Monthly Archives: June 2014

Section 16 Insider Reporting and Potential Liability for Short-Swing Trading Practices

A public company with a class of securities registered under Section 12 or which is subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) must file reports with the SEC (“Reporting Requirements”).  The required reports include an annual Form 10-K, quarterly Form 10Q’s and current periodic Form 8-K as well as proxy reports and certain shareholder and affiliate reporting requirements.

Last week, I wrote about the “certain shareholder” filing requirements under Sections 13d and 13g of the Exchange Act, Regulation 13D-G beneficial ownership reporting and related Schedules 13D and 13G.  This blog is a summary of the “certain shareholder and affiliate” reporting and related requirements under Section 16 of the Exchange Act.  In particular, all directors, executive officers and 10% stockholders (“Insiders”) of reporting companies are subject to the reporting and insider trading provisions of Section 16 of the Exchange Act.  At the end of the blog is a reference chart related to the Section 16 reporting obligations and short swing trading prohibitions as described herein.

A company becomes subject to the reporting requirements by filing an Exchange Act Section 12 registration statement on either Form 10 or Form 8-A (“Reporting Company”).  A Section 12 registration statement may be filed voluntarily or per statutory requirement if the issuer’s securities are held by either (i) 2,000 persons or (ii) 500 persons who are not accredited investors and where the issuer’s total assets exceed $10 million.  The Section 16 reporting and related obligations as to insiders is only applicable to the insiders of companies with a class of securities registered under Section 12 of the Exchange Act, commonly referred to as a ’34 Act filer.  Although companies that file a Form S-1 registration statement under the Securities Act of 1933, as amended (“Securities Act”) become temporarily subject to reporting requirements under Section 15(d) of the Exchange Act (a ’33 Act filer), like Section 13, Section 16 is not applicable to the insiders of a ’33 Act filer.

Overview

Section 16 is intended to prevent unfair use of inside information and discourage speculative trading by insiders by requiring them to report holdings and transactions in a reporting company’s securities (under Section 16(a)).  In addition, Section 16 also requires insiders to pay over to the reporting company any “profits” realized from any purchase and sale (or any sale and purchase) of the reporting company securities within a six-month period (under Section 16(b)).  Under Section 16(c), insiders are precluded from making short sales (sales of shares they do not own at the time of the sale) of the reporting company’s securities.

In addition, the SEC requires that the reporting company disclose in its annual proxy statement the names of insiders who have failed to make required Section 16 filings on a timely basis, and also to note the existence of such disclosure on the cover of its annual report on Form 10-K.

The rules under Section 16 are complex and contain a number of “gray” areas and potential traps for the unwary. Insiders should consult with counsel before engaging in any transactions in the company’s securities, particularly transactions involving “derivative” securities (such as options or warrants).

Who is an Insider?

Section 16(a) requires directors and executive officers of a reporting company to report their beneficial ownership of and transactions in the company’s securities to the SEC and the public. A “director” refers to a person who is a member of the board of directors of the reporting company.  Section 16 only covers certain named executive officers, including the (i) president and principal executive officer; (ii) any vice president in charge of a principal business unit, division or function; (iii) principal financial officer; (iv) principal accounting officer; and (v) any other person who performs similar policymaking functions for the company.  The key determination is the level of control and ability to perform significant policy making functions for the reporting company.  The SEC recognizes that reporting companies may give titles to individuals that include terms like “vice president of…” or “director of…” which individuals are not in a high-level control position.  These individuals are not considered Section 16 filers.

In addition to directors and executive officers, persons, including entities, who beneficially own more than 10% of a class of the company’s registered securities are subject to Section 16(a) reporting requirements.  As with other SEC rules and regulations, 10% ownership is based on beneficial ownership and not the legal title or record ownership.  Beneficial ownership is determined by the person’s ability to control the voting power of the securities, investment decisions related to the securities (whether to buy or sell), and monetary interests in the securities.  A monetary interest is the direct or indirect ability to profit from purchases or sales of securities.

An insider is considered to have a beneficial ownership interest of securities held by members of the insider’s immediate family sharing the same household.  Immediate family household members include grandparents, grandchildren, siblings and in-laws, as well as the insider’s spouse, children and parents.

An insider is considered a beneficial owner of shares in a trust for Section 16 purposes if the insider has or shares investment control over the trust securities and the insider is a: (i) trustee and such trustee or trustee’s family members have a monetary interest in the securities; (ii) beneficiary; or (iii) settlor with powers to revoke the trust. An insider who has control or a controlling influence over a partnership or corporation will generally have beneficial ownership of the securities held by that partnership or corporation.

Disclaimer of Beneficial Ownership

When there is doubt as to the beneficial ownership of securities, an insider should report such securities as being beneficially owned.  Such report will not amount to an admission of beneficial ownership if accompanied by a disclaimer of beneficial ownership.  To disclaim beneficial ownership, the following statement can be included on a Form 3, 4 or 5:

The undersigned disclaims beneficial ownership of the securities indicated, and the reporting herein of such securities, shall not be construed as an admission that the undersigned is the beneficial owner thereof for purposes of Section 16 or for any other purpose.

Section 16 Reporting Obligations

Section 16 requires insiders to file an initial statement of beneficial ownership of the company’s securities on Form 3 at the time that such insider becomes subject to Section 16 (when they become an insider), as well as periodic statements reflecting changes in such beneficial ownership.  Most changes in beneficial ownership (as defined below) must be reported electronically within two business days.  In addition to common stock ownership, insiders must report derivative securities ownership.  Derivative securities include options, stock appreciation rights, warrants, convertible securities or similar rights. Derivative securities also include third-party contracts: puts, calls, options or other rights to acquire the company’s securities.

The following are several relevant times and basic filing requirements:

• (a) An initial statement of beneficial ownership of equity securities on Form 3 must be filed by the date that the registration statement for the company’s initial public offering becomes effective or, thereafter, within 10 days of the date a person becomes an insider.  The initial Form 3 must include all of the insider’s holding of the reporting company’s securities.  An insider must file a Form 3 even if they do not have any beneficial ownership in the company’s securities.  For example, a newly elected director or newly appointed executive officer must file a Form 3 even if such director or officer does not have a beneficial interest in a single share of stock.
• (b) Generally, any change in an insider’s beneficial ownership of the company’s securities is reported on a Form 4 by the second business day following the transaction date.  The Form 4 must be filed for transactions, even if such transactions are exempt from the short swing profit rules discussed below.
• (c) The remaining reportable transactions (such as gifts), including any (late) reports of transactions and holdings not previously reported, must be reported on Form 5 within 45 days of the company’s fiscal year end, unless the insider voluntarily reports the transaction or holding earlier on Form 4.

