The Under $300 Million Market Cap Class
Depending on whom you ask, a public company with less than $300 million market cap could be considered a micro-cap company, a penny stock (unless their share price is over $5.00), a lower middle market company or even middle market. Divestopedia defines “lower middle market” as “the lower end of the middle market segment of the economy, as measured in terms of annual revenue of the firms. Firms with an annual revenue in the range of $5 million to $50 million are grouped under the lower middle market category.” Wikipedia defines “middle market” as “companies larger than small businesses but smaller than big businesses that account for the middle third of the U.S. economy’s revenue. Each of these companies earns an annual revenue of between $100 million and $3 billion.” In a speech to the Greater Cleveland Middle Market Forum, SEC Commissioner Robert J. Jackson, Jr. defined a middle market company as those with trailing twelve-month sales of $50 million to $1 billion.
As I’ve written about previously, Bank of America, and their brokerage, Merrill Lynch, will not transact business in the securities of companies with less than a $300 million market cap and less than a $5.00-per-share stock price. Moreover, even if the stock price is over $5.00, such transactions or requested trades will face increased scrutiny and may not be processed right away. See HERE .Bank of America clearly thinks that under $300 million is a micro-cap company.
I realize that I am interchanging between market cap and revenue, but that is also common. For example, SEC rules define a smaller reporting company (SRC) as those with less than a $250 million public float or if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. A Google search for definitions of micro-cap, small-cap, lower middle market and middle market resulted in as many variations to the definition, based on both revenues and market cap, as Google pages I took the time to peruse.
Last summer the Investor Responsibility Research Center (IRRC) Institute published a report titled “Microcap Board Governance” providing some interesting information on public companies with less than $300 million in market capitalization. Leaving aside the semantics of the class size of these companies, this blog will summarize some of the information in the IRRC Report and add my usual commentary.
The IRRC Report
Since most companies with less than a $300 million market cap are not included in any major indices nor receive widespread analyst coverage, there is less aggregated information on their board composition and governance practices. The IRRC Report examined 160 companies representing approximately 10% of this company class which are traded on U.S. stock exchanges. Seventy-three percent (73%) trade on the Nasdaq, and the balance are on the NYSE or NYSE American.
Of the 160 companies, three-quarters have been public for more than 5 years, illustrating that not all small public companies are early-stage growth companies. Only 14% of the companies were still led by their founder. Although the IRRC report didn’t address the reasons or meaning behind these numbers, I think it makes sense in the overall corporate ecosystem. Very few companies will successfully grow to large-cap entities, nor should they. High-growth models come with great risk and can often lead to a total business failure. For instance, a company that goes public with a $50 million market cap and then grows 10%-20% year over year would still be in the under $300 million market cap class after 5 years, but also will likely have strong infrastructure and internal controls and provide steady growth to its investors.
Furthermore, the majority of the companies are in industry sectors that lend themselves to either slow growth or have seen dramatic industry change over the last decade. Thirty percent (30%) of the companies were in the healthcare sector, which notoriously has a very long research and development, pre-revenue lifecycle. Finance companies comprised another 18%, which sector has transformed post-Dodd-Frank, which was enacted in 2010 (see HERE). Rounding out the industries were consumer goods and services (15%), energy and utilities (11%), basic industries and transportation (10%), capital goods (9%) and technology (7%).
More than half the companies went public in the first 10 years of their founding. Although private equity has become more readily available for some companies (technology companies in particular), postponing a public offering, in my experience smaller companies have more opportunity to access capital through public markets then private sources. In fact, I believe the benefits of public capital markets are even more pronounced for small companies because they tend to be more innovative than large companies and they account for a substantial percentage of the jobs created every year. Public markets give an opportunity for some recouping of early-stage investments, incentivize employees through stock options and grants, add economic exposure and, of course, enhance access to capital for continued growth.
The under $300 million class tends to have smaller boards (five or less) than larger companies (nine or more). Men dominate the boards in this class even more so than in larger companies. The majority (61%) of the under $300 million market cap companies studied have no female directors serving on their boards, compared to less than one-quarter (21%) of the Russell 3000 boards. Furthermore, only 12% of these companies have more than one female director, while nearly half (45%) of the Russell 3000 companies have more than one female director. Not surprisingly, the under $300 million class pays their CEO’s less than larger companies (with as much shareholder scrutiny), though the average CEO age (in their 50’s) is the same for other classes of public companies. Directors are also paid much less than their larger cap counterparties, with the average being $90,000 for the under $300 million class and $180,000 for serving on a Russell 3000 company.
With smaller boards come fewer independent directors, more variability in the number and timing of meetings, and a less complex committee structure with many electing not to appoint a chairman of the board. In a period of shareholder activism and socially motivated investing, the board composition of the under $300 million class could be a hindrance to some institutional investments. In reading this study, I see an opportunity for these companies to stand out from the average by putting more attention into their board composition as well as governance and process.
To further illustrate the importance of these factors, on February 6, 2019, the SEC issued two new identical C&DI related to disclosure of board diversity, and in particular:
Question: In connection with preparing Item 401 disclosure relating to director qualifications, certain board members or nominees have provided for inclusion in the company’s disclosure certain self-identified specific diversity characteristics, such as their race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background. What disclosure of self-identified diversity characteristics is required under Item 401 or, with respect to nominees, under Item 407?
Answer: Item 401(e) requires a brief discussion of the specific experience, qualifications, attributes, or skills that led to the conclusion that a person should serve as a director. Item 407(c)(2)(vi) requires a description of how a board implements any policies it follows with regard to the consideration of diversity in identifying director nominees. To the extent a board or nominating committee in determining the specific experience, qualifications, attributes, or skills of an individual for board membership has considered the self-identified diversity characteristics referred to above (e.g., race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background) of an individual who has consented to the company’s disclosure of those characteristics, we would expect that the company’s discussion required by Item 401 would include, but not necessarily be limited to, identifying those characteristics and how they were considered. Similarly, in these circumstances, we would expect any description of diversity policies followed by the company under Item 407 would include a discussion of how the company considers the self-identified diversity attributes of nominees as well as any other qualifications its diversity policy takes into account, such as diverse work experiences, military service, or socio-economic or demographic characteristics.
As with all public companies, the majority of the under $300 million class is incorporated in Delaware (59%) followed by Nevada (16%) and Maryland (7%). I note that as you move up the chain, Delaware comprises a larger and larger percentage of all public companies.
Not surprisingly, a greater majority of these companies tend to be owned by management and insiders than the larger companies. Management tends to face greater and greater dilution as a company grows and continues to access capital markets for financing or issues equity for mergers and acquisitions and employee stock grants. Also, the control ownership of this group tends to be in straight common stock, with only 7% of the companies examined having a dual stock class structure.
« SEC Rules For Disclosure Of Hedging Policies The 20% Rule- Acquisitions »
SEC Rules For Disclosure Of Hedging Policies
In December 2018, the SEC approved final rules to require companies to disclose practices or policies regarding the ability of employees or directors to engage in certain hedging transactions, in proxy and information statements for the election of directors. The new rules implement Section 14(j) of the Securities Exchange Act of 1934 (“Exchange Act”) as mandated by the Dodd-Frank Act and will require the robust disclosure on hedging policies and practices including a description of any hedging transactions that are specifically permitted or disallowed. The proposed rules had initially been published on February 9, 2015 – see HERE.
Smaller reporting companies and emerging growth companies must comply with the new disclosure requirements in their proxy and information statements during fiscal years beginning on or after July 1, 2020. All other companies must comply in fiscal years beginning July 1, 2019. As foreign private issuers (FPI) are not subject to the proxy statement requirements under Section 14 of the Exchange Act, FPIs are not required to make the new disclosures.
New Item 407(i) of Regulation S-K will require a company to describe any practices or policies it has adopted regarding the ability of its employees, officers or directors to purchase securities or other financial instruments, or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of equity securities granted as compensation, or held directly or indirectly by the employee or director. The disclosure requirement may be satisfied by providing a full summary of the practices or policies or by including the full policy itself in the disclosure.
The disclosure requirement extends to equity securities of parent and subsidiaries of the reporting company. The rules regulate disclosure of company policy as opposed to directing the substance of that policy or the underlying hedging activities. The rule specifically does not require a company to prohibit a hedging transaction or otherwise adopt specific policies; however, if a company does not have a policy regarding hedging, it must state that fact and the conclusion that hedging is therefore permitted.
The Senate Committee on Banking, Housing, and Urban Affairs stated in its report that Section 14(j) is intended to “allow shareholders to know if executives are allowed to purchase financial instruments to effectively avoid compensation restrictions that they hold stock long-term, so that they will receive their compensation even in the case that their firm does not perform.”
