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

SEC Continues Efforts To Prevent Microcap Fraud

Posted by Securities Attorney Laura Anthony | August 16, 2016 Tags: Finra, Micro-Cap Fraud, Microcap Fraud, SEC

As I’ve written about numerous times in the past, a primary agenda of the SEC and FINRA is to prevent small- and micro-cap fraud. On March 23, 2016, the SEC charged Guy Gentile with penny stock fraud. The SEC complaint, as well as numerous industry articles and a blog by Mr. Gentile himself, reveal in-depth efforts by the SEC together with FINRA and the FBI and DOJ to remove recidivist and bad actors from the micro-cap system. While the methods used by the regulators have been the subject of heated debates and articles, the message and result remain that the SEC is committed to its efforts to deter securities law violations.

Although small- and micro-cap fraud has always been an important area of concern and enforcement by the SEC since the financial crisis of 2008, it has increasingly been a focus. Regulators have amplified their efforts through regulations and stronger enforcement, including the SEC Broken Windows policy, increased Dodd-Frank whistleblower activity and reward payments, CEO and CFO liability for SEC reports under the Sarbanes-Oxley Act and increased bad actor prohibitions. See my blog HERE related to the SEC Broken Windows policy and CEO/CFO liability (as an aside, I note that the proposed Stronger Enforcement of Civil Penalties Act never made it past its introduction in July 2015) and HERE related to Rule 506 and Regulation A bad actor prohibitions.

The fight against small- and micro-cap fraud is an industry positive overall. While not a regulator, OTC Markets itself has taken great strides in improving the quality of and information available related to OTC Markets-traded companies, including through qualitative and quantitative standards for quotation on both the OTCQB (see my blog HERE) and OTCQX (see my blog HERE).

The Guy Gentile Case

On March 23, 2016, the SEC charged Guy Gentile with penny stock fraud. The SEC litigation release alleges that Gentile, who owned and operated Sure Trader, a registered broker-dealer, engaged in manipulative trading, provided illegal kickbacks, illegally issued unregistered stock and distributed promotional mailings of glossy newsletters using fake publication names to pump the stocks of at least two penny stocks (KYUS and RVNG). The SEC continues that Gentile misled investors with positive but fake price and volume trends while concealing the control persons’ identities and compensation. Apparently, Gentile, together with attorney Adam Gottbetter and a few stock promoters, controlled large blocks of the companies’ stock, which control was not disclosed in company filings or the promotional activities.

The SEC complaint, filed in March 2016, details Gentile’s actions involving KYUS and RVNG, which actions occurred in 2007 and 2008. As alleged by the SEC, the entire history of RVNG and KYUS was a fraud, from its creation using a sham registration (see my blog HERE for more on this) to its issuances of freely tradable securities to insiders, manipulative trades and promotional activities.

The SEC complaint does not address the fact that a period of 8-9 years went by between the illegal activities and the filing of the complaint. Guy Gentile has written a detailed blog explaining his version of events, or more precisely, what happened in the missing years. In particular, Gentile claims that he was arrested in 2012 and that from that time until the complaint against him in March 2016, he acted as a cooperating witness and SEC and FBI informant, assisting in the indictment of over a dozen individuals related to hundreds of millions of dollars in pump-and-dump and other illegal activities and resulting in over $12 million in fines and disgorgements with the potential of tens of millions more to come.

Gentile details his involvement in elaborate, and sometimes dangerous, undercover operations. The complaint, together with Gentile’s blog and numerous industry articles on the events, reads like a movie. It is undisputed that Gentile’s brokerage firm, Sure Trader, which was based in the Bahamas, remained in business and continued to market to U.S.-based retail customers after Gentile’s arrest in 2012 and through at least July 2015. It appears that the entire firm was wired up and all happenings were being recorded by the FBI.

Guy Gentile’s biggest defense is the statute of limitations, which is five years. However, apparently he signed a waiver of the statute of limitations while acting as an informant.

The prevention of fraud has been on the SEC agenda since the commission was founded in 1933, with efforts intensifying as the sophistication of the marketplace has grown. On November 17, 2009, President Obama established, by executive order, an Interagency Financial Fraud Enforcement Task Force to strengthen efforts to combat financial crime. To start, the Department of Justice led the task force and the Department of Treasury, HUD and the SEC served on the steering committee. The task force’s leadership, along with representatives from federal agencies and regulatory authorities, continue to work with state and local partners to investigate and prosecute significant financial crimes, address discrimination in the lending and financial markets, and recover proceeds for victims.

Putting aside the entertainment value of the entire case, it does fully illustrate the commitment by regulators to attack small- and micro-cap fraud. Clearly, the more of these egregious activities that are uncovered and prosecuted, the more success legitimate small businesses will have raising capital, growing, and supporting the U.S. economy including through job creation.

Conclusion

It is undisputed that emerging companies play a critical role in the U.S. economy, supporting growth, innovation and job creation. The JOBS Act made dramatic changes to the landscape for the marketing and selling of both private and public securities. These significant changes include: (i) the creation of Rule 506(c), which came into effect on September 23, 2013, and allows for general solicitation and advertising in private offerings where the purchasers are limited to accredited investors; (ii) the overhaul of Regulation A creating two tiers of offerings, which came into effect on June 19, 2015, and allows for both pre-filing and post-filing marketing of an offering, called “testing the waters”; (iii) the addition of Section 5(d) of the Securities Act, which came into effect in April 2012, permitting emerging-growth companies to test the waters by engaging in pre- and post-filing communications with qualified institutional buyers or institutions that are accredited investors; and (iv) Title III crowdfunding, which came into effect on May 19, 2016, and allows for the use of Internet-based marketing and sales of securities offerings.

Furthermore, the OTC Markets has proven itself as a small-cap venture exchange, supporting the secondary trading of small and emerging growth companies and providing a respected trading platform for companies prior to moving on to an exchange such as NASDAQ or the NYSE MKT.

The other side of these initiatives is the real concern of fraud. I’m not expressing an opinion on the methods used by the regulators in this case, but I do support the efforts. I also believe in the basic principle that it is better for the industry that investors believe egregious fraudulent activities will be prosecuted.

This firm does not participate in SEC enforcement proceedings or related litigation matters; however, as with any good securities attorney, we keep our clients informed of the law so that they can avoid participation in these proceedings.

The Author

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

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

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« SEC Issues Proposed Regulation S-K and S-X Amendments Smaller Reporting Companies vs. Emerging Growth Companies »

SEC Issues Proposed Regulation S-K and S-X Amendments

Posted by Securities Attorney Laura Anthony | August 9, 2016 Tags: Regulation S-K, Regulation S-K Amendments, Regulation S-X, Regulation S-X Amendments, S-K Amendments, S-X Amendments, SEC

On July 13, 2016, the SEC issued a 318-page 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). The proposed rule changes follow the 341-page 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.

The proposed S-K and S-X Amendments are intended to facilitate the disclosure of information to investors while simplifying compliance efforts by companies. The proposed S-K and S-X 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. Prior to the issuance of these S-K and S-X Amendments, on June 27, 2016, as part of the same initiative, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The S-K and S-X Amendments also seek comment on certain disclosure requirements that overlap with U.S. GAAP and possible recommendations to FASB, the regulatory body that drafts and implements GAAP, for conforming changes.

Background

The topic of disclosure requirements under Regulations S-K and S-X as pertains to financial statements and disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) has 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. Regulation S-X contains specific financial statement preparation and disclosure requirements.

In addition to affecting companies filing registration statements (including on Form 1-A in a Regulation A/A+ offering) and those filing reports with the SEC, the proposed S-K Amendments will affect acquired entities, acquirees, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.

The underlying basis of the disclosures required by Regulations S-K and S-X is to keep shareholders and the markets informed on a regular basis in a transparent manner. Reports and registration statements filed with the SEC can be viewed by the public on the SEC EDGAR website. A reporting company also has record-keeping requirements, must implement internal accounting controls and is subject to the Sarbanes-Oxley Act of 2002, including the CEO/CFO certification requirements. Under the CEO/CFO certification requirement, the CEO and CFO must personally certify the content of the reports filed with the SEC and the procedures established by the issuer to report disclosures and prepare financial statements. For more information on that topic, see my blog HERE.

The proposed 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.

Redundant or Duplicative Reporting Requirements

The proposed S-K and S-X Amendments seek to eliminate a laundry list of 26 redundant and duplicative disclosures. Most of these proposed 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 the proposed rule 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 propose to delete, scale back or integrate the overlapping disclosures to eliminate the overlap.

The SEC category of overlapping disclosures, and related Regulation S-K and S-X Amendments, have added broad considerations for which the SEC is seeking public comment. In particular, some of the proposed changes would result in the relocation of disclosures in the filings. This raises considerations related to the prominence of information in a particular report and moving information from outside to inside financial statements.

When information is in a different location in a report, it may receive more or less attention and be thought of as more or less prominent. Moreover, information inside of financial statements is subjected to audit and interim review, internal control over financial reporting and XBRL tagging. In addition, information inside of financial statements is not subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995 related to forward-looking statements.

