Securities Attorney Laura Anthony, Author at Reverse-Merger.com

Nasdaq Amends Its 20% Dilution Shareholder Approval Rule

Posted by Securities Attorney Laura Anthony | December 18, 2018 Tags: NASDAQ, Nasdaq Amends Its 20% Dilution Shareholder Approval Rule

Effective September 26, 2018, Nasdaq amended Rule 5635(d) to provide greater flexibility and certainty for companies to determine when a shareholder vote is necessary to approve a transaction that would result in the issuance of 20% or more of the outstanding common stock or 20% or more of outstanding voting power in a PIPE or similar private placement financing transaction. The amendment did not change the remainder of Rule 5635, which requires shareholder approval for transactions such as issuances involving an acquisition of stock or assets of another company, a change of control, or equity compensation that result in a 20% or greater dilution.

Generally, Rule 5635(d) requires Nasdaq-listed companies to obtain shareholder approval in private placement transactions involving the issuance of (i) common stock or securities convertible into or exercisable for common stock at a price less than the greater of book or market value which, together with sales by officers, directors or substantial shareholders of the company, equals 20% or more of common stock or 20% or more of the voting power outstanding before the issuance; or (ii) the sale, issuance, or potential issuance by the company of common stock or securities convertible into or exercisable for common stock equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. The amendment combines these two sections into one and amends the pricing test for triggering shareholder approval. The new pricing test amends the definition of “market value” solely for purposes of Rule 5635(d) to create a new “Minimum Price” as described below.

Prior to the amendment, Rule 5635(d) exempted from the shareholder approval requirement offerings priced at or above the greater of book or market value per share with market value defined as the closing bid price. That is, the Rule generally only required a vote if the dilution resulted from offerings that were priced at a discount to market value or book value. The Rule amendment eliminates the book value test, and revises the definition of market value to incorporate a five-day average and to use the last closing price instead of the consolidating closing bid price. As a result, under the amended Rule, a private offering involving the issuance of 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance will not require shareholder approval if the offer price is greater than or equal to the lesser of: (i) the last closing price immediately preceding the signing of a binding agreement; or (ii) the average closing price of the common stock on Nasdaq for the five trading days immediately preceding the signing of the binding agreement (the “Minimum Price”). Shareholder approval will be required for private placements priced below the Minimum Price.

Nasdaq’s impetus for amending the rule was to strike a balance between the protection of investors via the shareholder approval rule and a company’s flexibility to efficiently negotiate a deal to raise money quickly with a price that accurately reflects the market value of its security. In the Rule change release, Nasdaq noted that book value is based on historic values and, therefore, is not an appropriate measure of whether a transaction is dilutive or should otherwise require shareholder approval. Moreover, book value is one of several financial data points that is already incorporated into the market value of a security.

Using the last closing price, rather than the last closing bid price, reflects sale prices at one of the more liquid times of the day and, therefore, is believed to be more transparent to investors. Adding the option of choosing between the closing bid price and the five-day average closing price provides more flexibility and certainty for companies in their transactions. For example, in a declining market, the five-day average closing price will be above the current market price, which could make it difficult for companies to close transactions because investors could buy shares at a lower price in the market. Likewise, in a rising market, the five-day average could result in a below-market transaction triggering shareholder approval requirements.

The Rule amendment also combines the existing two sections of 5635(d) into one such that a 20% issuance for purposes of the Rule would involve a transaction other than a public offering, involving the sale, issuance, or potential issuance by the company of common stock or securities convertible into or exercisable for common stock, which, alone or together with sales by officers, directors, or substantial shareholders of the company, equals 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance. This change does not make any substantive change but certainly makes the language more clear and concise.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC 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, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with 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; 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 American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA 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 small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

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Noun

Lawcast is derived from the term podcast and specifically refers to a series of news segments that explain the technical aspects of corporate finance and securities law. The accepted interpretation of lawcast is most commonly used when referring to LawCast.com, Corporate Finance in Focus. Example; “LawCast expounds on NASDAQ listing requirements.”

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« The SEC’s Strategic Hub For Innovation And Financial Technology SEC Provides Enforcement Driven Guidance On Digital Asset Issuances And Trading »

The SEC’s Strategic Hub For Innovation And Financial Technology

Posted by Securities Attorney Laura Anthony | December 11, 2018

Responding to the growing necessity, in mid-October the SEC launched a Strategic Hub for Innovation and Financial Technology (FinHub). The FinHub will serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, such as distributed ledger technology (including digital assets), automated investment advice, digital marketplace financing, and artificial intelligence/machine learning. The FinHub also replaces and consolidates several SEC internal working groups that have been working on these matters.

According to the SEC press release on the matter, the FinHub will:

Provide a portal for the industry and the public to engage directly with SEC staff on innovative ideas and technological developments;
Publicize information regarding the SEC’s activities and initiatives involving FinTech on the FinHub web page;
Engage with the public through publications and events, including a FinTech Forum focusing on distributed ledger technology and digital assets planned for 2019;
Act as a platform and clearinghouse for SEC staff to acquire and disseminate information and FinTech-related knowledge within the agency; and
Serve as a liaison to other domestic and international regulators regarding emerging technologies in financial, regulatory, and supervisory systems.

Although I’m sure FinHub supports engagement in all FinTech areas, the website itself is broken into four categories: (i) blockchain/distributed ledger; (ii) digital marketplace financing; (iii) automated investment advice; and (iv) artificial intelligence/machine learning. Under each category the SEC has tabs with information such as regulations, speeches and presentations, opportunities for public input and empirical information.

Blockchain/Distributed Ledger

Blockchain and distributed ledger generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner. Blockchains are often used to issue and transfer ownership of digital assets that may be securities, depending on the facts and circumstances.

Clearly illustrating the need for regulatory initiatives, the “regulation, registration and related matters” tab under blockchain/distributed ledger is limited to public speeches, testimony and pronouncements, and enforcement actions, and not regulation (as none exists). Although certainly we in the community give public statements weight, they actually have no binding legal authority. The speeches, testimony and pronouncements that the SEC lists in this tab, and as such the ones that the SEC gives the most weight to, include (i) Chair Clayton’s testimony on virtual currencies to the Senate banking committee (see HERE); (ii) William Hinman’s speech on digital asset transactions (see HERE); (iii) statement on potentially unlawful online platforms for trading digital assets (see HERE); and (iv) remarks before the AICPA National Conference of Banks & Savings institutions (see HERE and HERE).

Providing more legal guidance are the enforcement proceedings. The SEC has provided a running list of all cyber enforcement actions broken down by category including digital asset/initial coin offerings; account intrusions; hacking/insider trading; market manipulation; safeguarding customer information; public company disclosure and controls; and trading suspensions.

Digital Marketplace Financing

Digital marketplace financing refers to fundraising using mass-marketed digital media – i.e., crowdfunding. In this category, the SEC includes traditional Title III Crowdfunding under Regulation CF and platforms for the marketing of Regulation D, Rule 506(c) offerings for the offering of debt or equity financing. Under the Regulation tab the SEC includes Regulation CF and the SEC’s Regulation CF homepage, including investor bulletins.

The SEC does not include a link to Rule 506(c) or Section 4(c) of the Securities Act, which provide an exemption for advertised offerings where all purchasers are accredited investors, and the platforms or web intermediaries that host such offerings, respectively. However, many securities token offerings are being completed relying on these exemptions from the registration provisions – in fact, more so than Regulation CF which is limited to $1,070,000 in any twelve-month period. In my opinion, this is a miss on the site layout.

This area of the FinHub website also provides a link to one of the first published SEC investor bulletins on initial coin offerings, including some high-level considerations to avoid a scam. Finally, this area provides a link to a Regulation CF empirical information page published by the SEC. Unfortunately I do not find the data to be user-friendly and could not determine how many, if any, Regulation CF offerings have included digitized assets or FinTech-related issuers.

Automated Investment Advice

Automated investment advisers or robo-advisers are investment advisers that typically provide asset management services through online algorithmic-based programs. Since their introduction, the SEC has been involved with regulating these market participants. Under this section, the SEC provides links to guidance related to robo-advisors.

Robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act. However, since robo-advisers rely on algorithms, provide advisory services over the internet, and may offer limited, if any, direct human interaction to their clients, their unique business models may raise certain considerations when seeking to comply with the Advisers Act. In particular, the Advisors Act requires that a client receive information that is critical to his or her ability to make informed decisions about engaging, and then managing the relationship with, the investment adviser. As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to, and to employ reasonable care to avoid misleading, clients. The information provided must be sufficiently specific so that a client is able to understand the investment adviser’s business practices and conflicts of interests. Such information must be presented in a manner that clients are likely to read (if in writing) and understand.

Since robo-advisors provide information and disclosure over the internet without human interaction and the benefit of back-and-forth discussions, the disclosures must be extra robust and provide thorough material on the use of an algorithm. The SEC’s guidance on the subject contains a fairly thorough list of matters that should be included in the client information.