Background
Currently disclosure requirements related to hedging policies are set forth in Item 402(b) of Regulation S-K and are included as part of a company’s Compensation Discussion and Analysis (“CD&A”). CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. Item 402(b) only requires disclosure of hedging policies “if material” and only for named executive officers. Moreover, CD&A is not required at all for smaller reporting companies, emerging growth companies, closed-end investment companies or foreign private issuers.
Hedging transactions themselves may be disclosed in other SEC reports. For example, Form 4 filings by officers, directors and greater than 10% shareholders would include disclosures of hedging transactions involving derivative securities. Hedging transactions involving pledged securities would be included in disclosures related to the beneficial ownership of officers, directors and greater than 5% shareholders in SEC reports such as a company’s annual report, registration statements or proxy materials. However, there is currently no rule that specifically requires the disclosure of hedging policies and that encompasses all reporting issuers.
New Item 407(i) of Regulation S-K
The SEC determined that disclosure of hedging policies constitutes a corporate governance disclosure and, as such, should be contained in Item 407, keeping all corporate governance disclosure requirements in one rule. As indicated above, the final new Item 407(i) of Regulation S-K will:
• require the company to describe any practices or policies it has adopted, whether written or not, regarding the ability of employees, officers, directors or their designees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds), or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities granted to the employee, officer, director or designee or held directly or indirectly by the employee, officer, director or designee;
• a company will be required either to provide a fair and accurate summary of any practices or policies that apply, including the categories of persons covered and any categories of hedging transactions that are specifically permitted and any categories that are specifically disallowed, or to disclose the practices or policies in full;
• if the company does not have any such practices or policies, require the company to disclose that fact or state that hedging transactions are generally permitted. Likewise, if a company only has a practice or policy that covers a subset of employees, officers or directors, they would need to affirmatively disclose that uncovered persons are permitted to engage in hedging transactions;
• specify that the equity securities for which disclosure is required include equity securities of the company or any parent, subsidiary, or subsidiaries of the company’s parent. Moreover, the disclosure is not limited to registered equity securities, but rather any class of securities;
• require the disclosure in any proxy statement on Schedule 14A or information statement on Schedule 14C with respect to the election of directors. Disclosure is not required in a Form 10-K even if incorporated by reference from the proxy or information statement; and
• clarify that the term “employee” includes officers of the company.
The essence of Item 407(i) is to disclose any allowable transactions that could result in downside price protection, regardless of how that hedging is achieved (for example, purchasing or selling a security, derivative security or otherwise). Accordingly, the rule specifically does not define the term “hedge” but rather is meant to cover any transaction with the economic effect of offsetting any decrease in market value.
Similarly, the Rule does not define the term “held directly or indirectly” but rather will leave it to a company to describe the scope of their hedging practices or policies, which may include whether and how they apply to securities that are “indirectly” held. To the extent that it is undefined or a person may not be covered based on the definition, again, a company would disclose that hedging is permitted as to those that are not covered.
The new Rule only requires disclosure of policies and practices and not hedging transactions themselves. CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. The new Rule adds an instruction to Item 402(b) related to CD&A such that the required disclosure can be satisfied by the new disclosure required by Item 407(i).
Section 14(j) specifically referred to any employee or member of the board of directors. The final rule clarified that officers are also covered in the disclosure. The Rule covers all employees, regardless of the materiality of their position. As the disclosure is about policies and practices, and does not mandate required policy or practice, the SEC saw no benefit in limiting the disclosure requirement to only certain covered persons. Consistently with the concept of allowing a company to define terms and scope in their adopted policies and practices, the definition and scope of “held directly or indirectly” will be left to a company to describe in its policy, if any, and associated disclosure.
« SEC Proposes Expanding Testing The Waters For All Companies The Under $300 Million Market Cap Class »
SEC Proposes Expanding Testing The Waters For All Companies
As anticipated, on February 19, 2019 the SEC voted to propose an expansion of the ability to “test the waters” prior to the effectiveness of a registration statement in a public offering, to all companies. Currently only emerging growth companies (“EGCs”) (or companies engaging in a Regulation A offering) can test the waters in advance of a public offering of securities. The proposal would implement a new Securities Act Rule 163B. For an in-depth analysis of testing the waters and communications during an offering process, see my two-part blog HERE and HERE. The SEC proposal is open for public comment for a sixty (60)-day period.
Historically all offers to sell registered securities prior to the effectiveness of the filed registration statement have been strictly regulated and restricted. The public offering process is divided into three periods: (1) the pre-filing period, (2) the waiting or pre-effective period, and (3) the post-effective period. Communications made by the company during any of these three periods may, depending on the mode and content, result in violations of Section 5 of the Securities Act of 1933 (the “Securities Act”). Communication-related violations of Section 5 during the pre-filing and pre-effectiveness periods are often referred to as “gun jumping.”
All forms of communication could create “gun-jumping” issues (e.g., press releases, interviews, and use of social media). “Gun jumping” refers to written or oral offers of securities made before the filing of the registration statement and written offers made after the filing of the registration statement other than by means of a prospectus that meet the requirements of Section 10 of the Securities Act, a free writing prospectus or a communication falling within one of the several safe harbors from the gun-jumping provisions.
In April 2012, the JOBS Act established a new process and disclosures for public offerings by a new class of companies – i.e., emerging growth companies (“EGCs.”) An EGC is defined as a company with total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year that first sells equity in a registered offering after December 8, 2011. In particular, Section 5(d) of the Securities Act of 1933 (“Securities Act”) allows EGCs to test the waters by engaging in communications with certain qualified investors. The SEC proposal would create a new Securities Act Rule 163B allowing all companies intending to file, or who have filed, a registration statement.
Permitting companies to test the waters is intended to provide increased flexibility to such issuers with respect to their communications about contemplated registered securities offerings, as well as a cost-effective means for evaluating market interest before incurring the costs associated with such an offering. Since the enactment of the JOBS Act, 87% of all IPOs have been by EGCs, leaving non-EGC companies at a disadvantage where specific rules favor EGC status.
The current proposal is consistent with other SEC actions to extend benefits afforded to EGCs to other issuers. That is, in June, 2017, the SEC expanded the ability to file confidential registration statements, previously only available to EGCs, to all companies – see HERE.
Section 5(d) of the Securities Act – Testing the Waters; Proposed New Rule 163B
Section 5(d) of the Securities Act provides an EGC with the flexibility to “test the waters” by engaging in oral or written communications with qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”) in order to gauge their interest in a proposed offering, whether prior to or following the first filing of any registration statement, subject to the requirement that no security may be sold unless accompanied or preceded by a Section 10(a) prospectus. Generally, in order to be considered a QIB, you must own and invest $100 million of securities, and in order to be considered an IAI, you must have a minimum of $5 million in assets.
Under the current rules, “well-known seasoned issuers,” or WKSIs, can engage in similar test-the-waters communications, but smaller reporting companies that do not otherwise qualify as an EGC cannot.
An EGC may utilize the test-the-waters provision with respect to any registered offerings that it conducts while qualifying for EGC status. Test-the-waters communications can be oral or written. An EGC may also engage in test-the-waters communications with QIBs and institutional accredited investors in connection with exchange offers and mergers. When doing so, an EGC would still be required to make filings under Sections 13 and 14 of the Exchange Act for pre-commencement tender offer communications and proxy soliciting materials in connection with a business combination transaction.
There are no form or content restrictions on these communications, and there is no requirement to file written communications with the SEC. During the first year or two following enactment of the JOBS Act, the SEC staff regularly asked to see any written test-the-waters materials during the course of the registration statement review process, but eventually these requests ceased. The SEC staff maintains the right to ask to review test-the-waters, or any, communications made by a company during the S-1 review process.
The new SEC proposal would expand the test-the-waters provisions currently available to EGCs, to all companies. In particular, proposed Securities Act Rule 163B would permit any issuer, including investment companies, or any person authorized to act on its behalf, to engage in oral or written communications with potential investors that are, or are reasonably believed to be, QIBs or IAIs, either prior to or following the filing of a registration statement, to determine whether such investors might have an interest in a contemplated registered securities offering. The proposed rule would be non-exclusive, and an issuer could rely on other Securities Act communications rules or exemptions when determining how, when, and what to communicate related to a contemplated securities offering.
The proposed rule would not require a filing with the SEC or any particular legend on the communications. Like other communications during a registration process, the test-the-waters communications must be consistent with and cannot conflict with the information in a related registration statement.
Companies that are subject to Regulation FD will need to be cognizant of whether any information in a test-the-waters communication would trigger a disclosure obligation under Regulation FD and make the required disclosure accordingly. As a reminder, Regulation FD requires that companies take steps to ensure that material information is disclosed to the general public in a fair and fully accessible manner such that the public as a whole has simultaneous access to the information. Regulation FD requires the filing of a Form 8-K immediately prior to or simultaneously with the issuance of the information. Where information is accidentally released, the filing must be made immediately after the release and on the same calendar day.
It is important to note that anti-fraud provisions, such as Section 12(a)(2) and 10(b), still apply to such communications.
