures. Mary Jo White suggested new rule making may be on the horizon, Corp Fin has been issuing a slew of comment letters, and there has even been word of enforcement proceedings on the matter.

In recent years management has used MD&A and other areas of its disclosure to not only explain the financial statements prepared in accordance with Regulation S-X, which in turn is based on US GAAP, but rather to explain away those financial statements. Approximately 90% of companies provide non-GAAP financial metrics to illustrate their financial performance and prospects. As an example, EBITDA is a non-GAAP number.

However, where EBITDA may not be controversial, the SEC has seen a slippery slope in the use of these non-GAAP measures. The comments letters, and objections by the SEC, relate to failure to abide by Regulation G in providing non-GAAP information, disclosures related to why non-GAAP measures are useful, and cherry-picking of adjustments within a non-GAAP measure. Corp Fin has expressed a particular concern regarding “the use of individually tailored accounting principles to calculate non-GAAP earnings; providing per share data for non-GAAP performance measures that look like liquidity measures; and non-GAAP tax expense.”

The “non-GAAP earnings” issue is really revenue recognition. Public companies are under constant pressure to increase revenues and have become creative in figuring out ways that GAAP revenue recognition standards can be adjusted to increase revenues. Where the elimination of a non-cash GAAP expense item, such as depreciation or derivative liability, seems relatively harmless, and in fact is presented in the statement of cash flows, the inclusion of unearned revenue is much more questionable. Another controversial item affecting revenue is the couching of recurring cash expenses as non-recurring to justify eliminating that item in a non-GAAP presentation. Many of the new C&DI discussed in Part I of this blog series, focus on revenue recognition.

Although I understand the SEC concern, I wonder about the continued and increasing proliferation of non-GAAP measures precipitating the controversy. If 90% of companies use non-GAAP numbers to explain their financial operations, perhaps the GAAP rules themselves needs some adjustment. If, on the other hand, the increase is due to greater economic factors, such as the fact that the US economy has been stagnant for six straight years with zero or near-zero interest rates and no real “boom” following the recession “bust” of 2008, then the SEC may be right in its recent hard-line stance. The pressure on public companies to display consistent growth and improved performance continues regardless of the state of the economy. More on that topic another day.

Regulation G and Item 10(e) of Regulation S-K

Regulation G was adopted January 22, 2003 pursuant to Section 401(b) of the Sarbanes-Oxley Act of 2002 and applies to all companies that have a class of securities registered under the Securities Exchange Act of 1934 (“Exchange Act”) or that are required to file reports under the Exchange Act. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and item 10(e) of Regulation S-K.

Regulation G governs the use of non-GAAP financial measures in any public disclosures including registration statements filed under the Securities Act of 1933 (“Securities Act”), registration statement or reports filed under the Exchange Act or other communications by companies including press releases, investor presentations and conference calls. Regulation G applies to print, oral, telephonic, electronic, webcast and any and all forms of communication with the public.

Item 10(e) of Regulation S-K governs all filings made with the SEC under the Securities Act or the Exchange Act and specifically prohibits the use of non-GAAP financial measures in financial statements or accompanying notes prepared and filed pursuant to Regulation S-X. Item 10(e) also applies to summary financial information in Securities Act and Exchange Act filings such as in MD&A.

Definition of non-GAAP financial measure and exclusions

A non-GAAP financial measure is any numerical measure of a company’s current, historical or projected future financial performance, position, earnings, or cash flows that includes, excludes, or uses any calculation not in accordance with U.S. GAAP.

Specifically, not included in non-GAAP financial measures for purposes of Regulation G and Item 10(e) are: (i) operating and statistical measures such as the number of employees, number of subscribers, number of app downloads, etc.; (ii) Ratios and statistics calculated based on GAAP numbers are not considered “non-GAAP”; and (iii) financial measures required to be disclosed by GAAP (such as segment profit and loss) or by SEC or other governmental or self-regulatory organization rules and regulations (such as measures of net capital or reserves for a broker-dealer).

Non-GAAP financial measures do not include those that would not provide a measure different from a comparable GAAP measure. For example, the following would not be considered a non-GAAP financial measure: (i) disclosure of amounts of expected indebtedness over time; (ii) disclosure of repayments on debt that are planned or reserved for but not yet made; and (iii) disclosure of estimated revenues and expenses such as pro forma financial statements as long as they are prepared and computed under GAAP.

Neither Regulation G nor Item 10(e) applies to non-GAAP financial measures included in a communication related to a proposed business combination, the entity resulting from the business combination or an entity that is a party to the business combination as long as the communication is subject to and complies with SEC rules on communications related to business combination transactions. This exclusion only applies to communications made in accordance with specific business combination communications, such as those in Section 14 of the Exchange Act and the rules promulgated thereunder. As clarified in SEC C&DI on the subject, if the same non-GAAP financial measure that was included in a communication filed under one of those rules is also disclosed in a Securities Act registration statement or a proxy statement or tender offer statement, no exemption from Regulation G and Item 10(e) of Regulation S-K would be available for that non-GAAP financial measure.

Regulation G and Item 10(e) requirements

Together, Regulation G and Item 10(e) require disclosure of and a reconciliation to the most comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.

As with any and all communications, non-GAAP financial measures are subject to the state and federal anti-fraud prohibitions. In addition to the standard federal anti-fraud provisions, Regulation G imposes its own targeted anti-fraud provision. Rule 100(b) of Regulation G provides that a company, or person acting on its behalf, “shall not make public a non-GAAP financial measure that, taken together with the information accompanying that measure and any other accompanying discussion of that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading.” As clarified in the new C&DI published by the SEC on May 17, 2016, even specifically allowable non-GAAP financial measures may violate Regulation G if it is misleading.

As is generally the case with SEC reporting, companies are advised to be consistent over time. Special rules apply to foreign private issuers, which rules are not discussed in this blog.

Below is a chart explaining the Regulation G and Item 10(e) requirements, which I based on a chart posted in the Harvard Law School Forum on Corporate Governance and Financial Regulation on May 23, 2013 and authored by David Goldschmidt of Skadden, Arps, Meagher & Flom, LLP. I made several additions to the original chart created by Skadden.

The Author

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

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

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

Download our mobile app at iTunes.

« OTC Markets Amends IPO Listing Standards for OTCQX NYSE MKT Listing Requirements »

OTC Markets Amends IPO Listing Standards for OTCQX

Posted by Securities Attorney Laura Anthony | May 31, 2016 Tags: OTC Markets, OTCQX, OTCQX Application, OTCQX Listing Requirements

OTC Markets has unveiled changes to the quotations rule and standards for the OTCQX, which proposed changes are scheduled to become effective on June 13, 2016. The proposed amendments are intended to address and accommodate companies completing an IPO onto the OTCQX and which accordingly have no prior trading history. Such entities either would have a recently cleared Form 211 with FINRA or are completing the 211 application process through a market maker, at the time of their OTCQX application. The initial qualification changes apply to OTCQX Rules for U.S. Companies, U.S. Banks and International Companies.

The OTCQX previously amended its listing standards effective January 1, 2016 to increase the quantitative criteria for listing and to add additional qualitative requirements further aligning the OTCQX with a national stock exchange. To read my blog on the January 1, 2016 amendments see HERE.

The new amendments will (i) allow companies that meet the $5 bid price test to use unaudited, interim financials to meet certain OTCQX financial standards; and (ii) provide a phase-in compliance period for US companies to meet the OTCQX corporate governance requirements.

A complete summary of all OTCQX listing requirements is included below.

Morningstar Collaboration

In addition, effective May 6, 2016 OTC Markets collaborated with Morningstar, an independent research and equity ratings firm, to provide research and ratings on all OTCQX companies. The research reports are available on a company’s quote page on the OTC Markets website. As part of each Morningstar report, the company’s equity is rated as to valuation, illustrating an over or under valuation, based on the Morningstar analysis. The Morningstar reports are updated daily.

Morningstar reports are also published under the research section of each OTCQX company’s quote page on the OTC Markets website.

A well-known issue for all small- and micro-cap companies is a lack of independent research or analysts’ coverage. I’ve reviewed several of the Morningstar reports and they provide very good information.

Specific Amendments for Listing

Compliance with penny stock exemptions under Rule 3a51-1 of the Exchange Act

To be eligible to trade on the OTCQX tier of OTC Markets, all companies must meet one of the following penny stock exemptions under Rule 3a51-1 of the Exchange Act: (i) have a bid price of $5 or more as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application, and as of the most recent fiscal year-end have at least one of the following: (w) net income of $500,000; (x) net tangible assets of $1,000,000; (y) revenues of $2,000,000; or (z) total assets of $5,000,000; or (ii) have net tangible assets of $2 million if the company has been in continuous operation for at least three years, or $5,000,000 if the company has been in continuous operation for less than three years, which qualification can be satisfied as of the end of a fiscal period or as a result of an interim capital raise; or (iii) have average revenue of at least $6,000,000 for the last three years.

The OTCQX is amending its eligibility requirements to allow for the use of CEO or CFO certified pro forma financial statements to satisfy the financial qualitative criteria associated with the $5 bid price penny stock exemption, where the company has not had a prior public market for its securities and where the company has an approved Form 211 with a bid price greater than $5 per share.

A company seeking to rely on pro forma financial statements must file such statements through the EDGAR database or on OTC Markets, and such statements must be certified by the company CEO or CFO. A company may also rely on its annual, quarterly or current financial statements filed with EDGAR in accordance with the registration requirements under the Securities Act of 1933 (such as a Form S-1) or Securities Exchange Act of 1934 (such as a Form 10) or its Exchange Act reports (i.e., Form 10-Q or 10-K) as long as such financial statements reflect information as of the most recent fiscal year-end.

In addition, a company must make a written request to OTC Markets for a waiver of the requirement that it maintain a bid price over $5 per share as of the close of business on each of the 30 consecutive days prior to the date of the application. OTC Markets may grant or deny the waiver at its sole discretion.

This amendment will allow a company that is completing the IPO process and has an approved 15c2-11 at $5.00 or greater to meet the penny stock exemption for OTCQX eligibility. In addition, such company will not need to wait until its current fiscal year-end audit is completed to satisfy the qualification criteria. This will be especially helpful for a company that is completing an IPO in Q1 of its fiscal year.

The amendment related to compliance with the penny stock exemptions applies to all issuers seeking application on the OTCQX including U.S. companies, international companies and banks.