Artificial Intelligence/Machine Learning

Machine learning and artificial intelligence refer to methods of using computers to mine and analyze large data sets. The SEC includes links to a few speeches and presentations under this tab. The SEC uses machine learning and AI in numerous ways, including market risk assessment and helping identify risks that could result in enforcement proceedings such as the detection of potential investment adviser misconduct.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HERE; HERE; and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« Proposed Rule Changes To Simplify Registered Debt Offerings Nasdaq Amends Its 20% Dilution Shareholder Approval Rule »

Proposed Rule Changes To Simplify Registered Debt Offerings

Posted by Securities Attorney Laura Anthony | December 4, 2018 Tags: Proposed Rule Changes To Simplify Registered Debt Offerings

This summer the SEC proposed rule changes to simplify disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, as well as for affiliates whose securities collateralize a company’s securities. The proposed amendments apply to Rules 3-10 and 3-16 of Regulation S-X and are aimed at making the disclosures easier to understand and to reduce the cost of compliance for companies. The proposed rules follow the September 2015 SEC request for comment related to the Regulation S-X financial disclosure obligations for certain entities other than the reporting entity. The September 2015 request for comment specifically discussed Rules 3-10 and 3-16, which comment responses were considered in the current proposed rules. For more on the September 2015 comment request, see HERE.

In addition to the amending the contents of the rules, the SEC plans to create a new Article 13 in Regulation S-X and renumber Rules 3-10 and 3-16 to Rules 13-01 and 13-02. The proposed amendments also include conforming changes to related rules in Regulations S-K and S-X and Securities Act and Exchange Act forms.

The SEC hopes that the rule changes will encourage registration of debt offerings which include a subsidiary guarantee or pledge of affiliate securities, where a company may previously have only completed such offerings using private placement exemptions due to the high costs and burdens associated with registration. Moreover, if the registration process is less expensive, it might encourage companies to use guarantees or pledges of affiliate securities as collateral when they structure debt offerings which could result in a lower cost of capital and an increased level of investor protection.

The following review is very high-level. The rules are complex and an application of the specific requirements requires an in-depth analysis of the particular facts and circumstances of an offering and the relationship between the issuer and guarantor/pledger.

Rule 3-10

Currently Rule 3-10 requires financial statements to be filed for all issuers and guarantors of securities that are registered or being registered, subject to certain exceptions. These exceptions are typically available for wholly owned individual subsidiaries of a parent company when each guarantee is “full and unconditional.” Moreover, certain conditions must be met, including that the parent company provides delineated disclosures in its consolidated financial statements. If the conditions are met, separate financial statements of each qualifying subsidiary issuer and guarantor may be omitted.

The theory behind requiring these financial statements is that guarantor of a registered security is considered an issuer because the guarantee itself is considered a separate security. Accordingly, both issuers of registered securities, and the guarantor of those registered securities, have historically been required to file their own audited annual and reviewed stub period financial statements under Rule 3-10. Where qualified, Rule 3-10 currently allows for a tabular footnote disclosure of this information, as opposed to full-blown audits and reviews of each affected subsidiary. The footnote tables are referred to as Alternative Disclosure.

The requirements under Alternative Disclosure include tables in the footnotes for each category of parent and subsidiary and guarantor. The table must include all major captions on the balance sheet, income statement and cash flow statement. The columns must show (i) a parent’s investment in all consolidated subsidiaries based on its proportionate share of the net assets; and (ii) a subsidiary issuer/guarantor’s investment in other consolidated subsidiaries using the equity accounting method.

To avoid a disclosure gap for recently acquired subsidiaries, a Securities Act registration statement of a parent must include one year of audited pre-acquisition financial statements for those subsidiaries in its registration statement if the subsidiary is significant and such financial information is not being otherwise included. A subsidiary is significant if its net book value or purchase price, whichever is greater, is 20% or more of the principal amount of the securities being registered. Currently, the parent company must continue to provide the Alternative Disclosure for as long as the guaranteed securities are outstanding.

When a subsidiary is not also considered an issuer of securities, a parent company consolidates the financial statements of its subsidiaries and no separate financial statements are provided for those subsidiaries. The SEC recognizes the overarching principle that it is really the parent consolidated financial statements upon which investors rely when making investment decisions. The existing rules impose certain eligibility restrictions and disclosure requirements that may require unnecessary detail, thereby shifting investor focus away from the consolidated enterprise towards individual entities or groups of entities and may pose undue compliance burdens for registrants.

The amendments would broaden the exception to the requirement to provide separate financial statements for certain subsidiaries as long as the parent company includes specific financial and non-financial disclosures about those subsidiaries. In particular, the amended rule would allow the exception for any subsidiary for which the parent consolidates financial statements as opposed to the current requirement that the subsidiary be wholly owned.

Furthermore, the amendments would replace the existing consolidated financial information with new summarized information, for fewer periods, and which may be presented on a combined basis. The new non-financial information disclosures would expand the qualitative disclosures about the guarantees and the issuers and guarantors, as well as require certain disclosure of additional information, including information about the issuers and guarantors, the terms and conditions of the guarantees, and how the issuer and guarantor structure and other factors may affect payments to holders of the guaranteed securities (“Proposed Alternative Disclosure”).

Importantly, the new disclosures may be provided in the body of a registration statement covering the offer and sale of the securities as opposed to the footnotes to the financial statements. However, the disclosures must move back to the financial statement footnotes beginning with the annual report for the fiscal year during which the first bona fide sale of the subject securities is completed.

The geography of a disclosure is significant. Disclosure contained in the footnotes to financial statements subject the information to audit and internal review, internal controls over financial reporting and XBRL tagging. Moreover, forward-looking statement safe-harbor protection is not available for information inside the financial statements.

The new rules would reduce the time that financial and non-financial disclosures are required to the time that the issuer and guarantor have an Exchange Act reporting obligation with respect to the guaranteed securities rather than for as long as the guaranteed securities are outstanding. The Exchange Act provides that if, at the beginning of any subsequent fiscal year after the effectiveness of a Securities Act registration statement, the securities of any class to which the registration statement relates are held of record by fewer than 300 persons, or in the case of a bank, a savings and loan holding company, or bank holding company, by fewer than 1,200 persons, the registrant’s Section 15(d) reporting obligation is automatically suspended with respect to that class.

Furthermore, the rule amendments would eliminate the requirement to provide pre-acquisition financial statements of recently acquired subsidiary issuers or guarantors.

Rule 3-16

Current Rule 3-16 requires a company to provide separate financial statements for each affiliate whose securities constitute a substantial portion of the collateral, based on a numerical threshold, for any class of registered securities as if the affiliate were a separate registrant. The affiliate’s portion of the collateral is determined by comparing (i) the highest amount among the aggregate principal amount, par value, book value or market value of the affiliate’s securities to (ii) the principal amount of the securities registered or to be registered. If the test equals or exceeds 20% for any fiscal year presented by the registrant, Rule 3-16 financial statements are required.

The proposed amendments would replace the existing requirement to provide separate financial statements for each affiliate whose securities are pledged as collateral with new financial and non-financial disclosures about the affiliate(s) and the collateral arrangement as a supplement to the consolidated financial statements of the company that issues the collateralized security.

In addition, the proposed amendment would change the geographic location of the disclosures to match the amendments to Rule 3-10. In particular, the new disclosures may be provided in the body of a registration statement covering the offer and sale of the securities as opposed to the footnotes to the financial statements. However, the disclosures must move back to the financial statement footnotes beginning with the annual report for the fiscal year during which the first bona fide sale of the subject securities is completed.

Furthermore, the proposed amendments would replace the requirement to provide disclosure only when the pledged securities meet or exceed a numerical threshold relative to the securities registered or being registered, with a requirement to provide the proposed financial and non-financial disclosures in all cases, unless they are immaterial to holders of the collateralized security.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« SEC Fall 2018 Regulatory Agenda The SEC’s Strategic Hub For Innovation And Financial Technology »

SEC Fall 2018 Regulatory Agenda

Posted by Securities Attorney Laura Anthony | December 4, 2018 Tags: SEC Fall 2018 Regulatory Agenda

In October 2018, the SEC posted its latest version of its semiannual regulatory agenda and plans for rulemaking with the U.S. Office of Information and Regulatory Affairs. The Office of Information and Regulatory Affairs, which is an executive office of the President, publishes a Unified Agenda of Regulatory and Deregulatory Actions (“Agenda”) with actions that 60 departments, administrative agencies and commissions plan to issue in the near and long term. The Agenda is published twice a year.

Like the Spring 2018 Agenda, the fall Agenda is broken down by (i) “Prerule Stage”; (ii) Proposed Rule Stage; (iii) Final Rule Stage; and (iv) Long-term Actions. The Proposed and Final Rule Stages are intended to be completed within the next 12 months and Long-term Actions are anything beyond that. The number of items to be completed in a 12-month time frame has jumped up with 36 items compared to 21 on the spring list.

Interestingly, following President Trump’s recent call to eliminate quarterly reporting for public companies, Chair Clayton remarked that “I don’t think quarterly reporting is going to change for our top names anytime soon. It was good of the president to raise it… as it could make sense to ease the requirement for smaller companies….” Of the three items in the pre-rule stage on the Fall Agenda, earnings releases and quarterly reports are one. Perhaps we will see a change in quarterly reporting requirements for smaller reporting companies. The other two items on the pre-rule list include the harmonization of exempt offerings to streamline the rules for exempt offerings and the modernization of investment company disclosures.

