OTC Markets Comments on Proposed SEC Rules Regarding Amendments to Regulation D, Form D and Rule 156
On July 10, 2013, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156. On September 23, 2013 the OTC Markets Group published a letter responding to the SEC’s request for comments on the proposed rules. The entire OTC Markets comment letter is available on both the OTC Markets website and the SEC website. The OTC Markets Group, through OTC Link, owns and operates OTC Markets and its quotation platforms including OTCQX, OTCQB and pink sheets.
Summary of Proposed Rule Changes
The proposed amendments will (i) require the filing of a Form D to be made before the Issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an Issuer from relying on Rule 506 for one year for future offerings if the Issuer, or any predecessor or affiliate of the Issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”
On August 20, 2013, I published a blog detailing the proposed rule changes related to Form D and Rule 507, which can be viewed here. On August 27, 2013, I published a blog detailing the remainder of the proposed rule changes including the proposed amendments to general solicitation materials and the temporary requirement that all such materials be submitted to the SEC, which can be viewed here.
OTC Markets Comment Letter
OTC Markets has been vocal about its support of the lifting of the ban on general solicitation and advertising, and it continues to be so in its comment letter. However, OTC Markets is not supportive of the proposed new rules and, in fact, is concerned that the rules “would counteract the positive impact of the new general solicitation and advertising rules, contradict the intent of the JOBS Act, and ultimately harm small capital formation.” The OTC Market’s biggest concern is the proposed advance Form D filing requirement.
OTC Markets Comments Related to the Proposed Advance Form D Requirement
Currently, an Issuer must file a Form 15 within 15 days of the first sale of securities in a Regulation D offering. An Issuer must file an amendment if there is a material change to the information filed in the original Form D. The proposed rule would require the Issuer to file an advance Form D with the SEC at least 15 days prior to using advertising or general solicitation in conjunction with the new 506(c) offering exemption. OTC Markets has many issues with the proposed new filing requirement.
First, OTC Markets is concerned that the advance filing requirement will chill communications between Issuers and potential investors. It is unclear what constitutes general solicitation and advertising or non-confidential information. This lack of clarity will likely result in confusion by Issuers as to when or if an advance Form D is required. Moreover, the lack of clarity could cause Issuers to err on the cautious side and instead of providing more information to the public, maintain such information as confidential. One of the underlying intents of the JOBS Act was to increase the amount of publicly available information about Issuers.
OTC Markets points out that “[F]or many small companies, the fear of violating the Advance Form D requirement will cause them to keep information confidential. Investors, employees, the press and regulators would be deprived of valuable company information, leading to unreliable price discovery, a lack of market efficiency, reduced incentive to participate in private offerings, and less capital raising by small companies.” OTC Markets goes further to conclude that “the Advance Form D requirement may completely frustrate the Congressional intent behind the JOBS Act and make the end of the ban on general solicitation and advertising a non-event for small companies.”
In addition, OTC Markets takes issue with the SEC’s reasoning behind the proposed advance Form D requirement. In particular, the SEC has indicated that the requirement will help it analyze and better understand the market for Rule 506(c) private placements. The SEC does not offer a rationale as to how an advance Form D would provide information not already provided by the current Form D. Moreover, the SEC has access to documents submitted to FINRA by broker dealers acting as placement agent or participating in private placements. The current Form D filing requirement together with FINRA information already provides the SEC with enough data to analyze any market impact of 506(c) offerings without the negative effect of chilling small companies’ communications and capital raising efforts.
In a point very well taken, the OTC Markets states, “[T]he capital formation process would be much better served if the SEC engaged in thoughtful private placement rulemaking 12 months from now after conducting a thorough analysis of the impact of the new general solicitation rules on the private placement market. Implementing the Advance Form D requirement simultaneously with the end of the ban on general solicitation and advertising deprives the markets of the opportunity to properly evaluate the impact of the JOBS Act on small company capital formation.”
OTC Markets Comments – the Benefits of Adequate Current Public Information
OTC Markets advocates full public disclosure by all Issuers, especially those engaging in private placement offerings. The OTC Markets comment letter advocates “mandatory public disclosure of the information required under Securities Act Rule 144 in connection with any Rule 506(c) offering that utilizes general solicitation and advertising.” Rule 144 requires adequate current public information as a prerequisite to the sale of securities under the Rule. For a reporting company, the current public information requirement is met by being current in its reporting requirements with the SEC. For a non-reporting company, the current public information requirement is met by having all the information required by SEC Rule 15c2-11 made publicly available. Generally, this information is uploaded onto the OTC Markets website.
OTC Markets points out that prior to the new Rule 506(c), Regulation D required that information be kept confidential and not publicly available. OTC Markets sees the new rule as an opportunity for the SEC to increase and encourage public information by Issuers.
Although OTC Markets does not address this in its letter, one of the SEC’s reasons behind previously prohibiting public information was to ensure that only qualified investors had access to such information. However, in the proverbial “throw the bath water out with the baby,” the result was an influx of private secondary markets (such as pre-IPO Facebook) where everyone could see the trading of a security but only a qualified few could access information related to the Issuer. The new 506(c) is a tremendous shift whereby everyone can access the public information but only a qualified investor can make the actual investment.
