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Applying the Howey Test to the DAO Tokens
Applying the Howey Test to the DAO Tokens- On July 25, 2017, the SEC issued its Report on an investigation into an ICO and related activities by the DAO, an unincorporated entity, Slock.it UG (“Slock.it”), a German corporation, and various principals and participants. Previously in this Lawcast series I went through the parameters of the Howey Test to determine if a particular investment contract is a “security” under the federal securities laws. I also have detailed the relevant facts related to the DAO and its ICO offering. Applying the Howey Test to the DAO Tokens, the SEC notes that “money” need not include cash, but rather can be anything of value. A contribution of ETH is an investment of “money” as considered by the Howey Test. Investors in the DAO were investing in a common enterprise with the expectation of profits, including dividends and increased value. The SEC also found that the profits were to be derived from the efforts of others, including Slock.it, its founders and the DAO curators. In its analysis of whether the DAO was a security, the SEC spent the most discussion on the “from the efforts of others” factor. Presumably this is because the DAO was established as an autonomous organization with participants voting on all projects. However, the Slock.it team, through its curators, management of the DAO website and participation in online forums, “led investors to believe that they could be relied on to provide the significant managerial efforts required to make the DAO a success.” Moreover, in fact, the curators and Slock.it team did exercise significant control over proposals and operations of the DAO and were responsible for stopping the hacking attack and coming up with a plan to rectify the situation. The SEC also noted that the DAO Token holders voting rights were limited. The DAO Token holders could only vote within the rules (code) established by the Slock.it management team. The SEC points to case law related to multi-level marketing schemes which were considered securities despite the labor put forth by the investors because the promoter dictated the terms and controlled the scheme itself. The SEC stated that “[T]he voting rights afforded DAO Token holders did not provide them with meaningful control over the enterprise, because (1) DAO Token holders’ ability to vote for contracts was a largely perfunctory one; and (2) DAO Token holders were widely dispersed and limited in their ability to communicate with one another.” Furthermore, the SEC questioned the level of disclosure on projects, believing that such disclosure was not “full and fair” such as to allow an informed investment decision. #LegalAndComplianceLLC
Regulation A+ and Tier 1 and 2 Offerings
Regulation A+ and Tier 1 and 2 Offerings- The new Regulation A+ actually divided Regulation A into two offering paths, referred to as Tier 1 and Tier 2. Tier 1 remains substantially the same as the old pre-JOBS Act Regulation A but with a higher offering limit and allowing more marketing. The old Regulation A was limited to offerings of $5 million or less in any 12-month period. The new Tier 1 has been increased to up to $20 million. Since Tier 1 does not pre-empt state law, it is really only useful for offerings that are limited to one but no more than a small handful of states. Tier 1 does not require the company to include audited financial statements and does not have any ongoing SEC reporting requirements. Tier 1 will likely not be used for a going public transaction. Both Tier I and Tier 2 offerings have minimum basic requirements, including issuer eligibility provisions and disclosure requirements. In addition to the affiliate resale restrictions, resales of securities by selling security holders are limited to no more than 30% of a total particular offering for all Regulation A+ offerings. For offerings up to $20 million, an issuer can elect to proceed under either Tier 1 or Tier 2. Both tiers will allow companies to submit draft offering statements for non-public SEC staff review before a public filing, permit continued use of solicitation materials after the filing of the offering statement and both use the EDGAR system for filings. Tier 2 allows a company to file an offering statement with the SEC to raise up $50 million in a 12-month period. Tier 2 pre-empts state blue sky law. The offering statement is a little less lengthy than a traditional IPO registration, though a Form S-1 format is permitted and is even required if the company intends to become subject to the full SEC reporting requirements or seek a listing on a national exchange. The SEC review process is a little shorter, and a company can market in a way that it cannot with a traditional IPO. The trade-off is that Regulation A+ is limited in dollar amount to $50 million, there are specific company eligibility requirements, and there are investor qualifications and associated per-investor investment limits. Also, the process is not inexpensive. Attorneys’ fees, accounting and audit fees and, of course, marketing expenses all add up. A company needs to be organized and ready before engaging in any offering process. Even though a lot of attorneys, myself included, will provide a flat fee for the process, that flat fee is dependent on certain assumptions, including the level of organization of the company. #LegalAndComplianceLLC
FINRA Proposes New Registration And Examination Rules
FINRA Proposes New Registration And Examination Rules- Today is the first in a LawCast series discussing FINRA’s proposed changes to its examination process and the implementation of a new Securities Industry Essentials Exam. On March 8, 2017, the Financial Industry Regulatory Authority, known as FINRA, filed a proposed rule change with the SEC to adopt amended registration rules and restructure the entry-level qualification examination for registered representatives. The new rules would also eliminate certain examination categories. FINRA is planning to implement the changes in two phases, with full implementation completed during the first half of 2017. As part of the proposed amendments, FINRA introduced a new beginning-level examination called the Security Industry Essentials (SIE), which can be taken by individuals without sponsorship by a broker-dealer. The SIE would be a general-knowledge examination including fundamentals such as basic product knowledge, structure and functioning of the securities industry markets, regulatory agencies and their functions, and regulated and prohibited practices. Under the proposed new rules, anyone desiring to work in the securities industry for a member firm would need to take the SIE. The SIE would also be open to anyone who desires to take it. When becoming employed by a member firm, a person would then need to take an additional exam associated with their particular job function (for example, series 7, 79 or 24). The new SIE exam would not change the requirement to pass tests associated with those additional licenses, or that such licenses expire if a person is not associated with a member firm for a two-year period. However, as discussed below, the proposed new rules add the ability to extend this two-year period in certain instances. Currently, in order to qualify to take a registered representative examination to become licensed in the securities industry, a person must be employed and sponsored by a FINRA member broker-dealer. The intent of the SIE is to prequalify potential job applicants, saving member firms time and expense on vetting registered representatives and putting them through the examination process. A member firm will be able to view the SIE passing status and score on FINRA’s CRD system. The proposed SIE is broken down into four categories: (i) “Knowledge of Capital Markets,” which focuses on topics such as types of markets and offerings, broker-dealers and depositories, and economic cycles; (ii) “Understanding Products and Their Risks,” which covers securities products at a high level as well as associated investment risks; (iii) “Understanding Trading, Customer Accounts and Prohibited Activities,” which focuses on accounts, orders, settlement and prohibited activities; and (iv) “Overview of the Regulatory Framework,” which encompasses topics such as SRO’s, registration requirements and specified conduct rules. Individuals that have passed the SIE but not yet taken a specialized knowledge examination, would not be subject to continuing education requirements. Individuals that are already licensed as of the effective date of the new SIE, will not need to take the exam and will be deemed to have passed such exam. The SIE qualification will remain valid for four years without the person being registered with a firm. However, other licenses, such as a Series 7, may lapse if a person is not associated with a member firm for a two-year period. Although not discussed by FINRA, I see an opportunity to use the SIE for multiple purposes going forward as the securities laws and regulations continue to evolve. In particular, the SIE could be a factor in considering whether a person is accredited. The SIE could also be a factor in considering exemptions from the registration requirements for finders, a topic that continues to be at the forefront for regulators and practitioners alike. #LegalAndComplianceLLC
OTC PINK Listing Requirements, Laura Anthony Attorney
OTC PINK Listing Requirements, Laura Anthony Attorney- The OTC Pink, which includes the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information, based on the level of disclosure and public information made available by the company either through the SEC or posted on OTC Markets through its alternative reporting standard. There are no qualitative standards beyond disclosure for OTC Pink companies, which include companies in all stages of development as well as shell and blank check entities. Companies with Current Information status on OTC Markets include both companies that are subject to and current in their SEC Exchange Act reporting requirements and either choose not to apply or do not meet all the requirements for a quotation on the OTCQB; and companies that file current information on OTC Markets in accordance with the OTC Markets Alternative Reporting Standards. • If the company is subject to and current in their SEC Exchange Act reporting requirements, they will satisfy the financial reporting requirements for Current Information; • If the company is not SEC reporting it must post certain financial information on the OTC Markets website including annual financial statements, including a balance sheet, income statement, statement of cash flows and notes to financial statements, for the previous two fiscal years or from inception if the company is less than two years old; • Audits are not required, but if financial statements are audited, the auditor report must be posted as well; • If the company’s financial statements are not audited, an annual Attorney Letter must be posted within 120 days of fiscal year end – no attorney letter is required if the financial statements are audited • The company profile page on OTC Markets must be current and accurate; • In addition to financial statements, the company must file annual and quarterly reports with narrative information and CEO and CFO certifications using a fillable form available through OTC Markets; • The quarterly report and financials must be posted within 45 days of quarter end and the annual within 90 days of fiscal year end • A company must file a Form 8-K if SEC reporting or submit a news release within 4 days of any of the 8-k triggering events (including for example, entry into a material agreement; the acquisition or disposition of assets outside the ordinary course of business; the sale of unregistered securities; and changes in officers, directors or control shareholders). In addition, to maintain Current information status, a company must subscribe to the OTC Disclosure & News Service with an annual fee of $4,200 and a one-time set-up fee of $500. In the next LawCast in this series I will discuss the Limited Information level of the OTC Pink marketplace. #LegalAndComplianceLLC
Finders Fees and the Consequences for Violations
Finders Fees and the Consequences for Violations- The SEC is authorized to seek civil penalties and injunctions for violations of the broker-dealer registration requirements. Egregious violations can be referred to the attorney general or Department of Justice for criminal prosecution. In addition to potential regulatory problems, using an unregistered person who does not qualify for either the statutory or another exemption to assist with the sale of securities may create a right of rescission in favor of the purchasers of those securities. That is a fancy way of saying they may ask for and receive their money back. Section 29(b) of the Exchange Act, provides in pertinent part: Every contract made in violation of any provision of this title or of any rule or regulation thereunder… the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this title or any rule or regulation thereunder, shall be void (1) as regards the rights of any person who, in violation of any such provision, rule or regulation, shall have made or engaged in the performance of any such contract… In addition to providing a defense by the issuing company to paying the unlicensed person, the language can be interpreted as voiding the contract for the sale of the securities to investors introduced by the finder. The SEC interprets its rules and regulations very broadly, and so do the courts and state regulators. Under federal law the rescission right can be exercised until the later of three years from the date of issuance of the securities or one year from the date of discovery of the violation. Accordingly, for a period of at least three years, an issuer that has utilized an unlicensed finder could have a contingent liability on their books and as a disclosure item. The existence of this liability can deter potential investors and underwriters and create issues in any going public transaction. In addition, SEC laws specifically require the disclosure of compensation and fees paid in connection with a capital raise. A failure to make such disclosure and to make it clearly and concisely is considered fraud under Section 10b-5 of the Securities Act of 1933. Fraud claims are generally brought against the issuing company and its participating officers and directors. Further, most underwriters and serious investors require legal opinion letters at closing, in which the attorney for the company opines that all previously issued securities were issued legally and in accordance with state and federal securities laws and regulations. Obviously an attorney will not be able to issue such an opinion following the use of an unlicensed or non-exempted person. In addition to the legal ramifications themselves and even with full disclosure and the time for liability having passed, broker-dealers and underwriters may shy away from engaging in business transactions with an issuer with a history of overlooking or circumventing securities laws. Historically, it was the person who had acted in an unlicensed capacity who faced the greatest regulatory liability; however, in the past ten years that has changed. The SEC now prosecutes issuers under Section 20(e) for aiding and abetting violations. The SEC has found it more effective and a better deterrent to prosecute the issuing company than an unlicensed person who is here today and gone tomorrow. The payment of finders’ fees is a complex topic requiring careful legal analysis on a case-by-case and state-by-state basis. No agreements for the payment or receipt of such fees should be entered into or performed without seeking the advice of competent legal counsel. I am a strong advocate for a regulatory framework that includes (i) limits on the total amount finders can introduce in a 12-month period; (ii) antifraud and basic disclosure requirements that match issuer responsibilities under registration exemptions; and (iii) bad-actor prohibitions and disclosures which also match issuer requirements under registration exemptions. I would even advocate for a potential general securities industry exam for individuals as a precondition to acting as a finder, without related licensing requirements. For example, FINRA, together with the SEC Division of Trading and Markets, could fashion an exam similar to the new FINRA Securities Industry Essentials Exam. #LegalAndComplianceLLC
FINRA and Finder Fees; Broker Dealers by Laura Anthony, Palm Beach
