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OTC Markets Group Establishes A Stock Promotion Policy

As OTC Markets Group continues to position itself as a respected venture trading platform, it has adopted a new stock promotion policy and best practices guidelines to improve investor transparency and address concerns over fraudulent or improper stock promotion campaigns. The stock promotion policy and best practices guidelines are designed to assist companies with responsible investor relations and to address problematic issues. Recognizing that fraudulent stock promotion is a systemic problem requiring an all-fronts effort by industry participants and regulators, the new policy focuses on transparency and disclosure of current information, and the correction of false statements or materially misleading information issued by third parties.

For several years, OTC Markets Group has been delineating companies with a skull-and-crossbones sign where they have raised concerns such as improper or misleading disclosures, spam campaigns, questionable stock promotion, investigation of fraudulent or other criminal activity, regulatory suspensions or disruptive corporate actions. While labeled with a skull and crossbones, a company that does not have current information or is not on the OTCQB or OTCQX will have its quote blocked on the OTC Markets website.

The new policy addresses: (i) publicly identifying securities being promoted; (ii) identifying fraudulent promotional campaigns; (iii) responsibilities of companies with promoted securities; (iv) the impact on OTCQX or OTCQB designations; (v) caveat emptor policy and stock promotion; and (vi) regulatory referrals. This blog summarizes both the new stock promotion policy and best practices guidelines.

OTC Markets Group Policy on Stock Promotion

The basic premise behind OTC Markets Group policy on stock promotion is the timely disclosure of material information, which includes the duty to dispel unfounded rumors, misinformation or false statements. Technology has increased the ability for companies, insiders and third parties to engage in improper and manipulative activities, including through spam campaigns, and anonymous social networks and message groups.

A company that is the subject of an active campaign or has a history of stock promotion may be denied an application for trading on the OTCQB or OTCQX. A company may be removed from the OTCQB or OTCQX, upon the sole discretion of OTC Markets Group, if it is involved in an active campaign involving misleading information or manipulative promotion. Furthermore, promotional activity of a shell company will result in the immediate removal from OTCQB (shells are not permitted on OTCQX). OTC Markets Group will continue to use the caveat emptor skull-and-crossbones designations as well. Where appropriate, OTC Markets Group will refer a company to the SEC, FINRA or other regulatory agency for investigation.

Paid promotions are often associated with pump-and-dump activities where a third party is attempting to pump the stock price to liquidate at inflated prices, following which the stock will inevitably go down. Improper and misleading promotional materials, which can often be in the form of e-mails, newsletters, social media outlets (such as message boards), press releases, videos, telephone calls, or direct mail, generally share the following common characteristics.

Failure to identify the sponsor of the promotion or if the promotion is paid for an anonymous third party

Information focuses on a company’s stock rather that its business;

Speculative language, including but not limited to grandiose claims and numbers related to the company’s business, industry, financial results or business developments;

Touting of performance or profit potential from trading in a company’s stock with unsupported or exaggerated statements, including related to stock price;

Making unreasonable claims related to a company’s performance;

Directly or indirectly promising specific future performance;

Providing little or no factual information about the company;

Urging immediate action to avoid missing out;

Failing to provide disclosures related to risks of an investment.

Although not included in OTC Markets’ list of common characteristics, another red flag is when there is a comparison between the company being promoted and a well-known successful or respected company.

OTC Markets Group monitors for paid promotional activity and reviews for anonymous promotions, connections to bad actors, and impacts on trading. Beginning in first quarter 2018, stocks associated with such promotional activity will be identified with a “risk flag” next to its symbol on the OTC Markets website.

OTC Markets Group may also request that a company that is subject to promotional activity issue a press release to: (i) identify promotional activity; (ii) confirm information in the promotion or identify misinformation; (iii) and/or disclose recent securities transactions by insiders and affiliates. Furthermore, OTC Markets group may request information from a company and/or its transfer agent related to transactions and request additional disclosures from the company related to share issuances, financing agreements and the identity of people or advisors associated with the transactions.

OTC Markets Group Best Practices Guidelines for Stock Promotion

As in its separate stock promotion policy, the OTC Markets Group best practices on stock promotion guidelines reiterate the core principle that the timely disclosure of material information is key, which includes the duty to dispel unfounded rumors, misinformation or false statements.

OTC Markets Group suggests that companies perform due diligence on investor relations firms and their principals prior to engaging services. This is advice I am constantly giving to my clients. Basic due diligence includes reviewing other represented clients and doing basic searches for regulatory issues or negative news. Companies should also be very clear on what services an investor relations firm will perform and what compensation will be paid for those services.

Very vague service descriptions often indicate an improper promotional campaign. OTC Markets Group also warns of red flags, including a request that payment be split among various individuals or groups.

A company that hires or sponsors investor relations is responsible for the content of communications made by that company and must ensure that all information is materially current and accurate. In addition, a company should retain editorial control and review all information before it is disseminated. Investor relations materials should not use language that makes assumptions, is speculative or misleading, or brazenly hypes the stock. Communications should not cover new material information that has not been previously disclosed, and should not extend beyond providing factual information to investors and shareholders.

The disclosures required by Section 17(b) must always be properly made, and OTC Markets Group specifically requires that any relationship between the investor relations individuals and entities and the company be fully disclosed.

Since third parties often engage in stock promotional activities without the knowledge or consent of a company, it is important for a company to know its investors, including the people behind any entities or investor groups. Investors that desire anonymity or utilize offshore entities raise a red flag. Furthermore, companies should be wary of shareholders that own significant control or investor groups that will qualify to remove restrictive legends on stock. Investor groups often change the name of their investment vehicle entity and, as such, due diligence should include prior entities.

OTC Markets Group warns against toxic or death spiral financing. Toxic or death spiral financing generally involves an investment in the form of a convertible promissory note or preferred stock that converts into common stock at a discount to market with no floor on the conversion price. As I have written about many times, there are quality investors and others that are not quality in the microcap space. The use of convertible instruments as a method to invest in public companies is perfectly legal and acceptable. However, like any other aspect of the securities marketplace, it can be abused. Further examples of abusive or improper activity could include: (i) backdating of notes or failure to provide the funding associated with the note; (ii) improper undisclosed affiliations between investors and the company or its officers and directors; (iii) manipulative trading practices; (iv) improper stock promotion; or (v) trading on insider information. Again, in choosing a transaction it is incumbent upon the company to conduct due diligence on the investor, including their reputation in the industry and trading history associated with other investments and conversions.

OTC Markets Group also warns of anonymous third-party promotions, noting that these promotions are a significant source of misleading and manipulative information. Any company-sponsored stock promotion must be disclosed, whether the company is involved directly or indirectly. The identity of a company’s investor relations firm must be disclosed on the company’s profile page on otcmarkets.com.

OTC Markets Group recommends that a company make a public announcement with the following information in the event it learns it is the subject of misleading or manipulative stock promotion.

A summary of the company’s understanding of the stock promotion, including how and when the company became aware of the campaign and a description of the promotion’s effect on the company’s trading activity;

Whether the content of the promotion is accurate or contains untrue or misleading information;

Conduct an inquiry of company management, officers and directors, to ascertain whether they are involved in the stock promotion and/or of have purchased or sold securities before, during or after the promotion;

Provide an up-to-date list of service providers who perform investor relations or similar services;

Disclose the issuance of convertible securities with variable rate or discount to market conversion rates. This disclosure should include details on the convertible instruments, including date, number of shares issued or issuable, price, conversion terms, and parties involved.