Corporate Governance Eligibility Criteria

The OTC Markets are also amending the requirements related to its corporate governance eligibility criteria for U.S. companies applying to the OTCQX in conjunction with an initial public offering. The amendment will allow a phase-in period to satisfy full compliance with the corporate governance requirements. The corporate governance amendments apply to U.S. and U.S. Premier applicants only.

Effective January 1, 2016, to list on OTCQX, U.S. companies are required to (i) have a minimum of 2 independent board members; (ii) have an audit committee comprised of a majority of independent directors; and (iii) conduct an annual shareholders meeting and submit annual financial reports to shareholders at least 15 calendar days prior to such meeting.

The new amendments, scheduled to be effective June 13, 2016, will allow a phase-in for compliance with these requirements for companies making application to the OTCQX in connection with its initial public offering and initial Form 211 application to FINRA. In particular: (i) at least one member of the board of directors and the audit committee must be independent at the time of the OTCQX application; and (ii) at least 2 members of the board of directors and a majority of the members of the audit committee must be independent at the later of 90 days after the company begins trading on the OTCQX or the company’s next shareholder meeting. Moreover, the company’s next shareholder meeting must be held within one year of the company joining OTCQX.

A Complete Summary of OTCQX Initial and Ongoing Listing Requirements

The following is a complete summary of the OTCQX listing standards as in effect on January 1, 2016 and including the proposed amendments scheduled to go effective June 13, 2016.

The OTCQX divides its listing criteria between U.S. companies and international companies, though they are very similar. The OTCQX has two tiers of quotation for U.S. companies: (i) OTCQX U.S. Premier (also eligible to quote on a national exchange); and (ii) OTCQX U.S. and two tiers for international companies: (i) OTCQX International Premier; and (ii) OTCQX International. Quotation is available for American Depository Receipts (ADR’s) or foreign ordinary securities of companies traded on a Qualifying Foreign Stock Exchange, and an expedited application process is available for such companies. The OTCQX also has specific listing criteria and rules for banks, which criteria and rules are not included in this blog.

Issuers on the OTCQX must meet specified eligibility requirements. Moreover, OTC Markets have the discretionary authority to allow quotation to substantially capitalized acquisition entities that are analogous to SPAC’s.

OTCQX – Requirements for Admission

To be eligible to be quoted on the OTCQX U.S., companies must:

Have $2 million in total assets as of the most recent annual or quarter end;

As of the most recent fiscal year-end, have at least one of the following: (i) $2 million in revenues; (ii) $1 million in net tangible assets; (iii) $500,000 in net income; or (iv) $5 million in market value of publicly traded securities;

Have a market capitalization of at least $10 million on each of the 30 consecutive calendar days immediately preceding the company’s application;

Meet one of the following penny stock exemptions under Rule 3a51-1 of the Exchange Act: (i) have a bid price of $5 or more as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application and, as of the most recent fiscal year-end, have at least one of the following: (a) net income of $500,000; (b) net tangible assets of $1,000,000; (c) revenues of $2,000,000; or (d) total assets of $5,000,000; or (ii) have net tangible assets of $2 million if the company has been in continuous operation for at least three years, or $5,000,000 if the company has been in continuous operation for less than three years, which qualification can be satisfied as of the end of a fiscal period or as a result of an interim capital raise; or (iii) have average revenue of at least $6,000,000 for the last three years;

Effective June 13, 2016, a company may satisfy the financial qualitative criteria associated with the $5 bid price penny stock exemption, where the company has not had a prior public market for its securities and where the company has an approved Form 211 with a bid price greater than $5 per share by using its most recent annual, quarterly or current event report filed through EDGAR or a pro forma financial statement, signed and certified by the CEO or CFO, posted through EDGAR or the OTC Markets Disclosure and News Service. In such case, the company may apply in writing for an exemption from the requirement to maintain a bid price over $5 per share as of the close of business on each of the 30 consecutive days prior to the company’s application day, which exemption may be granted by OTC Markets at its sole and absolute discretion.

Not be a blank check or shell company as defined by the Securities Act of 1933 (“Securities Act”);

Not be in bankruptcy or reorganization proceedings;

Be in good standing in its state of incorporation and in each state in which it conducts business;

Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;

Be quoted by at least one market maker on the OTC Link;

Have a minimum bid price of $0.25 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX. If (i) there has been no prior public market for the company’s securities in the S. and (ii) FINRA has approved a Form 211, then the company may apply to OTC Markets for an exemption from the minimum bid price requirements, which exemption is at the sole discretion of OTC Markets. In the event that the company is a Seasoned Public Issuer (i.e., has been in operation and quoted on either OTC Link, the OTCBB or an exchange for at least one year) that completed a reverse stock split within 6 months prior to applying for admission to OTCQX U.S., the company must have a minimum bid price of $0.25 per share for its common stock as of the close of business on each of the 5 consecutive trading days immediately preceding the company’s application for OTCQX, after the reverse split;

Have GAAP compliant (i) audited balance sheets as of the end of each of the two most recent fiscal years, or as of a date within 135 days if the company has been in existence for less than two fiscal years, and audited statements of income, cash flows and changes in stockholders’ equity for each of the fiscal years immediately preceding the date of each such audited balance sheet (or such shorter period as the company has been in existence), and must include all going concern disclosures including plans for mitigation; and GAAP compliant (ii) unaudited interim financial reports, including a balance sheet as of the end of the company’s most recent fiscal quarter, and income statements, statements of changes in stockholders’ equity and statements of cash flows for the interim period up to the date of such balance sheet and the comparable period of the preceding fiscal year;

Be included in a Recognized Securities Manual or be subject to the reporting requirements of the Exchange Act; and

Have an OTCQX Advisor.

To be eligible to be quoted on the OTCQX U.S. Premier, companies must:

Satisfy all of the eligibility requirements for OTCQX U.S. set forth above;

Meet one of the following: (i) Market Value Standard – have at least (a) $15 million in public float and (b) a market capitalization of at least $50 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; or (ii) Net Income Standard – have at least (a) $1 million in public float; and (b) a market capitalization of at least $10 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; and (c) $750,000 in net income as of the company’s most recent fiscal year-end;

Have at least 500,000 publicly held shares;

Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;

Have a minimum of 100 beneficial shareholders owning at least one round lot (100 shares) each;

Have a minimum bid price of $4.00 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX. If (i) there has been no prior public market for the company’s securities in the S. and (ii) FINRA has approved a Form 211 and (iii) the bid price is equal to or greater than $1.00, then the company may apply to OTC Markets for an exemption from the 30-day minimum bid price requirements, which exemption is at the sole discretion of OTC Markets. In the event that the company is a Seasoned Public Issuer (i.e., has been in operation and quoted on either OTC Link, the OTCBB or an exchange for at least one year) that completed a reverse stock split within 6 months prior to applying for admission to OTCQX U.S., the company must have a minimum bid price of $4.00 per share for its common stock as of the close of business on each of the 5 consecutive trading days immediately preceding the company’s application for OTCQX, after the reverse split;

Have at least $4 million in stockholder’s equity;

Have a 3-year operating history; and

Conduct annual shareholders’ meetings and submit annual financial reports to its shareholders at least 15 calendar days prior to such

To be eligible to be quoted as an OTCQX U.S. Acquisition Company, companies must:

Satisfy all of the eligibility requirements for OTCQX U.S. set forth above;

Have a minimum bid price of $5.00 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX; and

Be subject to the reporting requirements of the Exchange Act.

Corporate Governance Requirements for all OTCQX U.S., U.S. Premier and U.S. Acquisition Companies:

Have at least 2 independent board members on the board of directors;

Have an audit committee comprised of a majority of independent directors; and

Conduct annual shareholders’ meetings and submit annual financial reports to its shareholders at least 15 calendar days prior to such.

Effective June 13, 2016, the OTCQX will allow a phase-in for compliance with these requirements for companies making application to the OTCQX in connection with its initial public offering and initial Form 211 application to FINRA. In particular: (i) at least one member of the board of directors and the audit committee must be independent at the time of the OTCQX application; and (ii) at least 2 members of the board of directors and a majority of the members of the audit committee must be independent at the later of 90 days after the company begins trading on the OTCQX or the company’s next shareholder meeting. Moreover, the company’s next shareholder meeting must be held within one year of the company joining OTCQX.

To be eligible to be quoted on the OTCQX International, companies must:

Have U.S. $2 million in total assets as of the most recent annual or quarter end;

As of the most recent fiscal year-end, have at least one of the following: (i) U.S. $2 million in revenues; (ii) U.S. $1 million in net tangible assets; (iii)S. $500,000 in net income; or (iv) U.S. $5 million in global market capitalization;

Meet one of the following penny stock exemptions under Rule 3a51-1 of the Exchange Act: (i) have a bid price of $5 or more as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application, and as of the most recent fiscal year-end have at least one of the following: (a) net income of $500,000; (b) net tangible assets of $1,000,000; (c) revenues of $2,000,000 or (d) total assets of $5,000,000; or (ii) have net tangible assets of U.S. $2 million if the company has been in continuous operation for at least three years, orS. $5,000,000 if the company has been in continuous operation for less than three years; or (iii) have average revenue of at least U.S. $6,000,000 for the last three years;

Be quoted by at least one market maker on the OTC Link (which requires a 15c2-11 application if the company is not already quoted on a lower tier of OTC Markets);

Not be a shell company or blank check company;

Not be in bankruptcy or reorganization proceedings;

Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;

Be included in a Recognized Securities Manual or be subject to the reporting requirements of the Exchange Act;

Have its securities listed on a Qualifying Foreign Stock Exchange for a minimum of the preceding 40 calendar days – provided, however, that in the event the company’s securities are listed on a non-U.S. exchange that is not a Qualified Foreign Stock Exchange, then at the company’s request and subsequent to the company providing OTC Markets Group with personal information forms for each executive officer, director, and beneficial owner of 10% or more of a class of the company’s securities and such other materials as OTC Markets Group deems necessary to make an informed determination of eligibility, OTC Markets Group may, at its sole and absolute discretion, consider the company’s eligibility for OTCQX International;

Have a global market capitalization of at least $10 million on each of the 30 consecutive calendar days immediately preceding its application day;

Meet one of the following conditions: (i) be eligible to rely on the registration exemption found in Exchange Act Rule 12g-2(b) and be current and compliant in such requirements; or (ii) have a class of securities registered under Section 12(g) of the Exchange Act and be current in its SEC reporting requirements; or (iii) if such company is not eligible to rely on the exemption from registration provided by Exchange Act Rule 12g3-2(b) because it does not (A) meet the definition of “foreign private issuer” as that term is used in Exchange Act Rule 12g3-2(b) or (B) maintain a primary trading market in a foreign jurisdiction as set forth in Exchange Act Rule 12g3-2(b)(ii), and is not otherwise required to register under Section 12(g), be otherwise current and fully compliant with the obligations of a company relying on the exemption from registration provided by Exchange Act Rule 12g3-2(b); and

Have a Principal American Liaison (PAL).

