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

SEC Advisory Committee On Small And Emerging Companies Reviews Capital Formation

Posted by Securities Attorney Laura Anthony | March 22, 2016 Tags: private equity, private offerings, SEC, sec guidance

On February 25, 2016, the SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) met and listened to three presentations on access to capital and private offerings. The three presentations were by Jeffrey E. Sohl, Professor of Entrepreneurship and Decision Science Director, Center For Venture Research at University of New Hampshire; Brian Knight, Associate Director of Financial Policy, Center for Financial Markets at the Milken Institute; and Scott Bauguess, Deputy Director, Division of Economic and Risk Analysis at the SEC. The presentations expound upon the recent SEC study on unregistered offerings (see blog HERE).

The presentations were designed to provide information to the Advisory Committee as they continue to explore recommendations to the SEC on various capital formation topics. This blog summarizes the 3 presentations.

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

Presentation by Jeffrey E. Sohl, Professor of Entrepreneurship and Decision Science Director, Center For Venture Research at University of New Hampshire

As I’ve written about many times, all offers and sales of securities must be either registered under the Securities Act of 1933, as amended (“Securities Act”) or made in reliance on an available exemption from registration. The exemptions for private offerings are found in Sections 3 and 4 of the Securities Act. In particular, most private offerings are governed by Sections 4(a)(2), 3(b) and 3(a)(11) of the Securities Act. Rules 506(b) and 506(c) of Regulation D, Regulation S and 144A provide safe harbors under Section 4(a)(2). Section 3(b) provides the authority for Rules 504 and 505 of Regulation D. Section 3(a)(11) provides statutory authority for intrastate offerings. In addition Regulation Crowdfunding, expected to go effective in May 2016, will implement the much anticipated Title III crowdfunding as codified in the new Section 4(a)(6) (see HERE).

Crowdfunding generally is where an entity or individual raises funds by seeking contributions from a large number of people. Accordingly, any offering that allows solicitation of the crowd is viewed as a form of crowdfunding. Equity crowdfunding is currently accomplished through the use of: (i) Rule 506(c) offerings which allow for advertising and solicitation to a crowd as long as all sales are strictly limited to accredited investors, and such accredited status is reasonably verified by the issuer (see HERE); (ii) Intrastate offerings under Section 3(a)(11) and Rule 147 (see HERE); and (iii) Rule 504 state specific offerings (see HERE).

Mr. Sohl’s presentation concentrates on a statistical analysis of capital raising for pre-seed, seed/start-up, early-stage and later-stage enterprises. Pre-seed funds almost unilaterally come from founders, friends and family. Generally, no unaffiliated third-party source invests at this stage. Mr. Sohl’s presentation is in the form of a needs analysis illustrating the difficulties in accessing capital and the funding gaps for new businesses.

Third-party private equity can begin at the seed/start-up phase but grows with the level of maturity of the enterprise. Sohl begins with the premise that third-party private equity comes from three primary sources: crowdfunding, angels and venture capitalists, in that order, based on the maturity of the company. In other words, crowdfunding is likely to be involved in the seed/start-up phase followed by angels with venture funds stepping in at later series A and B rounds. According to Sohl, since 2013 equity crowdfunding has had a success rate of 19.6% with an average raise ask being $2,000,000 and an average actual raise being at $210,000. Of the funds raised, 21% have been convertible debt, 7% straight debt and 72% equity. Sohl presents similar statistics on the success of angel and venture capital rounds, average deal sizes and a breakdown by industry sector. The numbers are low. For example, only 4.2% of seed and start-up financing comes from venture capital sources.

Using Sohl’s data analytics and assuming that a new business has successfully begun using founders, friends and family funds, Sohl points out that there remains a large funding gap for seed/start-up and early-stage companies.

Presentation by Brian Knight, Associate Director of Financial Policy, Center for Financial Markets at the Milken Institute

Brian Knight’s presentation is titled “How Small and Mid-size Businesses are Funding Their Future.” Mr. Knight and Milken Institute surveyed 636 owners and c-suite executive of private companies with annual revenues from less than $500,000 up to $1 billion on the topic of how these small and mid-size businesses are funding their businesses, accessing capital and planning for growth. Mr. Knight and the Milken Institute published a complete report on their findings. This blog is a short summary based on the presentation made to the SEC Advisory Committee.

The key findings in the report are (i) debt is the preferred method of financing; (ii) when choosing between financing sources, price, ease of access, speed of funding and certainty are the highest ranking considerations; (iii) there is no clear preference between bank and non-bank financing though banking relationships are valued; and (iv) businesses have a lack of understanding, and interest, in alternative sources of funding and recent securities law changes (nearly 80% of those surveyed were unfamiliar with recent changes to the laws).

I find this last point very interesting and think that the lack of understanding and interest is a result of a lack of reliable succinct sources of information, presented in layman’s terms, together with a time of rapidly changing rules and regulations. The survey also found that 90% of businesses would not consider alternative financing such as crowdfunding, intrastate offerings or Regulation A. However, I think that this tells more about the pool of companies surveyed (only 636) and is a factor of the lack of knowledge by these companies.

The survey also asked what reasons a company would consider in using alternative financing sources, with those reasons being, in order of importance: (i) they believe it would be good for public relations/press; (ii) believe such funding could be achieved on better terms; (iii) believe such funding will be less expensive to pursue and have lower compliance costs; and (iv) they want to expand their investor base. To the contrary, the reasons for rejecting such financing options include: (i) lack of knowledge and understanding; (ii) uncertainty about legality; (iii) fear of investor fraud; and (iv) a desire to know their investors.

Of the firms surveyed, 32% had not raised capital in the last three years. Of those that raised capital, 32% did so through bank financing, 10% from non-bank loans, 9% from friends and family, 9% from family offices and 8% from other equity investment sources. The survey also showed that the majority of companies expected to be able to self-fund through current and retained revenues. The survey found what we all would logically expect, which is that the more advanced the business is in its life cycle, the less it needs outside funding sources.

Although debt is the preferred financing source, the same businesses almost unilaterally agree that little or no debt is best for a business’s balance sheet. The decision to incur debt financing is needs-driven. Businesses borrow when they need cash flow.

Presentation by Scott Bauguess, Deputy Director, Division of Economic and Risk Analysis at the SEC

The presentation by the SEC was organized as a discussion of the findings of the SEC study on unregistered offerings and recent activity resulting from the JOBS Act implementation. As a reminder, Title I of the JOBS Act, creating emerging growth companies (EGC) and providing a more cost-effective IPO onramp with greater test-the-waters abilities, was enacted on April 5, 2012. Since the creation of the EGC category of business, close to 85% of IPO’s are by EGC qualified businesses. Title II, creating Rule 506(c) allowing for general solicitation and advertising in private offerings, became effective on September 23, 2013. Title IV, creating Regulation A/A+, became effective on June 19, 2015. Very little Regulation A/A+ information is available as it is too new. Finally, Title III Crowdfunding is expected to become effective on May 16, 2016.

Continuing the trend discussed in the SEC survey, in 2014 and 2015, Regulation D remained the most often used method of raising capital. Small businesses continue to have the greatest need for capital and continue to be a driver of employment in the U.S. economy. Even amongst public companies, smaller reporting companies comprise the largest class of company at over 40% of all issuers. In 2013, there were more than 5 million businesses with fewer than 500 employees.

The SEC is hopeful that the JOBS Act provisions will both open opportunities to companies that would successfully raise capital from other sources, and provide an opportunity for businesses that otherwise could not raise capital from other sources.

Related to Rule 506(c), the SEC has not seen any increase in fraud on the market as a result of general solicitation. However, the SEC also notes that Rule 506(c) has been slow to gain traction but continues to be more and more widely used. The SEC will continue to monitor its use and report statistical findings.

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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« House Passes More Securities Legislation Responding To SEC Comments »

House Passes More Securities Legislation

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

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

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

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

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

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

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

Title I – Encouraging Employee Ownership Act of 2015

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

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

Brief Summary of Rule 701

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

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

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

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

Title II – Fair Access to Investment Research

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

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

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

Title IV – Small Company Disclosure Simplification

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

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

Title V – Streamlining Excessive and Costly Regulations Review

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

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

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

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

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

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

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

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

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

The Author

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

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

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

SEC Gives Insight On 2016 Initiatives

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

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

Consistent with her prior messages, Chair White focuses on enforcement, stating that the SEC “needs to go beyond disclosure” in carrying out its mission. That mission, as articulated by Chair White, is the protection of investors, maintaining fair, orderly and efficient markets, and facilitating capital formation. In 2015 the SEC brought a record number of enforcement proceedings and secured an all-time high for penalty and disgorgement orders. The primary areas of focus included cybersecurity, market structure requirements, dark pools, microcap fraud, financial reporting failures, insider trading, disclosure deficiencies in municipal offerings and protection of retail investors and retiree savings. In 2016 the SEC intends to focus enforcement on financial reporting, market structure, and the structuring, disclosure and sales of complex financial instruments.

2016 Disclosure Agenda

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

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

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

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

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

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

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

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

Mission and Philosophy

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

The Author

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

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

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

State Blue Sky Concerns; Florida and New York

Posted by Securities Attorney Laura Anthony | March 2, 2016 Tags: Blue Sky Laws, Florida Corporate Statutes

I have often written about state blue sky compliance and issues in completing offerings that do not pre-empt state law, including Tier 1 of Regulation A+ and initial or direct public offerings on Form S-1. I’ve also often expressed my opinion that the SEC, together with FINRA, is best suited to govern most securities-related registrations and exemptions, including both for offerings and broker-dealer matters, and that the states should be more focused on state-specific registrations and exemptions (such as intrastate offerings) and investigation and enforcement with respect to fraud or deceit, or unlawful conduct.

Despite the SEC support for the NASAA-coordinated review program to simplify the state blue sky process for securities offerings, such as under Tier 1 of Regulation A+, only 43 states participate. I say “only” in this context because the holdouts – including, for example, Florida, New York, Arizona and Georgia – are extremely active states for small business development and private capital formation. Moreover, even using the coordinated review program, the states have vastly different rules and interpretations of the same rules.

Blue sky compliance is tricky at best. In this blog I am discussing particular difficulties with the blue sky legislation in Florida and New York as an example of the types of traps an issuer can face without proper planning and, of course, competent legal counsel.

For a review of federal pre-emption of state securities laws, see my two-part blog on the National Markets Improvement Act of 1996 (NSMIA) HERE and HERE. For further information on the NASAA-coordinated review program, see my blog HERE for further discussion.

