Regulation S-K Archives - Reverse-Merger.com

SEC Proposes Rules to Modernize and Simplify Disclosures

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

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

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 In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.”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rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded.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

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

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

Proposed Amendments

A. Description of Property (Item 102)

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

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

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

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

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

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

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

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

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

E. Corporate Governance (Item 407)

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

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

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

G. Risk Factors (Item 503(c))

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

H. Plan of Distribution (Item 508)

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

I. Undertakings (Item 512)

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

J. Exhibits (Item 601)

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

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

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

K. Incorporation by Reference

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

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

L. Forms

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

M. XBRL

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

Further Reading on the FAST Act

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

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

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

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

Further Background on SEC Disclosure Effectiveness Initiative

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

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

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

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

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

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

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

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

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

The Author

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

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

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

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

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.

« NASDAQ Issues Report Advocating for The U.S. Public Markets Emerging Growth Companies Will Start To Grow Up »

Recommendations Of SEC Government-Business Forum On Small Business Capital Formation

Posted by Securities Attorney Laura Anthony | May 23, 2017 Tags: ATS Registration, Blue Sky Pre-Emption, Finra, Form S-3, NASAA, Non-GAAP Accounting Standards, OTC Markets, Regulation A, Regulation CF, Regulation S-K, Rule 144, Rule 147, Rule 147A, Rule 15C2-11, Rule 504, Rule 506(b) Offerings, SEC, SEC Advisory Committee, SEC Office of Small Business Policy, SEC Rule 15c2-11, Section 4(a)(2), Small Business Capital Formation, Smaller Reporting Companies

In early April, the SEC Office of Small Business Policy published the 2016 Final Report on the SEC Government-Business Forum on Small Business Capital Formation, a forum I had the honor of attending and participating in. As required by the Small Business Investment Incentive Act of 1980, each year the SEC holds a forum focused on small business capital formation. The goal of the forum is to develop recommendations for government and private action to eliminate or reduce impediments to small business capital formation.

The forum is taken seriously by the SEC and its participants, including the NASAA, and leading small business and professional organizations. The forum began with short speeches by each of the SEC commissioners and a panel discussion, following which attendees, including myself, worked in breakout sessions to drill down on specific issues and suggest changes to rules and regulations to help support small business capital formation, as well as the related, secondary trading markets. In particular, the three breakout groups were on exempt securities offerings; smaller reporting companies; and the secondary market for securities of small businesses.

Each breakout group is given the opportunity to make recommendations. The recommendations were refined and voted upon by the forum participants in the few months following the forum and have now been released by the SEC in a report containing all 15 final recommendations. In the process, the participants ranked the recommendations by whether it is likely the SEC will give high, medium, low or no priority to each recommendation.

Recommendations often gain traction. For example, the forum first recommended reducing the Rule 144 holding period for Exchange Act reporting companies to six months, a rule which was passed in 2008. Last year the forum recommended increasing the financial thresholds for the smaller reporting company definition, and the SEC did indeed propose a change following that recommendation. See my blog HERE for more information on the proposed change. Also last year the forum recommended changes to Rule 147 and 504, which recommendations were considered in the SEC’s rule changes that followed. See my blog HERE for information on the new Rule 147A and Rule 147 and 504 changes.

Forum Recommendations

The following is a list of the recommendations listed in order or priority. The priority was determined by a poll of all participants and is intended to provide guidance to the SEC as to the importance and urgency assigned to each recommendation. I have included my comments and commentary with the recommendations.

As recommended by the SEC Advisory Committee on Small and Emerging Companies, the SEC should (a) maintain the monetary thresholds for accredited investors; and (b) expand the categories of qualification for accredited investor status based on various types of sophistication, such as education, experience or training, including, but not limited to, persons with FINRA licenses, CPA or CFA designations, or management positions with issuers. My blog on the Advisory Committee on Small and Emerging Companies’ recommendations can be read HERE. Also, to read on the SEC’s report on the accredited investor definition, see HERE.
The definition of smaller reporting company and non-accelerated filer should be revised to include an issuer with a public float of less than $250 million or with annual revenues of less than $100 million, excluding large accelerated filers; and to extend the period of exemption from Sarbanes 404(b) for an additional five years for pre- or low-revenue companies after they cease to be emerging-growth companies. See my blog HERE for more information on the current proposed change to the definition of smaller reporting company and HERE related to the distinctions between a smaller reporting company and an emerging-growth company.
Lead a joint effort with NASAA and FINRA to implement a private placement broker category including developing a workable timeline and plan to regulate and allow for “finders” and limited intermediary registration, regulation and exemptions. I think this topic is vitally important. The issue of finders has been at the forefront of small business capital formation during the 20+ years I have been practicing securities law. The topic is often explored by regulators; see, for example, the SEC Advisory Committee on Small and Emerging Companies recommendations HERE and a more comprehensive review of the topic HERE which includes a summary of the American Bar Association’s recommendations.

Despite all these efforts, it has been very hard to gain any traction in this area. Part of the reason is that it would take a joint effort by FINRA, the NASAA and both the Divisions of Corporation Finance and Trading and Markets within the SEC. This area needs attention. The fact is that thousands of people act as unlicensed finders—an activity that, although it remains illegal, is commonplace in the industry. In other words, by failing to address and regulate finders in a workable and meaningful fashion, the SEC and regulators perpetuate an unregulated fringe industry that attracts bad actors equally with the good and results in improper activity such as misrepresentations in the fundraising process equally with the honest efforts. However, practitioners, including myself, remain committed to affecting changes, including by providing regulators with reasoned recommendations.