Explanation of 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: (i) 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 (ii) 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 under paragraph (b) of this section 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.

To be eligible to be quoted on the OTCQX International Premier, companies must:

Satisfy all of the eligibility requirements for OTCQX International set forth above;

Have a global market capitalization of at least $1 billion on each of the 30 consecutive calendar days immediately preceding its application day; and

Have one of the following over the prior 6 months: (i) average weekly trading volume of at least 200,000 shares; or (ii) average weekly trading volume of at least $1 million.

Application to the OTCQX

All U.S. companies that are quoted on the OTCQX must submit an application and pay an application fee. The application consists of (i) the application with information related to the company; (ii) the contractual agreement with OTCQX for quotation; (iii) personal information for each executive officer, director and beneficial owner of 5% or more of the securities, except for companies already traded on a foreign exchange or moving from a recognized U.S. exchange; (iv) designation of the OTCQX Advisor; (v) appointment form for the OTCQX Advisor; and (vi) a digital company logo.

All international companies that are quoted on the OTCQX must submit an application and pay an application fee. The application consists of (i) OTCQX application for international companies; (ii) the contractual agreement with OTCQX for international companies; (ii) the OTCQX application fee; (iv) the OTCQX Agreement for international companies; (v) an application for the international company’s desired PAL if such PAL is not already pre-qualified; (vi) an appointment form for the PAL; and (vii) a copy of the company’s logo in encapsulated postscript (EPS) format.

The application is subject to review and comment by OTC Markets. OTC Markets may require additional conditions or undertakings prior to admission. Moreover, the application may be denied if, in the opinion of OTC Markets, trading would be likely to impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors.

Initial Disclosure Obligations

A company must post its initial disclosure documents on the OTC Markets website as a precondition to acceptance of an application for quotation, and such posting must be confirmed with a letter by the company OTCQX ADVISOR/PAL.

Initial disclosure documents include: (i) SEC reports if the company is subject to the Exchange Act reporting requirements; (ii) current information in accordance with OTC Markets disclosure guidelines including financial statements; (iii) if the company is a Regulation A reporting company, it must be current in such reporting requirements; (iv) if the company was an SEC Reporting Company immediately prior to joining OTCQX and has a current 10-K on file with the SEC, or was a Regulation A Reporting Company immediately prior to joining OTCQX and has a current 1-K on file with the SEC, the company is not required to post an information statement through the OTC Markets, but subsequent to joining OTCQX must post all annual, quarterly, interim and current reports required pursuant to the Disclosure Guidelines; and (v) for international companies not subject to the SEC reporting requirements, all information required to be made public pursuant to Exchange Act Rule 12g3-2(b) for the preceding 24 months, which information must be posted in English.

A company must supplement and update any changes to the initial disclosure within 30 days of acceptance of its application for quotation. International companies must follow initial disclosure with a PAL Letter of Introduction.

Requirements for Ongoing Qualification for Quotation on the OTCQX

The following is a summary of the ongoing responsibilities for U.S. OTCQX quoted securities:

Compliance with Rules – OTCQX quoted companies must maintain compliance with the OTCQX rules including disclosure requirements. The company’s OTCQX ADVISOR/PAL is responsible for reporting their/its potential conflicts of interest;

Compliance with Laws – OTCQX quoted companies must maintain compliance with state and federal securities laws and must cooperate with any securities regulators, including self-regulatory organizations;

Blue Sky Manual Exemption – Companies must either properly qualify for a blue sky manual exemption or be subject to and current in their Exchange Act reporting requirements;

Retention and Advice of OTCQX ADVISOR – Companies must have an OTCQX ADVISOR at all times and are required to seek the advice of such OTCQX ADVISOR as to their OTCQX obligations;

Duty to Inform OTCQX ADVISOR – As part of its duty to seek advice from its OTCQX ADVISOR, a company has an obligation to provide disclosure and information to the OTCQX ADVISOR, including “complete access to information regarding the company, including confidential and propriety information”; access to personnel; updated personal information forms; and timely responses to requests for information or documents;

Notification of Resignation or Dismissal of OTCQX ADVISOR – A company must immediately notify OTC Markets in writing of the resignation or dismissal of the OTCQX ADVISOR for any reason;

Payment of Fees – a company must pay its annual fees to OTC Markets;

Sales of Company Securities by Affiliates – Prior to transacting in the company’s securities through a broker-dealer, each officer, director or other affiliate of the company shall make its status as an affiliate of the company known to the broker-dealer;

Distribution and Publication of Proxy Statements – The company shall solicit proxies for all meetings of shareholders. If the company is a Regulation A Reporting Company, the company shall publish, on EDGAR through SEC Form 1-U, copies of all proxies, proxy statements and all other material mailed by the company to its shareholders with respect thereto, within 15 days of the mailing of such material. If the company is not an SEC Reporting Company or a Regulation A Reporting Company, the company shall publish, through the OTC Markets, copies of all proxies, proxy statements and all other material mailed by the company to its shareholders with respect thereto, within 15 days of the mailing of such material;

Redemption Requirements – All redemptions must be either by lot or pro rata and require 15 days’ notice;

Changes in Form or Nature of Securities – All changes in form, nature or rights associated with securities quoted on the OTCQX require 20 days’ advance notice to OTC Markets;

Transfer Agent – Companies are required to use the services of a registered transfer agent and authorize such transfer agent to share information with OTC Markets;

Accounting Methods – Any change in accounting methods requires advance notice of such change and its impact, to OTC Markets;

Change in Auditors – All changes in auditor requires prompt notification and a letter from such auditor analogous to Form 8-K requirements;

Responding to OTC Markets Group Requests – OTCQX quoted companies are required to respond to OTC Markets comments and amend filings as necessary in response thereto;

Ongoing Disclosure Obligations – (i) Companies subject to the Exchange Act reporting requirements must remain current in such reports; (ii) Companies not subject to the Exchange Act reporting requirements must remain current with the annual, quarterly and current reporting requirements of OTC Markets, including posting annual audited financial statements prepared in accordance with GAAP and audited by a PCAOB auditor; (iii) Regulation A reporting companies shall maintain current compliance with their Regulation A reporting requirements and within 45 days of the end of the first and third fiscal quarters shall file quarterly disclosure including all information required in a semi-annual report (i.e., the company shall file quarterly and not just semi-annual reports); (iv) file a notification of late filing when necessary; (v) quickly release disclosure of material news and recent developments, whether positive or negative, through a press release on the OTC Markets website (in addition to SEC filings); (vi) an OTCQX company should also act promptly to dispel unfounded rumors which result in unusual market activity or price variations;

General requirements regarding integrity – OTCQX quoted companies are expected to act professionally and uphold the OTC Markets standards for “high quality,” and to release news and reports that are prepared factually and accurately with neither excessive puffery or conservatism; companies must not report or act in a way that could be misleading; must not inundate with non-material releases; and must not make misleading premature announcements;

Maintain Company Updated Profile – OTCQX quoted companies are required to maintain updated, accurate information on their profile page and to verify same every six months;

OTCQX ADVISOR Letter – Within 120 days of each fiscal year-end and after the posting of the company’s annual report, every company must submit an annual OTCQX ADVISOR letter;

To remain eligible for trading on the OTCQX U.S. tier, the company’s common stock must have a minimum bid price of $0.10 per share as of the close of business for at least one of every thirty consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $0.10 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $0.10 for ten consecutive trading days;

To remain eligible for trading on the OTCQX U.S. tier, the company must maintain a market capitalization of at least $5 million for at least one of every 30 consecutive calendar days;

To remain eligible for trading on the OTCQX U.S. tier, the company must have at least 2 market makers quote the stock;

To remain eligible for trading on the OTCQX S. Premier tier, the company’s common stock must have a minimum bid price of $1.00 per share as of the close of business for at least one of every thirty consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $1.00 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $1.00 for ten consecutive trading days. In the event that the company’s common stock does not regain compliance during the grace period, the company shall have a fast-track option to have its securities traded on the OTCQX U.S. tier.

To remain eligible for trading on the OTCQX S. Premier tier, the company must meet one of the following standards: (i) Market Value Standard – have at least (a) $15 million in public float and (b) a market capitalization of at least $35 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; or (ii) Net Income Standard – have at least (a) $1 million in public float; and (b) a market capitalization of at least $5 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; and (c) $500,000 in net income as of the company’s most recent fiscal year-end;

To remain eligible for trading on the OTCQX S. Premier tier, the company must have at least $1 million in stockholders’ equity;

To remain eligible for trading on the OTCQX S. Premier tier, the company must have at least 4 market makers quoting the stock;

All U.S. companies, whether U.S. standard or U.S. Premier, must maintain corporate governance standards including independent director and audit committee requirements. A company must notify OTC Markets immediately of a disqualification and must regain compliance by its next annual shareholder meeting or one year from the date of non-compliance.