Florida

Florida does not have an issuer exemption from broker-dealer registration for public offerings, including offerings made under Regulation A/A+ or self-underwritten public offerings made using Form S-1. Put another way, an issuer must register as a broker-dealer with the state of Florida (the state has an issuer registration process) in order to complete a Regulation A or direct public offering, and sell securities to investors within the state of Florida. Tier 2 of Regulation A+ pre-empts state law and accordingly, Florida cannot impose issuer broker-dealer registration.

The sale of Securities in Florida is regulated by the Florida Office of Financial Regulation, Division of Securities and is generally found in Chapter 517 Florida Statutes and corresponding rules adopted under the Florida Administrative Code (F.A.C.), Chapter 517, Florida Statutes – Securities and Investor Protection Act and Chapter 69W-100 through 69W-1000, Florida Administrative Code.

All sales of securities in Florida must be made by a properly registered dealer (Chapter 517.12(1), Florida Statutes) or by someone utilizing an exemption provided by Chapter 517.12(3), Florida Statutes. However, the broker-dealer registration exemptions, including the issuer exemption, only apply to exempt offerings. Neither a Regulation A nor a direct public offering are exempt offerings. Accordingly, persons who sell securities in a Tier 1 Regulation A offering or direct public offerings, including issuers and their officers, directors and employees, must register as a broker-dealer in the state of Florida to sell to investors within the state of Florida.

In addition, Florida law has another trap where an issuer or finder could inadvertently violate the law. Florida Statute §475.41 specifically states that a contract by an unlicensed broker to sell or to negotiate the purchase or sale of a business for compensation is invalid and in particular:

No contract for a commission or compensation for any act or service enumerated in §475.01(3) is valid unless the broker or sales associate has complied with this chapter in regards to issuance and renewal of the license at the time the act or service was performed.

Fla. Stat. §475.01(3) defines “operating” as a broker as meaning “the commission of one or more acts described in this chapter as operating as a broker.” “Broker” is defined broadly in Fla. Stat. §475.01(1)(a) and includes, among other things:

… a person who, for another, and for compensation or valuable consideration directly or indirectly paid or promised, expressly or impliedly, or with an intent to collect or receive compensation or valuable consideration therefore… sells… or negotiate[s] the sale, exchange, purchase, or rental of business enterprises or business opportunities… or who advertises or holds out to the public by any oral or printed solicitation or representation that she or he is engaged in the business of appraising, auctioning, buying, selling, exchanging, leasing or renting business enterprises or business opportunities… or who directs or assists in the procuring of prospects or negotiation or closing of any transaction which does, or is calculated to, result in a sale, exchange, or leasing thereof, and who receives, expects, or is promised any compensation or valuable consideration, directly or indirectly… (emphasis added)

Relying on these provisions, Florida courts and arbitration panels have found consulting and finder arrangements related to mergers and acquisitions and other corporate finance transactions that would otherwise not require federal broker-dealer registration, to be unlawful.

In addition to the conflict with federal law, the Florida statute is particularly troubling for practitioners as it is not included in the Florida Securities and Investor Protection Act found in chapter 517 of Florida Statutes. Florida Statute §517.12 is the state equivalent to Section 15(a)(1) of the Exchange Act requiring broker-dealer registration. Like the Exchange Act, §517.12 requires registration as a broker or dealer for the sale or offer of any securities.

Section 475, on the other hand, is the Florida statute governing “Real Estate Brokers, Sales Associates, Schools and Appraisers.” Section 517 gives no reference to Section 475 and vice versa. Other than through research of case law, a practitioner would have no reason to research laws governing real estate transactions in association with business mergers and acquisitions and the payment of related finders’ fees.

Selling securities without a license can be a criminal matter under §517.302. Violation of §517.302 is a third-degree felony, punishable by up to five years in prison and is a strict liability offense. A separate violation of §517.12 occurs every time the defendant sells a security without the proper license. Thus, a defendant who sells a security to eight different victims would commit eight separate violations of §517.12. Neither ignorance of the license requirement nor the defendant’s good faith reliance on the advice of counsel is a recognized defense.

The Florida provisions remind us of the complexities associated with state blue sky compliance.

New York

New York State’s securities statute, Articles 23-A of the General Business Law, known as the Martin Act, is unique among state securities laws in two important respects. First, the Martin Act does not require the registration of securities, other than securities sold in real estate offerings, theatrical syndications or intra-state offerings. Instead, it requires that issuers register as dealers in their own securities. New York exempts issuers from registering as dealers when they complete a firm commitment underwritten offering but not in other circumstances, including a best efforts underwritten offering or where no underwriter or placement agent is utilized.

Second, the Martin Act does not differentiate between registered or exempt offerings or provide for exemptions for federally covered (state pre-empted) offerings. The Martin Act requires that any person “engaged in the business of buying and selling securities from or to the public” to register as a broker-dealer. Although the Martin Act does not offer any guidance, case law has interpreted the words “to the public” to exclude private offerings under Section 4(a)(2). However, despite requests, New York has failed to amend the Martin Act to make any differentiation, leaving practitioners not knowing what, if any, notice filings would be required for private offerings.

As a result of the controversy surrounding New York’s blue sky compliance, many practitioners simply do not file any notice documents or pay any fees where the offering pre-empts state law under the NSMIA. As a reminder, securities subject to the NSMIA are called “covered securities.”

Covered securities may still be, and generally are, subject to notice filing requirements by the individual states. The NSMIA 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 that 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 and securities in Title III crowdfunding transactions except where 50% or greater of the securities are sold in a single state. Although a state may not condition the federal pre-emption granted by the NSMIA 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 Committee on Securities Regulation of the New York State Bar Association submitted a position paper to the Office of the New York State Attorney General in August 2002 related to New York’s overreaching blue sky laws with respect to private offerings; however, the state of New York did not respond.

The Committee concluded that all offerings exempt under Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D are exempt from the Martin Act and that New York cannot require issuers to register as broker-dealers for such federally pre-empted private offerings. The Committee goes further by stating that “[I]f New York State wishes to receive a notice and fee for Section 4(a)(2) and Rule 506 offerings, it must amend the Martin Act to require (or to permit the Attorney General to require) notice filings in non-public offerings.” Many practitioners rely on this position paper in support of the position that no filings must be made with New York when relying on Section 4(a)(2) of the Securities Act.

Conclusion

My consistent view is that the SEC, together with FINRA, is best suited to govern most securities-related registrations and exemptions, including both for offerings and broker-dealer matters, and that the states should be more focused on state-specific registrations and exemptions (such as intrastate offerings) and investigation and enforcement with respect to fraud or deceit, or unlawful conduct.

I am thrilled with the opportunity that Tier 2 of Regulation A+ offers for issuers in completing going public transactions that pre-empt state blue sky law and would like to see an expansion of the NSMIA for direct and initial public offerings using form S-1.

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 Transfer Agent Rules SEC Gives Insight On 2016 Initiatives »

SEC Proposes Transfer Agent Rules

Posted by Securities Attorney Laura Anthony | February 23, 2016 Tags: DTC Eligibility, SEC, Transfer Agent Rules

On December 22, 2015, the SEC issued an advance notice of proposed rulemaking and concept release on proposed new requirements for transfer agents and requesting public comment. The transfer agent rules were adopted in 1977 and have remained essentially unchanged since that time. An advance notice of proposed rulemaking (ANPR) describes intended new and amended rules and seeks comments on same, but is not in fact that actual proposed rule release. The SEC indicates that following the comment process associated with this ANPR, it intends to propose actual new rules as soon as practicable.

To invoke thoughtful comment and response, the SEC summarized the history of the role of transfer agents within the securities clearing system as well as the current rules and proposed new rules. In addition, the SEC discusses and seeks comments on broader topics that may affect transfer agents and the securities system as a whole. This blog gives a high level review of the whole APNR and concept release with a more detailed focus on the proposed rules and discussions that will directly impact the transfer and deposit of restricted securities in the small-cap industry.

Introduction

As set out by the SEC, among other functions, transfer agents (i) track, record and maintain the official shareholders registrar and ownership records; (ii) cancel, issue and transfer securities, both in certificate and book entry form; (iii) communicate with shareholders on behalf of issuers; and (iv) process dividends and corporate actions such as reverse splits. In addition, from my own experience, transfer agents will act as mailing agent for proxy and other communications from the issuer, sometimes offer EDGAR agent services, and facilitate DTC eligibility applications with DTC member firms, obtain DWAC/FAST DTC eligibility for issuers and act as a front line where shareholders are attempting to remove a restrictive legend and deposit securities with brokerage firms.

Transfer agents are also seen as a gatekeeper in the prevention of fraud, and compliance with the registration and exemption provisions of the federal securities laws. In that regard, the SEC intends to impose obligations on a transfer agent in the processing and transfer of restricted securities. A major focus of the rulemaking is related to combatting microcap fraud. This is consistent with the recent SEC approach of increasing obligations and pressure on the gatekeepers, including brokerage firms related to the deposit of securities (see my blog HERE), attorneys and auditors, and transfer agents.

For the discussion of the proposed new rules related to the transfers of restricted securities, see the discussion below under the subheading “Restricted Securities and Compliance with Federal Securities Laws.”

History and Background

The SEC ANPR is lengthy and provides an in-depth discussion of the history of the clearing and settlement process and role of transfer agents in the process. Briefly, the ownership of securities represents certain property rights and the securities themselves are a negotiable instrument under state law allowing the owner to transfer such property to a third party. Where federal securities laws govern the registration and exemption provisions, the individual state’s Uniform Commercial Code (UCC) governs the transfer of certificates and securities as property. Accordingly, in addition to compliance with federal law, the daily activities of a transfer agent require knowledge of and compliance with the UCC.

Under the UCC, in order to obtain valid title to a security, the seller must voluntarily transfer possession of the security and the buyer must give value, not have notice of any adverse claim to the security and actually obtain control over the security. It is compliance with the UCC that requires that a certificate be endorsed, the signature guaranteed, instructions and authority from the seller, proof of payment/consideration from the buyer, proper cancellation of certificates and the proper registration and recording on the shareholder list. Moreover, it is the UCC that governs the process for replacing lost or stolen certificates and for an issuer or security holder to impose stop transfer restrictions.

Technology has helped streamline some of this process and for traded securities in DTC eliminated paper certificates altogether, but as all in the industry know, the paperwork is still extensive. Article 8 of the UCC governs the transfer of electronic or uncertificated securities. The SEC gives an interesting background discussion of the Paperwork Crisis beginning in the 1960s resulting from the massive volumes of paper needed to transfer securities associated with the growing and active trading markets. As a result of the Paperwork Crisis, the Depository Trust Company (DTC) and its securities holding arm, CEDE, were formed.