OTC Markets also suggests that all companies have insider trading policies, a policy which I support and suggest to my clients.

Section 17(b) of the Securities Act of 1933

The federal securities laws also govern stock promotion activity. Section 17(b) of the Securities Act of 1933 is an antifraud provision which requires that any communications which “publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service or communication” which describes a security, must disclose any consideration received or to be received either in the past, present or future, whether directly or indirectly by the issuer of such communication. Generally the disclosure must include: (i) the amount of consideration; (ii) from whom it is received, such as the company, a third-party shareholder or an underwriter and the individual persons behind any corporate entity involved; (iii) the nature of the consideration (for example, cash or stock, and if stock, whether restricted or unrestricted); and (iv) if consideration is paid by a third party other than the company whose securities are being promoted, the relationship between the company and the third party. Moreover, I recommend that companies ensure such communications include a disclosure as to whether the issuer of such communications owns stock which may be sold in any upmarket created by the communication.

The disclosure required by Section 17(b) must be included in each and every published document, including emails, message board postings and all other communications.

Further Reading on OTC Markets Group Rules

For a review of the OTCQB listing standards, see HERE . For a review of the OTCQX listing standards, see HERE. For a review of the OTC Pink standards, see HERE.

The Author

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

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

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« SEC Statements On Cybersecurity – Part 2 SEC Publishes Report on Access to Capital and Market Liquidity »

SEC Statements On Cybersecurity – Part 2

Posted by Securities Attorney Laura Anthony | November 28, 2017 Tags: Cyber Unit, Enforcement Initiatives, Retail Strategy Task Force, SEC Enforcement Initiatives, SEC Statements On Cybersecurity, The Cyber Unit, The Retail Strategy Task Force

On September 20, 2017, SEC Chair Jay Clayton issued a statement on cybersecurity that included the astonishing revelation that the SEC Edgar system had been hacked in 2016. Since the original statement, the SEC has confirmed that personal information on at least two individuals was obtained in the incident. Following Jay Clayton’s initial statement, on September 25, 2017, the SEC announced two new cyber-based enforcement initiatives targeting the protection of retail investors, including protection related to distributed ledger technology (DLT) and initial coin or cryptocurrency offerings (ICO’s).

The issue of cybersecurity is at the forefront for the SEC, and Jay Clayton is asking the House Committee on Financial Services to increase the SEC’s budget by $100 million to enhance the SEC’s cybersecurity efforts.

This is the second in a two-part blog series summarizing Jay Clayton’s statement, the SEC EDGAR hacking and the new initiatives. Part I of this blog, which outlined Chair Clayton’s statement on cybersecurity and the EDGAR hacking, can be read HERE . This second part in the series discusses the new cyber-based enforcement initiatives.

Previously I issued a blog outlining SEC guidance on the disclosure of cybersecurity matters, which can be read HERE.

Enforcement Initiatives

The SEC has established two new cybersecurity-related enforcement initiatives to address cyber-based threats and protect retail investors. The first is a creation of a Cyber Unit that will focus on targeting cyber-related misconduct. The second is the formation of a retail strategy task force that will focus on issues that directly affect retail investors.

Cyber Unit

The Cyber Unit will focus on:

Market manipulation schemes involving false information spread through electronic and social media

Hacking to obtain material nonpublic information in order to trade in advance of some announcement or event, or to manipulate the market for a particular security or group of securities

Violations involving distributed ledger technology (blockchain) and initial coin offerings (ICO’s)

Misconduct perpetrated using the dark web

Intrusions into retail brokerage accounts to conduct manipulative trading

Cyber-related threats to trading platforms and other critical market infrastructure

Chair Clayton formed the group with the goal of creating a cybersecurity working group to coordinate information sharing, risk monitoring, and incident response efforts throughout the agency. The Enforcement Division of the SEC has had to fast-track its expertise on matters related to cybersecurity including the advanced technologies that can be utilized. It is thought that this focused enforcement initiative will further the SEC’s abilities to detect, respond to, and pursue misconduct.

On October 26, 2017, Stephanie Avakian, Co-Director of the Division of Enforcement gave a speech where she addressed both initiatives. She addressed the obvious need for the Cyber Unit in today’s world of ever increasing cyber-related misconduct affecting the securities markets.

Expanding on the SEC’s list of areas of attention, Ms. Avakian indicates that the Cyber-Unit will also focus on cases involving failures by registered entities to take appropriate steps to safeguard information or ensure system integrity. The Cyber-Unit will work closely with the Office of Compliance, Inspections and Examinations (OCIE) in this area.

Further, the Cyber-Unit will review cases involving the failure by publicly reporting entities to properly report and disclose cyber related issues. The SEC has not yet brought a case in this space, but is expected to do so. The SEC expects companies’ to report cyber issues in risk factors and management discussion and analysis where appropriate and believes that the failure to do so could rise to a fraud issue under Rule 10b-5.

Retail Strategy Task Force

The Retail Strategy Task Force is planning to develop targeted initiatives to identify and pursue misconduct impacting retail investors. The retail investor arena is a broad playing field including everything from the sales of unsuitable structured products to micro-cap pump-and-dump schemes. The Task Force will rely heavily on technology and analytics to identify problems. The Task Force includes enforcement personnel from around the country.

In her October 26, 2017 speech, Enforcement Co-Director, Stephanie Avakian stated, “this group will look at the many ways that retail investors intersect with the securities markets and look for widespread misconduct.” In a time of tight budgets, the SEC is focused on thinking strategically to identify problems and find the most efficient way to pursue enforcement actions including, as mentioned, with technology. Data analytics can be used to identify data by groups such as by product, by investor type, by location, by sales or trading practice, or by fee. The SEC is even figuring out ways to use technology and data analytics to analyze the more than 16,000 tips it receives each year and integrate that data with other data points to identify issues.

Ms. Avakian gave specific examples of areas that the Retail Strategy Task Force will examine beyond the obvious Ponzi schemes and offering fraud, including:

Investment professionals steering customers to mutual fund share classes with higher fees, when lower-fee share classes of the same fund are available.

Abuses in wrap-fee accounts, including failing to disclose the additional costs of “trading away” or trading through unaffiliated brokers, and purchasing alternative products that generate additional fees.

Investors buying and holding products like inverse exchange-traded funds (ETFs) for long-term investment. These can be highly volatile products that are generally intended as a hedge against exposure to downward moving markets, and that face a long-term high risk of losing their principal. The SEC is increasingly seeing retail investors holding these products long-term, including in retirement accounts.

Problems in the sale of structured products to retail investors, including a failure to fully and clearly disclose fees, mark-ups, and other factors that can negatively impact returns; and

Abusive practices like churning and excessive trading that generate large commissions at the expense of the investor.

In addition to enforcement, the Retail Strategy Task Force will have an investor outreach and education component. In that regard, we can expect to see Investor Bulletins and other SEC investor communications generated from the Task Force’s findings and efforts.

