Registering an IPO on Form S-1, Part Three
The second half of the Form S-1 registration statement contains supplemental information and formal legal requirements. This section is compromised of the subject Company’s financial information, sales and issuances of unregistered securities, the legal information regarding the exemptions relied upon in making such sales and issuances. In addition, a list of exhibits and information regarding these items is included as well.
Regulation S-X sets forth the form, content and requirements as to the financial statements that must be reviewed and audited by a PCAOB licensed accounting firm.
Item 601 of Regulation S-K lists required exhibits that must be filed with a Form S-1 (for example, original articles of incorporation and all amendments thereto; material contracts; auditor consent letter; legal opinions, etc.). These exhibits must be filed with the S-1 to become available for public review.
All registration statements must be written in “Plain English”, as opposed to technical legal or financial industry terminology. The Plain English rule requires that the registration statement be written using the following English grammatical principles: active voice; short sentences; definite, concrete, everyday words; tabular presentations of financial information and other applicable data; bullet lists for complex and material data, whenever possible; avoidance of legal jargon; avoidance of highly technical business terms; and no multiple negatives. The SEC enforces the plain English rule and will not hesitate to request that paragraphs or sections be re-written.
Once the Form S-1 is filed with the SEC, using the EDGAR and XBRL requirements, the SEC will inform the Issuer if the S-1 will be reviewed. The SEC assigns a team of legal and accounting experts to review the document and provide comments to the Issuer.
In response, the Issuer prepares and files an amendment to the S-1, making the required changes and addressing the comments put forth by the SEC. The issuer then prepares and files a responsive letter which sets forth written direct answers to each of the SEC’s comments. The comment process can, at times, be arduous and repetitive; however, Issuers should note that this is all part of the S-1 process. When the comments are addressed to the satisfaction of the SEC, the commission will issue an order allowing the registration statement to go effective.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Registering an IPO on Form S-1, Part Two Merger and Acquisitions, Part One – Structuring the Transaction »
Registering an IPO on Form S-1, Part Two
In my first blog on this topic, I set out very generally the time periods involved in an offering, the pertinent regulations and a very brief description of the contents of a registration statement. This Part II begins to explore, on a more in-depth level, the contents of a Form S-1 registration statement. The format of the S-1 is as follows: (i) cover page; (ii) Part I (the prospectus); (iii) Part II (supplemental disclosure); (iv) undertakings; (v) signatures and power of attorneys; (vi) consents; and (vii) exhibits.
The cover page of a Form S-1 is required to set out the following basic information about the issuer and the offering: (i) the issuer’s exact legal name; (ii) the issuer’s state of incorporation; (iii) the issuer’s SIC code; (iv) the Issuer’s tax id number; (v) the address and telephone number of the issuer’s principal executive offices and of its agent for service of process; (vi) the maximum amount of securities proposed to be offered and amount of registration fee; (vii) the approximate date of commencement of the offering; and (viii) whether any of the securities are being registered “on the shelf” pursuant to Rule 415.
Part I of the Form S-1 sets forth line items specifying required information by referencing the appropriate sections of Regulations S-K and S-X. The following is a brief description of each of the items required in Part 1 of Form S-1.
1. Description of Business, Properties and Legal Proceedings (Items 101 – 103 of Reg. S-K)
Item 101 of Reg S-K requires a description of the business over the prior 5 years (or 3 years for small public companies) or from inception as appropriate. Item 101 sets forth a list of required information (including, for example, year and state of incorporation; products and services; sources of raw materials; environmental issues; government regulations, research and development and number of employees). In addition, parts of Item 101 require discussion of future plans, for example, plans for expansion or increase in employees. Item 101 also requires a description of the Issuer’s competitors specifically and in the industry in general. This paragraph is a brief summary and examples of only a few of the numerous items that must be specifically disclosed and discussed in accordance with Item 101.
Item 102 of Reg S-K requires that the Issuer set forth the location and general character of the physical properties of the Issuer, including how titled and a description of any liens, mortgages or encumbrances.
Item 103 of Reg S-K requires that the Issuer disclose any pending or contemplated legal proceedings, including specifically required information about these proceedings. An Issuer need not disclose legal proceedings in the ordinary course of its business.
2. Securities (Items 201 and 202 of Reg S-K)
Items 201 and 202 requires a description of the securities offering as well as past and future information regarding these securities and all of the Issuers outstanding securities, including, for example, prior market and pricing activity, rights and preferences, outstanding warrants, and dividends.