FINRA and Finder Fees; Broker Dealers by Laura Anthony, Palm Beach- Broker-dealers lack an incentive to engage in small private capital-raising transactions. In addition to regulatory and liability concerns, the amount of a capital raise by small and emerging companies is often small (less than $5 million) and accordingly, the potential commission for a broker-dealer is limited as compared to the time and risk associated with the transaction. Most small and middle market bankers have base-level criteria for acting as a placement agent in a deal, which includes the minimum amount of commission they would need to collect to become engaged. From a regulatory perspective, when acting as placement agent in a private offering, broker-dealers must consider FINRA filing rules, general know-your-customer and suitability requirements as well as statutory liability under Dodd-Frank and the SEC antifraud provisions. Even when a broker agrees to act as placement agent, it can often be difficult to locate investors for small companies. It would be helpful if unlicensed individuals could refer investors to such a broker-dealer, who would then ensure that proper disclosure has been made to the investor, and that the investment is suitable for such investor. However, FINRA Rule 2040 prohibits the payment of transaction-based compensation by member firms to unregistered persons. FINRA Rule 2040 expressly correlates with Section 15(a) of the Exchange Act and prohibits the payment of transaction-related compensation unless a person is licensed or properly exempt from such licensing. Rule 2040 prohibits member firms from directly or indirectly paying any compensation, fees, concessions, discounts or commissions to: (1) any person that is not registered as a broker-dealer under SEA Section 15(a) but, by reason of receipt of any such payments and the activities related thereto, is required to be so registered under applicable federal securities laws and SEA rules and regulations; or (2) any appropriately registered associated person, unless such payment complies with all applicable federal securities laws, FINRA rules and SEA rules and regulations. FINRA guidance on the Rule states that a member firm can (i) rely on published releases, no-action letters or interpretations from the SEC staff; (ii) seek SEC no-action relief; or (iii) obtain a legal opinion from an independent, reputable U.S. licensed attorney knowledgeable in the area. This list is not exclusive and FINRA specifically indicates that member firms can take any other reasonable inquiry or action in determining whether a transaction fee can be paid to an unlicensed person. FINRA Rule 2040 specifically allows the payments of finders’ fees to unregistered foreign finders where the finder’s sole involvement is the initial referral to the member firm of non-U.S. customers and certain conditions are met, including but not limited to that (i) the person is not otherwise required to be registered as a broker-dealer in the U.S.; (ii) the compensation does not violate foreign law; (iii) the finder is a foreign national domiciled abroad; (iv) the customers are foreign nationals domiciled abroad; (v) the payment of the finder’s fee is disclosed to the customer; (vi) the customers provide written acknowledgment of receipt of the notice related to the payment of the fee; (vii) proper records regarding the payments are maintained; and (viii) each transaction confirm indicates that the finder’s fee is being paid. #LegalAndComplianceLLC
NASDAQ Capital Market Listing Requirements
NASDAQ Capital Market Listing Requirements- Today is the first LawCast in a series discussing NASDAQ listing requirements. The NASDAQ Stock Market currently has three tiers of listed companies: (1) The NASDAQ Global Select Market, (2) The NASDAQ Global Market and (3) The NASDAQ Capital Market. Each tier has increasingly higher listing standards, with the NASDAQ Global Select Market having the highest initial listing standards and the NASDAQ Capital Markets being the entry-level tier for most micro- and small-cap issuers. This LawCast series is focused on the NASDAQ Capital Market tier. A company seeking to list securities on NASDAQ must meet minimum listing requirements, including specified financial, liquidity and corporate governance criteria. NASDAQ has broad discretion over the listing process and may deny an application, even if the technical requirements are met, if it believes such denial is necessary to protect investors and the public interest. Although not in the rules, through experience, I know that NASDAQ pays close attention to trading volume and liquidity of applicants. NASDAQ has a valid concern that either once trading volume picks up, a company’s price will adjust downward and not meet the minimum requirements, or that the company will remain illiquid, either way, the company would not be a good candidate for the national exchange. Although also not in the rules, NASDAQ considers a company’s market cap. Where a company has a very high market capitalization considering its assets, revenues and other standard metrics of valuation, NASDAQ will be weary. Again the concern is that once trading on an exchange and garnering institutional attention and analyst coverage, the company’s valuation will adjust to a more probable number, which may result in a share price below the minimum NASDAQ requirements. In that regard, once listed, a company must meet continued listing standards. In order to apply for listing on NASDAQ, a company must complete and submit to NASDAQ a listing application including specified documents and information. The application process generally takes four to six weeks. Upon submittal of the application, a NASDAQ analyst will be assigned to the file as a lead interface with the company. The company will receive an initial comment letter within two to three weeks, and the comment and review process will continue until the application is either approved or denied. Like a filing with the SEC, a well prepared NASDAQ application will result in fewer comments and a smoother, quicker process. Generally, a company’s securities counsel takes the lead and is the point person in preparing the application and communicating with NASDAQ. Also similar to an SEC review process, NASDAQ will review publicly available information about a company, including but not limited to SEC filings, a company’s website, management communications and speeches, and press releases. For the most part, the back-and-forth process does not require a formal protocol, and communications will include e-mail correspondence and phone calls. #LegalAndComplianceLLC
Medallion Guarantees
Medallion Guarantees- A medallion guarantee is a special signature guarantee used for the transfer of securities. Although from a logistical standpoint, a medallion guarantee is similar to a notary, in that a person checks the signatory’s identification and puts a stamp on their signature, it has far different implications. Only specialized groups such as financial institutions, transfer agents, or broker dealers can offer medallion guarantee services. Institutions that offer the services must be part of one of three medallion guarantee programs, including: (i) securities transfer agents medallion program; (ii) stock exchanges medallion program; and (iii) New York Stock Exchange Medallion Signature Program. The medallion stamp confirms that the institution providing the stamp is a member of a Medallion signature guarantee program and is an acceptable signature guarantor. Also, the group providing the stamp is actually guaranteeing that the signature is not a forgery but rather is the authentic signature of the person providing such signature. Beyond that the Medallion guarantee confirms the authority of the individual signatore to sign for a particular entity, such as a corporate, trust or estate. Over the years, fewer financial institutions have been willing to provide a medallion guarantee, and most require that the person have an account with the financial institution as a precondition to providing the service. Recently, one internet based service, eSignature Guarantee Group, offers medallion guarantees through an online process. eSignature is a member of the Securities Transfer Agent Medallion Program. In the age of sophisticated cyber-security technology designed to authenticate identification, the eSignature program is both timely and necessary to the securities industry. eSignatureGuarantee.com has been a welcome solution for my clients across the board. #LegalAndComplianceLLC
Limited Finders Exemption
Limited Finders Exemption- The SEC generally prohibits the payments of commissions or other transaction-based compensation to individuals or entities that assist in effecting transactions in securities, including a capital raise, unless that entity is a licensed broker-dealer. The SEC considers the registration of broker-dealers as vital to protecting prospective purchasers of securities and the marketplace as a whole and actively pursues and prosecutes unlicensed activity. The registration process is arduous, including, for example, background checks, fingerprinting of personnel, minimum financial requirements, membership to a self regulatory organizations or SRO (i.e. FINRA), and ongoing regulatory and compliance requirements. However, despite the regulators efforts a whole cottage industry of unlicensed finders has developed, simply overshadowing efforts by regulators. Over the years, a small “finder’s” exemption has been fleshed out, mainly through SEC no-action letters and some court opinions. Bottom line: an individual or entity can collect compensation for acting as a finder as long as the finder’s role is limited to making an introduction. The mere providing of names or an introduction without more has consistently been upheld as falling outside of the registration requirements. The less contact with the potential investor, the more likely the finder is not required to be licensed. The finder may not participate in negotiations, structuring, document preparation or execution. Moreover, if such finder is “engaged in the business of effecting transactions in securities,” they must be licensed. In most instances, a person that acts as a finder on multiple occasions will be deemed to be engaged in the business of effecting securities transactions, and need to be licensed. The SEC will also consider the compensation arrangement with transaction or success-based compensation weighing in favor of requiring registration. The compensation arrangement is often argued as the gating or deciding factor, with many commentators expressing that any success-based compensation requires registration. The reasoning is that transaction-based compensation encourages high-pressure sales tactics and other problematic behavior. However, the SEC itself has issued no-action letters supporting a finder where the fee was based on a percentage of the amount invested by the referred people (see Moana/Kauai Corp., SEC No-Action Letter, 1974). More recently, the U.S. District court for the Middle District of Florida in SEC vs. Kramer found that compensation is just one of the many factual considerations and should not be given any “particular heavy emphasis” nor in itself result in a “significant indication of a person being engaged in the business of a broker.” Where a person acts as a “consultant” providing such services as advising on offering structure, market and financial analysis, holding meetings with broker-dealers, preparing or supervising the preparation of business plans or offering documents, the SEC has consistently taken the position that registration is required if such consultant’s compensation is commission-, success- or transaction-based. As pertains to finders that act on behalf of investors and investor groups, there is a lack of meaningful guidance. On a few occasions, the SEC has either denied no-action relief or concluded that registration was required. However, the same basic principles apply. The federal laws related to broker-dealer registration do not pre-empt state law. Accordingly, a broker-dealer must be licensed by both the SEC and each state in which they conduct business. Likewise, an unlicensed individual relying on an exemption from broker-dealer registration, such as a finder, must assure themselves of the availability of both a federal and state exemption for their activities. Interestingly a few state’s such as California and Texas have statutory finder’s exemptions, however, the finder would still need to comply with federal law. #LegalAndComplianceLLC
LawCast Guide to Broker-Dealer Registration and Finders Fees
LawCast Guide to Broker-Dealer Registration and Finders Fees- Periodically, and most recently in April 2008, the SEC updates its Guide to Broker-Dealer Registration explaining in detail the rules and regulations regarding the requirement that individuals and entities that engage in raising money for companies must be licensed by the SEC as broker-dealers. On a daily basis, thousands of individuals and entities offer to raise money for companies as “finders” in return for a “finder’s fee.” Other than as narrowly set forth above, such agreements and transactions are prohibited and carry regulatory penalties for both the company utilizing the finders’ services, and the finders. Each of the following individuals and businesses is required to be registered as a broker if they are receiving transaction-based compensation (i.e., a commission): • "finders," "business brokers," and other individuals or entities that engage in the following activities: o Finding investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries; o Finding investment banking clients for registered broker-dealers; o Finding investors for "issuers" (entities issuing securities), even in a "consultant" capacity; o Engaging in, or finding investors for, venture capital or "angel" financings, including private placements; o Finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved); • investment advisers and financial consultants; • persons that market real estate investment interests, such as tenancy-in-common interests, that are securities; • persons that act as "placement agents" for private placements of securities; • persons that effect securities transactions for the accounts of others for a fee, even when those other people are friends or family members; • persons that provide support services to registered broker-dealers; and • persons that act as "independent contractors," but are not "associated persons" of a broker-dealer (for information on "associated persons," see below). #LegalAndComplianceLLC
Testing the Waters – Free Writing Prospectus
Free Writing Prospectus- Other than a free writing prospectus for qualified companies and test-the-waters communications by an emerging growth company satisfying the requirements of Section 5(d) of the Securities Act... #LegalAndComplianceLLC
Going Public Without IPO
Going Public Without IPO- Today is the first in a LawCast series talking about direct public listings. On April 3, 2018, Spotify made a big board splash by debuting on the NYSE without an IPO. Instead, Spotify filed a resale registration statement registering the securities already held by its existing shareholders. The process is referred to as a direct listing. As most of those shareholders had invested in Spotify in private offerings, they were rewarded with a true exit strategy and liquidity by becoming the company’s initial public float. In order to complete the direct listing process, the NYSE had to implement a rule change. NASDAQ already allows for direct listings, although it has historically been rarely used. To the contrary, a direct listing has often been used as a going public method on the OTC Markets and in the wake of Spotify, may gain in popularity on national exchanges as well. As I will discuss in this LawCast series, there are some fundamental differences between the process for OTC Markets and for an exchange. In particular, when completing a direct listing onto an exchange, the exchange issues a trading symbol up front and the shares are available to be sold by the selling stockholders at prevailing market prices at any time. In an OTC Markets direct listing, a company must work with a market maker to file a 15c2-11 application with FINRA to obtain a trading symbol. Moreover, the registered securities may only be sold by the listed selling shareholders at the registered price, regardless of prevailing market price. However, once a company is trading on the OTCQB or OTCQX tier of OTC Markets, and as long as the offering is not considered an indirect primary offering, the company could amend the registration statement to allow shares to be sold at market price. Generally, an offering will be considered indirect primary if more than 30% of the float is being registered for resale. In a direct listing process, a company completes one or more private offerings of its securities, thus raising money up front, and then files a registration statement with the SEC to register the shares purchased by the private investors. Although a company can use a placement agent/broker-dealer to assist in the private offering, it is not necessary. A benefit to the company is that it has received funds much earlier in the process, rather than after a registration statement has cleared the SEC. The cost of completing an audit and legal fees associated with the registration process is expensive and is usually borne up front prior to receiving investor funds in a traditional IPO process. Where a broker-dealer assists in the private placement, the commission for the private offering may be slightly higher than the commissions in a public offering. One of the reasons is that FINRA regulates and must approve all public offering compensation, but does not limit or approve private offering placement agent fees. A second reason a broker-dealer may charge a higher commission is that there is higher risk to investors in a private offering that does not have an immediately available public exit. #LegalAndComplianceLLC