The Author

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

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« SEC Statements On Cybersecurity; An EDGAR Hacking – Part 1 OTC Markets Group Establishes A Stock Promotion Policy »

SEC Statements On Cybersecurity; An EDGAR Hacking – Part 1

Posted by Securities Attorney Laura Anthony | November 21, 2017 Tags: Chair Clayton’s Statement on Cybersecurity and the EDGAR Hacking, EDGAR Hacking, Enforcement of the Federal Securities Laws, Management of Internal Cybersecurity Risks, ncorporation of Cybersecurity Considerations in the SEC’s Disclosure-Based and Supervisory Efforts, SEC Statements On Cybersecurity

This is the first in a two-part blog series summarizing Jay Clayton’s statement, the SEC EDGAR hacking and the new initiatives. My prior blog outlining SEC guidance on the disclosure of cybersecurity matters can be read HERE.

Chair Clayton’s Statement on Cybersecurity and the EDGAR Hacking

Upon taking office in May, 2017, Chair Clayton formed a senior-level cybersecurity working group to coordinate the sharing of information, risk monitoring and incident response efforts. Chair Clayton’s September 20, 2017 statement was part of the SEC’s ongoing initiatives and necessary to inform the public of the SEC’s own hacking incident. In addition to the revelation regarding the EDGAR hacking, Chair Jay Clayton’s statement emphasized the importance of cybersecurity to not only the SEC, but all market participants.

All market participants engage in data collection, storage, analysis, availability and protection to some extent, all of which are open to cybersecurity risks. Cyber attacks can be perpetrated by identity thieves, unscrupulous contractors and vendors, malicious employees, business competitors, prospective insider traders and market manipulators, hackers, terrorists, state-sponsored actors and others. Furthermore, the effects of attacks can be significant, including loss or exposure of consumer data, theft or exposure of intellectual property, investor losses resulting from the theft of funds, market value declines in companies’ subject to cyber attacks, and regulatory, reputational and litigation risks.

Cybersecurity efforts must include, in addition to assessment, prevention and mitigation, resilience and recovery. Chair Clayton’s statement provides detail on the SEC’s approach to cybersecurity, including: (i) the types of data they collect, hold and make publicly available; (ii) how the SEC manages cybersecurity risks and responds to cyber events; (iii) how the SEC incorporates cybersecurity considerations in their risk-based supervision of entities they regulate; (iv) how the SEC coordinates with other regulators to identify and mitigate cybersecurity risks; and (v) how the SEC uses its oversight and enforcement authorities, including to pursue cyber threats.

EDGAR Hacking

Before summarizing the other components of Chair Clayton’s statement, I will jump right to the topic that has gained national attention: EDGAR was hacked! Sometime in 2016, a software vulnerability in the test filing component of the EDGAR system was hacked. The opening was patched once discovered, but the hackers were able to obtain information through test filings that was used to make illicit trading gains. The hackers also obtained personal information, including names, dates of birth and Social Security numbers of at least two individuals. Chair Clayton was not informed of the hacking until August 2017.

The test filing system of EDGAR allows a company to make a non-public test filing of a registration statement or report (or any document that can be filed through the EDGAR system) to be sure the actual filing will be processed correctly. The test filing is usually made hours before the actual filing, but it can be made a day in advance. By having access to material information in filings prior to the marketplace, the hackers could trade on such information and make illegal profits.

When the SEC first announced the hacking on September 20, 2017, it stated that no personal information had been compromised but in a second press release issued on October 2, 2017, the SEC confirmed that forensic data analysis uncovered further depths to the intrusion. In the October 2 press release, Chair Clayton outlined efforts to review and remediate the 2016 hacking, including

A review of the 2016 EDGAR intrusion by the Office of Inspector General;

An investigation by the Division of Enforcement in the potential illicit trading resulting from the 2016 EDGAR intrusion (which seems to indicate that the perpetrator has been uncovered). Chair Clayton was first informed of the hacking in connection with this enforcement investigation;

A focused review and appropriate uplift of the EDGAR system with a concentration on cybersecurity matters, including its security systems, processes and controls. This review will include assessing the types of data that run through the EDGAR system and whether EDGAR is the appropriate mechanism to funnel such data;

A focused review and appropriate uplift of all systems that include the identification of sensitive data or personally identifiable information. This review will include assessing the types of data the SEC keeps and the related security systems, processes and control; and

The SEC’s internal review of the 2016 EDGAR hacking to determine, among other things, the procedures followed in response to the intrusion. This review is being overseen by the Office of the General Counsel and includes an interdisciplinary investigative team including outside technology consultants. Related to this, the SEC will enhance protocols for cybersecurity incidents.

In furtherance of this review and plan, Chair Clayton authorized the immediate hiring of additional staff and outside technology consultants to protect the security of the SEC’s network, systems and data.

Based on the SEC’s statements and testimony on the matter, there still remains a lot of secrecy surrounding the incident. For instance, the date or dates of the hacking have not been made public. The hacking was reported to the Department of Homeland Security, but the SEC commissioners were not notified. Moreover, the SEC has not revealed the type of information that was accessed nor which companies were affected.

Collection and Use of Data by the SEC

The SEC collects, stores and transmits data in three broad categories, including: (i) public facing data through the EDGAR system; (ii) non-public information including personally identifiable information related to supervisory and enforcement functions; and (iii) non-public information including personally identifiable information related to the SEC’s internal operations.

The first category involves data provided to the SEC by companies (such as public reports under the Exchange Act, and notices of private offerings on Form D) and investors (such as Section 13 and Section 16 filings). The second category includes data on companies, broker-dealers, investment advisors, investment companies, self-regulatory organizations (including FINRA), alternative trading systems, clearing agencies, credit rating agencies, municipal advisors and other market participants. The third category of data includes personnel records, internal investigations and data related to risk management and internal control processes.

Management of Internal Cybersecurity Risks

Notably, Chair Clayton begins this part of his statement by disclosing that the SEC is “the subject of frequent attempts by unauthorized actors to disrupt access to our public-facing systems, access our data, or otherwise cause damage to our technology infrastructure, including through the use of phishing, malware and other attack vectors.” As did occur with the EDGAR hacking, attackers stand to profit from information through trading activities, identity theft and a myriad of other improper uses of the illegally obtained information.

In addition to outside attacks, the SEC monitors for unauthorized actions by personnel. In 2014, an internal review uncovered that certain laptops with sensitive information could not be located. There have also been instances where SEC personnel have used non-secure personal email accounts to transmit nonpublic information. The SEC mitigates the internal risk by requiring all personnel to complete privacy and security training.

To protect against all of its cyber-related threats, the SEC employs an agency-wide cybersecurity detection, protection and prevention program. The program includes cybersecurity protocols and controls, network protections, system monitoring and detection processes, vendor risk management processes, and regular cybersecurity and privacy training for employees. However, in light of current and changing technological advancements, the SEC intends to step up its efforts overall. As mentioned earlier, in that regard, the SEC is seeking an increase in its annual budget, and a lift on its current hiring limitations.

Just as the SEC expects public companies to maintain internal controls, including from the top down, on cybersecurity matters, so the SEC has internal policies and procedures requiring senior management to maintain policies, and to coordinate with other offices and divisions with respect to cybersecurity efforts, including risk reporting and testing.

Although all offices have responsibilities, the SEC Office of Information Technology has overall management and responsibility for the agency’s cybersecurity. The SEC’s cybersecurity program is subject to review from internal and external independent auditors, including to ensure compliance with the Federal Information Security Modernization Act of 2014 (“FISMA”).