3. Financial Information (Items 301-305 of Reg S-K)
Small Issuers (under $75 mil in revs) are not required to make disclosure under Items 301 and 302 which require that the Issuer provide a summary of financial data that is contained in the financial statements. All Issuers are required to provide disclosure under Item 303 – Management Discussion and Analysis of Financial Condition and Results of Operation (MD&A). MD&A often makes up the bulk of narrative discussion in a registration statement and is arguably the most important portion of the registration statement for investors to understand the Issuer and its management plans. A detailed discussion of the requirements of this section could fill up multiple blogs on the topic alone. However, very briefly, MD&A requires discussion of key financial elements and changes in those items over the prior 12 months. For example, MD&A would disclose revenues for the current term and prior year and explain why that number increased or decreased (for example, the company may have expanded or cut back on its sales force).
In addition, MD&A requires a detailed discussion of the Issuer’s future plans and the costs and intended source of financing for those plans. An Issuer cannot simply state that it plans to open 10 new locations, but instead would be required to give details as to where those locations were, what progress, if any had been made towards the plan, the costs of the plan and where the money is going to come from.
MD&A requires discussion regarding liquidity and capital resources. This would include breaking out balances owed or owing on various obligations sources and uses of funds for 12, 24 and 36 month periods. MD&A requires a discussion of the industry and competition, both generally and as may specifically effect the Issuer. Again, this is a very brief outline of MD&A.
4. Management and Certain Security Holders (Items 401-404 of Reg S-K)
Items 401 through 404 of Reg S-K requires disclosure of certain information regarding directors, executive officers, key employees and those that own 5% or more of the outstanding securities of the Issuer. Item 401 requires the Issuer to disclose certain biographical information about officers, directors and key employees. This information includes 5 years of business background, name, age, familial relationships among other disclosed individuals, related party transactions, and involvement in certain legal proceeding over the prior 10 years (such as convictions of crimes, governmental enforcement actions, and involvement in bankruptcies). Item 402 requires disclosure of executive compensation, both past, current and as obligated in the future. Item 404 requires disclosure of financial related party transactions.
5. Registration Statement and Prospectus Provisions (Item 501-512 of Reg S-K)
Items 501-512 (often referred to as standardized items) requires different disclosures and information throughout the Form S-1, including specific information on the front and back cover and throughout the Form S-1. For example, how the offering price was determined (Item 505); risk factors (Item 503); use of proceeds (Item 504); dilution (Item 506); disclosure of selling security holders if a secondary offering (Item 507); plan of distribution (Item 508); experts (Item 509); offering expenses (Item 511); and undertakings (Item 512).
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Registering An IPO On Form S-1, Part One Registering an IPO on Form S-1, Part Three »
Registering An IPO On Form S-1, Part One
Pursuant to Section 5 of the Securities Act of 1933, as amended (“Securities Act”), it is unlawful to “offer” or “sell” securities without a valid effective registration statement, unless an exemption is available. Companies desiring to offer and sell securities to the public must file with the SEC, and provide prospective investors, all material information concerning the company and the securities offered. The Securities Act sets forth in-depth rules on what constitutes material information, and on what forms and in what format, that material information must be disclosed.
There are generally three regulated time periods in an offering process:
(i) the pre-filing period – which begins when the Issuer decides to proceed with an offering. During this period, counsel prepares the registration statement and prospectus and the Issuer negotiates with underwriters, if applicable (the Issuer may determine to proceed with a self underwritten IPO which is commonly known as a DPO or direct public offering);
(ii) the “quiet period” – which is the time from the filing of the registration statement until it is declared effective. During this time the Issuer can engage in limited marketing (offers only) of the offering through the use of the filed registration statement, which must clearly indicate that it is not the final document (often referred to “red herring”).
(iii) post effective period – the registration statement is effective and the Issuer can proceed with sales of the securities registered
In addition to disclosure and regulations related to the offering during all three periods, marketing and public communications of the Issuer are restricted. For more information on this aspect please see other blogs I’ve written on this subject.
Rule 404(a) of the Securities Act sets forth the basic requirements for a registration statement. Rule 404(a) reads in part:
“A registration statement shall consist of the facing sheet of the applicable form; a prospectus containing the information called for by Part 1 of such form; the information, list of exhibits, undertakings and signatures required to be set forth in Part II of such form; financial statements and schedules; exhibits; any other information or documents filed as part of the registration statement; and all documents or information incorporated by reference in the foregoing.”
