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

Wyoming’s Blockchain Legislation

Posted by Securities Attorney Laura Anthony | July 31, 2018 Tags: Wyoming’s Blockchain Legislation

Wyoming continues to position itself as a business-friendly state most recently by passing groundbreaking blockchain legislation defining cryptocurrency coins or tokens as a whole new asset class separate from securities and commodities. While it is unlikely that Wyoming’s new statutes will impact the SEC’s view that most, if not all, cryptocurrencies, or at least those issued to investors or used for capital raising, are securities, or the CFTC’s view that cryptocurrencies that are used as a medium of exchange, are a commodity, Wyoming has done what federal lawmakers have not yet endeavored – created comprehensive blockchain legislation.

In March 2018, Wyoming passed five separate bills addressing securities, corporate, banking and tax matters which could entice cryptocurrency and blockchain businesses to locate within the state. The statutes are part of an initiative in Wyoming called ENDOW – Economically Needed Diversity Options for Wyoming.

HB 19

Wyoming House Bill 19 provides an exemption for virtual currency, including bitcoin and ethereum, used within Wyoming from money transmitter laws and regulations subject to providing certain specified verification authority to the Wyoming Secretary of State and Wyoming Banking Commissioner. The specified verification authority includes representations, warranties and undertakings by the issuer of “utility tokens” to confirm beneficial ownership of the token and to prevent unauthorized or fraudulent duplication of the token by third parties.

HB 19 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

As a reminder, the CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce. Beyond instances of fraud or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. Rather, these “exchanges” are regulated as payment processors or money transmitters under state law.

However, despite the Wyoming state law exemption, businesses which issue or exchange these tokens would still be subject to FinCEN’s regulations and the requirements to comply with the Bank Secrecy Act (BSA). The BSA requires virtual currency exchangers and administrators, including those businesses that issue a virtual currency in exchange for other virtual currencies, fiat currency or types of value, to complete anti-money laundering (AML), know your customer (KYC) and other procedures to combat the financing of terrorism and prevent or detect the abuse of virtual currency to facilitate cyber-crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes. For more on FinCEN and the BSA, see HERE.

HB 70

Wyoming House Bill 70 removes utility tokens from specified securities and money transmission laws. In particular, any person that develops, sells or facilitates the exchange of an open blockchain utility token would not be required to comply with specified securities and money transmission laws subject to providing specified verification authority. The purpose of the statute is to make clear that utility tokens issued for non-investment purposes, are exempt from the Wyoming securities laws including registration and exemption provisions and broker-dealer registration requirements.

HB 70 defines an “open blockchain token” as a digital unit which is: (i) created (a) in response to the verification or collection of a specified number of transactions relating to a digital ledger or database, (b) by deploying computer code to a blockchain network that allows for the creation of digital tokens or other units, or (c) using any combination of (a) and (b); (ii) recorded in a digital ledger or database that is chronological, consensus-based, decentralized and mathematically verified, especially related to the supply of units and their distributions; and (iii) capable of being traded or transferred between persons without an intermediary or custodian of value.

HB 70 provides that the purpose of the token must be for “a consumptive purpose, which shall only be exchangeable for, or provided for the receipt of, goods, services or content, including rights of access to goods, services or content.”

Furthermore, HB 70 would not apply where the developer or seller of the token sold the token to the initial buyer as a financial investment. The requirement that the token not be an investment can only be satisfied if: (i) the developer or seller does not market the token as a financial investment; and (ii) at least one of the following is true: (a) the developer or seller reasonably believed that it sold the token for a consumptive purpose; (b) the token has a consumptive purpose that is available at the time of sale and can be used at or near the time of sale; (c) if the token does not have a consumptive purpose at the time of sale, the token is prevented from being resold until the consumptive purpose is available; or (d) the developer or seller takes other reasonable precautions to prevent the buyers from purchasing the token as a financial investment.

The SEC has been clear in numerous statements that it believes that tokens that are issued for the purpose of capital raising and an increase in value, are securities offerings that must comply with the federal securities laws. The SEC’s position relates to factors such as the method of issuance and sale of the tokens, use of proceeds, investment intent and expectation of profit, ability to increase value, whether the “utility” has been built out or established, and ability for secondary trading. The SEC has specifically not taken into account the ultimate utility value of the token, nor directly answered the oft asked question of whether a token that is issued in a securities offering, can then morph into a commodity or other asset class, not subject to the securities laws. It is my view, and the general view of the marketplace, that “utility tokens” can be sold in a “securities offering.”

Although the Wyoming statute attempts to address the investment intent, and even appears to attempt to address the SEC main criteria, I would suggest that issuers of any tokens should continue to comply with the federal securities laws until there is further guidance and certainty at the federal level.

SF 111

SF 111 provides that virtual currency is not subject to taxation as “property” in Wyoming. That is, virtual currency would be treated as personal property, not subject to Wyoming property taxes. SF 111 amends a prior statute that exempted money and cash on hand, currency, gold, silver and related items by adding virtual currencies. Like HB 19, SF 111 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

HB 101

HB 101 allows for the maintenance of corporate records of Wyoming entities via blockchain that utilizes electronic keys, network signatures and digital receipts. In particular, the Act authorizes the use of electronic networks or databases for the creation or maintenance of corporate records, authorizes the use of a data address to identify shareholders, authorizes the acceptance of shareholder votes if signed by a network signature that corresponds to a data address and specifies the requirements for the use of electronic networks and databases. In addition, the Act requires the secretary of state to review and update its rules for consistency.

HB 126

HB 126 allows the creation and use of “series LLC’s.” Delaware is well known for its series LLC statute. Series LLC have become popular in the blockchain space and accordingly it is thought that this will attract blockchain-based businesses.

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 review of the CFTC’s role and position on cryptocurrencies, 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 platforms that trade cryptocurrencies and more on the continued regulatory confusion in the space, see HERE.

For information on FinCEN’s role and requirements related to the cryptocurrency marketplace, including requirements for issuers of ICOs, see HERE.

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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« Proposed SPAC Rule Changes SEC Issues Additional C&DI On Use Of Non-GAAP Measures »

Proposed SPAC Rule Changes

Posted by Securities Attorney Laura Anthony | July 24, 2018 Tags: Proposed SPAC Rule Changes

With the growing popularity of special purpose acquisition companies (SPACs), both the Nasdaq and NYSE have proposed rule changes that would make listings easier, although on June 1, 2018, the Nasdaq withdrew its proposal. SPACs raised more money last year than any year since the financial crisis. The SEC has been delaying action on the proposed rule changes, now pushing off a decision until at least August 2018.

A company that registers securities as a blank check company and whose securities are deemed a “penny stock” must comply with Rule 419 and thus are not eligible to trade. A brief discussion of Rule 419 is below. A “penny stock” is defined in Rule 3a51-1 of the Exchange Act and like many definitions in the securities laws, is inclusive of all securities other than those that satisfy certain delineated exceptions. The most common exceptions, and those that would be applicable to penny stocks for purpose of the SPAC, include: (i) have a bid price of $5 or more; or (ii) 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. For more on penny stocks, see HERE.