The SEC also must report cybersecurity matters to outside agencies, including the Office of Management and Budget and the Department of Homeland Security, and has established information-sharing relationships with the National Cybersecurity and Communications Integration Center (“NCCIC”), the Financial and Banking Information Infrastructure Committee (“FBIIC”), and the Financial Services Information Sharing and Analysis Center (“FS-ISAC”).

Incorporation of Cybersecurity Considerations in the SEC’s Disclosure-Based and Supervisory Efforts

The SEC incorporates cybersecurity considerations in its disclosure and supervisory programs, including in the context of the Commission’s review of public company disclosures, its oversight of critical market technology infrastructure, and its oversight of other regulated entities, including broker-dealers, investment advisors and investment companies. Related to public company disclosures, Chair Clayton referred to the SEC guidance summarized HERE.

Related to the SEC’s oversight of market infrastructure, including regulation of exchanges and clearing agencies, the SEC adopted Regulation Systems Compliance and Integrity in 2014. Regulation SCI was proposed and adopted to require key market participants to have comprehensive written policies and procedures to ensure the security and resilience of their technological systems, to ensure systems operate in compliance with federal securities laws, to provide for review and testing of such systems and to provide for notices and reports to the SEC. Key market participants generally include national securities exchanges and associations, significant alternative trading systems (such as OTC Markets, which has confirmed it is in compliance with the Regulation), clearing agencies, and plan processors. For a review of Regulation SCI, see HERE.

Furthermore, certain SEC rules and regulations governing broker-dealers, investment advisors and investment companies directly implicate information security practices. For example, Regulation S-P requires registered broker-dealers, investment companies and investment advisors to adopt written policies and procedures governing safeguards for the protection of customer information and records. Regulation S-ID requires these firms, to the extent they maintain certain types of covered accounts, to establish programs addressing how to identify, detect and respond to potential identity theft red flags.

Coordination with Other Governmental Entities

Effective cybersecurity programs require cooperation among government agencies. The SEC shares oversight responsibility on some matters with other agencies, including the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Furthermore, the SEC often coordinates with other agencies, such as the Federal Trade Commission and the Consumer Financial Protection Bureau. The SEC coordinates cybersecurity efforts with each of these agencies, and more.

Enforcement of the Federal Securities Laws

The SEC is committed to enforcing compliance with the cybersecurity disclosure obligations of reporting companies, and in enforcement proceedings against those that purse cyber threats. Part of these efforts include using advanced technology to monitor suspicious trading activity across companies, traders and geographic regions.

Chair Clayton sets out examples of enforcement actions, such as a case in 2016 against three traders for allegedly participating in a scheme to hack into two prominent New York-based law firms to steal information pertaining to clients that were considering mergers or acquisitions, which the hackers then used to trade. In another case, defendants allegedly hacked into newswire services to obtain non-public information about corporate earnings announcements. These are just two examples among dozens of cases.

The Author

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« Guidance On New Exhibit Rules In SEC Filings SEC Statements On Cybersecurity – Part 2 »

Guidance On New Exhibit Rules In SEC Filings

Posted by Securities Attorney Laura Anthony | November 14, 2017 Tags: ackground on the New Exhibit Rule, Guidance On New Exhibit Rules In SEC Filings, Item 601 Of Regulation S-K, Rule 102(d) of Regulation S-T, Rule 601(a)(2) of Regulation S-K, SEC, SEC Disclosure Effectiveness Initiative, XBRL exhibits

On March 1, 2017, the SEC passed a final rule requiring companies to include hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The rule change was made to make it easier for investors and other market participants to find and access exhibits listed in current reports, but that were originally provided in previous filings. A summary of the rule can be read HERE.

The new Rule went into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018.

In addition to the filing of exhibits and schedules, Item 601 of Regulation S-K requires each company to include an exhibit index list that lists each exhibit included as part of the filing. The list is cumulative. For example, the company’s articles of incorporation are required to be included as an exhibit with every 10-Q and 10-K filing. Once an exhibit has been filed once, the company could historically incorporate by reference by including a footnote as to which filing the original exhibit can be found in. Unfortunately, I find that companies often will indicate that an exhibit has been previously filed, without giving a specific reference as to which filing or when, leaving an investor or reviewer to go fish. The SEC rightfully asserts that requiring companies to include hyperlinks from the exhibit index to the actual exhibits filed would allow much easier access to these filings.

The new rule requires companies to include a hyperlink to each filed exhibit on the exhibit index as required by Item 601 of Regulation S-K, for virtually all filings made with the SEC, including XBRL exhibits. An active hyperlink will now be required in all filings made under the Securities Act or Exchange Act, provided however that if the filing is a registration statement, the active hyperlinks need only be included in the version that becomes effective.

The new rule also amends Rule 102(d) of Regulation S-T and Rule 601(a)(2) of Regulation S-K to require the exhibit index to “appear before the required signatures in the registration statement or report.” Previously, an exhibit index was to “precede immediately the exhibits filed with such registration statement.” This requirement has raised a question as to whether a historical exhibit index would need to appear twice, both combined with the full cumulative list before the required signatures and before the exhibits themselves. In practice, many companies have indeed included two lists.

As learned from a blog written by the excellent CorporateCounsel.Net, a fellow practitioner has contacted the SEC, who in turn informally confirmed that it is permissible to combine the exhibit table with the exhibit index and only present one list of exhibits with hyperlinks. A separate exhibit index is not required.

Further Background on the New Exhibit Rule

On April 15, 2016, the SEC issued a 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements in Regulation S-K (“S-K Concept Release”). The S-K Concept Release contained a discussion and request for comment on exhibit filing requirements. Item 601 of Regulation S-K specifies the exhibits that must be filed with registration statements and SEC reports. Item 601 requires the filing of certain material contracts, corporate documents, and other information as exhibits to registration statements and reports.

A particular area of discussion recently has been the need to file schedules to contracts. These schedules can be lengthy and lack materiality. Likewise, a recent area of discussion has been the necessity of filing an immaterial amendment to a material exhibit. The S-K Concept Release contains a lengthy discussion on exhibits, including drilling down on specific filing requirements. Many of the exhibit filing requirements are principle-based, including, for example, quantitative thresholds for contracts. Consistent with the rest of the S-K Concept Release, the SEC discusses whether these standards should be changed to a straight materiality approach. The SEC also discusses eliminating some exhibit filing requirements altogether, such as where the information is otherwise fleshed out in financial statements or other disclosures (for example, a list of subsidiaries).

Currently companies are allowed to reference exhibits filed in prior filings as opposed to refiling the exhibit with the SEC. The better practice has always been to include a specific reference to the filing, including the date of the filing, and where the original exhibit can be located. However, many companies do not do so, leaving the public to search through prior filings to find the listed exhibit. Moreover, as time goes by and companies switch counsel, some choose not to spend the time and funds to have new counsel update an exhibit list to include a full reference. The new rule will require them to do so. The rule amendment is limited to the presentation of the exhibit list and requires including a hyperlink to the actual filed exhibit.

Further Reading on the SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flex Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only incudes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

As discussed in this blog, on March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format.

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

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

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

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

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

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

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

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SEC Proposes Rules to Modernize and Simplify Disclosures

Posted by Securities Attorney Laura Anthony | October 31, 2017 Tags: Fast Act, Fixing America’s Surface Transportation Act, Regulation S-K, Regulation S-X, SEC Disclosure Effectiveness Initiative, SEC Proposes Rules to Modernize and Simplify Disclosures

On October 11, 2017, as part of the ongoing SEC Disclosure Effectiveness Initiative, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”).