Regulation A – Practice Tips
Regulation A – Practice Tips- In the last LawCast in this series, I talked about whether Regulation A is really a public or private offering and pointed out that it can be considered one or the other depending on the rule and reason for making the determination. However, it is clear that for purposes of SEC rules, a Form 1-A is not considered a “registration statement.” Accordingly, a Form 1-A would not technically be included in contractual provisions related to registration rights. In particular, the typical language in a piggyback or demand registration right provision creates the possibility that the company could do an offering under Regulation A/A+ and take the position that the shareholder is not entitled to participate under the registration rights provision because it did not do a “registration.” As an advocate of avoiding ambiguity, practitioners should carefully review these contractual provisions and add language to include a Form 1-A under Regulation A/A+ if the intent is to be sure that the shareholder is covered. Likewise, if the intent is to exclude Regulation A/A+ offerings from the registration rights, that exclusion should be added to the language to avoid any dispute. In the next several Lawcasts in this series I am going to go over the Regulation A rules indepth. Before that, I have a few general thoughts to share on the subject. Tier 2 offerings in particular present a much-needed opportunity for smaller companies to go public without the added time and expense of state blue sky compliance. To compromise with opponents to the state blue sky preemption, the SEC included investor qualifications for Tier 2 offerings. In particular, Tier 2 offerings have a limitation on the amount of securities non-accredited investors can purchase of no more than 10% of the greater of the investor’s annual income or net worth. However, as companies continue to learn about Regulation A+, many still do not understand that it is just a legal process with added benefits, such as active advertising and solicitation including through social media. There is no pool of funds to tap into; it is not a line of credit; it is just another process that companies can use to reach out to the investing public and try to convince them to buy stock in, or lend money to, their company. As such, companies seeking to complete a Regulation A offering must consider the economics and real-world aspects of the offering. Key to a successful offering are a reasonable valuation and rational use of proceeds. A company should demonstrate value through its financial statements and disclosures and establish that the intended use of proceeds will result in moving the business plan ahead and hopefully create increased value for the shareholders. Investors want to know that their money is being put to the highest and best use to result in return on investment. Repayment of debt or cashing out of series A investors is generally not a saleable use of proceeds. Looking for $50 million for 30% of a pre-revenue start-up just isn’t going to do it! The company has to be prepared to show the investor, that it has a plan, management, vision and ability to carry out the business proposition it is selling. From the investors’ perspective, these are risky investments by nature. Offering materials should be scrutinized. The SEC does not pass on the merits of an offering – only its disclosures. The fact that the prospectus has been qualified by the SEC has no bearing on the risk associated with or quality of the investment. That is for each investor to decide, either alone or with advisors, and requires really reviewing the offering materials and considering the viability of the business proposal. At the end of the day, the success of the business, and therefore the potential return on investment, requires the company to perform – to sell their widgets, keep ahead of the competition, and manage their business and growth successfully. #LegalAndComplianceLLC
Regulation A+ Eligibility
Regulation A+ Eligibility- Today is the continuation in a Lawcast series talking about Regulation A. Today I am talking about Regulation A eligibility. Regulation A+ is available to companies organized and operating in the United States and Canada. A company will be considered to have its “principal place of business” in the U.S. or Canada for purposes of determination of Regulation A/A+ eligibility if its officers, partners, or managers primarily direct, control and coordinate the company’s activities from the U.S. or Canada, even if the actual operations are located outside those countries. The following companies are not eligible for a Regulation A+ offering: • Companies currently subject to the reporting requirements of the Exchange Act; A company that was once subject to the Exchange Act reporting obligations but suspended such reporting obligations by filing a Form 15 is eligible to utilize Regulation A/A+. A company that voluntarily files reports under the Exchange Act is not “subject to the Exchange Act reporting requirements” and therefore is eligible to rely on Regulation A/A+. A wholly owned subsidiary of an Exchange Act reporting company parent is eligible to complete a Regulation A/A+ offering as long as the parent reporting company is not a guarantor or co-issuer of the securities being issued. • Investment companies registered or required to be registered under the Investment Company Act of 1940, including BDC’s; • Blank check companies, which are companies that have no specific business plan or purpose or whose business plan and purpose is to engage in a merger or acquisition with an unidentified target; however, shell companies are not prohibited, unless such shell company is also a blank check company. A shell company is a company that has no or nominal operations; and either no or nominal assets, assets consisting of cash and cash equivalents; or assets consisting of any amount of cash and cash equivalents and nominal other assets. Accordingly, a start-up business or minimally operating business may utilize Regulation A+; • Companies seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights; • companies that have been subject to any order of the SEC under Exchange Act Section 12(j) denying, suspending or revoking registration, entered within the past five years; • Companies that did not meet their ongoing Tier 2 Regulation A+ reporting requirements over the past two years; and • Companies that are disqualified under the “bad actor” rules and, in particular, Rule 262 of Regulation A+. Unfortunately, in what is clearly a legislative miss, companies that are already publicly reporting – that is, are already required to file reports with the SEC – are not eligible. OTC Markets has petitioned the SEC to eliminate this eligibility criteria, and pretty well everyone in the industry supports a change here, but for now it remains. Regulation A/A+ can be used for business combination transactions, but is not available for shelf SPAC’s (special purpose acquisition companies). #LegalAndComplianceLLC
Blockchain Technology and the Capital Markets
Blockchain Technology and the Capital Markets- Currently, market participants are experimenting with several uses of DLT within the market infrastructure and ecosystem. DLT can be used in specific markets, such as debt, equity and derivatives, and in specific market functions, such as clearing. Many discrete applications exist for the use of DLT, including, for example, clearing arrangements, recordkeeping requirements, and trade and order reporting and processing. In addition, DLT can impact financial condition recordkeeping and reporting, verification of assets, anti-money laundering, know-your-customer, supervision and surveillance, fees and commissions, payment to unregistered persons, customer confirmations, materiality impact on business operations, and business continuity plans. The most common current use of DLT is related to private company equities. DLT can be used to track transfers, maintain shareholder records and for capitalization tables. Nasdaq has utilized DLT technology to complete and record a private securities transaction using its Nasdaq Linq blockchain ledger technology. The Nasdaq platform allows private companies to use DLT to record and track trading of private securities. DLT will eventually be used for public company equities, but the regulatory aspects are behind the technology. However, Overstock’s Patrick Byrne has created and launched a private platform to allow for public trading of securities using blockchain, called t0 Technologies. The platform only currently trades Overstock’s digital shares, but as an SEC licensed alternative trading system (ATS), the foundation is in place for utilizing the platform to launch and trade public offerings of third-party securities. The debt market also sees the benefit of DLT. The current average settlement time for the secondary trading of syndicated loans is approximately a month. The repurchase agreement marketplace is filled with inefficiencies, as is the trading market for corporate bonds. DLT could be used in all aspects of these markets. It is thought that DLT can also be used to automate the derivative marketplace and create greater transparency. DLT technology is being worked on to create operational processes with the securities industry itself as well, including by creating central repositories of standardized reference data for various securities products, creating efficiencies for all participants. DLT can also centralize identity management functions, on a global scale. #LegalAndComplianceLLC
Is Regulation A a Private or Public Offering?
Is Regulation A a Private or Public Offering?- A question that the SEC and practitioners continue to discuss is whether Regulation A is a private or public offering? The legal nuance that Regulation A is an “exempt” offering under Section 5 has caused confusion and the need for careful thought by practitioners and the SEC staff alike. So far, it appears that Regulation A is treated as a public offering in almost all respects except as related to the applicability of Securities Act Section 11 liability. Section 11 of the Securities Act provides a private cause of action in favor of purchasers of securities, against those involved in filing a false or misleading public offering registration statement. Any purchaser of securities, regardless of whether they bought directly from the company or secondarily in the aftermarket, can sue a company, its underwriters, and experts for damages where a false or misleading registration statement had been filed related to those securities. Regulation A is not considered a public offering for purposes of Section 11 liability. Securities Act Section 12, which provides a private cause of action by a purchaser of securities directly against the seller of those securities, specifically imposes liability on any person offering or selling securities under Regulation A. The general antifraud provisions under Section 17 of the Securities Act, which apply to private and public offerings, also applies to Regulation A. When considering integration, the SEC has now confirmed that a Regulation A offering can rely on Rule 152 such that a completed exempt offering, such as under Rule 506(b), will not integrate with a subsequent Regulation A filing. Under Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the company subsequently makes a public offering. The SEC has also issued guidance that Rule 152 applies to prevent integration between a completed 506(b) offering and a subsequent 506(c) offering, indicating that the important factor in the Rule 152 analysis is the ability to publicly solicit regardless of the filing of a registration statement. However, in a nod to its technical exempt status, as mentioned in a prior Lawcast in this series, Item 6 of Part I of a Regulation A Form 1-A, which requires disclosure of unregistered securities issued or sold within the prior year, must include a disclosure of all securities issued or sold pursuant to Regulation A in the prior year. On the other hand, Regulation A is definitely used as a going public transaction and, as such, is very much a public offering. A recent SEC white paper refers to regulation A as a mini IPO. Securities sold in a Regulation A offering are not restricted and therefore are available to be used to create a secondary market and trade such as on the OTC Markets or a national exchange. Tier 2 issuers that have used the S-1 format for their Form 1-A filing are permitted to file a Form 8-A to register under the Exchange Act and become subject to its reporting requirements. A Form 8-A is a simple registration form used instead of a Form 10 for companies that have already filed the substantive Form 10 information with the SEC. Upon filing a Form 8-A, the company will become subject to the full Exchange Act reporting obligations which is a pre-requisite to making application to trade on a national exchange. #LegalAndComplianceLLC
LawCast – Seth Farbman of VStock Transfer Talks Transfer Agent Responsibilities
Seth Farbman of VStock Transfer Talks Transfer Agent Responsibilities- Today is a special LawCast segment featuring Seth Farbman, Chairman of VStock Transfer, one of the nation’s leading stock transfer agencies. #LegalAndComplianceLLC
The New PCAOB Auditor Report Requirements
The New PCAOB Auditor Report Requirements- Today is the first in a LawCast series talking about the new PCAOB auditor report requirements. In October 2017, the SEC approved a new rule by the Public Company Accounting Oversight Board (PCAOB) requiring significant changes to public company audit reports. Among other additions, an audit report will need to include critical audit matters (CAMs) and disclose the tenure of the auditor. The new rule and requirements related to audit reports are significant as the audit report is the document in which the auditor itself communicates to the public and investors. The new standard will require auditors to describe CAMs that are communicated to a company’s audit committee. Critical audit matters are those that relate to material financial statement entries or disclosures and require complex judgment. One of the purposes of the proposed change is to require the auditor to communicate to investors, via the audit report, those matters that were difficult or thought-provoking in the audit process and that the auditor believes an investor would want to know. The new audit report standard also adds information related to the audit firm tenure, and the auditor’s role and responsibilities. Tenure can be an important factor in an audit, including an auditor’s experience and thus understanding of a company’s business and audit risks. The process in finalizing the rule has been lengthy, having begun in 2010 in response to investor- and public-initiated comments. Once proposed, the rule went through three rounds of public solicitation for comment. Of particular concern is whether the new requirements will result in increased nuisance shareholder litigation, costing the company and its investors, and whether it will result in a chill on auditor-company communications. In a statement related to the new auditor report, SEC Chairman Jay Clayton expressly addressed this concern, stating: “I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships — with Main Street investors ending up in a worse position than they were before. I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release.” As an aside, as with any rule making, SEC rules and regulations can and do result in unintended consequences. This is an issue I’ve raised many times over the years in my blogs, including, for example, the multitude of differences between requirements for smaller reporting companies and emerging growth companies, a topic the SEC is now working on addressing and rectifying. It is great to see Chair Clayton discuss this phenomenon directly and for the rule itself to take measures to monitor and initiate changes based on implementation analysis. There are certain carve-outs from some of the rule requirements, including the CAM requirements. In particular, the CAM reporting does not apply to emerging growth companies (EGCs), broker-dealers, investment companies, business development companies or employee stock plans; however, they do specifically apply to smaller reporting companies. Moreover, the rule requires extensive post-implementation review, in light of the potential for negative unintended consequences, and such review could result in changes to the rule itself and its implementation schedule.