A complete detail of all the proposed Regulation S-K and S-X Amendment changes 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 proposes eliminating the same or similar requirement from interim financial statements.

For example, the SEC proposes eliminating 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. Likewise, the SEC makes the same proposed elimination of financial reporting in interim reports for a significant business disposition or discontinued operation.

As another example, currently Regulation S-X requires disclosure of certain subsequent events in the footnotes to interim financial statements and Item 303 of Regulation S-K related to management discussion and analysis (MD&A) requires substantially the same disclosure. The SEC proposes to delete the Regulation S-X requirement and only require disclosure of these subsequent events in the MD&A. Likewise, the SEC proposes eliminating segment financial information from the footnotes and leaving it only in MD&A.

In other cases, the SEC supports elimination of a disclosure in the body of a document in favor of a financial statement disclosure. For example, the SEC proposes eliminating 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.

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 propose to 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 would be amended to include only a reference to the SEC Internet address for EDGAR filings.

Another common-sense change is the proposal to eliminate 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 gone through and proposed 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

Prior to the S-K Concept Release and current Regulation S-K and S-X proposed amendments, 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.

The Author

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

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

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« SEC Advisory Committee On Small And Emerging Companies Issues Further Recommendations On Accredited Investor Definition SEC Continues Efforts To Prevent Microcap Fraud »

SEC Advisory Committee On Small And Emerging Companies Issues Further Recommendations On Accredited Investor Definition

Posted by Securities Attorney Laura Anthony | August 2, 2016 Tags: Accredited Investor, accredited investor definition, Accredited Investors

On July 19, 2016, the SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) met and drafted its recommendations and response to the SEC report on the definition of accredited investor. The subject of changes to the definition of accredited investor has been debated in a series of reports, recommendations, proposals and comment letters since early 2015.

On December 18, 2015, the SEC issued a 118-page report on the definition of “accredited investor” (the “report”). The report follows the March 2015 SEC Advisory Committee recommendations related to the definition. The SEC is reviewing the definition of “accredited investor” as directed by the Dodd-Frank Act, which requires that the SEC review the definition as relates to “natural persons” every four years to determine if it should be modified or adjusted. See my blog HERE on the report and additional background on the subject.

At the July 19 meeting, the Advisory Committee finalized a draft of a letter to the SEC outlining its recommendations on changes to the definition of accredited investor. The Advisory Committee had previously submitted a letter to the SEC on March 9, 2015, on the same subject; see my blog HERE for details.

The Advisory Committee made five recommendations related to the definition of “accredited investor,” each of which I support fully. In particular:

The core of prior recommendations remain the same, with the added statement that “the overarching goal of any changes the Commission might consider should be to ‘do no harm’ to the private offering ecosystem”;

The SEC should not change the current financial thresholds in the definition except to adjust for inflation on a going-forward basis

The definition should be expanded to take into account measure of non-financial sophistication, regardless of income or net worth, thereby expanding rather than contracting the pool of accredited investors;

“Simplicity and certainty are vital to the utility of any expanded definition of accredited investor. Accordingly, any non-financial criteria should be able to be ascertained with certainty”; and

The SEC should continue to gather data on this subject and, in particular, what “attributes best encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”

Advisory Committee Considerations in Support of its Recommendations

The Advisory Committee Letter lists practical facts and realities related to small business and emerging company capital formation in support of its recommendations. In particular:

Emerging companies play a significant role as drivers in the U.S. economy, including supporting innovation and job creation. The ability of these emerging companies to raise capital in unregistered offerings is critical to the economic well-being of the U.S.

The exemptions under Regulation D are the most widely used transactional exemptions, resulting in $1.35 trillion of raised capital in 2015, which amount is comparable to capital raised in registered offerings;

The accredited investor definition is the centerpiece of Regulation D and is intended to “encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”

Currently a natural person is an accredited investor if they have (i) earned income in excess of $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or (ii) a net worth in excess of $1 million excluding the value of their primary residence.

If the individual and net worth thresholds are raised significantly, it would considerably decrease the number of households that qualify as accredited investors. This decrease would disproportionately affect areas with a lower cost of living, which areas already coincide with regions of lower venture capital activity. Moreover, a decrease in the accredited investor pool would have a disproportionate effect on women and minority entrepreneurs.

The Advisory Committee notes that it is “unaware of any evidence suggesting that fraud in the private markets is driven or affected by the levels at which the accredited investor definition is set.”

Refresher on Current Accredited Investor Definition

An “accredited investor” is defined as any person who comes within any of the following categories:Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act, whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5) of the Act, whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;

Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;

Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his or her purchase exceeds $1,000,000, not including their principal residence;

Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;

Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii); and

Any entity in which all of the equity owners are accredited investors.

The Author

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

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

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

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« Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 2 SEC Issues Proposed Regulation S-K and S-X Amendments »

Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 2

Posted by Securities Attorney Laura Anthony | July 26, 2016 Tags: Regulation A, S-1 Public Offerings, Test The Waters, Testing The Waters

The JOBS Act enacted in 2012 made the most dramatic changes to the landscape for the marketing and selling of both private and public offerings since the enactment of the Securities Act of 1933. These significant changes include: (i) the creation of Rule 506(c), which came into effect on September 23, 2013, and allows for general solicitation and advertising in private offerings where the purchasers are limited to accredited investors; (ii) the overhaul of Regulation A, creating two tiers of offerings which came into effect on June 19, 2015, and allows for both pre-filing and post-filing marketing of an offering, called “testing the waters”; (iii) the addition of Section 5(d) of the Securities Act, which came into effect in April 2012, permitting emerging growth companies to test the waters by engaging in pre- and post-filing communications with qualified institutional buyers or institutions that are accredited investors; and (iv) Title III crowdfunding, which came into effect May 19, 2016, and allows for the use of Internet-based marketing and sales of securities offerings.

This is the second in a two-part blog on testing the waters. In the first in the series, I discussed test-the-waters marketing of Regulation A/A+ offerings. That blog can be read HERE. In this second part, I am discussing testing the waters in the standard IPO process including under Section 5(d) for public offerings by emerging growth companies.

Test The Waters– Transactions Using S-1

Historically all offers to sell registered securities prior to the effectiveness of the filed registration statement have been strictly regulated and restricted. The public offering process is divided into three periods: (1) the pre-filing period, (2) the waiting or pre-effective period, and (3) the post-effective period. Communications made by the company during any of these three periods may, depending on the mode and content, result in violations of Section 5 of the Securities Act of 1933 (the “Securities Act”). Communication-related violations of Section 5 during the pre-filing and pre-effectiveness periods are often referred to as “gun jumping.”

All forms of communication could create “gun-jumping” issues (e.g., press releases, interviews, and use of social media). “Gun jumping” refers to written or oral offers of securities made before the filing of the registration statement and written offers made after the filing of the registration statement other than by means of a prospectus that meet the requirements of Section 10 of the Securities Act, a free writing prospectus or a communication falling within one of the several safe harbors from the gun-jumping provisions.

“Offers” of securities are very broadly defined. Section 2(a)(3) of the Securities Act define “offer to sell,” “offer for sale,” or “offer” to include “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” The definition specifically excludes discussions and negotiations between a company and an underwriter or underwriters. The Section 2(a)(3) definition of an offer also specifically excludes research reports by broker-dealers, which provision was added by the JOBS Act and is touched on below.

In 2005, in order to modernize the offering process, the SEC adopted the “Securities Offering Reform,” which included adding a number of communication safe harbors from enforcement of Section 5, as discussed in more detail below. The JOBS Act added additional provisions allowing for test-the-waters communications by emerging growth companies during the offering process.

Test-the-waters communications involve solicitations of indications of interest for an offering prior to the effectiveness of a registration statement. Where Regulation A freely allows, and even encourages, test-the-waters communications, the standard IPO process using a Form S-1 still strictly limits pre-effectiveness solicitations of interest and offering communications overall. As with Regulation A, indications of interest as a result of test-the-waters communications are non-binding. Section 5(a) of the Securities Act prohibits the sale of securities before the registration statement is deemed effective.

Test The Waters communications during the pre-filing period

The pre-filing period is that time frame between the decision to proceed with a public offering and the actual filing of a registration statement with the Securities and Exchange Commission. During this period, a potential registrant is in the “quiet period” and is subject to restrictions on public disclosure relating to the offering. The pre-filing period begins when the company, and the underwriters where applicable, agree to proceed with a public offering.

Statements made within 30 days of filing a registration statement that could be considered an attempt to pre-sell the public offering may be considered an illegal prospectus, resulting in a Section 5 “gun-jumping” violation, if no exception or safe harbor applies. This might result in liability for violating securities laws, the SEC’s delaying of the public offering, and/or requiring prospectus disclosures of these potential securities law violations. Press interviews, participation in investment banker-sponsored conferences, and new advertising campaigns are generally discouraged during this period.