The FAST Act, passed in December 2015, contains two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 requires the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.” In accordance with that requirement, On July 13, 2016, the SEC issued proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded. See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in the report issued on November 23, 2016. Section 72003 specifically required that the report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information. The proposed amendments seek to implement the various findings and recommendations in the November report.

As further discussed in this blog, the proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks.

Proposed Amendments

A. Description of Property (Item 102)

Item 102 requires disclosure of the location and general character of the principal plants, mines, and other materially important physical properties of the company and its subsidiaries.The instructions to Item 102 require the company to disclose information reasonable to inform investors as to the suitability, adequacy, productive capacity and utilization of facilities. The proposed amendment will emphasize materiality and require a company to disclose physical properties only to the extent that such properties are material to the company.

B. Management’s Discussion and Analysis (MD&A) (Item 303)

Item 303(a) requires a company to discuss their financial condition, changes in financial condition, and results of operations using year-to-year comparisons. The discussion is required to cover the period of the financial statements in the report (i.e., 2 years for smaller reporting companies and emerging growth companies and 3 years for others). Where trend information is relevant, the discussion may include 5 years with a disclosure of selected financial data.

The proposed amendment would allow the company to eliminate the earliest year in its discussion as long as (1) the discussion is not material to an understanding of the current financial condition; and (ii) the company has filed a prior Form 10-K with an MD&A discussion of the omitted year. The proposed amendment will also eliminate the reference to a five-year look-back in the instructions, but rather a company will be able to use any presentation or information that it believes will enhance a reader’s understanding. The amendments will flow through to foreign private issuers as well with conforming changes to the instructions for Item 5 of Form 20-F.

C. Directors, Executive Officers, Promoters and Control Persons (Item 401)

Item 401 requires disclosure of identifying and background information about a company’s directors, executive officers, and significant employees. The proposed amendments will clarify the instructions to Item 401 to clarify that the information is not required to be duplicated in various parts of a Form 10-K and/or proxy statement, but need only appear once and may be incorporated by reference in other parts of the documents.

D. Compliance with Section 16(a) (Item 405)

Section 16(a) of the Exchange Act requires officers, directors, and specified types of security holders to report their beneficial ownership of a company’s equity securities using forms prescribed by the SEC, such as an initial Form 3, amendments on Form 4 and annual Form 5. Item 405 requires the company to disclose each person who failed to timely file a Section 16 report during the most recent fiscal year or prior years. Section 16 reporting persons are required to deliver a copy of their reports to the company, though in practice, this is rarely done. The proposed amendments remove this requirement and allow the company to review EDGAR filings for compliance with Section 16(a).

In addition, the proposed amendment would eliminate the need to include the heading at all if there are no delinquencies to report, rather than include the heading with a statement such as “none” and remove the checkbox on the cover page of Form 10-K related to the disclosure. The proposed amendment includes several changes to make the instructions and title of this section conform to the SEC’s “plain English” requirements.

E. Corporate Governance (Item 407)

The proposed amendment will update the instructions and information required under Item 407 to remove reference to an obsolete audit standard and rather just refer broadly to applicable PCAOB and SEC requirements. EGC’s and smaller reporting companies are both exempted from the Item 407 requirements, and the proposed amendment clarifies the instruction language accordingly.

F. Outside Front Cover Page of the Prospectus (Item 501(b))

The proposed amendments are designed to streamline the front cover page of a prospectus and give a company flexibility in designing the page to tailor to their business and particular offering. The proposed changes include (i) eliminating instructions related to changing or clarifying a name that may be confused with a well-known company; (ii) allowing for a statement that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus with a cross-reference to the page number; (iii) requiring the disclosure of the principal trading market and company symbol, even if such trading market is not a national exchange; and (iv) streamlining the “subject to completion” legend.

G. Risk Factors (Item 503(c))

A company is required to disclose the most significant factors that make an offering speculative or risky. Although the disclosure is intended to be principals-based, many examples are included in the instructions. The proposed amendments would move Item 503(c) to Subpart 100 to clarify that risk factors are also required in a Form 10 and Exchange Act periodic reports and not just offering-related disclosures. The proposed amendment would also eliminate the risk factor examples from the instructions.

H. Plan of Distribution (Item 508)

Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about underwriters. The term “sub-underwriter” is referred to in the rule; however, it is not defined. The proposed rules will define a “sub-underwriter” as “a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities but is not itself in privity of contract with the issuer of the securities.”

I. Undertakings (Item 512)

Item 512 provides undertakings that a company must include in Part II of its registration statement, depending on the type of offering. The proposed amendments simplify the undertakings requirements and eliminate provisions that are duplicative because the requirement already exists, or that are obsolete due to changes in the law. For example, Items 512(d), 512(e) and 512(f) are all obsolete and should be eliminated. Item 512(c) related to unsold rights offerings that are then offered to the public, can be eliminated as other provisions of the law would require the company to update the (or complete a new) registration statement regardless.

J. Exhibits (Item 601)

The proposed amendment makes several changes to the exhibit filing requirements to streamline and reduce the volume of documents, many of which may not be material, which are required to be filed. The proposed amendments also make at least one addition to the exhibit requirements and in particular, a company must disclose a subsidiaries LEI number if one has been issued. For information on a LEI, see HERE.

The proposed amendment add exhibits related to Item 202 disclosures (registered capital stock, debt securities, warrants, rights, American Depository Receipts, and other securities) to Exchange Act periodic reports on Form 10-K and 10-Q. Such exhibits are currently only required in registration statements, Form 8-K and Schedule 14A.

The proposed amendment also clarifies that schedules and exhibits to exhibits need not be filed unless they are, in and of themselves, material to an investment decision. Although historically the SEC did not object to the omission of schedules and exhibits to exhibits with personally identifiable information, the rules generally require the filing of a confidential treatment request for most omissions. The proposed amendments allow a company to omit schedules and exhibits to exhibits as long as a brief description of the omitted documents is included. In addition, a copy of the omitted items must be provided if requested by the SEC, though a confidential treatment request could also be made at that time. Likewise the proposed amendments will allow a company to redact information that is both (i) not material, and (ii) competitively harmful if disclosed.

K. Incorporation by Reference

Currently rules related to incorporation by reference are spread among a variety of regulations, including Regulation S-K, Regulation C, Regulation 12B and numerous forms. The proposed amendments would revise Item 10(d), Rule 411, and a number of SEC forms to simplify and modernize these rules while still providing all material information. Rule 12b-23 is proposed to be rescinded. The amendments streamline the rules and further allow for incorporation by reference to eliminate duplicative disclosure. The proposed rules will require a hyperlink to information that is incorporated by reference if the information is available on EDGAR.

The proposed rules specifically do not add or change the rules related to cross-references or other incorporation within the financial statements to other disclosure items. There is a concern as to the impact on auditor review requirements if such links or changes are added.

L. Forms

The proposed amendments include several amendments to forms to conform with and implement all the changes in the rules.

M. XBRL

The proposed amendments would require all of the information on the cover pages of Form 10-K, Form 10-Q, Form 8-K, Form 20-F, and Form 40-F to be tagged in Inline XBRL in accordance with the EDGAR Filer Manual.

