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SEC Proposed Rule Changes For Exempt Offerings – Part 4

Posted by Securities Attorney Laura Anthony | June 19, 2020 Tags: SEC Proposed Rule Changes For Exempt Offerings – Part 4

On March 4, 2020, the SEC published proposed rule changes to harmonize, simplify and improve the exempt offering framework. The SEC had originally issued a concept release and request for public comment on the subject in June 2019 (see HERE). The proposed rule changes indicate that the SEC has been listening to capital markets participants and is supporting increased access to private offerings for both businesses and a larger class of investors. Together with the proposed amendments to the accredited investor definition (see HERE), the new rules could have as much of an impact on the capital markets as the JOBS Act has had since its enactment in 2012.

The 341-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. I have been breaking the information down into a series of blogs, with this fourth blog focusing on amendments to Regulation A other than integration and offering communications which affect all exempt offerings and were discussed in the first two blogs in this series. The final blog in this series will discuss changes to Regulation Crowdfunding.

To review the first blog in this series, which centered on the offering integration concept, see HERE. To review the second blog in the series, which focused on offering communications, the new demo day exemption, and testing-the-waters provisions, see HERE. To review the third blog in this series, which focused on Regulation D, Rule 504 and the bad actor rules, see HERE.

Background; Current Exemption Framework

As I’ve written about many times, the Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or exempt from registration. The purpose of registration is to provide investors with full and fair disclosure of material information so that they are able to make their own informed investment and voting decisions.

Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). Currently, the requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

For more background on the current exemption framework, including a chart summarizing the most often used exemptions and their requirements, see Part 1 in this blog series HERE.

Proposed Rule Changes

The proposed rule changes are meant to reduce complexities and gaps in the current exempt offering structure. As such, the rules would amend the integration rules to provide certainty for companies moving from one offering to another or to a registered offering; increase the offering limits under Regulation A, Rule 504 and Regulation Crowdfunding and increase the individual investment limits for investors under each of the rules; increase the ability to communicate during the offering process, including for offerings that historically prohibited general solicitation; and harmonize disclosure obligations and bad actor rules to decrease differences between various offering exemptions.

Regulation A

The current two tier Regulation A offering process went into effect on June 19, 2015, as part of the JOBS Act. Since its inception there has been one rule modification opening up the offering to SEC reporting companies (see HERE) and multiple SEC guidance publications including through C&DI on the Regulation A process. For a recent summary of Regulation A, see HERE.

Increase in Offering Limit

On March 15, 2018, the U.S. House of Representatives passed H.R. 4263, the Regulation A+ Improvement Act, increasing the Regulation A+ Tier 2 limit from $50 million to $75 million in a 12-month period. On June 8, 2017, the U.S. House of Representatives passed the Financial Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs Act (the “Financial Choice Act 2.0”), which also included a provision increasing the Tier 2 offering limit to $75 million.

Following suit, the new proposed rule changes will increase the maximum Regulation A Tier 2 offering from $50 Million to $75 million in any 12-month period. As such, the 30% offering limit for secondary sales would increase from $15 million to $22.5 million. Tier 1 offering limits would remain unchanged.

Simplification

The SEC is also proposing to simplify the requirements for Regulation A and establish greater consistency between Regulation A and registered offerings by permitting Regulation A issuers to: (i) file certain redacted exhibits using the process previously adopted for registered offerings (see HERE); (ii) make draft offering statements and related correspondence available to the public via EDGAR to comply with the requirements of Securities Act Rule 252(d), rather than requiring them to be filed as exhibits to qualified offering statements; (iii) incorporate financial statement information by reference to other documents filed on EDGAR and generally allow incorporation by reference to the same degree as a registered offering (see HERE); and (iv) to have post-qualification amendments declared abandoned.

In March 2019, the SEC amended parts of Regulation S-K to allow companies to mark their exhibit index to indicate that portions of the exhibit or exhibits have been omitted, include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both not material and would be competitively harmful if publicly disclosed, and indicate with brackets where the information has been omitted from the filed version of the exhibit. At the time, the Regulation A rules were not changed such that Regulation A filers are still compelled to submit an application for confidential treatment in order to redact immaterial confidential information from material contracts and plans of acquisition, reorganization, arrangement, liquidation, or succession.

SEC staff would continue to review Forms 1-A filed in connection with Regulation A offerings and selectively assess whether redactions from exhibits appear to be limited to information that meets the appropriate standard. Upon request, companies would be expected to promptly provide supplemental materials to the SEC similar to those currently required, including an unredacted copy of the exhibit and an analysis of why the redacted information is both not material and the type of information that the company both customarily and actually treats as private and confidential.

Companies would also still be able to request confidentiality under Rule 83. For more on confidential treatment in SEC filings, see HERE

The SEC is also proposing to make draft offering statements and related correspondence available to the public via EDGAR to comply with the requirements of Securities Act Rule 252(d), rather than requiring them to be filed as exhibits to qualified offering statements. Currently confidential submittals must be filed as an exhibit to a public filing, which adds time and expense to the process. To the contrary, confidential registration statements filed under the Securities Act can simply be recoded to become publicly available. The proposed rules would add the same process for Regulation A filers.

The SEC is also proposing to allow previously filed financial statements to be incorporated by reference into a Regulation A offering circular. As proposed, companies that have a reporting obligation under Rule 257 or the Exchange Act must be current in their reporting obligations. In addition, companies would be required to make incorporated financial statements readily available and accessible on a website maintained by or for the company, and disclose in the offering statement that such financial statements will be provided upon request. Companies conducting ongoing offerings would still need to file an annual post-qualification amendment with updated financial statements.

Excluding Delinquent Reporting Companies

The proposed amendments would exclude reporting companies that are not current in periodic reports required under Section 13 or 15(d) of the Exchange Act from using Regulation A. Excluding companies that are subject to, but not current in, Exchange Act reporting obligations from eligibility under Regulation A may reduce the average level of information asymmetry about Regulation A issuers and incrementally increase investor interest in securities offered in this market.

« SPAC IPOs A Sign Of Impending M&A Opportunities SEC Proposed Rule Changes For Exempt Offerings – Part 5 »

SPAC IPOs A Sign Of Impending M&A Opportunities

Posted by Securities Attorney Laura Anthony | June 15, 2020 Tags: SPAC IPOs A Sign Of Impending M&A Opportunities

The last time I wrote about special purpose acquisition companies (SPACs) in July 2018, I noted that SPACs had been growing in popularity, raising more money in 2017 than in any year since the last financial crisis (see HERE). Not only has the trend continued, but the Covid-19 crisis, while temporarily dampening other aspects of the IPO market, has caused a definite uptick in the SPAC IPO world.

In April, the Wall Street Journal (WSJ) reported that SPACs are booming and that “[S]o far this year, these special-purpose acquisition companies, or SPACs, have raised $6.5 billion, on pace for their biggest year ever, according to Dealogic. In April, 80% of all money raised for U.S. initial public offerings went to blank-check firms, compared with an average of 9% over the past decade.”

I’m not surprised. Within weeks of Covid-19 reaching a global crisis and causing a shutdown of the U.S. economy, instead of my phone not ringing, I was inundated with inquiries relating to SPACs and reverse mergers. The sentiment is that there will be significant buying opportunities as the virus subsides and the economy recovers, including an even further increase in technology and new industries for our new normal.

Similarly, many companies that were planning a traditional IPO have adjusted their focus to a reverse merger. The thought is to go public quietly, make sure governance and processes are buttoned up, and be ready for follow-on offerings, and merger and acquisition opportunities, using stock as currency at the uptick in valuation that comes with the liquidity available to publicly traded companies.

Mid-tier bankers are in on the opportunities. Not all businesses are cash-strapped; in fact, some are enjoying the highest growth in their life cycle. Food-delivery businesses of all sorts, direct-to-consumer household product suppliers, personal protective equipment, including hand sanitizer manufacturers, video meeting and conferencing companies, virtual event planners and organizers and underlying technology providers and of course, e-commerce personalization technology companies, life science and biotech companies, including those that were already deep in viral or immunotherapy research and development, digital currency platforms are all booming. Many of these companies are looking at reverse merger opportunities and small-cap bankers are willing to invest a few million betting on the larger follow-on raise to come.

Those looking to go public via a SPAC or reverse merger have options. At the same time that the SPAC IPO market is booming, unfortunately, many public companies have been hard hit by the crisis and management is considering options, including taking the current business private or discontinuing operations, and finding value for their shareholders by completing a reverse acquisition.

Of course the benefit of a SPAC is that it comes with cash, but that is not a certainty either. A SPAC’s public stockholders can elect to have their shares redeemed for cash in connection with the business combination and as such, the amount of cash available for post-closing operations is uncertain. The target may require a minimum cash closing condition or, perhaps more importantly, that the SPAC have committed acquisition financing. As such, a SPAC can be substantially the same as any reverse merger with a simultaneous PIPE transaction.