The following is a summary of the ongoing responsibilities for OTCQX International quoted securities:

Eligibility Criteria – The international company must meet the above eligibility requirements as of the end of each most recent fiscal year;

Compliance with Rules – OTCQX quoted companies must maintain compliance with the OTCQX rules, including disclosure requirements. Officers and directors of the company are responsible for compliance and are solely responsible for the content of information;

Compliance with Laws – OTCQX quoted companies must maintain compliance with applicable securities laws of their country of domicile and applicable U.S. federal and state securities laws. The company must comply with Exchange Act Rule 10b-17 and FINRA rule 6490 regarding notification and processing of corporate actions (such as name changes, splits and dividends). The company must cooperate with any securities regulators, whether in their country of domicile or in the U.S., including self-regulatory organizations;

Blue Sky Manual Exemption – Companies must either properly qualify for a blue sky manual exemption or be subject to and current in their Exchange Act reporting requirements;

Retention and Advice of PAL – Companies must have a PAL at all times and are required to seek the advice of such PAL as to their OTCQX obligations;

Notification of Resignation or Dismissal of PAL – A company must immediately notify OTC Markets in writing of the resignation or dismissal of the PAL for any reason;

Payment of Fees – A company must pay its annual fees to OTC Markets;

Responding to OTC Markets Group Requests – OTCQX quoted companies are required to respond to OTC Markets comments and amend filings as necessary in response thereto;

To remain eligible for OTCQX International, the company must maintain a minimum bid price of $0.10 as of the close of business for at least one of every 30 consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $0.10 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $0.10 for ten consecutive trading days;

To remain eligible for OTCQX International, the company must maintain a market capitalization of at least $5 million for at least one of every 30 consecutive calendar days;

To remain eligible for OTCQX International, the company must maintain at least 2 market makers;

Ongoing Disclosure Obligations – (i) Companies subject to the Exchange Act reporting requirements must remain current in such reports; (ii) A company that is not an SEC Reporting Company must remain current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and in any event shall, on an ongoing basis, post in English through the OTC Disclosure & News Service or an Integrated Newswire, the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b); (iii) provide a letter to its PAL at least once a year, no later than 210 days after the fiscal year-end, which states that the company (a) continues to satisfy the OTCQX quotation requirements; and (b) is current and compliant in its obligations under Exchange Act Rule 12g3-2(b) and that the information required under such rule is posted, in English, on the OTC Markets website or that the company is subject to the SEC reporting requirements and is current in such reporting requirements;

PAL Letter – Within 225 days of each fiscal year-end and after the posting of the company’s annual report, every company must submit an annual PAL letter; and

To remain eligible for the OTCQX International Premier, the company must have (i) a global market capitalization of at least $500 million for at least one of every 30 consecutive calendar days; (ii) of one following over the prior 6 months (a) an average weekly trading volume of at least 100,000 shares or (b) an average weekly trading dollar volume of at least $500,000; and (iii) at least 4 market makers.

Removal from OTCQX International

A company may be removed from the OTCQX if, at any time, it fails to meet the eligibility and continued quotation requirements subject to a 30-day notice and opportunity to address them. In addition, OTC Markets Group may remove the company’s securities from trading on OTCQX immediately and at any time, without notice, if OTC Markets Group, at its sole and absolute discretion, believes the continued inclusion of the company’s securities would impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors. In addition, OTC Markets can temporarily suspend trading on the OTCQX pending investigation or further due diligence review.

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

Fees

Upon application for quotation on the OTCQX, companies must pay an initial non-refundable fee of $5,000. In addition, companies must pay an annual non-refundable fee of $20,000. The annual fee is based on the calendar year and is due by December 1st each year.

OTCQX Advisor (formerly known as Designated Advisors for Disclosure (“DAD”)) and Principal American Liaison (“PAL”) Requirements

As part of the rule changes, OTC Markets has renamed its U.S. Designated Advisor for Disclosure (DAD) to an OTCQX Advisor. All U.S. companies that are quoted on the OTCQX must have either an attorney or an Investment Bank OTCQX Advisor. A company may appoint a new OTCQX Advisor at any time, provided that the company retains an approved OTCQX Advisor at all times.

All International companies that are quoted on the OTCQX must have either an Attorney Principal American Liaison (“PAL”) or an Investment Bank PAL – provided, however, that if the company’s OTCQX traded security is an ADR, the international company may have an ADR PAL. All PAL’s must be approved by OTC Markets Group. A company may appoint a new PAL at any time provided they maintain a PAL at all times.

All OTCQX Advisors and PALs must be approved by OTCQX after submitting an application. Eligibility to act as an OTCQX Advisor or PAL is limited to experienced and qualified securities attorneys or qualified FINRA member investment banking firms. I am an approved OTCQX Advisor and PAL.

The primary roles of an OTCQX Advisor and PAL include (i) to provide advice and guidance to a company in meeting its OTCQX obligations; (ii) to provide professional guidance to the issuer on creating investor demand as they build long-term relationships with management; (iii) to assist companies in discerning the information that is material to the market and should be disclosed to investors; and (iv) to provide a professional review of the company’s disclosure. The OTCQX puts a great deal of onus on the OTCQX Advisor/PAL to be responsible for the company which it sponsors, emphasizing the negative impact on the OTCQX Advisor’s reputation for sponsoring companies that are not of acceptable quality. In addition to providing advice and counsel to a company, an OTCQX Advisor/PAL is required to conduct investigations to confirm disclosures. An OTCQX Advisor/PAL must submit a Letter of Introduction and subsequent annual letters confirming their duties and the attesting to the disclosures made by the company.

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 1 SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 2 »

SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 1

Posted by Securities Attorney Laura Anthony | May 24, 2016 Tags: C&DI, Non-GAAP Measures, Regulation G, SEC Issues New C&DI

On May 17, 2016, the SEC published 12 new Compliance & Disclosure Interpretations (C&DI) related to the use of non-GAAP financial measures by public companies. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, the reasons for presenting the non-GAAP numbers and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.

The new C&DI follows a period of controversy, press and speeches on the subject. In the last couple of months SEC Chair Mary Jo White, SEC Deputy Chief Accountant Wesley Bricker, Chief Accountant James Schnurr and Corp Fin Director Keith Higgins have all given speeches at various venues across the company admonishing public companies for their increased use of non-GAAP financial measures. Mary Jo White suggested new rule making may be on the horizon, Corp Fin has been issuing a slew of comment letters, and there has even been word of enforcement proceedings on the matter.

In this two-part blog I will start with the new and circle back to the old. Part I will summarize the new C&DI, and Part II will review Regulation G and Item 10(e) of Regulation S-K.

New C&DI

On May 17, 2016, the SEC published 12 new Compliance & Disclosure Interpretations (C&DI) related to the use of non-GAAP financial measures by public companies. Some of the C&DI are brand-new and some are revisions of existing guidance. Prior to this, the last published C&DI on non-GAAP financial measures was in July 2011.

Related to Revenue Recognition

The SEC issued four brand-new C&DI related to revenue recognition and, going directly to the issue of “misleading” information, the underpinning of fraud claims.

Question (100.01): Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.

Question (100.02): Can a non-GAAP measure be misleading if it is presented inconsistently between periods?

Answer: Yes. For example, a non-GAAP measure that adjusts a particular charge or gain in the current period and for which other, similar charges or gains were not also adjusted in prior periods could violate Rule 100(b) of Regulation G unless the change between periods is disclosed and the reasons for it explained. In addition, depending on the significance of the change, it may be necessary to recast prior measures to conform to the current presentation and place the disclosure in the appropriate context.

Question (100.03): Can a non-GAAP measure be misleading if the measure excludes charges, but does not exclude any gains?

Answer: Yes. For example, a non-GAAP measure that is adjusted only for non-recurring charges when there were non-recurring gains that occurred during the same period could violate Rule 100(b) of Regulation G.

Question (100.04): A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites?

Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G.

To be sure the point is being made that adjustments may violate rules and be considered misleading and thus add risk of enforcement proceedings, the SEC has added a reference to new Question 100.01 to an existing C&DI allowing adjustments. In particular:

Question (102.03): Item 10(e) of Regulation S-K prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. Is this prohibition based on the description of the charge or gain, or is it based on the nature of the charge or gain?

Answer: The prohibition is based on the description of the charge or gain that is being adjusted. It would not be appropriate to state that a charge or gain is non-recurring, infrequent or unusual unless it meets the specified criteria. The fact that a registrant cannot describe a charge or gain as non-recurring, infrequent or unusual, however, does not mean that the registrant cannot adjust for that charge or gain. Registrants can make adjustments they believe are appropriate, subject to Regulation G and the other requirements of Item 10(e) of Regulation S-K. See Question 100.01.

Three of the C&DI are amendments related to the use of “funds from operations” or “FFO” as defined by the National Association of Real Estate Investment Trusts (NAREIT). The SEC accepts the NAREIT’s definition of FFO and allows the presentation of FFO as a performance measure including FFO on a per share basis. However, the amended C&DI clarify that any adjustments to the standard FFO as defined by NAREIT must comply with Regulation G and that such adjustments “may trigger the prohibition on presenting this measure.” In other words, any adjustments will be scrutinized as possibly being misleading.

Related to earnings per share and liquidity measures

Further related to per share measures of performance, the SEC reiterates the rule that non-GAAP measures may not be used to present liquidity on a per share basis. In particular:

Question (102.05): While Item 10(e)(1)(ii) of Regulation S-K does not prohibit the use of per share non-GAAP financial measures, the adopting release for Item 10(e), Exchange Act Release No. 47226, states that “per share measures that are prohibited specifically under GAAP or Commission rules continue to be prohibited in materials filed with or furnished to the Commission.” In light of Commission guidance, specifically Accounting Series Release No. 142, Reporting Cash Flow and Other Related Data, and Accounting Standards Codification 230, are non-GAAP earnings per share numbers prohibited in documents filed or furnished with the Commission?

Answer: No. Item 10(e) recognizes that certain non-GAAP per share performance measures may be meaningful from an operating standpoint. Non-GAAP per share performance measures should be reconciled to GAAP earnings per share. On the other hand, non-GAAP liquidity measures that measure cash generated must not be presented on a per share basis in documents filed or furnished with the Commission, consistent with Accounting Series Release No. 142. Whether per share data is prohibited depends on whether the non-GAAP measure can be used as a liquidity measure, even if management presents it solely as a performance measure. When analyzing these questions, the staff will focus on the substance of the non-GAAP measure and not management’s characterization of the measure.

Similarly, the SEC adds a clarification to an existing C&DI (Question 102.07) to confirm that “free cash flow” is a liquidity measure that must not be presented on a per share basis.

The SEC also confirms that the generally non-controversial EBITDA may not be presented on a per share basis (Question 103.02).

Related to presentation including reconciliation and prominence

The new C&DI add completely new language, amend prior guidance and eliminate and replace other prior guidance. The new guidance provides:

Question (102.10): Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure, it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the Commission and also earnings releases furnished under Item 2.02 of Form 8-K. Are there examples of disclosures that would cause a non-GAAP measure to be more prominent?