Eighteen items are included in the final rule stage, up from 11 on the Spring Agenda. Disclosure on hedging by employees, officers and directors remains in the final rule stage. The proposed rules were issued in February 2015 (see HERE) and will result in checking another box on the Dodd-Frank rulemaking list. Still in the final rule stage are amendment to the SEC’s modernization of property disclosure for mining companies, disclosure on order handling information, amendments to municipal securities disclosures, a few rule changes related to investment advisors and a few related to swaps, and implementation of FAST Act report recommendations (see HERE).

Auditor independence with respect to loans or debtor-creditor relationships moved up from proposed to the final rule stage, as did amendments related to fair access to investment research and amendments to the whistleblower program.

Amendments to the SEC’s Freedom of Information Act Regulations, which was included in the Spring Agenda final rule stage, were enacted in June 2018. Regulation S-K disclosure updates and simplification rule changes remain on the final rule change list even though some amendments have been recently implemented (see HERE). Likewise, a change to the definition of a smaller reporting company has been completed and thus off the list (see HERE) as has the adoption of inline XBRL (see HERE). Business, Financial and Management Disclosure Required by Regulation S-K remains in the proposed rule stage, continuing the topic of disclosure reform.

Although investment company reporting modernization and amendments to the Investment Advisers Act were included in the Spring Agenda final rule stage, no rule changes have been made and as mentioned above, in the newest Agenda, the modernization of investment company disclosures is listed in the pre-rule stage.

Eighteen items are included in the proposed rule stage. Items of interest in the proposed rule stage include amendments extending the testing-the-waters provisions to non-emerging growth companies (see current testing-the-waters provisions HERE); financial disclosures about acquired businesses, disclosure of payments by resource extraction issuers, filing fee processing updates, bank holding company disclosures, exchange traded funds, and fund of fund arrangements. As promised by Chair Clayton, amendments to the definition of an accelerated filer appear on the proposed rule change list.

Regulation A amendments are now included in both the long-term action list and proposed rule stage. I am hopeful that these amendments may include an increase in the offering limits. We continue to wait for the SEC to amend the Regulation A rules to allow reporting issuers to utilize the offering as required by the Economic Growth, Regulatory Relief and Consumer Protection Act (see HERE).

Rules on disclosure for unit investment trusts and offering variable insurance products, offering reform for business development companies, use of derivatives by registered investment companies and business development companies, Business, Financial and Management Disclosure Required by Regulation S-K, standards for covered clearing agencies, and amendments to marketing rules under the Advisors Act, are also included in the proposed rule stage. Amendments to the transfer agent rules remains on the proposed rule list although it has been almost three years since the SEC published an advance notice of proposed rulemaking and concept release on new transfer agent rules (see HERE).

Fifty-two items are listed as long-term actions, including many that have been sitting on the list for a long time now. Still on the long-term actions are rules related to reporting on proxy votes on executive compensation (i.e., say-on-pay – see HERE), universal proxy, Form 10-K summary, corporate board diversity, investment company advertising, and revisions to audit committee disclosures.

Highly debated and much needed, but still on the long-term agenda, are the amendments to the accredited investor definition (see HERE). Also remaining on the long-term action list are Regulation Finders. The topic of finders has been ongoing for many years, and I am extremely pleased to see it make the list. See HERE for more information.

Other items remaining on the long-term agenda include amendments registration of security-based swaps and a few other swap-related rule changes, stress testing for large asset managers, prohibitions of conflicts of interest relating to certain securitizations, definitions of mortgage-related security and small-business-related security, numerous proxy rule amendments, conflict minerals amendments, amendments to Guide 5 on real estate offerings and Form S-11, incentive-based compensation arrangements, exchange traded products, various broker-dealer-related rule changes, and risk mitigation techniques. Also remaining on the long-term action list include simplification of disclosure requirements for emerging growth companies and forward incorporation by reference on Form S-1 for smaller reporting companies (EGCs may already incorporate by reference – see HERE), and Regulation Crowdfunding amendments.

Rule 701 and Form S-8 amendments have been added to the long term action list following the SEC’s recent rule changes and concept release (see HERE and HERE). Other interesting items added to the long-term agenda are rule changes to short sale disclosure reforms and registration of alternative trading systems. Alternative trading systems have garnered interest for their potential use for securities token trading.

Still on the long-term agenda are future Dodd-Frank rules, including proposed regulatory actions related to pay for performance (see HERE), executive compensation clawback (see HERE) and clawbacks of incentive compensation at financial institutions.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« Rule Changes for OTCQB and OTCQX Proposed Rule Changes To Simplify Registered Debt Offerings »

Rule Changes for OTCQB and OTCQX

Posted by Securities Attorney Laura Anthony | November 20, 2018 Tags: Rule Changes for OTCQB and OTCQX

Effective January 19, 2019, OTC Markets will require that all U.S.-incorporated OTCQB and OTCQX companies provide verified share data through a transfer agent that participates in its Transfer Agent Verified Shares Program. The Transfer Agent Verified Shares Program allows transfer agents to provide regular updated information on the number of authorized and outstanding shares to OTC Markets via a secure electronic file transfer.

The share data is used to ensure compliance with the OTCQB and OTCQX listing requirements, by broker-dealers and clearing firms and by investors in making investment decisions, keeping track of dilution, and ensuring compliance with Sections 13 and 16 of the Securities Exchange Act (see HERE). For a complete review of the OTCQB listing standards, see HERE. For a complete review of the OTCQX listing standards, see below.

Share data provided by participating transfer agents appears alongside a “Transfer Agent Verified” logo on the OTC Markets website. The authorized and outstanding share amounts appear on the profile page for an issuer.

OTC Markets has also published a Small-Cap Company Guide Best Practices for Being Public and Raising Capital (“Public Company Guide”). Noting that an IPO is an expensive and time consuming process, the Public Company Guide begins with a list of a few alternatives to the traditional IPO, including a reverse merger (for more information on reverse mergers see HERE), direct public offerings (see HERE) and Regulation A+ (see HERE).

Turning to Capital Raising, the Public Company Guide lists the following key considerations:

Know who you are working with. The small-cap finance market attracts bad actors and “predatory financiers.” Due diligence is key including reviewing the performance of other companies that an investor has invested in. I note this has been an ongoing topic and area of concern for OTC Markets, including discussion in its recent Regulatory Recommendations (see HERE) and stock-promotion policy and best practices guidelines to improve investor transparency and address concerns over fraudulent or improper stock promotion campaigns (see HERE).
Know the terms. Particularly, be cognizant of terms that will be highly dilutive to the company’s stock and current shareholders. In convertible note offerings, it is recommended to avoid floating rate conversions (discounts to market) with no floor or bottom price.
Be oversubscribed. To me this falls into the overly obvious. Of course, it is the best scenario for any company completing a fund raising to be oversubscribed, but the reality is that raising money is difficult and even meeting the upper limits of a proposed offering amount can be challenging.
Be careful of a need for fast cash. Working on the fundamentals of a business and planning ahead can help.
Avoid being desperate. Of course, desperation results in bad decisions.

The Public Company Guide next topic is creating a successful investor relations program. In addition to its published stock promotion policy and best practices guidelines to improve investor transparency and address concerns over fraudulent or improper stock promotion campaigns, OTC Markets provides some good top-level tips. Particularly, to be a successful public company it is important to (i) have a solid, experienced management team; (ii) provide timely, high-quality disclosures; and (iii) set clear, achievable investor relations goals and objectives.

Investor relations objective should include: (i) having an investment thesis and great investor-facing deck; (ii) telling the company’s story; (iii) an aggressive sell-side analyst strategy including targeting the right investor; (iv) attend investor conferences; and (v) using social media effectively.

A Complete Summary Of OTCQX Initial AND Ongoing Listing Requirements

The following is a complete summary of the OTCQX listing standards.

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;
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

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.

Trusts, funds and issuers with similar securities may qualify for an exemption from these corporate governance requirements.

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;
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;
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;
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 there has been no prior public market for the company’s securities in the S., FINRA must have approved a Form 211 with a minimum bid price of $0.25 or greater. If the company is applying to the OTCQX immediately following a delisting from a national securities exchange, it must have a minimum bid price of at least $0.10. The company must also maintain the applicable bid price for 30 days following its listing on OTCQX.
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 – 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 12g3-2(b) and be current and compliant in such requirements including posting a 12g3-2(b) Confirmation with OTC Markets; 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 noncompliance.

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 1 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
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« Recent Notable Changes To Delaware Corporate Law SEC Fall 2018 Regulatory Agenda »

Recent Notable Changes To Delaware Corporate Law

Posted by Securities Attorney Laura Anthony | November 13, 2018 Tags: Delaware Corporate Law, Recent Notable Changes To Delaware Corporate Law

This summer the Delaware legislature passed several amendments to the Delaware General Corporation Law (DGCL) which impact public and private companies incorporated in Delaware, and elsewhere, as many states follow the DGCL.