Background on SPACs

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

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

When a SPAC completes its IPO, usually 100%, but in no event less than 90%, of the funds raised are held in escrow to be released either upon completion of a business combination transaction, or back to shareholders in the event a transaction is not completed within a set period of time. Upon closing of a business combination, the SPAC investors can elect to continue as shareholders of the combined business or redeem their shares for cash. A SPAC business combination must have a market value of at least 80% of the value of the amount held in escrow at the time of the agreement to enter into the transaction.

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

SPAC IPOs are usually structured as unit offerings with both stock and warrants to entice investors to bet on the unknown future opportunity. The number of warrants and exercise price can vary. Although sponsors with a prominent track record can generally attract better valuations and investor deals, with the continuing popularity of SPACs over the years, that has become less important. As an alternative to warrants, some SPAC sponsors agree to over-fund the IPO trust account by some multiple to the investment amount, which over-funded amount would be distributed to the SPAC investors if a business combination is not completed.

The SPAC IPO process is the same as any other IPO process. That is, the SPAC files a registration statement on Form S-1 that is subject to a comment, review, and amend process until the SEC clears comments and declares the registration statement effective. Concurrent with the S-1 process, the SPAC will either have applied for a listing on a national exchange or, following the closing of the offering, will work with a market maker who will file a Form 211 application with FINRA to receive a trading symbol to trade on the OTCQX. The OTCQX is the only tier of OTC Markets that allows for SPAC trading. Also, although both NASDAQ and the NYSE have proposed SPAC eligibility rule changes over the years, as of now, they remain the same as for any other company seeking a listing as part of an IPO.

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

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

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

Upon approval of the business combination transaction, the funds in escrow will be released and used to satisfy any redemption requests and to pay for the costs of the transaction. Target companies generally require that a certain amount of cash remain after redemptions, as a precondition to a closing of the transaction, or as talked about above, that a simultaneous PIPE transaction provide the needed cash. The exchanges all require that the newly combined company satisfy their particular continued listing requirements.

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

A SPAC is an ineligible issuer that is not entitled to use a free writing prospectus in its IPO or subsequent offerings within three years of completing a business combination.
After completing the IPO and until it completes a business combination, the SPAC must identify its shell company status on the cover of its Exchange Act periodic reports.
A SPAC cannot use a Form S-8 to register any management equity plans until 60 days after completing a business combination.
A SPAC may not file an S-3 in reliance on Instruction 1.B.6 (the baby shelf rule) until 12 months after it ceases to be a shell and has filed “Form 10” information (i.e., the information that would be required if the company were filing a Form 10 registration statement) with the SEC reflecting its status as an entity that is no longer a shell company. See HERE on S-3 eligibility. Also, recently the SEC has been issuing comment letters where the company is filing an S-3 relying on Instructions 1.B.1 (full shelf) or 1.B.3 (re-sale) following a SPAC deal, suggesting they want those entities to wait 12 months as well. Historically, the SEC would include the SEC filings of the SPAC in the general requirement that the company have a class of securities registered for 12 months prior to use of S-3, but it seems they are changing their view and want the operating business to be public for the full 12 months. I wouldn’t be surprised if we see a rule change aligning all S-3 use with the current shell company requirements in Instruction 1.B.6.
Holders of SPAC securities may not rely on Rule 144 for resales of their securities after the SPAC completes a business combination until one year after the company has filed current “Form 10” information with the SEC reflecting its status as an entity that is no longer a shell company and so long as the SPAC remains current in its SEC reporting obligations.

Conclusion

Although all forms of going public have pros and cons, in a SPAC deal or other reverse merger, you have a motivated buyer. SPACs are required to liquidate if they do not complete a business combination within the legally specified time period, and the sponsor will lose their investment. In a reverse merger, the current public company must continue to fund SEC reporting requirements, EDGAR fees, transfer agent fees and the usual fees associated with being public, in addition to facing shareholder pressure to either make the current business work, or find an opportunity that has the potential to bring them future value.

For companies that are looking to go public without the traditional IPO, and especially those looking for growth through M&A activity, now is a great time to look at SPACs and reverse merger opportunities.

« Disclosures Related To Covid-19 – What Investors Want To Know SEC Proposed Rule Changes For Exempt Offerings – Part 4 »

Disclosures Related To Covid-19 – What Investors Want To Know

Posted by Securities Attorney Laura Anthony | June 5, 2020 Tags: Disclosures Related To COVID-19, What Investors Want To Know

I’ve written several times about the need for Covid-19 disclosures including public statements by Chair Clayton and William Hinman, the Director of the Division of Corporation Finance and the SEC Division of Corporation Finance Disclosure Guidance Topic No. 9 regarding the SEC’s current views on disclosures that companies should consider with respect to COVID-19. For my summary blog on the topic, see HERE.

As I’ve previously mentioned, my personal thought is that although there are many reasons why disclosure is important, it is especially important now to support investor confidence, activity in our markets and capital raising efforts. If investors are kept informed of the impact of COVID-19 on companies, see that these companies are continuing on and meeting their requirements and that the markets haven’t just fallen into Neverland, they will continue to invest through the trading of securities, and direct investments through PIPE transactions. Further on the broader economic level, transparency and information will bolster confidence on a B2B level such as between suppliers, manufacturers and retailers, allow for the extension of credit and support the general continued flow of business operations.

Not surprisingly, the topic of Covid-19 disclosure was front and center at the SEC’s Investor Advisory Committee (“IAC”) meeting on May 4, 2020 (held virtually, of course) with investors providing positive feedback on the SEC’s guidance to date, but also suggesting additional information that they would like to be informed about by public companies.

IAC meeting participants indicated that the SEC’s prior recommendations related to disclosures on business continuity, the receipt of federal aid and general financial impacts as laid out in Topic No. 9 have been very useful. A refresher on Topic No. 9 is included at the end of this blog.

Human Capital

Several participants at the IAC meeting encouraged the SEC to require more disclosure related to human capital and in particular, how human capital impacts a company’s ability to resume safe and sustainable operations. Human capital is typically considered an environmental, social and governance (ESG) related disclosure. The IAC has been a strong proponent of ESG disclosures, including related to human capital, so this is not surprising. See, for example, HERE.. Also, On May 14, 2020 the IAC published a recommendation to the SEC to require ESG disclosures.

Although the SEC has to date declined to require ESG related disclosures, its most recent published proposed amendments to the business description disclosure required by Regulation S-K includes suggested disclosure on human capital. The proposed amendments would include any human capital measures or objectives that management focuses on in managing the business, and the attraction, development and retention of personnel (such as in a gig economy). See HERE . For more on ESG in general, see HERE and for a summary of SEC Chair Jay Clayton’s views on ESG related disclosure, see HERE.

Getting back to human capital disclosures, as mentioned the IAC’s emphasis was on safe and sustainable workplaces. Drilling down to particular disclosures, investors are interested in: (i) workplace safety hazards and related risks; (ii) systems and controls to reduce hazards including air quality, employee barriers, cleaning supplies and training; (iii) the capacity for testing, contract tracing, and isolation of potentially infected employees including those that are asymptomatic but may have come into contact with an infected person; (iv) controls and accommodations to promote a safe work environment including cleaning supplies and hand washing stations; (v) human resource policies including paid sick leave and adjusted work schedules; (vi) the availability of personal protective equipment; (vii) workforce stability and turnover; and (viii) employee relations including supporting an environment where workers feel safe and plans for dealing with unrest.

Drill Down On Financial Impact

Although the SEC made several recommendations to management to consider in fashioning Covid-19 related disclosures, the IAC meeting participants think companies should really drill down further. For example, how will the impact of Covid-19, financial and otherwise, impact a company’s position vis-a-vis its competition, both domestically and internationally. The changing international hot zones and opening and closing of different countries at different times all impact a company’s operations. Investors would like to see disclosures related to revenues, as well as supply chains, including manufacturing and logistical issues.

Investors would like to see more current real-time disclosure. The SEC has indicated that it will not second-guess best-effort forward-looking statements during these difficult times. However, IAC members would like to see more real-time data, especially since expectations are so difficult to determine in a global crisis. Personally, I think too much real-time data would be confusing and cause unnecessary volatility for the markets. Of course if there is a material real-time negative impact on liquidity, operations, management or earnings (defaults on material obligations; the closing of a manufacturing facility; the shutdown of an export or import border; the infection of a senior executive) or a positive impact (the re-opening of a manufacturing facility; extensions or work-outs with creditors; recovery of sick executive; new funding sources, etc.) these should be reported whether specifically required by Form 8-K or not. For a review of Form 8-K requirements, see HERE.

Investors also want to be sure they are given a heads-up about actual or potential bankruptcy and the real impact of going concern statements. Participants of the meeting noted that during the 2008 recession, some companies filed bankruptcy without any forewarning or even auditor going concern opinions. Although not discussed at the IAC meeting, the fact is, the world has already seen several large bankruptcies as a result of Covid-19. It begs the question that if a company’s financial foundation is fragile enough to be knocked over in 3 months (or less), investors should know. Hertz filed for bankruptcy May 22, directly citing the coronavirus as a cause. Even as the company was beginning layoffs, it paid out a reported $16.2 million in executive bonuses. Certainly management and auditors had to know that the company’s financial position was precipitous, but the marketplace did not.