Over the years the SEC has created and eliminated various registration forms. Currently all domestic issuers must use either form S-1 or S-3. Form S-3 is limited to larger filers with a minimum of $75 million in annual revenues, among other requirements. All other Issuers must use form S-1. This blog solely discusses form S-1. In this series of blogs I will discuss the preparation and filing of a Form S-1.
There are four primary regulations governing the preparation and filing of Form S-1:
(i) Regulation C – contains the general requirements for preparing and filing the Form S-1. Including within Regulation C are regulations and procedures related to (a) the treatment of confidential information; (b) amending a registration statement prior to effectiveness; (c) procedures to file a post-effective amendment; and (d) the “Plain English” rule.
(ii) Regulation S-T – requires that all registration statements, exhibits and documents be electronically filed through the SEC’s EDGAR system – though it should be noted that the SEC is in the process of changing this system to XBRL filing
(iv) Regulation S-K – sets forth, in detail, all the disclosure requirements for all the sections of the S-1. Regulation S-K is the who, what, where, when and how requirements to complete the S-1.
(v) Regulation S-X – sets forth the requirements with respect to the form and content of financial statements to be filed with the SEC. Regulation S-X includes general rules applicable to the preparation of all financial statements and specific rules pertaining to particular industries and types of businesses.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« OTCQB and OTCQX Compared and Contrasted Registering an IPO on Form S-1, Part Two »
OTCQB and OTCQX Compared and Contrasted
Over the past few years, the historical PinkSheets has undergone some considerable changes, starting with the creation of certain tiers of Issuers and culminating in its refurbished website and new URL “OTCMarkets.com”.
The new OTCMarkets.com divides Issuers into three (3) levels: OTCQX; OTCQB and PinkSheets. From a fundamental perspective, Issuers on the OTCQX must be fully reporting and current in their reporting obligations with the SEC and also undergo a quality review by industry professionals. Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC but do not undergo additional quality review.
Issuers on the OTCQB are analogous to previous OTCBB listed entities. Although the OTCBB technically still exists, it is losing company quotations daily, mainly as market makers choose the full service, one stop shopping of the OTC Markets, to quote the stock of over the counter trading Issuers. OTCQB Issuers are current with their reporting requirements to the SEC pursuant to the Exchange Act of 1934. Market Makers quoting the stock of OTCQB Issuers either have a current 15c2-11 or are relying on the piggy back qualification.
Issuers with stock quoted on the OTCQX are not only current with their reporting obligations, but have undergone industry professional review. That is, in addition to meeting the requirements of the securities laws and SEC, these entities have opted to undergo greater scrutiny from the industry. The benefits to Investors in being able to rely on this quality review are enormous.
OTC Markets has established standardized methods for professionals to review the quality of Issuer information. In addition, OTC Markets has set forth standards for the qualifications of those responsible for undertaking the quality review. Lastly, OTC Markets maintains a strict accountability policy for securities attorneys, PCAOB auditors and other professionals who do not perform their review obligations properly and/or who do not adhere to OTC Markets standards. Issuer service providers that report false information to OTC Markets may ultimately find themselves blacklisted from the website. Consequently, it is essential that attorneys, auditors and any other professionals who submit Issuer data to OTC Markets confirm with absolute certainty that they their information is correct and complete.
Prior to the enactment of the OTCQX tier by the OTC Markets, for quality of disclosure review, Investors had to rely on either the SEC review process or analyst reports. However, these sources are not consistent and as for the later, not necessarily reliable. The SEC does not review all documents filed by all Issuers, not even close. They simply do not have the resources nor personnel to do so. Accordingly, the quality of disclosure of any given Issuer may not meet even basic legal requirements and an Investor would have no easy way of determining which filings have been reviewed and which have not.
Relying on analysts’ reports entails tremendous risk because not all of them are licensed. Many “analysts” are simply stock promoters being paid to write glowing recommendations about a particular stock. Even the most well-intentioned analysts do not always verify the information provided to them by the issuer. Many are seeking to line their own pockets by selling their shares in an inflated market after their favorable report is disseminated. Inversely, others have shorted the stock and will profit in the down market after their unfavorable report reaches the street. Ultimately, there is no easy way for an Investor to discern whether a given report is prepared by a licensed, unbiased, honest professional – until now.