Answer: Yes. Although whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made, the staff would consider the following examples of disclosure of non-GAAP measures as more prominent:

Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures;

Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;

Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure;

A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption);

Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure;

Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table;

Excluding a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the “unreasonable efforts” exception in Item 10(e)(1)(i)(B) without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence; and

Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence.

Question (102.11): How should income tax effects related to adjustments to arrive at a non-GAAP measure be calculated and presented?

Answer: A registrant should provide income tax effects on its non-GAAP measures depending on the nature of the measures. If a measure is a liquidity measure that includes income taxes, it might be acceptable to adjust GAAP taxes to show taxes paid in cash. If a measure is a performance measure, the registrant should include current and deferred income tax expense commensurate with the non-GAAP measure of profitability. In addition, adjustments to arrive at a non-GAAP measure should not be presented “net of tax.” Rather, income taxes should be shown as a separate adjustment and clearly explained.

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Issues Concept Release On Regulation S-K; Part 2 OTC Markets Amends IPO Listing Standards for OTCQX »

SEC Issues Concept Release On Regulation S-K; Part 2

Posted by Securities Attorney Laura Anthony | May 17, 2016 Tags: Form 8-K, MD&A, Regulation S-K, Regulation S-X, S-K Concept Release, SEC

On April 15, 2016, the SEC issued a 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements in Regulation S-K (“S-K Concept Release”). This blog is the second part discussing that concept release. In Part I, which can be read HERE, I discussed the background and general concepts for which the SEC provides discussion and seeks comment. In this Part II, I will discuss the rules and recommendations made by the SEC and, in particular, those related to the 100, 200, 300, 500 and 700 series of Regulation S-K.

Background

The fundamental tenet of the federal securities laws is defined by one word: disclosure. In fact, the SEC neither reviews nor opines on the merits of any company or transaction, but only upon the appropriate disclosure, including risks, made by that company. However, excessive rote immaterial disclosure can dilute the material important information regarding that particular company and have the unintended consequence of weakening necessary disclosure to potential investors and the public trading markets.

The SEC non-financial disclosure requirements for both registration statements and reports under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) are found in Regulation S-K.

At the highest level, the purpose of disclosure is to provide investors and the marketplace with information needed to make informed investment and voting decisions. As discussed in the S-K Concept Release, proper disclosure “may lead to more accurate share prices, discourage fraud, heighten monitoring of the managers of companies, and increase liquidity.” Further, effective disclosure should “increase the integrity of securities markets, build investor confidence, and support the provision of capital to the market.”

The SEC seeks comment on hundreds of questions from broad conceptual points to specific rule changes. In many cases the SEC indicates that additional disclosure might be necessary on a particular topic. Although disclosure improvement is the goal, that does not necessarily mean less information and, in many cases, may actually mean more information.

Description of Business and Properties

The SEC believes that the information elicited under Item 101 regarding a description of the company’s business and Item 102 related to the company’s materially important physical properties, provides the necessary foundation needed by investors to make investing and voting decisions. This basic information assists in putting other disclosure items into context. The SEC seeks comment on whether Items 101 and 102 should be eliminated or modified and whether new or different disclosure requirements should be added to these Items.

The Concept Release contains detailed discussion of each of the requirements under Items 101 and 102, including prior comments received from the public and SEC views. Currently Item 101 requires a description of the general development of the company’s business over the past 3 years for smaller reporting companies and 5 years for other classes of company, or such shorter period as the company has been in business. Item 102 requires disclosure of the location and general character of plants, mines and other materially important physical properties.

Examples of information required include disclosure of the basic background of the business such as: (i) the year of formation; (ii) type of entity; (iii) nature and results of any bankruptcy, receivership or similar; (iv) nature and result of any material reclassification, merger or consolidation; (v) the acquisition or disposition of any material assets outside the ordinary course of business; and (vi) material changes to the business operations. In addition, Item 101 requires a narrative description of a company’s business, including 13 specific areas as follows: (i) principal products produced and services rendered; (ii) new products or segments; (iii) sources and availability of raw materials; (iv) intellectual property; (v) seasonality of business; (vi) working capital practices; (vii) dependence on certain customers; (viii) dollar amount of backlog orders believed to be firm; (ix) business subject to renegotiation or termination of government contracts; (x) competitive conditions; (xi) company sponsored research and development activities; (xii) compliance with environmental laws; and (xiii) number of employees.

Smaller reporting companies benefit from several other scaled disclosures from the standard requirements, including: (i) elimination of the requirement to discuss seasonality, working capital practices, backlog or government contracts; (ii) names of principal suppliers; (iii) royalty agreements or labor contracts; (iv) need for government approval for products or services; and (v) effects of existing or probable government regulations.

Emerging growth companies must meet all of the standard requirements. Moreover, keeping in line with the concept of materiality, where a smaller reporting company is in a business that makes any of the standard disclosures material to its business, it must include those discussions, even if not technically required. Accordingly, for example, a smaller reporting company in a cannabis-related industry would need to include a discussion on the need for government approval for products and services, and the effects of existing or probable government regulations on its business, even though the scaled disclosure requirements would not otherwise require such discussion.

As with other areas of discussion, the SEC requests comments on the scaled disclosure requirements and whether the current disparities between requirements related to smaller reporting companies and emerging growth companies should be eliminated.

The SEC discusses eliminating redundancies in the 101 and 102 disclosure requirements. In particular there are several categories in Form 8-K that request the same information elicited in Items 101 and 102 and included in all 10-Q’s and 10-K’s. Information on business background is included in the MD&A discussion and in footnotes to financial statements. Redundancies could be eliminated by allowing cross-referencing, including internal hyperlinks. Moreover, the SEC could, and should, distinguish between new registrants disclosing their business background for the first time, and those that are established reporting companies repeating information again and again.

Many of the detailed requirements may not be relevant in today’s business environment, which differs greatly from even twenty years ago. For instance, many businesses no longer have physical locations or corporate headquarters but rather run through virtual offices. For those businesses, providing a detailed discussion of each location (home office…) would not be relevant and rather could diminish the value of the business discussion. Likewise, businesses in today’s world often outsource or hire independent contractors. Consideration should be given to expanding the requirements to include such independent contractors, or eliminate this requirement altogether where it does not add value to the particular business. For example, it may be important to know that certain companies are scaling back on their workforce, while for others, the information is not relevant.

Likewise, Regulation S-K does not currently address the current reliance on web-based and intellectual property-based assets and as such, additional disclosure items may need to be included. Another area that may need increased disclosure relates to international business operations and reliance on non-U.S.-based assets.

Management Discussion and Analysis

Although many aspects of disclosure are important, I believe none are quite as important as the financial information and future prospects. Regulation S-X contains the actual financial statement disclosure requirements, and Item 303 of Regulation S-K contains the narrative discussion requirements related to that financial information. This management, discussion and analysis (“MD&A”) not only delivers an explanation of the financial statements, but provides a unique opportunity in SEC reporting for a company to illustrate its distinctiveness among a sea of other fish.

MD&A is intended to provide a narrative of a company’s financial statements and future prospects through the eyes of management. The Regulation S-K Concept Release clearly shows the SEC propensity for MD&A to use a principles/materiality approach and to steer away from a recitation of the financial statements themselves. The SEC also recognizes the concerns that a company has in presenting forward-looking information, and in particular, 10b-5 liability if the plans do not turn out as disclosed.

In recent years management has used MD&A to not only explain the financial statements prepared in accordance with Regulation S-X, which in turn is based on US GAAP, but rather to explain away those financial statements. Approximately 90% of companies use MD&A to provide non-GAAP financial metrics to illustrate their financial performance and prospects. As an example, EBITDA is a non-GAAP number often included by management in MD&A. There has been a rise in recent controversy over the use of these non-GAAP numbers, an in-depth discussion of which will be the topic of a future blog.

However, the short version is that 90% of companies use non-GAAP numbers to explain their financial operations and the SEC is pushing back, making a review of the rules related to non-GAAP use a priority. There are very valid reasons for using non-GAAP numbers, such as EBITDA, which is an established indicator of a company’s performance and ability to meet financial obligations. Likewise, certain non-cash balance sheet items, such as derivative liability related to options, warrants, and other convertible instruments, are confusing and often are never realized in a way that has an actual impact on a company’s performance. However, there can be a slippery slope with a company cherry-picking GAAP and non-GAAP numbers to create a picture of financial stability that may not be accurate. I hope that in reviewing this area, the SEC is not myopically stuck on the purity of its view of GAAP, but considers that if 90% of companies find a need to go outside the rules, perhaps the rules themselves needs some adjustment.

Risk Factors

Risk-related disclosures need a thorough review and potential overhaul. Although the SEC has long stated that risk factors should not be boilerplate repetition of items applicable to the market as a whole and not necessarily applicable to a particular company, most companies use boilerplate language. I note that Item 503 contains examples of risks that a company can make related to its offerings, and so, of course, those risks, in boilerplate format, are always included in registration statements and reports.

Currently, risk-related disclosures are currently included in multiple items under Regulation S-K, including Item 503 related to investment risk and Item 305 related to market risk. The focus of the SEC discussion is on aggregating risk information in a more central readable format and improving the content to enhance investors’ ability to evaluate the particular risk factors.

Securities of the Company

Several Items in Regulation S-K address the securities of a company. For example, Item 202 requires a description of the terms and conditions of securities being registered; Item 201 requires disclosure of the number of holders of common securities; Item 701 requires disclosure of sales of unregistered securities and use of proceeds from offerings, and Item 703 requires disclosure of securities re-purchased by a company and its affiliates.

As with other areas, the SEC focuses on whether these disclosures should be modified, increased or eliminated and on the presentation of the information.

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 ofLawCast.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.

« SEC Issues Final Rules Implementing The JOBS ACT And Rules On The FAST ACT SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 1 »

NASDAQ Listing Requirements

Posted by Securities Attorney Laura Anthony | April 26, 2016 Tags: listing requirements for NASDAQ, NASADAQ Listing Application, NASDAQ, NASDAQ Capital Market, NASDAQ Listing Requirements, NASDAQ Requirements, NASDAQ Small Cap Listing Requirements, OTC to NASDAQ, The NASDAQ Global Market, The NASDAQ Global Select Market, The NASDAQ Stock Market

This blog is the first in a two-part series explaining the listing requirements for the two small-cap national exchanges, NASDAQ and the NYSE MKT, beginning with NASDAQ. In addition to often being asked about the listing requirements on NASDAQ and the NYSE MKT, I am asked about the benefits of trading on such an exchange. Accordingly, at the end of this blog I have included a discussion on such benefits.