A few transactions (such as acquisitions under certain tax qualified plans) need not be separately reported (although their effect on an insider’s holdings will ultimately be reflected).  In particular, exemptions from the two-day Form 4 filing requirement include (i) gifts; (ii) inheritances; and (iii) small acquisitions other than from the company that do not exceed in the aggregate $10,000 in market value within a six-month period, provided the insider makes no nonexempt dispositions during the six months thereafter.

Insiders are not required to report on Form 4 or 5 transactions that effect only a mere change in the form of the insider’s beneficial ownership. For example, a distribution to the insider of securities previously beneficially owned by the insider through an employee benefit plan merely changes the form of ownership (from indirect to direct) and is exempt from Forms 4 and 5 reporting requirements.

At the conclusion of this blog is a table of typical transactions an insider may encounter and when such insider must report them.  Even though the reporting of a few transactions may be deferred, it is advisable to report all reportable transactions on a Form 4 at the time of the transaction because it is possible that the insider may not recall the transaction when it is time to file the Form 5.  If Form 4 is filed for every reportable transaction, no Form 5 filing is required at the end of the company’s fiscal year.

Section 16 reports must now be filed using EDGAR, the SEC’s electronic filing system, so an insider must obtain a personal EDGAR access code before making a filing.  Forms 4 and 5 contain an “exit” box, which may be checked when an insider ceases to be an insider.  However, the insider would still be required to report a transaction after they cease to be an executive officer or director, if the transaction (such as a sale) “matches” with any transaction (such as a non‑exempt purchase) while they were an executive officer or director.

Section 16 rules mandate that companies post on their corporate websites all Forms 3, 4 and 5 filed by their insiders and 10% beneficial owners by the end of the business day after the date of filing. Companies must keep the reports posted for at least 12 months. Most post by hyperlinking to third-party service providers or to the EDGAR database on the SEC’s website. The hyperlink must link directly to the forms or a list of the forms, and the link caption must clearly indicate access to insider Section 16 reports.

Filing Deadlines and Consequences for Late Filings

Form 3’s are due on the date the company goes public or, thereafter, within 10 days of the date a person becomes an insider.  Forms 4 (other than voluntary filings) must be filed on or before the second business day after the reportable transaction occurred.  A voluntary Form 4 may be filed at any time.  Form 5 is due within 45 days after the end of the company’s fiscal year.  If any transactions should have been reported earlier, the delinquent reports of those transactions must be included in the Form 5 and a special box must be checked indicating that reporting delinquencies have occurred.  If all holdings and transactions have previously been reported, no Form 5 need be filed.  If the due date falls on a weekend or a national holiday, the form is due on the next business day.

Failure to file a Form 3, 4 or 5 in a timely manner can result in substantial penalties to the insider. The SEC can seek fines in judicial enforcement actions of up to $7,500 for each violation by an individual and up to $75,000 for corporations and other entities. If the violation includes fraud or deceit or deliberate disregard of a regulatory requirement, the fine can be as much as $150,000 for an individual and $725,000 for a corporation. The SEC can also issue cease-and-desist orders in administrative proceedings against future violations. Failure to file reports also prevents the two-year statute of limitations from running on suits against insiders to recover any profits due to the company under Section 16(b).

In addition, a reporting company must disclose by name in its proxy statement or annual Form 10-K any insiders who reported transactions late or failed to file required reports during the fiscal year. The reporting company must also report on the cover of its Form 10-K that the report discloses late or delinquent Section 16 filing.

To ensure compliance, it is highly recommended that reporting companies implement policies requiring all Section 16 insiders to pre-clear their transactions with the company at least two business days before they initial any transaction.   In addition, companyies should obtain a representation from departing directors and officers that no Form 5 is due and that there have been no unreported Form 4 transactions.

Avoiding Short-Swing Liability

In addition to making complete and timely reports under Section 16(a), an insider must also be careful to plan transactions to avoid short-swing liability under Section 16(b).  Section 16(b) is designed to discourage trading on inside information, and presumes that certain people inevitably benefit from their “insider” status.  Under Section 16(b), any purchase and sale, or sale and purchase, of a reporting company’s securities by a company insider made during any given six-month period will be matched.  Any “profit,” whether inadvertent or intentional, realized by matching a purchase and sale within a six-month period is recoverable by the company.  If the company fails to recover such profit, any shareholder of the company may sue to recover it on behalf of the company.  Forms 3, 4 and 5 filed with the SEC are publicly available and are routinely monitored by attorneys who make their living by threatening to file Section 16(b) suits on behalf of shareholders.  In the event of a violation of Section 16(b) by an insider, these attorneys are generally able to compel the company and/or the offending insider to pay their fees and expenses if the company had not acted to obtain restitution of the deemed “profit” from the insider prior to receiving a communication from the attorney.

Unlike other provisions in the federal securities laws, intent to take unfair advantage of non-public information is not required for recovery under Section 16(b).  In other words, transactions in the company’s securities within six months of one another can lead to recovery of profits irrespective of the reasons for or purposes of the transaction.

Except in the case of options and other derivative securities (for which there is a special rule for calculating profits), transactions are paired with mechanical rigidity so as to match the lowest purchase price with the highest sale price, thus squeezing out the maximum amount of “profit.”  Thus, although an insider may have realized an economic loss, they may be treated for Section 16(b) purposes as having realized a “profit.”

The table at the end of this blog includes typical transactions and how they would be treated.  It does not matter for Section 16(b) purposes whether the purchase or sale comes first.  It makes no difference that the particular shares sold happen to be shares held more than six months, since it is not necessary for the same shares to be involved in each of the “matched” transactions.  The rules apply not only to individual transactions but also to transactions engaged in by others if the insider is deemed to have a pecuniary interest in those shares.  Thus, a purchase by an insider could be matched with a sale of shares by the insider’s spouse.  Public and private transactions also can be matched.  In the case of officers and directors, transactions occurring while an insider may be matched with transactions after the person ceases to be an insider.  A 10% beneficial owner must, however, be a 10% beneficial owner at both the time of purchase and the time of sale to trigger Section 16(b) matching liability.