Internal Controls

Participants at the IAC meeting indicated they will want to know how a company’s internal controls over financial reporting held up during the Covid-19 crisis and if deficiencies were discovered, how they are being rectified. In addition, in-person auditor meetings and site reviews have been replaced with Zoom and other electronic communications. IAC members wonder what impact that has over internal controls and even noted that they have not seen an increase in any disclosure related to this dramatic system change.

Refresher On – Topic No. 9

The SEC Division of Corporation Finance has issued Disclosure Guidance Topic No. 9 regarding the SEC’s current views on disclosures and the obligations that companies should consider with respect to COVID-19. The overarching messaging is that a company must consider its COVID-19 impact in its disclosure documents and make necessary material disclosures using a principles-based strategy.

Certainly the actual impact and risks are difficult to ascertain and may be unknown or dependent on third parties, but the SEC encourages material disclosure on what management expects the virus’ future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties. Examples of areas of reports that may be impacted and thus require disclosure include management’s discussion and analysis, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting, and the financial statements.

Topic No. 9 suggests that management consider the following non-exclusive list in considering COVID-19 related disclosures:

How has COVID-19 impacted the financial condition and results of operations? How do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition? Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? Consider if the cost of or access to capital and funding sources has changed and whether it is likely to change or continue to change. Have sources and uses of cash been materially impacted? Has the ability to continue to meet ongoing credit agreements changed, or is it materially likely it will change? Disclosure should also be made as to the course of action a company has taken or proposes to take in light of the material impact on its financial resources.
How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets? For example, will there be significant changes in judgments in determining the fair value of assets measured in accordance with U.S GAAP or IFRS?
Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures? If so, what changes in your controls have occurred during the current period that materially affect or are reasonably likely to materially affect your internal control over financial reporting? What challenges do you anticipate in your ability to maintain these systems and controls?
Have you experienced challenges in implementing your business continuity plans or do you foresee requiring material expenditures to do so?
Do you expect COVID-19 to materially affect the demand for your products or services?
Do you anticipate a material adverse impact of COVID-19 on your supply chain or the methods used to distribute your products or services?
Will your operations be materially impacted by any constraints or other impacts on your human capital resources and productivity?
Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve your business goals?

The SEC notes that historical information is relatively less significant at this time, making forward-looking information all the more important. Investors and analysts are extremely interested to know where companies stand today and, importantly, how they have adjusted, and expect to adjust in the future, their operational and financial affairs to most effectively work through the COVID-19 health crisis. Detailed discussions of current liquidity positions and expected financial resource needs is particularly helpful to investors and markets. Where material, a company should disclose any CARES Act or similar federal or state assistance that has been applied for and/or received, including the nature, amount and effects of such assistance.

Forward-looking information will be protected under either Sections 27A and 21E of the Private Securities Litigation Reform Act of 1995 (PSLRA) or the common law bespeaks caution doctrine as long as proper disclaimers are included (for more information, see HERE.

In addition to other considerations, the SEC reminds companies of their obligations under Item 10 of Regulation S-K and Regulation G related to the presentation of non-GAAP financial measures. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, and the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information. For more on Item 10 and Regulation G, see HERE.

The Author

Laura Anthony, Esq.

Founding Partner

Anthony L.G., PLLC

A Corporate Law Firm

LAnthony@AnthonyPLLC.com

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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

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

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« SEC Proposed Rule Changes for Exempt Offerings – Part 3 SPAC IPOs A Sign Of Impending M&A Opportunities »

SEC Proposed Rule Changes for Exempt Offerings – Part 3

Posted by Securities Attorney Laura Anthony | May 29, 2020 Tags: SEC Proposed Rule Changes for Exempt Offerings

The 341-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. I have been breaking the information down into a series of blogs, with this third blog focusing on amendments to Rule 504, Rule 506(b) and 506(c) of Regulation D other than integration and offering communications which affect all exempt offerings and were discussed in the first two blogs in this series. In addition, this third blog will cover amendments to the bad-actor disqualification provisions. The final two blogs in this series will discuss changes to Regulation A and Regulation Crowdfunding.

To review the first blog in this series centered on the offering integration concept, see HERE. To review the second blog in the series which focused on offering communications, the new demo day exemption, and testing the waters provisions, see HERE.

Background; Current Exemption Framework

Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). Currently, the requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad-actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

For more background on the current exemption framework, including a chart summarizing the most often used exemptions and their requirements, see Part 1 in this blog series HERE.

Proposed Rule Changes

The proposed rule changes are meant to reduce complexities and gaps in the current exempt offering structure. As such, the rules would amend the integration rules to provide certainty for companies moving from one offering to another or to a registered offering; increase the offering limits under Regulation A, Rule 504 and Regulation Crowdfunding and increase the individual investment limits for investors under each of the rules; increase the ability to communicate during the offering process, including for offerings that historically prohibited general solicitation; and harmonize disclosure obligations and bad-actor rules to decrease differences between various offering exemptions.

Rule 506(c) Verification Requirements

Rule 506(c) allows for general solicitation and advertising; however, all sales must be made to accredited investors and the company must take reasonable steps to verify that purchasers are accredited. It is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering. For more on Rules 506(b) and 506(c), see HERE.

Rule 506(c) provides for a principles-based approach to determine whether an investor is accredited as well as providing a non-exclusive list of methods to determine accreditation. After consideration of the facts and circumstances of the purchaser and of the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the company would have to take to verify accredited investor status, and vice versa. Where accreditation has been verified by a trusted third party, it would be reasonable for an issuer to rely on that verification.

Examples of the type of information that companies can review and rely upon include: (i) publicly available information in filings with federal, state and local regulatory bodies (for example: Exchange Act reports; public property records; public recorded documents such as deeds and mortgages); (ii) third-party evidentiary information including, but not limited to, pay stubs, tax returns, and W-2 forms; and (iii) third-party accredited investor verification service providers.

Moreover, non-exclusive methods of verification include:

Review of copies of any Internal Revenue Service form that reports income including, but not limited to, a Form W-2, Form 1099, Schedule K-1 and a copy of a filed Form 1040 for the two most recent years along with a written representation that the person reasonably expects to reach the level necessary to qualify as an accredited investor during the current year. If such forms and information are joint with a spouse, the written representation must be from both spouses.
Review of one or more of the following, dated within three months, together with a written representation that all liabilities necessary to determine net worth have been disclosed. For assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraiser reports issued by third parties and for liabilities, credit reports from a nationwide agency.
Obtaining a written confirmation from a registered broker-dealer, an SEC registered investment advisor, a licensed attorney, or a CPA that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months.
A written certification verifying accredited investor status from existing accredited investors of the issuer that have previously invested in a 506 offering with the same issuer.

Related to jointly held property, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the accredited investor net worth test, but only to the extent of his or her percentage ownership of the account or property. The SEC has provided guidance regarding relying on tax returns by noting that in a case where the most recent tax return is not available but the two years prior are, a company may rely on the available returns together with a written representation from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specifies the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year. However, if the evidence is at all questionable, further inquiry should be made.

In the new proposed rule release, the SEC realizes that the non-exclusive list may create some uncertainty and lead to some companies to believe that they must rely only on the methods in the list. The SEC is proposing to add a new item to the non-exclusive list that allows for a company to accept the written representation of an investor that they are accredited if the company has previously taken steps to verify accredited status and is not aware of any new information to the contrary.

The amended rule will also reiterate the principles-based approach of the rule, including reminding companies to consider (i) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (ii) the amount and type of information that the company has about the purchaser; and (iii) the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

Rule 506(b); Harmonization of Disclosure Requirements

Currently Rule 506(b) has scaled disclosure requirements based on the size of the offering, where unaccredited investors are included. The proposed rules update the information requirements for investors under Rule 506(b) where any unaccredited investors are solicited. The new information requirements would align with information required under Regulation A. For Rule 506(b) offerings up to $20 million, the same financial information that is required for Tier 1 Regulation A offerings will be required. For offerings greater than $20 million, the same financial information that is required for Tier 2 Regulation A offerings will be required.

The effect of the rule change would be to eliminate the ability for a company that has trouble getting financial statements to be able to only provide a balance sheet. Foreign private issuers would be able to provide the financial information in either U.S. GAAP or IFRS as would be permitted in a registration statement.

If the company is not subject to the Exchange Act reporting requirements, it must also furnish the non-financial statement information required by Part II of Form 1-A or Part I of a Securities Act registration statement on a form that the issuer would be eligible to use (usually Form S-1). If the company is subject to the Exchange Act reporting requirements, it must provide its definitive proxy with annual report, or its most recent Form 10-K. These information requirements only apply where non-accredited investors will be solicited to participate in the offering.

Finally, as mentioned in Part I of this blog series related to integration where an issuer conducts more than one offering under Rule 506(b), the number of non-accredited investors purchasing in all such offerings within 90 calendar days of each other would be limited to 35.