Thoughts on the Proposal
The SEC believes that by allowing more test-the-waters communications, companies will be encouraged to participate in public markets which, in turn, promotes more investment opportunities for more investors and improves transparency and resiliency in the marketplace. Furthermore, added communication can enhance the ability of issuers to conduct successful offerings and lower the cost of capital. I agree, but it is not enough. Although the proposal is certainly welcome, and I’m sure will pass through the comment process and be enacted by the SEC, I would advocate for a rule amendment that not only expands test-the-waters communications for all issuers but that broadens the category of potential investor that could be the subject of such communications, to include all accredited investors.
In its proposal release, the SEC notes that the 2015 modernization of Regulation A, which allows companies to test the waters with all potential investors, without restriction as to the type of investors, has helped modernize the Securities Act communication rules. I have trouble understanding why the SEC is comfortable with the unfettered Regulation A test-the-waters communications, but is limiting offerings registered under the Securities Act to qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”). Certainly the potential total investor loss is limited in a Regulation A offering (with the high end maxing out at $50 million for a Tier 2 offering) and Regulation A communications require specified disclaimers and filing with the SEC, but I still find it to be a disconnect.
In the proposal, on several occasions, the SEC points out that QIBs and IAIs are sophisticated and do not need the protections of the Securities Act. I believe that the current change is in line with a conservative “incremental change” approach. A next-step middle ground could be to require any test-the-waters communications that are made available to potential investors that are not QIBs or IAIs to contain a specified legend and be filed with the SEC. That way, a company embarking on an offering could decide if it wants to take on the filing liability under Section 11 of the Securities Act or limit its test-the-waters communications to QIBs and IAIs.
« NYSE American Compliance Guidance MEMO SEC Rules For Disclosure Of Hedging Policies »
SEC Cautionary Statement on Audits of Public Companies Operating in China
Eight years following the crash of the Chinese reverse merger boom and a slew of SEC enforcement proceedings, the SEC is once again concerned with the financial reporting by U.S. listed companies with operations based in China. In December 2018, the SEC issued a cautionary public statement from SEC Chair Jay Clayton, SEC Chief Accountant Wes Bricker and PCAOB Chairman William D. Duhnke III entitled “Statement on the Vital Role of Audit Quality and Regulatory Access to Audit and Other Information Internationally – Discussion of Current Information Access Challenges with Respect to U.S.-listed Companies with Significant Operations in China.”
Just reading the title reminded me of the boom in China-based reverse mergers around 2009-2010 followed by the trading halts or delistings of at least 50 companies in 2011 and 2012. In the summer of 2010, the SEC launched an initiative to determine whether certain companies with foreign operations—including those that were the product of reverse mergers—were accurately reporting their financial results, and to assess the quality of the audits being done by their auditors. By June 2011, the SEC was strongly warning investors of the risks posed by reverse mergers in general, and Chinese deals in particular, singling out six Chinese issuers.
Numerous SEC enforcement actions and civil lawsuits were filed claiming fraud and misrepresentations in SEC filings including financial reports. Partially as a result of the crisis, in late 2011 both the NYSE and Nasdaq amended their listing requirements to add a seasoning requirement following a reverse merger. The seasoning rules prohibit a company that has completed a reverse merger with a public shell from applying to list until the combined entity had traded in the U.S. over-the-counter market, on another national securities exchange, or on a regulated foreign exchange, for at least one year following the filing of all required information about the reverse merger transaction, including audited financial statements. In addition, the rules require that the new reverse merger company has filed all of its required reports for the one-year period, including at least one annual report.
In addition, the seasoning rule requires that the reverse merger company “maintain a closing stock price equal to the stock price requirement applicable to the initial listing standard under which the reverse merger company is qualifying to list for a sustained period of time, but in no event for less than 30 of the most recent 60 trading days prior to the filing of the initial listing application.” The rule includes an exception for companies that complete a firm commitment offering resulting in net proceeds of at least $40 million.
In addition to the specific additional listing requirements contained in the new rule, the Exchange may “in its discretion impose more stringent requirements than those set forth above if the Exchange believes it is warranted in the case of a particular reverse merger company based on, among other things, an inactive trading market in the reverse merger company’s securities, the existence of a low number of publicly held shares that are not subject to transfer restrictions, if the reverse merger company has not had a Securities Act registration statement or other filing subjected to a comprehensive review by the SEC, or if the reverse merger company has disclosed that it has material weaknesses in its internal controls which have been identified by management and/or the reverse merger company’s independent auditor and has not yet implemented an appropriate corrective action plan.”
Slowly since that time, Chinese companies have again started to access U.S. capital markets via both reverse mergers and direct IPO’s. However, clearly the issues and concerns raised by the SEC in 2011 have not all been resolved.
SEC Public Statement
The SEC’s recent cautionary public statement was issued jointly from SEC Chair Jay Clayton, SEC Chief Accountant Wes Bricker and PCAOB Chairman William D. Duhnke III. The statement’s opening sentence sets the tone for the rest of the content, and in particular, “[A]s we are nearing the end of the fiscal year for many reporting companies, it is important to remember that complete, accurate financial statements and credible audits are things we—investors, issuers, and regulators worldwide—all care about.”
The statement continues with a recognition of the global nature of both capital markets and companies, with U.S.- and non-U.S.-based companies seeking access to the U.S. capital markets and the fundraising and liquidity they bring. The statement points out that U.S.-listed companies accounted for approximately 40% of the market capitalization of global public companies in 2017. Capital access and liquidity are made possible by the assurance that companies that list and trade on U.S. markets provide high-quality and reliable financial information and that U.S. rules, regulations, and regulatory oversight apply. When the listed company operates outside the U.S., regulators must operate in multiple jurisdictions to be able to access audit-related information and otherwise effectuate their responsibilities over any company trading in the U.S. markets.
A multinational company must comply with financial reporting obligations in many of the countries in which it operates and its auditors must be able to operate on a worldwide basis. The multi-jurisdictional aspect is sometimes challenging in that information necessary for regulatory oversight does not always flow back to the U.S. as it should. Barriers to the information flow include data protection, privacy, confidentiality, bank secrecy, state secrecy, or national security laws. The U.S. has been working with foreign jurisdictions to address these laws and barriers where a company subjects itself to U.S. regulatory oversight by listing on U.S. securities exchanges and accessing U.S. capital markets. For example, the SEC is one of over 120 signatories to the International Organization of Securities Commissions (IOSCO) Multilateral Memorandum of Understanding, which provides for enforcement consultation and cooperation, and the exchange of information. Moreover, the SEC has over 75 formal cooperative arraignments with foreign regulators, the PCAOB has conducted inspections of registered accounting firms in over 50 foreign countries, and the PCAOB has cooperative arrangements with 23 foreign regulators.
Unfortunately, China is not one of these cooperative arrangements, and the PCAOB has been facing issues being able to inspect auditing firms in China, as well as Hong Kong where the audit client has operations in mainland China. Based on reports to the PCAOB from audit firms up to March 31, 2018, there were 213 listed companies in China and 11 in Belgium for which the PCAOB and SEC have not been able to inspect audit records despite ongoing and significant efforts. From March 31 to the date of the SEC’s public statement, some of those companies changed their listing or trading status, dropping the number down to 178 companies.
The SEC is and remains the principal regulator of the world’s largest securities markets and, as such, must often deal with cross-border issues. The SEC sees its mission as administering and enforcing requirements for reliable financial reporting globally in light of the global nature of the economy and the many companies that operate worldwide. The SEC furthers this mission by communicating and cooperating with regulators in other countries and by participating in international organizations such as IOSCO (the International Organization of Securities Commissions) and The Monitoring Group, which engages in the monitoring of international accounting, auditing, and ethics standards.
The SEC also oversees the PCAOB which, in turn, is the principal U.S. regulator that oversees the audits of public companies and SEC-registered brokers and dealers. The PCAOB is required by U.S. law to conduct regular inspections of all registered public accounting firms, both domestic and foreign, that issue audit reports or that play a substantial role in their preparation. As noted above, the PCAOB has inspected audit firms in 50 different foreign countries. The PCAOB also often works in cooperation with foreign regulators and their audit inspection authorities.
However, despite the cooperative arrangements, there are legal impediments blocking the free flow of information from some countries. In particular, blocking statutes and data protection, privacy, confidentiality, bank secrecy, state secrecy, and national security laws sometimes complicate or outright restrict the sharing of information with U.S. regulators. Some of these laws prohibit foreign-domiciled companies from responding directly to SEC requests for information and documents or doing so, in whole or in part, only after protracted delays in obtaining authorization. Other laws can prevent the SEC from being able to conduct any type of examination, either on-site or by correspondence. Accordingly, securities regulators around the world seek agreements with one another for access to business books and records or auditor documentation. Likewise, some countries prohibit the PCAOB from inspecting audit firms within their borders, even if the auditor is PCAOB-registered. In that case, the PCAOB usually enters into cooperative arrangements with local regulators that allows them to jointly inspect a firm.