Moreover, for those interested, the APNR and concept release provides a thorough history of the creation and amendments to the national market system, national clearing and settlement system, SIPC, DTC the FAST program, and development of laws allowing for the holding and trading of book entry and electronic securities. Although this history is well beyond the scope of this blog, what I found particularly interesting is how recent many of these developments have been. For instance, it was only in 1996 that the Direct Registration System (DRS) was implemented that allowed investors to hold uncertificated securities in registered form on the books of the transfer agent and to utilize the FAST system to transfer shares to and from and brokerage account. It was during the late 1990s that DTC really flourished to become the largest depository and clearing house in the US. Today DTC provides the depository and book entry services for virtually all securities available for trading in the US.

Transfer Agent Role in Clearance and Settlement Processes

A transfer agent is an integral part of the National C&S System. The clearance and settlement process depends on the type of security being traded (stock, bond, etc.), how the security is owned (registered or beneficial), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved. I will detail the clearing and settlement process in a future blog.

Security ownership can be either registered or beneficial. State corporate law conveys certain rights to registered owners that beneficial owners may not receive. For example, the right to examine a stockholder list at a meeting is limited to registered and not beneficial owners. Registered owners are listed on the stockholder list by name and are sometimes referred to as “holders of record.” In addition to state law rights, the holders of record is an important concept throughout the securities laws. For example, Section 12(g) of the Securities Exchange Act requires a company to register when it has 2,000 or more holders of record. Likewise, deregistration eligibility is determined in part by the number of holders of record.

A transfer agent often deals directly with a holder of record, including in the provision of transfer services, dividend payments and communications, such as the delivery of proxy forms. Record holders may hold their securities in either certificate or book entry form.

The majority of shareholders of a public company are beneficial owners rather than record holders. Beneficial ownership refers to securities held in street name which have been deposited with a brokerage firm and are in the DTC system. These securities usually show up on the shareholder list in the Cede account and sometimes in the name of the particular brokerage firm. Each brokerage and clearing firm maintains records and facilitates transfers for its beneficial owner account holders. Transfer agents process the restrictive legend removal for the initial deposit of securities into the brokerage firm but do not process transfers once in the system.

Current Transfer Agent Regulations

Transfer agents have been regulated by federal securities laws since 1975. A “transfer agent” is defined as any person who engages in the following activities on behalf of an issuer: (i) countersigning securities upon issuance; (ii) monitoring issuances and preventing unauthorized issuances; (iii) registering the transfer of securities; (iv) exchanging or converting securities; or (v) processing transfer and maintaining book entry ownership records. Public company transfer agents are required to be registered with the SEC.

The SEC currently regulates (i) registration and annual reporting requirements; (ii) timing and certain notice and reporting requirements (the “turnaround rules”); and (iii) recordkeeping and record retention rules and safeguarding requirements for securities and funds. The current transfer agent rules are extensive, and below is just a very high-level brief overview.

Current Registration and Annual Reporting Requirements

The current registration and annual reporting requirements are found in Exchange Act Rules 17Ac2-1 through 17Ac3-1. All transfer agents must register with the SEC on Form TA-1. The rules include eligibility prohibitions against certain “bad actors” similar to other bad actor rules within the securities laws. All transfer agents must file an annual report on Form TA-2, including information on compliance with turnaround rules, number of accounts, items received, funds distributed and lost securities. Both the application and the annual report can be viewed by the public on EDGAR. In addition to reviewing these forms, the SEC performs site visits and examinations of transfer agents.

Current Processing, Reporting, Recordkeeping and Exemptions

Exchange Act Rules 17Ad-1 through 17Ad-7 set forth performance standards for transfer agents. In relation to these rules, transfer agents must have written internal controls and procedures. The rules focus on establishing minimum performance and recordkeeping standards for routine transfers, cancellations and issuances. Routine items must be processed within 3 business days of receipt and non-routine items must receive “diligent and continuous attention” and be “turned around as soon as possible.” Routine items are defined in the negative such that all items are routine except items (i) requiring the issuance of a new certificate that the transfer agent does not have; (ii) subject to stop order, adverse claim or other restriction; (iii) requiring additional documentation to review and complete; (iv) are part of a corporate action (such as split or dividend); (v) are part of a public or private offering; or (vi) certain warrants, options or other convertible securities. The performance rules contain certain exemptions, such as for the processing of limited partnerships and redemptions for registered investment companies and for certain very small transfer agents.

The performance rules also require a transfer agent to respond to certain written inquiries within prescribed time periods and, in particular, within 5, 10 or 20 days depending on the person making the inquiry and the subject of the inquiry.

Transfer agents are required to keep detailed, defined records including minimum delineated information that allows for the prompt delivery of information related to shareholders, ownership positions and historical records related to same. Records, funds and securities in a transfer agent’s custody must be safeguarded to prevent theft, loss, destruction or misuse.

Transfer agents are required to notify DTC when terminating or assuming transfer agent services for an issuer.

SRO Rules and Requirements

In addition to federal securities laws, transfer agents are regulated by SRO’s including, for example, the NYSE and DTC. The NYSE requirements include further regulation on turnaround times and recordkeeping as well as capitalization and insurance requirements.

All transfer agents that include electronic or book entry services (which is really all of them) must comply with DTC rules including (i) being “Limited Participants” in DTC; (ii) participate in the FAST program and agree to DTC’s Operational Arrangements; (iii) link with DTC’s electronic communication system; and (iv) participate in DTC’s Profile Surety Program.

State Law

As briefly discussed above, transfer agents must comply with state corporate statutes related to recordkeeping and notice requirements as well as each state’s Uniform Commercial Code.

Proposed New Rules

The SEC has issued an advance notice of proposed rulemaking (ANPR) which describes intended new and amended rules and seeks comments on same, but is not in fact that actual proposed rule release. Following the receipt of public comment on the ANPR, the SEC will publish proposed rules. The ANPR reveals a thorough revamping of the transfer agent rules.

The ANPR proposes rules to (i) increase the scope of information on the registration application (Form TA-1) and annual report (Form TA-2) for transfer agents; (ii) require all contracts between a transfer agent and issuer to be in writing, which includes a fee schedule and termination provisions, including provisions for handing over information to a new transfer agent; (iii) enhance transfer agent requirements for the safeguarding of funds and securities; (iv) apply anti-fraud provisions to specific transfer agent activities; (v) require transfer agents to establish business continuity and disaster recovery plans; (vi) require transfer agents to establish basic procedures regarding the use of information, including safeguarding personal information; (vii) revise recordkeeping requirements; and (viii) conform and update various terms and definitions and eliminate those that are obsolete.

Restricted Securities and Compliance with Federal Securities Laws

All sales of securities, including the re-sale of restricted securities held by a current shareholder, must either be registered under the Securities Act or there must be an available exemption. The most common exemption for the resale of restricted securities is Section 4(a)(1) of the Securities Act and Rule 144, which is a safe harbor under Section 4(a)(1). Since transfer agents are responsible for affixing a restrictive legend on stock certificates or making a restrictive notation on book entry securities and for processing the transfer and legend removal from such securities, they are an important gatekeeper in the prevention of fraud and unregistered distributions.

Transfer agents are subject to aiding and abetting liability for violations of the registration requirements under Section 5 of the Securities Act. In addition, like any market participant, a transfer agent could be charged with fraud violations under Section 10(b) and Rule 10b-5 under the Exchange Act and Section 17(a) of the Securities Act.

Currently a transfer agent must determine whether any particular request is routine and thus requires a 3-day turnaround, and whether the state UCC requires the processing of a request. Neither federal nor state UCC regulations require the processing of a request that does not comply with the federal securities laws. Accordingly, the transfer agent must determine whether a particular request complies with federal (or state) securities laws and thus what their particular processing requirements are. It is this determination that has made it an industry practice to require an opinion letter from counsel with each request to transfer or remove a legend from restricted securities. The SEC is concerned that reliance on opinion letters from a shareholder’s or issuer’s counsel does not offer enough protection against improper transfers or fraud.

Accordingly, the SEC proposes new rules prohibiting any registered transfer agent or its officers, directors or employees from directly or indirectly taking any action to facilitate a transfer of securities if such person knows or has reason to know that an illegal distribution of securities would occur in connection with the transfer. Such knowledge qualifier carries a duty to make reasonable inquiry.

Moreover, the SEC proposes new rules prohibiting any registered transfer agent or its officers, directors or employees from making any materially false statements or omissions or engaging in any other fraudulent activity in connection with the performance of their duties.

In addition, the SEC proposes new rules requiring each transfer agent to adopt internal controls, policies and procedures reasonably designed to ensure compliance with securities laws and requiring that each transfer agent designate a chief compliance officer.

There is no proposal to adopt rules that would provide specificity to a transfer agent related to the removal of a restrictive legend or transfer of restricted securities. However, the SEC does seek comment on same and, in particular, whether there should be requirements related to (i) obtaining an attorney opinion letter; (ii) obtaining issuer approval; (iii) requiring evidence of a registration statement or available exemption; (iv) requiring evidence of beneficial ownership; (v) requiring representations related to affiliation; and/or (vi) conducting some level of due diligence. I would advocate for such guidelines.

As the SEC notes, there is a potential conflict between a transfer agent’s duties to process a transfer and to ensure compliance with federal securities laws. However, in my opinion, from a transfer agent’s perspective, there are certain rules (turnaround rules and the UCC) requiring processing and only a vague fear of being charged with aiding and abetting related to ensuring compliance with federal securities laws. The proposed new rule generally increasing the potential liability on the transfer agent is likewise vague in the APNR. Without specific guidelines and standards, transfer agents will have a hard time navigating the new regulatory environment and all market participants will pay the price.

In fact, fear of regulatory retribution has already created a very challenging environment in the small-and mid-cap marketplace. The deposit of penny stock securities has become extremely difficult and expensive, but the flow of information to the market participants as to what is and is not acceptable has been slow and disjointed. At the same time that the OTC Markets has created self-imposed quantitative and qualitative standards to improve the marketplace and has been attempting to support small and emerging growth business capital formation, the secondary trading becomes increasingly difficult.

Moreover, there is a contrarian reality among the legislature, the SEC’s public position, and again, the actual small-cap secondary trading market, including the ability to deposit securities. The JOBS Act, including Regulation Crowdfunding, and the FAST Act are designed to improve capital formation in the small and emerging growth sectors, including a specific focus on allowing companies easier access to public markets and facilitating going public transactions. The advent of Regulation A+ and 506(c), the creation of the emerging growth company category, the various provisions of the FAST Act including improvements to the Form S-1 filing process and the SEC initiatives to modernize and update disclosure obligations are all meant to ease capital formation and public filings for micro- and small-cap companies.