The SEC should adopt rules that pre-empt state registration for all primary and secondary trading of securities qualified under Regulation A/Tier 2, and all other securities registered with the SEC. I have been a vocal proponent of state blue sky pre-emption, including related to the secondary trading of securities. Currently, such secondary trading is usually achieved through the Manual’s Exemption, which is not recognized by all states. There is a lack of uniformity in the secondary trading market that continues to negatively impact small business issuers. For more on this topic, see my two-part blog HERE and HERE.
Regulation A should be amended to: (i) pre-empt state blue sky regulation for all secondary sales of Tier 2 securities (included in the 4th recommendation above); (ii) allow companies registered under the Exchange Act, including at least business development companies, emerging-growth companies and smaller reporting companies, to utilize Regulation A (see my blog on this topic, including a discussion of a proposed rule change submitted by OTC Markets, HERE ); and (iii) provide a clearer definition of what constitutes “testing-the-waters materials” and permissible media activities.
Simplify disclosure requirements and costs for smaller reporting companies and emerging-growth companies with a principles-based approach to Regulation S-K, eliminating information that is not material, reducing or eliminating non-securities-related disclosures with a political or social purpose (such as pay ratio, conflict minerals, etc.), making XBRL compliance optional and harmonizing rules for emerging-growth companies with smaller reporting companies. For more on the ongoing efforts to revise Regulation S-K, including in manners addressed in this recommendation, see HERE and for more information on the differences between emerging-growth companies and smaller reporting companies, see HERE.
Mandate comparable disclosure by short sellers or market makers holding short positions that apply to long investors, such as through the use of a short selling report on Schedule 13D.
The SEC should provide scaled public disclosure requirements, including the use of non-GAAP accounting standards that would constitute adequate current information for entities whose securities will be traded on secondary markets. This recommendation came from the secondary market for securities of small businesses breakout group. I was part of the smaller reporting companies breakout group, so I did not hear the specific discussion on this recommendation. However, I do note that Rule 144 does provide for a definition of adequate current public information for companies that are not subject to the Exchange Act reporting requirements. In particular, Rule 144 provides that adequate current public information would include the information required by SEC Rule 15c2-11 and OTC Markets specifically models its alternative reporting disclosure requirements to satisfy the disclosures required by Rule 15c2-11.
The eligibility requirements for the use of Form S-3 should be revised to include all reporting companies. For more on the use of Form S-3, see my blog HERE.
The SEC should clarify the relationship of exempt offerings in which general solicitation is not permitted, such as in Section 4(a)(2) and Rule 506(b) offerings, with Rule 506(c) offerings involving general solicitation in the following ways: (i) the facts and circumstances analysis regarding whether general solicitation is attributable to purchasers in an exempt offering should apply equally to offerings that allow general solicitation as to those that do not (such that even if an offering is labeled 506(c), if in fact no general solicitation is used, it can be treated as a 506(b); and (ii) to clarify that Rule 152 applies to Rule 506(c) so that an issuer using Rule 506(c) may subsequently engage in a registered public offering without adversely affecting the Rule 506(c) exemption. I note that within days of the forum, the SEC did indeed issue guidance on the use of Rule 152 as applies to Rule 506(c) offerings, at least as relates to an lternative trading systemintegration analysis between 506(b) and 506(c) offerings. See my blog HERE.
The SEC should amend Regulation ATS to allow for the resale of unregistered securities including those traded pursuant to Rule 144 and 144A and issued pursuant to Sections 4(a)(2), 4(a)(6) and 4(a)(7) and Rules 504 and 506.
The SEC should permit an ATS to file a 15c2-11 with FINRA and review the FINRA process to make sure that there is no undue burden on applicants and issuers. An ATS is an “alternative trading system.” The OTC Markets’ trading platform is an ATS. This recommendation would allow OTC Markets to directly file 15c2-11 applications on behalf of companies. A 15c2-11 application is the application submitted to FINRA to obtain a trading symbol and allow market makers to quote the securities of companies that trade on an ATS, such as the OTC Markets. Today, only market makers seeking to quote the trading in securities can submit the application. Also today, the application process can be difficult and lack clear guidance or timelines for the market makers and companies involved. This process definitely needs attention and this recommendation would be an excellent start.
Regulation CF should be amended to (i) permit the usage of special-purpose vehicles so that many small investors may be grouped together into one entity which then makes a single investment in a company raising capital under Regulation CF; and (ii) harmonize the Regulation CF advertising rules to avoid traps in situations where an issuer advertises or engages in general solicitations under Regulation A or Rule 506(c) and then converts to or from a Regulation CF offering.
The SEC should provide greater clarity on when trading activities require ATS registration, and when an entity or technology platform needs to a funding portal, broker-dealer, ATS and/or exchange in order to “be engaged in the business” of secondary trading transactions.
Reduce the Rule 144 holding period to 3 months for reporting companies. I fully support this recommendation.

The Author

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

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

« Road Shows FINRA Proposes New Registration And Examination Rules »

SEC Issues Final Rules Requiring Links To Exhibits

Posted by Securities Attorney Laura Anthony | April 11, 2017 Tags: EDGAR filings, EDGAR system, Item 601 Of Regulation S-K, Regulation S-K, SEC Advisory Committee, SEC Advisory Committee on Small and Emerging Companies, SEC Issues Final Rules Requiring Links To Exhibits, Small Reporting Company

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

The SEC first proposed the rule change on August 31, 2016, as discussed in my blog HERE. The new rule continues the SEC’s Division of Corporation Finance’s ongoing Disclosure Effectiveness Initiative. I anticipate that this initiative will not only continue but gain traction in the coming years under the new administration as, hopefully, more duplicative, antiquated and immaterial requirements come under scrutiny. At the end of this blog, I include an up-to-date summary of the proposals and request for comment related to the ongoing Disclosure Effectiveness Initiative.

Background

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

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

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

Rule Amendments

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

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

Currently exhibits may be filed in the EDGAR system in either ASCII or HTML format. HTML format allows for hyperlinks to another place within the same document or to a separate document. ASCII does not support such hyperlinks. Over the years HTML has become the standard used for EDGAR filings, with 99% of filings in 2015 using HTML. The rule amendment will now prohibit the use of ASCII for exhibits and require only HTML with the newly required hyperlinks.

In addition, the rule changes include conforming changes to Rule 105 of Regulation S-T. Rule 105 sets forth the limitations and liabilities for the use of hyperlinks. Rule 105 allows hyperlinks to other documents within the same filing or previously filed documents on EDGAR but prohibits hyperlinks to sites, locations, or documents outside the EDGAR system.

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

Further Background

I have been keeping an ongoing summary of the SEC’s ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. However, I note that with the recent election, and the GOP sweeping control of both the House and Senate, it is unclear what the future of these initiatives holds.

On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format. See my blog HERE on the Item 601 proposed changes.

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

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

Click Here To Print- PDF Printout SEC Issues Final Rules Requiring Links To Exhibits

The Author

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

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

« The Acting SEC Chair Has Trimmed Enforcement’s Subpoena Power SEC Adopts The T+2 Trade Settlement Cycle »

SEC Eliminates The “Tandy Letter”

Posted by Securities Attorney Laura Anthony | December 20, 2016 Tags: Reg S-K, Regulation S-K, Regulation S-X, responding to sec comments, SEC Comment Letter, sec comment process, SEC Response Letter, Tandy Language, Tandy Letter

ABA Journal’s 10th Annual Blawg 100

——————————————————————————————————

On October 5, 2016, the SEC Division of Corporation Finance (CorpFin) announced that, effective immediately, it would no longer require companies to include “Tandy” letter representations in comment letter response or registration acceleration requests addressed to the SEC.

