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The SEC has Issued Proposed Rules Amending Regulation D, Form D and Rule 156 – Part II

by Laura Anthony, Esq. on August 27, 2013 in Form D, Private Placement, Regulation D, Rule 156, Rule 506, SEC Guidance, Securities Attorneys with No Comments

July 10, 2013, the same day the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rules 506 and 144A offerings as required by Title II of the JOBS Act, and adopted new rules disqualifying felons and other bad actors from participating in Rule 506 offerings as required by Section 926 of the Dodd-Frank Act, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156. On August 19, 2013, I published a blog detailing the proposed rule changes related to Form D and Rule 507. This Part II addresses the proposed amendments to general solicitation materials, including the temporary requirement that all such materials be submitted to the SEC.

Summary of Proposed Rule Changes

The proposed amendments will (i) require the filing of a Form D to be made before the Issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an Issuer from relying on Rule 506 for one year for future offerings if the Issuer, or any predecessor or affiliate of the Issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”

Proposed New Rule 509

The SEC has proposed a new Rule 509 of Regulation D which would require all Issuers to include prescribed legends in any written communication used in general solicitation in a 506(c) offering. The new Rule 509 would require all Issuers to include the following legends, prominently placed, on all written general solicitation materials:

The securities may be sold only to accredited investors, which for natural persons are investors who meet certain minimum annual income or net worth thresholds;

The securities are being offered in reliance on an exemption from the registration requirements of the Securities Act and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act;

The Commission has not passed upon the merits of or given its approval to the securities, the terms of the offering, or the accuracy or completeness of any offering materials;

The securities are subject to legal restrictions on transfer and resale, and investors should not assume that they will be able to resell their securities; and

Investing in securities involves risk, and investors should be able to bear the loss of their investment.

In addition to each of the above legends, private funds, such as hedge funds, would also be required to include a legend disclosing that the securities being offered are not subject to protections under the Investor Company Act of 1940[1]. Moreover, the new rule would require any private fund written general solicitation materials that include performance data to also include a legend disclosing that:

Performance data represents past performance;

Past performance does not guarantee future results;

Current performance may be lower or higher than the performance data presented;

The private fund is not required by law to follow any standard methodology when calculating and representing performance data;

The performance of the fund may not be directly comparable to the performance of other private or registered funds; and

Identification of either telephone number or website where an investor may obtain current performance data.

All performance data used in solicitation materials must be from the most recent practicable period and dated. The data must include disclosure as to whether the numbers are gross or net of fees and expenses. Other than these legend and disclosure requirements, and of course general antifraud provisions, there are no current or proposed content restrictions on solicitation materials for private funds, including hedge funds. However, the SEC has requested public comment on such possible restrictions and may impose them in the future.

Although a failure to comply with this rule does not automatically disqualify the 506(c) exemption, a failure to comply resulting in an order or judgment would disqualify the Issuer from relying on Rule 506 for future offerings.

Importantly, written general solicitation material is and remains undefined in the proposed rule. The SEC has requested comment as to whether such a definition should be added to the rules and if so, whether such definition should match current Rule 405 related to registered offerings. Rule 405 defines “written communications” as any communication that is written, printed, a radio or television broadcast, or a graphical communication. Graphical communication includes all forms of electronic media, including, but not limited to, audiotapes, videotapes, facsimiles, CD-ROMs, e-mail, Internet websites, telephone answering or voice mail systems, and basically all computer-generated information.

Clearly, most issuers, including reasonably well-educated executives, would not consider radio and TV ads or audio or videotapes to be written solicitations. However, securities attorneys and practitioners familiar with Rule 405 will likely defer to it as guidance in applying the legend placement requirements. Accordingly, if the rule does pass as written, I suspect a broad disparity in its application.