Rule 504

On October 26, 2016, the SEC passed new rules to modernize intrastate and regional securities offerings. The final new rules amended Rule 147 to allow companies to continue to offer securities under Section 3(a)(11) of the Securities Act and created a new Rule 147A to accommodate adopted state intrastate crowdfunding provisions. Rule 147A allows intrastate offerings to access out-of-state residents and companies that are incorporated out of state, but that conduct business in the state in which the offering is being conducted. At that time, the SEC also amended Rule 504 of Regulation D to increase the aggregate offering amount from $1 million to $5 million and to add bad-actor disqualifications from reliance on the rule. For more on the 2016 rule amendments, see HERE.

Currently Rule 504 provides an exemption for offerings up to $5 million in any twelve-month period. Rule 504 is unavailable to companies that are subject to the reporting requirements of the Securities Exchange Act, are investment companies or are blank-check companies. Rule 504 does not have any specific investor qualification or limitations. However, Rule 504 does not pre-empt state law and as such, the law of each state in which an offering will be conducted must be reviewed and complied with.

The proposed rule changes will increase the maximum offering under Rule 504 from $5 million to $10 million in any 12-month period.

Bad-Actor Provisions

Rules 504, 506(b), 506(c), Regulation A and Regulation Crowdfunding all have bad-actor disqualification provisions. While the disqualification provisions are substantially similar, the look-back period for determining whether a covered person is disqualified differs between Regulation D and the other exemptions. The proposed rules will harmonize the bad-actor provisions among Regulations D, A and Crowdfunding by adjusting the look-back requirements in Regulation A and Regulation Crowdfunding to include the time of sale in addition to the time of filing.

Under Regulation D, the disqualification event is measured as of the time of sale of the securities in the offering. Under Regulation A and Regulation Crowdfunding, the look-back period is measured from the time the company files an offering statement. However, the SEC believes that it is important to look to both the time of filing of the offering document and the time of the sale with respect to disqualifying bad actors from participating in an offering. The proposed rule change will add “or such sale” to any look back references in Regulation A and Regulation Crowdfunding.

The Author

Laura Anthony, Esq.

Founding Partner

Anthony L.G., PLLC

A Corporate Law Firm

LAnthony@AnthonyPLLC.com

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

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

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« NASDAQ Provides Additional Relief To Shareholder Approval Requirements For Companies Affected By Covid-19 Disclosures Related To Covid-19 – What Investors Want To Know »

NASDAQ Provides Additional Relief To Shareholder Approval Requirements For Companies Affected By Covid-19

Posted by Securities Attorney Laura Anthony | May 22, 2020 Tags: NASDAQ Provides Additional Relief To Shareholder Approval Requirements For Companies Affected By Covid-19

Nasdaq has provided additional relief to listed companies through temporary rule 5636T easing shareholder approval requirements for the issuance of shares in a capital raise. The rule was effective May 4, 2020 and will continue through and including June 30, 2020. The purpose of the rule change is to give listed companies affected by Covid-19 quicker access to much-needed capital.

Temporary Rule 5636T is limited to the transactions and shareholder approval requirements specifically stated in the rule. If shareholder approval is required based on another rule, such as a change of control, or another Nasdaq rule is implicated, those other rules will need to be complied with prior to an issuance of securities.

The Nasdaq shareholder approval rules generally require companies to obtain approval from shareholders prior to issuing securities in connection with: (i) certain acquisitions of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants (see HERE); (iii) a change of control (see HERE); and (iv) certain private placements at a price less than the minimum price as defined in Listing Rule 5635(d) (see HERE.)

Earlier in the Covid-19 crisis, Nasdaq indicated that it will consider the impact of disruptions caused by the pandemic in its review of any pending or new requests for a financial viability exception. Nasdaq required that reliance by the company on a financial viability exception be expressly approved by the company’s audit committee and that the company obtain Nasdaq’s approval prior to proceeding with the transaction. Under the rule, companies also have to provide notice to shareholders at least ten days prior to issuing securities in the exempted transaction.

Exception to Private Placement 20% Rule

Nasdaq now has enacted temporary rule 5636T formalizing an exception to the shareholder approval requirement in Rule 5635(d) (the private placement 20% Rule) through June 30, 2020. Nasdaq Rule 5635(d) requires shareholder approval prior to a 20% issuance of securities at a price that is less than the Minimum Price in a transaction other than a public offering. A 20% issuance is a transaction, other than a public offering, involving the sale, issuance or potential issuance by the company of common stock (or securities convertible into or exercisable for common stock), which alone or together with sales by officers, directors or substantial shareholders of the company, equals 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance. “Minimum Price” means a price that is the lower of: (i) the closing price (as reflected on Nasdaq.com) immediately preceding the signing of the binding agreement; or (ii) the average closing price of the common stock (as reflected on Nasdaq.com) for the five trading days immediately preceding the signing of the binding agreement.

The exception is limited to circumstances where the delay in obtaining shareholder approval would: (i) have a material adverse impact on the company’s ability to maintain operations under its pre-Covid-19 business plan; (ii) result in workforce reductions; (iii) adversely impact the company’s ability to undertake new initiatives in response to Covid-19; and (iv) seriously jeopardize the financial viability of the company. In addition, in order to rely on the exception, the company has to demonstrate to Nasdaq that the need for the transaction is due to circumstances related to COVID-19 and that the company undertook a process designed to ensure that the proposed transaction represents the best terms available to the company.

No prior approval of the exception by Nasdaq is required if the maximum amount of common stock (or securities convertible into common stock) issuable in the transaction is less than 25% of the total shares outstanding and less than 25% of the voting power outstanding before the transaction and the maximum discount to the Minimum Price at which shares could be issued is 15%. Although prior approval is not necessary, companies must notify Nasdaq about such transactions as promptly as possible, and file a listing of additional shares (LAS) notification at least two days before issuing shares. An LAS notification is required where a transaction may result in the potential issuance of common stock, or securities convertible into common stock, of greater than 10% of either the total shares outstanding or the voting power outstanding on a pre-transaction basis and therefore would always be required where the shareholder approval requirements under Rule 5635(d) are invoked. The LAS must normally be filed 15 calendar days prior to issuing the additional shares.

For transactions where greater than 25% of the shares or voting power will be issued or where the discount is in excess of 15% of the Minimum Price, a company must get Nasdaq’s approval prior to the share issuance. Companies can seek approval by filing the LAS notification and the required supplement. Once approval is received, the company can proceed with the transaction (i.e., it does not have to wait 15 days).

The LAS Supplement must include a cover letter addressing the following factors:

(i) The need for the transaction is due to Covid-19 circumstances. This section should provide specific details of the facts and circumstances including the impact of Covid-19 on the company’s operations, workforce, new initiatives and financial viability.

(ii) The delay in securing shareholder approval would have a material impact on the company’s ability to maintain operations under its Covid-19 business plan; would result in workforce reductions; would adversely impact the company ability to undertake new initiatives in response to Covid-19; or would seriously jeopardize the company financial viability. This section should provide specific details and address at least one of the following: (i) how long the company will be able to meet its current obligations such as payroll, lease payments and debt servicing if it does not complete the proposed transaction; (ii) what is the current and projected cash position and burn rate; (iii) would the company be required to file for bankruptcy if it had to wait for shareholder approval; and (iv) what would be the impact to the company’s operations if it had to wait for shareholder approval.

(iii) The company undertook a process designed to ensure that the proposed transaction represents the best terms available to the company. This section should include an overview of all meetings, inquiries and communications conducted by the company and its outside advisors when structuring the transaction and any other factors considered in reaching the decision to proceed.

(iv) The audit committee or comparable body of the board of directors, comprised solely of independent, disinterested directors, expressly approved reliance on the temporary rule and the transaction itself and that it is in the best interest of shareholders. This section should include a copy of the operable executed resolution or minutes of the board committee approving the transaction and setting forth the required criteria.

Furthermore, in order to rely on the Rule the company must execute a binding agreement, receive Nasdaq approval, if necessary, and have filed its LAS notification if required, prior to the close of business on June 30, 2020. However, the shares can be issued after June 30, 2020 as long as the issuance is no more than 30 calendar days following the date of the binding agreement.

Nasdaq also requires that the company notify the public about the transaction and reliance on the temporary rule by filing a Form 8-K if required by SEC rules or by issuing a press release no later than two business days before issuing the securities. The 8-K or press release must disclose: (i) the terms of the transaction, including the number of shares of common stock that could be issued; (ii) that shareholder approval would ordinarily be required under Nasdaq rules; (iii) that the company is relying on the temporary rule excepting shareholder approval; and (iv) that the audit committee or comparable body of the board of directors, comprised solely of independent, disinterested directors, expressly approved reliance on the temporary rule and the transaction itself and that it is in the best interest of shareholders.

Nasdaq will aggregate issuances of securities in reliance on the exception in Rule 5636T with any subsequent issuance by the company, other than a public offering, at a discount to the Minimum Price if the binding agreement governing the subsequent issuance is executed within 90 days of the prior issuance.