Background

Beginning in the 1970s the SEC began to require an affirmative statement from the company acknowledging that the company cannot use the SEC’s comment process as a defense in any securities-related litigation. Named after the first company required to provide the affirmations, this language is referred to as a “Tandy” letter. By 2004 the “Tandy” letter was required in all comment letter responses to the SEC as well as registration acceleration requests. The “Tandy” portion of a response was required to be agreed to by the company itself, so if the response letter was on attorney letterhead, a signature line was required to be included for the company or the company could submit a separate letter. The Tandy language for an Exchange Act filing was as follows:

The company acknowledges that:

the company is responsible for the adequacy and accuracy of the disclosure in the filing;

staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and

the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

Tandy language for a Securities Act registration statement was as follows:

The company acknowledges the following:

Should the commission or the staff, acting pursuant to delegated authority, declare the filing effective, it does not preclude the commission from taking any action with respect to the filing;

the action of the Commission or the staff, acting pursuant to the delegated authority, in declaring the filing effective does not relieve the company from its full responsibility for adequacy and accuracy of the disclosure in the filing; and

the company may not assert staff comments and the declaration of effectiveness as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

The End of Tandy Letters

On October 5, 2016, CorpFin announced that it would no longer require companies to include “Tandy” letter representations in comment letter response or registration acceleration requests addressed to the SEC. In its release the SEC notes that “while it remains true that companies are responsible for the accuracy and adequacy of the disclosure in their filings, the staff does not believe that it is necessary for them to make the affirmative representations in their filing review correspondence.”

Rather than require “Tandy” representations, the SEC will now include the following statement in all comment letters:

We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff.

The end of the “Tandy” letter requirements was effective on October 5, 2016. As the requirement was a staff policy and not a rule, no rule release or other formal publication from the SEC was required.

Although the written “Tandy” letter is no longer required, the meaning of the words has not changed. That is, regardless of the writing, a company may still not assert staff comments, the clearing of such comments, or the fact of an SEC review of any filing, as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.

As a securities attorney it is important to educate clients on what the comment and review process means, and does not mean. The purpose of a review by CorpFin is to ensure compliance with the disclosure requirements under the federal securities laws, including Regulation S-K and Regulation S-X, and to enhance such disclosures as to each particular issuer. CorpFin will also be cognizant of the antifraud provisions of the federal securities laws and may refer a matter to the Division of Enforcement where material concerns arise over the adequacy and accuracy of reported information or other securities law violations, including violations of the Section 5 registration requirements. CorpFin has an Office of Enforcement Liason in that regard.

However, neither the SEC nor CorpFin evaluates the merits of any transaction or makes an assessment or determination as to whether a transaction or company is appropriate for any particular investor or the marketplace as a whole. The purpose of a review is to ensure compliance with the disclosure requirements of the securities laws. In that regard, CorpFin may ask for increased risk factors and clear disclosure related to the merits or lack thereof of a particular transaction, but they do not assess or comment upon those merits beyond the disclosure.

As the “Tandy” Letter made clear to companies, they are still responsible for the contents of their filings, and both private litigation and enforcement proceedings may be brought regardless of an SEC review. With the end of the “Tandy” Letter, it is incumbent upon SEC counsel to remind clients of their obligations and the role of the SEC.

Further Reading

For further reading on the comment and review process, see my blog HERE .

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

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

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

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Cracks Down On Failure To File 8-K For Financing Activities; An Overview Of Form 8-K SEC Proposes Shortening Trade Settlement »

SEC Issues Proposed Amendments To Item 601 Of Regulation S-K Related To Exhibits

Posted by Securities Attorney Laura Anthony | September 20, 2016 Tags: Item 601 Of Regulation S-K, Regulation S-K, SEC

This newest proposed rule change to Regulation S-K is part of the SEC Division of Corporation Finance’s Disclosure Effectiveness Initiative. At the end of this blog, I include an up-to-date summary of the proposals and request for comment related to the ongoing Disclosure Effectiveness Initiative.

Background

Companies are allowed to reference exhibits filed in prior filings as opposed to refiling the exhibit with the SEC. The current proposed rule amendment is limited to the presentation of such information and, in particular, including a hyperlink to the actual filed exhibit. I suspect the SEC shall issue further amendments related to exhibits as it continues its initiative and rule changes related to Regulation S-K.

Proposed Amendments

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

The proposed rule change would require companies to include a hyperlink to each filed exhibit on the exhibit index for virtually all filings made with the SEC, including XBRL exhibits. An active hyperlink would be required in all filings made under the Securities Act or Exchange Act, provided however, that if the filing is a registration statement, the active hyperlinks need only be included in the version that becomes effective.

Currently exhibits may be filed in the EDGAR system in either ASCII or HTML format. HTML format allows for hyperlinks to another place within the same document or to a separate document. ASCII does not support such hyperlinks. Over the years HTML has become the standard used for EDGAR filings, with 99% of filings in 2015 using HTML. The current proposed rule would prohibit the use of ASCII for exhibits and require onlyHTML with the newly required hyperlinks.

In addition, the proposed rule changes would include conforming changes to Rule 105 of Regulation S-T. Rule 105 sets forth the limitations and liabilities for the use of hyperlinks. Rule 105 allows hyperlinks to other documents within the same filing or previously filed documents on EDGAR but prohibits hyperlinks to sites, locations, or documents outside the EDGAR system.

Further Background

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE. On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE.

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

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

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

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

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Requests Comment On Changes To Subpart 400 To Regulation S-K SEC Whistleblower Awards Pass $100 Million As It Continues To Crack Down On Confidentiality Provisions In Employment Agreements »

SEC Requests Comment On Changes To Subpart 400 To Regulation S-K

Posted by Securities Attorney Laura Anthony | September 13, 2016 Tags: Fast Act, Regulation S-K, Regulation S-X, SEC, Smaller Reporting Company, Subpart 400, The Fast Act

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. The request for comment is part of the ongoing SEC Division of Corporation Finance’s Disclosure Effectiveness Initiative and as required by Section 72003 of the FAST Act.

Background

The topic of disclosure requirements under Regulations S-K and S-X as pertains to financial statements and disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) has come to the forefront over the past couple of years. The purpose of the Disclosure Effectiveness Initiative is to assess whether the business and financial disclosure requirements continue to provide the information investors need to make informed investment and voting decisions.

Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.

In addition to affecting companies filing registration statements (including on Form 1-A in a Regulation A/A+ offering) and those filing reports with the SEC, any changes to Regulations S-K or S-X will affect acquired entities, acquirees, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.