Further Reading on the FAST Act

I’ve blogged several times on the FAST Act since its initial passing on December 15, 2015. An initial discussion and summary of the FAST Act can be read HERE. A summary of the SEC guidance on the FAST Act as relates to savings and loan companies can be read HERE.

On January 13, 2016, the SEC issued interim final rules memorializing two provisions of the FAST Act. In particular, the SEC revised the instructions to Forms S-1 and F-1 to allow the omission of historical financial information and to allow smaller reporting companies to use forward incorporation by reference to update an effective S-1. A summary can be read HERE. On May 3, 2016, the SEC issued final amendments to revise the rules related to the thresholds for registrations, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934. The amendments mark the final rule making and implementation of all provisions under the JOBS Act, and implement further provisions under the FAST Act. A summary can be read HERE.

On August 17, 2017, the SEC issued guidance on financial statement requirements for confidential and public registration statement filings by both emerging growth companies (EGC) and non-emerging growth companies. The new Compliance and Disclosure Interpretations (C&DI’s) follow the SEC’s decision to permit all companies to submit draft registration statements, on a confidential basis. For a summary see HERE and HERE.

As required by Section 72003 of the Fixing America’s Surface Transportation Act (the “FAST Act”), on November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K including detailed recommendations for changes. For a summary see HERE.

Further Background on SEC Disclosure Effectiveness Initiative

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

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

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

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

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

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SEC Chief Accountant Speaks On Initial Coin Offerings ( ICO’s)

Posted by Securities Attorney Laura Anthony | October 17, 2017 Tags: blockchain, cryptocurrencies, digital coins, Distributed Ledger Technology, DLT, ICO by the DAO, ICOs, SEC Chief Accountant Speaks On Initial Coin Offerings, secondary token trading

On September 11, 2017, the SEC Chief Accountant, Wesley R. Bricker, gave a speech before the AICPA National Conference on Banks & Savings Institutions. The bulk of the speech was similar to Mr. Bricker’s June 2017 speech before the 36th Annual SEC and Financial Reporting Institute Conference, summarized HERE. However, one topic that was new, and interesting enough to spark this blog, was related to initial coin offerings (ICO’s). Note that offers and sales of digital coins, cryptocurrencies or tokens using distributed ledger technology (DLT) or blockchain have become widely known as ICO’s.

As the capital markets become more and more focused on all things blockchain, including ICO’s, secondary token trading, and disruptive changes made possible by distributed ledger technology (DLT), which is inevitably transforming capital market processes, the SEC is fronting a wave of questions and concerns on the subject. On July 25, 2017, the SEC issued a report on an investigation related to an ICO by the DAO and statements by the Divisions of Corporation Finance and Enforcement related to the investigative report. On the same day, the SEC issued an Investor Bulletin related to ICO’s. (See summary of the report, statement and investor bulletin HERE).

Almost all divisions and committees of the SEC are and will be impacted by DLT and ICO’s and are working diligently to address the technology and the public markets’ wave of interest. In August 2017 the SEC suspended the trading in a slew of bitcoin-based companies questioning the accuracy of publicly reported information and press releases. On September 20, 2017, the SEC’s Investor Advisory Committee announced the agenda for its next meeting to be held on October 12, the first item on which is blockchain and other distributed ledger technology and its implications for securities markets.

FINRA is likewise as attentive to DLT and its far-reaching implications. On July 13, 2017, FINRA held a Blockchain Symposium including participation by the Office of the Comptroller of Currency, the US Commodity Futures Trading Commission (CFTC), the Federal Reserve Board and the SEC. Earlier in the year, FINRA published a report on the technology and its potential impacts on broker-dealers and the markets in general. See HERE for a summary.

Although outside of my practice area, the Internal Revenue Service is stepping up efforts to make sure taxes are reported and paid for trading profits and other taxable income related to cryptocurrencies. In that regard, the IRS has contracted with a company that provides software that analyzes and tracks bitcoin transactions.

Mr. Bricker’s Remarks on ICO’s

Mr. Bricker begins by talking about the SEC report on the DAO investigation, stating that “[T]he report makes clear that the federal securities laws apply to those who offer and sell securities in the U.S., regardless of whether the issuing entity is a traditional company or a decentralized autonomous organization, whether those securities are purchased using U.S. dollars or virtual currencies, or whether they are distributed in certificated form or through distributed ledger technology.”

All offers and sales of securities in the U.S. must either be registered with the SEC or must qualify for an exemption. The SEC’s registration requirements include the filing of audited financial statements. In addition, I note that many exemptions likewise require the disclosure of either audited or unaudited financial statements. Furthermore, the basic antifraud principles encompassed in Rule 10b-5 of the Securities Exchange Act of 1934 and Section 17(a) of the Securities Act of 1933, require full and fair disclosure, which includes financial information about the issuer.

Mr. Bricker confirms the basics that U.S. accounting principles apply to ICO’s as they do with any other offerings. Issuing companies should review guidance related to the presentation and disclosure of financial statements, consolidation, translation, assets, liabilities, revenue, expenses and ownership.

Mr. Bricker lists questions that both issuers and holders should consider:

Issuers:

What are the necessary financial statement filing requirements?

Are there liabilities requiring recognition or disclosure?

Are there previously recognized assets that require de-recognition?

Are there revenues or expenses requiring recognition or deferral?

Is there a transaction with owners, resulting in debt or equity classification and possibly compensation expense?

Are there implications for the provision for income taxes?

Holders:

Does specialized accounting guidance (such as for investment companies) apply to the holder’s financial statement presentation?

What are the characteristics of the coin or token in considering whether, how, and at what value the transaction should affect the holder’s financial statements?

What is the nature of the holder’s involvement in considering whether the issuer’s activities should be consolidated or accounted for under the equity method?

A new wave of ICO’s

Since the SEC issued its report on the DAO, my office has been actively involved with clients and potential clients interested in structuring ICO’s which comply with the federal (and state) securities laws. Although I have yet to see a registered ICO, several are now utilizing 506(b) or 506(c) to complete their offerings. For instance, the recent $285 million Filecoin ICO was completed in reliance on Rule 506(c) and included such institutional investors as Sequoia Capital, Andreessen Horowitz and Union Square Ventures. Other similar offerings have been and continue to be launched on platforms such as CoinList (which is partnered with AngelList) and now more traditional securities offering platforms such as Start Engine. I am certain the number of securities ICO’s relying on traditional securities offering registration or exemption rules and regulations will continue to increase dramatically.

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SEC Provides Regulatory Relief To Hurricane Victims

Posted by Securities Attorney Laura Anthony | October 3, 2017 Tags: Form ADV Filing Deadline, Form ADV Filing Requirements, SEC Provides Regulatory Relief To Hurricane Victims

On September 28, 2017, the SEC announced interim final temporary rules (“Exemptive Order”) to provide relief to publicly trading companies, investment companies, accountants, transfer agents, municipal advisors and others affected the Hurricanes Harvey, Irma and Maria. In addition to the interim rules, the SEC urges others not covered by the relief but affected in their ability to provide information to the SEC or shareholders to contact the SEC to seek relief on a case-by-case basis.

Interim Final Temporary Rules

Generally the due date for Exchange Act reports for companies relying on the Exemptive Order shall be October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma, and November 2, 2017 for those affected by Hurricane Irma. As such, companies with such extended due dates may also file an additional extension on Form 12b-25 on those dates, and benefit from an additional five days for a Form 10-Q and 15 days for a Form 10-K. As long as the subject report is filed within the time specified in the 12b-25, such company will still be considered timely and current in its reporting requirements.