Exception to Equity Compensation Rule

Temporary Rule 5636T can also be relied upon where Rule 5635(c) would trigger a shareholder approval requirement as part of the transaction. Nasdaq Rule 5635(c) requires shareholder approval prior to the issuance of securities when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants, except for: (1) warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company (such as a typical dividend reinvestment plan); (2) tax qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans (including foreign plans complying with applicable foreign tax law), provided such plans are approved by the company’s independent compensation committee or a majority of the company’s Independent Directors; or plans that merely provide a convenient way to purchase shares on the open market or from the company at market value; (3) plans or arrangements relating to an acquisition or merger as permitted under IM-5635-1; or (4) issuances to a person not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to the individual’s entering into employment with the company, provided such issuances are approved by either the company’s independent compensation committee or a majority of the company’s Independent Directors.

Unaffiliated investors often require a company’s senior management to put their personal capital at risk and participate in a capital raising transaction alongside the unaffiliated investors. This request is likely to increase where a company affected by Covid-19 seeks to raise capital. Temporary Rule 5636T provides for an exception from shareholder approval under Rule 5635(c) for an affiliate’s participation in the transaction provided the affiliate’s participation in the transaction was specifically required by unaffiliated investors. The temporary rule limits each affiliate’s participation to no more than 5% of the transaction and all affiliates’ participation collectively must be less than 10% of the transaction total. Any affiliate investing in the transaction must not have participated in negotiating the economic terms of the transaction.

« SEC Publishes FAQ On COVID-19 Effect On S-3 Registration Statements SEC Proposed Rule Changes for Exempt Offerings – Part 3 »

SEC Publishes FAQ On COVID-19 Effect On S-3 Registration Statements

Posted by Securities Attorney Laura Anthony | May 15, 2020 Tags: SEC, SEC Publishes FAQ On COVID-19 Effect On S-3 Registration Statements

The SEC has issued FAQ on Covid-19 issues, including the impact on S-3 shelf registration statements. The SEC issued 4 questions and answers consisting of one question related to disclosure and three questions related to S-3 shelf registrations.

SEC FAQ

Disclosure

Confirming prior guidance, the SEC FAQ sets forth the required disclosures in the Form 8-K or 6-K filed by a company to take advantage of a Covid-19 extension for the filing of periodic reports. In particular, in the Form 8-K or Form 6-K, the company must disclose (i) that it is relying on the COVID-19 Order (for more information on the Order, see HERE); (ii) a brief description of the reasons why the company could not file the subject report, schedule or form on a timely basis; (iii) the estimated date by which the report, schedule or form is expected to be filed; and (iv) a company-specific risk factor or factors explaining the impact, if material, of COVID-19 on the company’s business. Also, if the reason the report cannot be filed timely relates to the inability of any person, other than the company, to furnish any required opinion, report or certification, the company must also attach, as an exhibit to the Form 8-K or Form 6-K, a statement signed by such person stating the specific reasons why the person is unable to furnish the required opinion, report or certification. The Form 8-K or 6-K must be filed with the SEC on or before the original due date of such report.

Furthermore, when the delayed report is filed it must contain disclosures that it was delayed based on the Covid-19 Order and reiterate the reasons it could not timely file the report.

Effect on Form S-3

S-3 eligibility and the ability to take down periodic offerings from an effective S-3 registration statement is often the lifeblood for publicly traded companies, especially during times of financial hardship. For a detailed review of S-3 eligibility, see HERE.

Generally speaking, a company must be current in its SEC reporting requirements in order to file or utilize an existing S-3 shelf. Moreover, a company must re-assess its eligibility to continue to use the shelf each time it files an update to the registration statement, which could be through a post-effective amendment or a Form 10-K which is automatically incorporated by reference and acts as a prospectus update.

The SEC has issued three question-and-answer FAQs related to the ability to use or file an S-3 shelf registration statement while relying on the Order allowing for an extension of the filing of periodic reports due to Covid-19.

The first question confirms that a company can continue to conduct takedowns using an already effective registration statement while relying on the Covid-19 Order for an extension to the filing date of a report, including a Form 10-K. However, in order to continue to use an existing S-3, the company must make a determination that the prospectus, as it exists at that time, complies with Section 10(a) of the Securities Act. This is no different than at any other time a shelf is used – that is, it is always incumbent upon a company to believe that its prospectus complies with Section 10(a). Section 10(a)(3) requires that when a prospectus is used more than nine months after the effective date of the registration statement, the information contained in the prospectus cannot be older than 16 months.

However, Section 10(a)(3) has a qualifier that information must be updated at 16 months “so far as such information is known to the user of such prospectus or can be furnished by such user without unreasonable effort or expense.” The new SEC FAQ provides that “[A]lthough Section 10(a)(3) may permit registrants relying on the COVID-19 Order to conduct a takedown using a prospectus that contains information older than sixteen months in the event that updated information cannot be furnished without unreasonable effort or expense, registrants and their legal advisers will need to determine when it is appropriate to update the prospectus. Registrants are responsible for the accuracy and completeness of their disclosure.”

In addition, shelf offerings pursuant to Rule 415 require a company to file a post-effective amendment (which could be via a Form 10-K that is forward incorporated by reference) to reflect any facts or events arising after the effective date which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. In other words, if the information in the prospectus is materially inaccurate, it cannot be used.

The second question confirms that a company must re-assess its eligibility to continue to use Form S-3 at the time of the filing of its Form 10-K. In general, each time a company files a post-effective amendment to its Form S-3, including through the filing of a Form 10-K, the company must assess its eligibility to continue to use the Form. For example, to continue to be eligible the company must have timely filed all of its periodic reports (with some limited Form 8-K exceptions) for a period of at least 12 calendar months. For a complete and detailed list of eligibility requirements, see HERE. Where the company has relied on the Covid-19 Order to extend the filing deadline for that Form 10-K, it can make its eligibility assessment at the time of filing under the new deadline.

The third question confirms that a company may file a new s-3 registration statement between the original due date of a required filing and the due date as extended by the COVID-19 Order, even if the company has not yet filed the required periodic report. The SEC will consider a company current and timely in its Exchange Act reports as long as it timely filed the Form 8-K for an extension of the deadline for a particular report such as a Form 10-Q or 10-K. However, although the company can file a new Form S-3, the SEC will not likely accelerate its effectiveness until the delayed periodic report has been filed. The company will no longer be considered current and timely, and will lose eligibility to file new registration statements on Form S-3, if it fails to file the required report by the due date as extended by the COVID-19 Order.

« SEC Enacts Temporary Expedited Crowdfunding Rules NASDAQ Provides Additional Relief To Shareholder Approval Requirements For Companies Affected By Covid-19 »

SEC Enacts Temporary Expedited Crowdfunding Rules

Posted by Securities Attorney Laura Anthony | May 8, 2020 Tags: Crowdfunding Rules, SEC, SEC Enacts Temporary Expedited Crowdfunding Rules

Following the April 2, 2020 virtual meeting of the SEC Small Business Capital Formation Advisory Committee in which the Committee urged the SEC to ease crowdfunding restrictions to allow established small businesses to quickly access potential investors (see HERE), the SEC has provided temporary, conditional expedited crowdfunding access to small businesses. The temporary rules are intended to expedite the offering process for smaller, previously established companies directly or indirectly affected by Covid-19 that are seeking to meet their funding needs through the offer and sale of securities pursuant to Regulation Crowdfunding.

The temporary rules will provide eligible companies with relief from certain rules with respect to the timing of a company’s offering and the financial statements required. To take advantage of the temporary rules, a company must meet enhanced eligibility requirements and provide clear, prominent disclosure to investors about its reliance on the relief. The relief will apply to offerings launched between May 4, 2020 and August 31, 2020.

TEMPORARY RULES

Title III of the JOBS Act, enacted in April 2012, amended the Securities Act to add Section 4(a)(6) to provide an exemption for crowdfunding offerings. Regulation Crowdfunding went into effect on May 16, 2016. The exemption allows issuers to solicit “crowds” to sell up to $1,070,000 (as adjusted for inflation in 2017) in securities in any 12-month period as long as no individual investment exceeds certain threshold amounts. The threshold amount sold to any single investor cannot exceed (a) the greater of $2,000 or 5% of the lower of annual income or net worth of such investor if the investor’s annual income or net worth is less than $100,000; and (b) 10% of the annual income and net worth of such investor, not to exceed a maximum of $100,000, if the investor’s annual income or net worth is more than $100,000. When determining requirements based on net worth, an individual’s primary residence must be excluded from the calculation. Regardless of the category, the total amount any investor can invest is limited to $100,000. For a summary of the provisions, see HERE.

In March 2020, the SEC published proposed rule changes to harmonize, simplify and improve the exempt offering framework including Regulation Crowdfunding. The proposed rules would increase the offering limit to $5 million; increase the investment limit by altering the formula to be based on the greater of, rather than lower of, an investor’s annual income or net worth; remove investment limits on accredited investors; allow the use of special purpose vehicles and reduce the types of securities that can be sold in a Regulation Crowdfunding offering. However, the timing for implementation of the proposed rules, either as proposed or with changes, is uncertain.

