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The ECOS Matter; When Is A Reverse Split Effective?

by Laura Anthony, Esq. on September 30, 2014 in FINRA, FINRA Compliance, OTC Market, Reverse Split, Rule 10b-17, Small Cap Market, Uncategorized with No Comments

In what was presumably an unintended consequence, the application of an SEC- approved FINRA regulation has resulted in a conflict between state and federal corporate law for a small publicly traded company.

On September 16, 2014, Ecolocap Solutions, Inc. (“ECOS”) filed a Form 8-K in which it disclosed that FINRA had refused to process its 1-for-2,000 reverse split. At the time of the FINRA refusal, ECOS had already received board and shareholder approval and had filed the necessary amended articles with the State of Nevada, legally effectuating the reverse split in accordance with state law. Moreover, ECOS is subject to the reporting requirements under the Securities Exchange Act of 1934, as amended (“Exchange Act”), and had filed a preliminary and then definitive 14C information statement with the SEC, reporting the shareholder approval of the split.

The ECOS 8-K attached a copy of the FINRA denial letter, which can be viewed HERE. In support of its denial of the reverse split, FINRA relied upon its discretion under FINRA Rule 6490 and the existence of a previous SEC action against an individual who is the principal of an entity that is a convertible note holder of ECOS. In particular, FINRA cited an SEC order issued on November 25, 2013 against Curt Kramer, Mazuma Corporation, Mazuma Funding Corporation and Mazuma Holding Corporation involving violations of Section 5 of the Securities Act of 1933 and Rule 504. FINRA cited that Curt Kramer is a principal of Asher Enterprises and that Asher Enterprises, in turn, is a convertible note holder in ECOS and therefore FINRA was refusing to process the reverse split.

In its 8-K filing, ECOS took a strong stance against FINRA, stating that pricing information published by FINRA is inaccurate. In support of their position, ECOS sets forth that the subject reverse split was already legally effective in accordance with state law and therefore FINRA’s refusal to reflect such capital change in ECOS trading quotation results in public misinformation regarding the company’s capitalization. ECOS also objected to FINRA’s application of Rule 6490 in this case by denying that either Mr. Kramer or Asher Enterprises is “connected” with the company as contemplated by the Rule. Furthermore, they stated that the subject SEC action was completely unrelated to ECOS or the reverse split.

Although FINRA has not issued a responsive statement, one of its mandates is to protect investors and maintain fair and orderly markets. In this instance, the Company’s stock is actively trading at $.0001 per share. The Company’s total outstanding shares increased from 893,615,983 one year ago to 6,865,010,372 as of April 2014. ECOS has been in the development stage since January 1, 2007 and has not reported any revenues since September, 2010. The overwhelming majority of the increase in outstanding stock is the result of the conversion of convertible debt, and most of funds received by the company from the note holders was used for salaries, as well as interest on the convertible debt and fees for staying a publicly-traded company (such as satisfying reporting obligations). Although the information in the Company’s filings as to its business operations is sparse, it has been in the same business with the same management since 2007, without any financial success. As of June 30, 2014, the Company had approximately $664,000 in convertible outstanding notes payable. The Company intends to complete a 1:2000 reverse split, which will reduce the total outstanding shares to 3.9 million and presumably increase the share price to $.20.

However, the Company’s new, higher share price will likely be temporary due to the lack of any underlying business success to create support for a higher market valuation. In addition, FINRA realizes that in all probability, upon enactment of the inflated share price, existing note holders have an increased incentive to convert their debt into freely tradable shares and may begin selling these shares in the market. Should such selling pressure occur, and the new share price decrease, any shareholder that purchased at $.20 will most likely suffer a loss. Should the cycle of selling continue, the outstanding shares will increase, potentially into the billions, until the share price is once again $.0001. Taking this into account, FINRA’s concerns are self-evident.

There clearly exists a fundamental conflict between federal and state law and the ability to regulate corporate actions. It raises the basic question of “When is a reverse split effective?” If pursued, this action opens the door for court interpretation of FINRA’s authority under Rule 6490 in general.