In accordance with its mandate under Section 72003 of the FAST Act, the SEC is studying and seeking comment to:

Determine how to modernize and simplify disclosure requirements to reduce the costs and burdens to the company while still providing all material and necessary information to investors;

Further a principles-based approach whereby companies and their management can determine the relevancy and materiality of information provided instead of just including boilerplate language or filling space to meet a static requirement. Of course, this needs to be balanced with the need to ensure completeness and comparability of information among different companies; and

Evaluate information delivery methods and explore ways to eliminate repetition and the disclosure of immaterial information.

Request for Comment

Subpart 400 of Regulation S-K, including Items 401 through 407, require disclosures on directors, executive officers, control persons and promoters; executive compensation; security ownership of certain beneficial owners and management; transactions with related persons, promoters and control persons; ethics and corporate governance.

The SEC’s request for comment does not provide any commentary about particular concerns, thoughts, or questions by the SEC, but is a short general request on “existing requirements in these rules as well as on potential disclosure issues that commenters believe the rules should address.”

Overview of Subpart 400

Item 401 – Directors, Executive Officers, Promoters and Control Persons

Item 401 of Regulation S-K requires the disclosure of the identity and ages of all directors and persons nominated to become a director. In addition, Item 401 requires disclosure of all positions held at the company by that director or nominee, their term of office, and any arrangement or understanding between that person and another person “pursuant to which he was or is to be selected as a director or nominee.” The instructions provide some clarity. Compensation for service as a director is not included in arrangements with other persons. A person must consent to being included as a nominee. No information need be provided on an outgoing director.

Item 401 requires the disclosure of the identity and ages of all executive officers. In addition, Item 401 requires disclosure of all positions held at the company by that executive officer, their term of office, and any arrangement or understanding between that person and another person pursuant to which he was or is to be selected as an officer. A person must consent to being included as an executive officer.

For a first-time registration statement or a registration statement by a company not subject to the reporting requirements under the Securities Exchange Act, Item 401 requires the identification of certain significant employees – in particular, where a person is not an executive officer but otherwise makes a significant contribution to the company’s business. The same information required for executive officers is required for significant employees. Similarly, for a first-time registration statement or registration statement by a company that has not been subject to the reporting requirements for at least 12 months, the same information must be provided for promoters and control persons.

In addition, family relationships, business experience for the past five years, and disclosures of certain legal proceedings must be made for each director and executive officer. The legal proceeding disclosure is a scaled-down version of the bad-actor requirements found elsewhere in the rules, such as Rule 506 and Regulation A. Also, Item 401 requires disclosure of bankruptcy proceedings involving the person or a company for which they were an executive officer during the past five years.

Item 402 – Executive Compensation

An entire treatise could be written on Item 402. From a high level, Item 402 requires disclosure of all compensation awarded to, earned by, or paid to a company’s executive officers and directors. Item 402 also requires disclosures related to pay ratio and require “say on pay” advisory votes. See my blog HERE.

Compensation must be disclosed in tabular form and is meant to encompass any and all benefits received by an executive officer or director, including salary, bonuses, stock awards (including under a plan or not, qualified or non-qualified), option awards, non-equity incentive plans, pension value, benefits, perquisites and all other forms of compensation. Moreover, Item 402 requires a compensation discussion and analysis explaining the presented information.

Item 402 requires details of outstanding stock awards and options, including exercise dates and prices, the market value of underlying securities and vesting schedules. Detailed information is also required regarding pension benefits.

Emerging-growth and smaller reporting companies provide a scaled-down disclosure under Item 402. For details on the Item 402 scaled-down requirements related to emerging growth and smaller reporting companies, see my blog HERE.

Item 403 – Security Ownership of Certain Beneficial Owners and Management

Item 403 requires disclosure of the security ownership of officers, directors and 5% or greater shareholders, including the beneficial owner or natural person behind any entity ownership. Ownership is disclosed in tabular form and includes name, address, number of securities owned and percentage owned of that class. Item 403 requires disclosure of all classes of outstanding equity regardless of whether such class is registered or publicly trades.

Item 404 – Transactions with Related Persons, Promoters, and Certain Control Persons

Item 404 requires the disclosure of material related party transactions. For purposes of Item 404, related parties include officers or officer nominees, directors or director nominees, a family member of a director or executive office, 5% or greater shareholders, or any person that has a direct or indirect material interest in the company. Companies other than emerging-growth or smaller reporting companies must also disclose the company’s policy for the review, approval or ratification of related party transactions. Item 404 also requires the disclosure of compensations, assets or benefits to be received by promoters where the company is filing an S-1 or Form 10 registration statement.

A “promoter” has a specific definition in the securities laws and is not tied to stock promotion in the sense that many may think. A “promoter” is defined in Rule 405 of the Securities Act as including:

(1) Any person who, acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer; or

(2) Any person who, in connection with the founding and organizing of the business or enterprise of an issuer, directly or indirectly receives in consideration of services or property, or both services and property, 10 percent or more of any class of securities of the issuer or 10 percent or more of the proceeds from the sale of any class of such securities. However, a person who receives such securities or proceeds either solely as underwriting commissions or solely in consideration of property shall not be deemed a promoter within the meaning of this paragraph if such person does not otherwise take part in founding and organizing the enterprise.

(3) All persons coming within the definition of promoter in paragraph (1) of this definition may be referred to as founders or organizers or by another term provided that such term is reasonably descriptive of those persons’ activities with respect to the issuer.

Item 404 expands the definition of promoter to include “any person who acquired control of a registrant that is a shell company, or any person that is part of a group, consisting of two or more persons that agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of a registrant, that acquired control of a registrant that is a shell company.”

Item 405 – Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act requires the filing of Forms 3 and 4 by officers, directors or 10%-or-greater shareholders. For a review of the Section 16 filing requirements, see my blog HERE. Item 405 requires a company to disclose failures to meet these filing requirements.

Item 406 – Code of Ethics

Item 406 requires a company to disclose whether it has adopted a code of ethics for the executive officers and accounting controller. A copy of the code of ethics must also be filed with the SEC and included on the company’s website.

Item 407 – Corporate Governance

Item 407 requires disclosure of corporate governance standards, including those related to director independence; board committees, including audit compensation, and nominating committees; and annual meeting attendance. Item 407 requires detailed information for each category of corporate governance as well as the policies and procedures of each board committee.

Further Background

The request for comment follows the July 13, 2016 proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. That proposed rule change followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept ReleaseHERE and HERE.

As part of the same initiative on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.

Prior to the S-K Concept Release and current Regulation S-K and S-X proposed amendments, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

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

The Author

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

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

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

Download our mobile app at iTunes.