As noted, the temporary rules are intended to provide existing eligible smaller businesses with quick access to capital by reaching out to the “crowd” which may include local investors, customers, vendors, etc., that are willing to support small businesses. This table, which was included in the SEC press release announcing the temporary rules, and to which I have provided explanatory and further detailed information, is a very good summary of the temporary rules.

Requirement	Existing Regulation Crowdfunding	Temporary Amendment
Eligibility	The exemption is not available to: Non-U.S. issuers; Issuers that are required to file reports under Section 13(a) or 15(d) of the Securities Exchange Act of 1934; Investment companies; Blank check companies; Issuers that are disqualified under Regulation Crowdfunding’s disqualification rules; and Issuers that have failed to file the annual reports required under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement.	To rely on the temporary rules, issuers must meet the existing eligibility criteria PLUS: The issuer cannot have been organized and cannot have been operating less than six months prior to the commencement of the offering; and An issuer that has sold securities in a Regulation Crowdfunding offering in the past, must have complied with the requirements in section 4A(b) of the Securities Act and the related rules (that is, they must have complied with all the Regulation Crowdfunding rules and requirements).
Offers permitted	After filing of offering statement (including financial statements)	After filing of offering statement, but financial statements may be initially omitted (if not otherwise available)
Investment commitments accepted	After filing of offering statement on Form C (including financial statements)	After filing of offering statement on Form C that includes financial statements or amended offering statement that includes financial statements.That is, the temporary rule allows a test-the-waters period by allowing the company to file a Form C and post offering information on a funding platform, gathering indications of interest, prior to filing financial statements. If the offering does not garner interest, the company may determine to abandon or delay the offering and would not have occurred the expense of financial statement preparation. Certain disclosures will need to be added if no financial statements are included and no investment commitments can be accepted until the financial statements have been provided.
Financial statements required when issuer is offering more than $107,000 and not more than $250,000 in a 12-month period	Financial statements of the issuer reviewed by a public accountant that is independent of the issuer	Financial statements of the issuer and certain information from the issuer’s federal income tax returns, both certified by the principal executive officer.Must also provide a statement that financial information certified by the principal executive officer has been provided instead of financial statements reviewed by an independent public accountant.
Sales permitted	After the information in an offering statement is publicly available for at least 21 days	As soon as an issuer has received binding investment commitments covering the target offering amount (note: commitments are not binding until 48 hours after they are given)
Early closing permitted	Once target amount is reached if: The offering remains open for a minimum of 21 days; The intermediary provides notice about the new offering deadline at least five business days prior to the new offering deadline; Investors are given the opportunity to reconsider their investment decision and to cancel their investment commitment until 48 hours prior to the new offering deadline; and At the time of the new offering deadline, the issuer continues to meet or exceed the target offering amount.	As soon as binding commitments are received reaching target amount if: The issuer has complied with the disclosure requirements in temporary Rule 201(z) (which is a statement that the offering is being conducted on an expedited basis due to circumstances relating to Covid-19 and pursuant to the SEC’s temporary relief and any additional statements related to the particular relief being relied upon such as financial statement relief); The intermediary provides notice that the target offering amount has been met; and At the time of the closing of the offering, the issuer continues to meet or exceed the target offering amount.
Cancellations of investment commitments permitted	For any reason until 48 hours prior to the deadline identified in the issuer’s offering materials. Thereafter, an investor is not able to cancel any investment commitments made within the final 48 hours of the offering (except in the event of a material change to the offering).	For any reason for 48 hours from the time of the investor’s investment commitment (or such later period as the issuer may designate). After such 48-hour period, an investment commitment may not be cancelled unless there is a material change to the offering.

e Crowdfunding Professional Association (C

« SEC Proposed Rule Changes for Exempt Offerings – Part 2 SEC Publishes FAQ On COVID-19 Effect On S-3 Registration Statements »

SEC Proposed Rule Changes for Exempt Offerings – Part 2

Posted by Securities Attorney Laura Anthony | May 1, 2020 Tags: SEC, SEC Proposed Rule Changes for Exempt Offerings, SEC Proposed Rule Changes for Exempt Offerings – Part 2

The 341-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. As such, I will break it down over a series of blogs, with the second blog in the series which focuses on offering communications, the new demo day exemption, and testing the waters provisions. The first in this series centered on the offering integration concept and can be read HERE.

Background; Current Exemption Framework

Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

For more background on the current exemption framework, including a chart summarizing the most often used exemptions and there requirements, see Part 1 in this blog series HERE.

Proposed Rule Changes

Offering Communications; Expansion of Test-the-Waters Communications; Addition of “Demo Days”

Section 4(a)(2) of the Securities Act exempts transactions by an issuer not involving a public offering, from the Act’s registration requirements. The Supreme Court case of SEC v. Ralston Purina Co. and its progeny Doran v. Petroleum Management Corp. and Hill York Corp. v. American Int’l Franchises, Inc. together with Securities Act Release No. 4552 set out the criteria for determining whether an offering is public or private and therefore the availability of Section 4(a)(2). In order to qualify as a private placement, the persons to whom the offer is made must be sophisticated and able to fend for themselves without the protection of the Securities Act and must be given access to the type of information normally provided in a prospectus.

All facts and circumstances must be considered including the relationship between the offerees and the issuer, and the nature, scope, size, type, and manner of the offering. Section 4(a)(2) does not limit the amount a company can raise or the amount any investor can invest. Rule 506 is “safe harbor” promulgated under Section 4(a)(2). That is, if all of the requirements of Rule 506 are complied with, then the exemption under Section 4(a)(2) would likewise be complied with. An issuer can rely directly on Section 4(a)(2) without regard to Rule 506; however, Section 4(a)(2) alone does not pre-empt state law and thus requires blue sky compliance.

Effective September 2013, in accordance with the JOBS Act, the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rule 506 by bifurcating the rule into two separate offering exemptions. The historical Rule 506 was renumbered to Rule 506(b) new rule 506(c) was enacted. Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors – provided, however, that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, are provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering.

Rule 506(c) allows for general solicitation and advertising; however, all sales must be strictly made to accredited investors and this adds a burden of verifying such accredited status to the issuing company. In a 506(c) offering, it is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering. Accordingly, in the Rule 506 context, determining whether solicitation or advertising has been utilized is extremely important.

Likewise, other offerings allow for solicitation and advertising. In particular, Regulation A, Regulation Crowdfunding, Rule 147 and 147A, and Rule 504 all allow for solicitation and advertising. For more information on Rule 504, Rule 147 and 147A, see HERE; on Regulation A, see HERE ; and on Regulation Crowdfunding, see HERE. Part 1 of this blog series talked about issues with integration, including between offerings that allow and don’t allow solicitation, but equally important is determining what constitutes solicitation in the first place.

Generally, testing the waters through contacting potential investors in advance of an exempt offering to gauge interest in the future offering, could be deemed solicitation. In 2015 the SEC issued several C&DI to address when communications would be deemed a solicitation or advertisement, including factual business communications in advance of an offering and demo day or venture fairs.

At that time, the SEC indicated that participation in a demo day or venture fair does not automatically constitute general solicitation or advertising under Regulation D. If a company’s presentation does not involve the offer of securities at all, no solicitation is involved. If the attendees of the event are limited to persons with whom either the company or the event organizer have a pre-existing, substantive relationship, or have been contacted through a pre-screened group of accredited, sophisticated investors (such as an angel group), it will not be deemed a general solicitation. However, if invitations to the event are sent out via general solicitation to individuals and groups with no established relationship and no pre-screening as to accreditation, any presentation involving the offer of securities would be deemed to involve a general solicitation under Regulation D. For more on a pre-existing substantive relationship, see HERE.

The proposed rule would expand test-the-waters for all companies to be able to use generic solicitations of interest communications prior to determining which exempt offering they will rely upon or pursue. Also, Regulation Crowdfunding would allow for test-the-waters much the same as Regulation A. Furthermore, a new “demo day” will be allowed for all offerings which would be exempted from the definition of general solicitation or advertising.

The SEC considered but determined not to add a rule that statutorily defines a substantive pre-existing relationship or to add to or expand on the examples of solicitation and advertising currently contained in Rule 502(c). As a reminder, Rule 502(c) lists the following examples of solicitation or advertising:

Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising; provided, however,that publication by a company of a notice in accordance with Rule 135c or filing with the SEC of a Form D shall not be deemed to constitute general solicitation or general advertising; provided further, that, if the requirements of Rule 135e are satisfied, providing any journalist with access to press conferences held outside of the U.S., to meetings with companies or selling security holder representatives conducted outside of the U.S., or to written press-related materials released outside the U.S., at or in which a present or proposed offering of securities is discussed, will not be deemed to constitute general solicitation or general advertising.

Demo Days; New Rule 148

New Rule 148 would provide that certain demo day communications would not be deemed general solicitation or advertising. Specifically, as proposed, a company would not be deemed to have engaged in general solicitation if the communications are made in connection with a seminar or meeting by a college, university, or other institution of higher education, a local government, a nonprofit organization, or an angel investor group, incubator, or accelerator sponsoring the seminar or meeting.