Rule 6490

Effective September 27, 2010, the SEC approved FINRA Rule 6490 (Processing of Company Related Actions). Rule 6490 requires that corporations whose securities are trading on the over-the-counter market (OTCQX, OTCQB, OTCBB or pinksheets) timely notify FINRA of certain corporate actions, such as dividends, forward or reverse splits, rights or subscription offerings, and name changes. The Rule grants FINRA discretionary power when processing documents related to the announcements.

Rule 6490 works in conjunction with Exchange Act Rule 10b-17. Rule 10b-17 provides that “it shall constitute a manipulative or deceptive device or contrivance as used in section 10(b) of the Act for any issuer of a class of securities publicly traded… to fail to give notice in accordance with paragraph (b) of this section of the following actions relating to such class of securities: (1) a dividend or other distribution in cash or in kind… (2) a stock split or reverse split; or (3) a rights or other subscription offering.” Section (b) requires that notice be given to FINRA “no later than 10 days prior to the record date involved.”

FINRA also issues trading symbols to over-the-counter traded issuers and maintains a database of trading symbols for issuers. When FINRA completes the processing of a corporate action, OTC marketplace is notified of such changes and actions. Most commonly, changes and actions include the re-pricing of securities after a forward or reverse split and the issuance of a new trading symbol following a name change or merger.

Prior to 2010, FINRA’s role has been predominantly ministerial due to their limited jurisdictional ability to impose informational or other regulatory requirements, and fundamental lack of power to reject requested changes. However, since the SEC began expressing concern that entities were using FINRA to assist in fraudulent activities, Rule 6490 was created.

The Rule codifies FINRA’s authority to conduct in-depth reviews of company-related actions and equips the staff with discretion to refuse the processing of such actions in situations when the information or requisite forms are incomplete or when certain indicators of potential fraud exist. FINRA staff now possesses broad discretion to request additional documents and supporting evidence to verify the accuracy of submitted information.

Rule 6490(d)(3) provides:

(3) Deficiency Determination

In circumstances where an SEA Rule 10b-17 Action or Other Company-Related Action is deemed deficient, the Department may determine that it is necessary for the protection of investors, the public interest and to maintain fair and orderly markets, that documentation related to such SEA Rule 10b-17 Action or Other Company-Related Action will not be processed. In instances where the Department makes such a deficiency determination, the request to process documentation related to the SEA Rule 10b-17 Action or Other Company-Related Action, as applicable, will be closed, subject to paragraphs (d)(4) and (e) of this Rule. The Department shall make such deficiency determinations solely on the basis of one or more of the following factors: (1) FINRA staff reasonably believes the forms and all supporting documentation, in whole or in part, may not be complete, accurate or with proper authority; (2) the issuer is not current in its reporting requirements, if applicable, to the SEC or other regulatory authority; (3) FINRA has actual knowledge that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected to the issuer or the SEA Rule 10b-17 Action or Other Company-Related Action are the subject of a pending, adjudicated or settled regulatory action or investigation by a federal, state or foreign regulatory agency, or a self-regulatory organization; or a civil or criminal action related to fraud or securities laws violations; (4) a state, federal or foreign authority or self-regulatory organization has provided information to FINRA, or FINRA otherwise has actual knowledge indicating that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected with the issuer or the SEA Rule 10b-17 Action or Other Company-Related Action may be potentially involved in fraudulent activities related to the securities markets and/or pose a threat to public investors; and/or (5) there is significant uncertainty in the settlement and clearance process for the security. (emphasis added)

Exchange Act Rule 10b-17 appears to be limited to notice and allows the SEC to pursue an enforcement action for the failure to give such notice in a timely manner. Rule 6490 goes further, stating a corporation action “will not be processed” if FINRA makes a “deficiency determination.” Clearly subsections (3) and (4) give broad discretionary authority to FINRA to render such a deficiency determination and refuse to process an action.

Further exacerbating the existing conflict between the application of state and federal law is the fact that FINRA requires that a Company submit the file-stamped amendments to its corporate charter as part of their review process. Simply stated, the FINRA corporate action process requires that a Company legally completes the corporate action (reverse split, name change, etc.) on the state level prior to issuing a determination as to whether it will process the already-completed change with the marketplace.