The purchase and sale of securities that are convertible into or exercisable for the purchase of shares of common stock may be matched either against the sale and purchase of other securities which are so convertible or the sale and purchase of shares of common stock.  For example, a sale of common stock might be matched either against a purchase of convertible securities or a purchase of common stock within six months before or after such sale.  The acquisition of options, warrants or convertible securities will also generally be treated as an acquisition of the underlying equity security, but the exercise of such option or warrant or conversion of such convertible securities will not be treated as a matchable purchase.

Any acquisition by an officer or director (but not a 10% holder) from the company, or any disposition by an officer or director to the company, is exempt from matching if approved in advance by the board of directors or a properly constituted committee of the board.  Thus, neither the grant nor the exercise of an option issued under the company’s stock option plans will generally be treated as a matchable “purchase” for purposes of Section 16(b).  Acquisitions of common stock under the company’s employee stock purchase plans will not generally be treated as matchable purchases for purposes of Section 16(b).  If the officer or director elects to pay the exercise price (and/or any tax withholding obligations) by withholding option shares or tendering previously held shares to the company, the disposition of such shares will likewise be exempt from matching if properly approved in advance.  However, the sale of shares by a broker to pay the exercise price and/or tax withholding would be treated as a matchable “sale” for purposes of Section 16(b).

Short Sales

In general, Section 16(c) of the Exchange Act makes it unlawful for an insider to make “short sales” or “sales against the box” when the securities sold are not delivered within the time periods set forth in Section 16(c).  A “short sale” is any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller.  A “sale against the box” is the type of short sale in which the seller actually owns sufficient shares to make delivery but chooses to borrow shares to cover the sale.  The seller subsequently can either buy securities or use his own securities to repay the lender to complete the transaction.

Avoiding Liability under Other Insider Trading Rules

Section 16 is based on a presumption that certain people inevitably benefit from their access to inside information.  Insiders should not forget that the Securities Exchange Act also prohibits the actual use of inside information, whether or not this involves six-month matching of purchase and sale transactions.  Although this topic will be covered in depth in a future blog, in addition to the direct liability of insiders for insider trading violations, companies and their directors and officers may also be legally liable for failing to prevent such violations by company personnel.  In light of this potential indirect liability, and the severity of possible sanctions both to you and to the company for insider trading violations, the company’s policies and procedures set forth in its insider trading policy statement should be observed at all times.

(1)       Assuming that the specific approval of the transaction required by new Rule 16b‑3 has been obtained or, in the case of an acquisition, the security is held at least six months.

(2)       Transactions that are not required to be reported as separate line items must be reflected in end-of-period holdings.  Insiders may choose to indicate, by a footnote, that the report reflects the results of transactions which are not required to be itemized.

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.

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Tags: 10% Beneficial Owner, Beneficial Owner, Form 3, Form 4, Form 5, Section 16, Section 16(a), Section 16(b), Section 16(c)

Schedule 13D and 13G Filing Requirements for Public Company Shareholders

A public company with a class of securities registered under Section 12 or which is subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) must file reports with the SEC (“Reporting Requirements”).  The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner.  Reports filed with the SEC can be viewed by the public on the SEC EDGAR website.  The required reports include an annual Form 10-K, quarterly Form 10Q’s and current periodic Form 8-K as well as proxy reports and certain shareholder and affiliate reporting requirements.

This blog discusses the “certain shareholder” filing requirements under Sections 13d and 13g of the Exchange Act, Regulation 13D-G beneficial ownership reporting and related Schedules 13D and 13G.  This blog is a summary of the large body of rules and interpretations related to Sections 13d and 13g, including the SEC’s Compliance and Disclosure Interpretations (C&DI’s) publication on the rules and filing requirements.  Shareholders that may become subject to these rules and filing requirements should seek the advice of securities counsel to ensure compliance.

A company becomes subject to the Reporting Requirements by filing an Exchange Act Section 12 registration statement on either Form 10 or Form 8-A.  A Section 12 registration statement may be filed voluntarily or per statutory requirement if the issuer’s securities are held by either (i) 2,000 persons or (ii) 500 persons who are not accredited investors and where the issuer’s total assets exceed $10 million.  Although companies that file a Form S-1 registration statement under the Securities Act of 1933, as amended (“Securities Act”) become subject to Reporting Requirements under Section 15(d) of the Exchange Act, only the shareholders of companies that have a class of securities registered under Section 12 of the Exchange Act are subject to the 13d and 13g filing requirements.

Section 13 of the Exchange Act requires any person acquiring more than five percent of a voting class of a company’s Section 12 registered equity securities directly or by tender offer to file a Schedule 13D or 13G. Depending upon the facts and circumstances, the person or group of persons may be eligible to file the more abbreviated Schedule 13G in lieu of Schedule 13D.  Generally, the obligation to file an initial beneficial ownership statement on Schedule 13D or 13G is triggered by the person directly or indirectly acquiring or possessing beneficial ownership of more than 5% of a class of equity securities.

The obligations to file Scheduled 13D and 13G are in addition to and separate from any other filing requirements, including Forms 3, 4 and 5 under Section 16 of the Exchange Act.  That is, a person that becomes an officer, director or 10% shareholder, who is also a 5% shareholder, would be required to file both a Form 3 and Schedule 13D initially and Forms 4 and amended Schedule 13D’s upon changes in the information contained in the initial filings.  Schedules 13D and 13G may be filed by groups of shareholders who through shared control, such as a shareholders agreement or common ownership in an entity, own in excess of 5% of the public company’s stock.

Generally officers and directors have the ability to directly or indirectly influence the management and policies of an issuer and therefore are considered control persons who would not qualify to file a Schedule 13G as opposed to a Schedule 13D.

Schedule 13D

A Schedule 13D is lengthier than a Schedule 13G and is often referred to as a long-form beneficial ownership disclosure statement. Following a company’s IPO or initial going public transaction, any shareholder that acquires 5% or more of the company’s stock may be required to file a Form 13D.  The requirement to file a Schedule 13D is triggered by an acquisition.  The full contents and instructions of a Schedule 13D can be found HERE.