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

The contrary side to all of this is the extreme difficulty in depositing securities for small- and micro-cap public companies and in creating a vibrant trading market. Although not comprehensive on the issues, see my blogs HERE regarding broker duties in depositing stocks and HERE regarding the need for a venture exchange.

The small- and micro-cap marketplace needs more definitive standards that companies and practitioners can rely upon. The fact is, it is relatively easy for a company to pass a footnote 32 type vehicle through the SEC and obtain a ticker symbol from FINRA and then extremely difficult to do anything with it. See my blog HERE. The fact that it is easy to create the vehicles in the first place creates a sort of confusion and disconnect in the marketplace. I’d rather see the SEC and FINRA be more stringent in their review process on these obvious vehicles and require that they label themselves a shell such that brokers and transfer agents have some comfort that when a company has cleared the SEC and FINRA, it is as labeled, subject of course to post effectiveness changes.

Of course, brokers and transfer agents still need to be gatekeepers, but the standards they are relying upon and the issues they are facing in their own SEC investigations and reviews need to be articulated and communicated to the marketplace. New proposed transfer agent rules is a step in the right direction and a very good start, but if those rules include a vague requirement that the transfer agent follow the law, we will not have made the type of headway that is badly needed to support real and viable small businesses and their capital formation.

I note that as part of the SEC request for comment there are some extreme thoughts. For instance, the SEC requests comment on whether a transfer agent should be required to (i) confirm the existence and legitimacy of an issuer’s business by reviewing contracts and corporate records; (ii) conduct credit and criminal background checks for issuers and their officers and directors; (iii) obtain information on shareholders before processing requests for legend removal; and (iv) review public news and information on issuers and principals. My view is that this level of review by a transfer agent is too extreme. I strongly oppose giving a transfer agent that level of independent power over an issuer and its shareholders. In addition to the shutdown in the small and micro-cap markets that would entail, the re-tooling of current transfer agents to adequately be able to satisfy this level of responsibility would be cost-prohibitive both to the transfer agents and their clientele.

Some of the other comment requests of interest (and my view in parentheses) include: (i) should the SEC enumerate red flags that would trigger a duty of further inquiry by a transfer agent (yes); (ii) should there be a heightened review for securities of non-reporting issuers (yes, if no current information); (iii) should a transfer agent be required to deliver securities only to the registered shareholder and not third parties (yes, unless the third party is an attorney or other proper representative of the shareholder); and (iv) should transfer agents be prohibited from accepting stock as compensation (no).

Registration and Annual Reporting

The purpose of the registration and annual reporting requirements is to assist the regulators, issuers and investors in determining whether a transfer agent is performing its functions properly, determining the nature of a particular transfer agent’s business, assisting the SEC in making examination and investigation decisions, including areas of concern, monitoring the transfer agents activities and ensuring compliance with rules and regulations.

The SEC proposes to add information to the registration and annual reporting requirements, including financial information, potential conflicts of interest and details about the types of services being provided and the transfer agent’s clientele. For example, it is proposed that a transfer agent disclose any past or present affiliations with or ownership of issuers or broker-dealers serviced by or affiliated with a transfer agent. I note that several small-cap broker-dealers have sister transfer agencies and do not believe such vertical business investment is problematic nor should it be construed as nefarious. However, I do see benefit in the disclosure of same.

The SEC also proposed to require a transfer agent to designate a chief compliance officer with responsibilities to ensure compliance with written internal controls and procedures.

Written Agreements Between Transfer Agents and Issuers

The APNR proposed to require written agreements between transfer agents and issuers. Although it is not now a legal requirement, I think most transfer agents do have such agreements. I am hard-pressed to think of any issuer clients that do not have a written contract with their transfer agent, and most are quick to require the signing of an addendum or updated contract where there is a change of management or control of the issuer.

However, the SEC rightfully points out that where there is either no written agreement or the agreement does not cover certain questions, there is an increase of disputes with respect to (i) the duration of the arrangement; (ii) termination rights; (iii) the disposition of records and transfer of records to a new transfer agent; and (iv) fees. These issues are most prevalent in the small-cap world, especially where a transfer agent “holds records hostage” in exchange for a large termination fee. The APNR does not suggest that the transfer agent be limited in allowable termination fees, nor that a transfer agent be required to turn over records regardless of sums owed or the payment of a termination fee, though it does seek comment on such issues.

Safeguarding Funds and Securities

Transfer agents often provide administrative and processing services in relation to dividends, payouts associated with splits (paying agent services) and other transactional escrow services. The APNR proposes a more robust set of standards for transfer agents acting as a paying agent or providing escrow services. The APNR indicates the SEC will provide new rules such as (i) maintaining secure vaults; (ii) installing theft and fire alarms; (iii) having written procedures related to access and control over accounts and information; (iv) greater bookkeeping requirements; (v) and specific unclaimed property procedures. In addition, the SEC intends to impose rules similar to those for broker-dealers, requiring internal controls, annual reporting and independent audits related to these services.

Cybersecurity, Information Technology and Related Issues

Cybersecurity is a big concern for the SEC. In 2014 the SEC adopted Regulation Systems, Compliance and Integrity requiring covered entities to test their automated systems for vulnerabilities, test their business continuity and disaster recovery plans and notify the SEC of intrusions. In particular, the SEC intends to propose new or amended rules requiring registered transfer agents to, among other things: (i) create and maintain a written business continuity plan; (ii) create and maintain basic procedures and guidelines governing the transfer agent’s use of information technology, including methods of safeguarding data and personally identifiable information; and (iii) create and maintain appropriate procedures and guidelines related to a transfer agent’s operational capacity, such as IT governance and management.

Concept Release and Request for Additional Comment

The SEC concept release contains discussion and seeks comment from the public on issues outside of and in addition to the APNR. The SEC highlights different questions and issues such as whether brokerage firms should also be required to be registered as transfer agents when they hold securities in nominee accounts; specific issues affecting transfer agents for mutual funds and transfer agents that serve as administrators for employee stock option and similar plans. The concept release also seeks comment on a transfer agent’s role in a Regulation Crowdfunding offering (Title III Crowdfunding).

The Author

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

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

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

Download our mobile app at iTunes.

« SEC’s Financial Disclosure Requirements For Sub-Entities Of Registered Companies State Blue Sky Concerns; Florida and New York »

SEC’s Financial Disclosure Requirements For Sub-Entities Of Registered Companies

Posted by Securities Attorney Laura Anthony | February 16, 2016 Tags: SEC

As required by the JOBS Act, in 2013 the SEC launched its Disclosure Effectiveness Initiative and has been examining disclosure requirements under Regulation S-K and Regulation S-X and methods to improve such requirements. In September 2015, the SEC issued a request for comment related to the Regulation S-X financial disclosure obligations for certain entities other than the reporting entity. In particular, the SEC is seeking comments on the current financial disclosure requirements for acquired businesses, subsidiaries not consolidated, 50% or less owned entities, issuers of guaranteed securities, and affiliates whose securities collateralize the reporting company’s securities.

It is important to note that the SEC release relates to general financial statement and reporting requirements, and not the modified reporting requirements for smaller reporting companies or emerging growth companies. In particular, Article 8 of Regulation S-X applies to smaller reporting companies and Article 3 to those that do not qualify for the reduced Article 8 requirements. The SEC discussion and request for comment specifically addresses certain Article 3 rules.

As my clients are, for the most part, either smaller reporting companies or emerging growth companies, I have provided information related to those entities where applicable. In the request for comment, the SEC does ask for input and comments on the correlating Article 8 rules where applicable.

Specific rules being addressed

The SEC request for comment is specifically related to the following rules and their related requirements:

Rule 3-05, Financial Statements of Businesses Acquired or to be Acquired;

Rule 3-09, Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons;

Rule 3-10, Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered; and

Rule 3-16, Financial Statements of Affiliates Whose Securities Collateralize an Issue Registered or Being Registered.

The comments sought and the SEC review are centered on how these requirements assist and inform investors and potential investors in making investment and voting decisions on the one hand, and the challenges and issues of the reporting company in preparing and providing the information on the other hand. Moreover, as required by the Exchange Act in all SEC rulemaking, the SEC must consider how any changes will promote efficiency, competition and capital formation.

Rule 3-05 of Regulation S-X – Financial Statements of Businesses Acquired or to be Acquired

Summary of current rule

Rule 3-05 of Regulation S-X requires a reporting company to provide separate audited annual and reviewed stub period financial statements for any business that is being acquired if that business is significant to the company. A “business” can be acquired whether the transaction is fashioned as an asset or stock purchase. The question of whether it is an acquired “business” revolves around whether the revenue-producing activity of the target will remain generally the same after the acquisition. Accordingly, the purchase of revenue producing assets will likely be treated as the purchase of a business.

In determining whether an acquired business is significant, a company must consider the investment, asset and income tests set out in Rule 1-02 of Regulation S-X. The investment test considers the value of the purchase price relative to the value of the total assets of the company prior to the purchase. The asset test considers the total value of the assets of the company pre and post purchase. The income test considers the change in income of the company as a result of the purchase.

Rule 3-05 requires increased disclosure as the size of the acquisition, relative to the size of the reporting acquiring company, increases based on the investment, asset and income test results. If none of the test results exceed 20%, there is no separate financial statement reporting requirement as to the target company. If one of the tests exceeds 20% but none exceed 40%, Rule 3-05 requires separate target financial statements for the most recent fiscal year and any interim stub periods. If any Rule 3-05 text exceeds 40% but none exceed 50%, Rule 3-05 requires separate target financial statements for the most recent two fiscal year and any interim stub periods. When at least one Rule 3-05 test exceeds 50%, a third fiscal year of financial statements are required, except that smaller reporting and emerging growth companies are never required to add that third year.

Rule 8-04 is the sister rule to 3-05 for smaller reporting companies. Rule 8-04 is substantially similar to Rule 3-05 with the same investment, asset and income tests and same 20%, 40% and 50% thresholds. However, Rule 8-04 has some pared-down requirements, including, for example, that a third year of audited financial statements is never required where the registrant is a smaller reporting company.

Both Rule 3-05 and 8-04 require pro forma financial statements. Pro forma financial statements are the most recent balance sheet and most recent annual and interim income statements, adjusted to show what such financial statements would look like if the acquisition had occurred at that earlier time.

An 8-K must be filed within 4 days of a business acquisition, disclosing the transaction. The Rule 3-05 or 8-04 financial statements must be filed within 75 days of the closing of the transaction via an amendment to the initial closing 8-K. Where the acquiring public reporting company is a shell company, the required Rule 8-04 financial statements must be included in that first initial 8-K filed within 4 days of the transaction closing (commonly referred to as a Super 8-K). By definition, a shell company would always be either an emerging growth or smaller reporting company and accordingly, the more extensive Rule 3-05 financial reporting requirements would not apply in that case.