The NASDAQ Stock Market

The NASDAQ Stock Market currently has three tiers of listed companies: (1) The NASDAQ Global Select Market, (2) The NASDAQ Global Market and (3) The NASDAQ Capital Market. Each tier has increasingly higher listing standards, with the NASDAQ Global Select Market having the highest initial listing standards and the NASDAQ Capital Markets being the entry-level tier for most micro- and small-cap issuers. Keeping in line with the focus of my blogs and practice, this blog is focused on the NASDAQ Capital Market tier.

A company seeking to list securities on NASDAQ must meet minimum listing requirements, including specified financial, liquidity and corporate governance criteria. NASDAQ has broad discretion over the listing process and may deny an application, even if the technical requirements are met, if it believes such denial is necessary to protect investors and the public interest.

Once listed, a company must meet continued listing standards. In order to apply for listing on NASDAQ, a company must complete and submit to NASDAQ a listing application including specified documents and information.

The application process generally takes four to six weeks. Upon submittal of the application, a NASDAQ analyst will be assigned to the file as a lead interface with the company. The company will receive an initial comment letter within two to three weeks, and the comment and review process will continue until the application is either approved or denied. Like a filing with the SEC, a well prepared NASDAQ application will result in fewer comments and a smoother, quicker process. Generally, a company’s securities counsel takes the lead and is the point person in preparing the application and communicating with NASDAQ.

Also similar to an SEC review process, NASDAQ will review publicly available information about a company, including but not limited to SEC filings, a company’s website, management communications and speeches, and press releases. For the most part, the back-and-forth process does not require a formal protocol, and communications will include e-mail correspondence and phone calls.

Listing Criteria for NASDAQ

To list its securities on NASDAQ, a company is required to meet: (a) certain initial quantitative and qualitative requirements and (b) certain continuing quantitative and qualitative requirements. The quantitative listing thresholds for initial listing are generally higher than for continued listing, thus helping to ensure that companies have reached a sufficient level of maturity prior to listing. NASDAQ also requires listed companies to meet stringent corporate governance standards.

Prior to submitting a full listing application, a company can seek a preliminary listing eligibility review. The Listing Qualifications staff will review the company’s public filings to determine if it satisfies the numerical listing requirements. The staff will also consider compliance with the corporate governance requirements of Marketplace Rules (“Rules”).

Once the preliminary review is completed, the Listing Qualifications staff will determine whether the company satisfies the numerical listing criteria and whether any corporate governance or regulatory issues raised by the company would preclude listing approval. Any final approval, however, will require the company to submit a formal listing application, which application will undergo an extensive review by NASDAQ Listing Qualifications staff. Moreover, any final approval will require satisfactory compliance with certain other qualitative reviews, including a review of the regulatory history of the company’s officers, directors and significant shareholders.

The following information sets forth the requirements to list on the NASDAQ Capital Market, the lowest of the three NASDAQ market tiers, as well as the Corporate Governance Requirements required for such tiers…

Click Here To Download Whitepaper- NASDAQ Listing Requirements

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 includingNASDAQ 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.

« The U.S. Capital Markets Clearance And Settlement Process SEC Issues Final Rules Implementing The JOBS ACT And Rules On The FAST ACT »

House Passes More Securities Legislation

Posted by Securities Attorney Laura Anthony | March 15, 2016 Tags: House Passes More Securities Legislation

In what must be the most active period of securities legislation in recent history, the US House of Representatives has passed three more bills that would make changes to the federal securities laws. The three bills, which have not been passed into law as of yet, come in the wake of the Fixing American’s Surface Transportation Act (the “FAST Act”), which was signed into law on December 4, 2015.

The 3 bills include: (i) H.R. 1675 – the Capital Markets Improvement Act of 2016, which has 5 smaller acts imbedded therein; (ii) H.R. 3784, establishing the Advocate for Small Business Capital Formation and Small Business Capital Formation Advisory Committee within the SEC; and (iii) H.R. 2187, proposing an amendment to the definition of accredited investor. None of the bills have been passed by the Senate as of yet.

Meanwhile, the SEC continues to finalize rulemaking under both the JOBS Act, which was passed into law on April 5, 2012, and the Dodd-Frank Act, which was passed into law on July 21, 2010. The SEC provides comprehensive information on its progress under each of the Acts on its website. For Dodd-Frank see HERE and for the JOBS Act see HERE.

H.R. 1675 – Capital Markets Improvement Act of 2016

On February 3, 2016, the House passed H.R. 1675, the Capital Markets Improvement Act of 2016, comprising 5 titles including (i) Title I – Encouraging Employee Ownership Act of 2015; (ii) Title II – Fair Access to Investment Research; (iii) Title III – Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification; (iv) Title IV – Small Company Disclosure Simplification; and (v) Title V – Streamlining Excessive and Costly Regulations Review.

The Executive Office strongly opposes H.R. 1675 and has issued a Statement of Administration Policy voicing its objections. The Executive Office points out that the bill has many flaws, imposes risks to investors, is overly broad, allows financial institutions to avoid appropriate oversight and is duplicative of existing administration authorities. I will continue to monitor progress and provide updates.

Title I – Encouraging Employee Ownership Act of 2015

The bill requires the SEC to amend Securities Act Rule 701 to require an issuer to provide certain delineated disclosures to employee investors regarding compensatory benefit plans if the aggregate sales price or aggregate amount of securities sold in any 12-month period exceeds $10 million, indexed for inflation every 5 years. The current regulations have a threshold of $5 million.

The Executive Branch strongly opposes the bill and even issued an official Statement of Administration Policy expressing its opposition.

Brief Summary of Rule 701

Rule 701 provides an exemption from the registration requirements under Section 5 of the Securities Act for offers and sales of securities pursuant to certain compensatory benefit plans and contracts related to compensation. The exemption only applies to issuers that are not subject to the reporting requirements of the Securities Exchange Act and is generally used by private companies.

The aggregate amount of sales under Rule 701 is limited to the greater of: (i) $1,000,000; (ii) 15% of the total assets of the issuer (or of the parent if the parent is a co-issuer or guarantor); or (iii) 15% of the total outstanding of the class of securities being offered. Rule 701 currently requires the delivery of the compensatory benefit plan or contract as applicable and additional disclosure if the aggregate sales exceed $5 million. Those additional disclosure include risk factors, a summary of the plan and financial statements prepared in accordance with U.S. GAAP.

Although securities issued under Rule 701 are restricted under Rule 144, they become freely tradable 90 days after the issuer becomes subject to the reporting requirements of the Securities Exchange Act without regard to the current information and holding period requirements under Rule 144 for non-affiliates and without regard to the holding period requirements for affiliates.

Like other exemptions, Rule 701 transactions are still subject to the anti-fraud provisions of the federal securities laws. Rule 701 does not pre-empt state law and accordingly, state securities laws must be complied with in any issuance under the Rule.

Title II – Fair Access to Investment Research

Title II requires the SEC to adopt rules providing that research issued by investment funds will not be deemed to be an offer for the sale of securities regardless of whether the report covers an issuer that is going to or has embarked on a registered offering and regardless of whether a broker-dealer associated with the fund will participate in the offering. The Act contains strong language, including prohibiting an SRO (FINRA) from maintaining or enforcing any rules conditioning the ability of a member to publish or distribute research on whether the member is participating in a registered offering.

Title III – Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification

Title III attempts to codify a broker-dealer registration exemption for mergers and acquisition brokers. The Executive Office Statement of Administration Policy points out that Title III as written is overly broad and would eliminate the registration requirements for M&A brokers engaged in a transaction for any privately held company with gross revenues up to $250 million. The Executive Office thinks this exemption amount is too high, among other issues. Moreover, the Executive Office notes that the SEC has already recognized an exemption for M&A brokers though a no action letter (see my blog HERE).

Title IV – Small Company Disclosure Simplification

Title IV creates an exemption from the XBRL requirements for small and emerging growth companies. The Executive Office also opposes this change on the grounds that “[o]pen data disclosure systems benefit investors, issuers, and the public, increasing transparency of publicly traded companies by making their filings more easily accessible. Impeding regulators’ ability to use 21^st century technological tools to regulate markets and protect investors is contrary to the SEC’s mission.”

I support Title IV and the exemption from the XBRL requirements.

Title V – Streamlining Excessive and Costly Regulations Review

Title V may be herculean in nature. Title V requires the SEC to review each significant regulation issued by the SEC to determine by vote of the SEC if such regulation is (i) outmoded, ineffective, insufficient or excessively burdensome; or (ii) is no longer necessary in the public interest or consistent with the SEC’s mandate to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation. Title V requires the immediate review and a 10-year periodic review. The Executive Office statement of opposition states that “[T]hese requirements are unnecessarily duplicative, wasteful and costly. The SEC already complies with the Regulatory Flexibility Act and is encouraged, under Executive Order 13579, to review rules to assess whether they are outdated or excessively burdensome. Requiring a review and full Commission vote on every major rule every 10 years under full Administrative Procedure Act-style requirements would severely hinder the SEC’s ability to monitor markets and protect investors.”

H.R. 3784 – Establishing Advocate for Small Business Capital Formation and Small Business Capital Formation Advisory Committee

On February 1, 2016, the House passed H.R. 3784, the SEC Small Business Advocate Act. The Act proposes to amend the Securities Exchange Act to establish the Advocate for Small Business Capital Formation within the SEC. The office would be charged with (i) assisting small businesses and their investors in resolving significant problems with the SEC and other SROs; (ii) identifying areas where small businesses and their investors would benefit from changes in SEC and other SRO regulation; (iii) identifying problems small businesses have with security access to capital; (iv) analyzing the potential impact of proposed rules and regulations on small businesses; (v) conduct outreach programs with small businesses and their investors; and (vi) work to propose these changes to the SEC and Congress.

In addition, the Act would create the Small Business Capital Formation Advisory Committee. The committee would provide the SEC with advice on SEC rules, regulations, and policies relating to (i) capital raising by emerging, privately held small businesses and publicly traded companies with less than $250 million in public market capitalization through securities offerings; (i) trading in the securities of such businesses and companies; and (3) public reporting and corporate governance requirements of such businesses and companies.