« FinCEN Updates Due Diligence Rules SEC Issues Proposed Amendments To Item 601 Of Regulation S-K Related To Exhibits »

SEC Issues Proposed Regulation S-K and S-X Amendments

Posted by Securities Attorney Laura Anthony | August 9, 2016 Tags: Regulation S-K, Regulation S-K Amendments, Regulation S-X, Regulation S-X Amendments, S-K Amendments, S-X Amendments, SEC

On July 13, 2016, the SEC issued a 318-page proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). The proposed rule changes follow the 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

The proposed S-K and S-X Amendments are intended to facilitate the disclosure of information to investors while simplifying compliance efforts by companies. The proposed S-K and S-X Amendments come as a result of the Division of Corporation Finance’s Disclosure Effectiveness Initiative and as required by Section 72002 of the FAST Act. Prior to the issuance of these S-K and S-X Amendments, on June 27, 2016, as part of the same initiative, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The S-K and S-X Amendments also seek comment on certain disclosure requirements that overlap with U.S. GAAP and possible recommendations to FASB, the regulatory body that drafts and implements GAAP, for conforming changes.

Background

The topic of disclosure requirements under Regulations S-K and S-X as pertains to financial statements and disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) has come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.

In addition to affecting companies filing registration statements (including on Form 1-A in a Regulation A/A+ offering) and those filing reports with the SEC, the proposed S-K Amendments will affect acquired entities, acquirees, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.

The underlying basis of the disclosures required by Regulations S-K and S-X is to keep shareholders and the markets informed on a regular basis in a transparent manner. Reports and registration statements filed with the SEC can be viewed by the public on the SEC EDGAR website. A reporting company also has record-keeping requirements, must implement internal accounting controls and is subject to the Sarbanes-Oxley Act of 2002, including the CEO/CFO certification requirements. Under the CEO/CFO certification requirement, the CEO and CFO must personally certify the content of the reports filed with the SEC and the procedures established by the issuer to report disclosures and prepare financial statements. For more information on that topic, see my blog HERE.

The proposed S-K and S-X Amendments cover:

Duplicative requirements, including duplications between financial footnote requirements and disclosures in the body of a registration statement or report;

Overlapping requirements which may not be completely duplicative. The S-K Amendments consider whether to delete certain disclosure requirements that are covered in GAAP or other financial reporting or integrate such disclosures into a single rule source;

Outdated requirements which have become obsolete due to the passage of time or changes regulations, business or technology; and

Superseded requirements which are inconsistent with recent legislation or updated rules and regulations.

Redundant or Duplicative Reporting Requirements

The proposed S-K and S-X Amendments seek to eliminate a laundry list of 26 redundant and duplicative disclosures. Most of these proposed changes are technical and nuanced related to particular Regulation S-X GAAP and other financial statement disclosures—for example, foreign currency; financial statement consolidation, income tax disclosures, contingencies and interim accounting adjustments. As the proposed rule eliminations are duplicative, they will not change the financial reporting or disclosure requirements.

Overlapping Requirements

Similar to redundant and duplicative disclosures, the SEC has identified numerous disclosure requirements that are related to, but not exactly the same as, GAAP, IFRS and other SEC disclosure obligations. The Regulation S-K and S-X Amendments propose to delete, scale back or integrate the overlapping disclosures to eliminate the overlap.

The SEC category of overlapping disclosures, and related Regulation S-K and S-X Amendments, have added broad considerations for which the SEC is seeking public comment. In particular, some of the proposed changes would result in the relocation of disclosures in the filings. This raises considerations related to the prominence of information in a particular report and moving information from outside to inside financial statements.

When information is in a different location in a report, it may receive more or less attention and be thought of as more or less prominent. Moreover, information inside of financial statements is subjected to audit and interim review, internal control over financial reporting and XBRL tagging. In addition, information inside of financial statements is not subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995 related to forward-looking statements.

A complete detail of all the proposed Regulation S-K and S-X Amendment changes related to overlapping disclosures is beyond the scope of this blog; however, a few items deserve discussion.

In general, many of the changes proposed by the SEC relate to interim financial reporting. In some cases where items are fully required to be reported in a Form 8-K, annual report or management discussion and analysis (MD&A), the SEC proposes eliminating the same or similar requirement from interim financial statements.

For example, the SEC proposes eliminating significant business combination pro forma financial statement requirements from interim financial statements for smaller reporting companies and Regulation A filers. The pro forma financial statements are already sufficiently required by Item 9.01 of Form 8-K. Likewise, the SEC makes the same proposed elimination of financial reporting in interim reports for a significant business disposition or discontinued operation.

As another example, currently Regulation S-X requires disclosure of certain subsequent events in the footnotes to interim financial statements and Item 303 of Regulation S-K related to management discussion and analysis (MD&A) requires substantially the same disclosure. The SEC proposes to delete the Regulation S-X requirement and only require disclosure of these subsequent events in the MD&A. Likewise, the SEC proposes eliminating segment financial information from the footnotes and leaving it only in MD&A.

In other cases, the SEC supports elimination of a disclosure in the body of a document in favor of a financial statement disclosure. For example, the SEC proposes eliminating a discussion of warrants, rights and convertible instruments from the body of a Form 10 or S-1, noting that a complete disclosure including dilution is required in financial statements.

Outdated Requirements

The SEC has identified disclosure requirement that have become obsolete as a result of time, regulatory, business or technological changes. The Regulation S-K and S-X Amendments propose to amend and sometimes add, but not delete, disclosure as a result of outdated requirements.

Again, most of the outdated requirements are technical (for example, income tax disclosures) in nature and beyond the scope of this blog. Some are common sense; for example, a reference to information being available in the SEC public reference room would be amended to include only a reference to the SEC Internet address for EDGAR filings.

Another common-sense change is the proposal to eliminate the requirement to post the high and low bid or trading prices for each quarter for the prior two fiscal years in an annual 10-K. The SEC reasons that the daily market and trading prices of a security are readily available on a number of websites. Moreover, these websites allow for the download and collation of trading prices over periods of time and provide much more robust information than currently contained in a 10-K.

Superseded Requirements

The constant change in accounting and disclosure requirements and regulations have created inconsistencies in Regulation S-K and S-X. The SEC has gone through and proposed amendments to eliminate such inconsistencies. For example, certain provisions in Regulation S-X still refer to development-stage companies, a concept that was eliminated by FASB in June 2014.

The SEC also took this opportunity to clean up some nonexistent or incorrect references that resulted from regulatory changes over time.

Further Background

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

The Author

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

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

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

Download our mobile app at iTunes.