However, the SEC is generally not satisfied with their ability to inspect, investigate and enforce the U.S. securities laws in China. Despite the significant value of China-based companies trading in U.S. markets, Chinese law requires that the business books and records related to transactions and events occurring within China be kept and maintained there. China also restricts the auditor’s documentation of work performed in the country from being transferred out of China. Also, Chinese laws governing the protection of state secrets and national security have been invoked to limit foreign access to China-based business books and records and audit work papers. As a result, for certain China-based companies listed on U.S. stock exchanges, the SEC and PCAOB have not had access to the books and records and audit work papers. The SEC and PCAOB are engaging in ongoing discussions with Chinese officials and regulators but have not made satisfactory progress.
The SEC believes that if a company wants to access U.S. securities markets, the SEC needs to be able to directly supervise these entities and the auditors that audit their books and records. Any audit firm that registers with the PCAOB is legally obligated to cooperate and provide documents and testimony, if requested, in connection with inspections and investigations regardless of their locations. If the SEC and/or PCAOB cannot access a company or its auditor, they will seek sanctions and other remedial measures. To help keep investors informed of these issues, the PCAOB publishes a list of companies and auditors for which they have not been able to conduct inspections or obtain sufficient information.
The SEC continues to try and negotiate with Chinese authorities to improve relations and allow the SEC and PCAOB to have timely access to information necessary to conduct investigations or inspections but has not been successful to date. Many China-based companies and companies with significant operations in China want to access U.S. securities markets, but the inability of U.S. regulators to properly access records is causing the SEC concern about the risk to investors. Even if an audit is conducted correctly and financial reports are accurate, there is a greater risk to investors if the SEC cannot do its job and inspect the records. Of course, there is also the very real risk of fraud, which could emanate from a large company (for example, Enron or WorldCom) and have a broad market impact. The SEC is considering remedial measures, which could include requiring affected companies to make additional disclosures and placing additional restrictions on new securities issuances.
« Updated Disclosures for Mining Companies S-3 Eligibility »
Updated Disclosures for Mining Companies
In the 4th quarter of 2018, the SEC finalized amendments to the disclosure requirements for mining companies under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The proposed rule amendments were originally published in June 2016. In addition to providing better information to investors about a company’s mining properties, the amendments are intended to more closely align the SEC rules with current industry and global regulatory practices and standards as set out in by the Committee for Reserves International Reporting Standards (CRIRSCO). In addition, the amendments rescind Industry Guide 7 and consolidate the disclosure requirements for registrants with material mining operations in a new subpart of Regulation S-K.
The final amendments require companies with mining operations to disclose information concerning their mineral resources and mineral reserves. Disclosures on mineral resource estimates were previously only allowed in limited circumstances. The rule amendments provide for a two-year transition period with compliance beginning in the first fiscal year on or after January 1, 2021.
Summary of the Final Rules
In amending the disclosure rules for mining companies, the SEC considered that many companies are already subject to one or more of the s and that by aligning the SEC reporting requirements to these rules, the compliance burden and costs for these companies could be reduced while still providing the necessary investor protections.
Under the final rules, a company with material mining operations must disclose specific information related to its mineral resources and mineral reserves on one or more of its properties. The rules define “mineral reserve” to include diluting materials and allowances for losses that may occur when the material is mined or extracted. The rules also amend the definition of “mineral resource” to exclude geothermal energy. Consistent with CRIRSCO standards, a company must disclose exploration results, mineral resources, or mineral reserves in SEC filings based on information and supporting documentation prepared by a mining expert referred to as a “qualified person.”
A company must obtain a dated and signed technical report summary from the qualified person related to mineral resources and reserves determined to be on each material property. The report must be signed either directly by the qualified person or the firm that employs them. Moreover, multiple qualified persons may take part in preparing the final technical report summary. The qualified person may conduct either a pre-feasibility or final feasibility study to support a determination of mineral reserves even in high-risk situations. The report must be filed as an exhibit to the company’s SEC report when first disclosed and subsequent changes or amendments to the report must also be filed as exhibits. A technical report on exploration results may also be voluntarily filed as an exhibit.
The final rules require the qualified person to use a price for each commodity that provides a reasonable basis for establishing estimates of mineral resources or reserves. The price may be either historical or forward-looking, but the report must disclose and explain the reasons for using the selected price, including any material underlying assumptions. Similarly, instead of requiring a specific point of reference, the qualified person may choose any point of reference subject to disclosure and explanations. The technical report summary may disclose mineral resources as mineral reserves as long as it also discloses mineral resources excluding mineral reserves.
A qualified person is not subject to expert liability under Section 11 of the Securities Act of 1933 (“Securities Act”) for information and factors that are outside that person’s expertise, even if discussed in the technical report.
Although the proposed rule amendment provided for quantitative presumptions as to when mineral resources or reserves will be deemed material, the final rule did not include this provision, instead allowing management to rely on a principles-based approach in determining materiality. Likewise, management can determine when a change in previously reported estimates of mineral resources or reserves is material. Also, the proposed rule would have required a table with certain information on a company’s top 20 properties, but the final rule instead also uses a principles-based approach, again leaving it to the company to determine material disclosures of its properties and mining operations.
Materiality relating to mineral resources and reserves has been modified to consistently rely on a principles-based approach. A principles-based approach requires the company to “rely on a registrant’s management to evaluate the significance of information in the context of the registrant’s overall business and financial circumstances” and to “exercise judgment” in determining whether disclosure is required. The SEC has shown a trend towards this principles-based approach for determining materiality for purposes of disclosure in its recent reviews and amendments to Regulation S-K and Regulation S-X (see, for example, HERE and HERE). Practitioners, including the American Bar Association (“ABA”), have advocated for principles-based disclosure over quantitative or bright line tests (see HERE) believing that a quantitative guideline results in lengthy, and often immaterial, information. Congressional lawmakers have also supported this approach requiring the SEC to conduct a study on shifting even more disclosure requirements to principles based, as part of the FAST Act (see HERE).
The number of summaries and tables that are currently required has been reduced from seven to two and the company may now choose to make its disclosures using either tables or a narrative format. A company is permitted to voluntarily disclose exploration targets in its SEC reports as long as they are accompanied by certain specified cautionary and explanatory statements. Disclosure of exploration activity and results is mandatory once the company determines the information is material to investors. Also, the qualified person may include inferred resources in their economic analysis as long as certain conditions are met.
A company may now use historical estimates of mineral resources or reserves in SEC filings pertaining to mergers, acquisitions, or business combinations if they are unable to update the estimate prior to the completion of the relevant transaction, provided that the company discloses the source and date of the estimate, and does not treat the estimate as a current estimate.
Finally, the amended rules allow a company holding a royalty or similar interest to omit any information required under the summary and individual property disclosure provisions to which it lacks access and which it cannot obtain without incurring an unreasonable burden or expense.
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An IPO Without The SEC
On January 23, 2019, biotechnology company Gossamer Bio, Inc., filed an amended S-1 pricing its $230 million initial public offering, taking advantage of a rarely used SEC Rule that will allow the S-1 to go effective, and the IPO to be completed, 20 days from filing, without action by the SEC. Since the government shutdown, several companies have opted to proceed with the effectiveness of a registration statement for a follow-on offering without SEC review or approval, but this marks the first full IPO, and certainly the first of any significant size. The Gossamer IPO is being underwritten by Bank of America Merrill Lynch, SVB Leerink, Barclays and Evercore ISI. On January 24, 2019, Nasdaq issued five FAQ addressing their position on listing companies utilizing Section 8(a). Although the SEC has recommenced full operations as of today, there has non-the-less been a transformation in the methods used to access capital markets, and the use of 8(a) is just another small step in a new direction.
Section 8(a) of the Securities Act
Section 8(a) of the Securities Act of 1933 (“Securities Act”) provides for the effectiveness of registration statements and amendments. In particular, the statute provides that a registration statement shall automatically go effective on the 20th day after its filing or such earlier date as the SEC may determine. Section 8(b) gives the SEC the power to issue a stop order to prevent a registration statement from going effective in accordance under Section 8(a) if the registration statement is “on its face incomplete or inaccurate in any material respect.”
In practice, companies avoid the Section 8(a) effectiveness by adding language to their registration statements known as the “delaying amendment.” The typical language for a delaying amendment is similar to the following:
The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted.
… and with that provision, Section 8(a) is avoided. A company then goes through a comment, review and amendment process with the SEC which ultimately results in the SEC informing the company that it has cleared comments. A company then files a letter with the SEC, relying on another rule (Rule 461) requesting that the registration statement become effective. Technically the request is that the SEC accelerate the effectiveness of the registration statement so that a company does not have to file a final amendment removing the “delaying amendment” language and adding Section 8(a) language and then waiting 20 days for the registration statement to go effective.