A Schedule 13D must be filed within 10 days of the triggering event requiring the filing.  The filing discloses ownership on the date of such filing.  Accordingly, if a person acquires 5% of the company’s securities, the filing requirement is triggered.  If that person then makes additional acquisitions or dispositions during that 10-day period, the filing would report the ownership as of the date of filing.  Schedule 13D requires disclosure of all transactions in the company’s stock that were effected during the past sixty days or since the most recent filing of Schedule 13D, whichever is less, and accordingly would include a description of the acquisitions and dispositions during the 10-day period between the event that triggered the filing requirement and the filing itself.

Although changes in the number of outstanding securities that result in an increase of ownership to over 5% are not acquisitions resulting in an initial Schedule 13D filing, they would result in the requirement to file an amended Schedule 13D to report the “material increase or decrease” in the percentage of the beneficial ownership.

As discussed below, a shareholder that already owns 5% of the company’s stock at the time of an IPO or going public transaction must file a Schedule 13G within 45 days of the IPO or going public transaction.  These shareholders are referred to as “exempt shareholders” and are only required to file a Schedule 13D if they acquire more than 2% of the company’s stock in a 12-month period following the IPO or going public transaction.

Subject to certain exclusions, including the ability to file a Schedule 13G rather than a Schedule 13D, any event that results in an acquisition resulting in a beneficial ownership of more than 5% triggers the 13D filing requirement.  Accordingly, the formation of a group and the transfer to a trustee could result in a Schedule 13D filing requirement, in addition to straightforward purchases of stock.

Under the authority of Section 13d of the Exchange Act, the SEC has enacted certain exemptions to the Schedule 13D filing requirement.  Generally, these exemptions only allow the filing of the shorter 13G and not a relief from any filing.  Executors or administrators of a decedent’s estate generally will be presumed not to have acquired beneficial ownership of the securities in the decedent’s estate until such time as such executors or administrators are qualified under local law to perform their duties.

Schedule 13D filers are required to file amendments to report any change (increase or decrease) in beneficial ownership of 1% or more.  For purposes of Section 13 of the Exchange Act, beneficial ownership includes the right to acquire securities within 60 days of the reporting date.  Accordingly, a shareholder that owns convertible notes, warrant or option that entitle that shareholder to acquire securities under the convertible instrument must include the securities which the shareholders could acquire in the calculation of beneficial ownership.  Moreover, if the number of shares that a convertible note holder owns changes by 1% or more due to fluctuations in a conversion price that is tied to market price, each such 1% change requires the filing of an amended Schedule 13D.

The 60-day beneficial ownership period is calculated based on securities that the shareholder has a right to acquire within the 60 days.  If the right to acquire securities is pre-conditioned on an event (such as a transaction closing) that has not occurred, or contractually limited (such as a provision limiting the acquisition right to no more than 4.9% of outstanding securities), the right to acquire such securities is likewise limited as is the concurrent ownership reporting obligation.

Any material changes in a previously filed Schedule 13D require an amendment to such filing, even if that material change is not in beneficial ownership.  For instance, a Schedule 13D requires reporting of plans to acquire additional securities and material contracts related to the securities.  Therefore, if a shareholder acquired warrants to purchase more than 1% of the outstanding securities, not exercisable for six months, its beneficial ownership would not have changed but its plan to acquire additional securities and contracts related to such securities would have materially changed, triggering the requirement to file an amended Schedule 13D.

The requirement to file amendments to a previously filed Schedule 13D continues until such filer has reported ownership below 5%.  Accordingly, if a change of beneficial ownership results in ownership below 5%, but such change is not a 1% change that would otherwise trigger the requirement to file an amendment, that shareholder can voluntarily file such an amendment to relieve themselves of the Schedule 13D filing requirement going forward (or at least until a new triggering event required such filing in the future).

Schedule 13G

A Schedule 13G is a shorter and simpler form than a Schedule 13D.  Schedule 13G eligible filers include (i) qualified institutional investors; (ii) passive investors; and (iii) exempt investors.  The full contents and instructions of a Schedule 13G can be found HERE.

Qualified Institutional Investors

Rule 13d-1 allows qualified institutional investors to file on Schedule 13G instead of 13D.  A qualified institutional investor is an investor that acquired the securities in the ordinary course of business and not with the purpose nor with the effect of changing or influencing the control of the issuer and is also one of the following:

• A registered broker-dealer;

• A registered investment adviser;

• A registered investment company;

• A church plan excluded from the definition of an investment company;

• A bank;

• A savings association under the FDIC;

• An insurance company;

• A parent holding company holding less than 1% of the outstanding stock;

• An employee benefit plan subject to the Employee Retirement Income Security Act;

• A non-U.S. institution that is the functional equivalent of any of the above institutions, provided it is subject to a comparable regulatory scheme; and

• A group provided that all members of the group qualify as any of the above institutions.

Qualified institutional investors must file a Schedule 13G within 10 days of the end of the month of the triggering event requiring the filing and must amend the Schedule 13G each year within 45 days of the end of the calendar year to report changes in beneficial ownership.  However, if a 13G filing shareholder acquires in excess of 10% of the company’s stock, an amended 13G must be within 10 days of the acquisition.  Moreover, an amendment must also be filed within 10 days to report increases or decreases of beneficial ownership of more than 5%.

Passive Investors

Shareholders who are passive investors can file or continue to file reports on Schedule 13G, avoiding the more burdensome Schedule 13D. Passive investors must file their Schedule 13G within 10 days of the triggering event requiring the filing.  Rule 13d-1(c) defines a passive investor as a person that: (i) has not acquired the securities with any purpose, or with the effect of, changing or influencing the control of the issuer, or in connection with or as a participant in any transaction having that purpose or effect, other than a qualified institutional investor; and (ii) is not directly or indirectly the beneficial owner of 20% or more of the class.

A change in the number of outstanding securities that results in a passive investor owning more than 5% of the outstanding class of securities will trigger a Schedule 13G filing requirement.  A shareholder that receives a dividend in a subsidiary spin-off, in excess of 5% of the outstanding securities of the spun-off subsidiary, would be considered a passive investor and eligible to file Schedule 13G, as long as such shareholder was not in fact an officer, director or otherwise a control person of the spun-off subsidiary.