Section 5(c) of the Securities Act generally prohibits oral and written offers of a security before a registration statement is filed, which encompasses the quiet and pre-filing period. There are, however, many exceptions and safe harbor rules to this general prohibition.

Section 105(c) of the JOBS Act – “Test The Waters” by an Emerging Growth Company:

In April 2012, the Jumpstart Our Business Startups Act (the “JOBS Act”) was enacted, which, in part, established a new process and disclosures for public offerings by a new class of companies referred to as “emerging growth companies” or “EGCs.” An EGC is defined as a company with total annual gross revenues of less than $1 billion during its most recently completed fiscal year that first sells equity in a registered offering after December 8, 2011.

Section 105(c) of the JOBS Act provides an EGC with the flexibility to “test the waters” by engaging in oral or written communications with qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”) in order to gauge their interest in a proposed offering, whether prior to (irrespective of the 30-day safe harbor) or following the first filing of any registration statement, subject to the requirement that no security may be sold unless accompanied or preceded by a Section 10(a) prospectus. Generally, in order to be considered a QIB, you must own and invest $100 million of securities, and in order to be considered an IAI, you must have a minimum of $5 million in assets.

As an EGC would not have filed any documents or requests with the SEC at this stage, it will be up to the EGC to determine whether it qualifies as an EGC prior to commencing test-the-waters communications. Under the rules, “well-known seasoned issuers,” or WKSIs, can engage in similar test-the-waters communications, but smaller reporting companies that do not otherwise qualify as an EGC cannot.

An EGC may utilize the testing-the-waters provision with respect to any registered offerings that it conducts while qualifying for EGC status. Test-the-waters communications can be oral or written. An EGC may also engage in test-the-waters communications with QIBs and institutional accredited investors in connection with exchange offers and mergers. When doing so, an EGC would still be required to make filings under Sections 13 and 14 of the Exchange Act for pre-commencement tender offer communications and proxy soliciting materials in connection with a business combination transaction.

There are no form or content restrictions on these communications, and there is no requirement to file written communications with the SEC. During the first year or two following enactment of the JOBS Act, the SEC staff regularly asked to see any written test-the-waters materials during the course of the registration statement review process, but eventually these requests ceased. The SEC staff maintains the right to ask to review test-the-waters, or any, communications made by a company during the S-1 review process. For more information on the SEC review process and responding the SEC comments in general, see my blog HERE.

In practice the marketing of an IPO offering generally begins during the waiting period after the filing of the S-1 with the SEC and generally not until the two to three weeks prior to the effectiveness of the registration and launching of the offering itself. However, an EGC can make test-the-waters communications even before filing the registration statement. It is important to note that anti-fraud provisions, such as Section 12(a)(2) and 10(b), still apply to such communications.

Exception for Research Reports

Section 105(a) of the JOBS Act amended Section 2(a)(3) of the Securities Act to eliminate restrictions on publishing analyst research and communications while IPOs are under way. Under prior law, research reports by analysts, especially those participating in an underwriting of securities of the subject company, could be deemed to be “offers” of those securities under the Securities Act and, as result, could not be issued prior to completion of an offering. Section 2(a)(3) of the Securities Act as amended by Section 105(a) of the JOBS Act provides that publication or distribution by a broker or dealer of a research report about an EGC that is the subject of a proposed public offering of its securities does not constitute an offer of securities, even if the broker or dealer that publishes the research is participating or will participate as an underwriter in the offering. Moreover, the term “research” is defined broadly as any information, opinion or recommendation about a company and includes oral as well as written and electronic communications. This research need not be accompanied by a full prospectus and need not provide information “reasonably sufficient upon which to base an investment decision.” The research need not even be consistent with the prospectus, if there is one. In other words, research providers are free to say just about anything they wish about an IPO candidate, limited only by the general anti-fraud rules.

Section 105(b) of the JOBS Act eliminates existing restrictions on publishing research following an IPO or around the time the IPO lockup period expires or is released. Currently, under SEC and Financial Industry Regulatory Authority (“FINRA”) rules, underwriters of an IPO cannot publish research for 25 days after the offering (40 days if they served as a manager or co-manager), and managers or co-managers cannot publish research within 15 days prior to or after the release or expiration of the IPO lockup agreements (so-called “booster shot” reports). The Act requires FINRA and the SEC to eliminate these restrictions with respect to EGCs. As a result, any research analyst will be able to publish at any time after an EGC IPO, including immediately after the offering. On October 11, 2012, FINRA amended its rules to conform with the requirements under Section 105(b) of the JOBS Act. In particular, it amended NASD Rule 2711 to eliminate all quiet periods.

Rule 135 Safe Harbor

Rule 135 allows for the publication of a limited announcement of a proposed public offering before the filing of the registration statement. The Rule 135 notice is often referred to as a “tombstone” ad. Such tombstone notice is limited to: (i) the name of the company; (ii) the title, amount, and basic terms of the securities; (iii) the amount to be offered by any selling shareholders; (iv) the anticipated timing of the offering; (v) a brief statement of the manner and purpose of offering, without naming the underwriters; (vi) whether the offering is directed to a particular class of purchaser (such as accredited only); and (vii) state and federal legends as required by law (including that it is not an “offer”). If the “tombstone” notice complies with the above Rule 135 requirements, the notice will not be treated as an “offer.”

A Rule 135 communication must contain a disclaimer/legend “to the effect that it does not constitute an offer of any securities for sale.” Sample legends include:

This announcement is being made pursuant to and in accordance with Rule 135 under the Securities Act of 1933. As required by Rule 135, this press release does not constitute an offer to sell or the solicitation of an offer to buy securities, and shall not constitute an offer, solicitation or sale in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of that jurisdiction.

Rule 135 can be effective as a test-the-waters tool. Responses to a publication, or lack thereof, can provide valuable information regarding the public interest in a particular planned public offering. A Rule 135announcement can only be made before a registration statement is filed. Following the filing, the appropriate announcement would be under Rule 134 as discussed below.

Test The Waters Communications during the Post-filing, Pre-effectiveness Period

The waiting or pre-effective period is that time frame between the filing date and the effective date of the registration statement. During this period, the company may generally make oral offers, but may not enter into binding agreements to sell the offered security.

The pre-effective period is the period during which, among other things, the company begins marketing the offering, through real-time oral offers, including calls to potential investors. Section 5(b)(1) of the Securities Act prohibits written offers other than by means of a prospectus that meets the requirements of Section 10 of the Securities Act. An S-1 meets such requirements. Such bans are designed to prohibit inappropriate marketing, conditioning or “hyping” of the security before all investors have access to publicly available information about the company so that they can make informed investment decisions.

Oral communications are allowed following the filing of a registration statement, subject to the anti-fraud provisions.

Other than a free writing prospectus for qualified companies and test-the-waters communications by an EGC satisfying the requirements of Section 5(d) of the Securities Act (i.e., Rule 105(c) of the JOBS Act), the only written sales material that may be distributed by the company during this period is the preliminary prospectus, which must satisfy specified SEC requirements. While binding commitments cannot be made during this period, the underwriters will receive indications of interest from potential purchasers, indicating the price they would be willing to pay and the number of shares they would purchase.

During this period, key management personnel generally will make a series of presentations covering the company’s business and industry, market opportunities and financial matters to the investment community. The underwriters will use these presentations as an opportunity to ask questions and establish their due diligence. This presentation period is commonly referred to as the “road show” and generally is conducted in the two-to-three-week period immediately prior to the effectiveness of the registration statement and ability to complete sales of the securities.

As with other offering periods, many exemptions and safe harbors exist to allow for communications during the pre-effective waiting period.

Section 105(c) of the JOBS Act – “Test The Waters” by an EGC:

Section 105 of the JOBS Act is also available during the post-filing, pre-effective waiting period.

Rule 134 Written Solicitation of Interest:

Rule 134 permits the company to communicate limited factual information about the offering after the Section 10 prospectus is filed (i.e., an S-1). Rule 134 communications are not deemed to be either prospectuses or free writing prospectuses. Rule 134 communications may only be made after a registration statement has been filed with the SEC. The allowable content of a Rule 134 communication is similar to that of a Rule 135 communication; however, a Rule 135 communication is just a notice of a proposed registered offering, whereas a Rule 134 communication relates to a filed registration statement for a particular offering.

A Rule 134 communication may include one or more of the following information: (i) factual information about the legal identity and business location of the company including name, address, phone number, web address, e-mail address, principal office location, investor relations contact information, country or state of location or organization and similar information; (ii) the title and amount of securities offered, which can include a designation such as “preferred,” “convertible” or “secured”; (iii) a brief statement of the general type of business of the company; (iv) the price of the security, if known; (v) a brief description of the intended use of proceeds; (vi) the type of underwriting (self, firm commitment or best efforts); (vii) names of underwriters and other offering participants; (viii) schedule and timing of the offering, including road show dates, times and locations; (ix) legal opinions as to specified tax treatment; (x) the names of selling security holders; (xi) names of exchanges or other markets where the security currently trades, and (x) the ticker symbol.