The reasons that Section 8(a) is not used in practice are twofold. The first is that a company and its attorneys, auditors and underwriters believe that there is too much risk of litigation associated with forgoing SEC review. If the registration statement disclosures are later shown to have shortcomings, the unusual lack of SEC review adds fuel to the plaintiff’s lawyer’s claims. However, the SEC does not conduct a merit review, but rather just reviews to determine if the disclosures comply with the rules and regulations. Not only does the SEC not pass on whether a deal is good or bad, but making a statement to the contrary is a criminal offense and Item 501 of Regulation S-K specifically requires a disclaimer on the subject with suggested language, to wit:
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
It seems that if a company has competent counsel and the underwriter has competent counsel, they can together review the disclosures to determine if they are accurate and complete. Moreover, the fact is that if the stock price goes way down, the company is likely to face an investor lawsuit anyway, regardless of what the SEC reviews or doesn’t review. Besides, risk factors are designed to warn investors of potential issues, and Gossamer did so with its newest SEC filing adding the following risk factor:
As a result of the shutdown of the federal government, we have determined to rely on Section 8(a) of the Securities Act to cause the registration statement of which this prospectus forms a part to become effective automatically. Our reliance on Section 8(a) could result in a number of adverse consequences, including the potential for a need for us to file a post-effective amendment and distribute an updated prospectus to investors, or a stop order issued preventing use of the registration statement, and a corresponding substantial stock price decline, litigation, reputational harm or other negative results.
The registration statement of which this prospectus forms a part is expected to become automatically effective by operation of Section 8(a) of the Securities Act on the 20th calendar day after the most recent amendment of the registration statement filed with the SEC, in lieu of the SEC declaring the registration statement effective following the completion of its review. Although our reliance on Section 8(a) does not relieve us and other parties from the responsibility for the adequacy and accuracy of the disclosure set forth in the registration statement and for ensuring that the registration statement complies with applicable requirements, use of Section 8(a) poses a risk that, after the date of this prospectus, we may be required to file a post-effective amendment to the registration statement and distribute an updated prospectus to investors, or otherwise abandon this offering, if changes to the information in this prospectus are required, or if a stop order under Section 8(d) of the Securities Act prevents continued use of the registration statement. These or similar events could cause the trading price of our common stock to decline substantially, result in securities class action or other litigation, and subject us to significant monetary damages, reputational harm and other negative results.
The second is that the S-1, which will go effective after 20 days, must be totally complete, including pricing information. In a traditional IPO or follow-on offering, the company does not file the final amendment with pricing information until the day it goes effective. This allows a company to judge the market at the moment of sale to choose the best price, which is especially important in a firm commitment underwritten deal where the underwriter buys all the company’s registered stock in the IPO and immediately resells it to customers and syndicated broker-dealers. A company also may get feedback during its roadshow, which typically occurs in the 10-15 days prior to effectiveness that affects pricing decisions.
Interestingly, Gossamer has decided to ignore these market factors and let the world know its believed value up front. I’m actually not surprised at all. This is just another way that capital markets are shifting. There has been a recent rise in different methods of going public including direct public listings without an IPO (see HERE).
Nasdaq FAQ
On January 24, 2019, Nasdaq issued five FAQ addressing the listing of new companies during the government shutdown and the impact on already listed companies. Nasdaq will list companies that had cleared comments, but whose registration statement had not yet been declared effective at the time of the shutdown. Likewise if a company has substantially cleared comments, Nasdaq is willing to proceed with the listing under certain circumstances. In particular, the company will have had to clearly address the outstanding comments and Nasdaq will require a representation from the company’s counsel and auditor that they believe all disclosure and accounting comments have been fully addressed. Nasdaq will not list a company that has not yet received SEC comments or that first filed for its IPO during the shutdown. Gossamer announced that it has applied for the Nasdaq Global Select Market and so it will likely amend its S-1 to allow SEC review.
Nasdaq will also allow certain up-listings from the OTC Markets to proceed as long as the company satisfies the listing requirement. In particular, if the company only needs to file a registration statement under the Securities Exchange Act of 1934 (“Exchange Act”), such as a Form 10 or Form 8-A, Nasdaq will allow it to continue. Keep in mind a registration statement under the Exchange Act does not involve the offer or sale of any securities. However, if the up-listing involves an offering and the filing of a registration statement under the Securities Act, Nasdaq will review the application the same as a new IPO. That is, if the company has already cleared or substantially cleared comments, they may continue, if not, they will need to complete the SEC review process.
If a company is already listed on Nasdaq, they may proceed with a follow-on offering without SEC review.
Although the SEC is again operational, they will be backlogged, so presumably Nasdaq is still willing to proceed with certain companies without SEC action. Companies that have already filed a registration statement without the delaying amendment and with the appropriate Section 8(a) amendment will likely proceed. For those that had one or two unsubstantial comments left, they will need to assess which route will be the quickest, wait for the SEC to review the final comments or file a new fully completed registration using Section 8(a). Of course, Nasdaq may issue updated FAQ altering their position on accepting these applications.
Continued Shifting Capital Markets
The rise of decentralized platforms and imminent change in how the capital markets function as a whole and the role of intermediaries in the process has opened the market’s view to relying less on the SEC’s input in their disclosures. tZero is scheduled to launch its security token platform this week, introducing a new way in which securities, or fractional ownership interests in a company, can be bought and sold. tZero is starting with launching its own securities tokens on the platform but will soon open up to third-party companies and reportedly already has applications from over 60 companies. tZero may be the first to launch, but it will not be the only and soon we will have independent markets competing with Nasdaq and the NYSE. Moreover, the securities token markets will have sectors for private company markets and public company markets, blurring the current private equity silo with public trading.
Much more significantly, though, is that this is the first step in a retooling and complete change in how the clearing and settlement of securities functions (for more on the current clearing and settlement, see HERE and HERE). The new blockchain technology will allow for instantaneous clearing and settlement, a big change from the current t+2 and sometimes t+3 settlement of today (thus the name tZero). Notably, blockchain eliminates the need for a trusted intermediary, thus opening up the question as to the future role of DTC and its custodial arm, Cede & Co.
No regulator, the SEC or FINRA included, is ready for a complete disruption of the capital markets system, but they have been thinking about it for a while. FINRA published a report on the implications of blockchain for the securities industry back in January 2017 (see HERE). Furthermore, the SEC has reportedly told tZero, and presumably others following in their lead, that they will allow incremental changes in the market system.
This is a small concession considering that they will have no choice as the proverbial train has left the station. tZero is launching a joint venture with Boston Options Exchange, which is one of 12 SEC-listed security exchanges which together comprise the National Market System network. The joint venture seeks to launch a marketplace able to deal in both public securities and digital tokens. Nasdaq Financial Framework, a software company owned by the exchange, just closed a $20 million Series B funding round into Symbiont which is working to “give Nasdaq the ability to originate a financial instrument and the smart contract to custody it on a blockchain, to allow trading to occur with their matching engine, to allow surveillance to occur across the network using Nasdaq technology and then to perform settlement on a blockchain.”
Meanwhile, the SEC is clearly not against forgoing the comment and review process and relying on Section 8(a). As it was shutting down, the SEC posted an FAQ on its website reminding companies that they can proceed to rely on Section 8(a) to effectuate their registration statements, and even providing the exact language that needs to be included in order to accomplish this. In particular: “This registration statement shall hereafter become effective in accordance with the provisions of Section 8(a) of the Securities Act of 1933.” Even with the re-opening of the SEC, CorpFin will be exponentially backlogged compared to the time it was shutdown. It will be interesting to see how the SEC handles the workload – perhaps in addition to simply foregoing comments on many filings, the SEC will continue to support the use of 8(a) on others, especially follow-on offerings completed for a company that has had a full review in the last few years.
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SEC Solicits Comment On Earnings Releases And Quarterly Reports
On December 18, 2018, the SEC published a request for comment soliciting input on the nature, content, and timing of earnings releases and quarterly reports made by reporting companies. The comment period remains open for 90 days from publication. The request is not surprising as earnings releases and quarterly reports were included in the pre-rule stage in the Fall 2018 SEC semiannual regulatory agenda and plans for rulemaking.
The request for comment seek input on how the SEC can reduce burdens on publicly reporting companies associated with quarterly reports while maintaining disclosure effectiveness and investor protections. The SEC also seeks comment on how the existing reporting system, earnings releases and earnings guidance may foster an overly short-term focus by companies and market participants. In addition, the SEC is looking for input on how to make the reporting process less cumbersome to investors, such as by having to compare an earnings release and Form 10-Q for differences.
This has been a hot topic over the years, with President Trump publicly calling for an elimination of quarterly reporting. The April 2016 concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements also requested comment on the subject. See my two-part blog on the S-K Concept Release HERE and HERE. The newest request for comment takes into consideration comments received in response to the 2016 release and drills down further on the quarterly reporting process.