Proposed Amendments to Rule 156

Rule 156 provides guidance on the types of information in investment company sales literature that could be misleading. The SEC has proposed to amend Rule 156 to extend the antifraud guidance in the rule to specifically include the sales literature of private funds (hedge funds). Rule 156 applies to all funds, whether engaged in an offering under Rule 506(c) or otherwise. The rule amendment is intended to specifically address concerns about (i) advertising performance without providing information about unusual or extraordinary circumstances that might have affected that performance; (ii) advertising performance without providing adequate disclosure of the performance period or current information; and (iii) advertising performance based on selective time periods without providing disclosure regarding the full picture including all current time periods.

Additional Rules Relating to Advertising Materials of Private Funds, Including Hedge Funds

Other than as discussed herein, neither the current rule nor proposed rules provide specific restrictions on either the manner or content of general solicitation materials used solely by private funds. The SEC is requesting comment on whether such rules should be implemented.

Private funds are not subject to standardized performance calculations or reporting requirements. Moreover, private funds securities tend to be more illiquid and more difficult to evaluate. Accordingly, even if materials are true and correct, they can be confusing to investors looking to compare the results of different funds in making an investment decision.

As there are legitimate reasons for using different methods of valuation, the SEC is not proposing standardized calculations or valuation rules at this time. However, the SEC is seeking comments on whether other rules relating to the manner or content of private funds solicitations are appropriate. Examples of rules may be the prohibition of including performance materials or additional information regarding performance calculations, or requiring additional investor sophistication beyond being accredited for hedge fund investors.

Proposed Rule for the Temporary Mandatory Submission of Written General Solicitation Materials

The SEC has proposed new temporary Rule 510T to require issues to temporarily submit all written general solicitation materials used in their Rule 506(c) offerings to the SEC no later than the date of the first use of such materials. Materials would be submitted electronically through a portal on the SEC website established for this purpose. This rule is temporary in that it is meant to provide the SEC with information and research materials to better monitor the use of new Rule 506(c) and ascertain rules and guidance that may be required in the future. The proposed rule would expire two years after effectiveness.

Submissions under proposed Rule 510T would not be treated as filed or furnished for purposes of the Securities Act or Exchange Act and therefore would not be subject to the liability provisions for such filings. Like proposed Rule 509, a failure to comply with Rule 510T will not automatically disqualify the 506(c) exemption; however, a failure to comply resulting in an order or judgment would disqualify the Issuer from relying on Rule 506 for future offerings.

As with Rule 509, written general solicitation material is and remains undefined in the proposed rule 510T. The SEC is requesting comment on whether a definition of written materials should be included, and in reading the comments thus far submitted on the proposed rule, it is clear that some guidance is needed. Some practitioners have automatically assumed that the proposed Rule would encompass the same definition of written materials as Rule 405, and others have assumed otherwise.

Most commenters have three objections to the rule. One is that the Rule is too broad and burdensome and Issuers simply will not abide by the Rule, or will only partially abide. The second is that the SEC does not have the technological capability to handle the influx of information and materials that will flood the system and the SEC site will crash. The third objection is that the SEC will not have the staff or ability to actually review the bulk of the information provided and accordingly, the purpose of the Rule—to provide the SEC with information for future rule making—will be obfuscated.

Request for Comment on the Definition of “Accredited Investor”

The SEC believes the definition of “Accredited Investor,” as it relates to natural persons, needs to be amended. The SEC is considering changes to both the net worth and income tests for accredited investors and even adding non-monetary criteria such as investment experience.

The Author

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

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

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

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Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

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[1] For example, the 1940 Act includes limitations on self-dealing, affiliated transactions and leverage, and board independence requirements, none of which apply to private hedge funds.