The communications must contain the prescribed legend, be preceded or accompanied by a Section 10 prospectus, and state where the statutory prospectus can be obtained. The required legend is as follows:

A registration statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective.

Subject to limited exceptions, the following should also be included:

No offer to buy the securities can be accepted and no part of the purchase price can be received until the registration statement has become effective, and any such offer may be withdrawn or revoked, without obligation or commitment of any kind, at any time prior to notice of its acceptance given after the effective date.

Free Writing Prospectus

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

For purposes of rules related to free writing prospectuses, all communications that can be reduced to writing are considered a written communication. Accordingly, radio and TV interviews, other than those published or given to unaffiliated and uncompensated media, would be considered a free writing prospectus and subject to the SEC use and filing rules.

All free writing prospectuses must contain a specific notice legend as set forth in Rule 433 of the Securities Act. A free writing prospectus must be filed with the SEC, using Form 8-K, no later than the date of first use. An after-hours filing will satisfy this requirement as long as it is the same calendar day. Moreover, all free writing prospectuses must be filed with the SEC, whether distributed by the registrant or another offering participant and whether such distribution was intentional or unintentional.

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

Small- and micro-cap issuers will rarely be eligible to use a free writing prospectus.

Live Road Shows

A road show is regulated under Rule 433 of the Securities Act and the free writing prospectus rules. Written road show materials may be considered free writing prospectus and must be filed with the SEC, and may only be used by companies eligible to use a free writing prospectus. As mentioned, if the writing is simply a repetition of the information contained in the filed registration statement, it is not considered a free writing prospectus and may be used by all companies that have filed a registration statement with the SEC. Accordingly, written materials used in a road show by any company that is not eligible to use a free writing prospectus (such as most small- and micro-cap companies) are strictly limited to the contents of the registration statement itself.

Oral communications in a live road show are exempt from the free writing prospectus requirements under Rule 433 and accordingly may be used by all companies with a filed registration statement (not before).

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

Smaller Reporting Company Dilemma

The opportunities for a smaller reporting company to engage in marketing, test-the-waters, and other pre-effective communications related to a public offering are limited. A “smaller reporting company” is defined as one that, among other things, has a public float of less than $75 million in common equity, or if unable to calculate the public float, has less than $50 million in annual revenues. As described above, an “emerging growth company” is one with total annual gross revenues of less than $1 billion during its most recently completed fiscal year that first sells equity in a registered offering after December 8, 2011. At times a company will qualify as both a smaller reporting company and an emerging growth company, but not always.

A smaller “reporting” company is, by definition, a company subject to the “reporting” requirements of the Securities Exchange Act of 1934 (“Exchange Act”). Companies that are subject to the Exchange Act do not qualify to use Regulation A. Accordingly, a smaller reporting company cannot avail itself of the broad allowable pre-offering test-the-waters communications allowed in a Regulation A public offering. I do note that some smaller reporting companies are voluntary filers. That is, they voluntarily file reports with the SEC and are not actually subject to the Exchange Act reporting requirements. These companies can complete a Regulation A public offering.

Where a smaller reporting company is not also an EGC, it cannot engage in Section 105(c) test-the-waters communications made available under the JOBS Act. This is clearly a legislative miss. The JOBS Act is intended to create capital raising opportunities for small companies. Although I understand that the thought was to assist EGC’s in the IPO process, the fact is that many smaller reporting companies engage in a series of follow-on public offerings before reaching a size and level of maturity where they no longer need the assistance of rules and laws designed to encourage capital in smaller companies. Ironically, by that point, these companies will be able to engage in additional communications only available to eligible larger issues, such as free writing prospectus and Rule 163 communications. Rule 163 communications are only available to well-known, seasoned issuers (big companies) and have not been addressed in this blog.

Many of these smaller reporting companies trade on the OTC Markets, which, despite continued and ongoing best efforts, face liquidity issues and need extra legislative support in conducting offerings just as the legislature clearly realizes an EGC’s needs. For a good refresher on liquidity issues for small companies, see my blog HERE.

That leaves a copy of the actual filed registration statement, Rules 134 and 135 for written communications and live road shows for smaller reporting companies engaging in initial and follow-on public offerings.

Smaller reporting companies are usually better off engaging in a Rule 506(c) advertised private offering than a registered public offering from a marketing perspective. This likely unintended consequence seems a dichotomy to the SEC objective of preferring registration and its accompanying complete disclosure in the issuance of securities.

The Author

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

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

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« Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 1 SEC Advisory Committee On Small And Emerging Companies Issues Further Recommendations On Accredited Investor Definition »

Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 1

Posted by Securities Attorney Laura Anthony | July 19, 2016 Tags: Blue Sky Laws, Blue Sky Notice Filing, Blue Sky Notice Filings, NSMIA, Regulation A, S-1 Public Offering, S-1 Public Offerings

The JOBS Act enacted in 2012 made the most dramatic changes to the landscape for the marketing and selling of both private and public offerings since the enactment of the Securities Act of 1933. These significant changes include: (i) the creation of Rule 506(c), which came into effect on September 23, 2013 and allows for general solicitation and advertising in private offerings where the purchasers are limited to accredited investors; (ii) the overhaul of Regulation A creating two tiers of offerings, which came into effect on June 19, 2015 and allows for both pre-filing and post-filing marketing of an offering, called “testing the waters”; (iii) the addition of Section 5(d) of the Securities Act, which came into effect in April 2012, permitting emerging growth companies to test the waters by engaging in pre- and post-filing communications with qualified institutional buyers or institutions that are accredited investors; and (iv) Title III crowdfunding, which came into effect May 19, 2016 and allows for the use of Internet-based marketing and sales of securities offerings.

This two-part blog series focuses on test-the-waters marketing of Regulation A/A+ offerings and Section 5(d) for public offerings by emerging growth companies. Part I discussed Regulation A/A+ and Part II discusses Section 5(d) for IPO’s by emerging growth companies.

Test The Waters In Regulation A/A+ Offerings

On June 19, 2015 the new rules for Regulation A/A+ came into effect. Regulation A was divided into two tiers: Tier I Regulation A, which does not preempt state law, allows offerings of up to $20 million in any 12-month period and Tier 2, which does preempt state law, allows offerings of up to $50 million in any 12-month period. Issuers may elect to proceed under either Tier I or Tier 2 for offerings up to $20 million. Since enactment of the rules, the SEC has issued guidance via Compliance and Disclosure Interpretations (C&DI) and industry participants have guided each other, communicating about experiences, successes and frustrations.

Regulation A+ allows for prequalification solicitations of interest in an offering, commonly referred to as “testing the waters.” As mentioned above, Tier 1 offerings do not preempt state law and accordingly, any issues intending to test the waters for a Tier 1 offering must comply with the individual state law(s) in which they intend to qualify the offering. This process can be expensive and tricky and as such, the vast majority of Regulation A+ offerings have been filed under Tier 2 and almost all, if not all, test-the-waters campaigns are for Tier 2 offerings. This initial discussion assumes a Tier 2 offering, though I will touch on Tier 1 below as well.

Issuers can use “test-the-waters” solicitation materials both before and after the initial filing of the Form 1-A registration statement. In the event that materials are issued after the filing of the Form 1-A, the materials must include Form 1-A itself or information on where one can be obtained. This requirement is satisfied by providing a link to the Form 1-A filing on the EDGAR database.

Moreover, solicitation material used before qualification of the Form 1-A must contain a legend stating that no money or consideration is being solicited and none will be accepted, no offer to buy securities can be accepted and any offer can be withdrawn before qualification, and a person’s indication of interest does not create a commitment to purchase securities.

Generally a test-the-waters legend appears on the bottom of a webpage or on the first page of a PowerPoint or other investor deck. An example of a disclosure utilized prior to the filing of a Form 1-A would be:

No money or other consideration is being solicited for our Regulation A+ offering at this time and if sent in to Acme, Inc. will not be accepted. No offer to buy securities in a Regulation A+ offering of Acme can be accepted and no part of the purchase price can be received until Acme’s offering statement is qualified with the SEC. Any such offer to buy securities may be withdrawn or revoked, without obligation or commitment of any kind, at any time before notice of its acceptance given after the qualification date. Any indications of interest in Acme’s offering involves no obligation or commitment of any kind.

In addition to the above pre-filing disclosure, I often see and use an added disclosure similar to the following:

Acme Inc. is testing the waters under Regulation A of the Securities Act of 1933, as amended. This process allows companies to determine whether there may be interest in an eventual offering of its securities. Acme is not under any obligation to make an offering under Regulation A. Acme may choose to make an offering to some, but not all, of the people who indicate an interest in investing, and that offering may not be made under Regulation A. For example, Acme may determine to proceed with an offering under Rule 506(c) of Regulation D, in which case we will only offer our securities to accredited investors as defined by Rule 501(a) of Regulation D. If Acme does go ahead with an offering under Regulation A, it will only be able to make sales after it has filed an offering statement with the Securities and Exchange Commission (“SEC”) and only after the SEC has qualified such offering statement. The information in the offering statement will be more complete than the test-the-waters materials and could differ in important ways. You must read the offering statement filed with the SEC.