Mergers Using DGCL Section 251(h)

Section 251(h) was first enacted in 2013. Section 251(h) eliminates the need for shareholder approval to complete a merger, where such merger is completed following a tender or exchange offer and the acquirer owns at least the percentage amount of the target that is needed to approve the merger. That is, Section 251(h) eliminates unnecessary time and expense related to a vote on a merger when certain preconditions have been satisfied. These preconditions include:

The merger must be consummated as soon as practicable following the tender offer or exchange offer;
The underlying tender or exchange offer must be for all of the outstanding stock of the target, except for the stock owned by the acquirer or any person that directly or indirectly owns all outstanding stock of the acquirer, and any direct or indirect wholly owned subsidiary of any of the foregoing;
The use of Section 251(h) can be a contractual election by the parties to the merger.

Section 251(h), when first adopted, prohibited its use when one of the merger parties was an “interested party”; however, a 2014 amendment eliminated this prohibition. DGCL Section 203 defines an “interested stockholder” to include any person who “has the right to acquire” 15 percent or more of the target’s voting stock.

The newest statutory change amends Section 262(b) governing shareholder appraisal (dissenter) rights to apply the “market out” exception to the availability of statutory appraisal rights for mergers consummated pursuant to Section 251(h) without a shareholder vote, following a tender or exchange offer. Prior to the amendment, Section 262(b) provided for appraisal rights in a 251(h) merger if not all the shares were held by the parent company.

Amended 262(b) aligns appraisal rights for Section 251(h) mergers to the same circumstances as one-step mergers where a vote of stockholders is required. That is, no appraisal rights are available for shareholders of any class or series of stock of a target corporation that is listed on a national securities exchange or held of record by more than 2,000 holders if the merger consideration for such shares consists solely of (i) stock of the surviving corporation or any other corporation (or depositary receipts in respect thereof) that is listed on a national securities exchange or held of record by more than 2,000 holders, (ii) cash in lieu of fractional shares or depositary receipts, or (iii) any combination of the foregoing. This provision is often referred to as the “market out” exception to appraisal rights.

Prior to this amendment, very few exchange traded companies relied on Section 251(h) to effectuate a merger after a tender offer or exchange involving stock consideration. With the amendment applying the market out provision to mergers under Section 251(h), the provision will likely gain in use.

In addition, the 2018 amendments modify Section 262(e) delineating the information which must be provided to dissenting shareholders in connection with a 251(h) merger. Section 262(e) previously required that the statement to dissenting stockholders include a disclosure of the aggregate number of shares not voted in favor of the merger, and for which appraisal rights were demanded and the aggregate number of holders of such shares. However, this provision was defective on its face, since the mechanics of Section 251(h) specifically eliminate the shareholder vote requirement and rather provides a mechanism by which a company can complete a merger following a tender or exchange offer without such shareholder approval. Amended Section 262(e) clarifies that the company must disclose the number of shares not purchased in the tender or exchange offer, and only upon request by a stockholder.

Appraisal Rights

Appraisal rights are a statutory right whereby a company must offer certain dissenting or minority shareholders the right to receive the fair value of their shareholdings under certain circumstances, including merger transactions. That is, a shareholder can elect to be cashed out at the fair value of their equity instead of participating in a particular transaction. To elect their appraisal rights, a shareholder must follow very specific statutory formalities.

Section 262 of the DGCL governs appraisal rights for Delaware corporations. If a corporation is required to seek shareholder approval of a merger or consolidation, it must notify the shareholders that are entitled to vote on such merger or consolidation, of the availability of appraisal rights. Notice of the meeting and appraisal rights must be provided at least 20 days prior to the shareholder meeting. Moreover, the notice must include a copy of Section 262 of the DGCL itself for the shareholders to review.

In order to exercise their appraisal rights, a dissenting shareholder must (a) deliver a written demand to the company exercising their appraisal rights prior to the shareholder vote; (b) not vote in favor of the merger or consolidation; and (c) continuously hold their shares from the date of making the appraisal right demand through the date of the closing of the merger or consolidation. Thereafter, within 10 days of the closing of the merger or consolidation, the company must provide notice to all shareholders who properly delivered notification of appraisal rights that the transaction has closed.

Within 120 days of the effective date of the merger or consolidation, either the surviving corporation or any shareholder that has properly demanded appraisal rights and otherwise complied with Section 262, can commence an action in the Delaware Court of Chancery for the determination of the fair value of the shares held by such shareholder(s). Fair value is determined without including any added value from the merger or consolidation. That is, the dissenting shareholder is not entitled to vote against a transaction and request appraisal rights and get the increased (or decreased) value associated with the transaction.

For a more in-depth discussion of Delaware appraisal rights, see HERE.

Ratification of Defective Corporate Acts

Section 204 of the DGCL, which was first enacted in 2014, provides a method in which a corporation can ratify prior defective acts and stock issuances. Prior to the enactment of Section 204, courts had found that defective corporate acts or stock issuance could not be retroactively ratified. With the enactment of Section 204, the Delaware legislature allows a company to resolve defective corporate acts and uncertainties without disproportionately disruptive consequences. Section 204(a) sets forth a road map for a board to remedy what would otherwise be void or voidable corporate acts and stock issuances, and provides that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in [Section 204] or validated by the Court of Chancery in a proceeding brought under [Section] 205.” Pursuant to Section 204, a corporation’s board of directors may ratify one or more defective corporate acts by adopting resolutions setting forth the defective corporate act to be ratified, the date on which that act occurred, the reason why it is defective and that the board has approved the ratification of the defective corporate act or acts. A stockholder vote also is required to ratify the defective act if such a vote was required either at the time of the defective corporate act or at the time the board adopts the resolutions ratifying such act.

The 2018 amendments made several changes to Section 204. First, the amendments confirm that Section 204 remains available for ratifying defective corporate acts in circumstances where no shares of valid stock are outstanding. This amendment eliminates the need for any stockholder vote on the ratification of a defective corporate act in such circumstances, even if a vote of stockholders would otherwise be required under Section 204.

Second, the amendments provide that, in cases where a defective act involves the establishment of a record date for a vote of stockholders, and where a vote of stockholders will likewise be required for ratification of the act, the notice of the stockholder meeting for the ratification may be given to such holders as of the record date for the defective corporate act. This change will assist with a corporation’s ability to use the ratification mechanisms in Section 204 since most corporations, especially large ones, are likely to have a list of stockholders as of the record date for the defective corporate act. Furthermore, the amendments allow a public company that is listed on a national exchange to provide shareholder notice of a ratification through filings with the SEC under Exchange Act Sections 13, 14 or 15(d). As a reminder, Sections 13 and 15(d) provide for the general periodic reporting requirements of publicly reporting companies and Section 14 contains the proxy rules.

Third, the amendments confirm that a corporation may ratify a corporate act or transaction even if such act was void or voidable due to a failure of authorization. The amendment is intended to statutorily eliminate any implication arising from the court case of Nguyen v. View, Inc., which stated that an act or transaction may not be within the power of a corporation and therefore may not constitute a “defective corporate act” which could be cured by ratification, solely on the basis that it was not approved in accordance with the provisions of the DGCL or the corporation’s certificate of incorporation or bylaws. This amendment assumes that the failure to obtain proper authorization was not willful or purposeful. In the case where the failure to obtain authorization was deliberate, the subject corporate act could still be found to be void or voidable by a court.

Finally, the amendments allow for the ratification of an act or transaction that was consummated other than as disclosed in any proxy statement or consent solicitation. That is, if the disclosure that preceded the original shareholder approval was deficient in the first instance, Section 204 can be relied upon to cure the issue and ratify the act or transaction.

Forfeiture of Charter

The 2018 amendments modify Section 284 confirming that the Delaware attorney general has the exclusive authority to move for the revocation or forfeiture of a corporation charter for abuse, misuse or nonuse of its corporate powers, privileges or franchises by filing a complaint in the Court of Chancery. Section 284, as amended, provides that the Court of Chancery has the power to appoint a trustee to administer and wind up the affairs of a corporation whose charter has been revoked or forfeited pursuant to Section 284.

Anti-Sandbagging

The recent Supreme Court of Delaware case, Eagle Force Holdings, LLC and EF Investments, LLC v. Campbell, has called into question whether Delaware will follow other states and allow representations and warranties to be enforced where the party seeking enforcement knew them to be false at the time of entering into the contract. Relying on the CBS v. Ziff-Davis case out of New York, most states do not require that a party prove reliance on representations and warranties in a claim for breach of such representations and warranties. Of course, if the party knew the representations were false at the time they were made and the contract entered into, they could not later claim that they relied on their truthfulness.