« SEC Advisory Committee On Small And Emerging Companies Issues Further Recommendations On Accredited Investor Definition SEC Continues Efforts To Prevent Microcap Fraud »

SEC Proposes Amendments To Definition Of “Small Reporting Company”

Posted by Securities Attorney Laura Anthony | July 12, 2016 Tags: Accelerated Filer, Large Accelerated Filer, Non-Accelerated Filer, Regulation S-K, Regulation S-X, Small Reporting Company, Smaller Reporting Company

On June 27, 2016, the SEC published proposed amendments to the definition of “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. The amendments would expand the number of companies that qualify as a smaller reporting company and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The rule change follows the SEC concept release and request for public comment on sweeping changes to the business and financial disclosure requirements in Regulation S-K. Throughout the SEC Concept Release, it referenced the scaled and different disclosure requirements for the different categories of company and affirmed that it was evaluating and considering changes to the eligibility criteria for each.

If the rule change is passed, the number of companies qualifying as a smaller reporting company will increase from 32% to 42% of all reporting companies.

The proposed rule change follows the SEC Advisory Committee on Small and Emerging Companies recommendations to the SEC on the point. In particular, the SEC proposes to amend the definition of a smaller reporting company to include companies with less than a $250 million public float as compared to the $75 million threshold in the current definition. In addition, if a company does not have an ascertainable public float, a smaller reporting company would be one with less than $100 million in annual revenues, as compared to the current threshold of less than $50 million. Once considered a smaller reporting company, a company would maintain that status unless its float drops below $200 million or its annual revenues below $80 million.

In addition, the SEC proposes to change the definition of “accelerated filer” and “large accelerated filer” to eliminate an exclusion from such definitions for smaller reporting companies. That is, the SEC specifically chose not to increase the $75 million threshold in the “accelerated filer” definition. Accordingly, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file its periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002.

In its press release accompanying the proposed rule changes, SEC Chair Mary Jo White was quoted as saying, “[R]aising the financial thresholds in the smaller reporting company definition is intended to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections. The Commission will benefit greatly from the public comments we receive from investors, issuers and other affected market participants on today’s proposal, as well as comments we receive on the Regulation S-K concept release, which will help inform any changes to the scaled disclosure system or other changes to our disclosure requirements.”

Background

The topic of disclosure requirements under Regulation S-K as pertains to disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) have come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC (“Reporting Requirements”). The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner.

The SEC disclosure requirements are scaled based on company size. The SEC established the smaller reporting company category in 2007 to provide general regulatory relief to these entities. A “smaller reporting company” is currently defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter; or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

The following table, copied from the SEC rule release, summarizes the scaled disclosure accommodations available to smaller reporting companies:

The Author

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

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

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

Download our mobile app at iTunes.

« Confidentially Marketed Public Offerings (CMPO) Testing The Waters; Regulation A+ And S-1 Public Offerings – Part 1 »

SEC Issues Concept Release On Regulation S-K; Part 2

Posted by Securities Attorney Laura Anthony | May 17, 2016 Tags: Form 8-K, MD&A, Regulation S-K, Regulation S-X, S-K Concept Release, SEC

On April 15, 2016, the SEC issued a 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements in Regulation S-K (“S-K Concept Release”). This blog is the second part discussing that concept release. In Part I, which can be read HERE, I discussed the background and general concepts for which the SEC provides discussion and seeks comment. In this Part II, I will discuss the rules and recommendations made by the SEC and, in particular, those related to the 100, 200, 300, 500 and 700 series of Regulation S-K.

Background

The fundamental tenet of the federal securities laws is defined by one word: disclosure. In fact, the SEC neither reviews nor opines on the merits of any company or transaction, but only upon the appropriate disclosure, including risks, made by that company. However, excessive rote immaterial disclosure can dilute the material important information regarding that particular company and have the unintended consequence of weakening necessary disclosure to potential investors and the public trading markets.

The SEC non-financial disclosure requirements for both registration statements and reports under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) are found in Regulation S-K.

At the highest level, the purpose of disclosure is to provide investors and the marketplace with information needed to make informed investment and voting decisions. As discussed in the S-K Concept Release, proper disclosure “may lead to more accurate share prices, discourage fraud, heighten monitoring of the managers of companies, and increase liquidity.” Further, effective disclosure should “increase the integrity of securities markets, build investor confidence, and support the provision of capital to the market.”

The SEC seeks comment on hundreds of questions from broad conceptual points to specific rule changes. In many cases the SEC indicates that additional disclosure might be necessary on a particular topic. Although disclosure improvement is the goal, that does not necessarily mean less information and, in many cases, may actually mean more information.

Description of Business and Properties

The SEC believes that the information elicited under Item 101 regarding a description of the company’s business and Item 102 related to the company’s materially important physical properties, provides the necessary foundation needed by investors to make investing and voting decisions. This basic information assists in putting other disclosure items into context. The SEC seeks comment on whether Items 101 and 102 should be eliminated or modified and whether new or different disclosure requirements should be added to these Items.

The Concept Release contains detailed discussion of each of the requirements under Items 101 and 102, including prior comments received from the public and SEC views. Currently Item 101 requires a description of the general development of the company’s business over the past 3 years for smaller reporting companies and 5 years for other classes of company, or such shorter period as the company has been in business. Item 102 requires disclosure of the location and general character of plants, mines and other materially important physical properties.

Examples of information required include disclosure of the basic background of the business such as: (i) the year of formation; (ii) type of entity; (iii) nature and results of any bankruptcy, receivership or similar; (iv) nature and result of any material reclassification, merger or consolidation; (v) the acquisition or disposition of any material assets outside the ordinary course of business; and (vi) material changes to the business operations. In addition, Item 101 requires a narrative description of a company’s business, including 13 specific areas as follows: (i) principal products produced and services rendered; (ii) new products or segments; (iii) sources and availability of raw materials; (iv) intellectual property; (v) seasonality of business; (vi) working capital practices; (vii) dependence on certain customers; (viii) dollar amount of backlog orders believed to be firm; (ix) business subject to renegotiation or termination of government contracts; (x) competitive conditions; (xi) company sponsored research and development activities; (xii) compliance with environmental laws; and (xiii) number of employees.

Smaller reporting companies benefit from several other scaled disclosures from the standard requirements, including: (i) elimination of the requirement to discuss seasonality, working capital practices, backlog or government contracts; (ii) names of principal suppliers; (iii) royalty agreements or labor contracts; (iv) need for government approval for products or services; and (v) effects of existing or probable government regulations.

Emerging growth companies must meet all of the standard requirements. Moreover, keeping in line with the concept of materiality, where a smaller reporting company is in a business that makes any of the standard disclosures material to its business, it must include those discussions, even if not technically required. Accordingly, for example, a smaller reporting company in a cannabis-related industry would need to include a discussion on the need for government approval for products and services, and the effects of existing or probable government regulations on its business, even though the scaled disclosure requirements would not otherwise require such discussion.