The Rule 3-05 or Rule 8-04 financial statements will also be required in a pre-closing registration statement filed to register the transaction shares or certain other pre-closing registration statements where the investment, asset or income tests exceed 50%. Likewise, the Rule 3-05 or Rule 8-04 financial statements are required to be included in pre-closing proxy or information statements filed under Section 14 of the Exchange Act seeking either shareholder approval of the transaction itself or corporate actions in advance of a transaction (such as a reverse split or name change). See my short blog HERE discussing pre-merger Schedule 14C financial statement requirements.

In what could be a difficult and expensive process for companies engaged in an acquisition growth model, if the aggregate impact of individually insignificant business acquisitions exceeds 50% of the investment, asset or income tests, Rule 3-05 or Rule 8-04 financial statements and pro forma financial statements must be included for at least the substantial majority of the individual acquired businesses.

Reason for the rules and request for comment

Clearly financial disclosure regarding acquired businesses is important for an investor to understand the impact of transactions. An acquisition will change a company’s financial condition, results of operation, liquidity and future prospects. However, the SEC admits that the type of information currently required may have limitations vis-à-vis the intended purpose. Many commentators have questioned the need and utility of historical financial information on the acquired business. Historical financial statements do not reflect the new accounting basis resulting from the acquisition, changes in management, changes in business plan, the efficiencies of scale of the combined entities (such as workforce reductions and facility closings), etc.

Related to the financial statement requirements, the SEC specifically requested comments associated with (i) how investors use the financial information; (ii) what changes would make the information more useful to investors and what challenges are there to providing this information; (iii) what challenges companies have in providing the currently required financial information and how these could be addressed; (iv) whether the current requirements include information that is not useful; (v) how pro forma requirements could be changed to make them more useful; (vi) whether the 75-day rule should be shortened; and (vii) whether the pre-closing requirements for registration statements and Section 14 (Schedule 14C or 14A) filings should be modified.

Related to the investment, asset and income tests, the SEC specifically requested comments on (i) whether the current significance tests are the appropriate measure to determine the nature, timing and extent of financial statement disclosure requirements; (ii) what changes or alternatives the SEC should consider; (iii) whether the current test thresholds should be modified; (iv) whether additional or different tests should be implemented (such as purchase price compared to market cap); and (v) whether companies should be given more judgment in determining what is significant.

The SEC has also asked for comment on the application of changes to Rule 8-04 for smaller reporting companies and application of the rules to different issuers such as investment companies and foreign private issuers.

Rule 3-09 of Regulation S-X – Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons

Summary of current rule

Rule 3-09 does not apply to smaller reporting companies or emerging growth companies at all and, as such, I am only providing a very brief review. Rule 3-09 requires that certain separate financial statements be provided for subsidiaries and persons even if the reporting company owns less than 50% if the investment is significant. Significance is determined using modifications of the investment and income tests. If neither of the tests exceed 20%, no Rule 3-09 financial statements are required, but if either exceeds 20%, all financial statements are required and such statements must be audited for each year that a test exceeds the 20% threshold.

Separately Rule 4-08 requires summarized financial information in the notes to financial statements if a Rule 3-09 test exceeds 10%. This summarized financial information is not required if the full separate financial statements are otherwise provided.

Reason for the rules and request for comment

Even investments in businesses that are not controlling (over 50%) impact financial condition, results of operation, liquidity and future prospects – hence, the Rule 3-09 requirements. However, as with Rule 3-05, the SEC recognizes the limited utility of the current requirements. One of the biggest concerns is the inability to reconcile separate financial statements for these investment entities, with the value of such investment on the financial statement on the registrant’s balance sheet. Moreover, the aggregation of investments in the summary presentations further dilutes the ability to discern particular value for any one individual entity’s separate financial statements.

The SEC is requesting comment on (i) how investors use Rule 3-09 financial information; (ii) what changes could be made to make the information more useful to investors; (iii) what challenges companies face in obtaining and preparing this financial information; (iv) how those challenges can be addressed or improved; and (v) whether there are parts of the current requirements that are not useful.

Related to the investment and income tests, the SEC specifically requested comments on (i) whether the current significance tests are the appropriate measure to determine the nature, timing and extent of financial statement disclosure requirements; (ii) whether the Rule 3-09 tests should be modified to correlate more closely with other financial statement requirements in Regulation S-X (such as Rule 10-01); (iii) what changes or alternatives the SEC should consider; (iv) whether the current test thresholds should be modified; (v) whether additional or different tests should be implemented (such as purchase price compared to market cap); and (vi) whether companies should be given more judgment in determining what is significant.

The SEC has also requested comment on whether Rule 3-09 should be expanded to include smaller reporting companies and emerging growth companies. My view on this is a definite “no.” The SEC has asked comment on whether Rule 3-09 should be modified for business development companies and, if so, in what way. My view on this is “yes,” but an in-depth discussion on business development companies is beyond the scope of this blog.

Rule 3-10 of Regulation S-X – Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered

Summary of current rule

A guarantor of a registered security is considered an issuer because the guarantee itself is considered a separate security. Accordingly, both issuers of registered securities, and the guarantor of those registered securities, must file their own audited annual and reviewed stub period financial statements under Rule 3-10 of Regulation S-X. Rule 3-10 provides certain exemptions, including (i) where a parent company offers securities guaranteed by one or more of its subsidiaries; or (ii) where a subsidiary offers securities guaranteed by another subsidiary.

Also, if the subsidiary issuer and guarantor satisfy certain conditions, the parent company can provide disclosures in its regular annual and interim consolidated financial statements for each subsidiary and guarantor (called “Alternative Disclosure”). Without getting into the minutiae of how to qualify for Alternative Disclosure, generally to qualify the subsidiary issuer/guarantor must be 100% owned by the parent and the guarantees must be full and unconditional.

In simple terms, usually a parent company merely consolidates the financial statements of its subsidiaries and no separate financial statement information is provided for individual operating subs. Where a sub or parent becomes a separate issuer or guarantor, separate financial information must be filed for those subsidiaries. Where qualified, Rule 3-10 allows for a tabular footnote disclosure of this information, as opposed to full-blown audits and reviews of each affected subsidiary. The footnote tables are referred to as Alternative Disclosure.

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

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

Reason for the rules and request for comment

The rule is designed to provide investors with information to evaluate the likelihood of payment by the issuer and guarantors. The format and content of the Alternative Disclosure is unique and not found elsewhere in SEC rules or accounting standards.

The SEC has requested comment on (i) how investors use Rule 3-10 financial information; (ii) what changes could be made to make the information more useful to investors; (iii) what challenges companies face in obtaining and preparing this financial information; (iv) how those challenges can be addressed or improved; and (v) whether there are parts of the current requirements that are not useful.

In addition, the SEC has requested comments on the conditions that must be satisfied to qualify for Alternative Disclosure and the time periods for providing such disclosure.

Rule 3-16 of Regulation S-X – Financial Statements of Affiliates Whose Securities Collateralize an Issue Registered or Being Registered

Summary of current rule

Rule 3-16 requires a company to provide separate financial statements for each affiliate whose securities act as a substantial part of collateral for securities being registered. The financial statements must be provided as if that affiliate were a separate registrant. The affiliate’s portion of the collateral is determined by comparing (i) the highest amount among the aggregate principal amount, par value, book value or market value of the affiliate’s securities to (ii) the principal amount of the securities registered or to be registered. If the test equals or exceeds 20% for any fiscal year presented by the registrant, Rule 3-16 financial statements are required. Similarly, but separately, Rule 4-08 requires financial statement footnote disclosure of amounts of assets mortgaged, pledged or otherwise subject to a lien.

Reason for the rules and request for comment

The disclosures are meant to provide information on the ability of an affiliate to meet an obligation where the registrant defaults. However, many believe that the financial disclosure is confusing and not very useful to meet its intended purpose.

The SEC has requested comment on (i) whether the Rule 3-16 requirements influence the structure of collateral arrangements and, if so, what the consequences are to investors and registrants; (ii) how investors use Rule 3-16 financial information; (iii) what changes could be made to make the information more useful to investors; (iv) what challenges companies face in obtaining and preparing this financial information; (v) how those challenges can be addressed or improved; and (vi) whether there are parts of the current requirements that are not useful.

Additional information and further reading

The SEC has received many comment letters in response to its request and, on January 13, 2016, met with representatives of Deloitte & Touche on the subject. This blog summarizes the current rules and the SEC request for comment but does not include a discussion of the comment letters submitted to the SEC. Although many of the comment letters themselves contain useful and thought-provoking information, they are numerous and lengthy and such discussions may or may not ultimately influence the actual rules we practitioners work with. I will, of course, blog about future rules and rule amendments resulting from these discussions. For those interested in reading the comment letters, they can be found HERE.

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

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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« SEC Study On Unregistered Offerings SEC Proposes Transfer Agent Rules »

SEC Study On Unregistered Offerings

Posted by Securities Attorney Laura Anthony | February 9, 2016 Tags: SEC, Unregistered Offerings

In October 2015, the SEC Division of Economic and Risk Analysis issued a white paper study on unregistered securities offerings from 2009 through 2014 (the “Report”). The Report provides insight into what is working in the private placement market and has been on my radar as a blog since its release, but with so many pressing, timely topics to write about, I am only now getting to this one. The SEC Report is only through 2014; however, at the end of this blog, I have provided supplemental information from another source related to PIPE (private placements into public equity) transactions in 2015.

Private offerings are the largest segment of capital formation in the U.S. markets. In 2014 private offerings raised more than $2 trillion. The SEC study used information collected from Form D filings to provide insight into the offering characteristics, including types of issuers, investors and financial intermediaries that participate in offerings. The Report focuses on Regulation D offerings and in particular Rules 504, 505, 506(b) and 506(c).

A summary of the main findings in the Report includes:

In 2014, there were 33,429 Regulation D offerings reported on Form D filings, accounting for more than $1.3 trillion raised.

Issuers in non-financial industries reported raising $133 billion in 2014. Among financial issuers, hedge funds raised $388 billion, private equity funds raised $316 billion and non-pooled investment funds (such as banks, insurance companies and investment banks) raised $375 billion.

Foreign issuers accounted for 20% of the 2014 total. Most foreign issuers are based on Canada, the Cayman Islands or Israel.

Rule 506 accounts for 99% of all private offerings. Rule 506 was used 97% of the time for offerings below the Rule 504 and 505 limits, showing that Rule 506 is preferred regardless of the amount of the offering (I believe this is firmly as a result of the state law pre-emption in a 506 offering).