For purposes of this blog, the discussion of “SPACs” refers to trading SPACs and thus those that are not required to comply with the provisions of Rule 419. However, I have included information on the protections afforded through Rule 419, and thus not included in a SPAC, and a brief summary of the Rule 419 requirements.

What is a SPAC?

A special purpose acquisition company (SPAC) is a blank check company formed for the purpose of effecting a merger, share exchange, asset acquisition, or other business combination transaction with an unidentified target. Generally, SPACs are formed by sponsors who believe that their experience and reputation will facilitate a successful business combination and public company. SPACs are often sponsored by investment banks together with a leader in a particular industry (manufacturing, healthcare, consumer goods, etc.) with the specific intended purpose of effecting a transaction in that particular industry. However, a SPAC can be sponsored by an investment bank alone, or individuals without an intended industry focus.

The sponsor of a SPAC contributes 10% of the total post initial public offering (IPO) capital of the company. The sponsor’s 10% capital is used to cover the IPO and ongoing SEC reporting and administration expenses. Although a sponsor will invest 10% of the capital, they typically receive founder’s shares in the SPAC that results in approximately 20% ownership in the post IPO company. Sponsors do not make money unless a successful business combination is completed and the value of their ownership increases enough to justify the time and capital commitment of acting as a sponsor.

When a SPAC completes its IPO, usually 100%, but in no event less than 90%, of the funds raised are held in escrow to be released either upon completion of a business combination transaction, or back to shareholders in the event a transaction is not completed within a set period of time. A SPAC business combination must have a market value of at least 80% of the value of the amount held in escrow at the time of the agreement to enter into the transaction. Shareholders that object to the business combination have the right to convert their shares into a pro rata share of the funds held in escrow.

A SPAC generally has 24 months to complete a business combination; however, it can get up to one extra year with shareholder approval. If a business combination is not completed within the set period of time, all money held in escrow goes back to the shareholders and the sponsors will lose their investment.

SPAC IPOs are usually structured as unit offerings with both stock and warrants to entice investors to bet on the unknown future opportunity. The number of warrants and exercise price can vary and usually have a direct correlation to the prominence and track record of the sponsors and underwriters. That is, the more prominent the sponsor and underwriter, the fewer warrants and higher the strike price. As an alternative to warrants, some SPAC sponsors agree to over-fund the IPO trust account by some multiple to the investment amount, which over-funded amount would be distributed to the SPAC investors if a business combination is not completed.

The SPAC IPO process is the same as any other IPO process. That is, the SPAC files a registration statement on Form S-1 that is subject to a comment, review, and amend process until the SEC clears comments and declares the registration statement effective. Concurrent with the S-1 process, the SPAC will either have applied for a listing on a national exchange or, following the closing of the offering, will work with a market maker who will file a Form 211 application with FINRA to receive a trading symbol to trade on the OTCQX.

At the time of its IPO, the SPAC cannot have identified a business combination target; otherwise, it would have to provide disclosure regarding that target in its IPO registration statement. Moreover, most SPACs (or all) will qualify as an emerging growth company (EGC) and will be subject to the same limitations on communications as any other IPO for an EGC. See HERE related to an IPO process in general; HERE related to testing the waters and public communications during the IPO process; and HERE related to a Form 211 application.

When trading commences, investors can trade out of their shares, choosing to attempt to make a short-term profit while the company is looking for a business opportunity. Likewise, buyers of SPAC shares in the secondary market are generally either planning to quickly trade in and out for a short-term profit or betting on the success of the eventual merged entity. If a deal is not closed within the required time period, holders of the outstanding shares at the time of liquidation receive a distribution of the IPO proceeds that have been held in escrow.

Upon entering into an agreement for a business combination, the SPAC will file an 8-K regarding same and then proceed with the process of getting shareholder approval for the transaction. The SPAC must offer each public shareholder the right to redeem their shares and request a vote on whether to approve the transaction. Shareholder approval is solicited in accordance with Section 14 of the Exchange Act, generally using a Schedule 14A, and must include delineated disclosure about the target company, including audited financial statements.

Upon approval of the business combination transaction, the funds in escrow will be released and used to satisfy any redemption requests and to pay for the costs of the transaction. Target companies generally require that a certain amount of cash remain after redemptions, as a precondition to a closing of the transaction. As will be discussed further below, the exchanges all require that the newly combined company satisfy their particular continued listing requirements.

SPACs are, by nature, “shell companies” as defined by the federal securities laws. Accordingly, SPACs have all the same limitations as other shell companies, including, but not limited to:

A SPAC is an ineligible issuer that is not entitled to use a free writing prospectus in its IPO or subsequent offerings within three years of completing a business combination.
After completing the IPO and until it completes a business combination, the SPAC must identify its shell company status on the cover of its Exchange Act periodic reports.
A SPAC cannot use a Form S8 to register any management equity plans until 60 days after completing a business combination.
Holders of SPAC securities may not rely on Rule 144 for resales of their securities after the SPAC completes a business combination until one year after the company has filed current “Form 10” information (i.e., the information that would be required if the company were filing a Form 10 registration statement) with the SEC reflecting its status as an entity that is no longer a shell company and so long as the SPAC remains current in its SEC reporting obligations.

OTCQX SPAC Eligibility

The OTCQX tier of OTC markets allows for the listing and trading of SPACs and is the only tier of OTC Markets that does so. OTC Markets Group will consider on a case-by-case basis the listing of a SPAC that satisfies all of the eligibility requirements for the OTCQX other than the general prohibition against shell and blank check companies (for a full list of requirements, see HERE), and in addition must satisfy the following requirements:

a) As of the most recent annual or quarterly period end, have $25 million in net tangible assets;
b) Have a minimum bid price of $5.00 per share as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX; and
c) Be an SEC Reporting Company or a Regulation A Reporting Company.

Nasdaq Proposed Rule Changes

Nasdaq had proposed rule changes to its SPAC listing requirements reducing the number of required round lot shareholders (i.e., shareholders that own at least 100 shares) from 300 to 150 and to likewise eliminate the 300-round lot shareholder continued listing requirement. Round-lot requirements are meant to assure that public companies have a deep enough investor base to encourage stable trading and limit price volatility. However, Nasdaq asserts that price volatility is less of a concern with a SPAC as it has no operations and at least 90% of the cash that a SPAC raises in an IPO must be held in escrow until a business combination is completed.

Nasdaq also wanted to require that a SPAC listed on the Nasdaq Capital Market maintain at least $5 million in net tangible assets to ensure that the SPAC does not fall within the definition of a penny stock. The proposed rules would have imposed a 30-day deadline for SPACs listed on any of its three markets to demonstrate compliance with initial listing requirements following a merger. However, on June 1, 2018 Nasdaq withdrew its proposal without further explanation.