Such passive investor loses Schedule 13G eligibility and must file a Schedule 13D within 10 days of acquiring 20% or more of the company’s stock.  A person in a control position, such as a director or executive officer, will not qualify as a passive investor.

Exempt Investors

Exempt investors include every person or entity that beneficially owned more than 5% of the company’s stock at the time of the IPO or going public transaction.  The filing requirement for Schedule 13D is triggered by an acquisition of 5% or more of securities of a company with securities registered under Section 12 of the Exchange Act.  Accordingly, these initial 5% shareholders are referred to as exempt shareholders because their shares were acquired prior to the company’s IPO or going public transaction – i.e., prior to the company having a class of securities registered under Section 12 of the Exchange Act.

Exempt investors must file a Schedule 13G within 45 days following the end of the calendar year in which a company completes its IPO or other going public transaction.

Generally, a shareholder must amend a Schedule 13G each year within 45 days of the end of the calendar year to report changes in beneficial ownership.  However, if a 13G filing shareholder acquires in excess of 10% of the company’s stock, an amended 13G must be within 10 days of the acquisition.  Moreover, an amendment must also be filed within 10 days to report increases or decreases of beneficial ownership of more than 5%.

Moving from Schedule 13G to Schedule 13D

If an exempt investor who previously reported on Schedule 13G later becomes subject to Rule 13d-1(a) due to a nonexempt acquisition, then a Schedule 13D must be filed within 10 days of the acquisition.  Nonexempt transactions that require the filing of a Schedule 13D include any acquisition with a view towards changing or influencing the control of the issuer.  In addition, any acquisition of the beneficial ownership of a security which, together with all other acquisitions by the same person (or group of persons) of securities of the same class during the preceding twelve months, that results in ownership in excess of 2% of that class eliminates the ability to rely on Schedule 13G and requires the filing of a Schedule 13D.

Accordingly, if a group of exempt investors reporting on Schedule 13G adds a new member who owns more than 2 percent of the same class of equity securities, then each member of the group loses their exempt investor status as a result of acquiring the equity securities owned by the new group member, and a Schedule 13D must be filed within 10 days of the acquisition.  A passive investor or qualified institutional investor loses that status upon acquiring or holding a class of equity securities with a purpose or effect of changing or influencing control of the issuer. Similarly, a passive investor also loses that status upon acquiring 20% or more of a class of equity securities.

Only security holders who were once eligible to file on Schedule 13G and were required to switch to a Schedule 13D may switch back to a Schedule 13G filing.  Security holders who were initially required to report on Schedule 13D must continue to report on Schedule 13D thereafter.

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.

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

Download our mobile app at iTunes.

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

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

© Legal & Compliance, LLC 2016

Tags: 13 G Filing, 13G, 13G Filing, 13G Filing Rules, 13G Filing Shareholder, Form 13D, IPO, Schedule 13D, Schedule 13D Filers, Schedule 13G, Section 12, subsidiary spin-offs, The 60-Day Beneficial Ownership Period

SEC Chair Mary Jo White Speaks on Equity Market Structure

On June 5, 2014, Mary Jo White gave a speech at a conference on the topic of the structure of equity markets, the entire text of which is available on sec. gov.  The speech was very high-level and broad-based with few specific initiative announcements.  However, it does provide some insight into the direction of planned market structure initiatives and rule releases.  This blog is a summary of her speech.

Ms. White began her speech by acknowledging that the SEC agrees with the basic premise that “investors and public companies benefit greatly from robust and resilient equity markets.”

Ms. White announced that she is recommending additional measures to “further promote market stability and fairness, enhance market transparency and disclosures, and build more effective markets for smaller companies.”  In addition, she will request that the SEC create a new Market Structure Advisory Committee of experts to review specific initiatives and rule proposals.

Current Market Structure

As noted in Ms. White’s speech, today’s markets are computer-based, with algorithms providing the backbone for trading and monitoring of such trading activities.  The SEC believes that today’s electronic system provides a level of stability, trustworthiness (Ms. White asserts that today’s markets are not “rigged”) and reduced costs, and Ms. White gave a few interesting facts to support this view.  In particular:

• For institutional investors, the costs of executing large orders, measured in terms of price, were more than 10 percent lower in 2013 than in 2006. This is true even though fundamental volatility was slightly higher in 2013 than it was in 2006.
• The level of intraday volatility also has returned to low levels after spiking during the financial crisis. Intraday volatility of the S&P 500 Index was nearly the same in 2013 as it was in 2006 — for both average and maximum volatility.
• The spreads between bid and ask prices for the broader market also are as narrow as they have ever been. These narrower spreads are particularly important for retail investors because they reflect the cost of trading immediately at the best prices, which is generally the objective of retail investors.

However, despite these positive facts, the small cap market has not seen the bulk of these benefits and continues to have high costs, large spreads, and both long- and short-term volatility.  In that regard, Ms. White briefly addresses the topics of market instability, high-frequency trading, fragmentation, broker conflicts, and the quality of markets for smaller companies.

Market Instability

Ms. White points out the recent rule changes and initiatives that the SEC has taken to help maintain market stability including the “limit-up-limit-down” rule which went effective February 2013.  This rule prevents trades in individual exchange-listed stocks from occurring outside of a specified price range.

In addition, also in February 2013, the SEC enacted updated market-wide circuit breakers.  The market-wide circuit breakers will halt trading completely on an exchange in response to market declines of 7%, 13% and 20% from the prior day’s closing price based on the S&P 500 Index.  The halts last for 15 minutes if triggered before 3:25 p.m. and for the remainder of the day if triggered after 3:25 p.m.

The SEC is “vigorously enforcing” its Market Access Rule, which requires brokers to implement risk controls as a precondition to market access.  The rule is designed to prevent unfiltered market access, including the risk of erroneously submitting a single large order or flood of small orders that could disrupt trading.

The SEC is working on final rules related to its proposed Regulation SCI which will further regulate technology used by exchanges, large alternative trading systems, clearing agencies, and securities information processors (SIP’s).