OTC Markets rightfully points out that “[Public] availability of company information builds trust in our capital markets and provides vital protection against fraud.”
OTC Markets Comments on Proposed 506 Ban for Form D Noncompliance
The SEC has proposed a rule whereby Issuers would be banned from Rule 506 offerings for one year if that Issuer has failed to comply with the Form D filing requirements within the past 5 years. OTC Markets points out—and I couldn’t agree more—that the complexity of the Form D filing requirements, especially if the advance Form D is required, will lead to substantial technical noncompliance by well-intentioned Issuers. The one-year penalty is an overly severe punishment, especially in the environment of changing rules and regulations.
The Author
Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the host of LawCast.com, the securities law network.
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Legal & Compliance, LLC 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.
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« SEC Has Approved A Two-Year Tick Size Pilot Program For Smaller Public Companies SEC Proposed Executive Compensation Clawback Rules »
SEC Has Approved A Two-Year Tick Size Pilot Program For Smaller Public Companies
On May 6, 2015 the SEC approved a two-year pilot program with FINRA and the national securities exchanges that will widen the minimum quoting and trading increments, commonly referred to as tick sizes, for the stocks of smaller public companies. The goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks.
The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading. If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies. The other side of the coin is that larger spreads and more profit for the traders equates to increased costs to the investors whose accounts are being traded.
The tick size program includes companies that meet the following $3 billion or less in market capitalization, an average trading volume of one million shares or less, and a volume weighted average price of at least $2.00 for every trading day. The pilot study group includes a control group of 1400 securities and three test groups with 400 securities in each. Notably, the tick size program will not include micro-cap securities with a weighted average price of less than $2.00 per day.
During the pilot the control group will be quoted at the current tick size increment of $.01 per share and will trade at the currently permitted increments. The first test group will be quoted in increments of $.05 but will continue to trade at any price increment that is currently permitted. The second test group will be quoted in increments of $.05 and will also trade at $.05 minimum increments subject to certain exceptions. The third test group will be quoted in increments of $.05 and will be subject to an additional “trade at” requirement to prevent price matching. The third test group will have the same exceptions as the second and an additional block size exception.
Background and Reasoning for the Program
Since the inception of decimalization in 2001 and minimum price variation of one penny for exchange-traded companies, there has been a significant change in the nature of trading and role of market participants. Many market participants believe that underwriters and market makers have lost their incentive to make markets and produce research for micro-, small- and mid-capitalization companies.
The JOBS Act directed the SEC to conduct a study and report to Congress on how decimalization affected the number of IPO’s and the liquidity and trading of stock in smaller public companies. The JOBS Act also gives the SEC the authority to designate a minimum increment for the trading of emerging growth companies that is more than $.01 but less than $.10. In July 2012 the SEC submitted the “Decimalization Report” to Congress, failing to reach a firm conclusion and instead realizing further research was needed, including by pursuing a pilot program to study the impact of wider tick sizes. The SEC believes that the current approved tick size pilot program will provide the necessary information to determine whether to permanently change tick sizes for these smaller companies.
As mentioned, the goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks. The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading. If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies. Moreover, additional market makers may enter the market as they see an opportunity to earn value. Additional market makers will equate to additional liquidity, which in turn attract more investors.
Issuers benefit from increased liquidity and market activity and quality in several ways. More trading activity and increased investor awareness could reduce the company’s cost of capital and improve opportunities to attract capital. That is, more investors will be willing to invest directly into the company, through PIPE transactions, registered secondary offerings, equity lines and the like as they will see a strong exit strategy. Moreover, with higher liquidity and market value, the ultimate exit by these investors will have less of a downward impact on trading price. Where the investment instrument was convertible (such as convertible debt, warrants and options) using a market price formula, less downward pressure on trading price will mean fewer shares will need to be issued in the conversion and the existing shareholders will suffer less dilution.
In addition, one of the main purposes of going public is to use capital stock as currency in making acquisitions and attracting key executives. Where the company has an active trading market, market maker support and strong liquidity, the value of the capital stock is likewise higher. Not only will the capital cost of making stock-based acquisitions and attracting and retaining high-quality key executives be reduced but for some issuers, it will make the difference of being able to utilize this benefit of being public at all.
Although there is no doubt that improved liquidity, market activity and market maker and underwriter support is extremely beneficial to all public companies, and in serious need for improvement for smaller public companies, it is not known whether the increased tick size will have the desired outcome.
The other side of the coin is that larger spreads and more profit for the traders with the increased tick size equates to increased costs to the investors whose accounts are being traded. Moreover, the program itself will be complex and costly to implement for market participants. Market participants have stringent rules to follow for each test group to ensure a valid test result. Each participant must adopt written policies and procedures and monitor and report results.
Conclusion
It is important that the SEC and market participants actively seek to improve the market quality for smaller public companies, and this is just one measure in that wheelhouse. However, it is a two-year program. I’m anxious to see more timely efforts in this arena, such as through the launch of venture exchanges.
The Author
Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the host of LawCast.com, the securities law network.
Contact Legal & Compliance LLC. Technical inquiries are always encouraged.
Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.
Download our mobile app at iTunes and Google Play.
Legal & Compliance, LLC 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 Legal & Compliance, LLC 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.
© Legal & Compliance, LLC 2015
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