The request for comment specifically addresses (i) the nature and timing of disclosures in quarterly reports, including when the disclosures overlap with voluntary earnings releases in Forms 8-K; (ii) how the SEC can make the process more efficient by eliminating duplication and how that can affect capital formation; (iii) whether the SEC should allow some or all reporting companies flexibility on the frequency of periodic reporting; and (iv) how the existing periodic reporting system may affect corporate decision making and may foster an inefficient outlook by focusing on short-term results.
Background on Form 10-Q
In addition to annual reports on Form 10-K and current reports on Form 8-K, companies subject to the periodic reporting requirements under the Securities Exchange Act of 1934 (“Exchange Act”), other than foreign private issuers, must file quarterly reports on Form 10-Q, which include independent auditor-reviewed interim financial statements and other disclosure items. For more information on SEC reporting requirements, see HERE and related to foreign private issuers, see HERE. Foreign private issuers must file annual but not quarterly reports.
These quarterly reports, as well as other periodic reports, may be forward incorporated by reference into Securities Act of 1933 (“Securities Act”) registration statements such as Forms S-1 and S-3, reducing the need for duplication of this information through post effective updates. As an aside, the FAST Act, passed into law on December 4, 2015, amended Form S-1 to allow for forward incorporation by reference by smaller reporting companies (see HERE), which category of company has recently increased with the amended definition of a smaller reporting company (see HERE). Other categories of filers, including accelerated and large accelerated filers, were already allowed to forward incorporate by reference.
A Form 10-Q is subject to the anti-fraud provisions of Sections 10(b) and 18 of the Exchange Act and Rule 10(b)(5) and can be the source of liability to the company, affiliates and underwriters under Sections 11, 12 and 17 of the Securities Act, related to the offer and sales of securities offerings. Each of these provisions imposes liability on companies in certain instances for making any untrue statements of a material fact or omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. The difference in the Sections relate to whether the cause of action is private or can only be pursued by a regulator or governmental body, if private, who has a right to pursue the action (for example, Section 11 provides an action for any purchaser of securities, regardless of whether they bought directly from the company or secondarily in the aftermarket), the elements of proof (such as scienter or intent or loss causation), allowable damages, the standard of proof, etc..
Liability under certain of these provisions, such as Sections 11 and 12 of the Securities Act and Section 18 of the Exchange Act, attaches only to documents that are filed with the SEC or incorporated by reference into a Securities Act registration statement. A Form 10-Q is always deemed filed with the SEC.
However, the SEC allows certain information to be furnished as opposed to filed as long as the company specifically discloses that it is avowing itself of the ability to furnish and not file. For example, reports in a Form 8-K under Regulation FD and earnings press releases under Item 2.02 related to results of operations and financial condition are allowed to be furnished and not filed. Although liability under Section 10(b) and Rule 10b-5 of the Exchange Act may attach to documents that are “furnished,” the standard of proof and elements to state a cause of action are different under these rules.
As mentioned above, foreign private issuers must file annual but not quarterly reports. However, a foreign private issuer has obligations to furnish certain information under a Form 6-K, including, for example, information it (i) makes or is required to make public pursuant to the law of the jurisdiction of its domicile or in which it is incorporated or organized, or (ii) files or is required to file with a stock exchange on which its securities are traded and which was made public by that exchange, or (iii) distributes or is required to distribute to its security holders. This information is subject to liability under Section 10(b) and Rule 10b-5 of the Exchange Act and if incorporated into a registration statement, becomes filed in that registration statement, and subject to liability under Sections 11, 12 and 17 of the Securities Act.
As a result of these requirements, reports on Form 6-K often include quarterly reports or financial statements. For example, Canada, Hong Kong and Japan all require quarterly reporting. On the other hand, in 2013 the European Union (“EU”) amended its reporting requirements to eliminate the requirement to file quarterly reports altogether, which even prior to that time did not include financial statements. The EU found that quarterly reports were a burden for small and medium-sized companies, didn’t add to investor protection, encouraged a focus on short-term performance and discouraged long-term investments. Companies may still voluntarily file quarterly.
Earnings Releases
Many companies that file quarterly Form 10-Q’s also voluntarily issue quarterly financial results through earnings press releases, earnings calls and/or forward-looking earnings guidance. Other than through the anti-fraud rules, the presentation of non-GAAP financial measures (see HERE) and the requirement to file a Form 8-K, the SEC does not regulate these disclosures. Although when a company does issue earnings release information, it is generally duplicative to some information in the Form 10-Q, the Form 10-Q is more robust and includes XBRL interactive data. Disclosures in a Form 10-Q that are not in an earnings release also include full financial statements and notes to financial statements as opposed to summaries and a management discussion and analysis. Moreover, the financial statements in the Form 10-Q are reviewed by an independent auditor and the filing includes Sarbanes-Oxley certifications by the principal executive and financial officers. Contrarily, a Form 10-Q generally does not include expectations of future performance or forward-looking earnings guidance.
Request for Comments
In addition to the general request for comment on the issues and matters described above, the SEC drills down their requests into specific questions on the topic, such as why companies choose to issue earnings releases in addition to a Form 10-Q and what would be the impact on these releases if quarterly reports were not required. The SEC seeks information on the specific benefits of both earnings releases and Form 10-Q and standard market expectations and responses to both. Certainly, as a regulator the SEC understands the legal impact of “furnished vs. filed” and the various liability provisions, but their questions are more focused on the market players and investors uses of and needs for information as well as the burdens of providing same. The SEC also touches on XBRL, which has also been oft debated, especially for smaller reporting companies. The SEC lists 14 multifaceted in this area under the heading “Information Content Resulting from the Quarterly Reporting Process.”
The SEC requests comment on 3 additional multi-layered points related to the timing of the quarterly reporting process including vis-à-vis earnings releases. In particular, some companies issue an earnings release prior to the Form 10-Q while others wait until the same day or close thereafter. Earnings calls can be scheduled anywhere around the time of either filing or after. The SEC queries the reasons why and impacts of the timing.
The next area of questions relates to whether earnings releases should be the core quarterly disclosure, with 12 multi-layered queries. In this area it seems that the SEC is considering making an earnings release an optional alternative to a Form 10-Q by allowing the Form 10-Q to incorporate the earnings release by reference and/or only provide supplemental information in the Form 10-Q to the extent it was not included in the earnings release.
Finally, the SEC tackles the topic of reporting frequency, including considering semi-annual reporting with 17 in-depth, multifaceted questions for consideration.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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The SEC’s Strategic Hub For Innovation And Financial Technology
Responding to the growing necessity, in mid-October the SEC launched a Strategic Hub for Innovation and Financial Technology (FinHub). The FinHub will serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, such as distributed ledger technology (including digital assets), automated investment advice, digital marketplace financing, and artificial intelligence/machine learning. The FinHub also replaces and consolidates several SEC internal working groups that have been working on these matters.
According to the SEC press release on the matter, the FinHub will:
- Provide a portal for the industry and the public to engage directly with SEC staff on innovative ideas and technological developments;
- Publicize information regarding the SEC’s activities and initiatives involving FinTech on the FinHub web page;
- Engage with the public through publications and events, including a FinTech Forum focusing on distributed ledger technology and digital assets planned for 2019;
- Act as a platform and clearinghouse for SEC staff to acquire and disseminate information and FinTech-related knowledge within the agency; and
- Serve as a liaison to other domestic and international regulators regarding emerging technologies in financial, regulatory, and supervisory systems.
Although I’m sure FinHub supports engagement in all FinTech areas, the website itself is broken into four categories: (i) blockchain/distributed ledger; (ii) digital marketplace financing; (iii) automated investment advice; and (iv) artificial intelligence/machine learning. Under each category the SEC has tabs with information such as regulations, speeches and presentations, opportunities for public input and empirical information.
Blockchain/Distributed Ledger
Blockchain and distributed ledger generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner. Blockchains are often used to issue and transfer ownership of digital assets that may be securities, depending on the facts and circumstances.
Clearly illustrating the need for regulatory initiatives, the “regulation, registration and related matters” tab under blockchain/distributed ledger is limited to public speeches, testimony and pronouncements, and enforcement actions, and not regulation (as none exists). Although certainly we in the community give public statements weight, they actually have no binding legal authority. The speeches, testimony and pronouncements that the SEC lists in this tab, and as such the ones that the SEC gives the most weight to, include (i) Chair Clayton’s testimony on virtual currencies to the Senate banking committee (see HERE); (ii) William Hinman’s speech on digital asset transactions (see HERE); (iii) statement on potentially unlawful online platforms for trading digital assets (see HERE); and (iv) remarks before the AICPA National Conference of Banks & Savings institutions (see HERE and HERE).
Providing more legal guidance are the enforcement proceedings. The SEC has provided a running list of all cyber enforcement actions broken down by category including digital asset/initial coin offerings; account intrusions; hacking/insider trading; market manipulation; safeguarding customer information; public company disclosure and controls; and trading suspensions.