High-Frequency Trading and Promoting Fairness

As market participants are aware, and Ms. White points out, “algorithmic traders, which include high frequency trading firms and a large percentage of institutional trading, likely represent well over a majority of trading volume.”  These computer-generated trading systems, although a sign of the technologically advanced times, can put regular investors at a disadvantage in the marketplace.  Although today the SEC does not have a definitive plan to address these issues, they are considering various rule initiatives including rules “tailored to apply to active proprietary traders in short time periods when liquidity is most vulnerable and the risk of price disruption caused by aggressive short-term trading strategies is highest.”

Importantly, Ms. White disclosed that the SEC is currently working on rules that will subject unregistered active proprietary traders to SEC rules as dealers.

Further, the SEC and FINRA are working on rules and systems to minimize consolidated data delays. The exchanges and FINRA have an obligation to provide data to the SIPs in a way that is not unreasonably discriminatory. They are not allowed to transmit data to direct customers any sooner than they transmit data to the SIP, and the technology used for transmitting data to the SIP must be on a par with what is used for transmitting data to direct feeds.  The SEC is looking into several initiatives in this regard including additional time stamping of feeds, and further disclosure by traders on the use of feeds.

Enhancing Market Transparency and Potential Trading Venue Regulation

“Order flow in exchange-listed equities is divided among many trading venues — 11 exchanges, more than 40 alternative trading systems, and more than 250 broker-dealers.”  Although in many aspects multiple order flow venues is a benefit including increased competition, checks and balances, and alternative routes in the event of malfunctions or disruptions, there are also added risks and concerns.  In particular, multiple venues allow for an arbitrage of these venues and trading on what the SEC calls “dark venues.”

Ms. White explains, “dark trading venues generally reference the quoted prices displayed by the lit exchanges and do not publicly display quotes or otherwise provide pre-trade transparency of the prices at which they will execute orders.” Today, dark trading accounts for approximately 35% of all market trading.  Ms. White points out that “Although the trades of dark venues are reported in real time, the identity of participants in the dark venue is not disclosed to the public. And dark venues generally only provide limited information about how they operate. ATSs, for example, file a form with the SEC on some aspects of their operations, but the forms are not publicly available under current rules.”

Ms. White’s speech offers no particular solutions to issues created by market fragmentation and multiple trading venues and platforms, other than to point out that the issue is on the SEC’s radar and that together with FINRA, market effects and possible solutions are being examined.  The SEC has not conducted an in-depth review of trading alternatives for 20 years and is proceeding to do so now with a view towards comprehensive changes in the regulations.

Broker Conflicts

Investors rely on their brokers to figure out how and where to execute orders on their behalf for the best result.  Ms. White states, “The cost to the broker for executing in different venues can vary widely. Some venues make payments directly to brokers as a means to attract particular types of order flow. These payments include the liquidity rebates paid by exchanges that use a ‘maker-taker’ fee structure. They also include payments offered by off-exchange market makers to retail brokers for the marketable order flow of their customers.”

The conflict is obvious: a broker may be motivated to execute an order on a venue that provides kickback-type payments, to the detriment of the customer/investor.  The SEC is considering rules that would enhance order routing disclosures.

View on Smaller Companies

Ms. White’s speech points out that the number of domestic companies listed on U.S. exchanges has dropped by half from the highs of more than 7,000 in the 1990s, and that a large part of this decline has been from a reduction in the number of IPOs, particularly IPOs of smaller companies.  However, other than the current initiative related to wider tick sizes, Ms. White does not offer any current ideas or plans to help smaller companies.

As an attorney representing these smaller companies on a daily basis, I see many areas that could use improvement.  For example, the SEC and FINRA could offer assistance to smaller companies being damaged by the shorting of their stock.  Although naked shorts are not allowed, it is the overwhelming belief in the small cap industry that naked shorting is rampant and masked by the use of offshore accounts and trading platforms, and cross covers among clearinghouses.

The small and micro-cap industries are still awaiting final rules related to Regulation A and A+ and Title III Crowdfunding under the JOBS Act, which are anticipated to assist in access to capital markets.

Further initiatives towards reducing costs, such as simplifying the use of the EDGAR system and reducing or eliminating XBRL requirements for small reporting companies, would be welcome.

Finally, the deposit and clearing of penny stocks has become an overwhelming problem in the industry.  I understand the view that there are risks in trading in low-priced penny stocks, but there are also risks in trading in high-priced entities and in fact, when there are problems in the large cap industry, those problems have a much greater impact on the national economy and business industries as a whole.  FINRA and the SEC should be looking at initiatives that provide for a system of checking the veracity of deposited penny stocks, without penalizing the industry as a whole and clearing firms that cater to these entities and their shareholders.

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.

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

Download our mobile app at iTunes.

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

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

© Legal & Compliance, LLC 2016

Tags: Equity Market Structure, Market Structure Advisory Committee, Mary Jo White, Regulation SCI, sec, Small Cap Market

An Overview of MD&A

Management’s discussion and analysis of financial condition and results of operation, commonly referred to as MD&A, is an integral part of annual (Form 10-K) and quarterly (Form 10-Q) reports filed with the Securities and Exchange Commission (SEC).  MD&A is also included in registration statements filed under both the Securities Exchange Act of 1934 (Form 10) and Securities Act of 1933 (Form S-1).  MD&A requires the most input and effort from officers and directors of a company and, due to the many components of required information, often generates SEC review and comments.  Item 303 of Regulation S-K sets forth the required content for MD&A.   This discussion will be limited to the requirements for small public companies (i.e., those with revenues of less than $75 million).

A MD&A discussion for quarterly reports on Form 10-Q is abbreviated from the requirements for annual reports on Form 10-K and registration statements and should concentrate on updating and supplementing the annual report discussion.  Although quarterly reports must discuss each item enumerated below, the discussion is expected to be more focused, concentrating on the most relevant and material items.

In December 2003, the SEC issued detailed interpretive guidance regarding disclosure in MD&A, which is helpful in understanding its required content.  Pursuant to the SEC, MD&A has three primary purposes.  These are:

• to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;
• to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
• to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

Management and company counsel should keep these purposes in mind in drafting and finalizing MD&A.  The content should not be overly technical, but neither should it be a forum for marketing content.  MD&A should include an executive-level overview to provide a context for its presentation.  In order to avoid a long, rambling discussion, MD&A should concentrate on the most material, relevant information in light of the particular areas of disclosure required by Rule 303.  Moreover, MD&A should not be a recitation of financial statement footnotes or a duplication of disclosures in other areas of the subject report.