In addition, OTCQX offers Investors and Issuers various perks usually associated with trading on an Exchange (a stock exchange, such as the NASDAQ is different than the Over the Counter Market in that they have listing standards, such as price of stock, and have ongoing governance and compliance standards, such as audit committee review). These perks include, but are not limited to, real time quotes and various computerized communication resources for investor relations.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Performing Due Diligence on Subject Companies During Reverse Mergers Registering An IPO On Form S-1, Part One »
Performing Due Diligence on Subject Companies During Reverse Mergers
Due diligence is a critical component of structuring any business transaction. In a reverse merger scenario there are two sides to the due diligence equation. There is the due diligence performed by the private company merging with the public shell (“Public Shell”) and there is the performance by the shell company of due diligence on the private company (“Private Company”).
In order to successfully complete a reverse merger it is essential for the Public Shell to perform appropriate financial, legal, corporate, market, and management due diligence on the private company merging with the Public Shell. At the most basic level the Public Shell needs to satisfy itself that the Private Company has all information completed and ready to file its Super 8-K within 4 days of completing the merger, including having audited financial statements prepared by a PCAOB licensed auditor.
As far as due diligence is concerned, particularly from a functionality standpoint, understanding management’s reasons for going public, as well as knowing the extent of their knowledge regarding public company operations, is critical to success and timeliness. Investors typically do not invest in the horse, but rather the jockey.
Post merger, the once private company will need to file quarterly, annual and periodic reports pursuant to the Securities Exchange Act of 1934, as amended, and must have the internal controls in place to ensure compliance with these reporting requirements. Hence, determining beforehand the qualifications of management is invaluable to ensuring a successful post merger operation.
Essential questions to be answered during the personal interview phase are set forth in the reporting requirements enumerated in Items 401 through 404 of Regulation S-K. From a fundamental business perspective, these Items will help current and future shareholders determine:
1. Is management competent?
2. How many years of experience in the industry do they possess?
3. Has management been successful in running the operation to date?
4. Does management understand the difference between running a private company verses the rigorous legal, investor relations and accounting demands of a public company?
5. Are there any legal roadblocks to future offerings or extremely detrimental disclosure items (i.e. bad boy provisions)?
Furthermore, the shell company’s due diligence should gain insight as to the ability of the private company, through management and/or hired professionals, to address and remain compliant with: Sarbanes Oxley, GAAP, Exchange Act reporting requirements, including yearly 10-K’s, quarterly 10-Q’s and periodic 8-K’s, Investor Relations, internal controls, Annual Report filings and annual meeting, as well as other basics concerning the general daily operational factors of a public company.
At the corporate level of the due diligence process the public shell needs to review basic corporate records to determine that the Private Company is in legal corporate good standing and has maintained adequate books and records.
Legal due diligence encompasses such things as ensuring loans by insiders have been documented, extensions on outstanding obligations have been memorialized and documented, title to ownership of assets (including intellectual property and real estate) is in the corporate name and if not, proper linking documents (such as a lease agreement or assignment) have been prepared and executed. Does the Private Company rely on a distribution network? Make sure it’s in writing. In short, legal due diligence involves crossing the T’s and dotting the I’s and is part and parcel with the auditor’s job.
In addition to the personal matters there also exist the typical concerns of pending or anticipated litigation issues. These issues include, but are not limited to, product liability; hazardous waste; real estate liens; employment discrimination suits; other environmental concerns and other legal issues that could have a “material” negative impact in the future.
As stated, where relevant to the particular private company, environmental issues are an extremely important legal due diligence point. Environmental laws and the gaining power of the Environmental Protection Agency make this a critical factor. Failure to ensure that appropriate Phase I and Phase II environmental reports are in order could lead to expensive future cleanup and litigation costs. Furthermore, it is suggested that any potential future liability be signed off on by the appropriate agency or authority.
Now to the most important due diligence matter: financial due diligence. If the target entity does not have or cannot obtain completed audited financial statements, prepared by a PCAOB qualified auditor in accordance with GAAP, there exists no rationale to move forward with the merger.
Financial due diligence is the key element in the due diligence process. The Public Shell Company should be meticulous in reviewing the financials, margins, inventory and equipment lists of the private company going public. In addition there may be patents, intellectual property and employee compensation agreements that need to be reviewed. The Public Shell should be comfortable with the footnotes as well as the line item financial statements.
It must be understood that there are always going to be some sort of issues. However, the Public Shell Company’s objective is to address significant material issues via the due diligence process. By doing so the Shell Company enhances the probability of a successful reverse merger.