Coinbase's Acquisition of Keystone Capital
Coinbase’s acquisition of Keystone Capital- Today is a special LawCast reporting on Coinbase’s acquisition of Keystone Capital. As reported by the Wall Street Journal, Coinbase, one of the leading cryptocurreny trading platforms, has entered into an agreement to acquire Keystone Capital Corp, a FINRA registered and licensed broker dealer. Keystone has licenses to operate as a registered investment advisor and to run an alternative trading system, or ATS. As the SEC has pointed out many times, only a securities licensed trading platform, could legally operate as an exchange for securities tokens. The SEC also believes that most tokens issued in ICO’s are securities tokens. Coinbase’s new ATS could be that platform. Moreover, many companies are now issuing or exploring the issuance of securities tokens to take the place of or supplement other forms of equity in the company. The Coinbase/Keystone ATS and brokerage firm could act as the platform for these securities ICO’s. Coin offerings have raised more than $13 billion since the start of 2017. Being first to offer a licensed platform for the launch and subsequent trading of coin offerings would be a huge win for Coinbase. Even before there is an operational securities token ATS, just having securities licenses will add legitimacy to Coinbase, which is already set the standard by becoming one of the first crypto trading platforms with money transmitter licenses from every state in which it operates. Coinbase is one of the largest in the business as of today with over 20 million customers and operating in 33 countries. Coinbase has stayed on the right side of regulators, only trading the largest cryptocurrencies, such as bitcoin, ether and litecoin. The Wall Street Journal article reports that Coinbase has said it will wind down Keystone’s other operations and integrate its business and licenses into the Coinbase platform. Coinbase has said it will keep most of the Keystone staff. In addition to the optics of keeping existing Keystone personnel, it will probably make the process of completing the transaction and launching, much smoother. FINRA must approve all changes of control of a broker dealer, including this one. The FINRA approval process will be quicker and easier if existing licensed and experienced management and personnel continue with the company. Interestingly, Keystone is the same broker dealer that T-Zero had planned to partner with to launch its ATS. It is reported that the T-Zero – Keystone deal will be wound down. T-Zero is now working with a different company, the TMX Group out of Canada, to build an exchange for securities tokens. #LegalAndComplianceLLC
The Direct Listing Process for Trading on NASDAQ and NYSE
The Direct Listing Process for Trading on NASDAQ and NYSE- NASDAQ has allowed for a direct listing although historically it has rarely been used. The process to achieve a direct listing on NASDAQ is substantially the same as OTC Markets with some key differences. This section will only discuss the differences. The biggest difference is that when completing a direct listing onto an exchange, the exchange issues a trading symbol upon effectiveness of the registration statement and filing of an 8-A, and the shares are then available to be sold by the selling stockholders at prevailing market prices. An S-1 registration statement is a registration statement filed under the Securities Act of 1933. In order to qualify to trade on a national exchange, a company must also be registered under the Securities Exchange Act of 1934. This is not a requirement for OTC Markets. A Form 8-A is a simple (generally 2-page) Exchange Act registration form used instead of a Form 10 for companies that have already filed the substantive Form 10 information with the SEC (generally through an S-1). When the Form 8-A is for registration with a national securities exchange under Section 12(b) of the Exchange Act, the 8-A becomes effective on the later of the day the 8-A if filed, the day the national exchange files a certification with the SEC confirming the listing, or the effective date of the S-1 registration statement. An NYSE direct listing follows the same process on NASDAQ; however, previously NYSE rules required an underwriter to determine or at least sign off on valuation in connection with an initial public offering. On February 2, 2018, the SEC approved a proposed rule change by the NYSE to allow a company that had not previously been registered with the SEC and which is not being listed as part of an underwritten initial public offering, to apply for and if qualified, trade on the NYSE. The amended rules modify the provisions relating to qualification of companies listing without a prior Exchange Act registration in connection with an underwritten initial public offering and amend Exchange rules to address the opening procedures on the first day of trading of such securities. The rule amendments modify the determination of market value such that the NYSE has discretion to determine that a company meets the minimum market value requirements for a listing based on an independent third-party valuation. #LegalAndComplianceLLC
The Latest Guidance from the SEC on Cryptocurrencies as a Security
The Latest Guidance from the SEC on Cryptocurrencies as a Security- Today is the continuation in a LawCast series talking about the latest guidance from the SEC on cryptocurrencies as a security. On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made two huge revelations for the crypto marketplace. The first is that he believes a cryptocurrency issued in a securities offering could later be purchased and sold in transactions not subject to the securities laws. The second is that Ether and Bitcoin are not currently securities. Also, for the first time, Hinman gives the marketplace guidance on how to structure a token or coin such that it might not be a security. Prior to Mr. Hinman’s comments, CorpFin issued comments to our clients, which comment letters gave an indication of the progression of the SEC’s thinking. In particular, in an earlier letter the SEC comment was in relevant part as follows: We note that you will accept Bitcoin, Ether, Litecoin or Bitcoin Cash as payment for your common stock. Please disclose the mechanics of the transaction. For example, explain the following: • whether the digital assets are securities and, where you have determined they are, how you will structure each individual transaction so that you are in compliance with the federal securities laws; • disclose how long the company would typically hold these digital assets, some of which may be securities, before converting to U.S. dollars; • include risk factor disclosure discussing the impact of holding such assets and/or accepting this form of payment, including price volatility and liquidity risks as well as risks related to the fragmentation, potential for manipulation, and general lack of regulation underlying these digital asset markets; and • disclose how you will hold the digital assets that you may receive in this offering as payment in exchange for shares of your common stock. If you intend to act as custodian of these digital assets, some of which may be securities, please tell us whether you intend to register as a custodian with state or federal regulators and the nature of the registration. The comment letter included many other points on cybersecurity, price volatility, risk factors and other issues not related to whether the Bitcoin or Ether were a security. In a recent comment letter for a different client, also offering tokens in a Regulation A offering and accepting Bitcoin and Ether as payment, the SEC did not issue any questions as to whether Bitcoin or Ether were a security, but did include substantially the same questions related to cybersecurity, price volatility, risk factors and other business points. The SEC CorpFin is pragmatic in its approach and despite frustrations at times, would not allow its Division Director to make public statements and then allow its staff to issue comments or take positions that were in direct contravention to those statements. Keep in mind that SEC no-action letters technically do not set precedence or have any legal bearing outside of the parties to the letter, but are regularly relied upon by the SEC and practitioners for guidance. #LegalAndComplianceLLC
FINRA and SIE Examinations
FINRA and SIE Examinations- On March 8, 2017, FINRA, filed a proposed rule change with the SEC to adopt amended registration rules and restructure the entry-level qualification examination for registered representatives. The new rules would also eliminate certain examination categories. In the last LawCast in this series I talked about the new Securities Industry Essentials or the SIE exam. The proposed new rules also seek to extend the period of time prior termination of a license. Currently, if a registered person is not employed with a member firm for a period of two years, their securities license will lapse (except for the SIE which is good for 4 years) and they will need to retake a particular examination if they become re-employed by a member firm. The new rules allow this two-year period to be extended for up to seven years where a person is working for a non-FINRA member financial services affiliate. That is, a person can maintain licensing for up to seven years while working for a non-FINRA member financial services affiliate of the member firm (such as a parent company) if the following conditions are met: (i) the person has been registered with a FINRA member for a total of five out of the past ten years, the most recent of which must be their current employer; (ii) when the person transitions to the affiliate, a Form U-5 must be filed notifying FINRA of the transition; (iii) the person must continue to satisfy continuing education requirements and have no pending or adverse regulatory matters; and (iv) the person must continuously work for the financial services affiliate. If each of these qualifications is met, the person can re-register with a member firm for up to seven years without retaking a licensing examination. The new rules also seek to consolidate the examination structure. Over time, the number of exams and licensing levels has expanded such that as of today, there are 16 exams with a considerable amount of content overlap and requirements for individuals to pass multiple exams to work in a given job function. There are 11 FINRA exams alone for a registered representative engaging in sales activities with investors, most of which focus on specific products, such as options or private securities. The proposed consolidation and simplification of the examination process is the outcome of an effort to reduce redundancies and simplify the process, resulting in cost savings for all parties including FINRA, the member firm and representatives, and eliminating outdated examinations and materials. In the next LawCast in this series I will continue to discuss the exam consolidation proposal #LegalAndComplianceLLC
M&A Broker Dealer Requirements
M&A Broker Dealer Requirements- Part 3- Following the SEC’s lead, effective July 1, 2016, Florida passed a statutory exemption from the broker-dealer registration requirements for entities effecting securities transactions in connection with the sale of equity control of private operating businesses (“M&A Broker”). Like the federal rule, the Florida M&A broker exemption sets forth certain limitations and restrictions related to the exemption. #LegalAndComplianceLLC
The Direct Listing Process for Trading on OTC Markets
The Direct Listing Process for Trading on OTC Markets- Ultimately a company will be registering common stock and that common stock will trade on the OTC Markets, but the initial private placement investment itself can take many forms, including convertible preferred stock, units consisting of current equity in the form of common and/or preferred stock and options or warrants, or units consisting of any combination of debt and equity. Private offerings often include registration rights agreements to require the company to file a resale registration statement within a certain period of time.In structuring the private offering(s) and subsequent resale registration statement, thought must be given to the public trading markets, including obtaining a trading symbol, qualifying for various tiers of OTC Markets, and hopefully, having an active trading market. Part of this process includes planning for the Form 211 Application, which will be filed by a market maker after effectiveness of the S-1 registration statement. When reviewing a market maker’s Form 211 application for the issuance of a trading symbol, FINRA conducts an in-depth review of the company, its shareholders and capitalization. One matter which FINRA reviews in determining whether to grant a trading symbol is “concentration of ownership.” FINRA will not grant a trading symbol unless there are enough non-affiliated shareholders holding freely tradeable shares, to establish a public float. Although there is no rule on this, my experience indicates that an initial float must be comprised of a minimum of 30 shareholders with more being better. FINRA will also consider the percentage of the company owned by these non-affiliated shareholders. Again, although there is no hard rule, in order to obtain a trading symbol, at least 20% or greater of the company’s common stock, on a fully diluted basis, should be in the hands of the public float. Likewise, OTC Markets now considers concentration of ownership in determining whether to grant an application to trade on the OTCQB or OTCQX tiers. OTC Markets generally follows the same parameters as FINRA, though if other red flags or negative factors exist, such as recent shell company status, at least 25%-30% of the company common stock, on a fully diluted basis, will need to be in the hands of the public float in order to trade on these higher tiers. Furthermore, counsel must be sure to assist with any blue sky compliance in the process. Once all private offerings are completed and the company has its intended capital structure and number of shareholders, and the company audit is completed, the S-1 registration statement will be drafted and filed with the SEC. A company can choose to file confidentially but will need to make all filings public at least 15 days prior to the registration statements effectiveness. Within 30 days of filing the S-1 registration statement, the company will receive initial comments from the SEC. The comment and review process will continue with the SEC for approximately 3-4 months, at which time the SEC will clear the S-1 to be declared effective. When a company is trading on a national exchange, they have generally timed the application with the exchange so that the shares begin trading shortly after the S-1 is declared effective and in particular, upon filing and effectiveness of a Form 8-A to complete the full registration process for the company. A Form 8-A will discussed later in this Lawcast series. In an OTC Markets listing, a Form 211 Application must be filed with FINRA to receive a ticker symbol and begin trading. The Form 211 is filed by a market maker. Generally, a company will begin to speak with a market maker shortly before the filing of the Form 211. The FINRA process will take a minimum of two weeks and can go on for several months. Preparation of an organized and complete file will make a big difference in the timing of the process. Concurrent with the Form 211 process, the company will apply to OTC Markets and determine which tier it qualifies for. Once FINRA issues a ticker symbol, the company can trade; however, to gain liquidity the company will also need to obtain DTC eligibility. The market maker that assists with the Form 211 Application can submit the DTC application as well. The stockholders listed in the S-1 registration statement are then free to sell their registered shares at the price registered with the SEC. #LegalAndComplianceLLC
Foreign Private Issuers – an Introduction
An Introduction- The determination of foreign private issuer status is not just dependent on the country of domicile, though a U.S. company can never qualify regardless of the location of its operations, assets, management and subsidiaries...
Regulation A and Blue Sky Registration
Regulation A and Blue Sky Registration- The original Regulation A was adopted in the 1960s as a sort of short-form registration process with the SEC. However, since Regulation A still required a lengthy and expensive state review and qualification process, known as “blue sky registration,” over the years it was used less and less until it was barely used at all. Literally years would go by with only a small handful, if any, Regulation A filings; however, the law remained on the books and the authors and advocates behind the JOBS Act saw potential to use Regulation A to democratize the IPO process by implementing some changes. Without going down a rabbit hole on “blue sky laws” from a high level, in addition to the federal government, every state has its own set of securities laws and securities regulators. Unless the federal law specifically “pre-empts” or overrules state law, every offer and sale of securities must comply with both the federal and the state law. There are 54 U.S. jurisdictions, including all 50 states and 4 territories, each with separate and different securities laws. Even in states that have identical statutes, the state’s interpretations or focus under the statutes differs greatly. On top of that, each state has a filing fee and a review process that takes time to deal with. It’s difficult, time-consuming and expensive. Title IV of the JOBS Act that was signed into law on April 5, 2012, set out the framework for the new Regulation A and required the SEC to adopt specific rules to implement the new provisions, which it did. The new rules came into effect on June 19, 2015. New Regulation A, which is often referred to as Regulation A+, has a path to pre-empt state law, and allows for unlimited marketing – as long as certain disclaimers are used, and of course, subject to antifraud laws – you have to be truthful. As with all of the provisions in the JOBS Act, Regulation A+ was created to provide a less expensive and easier method for smaller companies to access capital. One of the biggest impediments to reaching potential investors has always been strict prohibitions against marketing offerings – whether the offerings were registered with the SEC or under a private placement. Historically, companies wishing to sell securities could only contact people they know and have a business relationship with – which was a small group for anyone. Even the marketing of non-Regulation A registered offerings and IPO’s have been strictly limited. The use of a broker-dealer would be helpful because a company could then access that broker’s client base and contacts, but broker-dealers are not always interested in helping smaller companies raise money. The JOBS Act made the most dramatic changes to the landscape for the marketing and selling of both private and public offerings since the enactment of the Securities Act of 1933, one of which is the overhaul of Regulation A. In essence, new Regulation A has given companies a mechanism and tools to empower them to reach out to the masses in completing an IPO and has concurrently put protections in place to prevent an abuse of the process.