The disclaimer legend for testing-the-waters materials utilized following the filing of a Form 1-A with the SEC will be substantially the same, but will contain a link to the filed preliminary Form 1-A on the SEC EDGAR database.

“Test-the-waters” solicitations may be made both orally and in writing.

All solicitation material must be submitted to the SEC as an Exhibit under Part III of Form 1-A. This is a significant difference from S-1 filers, who are not required to file “test-the-waters” communications with the SEC.

Unlike the “testing of the waters” by emerging growth companies that are limited to QIBs and accredited investors, a Regulation A+ company could reach out to retail and non-accredited investors. After the public filing but before SEC qualification, a company may use its preliminary offering circular to make written offers.

Of course, all “test-the-waters” materials are subject to the antifraud provisions of federal securities laws.

Like registered offerings, ongoing regularly released factual business communications, not including information related to the offering of securities, will be allowed and will not be considered solicitation materials.

On June 23, 2015, the SEC updated its Division of Corporation Finance C&DI to provide guidance related to Regulation A/A+ including guidance on testing the waters. In particular, the SEC provided the following guidance related to testing the waters using social media:

A company can use Twitter and other social media that limit the number of characters in a communication, to test the waters as long as the company provides a hyperlink to the required disclaimers. In particular, a company can use a hyperlink to satisfy the disclosure and disclaimer requirements in Rule 255 as long as (i) the electronic communication is distributed through a platform that has technological limitations on the number of characters or amount of text that may be included in the communication; (ii) including the entire disclaimer and other required disclosures would exceed the character limit on that particular platform; and (iii) the communication has an active hyperlink to the required disclaimers and disclosures and, where possible, prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.

Practical Considerations

In addition to the legal aspects of testing the waters, a company needs to consider the practical business aspects as well, including whether they should test the waters at all. I’ve engaged in quite a bit of healthy discussion on the topic, and read just as much.

Testing the waters can be very helpful in determining whether proceeding with a Regulation A offering is the right course for a company. A Regulation A offering is not inexpensive. A company needs to complete an audit, incur legal fees and incur direct and indirect marketing and offering expenses. In addition to the direct offering expenses, management will need to focus an inordinate amount of time on the offering itself, which time will detract from business operations.

Testing the waters can also help to build up investor interest and excitement for an offering prior to its actual launch or “going live,” thus making the selling process exponentially quicker and easier. It takes time to educate the public about a company and an offering, and through testing the waters, this process can be completed concurrently with the SEC review of the Form 1-A rather than after. Moreover, testing the waters may have the secondary effect of increasing product sales, customer acquisition and brand awareness.

Keep in mind that a successful test-the-waters process does not ensure a successful offering. Although the process is still new, so far less than 50% of potential investors that indicate interest in an offering actually follow through with an investment. That figure may actually be far lower. I’ve read at least one credible source who believes that the conversion from a test-the-waters indication of interest to an actual investment is closer to 5%.

As with all matters, there is a counter to the positive. An ill-prepared or poorly executed test-the-waters campaign may prove extremely detrimental to what may otherwise have been a successful offering process. I have seen some companies attempt to test the waters without any legal or other guidance whatsoever, through social media or their own websites. These campaigns generally are not only unsuccessful but present a poor public image of the company. In this case, a company may need to pull all offering plans for a “cooling-off period” before launching again with better guidance.

As with all public offering matters, a company must also consider the public availability of test-the-waters materials, and education for competitors, including knowledge of the offering itself. To me this is less of a consideration; if a company does not want a competitor to learn of their business and offering plans, a Regulation A public offering is probably not the right choice in the first place. That company may be better suited filing a confidential registration statement on Form S-1 or sticking with private offerings.

Once a company determines to proceed with testing the waters, preparation is key. A company and its advisors need to prepare materials that are not only creatively compelling from a general marketing standpoint but that are also compelling to a reasonably sophisticated investor. That requires researching recent deal flow from the same and similar industry groups, as well as knowing what deal parameters have been successful and what have not and understanding the constantly changing investor appetite.

A company must also consider who it is directing its campaign towards. A different approach may be used when soliciting a long-standing customer or fan base with prior knowledge of a business, than for a list of broker-dealer clients that have never heard of the company before.

State Law Concerns

Tier 1 offerings do not preempt state law and accordingly, any issues intending to test the waters for a Tier 1 offering must comply with the individual state law(s) in which they intend to qualify the offering. This process can be expensive and tricky and as such, the vast majority of Regulation A+ offerings have been filed under Tier 2 and almost all, if not all, test-the-waters campaigns are for Tier 2 offerings.

Although a Tier 2 offering does not require state registration and review, the individual states specifically maintain the right and jurisdiction to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by an issuer, related party or any broker, dealer or funding portal in any transaction. Moreover, the states can require a notice filing requirement. The law specifically allows the states to require a copy of any document filed with the SEC, together with annual or periodic reports of the value of securities sold or offered to be sold to persons located in the state (if not already included in the SEC filing) as long as such filing is solely for notice purposes and for the assessment or calculation of a fee. States may also require the filing of consent to service of process.

States may also require the payment of a fee in connection with a notice filing, except when fees are specifically prohibited in connection with securities that are listed or authorized for listing on a national securities exchange such as the NYSE or NASDAQ. No Regulation A offerings have been completed resulting in a security trading on a national exchange as of the date of this blog, but it is legally possible and I suspect will happen. Although a state may not condition the federal preemption granted by the federal law upon the payment of a fee, it can suspend an otherwise covered offering in its state for the failure to file a notice filing and pay the fee.

The timing and fees associated with blue sky notice filings vary. Accordingly, even for covered securities, a review of state blue sky laws is necessary.

As a result of potential blue sky issues when testing the waters under Tier 2, for prequalification test-the-waters materials, I often use an added disclaimer as follows:

No offer to sell securities or solicitation of an offer to buy securities is being made in any state where such offer or sale is not permitted under the blue sky or state securities laws thereof. No offering is being made to individual investors unless and until the offering has been registered in that state or an exemption from registration exists. Acme, Inc. intends to complete an offering under Tier 2 of Regulation A and as such intends to be exempted from state registration pursuant to federal law. Although an exemption from registration under state law may be available, Acme may still be required to provide a notice filing and pay a fee in individual states.

For a review of federal preemption of state securities laws, see my two-part blog on the National Markets Improvement Act of 1996 (NSMIA) HERE and HERE. Note that these blogs were written prior to the adoption of the new Regulation A rules and do not take into account the addition of Regulation A Tier 2 offerings as a “covered security.”

Also, as I have previously written about, even when an offering is preempted from state blue sky laws, the ability to sell the offering may not be. In particular, the NSMIA offering preemption law does not preempt broker-dealer registration requirements associated with such offering. At least two states, Florida and New York, do not provide exemptions for issuers who self-underwrite or self-place public offerings. A Regulation A offering is a public offering. For more information on these issues and Florida and New York in particular, please see my blog HERE. Note that following the publication of that blog, Florida has passed an exemption from the broker-dealer registration requirements for merger and acquisition brokers similar to the federal exemption. I will be writing about Florida’s new broker-dealer exemption in an upcoming blog.

The Author

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

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

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« SEC Proposes Amendments To Definition Of “Small Reporting Company” Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 2 »

SEC Proposes Amendments To Definition Of “Small Reporting Company”

Posted by Securities Attorney Laura Anthony | July 12, 2016 Tags: Accelerated Filer, Large Accelerated Filer, Non-Accelerated Filer, Regulation S-K, Regulation S-X, Small Reporting Company, Smaller Reporting Company

On June 27, 2016, the SEC published proposed amendments to the definition of “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 would expand the number of companies that qualify as a smaller reporting company and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The rule change follows the SEC concept release and request for public comment on sweeping changes to the business and financial disclosure requirements in Regulation S-K. Throughout the SEC Concept Release, it referenced the scaled and different disclosure requirements for the different categories of company and affirmed that it was evaluating and considering changes to the eligibility criteria for each.

If the rule change is passed, the number of companies qualifying as a smaller reporting company will increase from 32% to 42% of all reporting companies.

The proposed rule change follows the SEC Advisory Committee on Small and Emerging Companies recommendations to the SEC on the point. In particular, the SEC proposes to amend the definition of a smaller reporting company to include companies with less than a $250 million public float as compared to the $75 million threshold in the current definition. In addition, if a company does not have an ascertainable public float, a smaller reporting company would be one with less than $100 million in annual revenues, as compared to the current threshold of less than $50 million. Once considered a smaller reporting company, a company would maintain that status unless its float drops below $200 million or its annual revenues below $80 million.