In summary, the due diligence process is designed to uncover material facts that may adversely impact the transaction. The process is not designed to destroy the deal but moreso to address key issues in order to strengthen the transaction and protect shareholders. Inversely, properly completed due diligence on the Public Shell Company to be acquired ensures that the merging Private Company reaps the benefits of a viable public entity by which to grow and enhance shareholder value.
Comprehensive, detailed and meticulous due diligence creates a foundation of integrity, authenticity and transparency on which a strong, operating public company can be built. The due diligence process can be time consuming, but it is most easily completed when all parties involved operate reasonably and professional cooperation is maintained throughout the due diligence process.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Potential Liabilities In The IPO Process– Part III OTCQB and OTCQX Compared and Contrasted »
Potential Liabilities In The IPO Process– Part III
Rule 10(b) and 10b-5 of the Securities Exchange Act of 1934 (“Exchange Act”) is commonly known as the anti-fraud rule. Rule 10b-5 applies to any oral or written communication in connection with the purchase and sale of securities. To establish a claim under Rule 10b-5, the claimant must show fraud in the form of an omission or misstatement and that such fraud occurred in connection with the purchase or sale of a security. Rule 10b-5 provides a private cause of action by a purchaser of securities against any person who makes an untrue statement or omits a material fact, not just the Issuer.
To make a claim under 10b-5 a person must establish:
Misrepresentation or Omission of a Material Fact – the key point here being “material”. A fact is material if, in light of the totality of information, it is substantially likely it would impact a reasonable persons investment decision. The test is based on a reasonable man’s perspective, not necessarily the investor making the claim.
Scienter/State of Mind – Rule 10b-5 requires that the defendant be aware of the fraud. Awareness can be established either by actual awareness (defendant states that they have 5 contracts when there is only 3) or by showing that the defendant should have been aware with reasonable inquiry and diligence (defendant had the contracts available to review, but just didn’t).
Reliance – the plaintiff in a 10b-5 claim must show that they relied on the misinformation or lack of information. In other words there must be a link between the alleged fraud and the investment decision. It is presumed when material information is withheld there is reliance. The presumption of reliance can be rebutted by showing that the claimant’s decision to purchase or sell shares was not influenced by the alleged fraud, or that the alleged fraud did not alter or change the stock price.
Causation – the plaintiff in a 10b-5 claim must show that the fraud caused damages. Damages is a calculation of the monetary loss of the claimant and such damages must be linked to the fraud.
Damages – in addition to linking the damages to the fraud, the claimant must actually have damages. That is, they must have lost money.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Potential Liabilities In The IPO Process-Part II Performing Due Diligence on Subject Companies During Reverse Mergers »
Potential Liabilities In The IPO Process-Part II
Section 12(a)(1) of the Securities Act of 1933 (“Securities Act”) imposes liability on any person who offers or sells a security in violation of Section of the Securities Act. Part I of this blog series discussed the ability of the SEC to bring enforcement proceedings against persons who violate Section 5 of the Securities Act. Part I related to Section 12(a)(2) of the Securities Act. Section 12(a)(1) is the sister to that provision, providing a method for a purchaser of a security, i.e. another person, to bring a civil action against another person who has sold them a security in violation of Section 5.
Section 12(a)(1) provides that a single violation of the registration provisions at the time of an offer will create a cause of action available to all of the purchasers in the offering, even if the conditions of Section 5 are actually complied with at the time an individual sale is made. The possibility of a Section 12(a)(1) claim illustrates the importance of understanding what constitutes an “offer” during the period prior to and following the filing of the registration statement, but before the registration statement becomes effective.
Section 2(a)(3) of the Securities Act defines an “offer to sell”, “offer for sale”, or “offer” shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value. Preliminary negotiations or agreements between an issuer (or any person directly or indirectly controlling or controlled by an issuer, or under direct or indirect common control with an issuer) and any underwriter are excluded from the definition.
Securities Act claims, both by persons pursuant to this Section, or by the SEC in an enforcement proceeding, can be brought against any individual who signs the registration statement, in addition, to the Issuer. If state law allows, the officers or directors who sign the registration statement can seek indemnification from the Issuer. However, the SEC itself does not “agree” with the right to indemnification and requires all Issuers to include a statement setting forth the SEC’s position on indemnification in all registration statements.