NYSE Proposed Rule Change

The NYSE has effectuated a series of rule changes related to SPACs throughout 2017. In particular, the NYSE now requires a majority of the SPAC’s independent directors to approve the business combination. In addition, the NYSE as changed the continued listing distribution standard from a requirement of 300 total stockholders to a requirement of 300 public stockholders. The NYSE also now specifically allows a company to follow the tender offer rules under Section 14 of the Exchange Act in lieu of the proxy rules under the same section, to solicit shareholder approval and redemptions related to business combinations.

The more recent November 2017 proposed changes are more substantial, mirroring the Nasdaq proposed rule changes. Like Nasdaq, the NYSE has proposed cutting the minimum number of required odd lot shareholders in half from 300 to 150. The NYSE has also proposed adding a $5 million minimum capital requirement to ensure that SPAC securities could not be deemed a penny stock. Upon completion of a business acquisition, the new combined company would have a 30-day grace period to prove continued listing eligibility.

Rule 419

The provisions of Rule 419 apply to every registration statement filed under the Securities Act of 1933, as amended, by a blank check company that is issuing securities which fall within the definition of a penny stock. A “penny stock” is defined in Rule 3a51-1 of the Exchange Act and like many definitions in the securities laws, is inclusive of all securities other than those that satisfy certain delineated exceptions. The most common exceptions, and those that would be applicable to penny stocks for purpose of this Rule 419 discussion, include: (i) have a bid price of $5 or more; or (ii) 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.

Rule 419 requires that a blank check company filing a registration statement deposit the securities being offered and proceeds of the offering into an escrow or trust account pending the execution of an agreement for an acquisition or merger. The securities of a blank check company which is required to comply with Rule 419 are not eligible to trade, but rather must remain in escrow.

Rule 419 of the Securities Act imposes certain obligations and restrictions upon issuers that are deemed to be “blank check” companies under applicable rules and regulations. Blank check companies generally lack any revenues, assets, operating history or plan of operations. Among other things, Rule 419 requires that nearly all of a “blank check” issuer’s offering proceeds be placed in escrow until the issuer has completed a business combination. All of a “blank check” company’s securities must also be placed in escrow until after the completion of a business combination, and no trading may occur until the issuer’s securities have been released from escrow. Notably, the definition of a “blank check” company set forth in Rule 419 excludes issuers whose outstanding shares are not deemed to be “penny stock.” In turn, the definition of “penny stock” set forth in Rule 3a51-1 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), provides an exception for issuers with less than three years of operations who have a minimum of $5 million in net assets.

The staff of the SEC has previously determined through interpretive guidance that, to the extent an issuer files a current report on Form 8-K promptly upon consummation of an IPO indicating that net assets are in excess of $5 million, the staff will not deem the issuer to be a blank check company subject to the requirements of Rule 419. As a result, SPACs generally file such a current report on Form 8-K once the IPO is consummated, thereby avoiding the restrictions imposed by the requirements of Rule 419.

Companies subject to Rule 419 are required to file a post-effective amendment to the registration statement containing the same information as found in a Form 10 registration statement on the target company. The post-effective amendment must be filed upon the execution of an agreement for an acquisition or merger. The Rule provides procedures for the release of the offering funds held in escrow in conjunction with the post-effective acquisition or merger. The obligations to file post-effective amendments are in addition to the obligations to file Forms 8-K to report both the entry into a material non-ordinary course agreement and the completion of the transaction. Rule 419 applies to both primary and re-sale or secondary offerings.

Within five (5) days of filing a post-effective amendment setting forth the proposed terms of an acquisition, the company must notify each investor whose shares are in escrow. Each investor then has no fewer than 20 and no greater than 45 business days to notify the company in writing if they elect to remain an investor. A failure to reply indicates that the person has elected to not remain an investor. As all investors are allotted this second opportunity to determine to remain an investor, acquisition agreements should be conditioned upon having enough funds remaining in escrow to close the transaction.

For purposes of Rule 419, the term “blank check company” means a company that:

Is a development stage company that has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person; and
Is issuing “penny stock,” as defined in Rule 3a51-1 under the Securities Exchange Act of 1934.

The Author

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« SEC Amends Definition of “A Smaller Reporting Company” Wyoming’s Blockchain Legislation »

SEC Amends Definition of “A Smaller Reporting Company”

Posted by Securities Attorney Laura Anthony | July 17, 2018 Tags: SEC, Smaller Reporting Company

On June 28, 2018, the SEC adopted the much-anticipated 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. The amendments come almost two years to the day since the initial publication of proposed rule changes (see HERE).

Among other benefits, it is hoped that the change will help encourage smaller companies to access US public markets. The amendment expands the number of companies that qualify as a smaller reporting company (SRC) and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The SEC estimates that an additional 966 companies will be eligible for SRC status in the first year under the new definition.

As proposed, and as recommended by various market participants, the new definition of a SRC will now include companies with less than a $250 million public float as compared to the $75 million threshold in the prior definition. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million and only included companies with no ascertainable public float.

Once considered a SRC, a company would maintain that status unless its float drops below $200 million if it previously had a public float of $250 million or more. The revenue thresholds have been increased for requalification such that a company can requalify if it has less than $80 million of annual revenues if it previously had $100 million or more, and less than $560 million of public float if it previously had $700 million or more.

The SEC also made related rule changes to flow through the increased threshold concept. In particular, Rule 3-05 of Regulation S-X has been amended to increase the net revenue threshold in the rule from $50 million to $100 million. As a result, companies may omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 if the net revenues of that business are less than $100 million.

Furthermore, the conforming changes include changes to the cover page for most SEC registration statements and reports including, but not limited to, Forms S-1, S-3, S-4, S-11, 10-Q and 10-K.

The new rules did not change the definitions of either “accelerated filer” or “large accelerated filer.”As a result, companies with $75 million or more of public float that qualify as SRCs will remain subject to the requirements that apply to accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chair Clayton as directed the SEC staff to make recommendations for additional changes to the definitions to reduce the number of companies that would qualify as accelerated filers.

Background

The topic of disclosure requirements under Regulation S-K as pertains to disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) have come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act.

A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC (“Reporting Requirements”). The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner. Over the years Regulation S-K has not been kept current with other Rule changes, the arduous reporting requirements for smaller companies has resulted in stifled capital formation and fewer smaller IPOs, and investors have questioned the quality and relevancy of information required to be included in reports.