As with other areas of discussion, the SEC requests comments on the scaled disclosure requirements and whether the current disparities between requirements related to smaller reporting companies and emerging growth companies should be eliminated.

The SEC discusses eliminating redundancies in the 101 and 102 disclosure requirements. In particular there are several categories in Form 8-K that request the same information elicited in Items 101 and 102 and included in all 10-Q’s and 10-K’s. Information on business background is included in the MD&A discussion and in footnotes to financial statements. Redundancies could be eliminated by allowing cross-referencing, including internal hyperlinks. Moreover, the SEC could, and should, distinguish between new registrants disclosing their business background for the first time, and those that are established reporting companies repeating information again and again.

Many of the detailed requirements may not be relevant in today’s business environment, which differs greatly from even twenty years ago. For instance, many businesses no longer have physical locations or corporate headquarters but rather run through virtual offices. For those businesses, providing a detailed discussion of each location (home office…) would not be relevant and rather could diminish the value of the business discussion. Likewise, businesses in today’s world often outsource or hire independent contractors. Consideration should be given to expanding the requirements to include such independent contractors, or eliminate this requirement altogether where it does not add value to the particular business. For example, it may be important to know that certain companies are scaling back on their workforce, while for others, the information is not relevant.

Likewise, Regulation S-K does not currently address the current reliance on web-based and intellectual property-based assets and as such, additional disclosure items may need to be included. Another area that may need increased disclosure relates to international business operations and reliance on non-U.S.-based assets.

Management Discussion and Analysis

Although many aspects of disclosure are important, I believe none are quite as important as the financial information and future prospects. Regulation S-X contains the actual financial statement disclosure requirements, and Item 303 of Regulation S-K contains the narrative discussion requirements related to that financial information. This management, discussion and analysis (“MD&A”) not only delivers an explanation of the financial statements, but provides a unique opportunity in SEC reporting for a company to illustrate its distinctiveness among a sea of other fish.

MD&A is intended to provide a narrative of a company’s financial statements and future prospects through the eyes of management. The Regulation S-K Concept Release clearly shows the SEC propensity for MD&A to use a principles/materiality approach and to steer away from a recitation of the financial statements themselves. The SEC also recognizes the concerns that a company has in presenting forward-looking information, and in particular, 10b-5 liability if the plans do not turn out as disclosed.

In recent years management has used MD&A to not only explain the financial statements prepared in accordance with Regulation S-X, which in turn is based on US GAAP, but rather to explain away those financial statements. Approximately 90% of companies use MD&A to provide non-GAAP financial metrics to illustrate their financial performance and prospects. As an example, EBITDA is a non-GAAP number often included by management in MD&A. There has been a rise in recent controversy over the use of these non-GAAP numbers, an in-depth discussion of which will be the topic of a future blog.

However, the short version is that 90% of companies use non-GAAP numbers to explain their financial operations and the SEC is pushing back, making a review of the rules related to non-GAAP use a priority. There are very valid reasons for using non-GAAP numbers, such as EBITDA, which is an established indicator of a company’s performance and ability to meet financial obligations. Likewise, certain non-cash balance sheet items, such as derivative liability related to options, warrants, and other convertible instruments, are confusing and often are never realized in a way that has an actual impact on a company’s performance. However, there can be a slippery slope with a company cherry-picking GAAP and non-GAAP numbers to create a picture of financial stability that may not be accurate. I hope that in reviewing this area, the SEC is not myopically stuck on the purity of its view of GAAP, but considers that if 90% of companies find a need to go outside the rules, perhaps the rules themselves needs some adjustment.

Risk Factors

Risk-related disclosures need a thorough review and potential overhaul. Although the SEC has long stated that risk factors should not be boilerplate repetition of items applicable to the market as a whole and not necessarily applicable to a particular company, most companies use boilerplate language. I note that Item 503 contains examples of risks that a company can make related to its offerings, and so, of course, those risks, in boilerplate format, are always included in registration statements and reports.

Currently, risk-related disclosures are currently included in multiple items under Regulation S-K, including Item 503 related to investment risk and Item 305 related to market risk. The focus of the SEC discussion is on aggregating risk information in a more central readable format and improving the content to enhance investors’ ability to evaluate the particular risk factors.

Securities of the Company

Several Items in Regulation S-K address the securities of a company. For example, Item 202 requires a description of the terms and conditions of securities being registered; Item 201 requires disclosure of the number of holders of common securities; Item 701 requires disclosure of sales of unregistered securities and use of proceeds from offerings, and Item 703 requires disclosure of securities re-purchased by a company and its affiliates.

As with other areas, the SEC focuses on whether these disclosures should be modified, increased or eliminated and on the presentation of the information.

The Author

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

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

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

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

Download our mobile app at iTunes.

« SEC Issues Final Rules Implementing The JOBS ACT And Rules On The FAST ACT SEC Issues New C&DI On Use Of Non-GAAP Measures; Regulation G – Part 1 »

Risk Factor Disclosures For Reporting Public Companies

Posted by Securities Attorney Laura Anthony | March 11, 2015 Tags: Item 503, Regulation C, Regulation S-K, Risk Factor Disclosures, Risk Factors, Safe Harbor, Section 21E

A risk factor disclosure involves a discussion of circumstances, trends, or issues that may affect a company’s business, prospects, operating results, or financial condition. Risk factors must be disclosed in registration statements under the Securities Act and registration statements and reports under the Exchange Act. In addition, risk factors must be included in private offering documents where the exemption relied upon requires the delivery of a disclosure document, and is highly recommended even when such disclosure is not statutorily required.

The Importance of Risk Factors

Risk factors are one of the most often commented on sections of a registration statement. The careful crafting of pertinent risk factors can provide leeway for more robust discussion on business plans and future operations, and can satisfy a wide arrange of SEC concerns regarding existing financial and non-financial matters (such as potential default provisions in debt, dilution matters, inadvertent rule violations, etc.).

Although smaller reporting companies are not required to include risk factors in their annual Form 10-K and quarterly Form 10-Q, they may do so voluntarily and we recommend that such risk factors be included in their annual Form 10-K. As a reminder, a “smaller reporting company” is an issuer that is not an investment company or asset-backed issuer or majority-owned subsidiary and that (i) had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter; or (ii) in the case of an initial registration statement, had a public float of less than $75 million as of a date within days of the filing of the registration statement; or (iii) in the case of an issuer whose public float as calculated by (i) or (ii) is zero, had annual revenues of less than $75 million during the most recently completed fiscal year for which audited financial statements are available.