The bottom line is that if an officer or director signs a registration statement which is filed with the SEC and which contains misstatements or fails to contain material information, they may be subject to liability on two fronts – from the SEC in an enforcement proceeding, and from individuals and entities in a private civil claim.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Potential Liabilities In The IPO Process Potential Liabilities In The IPO Process– Part III »
Potential Liabilities In The IPO Process
Both the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934, as amended (“Exchange Act”) provide remedies to investors in the IPO process. The basic premise of such liability is that either an investor was not given an opportunity to review investment disclosure documents prior to making the investment, or such disclosure documents contained inaccurate information or failed to contain material information. In the coming months we will also analyze various IPO liability provisions.
Section 11(a) of the Securities Act covers material misstatements or omissions in the registration statement at the time the registration statement becomes effective (later clarifications do not necessarily “cure” defects). Section 11(a) provides relief to any person who has acquired a security registered in a registration statement, whether in the initial IPO or after market, who did not have knowledge of the misstatement or omission at the time of the purchase.
The liability under Section 11(a) extends to (1) the Issuer; (2) any person who signed the registration statement; (3) every director at the time of the filing of the registration statement; (4) every person who is named, with his consent, as being about to become a director; (5) experts named in the registration statement (such as accountants); and (6) underwriters. Section 11(a) is a strict liability provision, meaning that the investor does not have to prove that he relied on the misstatements or omissions, only that they existed. However, other than the Issuer, those facing liability can claim the defense of due diligence. For example, if a director takes all reasonable steps (including seeking the advice of experts, thoroughly reviewing all available documents and information, etc.) to verify the information in the registration statement, they may be relieved of liability.
The misstatements or omissions, however, must be material. Materiality is defined as whether the misstatements or omissions, considered in context, would affect the investment decision of a reasonable investor. The statute of limitations for Section 11 liability is one year from the discovery of the misstatements or omissions, but not more than three years from the effectiveness of the registration statement. Section 11 limits the damages available to the investor to “the difference between the amount paid for the security and either (1) the value of the security at the time bought; or (2) the price the security was later sold for, if already sold.
Section 12(a)(2) of the Securities Act imposes liability for false or misleading statements or omissions by prospectus or oral communications involved in the offer or sale of securities. This Section imposes liability upon sellers for offers or sales of any security by means of a prospectus or oral communication. The pertinent “moment of time” for considering liability is the time the investor makes a commitment for purchase. Use of this Section is only available to initial purchasers, not after market buyers. Liability is limited to persons who offer or sells the security; i.e. it does not automatically extend to directors, experts, etc. Section 12 requires that the investor proof causation that is, that they relied on the misleading information and as a result of relying on such information, they were damaged. Moreover, the seller of the securities can raise several defenses, such as proof that the investor had actual knowledge of the information or should have been aware of the information if they had taken reasonable care and inquiry.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Alternatives To Going Public – Private Company Financing Options Potential Liabilities In The IPO Process-Part II »
Alternatives To Going Public – Private Company Financing Options
Many companies seek to go public as a source of obtaining capital financing. In order to make the most intelligent decision private financing options should also be considered.
Section 4(2) of the Securities Act of 1933, as amended (Securities Act) provides a broad based exemption for “transactions not involving any public offering.” The SEC has promulgated several Safe Harbor rules under Section 4(2) the most well known being Regulation D. The three private placement exemptions in Regulation D are Rule 504, 505 and 506, the difference being based on the size of the offering, the number and qualification of investors and restrictions on advertising and resale of the securities. Other than in certain instances under Rule 504, securities issued in a private placement are restricted and may not be resold unless they are registered or an exemption exists (such as Rule 144).
Briefly, Rule 504 allows a non-reporting public or private company to raise up to $1,000,000 from any number of individuals, which individuals do not need to be accredited. Rule 504 requires that the Issuer comply with applicable state law regarding the exemption. Each states rules and regulation vary widely and accordingly, relying on this exemption is only cost effective if the offering is limited to one or a small number of states.
Rule 505 allows an Issuer to raise up to $5,000,000 in a 12 month period, from up to 35 unaccredited investors and an unlimited number of accredited investors. Like Rule 504, an Issuer must comply with a complex and varying set of different state laws when relying on this exemption. Over the years this exemption has been used rarely.