In a footnote, the Eagle case states:

We acknowledge the debate over whether a party can recover on a breach of warranty claim where the parties know that, at signing, certain of them were not true. Campbell argues that reliance is required, but we have not yet resolved this interesting question. See Genencor Int’l, Inc. v. Novo Nordisk A/S, 766 A.2d 8, 12 n.8 (Del. 2000) (noting that the Court did not need to decide whether detrimental reliance is an element of a claim for a breach of warranty because that issue was not squarely at issue in the case). And we observe that a majority of states have followed the New York Court of Appeals’ decision in CBS Inc. v. Ziff–Davis Publishing Co., 75 N.Y.2d 496, 554 N.Y.S.2d 449, 553 N.E.2d 997 (1990), which holds that traditional reliance is not required to recover for breach of an express warranty: the only “reliance” required is that the express warranty is part of the bargain between the parties. Id., 554 N.Y.S.2d 449, 553 N.E.2d at 1001 (“This view of ‘reliance’—i.e., as requiring no more than reliance on the express warranty as being a part of the bargain between the parties—reflects the prevailing perception of an action for breach of express warranty as one that is no longer grounded in tort, but essentially in contract.”); see also See Tina L. Stark, Nonbinding Opinion, Bus. Law Today, Jan.–Feb. 2006, at https://apps.americanbar.org/buslaw/blt/2006-01-02/nonbindingopinion.html (“Since the CBS case was decided, the majority of states have followed New York.”). We need not decide this interesting issue because such claims are not before the court. Further, Article IV, the “Representations and Warranties of Campbell,” begins by stating that “Campbell hereby represents and warrants to the Company that the following representations and warranties are, as of the Execution Date, and will be, as of the Closing Date, true and correct.” Executed Contribution Agreement, supra note 55, Article IV, at A668 (emphasis added). Thus, even though the parties apparently appreciated that the “reality” of not having signed releases in hand did not comport with certain representations at the time of execution, it appears the parties were willing to overlook any problem at signing and allow Campbell to strive to obtain any necessary releases by Closing.

To avoid an issue, I recommend adding an “anti-sandbagging” provision to all Delaware law-based contracts. Since courts will look to the plain language of a contract in the first instance, such provision expressly providing that there can be no waiver of an enforcement right, regardless of knowledge, will protect against the uncertainty of the court.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« Financial Statement Disclosure Relief Under Rule 3-13 Rule Changes for OTCQB and OTCQX »

Financial Statement Disclosure Relief Under Rule 3-13

Posted by Securities Attorney Laura Anthony | November 6, 2018

Rule 3-13 of Regulation S-X allows a company to request relief from the SEC from the financial statement disclosure requirements if they believe that the financial information is burdensome and would result in disclosure of information that goes beyond what is material to investors. Consistent with the ongoing message of open communication and cooperation, the current SEC regime has been actively encouraging companies to avail themselves of this relief and has updated the CorpFin Financial Reporting Manual to include contact information for staff members that can assist.

As part of its ongoing disclosure effectiveness initiative, the SEC is also considering amendments to the financial statement disclosure process and the publication of further staff guidance. In addition to advancing disclosure changes, allowing for relief from financial statement requirements could help encourage smaller companies to access public markets, an ongoing goal of the SEC and other financial regulators. For a review of the October 2017 Treasury Department report to President Trump, including discussions related to the need to promote public markets, see HERE. For a review of Nasdaq’s publication “The Promise of Market Reform: Reigniting American’s Economic Engine,” see HERE.

In fact, the SEC, under Chair Jay Clayton, has used current rules and staff prerogative to implement changes over the past two years for the direct purpose of removing barriers to capital formation and making the U.S public markets more attractive. For example, In June 2017 the SEC announced that the Division of Corporation Finance will permit all companies to submit draft registration statements, on a confidential basis. For more information see HERE.

Rule 3-13 of Regulation S-X

Rule 3-13 of Regulation S-X reads in total:

The Commission may, upon the informal written request of the registrant, and where consistent with the protection of investors, permit the omission of one or more of the financial statements herein required or the filing in substitution therefor of appropriate statements of comparable character. The Commission may also by informal written notice require the filing of other financial statements in addition to, or in substitution for, the statements herein required in any case where such statements are necessary or appropriate for an adequate presentation of the financial condition of any person whose financial statements are required, or whose statements are otherwise necessary for the protection of investors.

That is, the Rule gives the SEC the authority to modify or waive financial statement requirements under Regulation S-X as long as the modification is consistent with investor protections. The SEC has delegated the authority to the Division of Corporation Finance. Rule 3-13 applies to all financial statement requirements under Regulation S-X including financial information that a company may have to provide from other entities such as acquired businesses, subsidiaries, tenants with triple net lease arrangements that comprise a concentration of assets, certain related parties and others. For more information on financial statement requirements for entities other than the registrant, see HERE.

Although the requirement that relief be consistent with investor protections is not defined by any rules, the SEC uses the concept of materiality as guidance. Materiality requires a facts-and-circumstances analysis. In TSC Industries, Inc. v. Northway, Inc., the U.S. Supreme Court defined materiality as information that would have a substantial likelihood of being viewed by a reasonable investor as having significantly altered the total mix of information available.

The Financial Accounting Standards Board (FASB) has also published guidance on the utilization of the materiality standard in financial reporting. In September 2015, FASB published two concept papers recommending changes to the rules and analysis related to determining materiality. The changes would have given companies more flexibility in determining materiality. FASB’s proposed changes met with opposition from investor groups. After two years of a back-and-forth process, in November 2017, FASB abandoned its proposed changes and reverted to an earlier materiality standard.

FASB now defines materiality in the context of “the magnitude of an omission or misstatement of accounting information that, in light of the surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information, would have been changed or influenced by the omission or misstatement.” The FASB materiality analysis is primarily quantitative although circumstances, such as whether a particular matter is outside the ordinary course of business or could have an impact on larger contractual obligations, must also be considered.

This definition is consistent with the standard used by the SEC, the PCAOB and the AICPA. The old and now new again materiality standard is set forth in FASB’s Statement of Financial Accounting Concepts No. 2 Qualitative Characteristics of Accounting Information.

A materiality analysis must also take into account the relevance of the information. That is, information may be material based on pure magnitude but it may lack relevance. Relevance is generally information that would make a difference to a decision maker such as in making predictions about outcomes of past, present, and future events or to confirm or correct prior expectations. By its very nature, relevant information is timely. If information is not available when it is needed or becomes available so long after the reported events that it has no value for future action, it lacks relevance and is of little or no use.

How to Seek Relief

As with all communications with the SEC, the company should ensure it is prepared prior to seeking relief. Being prepared includes conducting research to see if the SEC has issued guidance on a particular topic or provided relief, such as no-action relief, to other companies in similar circumstances. The SEC’s Financial Reporting Manual (FRM) should always be reviewed.

The FRM may even provide for self-executing relief from certain requirements, especially where the SEC has granted similar relief on a regular basis. For example, the FRM now allows a company to file a “super 10-K” to catch up delinquent reports, without seeking relief from the SEC prior to doing so. As another example, companies may provide abbreviated financial statements for certain oil and gas properties without first seeking SEC relief. Furthermore, the FRM provides guidance on seeking relief in certain circumstances, including the criteria the staff will consider.

As indicated in the rule, a request for relief should be in writing to the appropriate staff member(s). However, under the new regime, the SEC encourages companies to engage in conversations with the SEC staff prior to submitting the written request. The company can discuss any items they believe are relevant to the determination, why they believe a particular disclosure is not necessary for that company’s investors and how and why preparation of the rule-mandated financial statements would be overly burdensome. To avoid unnecessary logjam, the SEC staff cautions against providing unnecessary background or peripheral information.

Further

Background on SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes.

In December 2017, the American Bar Association (“ABA”) submitted its fourth comment letter to the SEC related to the financial and business disclosure requirements in Regulation S-K. The comment letter focused on disclosures related to materiality, known trends or uncertainties, critical accounting estimates, strategy, intellectual property rights, sustainability, litigation and risk factors. For a review of the comment letter, see HERE.

In October, 2017 the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Capital Markets” (the “Treasury Report”). The Treasury Report made specific recommendations for change to the disclosure rules and regulations, including those related to special interest and social issues and duplicative disclosures. See more on the Treasury Report HERE.

On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The new Rule goes into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018. See my blog HERE on the Item 601 rule changes and HERE related to SEC guidance on same.

On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read HERE.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

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

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

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

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

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

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.

Listen toour podcast on iTunes Podcast channel.

law·cast

Noun

« SEC Commissioner Hester Peirce Continues to Support Technology Recent Notable Changes To Delaware Corporate Law »

SEC Commissioner Hester Peirce Continues to Support Technology

Posted by Securities Attorney Laura Anthony | October 30, 2018 Tags: SEC, SEC Commissioner Hester Peirce Continues to Support Technology

In three recent speeches, SEC Commissioner Hester Peirce continued to proclaim her support for technological innovation and freedom in capital markets. On September 12, 2018, Ms. Peirce gave a speech at the Cato Institute’s FinTech Unbound Conference which she titled Motherhood and Humble Pie, on September 24 she spoke at the University of Michigan Law School titling her speech Wolves and Wolverines, and then on October 2 she spoke at the Financial Planning Association 2018 Major Firms Symposium, calling that speech Pickups and Put Downs. Besides the great titles, I applaud her content and perspective.

Motherhood and Humble Pie

A prevailing theme in all three speeches centered on her dissent to the SEC’s rejection of an exchange traded product or mutual fund. As an aside, since I wrote this blog on the SEC’s published concerns related to a cryptocurrency-related exchange traded product or mutual fund, HERE, the SEC has continued to deny several more applications for such a product.

As the title of her first speech in the series indicates, she uses motherhood as a metaphor to express her view that the SEC has been acting like a helicopter mother as opposed to a free-range mother, by refusing to let its “children” take risks by exploring new financial products that involve cryptocurrencies. In one of my favorite lines in her speech, she states, “[B]etter, we naturally think, not to allow the investor to leave the house, even for a quick trip down the street, unless properly helmeted, swaddled in regulation protective gear, and strapped into a vaguely European-branded car seat that is secured exactly in the center of the back seat of the largest SUV that an upper-middle class professional’s salary can buy.”