The SEC disclosure requirements are scaled based on company size. The SEC established the smaller reporting company category in 2007 to provide general regulatory relief to these entities. Prior to this rule change, a “smaller reporting company” was defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter; or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

The following table, copied from the SEC rule release, summarizes the scaled disclosure accommodations available to smaller reporting companies:

Regulation S-K
Item	Scaled Disclosure Accommodation
101 − Description of Business	May satisfy disclosure obligations by describing the development of its business during the last three years rather than five years. Business development description requirements are less detailed than disclosure requirements for non- smaller reporting companies.
201 − Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters	Stock performance graph not required.
301 – Selected Financial Data	Not required.
302 – Supplementary Financial Information	Not required.
303 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)	Two-year MD&A comparison rather than three-year comparison. Two year discussion of impact of inflation and changes in prices rather than three years. Tabular disclosure of contractual obligations not required.
305 – Quantitative and Qualitative Disclosures About Market Risk	Not required.
402 – Executive Compensation	Three named executive officers rather than five. Two years of summary compensation table information rather than three. Not required: · Compensation discussion and analysis. · Grants of plan-based awards table. · Option exercises and stock vested table. · Pension benefits table. · Nonqualified deferred compensation table. · Disclosure of compensation policies and practices related to risk management. · Pay ratio disclosure.
Regulation S-K
Item	Scaled Disclosure Accommodation
404 – Transactions With Related Persons, Promoters and Certain Control Persons16	Description of policies/procedures for the review, approval or ratification of related party transactions not required.
407 – Corporate Governance	Audit committee financial expert disclosure not required in first year. Compensation committee interlocks and insider participation disclosure not required. Compensation committee report not required.
503 – Prospectus Summary, Risk Factors and Ratio of Earnings to Fixed Charges	No ratio of earnings to fixed charges disclosure required. No risk factors required in Exchange Act filings.
601 – Exhibits	Statements regarding computation of ratios not required.
Regulation S-X
Rule	Scaled Disclosure
8-02 – Annual Financial Statements	Two years of income statements rather than three years. Two years of cash flow statements rather than three years. Two years of changes in stockholders’ equity statements rather than three years.
8-03 – Interim Financial Statements	Permits certain historical financial data in lieu of separate historical financial statements of equity investees.
8-04 – Financial Statements of Businesses Acquired or to Be Acquired	Maximum of two years of acquiree financial statements rather than three years.
8-05 – Pro forma Financial Information	Fewer circumstances under which pro forma financial statements are required.
8-06 – Real Estate Operations Acquired or to Be Acquired	Maximum of two years of financial statements for acquisition of properties from related parties rather than three years.
8-08 – Age of Financial Statements	Less stringent age of financial statements requirements.

Final Amendments to Smaller Reporting Company Definition

The SEC has competing goals of protecting investors and the marketplace through requiring companies to provide disclosure needed to make informed investment and voting decisions and promoting capital formation and reducing compliance costs for smaller companies. The SEC believes that by raising the financial thresholds for the smaller reporting company definition and thereby expanding the number of companies eligible to use the available scaled disclosure, it will be satisfying its goals and appropriately responding to comments and recommendations by the Advisory Committee on Small and Emerging Growth Companies, the SEC Government Business Forum on Small Business Capital Formation, Congress and industry commenters.

The SEC summarizes many of these recommendations, initiatives and comments in its rule release. For example, 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 a summary of the recommendations, see my blog HERE. The FAST Act, which was passed into law on December 4, 2015, required the SEC to scale or eliminate duplicative, antiquated or unnecessary disclosure requirements for emerging growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K.

The SEC considered comments it received to the initial proposed rule release (see HERE) and comments it received in response to the published concept release and request for public comment on Regulation S-K. My two-part blog on that concept release can be read HERE and HERE. As indicated above, the new definition of a SRC will now include companies with less than a $250 million public float as compared to the $75 million threshold in the prior definition. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million and only included companies with no ascertainable public float.

Furthermore, the conforming changes include changes to the cover page for most SEC registration statements and reports including, but not limited to, Forms S-1, S-3, S-4, S-11, 10-Q and 10-K.

My blog HERE contains a summary of the scaled disclosures available to smaller reporting companies. In addition, the FAST Act, passed into law on December 4, 2015, amended Form S-1 to allow for forward incorporation by reference by smaller reporting companies. A smaller reporting company may now incorporate any documents filed by the company, following the effective date of a registration statement, into such effective registration statement. In what was probably unintended in the drafting, the FAST Act changes only include smaller reporting companies and not emerging growth companies or non-accelerated filers. Other categories of filers, including accelerated and large accelerated filers, were already allowed to forward incorporate by reference. Accordingly, among the other benefits of the current proposed rule change, the number of companies that can utilize forward incorporation by reference in a Form S-1 will increase.

Amendments to Accelerated Filer and Large Accelerated Filer Definitions

The new rules did not change the definitions of either “accelerated filer” or “large accelerated filer.”As a result, companies with $75 million or more of public float that qualify as SRCs will remain subject to the requirements that apply to accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chair Clayton has directed the SEC staff to make recommendations for additional changes to the definitions to reduce the number of companies that would qualify as accelerated filers.

The public float threshold for an accelerated filer is $75 million. Companies that currently file as an accelerated filer would continue to do so under the new rules, but would be able to benefit from the scaled disclosure requirements available to smaller reporting companies. The filing deadlines for each category of filer are:

Filer Category	Form 10-K	Form 10-Q
Large Accelerated Filer	60 days after fiscal year-end	40 days after quarter-end
Accelerated Filer	75 days after fiscal year-end	40 days after quarter-end
Non-accelerated Filer	90 days after fiscal year-end	45 days after quarter-end
Smaller Reporting Company	90 days after fiscal year-end	45 days after quarter-end

Statements of Commissioners on Rule Amendment

Commissioners Hester Peirce and Michael Piwowar made public statements regarding the rule change both supporting the amendment but expressing disappointment that it did not also include a change in the definition of an accelerated filer. Both commissioners think it is not enough to reduce regulatory burdens to encourage more companies to go public. Section 404(b) of the Sarbanes-Oxley Act is one of the largest burdens that face smaller public companies and Commissioner Piwowar believes that until that is changed, there will be no improvement in efforts to raise capital by smaller companies. Ms. Peirce goes further, stating that the failure to make a conforming change to the definition of an accelerated filer will actually be confusing to companies. That is, prior to the rule change, a smaller reporting company was always exempted from Section 404(b) compliance; however, now that will not be the case.

Ms. Peirce points to a poignant example from the comment letters. A group of biotech companies rightfully stated that money spent on compliance is less money spent on research and development and that investors in a smaller biotech company are more interested in getting FDA approval than the auditors’ blessing on internal controls.

On the upside, Chair Clayton has committed to continue to review this matter and work on changes to the definition of accelerated filer and/or changes to the requirements of 404(b) compliance.

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« FinCEN’S Role In Cryptocurrency Offerings Proposed SPAC Rule Changes »

FinCEN’S Role In Cryptocurrency Offerings

Posted by Securities Attorney Laura Anthony | July 10, 2018 Tags: Cryptocurrecy, Cryptocurrecy Offerings, Cryptos, FinCEN, FinCEN’S Role In Cryptocurrecy Offerings

In the continuing dilemma over determining just what kind of asset a cryptocurrency is, multiple regulators have expressed opinions and differing views on regulations. Likewise, multiple regulators have conducted investigations and initiated enforcement proceedings against those in the cybersecurity space. The SEC has asserted the opinion that most, if not all, cryptocurrencies are securities; the CFTC has found them to be commodities; the IRS’s official definition is the same as the CFTC, and in particular a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, and now the Financial Crime Enforcement Network (FinCEN) has asserted that issuers of cryptocurrencies are money transmitters.