Rule 506 allows an Issuer to raise an unlimited amount of capital form any number of accredited investors and no more than 35 unaccredited “sophisticated” investors. Sophisticated, in this case, means that the investor must have adequate experience in financial and business matters to understand the investment being made and the risk involved. Rule 506 offerings are guided by federal law which federal law pre-empts individual state requirements. However, individual states can require that an Issuer make minimal filings (a copy of the Form D filed with the SEC and a consent to service of process) and can require the payment of a fee.
Section 3(1)(11) of the Securities Act and Rule 147 promulgated thereunder provides an exemption from registration of securities as long as the Issuer is incorporated in the state where it offers the securities; conducts a significant amount of its business in that state; and makes offers and sales only to residents of that state. Federal law imposes no limits on the size of the offering, or the number or qualification of the investors, however, an Issuer must abide by the laws of the particular state it is making the offering in, which laws may impose such restrictions.
Regulation A is promulgated under Section 3(b) of the Securities Act, which Section allows the SEC to formulate exemptions for small public offerings under $5,000,000. Like a larger public offering, the Issuer must file a prospectus with the SEC and clear comments prior to embarking on the offering. However, unlike a larger public offering, following the effectiveness of the registration statement, the Issuer is not subject to any ongoing reporting requirements. Moreover, the Issuer has the option of remaining “private” or seeking to have their securities traded on the over the counter market.
There are many venture capital firms, angel investors, and private investor groups looking for ground floor opportunities with new business ventures. However, generally these investors seek large equity positions with a Company and often participate in management and operations of the Company.
This type of financing is more typical and similar to bank financing with higher costs and interest rates.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« The End Of An Era; The OTCBB Has Been Replaced By The OTCQB Potential Liabilities In The IPO Process »
The End Of An Era; The OTCBB Has Been Replaced By The OTCQB
A few months ago I wrote an article predicting that the new “OTC Markets,” formerly known as the Pink Sheets, and it’s OTCQX and OTCQB quotation tiers were replacing the antiquated, formerly FINRA-run OTCBB. Current events add further evidence to this view. Recently, more than 1000 Companies which were trading on both the OTCBB and OTCQB were delisted from the OTCBB and now trade exclusively on the OTCQB tier of the OTC Markets. These entities are quickly becoming known by their new moniker, OTCQB Companies.
The Investment Banking firm of Rodman & Renshaw acquired the OTCBB from FINRA last year.
An OTCBB By Any Other Name
For more than a year leading up to this large scale, mass delistment, it has been impossible to decipher between an OTCBB Company and a Reporting Pink Sheet Company when viewing the OTC Markets website. Both entities appeared under the heading of “OTCQB.” It was essential to reference other source material in order to make the distinction.
The now privately owned and operated OTCBB quietly delisted approximately 1,000 fully reporting and current, public companies from its quotation medium, initially citing “failure to comply with Rule 15c2-11”. Subsequent delistments cited “Ineligible for quotation on OTCBB due to quoting inactivity under SEC Rule 15c2-11.”
Delistments Means Little to Nothing
Most, if not all, of these companies did not receive notice of their “delisting”. Moreover, most, if not all, of these companies still do not know that they are no longer OTCBB quoted companies. In fact, the change has had little if no impact on these companies and will likely not have future impact. Each of these companies continue to be quoted on the OTCQB on the website for OTC Markets.
Issuer Reporting Obligations
Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC. Although the entire Over the Counter is regulated by the SEC and FINRA, the OTC Markets and the OTCBB are both now privately owned and merely serve as quotation mediums. However, and most importantly, the OTC Markets is more user friendly and factually up to date and accurate than the website for the OTCBB. So, if all Over the Counter quotes can be found at www.otcmarkets.com and companies trading on the OTCQB have the exact same standards as the OTCBB, and FINRA is no longer directly associated with the OTCBB, is there any reason for the OTCBB to even exist?
The fact sheet on www.otcmarkets.com has this to say regarding OTCQB quoted securities:
“With over 94% of all market maker quotes in OTC securities published on OTC Markets Group’s platform vs. 6% on the FINRA BB, it is important that OTC Markets Group provide a separate designation to identify OTC-traded companies that are U.S. registered and reporting. OTC Markets Group has launched the OTCQBtm marketplace to help investors easily identify SEC reporting companies and regulated banks that are current with their disclosure obligations.”
In summary, the curtains have closed on the OTCBB in name only and its business as usual for the new OTCQB.
The Author
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance. LLC for a free initial consultation or second opinion on an existing matter.
Alternatives To Going Public – Private Company Financing Options »