Regulation A – Types of Securities
Regulation A – Types of Securities- Regulation A limits securities that may be issued under the rules to equity securities, including common and preferred stock and options, warrants and other rights convertible into equity securities, debt securities and debt securities convertible or exchangeable into equity securities, including guarantees. If convertible securities or warrants are offered that may be exchanged or exercised within one year of the offering statement qualification (or at the option of the issuer), the underlying securities must also be qualified and the value of such securities must be included in the aggregate offering value. Accordingly, the underlying securities will be included in determining the offering limits of $20 million and $50 million, respectively. Asset-backed securities are not allowed to be offered in a Regulation A+ offering. REIT’s and other real estate-based entities may use Regulation A+ and provide information similar to that required by a Form S-11 registration statement. Continuous or delayed offerings (a form of a shelf offering) will be allowed if (i) they commence within two days of the offering statement qualification date, (ii) are made on a continuous basis, (iii) will continue for a period of in excess of thirty days following the offering statement qualification date, and (iv) at the time of qualification are reasonably expected to be completed within two years of the qualification date. Issuers that are current in their Tier 2 reporting requirements may make continuous or delayed offerings for up to three years following qualification of the offering statement. Moreover, in the event a new qualification statement is filed for a new Regulation A+ offering, unsold securities from a prior qualification may be included, thus carrying those unsold securities forward for an additional three-year period. Continuous or delayed offerings are available for all securities qualified in the offering, including securities underlying convertible securities, securities offered by an affiliate or other selling security holder, and securities pledged as collateral. In the next LawCast in this series I will talk about Testing the Waters, and general solicitation and advertising in Regulation A offerings. #LegalAndComplianceLLC
Distributed Ledger Technology or Blockchain Continued
Distributed Ledger Technology or Blockchain Continued- Distributed Ledger Technology called DLT or blockchain involves a distributed database maintained over a network of computers where information can be added by the network participants. Each added layer of information or data is referred to as a block. The network participants can share and retain identical cryptographically secured information and records. DLT uses either a public or private network. A public network is open and accessible to anyone that joins, without restrictions. All data stored on a public network is visible to anyone on the network, although it is encrypted. A public network has no central authority and relies solely on the network participants to verify transactions and record data on the network. Algorithm and computational technology is used to protect the integrity of the data. A private network is limited to individuals and entities that are granted access by a network operator. Access can be tiered with different entities being allowed differing levels of authority to transact and view data. In the financial services industry, it is likely that networks will be private. The transactions and data on the network usually represent an underlying asset that may be digital assets, such as cryptosecurities and cryptocurrencies, or a representation of a hard asset stored offline (a token representing an interest in a gold bar, for example). Assets on a DLT network are cryptographically secured using public and private key combinations. The public key combination allows access to the network itself, and the private key is for access to the asset itself and is held by the asset holder or its agent. A transaction may be initiated by any party on the network that holds assets on that network. When a transaction is initiated, it is verified using a predetermined process that can be either consensus-based or proof-of-work based, although new verification processes are being explored. In layman’s terms, the verification process is based on digital computations. The settlement of the transaction occurs when verification is completed. Currently this can occur immediately or take a few hours. Once verified, a transaction is “cryptographically hashed” and forms a permanent record on the DLT network. Records are time-stamped and displayed sequentially to all parties with network access. Currently, historical records cannot be edited or changed, though technology is being developed to change that.
Changes to Public Company Audit Reports (PCAOB)
Changes to Public Company Audit Reports (PCAOB)- In October 2017, the SEC approved a new rule by the Public Company Accounting Oversight Board (PCAOB) requiring significant changes to public company audit reports. The new rules have broken old AS 3101, which covered all audit reports, into two parts: (i) AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and (ii) AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances. From a high level, audit reports have a pass/fail standard—i.e., they are either qualified or unqualified. The new rules clarify the auditor’s report standards in each case. The new rules require an auditor to communicate critical audit matters (CAMs) in the audit report, or affirmatively state that there were no CAMs. A CAM is defined as “any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (i) relates to accounts or disclosures that are material to the financial statements; and (ii) involved especially challenging, subjective or complex auditor judgment.” For clarity, the rules provide a list of considerations when determining whether a matter was especially challenging, subjective or complex. These considerations include: (i) the auditor’s assessment of the risks of material misstatement; (ii) the degree of auditor judgment in areas that involved a high degree of judgment or estimation by management, including any measurements with significant uncertainty; (iii) the nature and timing of significant unusual transactions and audit effort and judgment involved; (iv) the degree of auditor subjectivity in applying audit procedures; (v) the nature and extent of audit effort, including specialized skill or knowledge or need for outside consultation; and (vi) the nature of audit evidence. The SEC rule release and PCAOB release stress that CAMs should not be boilerplate disclosures carried in each report, which would then lessen their impact and usefulness. Rather, a CAM should only be a material event that has required thought and complexity to the auditor and company. Furthermore, a CAM only includes those matters that meet each element of the definition, including materiality, requirement to communicate with the audit committee, and matters involving especially challenging, subjective or complex judgment. Each audit report must: (i) identify the CAM; (ii) describe the considerations that led the auditor to determine that the matter is a CAM; (iii) describe how the CAM was addressed in the audit; and (iv) refer to the relevant financial statement accounts or disclosures. That is, an auditor must articulate “why” a matter is a CAM and how it was addressed. The auditor must keep documentation and thorough records on the process, including how any particular issue was determined to be a CAM or not. The CAM reporting does not apply to emerging growth companies (EGCs), broker-dealers, investment companies, business development companies or employee stock plans. Although EGCs are exempt, smaller reporting companies are not. The SEC comment process concluded that CAMs could provide new information about smaller reporting companies, and in fact may be even more critical since these smaller companies generally have less analyst coverage and other reliable outside information sources. Auditors for smaller reporting companies have an additional 18 months to comply with the new rules. In addition to CAM discussions, the new rules require the following additions to the audit report: (i) a disclosure of the auditor tenure, including the year the auditor began serving the company; (ii) a statement regarding the auditor independence requirement; (iii) addressing the report to both the company’s shareholders and board of directors; (iv) adding particular standardized language, phrases and qualifiers, including adding the phrase “whether due to error or fraud” when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatement; and (v) standardizing the form of the report, including adding sections and titles to guide the reader. #LegalAndComplianceLLC
Attorney Laura Anthony Explains Form 8-K
Attorney Laura Anthony Explains Form 8-K- Today is the first in a Lawcast series talking about Form 8-K. On September 26, 2016, and again on the 27th, the SEC brought enforcement actions against issuers for the failure to file 8-K’s associated with corporate finance transactions and in particular PIPE transactions involving the issuance of convertible debt, preferred equity, warrants and similar instruments. Prior to the release of these two actions, I have been hearing rumors in the industry that the SEC has issued “hundreds” of subpoenas to issuers related to PIPE transactions and in particular to determine 8-K filing deficiencies, Although hundreds is likely an exaggeration, the SEC is certainly focusing on this space. Back in August 2014, the SEC did a similar sweep related to 8-K filing failures associated with 3(a)(10) transactions. The 8-K filing deficiency actions were a precursor to a larger SEC investigation on 3(a)(10) transactions themselves which culminated in two well-known enforcement actions against active 3(a)(10) participants (the Ironridge companies and IBC Funds) and resulted in a chill on the 3(a)(10) activity in the industry as a whole. 3(a)(10) actions continue today but the volume of transactions has dramatically reduced and the attention to due diligence, detail and reporting requirements has likewise increased. The SEC rarely takes enforcement action or expends time or resources on investigating the failure to file an 8-K. When such issues arise, it is usually in connection with a routine review of a company’s SEC reports or as part of the comment and review process associated with the filing of a registration statement. All reports filed with the SEC are subject to SEC review and comment and the Sarbanes-Oxley Act requires that the SEC undertake some level of review of every reporting company at least once every three years. As was the case with the SEC’s investigation into 3(a)(10) transactions, it is my belief that the SEC is reviewing the PIPE industry as a whole and in particular the process, procedure and effects associated with convertible instruments. The majority of these transactions involve the issuance of convertible notes which then convert into common stock following a holding period in reliance on Rule 144 and Section 3(a)(9) of the Securities Act of 1933. Any convertible instrument can be used in the same manner, such as preferred stock and warrants. The use of convertible instruments in PIPE transactions is perfectly legal and acceptable. However, like any other aspect of the securities marketplace, it can be abused. My belief is that the SEC is using the investigation into the failure to file 8-K’s in association with these transactions to assist in a larger investigation into related fraud and other violations. If a company is failing to file an initial 8-K for the transaction and subsequent 8-K’s to report the issuance of securities upon a conversion, there may also be other issues and violations. Examples of abusive or improper activity could include: (i) backdating of notes or failure to provide the funding associated with the note; (ii) improper undisclosed affiliations between investors and the company or its officers and directors; (iii) manipulative trading practices; (iv) improper stock promotion; or (v) trading on insider information. #LegalAndComplianceLLC
OTC Markets Stock Promotion Policy
OTC Markets Stock Promotion Policy- As OTC Markets Group continues to position itself as a respected venture trading platform, it has adopted a new stock promotion policy and best practices guidelines to improve investor transparency and address concerns over fraudulent or improper stock promotion campaigns. The stock promotion policy and best practices guidelines are designed to assist companies with responsible investor relations and to address problematic issues. Recognizing that fraudulent stock promotion is a systemic problem requiring an all-fronts effort by industry participants and regulators, the new policy focuses on transparency and disclosure of current information, and the correction of false statements or materially misleading information issued by third parties. For several years, OTC Markets Group has been delineating companies with a skull-and-crossbones sign where they have raised concerns such as improper or misleading disclosures, spam campaigns, questionable stock promotion, investigation of fraudulent or other criminal activity, regulatory suspensions or disruptive corporate actions. While labeled with a skull and crossbones, a company that does not have current information or is not on the OTCQB or OTCQX will have its quote blocked on the OTC Markets website. The new policy addresses: (i) publicly identifying securities being promoted; (ii) identifying fraudulent promotional campaigns; (iii) responsibilities of companies with promoted securities; (iv) the impact on OTCQX or OTCQB designations; (v) caveat emptor policy and stock promotion; and (vi) regulatory referrals. This Lawcast series summarizes both the new stock promotion policy and best practices guidelines. The basic premise behind OTC Markets Group policy on stock promotion is the timely disclosure of material information, which includes the duty to dispel unfounded rumors, misinformation or false statements. Technology has increased the ability for companies, insiders and third parties to engage in improper and manipulative activities, including through spam campaigns, and anonymous social networks and message groups. A company that is the subject of an active campaign or has a history of stock promotion may be denied an application for trading on the OTCQB or OTCQX. A company may be removed from the OTCQB or OTCQX, upon the sole discretion of OTC Markets Group, if it is involved in an active campaign involving misleading information or manipulative promotion. Furthermore, promotional activity of a shell company will result in the immediate removal from OTCQB (shells are not permitted on OTCQX). OTC Markets Group will continue to use the caveat emptor skull-and-crossbones designations as well. Where appropriate, OTC Markets Group will refer a company to the SEC, FINRA or other regulatory agency for investigation.