Tags: Failure To File Form D, Filing Form D, form d, Rule 156, Rule 405, Rule 506 Offerings, Rule 506(c), Rule 507, Rule 509, Rule 510T

The SEC has Issued Proposed Rules Amending Regulation D, Form D and Rule 156 – Part I

by Laura Anthony, Esq. on August 20, 2013 in Form D, Regulation D, Rule 156, Rule 506, SEC Guidance, Securities Attorneys, Uncategorized with No Comments

On July 10, 2013, the same day the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rules 506 and 144A offerings as required by Title II of the JOBS Act, and adopted new rules disqualifying felons and other bad actors from participating in Rule 506 offerings as required by Section 926 of the Dodd-Frank Act, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156.

Summary of Proposed Rule Changes

The proposed amendments will (i) require the filing of a Form D to be made before the issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”

This blog addresses the proposed rule changes to Form D and Rule 507. Part II in the series will discuss the proposed amendments to general solicitation materials, including the temporary requirement that all such materials be submitted to the SEC.

Proposed Amendments Related to Form D

A Form D is a notice of an offering of securities conducted under Regulation D that must be filed with the SEC no later than 15 calendar days from the first sale of the securities in the offering. The current information in a Form D includes identifying information such as the issuer’s full name and address; year and place of incorporation; information about executive officers, directors and promoters; the exemption being claimed; and factual information about the offering such as the type of securities and amount and the states of resident of investor purchasers. Currently, the failure to file a Form D in and of itself does not disqualify the use of an exemption.

With respect to Form D, the SEC is proposing to:

Amend Rule 503 to require: (1) the filing of a Form D no later than 15 calendar days in advance of the first use of general solicitation in a Rule 506(c) offering; (2) the filing of an amended Form D within 15 days of the first sale of securities under the offering; and (3) the filing of a closing amended Form D within 30 calendar days of the termination of the offering (in the case where an issuer does not use general solicitation and advertising until 15 days or more after the first sale, (1) and (2) would be accomplished in a single filing);

Amend Form D to require additional information regarding offerings;

Amend Rule 507 to disqualify an issuer from relying on Rule 506, for one year, if the issuer or any predecessor or affiliate of the issuer failed to comply with the Form D filing requirements within the last five (5) years.

One of the main purposes of requiring an advance filing of a Form D is for state regulators, who often review Form D filings for red flags that the offering may be fraudulent, and will be given advance warning of any offering that may be advertised in their state. In addition, the SEC believes it, together the closing Form D, will provide both the SEC and state regulators with useful information in analyzing the impact of the new Rule 506(c) offering.

The proposed rule changes will not change the existing requirements that an issuer file an amendment to correct material mistakes of fact or other errors or a change in information previously provided, and file a new Form D annually for ongoing offerings.

The proposed changes related to additional information requirements are specific to Rule 506 and especially Rule 506(c) offerings, including information related to the types of general solicitation used and methods used to verify accredited investor status of purchasers. In addition, issuers would be required to provide their website address, if any; the identity of controlling persons that are not otherwise disclosed as officers, directors or promoters; the issuer’s industry group; information about the issuer’s size, including revenues (subject to certain rights to decline to disclose based on confidentiality); identification of trading symbol and cusip, if applicable; additional information on the investors including whether they are natural persons or entities; additional information on use of proceeds and specifically uses related to the repurchase of existing securities, payment of offering expenses, acquisition of assets out of the ordinary course of business, financing acquisitions, working capital and to discharge indebtedness.

Proposed Amendment to Rule 507

The SEC has proposed to amend Rule 507 to disqualify an Issuer from relying on Rule 506, for one year, for future offerings, if the Issuer or any predecessor or affiliate of the issuer failed to comply with the Form D filing requirements within the last five (5) years. Compliance with Form D filing requirements would include requirements to file any amendments or closing Form D’s.

Currently, an Issuer is only disqualified if it has been subject to a court order or injunction for failure to file a Form D. The new proposed amendment contains an automatic disqualification. The rule change is significant as an Issuer that engages in a 506 offering which otherwise follows the letter of the law, but for which they are subject to the automatic disqualification, would be guilty of a section 5 violation and face severe consequences, including the requirement to offer rescission to investors, exposure to civil claims by investors and exposure to civil regulatory enforcement proceedings by regulators that would likely seek both monetary and injunctive relief.