The filing extensions apply to all Exchange Act reports, including under Sections 13(a) such as Forms 10-Q, 10-K and 8-K; 13(d), (f) and (g) for reports of ownership in excess of 5%; Section 14 proxy, information, and tender offer filing; Section 15(d) filings, including Forms 10-Q, 10-K and 8-K; and 16(a), Regulations 13A, 13D-G, 14A, 14C and 15D, and Exchange Act Rules 13f-1, 14f-1 and 16a-3.

Where the company is seeking relief from a requirement to deliver a report or information to shareholders, such as proxy or tender offer information under Section 14 of the Exchange Act, in addition to the time periods, the company must show that the shareholders had a mailing address located in the zip codes affected by Hurricanes Harvey, Irma or Maria and that mail service was suspended.

For purposes of the eligibility to use Form S-3, a company relying on the Exemptive Order will be considered current and timely in its Exchange Act filing requirement during the relief period, if such company was current and timely prior to the first day of the period specified in the Order. As a reminder, among other requirements, to qualify to use an S-3 registration statement a company must have filed all Exchange Act reports in a timely manner, including Form 8-K, within the prior 12 months. Any delayed reports need to be filed by October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma and November 2, 2017 for those affected by Hurricane Irma.

For purposes of Form S-8 eligibility and the current information requirements under Rule 144(c), a company relying on the Exemptive Order will be considered current in its Exchange Act filing requirements if such company was current and timely prior to the first day of the period specified in the Order. Again, any delayed reports need to be filed by October 10, 2017 for those affected by Hurricane Harvey, October 19, 2017 for those affected by Hurricane Irma and November 2, 2017 for those affected by Hurricane Irma.

Registered transfer agents either in areas affected by the Hurricanes, or unable to provide services to security holders in the affected areas, were also granted relief. Registered transfer agents unable to provide services under Sections 17A and 17(f) of the Exchange Act are granted temporary exemptive relief from compliance from August 25, 2017 through November 2, 2017 if: (i) they notify the SEC in writing by November 2, 2017 that they are relying on the Exemptive Order; (ii) the notification provides a statement of the reasons why, in good faith, the transfer agent was unable to comply with the rules; (iii) if the transfer agent knows or believes that the books and records it is required to maintain were lost, destroyed or materially damaged, the extent of such loss, the affected issuers, and steps taken to rectify the damage; (iv) if the transfer agent knows or believes that funds or securities belonging to either an issuer or security holder that were within its possession were lost, destroyed or materially damaged, the extent of such loss and steps taken to rectify the damage; and (v) the transfer agent must take steps to protect remaining books, records, funds and securities.

The Exemptive Order also allows independent auditors to provide books and records to issuer clients to assist in the reconstruction of accounting records, without infringing on such auditors’ independence. In particular, Exchange Act rules and Regulation S-X prohibit an independent auditor from “maintaining or preparing the audit client’s accounting records” or “preparing or originating source data underlying the audit client’s financial statements.” Relief under the Exemptive Order is conditioned upon limiting services by the independent auditor to reconstruction of previously existing accounting records that were lost or destroyed as a result of the hurricanes and that such services cease as soon as the audit client’s lost or destroyed records are reconstructed, its financial systems are fully operational and the client can effect an orderly and efficient transition to management or other service provider. In addition, the company’s audit committee must specifically approve the auditor’s services.

During the period from August 25, 2017 to November 1, 2017, a registered open-end investment company and a registered unit investment trust will be considered to have satisfied the requirements of Section 5(b)(2) of the Securities Act to deliver a summary or a statutory prospectus to an investor, provided that: (1) the sale of shares to the investor was not an initial purchase by the investor of shares of the company or unit investment trust; (2) the investor’s mailing address for delivery, as listed in the records of the company or unit investment trust, has a ZIP code for which the common carrier has suspended mail service, as a result of Hurricanes Harvey, Irma, Maria, of the type or class customarily used by the company or unit investment trust, to deliver summary or statutory prospectuses; and (3) the company, or unit investment trust, or other person promptly delivers the summary or statutory prospectus, either (a) if requested by the investor, or (b) by the earlier (i) of November 2, 2017 or (ii) the resumption of the applicable mail service. The same dates and parameters apply to registered investment advisers for the delivery of written disclosure statements to advisory clients.

A registered investment advisor affected by Hurricane Harvey will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between August 25, 2017 and October 6, 2017; and (ii) they filed by October, 10, 2017.

A registered investment advisor affected by Hurricane Irma will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between September 6, 2017 and October 18, 2017; and (ii) they filed by October, 19, 2017.

A registered investment advisor affected by Hurricane Maria will be considered to have satisfied their Form ADV filing requirements under the Advisors Act, if: (i) their Form ADV filing deadline was between September 20, 2017 and November 1, 2017; and (ii) they filed by November 2, 2017.

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The SEC Provides Further Guidance On Financial Statement Requirements In Registration Statements

Posted by Securities Attorney Laura Anthony | September 26, 2017 Tags: Background on Section 71003 of the FAST Act, Financial Statement Requirements for Companies Other than an Emerging Growth Company, Financial Statement Requirements for Emerging Growth Companies, Financial Statement Requirements In Registration Statements, Guidance On Financial Statement Requirements In Registration Statements, Section 71003 of the FAST Act

Earlier in the summer, the SEC expanded the JOBS Act benefit available to emerging growth companies, to be able to file confidential draft registration statements, to all companies. Confidential draft submissions are now available for all Section 12(b) Exchange Act registration statements, initial public offerings (IPO’s) and for secondary or follow-on offerings made in the first year after a company becomes publicly reporting.

Title I of the JOBS Act initially allowed for confidential draft submissions of registration statements by emerging growth companies but did not include any other companies, such as smaller reporting companies. Regulation A+ as enacted on June 19, 2015, also allows for confidential submissions of an offering circular by companies completing their first Regulation A+ offering.

The new C&DI’s expand certain FAST Act benefits also only statutorily available to emerging growth companies, to all companies. Like the earlier expansion of the JOBS Act benefit, the new extension of rights was made by staff policy and not a formal rule change.

Background on Section 71003 of the FAST Act

Section 71003 of the FAST Act allows an EGC that is filing a registration statement under either Form S-1 or F-1 to omit financial information for historical periods that would otherwise be required to be included, if it reasonably believes the omitted information will not be included in the final effective registration statement used in the offering, and if such final effective registration statement includes all up-to-date financial information that is required as of the offering date. As directed by the FAST Act, the SEC revised the instructions to Forms S-1 and F-1 to reflect the new law.

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

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

As a reminder, an EGC is defined as an issuer with less than $1,070,000,000 in total annual gross revenues during its most recently completed fiscal year. If an issuer qualifies as an EGC on the first day of its fiscal year, it maintains that status until the earliest of the last day of the fiscal year of the issuer during which it has total annual gross revenues of $1,070,000,000 or more; the last day of its fiscal year following the fifth anniversary of the first sale of its common equity securities pursuant to an effective registration statement; the date on which the issuer has, during the previous 3-year period, issued more than $1,070,000,000 in non-convertible debt; or the date on which the issuer is deemed to be a “large accelerated filer.”