Risk factors, together with safe harbor language regarding forward-looking statements, can provide protection for forward-looking information contained in a document, such as plans and expectations, that do not pan out as expected or intended. Risk factors warn current and potential investors as to the risks of either purchasing or continuing to own the company’s stock. As the securities of smaller reporting companies are often high-risk penny stocks or thinly traded, and such companies tend to be in the business development and growth stage of their corporate life cycle, protections against failed or changed plans is fundamental.

By providing proper disclosure of the material risks associated with investing in a company’s securities, a company can mitigate the risk of liability to its shareholders should that risk come to pass. Risk factors act as an insurance policy and strong defense in the face of shareholder litigation.

The “bespeaks caution” doctrine refers to a line of judicial case law holding that statements of future forecasts, projections and expectations in an offering or other disclosure document are not misleading as long as they contain adequate cautionary language disclosing specific risks. Section 21E of the Exchange Act, enacted as part of the Private Securities Litigation Reform Act of 1995, codifies this doctrine for qualifying issuers. Section 21E provides a public company with a safe harbor defense in securities litigation challenging forward-looking statements. Among other exclusions, companies that issue penny stocks may not rely on Section 21E, but may rely on the “bespeaks caution” line of case law.

To avail itself of the safe harbor protection, the forward-looking statements must be identified and be accompanied by meaningful, cautionary language that identifies important factors that could cause actual results to differ materially from those projected—i.e., risk factors. To provide protection, the risk disclosure must be specific, not just boilerplate.

SEC Rules and Guidance on Risk Factors

Regulation S-K sets forth the non-financial statement disclosure requirements for both the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) and is applicable to both registration statements and ongoing reporting requirements. In addition, Regulation S-K serves as a guide in the preparation of private placement disclosure documents. Items 501 and 503 of Regulation S-K include the requirements for the disclosure of risk factors.

Risk factors must be disclosed in registration statements under the Securities Act and registration statements and reports under the Exchange Act. Item 503 of Regulation S-K requires concise, logically organized statements of the particular risks involving either the company, industry or the offering being made by the company. The statements should be categorized and appear in order of importance under each category. Item 503 requires that the disclosure of risk factors in a registration statement be included in the beginning immediately following the summary section, or if there is no summary section, immediately following the cover page.

Item 501 requires that the risk factor section must be prominently cross-referenced by page number, on the cover page of a registration statement. Most companies comply with this rule by using bold, italics, larger font size or a combination thereof to comply with this rule.

Risk factor disclosures cannot contain countervailing or offsetting language. That is, a company cannot explain away the risk.

Like many areas of securities laws, the SEC gives broad guidance on disclosure, trying to avoid boilerplate language. The SEC requires the reporting company to make relevant risk factor disclosures that are germane, concise and written in plain English. The risk factors should be written as of the date of the report in which they are contained regardless of the period of the financial statements contained in such report. Each risk must have a heading that adequately describes the risk being disclosed and such heading should be bolded, italicized or both. Each risk must be concise and focused on a single material risk. The risks must be easy to read and written in such a way to highlight the most important information.

As mentioned above, the SEC requires that the risks be written in plain English. This requirement is codified in Rule 421(d) of Regulation C. Over the years, the SEC has published and updated plain English handbooks. The SEC plain English guidelines require that the risk factor section contain (i) short sentences; (ii) definitive, concrete, everyday words; (iii) active voice; (iv) tables or bullet point lists, whenever possible; (v) no legal jargon or highly technical business terms; and (vi) no multiple negatives.

Categories of Risk Factors

In general, risk factors pertain to the company, the industry, or the investment or offering. Company risks are those specific to the reporting company such as particular restrictive covenant documents, reliance or dependence on a concentrated source, or a history of losses. Industry risks are particular to the industry of the reporting company, such as technology, manufacturing, textile, or commonly in today’s market, cannabis. Investment or offering risks are those specifically tied to the security or trading market for the company’s securities, such as illiquidity. The risks included in each category should be organized in the order of materiality and importance.

The common broad areas of risk factor disclosure include:

Absence of an operating history;
Absence of revenues;
Absence of profits;
An accumulated deficit;
High degree of leverage (debt);
Dependence on a single or small number of products, suppliers, customers, manufacturers or markets;
Dependence on key personnel;
Dependence on particular financial resources or source of capital;
Early stage of product development;
Competition;
Adequacy of production and/or distribution;
Technological factors such as possible obsolescence;
Capital needs and the lack of adequate current or future funding;
A concentration of voting control in management or others;
The absence of a trading market or a thinly traded, low-priced market;
Litigation;
Governmental regulations;
Foreign operations and the effects of foreign regulations, export laws, and currency fluctuations;
Labor matters;
Intellectual property matters;
Restrictive covenants in contracts; and
Off-balance sheet arrangements

Risks that apply to any issuer or any offering should be avoided. For example, a general statement that an economic downturn would negatively impact a business should not be included; however, a concise statement that a particular economic change, such as a reduction or increase in the federal interest rate (or whatever change impacts the reporting business), and the particular risk associated with that change, could be included. Specific example are encouraged.

Typical SEC Comments on Risk Factors

Risk factors are one of the most often commented on sections of a registration statement or SEC report. These common SEC comments illustrate the SEC’s focus in reviewing risk factor disclosures.

We suggest that you revise your risk factor captions to make your disclosure more meaningful to your investors and shareholders. Some of your risk factors merely state a fact about your business. You should succinctly state in your captions the particular risk that results from the uncertainty.
Some of your risk factors are too vague and generic and do not adequately describe the risk that follows. Readers should be able to read the risk factor heading and come away with a strong understanding of what the risk is and the result of the risk as it specifically applies to you. Revise your subheadings accordingly.
In each risk factor, get to the risk as quickly as possible and provide only enough detail to place the risk in context. In some of your risk factors, the actual risk you are trying to convey does not stand out from the rest of the information.
Avoid presenting risks that could apply to any issuer in your industry, do not reflect your current operations, are not material, or are generic, boilerplate disclosures. Rather, tailor each risk factor to your specific facts and circumstances.
Revise each risk to remove mitigating information.
Consider including a risk factor that addresses XYZ.
Provide the information investors need to assess the magnitude of the risk.
Where possible, quantify the risk.
The introductory paragraph to your risk factors section is not complete, there may be risks that you do not consider material now but may become material, or there may be risks that you have not yet identified. You must disclose all risks that you believe are material at this time.
You include more than one risk under one subheading. Revise to include only one risk under each subheading.

As always, competent legal counsel should be utilized in crafting SEC reports and/or offering disclosure documents.

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.

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.

« SEC Suspends Trading On 128 OTC Markets Companies Penny Stock Rules And Broker Dealers »