Although an Issuer would be disqualified from relying on Rule 506 for future offerings for the failure to file a Form D, the failure to file the Form D, in and of itself, does not result in a loss of the exemption for the current offering. The proposed amendment to Rule 507 is not retroactive. That is, disqualification will only occur for the failure to file a Form D for an offering after the Rule 507 amendment goes into effect.

Moreover, in light of the severe impact of the failure to file, the SEC has proposed a one-time cure period of 30 calendar days following the missed due date for the Form D filing. Issuers will not be able to rely on the cure period more than once.

An Issuer may petition the SEC for a waiver of the disqualification. A waiver will only be granted if the Issuer can demonstrate good cause. Good cause could include a complete change of control over the Issuer since the missed filing or that a predecessor Issuer no longer exists and therefore cannot cure the missed filings.

The SEC Comment Requests

In its requests for comments, the SEC poses specific questions which are often telling in regard to possible changes to the proposed rules, or future rule making. The SEC has requested comments on the above rule changes in general, and in particular is seeking input on the following (note that this is not a complete list of the comment requests):

What should the consequences be for the failure to file the advance Form D in a 506(c) offering, including whether it should include an immediate loss of the use of the exemption?

What is the impact to the issuer if a third party engages in some form of solicitation or advertising before the filing of the Form D and without the issuer’s consent? Can the issuer cure with the immediate filing of an advance Form D?

Should a Form D have additional information requirements and suggestions as to this additional information?

Will the proposed new Form D filing requirements deter issuers from capital raising activities or chill the marketplace in any way?

Should the issuer lose the 506 exemption if they fail to file the closing Form D?

Should the SEC provide a better explanation of what constitutes a termination of the offering?

Should the SEC provide additional rules as to what constitutes a change so as to require the filing of an amendment to the Form D?

Should any additional information be required in the Form D or any of its amendments, including the closing amendment?

Should the SEC require amendments as milestones are reached – for example, the sale of 10% of the offering, etc.?

Should pooled investment funds (hedge funds) be required to provide different information in a Form D?

Is disqualification too harsh a consequence for the failure to file a Form D, its amendments or a closing Form D?

Should the Rule 507 amendment be retroactive?

Should Rule 507 have different requirements for pooled investment funds (hedge funds)?

Should disqualification be automatic or only following an SEC order or court order?

The Author

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

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

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Tags: 506 Exemption, form d, Private Placement Offering, Regulation D, Rule 156, Rule 503, rule 506, Rule 506(c), Rule 507

SEC Issued Risk Alert on Options Trading Used to Evade Short Sale Requirements

by Laura Anthony, Esq. on August 15, 2013 in Regulation SHO, Risk Alert, SEC Guidance, Securities Attorneys, Uncategorized with No Comments

On Friday August 9, 2013, the Securities and Exchange Commission issued a Risk Alert to help market participants detect and prevent options trading that circumvents an SEC short sale rule.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued the alert after its examiners observed options trading strategies that appeared to evade certain requirements of the short-sale rule. The alert describes and warns of the strategies used by some customers, broker-dealers and clearing firms, summarizes related enforcement actions, and makes suggestions regarding practices found to be effective in detecting and preventing trading intended to evade Regulation SHO.

Regulation SHO tightened requirements for short sales, which involve the selling of securities not already owned, usually by the borrowing of securities. Short sellers profit from price declines by replacing borrowed securities at a lower price. Under Regulation SHO, short sellers who fail to deliver securities after the settlement date are required to close out their position immediately, unless they qualify as a market maker. The trading strategies observed by the OCIE staff may give the impression of satisfying the Regulation SHO “closeout requirement,” while in effect evading it.