In addition, as guidance in drafting the MD&A, management should identify and discuss the key performance metrics that management uses to run the business, focus on material information, and explain management’s view of the significance of the information presented.  MD&A also requires a discussion of known trends and uncertainties that can impact the issuer’s business and prospects and management’s view of these trends.

In the MD&A portion of each annual report on Forms 10-Q and 10-K, and registration statements on either Form 10 or S-1, a company must discuss its financial condition, changes in financial condition and results of operations.  In addition to the areas of discussion listed below, a company must include any other relevant information within its knowledge, which information provides a better or more complete understanding of the company’s finances and financial condition.  MD&A discussion must include:

 1.      Overview of Business

 Without merely repeating the business section of the report or registration statement, MD&A should discuss a company’s lines of business, locations of operations, and principal products and services, including any weaknesses and strengths and plans to improve the weaknesses and capitalize on the strengths.  This discussion should include material opportunities, challenges and risks, trends and economic factors.  Moreover, this discussion should both a short-term and long-term perspective.

 2.      Liquidity

 A company must identify any known trends or known demands, commitments, events or uncertainties that will result in or reasonably could result in an increase or decrease in liquidity.  In addition, a company must identify sources and uses of liquidity and any known changes thereto.  An explanation of the information provided is required.  In layman’s terms, liquidity is a discussion of sources of cash and uses of cash, and factors that could change or impact either, both as reflected in the financial period covered by the subject report, and for the future. Although not all-inclusive, the discussion, at a minimum, should address the items included in the statement of cash flows provided as part of the financial statements.

Discussions on liquidity and capital resources are considered so important that in September 2010, the SEC issued an interpretive release addressing these two areas separately from the rest of MD&A.  The SEC reminded companies to “identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquidity.”

Both the 2003 and 2010 interpretive releases emphasize the need to “provide investors with disclosure that facilitates an appreciation of known trends and uncertainties that have impacted historical results or are reasonably likely to shape future periods.”  The “reasonably likely” standard is higher than “possible.”

Companies should identify trends, demands, commitments and uncertainties relating to liquidity and capital resources, such as any trends or uncertainties relating to the company’s ability to access the capital markets, including both debt and equity markets. Additional important trends and uncertainties include reliance on commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral and counterparty risk.

In addition, the SEC advised companies to disclose material variations in liquidity and capital resources (for example, arising from the issuance of commercial paper), the company’s cash and risk management policies and the nature and composition of the company’s cash portfolio.  The SEC has emphasized many times the need to disclose any known commitment, event or uncertainty that will result in or is reasonably likely to result in an increase or decrease in liquidity in a material way.

Companies should also provide detailed disclosure regarding debt instruments, guarantees and related covenants that will impact the liquidity.  A detailed discussion of short-term debt should be a part of all liquidity disclosures.  The SEC even proposed a separate rule related to short-term debt disclosure, which, although never enacted into law, provided insight into the SEC’s view of the importance of this area of disclosure.

 3.      Capital Resources

A discussion of capital resources includes all material commitments for capital expenditures, the purpose and the source of funds for these commitments.  This would include outstanding debts and obligations and, simply put, where the money will come from to pay them.  In addition, capital resources includes a discussion of trends, favorable and unfavorable, that could impact capital resources and management’s view and plans related to these trends.  An obvious example would be a change in government regulation directly related to the company’s business.

 4.      Results of Operations

Results of operations include four areas of discussion: (i) unusual or infrequent events that have impacted on a companies’ financial condition.  An example would be a discontinuance of a specific product line, or sale of company subsidiary; (ii) trends that could have an impact on sales or revenues or income in general, including trends impacting costs and expenses; (iii) a narrative discussion of increases or decreases in sale or revenues; and (iv) impact of inflation and other external financial conditions.

 5.      Off-Balance-Sheet Arrangements

Off-balance-sheet arrangements gained notoriety during the mortgage scandal and economic turmoil that resulted.  An off-balance-sheet arrangement is any arrangement that could have an impact on a balance sheet, but does not currently appear on the balance sheet, the most obvious example being a guarantee of a third party’s obligation.  A second material off-balance-sheet arrangement involves re-purchase agreements.  A repurchase agreement is generally where a company sells an asset and concurrently enters into an agreement that would allow or require the company to repurchase the asset under certain circumstances.  Accordingly, if a company has such an arrangement to report, they are required to provide a detailed analysis including the potential impact and relative importance of the arrangement.

 6.      Critical Accounting Estimates

Although management is not required to and should not merely repeat the critical accounting policies set forth in the notes to financial statements, they should include a discussion of estimates and assumptions that resulted from the accounting policies, especially where such involved judgment calls on the part of management.

Click Here to Print An Overview of MD&A- LC An Overview of MD&A

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.

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

Download our mobile app at iTunes.

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

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

© Legal & Compliance, LLC 2016

Tags: Capital Resources, Debt and Equity Markets, form 10-k, form 10-q, Liquidity, Management Discussion and Analysis Requirements, MD&A, Off-Balance Sheet Arrangement, Rule 303

FINRA Amends Rules 5110 and 5121 Related to Corporate Financing and Conflicts Of Interest

 On April 28, 2014 and on May 7, 2014, the SEC approved the Financial Industry Regulatory Authority’s (FINRA) amendments to Rule 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements) and 5121 (Public Offerings of Securities with Conflicts of Interest) in order to simplify and refine the scope of the rules.  FINRA is the self-regulatory body that regulates and governs securities firms.  All securities firms are required to be licensed broker-dealers and are required to be members of FINRA.

FINRA rules and regulations are subject to review and approval by the SEC.  Section 15A of the Securities Exchange Act of 1934, as amended, requires that FINRA rules be “designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and in general, to protect investors and the public interest.”

Together the Rule 5110 and 5121 amendments:

• Amend the definition of “participation or participating in a public offering” to exclude members that act as a financial advisor or consultant to an issuer without direct involvement in the distribution of securities;
• Exclude from the current lock-up restrictions of Rule 5110 certain securities acquired or converted by a member as a result of an issuer reorganization or to prevent dilution;
• Amend affiliation disclosures to only include affiliations with participating members using the new narrower definition of “participating”;
• Amend the definition of “control” in Rule 5121 related to conflicts of interest; and
• Expand the circumstances under which participating members may receive termination fees and rights of first refusal for future services.