Since the effectiveness of Rule 506(c) on September 23, 2013, allowing for general solicitation and advertising, only a small portion of raises – i.e., 2% of the total or $33 billion – relied on this exemption.

Capital raised through private markets correlates with the strength of public markets. The strength of the private market is closely tied to the health of the public market.

The median offer size of non-financial issuers is less than $2 million, indicating that small businesses rely on private, unregistered offerings the most.

Approximately 301,000 investors participated in Regulation D offerings during 2014. A large majority of these investors participated in offerings by non-financial issuers (presumably because financial issuers relied on a small number of institutional investors). Non-accredited investors participated in only 10% of the offerings.

Background on private offerings

All offers and sales of securities must be either registered under the Securities Act of 1933, as amended (“Securities Act”) or made in reliance on an available exemption from registration. Public offerings generally must always be registered (with the exception of a Rule 506(c) offering) and private offerings can generally be completed in reliance on an exemption. The private offering rules have various investor restrictions (limits on sales to unaccredited investors), information requirements and/or offering limits to balance the competing directives of the SEC to assist with capital formation and protect investors.

The exemptions for private offerings are found in Sections 3 and 4 of the Securities Act. In particular, most private offerings are governed by Sections 4(a)(2), 3(b) and 3(a)(11) of the Securities Act. Rules 506(b) and 506(c) of Regulation D, Regulation S and 144A provide safe harbors under Section 4(a)(2). Section 3(b) provides the authority for Rules 504 and 505 of Regulation D. Section 3(a)(11) provides statutory authority for intrastate offerings.

Even after the JOBS Act, private offerings remain the biggest source of capital formation for small and emerging companies, which companies are the largest source for creating new jobs, driving innovation and accelerating economic growth. At $1.3 trillion raised in 2014, private offerings represented more than what was raised in public equity and debt offerings combined.

From 2009 – 2014, there were more than 64,000 offerings by small businesses with a median offer size of less than $2 million. Only 21% of private offerings reported using a financial intermediary such as a broker-dealer. For those that did use such a placement agent, the average commission size was 5%.

Although the Report was issued in October 2015, it only examines the private offering market through 2014. The Report indicates that the vast majority of offerings are completed under Rule 506(b) with Rule 506(c) being only a very small percentage.

The analysis in the Report takes into consideration factors that may affect an issuer’s choice of private offering exemption, including pre-emption of state securities laws, ability to advertise, ability to sell to non-accredited investors, limits on amount of capital raise, geographical constraints, and levels of required disclosure. The Report is organized by discussions on the overall private offering market; capital formation in the market for Regulation D offerings and characteristics of market participants. This blog maintains that order of discussion.

The size of the private offerings market

The SEC Report does not give complete information on the size of the private offerings market. The information in the Report is based on Form D filings, which does not necessarily include offerings relying on straight Section 4(a)(2) or Regulation S as neither of these require a Form D filing. Moreover, many issuers that rely on Regulation D neglect to file a Form D and accordingly, the market size is somewhat larger than as stated in the SEC report.

In 2014 registered offerings accounted for $1.35 trillion compared to $2.1 trillion raised in private offerings. As reported by the SEC, Regulation D and Rule 144A are the most common offering methods, being primarily equity and Rule 144A being primarily debt. The Report includes comparative information on registered offerings as well. During the years 2009-2014, registered debt offerings far outweighed equity offerings.

The number of private offerings per year also far outweighs the number of registered offerings, though this is to be expected. A private offering can be completed far quicker and with greater frequency than a public offering that is subject to SEC filings, comment process and effectiveness procedures. As Regulation D is commonly used by smaller entities, it follows that there are significantly more of such offerings at smaller dollar values. Rule 144A, on the other hand, usually involves institutional investors at a much higher dollar amount and lower frequency. For instance, there were approximately 33,429 Regulation D offerings in 2014 compared to 1,534 Rule 144A offerings in the same year. In 2014 there were 1,176 registered public equity offerings and 1,576 registered public debt offerings.

The Report gives comparable information for each year from 2009 through 2014 as well. As a summary, 2010 was a very big year in the offering marketplace (both private and public), skewing the results somewhat, but other than that, the number of all offerings has increased year over year since 2009.

The Regulation D market

The Regulation D market is comprised of Rules 504 and 505 promulgated under Section 3(b) of the Securities Act and Rules 506(b) and 506(c), both of which are safe harbors under Section 4(a)(2) of the Securities Act. Again, the SEC Report is only based on Form D filings and, accordingly, is subject to deviation for offerings that did not file and/or inaccurate or incomplete information reported by issuers.

Both the number of and dollar value of Regulation D offerings has been increasing from 2009 through 2014. For instance, there were 13,764 reported Regulation D offerings in 2009 and 22,004 in 2014. The total amount sold in 2009 was $595 billion and in 2014 was $1,332 billion. Interestingly, the average offering size was larger in 2009 at $36 million than in 2014 at $24 million.

The SEC Report discussed the cyclicality of offerings as well. Although it is well documented that public markets are cyclical and depend on such factors as business cycle, investor sentiment and time varying information asymmetry, comparable information is not available for the private offering markets. Just based on Form D filings, the SEC Report considers whether there is support for the theory that companies rely on private markets when public markets are in distress, such as during a recession. There is not. In fact, rather it appears that the private offering market increases during strong public markets and decreases during weak public markets. The health of the private offering market correlates with the health of the public market.

As noted in the Report, “there is a strong, positive correlation of the incidence of new Regulation D offerings with the economic condition of the public markets. In particular the level of Regulation D offering activity closely follows the level of the S&P 500 index.” From 2009-2014 there has been an increase in Regulation D offering activity consistent with the steady increase in the S&P 500.

The Regulation D marketplace for non-financial issuers generally comprises equity offerings as opposed to debt offerings, which are more common in the public market. Moreover, equity is usually indicative of new money and capital whereas debt is often used as a refinancing tool for existing debt. Financial issuers generally use Rule 144A and such offerings are generally debt. In other words, small businesses looking to grow with new capital rely on Regulation D equity offerings.

Rule 506 of Regulation D continues to be the most common exemption. Since 2009, 95% of private offerings are completed under Rule 506. It is clear to me, and the SEC, that the reason for this is that Rule 506 pre-empts state law, avoiding state registration and other arduous blue sky process. The SEC points out that depending on state law, Rule 504 and 505 offerings can be sold to non-accredited investors and, under Rule 504, can be freely tradeable. Despite this benefit, issuers clearly find the state law pre-emption as a more important deciding factor and are willing to accept the restrictions under Rule 506 as a trade-off (i.e., either accredited only or a limit of 35 unaccredited, restricted securities, no general solicitation or advertising under 506(b) and added accredited verification under 506(c), etc.).

From September 23, 2013, the date of enactment, through December 31, 2014, a total of 2,117 Rule 506(c) offerings were reported on Form D by a total of 1,911 issuers (some issuers had multiple offerings). During this time a total of $32.5 billion was reported as being raised. As a comparison, during the same time period there were 24,500 Rule 506(b) offerings that raised $821.3 billion. Moreover, even after the enactment of Rule 506(c), the number of new 506(b) offerings continues to increase and vastly outpace the number of new Rule 506(c) offerings.

I am not surprised by this information as I think that the 506(c) marketplace has taken its time to find its place in the private offering market as a whole, and continues to do so. From my own experience it is clear that accredited investors do not just look at a website and send money! Offerings are sold, not bought, and the advertising and marketing is good for lead generation, ease of information flow, and general exposure, but does not cause a sophisticated investor to part with their money without more. Even though the accredited verification process has become easier with services such as Crowdcheck, it is clear that issuers, placement agents, and the investing public still prefer the old-fashioned Rule 506(b) and avoiding the accredited verification process. See, for example, my blog HERE discussing new SEC guidance and the Citizen VC no action letter.

I still strongly believe in the benefits of Rule 506(c) and its viability. The SEC Report does as well, pointing out that issuers will become more comfortable with market practices, accredited investor verification procedures, and methods of advertising and solicitation over time.

During this same time period there continues to be a decline in the use of Rules 504 and 505. For example, there were only 544 Rule 504 offerings and 289 Rule 505 offerings in 2014. The SEC Report contains quite a bit of comparative information on Rules 504 and 505 for those interested in further information. As I’ve previously written about, the SEC has proposed new amendments for Rules 504 and 505 which may increase their use, though I do not expect a big impact. My blog on these proposed rules can be read HERE.

Both foreign issuers and public companies rely on Regulation D. For example, 20% of all Regulation D offerings from 2009-2014 were completed by foreign issuers. Public issuers are active in PIPE transactions as well, with 13% of Regulation D offerings being completed by public companies. At the end of this blog I have a section with 2015 data on the PIPE market from other sources.

Regulation D market participants

Pooled investment funds such as hedge funds, venture capital and private equity funds represent the largest business category, by amount raised, utilizing Regulation D. From 2009-2014 pooled investment funds raised $4.8 trillion as compared to $905 billion by non-funds. Non-funds, however, use Rule 506(c) more than pooled funds, representing 75% of those offerings. Moreover, non-funds account for a much higher percentage of total offerings by number of offerings, representing 60% of all new Form D filings.

Companies completing Rule 506(c) offerings usually check the “other,” “other technology,” “other real estate,” “oil and gas,” or “commercial” industry boxes of their Form D filings. Counting all non-funds using all Regulation D offerings, the industries in order of most often used are banking, technology, real estate, health care and energy. Interestingly, the number of offerings by banking entities and manufacturing industries have both decreased during the study period. There has been a big uptick in real estate offerings in 2013 and 2014, which makes sense in light of the improved real estate market since 2008.

The median offering size for these non-fund issuers is $1 million compared to $11 million for hedge funds and $30 million for private equity funds. As mentioned above, this information indicates that small businesses are utilizing Regulation D, which the Report finds is consistent with the regulatory objectives.

The majority of issuers decline to disclose revenue and of those that did, most disclosed less than $1 million. This is consistent with the findings that Regulation D is widely used by small businesses. Beyond that, I can’t find a lot of meaning in that information, other than that smaller issuers are most likely to file a Form D without the assistance of counsel, and counsel usually recommends not disclosing revenue.

The Form D’s do show that a majority (67%) of companies that file a Form D are less than 3 years old. This is true for both fund and non-fund entities. I note that this is consistent with the SEC Advisory Committee on Small and Emerging Companies’ consistent message that new entities are the most in need of methods to raise capital and secondarily that those same new entities create the most new jobs.