Digital Marketplace Financing
Digital marketplace financing refers to fundraising using mass-marketed digital media – i.e., crowdfunding. In this category, the SEC includes traditional Title III Crowdfunding under Regulation CF and platforms for the marketing of Regulation D, Rule 506(c) offerings for the offering of debt or equity financing. Under the Regulation tab the SEC includes Regulation CF and the SEC’s Regulation CF homepage, including investor bulletins.
The SEC does not include a link to Rule 506(c) or Section 4(c) of the Securities Act, which provide an exemption for advertised offerings where all purchasers are accredited investors, and the platforms or web intermediaries that host such offerings, respectively. However, many securities token offerings are being completed relying on these exemptions from the registration provisions – in fact, more so than Regulation CF which is limited to $1,070,000 in any twelve-month period. In my opinion, this is a miss on the site layout.
This area of the FinHub website also provides a link to one of the first published SEC investor bulletins on initial coin offerings, including some high-level considerations to avoid a scam. Finally, this area provides a link to a Regulation CF empirical information page published by the SEC. Unfortunately I do not find the data to be user-friendly and could not determine how many, if any, Regulation CF offerings have included digitized assets or FinTech-related issuers.
Automated Investment Advice
Automated investment advisers or robo-advisers are investment advisers that typically provide asset management services through online algorithmic-based programs. Since their introduction, the SEC has been involved with regulating these market participants. Under this section, the SEC provides links to guidance related to robo-advisors.
Robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act. However, since robo-advisers rely on algorithms, provide advisory services over the internet, and may offer limited, if any, direct human interaction to their clients, their unique business models may raise certain considerations when seeking to comply with the Advisers Act. In particular, the Advisors Act requires that a client receive information that is critical to his or her ability to make informed decisions about engaging, and then managing the relationship with, the investment adviser. As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to, and to employ reasonable care to avoid misleading, clients. The information provided must be sufficiently specific so that a client is able to understand the investment adviser’s business practices and conflicts of interests. Such information must be presented in a manner that clients are likely to read (if in writing) and understand.
Since robo-advisors provide information and disclosure over the internet without human interaction and the benefit of back-and-forth discussions, the disclosures must be extra robust and provide thorough material on the use of an algorithm. The SEC’s guidance on the subject contains a fairly thorough list of matters that should be included in the client information.
Artificial Intelligence/Machine Learning
Machine learning and artificial intelligence refer to methods of using computers to mine and analyze large data sets. The SEC includes links to a few speeches and presentations under this tab. The SEC uses machine learning and AI in numerous ways, including market risk assessment and helping identify risks that could result in enforcement proceedings such as the detection of potential investment adviser misconduct.
Further Reading on DLT/Blockchain and ICOs
For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.
For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.
For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.
For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.
For an update on state-distributed ledger technology and blockchain regulations, see HERE.
For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.
For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.
For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.
To learn about SAFTs and the issues with the SAFT investment structure, see HERE.
To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.
For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.
For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.
For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.
For a review of Wyoming’s blockchain legislation, see HERE.
For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.
For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HERE; HERE; and HERE.
For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.
Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.
Listen toour podcast on iTunes Podcast channel.
Noun
Lawcast is derived from the term podcast and specifically refers to a series of news segments that explain the technical aspects of corporate finance and securities law. The accepted interpretation of lawcast is most commonly used when referring to LawCast.com, Corporate Finance in Focus. Example; “LawCast expounds on NASDAQ listing requirements.”
Anthony L.G., PLLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Anthony L.G., PLLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Anthony L.G., PLLC
« Proposed Rule Changes To Simplify Registered Debt Offerings Nasdaq Amends Its 20% Dilution Shareholder Approval Rule »
Proposed Rule Changes To Simplify Registered Debt Offerings
This summer the SEC proposed rule changes to simplify disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, as well as for affiliates whose securities collateralize a company’s securities. The proposed amendments apply to Rules 3-10 and 3-16 of Regulation S-X and are aimed at making the disclosures easier to understand and to reduce the cost of compliance for companies. The proposed rules follow the September 2015 SEC request for comment related to the Regulation S-X financial disclosure obligations for certain entities other than the reporting entity. The September 2015 request for comment specifically discussed Rules 3-10 and 3-16, which comment responses were considered in the current proposed rules. For more on the September 2015 comment request, see HERE.
In addition to the amending the contents of the rules, the SEC plans to create a new Article 13 in Regulation S-X and renumber Rules 3-10 and 3-16 to Rules 13-01 and 13-02. The proposed amendments also include conforming changes to related rules in Regulations S-K and S-X and Securities Act and Exchange Act forms.
The SEC hopes that the rule changes will encourage registration of debt offerings which include a subsidiary guarantee or pledge of affiliate securities, where a company may previously have only completed such offerings using private placement exemptions due to the high costs and burdens associated with registration. Moreover, if the registration process is less expensive, it might encourage companies to use guarantees or pledges of affiliate securities as collateral when they structure debt offerings which could result in a lower cost of capital and an increased level of investor protection.
The following review is very high-level. The rules are complex and an application of the specific requirements requires an in-depth analysis of the particular facts and circumstances of an offering and the relationship between the issuer and guarantor/pledger.
Rule 3-10
Currently Rule 3-10 requires financial statements to be filed for all issuers and guarantors of securities that are registered or being registered, subject to certain exceptions. These exceptions are typically available for wholly owned individual subsidiaries of a parent company when each guarantee is “full and unconditional.” Moreover, certain conditions must be met, including that the parent company provides delineated disclosures in its consolidated financial statements. If the conditions are met, separate financial statements of each qualifying subsidiary issuer and guarantor may be omitted.
The theory behind requiring these financial statements is that guarantor of a registered security is considered an issuer because the guarantee itself is considered a separate security. Accordingly, both issuers of registered securities, and the guarantor of those registered securities, have historically been required to file their own audited annual and reviewed stub period financial statements under Rule 3-10. Where qualified, Rule 3-10 currently allows for a tabular footnote disclosure of this information, as opposed to full-blown audits and reviews of each affected subsidiary. The footnote tables are referred to as Alternative Disclosure.
The requirements under Alternative Disclosure include tables in the footnotes for each category of parent and subsidiary and guarantor. The table must include all major captions on the balance sheet, income statement and cash flow statement. The columns must show (i) a parent’s investment in all consolidated subsidiaries based on its proportionate share of the net assets; and (ii) a subsidiary issuer/guarantor’s investment in other consolidated subsidiaries using the equity accounting method.
To avoid a disclosure gap for recently acquired subsidiaries, a Securities Act registration statement of a parent must include one year of audited pre-acquisition financial statements for those subsidiaries in its registration statement if the subsidiary is significant and such financial information is not being otherwise included. A subsidiary is significant if its net book value or purchase price, whichever is greater, is 20% or more of the principal amount of the securities being registered. Currently, the parent company must continue to provide the Alternative Disclosure for as long as the guaranteed securities are outstanding.
When a subsidiary is not also considered an issuer of securities, a parent company consolidates the financial statements of its subsidiaries and no separate financial statements are provided for those subsidiaries. The SEC recognizes the overarching principle that it is really the parent consolidated financial statements upon which investors rely when making investment decisions. The existing rules impose certain eligibility restrictions and disclosure requirements that may require unnecessary detail, thereby shifting investor focus away from the consolidated enterprise towards individual entities or groups of entities and may pose undue compliance burdens for registrants.
The amendments would broaden the exception to the requirement to provide separate financial statements for certain subsidiaries as long as the parent company includes specific financial and non-financial disclosures about those subsidiaries. In particular, the amended rule would allow the exception for any subsidiary for which the parent consolidates financial statements as opposed to the current requirement that the subsidiary be wholly owned.
Furthermore, the amendments would replace the existing consolidated financial information with new summarized information, for fewer periods, and which may be presented on a combined basis. The new non-financial information disclosures would expand the qualitative disclosures about the guarantees and the issuers and guarantors, as well as require certain disclosure of additional information, including information about the issuers and guarantors, the terms and conditions of the guarantees, and how the issuer and guarantor structure and other factors may affect payments to holders of the guaranteed securities (“Proposed Alternative Disclosure”).
Importantly, the new disclosures may be provided in the body of a registration statement covering the offer and sale of the securities as opposed to the footnotes to the financial statements. However, the disclosures must move back to the financial statement footnotes beginning with the annual report for the fiscal year during which the first bona fide sale of the subject securities is completed.
The geography of a disclosure is significant. Disclosure contained in the footnotes to financial statements subject the information to audit and internal review, internal controls over financial reporting and XBRL tagging. Moreover, forward-looking statement safe-harbor protection is not available for information inside the financial statements.