In addition, the Risk Alert describes activities that the staff has observed that may indicate an attempt to circumvent Regulation SHO. These include:

Trading exclusively or excessively in hard-to-borrow securities or threshold list securities, or in near-term listed options on such securities

Large short positions in hard-to-borrow securities or threshold list securities

Large failure to deliver positions in an account, often in multiple securities

Continuous failure to deliver positions

Using buy-writes, married puts, or both, particularly deep in-the-money buy-writes or married puts, to satisfy the closeout requirement

Using buy-writes with little to no open interest aside from that trader’s activity, resulting in all or nearly all of the call options being assigned

Trading in customizable FLEX options in hard-to-borrow securities or threshold list securities, particularly very short-term FLEX options

Purported market makers trading in hard-to-borrow or threshold list securities claiming the exception from the locate requirement of Regulation SHO; often these traders do not make markets in these securities, but instead make trades only to take advantage of the option mispricing

Multiple large trades with the same trader acting as a contra-party in several hard-to-borrow or threshold list securities; often traders assist each other to avoid having to deliver shares

The text of the entire alert is available on the SEC website.

The Author

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

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

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Tags: OCIE, Options Trading, Regulation SHO, sec, Short Sale Rule

SEC Updates May Benefit Equity Line Financing Providers and Issuers

by Laura Anthony, Esq. on August 13, 2013 in OTC Market, OTCBB, OTCQB, OTCQB and OTCQX, OTCQX, Pinksheets, Private Investment in Public Equity (PIPE), S-1 Registration Statement, Securities Attorneys with No Comments

On May 16, 2013, the SEC updated their Compliance and Disclosure Interpretations addressing the point at which an equity line agreement can be determined to be a completed transaction for purposes of filing a resale registration statement.

Background

Equity line financings are transactions where a company has a long-term contract to put shares to an investor (the equity line provider) at a price, generally determined by a formula based on a discount to market price. That is, the Issuer has the right to tell the investor when to buy securities from the Issuer over a set period of time and the investor has no right to decline to purchase the securities (or a limited right to decline). Generally, the dollar value of the equity line is set in the written agreement, but the number of securities varies based on a formula tied to the market price of the securities at the time of each “put.”

Most equity line financing arrangements are similar to a PIPE (private investment into public entity) transaction such that the Issuer relies on the private placement exemption from registration to sell the securities under the equity line and then files a registration statement for the resale of such securities by the investor. However, whereas in a PIPE transaction the investor bears the risk, in an equity line transaction the investor often bears little risk due to the delayed nature of the puts coupled with the price of the securities being a formula tied to market price. Accordingly, the SEC views equity line financing registrations as indirect primary offerings.

The SEC Requirements

On May 16, 2013, the SEC added the following to its Compliance and Disclosure Interpretations:

“Question: When may a company file a registration statement for the resale by the investors of securities sold in a private equity line financing?

Answer: In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then register the ‘resale’ of the securities sold in the equity line financing. In these types of equity line financings, the delayed nature of the puts and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings.

While we analyze private equity line financings as indirect primary offerings, we recognize that the ‘resale’ form of registration is sought in these financings. As such, we will permit the company to register the ‘resale’ of the securities prior to its exercise of the put if the transactions meet the following conditions:

the company must have ‘completed’ the private transaction of all of the securities it is registering for ‘resale’ prior to the filing of the registration statement;
the ‘resale’ registration statement must be on the form that the company is eligible to use for a primary offering; and
in the prospectus, the investor(s) must be identified as underwriter(s), as well as selling shareholder(s).

We will not object that a private transaction is not ‘completed’ based on the lack of a fixed price if the agreement provides for pricing based on a formula tied to market price and there is an existing market for the securities as evidenced by trading on a national securities exchange or through the facilities of the OTC Bulletin Board or the OTCQX or OTCQB marketplaces of OTC Link ATS. [May 16, 2013]”

Importantly, the only change to the SEC’s prior standard is the final paragraph recognizing the OTCQX or OTCQB marketplaces. However, this change is significant, which I will discuss in further detail below.