Most U.S. companies that file Form D’s have their principal place of business in California and New York with Texas, Florida and Massachusetts following. These are also the most common states of investor location. Most investors are accredited.

Less than a fifth of all issuers reported repeat offerings but 25% of non-fund issuers had repeat offerings. Form D filings do not tell of the success of an offering; however, 31% of issuers had raised 100% of their offering at the time they filed the Form D, which is typical of PIPE transactions offerings with a small handful of investors.

Form D’s will also not tell the final investor count or breakdown, but compiling Form D information shows that only 300,000 investors participated in Regulation D offerings in 2014 and only 110,000 in non-financial issuers. That seems to be a very small number of investors overall and clearly shows the importance of properly packaging an offering and presenting it to the right audience.

Only 21% of offerings for the period 2009-2014 used a placement agent, with a decrease in their use in 2014 compared to 2009-2013. Issuers in non-financial industries paid an average of 6% commission and in financial industries, an average of 1.4%. This is likely because the size of the offering is much larger and number of investors much smaller in the financial industry. On average, higher fees are paid for Rule 506(c) offerings than 506(b), which makes sense in light of additional work (verification of accreditation) and risk associated with advertising.

2015 PIPE Market

A PIPE is a private placement into public equity, or in other words, a private placement by a public company. According to PrivateRaise, a private placement data service, PIPE’s raised $89.97 billion in 2015, up 14.8% from 2014. The amount was spread over approximately 1,000 offerings.

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Issues Rules Implementing Certain Provisions Of The FAST Act SEC’s Financial Disclosure Requirements For Sub-Entities Of Registered Companies »

SEC Issues Rules Implementing Certain Provisions Of The FAST Act

Posted by Securities Attorney Laura Anthony | February 2, 2016 Tags: Fast Act, SEC, The Fast Act

On December 4, 2015, President Obama signed the Fixing America’s Surface Transportation Act (the “FAST Act”) into law, which included many capital markets/securities-related bills. The FAST Act is being dubbed the JOBS Act 2.0 by many industry insiders. The FAST Act has an aggressive rulemaking timetable and some of its provisions became effective immediately upon signing the bill into law on December 4, 2015. Accordingly there has been a steady flow of new SEC guidance, and now implementing rules.

On January 13, 2016, the SEC issued interim final rules memorializing two provisions of the FAST Act. In particular, the SEC revised the instructions to Forms S-1 and F-1 to allow the omission of historical financial information and to allow smaller reporting companies to use forward incorporation by reference to update an effective S-1. This blog summarizes these rules.

On December 10, 2015, the SEC Division of Corporate Finance addressed the FAST Act by making an announcement with guidance and issuing two new Compliance & Disclosure Interpretations (C&DI). My blog on the FAST Act and the first two C&DI on the Act can be read HERE. On December 21, 2015, the SEC issued 4 additional C&DI on the FAST Act. Each of the new C&DI addresses the FAST Act’s impact on Section 12(g) and Section 15(d) of the Exchange Act as related to savings and loan companies. My blog on this guidance can be read HERE.

The Amendments – an Overview

Form S-1 is the general form for the registration of securities under the Securities Act of 1933, as amended (“Securities Act”) and Form F-1 is the corresponding form for foreign private issuers.

Section 71003 of the FAST Act

Section 71003 of the FAST Act allows an emerging growth company (“EGC”) that is filing a registration statement under either Form S-1 or F-1 to omit financial information for historical periods that would otherwise be required to be included, if it reasonably believes the omitted information will not be included in the final effective registration statement used in the offering, and if such final effective registration statement includes all up-to-date financial information that is required as of the offering date. This provision automatically went into effect 30 days after enactment of the FAST Act. As directed by the FAST Act, the SEC has now revised the instructions to Forms S-1 and F-1 to reflect the new law.

The Section 71003 provisions do not allow for the omission of stub period financial statements if that stub period will ultimately be included in a longer stub period or year-end audit before the registration statement goes effective. In a C&DI, the SEC clarified that the FAST Act only allows the exclusion of historical information that will no longer be included in the final effective offering. The C&DI clarifies that “Interim financial information ‘relates’ to both the interim period and to any longer period (either interim or annual) into which it has been or will be included.” For example, an issuer could not omit first-quarter financial information if that first quarter will ultimately be included as part of a second- or third-quarter stub period or year-end audit.

An SEC C&DI has clarified that Section 71003 allows for the exclusion of financial statements for entities other than the issuer if those financial statements will not be included in the final effective registration statement. For example, if the EGC has acquired a business, it may omit that acquired business’ historical financial information as well. In a C&DI, the SEC confirms that: “Section 71003 of the FAST Act is not by its terms limited to financial statements of the issuer. Thus, the issuer could omit financial statements of, for example, an acquired business required by Rule 3-05 of Regulation S-X if the issuer reasonably believes those financial statements will not be required at the time of the offering. This situation could occur when an issuer updates its registration statement to include its 2015 annual financial statements prior to the offering and, after that update, the acquired business has been part of the issuer’s financial statements for a sufficient amount of time to obviate the need for separate financial statements.”

As a reminder, an EGC is defined as an issuer with less than $1 billion in total annual gross revenues during its most recently completed fiscal year. If an issuer qualifies as an EGC on the first day of its fiscal year, it maintains that status until the earliest of the last day of the fiscal year of the issuer during which it has total annual gross revenues of $1 billion or more; the last day of its fiscal year following the fifth anniversary of the first sale of its common equity securities pursuant to an effective registration statement; the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt; or the date on which the issuer is deemed to be a “large accelerated filer.”

Section 84001 of the FAST Act

Section 84001 of the FAST Act requires the SEC to revise Form S-1 to permit smaller reporting companies to incorporate by reference, into an effective registration statement, any documents filed by the issuer following the effective date of such registration statement. That is, Section 84001 allows forward incorporation by reference. At first, I thought this would be a significant change, as currently smaller reporting companies are specifically prohibited from incorporating by reference and must prepare and file a post-effective amendment to keep a resale “shelf” registration current, which can be expensive. However, the SEC rule release includes eligibility requirements, including a prohibition for use by penny stock issuers, which will greatly limit the use of forward incorporation by reference, significantly reducing the overall impact of this change.

As a reminder, a “smaller reporting company” is defined as an issuer that had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter or had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

As directed by the FAST Act, the SEC has now revised Item 12 of Form S-1 to reflect the changes and to include eligibility requirements for an issuer to be able to avail itself of the new provisions. That is, there are currently eligibility requirements for an issuer to be able to use historical incorporation by reference in a Form S-1. The new rules do not alter these existing eligibility requirements and rather attach the existing eligibility requirements related to historical incorporation by reference to the ability to be able to utilize the new provisions, allowing forward incorporation by reference.

The instructions to Form S-1 include the eligibility requirements to use historical, and now forward, incorporation by reference and include:

The company must be subject to the reporting requirements of the Exchange Act (not a voluntary filer);

The company must have filed all reports and other materials required by the Exchange Act during the prior 12 months (or such shorter period that such company was reporting);

The company must have filed an annual report for its most recently completed fiscal year;

The company may not currently be, and during the past 3 years neither the company nor any of its predecessors were, (i) a blank check company; (ii) a shell company; (iii) have offered a penny stock;

The company cannot be registering an offering for a business combination transaction; and

The company must make its reports filed under the Exchange Act that are incorporated by reference, available on its website, and include a disclosure of such availability that it will provide such document upon request.

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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« FINRA Proposes New Category Of Broker-Dealer For “Capital Acquisition Brokers” SEC Study On Unregistered Offerings »

FINRA Proposes New Category Of Broker-Dealer For “Capital Acquisition Brokers”

Posted by Securities Attorney Laura Anthony | January 26, 2016 Tags: Broker Dealer, CAB

In December, 2015, FINRA proposed rules for a whole new category of broker-dealer, called “Capital Acquisition Brokers” (“CABs”), which limit their business to corporate financing transactions. In February 2014 FINRA sought comment on the proposal, which at the time referred to a CAB as a limited corporate financing broker (LCFB). Following many comments that the LCFB rules did not have a significant impact on the regulatory burden for full member firms, the new rules modify the original LCFB proposal in more than just name. The new rules will take effect upon approval by the SEC and are currently open to public comments.

A CAB will generally be a broker-dealer that engages in M&A transactions, raising funds through private placements and evaluating strategic alternatives and that collects transaction based compensation for such activities. A CAB will not handle customer funds or securities, manage customer accounts or engage in market making or proprietary trading.

As with all FINRA rules, the proposed CAB rules are designed to comply with Section 15A of the Exchange Act related to FINRA rules and, in particular, that such rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principals of trade, and in general to protect investors and the public interest.

What is a Capital Acquisition Broker (“CAB”)?

There are currently FINRA registered firms which limit their activities to advising on mergers and acquisitions, advising on raising debt and equity capital in private placements or advising on strategic and financial alternatives. Generally these firms register as a broker because they may receive transaction-based compensation as part of their services. However, they do not engage in typical broker-dealer activities, including carrying or acting as an introducing broker for customer accounts, accepting orders to purchase or sell securities either as principal or agent, exercising investment discretion over customer accounts or engaging in proprietary trading or market-making activities.

The proposed new rules will create a new category of broker-dealer called a Capital Acquisition Broker (“CAB”). A CAB will have its own set of FINRA rules but will be subject to the current FINRA bylaws and will be required to be a FINRA member. FINRA estimates there are approximately 750 current member firms that would qualify as a CAB and that could immediately take advantage of the new rules.

FINRA is also hopeful that current firms that engage in the type of business that a CAB would, but that are not registered as they do not accept transaction-based compensation, would reconsider and register as a CAB with the new rules. In that regard, FINRA’s goal would be to increase its regulatory oversight in the industry as a whole. I think that on the one hand, many in the industry are looking for more precision in their allowable business activities and compensation structures, but on the other hand, the costs, regulatory burden, and a distrust of regulatory organizations will be a deterrent to registration. It is likely that businesses that firmly act within the purview of a CAB but for the transactional compensation and that intend to continue or expand in such business, will consider registration if they believe they are “leaving money on the table” as a result of not being registered. Of course, such a determination would include a cost-benefit analysis, including the application fees and ongoing legal and compliance costs of registration. In that regard, the industry, like all industries, is very small at its core. If firms register as a CAB and find the process and ongoing compliance reasonable, not overly burdensome and ultimately profitable, word will get out and others will follow suit. The contrary will happen as well if the program does not meet these business objectives.