NEW CD&I

Financial Statement Requirements for Emerging Growth Companies

Using staff policy, the SEC will not require an EGC to include interim financial information in its draft registration statements, that it reasonably believes it will not be required to present separately at the time of the contemplated offering. For example, if an EGC with a calendar fiscal year-end submits a draft registration statement in November 2017, but does not expect to launch the offering until April 2018, after the full 2017 audit would be required, such EGC could omit the 2015 annual financial statements and stub period information for both 2016 and 2017. That is, since only full-year audits for 2016 and 2017, and no stub period statements for nine months ended 2016 and 2017, would be included in the final effective registration statement, neither the stub periods nor the 2015 statements would need to be included in the draft registration.

Financial Statement Requirements for Companies Other than an Emerging Growth Company

The SEC has extended the benefit of Section 71003 of the FAST Act to companies that do not qualify as an EGC to allow for the omission of historical financial statements in its confidential draft registration statements, that it reasonably believes will not be required to be included at the time it files its registration statement publicly.

A company must publicly file its registration statement and all nonpublic draft submissions at least 15 days prior to any road show, and in the absence of a road show, at least 15 days prior to the requested effective date of the registration statement.

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SEC Monitors Impact of Hurricanes On Capital Markets

Posted by Securities Attorney Laura Anthony | September 19, 2017 Tags: Capital Markets, Hurricanes, Impact of Hurricanes On Capital Markets, SEC

As I wrote this blog I continued to have no power at my home after one week, though thankfully it has returned by publication date. Living in South Florida, our firm has felt and seen the devastating impact of Hurricane Irma on the state and send our thoughts and wishes to all affected by both Irma and Hurricane Harvey in Texas.

On September 13, 2017, the SEC issued a press release confirming that it is closely monitoring the effects of both Irma and Harvey on the capital markets. In particular, the SEC is working to make sure that investors have access to their securities accounts and evaluating the need for extending filing deadlines for reporting companies. Furthermore, the SEC is watching for and will keep investors updated via alerts on storm-related scams.

Despite the announcement that the SEC is monitoring the markets and considering extending filing deadlines, no specific broad-based relief has been granted. As has been done historically, I believe the SEC will grant filing deadline extensions to those companies that request such relief and demonstrate they are in an affected area and that the specific report cannot be completed in a timely manner without undue hardship.

Companies seeking an extension for a filing should contact the SEC Division of Corporation Finance at 202-551-3500 or via online submission at www.sec.gov/forms/corp_fin_interpretive.

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SEC Announces Regulatory Agenda

Posted by Securities Attorney Laura Anthony | September 12, 2017 Tags: SEC, SEC Announces Regulatory Agenda, SEC Disclosure Effectiveness Initiative, SEC Disclosure Effectiveness Initiatives, SEC Flex Regulatory Agenda

In July 2017 the SEC posted its latest version of its semi-annual regulatory agenda and plans for rulemaking with the U.S. Office of Information and Regulatory Affairs. The agenda is as interesting for what’s on it, as for what isn’t. The semi-annual list only contains 33 legislative action items that the SEC intends to propose or finalize in the next 12 months. The fall 2016 list contained 62 items. As further discussed in this blog, the list does not include proposals on executive compensation, or many other Dodd-Frank mandated rules.

In the preamble to the list it indicates that it was completed in March, when Michael Piwowar was acting Chair of the SEC. Chair Jay Clayton and now Commissioner Michael Piwowar have been publicly like-minded, with a goal of directing the SEC towards assisting in small and emerging business growth and capital raise activities, while remaining tough on fraud. A summary of Chair Clayton’s first public speech as head of the SEC can be read HERE and a summary of Commissioner Piwowar’s words on the U.S. IPO market can be read HERE.

The Unified Agenda of Regulatory and Deregulatory Actions

The Office of Information and Regulatory Affairs, which is an executive office of the President, publishes a Unified Agenda of Regulatory and Deregulatory Actions (“Agenda”) with actions that 60 departments, administrative agencies and commissions plan to issue in the near and long term. The Agenda is published twice a year, though the fall edition contains statements of regulatory priorities and additional information about the most significant regulatory activities planned for the coming year.

The Office of Information and Regulatory Affairs states that the current Agenda “represents the beginning of fundamental regulatory reform and a reorientation toward reducing unnecessary regulatory burden on the American people.” Furthermore, the Office states, “[B]y amending and eliminating regulations that are ineffective, duplicative, and obsolete, the Administration can promote economic growth and innovation and protect individual liberty.”

Executive Orders 13771 and 13777 require agencies to reduce unnecessary regulatory burden and to enforce regulatory reform initiatives. Each agency was requested to carefully consider the costs and benefits of each regulatory or deregulatory action and to prioritize to maximize the net benefits of any regulatory action. The SEC is not the only agency with a reduced Agenda. In total, agencies withdrew 469 actions that were initially proposed in the fall 2016 Agenda. Agencies moved 391 actions to either long-term or inactive. There are only 58 proposed economically significant regulations, about half from last year. Also, adding transparency for those of us who like to stay up on these matters, for the first time, the agencies will post and make public their list of “inactive” rules.

SEC Flex Regulatory Agenda

As mentioned, in the preamble to the list it indicates that it was completed in March, when Michael Piwowar was acting Chair of the SEC, and reflects his priorities. The preamble to the newest agenda is short. The fall 2017 agenda will reflect the priorities of Chair Jay Clayton and contains more information, including “The Regulatory Plan” of the SEC with a statement of regulatory priorities for the coming year.

The newest agenda is in line with the SEC’s new leader’s promise of support to small and emerging companies. It is also in line with the current administration’s lack of support for Dodd-Frank. The list does not include proposed regulatory actions related to pay for performance (see HERE), executive compensation clawback (see HERE), hedging (see HERE), universal proxies (see HERE), and clawbacks of incentive compensation at financial institutions, although many of these items remain on the “long-term actions” schedule.

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

Interesting items in the final rule stage include disclosure update and simplification (again see summary at end of this blog), simplification of disclosure requirements for emerging-growth companies and forward incorporation by reference on Form S-1 for smaller reporting companies (see HERE), Form 10-K summary, amendments to smaller reporting company definition (see HERE), and regulation of NMS Stock Alternative Trading Systems.

Items of interest in the proposed rule stage include amendments to the interactive data (XBRL) program, amendments to financial disclosures about entities other than the registrant (see HERE), business and financial disclosure required by Regulation S-K (see end of this blog for the most recent summary on Regulation S-K changes), reporting on proxy votes on executive compensation (i.e., say-on-pay – see HERE), transfer agents (see HERE), implementation of FAST Act report recommendations (see HERE), and concept release on possible audit committee disclosures.

Also interesting is the many items that appeared on the proposed rule list in fall 2016 that have now been moved to “long-term actions.” Items moved from proposed to long-term include registration of security-based swaps, universal proxy, corporate board diversity, investment company advertising, personalized investment advice standard of conduct, stress testing for large asset managers, prohibitions of conflicts of interest relating to certain securitizations, commission guidance on definitions of mortgage-related security and small-business-related security, standards for covered clearing agencies, and risk mitigation techniques.

Other items on the long-term action list include pay versus performance, amendments to Regulation D, Form D and Rule 156, hedging disclosures, several securities-based swaps regulatory actions, exchange traded products, and disclosures of payments by resource extraction issuers.

Further Reading on the SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC’s ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flexibility Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only incudes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

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

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

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