The new rules would reduce the time that financial and non-financial disclosures are required to the time that the issuer and guarantor have an Exchange Act reporting obligation with respect to the guaranteed securities rather than for as long as the guaranteed securities are outstanding. The Exchange Act provides that if, at the beginning of any subsequent fiscal year after the effectiveness of a Securities Act registration statement, the securities of any class to which the registration statement relates are held of record by fewer than 300 persons, or in the case of a bank, a savings and loan holding company, or bank holding company, by fewer than 1,200 persons, the registrant’s Section 15(d) reporting obligation is automatically suspended with respect to that class.
Furthermore, the rule amendments would eliminate the requirement to provide pre-acquisition financial statements of recently acquired subsidiary issuers or guarantors.
Rule 3-16
Current Rule 3-16 requires a company to provide separate financial statements for each affiliate whose securities constitute a substantial portion of the collateral, based on a numerical threshold, for any class of registered securities as if the affiliate were a separate registrant. The affiliate’s portion of the collateral is determined by comparing (i) the highest amount among the aggregate principal amount, par value, book value or market value of the affiliate’s securities to (ii) the principal amount of the securities registered or to be registered. If the test equals or exceeds 20% for any fiscal year presented by the registrant, Rule 3-16 financial statements are required.
The proposed amendments would replace the existing requirement to provide separate financial statements for each affiliate whose securities are pledged as collateral with new financial and non-financial disclosures about the affiliate(s) and the collateral arrangement as a supplement to the consolidated financial statements of the company that issues the collateralized security.
In addition, the proposed amendment would change the geographic location of the disclosures to match the amendments to Rule 3-10. In particular, the new disclosures may be provided in the body of a registration statement covering the offer and sale of the securities as opposed to the footnotes to the financial statements. However, the disclosures must move back to the financial statement footnotes beginning with the annual report for the fiscal year during which the first bona fide sale of the subject securities is completed.
Furthermore, the proposed amendments would replace the requirement to provide disclosure only when the pledged securities meet or exceed a numerical threshold relative to the securities registered or being registered, with a requirement to provide the proposed financial and non-financial disclosures in all cases, unless they are immaterial to holders of the collateralized security.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.
Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.
Listen toour podcast on iTunes Podcast channel.
Noun
Lawcast is derived from the term podcast and specifically refers to a series of news segments that explain the technical aspects of corporate finance and securities law. The accepted interpretation of lawcast is most commonly used when referring to LawCast.com, Corporate Finance in Focus. Example; “LawCast expounds on NASDAQ listing requirements.”
Anthony L.G., PLLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Anthony L.G., PLLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Anthony L.G., PLLC
« SEC Fall 2018 Regulatory Agenda The SEC’s Strategic Hub For Innovation And Financial Technology »
SEC Fall 2018 Regulatory Agenda
In October 2018, the SEC posted its latest version of its semiannual regulatory agenda and plans for rulemaking with the U.S. Office of Information and Regulatory Affairs. 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.
Like the Spring 2018 Agenda, the fall Agenda is broken down by (i) “Prerule Stage”; (ii) Proposed Rule Stage; (iii) Final Rule Stage; and (iv) Long-term Actions. The Proposed and Final Rule Stages are intended to be completed within the next 12 months and Long-term Actions are anything beyond that. The number of items to be completed in a 12-month time frame has jumped up with 36 items compared to 21 on the spring list.
Interestingly, following President Trump’s recent call to eliminate quarterly reporting for public companies, Chair Clayton remarked that “I don’t think quarterly reporting is going to change for our top names anytime soon. It was good of the president to raise it… as it could make sense to ease the requirement for smaller companies….” Of the three items in the pre-rule stage on the Fall Agenda, earnings releases and quarterly reports are one. Perhaps we will see a change in quarterly reporting requirements for smaller reporting companies. The other two items on the pre-rule list include the harmonization of exempt offerings to streamline the rules for exempt offerings and the modernization of investment company disclosures.
Eighteen items are included in the final rule stage, up from 11 on the Spring Agenda. Disclosure on hedging by employees, officers and directors remains in the final rule stage. The proposed rules were issued in February 2015 (see HERE) and will result in checking another box on the Dodd-Frank rulemaking list. Still in the final rule stage are amendment to the SEC’s modernization of property disclosure for mining companies, disclosure on order handling information, amendments to municipal securities disclosures, a few rule changes related to investment advisors and a few related to swaps, and implementation of FAST Act report recommendations (see HERE).
Auditor independence with respect to loans or debtor-creditor relationships moved up from proposed to the final rule stage, as did amendments related to fair access to investment research and amendments to the whistleblower program.
Amendments to the SEC’s Freedom of Information Act Regulations, which was included in the Spring Agenda final rule stage, were enacted in June 2018. Regulation S-K disclosure updates and simplification rule changes remain on the final rule change list even though some amendments have been recently implemented (see HERE). Likewise, a change to the definition of a smaller reporting company has been completed and thus off the list (see HERE) as has the adoption of inline XBRL (see HERE). Business, Financial and Management Disclosure Required by Regulation S-K remains in the proposed rule stage, continuing the topic of disclosure reform.
Although investment company reporting modernization and amendments to the Investment Advisers Act were included in the Spring Agenda final rule stage, no rule changes have been made and as mentioned above, in the newest Agenda, the modernization of investment company disclosures is listed in the pre-rule stage.
Eighteen items are included in the proposed rule stage. Items of interest in the proposed rule stage include amendments extending the testing-the-waters provisions to non-emerging growth companies (see current testing-the-waters provisions HERE); financial disclosures about acquired businesses, disclosure of payments by resource extraction issuers, filing fee processing updates, bank holding company disclosures, exchange traded funds, and fund of fund arrangements. As promised by Chair Clayton, amendments to the definition of an accelerated filer appear on the proposed rule change list.
Regulation A amendments are now included in both the long-term action list and proposed rule stage. I am hopeful that these amendments may include an increase in the offering limits. We continue to wait for the SEC to amend the Regulation A rules to allow reporting issuers to utilize the offering as required by the Economic Growth, Regulatory Relief and Consumer Protection Act (see HERE).
Rules on disclosure for unit investment trusts and offering variable insurance products, offering reform for business development companies, use of derivatives by registered investment companies and business development companies, Business, Financial and Management Disclosure Required by Regulation S-K, standards for covered clearing agencies, and amendments to marketing rules under the Advisors Act, are also included in the proposed rule stage. Amendments to the transfer agent rules remains on the proposed rule list although it has been almost three years since the SEC published an advance notice of proposed rulemaking and concept release on new transfer agent rules (see HERE).
Fifty-two items are listed as long-term actions, including many that have been sitting on the list for a long time now. Still on the long-term actions are rules related to reporting on proxy votes on executive compensation (i.e., say-on-pay – see HERE), universal proxy, Form 10-K summary, corporate board diversity, investment company advertising, and revisions to audit committee disclosures.
Highly debated and much needed, but still on the long-term agenda, are the amendments to the accredited investor definition (see HERE). Also remaining on the long-term action list are Regulation Finders. The topic of finders has been ongoing for many years, and I am extremely pleased to see it make the list. See HERE for more information.
Other items remaining on the long-term agenda include amendments registration of security-based swaps and a few other swap-related rule changes, stress testing for large asset managers, prohibitions of conflicts of interest relating to certain securitizations, definitions of mortgage-related security and small-business-related security, numerous proxy rule amendments, conflict minerals amendments, amendments to Guide 5 on real estate offerings and Form S-11, incentive-based compensation arrangements, exchange traded products, various broker-dealer-related rule changes, and risk mitigation techniques. Also remaining on the long-term action list include simplification of disclosure requirements for emerging growth companies and forward incorporation by reference on Form S-1 for smaller reporting companies (EGCs may already incorporate by reference – see HERE), and Regulation Crowdfunding amendments.
Rule 701 and Form S-8 amendments have been added to the long term action list following the SEC’s recent rule changes and concept release (see HERE and HERE). Other interesting items added to the long-term agenda are rule changes to short sale disclosure reforms and registration of alternative trading systems. Alternative trading systems have garnered interest for their potential use for securities token trading.
Still on the long-term agenda are future Dodd-Frank rules, including proposed regulatory actions related to pay for performance (see HERE), executive compensation clawback (see HERE) and clawbacks of incentive compensation at financial institutions.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.
Follow Anthony L.G., PLLC on Facebook, LinkedIn, YouTube, Pinterest and Twitter.
Listen toour podcast on iTunes Podcast channel.
Noun
Lawcast is derived from the term podcast and specifically refers to a series of news segments that explain the technical aspects of corporate finance and securities law. The accepted interpretation of lawcast is most commonly used when referring to LawCast.com, Corporate Finance in Focus. Example; “LawCast expounds on NASDAQ listing requirements.”
Anthony L.G., PLLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Anthony L.G., PLLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Anthony L.G., PLLC
« Rule Changes for OTCQB and OTCQX Proposed Rule Changes To Simplify Registered Debt Offerings »