A CAB will be defined as a broker that solely engages in one or more of the following activities:

Advising an issuer on its securities offerings or other capital-raising activities;

Advising a company regarding its purchase or sale of a business or assets or regarding a corporation restructuring, including going private transactions, divestitures and mergers;

Advising a company regarding its selection of an investment banker;

Assisting an issuer in the preparation of offering materials;

Providing fairness opinions, valuation services, expert testimony, litigation support, and negotiation and structuring services;

Qualifying, identifying, soliciting or acting as a placement agent or finder with respect to institutional investors in respect to the purchase or sale of unregistered securities (see below for the FINRA definition of institutional investor, which is much different and has a much higher standard than an accredited investor);

Effecting securities transactions solely in connection with the transfer of ownership and control of a privately held company through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the company, in accordance with the SEC rules, rule interpretations and no action letters. For more information on this, see my blog HERE regarding the SEC no action letter granting a broker registration exemption for certain M&A transactions.

Since placing securities in private offerings is limited to institutional investors, that definition is also very important. Moreover, FINRA considered but rejected the idea of including solicitation of accredited investors in the allowable CAB activities. Under the proposed CAB Rules, an institutional investor is defined to include any:

Bank, savings and loan association, insurance company or registered investment company;

Government entity or subdivision thereof;

Employee benefit plan that meets the requirements of Sections 403(b) or 457 of the Internal Revenue Code and that has a minimum of 100 participants;

Qualified employee plans as defined in Section 3(a)(12)(C) of the Exchange Act and that have a minimum of 100 participants;

Any person (whether a natural person, corporation, partnership, trust, family office or otherwise) with total assets of at least $50 million;

Persons acting solely on behalf of any such institutional investor; and

Any person meeting the definition of a “qualified purchaser” as defined in Section 2(a)(51) of the Investment Company Act of 1940 (i.e., any natural person that owns at least $5 million in investments; family offices with at least $5 million in investments; trusts with at least $5 million in investments; any person acting on their own or as a representative with discretionary authority, that owns at least $25 million in investments).

A CAB will not include any broker that does any of the following:

Carries or acts as an introducing broker with respect to customer accounts;Holds or handles customers’ funds or securities;

Accepts orders from customers to purchase or sell securities either as principal or agent for the customer;

Has investment discretion on behalf of any customer;

Produces research for the investing public;

Engages in proprietary trading or market making;

Participates in or maintains an online platform in connection with offerings of unregistered securities pursuant to Regulation Crowdfunding or Regulation A under the Securities Act (interesting that FINRA would include Regulation A in this, as currently no license is required at all to maintain such a platform – only platforms for Regulation Crowdfunding require such a license).

Application; Associated Person Registration; Supervision

A CAB firm will generally be subject to the current member application rules and will follow the same procedures for membership as any other FINRA applicant with four main differences. In particular: (i) the application has to state that the applicant will solely operate as a CAB; (ii) the FINRA review will consider whether the proposed activities are limited to CAB activities; (iii) FINRA has set out procedures for an existing member to change to a CAB; and (iv) FINRA has set out procedures for a CAB to change its status to regular full-service FINRA member firm.

The CAB rules also set out registration and qualification of principals and representatives, which incorporate by reference to existing NASD rules, including the registration and examination requirements for principals and registered representatives. CAB firm principals and representatives would be subject to the same registration, qualification examination and continuing education requirements as principals and representatives of other FINRA firms. CABs will also be subject to current rules regarding Operations Professional registration.

CABs would have a limited set of supervisory rules, although they will need to certify a chief compliance officer and have a written anti-money laundering (AML) program. In particular, the CAB rules model some, but not all, of current FINRA Rule 3110 related to supervision. CABs will be able to create their own supervisory procedures tailored to their business model. CABs will not be required to hold annual compliance meetings with their staff. CABs are also not subject to the Rule 3110 requirements for principals to review all investment banking transactions or prohibiting supervisors from supervising their own activities.

CABs would be subject to FINRA Rules 3220 – Influencing or Rewarding Employees of Others, Rule 3240 – Borrowing form or Lending to Customers, and Rule 3270 – Outside Activities of Registered Persons.

Conduct Rules for CABs

The proposed CAB rules include a streamlined set of conduct rules. This is a brief summary of some of the conduct rules related to CABs. CABs would be subject to current rules on Standards of Commercial Honor and Principals of Trade (Rule 2010); Use of Manipulative, Deceptive or Other Fraudulent Devices (Rule 2020); Payments to Unregistered Persons (Rule 2040); Transactions Involving FINRA Employees (Rule 2070); Rules 2080 and 2081 regarding expungement of customer disputes; and the FINRA arbitration requirements in Rules 2263 and 2268. CABs will also be subject to know-your-customer and suitability obligations similar to current FINRA rules for full-service member firms, and likewise will be subject to the FINRA exception to that rule for institutional investors. CABs will be subject to abbreviated rules governing communications with the public and, of course, prohibitions against false and misleading statements.

CABs are specifically not subject to FINRA rules related to transactions not within the purview of allowable CAB activities. For example, CABs are not subject to FINRA Rule 2121 related to fair prices and commissions. Rule 2121 requires a fair price for buy or sell transactions where a member firm acts as principal and a fair commission or service charge where a firm acts as an agent in a transaction. Although a CAB could act as an agent in a buy or sell transaction where a counter-party is an institutional investor or where it arranges securities transactions in connection with the transfer of ownership and control of a privately held company to a buyer that will actively operate the company, in accordance with the SEC rules, rule interpretations and no action letters on such M&A deals, FINRA believes these transactions are outside the standard securities transactions that typically raise issues under Rule 2121.

Financial and Operational Rules for CABs

CABs would be subject to a streamlined set of financial and operational obligations. CABs would be subject to certain existing FINRA rules including, for example, audit requirement, maintenance of books and records, preparation of FOCUS reports and similar matters.

CABs would also have net capital requirements and be subject to suspension for non-compliance. CABs will be subject to the current net capital requirements set out by Exchange Act Rule 15c3-1.

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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« The SEC Issues Guidance On The FAST Act As It Relates To Savings And Loan Companies SEC Issues Rules Implementing Certain Provisions Of The FAST Act »

The SEC Issues Guidance On The FAST Act As It Relates To Savings And Loan Companies

Posted by Securities Attorney Laura Anthony | January 19, 2016 Tags: SEC, The Fast Act

On December 10, 2015, the SEC Division of Corporate Finance addressed the FAST Act by making an announcement with guidance and issuing two new Compliance & Disclosure Interpretations (C&DI). As the FAST Act is a transportation bill that rolled in securities law matters relatively quickly and then was signed into law even quicker, this was the first SEC acknowledgement and guidance on the subject.

My blog on the FAST Act and the first two C&DI on the Act can be read HERE.

On December 21, 2015, the SEC issued 4 additional C&DI on the FAST Act. Each of the new C&DI addresses the FAST Act’s impact on Section 12(g) and Section 15(d) of the Exchange Act.

Section 85001 of the FAST Act amends Section 12(g) and Section 15(d) of the Securities Exchange Act such that savings and loan holding companies are treated similar to banks for purposes of the registration, termination of registration and suspension of reporting obligations under the Exchange Act.

In particular, the FAST Act amends Section 12(g) and Section 15(d) of the Exchange Act as follows:

Savings and loan holding companies, as such term is defined in Section 10 of the Home Owners’ Loan Act, will have a Section 12(g) registration obligation as of any fiscal year-end after December 4, 2015, with respect to a class of equity security held of record by 2,000 or more persons.

The holders of record threshold for Section 12(g) deregistration for savings and loan holding companies has been increased from 300 to 1,200 persons.

The holders of record threshold for the suspension of reporting under Section 15(d) for savings and loan holding companies has been increased from 300 to 1,200 persons.

The new guidance explains the timing of the new provisions. The SEC clarifies:

Under Section 12(g)(1)(B), a savings and loan holding company will have a Section 12(g) registration obligation if, as of any fiscal year-end after December 4, 2015, it has total assets of more than $10 million and a class of equity security held of record by 2,000 or more persons. We consider that the effect of this provision is to eliminate, for savings and loan holding companies, any Section 12(g) registration obligation with respect to a class of equity security as of a fiscal year-end on or before December 4, 2015. Therefore, if a savings and loan holding company has filed an Exchange Act registration statement and the registration statement is not yet effective, then it may withdraw the registration statement. If a savings and loan holding company has registered a class of equity security under Section 12(g), it would need to continue that registration unless it is eligible to deregister under Section 12(g) or current rules.

Similarly as relates to the termination of registration:

If the class of equity security is held of record by less than 1,200 persons, the savings and loan holding company may file a Form 15 to terminate the Section 12(g) registration of that class. Until rule amendments are made to reflect the change to Section 12(g)(4), the savings and loan holding company should include an explanatory note in its Form 15 indicating that it is relying on Exchange Act Section 12(g)(4) to terminate its duty to file reports with respect to that class of equity security.

Pursuant to Section 12(g)(4), the Section 12(g) registration will be terminated 90 days after the savings and loan holding company files a Form 15. Until that date of termination, the savings and loan holding company is required to file all reports required by Exchange Act Sections 13(a), 14 and 16.

Alternatively, a savings and loan holding company could rely on Exchange Act Rule 12g-4, which permits the immediate suspension of Section 13(a) reporting obligations upon filing a Form 15, if it meets the requirements of that rule. Note that Rule 12g-4 has not yet been amended to incorporate the new 1,200 holder deregistration threshold.

Finally, as relates to the suspension of reporting obligations:

In general, the Section 15(d) reporting obligation is suspended if, and for so long as, the issuer has a class of security registered under Section 12. When an issuer terminates Section 12 registration, it must address any Section 15(d) obligation that would apply once the Section 15(d) suspension is lifted.

For the current fiscal year, a savings and loan holding company can suspend its obligation to file reports under Section 15(d) with respect to a class of security that was sold pursuant to a Securities Act registration statement and that was held of record by less than 1,200 persons as of the first day of the current fiscal year. Such suspension would be deemed to have occurred as of the beginning of the fiscal year in accordance with Section 15(d) (as amended by the FAST Act). If, during the current fiscal year, a savings and loan holding company has a registration statement that becomes effective or is updated pursuant to Securities Act Section 10(a)(3), then it will have a Section 15(d) reporting obligation for the current fiscal year.

If a savings and loan holding company with a class of security held of record by less than 1,200 persons as of the first day of the current fiscal year has a registration statement that was updated during the current fiscal year pursuant to Securities Act Section 10(a)(3), but under which no sales have been made during the current fiscal year, the savings and loan holding company may suspend its Section 15(d) reporting obligation consistent with the guidance in Staff Legal Bulletin No. 18 (March 20, 2010) and GlenRose Instruments Inc. (July 16, 2012).

The Author

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

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

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

Download our mobile app at iTunes.

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