Item 3 and 4 of Form 8-K
Item 3 and 4 of Form 8-K- Any company subject to the reporting requirements of the Securities Exchange Act of 1934, must file periodic reports on Form 8-K. I have been going through the events that trigger such 8-K filing requirement. Section 3 relates to Securities and Trading Markets. Item 3.01 reports a Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing – An example would be a notice of delinquency with the listing requirements of an exchange such as the NASDAQ or NYSE MKT. If such notice culminates in an actual delisting, another 8-K would need to be filed under this item. Likewise, a company’s decision to delist and move to the OTC Markets would be reportable. Item 3.02 reports Unregistered Sales of Equity Securities – For a smaller reporting company, this Item requires that a company report the unregistered sale of securities if the aggregate sales/issuances of securities constitutes 5% or more of the outstanding securities since the last reported number filed with the SEC. For all other companies, the threshold is triggered at a 1% change. I have discussed this Item in more detail earlier in this Lawcast series related to PIPE transactions involving convertible debt, preferred stock, options and warrants Item 3.03 reports Material Modification to Rights of Security Holders – Examples would be amendments to preferred stock preferences or the issuance of senior securities. Section 4 – reports Matters Related to Accountants and Financial Statements Item 4.01 reports Changes in the Company’s Certifying Accountant – An 8-K filing under this Item will always be reviewed by the SEC and must meet the exact particular disclosure requirements set forth in the Form 8-K. Item 4.02 reports a Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review – A filing on this Item is usually accompanied by or quickly followed by an amendment to the subject report and financial statements. Moreover, if the amended underlying report is not concurrently filed, an Item 4.02 filing in essence reports that the company is delinquent in its filing requirements, as an unreliable report is equivalent to no report. An Item 4.02 filing is due within 2 days of receipt of an auditor’s restatement letter. #LegalAndComplianceLLC
The OTC Markets Group Best Practices On Stock Promotion Guidelines
The OTC Markets Group Best Practices on Stock Promotion Guidelines- As in its separate stock promotion policy, the OTC Markets Group best practices on stock promotion guidelines reiterate the core principle that the timely disclosure of material information is key, which includes the duty to dispel unfounded rumors, misinformation or false statements. OTC Markets Group suggests that companies perform due diligence on investor relations firms and their principals prior to engaging services. This is advice I am constantly giving to my clients. Basic due diligence includes reviewing other represented clients and doing basic searches for regulatory issues or negative news. Companies should also be very clear on what services an investor relations firm will perform and what compensation will be paid for those services. Very vague service descriptions often indicate an improper promotional campaign. OTC Markets Group also warns of red flags, including a request that payment be split among various individuals or groups. A company that hires or sponsors investor relations is responsible for the content of communications made by that company and must ensure that all information is materially current and accurate. In addition, a company should retain editorial control and review all information before it is disseminated. Investor relations materials should not use language that makes assumptions, is speculative or misleading, or brazenly hypes the stock. Communications should not cover new material information that has not been previously disclosed, and should not extend beyond providing factual information to investors and shareholders. The disclosures required by Section 17(b) must always be properly made, and OTC Markets Group specifically requires that any relationship between the investor relations individuals and entities and the company be fully disclosed. Since third parties often engage in stock promotional activities without the knowledge or consent of a company, it is important for a company to know its investors, including the people behind any entities or investor groups. Investors that desire anonymity or utilize offshore entities raise a red flag. Furthermore, companies should be wary of shareholders that own significant control or investor groups that will qualify to remove restrictive legends on stock. Investor groups often change the name of their investment vehicle entity and, as such, due diligence should include prior entities. OTC Markets Group warns against toxic or death spiral financing. Toxic or death spiral financing generally involves an investment in the form of a convertible promissory note or preferred stock that converts into common stock at a discount to market with no floor on the conversion price. As I have written about many times, there are quality investors and others that are not quality in the microcap space. The use of convertible instruments as a method to invest in public companies is perfectly legal and acceptable. However, like any other aspect of the securities marketplace, it can be abused. Further examples of abusive or improper activity could include: (i) backdating of notes or failure to provide the funding associated with the note; (ii) improper undisclosed affiliations between investors and the company or its officers and directors; (iii) manipulative trading practices; (iv) improper stock promotion; or (v) trading on insider information...
CFTC Position On Cryptocurrency
CFTC Position On Cryptocurrency- Today’s LawCast talks about the CFTC and cryptocurrencies. The SEC and U.S. Commodity Futures Trading Commission (CFTC) have been actively policing the crypto or virtual currency space. Both regulators have filed multiple enforcement actions against companies and individuals for improper activities including fraud. On January 25, 2018, SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo published a joint op-ed piece in the Wall Street Journal on the topic. Backing up a little, on October 17, 2017, the LabCFTC office of the CFTC published “A CFTC Primer on Virtual Currencies” in which it defines virtual currencies and outlines the uses and risks of virtual currencies and the role of the CFTC. The CFTC first found that Bitcoin and other virtual currencies are properly defined as commodities in 2015. As such, the CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce. Beyond instances of fraud or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. Rather, these “exchanges” are regulated as payment processors or money transmitters under state law. The role of the CFTC is substantially similar to the SEC with a mission to “foster open, transparent, competitive and financially sound markets” and to “protect market users and their funds, consumers and the public from fraud, manipulation and abusive practices related to derivatives and other products subject to the Commodity Exchange Act (CEA).” The definition of a commodity under the CEA is as broad as the definition of a security under the Securities Act of 1933, including a physical commodity such as an agricultural product, a currency or interest rate or “all services, rights and interests in which the contracts for future delivery are presently or in the future dealt in” (i.e., futures, options and derivatives contracts). Where the SEC regulates securities and securities markets, the CFTC does the same for commodities and commodity markets. At times the jurisdiction of the two regulators overlaps, such as related to swap transactions. Right now while there are no SEC licensed securities exchanges which trade virtual currencies or any tokens, there are several commodities exchanges that trade virtual currency products such as swaps and options, including the TeraExchange, North American Derivatives Exchange and LedgerX. The Commodity Exchange Act would prohibit the trading of a virtual currency future, option or swap on a platform or facility not licensed by the CFTC. Moreover, the National Futures Association (NFA) is now requiring member commodity pool operators (CPO’s) and commodity trading advisors (CTA’s) to immediately notify the NFA if they operate a pool or manage an account that engaged in a transaction involving a virtual currency or virtual currency derivative. The CFTC refers to the IRS’s definition of a “virtual currency” and in particular: A virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments it operates like real currency but it does not have legal tender status in the U.S. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as a convertible virtual currency. Bitcoin is one example of a convertible virtual currency. I note that neither the CFTC’s definition of Bitcoin as a commodity, nor the IRS’s definition of a virtual currency, conflicts with the SEC’s position that most cryptocurrencies and initial cryptocurrency offerings today are securities requiring compliance with the federal securities laws. The SEC’s position is based on an analysis of the current market for ICO’s and the issuance of “coins” or “tokens” for capital raising transactions and as speculative investment contracts. In my view, a cryptocurrency which today may be an investment contract (security) can morph into a commodity (currency) or other type of digital asset. For example, an offering of XYZ token for the purpose of raising capital to build a software or blockchain platform or community where XYZ token can be used as a currency would rightfully be considered a securities offering that needs to comply with the federal securities laws. However, when the XYZ token is issued, the platform built, its utility established and it can be used as a form of currency, it could become a commodity. Obvioulsy, the bundling of a token securities offering to include options or futures contracts may implicate both SEC and CFTC compliance requirements. #LegalAndComplianceLLC
Direct Listing Process for OTC Markets
Direct Listing Process for OTC Markets- DIRECT PUBLIC LISTING - There are some fundamental differences between the direct listing process for OTC Markets and for an exchange. In particular, when completing a direct listing onto an exchange, the exchange issues a trading symbol upfront and the shares are available to be sold by the selling stockholders at prevailing market prices at any time. In an OTC Markets direct listing, a company must work with a market maker to file a 15c2-11 application with FINRA to obtain a trading symbol. When completing a direct listing onto OTC Markets, the registered securities may only be sold by the listed selling shareholders at the registered price, regardless of prevailing market price. However, once a company is trading on the OTCQB or OTCQX tier of OTC Markets, and as long as the offering is not considered an indirect primary offering, the company could amend the registration statement to allow shares to be sold at market price. Generally an offering will be considered indirect primary if more than 30% of the float is being registered for resale. Overall the direct listing process is a little less expensive and little quicker than a direct IPO process. The reason for this is that the company can work with a market maker to apply for a trading symbol immediately upon effectiveness of the S-1 as opposed to having to wait until after an offering has been sold and closed out. I will now begin summarizing the direct listing process for an OTC Markets listing. To begin, a company should retain its team including legal, accounting and auditor. The company will also need a transfer agent and EDGAR agent. Our firm often makes referrals and recommendations as to various other service providers. A company may also use a broker-dealer placement agent in the private offering phase. Generally, counsel will prepare a full transaction checklist including who is responsible for what items from the beginning until completion of the direct listing. The beginning of the process includes gathering due diligence and completing any corporate cleanup or reorganization that may be necessary in advance of a public listing. All companies need some level of cleanup, which can include amending articles of incorporation and bylaws to make them public company-friendly; creating employee stock option plans; entering into employment contracts with key officers; ensuring that licensing agreements and intellectual property rights are secure; adding board members and committees such as an audit committee; and establishing corporate governance including an insider trading policy. While the company’s accounting and auditing are being completed, legal counsel will complete corporate cleanup and begin to draft the private offering documents, if the company is completing a new private offering round (sometimes a company begins the process after several prior rounds of offerings and will not need to complete another). In addition, legal counsel, together with the investment bankers if any, and other advisors will work with the company to determine valuation and the best structure for the private offering and the registration statement pricing. The final registration statement pricing will not need to be determined until the final pre-effective amendment is filed with the SEC. #LegalAndComplianceLLC
How is a particular Token or Digital Coin Structured as a Utility?
How is a particular TOKEN or DIGITAL COIN Structured as a Utility?- On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made several revelations for the crypto marketplace. Hinman for the first time, gives some guidance to issuers and their counsel in determining whether a particular token or coin is being structured as a security. Hinman is clear that this list of factors is not comprehensive but rather lays the groundwork for a thoughtful analysis. Items to consider include: 1. Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation? 2. Are independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading? 3. Is it clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment? Have purchasers made representations as to their consumptive, as opposed to their investment, intent? Are the tokens available in increments that correlate with a consumptive versus investment intent? 4. Are the tokens distributed in ways to meet users’ needs? For example, can the tokens be held or transferred only in amounts that correspond to a purchaser’s expected use? Are there built-in incentives that compel using the tokens promptly on the network, such as having the tokens degrade in value over time, or can the tokens be held for extended periods for investment? 5. Is the asset marketed and distributed to potential users or the general public? 6. Are the assets dispersed across a diverse user base or concentrated in the hands of a few that can exert influence over the application? 7. Is the application fully functioning or in early stages of development? In another step towards regulatory guidance, Hinman said the SEC is prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use. As recently as 3 months ago, the SEC had indicated it was not processing no-action letters on the subject at that time. In his speech, Hinman recognizes the implication of determining something is a security, including related to broker-dealer licensing, exchange registration, fund registration, investment advisor registration requirements, custody and valuation issues. Hinman also expressed excitement about the potential surrounding digital ledger technology, including advancements in supply chain management, intellectual property rights licensing, and stock ownership transfers. He thinks the craze behind ICOs has passed, and I agree. In particular, as he states, realizing that securities laws apply to an ICO that funds development, industry participants have started to revert back to traditional debt or equity offerings and only selling a token once the network has been established, and then only to those that need the functionality of the network and not as an investment. There have been earlier signs that the SEC is softening and rethinking its approach to cryptocurrencies as well. In a speech to the Medici Conference in Los Angeles on May 2, 2018, SEC Commissioner Hester M. Peirce warned against regulators stifling the innovation of blockchain by trying to label token and coins as securities and even when they are securities, being myopic on the need to fit within existing securities laws and regulations. Like Director Hinman, Commissioner Peirce encourages communication between market participants and the SEC as everyone tries to navigate the marketplace and technology. #LegalAndComplianceLLC
SEC Amends Definition of “A Smaller Reporting Company”
SEC Amends Definition of “A Smaller Reporting Company”- Today is the first in a LawCast series talking about the new amendment to the SEC definition of a smaller reporting company. On June 28, 2018, the SEC adopted the much-anticipated amendments to the definition of a “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 come almost two years to the day since the initial publication of proposed rule changes. Among other benefits, it is hoped that the change will help encourage smaller companies to access US public markets. The amendment expands the number of companies that qualify as a smaller reporting company (SRC) and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The SEC estimates that an additional 966 companies will be eligible for SRC status in the first year under the new definition. As proposed, and as recommended by various market participants, the new definition of a SRC will now include companies with less than a $250 million public float as compared to the $75 million threshold in the prior definition. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million and only included companies with no ascertainable public float... #LegalAndComplianceLLC
The New SEC Guidance On Cybersecurity
The New SEC Guidance on Cybersecurity- Today is the first in a LawCast series talking about the new SEC guidance on cybersecurity. On February 20, 2018, the SEC issued new interpretative guidance on public company disclosures related to cybersecurity risks and incidents. In addition to addressing public company disclosures, the new guidance reminds companies of the importance of maintaining disclosure controls and procedures to address cyber-risks and incidents and reminds insiders that trading while having non-public information related to cyber-matters could violate federal insider-trading laws. The new guidance is not dramatically different from the 2011 guidance. The topic of cybersecurity has been in the forefront in recent years, with the SEC issuing a series of statements and creating two new cyber-based enforcement initiatives targeting the protection of retail investors, including protection related to distributed ledger technology (DLT) and initial coin or cryptocurrency offerings (ICO’s). The SEC has also asked the House Committee on Financial Services to increase the SEC’s budget by $100 million to enhance the SEC’s cybersecurity efforts. The SEC incorporates cybersecurity considerations in its disclosure and supervisory programs, including in the context of its review of public company disclosures, its oversight of critical market technology infrastructure, and its oversight of other regulated entities, including broker-dealers, investment advisors and investment companies. Considering rapidly changing technology and the proliferation of cybersecurity incidents affecting both private and public companies (including a hacking of the SEC’s own EDGAR system and a hacking of Equifax causing a loss of $5 billion in market cap upon disclosure), threats and risks, public companies have been anticipating a needed update on the SEC disclosure-related guidance. SEC Commissioner Kara Stein’s statement on the new guidance is grim on the subject, pointing out that the risks and costs of cyberattacks have been growing and could result in devastating and long-lasting collateral affects. Commissioner Stein cites a Forbes article estimating that cyber-crime will cost businesses approximately $6 trillion per year on average through 2021 and an Accenture article citing a 62% increase in such costs over the last five years. Commissioner Stein also discusses the inadequacy of the 2011 guidance in practice and her pessimism that the new guidance will properly fix the issue. She notes that most disclosures are boilerplate and do not provide meaningful information to investors despite the large increase in the number and sophistication of, and damaged caused by, cyberattacks on public companies in recent years. Commissioner Stein includes a list of requirements that she would have liked to see in the new guidance, including, for example, a discussion of the value to investors of disclosing whether any member of a company’s board of directors has experience, education, expertise or familiarity with cybersecurity matters or risks. I have read numerous media articles and blogs related to the disclosure of cyber-matters in SEC reports. One such blog was written by Kevin LaCroix and published in the D&O Diary. Mr. LaCroix’s blog points out that according to a September 19, 2016, Wall Street Journal article, cyber-attacks are occurring more frequently than ever but are rarely reported. The article cites a report that reviewed the filings of 9,000 public companies from 2010 to the present and found that only 95 of these companies had informed the SEC of a data breach. #LegalAndComplianceLLC
Form 1-A and Regulation A
LawCast with Attorney Laura Anthony: Form 1-A and Regulation A- Form 1-A consists of three parts: Part I – Notification, Part II – Offering Circular, and Part III – Exhibits. Part I calls for certain basic information about the company and the offering, and is primarily designed to confirm and determine eligibility for the use of a Regulation A offering in general. Part I also includes disclosure related to the application of the bad actor disqualification; jurisdictions in which securities are to be offered; and unregistered securities issued or sold within the prior one year. Part II is the offering circular and is similar to the prospectus in a registration statement. Part II requires disclosure of basic information about the company and the offering; material risks; dilution; plan of distribution; use of proceeds; description of the business operations; description of physical properties; discussion of financial condition and results of operations (MD&A); identification of and disclosure about directors, executives and key employees; executive compensation; beneficial security ownership information; related party transactions; description of offered securities; and two years of financial information. The required information in Part 2 of Form 1-A is scaled down from the requirements in Regulation S-K applicable to Form S-1. However, companies can complete Part 2 by either following the Form 1-A disclosure format or by including the information required by Part I of Form S-1 or Form S-11. Only companies that elect to use the S-1 or S-11 format qualify to file an 8-A to register and become subject to the Exchange Act reporting requirements. Companies that had previously completed a Regulation A offering and filed reports with the SEC under Tier 2 can incorporate by reference from those reports in future Regulation A offering circulars. Form 1-A requires two years of financial information. All financial statements for Regulation A offerings must be prepared in accordance with GAAP. Financial statements for a Tier 1 offering are not required to be audited. Audited financial statements are required for Tier 2 offerings. Audit firms must be independent and PCAOB-qualified. An offering statement cannot be qualified if the date of the balance sheet is more than nine months prior to the date of qualification. A recently created entity may choose to provide a balance sheet as of its inception date as long as that inception date is within nine months before the date of filing or qualification and the date of filing or qualification is not more than three months after the entity reached its first annual balance sheet date. The date of the most recent balance sheet determines which fiscal years, or period since existence for recently created entities, the statements of income, cash flows and changes in stockholders’ equity must cover. When the balance sheet is dated as of inception, the statements of income, cash flows and changes in stockholders’ equity will not be applicable. Part III requires an exhibits index and a description of exhibits required to be filed as part of the offering statement.