In addition, the SEC proposes to change the definition of “accelerated filer” and “large accelerated filer” to eliminate an exclusion from such definitions for smaller reporting companies. That is, the SEC specifically chose not to increase the $75 million threshold in the “accelerated filer” definition. Accordingly, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file its periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002.

In its press release accompanying the proposed rule changes, SEC Chair Mary Jo White was quoted as saying, “[R]aising the financial thresholds in the smaller reporting company definition is intended to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections. The Commission will benefit greatly from the public comments we receive from investors, issuers and other affected market participants on today’s proposal, as well as comments we receive on the Regulation S-K concept release, which will help inform any changes to the scaled disclosure system or other changes to our disclosure requirements.”

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.

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. A “smaller reporting company” is currently 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:

The Author

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

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

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« Confidentially Marketed Public Offerings (CMPO) Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 1 »

Confidentially Marketed Public Offerings (CMPO)

Posted by Securities Attorney Laura Anthony | July 5, 2016 Tags: CMPO, Confidentially Marketed Public Offering, Confidentially Marketed Public Offerings, Form 8-K, NASDAQ Considerations, NASDAQ Rules, Regulation FD, S-3 Eligibility, S-3 Registration Statement, S-3 Shelf Registration

Not surprisingly, I read the trades including all the basics, the Wall Street Journal, Bloomberg, The Street,The PIPEs Report, etc. A few years ago I started seeing the term “confidentially marketed public offerings” or “CMPO” on a regular basis. The weekly PIPEs Report breaks down offerings using a variety of metrics and in the past few years, the weekly number of completed CMPOs has grown in significance. CMPOs count for billions of dollars in capital raised each year.

CMPO Defined

A CMPO is a type of shelf offering registered on a Form S-3 that involves speedy takedowns when market opportunities present themselves (for example, on heavy volume). A CMPO is very flexible as each takedown is on negotiated terms with the particular investor or investor group. In particular, an effective S-3 shelf registration statement allows for takedowns at a discount to market price and other flexibility in the parameters of the offering such as the inclusion of warrants and terms of such warrants. A CMPO is sometimes referred to as “wall-crossed,” “pre-marketed” or “overnight” offerings.

In a typical CMPO, an underwriter confidentially markets takedowns of an effective S-3 shelf registration statement to a small number of institutional investors. The underwriter will not disclose the name of the issuing company until the institutional investor agrees that they have a firm interest in receiving confidential information and agrees not to trade in such company’s securities until the offering is either completed or abandoned.

When an investor confirms their interest, the company and its banker will negotiate the terms of the offering with the investor(s), including amount, price (generally a discount to market price), warrant coverage and terms of such warrant coverage. The disclosure of the name of the issuer and confidential information related to the offering is referred to as bringing the investor “over the wall.” Once brought over the wall, the potential investor(s) will complete due diligence. This process is completed on a confidential basis.

Once the terms have been agreed upon, the offering is “flipped” from confidential to public and a prospectus supplement, free writing prospectus, if any, a Rule 134 press release and a Form 8-K are prepared and filed informing the market of the offering. These public documents are almost always filed after the market closes and the offering itself generally closes that night as well, though sometimes the closing occurs the next trading day. The closing is the same as a firm commitment underwritten offering, such that there is a single closing of the entire takedown. The closing process and documents are also the same as a firm commitment underwritten offering including an underwriting agreement, opinion of counsel and a comfort letter. As the public disclosure and closing of the offering generally occurs overnight, a CMPO earned the name an “overnight” offering.

Generally the necessary closing documents and public filings have been prepared and are on standby ready to be utilized when a deal is agreed upon. Both the company and investors will wait for a favorable market window, such as an increase in the price and volume of the company’s stock, to close the offering.

S-3 Eligibility; NASDAQ Considerations; FINRA

A CMPO requires an effective S-3 shelf registration statement and accordingly is only available to companies that qualify to use an S-3. Among other requirements, to qualify to use an S-3 registration statement a company must have timely filed all Exchange Act reports, including Form 8-K, within the prior 12 months. An S-3 also contains certain limitations on the value of securities that can be offered. Companies that have an aggregate market value of voting and non-voting common stock held by non-affiliates of $75 million or more, may offer the full amount of securities under an S-3 registration. For companies that have an aggregate market value of voting and non-voting common stock held by non-affiliates of less than $75 million, the company can offer up to one-third of that market value in any trailing 12-month period. This one-third limitation is referred to as the “baby shelf rule.”

To calculate the non-affiliate float for purposes of S-3 eligibility, a company may look back 60 days and select the highest of the last sales prices or the average of the bid and ask prices on the principal exchange. The registration capacity for a baby shelf is measured immediately prior to the offering and re-measured on a rolling basis in connection with subsequent takedowns. The availability for a particular takedown is measured as the current allowable offering amount less any amounts actually sold under the same S-3 in prior takedowns. Accordingly, the available offering amount will increase as a company’s stock price increases, and decrease as a stock price decreases.

A company should be careful that a CMPO is structured to comply with the NASDAQ definition of “public offering,” thereby avoiding NASDAQ’s rules requiring shareholder approval for private placements where the issuance will or could equal 20% or more of the pre-transaction outstanding shares. In particular, NASDAQ requires advance shareholder approval when a company sells 20% or more of its outstanding common stock (or securities convertible into common stock) in a private offering, at a discount to the greater of the market price or book value per share of the common stock. A separate NASDAQ rule also requires shareholder approval where officers, directors, employees, consultants or affiliates are issued common stock in a private placement at a discount to market price. CMPO’s have been stopped in their tracks by NASDAQ requiring pre-closing shareholder approval.

A CMPO differs from a standard public offering as it is confidentially marketed and is completed with little or no advance market notice. Accordingly, in determining whether a CMPO qualifies as a public offering, NASDAQ will consider: (i) the type of offering including whether it is being completed by an underwriter on a firm commitment or best-efforts basis (firm commitment being favorable); (ii) the manner of offering and marketing, including number of investors marketed to and how such investors were chosen (the more broad the marketing, the better); (iii) the prior relationship between the investors and the company or underwriter (again, the more broadly marketed, the better, as public offerings are generally widely marketed); (iv) offering terms including price (a deeper discount is unfavorable); and (v) the extent to which the company controls the offering and its distribution (insider participation is unfavorable).

NASDAQ also has rules requiring an advance application for the listing of additional shares resulting from follow-on offerings. Generally NASDAQ requires 15 days advance notice, but will often waive this advance notice upon request.

A CMPO will need to comply with FINRA rule 5110, the corporate finance rule. Generally FINRA will process a 5110 clearance on the same day. Moreover, there are several exemptions to issuer 5110 compliance, including based on the size of the company’s public float. For a brief overview of Rule 5110, see my blogHERE.

Confidentiality; Regulation FD; Insider Trading

By nature a CMPO involves the disclosure of confidential information to potential investors, including, but not limited to, that the company is considering a public offering takedown, the pricing terms of the offering, warrant coverage, and the disclosure of potentially confidential information during the due diligence phase. To ensure compliance with Regulation FD and avoid insider trading, the company and its underwriters will obtain a confidentiality agreement from the potential investors. The agreement will include a trading blackout for a specific period of time, generally until the offering either closes or is abandoned.

Although the confidential portion of the CMPO usually occurs very quickly (a week or two), many institutional investors require that the company issue a public “cleansing” statement if the offering does not proceed within a specified period of time. The cleansing statement would need to disclose any material non-public information disclosed to the potential investor as part of the negotiation and due diligence related to the offering. In the event the offering proceeds to a close, the offering documents (including potential free writing prospectus or prospectus supplement, Rule 134 press release and 8-K) will include all material non-public information previously disclosed to potential investors during the confidential phase. Both the company and the investor need to be careful that the filed offering materials and/or cleansing statement contain all necessary information to avoid potential insider trading issues.

The company must be sure to also file with the SEC all written marketing offering materials associated with a registered offering either as part of the prospectus or as a free writing prospectus. Generally with a CMPO, the written materials provided to investors are limited to public filings and investor presentation materials such as a PowerPoint already in the public domain that do not, in and of themselves, contain any material non-public information and therefore do not need to be filed with the SEC as offering materials.

As a reminder, Regulation FD excludes communications (i) to a person who owes the issuer a duty of trust or confidence such as legal counsel and financial advisors; (ii) communications to any person who expressly agrees to maintain the information in confidence (such as potential investors in a CMPO); and (iii) communications in connection with certain offerings of securities registered under the Securities Act of 1933 (this exemption does not include registered shelf offerings and, accordingly, generally does not include a CMPO).

Benefits of a CMPO

A CMPO offers a great deal of flexibility to a company and its bankers. Utilized correctly, a CMPO can have minimal market impact. It is widely believed that announcements of public offerings, and impending dilution and selling pressure, invite short selling and speculative short-term market activity. Since a CMPO is confidential by nature and the time between the public awareness and completion of a particular takedown is very short (oftentimes the same day), the opportunity for speculating and short sellers is minimized. Moreover, as a result of the confidential nature of a CMPO, if a particular offering or takedown is abandoned, the market is unaware, relieving the company of the typical downward pricing pressure associated with an abandoned offering. Likewise, this confidential process allows the company to test the waters and only proceed when investor appetite is confirmed.