Certainly there is risk that investors will lose money and that there will be backlash against the regulatory body for failing to put proper protections in place, but Ms. Peirce thinks that the free-market environment should support such risk. Regardless of the level of regulatory protection, there will always be investor losses. Companies will fail, fraudsters will cheat and markets will downturn. Furthermore, capital markets are, by nature, risky. As Ms. Peirce notes, “[A] key purpose of financial markets is to permit investors to take risks, commensurate with their own risk appetites and circumstances, to earn returns on their investments.”

Ms. Peirce opines that the protection against the risk of cryptocurrency investments could go beyond the SEC’s actual authority. Congress has not empowered the SEC with eliminating risk or substituting the SEC’s investment judgment for that of an investor. The SEC also does not have the authority to regulate or require regulation of assets underlying securities, including digital assets. As I’ve written about in my blogs several times, the SEC regulatory framework centers around disclosure and not a merit review. For example, the SEC does not have the power to prohibit a registration statement from going effective if the disclosures are complete and compliant with Regulations S-K and S-X, regardless of how terrible the investment may be.

Specifically, the SEC’s high-level mandates are to protect investors, facilitate capital formation and maintain fair, orderly and efficient markets. For more on the SEC’s purpose, see HERE. Ms. Peirce believes this mandate requires the SEC to ensure that investors have access to products to allow them to create their own investment portfolios, including with new and expanding asset classes such as cryptocurrencies.

People already invest in cryptocurrencies, but they must do so through direct purchases on various exchanges, outside of their regular investment accounts. The individual investor is charged with keeping records and having a certain technical know-how to play in this marketplace. It is clear that there is a strong interest among investors to access this new type of investment, and for it to be available via exchange traded products, thus the consistent new applications by industry institutions.

Ms. Peirce lists five lessons that the SEC should learn when considering cryptocurrency products and technological innovation. In particular:

The SEC should avoid supplanting its own judgment with that of investors’ and avoid attempting to ascertain the viability of new technology in advance of its release in the marketplace as long as proper disclosures are in place.
The SEC’s efforts to protect investors from the risks of innovation will not change the desire for the marketplace to have access to these products and instead will cause investors to seek investment opportunities in other countries and markets that may be even less regulated than the US markets.
The SEC must be more accessible and willing to engage with entrepreneurs and market participants seeking to bring cryptocurrency products to market. Furthermore, the SEC needs to provide clear and reasonable rules for innovators.
The SEC needs to commit to expanding investor access to financial markets, including through innovative technology. Innovation does not just mean cryptocurrency products but includes mobile access to investment products, online disclosures, and all fintech.
The SEC has to consider the resources it requires in meeting regulatory burdens, including financial, coding and data analytics. These regulatory burdens take away resources that could be used on customer-serving innovation and stifle smaller businesses from pursuing technological innovation.

Ms. Peirce ends with calling for an SEC Office of Innovation, a request that was granted. On October 18, 2018, the SEC launched its new Strategic Hub for Innovation and Financial Technology (FinHub), which is a topic for an upcoming blog.

Wolves and Wolverines

Commissioner Peirce’s September 24 speech at the University of Michigan Law School focused on arbitration between public companies and their shareholders and my favorite topic, digital assets. Solidifying me as a fan even more, Ms. Peirce begins by pointing out that corporate law is a form of public interest law, noting that “[T]he hunt for profit drives companies to strive to identify and meet people’s needs using as few resources as possible.” The corporate ecosystem, including dealing with customers, supplies, creditors, shareholders, employees and communities, requires mutual responsibility and an obligation to exercise sound judgment and respectable ethics.

This sentiment, however, acted as a segue to discuss the fact that failures in corporate ethics, such as the Enron scandal, have resulted in a more conservative SEC and regulatory regime. Repeating her earlier speech, Ms. Peirce conveys her views that the SEC should not be substituting its judgment for that of the investment community. Rather, the SEC should be ensuring that the regulatory framework requires proper disclosure so that investors can make an informed decision, whether it be to trade in particular stocks or products on the public markets, or invest in a private company with “world-changing ideas.”

In addition to her views on access to cryptocurrency, Ms. Peirce has been targeted by pro-regulatory enthusiasts for her statement on mandatory arbitration in the corporate context. In particular, in response to a reporter’s question, she answered that she supports mandatory arbitration since shareholder litigation is expensive and costs all shareholders regardless of the merits of the claims. Arbitration can be more effective, quicker and less costly. Despite the fact that the topic of arbitration between corporations and their shareholders is within the jurisdiction of state corporate law, the SEC could exert its influence by using public policy to affect the ability of a company to register securities if it has an offending policy. Ms. Peirce is consistent with her conviction that on this topic, as with others, the SEC should not impose its judgment on such free-market matters but rather leave it to supply, demand and the investors’ own due diligence.

Ms. Peirce then turned to the topic of cryptocurrency-related exchange traded products and mutual funds. She reiterated much of her sentiment from her prior speech, spending even more time on her concern that the regulatory treatment of cryptocurrencies will stifle all technological innovation in the capital markets, not just those related to digital assets.

Ms. Peirce also impressively took on the question as to whether she thinks all ICOs involve the offering of securities and whether a token security can become a non-security (utility) thereafter. Although months earlier William Hinman, the Director of the SEC Division of Corporation Finance, had expressed his views that a token can become a utility or non-security (see HERE), Commissioner Peirce hedged on the answer but left the impression that she may lean toward continuing to view cryptocurrencies as securities over the long term. Interestingly, although she is very clear that she does not support any merit review, no matter how veiled behind investor protection, she also seems to support some new regulatory structure that would cover digital assets through a longer period of time, while fostering and allowing development and market testing.

Pickups and Put Downs

On October 2, Commissioner Peirce spoke at the Financial Planning Association 2018 Major Firms Symposium. Although Commissioner Peirce stays true to her belief in a more technology- and innovation-friendly SEC, this speech was geared towards its audience and concentrated on the fund management marketplace.

Of course, she could not resist expressing her disappointment with the SEC for denying cryptocurrency-related exchange traded products, stating that “[T]he regulatory process can be a formidable roadblock to the development of new products that could provide investors with more diversity and protection in their investment portfolios.” Ms. Peirce believes the SEC should be less concerned with the volatility and risk associated with a cryptocurrency investment, which involves an investor’s personal decision as long as they have proper disclosure, and instead consider.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

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« Shifting Capital Markets; Bank of America’s Merrill Lynch Exits the Penny Stock Business Financial Statement Disclosure Relief Under Rule 3-13 »

Shifting Capital Markets; Bank of America’s Merrill Lynch Exits the Penny Stock Business

Posted by Securities Attorney Laura Anthony | October 23, 2018 Tags: Shifting Capital Markets; Bank of America's Merrill Lynch Exits the Penny Stock Business

There is a strange dichotomy building in the capital markets and what some are calling a clearing firm crisis. At the same time that the world of penny stocks and low-priced securities is on shaky ground with regulators and market participants, the U.S. is trying to regenerate the IPO marketplace, and a whole world of cryptocurrency investments and global trading continues to flourish. However, the IPO market cannot flourish for small companies if stockholders cannot clear their securities and sell into a secondary market. Recently, penny stocks have experienced a one-two punch that leaves me, and many of my colleagues, wondering how the marketplace will respond and evolve. Furthermore, as the inevitable birth of securities tokens and an actual licensed operational securities token exchange looms on the near-term horizon, it is clear we are at the precipice of experiencing fundamental changes in the capital markets.

Background on Penny Stocks

Penny stocks and low-priced securities have always been considered speculative and risky investments, with the potential for large swings in value, thus enticing investors with an appetite for risk. As a result of the risk associated with penny stock trading, Congress enacted the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) requiring the SEC to enact rules requiring brokers or dealers to provide disclosures to customers affecting trades in penny stocks. The rules prohibit broker-dealers from effecting transactions in penny stocks unless they comply with certain stringent rules, including providing a Schedule 15G risk disclosure document. Since enactment of the Penny Stock Act, broker-dealers do not recommend or solicit transactions in penny stocks, but have, at least until recently, effectuated client-requested transactions. For more information on the penny stock rules, see HERE.

A penny stock is defined in Exchange Act Rule 3a51-1. Like many SEC rules, the penny stock rule begins by including all equity securities and then carves out exemptions (for example, all offers and sales of securities must be registered unless an exemption applies). In particular, Rule 3a51-1 defines a penny stock as any equity security other than:

(a) A NMS (national market system) stock that is a reported security that is (i) registered on a national securities exchange that is grandfathered in because it has been in continuous operation since prior to April 20, 1992; or (ii) is quoted on either a national securities exchange or automated quotation system that that has certain quantitative initial listing standards and continued listing standards that are reasonably related to the initial listing standards. The listing standards must meet or exceed the following criteria: (a) the issuer must have $5 million of stockholders’ equity, market value of listed securities of $50 million for 90 consecutive days prior to applying, or net income of $750,000 (excluding extraordinary or non-recurring items) in the most recently completed fiscal year or in two or the last three most recently completed fiscal years; (b) the issuer must have an operating history of at least one year or a market value of listed securities of $50 million; (c) the issuer’s stock must have a minimum bid price of $4 per share; (d) there shall be at least 300 round lot holders of common stock; and (e) there must be at least 1,000,000 publicly held common shares with a market value of at least $5 million;

(b) Is issued by an investment company registered under the Investment Company Act of 1940, as amended;

(d) Has an inside bid quotation price of $5.00 (the Rule requires that the price be net of broker or dealer commissions, mark-up or mark-downs);

(e) Is registered, or approved for registration upon notice of issuance, on a national securities exchange that makes price and volume transaction reports available, subject to restrictions provided in the rule;

(f) Is a security futures product listed on a national securities exchange or an automated quotation system sponsored by a registered national securities association; or

(g) Whose issuer has: (i) net tangible assets (as calculated in accordance with the rule) in excess of $2 million, if the issuer has been in continuous operation for at least three years, or $5 million, if the issuer has been in continuous operation for less than three years; or (ii) average revenue (as calculated in accordance with the rule) of at least $6 million for the last three years.