In particular, in a letter written to the US Senate Committee on Finance on February 13, 2018, FinCEN indicates that it expects issuers of initial coin offerings (ICOs) to comply with the Bank Secrecy Act (BSA), including its anti-money laundering (AML) and know your customer (KYC) requirements. FinCEN’s letter responded to a December 14, 2017 directed to it from the US Senate Committee on Finance requesting information on FinCEN’s oversight and enforcement capabilities over virtual currency financial activities. As with other agencies such as the SEC and CFTC, FinCEN desires to promote the financial innovation that can come with blockchain technology and cryptocurrencies, while preventing criminals, hackers, sanctions evaders and hostile foreign actors.

Virtual currency exchanges and administrators

FinCEN has been working with the Office of Terrorism and Financial Intelligence (FTI) to ensure that AML and procedures to combat the financing of terrorism apply to virtual currency exchanges and administrators that are in the US or do business in whole or part in the US, but do not have a physical presence here. Virtual currency exchanges and administrators have been subject to the BSA’s money transmitter requirements since 2011. In 2013 FinCEN issued specific guidance that explicitly states that virtual currency exchangers and administrators are money transmitters that must comply with the BSA. An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency or other value that substitutes for currency, is a money transmitter that is subject to the BSA.

To assist in identifying risks and the illicit use of virtual currency, including the abuse of virtual currency to facilitate cyber crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes, FinCEN examines BSA filings from virtual currency money services businesses (MSB) and other emerging payments providers, including filings pertaining to digital coins, tokens and ICOs. Trends, red flags and risks and reported to US law enforcement and other governmental agencies.

Entities that are subject to the BSA must: (i) register with FinCEN as a MSB; (ii) prepare a written AML compliance program that is designed to mitigate risks, including AML risks, and to ensure compliance with all BSA requirements including the filing of suspicious activity reports (SAR) and currency transaction reports; (iii) keep records for certain types of transactions at specific thresholds; and (iv) obtain customer identification information sufficient to comply with the AML program and recordkeeping requirements.

SAR reports that are filed with FinCEN have identifying information about the owner/customer. In cases where a bitcoin address is identified, FinCEN performs a blockchain analysis which can often enable investigators to tie it to a virtual currency exchanger, hosted wallet, or other source that may have the identity of the account owner. Blockchain network analytic tools can also tie a targeted bitcoin address to other persons that have transacted with a particular bitcoin address. The investigative process may involve the issuance of subpoenas and FinCEN cooperates with law enforcement to help identify and trace bitcoin used in criminal activity.

FinCEN also conducts reviews and exams of registered MSBs. Of the approximate 100 registered entities, FinCEN has examined approximately one-third and has initiated several enforcement proceedings as a result of those exams. However, financial crimes and terrorism are international issues and not all countries regulate virtual currency businesses or require them to keep records. Accordingly, FinCEN has been working to encourage foreign countries to regulate these businesses and to cooperate in criminal investigations.

ICO issuers

FinCEN is working with the SEC and CFTC to clarify and enforce AML and counterterrorism obligations of businesses that engage in ICO activities. Although the FinCEN letter indicates that the obligation to comply with the BSA and its ensuing AML, registration, SAR and other requirements depends on the nature of the financial activity and a facts-and-circumstances analysis, ICO participants have unilaterally interpreted the FinCEN letter as requiring all ICO issuers to comply in one way or another.

FinCEN specifically states that an issuer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value, including fiat currency, is a money transmitter that must register as an MSB and comply with the BSA, including AML and KYC procedures. However, to the extent that an ICO involves the sale of securities or derivatives that would be under the jurisdiction of the SEC through its regulation of broker-dealers or CFTC through its regulation of merchants and brokers in commodities, those entities could comply with the SEC and CFTC’s AML and counterterrorism requirements.

The Securities Exchange Act of 1934 (“Exchange Act”) specifically requires brokerage firms to comply with the BSA and FinCEN rules. Brokerage firms are also required to comply with AML rules established by FINRA, including FINRA Rule 3310. The purpose of the AML rules is to help detect and report suspicious activity including the predicate offenses to money laundering and terrorist financing, such as securities fraud and market manipulation. FINRA also provides a template to assist small firms in establishing and complying with AML procedures.

In May 2016, FinCEN issued new final rules under the BSA requiring financing institutions, including brokerage firms, to adopt additional anti-money laundering (AML) procedures that include specific due diligence and ongoing monitoring requirements related to customer risk profiles and customer information. The rules also require financial institutions to collect and verify information about beneficial owners and control person of legal entity customers. My blog on those rules can be read HERE.

FinCEN requires that financial institutions address the following four key elements in all of their AML programs: (i) customer identification and verification; (ii) beneficial ownership identification and verification; (iii) understanding the nature and purpose of customer relationships to develop risk profiles; and (iv) ongoing monitoring for reporting suspicious transactions and maintaining and updating customer information.

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 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 review of the CFTC role and position on cryptocurrencies, 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 platforms that trade cryptocurrencies and more on the continued regulatory confusion in the space, see HERE.

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« Regulation A For Publicly Reporting Companies, Economic Growth and Regulatory Relief SEC Amends Definition of “A Smaller Reporting Company” »

Regulation A For Publicly Reporting Companies, Economic Growth and Regulatory Relief

Posted by Securities Attorney Laura Anthony | July 3, 2018 Tags: Regulation A, Regulation A For Publicly Reporting Companies

Regulation A+ will soon be available for publicly reporting companies. On May 24, 2018, President Trump signed the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”) into law. Although the Act largely focuses on the banking industry and is being called the Dodd-Frank Rollback Act by many, it also contained much-needed provisions amending Regulation A+ and Rule 701 of the Securities Act.

The Act also amends Section 3(c)(1) of the Investment Company Act of 1940 to create a new category of pooled fund called a “qualifying venture capital fund,” which is a fund with less than $10,000,000 in aggregate capital contributions. A qualifying venture capital fund is exempt from the registration requirements under the 1940 Act as long as it has fewer than 250 investors. Section 3(c)(1) previously only exempted funds with fewer than 100 investors. The amendment is effective immediately and does not require rulemaking by the SEC, although I’m sure it will be followed by conforming amendments.

Giving strength to the annual Government-Business Forum on Small Business Capital Formation (the “Forum”), the Act amends Section 503 of the Small Business Investment Incentive Act of 1980 to require the SEC to review the findings and recommendations of the Forum and to promptly issue a public statement assessing the finding or recommendation and disclosing the action, if any, the SEC intends to take with respect to the finding or recommendation. For a review of the finding and recommendation of the 2017 Forum, see HERE. This provision is effective immediately without the requirement of further action.

Regulation A

Section 508 of the Act directs the SEC to amend Regulation A+ to remove the provision making companies subject to the SEC Securities Exchange Act reporting requirements ineligible to use Regulation A/A+ and to add a provision such that a company’s Exchange Act reporting obligations will satisfy Regulation A+ reporting requirements.