As a registered offering, CMPO securities are freely tradable and immediately transferable, incentivizing investment activity and reducing the negotiated discount to market associated with restricted securities. Offering expenses for a CMPO are also less than a fully marketed follow-on public offering. The CMPO is based on an existing S-3 shelf registration, thus reducing drafting costs. Also, the expense of marketing an offering itself, including a road show, is reduced or eliminated altogether.

Although the structure of a CMPO requires that the issuing company be S-3 shelf registration eligible, CMPOs are often used by small and development-stage companies (such as technology and biotech companies) that have smaller market capitalizations and need to tap into the capital of the public markets on a more frequent basis to fund ongoing research and development of products.

The Author

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

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

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« OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies SEC Proposes Amendments To Definition Of “Small Reporting Company” »

OTC Markets Petitions The SEC To Expand Regulation A To Include SEC Reporting Companies

Posted by Securities Attorney Laura Anthony | June 28, 2016 Tags: OTC Markets, OTC Markets Listing Requirements, OTCQB, OTCQX, Regulation A, Regulation a SEC, SEC, SEC Regulation A, SEC Reporting Companies

On June 6, OTC Markets filed a petition for rulemaking with the SEC requesting that the SEC amend Regulation A to expand the eligibility criteria to include all small issuers, including those that are subject to the Securities Exchange Act of 1934 (“Exchange Act”) reporting requirements and to allow “at-the-market offerings.”

Background

On March 25, 2015, the SEC released final rules amending Regulation A. The new Regulation A creates two tiers of offerings. Tier I of Regulation A, which does not preempt state law, allows offerings of up to $20 million in a twelve-month period. Due to difficult blue sky compliance, Tier 1 is rarely used. Tier 2, which does preempt state law, allows a raise of up to $50 million. Issuers may elect to proceed under either Tier I or Tier 2 for offerings up to $20 million. The new rules went into effect on June 19, 2015 and have been gaining traction ever since. Since that time, the SEC Division of Corporation Finance has issued periodic Compliance and Disclosure Interpretations (C&DI) to provide guidance related to Regulation A. I have previously written several articles on Regulation A and the C&DI. For a good review and summary, please see my blog HERE.

From inception, a Regulation A company could apply for a listing on the OTC Markets OTCQX Tier assuming it meets the qualifications. Elio Motors trades on the OTCQX. For a review of such qualifications, see my blog HERE. Unlike the OTCQX, generally a company that is not subject to the Exchange Act reporting requirements did not qualify for the OTCQB; however, effective July 10, the OTCQB has amended their rules to allow a Tier 2 reporting entity to qualify to apply for and trade on the OTCQB. My blog on the OTCQB rules related to Regulation A can be read HERE.

Whether trading on the OTCQX or OTCQB, keep in mind that unless the issuer has filed a Form 8-A or Form 10, they will not be considered “subject to the Exchange Act reporting requirements” for purposes of benefiting from the shorter 6-month Rule 144 holding period. For a short overview of Rule 144, see HERE.

Regulation A Eligibility – Reporting Issuers

As enacted, Regulation A is available to companies organized and operating in the United States and Canada. The following issuers are not be eligible for a Regulation A+ offering:

Companies currently subject to the reporting requirements of the Exchange Act;
Investment companies registered or required to be registered under the Investment Company Act of 1940, including BDC’s;
Blank check companies, which are companies that have no specific business plan or purpose or whose business plan and purpose is to engage in a merger or acquisition with an unidentified target; however, shell companies are not prohibited, unless such shell company is also a blank check company. A shell company is a company that has no or nominal operations; and either no or nominal assets, assets consisting of cash and cash equivalents, or assets consisting of any amount of cash and cash equivalents and nominal other assets. Accordingly, a start-up business or minimally operating business may utilize Regulation A+;
Issuers seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights;
Issuers that have been subject to any order of the SEC under Exchange Act Section 12(j) denying, suspending or revoking registration, entered within the past five years;
Issuers that became subject to Exchange Act reporting requirements, such as through a Tier 2 offering, and did not file required ongoing reports during the preceding two years; and
Issuers that are disqualified under the “bad actor” rules and, in particular, Rule 262 of Regulation A+.

Although companies subject to the reporting requirement have been disqualified from day one, the SEC quickly issued guidance clarifying that Regulation A may be used by many existing “reporting entities” either because they voluntarily report (generally because they never filed a Form 8-A or Form 10 after an S-1 registration statement and the initial required reporting period has passed) or through a wholly owned subsidiary resulting in a complete or partial spin-off.

The SEC specifically provided that 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. The determination of eligibility is made at the time of the offering. Moreover, a company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to rely on Regulation A. In addition, 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.

Related to small business issuers, the current rules create an unfair distinction. A company trading on the OTC Markets that voluntarily reports to the SEC would be eligible, whereas a company that may be substantially similar but is required to file reports would be ineligible to utilize Regulation A+.

On June 6, 2016, OTC Markets filed a petition for rulemaking with the SEC requesting that the SEC amend Regulation A+ to expand the eligibility criteria to include all small issuers, including those that are subject to the Exchange Act reporting requirements and to allow “at-the-market offerings.”

The OTC Markets petition is concise and to the point. When Congress passed the JOBS Act, it left the particulars of Regulation A+ rulemaking to the SEC with only the following mandates:

The aggregate offering amount of all securities sold within a 12-month period shall not exceed $50,000,000;
The securities may be offered and sold publicly;
The securities shall not be restricted securities within the meaning of the federal securities laws;
The civil liability provisions under Section 12(a)(2) of the Securities Act shall apply to any person offering or selling Regulation A securities;
The issuer may solicit interest in the offering prior to filing any offering statement, on such terms and condition as the SEC may prescribe in the public interest and protecting investors;
The SEC shall require the issuer to file annual audited financial statements; and
Such other terms and conditions as the SEC shall determine are necessary in the public interest and protecting investors.

The JOBS Act itself did not prohibit or limit the use of Regulation A+ for reporting companies, and accordingly, that decision is within the SEC rulemaking discretion. In fact, throughout the JOBS Act and in particular in Title IV related to Regulation A+, Congress refers to expanding capital formation for “small issues” under $50 million with the goal of increasing capital to all small companies.

The SEC reasoning for excluding reporting companies in the first place is weak at best. In particular, the SEC excluded reporting issuers because the prior Regulation A rules, which were admittedly rarely used and ineffective at assisting in small business capital formation, contained the exclusion. That is, when revamping Regulation A+ as mandated by the JOBS Act, the SEC just didn’t change that provision.

The OTC Markets points out that the Regulation A+ rules as enacted offer more protections for non-accredited investors than a fully registered S-1 or S-3 offering. In particular, there are no investor limitations for unaccredited purchasers in an S-1 or S-3 offering, whereas a Regulation A+ offering limits investments by unaccredited investors to no more than 10% of the greater of the investor’s annual income or net worth. In addition, a traditional S-1 or S-3 does not have any limitations or prohibitions related to bad actor disqualifications, whereas Regulation A+ does prohibit use by “bad actors.”

The OTC Markets petition also contains a good discussion on the costs associated with an S-1 or S-3 offering, including added costs of state blue sky law compliance. State blue sky preemption is one of the cornerstones of Tier 2 Regulation A+ offerings that benefit issuers. Moreover, generally only much larger issuers are S-3 eligible and thus S-3 is not considered a “small company” capital formation tool. Similarly, private offerings under Regulation D are not registered and so do not offer the same level of investor protections. These offerings also result in restricted securities and thus less investor incentive to participate.

In addition to the obvious benefit to small and emerging company capital formation of allowing small reporting companies to utilize Regulation A+, there is also an added potential benefit to the capital markets as a whole. OTC Markets opines that the flow of freely tradable securities into the marketplace for existing public companies could have a positive uptick on the liquidity and overall growth and vitality of venture markets. Regulation A+ could have the benefit of pushing forward the much needed venture market for the secondary trading of securities of early-stage, small and emerging growth companies. OTC Markets points out that it could and should be that venture market.

The OTC Markets petition contains a pointed discussion on the market benefits, including noting that “Regulation A+ allows smaller companies, traditionally lacking the backing of bulge bracket investment banks and the large base of institutional ownership needed to fund ongoing research coverage, to reach out to a broader pool of potential investors through ‘testing the waters’ provisions and the efficient economical reach of the Internet and social media. Emerging companies can use Regulation A+ online offerings to tap into large numbers of individual investors and efficiently target smaller institutions. Allowing fully SEC reporting companies the same ability to leverage technology and transparency to reach potential investors would be expected to provide a ready source of growth capital, and, equally important, an increase in liquidity in the secondary market.”