In reading the definition of a penny stock, it mainly includes those that do not trade on a national exchange or rather those that do trade on the OTC Markets. Both the Nasdaq and NYSE American have initial listing standards that generally fit within the exclusion from the definition of a penny stock; however, the continued listing requirements would allow a company to fail to meet the net tangible assets and revenue tests or otherwise fail to fall within one of the Rule 3a51-1 exclusions. Nasdaq actually publishes a daily list of those companies that it believes are considered a penny stock and subject to the Penny Stock Act.

Which leaves OTC Markets. The SEC has been unfavorable to OTC Markets in the past, which is somewhat understandable as it has undeniably been a forum for fraud, but it is also undeniably a venture and growth market for solid companies seeking to access capital markets. OTC Markets and its management group have been working hard to gain favor with the SEC and initiate regulatory changes that would help reduce micro-cap fraud.

The SEC has always publicly fought a battle against micro-cap fraud and back in December 2016, it published an antagonistic white paper detailing the risks associated with investing in OTC Markets securities. I blogged about the white paper at the time (see HERE), including my issues with its framework, lack of understanding of the multiple tiers of trading on OTC Markets (OTC Pink, OTCQB and OTCQX) and data sources (i.e., SEC enforcement actions). Furthermore, the SEC was the impetus behind FINRA’s withdrawal of its request to delete the OTCBB and later proposal to expand its operations. See HERE, though as of today, this proposal remains just that: a proposal. Despite some temporary negative publicity, the white paper did not appear to impact the OTC Markets’ business.

Both before and after the white paper, the OTC Markets has continued to make self-regulating changes to its marketplace, including adding various “flags” such as the “shell risk” and “stock promotion” flags. The “shell risk” designation indicates that a company displays characteristics common to shell companies. This designation is made at OTC Markets’ sole and absolute discretion based on an analysis of the company’s annual financial data and may differ from a company’s self-reported shell classifications in their own public filings. For more on the OTC Markets stock promotion policy, see HERE.

Moreover, OTC Markets has added quantitative and qualitative listing requirements for both the OTCQB and OTCQX, such as a minimum number of shareholders and public float (see HERE), IPO listing standards (see HERE) and change of control re-application procedures (see HERE). Effective January 1, 2019 OTC Markets is also requiring all OTCQB and OTCQX companies to provide verified share data directly to OTC Markets through a transfer agent that participates in its Transfer Agent Verified Shares Program (blog coming).

In March of this year, OTC Markets made a presentation to the SEC’s Investor Advisory Committee (“IAC”) as part of a panel on “Discussion of Regulatory Approaches to Combat Retail Investor Fraud.” During the meeting, Mr. Coulson discussed the most serious market risks and presented a list of 14 OTC Markets regulatory recommendations to improve disclosure and combat these market risks. The recommendations include items that could increase the liquidity and facilitate capital formation, but also include recommendations to improve regulatory responsiveness and reduce fraud. For more on Coulson’s presentation and a complete list of the 14 regulatory recommendations, see HERE.

Also, on September 26, 2018, OTC Markets took part in the SEC’s Roundtable on Regulatory Approaches to Combating Retail Investor Fraud hosted by the SEC Division of Trading and Markets, at which Cromwell Coulson and OTC Markets General Counsel Dan Zinn both sat on panels focused on combating fraud and stock manipulation.

Despite these self-regulating and lobbying efforts, recent developments have leveled an attack on the marketplace.

Recent Developments

Bank of America’s Merrill Lynch bans penny stocks

Bank of America’s Merrill Lynch brokerage division has shut down business in penny stocks. The big wire house has told its customers, including its 17,442 financing advisors, that it will no longer allow any transactions involving the purchase of securities that are priced below $5.00 per share and that trade on the OTC Markets. This change went into effect in July of this year, but many clients were not informed until they tried to execute a purchase order. Effective September 30, the company has also added increased compliance controls for all securities that are under $5.00 per share with a market capitalization under $300 million, regardless of where they trade. Although at first the firm indicated it would likewise prevent sales of such securities, it has since loosened that policy to allow for the orderly sell-off and/or transfer to other firms of these low-priced securities. Bank of America is the first major wirehouse to completely restrict transactions in penny stocks.

Clients and financial advisors have been trying to figure out the best way to sell off or transfer their holdings to other firms. The increased compliance controls cause a delay in execution of sell orders, and not all sales will be allowed. For example, the wirehouse will not allow any sales of a security designated with a skull and crossbones on the OTC Markets website. As discussed below, moving the securities to another brokerage or clearing house has its own hurdles as others restrict deposits as well.

The move is surprising even though CEO Brian Moynihan is publicly conservative. I certainly can understand greater compliance controls and increased scrutiny over suspicious activity, but am surprised to see the bank shut down an entire asset class. The company is likewise averse to cryptocurrencies, having halted clients from using credit cards to purchase bitcoin and other cryptos back in February of this year.

Cor Clearing Exits the Penny Stock Business

In a settled enforcement proceeding with the SEC published on September 28, 2018, Cor Clearing, LLC (“COR”) has agreed to exit the penny stock business, agreeing not to effectuate any sales in any equity security that does not trade on a national securities exchange and trades at a price of less than $5 per share subject to certain limited exceptions. In other words, COR has ceased trading in OTC Markets securities below $5.00 per share. The limited exceptions in which COR may execute a sell order include:

(a) COR obtains and retains a trade confirmation evidencing that the securities were purchased on the open market as opposed to having been deposited at COR another broker-dealer;

(b) The securities are exemption from the Securities Act registration requirements under Section 3(a)(2) (i.e., a security issued or guaranteed by a governmental body) or Section 3(a)(5) (i.e., a security issued by a savings and loan, farmer’s coop or charitable organization), or the securities are defined as government securities under Section 3(a)(42) of the Exchange Act;

(d) The aggregate value of the sale of the securities of any particular company is less than $10,000 and the customer has not availed itself of this exception within the last three months in any account in the name of the customer or in which it has a beneficial interest.

The SEC investigation involved the failure by COR to file suspicious activity reports (SAR’s) related to the trading in customer accounts. For more on a broker’s responsibility to file SARs, see HERE and HERE This order has had and will continue to have, at least for the short term, a significant impact on the trading in OTC Markets securities. COR was one of the largest clearing firms in the penny stock marketplace, where few others play. In fact, only a small handful of clearing firms actively, or did actively, participate in the penny stock marketplace on a regular basis. In 2016, the year that triggered the SEC enforcement investigation, COR ranked second among all broker-dealers in the total dollar value of sub-$1 penny stocks that it cleared. Alpine ranked first, and they have their own issue as discussed below. Additionally, the vast majority of COR’s clearing activity in penny stocks was on behalf of introducing broker-dealers, which are now scrambling for a new clearing arrangement or likewise exiting the penny stock business.

Within days of the SEC’s Order, it was announced that COR has entered into a contract to be sold to Axos Financial. The acquisition is expected to close in early 2019. Although Axos expects to have a presence in low-priced securities, it will be subject to the SEC order related to COR’s activities. It will be interesting to see how the business evolves. Up to now, Axos has operated more of a traditional bank (BofI Federal Bank) with customer deposits and the majority of income generated from loan activity, including mortgages.

Alpine Securities

In June 2017, the SEC filed a complaint in the United States District of New York against Alpine Securities Corporation, claiming a violation of the same activity in the COR matter, and in particular the failure to file suspicious activity reports (SARs) for penny stock transactions. The SEC is seeking $20,000,000 in fines and penalties, including injunctive relief. Unlike COR, Alpine decided to fight the SEC action and proceed with litigation. However, in April 2018, the SEC won a partial summary judgment against Alpine on all but one of their claims, and Alpine appealed. Litigation continues with Alpine’s survival at stake – literally – if the SEC wins, it is likely Alpine will no longer be able to continue in business.

In April, around the time the SEC won its partial summary judgment, Alpine lost its X-clearing arrangement with Merrill Lynch. Trades in securities are deemed “X-Clearing” when they are settled outside of the DTCC FAST system. DTC’s subsidiary, the National Securities Clearing Corp (NSCC), charges large “illiquid fees” for the clearing of securities that are low-priced and not traded on a national exchange (for more on the settlement and clearing process and the role of the NSCC, see HERE and HERE). To manage these charges, small clearinghouses such as Alpine can enter into arrangements with larger clearinghouses that can clear the securities for them outside of the DTC system. As a result of losing its x-clearing arrangement, Alpine no longer processes transactions for securities priced below $0.10.