Discussion of the SEC requirement that the transaction be completed

Although the SEC views the equity line as an indirect primary offering, it allows the filing of resale type registrations if the following conditions are met:

The Issuer must have completed the private transaction prior to filing the registration statement (i.e., both parties must be fully contractually bound, with all material points agreed upon)
The “resale” registration statement must be on the form that the Issuer is eligible to use for a primary offering; and
In the prospectus, the investors must be identified as both underwriter(s) and selling shareholder(s).

In order for the first condition to be met, the Investor must be irrevocably bound to purchase all the securities. That is, only the Issuer can have the right to exercise the put and, except for conditions outside the investor’s control, the investor must be irrevocably bound to purchase the securities once the Issuer exercises the put. In addition, the obligations of the Investor must be non-assignable to meet the “irrevocably bound” condition.

Moreover, if the Investor has the ability to make investment-related decisions under the terms of the contract, they will not be deemed to be irrevocably bound allowing for the filing of a resale registration statement. Examples of investment decisions that would be viewed by the SEC as creating a continuing transaction (and not a completed transaction allowing for the filing of a registration statement) include:

Agreements that give the Investor the right to acquire additional securities (including through warrants) at the same time or after the Issuer exercises a put;
Agreements that permit the Investor to decide when or at what price to purchase the securities underlying the put;
Agreements with termination provisions that have the effect of causing the Investor to no longer be irrevocably bound to purchase the securities; and
Agreements that allow the Investor to exercise a “due diligence out.”

However, the agreements may allow for customary “bring-downs” as conditions to closing such as customary representations and warranties and customary clauses regarding no material adverse changes affecting the Issuer that would be within the Investor’s control.

Significance of Recognizing the OTCQB and OTCQX as Markets

Over the past years, the historical “pinksheets” underwent major changes, including the creation of certain “tiers” of Issuers and a new name for the inter-dealer quotation system – the OTC Link. The OTC Link divides Issuers into three (3) levels: OTCQX, OTCQB, and pinksheets. Quotation on both the OTCQB and OTCQX requires that the Issuer be subject to and current with the reporting requirements of the Securities Exchange Act of 1934. However, up until the May 16 change, the SEC viewed all three tiers of the otcmarkets.com as just the “pinksheets.” As the OTC Link was not considered a market: (1) there could be no at-the-market pricing of securities registered for resale by an Issuer on behalf of its selling shareholders; and (2) there could be no equity lines or similar financing transactions and no registration of underlying convertible equities which are priced based on a formula tied to the trading price (usually a discount to market) for OTC Link quoted securities.

Accordingly, where OTCQB and OTCQX quoted securities could not avail themselves of equity line financings prior to May 16, 2013, they now can.

The Author

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

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

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Tags: OTC Link ATS, OTCQB, OTCQX, Pinksheets, PIPE, Private Equity Line Financing, Resale Registration Statement

An Overview of Exemptions for Hedge Fund Advisors: Exemptions for Advisors to Venture Capital Funds, Private Fund Advisers with Less Than $150 Million in Assets Under Management, and Foreign Private Advisers – Part III

by Laura Anthony, Esq. on August 07, 2013 in Dodd-Frank Act, JOBS ACT, Rule 506, Securities Attorneys with No Comments

As the rules that will allow general solicitation and advertising for Rule 506(c) and 144A offerings near effectiveness, our firm has noticed a spike in inquiries related to small hedge funds and feeder funds. The JOBS Act is not the only recent congressional act to change the landscape of hedge funds; the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) made significant changes as well.

In particular, the Dodd-Frank Act eliminated the oft relied upon exemption from registration for private hedge fund advisors for those advisors with fewer than 15 clients. While eliminating the private advisor exemption, Dodd-Frank created three new exemptions, which are the operable hedge fund advisor exemptions today. These exemptions are for:

(1) Advisors solely to venture capital funds;

(2) Advisors solely to private funds with less than $150 million in assets under management in the U.S.; and

(3) Certain foreign advisers without a place of business in the U.S.