Rule 5110 – Corporate Financing Rule – Underwriting Terms and Arrangements

In General

Rule 5110 regulates underwriting compensation and prohibits unfair arrangements in connection with the public offerings of securities.  The Rule prohibits member firms from participating in a public offering of securities if the underwriting terms and conditions, including compensation, are unfair as defined by FINRA.  The Rule requires FINRA members to make filings with FINRA disclosing information about offerings they participate in, including the amount of all compensation to be received by the firm or its principals, and affiliations and relationships that could result in the existence of a conflict of interest.  In addition, the Rule limits certain compensation such as termination or tail fees and rights of first refusal and imposes lock-up restrictions related to the sale or transfer of securities received as compensation.  The lock-up restrictions apply to a period beginning six months prior to the initial filing of a registration statement with the SEC and end 90 days following the effectiveness of the registration statement.

The Rule 5110 amendments (i) narrow the scope of the definition of “participation or participating in a public offering”; (ii) modify lock-up restrictions to exclude securities acquired or converted to prevent dilution; and (iii) clarify that information required to be filed with FINRA only apply to “participating” members.  One of the goals of the rule change is to allow issuers to seek advice, including investment banking advisory services, from member securities firms without that member being deemed to be participating in an offering.

Independent Financial Advisor Exception

Specifically, amended Rule 5110 provides that an “independent financial adviser” that provides advisory or consulting services to the issuer would not meet the definition of “participation in a public offering” as defined in Rule 5110(a)(5) and would therefore not be subject to the compensation limitations of Rule 5110, lock-up period and information filing requirements. The amended Rule defines an independent financial adviser as “a member that provides advisory or consulting services to the issuer and is neither engaged in, nor affiliated with any entity that is engaged in, the solicitation or distribution of the offering.”  The Rule will allow issuers to engage member firms to provide advice and consultation regarding financing options, the advantages and disadvantages of these options, the terms and conditions of an underwriting proposed by another member firm (assuming the advisory and underwriter firm are independent of each other), and all matters of corporate finance without automatically being deemed to be engaged in a public offering should one ensue.  If the securities firm also engages in solicitation or distribution activities in addition to providing advisory or consulting services, the exclusion of the advisory-related compensation would not be available and all of the compensation received by that firm in connection with the offering would be subject to the compensation limitations and disclosure requirements.

Lock-Up Provisions

Rule 5110 generally includes all items of value as underwriting compensation including restricted securities received or to be received in the six months prior to the filing of a registration statement, subject to certain exceptions.  The Rule provides five exceptions that permit participating members to acquire securities of the issuer during that 6-month period without the securities being deemed to be underwriting compensation.  In particular, excluded from the definition of underwriting compensation is the receipt of additional securities to prevent dilution of the investor’s investment (e.g., securities acquired as a result of a stock-split or a pro-rata rights or similar offering) as long as the original securities were acquired before the six-month period.  Although these securities have been excluded from the definition of underwriter’s compensation, they were previously included in lock-up restrictions.  The amended Rule also excludes these securities from the lock-up provisions.

Information Filing Requirements

Rule 5110 requires members “participating in an offering” to make certain filing and disclosures to FINRA including affiliations between the member and any officer, director or control shareholder of the issuer, or beneficial ownership of securities of the issuer and control relationships with the issuer.  For purposes of determining “control,” Rule 5121 is cross-referenced.  The Rule amendment narrows the definition of “participating” and therefore narrows the scope of member firms that must file affiliation disclosures with FINRA.  Firms that provide independent financial advisory services to issuers without participating in an offering will not be required to make filings with FINRA to disclose affiliations.

In addition, as discussed below, Rule 5121 is amended to narrow the definition of “control” and therefore narrow Rule 5110 related reporting requirements.

Termination (“Tail”) Fees and Rights of First Refusal

On May 7, 2014, the SEC approved changes to Rule 5110 related to certain underwriting compensation.

The Rule amendment expands the circumstances under which member firms may charge termination fees and may include rights of first refusal as part of their underwriting compensation.  A termination fee is a fee charged when a public offering is not completed in accordance with the agreement between the underwriter and issuer.  Generally termination or “tail” fees are prohibited.

The Rule amendment permits termination fees where: (i) the agreement between the participating member and the issuer specifies that the issuer maintains the right to terminate “for cause” without the imposition of a fee; (ii) a termination “for cause” eliminates any obligations with respect to the payment of a termination fee; (iii) the amount of the termination fee is reasonable in relation to the services to be performed; and (iv) the fee is not payable unless the issuer completes an offering with a different member firm within two years from the termination date (the “tail” fee).

A right of first refusal generally provides a member firm with the right to underwrite or participate in future public offerings, private placements or other financings of the issuer.  Rule 5110 prohibits rights of first refusal that extend beyond three (3) years from the date of the current public offering or grant the member firm more than one opportunity to charge a fee to waive or terminate such right of first refusal.

The Rule amendment permits rights of first refusal where: (i) the agreement between the participating member and the issuer specifies that the issuer maintains the right to terminate “for cause”’ (ii) a termination “for cause” eliminates any obligations with respect to the right of first refusal; and (iii) any fees arising from services provided under the right of first refusal are customary for those types of services.  The three (3)-year limitation is unchanged and is counted from the date the public offering commences or is terminated as the case may be.

Rule 5121 – Public Offerings of Securities with Conflicts of Interest

Where Rule 5110 requires the disclosure of affiliations, Rule 5121 goes further and prevents member firms from participating in offerings where certain conflicts of interest exist.  Member firms are prohibited from participating in a public offering where certain conflicts exist, including where the issuer is controlled by or under common control with the FINRA member firm or is associated persons.  Control historically included being a holder of 10% or more of the debt of the issuer.  The amended Rule narrows the scope of the definition of “control” by eliminating the debt holder provision.

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.

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Tags: FINRA, Lock-Up Period, Pro-Rata, Rule 5110, Rule 5110(a)(5), Rule 5121, Section 15A, Stock Split, Tail Fees