In an effort to assist Alpine Securities with its twofold predicaments, a special purpose vehicle has been set up to raise funds privately, which funds will be used to invest in SCA Clearing, LLC, the holding company for Alpine Securities. The purpose of the investment will be to increase Alpine’s net capital so that it can reduce its NSCC illiquid charges. Although I have no direct knowledge of the status of the private offering, I find it difficult to imagine that investors will invest in light of the risk imposed by the SEC litigation.

Inevitable Securities Token Exchange

I’ve written a lot on blockchain, cryptocurrencies and my belief that a change in capital markets is inevitable. I believe that the sale of digital assets as a security is here to stay and that several of the companies that claim to be seeking proper registration and licensing to operate a secondary marketplace for the trading of these digital assets, will succeed. FINRA is actively working with broker-dealers and licensed ATSs to figure out the operations, compliance and regulatory aspects of an operational exchange (see HERE). Furthermore, the SEC has proven that it will take enforcement action against those that operate without such appropriate licenses (see HERE).

However, the vast majority of the companies that are issuing crypto and securities tokens are very early-stage with valuations that, even if inflated today, will adjust to reasonable levels. That is, the vast majority of crypto and securities tokens, are and will be, just another form of a penny stock. As quickly as clearing firms exit the penny stock marketplace, a new platform is building to provide an alternative. The race is on for the first entrant with T-Zero, Coinbase, Templum, SharesPost and others all vying for the prize.

I don’t know which clearing firms will be involved in the trading and clearing of securities tokens on individual ATSs, but I believe it will be new players that are working with individual ATSs as I write this. Also, it could be that the trading on a particular ATS will be siloed such that the trading of a security token on one ATS will be independent from the trading of that same token on another ATS. A clearing firm could be tied to a particular ATS, which in turn is run by a single broker-dealer, creating multiple individual marketplaces. That is how it works on crypto-exchanges today, which is why, for example, bitcoin can be a slightly different price or rise and fall in different patterns on different exchanges.

Conclusion

During an industry life cycle, it is normal to see the rise and fall of key participants; Lehman Brothers and others have once been too big to fail and plenty of smaller players have closed their doors along the way. Likely, this is a similar scenario for clearing firms and new players will see the opportunity and enter the penny stock marketplace. OTC Markets is invariably working hard to help its customers, and their stockholders, have the ability to gain liquidity. However, with the rise of alternative markets, it will be interesting to see the changes that take place over the next few years.

The Author

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

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

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« SEC Adopts Amendments to Simplify Disclosure Requirements SEC Commissioner Hester Peirce Continues to Support Technology »

SEC Adopts Amendments to Simplify Disclosure Requirements

Posted by Securities Attorney Laura Anthony | October 16, 2018 Tags: SEC Adopts Amendments to Simplify Disclosure Requirements

In August the SEC voted to adopt amendments to certain disclosure requirements in Regulations S-K and S-X (the “S-K and S-X Amendments”) as well as conforming changes throughout the federal securities laws and related forms. The amendments are intended to simplify and update disclosure requirements that are redundant, duplicative, overlapping, outdated or superseded with the overriding goal of reducing compliance burdens on companies without reducing material information for investors. The new amendments finalize and adopt the proposed rules that had previously been issued on July 13, 2016. See my blog on the proposed rule change HERE. The final rule changes were substantially, but not entirely, as proposed.

The Regulation S-X and S-K Amendments come as a result of the Division of Corporation Finance’s Disclosure Effectiveness Initiative and as required by Section 72002 of the FAST Act. The proposing release also requested public comment on a number of disclosure requirements that overlap with, but require information incremental to, U.S. GAAP to determine whether further changes should be made.

The S-K and S-X Amendments cover:

Duplicative requirements, including duplications between financial footnote requirements and disclosures in the body of a registration statement or report;
Overlapping requirements which may not be completely duplicative. The S-K Amendments consider whether to delete certain disclosure requirements that are covered in GAAP or other financial reporting or integrate such disclosures into a single rule source;
Outdated requirements which have become obsolete due to the passage of time or changes regulations, business or technology; and
Superseded requirements which are inconsistent with recent legislation or updated rules and regulations.

The amendments are set to go effective thirty (30) days after publication in the federal register. As of the date of this blog, the amendments have not been published. There have been a few blogs and some commentary as to the reason for the delay, but regardless of the reason, the delay has caused some question as to whether certain changes will need to be implemented in the upcoming 10-Q’s to be filed for companies with a September 30 quarter-end. In particular, the new amendments will require companies to present a change in shareholders’ equity as part of its quarterly financial statements, which statement was previously only required in annual reports.

Responding to the marketplace questions, on September 25, 2018, the SEC published a new Compliance and Disclosure Interpretation (C&DI) on the matter. New question 105.09 clarifies that the amendments are effective for all filings made 30 days after publication in the federal register. However, despite this effective date, the SEC would not object if the first quarterly statement of changes in shareholder’s equity is included in a company’s Form 10-Q filed for the quarter that begins after the effective date of the amendments.

Disclosure Location

Some of the amendments change the location of information in a filing which can have a material impact. Location changes involve:

Prominence Considerations – the location of a disclosure may provide for a certain level of prominence of the information.
Financial Statement Considerations – some amendments relocate disclosure from outside to inside the financial statements, thus subjecting the information to audit and internal review, internal controls over financial reporting and XBRL tagging. Furthermore, forward-looking statement safe-harbor protection is not available for information inside the financial statements. Conversely, some amendments relocate disclosures from inside to outside the financial statements.
Bright-line Disclosure Threshold Considerations – some amendments removed bright-line disclosure requirements.

Redundant or Duplicative Requirements

The Regulation S-K and S-X Amendments eliminate a laundry list of 25 redundant and duplicative disclosures. Most of these changes are technical and nuanced related to particular Regulation S-X GAAP and other financial statement disclosures—for example, foreign currency, financial statement consolidation, income tax disclosures, contingencies and interim accounting adjustments. As these eliminations are duplicative, they will not change the financial reporting or disclosure requirements.

Overlapping Requirements

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

The proposed rule release categorized changes as either deleting a disclosure requirement or integrating a requirement with another rule. Some of the proposed changes involved a change in disclosure location, with considerations outlined above in my discussion of disclosure location.

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

In general, many of the changes proposed by the SEC relate to interim financial reporting. In some cases where items are fully required to be reported in a Form 8-K, annual report or management discussion and analysis (MD&A), the SEC has eliminated the same or similar requirement from interim financial statements. For example, the SEC eliminated significant business combination pro forma financial statement requirements from interim financial statements for smaller reporting companies and Regulation A filers. The pro forma financial statements are already sufficiently required by Item 9.01 of Form 8-K. However, at this time the SEC retained the financial reporting in interim reports for a significant business disposition or discontinued operation.

In some cases, the SEC eliminated disclosures in financial statements, leaving only the disclosure in the body of the filing. For example, the SEC eliminated segment financial information from the footnotes, leaving it only in the MD&A.

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

Not all of the proposed amendments were included in the final S-K and S-X Amendments. For example, rules related to the financial disclosure requirements related to repurchase and reverse repurchase agreements have overlapping provisions. However, the comments to the proposed elimination of these overlapping requirements prompted the SEC to retain the provisions as is, and refer the requirements to FASB for potential incorporation into U.S. GAAP. Similarly, although most of the proposed amendments related to derivative accounting were included in the final rule release, the requirement to disclose where in the statement of cash flows the effect of derivative financial instruments is reported remains, again with a referral to FASB to consider incorporation with U.S. GAAP. Likewise, disclosures related to equity compensation plans remain unchanged but were referred to FASB for potential incorporation with U.S. GAAP.

Outdated Requirements

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

Again, most of the outdated requirements are technical (for example, income-tax disclosures) in nature and beyond the scope of this blog. Some are common sense; for example, a reference to information being available in the SEC public reference room has been amended to include only a reference to the SEC Internet address for EDGAR filings. Another common-sense change is the elimination of the requirement to post the high and low bid or trading prices for each quarter for the prior two fiscal years in an annual 10-K. The SEC reasons that the daily market and trading prices of a security are readily available on a number of websites. Moreover, these websites allow for the download and collation of trading prices over periods of time and provide much more robust information than currently contained in a 10-K.

Superseded Requirements

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

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

Further Background on SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes.

On June 28, 2018, the SEC adopted amendments to the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. See HERE. The initial proposed amendments were published on June 27, 2016, (see HERE).

In October 2017, the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Capital Markets” (the “Treasury Report”). The Treasury Report made specific recommendations for change to the disclosure rules and regulations, including those related to special-interest and social issues and duplicative disclosures. See more on the Treasury Report HERE.

On October 11, 2017, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”). The proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk-factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks. See my blog HERE.. March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The new Rule goes into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018. See my blog HERE on the Item 601 rule changes and HERE related to SEC guidance on same.

On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read HERE.

The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.

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

The Author

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

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« Securities Token Or Not? A Case Study – Part III Shifting Capital Markets; Bank of America’s Merrill Lynch Exits the Penny Stock Business »