Introduction to Distributed Ledger Technology or Blockchain
Introduction to Distributed Ledger Technology or Blockchain- On July 13, 2017, FINRA held a Blockchain Symposium to assess the use of distributed ledger technology (DLT) in the financial industry, including the maintenance of shareholder and corporate records. DLT is commonly referred to as blockchain. The symposium included participation by the Office of the Comptroller of Currency, the US Commodity Futures Trading Commission (CFTC), the Federal Reserve Board and the SEC. FINRA also published a report earlier in the year discussing the implications of DLT for the securities industry. Delaware, Nevada and Arizona have already passed statutes allowing for the use of DLT for corporate and shareholder records. This is the first in many LawCasts that will discuss DLT as this exciting new era of technology continues to unfold and impact the securities markets. In this LawCast series I will discuss FINRA’s report published in January 2017 and in the next series, I will summarize the recent SEC investigative report on initial coin offerings and conclusion that cryptocurrencies and tokens can be securities. I will also be completing a LawCast series summarizing the state blockchain legislation to date, including Delaware’s groundbreaking statute. Blockchain is an openly distributed database which is used to continuously maintain a list of records, called blocks. Each new block is linked to prior blocks in such a way that data cannot be retroactively changed in a prior block without changing all blocks, which is virtually impossible, although technology is being developed to correct prior transactions on the chain. A DLT ledger is shared among a network of participants, instead of relying on a single central ledger. The blockchain technology could be used to maintain shareholder records in a secure immediate form as well as to process capital markets trades instantaneously. It is thought that stock ledgers and any transfers would be updated instantaneously, effectively allowing for T+0 settlement of trades without the need for intermediaries. A change of this magnitude in our trading markets is many years away as effective regulation and consideration on market impacts will take time. However, many top transfer agents are developing blockchain systems for shareholder records and some will be available for testing in a matter of months. The technology is already being utilized, most notably by the cryptocurrency industry. At least one industry leader, Overstock CEO Patrick Byrne’s t0 Technologies, has created a system that could form the basis for widely used blockchain technology which disrupts the capital market trading systems. I don’t expect quick changes to trading systems and settlement. Blockchain remains widely unregulated and without consensus from top financial regulators, any change to capital market structures will face roadblocks. However, I expect that the ability for public companies to maintain stock ledgers using DLT technology will be forthcoming very soon. #LegalAndComplianceLLC
Reverse Mergers – Determining the Valuation of the Operating Business
Determining the Valuation of the Operating Business- Determining the valuation of the operating business is necessary where negotiating an equity deal or concurrent financing transaction as part of a reverse merger...
Regulation A; Offering Circular
LawCast with Attorney Laura Anthony: Regulation A; Offering Circular- A company intending to conduct a Regulation A offering must file an offering circular with, and have it qualified by, the SEC. The offering circular will be filed with the SEC using the EDGAR database filing system. Solicited prospective investors must be provided with the filed pre-qualified offering statement and once qualified, investors must be provided with the final qualified offering circular. Regulation A+ rules provide for an “access equals delivery” model, whereby access to the offering statement via by providing a hyperlink to the EDGAR database will satisfy the delivery requirements. The offering statement will be reviewed much like an S-1 registration statement and declared "qualified” by the SEC with an issuance of a “notice of qualification.” Like an S-1 process reviewers will be assigned filings based on industry group. The SEC has been true to its word that the review process will be lighter and less intensive than an S-1 process. Accordingly the process is also quicker, averaging 2-3 months as opposed to the 4+ months for an S-1. Companies may file certain updates and changes using a post qualification addendum. Other more material changes, including the qualification of additional securities, not originally included in the Form 1-A, require a full post qualification amendment and a new review process. Some companies are eligible to submit an offering circular to the SEC on a confidential basis. In particular, only companies that have not previously sold securities under a Regulation A or a Securities Act registration statement may submit the offering confidentially. Confidential submissions will allow a Regulation A issuer to get the process under way while soliciting interest of investors using the “test the waters” provisions without negative publicity risk if it alters or withdraws the offering before qualification by the SEC. The confidential filing, SEC comments, and all amendments must be publicly filed as exhibits to the offering statement at least 15 calendar days before qualification. Confidential submissions to the SEC are completed by choosing a “confidential” setting in the EDGAR system. To satisfy the requirement to publicly file the previous confidential information, the company can file all prior confidential information as an exhibit to its non-confidential filing, or change the setting in the EDGAR system on its prior filings, from “confidential” to “public.” If the company chooses to change its EDGAR setting to “public,” it would not have to re-file all prior confidential material as an exhibit to a new filing. If a company wants to keep certain information confidential, even after the required time to make such information public, it will need to submit two confidential requests, one as part of the registration review process and one when prior confidential filings are made public. During the confidential Form 1-A review process, the company should submit a request under Rule 83 in the same manner it would during a typical review of a registered offering. Once the company is required to make the prior filings “public”, the company would make a new request for confidential treatment under Rule 406 in the same manner other confidential treatment requests are submitted. For a confidential treatment request under Rules 83 and 406, a company must submit a redacted version of the document via EDGAR with the appropriate legend indicating that confidential treatment has been requested. Concurrently, the company must submit a full, unredacted paper version of the document to the SEC using the ordinary confidential treatment procedure.
SEC Issued New Guidance On Cybersecurity Risks and Incidents
SEC Issued New Guidance On Cybersecurity Risks and Incidents- On February 20, 2018, the SEC issued new interpretative guidance on public company disclosures related to cybersecurity risks and incidents. In addition to addressing public company disclosures, the new guidance reminds companies of the importance of maintaining disclosure controls and procedures to address cyber-risks and incidents and reminds insiders that trading while having non-public information related to cyber-matters could violate federal insider-trading laws. Public companies have many disclosure requirements, including through periodic reports on Forms 10-K, 10-Q and 8-K, through Securities Act registration statements such as on Forms S-1 and S-3 and generally through the antifraud provisions of both the Exchange Act and Securities Act, which requires a company to disclose “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.” The SEC considers omitted information to be material if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or that disclosure of the omitted information would have been viewed by the reasonable investor as having significantly altered the total mix of information available. As with all disclosure requirements, the disclosure of cybersecurity risk and incidents requires a materiality analysis. Although there continues to be no specific disclosure requirement or rule under either Regulation S-K or S-X that addresses cybersecurity risks, attacks or other incidents, many of the disclosure rules encompass these disclosures indirectly, such as risk factors, internal control assessments, management discussion and analysis, legal proceedings, disclosure controls and procedures, corporate governance and financial statements. As with all other disclosure requirements, an obligation to disclose cybersecurity risks, attacks or other incidents may be triggered to make other required disclosures not misleading considering the circumstances. A company has two levels of cybersecurity disclosure to consider. The first is its controls and procedures and corporate governance to both address cybersecurity matters themselves and to address the timely and thorough reporting of same. The second is the reporting of actual incidents. In determining the materiality of a particular cybersecurity incident, a company should consider (i) the importance of any compromised information; (ii) the impact of an incident on company operations; (iii) the nature, extent and potential magnitude of the event; and (iv) the range of harm such incident can cause, including to reputation, financial performance, customer and vendor relationships, litigation or regulatory investigations. Of course, the new guidance is also clear that a company would not need to disclose the depth of information that could, in and of itself, provide information necessary to breach cyber-defenses. A company would not need to disclose specific technical information about cybersecurity systems, related networks or devices or specific devices and networks that may be more susceptible to attack due to weaker systems. The new guidance also reminds companies that they have a duty to correct prior disclosures that the company determines were untrue at the time material information was made or omitted, and to update disclosures that become inaccurate after the fact. Like the prior guidance, the new guidance provides specific input into areas of disclosure which I will discuss in the next LawCast in this series. #LegalAndComplianceLLC
Regulation SCI and Cybersecurity
Regulation SCI and Cybersecurity- The SEC adopted Regulation Systems Compliance and Integrity (Regulation SCI) on November 3, 2015 to improve regulatory standards and processes related to technology in the securities business including by financial services firms. Regulation SCI was originally proposed in March 2013. Technology has transformed the securities industry over the last years both in the area of regulatory oversight such as through algorithms to spot trading anomalies that could indicate manipulation and/or insider trading issues, and for market participants through enhanced speed, capacity, efficiency and sophistication of trading abilities. As I have been reviewing in this Lawcast series, enhanced technology carries the corresponding risk of failures, disruptions and of course hacking/intrusions. As U.S. securities market systems are interconnected; an issue with one entity or system can have widespread consequences for all market participants. Regulation SCI was proposed and adopted to require key market participants to maintain comprehensive written policies and procedures to ensure the security and resilience of their technological systems, to ensure systems operate in compliance with federal securities laws, to provide for review and testing of such systems and to provide for notices and reports to the SEC. Key market participants generally include national securities exchanges and associations, significant alternative trading systems (such as OTC Markets, which has confirmed is in compliance with the Regulation), clearing agencies, and plan processors. Prior to enactment of Regulation SCI, there was no formal regulatory oversight of U.S. securities markets technological systems. Rather, oversight was historically through a voluntary Automation Review Policy (“ARP”). Under the ARP, the SEC created an ARP Inspection Program as well as policy statements and ongoing guidance. Compliance with ARP policies has been included in rules over the years, including Regulation ATS for high-volume automated trading systems. Although most major market participants, including SRO’s and national exchanges, participate in the ARP program, it remained voluntary and the SEC had no power to ensure compliance or enforce standards. In recent years technology has outpaced the ARP program’s reach. Today the U.S. securities markets are almost entirely electronic and highly dependent on sophisticated trading and other technology, including complex and interconnected routing, market data, regulatory, surveillance and other systems. The need for a codified regulatory system has been amplified by real-world issues such as, for example, the effects of hurricane Sandy in New York on DTC and the markets in general; the multiple occasions of halting and delay of trading on exchanges due to systems issues; the highly publicized NYSE breakdown resulting in orders being booked at incorrect prices as well as multiple well known breaches in security including the EDGAR hacking.