I have often blogged about this peculiar eligibility standard. Although Regulation A is unavailable to Exchange Act reporting companies, a company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to use Regulation A. Moreover, a company that was once subject to the Exchange Act reporting obligations but suspended such reporting obligations by filing a Form 15 is eligible to utilize Regulation A. A wholly owned subsidiary of an Exchange Act reporting company parent is eligible to complete a Regulation A offering as long as the parent reporting company is not a guarantor or co-issuer of the securities being issued. It just didn’t make sense to preclude Exchange Act reporting issuers, and the marketplace has been vocal on this.

In September 2017 the House passed the Improving Access to Capital Act, which would allow companies subject to the reporting requirements under the Exchange Act to use Regulation A/A+. See HERE. OTC Markets also petitioned the SEC to eliminate this eligibility criterion, and pretty well everyone in the industry supports the change. For more information on the OTC Markets’ petition and discussion of the reasons that a change is needed in this regard, see my blog HERE.

As noted, the Act directs the SEC to amend Regulation A to enact the changes; however, the timing remains unclear. Whereas many provisions in the Act have specific timing requirements, including a requirement that the changes to Rule 701 be completed within 60 days, Section 508 has no timing provisions at all.

For a recent comprehensive review of Regulation A/A+, see HERE.

Rule 701

Rule 701 of the Securities Act provides an exemption from the registration requirements for the issuance of securities under written compensatory benefit plans. Rule 701 is a specialized exemption for private or non-reporting entities and may not be relied upon by companies that are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (“Exchange Act”). The Rule 701 exemption is only available to the issuing company and may not be relied upon for the resale of securities, whether by an affiliate or non-affiliate.

Section 507 of the Act directs the SEC to increase Rule 701’s threshold for providing additional disclosures to employees from aggregate sales of $5,000,000 during any 12-month period to $10,000,000. In addition, the threshold is to be inflation-adjusted every five years. The amendment must be completed within 60 days.

For a review of Rule 701, including recent guidance, see HERE.

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« SEC Spring 2018 Regulatory Agenda FinCEN’S Role In Cryptocurrency Offerings »

SEC Spring 2018 Regulatory Agenda

Posted by Securities Attorney Laura Anthony | June 26, 2018 Tags: SEC Chairman Jay Clayton, SEC Spring 2018 Regulatory Agenda

On May 9, 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. According to the preamble, information in the agenda was accurate as of March 13, 2018. On April 26, 2018, SEC Chairman Jay Clayton gave testimony before the Financial Services and General Government Subcommittee of the House Committee on Appropriations regarding the SEC’s requested fiscal year 2019 budget. This blog will summarize the newest regulatory agenda and SEC upcoming budgetary requests.

Usually the agenda is separated into two categories: (i) Existing Proposed and Final Rule Stages; and (ii) Long-term Actions. The Spring 2018 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 have been consistently reduced in each agenda over the last two years. The newest agenda has 21 items, the semiannual list published in December, 2017 had 26, the July 2017 list contained 33 legislative action items to be completed, and the prior Fall 2016 list had 62 items.

Whereas the agenda concentrates on specific rulemaking, the SEC’s budget request seems more focused on the SEC’s need to modernize its information technology infrastructure and improve cybersecurity risk management. Of course budgetary needs encompass enforcement which would not appear on a rulemaking agenda. Chair Jay Clayton does, however, address the regulatory agenda in his budget request testimony, specifically noting that the reduced number of items on the short term regulatory list does not indicate a shift in the SEC’s needs and focus, but rather is meant to be more realistic regarding what the SEC can accomplish in a 12-month period.

Whereas the SEC asked for an increase of $100 million in its budget for fiscal year 2018, the current requested increase is $60 million from $1.652 billion to $1.658 billion. Chair Clayton’s particular areas of focus include (i) leveraging technology and enhancing cybersecurity and risk management; (ii) facilitating capital formation; (iii) protecting Main Street investors through multiple channels, including focusing on the most vulnerable investors, markets that are fertile ground for fraud and market integrity efforts such as combating insider trading, market manipulation and accounting fraud; (iv) maintaining effective oversight of changing markets; and (v) supporting SEC leasing efforts. The increased budget would also lift the current hiring freeze and allow the hiring of approximately 100 positions to help fill the approximately 400 position that were lost during the freeze.

Related to technology and cybersecurity, the SEC has an immediate plan to (i) invest in information security to improve monitoring, protect against advanced persistent threats and strengthen risk management; (ii) retire antiquated IT systems to improve cybersecurity; (iii) expand data analytics tools to facilitate earlier detection of potential fraud or suspicious behavior and better identify high-risk activities deserving examination; and (iv) modernize the EDGAR electronic filing system to make it more secure, more useful for investors and less burdensome for filers. For more information on the SEC’s cybersecurity efforts and the EDGAR hacking, see HERE and HERE

Regarding the need to facilitate capital formation, Chair Clayton testified about different initiatives the SEC has already undertaken, such as the staff rule allowing confidential submissions of registration statements (see HERE). On a forward-looking basis, Chair Clayton admits that there is a need to encourage small and emerging growth companies to access public markets; however, he does not make any particular suggestions, but rather just states that the SEC is trying to come up with ideas and initiatives.

In the area of protections for Main Street investors and markets, the SEC is focused on conduct by investment advisors and broker-dealers. Where Clayton sees the need to increase standards of conduct for both investment advisors and broker-dealers, he, like many in the marketplace, is not an advocate of the Department of Labor’s fiduciary rule. The SEC also supports “vigorous enforcement” against fraud and improper market activity by both market insiders such as investment advisors and broker-dealers, and by all market participants.

The Unified Agenda of Regulatory and Deregulatory Actions

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.

The first Agendas published after the 2016 presidential election stated that the Agenda “represents the beginning of fundamental regulatory reform and a reorientation toward reducing unnecessary regulatory burden on the American people.” Furthermore, the Office states, “[B]y amending and eliminating regulations that are ineffective, duplicative, and obsolete, the Administration can promote economic growth and innovation and protect individual liberty.”

Executive Orders 13771 and 13777 require agencies to reduce unnecessary regulatory burden and to enforce regulatory reform initiatives. Each agency was requested to carefully consider the costs and benefits of each regulatory or deregulatory action and to prioritize to maximize the net benefits of any regulatory action. The SEC is not the only agency with a reduced Agenda. Agencies withdrew over 1,600 actions that were initially proposed in the Fall 2016 Agenda. Also, adding transparency for those of us who like to stay up on these matters, the agencies will now post and make public their list of “inactive” rules.

SEC Flex Regulatory Agenda

Only 11 items are listed in the final rule stage. On the Agenda in the final rule stages are Regulation S-K disclosure updates and simplification rule changes we have all expected. The proposed rule change was issued in October 2017, a summary of which can be read HERE. Business, Financial and Management Disclosure Required by Regulation S-K remains in the proposed rule stage, continuing the topic of disclosure reform.

Included in the final rule stage are amendments to the smaller reporting company definition (see HERE), and regulation of NMS Stock Alternative Trading Systems. Amendments to the interactive data (XBRL) program have been moved up from proposed to final rule stage since July 2017.

Disclosure on hedging by employees, officers and directors was moved from long-term action to 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. Also moved from proposed to final is implementation of FAST Act report recommendations (see HERE).