The new proposed committee seems duplicative of the existing SEC Advisory Committee on Small and Emerging Companies, which was organized by the SEC to provide advice on SEC rules, regulations and policies regarding “its mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation” as related to (i) capital raising by emerging privately held small businesses and publicly traded companies with less than $250 million in public market capitalization; (ii) trading in the securities of such businesses and companies; and (iii) public reporting and corporate governance requirements to which such businesses and companies are subject.

H.R. 2187 – Amendment to the Definition of Accredited Investor

Also on February 1, 2016, the House passed H.R. 2187, the Fair Investment Opportunities for Professional Experts Act, proposing an amendment to the definition of accredited investor as to natural persons. In particular, the bill proposes to add provisions to the definition of accredited investor to include (i) any natural person who is currently licensed or registered as a broker or investment adviser by the SEC, FINRA or a state securities regulator and (ii) any natural person the SEC determines by regulation to have demonstrable education or job experience to qualify such person as having professional knowledge of a subject related to a particular investment, and whose education or job experience is verified by FINRA.

In addition, the bill tweaks other aspects of the definition related to natural persons. The bill proposes to adjust the current $1,000,000 net worth accredited investor eligibility standard every 5 years for inflation. The bill tweaks the exclusion of a person’s primary residence from the calculation such that any indebtedness secured by the residence (i.e., a mortgage) that is in excess of the fair market value of the home, will be included as a liability in determining net worth. I think this creates ongoing calculation issues as the value of homes can vary widely in a short period of time.

I doubt the bill in its current form will gain any traction or ultimately become law, but we will, no doubt, see changes to the accredited investor definition in the near future. For further discussion, see my blog HERE.

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Gives Insight On 2016 Initiatives SEC Advisory Committee On Small And Emerging Companies Reviews Capital Formation »

SEC Gives Insight On 2016 Initiatives

Posted by Securities Attorney Laura Anthony | March 8, 2016 Tags: dodd-frank act, mary jo white, SEC, The Fast Act, the jobs act

SEC Chair Mary Jo White gave a speech at the annual mid-February SEC Speaks program and, as usual, gave some insight into the SEC’s focus in the coming year. This blog summarized Chair White’s speech and provides further insight and information on the topics she addresses.

Consistent with her prior messages, Chair White focuses 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. The primary areas of focus included cybersecurity, market structure requirements, dark pools, microcap fraud, financial reporting failures, insider trading, disclosure deficiencies in municipal offerings and protection of retail investors and retiree savings. In 2016 the SEC intends to focus enforcement on financial reporting, market structure, and the structuring, disclosure and sales of complex financial instruments.

2016 Disclosure Agenda

Chair White hit on the tremendous volume of regulatory changes and congressional mandates. Since 2010 Congress has given the SEC nearly 100 statutory mandates covering a multitude of complex rule requirements, with the FAST Act, JOBS Act, and the Dodd-Frank Act just being 3 examples. White confirms that the amount of recent rulemaking is of historic proportions, completing or overhauling many regulatory areas and providing dramatic changes to others. Again, 3 small examples are the FAST Act, JOBS Act and the Dodd-Frank Act, with the multitude of regulatory changes flowing from these 3 statutory directives.

In 2016 the SEC will continue implementing rules as directed by Congress. In addition to finalizing the remaining security swap and security-based swap dealer requirements under the Dodd-Frank Act, the SEC hopes to continue rulemaking related to the asset management industry, the structure of the equity markets and disclosure requirements (under Regulation S-K and Regulation S-X).

Related to the asset management industry, in May 2015 the SEC proposed increased reporting for investment advisers and mutual funds, including a requirement that funds report risk metrics, the use of derivatives, securities lending and liquidity of holdings.

Related to the structure of equity markets, the SEC has increased oversight over proprietary traders (see my blog HERE) and has proposed major revisions to regulations for alternative trading systems (this will be the subject of a future blog). Also related to equity markets, Chair White referenced the recent ANPR on new transfer agent rules (see my blog HERE) and the Tick Size Pilot program (see my blog HERE). Moreover, Chair White revealed that the SEC intends to shorten the clearing settlement life cycle from T+3 to T+2.

Disclosure effectiveness has been an ongoing central topic since the JOBS Act required the SEC to launch its Disclosure Effectiveness Initiative. The SEC intends to continue its focus in this arena and expects both additional rulemaking and industry guidance in 2016.

I have written several times on the SEC initiative and the subject of improving the disclosure requirements for reporting companies. Recently the SEC sought comment on financial disclosure requirements for subsidiaries and affiliate entities (see my blog HERE). Moreover, several of the provisions in the recent FAST Act were related to these initiatives. In particular, The FAST Act adopted many of the provisions of a bill titled the Disclosure Modernization and Simplification Act, including rules to: (i) allow issuers to include a summary page to Form 10-K (Section 72001); and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for EGCs, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K (Section 72002). In addition, the SEC is required to conduct yet another study on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information (Section 72003). See my blog on the FAST Act and these provisions HERE.

In September 2015, the SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. My blog on these recommendations can be read HERE.

Prior to that, in March 2015, the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For a review of these recommendations, see my blog HERE.

Mission and Philosophy

Chair White made a point of conveying the message that the SEC is not just about disclosure. They have broad regulatory authority over trading markets, broker-dealers, SRO’s, the settlement and clearing process and the PCAOB. The SEC intends to continue to work in each of these areas, including additional regulations on the swaps markets, clearing agencies, transfer agents, and technology systems. In addition, the SEC has and will continue to seek public comment on proposed rules, ideas related to proposed rules, and concepts in general. As Chair White states, “[W]e are therefore increasingly considering using measures beyond disclosure to fulfill our mission of providing strong investor protection, safeguarding market integrity, and achieving other regulatory objectives.”

The Author

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

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

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

Download our mobile app at iTunes.

« State Blue Sky Concerns; Florida and New York House Passes More Securities Legislation »

SEC Guidance On Proxy Presentation Of Certain Matters In The Merger And Acquisition Context

Posted by Securities Attorney Laura Anthony | January 7, 2016 Tags: 14A Proxy Solicitation

In late October the SEC issued its first updated Staff Legal Bulletin on shareholder proposals in years – Staff Legal Bulletin No. 14H (“SLB 14H”). Please see my blog on SLB 14H HERE. On the same day the SEC published two new Compliance and Disclosure Interpretations (“C&DI”) related to the unbundling of matters presented for a vote to shareholders in merger and acquisition transactions. The new C&DI has in essence granted voting rights to target company shareholders, on acquiring company organizational documents, where none existed before and has in essence pre-empted state law on the issue.

Unbundling under Rule 14a-4(a)(3) in the M&A Context

Exchange Act Rule 14a-4 relates to the requirements for a proxy card general. Rule 14a-4(a) provides:

(A) The form of proxy:

(1) Shall indicate in bold-face type whether or not the proxy is solicited on behalf of the registrant’s board of directors or, if provided other than by a majority of the board of directors, shall indicate in bold-face type on whose behalf the solicitation is made;

(2) Shall provide a specifically designated blank space for dating the proxy card; and

(3) Shall identify clearly and impartially each separate matter intended to be acted upon, whether or not related to or conditioned on the approval of other matters, and whether proposed by the registrant or by security holders.

Part (b) continues with a requirement that the proxy shall provide a means “whereby the person solicited is afforded an opportunity to specify by boxes a choice between approval or disapproval of, or abstention with respect to each separate matter” other than director elections and votes on the frequency of votes on executive compensation (i.e., frequency of say-on-pay votes).

Exchange Act Rule 14a-4(a)(3) relates to the unbundling of separate matters that are submitted to a shareholder vote through proxy materials. The SEC previously issued C&DI guidance in January 2014. The new C&DI specifically addresses Rule 14a-4(a)(3) in the context of mergers, acquisitions and similar transactions. The SEC has historically been against bundling of proposals in a proxy and that trend continues with the new C&DI.

Following the January 2014 C&DI, the rules substantially provided that multiple matters that are inextricably intertwined need not be unbundled. However, separate matters do not rise to the level of “inextricably intertwined” just because they were negotiated as part of a single transaction with a third party. Moreover, matters that are immaterial may be bundled with other matters. Materiality is determined by considering whether a matter substantially affects shareholder rights or whether a shareholder would reasonably be expected to express or want to express a view on a matter.

The SEC has issued 2 new C&DI as follows:

Question: Rule 14a-4(a)(3) requires that the form of proxy “identify clearly and impartially each separate matter intended to be acted upon.” Rule 14a-4(b)(1) further requires that the form of proxy provide a means for shareholders “to specify by boxes a choice… with respect to each separate matter referred to therein as intended to be acted upon.” In a merger, acquisition, or similar transaction in which shareholders of the target are receiving equity securities of the acquirer, amendments to the organizational documents of the acquirer can often be required by the transaction agreement. Under these proxy rules, under what circumstances must a target seeking shareholder approval of such a transaction present separately on its form of proxy a proposal or proposals relating to the amendments to the organizational documents of the acquirer? In other words, when are these amendments which are embedded within the transaction agreement a “separate matter” for target shareholders?

Answer: As a preliminary matter, if a material amendment to the acquirer’s organizational documents would require the approval of its shareholders under state law, the rules of a national securities exchange, or its organizational documents if presented on a standalone basis, the acquirer’s form of proxy must present any such amendment separately from any other material proposal, including, if applicable, approval of the issuance of securities in a triangular merger or approval of the transaction agreement in a direct merger. See Question 101.02 relating to “Unbundling under Rule 14a-4(a)(3) Generally.” As a general principle, however, only material matters must be unbundled, and acquirers should consider whether the provisions in question substantively affect shareholder rights. Examples of provisions meeting this standard that may be adopted in connection with a transaction include governance and control-related provisions, such as classified or staggered boards, limitations on the removal of directors, supermajority voting provisions, delaying the annual meeting for more than a year, eliminating the ability to act by written consent, or changes in minimum quorum requirements. In contrast, provisions such as name changes, restatements of charters, or technical changes, such as those resulting from anti-dilution provisions, would likely be immaterial.