Sponsors of events would not be permitted to make investment recommendations or provide investment advice to attendees of the event, nor to engage in any investment negotiations between the company and investors attending the event. The sponsor would not be able to charge fees beyond a reasonable administrative fee and could not receive compensation for making introductions. Advertising for the event would also be limited such that specific offerings could not be advertised and the information about a presenting company would be limited to: (i) notice that the company is conducting or planning to conduct an offering; (ii) the type and amount of securities offered; and (iii) the intended use of proceeds.

The new rule is similar to the broker-dealer exemption included in Securities Act Section 4(b) for online portals hosting offerings that allow for general solicitation and advertising such as Rule 506(c), Regulation A and Rule 147 and 147A intrastate offerings. For more on Section 4(b), see HERE.

Solicitations of Interest

Prior to the JOBS Act, almost no exempt offerings (except intrastate offerings when allowed by the state) allowed for advertising or soliciting, including solicitations of interest or testing the waters. The JOBS Act created the current Regulation A, which allows for testing the waters subject to certain SEC filing requirements and the inclusion of specific legends on the offering materials. For a discussion on Regulation A test-the-waters provisions, see HERE. In the current rule release, the SEC notes that “[W]e believe that the existing testing the-waters provisions allow issuers to consult effectively with investors as they evaluate market interest in a contemplated registered or Regulation A securities offering before incurring the costs associated with such an offering, while preserving investor protections.”

The SEC is proposing a new rule to allow companies to solicit indications of interest in an exempt offering, either orally or in writing, prior to determining which exemption they will rely upon, even if the ultimate exemption does not allow general solicitation or advertising. Likewise, the SEC is proposing to allow test-the-waters communications for Regulation Crowdfunding and to align the provisions such that a company could ultimately choose either a Regulation A or Regulation Crowdfunding offering.

The pre-offering determination generic solicitations, set forth in new Rule 241, would be similar to existing Rule 255 of Regulation A. Rule 241 would require a legend or disclaimer stating that: (i) the company is considering an exempt offering but has not determined the specific exemption it will rely on; (ii) no money or other consideration is being solicited, and if sent, will not be accepted; (iii) no sales will be made or commitments to purchase accepted until the company determines the exemption to be relied upon and where the exemption includes filing, disclosure, or qualification requirements, all such requirements are met; and (iv) a prospective purchaser’s indication of interest is non-binding. The solicitations would be subject to the antifraud provisions of the federal securities laws.

Once a company determines which type of offering it intends to pursue, it would no longer be able to rely on Rule 241 but would need to comply with the rules associated with that particular offering type, including its solicitation of interest and advertising rules. Moreover, since the solicitation of interest would likely be a general solicitation, if the chosen offering does not allow general solicitation or advertising, the company would need to conduct an integration analysis to make sure that there would be no integration between the solicitation of interest and the offering. Under the new rules, that would generally require the company to wait 30 days between the solicitation of interest and the offering (see Part 1 of this blog series HERE). I say “would likely be a general solicitation” because a company may still indicate interest from persons that it has a prior business relationship with, without triggering a general solicitation, as they can now under the current rules.

If a company elects to proceed with a Regulation A or Regulation Crowdfunding offering, it would need to file the Rule 241 test-the-waters materials if the Rule 241 solicitation is within 30 days of the ultimate offering as such solicitation of interest would then integrate with the following offering. If more than 30 days pass, the Rule 241 communications would not need to be filed, but any Rule 255 communication would need to filed in a Regulation A offering and proposed new Rule 206 communications would need to be filed in a Regulation Crowdfunding offering.

Although new Rule 241 does not limit the type of investor that can be solicited (accredited or non-accredited), under the new rules, if a company determines to proceed with a Rule 506(b) offering after obtaining indications of interest, it must provide the non-accredited investors, if any, with a copy of any written solicitation of interest materials that were used.

New Rule 241 would not pre-empt state securities laws. Accordingly, if a company ultimately proceeds with an offering that does not pre-empt state law, it will need to consider whether it has met the state law requirements, including whether each state allows for solicitations of interest prior to an offering. This provision will likely be a large impediment to a company that is considering an offering that does not pre-empt state law.

As an aside, the SEC has also expanded the ability for companies to test the waters in association with registered offerings – see HERE – but I believe those provisions should be expanded to be more analogous to Regulation A.

Regulation Crowdfunding

Currently a company may not solicit potential investors until their Form C is filed with the SEC. The proposed new rule will allow both oral and written test-the-waters communications prior to the filing of a Form C much the same as Regulation A. The new Regulation Crowdfunding test-the-waters provisions are proposed in new Rule 206.

Under proposed Rule 206, companies would be permitted to test the waters with all potential investors. The testing-the-waters materials would be considered offers that are subject to the antifraud provisions of the federal securities laws. Like Regulation A, any test the waters communications would need to contain a legend including: (i) no money or other consideration is being solicited, and if sent, will not be accepted; (ii) no sales will be made or commitments to purchase accepted until the Form C is filed with the SEC and only through an intermediary’s platform; and (iii) a prospective purchaser’s indication of interest is non-binding. Any test-the-waters materials will need to be filed with the SEC as an exhibit to the Form C.

As discussed above, Rule 206 is separate from the proposed new Rule 241. Rule 241 requires an integration analysis. Accordingly, if Rule 241 test-the-waters materials were used within 30 days of the commencement of a Regulation Crowdfunding offering, they would need to be filed with the SEC with the Form C together with any subsequent Rule 206 materials.

« NYSE, Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19 SEC Enacts Temporary Expedited Crowdfunding Rules »

NYSE, Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19

Posted by Securities Attorney Laura Anthony | April 24, 2020 Tags: NYSE Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19

In addition to the SEC, the various trading markets, including the Nasdaq, NYSE and OTC Markets are providing relief to trading companies that are facing unprecedented challenges as a result of the worldwide COVID-19 crisis.

NYSE

The NYSE has taken a more formal approach to relief for listed companies. On March 20, 2020 and again on April 6, 2020 the NYSE filed a notice and immediate effectiveness of proposed rule changes to provide relief from the continued listing market cap requirements and certain shareholder approval requirements.

Recognizing the extremely high level of market volatility as a result of the COVID-19 crisis, the NYSE has temporarily suspended until June 30, 2020 its continued listing requirement that companies must maintain an average global market capitalization over a consecutive 30-trading-day period of at least $15 million. Likewise, the NYSE is suspending the requirement that a listed company maintain a minimum trading price of $1.00 or more over a consecutive 30-trading-day period, through June 30, 2020.

The NYSE intends to waive certain shareholder approval requirements for continued listing on the NYSE through June 30, 2020. In particular, in light of the fact that many listed companies will have urgent liquidity needs in the coming months due to lost revenues and maturing debt obligations, the NYSE is proposing to ease shareholder approval requirements to allow capital raises. The big board amendments align the requirements more closely with the NYSE American requirements.

The NYSE big board rules prohibit issuances to related parties if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance subject to a limited exception if the issuances are above a minimum price and no more than 5% of the outstanding common stock. For a review of the NYSE American rule for affiliate issuances, see HERE. The NYSE also requires shareholder approval for private issuances below the minimum price for any transactions relating to 20% or more the outstanding common stock or voting power. For a review of the 20% rule for the NYSE American, see HERE.

Realizing that existing large shareholders and affiliates are often the only willing providers of capital when a company is undergoing difficult times, the rule change allows for the issuance of securities to affiliates that exceed the 1% or 5% limits if completed prior to June 30, 3030 where the securities are sold for cash that meets the minimum price and if the transaction is reviewed and approved by the company’s audit committee or a comparable committee comprised solely of independent directors. The waiver cannot be relied upon if the proceeds would be used for an acquisition of stock or assets of another company in which the affiliate has a direct or indirect interest. Furthermore, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule. The substantially similar NYSE American rules can be reviewed HERE – equity compensation, and HERE – change of control.

The NYSE has also waived the 20% rule for private placements completed through and including June 30, 2020 where a bona fide financing is made to a single purchaser for cash meeting the minimum price requirement. Again, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule.

Nasdaq

The Nasdaq has taken a less formal approach on some of its requirements and a formal rule amendment on others. Although Nasdaq has not suspended its listing requirements, it will give due weight to the realities surrounding the worldwide crisis in both considering listing standards compliance and requests for financial viability waivers, such as under Rule 5635.

Generally, companies newly deficient with the bid price, market value of listed securities, or market value of public float requirements have at least 180 days to regain compliance and may be eligible for additional time. Nasdaq has enacted a temporary rule change such that companies that fall out of compliance with these listing standards related to price through and including June 30, 2020 will have additional time to regain compliance. That is, the non-compliance period will be tolled through June 30, 2020 and not counted in the 180 day period. Companies will still receive notification of non-compliance and will still need to file the appropriate Form 8-K. Companies that no longer satisfy the applicable equity requirement can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months plus the tolling period, to come back into compliance with the requirement.