Also included for final rules are amendment to the SEC’s Freedom of Information Act Regulations, modernization of property disclosure for mining companies, investment company reporting modernization and amendments to the Investment Advisers Act, disclosure or order handling information, and amendments to municipal securities rules.

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) which were previously on the long-term list; financial disclosures about entities other than the registrant (see HERE), disclosure of payments by resource extraction issuers, amendments to the financial disclosure for registered debt security offerings, filing fee processing updates, bank holding company disclosures, exchange traded funds, auditor independence with respect to loans or debtor-creditor relationships, amendments related to fair access to investment research, fund of fund arrangements, investment company liquidity disclosure, and amendments to the Whistleblower Program Rules.

Rule on disclosure for unit investment trusts and offering variable insurance products, use of derivatives by registered investment companies and business development companies, Business, Financial and Management Disclosure Required by Regulation S-K, personalized investment advice standards of conduct, and amendments to marketing rules under the Advisors Act, are also included in the proposed rule stage.

Still on the long-term actions are rules related to reporting on proxy votes on executive compensation (i.e., say-on-pay – see HERE), transfer agents (see HERE), Form 10-K summary, and revisions to audit committee disclosures.

Items on the long-term agenda include amendments to the accredited investor definition (see HERE), registration of security-based swaps, universal proxy, corporate board diversity, investment company advertising, 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, standards for covered clearing agencies, and risk mitigation techniques.

Other items of interest 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), Regulation Crowdfunding amendments, several securities-based swaps regulatory actions, conflict minerals amendments, amendments to Guide 5 on real estate offerings and Form S-11, and incentive-based compensation arrangements.

Added as a Prerule Stage item is fund retail investor experience and disclosure requests for comment.

Regulation A amendments are on the long-term action list. I am hopeful that these amendments may include an increase in the offering limits and opening up Regulation A to reporting issuers. See HERE. Moreover, now that the Economic Growth, Regulatory Relief and Consumer Protection Act has been signed into law requiring that Regulation A be amended to allow for use by reporting companies, I suspect this item will be moved up the line.

Not included in previous lists, and now on the long-term action list, is 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.

Still not on the short-term agenda are future Dodd-Frank rules, including proposed regulatory actions related to pay for performance (see HERE), executive compensation clawback (see HERE) (which is not on the agenda at all), and clawbacks of incentive compensation at financial institutions (also not on the list at all), although some of these items remain on the “long-term actions” schedule.

The SEC rulemaking agenda may not include further rulemaking on many Dodd-Frank rules, but it also does not include specific rulemaking to repeal existing regulations, such as the pay ratio disclosure rules which were adopted in August 2015 and initially apply to companies for their first fiscal year beginning on or after January 1, 2017. See HERE for more information on this rule. The pay ratio rules do not apply to emerging-growth companies, smaller reporting companies, foreign private issuers, U.S-Canadian Multijurisdictional Disclosure System filers, and registered investment companies. All other reporting companies are subject to the new rules. In October 2016 the SEC published five new compliance and disclosure interpretations (C&DIs) on certain aspects of the final rules. The C&DIs covered two main topics: (i) the use of a consistently applied compensation measure in identifying a company’s median employee; and (ii) the application of the term “employee” to furloughed employees and independent contractors or “leased” workers.

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« The SEC Has Provided Guidance On Ether and Bitcoin, Sort Of Regulation A For Publicly Reporting Companies, Economic Growth and Regulatory Relief »

The SEC Has Provided Guidance On Ether and Bitcoin, Sort Of

Posted by Securities Attorney Laura Anthony | June 19, 2018 Tags: Bitcoin, Ether, SEC, Sort Of, The SEC Has Provided Guidance On Ether and Bitcoin

On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made two huge revelations for the crypto marketplace. The first is that he believes a cryptocurrency issued in a securities offering could later be purchased and sold in transactions not subject to the securities laws. The second is that Ether and Bitcoin are not currently securities. Also, for the first time, Hinman gives the marketplace guidance on how to structure a token or coin such that it might not be a security.

While this gives the marketplace much-needed guidance on the topic, a speech by an executive with the SEC has no legal force. As a result, the blogs and press responding to Mr. Hinman’s speech have been mixed. Personally, I think it is a significant advancement in the regulatory uncertainty surrounding the crypto space and a signal that more constructive guidance will soon follow. I will summarize the entire speech later in this blog, but first right to the most salient point.

Although a speech by an SEC official does not have legal weight, it does give practitioners a firm foot on which to proceed. William Hinman is the Director of the Division of Corporation Finance (“CorpFin”), whose responsibility includes reviewing and commenting on SEC filings, a topic I’ve written about before. As described in my recent blog on the subject (see HERE), when responding to SEC comments, a company may also “go up the ladder,” so to speak, in its discussion with the CorpFin review staff. Such further discussions are not discouraged or seen as an adversarial attack in any way. For instance, if the company does not understand or agree with a comment, it may first talk to the reviewer. If that does not resolve the question, they may then ask to talk to the particular person who prepared the comment or directly with the legal branch chief or accounting branch chief identified in the letter. A company may even then proceed to speak directly with the assistant director, deputy director, and then even director.

Related to Bitcoin, Director Hinman stated, “…when I look at Bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise. The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.” Similarly, related to Ether, Mr. Hinman stated, “…putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.”

As a direct result of these statements, at least 2 of our clients, with our support, have shifted how they will proceed with Regulation A offerings in which tokens are being offered, and Bitcoin and Ether expected to be accepted as a form of payment. Prior to Mr. Hinman’s comments, CorpFin issued comments to our clients, which comment letters gave an indication of the progression of the SEC’s thinking. In particular, in an earlier letter the SEC comment was in relevant part as follows:

We note that you will accept Bitcoin, Ether, Litecoin or Bitcoin Cash as payment for your common stock. Please disclose the mechanics of the transaction. For example, explain the following:

whether the digital assets are securities and, where you have determined they are, how you will structure each individual transaction so that you are in compliance with the federal securities laws;
disclose how long the company would typically hold these digital assets, some of which may be securities, before converting to U.S. dollars;
include risk factor disclosure discussing the impact of holding such assets and/or accepting this form of payment, including price volatility and liquidity risks as well as risks related to the fragmentation, potential for manipulation, and general lack of regulation underlying these digital asset markets; and
disclose how you will hold the digital assets that you may receive in this offering as payment in exchange for shares of your common stock. If you intend to act as custodian of these digital assets, some of which may be securities, please tell us whether you intend to register as a custodian with state or federal regulators and the nature of the registration.

The comment letter included many other points on cybersecurity, price volatility, risk factors and other issues not related to whether the Bitcoin or Ether were a security. In a recent comment letter for a different client, also offering tokens in a Regulation A offering and accepting Bitcoin and Ether as payment, the SEC did not issue any questions as to whether Bitcoin or Ether were a security, but did include substantially the same questions related to cybersecurity, price volatility, risk factors and other business points.