Federal M&A Broker Exemption
Federal M&A Broker Exemption- On January 31, 2014, the SEC Division of Trading and Markets issued a no-action letter in favor of entities effecting securities transactions in connection with the sale of equity control of private operating businesses (“M&A broker”). The SEC stated that it would not require broker-dealer registration for M&A brokers arranging for the sale of privately held businesses. The SEC M&A Broker no action letter specifically excludes transactions involving an Exchange Act reporting public company. In addition, the SEC set forth the following limitations and restrictions: (i) M&A brokers cannot bind parties to a transaction; (ii) M&A brokers cannot directly or indirectly provide financing for M&A transactions; (iii) M&A brokers cannot have custody, control or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A transaction; (iv) No M&A transaction can involve a public offering. Any offering or sale of securities must be conducted in compliance with an applicable exemption from registration. No party to any M&A transaction may be a shell company. (v) To the extent that M&A brokers represent both buyers and sellers, they must provide clear written representations as to whom they are representing and must obtain written consent from both parties for joint representation. (vi) If the M&A transaction involves a buyer group, the M&A broker may not be involved in forming the group; (vii) The buyer or group of buyers will control and actively operate the company or business and cannot be passive buyers. The buyer will be considered to have control if it has the power, directly or indirectly, to direct management or policies of the company, whether through ownership of securities, by contract or otherwise. The necessary control will be presumed if, upon completion of the transaction, the buyer or group of buyers has the right to vote 25% or more of the securities, has the power to sell or direct the sale of 25% or more of the securities, or in the case of a limited partnership or LLC, has the right to receive upon dissolution or has contributed 25% of more of the capital. (ix) Any securities received by the buyer or M&A broker in the transaction will be restricted within the meaning of Rule 144; (x) The M&A broker, and if an entity, each officer director or employee of the M&A broker: (a) has not been barred from association with a broker-dealer by the SEC or any state or any self-regulatory organization; (b) is not suspended from association with a broker-dealer.
OTC Markets and Stock Promotion Activity
OTC Markets and Stock Promotion Activity- Paid promotions are often associated with pump-and-dump activities where a third party is attempting to pump the stock price to liquidate at inflated prices, following which the stock will inevitably go down. Improper and misleading promotional materials, which can often be in the form of e-mails, newsletters, social media outlets (such as message boards), press releases, videos, telephone calls, or direct mail, generally share the following common characteristics: • Failure to identify the sponsor of the promotion or if the promotion is paid for an anonymous third party; • Information focuses on a company’s stock rather that its business; • Speculative language, including but not limited to grandiose claims and numbers related to the company’s business, industry, financial results or business developments; • Touting of performance or profit potential from trading in a company’s stock with unsupported or exaggerated statements, including related to stock price; • Making unreasonable claims related to a company’s performance; • Directly or indirectly promising specific future performance; • Providing little or no factual information about the company; • Urging immediate action to avoid missing out; • Failing to provide disclosures related to risks of an investment. Although not included in OTC Markets’ list of common characteristics, another red flag is when there is a comparison between the company being promoted and a well-known successful or respected company. OTC Markets Group monitors for paid promotional activity and reviews for anonymous promotions, connections to bad actors, and impacts on trading. Beginning in first quarter 2018, stocks associated with such promotional activity will be identified with a “risk flag” next to its symbol on the OTC Markets website. OTC Markets Group may also request that a company that is subject to promotional activity issue a press release to: (i) identify promotional activity; (ii) confirm information in the promotion or identify misinformation; (iii) and/or disclose recent securities transactions by insiders and affiliates. Furthermore, OTC Markets group may request information from a company and/or its transfer agent related to transactions and request additional disclosures from the company related to share issuances, financing agreements and the identity of people or advisors associated with the transactions. The federal securities laws also govern stock promotion activity. Section 17(b) of the Securities Act of 1933 is an antifraud provision which requires that any communications which “publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service or communication” which describes a security, must disclose any consideration received or to be received either in the past, present or future, whether directly or indirectly by the issuer of such communication. Generally the disclosure must include: (i) the amount of consideration; (ii) from whom it is received, such as the company, a third-party shareholder or an underwriter and the individual persons behind any corporate entity involved; (iii) the nature of the consideration (for example, cash or stock, and if stock, whether restricted or unrestricted); and (iv) if consideration is paid by a third party other than the company whose securities are being promoted, the relationship between the company and the third party. Moreover, I recommend that companies ensure such communications include a disclosure as to whether the issuer of such communications owns stock which may be sold in any upmarket created by the communication. The disclosure required by Section 17(b) must be included in each and every published document, including emails, message board postings and all other communications.
Section 1 of Form 8-K
Section 1 of Form 8-K- As I’ve been talking about in this Lawcast series, any U.S. reporting company must file periodic reports on Form 8-K. A foreign issuer uses a Form 6-K, which has different requirements. In this and the rest of the Lawcasts in this series I will highlight the events that trigger an 8-K filing. Many transactions will require the filing under multiple Item numbers, in which case the company can set forth all the material information and cross-reference the disclosure under each Item. Also, a Form 8-K can serve double duty and satisfy certain other filing requirements, such as those related to proxy proceedings or business combination transactions. The front page of the form 8-K provides check boxes to disclose such double use. Section 1 relates to the company’s business and operations Item 1.01 disclosed the Entry into a Material Definitive Agreement – Material agreements are those that create material obligations that are enforceable by or against a company. As a rule of thumb, if an agreement is material enough to require separate board or shareholder consent, it requires an 8-K filing. Non-binding term sheets or letters of intent generally do not trigger a filing requirement, though material binding provisions in the document may, such as significant breakup fees. A company is not required to file a copy of the agreement itself with the 8-K, but if it does not, the agreement must be filed with the next periodic report on either Form 10-Q or 10-K. As is encouraged by the SEC, I usually recommend that the agreement be filed with the 8-K. The determination of an 8-K filing requirement is made at the time the agreement is entered into. If an agreement becomes material through the passage of time or events, an 8-K filing is not later triggered – though disclosure would then be made in a 10-Q or 10-K. Item 1.02 discloses the Termination of a Material Definitive Agreement – The termination of an agreement that is reported or reportable in Item 1.01, must be reported, unless that termination occurs in accordance with the terms of the agreement itself. Item 1.03 discloses Bankruptcy or Receivership – An 8-K must be filed for bankruptcy or receivership actions involving either the company or its parent i.e. its majority shareholder. Item 1.04 discloses Mine Safety and the Reporting of Shutdowns and Patterns of Violations – The requirement for an 8-K is triggered by the receipt of a notice under the Federal Mine Safety and Health Act of 1977 or from the Mine Safety and Health Administration. #LegalAndComplianceLLC
SEC’s Proposed Rule Amendments For Disclosure Requirements For Public Companies
SEC’s Proposed Rule Amendments For Disclosure Requirements For Public Companies- In the next few Lawcasts in this series I will go through the rule amendments proposed by the SEC on October 11, 2017 following which I will go through rule amendments proposed earlier on July 13, 2016, which amendments are slated for action this year. First - 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. Second- 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. Next - 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.
OTC Markets Issues Comment Letters On FINRA Rules 6432 And 5250; The 15c2-11 Rules
OTC Markets Issues Comment Letters On FINRA Rules 6432 And 5250; The 15c2-11 Rules- Today is the first in a LawCast series talking about 15c2-11 requirements. On January 8, 2018, OTC Markets Group submitted a comment letter to FINRA related to FINRA Rule 6432. Rule 6432 requires that a market maker or broker-dealer have the information specified in Securities Exchange Act Rule 15c2-11 before making a quotation in a security on the over-the-counter market. Although I will summarize the salient points of the OTC Markets comment letter in this Lawcast series, I encourage those interested to read the entire letter, which contains an in-depth analysis and comprehensive arguments to support its position. On February 8, 2018, OTC Markets submitted a second comment letter to FINRA, this one related to FINRA Rule 5250. Rule 5250 prohibits companies from compensating market makers in connection with the preparation and filing of a Form 211 application. Rule 6432 is entitled Compliance with the Information Requirements of SEA Rule 15c2-11 Subject to certain exceptions, including the “piggyback exception” which I will explain, Rule 6432 requires that all broker-dealers have and maintain certain information on a non-exchange traded company security prior to resuming or initiating a quotation of that security. Generally, a non-exchange traded security is quoted on the OTC Markets. Compliance with the rule is demonstrated by filing a Form 211 with FINRA. Although the rule requires that the Form 211 be filed at least three days prior to initiating a quotation, in reality FINRA reviews and comments on the filing in a back-and-forth process that can take several weeks or even months. The specific information required to be maintained by the broker-dealer is delineated in Securities Exchange Act Rule 15c2-11. The core principle behind Rule 15c2-11 is that adequate current information be available when a security enters the marketplace. The information required by the Rule includes either: (i) a prospectus filed under the Securities Act of 1933, such as a Form S-1, which went effective less than 90 days prior; (ii) a qualified Regulation A offering circular that was qualified less than 40 days prior; (iii) the company’s most recent annual report filed under Section 13 or 15(d) of the Exchange Act or under Regulation A and quarterly reports to date; (iv) information published pursuant to Rule 12g3-2(b) for foreign issuers; or (v) specified information that is similar to what would be included in items (i) through (iv). In addition, Rule 6432 requires the submittal of specified information about the security being quoted (for example, common stock, an ADR or warrant), the quotation medium (for example, OTCQB) and if priced, the basis upon which the price was determined. Rule 6432 requires a certification confirming that the member broker-dealer has not accepted any payment or other consideration in connection with the submittal of the Form 211 application as prohibited by Rule 5250. Rule 15c2-11(f)(2) allows a member firm to quote or process an unsolicited order on behalf of a customer without compliance with the information requirements. In such case, the member must document the name of the customer, date and time of the unsolicited order and identifying information on the security. #LegalAndComplianceLLC
Item 6, 7, and 8 of Form 8-K
Item 6, 7, and 8 of Form 8-K- Any company subject to the reporting requirements of the Securities Exchange Act of 1934, must file periodic reports on Form 8-K. I have been going through the events that trigger such 8-K filing requirement. Section 6 relates to Asset-Backed Securities Item 6.01 reports ABS Informational and Computational Materials Item 6.02 reports the Change of Servicer or Trustee – This Item includes changes, whether through resignation or termination. Item 6.03 reports the Change in Credit Enhancement or Other External Support and requires a report of any material changes, whether through the loss, addition or change in support. Item 6.04 reports the Failure to Make a Required Distribution – Item 6.04 Only requires the report of material failures to distribute in a timely manner. Item 6.05 reports Securities Act Updating Disclosure and Includes material changes in an offering of AB securities. Item 6.06 reports a Static Pool and is used as an Alternative to filing a prospectus supplement required by Item 1105 of Regulation AB. Section 7 relates to Regulation FD Item 7.01 reports Regulation FD Disclosure – Item 7.01 Information should be furnished and not filed. Where the information is material non-public information, such as in a press release, the filing must be made immediately prior to or simultaneously with the issuance of the release. Where information is accidentally released, the filing must be made immediately after the release and on the same calendar day. Regulation FD disclosures are an exception to the usual four-day filing rule. Section 8 relates to Other Events Item 8.01 reports Other Events – This is a catch-all voluntary filing by companies that wish to report information that does not otherwise fit within an 8-K category. Because the information is voluntary and not otherwise required, there is no four-day filing rule. Section 9 relates to Financial Statements and Exhibits and is the last category of Form 8-K Item 9.01 includes Financial Statements and Exhibits – Item 9.01 Requires the filing of all financial statements and exhibits required by other Items on Form 8-K and specifies such financial statement requirements. In addition, Item 9.01 sets forth the timing of filing of the financial statements for both shell and non-shell companies. Late or missed filings carry severe consequences to companies. To qualify to use Form S-3, a company must have filed all SEC reports in a timely manner, including Form 8-K, for the prior 12 months. Filing failures can also result in enforcement proceedings and the conclusion of and disclosure related to inadequate controls and procedures. I have mentioned that some information may be furnished and not filed. Section 18 of the Exchange Act imposes liability for material misstatements or omissions contained in reports and other information filed with the SEC. However, reports and other information that are “furnished” to the SEC do not impose liability under Section 18. The SEC allows certain information to be furnished as opposed to filed; however, it is incumbent upon the company to clearly disclose that it is avowing itself of the ability to furnish and not file. Unless otherwise specifically disclosed, information in a report made with the SEC will be deemed filed, not furnished. Also note that other liability provisions under the Exchange Act may apply that are not dependent on the filing of documents, such as the anti-fraud provisions under Rule 10b-5.

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