The information memorandum confirms that listed companies that avail themselves of the 45-day extension for Exchange Act filings (see HERE) will not be considered deficient under Nasdaq Rule 5250(c) which requires all listed companies to timely file all required SEC periodic financial reports. Companies that are unable to file a periodic report by the relevant due date, but that are not eligible for the relief granted by the SEC, can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months to file.

As discussed in my blog related to SEC COVID-19 relief (see HERE), the SEC has granted relief where a company is required to comply with Exchange Act Sections 14(a) or 14(c) requiring the furnishing of proxy or information statements to shareholders, and mail delivery is not possible due to the coronavirus and the company has made a good-faith effort to deliver such materials. Nasdaq likewise will not consider a company in non-compliance with Rule 5250(d) requiring companies to make available their annual, quarterly and interim reports to shareholders or Rule 5620(b) requiring companies to solicit proxies and provide proxy statements for all meetings of shareholders when relying on the SEC relief. Nasdaq confirms that it permits virtual shareholder meetings as long as it is permissible under the relevant state law and shareholders have the opportunity to ask questions of management.

An exception is available for companies in financial distress where the delay in securing stockholder approval would seriously jeopardize the financial viability of the company. To request a financial viability exception, the company must complete a written request including a letter addressing how a delay resulting from seeking shareholder approval would seriously jeopardize its financial viability and how the proposed transaction would benefit the company. The standard is usually difficult to meet; however, Nasdaq has indicated that it will consider the consider the impact of disruptions caused by COVID-19 in its review of any pending or new requests for a financial viability exception. In addition, reliance by the company on a financial viability exception must expressly be approved by the company’s audit committee and the company must obtain Nasdaq’s approval to rely upon the financial viability exception prior to proceeding with the transaction. Under the rule, companies must also provide notice to shareholders at least ten days prior to issuing securities in the exempted transaction.

OTC Markets

OTC Markets Group has provided blanket relief for OTCQB and OTCQX companies with certain deficiencies until June 30, 2020. Until that date, no new compliance deficiency notices will be sent related to bid price, market cap, or market value of public float. Also, any OTCQX or OTCQB company that has already received a compliance notice related to bid price, market cap, or market value of public float with a cure period expiring between March and June will automatically receive an extension until June 30, 2020 to cure their deficiency.

OTC Markets has also extended the implementation date for compliance with the OTCQB rules requiring at least 50 beneficial shareholders and minimum float of 10% or $2 million in market value of public float, respectively, until June 30, 2020. The extension applies only to companies already traded on OTCQB as of May 20, 2018. All other companies were subject to these requirements effective May 20, 2018.

« Disclosures Related To COVID-19 SEC Proposed Rule Changes for Exempt Offerings – Part 2 »

Disclosures Related To COVID-19

Posted by Securities Attorney Laura Anthony | April 17, 2020 Tags: Disclosures Related To COVID-19

The SEC has been reiterating the need for robust disclosures related to the impact of COVID-19 on publicly reporting companies. In the last few weeks I have written about some of the guidance issued by the SEC including Disclosure Guidance Topic No. 9. Since that time the SEC has continued to issue guidance in the form of public statements. This blog will summarize the SEC guidance and statements on disclosures up to date, and include a sample risk factor for inclusion in SEC reports.

Public Statement by Chair Jay Clayton and Director of the Division of Corporation Finance, William Hinman

On April 8, 2020, SEC Chairman Jay Clayton and William Hinman, the Director of the Division of Corporation Finance, issued a joint public statement on the importance of disclosure during the COVID-19 crisis.

Before I get into summarizing the statement, my personal thought is that although there are many reasons why disclosure is important, including the basic premise that the securities laws are founded on that very concept, it is especially important now to support investor confidence, activity in our markets and capital raising efforts. If investors are kept informed of the impact of COVID-19 on companies, see that these companies are continuing on and meeting their requirements and that the markets haven’t just fallen into Neverland, they will continue to invest through the trading of securities, and direct investments through PIPE transactions. Without adequate information, not only will investors not likely invest directly in companies, but a company may be prohibited from accepting funds even if they want to if there is a concern of trading on material non-public information.

In my view the best way to protect the capital markets is to encourage confidence and investments. I’ve seen a noticeable uptick in liquidity in the small-cap space. My belief is that many people who are staying at home, are not just watching Netflix, but rather are actively trading the markets, making both short-term and long-term plays, following the markets very closely, reviewing companies for undervalued opportunities and spending more time researching than ever before. My advice to all my clients, and readers, is to make sure that information is being disseminated as quickly as available and as often as possible.

Further on the broader economic level, transparency and information will bolster confidence on a B2B level such as between suppliers, manufacturers and retailers, allow for the extension of credit and support the general continued flow of business operations.

Reporting Earnings and Financial Results

Both Topic No. 9 and the Public Statement encourage companies to proactively address financial reporting matters earlier than usual. Many companies will rely on the available 45-day extension and will be grappling with the accounting complexities of the COVID-19 impact including short-term dramatic changes in expenses and revenues. The SEC suggests engaging needed experts and beginning an analysis of the potential impacts as quickly as possible to be prepared to meet filing deadlines, even with the extensions.

Many companies, although not obligated, choose to issue earnings releases and conduct investor and analyst calls (for more on earnings releases, see HERE. In their Public Statement, Chair Clayton and Director Hinman urged companies to provide as much information as practicable regarding their current and future financial and operating status. Disclosures should include any information on the impact of COVID-19 as it stands today, how the company is responding to COVID-19 including how it is protecting the health and well-being of its workers and customers, and how operations and financial condition may change in the future as a result of the virus. The SEC advises against boilerplate information, but rather companies should make a concerted effort to provide meaningful information on key operational and financial considerations and challenges.

With that said, to the extent that a company had previously issued 2020 guidance which remains in place, it is important to address the degree to which the company believes it can continue to meet those previous projections and any changes to that prior guidance. Obviously, all companies should be reviewing prior guidance to determine if it should be withdrawn.

In addition to other considerations, the SEC reminds companies of their obligations under Item 10 of Regulation S-K and Regulation G related to the presentation of non-GAAP financial measures. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information. For more on Item 10 and Regulation G, see HERE.

Topic No. 9 specifically acknowledges that there may be instances where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by a COVID-19 related adjustment that may require additional information and analysis to complete. In these situations, the SEC would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results. For example, if a company intends to disclose EBITDA on an earnings call, it could reconcile that measure to either its GAAP earnings, a reasonable estimate of its GAAP earnings that includes a provisional amount, or its reasonable estimate of a range of GAAP earnings. In filings where GAAP financial statements are required, such as on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.

The SEC also cautions companies against using the Topic No. 9 guidance and current SEC flexibility to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.

General Disclosure Guidance – Topic No. 9

Topic No. 9 suggests that management consider the following non-exclusive list in considering COVID-19 related disclosures:

How has COVID-19 impacted the financial condition and results of operations? How do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition? Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? Consider if the cost of or access to capital and funding sources has changed and whether it is likely to change or continue to change. Have sources and uses of cash been materially impacted? Has the ability to continue to meet ongoing credit agreements changed or is it materially likely it will change? Disclosure should also be made as to the course of action a company has taken or proposes to take in light of the material impact on its financial resources.
How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets? For example, will there be significant changes in judgments in determining the fair-value of assets measured in accordance with U.S GAAP or IFRS?
Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures? If so, what changes in your controls have occurred during the current period that materially affect or are reasonably likely to materially affect your internal control over financial reporting? What challenges do you anticipate in your ability to maintain these systems and controls?
Have you experienced challenges in implementing your business continuity plans or do you foresee requiring material expenditures to do so?
Do you expect COVID-19 to materially affect the demand for your products or services?
Do you anticipate a material adverse impact of COVID-19 on your supply chain or the methods used to distribute your products or services?
Will your operations be materially impacted by any constraints or other impacts on your human capital resources and productivity?
Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve your business goals?

Sample Risk Factor

Although COVID-19 risk factors have taken many forms, it is important to try and be specific as to a particular business impact. An outline of a risk factor that can be amended to address particular business situations is:

Public health epidemics or outbreaks, such as COVID-19, could materially and adversely impact our business.

In December 2019, a novel strain of coronavirus (COVID-19) emerged in Wuhan, Hubei Province, China. While initially the outbreak was largely concentrated in China and caused significant disruptions to its economy, it has now spread to several other countries and infections have been reported globally.

Because COVID-19 infections have been reported throughout the United States, certain federal, state and local governmental authorities have issued stay-at-home orders, proclamations and/or directives aimed at minimizing the spread of COVID-19. Additional, more restrictive proclamations and/or directives may be issued in the future. As a result, all of our [describe business locations] have been closed effective April 1, 2020. [Describe risk of loss of franchise fees, rents, consumer/customer payments].

The ultimate impact of the COVID-19 pandemic on the Company’s operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but is anticipated to have a material adverse impact on our business, financial condition and results of operations.

The measures taken to date will impact the Company’s business for the fiscal fourth quarter and potentially beyond. Management expects that all of its business segments, across all of its geographies, will be impacted to some degree, but the significance of the impact of the COVID-19 outbreak on the Company’s business and the duration for which it may have an impact cannot be determined at this time.

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