The SEC CorpFin is pragmatic in its approach and despite frustrations at times, would not allow its Division Director to make public statements and then allow its staff to issue comments or take positions that were in direct contravention to those statements. Keep in mind that SEC no-action letters technically do not set precedence or have any legal bearing outside of the parties to the letter, but are regularly relied upon by the SEC and practitioners for guidance.

Although Mr. Hinman’s speech does not have legal authority, I am confident that the SEC will not raise the issue or question whether Bitcoin or Ether are a security in current and future registration statements or Regulation A offerings, at least until there is different legal authority than exists today.… And, there could be different legal authority in the future. I attended a Regulation A conference in New York in the beginning of June, and one of the panels was related to cyrptocurrencies. In addition to attorneys in the space, the panel included Anita Bandy, Assistant Director of the SEC Division of Enforcement. Referring to token or coin offerings, one of the panel members specifically stated that Ether is a security and Ms. Bandy did not correct him. Furthermore, at the end of the panel, I privately asked Ms. Bandy if it is her opinion that Ether is a security today. She politely refused to answer the question, letting me know that she couldn’t express an opinion on that without conferring with other SEC management. Two days later, Mr. Hinman gave his speech.

…. But, Mr. Hinman is Director of CorpFin and Ms. Bandy is part of the Division of Enforcement. Although I believe that the SEC divisions are communicating with each other on the very relevant and important subject of cryptocurrency, and have even issued joint statements on the subject, they are separate. Moreover, decoding Mr. Hinman’s statements further, he said, “… putting aside the fundraising that accompanied the creation of Ether…” This begs the question: What would happen if the SEC Division of Enforcement took action related to the initial fundraising and creation of Ether, and how would that impact the current status of Ether? My thought is that they are mutually exclusive. Ether is decentralized today and will continue its own course.

The SEC Division of Enforcement could take action similar to the Munchee, Inc. case where it settled the proceeding with no civil penalty. The SEC could also issue another report on Ether similar to the Section 21(a) Report on the DAO issued a year ago in July 2017, though I don’t know what new or different information it could add to that analysis. If Ether violated the federal securities laws at its issuance, it did so in the same way as the DAO, using the SEC v. W. J. Howey Co. test. Perhaps a new report could provide more guidance as to the analysis of when a crypto reaches a point where it is decentralized enough such that it no longer meets the parameters laid out in Howey, or that might be wishful thinking on my part.

Director Hinman’s Speech “Digital Asset Transactions: When Howey Met Gary (Plastic)”

Director Hinman opens his speech with the gating question of whether a digital asset that is offered and sold as a security can, over time, become something other than a security. He then continues that in cases where the digital asset gives the holder a financial interest in an enterprise, it would remain a security. However, in cases where the enterprise becomes decentralized or the digital asset can only be used to purchase goods or services available through a network, the purchase and sale of the digital asset would no longer have to comply with the securities laws.

Reiterating the oft-repeated view of the SEC, Hinman notes that most initial coin or token offerings are substantially similar to debt or equity offerings in that they are just another way to raise money for a business or enterprise. In particular, funds are raised with the expectation that the network or system will be built and investors will get a return on their investment. The investment is often made for the purpose of the return and not by individuals that would ever use the eventual utility of the token. The return is often through the resale of the tokens or coins in a secondary market on cryptocurrency trading platforms.

In this case, the Howey Test is easy to apply to the initial investment. The Howey Test requires an investment of money in a common enterprise with an expectation of profit derived from the efforts of others. The emphasis is not on the thing being sold but the manner in which it is sold and the expectation of a return. Certainly, the thing being sold is not a security on its face; it is simply computer code. But the way it is sold – as part of an investment, to non-users, by promoters to develop the enterprise – can be, and in that context most often is, a security. Furthermore, in the case of ICOs, which are high-risk by nature, the disclosure requirements of the federal securities laws are fulfilling their purpose.

The securities laws apply to both the issuance or initial sale, and the resale of securities. In the case of coins or tokens, a careful analysis must be completed to determine if the resale of the coin or token also involves the sale of a security and compliance with the securities laws. If the network on which the token or coin is to function is sufficiently decentralized such that purchasers would not reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the assets may no longer represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful, such as with Ether and Bitcoin as discussed above.

An analysis as to whether an investment contract and therefore a security is being sold must be made based on facts and circumstances at any given time. Investment contracts can be made out of virtually any asset if it is packaged and promoted as such. Accordingly, although Bitcoin or Ether may not be a security on their own, if they were packaged as part of a fund or trust, they could be part of an investment contract that would need to comply with the federal securities laws.

Hinman provides some guidance in determining whether a particular sale involves the sale of an investment contract. The primary consideration is whether a third party, such as a person, entity, or coordinated group, drives the expectation of a return on investment. Questions to consider include:

Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?
Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?
Has the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the enterprise? Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system within which the tokens operate?
Are purchasers “investing,” i.e., seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?
Does application of the Securities Act protections make sense? Is there a person or entity others are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors? Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?
Do persons or entities other than the promoter exercise governance rights or meaningful influence?

Hinman then, for the first time, gives some guidance to issuers and their counsel in determining whether a particular token or coin is being structured as a security. Hinman is clear that this list of factors is not comprehensive but rather lays the groundwork for a thoughtful analysis. Items to consider include:

Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation?
Are independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading?
Is it clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment? Have purchasers made representations as to their consumptive, as opposed to their investment, intent? Are the tokens available in increments that correlate with a consumptive versus investment intent?
Are the tokens distributed in ways to meet users’ needs? For example, can the tokens be held or transferred only in amounts that correspond to a purchaser’s expected use? Are there built-in incentives that compel using the tokens promptly on the network, such as having the tokens degrade in value over time, or can the tokens be held for extended periods for investment?
Is the asset marketed and distributed to potential users or the general public?
Are the assets dispersed across a diverse user base or concentrated in the hands of a few that can exert influence over the application?
Is the application fully functioning or in early stages of development?

In another step towards regulatory guidance, Hinman said the SEC is prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use. As recently as 3 months ago, the SEC had indicated it was not processing no-action letters on the subject at that time. In his speech, Hinman recognizes the implication of determining something is a security, including related to broker-dealer licensing, exchange registration, fund registration, investment advisor registration requirements, custody and valuation issues.

Hinman also expressed excitement about the potential surrounding digital ledger technology, including advancements in supply chain management, intellectual property rights licensing, and stock ownership transfers. He thinks the craze behind ICOs has passed, and I agree. In particular, as he states, realizing that securities laws apply to an ICO that funds development, industry participants have started to revert back to traditional debt or equity offerings and only selling a token once the network has been established, and then only to those that need the functionality of the network and not as an investment.

There have been earlier signs that the SEC is softening and rethinking its approach to cryptocurrencies as well. In a speech to the Medici Conference in Los Angeles on May 2, 2018, SEC Commissioner Hester M. Peirce warned against regulators stifling the innovation of blockchain by trying to label token and coins as securities and even when they are securities, being myopic on the need to fit within existing securities laws and regulations. Like Director Hinman, Commissioner Peirce encourages communication between market participants and the SEC as everyone tries to navigate the marketplace and technology.