Moreover, the Dodd-Frank Private Fund Investment Advisers Registration Act of 2010 (the “Advisers Act”) imposed certain limited filing requirements for those advisers claiming one of the 3 new exemptions.

In this series of blogs, I am providing an overview of each of these exemptions and of the form filing and limited reporting requirements for exempt advisors. This is Part III in the series and discusses the exemption for advisors to private funds with less than $150 million in assets under management in the U.S. Part I in the series was initially published on May 16, 2013 and Part II on May 21, 2013. Both can be reviewed at my blog site: www.securities-law-blog.com.

Exemption for Advisers to Funds with Less Than $150 Million in Assets Under Management in the U.S. Section 203(m) of the Advisors Act exempts from registration advisors solely to private funds that have less than $150 million in assets under management in the U.S. The advisor may advise an unlimited number of private funds as long as the aggregate value of all assets of all the private funds is less than $150 million. The enacted exemption is commonly referred to as the “private fund adviser exemption.”

In the case of an advisor located outside the U.S., the exemption will apply as long as all of the advisor’s clients that are in the U.S. are private and the aggregate amount of funds under management is below $150 million. For purposes of the exemption it is irrelevant how many, the type of, or dollar value of funds under management outside the U.S.—provided, however, that the adviser and its principal offices must be located outside the U.S. For advisers that are located in the U.S. and whose principal offices are in the U.S., all funds under management are considered U.S. funds.

Private funds include hedge funds, private equity funds and other types of pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 1940 under either section 3(c)(1) or 3(c)(7). Section 3(c)(1) is available to a fund that does not publicly offer its securities and has 100 or fewer beneficial owners of its securities. Section 3(c)(7) is available to a fund that does not publicly offer its securities and limits the owners of its securities to qualified investors. In addition, for purposes of this exemption a private fund is one that qualifies for an exclusion under any other provisions of the Investment Company Act, in addition to section 3(c)(1) or 3(c)(7).

Method and Frequency of Calculation of Assets

An adviser must aggregate the value of all assets of private funds it manages to determine if it is below the $150 million threshold. Instruction Form ADV provides a required and uniform method of calculating assets under management. Although an in-depth review of such calculations is beyond the scope of this blog, in summary, advisers must include proprietary assets and assets managed without compensation as well as uncalled capital commitments. In addition, asset value must be based on gross market value or gross fair value if market value cannot be determined. Deductions may not be made for liabilities, accrued fees or expenses.

An analyst relying on this exemption must annually calculate the amount of the private fund assets it manages and report the amount on its annual updated Form ADV. Accordingly, if the value of assets increases to over $150 million in a year, the adviser would be required to register, unless another exemption is available. If no other exemption is available, and as long as the adviser is current with its ADV reporting requirements, the adviser has up to 90 days to register with the SEC and may continue to act as an adviser during the transition period. Moreover, as the annual ADV which calculates assets under management is not due until 90 days after the end of the fiscal year, the adviser would in effect have 180 days from the end of the fiscal year to register.

Filing Requirements for Exempt Advisers

Exempt advisers are still required to file a Form ADV and to update such form annually. The Form ADV will require basic organizational and operational information about each fund such adviser manages, such as the type of fund (hedge fund, private equity fund, etc.), general information about the size and ownership of the fund, general fund data and information about the adviser’s services to the fund. In addition, the Form ADV must identify the five gatekeepers to the fund (auditor, prime brokers, custodians, administrators and marketers). Finally, the Form ADV requires information regarding the business practices (subcontracting, affiliations, etc.), types of clients the adviser advises in general, number of employees and types of services provided.

The Author

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

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Tags: Advisors Act, Dodd-Frank Act, Investment Company Act of 1940, Rule 506(c)

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