Interestingly, OTC argues that opening up Regulation A+ to small reporting companies may reduce or minimize the use of toxic financing options which carry substantial dilution and downward pricing pressure on company stock. Moreover, allowing small reporting companies to utilize Regulation A+ may raise the interest in these offerings for investment banks.

Finally, in order to make Regulation A+ the most useful for reporting companies, OTC Markets requests that the SEC also amend the rules to allow “at-the-market” offerings. Currently all Regulation A+ offerings must be priced. In the case of a security that is already trading, the ability to price accurately is difficult and the inability to adjust such pricing in response to fluctuating market conditions can impede the success of the offering.

Further Thoughts

From my perspective, Regulation A has become the most popular method of fundraising and private-to-public transactions for small business issuers. Although as of the date of this blog, only one issuer, Elio Motors, Inc., has received a trading symbol and actively trades, many others are in the works and I think we will see an opening of the floodgates. As Tier 2 requires audited financial statements, the preparation process can take months and the placement of an offering can also take months.

A traditional IPO is completed using an underwriter on a “firm commitment” basis where the underwriter buys all the company’s securities on the first day of the IPO and proceeds to resell them. No Regulation A offerings have yet been completed in a firm commitment underwritten offering. To the contrary, current Regulation A offerings are either self-placed by the issuing company, or completed with the assistance of a broker-dealer placement agent on a best efforts basis. This placement process can take several months to complete. Accordingly, many issuers have not closed out their offerings as of yet and therefore have not reached the point of eligibility to apply for a trade symbol. My office alone has over half a dozen Regulation A offerings in the works.

Tier 2 offerings in particular present a much-needed opportunity for smaller companies to go public without the added time and expense of state blue sky compliance but with added investor qualifications. Tier 2 offerings preempt state blue sky laws. To compromise with opponents to the state blue sky preemption, the SEC included investor qualifications for Tier 2 offerings. In particular, Tier 2 offerings have a limitation on the amount of securities non-accredited investors can purchase of no more than 10% of the greater of the investor’s annual income or net worth. It is the obligation of the issuer to notify investors of these limitations. Issuers may rely on the investors’ representations as to accreditation and investment limits with no added verification.

Tier 2 issuers that have used the S-1 format for their Form 1-A filing will be permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements. A Form 8-A is a simple registration form used instead of a Form 10 for issuers that have already filed the substantive Form 10 information with the SEC. Upon filing a Form 8-A, the issuer will become subject to the full Exchange Act reporting obligations, and the scaled-down Regulation A+ reporting will automatically be suspended. With the filing of a Form 8-A, the issuer can apply to trade on a national exchange.

This marks a huge change and opportunity for companies that wish to go public directly and raise less than $50 million. An initial or direct public offering on Form S-1 does not preempt state law. By choosing a Tier 2 Regulation A+ offering followed by a Form 8-A, the issuer can achieve the same result – i.e., become a fully reporting trading public company, without the added time and expense of complying with state blue sky laws. The other consideration would be the added investor qualifications, but if the issuer meets the requirements for and lists on a national exchange, the added investor qualifications no longer apply.

The SEC has a well published mission of “protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation.” Regulation A+ offers significant investor protections in that a form of registration statement is filed with the SEC and subject to a review and comment process. In addition, Regulation A+ allows for pre- and post-filing marketing using the Internet, social media, presentations and the like, provided all such materials are filed with the SEC and subject to review and comment. This process provides significant investor protections, including a permanent record of disclosures made during the offering process. Regulation A+ also provides a streamlined, affordable registration process with access to an expanded pool of investors, thus facilitating capital formation.

To the contrary, private offering documents are not filed or reviewed with the SEC and the process and level of disclosure are far less regulated. Public offerings using Form S-1 limit offering communications, and those communications are not necessarily filed or reviewed by the SEC. The Form S-1 process does not allow for broad Internet, crowd or social media marketing. A Form S-1 process also does not preempt state law and accordingly has significant added costs for a company. A Form S-1 works best for larger issuers with strong underwriter and institutional support. Regulation A+ provides the best method of registered capital formation for small companies, including those that are already subject to the SEC reporting requirements.

As was understood in passing the JOBS Act in 2012, the transparent Regulation A+ process is a preferred method of capital raising for small businesses, especially companies already subject to the reporting requirements who have audited financial statements readily available and processes in place for meeting SEC reporting and review requirements.

When the SEC issued the Regulation A+ rules on March 25, 2015, it issued a press release in which SEC Chair Mary Jo White was quoted as saying, “These new rules provide an effective, workable path to raising capital that also provides strong investor protections. It is important for the Commission to continue to look for ways that our rules can facilitate capital raising by smaller companies.” Allowing small reporting companies to partake in Regulation A+ meets all the mandates of the JOBS Act while concurrently satisfying the SEC goal of providing investor protections, and I am a strong advocate in support of a rule change in that regard.

The Author

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

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

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

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« A Comparison Of Nevada, Delaware And Florida Corporate Statutes Confidentially Marketed Public Offerings (CMPO) »

A Comparison Of Nevada, Delaware And Florida Corporate Statutes

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

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

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

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

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

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

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

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

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

Read More

The Author

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

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

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NYSE MKT Listing Requirements

Posted by Securities Attorney Laura Anthony | June 14, 2016 Tags: NYSE MKT, NYSE MKT Listing Requirements, NYSE MKT Rules

This blog is the second in a two-part series explaining the listing requirements for the two small-cap national exchanges, NASDAQ and the NYSE MKT. The first one, discussing NASDAQ, can be read HERE.

General Information and Background on NYSE MKT

The NYSE MKT is the small- and micro-cap exchange level of the NYSE suite of marketplaces. The NYSE MKT was formerly the separate American Stock Exchange (AMEX). In 2008, the NYSE Euronext purchased the AMEX and in 2009 renamed the exchange the NYSE Amex Equities. In 2012 the exchange was renamed to the current NYSE MKT LLC. The NASDAQ and NYSE MKT are ultimately business operations vying for attention and competing to attract the best publicly traded companies and investor following. The NYSE MKT homepage touts the benefits of choosing this exchange over others, including “access to dedicated funding, advocacy, content and networking and the industry’s first small-cap services package.”

Although there are substantial similarities among the different exchanges, and each is governed by the same overall SEC rules and regulations, each exchange also has its own unique differences. Moreover, each exchange has its own sets of rules and regulations that listing companies must comply with in order to obtain and maintain its listing qualification.

Like all exchanges, and the OTCQX tier of the OTC Markets, the NYSE MKT offers investor relations, broker-dealer networking and marketing services to its listed companies. The NYSE MKT’s distinctive formula is the Designated Market Maker (DMM) model (formerly referred to as a Specialist). A DMM is assigned to each security and uses both manual and electronic metrics and algorithms to help stabilize market price and trading volume.

NASDAQ does not have internal DMM’s (or Specialists), but rather relies on market makers in general to increase volume and liquidity in NASDAQ traded securities and hopefully decrease volatility. Whereas the NYSE MKT relies on both manual (human) and electronic trading oversight, the NASDAQ is purely electronic. The NYSE MKT has an auction model run by the DMM’s. The DMM reports all bids and asks into the marketplace, quoting the National Best Bid and Offer (NBBO) a required minimum percentage of time, and sets the opening price of its assigned securities each day. The opening price may be different than the prior day’s closing price due to after-market trading or any other factor that affects supply and demand.

In other words, the DMM is an intermediary between the broker/dealer/market participants and the execution of trades themselves. It is thought that using a DMM will increase trading liquidity and volume, because the DMM is motivated to match buyers and sellers and fulfill trading requests by either using its own inventory of the security or finding broker-dealers with matching orders. A DMM may even solicit a broker-dealer to act as the counterparty to a requested trade.

NASDAQ does not have the auction or DMM model. Rather, NASDAQ relies on market makers. Market makers must quote both a firm bid price and firm ask price they are willing to honor. Each NASDAQ security has multiple market makers (generally at least 14) competing for trades, and helping to ensure that the bid-ask spread is low and that supply and demand results in the best execution prices.

Initial and Continuing Listing Standards

A company seeking to list securities on NYSE MKT must meet minimum listing requirements, including specified financial, liquidity and corporate governance criteria. NYSE MKT has broad discretion over the listing process and may deny an application, even if the technical requirements are met, if it believes such denial is necessary to protect investors and the public interest. Factors the NYSE MKT consider include, but are not limited to, the nature of a company’s business; the market for its products; its regulatory history; its past corporate governance activities; the reputation of its management; its historical record and pattern of growth; its financial integrity (including filing for bankruptcy); its demonstrated earning power and its future outlook.

Once listed, a company must meet continued listing standards. In order to apply for listing on NYSE MKT, a company must complete and submit a listing application including specified documents and information. The quantitative and qualitative standards for initial listing of U.S. companies on NYSE MKT (the “Exchange”) are summarized below.

Read More

Click Here To Download Whitepaper- NYSE MKT Listing Requirements

The Author

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

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

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