If, consistent with the guidance in Question 101.02, the acquirer is required under Rule 14a-4(a)(3) to present an amendment or multiple amendments separately on its form of proxy, or would be so required if it were conducting a solicitation subject to Regulation 14A, then a target subject to Regulation 14A also must present any such amendment separately on its form of proxy. This is because the amendment, which is a term of the transaction agreement that target shareholders are being asked to approve, would effect a material change to the equity security that target shareholders are receiving in the transaction. Target shareholders should have an opportunity to express their views separately on these material provisions that will establish their substantive rights as shareholders, even if as a matter of state law these provisions might not require a separate vote. Similarly, if the acquirer presents a material amendment on its form of proxy as the only matter to be approved by acquirer’s shareholders, then the target must present the amendment separately on its form of proxy. The target need not present as a separate matter on its form of proxy an amendment to increase the number of authorized shares of the acquirer’s equity securities, provided that the increase is limited to the number of shares reasonably expected to be issued in the transaction.

In all cases, the parties are free to condition completion of a transaction on shareholder approval of any separate proposals. Any such conditions should be clearly disclosed and indicated on the form of proxy.

Question 201.02

Question: Does the answer to Question 201.01 change if the parties form a new entity to act as an acquisition vehicle that will issue equity securities in the transaction?

Answer: No. In that case, the party whose shareholders are expected to own the largest percentage of equity securities of the new entity following consummation of the transaction would be considered the acquirer for purposes of this analysis. As in Question 201.01, the acquirer must present separately on its form of proxy any material provision or provisions of the new entity’s organizational documents that are a term of the transaction agreement, if the provision or provisions represent a material change from the acquirer’s organizational documents, and the change would require the approval of the acquirer’s shareholders under state law, the rules of a national securities exchange, or its organizational documents if proposed to be made directly to its own organizational documents. Provisions that are required by law in the jurisdiction of incorporation of the new entity need not be presented separately on the form of proxy. As in Question 201.01, if the acquirer is or would be required under Rule 14a-4(a)(3) to present separately on its form of proxy any provision of the new entity’s organizational documents that is a term of the transaction agreement, then a target subject to Regulation 14A must also present the same provision separately on its form of proxy.

Question 101.02 referred to in Question 201.01 provides:

Question: Management of a registrant intends to present an amended and restated charter to shareholders for approval at an annual meeting. The proposed amendments would change the par value of the common stock, eliminate provisions relating to a series of preferred stock that is no longer outstanding and is not subject to further issuance, and declassify the board of directors. Under Rule 14a‑4(a)(3), must the individual amendments that are part of the restatement be unbundled into separate proposals?

Answer: No. The staff would not ordinarily object to the bundling of any number of immaterial matters with a single material matter. While there is no bright-line test for determining materiality in the context of Rule 14a‑4(a)(3), registrants should consider whether a given matter substantively affects shareholder rights. While the declassification amendment would be material under this analysis, the amendments relating to par value and preferred stock do not substantively affect shareholder rights, and therefore both of these amendments ordinarily could be included in a single restatement proposal together with the declassification amendment. However, if management knows or has reason to believe that a particular amendment that does not substantively affect shareholder rights nevertheless is one on which shareholders could reasonably be expected to wish to express a view separate from their views on the other amendments that are part of the restatement, the amendment should be unbundled.

The staff notes that the analysis under Rule 14a-4(a)(3) is not governed by the fact that, for state law purposes, these amendments could be presented to shareholders as a single restatement proposal. If, for example, the restatement proposal also included an amendment to the charter to add a provision allowing shareholders representing 40% of the outstanding shares to call a special meeting, the staff would view the special meeting amendment as material and therefore required to be presented to shareholders separately from the similarly material declassification amendment.

In an M&A context the new guidance is a significant change. The SEC is in essence requiring that target company shareholders be afforded an opportunity to vote on changes to the acquiring company’s organizational documents, separate and apart from voting on the merger itself. The SEC reasons that since the target company shareholders will become acquiring company shareholders, they have an interest in the organizational documents. Although I understand that argument, I would think that the target company shareholders could consider the acquiring company’s organizational documents, or changes thereto, in deciding whether to vote on the merger or not. I fail to see the benefit of a separate vote, nor the practical result if, for instance, the target company shareholders approve a merger but not the organizational document changes (other than giving plaintiff’s attorneys another matter to litigate!)

From a company’s point of view, it can make more sense to present an integrated proposal for a full merger plan. By unbundling the various items to the plan, including corporate governance and structure changes, the company could have a shareholder approval of the corporate changes but not the merger itself or vice versa. Moreover and worse yet, the reconfigured pieces of the transaction, following a shareholder vote on the parts as opposed to the whole, may have an unintended result. The SEC suggests that one can be conditioned on the other, but if that is the case, why require the unbundling in the first place?

The new C&DI continues the trend that I have written of several times, of the federal government imposing on state corporate law regulations. I am a vocal advocate of federal pre-emption of state securities laws, but am also an advocate of leaving corporate law matters to the states. In this case the SEC clearly spreads its reach into state law with the statement “[T]arget shareholders should have an opportunity to express their views separately on these material provisions that will establish their substantive rights as shareholders, even if as a matter of state law these provisions might not require a separate vote.” In this instance, the target shareholders do not have the right to vote on the acquirer’s organizational documents under state law, but apparently do have such right if the acquirer is subject to the SEC proxy rules.

The new C&DI goes beyond the historical SEC requirements to provide information in a proxy related to corporate organizational changes, in advance of a merger (see my blog HERE for more on that topic) and grants voting rights where none existed previously.

The Author

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

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

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

Download our mobile app at iTunes.

« OTC Markets Amends Listing Standards For The OTCQX SEC Issues Report On Accredited Investor Definition »

SEC Has Approved A Two-Year Tick Size Pilot Program For Smaller Public Companies

Posted by Securities Attorney Laura Anthony | July 29, 2015 Tags: Going public attorneys-2, LawCast-2, OTC Attorneys, OTC Law Firm, OTC Law firm-2, OTC Law Firms, OTC Lawyers, OTC Market Attorneys, OTC Markets Attorneys, otc markets attorneys-2, OTC Securities Attorneys, OTC Securities Attorneys-2, Reverse Merger Attorneys, Reverse merger attorneys-2, Reverse Mergers Attorneys, Securities Attorneys

On May 6, 2015 the SEC approved a two-year pilot program with FINRA and the national securities exchanges that will widen the minimum quoting and trading increments, commonly referred to as tick sizes, for the stocks of smaller public companies. The goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks.

The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading. If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies. The other side of the coin is that larger spreads and more profit for the traders equates to increased costs to the investors whose accounts are being traded.

The tick size program includes companies that meet the following $3 billion or less in market capitalization, an average trading volume of one million shares or less, and a volume weighted average price of at least $2.00 for every trading day. The pilot study group includes a control group of 1400 securities and three test groups with 400 securities in each. Notably, the tick size program will not include micro-cap securities with a weighted average price of less than $2.00 per day.

During the pilot the control group will be quoted at the current tick size increment of $.01 per share and will trade at the currently permitted increments. The first test group will be quoted in increments of $.05 but will continue to trade at any price increment that is currently permitted. The second test group will be quoted in increments of $.05 and will also trade at $.05 minimum increments subject to certain exceptions. The third test group will be quoted in increments of $.05 and will be subject to an additional “trade at” requirement to prevent price matching. The third test group will have the same exceptions as the second and an additional block size exception.

Background and Reasoning for the Program

Since the inception of decimalization in 2001 and minimum price variation of one penny for exchange-traded companies, there has been a significant change in the nature of trading and role of market participants. Many market participants believe that underwriters and market makers have lost their incentive to make markets and produce research for micro-, small- and mid-capitalization companies.

The JOBS Act directed the SEC to conduct a study and report to Congress on how decimalization affected the number of IPO’s and the liquidity and trading of stock in smaller public companies. The JOBS Act also gives the SEC the authority to designate a minimum increment for the trading of emerging growth companies that is more than $.01 but less than $.10. In July 2012 the SEC submitted the “Decimalization Report” to Congress, failing to reach a firm conclusion and instead realizing further research was needed, including by pursuing a pilot program to study the impact of wider tick sizes. The SEC believes that the current approved tick size pilot program will provide the necessary information to determine whether to permanently change tick sizes for these smaller companies.

As mentioned, the goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks. The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading. If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies. Moreover, additional market makers may enter the market as they see an opportunity to earn value. Additional market makers will equate to additional liquidity, which in turn attract more investors.

Issuers benefit from increased liquidity and market activity and quality in several ways. More trading activity and increased investor awareness could reduce the company’s cost of capital and improve opportunities to attract capital. That is, more investors will be willing to invest directly into the company, through PIPE transactions, registered secondary offerings, equity lines and the like as they will see a strong exit strategy. Moreover, with higher liquidity and market value, the ultimate exit by these investors will have less of a downward impact on trading price. Where the investment instrument was convertible (such as convertible debt, warrants and options) using a market price formula, less downward pressure on trading price will mean fewer shares will need to be issued in the conversion and the existing shareholders will suffer less dilution.

In addition, one of the main purposes of going public is to use capital stock as currency in making acquisitions and attracting key executives. Where the company has an active trading market, market maker support and strong liquidity, the value of the capital stock is likewise higher. Not only will the capital cost of making stock-based acquisitions and attracting and retaining high-quality key executives be reduced but for some issuers, it will make the difference of being able to utilize this benefit of being public at all.

Although there is no doubt that improved liquidity, market activity and market maker and underwriter support is extremely beneficial to all public companies, and in serious need for improvement for smaller public companies, it is not known whether the increased tick size will have the desired outcome.

The other side of the coin is that larger spreads and more profit for the traders with the increased tick size equates to increased costs to the investors whose accounts are being traded. Moreover, the program itself will be complex and costly to implement for market participants. Market participants have stringent rules to follow for each test group to ensure a valid test result. Each participant must adopt written policies and procedures and monitor and report results.

Conclusion

It is important that the SEC and market participants actively seek to improve the market quality for smaller public companies, and this is just one measure in that wheelhouse. However, it is a two-year program. I’m anxious to see more timely efforts in this arena, such as through the launch of venture exchanges.

The Author

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

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the host of LawCast.com, the securities law network.

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

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

Download our mobile app at iTunes and Google Play.

« The ECOS Matter; When Is A Reverse Split Effective? OTC Markets Comments on Proposed SEC Rules Regarding Amendments to Regulation D, Form D and Rule 156 »