State vs. Federal Regulation of Corporate Law

Historically the regulation of corporate law has been firmly within the power and authority of the states. However, over the past few decades the federal government has become increasingly active in matters of corporate governance. In waves, typically following a period of scandal in business or financial markets, the federal government has enacted regulation either directly or indirectly imposing upon state corporate regulations. The predominant method of federal regulation of corporate governance is through the enactment of mandatory terms that either reverse or preempt state law rules on the same point.

State corporation law is generally based on the Delaware and Model Act and offers corporations a degree of flexibility from a menu of reasonable alternatives that can be tailored to companies’ business sectors, markets and corporate culture. Moreover, state judiciaries review and rule upon corporate governance matters considering the facts and circumstances of each case and setting factual precedence based on such individual circumstances. The traditional fiduciary duties that govern state corporations laws include the duties of care and loyalty and are tempered by the business judgment rule.

The duty of care requires that directors exercise the same level of care that would be expected from an ordinarily prudent person in the conduct of his or her own affairs. This includes making an informed decision, seeking the advice of experts when necessary, and considering both the positive and negative impacts of a decision. The duty of loyalty is essentially a proscription against conflict of interest and self-dealing. The business judgment rule basically says that if a director follows both his duty of loyalty and duty of care, then the decision should be deferred to.

Director actions that result in a fraud upon shareholders and investors is actionable under federal (and state) securities laws. Both the state and federal securities regulators are charged with preventing fraud on the markets and protecting the integrity of the trading markets in general.

Conclusion

The ECOS matter has raised heated debate on whether FINRA fairly applied its authority in this case and as to the meaning of “connected.” Publicly traded companies, by nature, have ever-evolving shareholders and investors, the identities of which are often not in the power or control of the company itself. Stock is personal property that generally may be freely transferred by its owners (which should not be confused with suggesting that such transferred stock is always freely tradable on a public market). Debt instruments are negotiable instruments and generally transferrable by the debt holder. The sale and transfer of such debt instruments is common. In the small cap world, changes in management and control are fairly commonplace, as is the change in the business direction of a company.

Regulators are tasked with the job of supporting these changes in the small and micro-cap space and giving every entrepreneur a fair shot while preventing abuses in the system and what such as in this case, they ultimately see, as crossing the line.

Clearly it is problematic when state and federal rules and regulations cause a conflicting result, leaving a board of directors, shareholders and the investing public in a state of flux. What is the capitalization of ECOS? In accordance with state law, the company has approximately 3.4 million shares issued and outstanding; however, according to the over-the-counter marketplace, the company has approximately 6.8 billion shares outstanding. Legally it seems that the company has 3.4 million shares of stock outstanding at a trading price of $.0001 and that FINRA’s refusal to process relates solely to a refusal to re-price the stock as a result of the reverse split and not a broader refusal to recognize the validly of the share reduction itself.

However, many people in the industry are debating the impact and meaning of the decision with divergent views and conclusions, including the legal effect of the reverse split.

A discussion of federal law pre-emption is beyond the scope of this blog. However, even if I did include a treatise on the subject, the answer would be difficult. As an attorney I could write a very good argument that state law applies (the states regulate corporations and where the federal law would yield a different result, state law should apply), and I could also write a very good argument that federal law applies (the states regulate corporations and where the federal law would yield a different result, state law should apply except where there is a competing strong federal policy – such as the regulation of public markets). I could argue that the federal government has no right to stop a corporation from effectuating a name change or reverse split but only the power to prosecute the failure to provide adequate notice of same. I could also argue that the federal government has the right to take actions that may prevent fraud being committed on public markets, including by refusing to allow a name change or reverse split.

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: Duty of Care, FINRA, OTC Marketplace, Reverse Split, Rule 10b-17, Rule 6490, sec, Securities Exchange Act of 1934

SEC Filed Actions Against 19 Firms and One Individual Trader for Violation of Rule 105 of Regulation M

by Laura Anthony, Esq. on September 23, 2014 in Regulation M, Regulation SHO, Rule 144, Uncategorized with No Comments

On September 16, 2014, the SEC filed actions against 19 firms and one individual trade for short selling violations in advance of public stock offerings in violation of Rule 105 of Regulation M. The SEC has actively enforced Regulation M since its enactment in 1996. Regulation M is designed to prevent stock manipulation during public offerings and Rule 105 particularly prohibits short selling of stock within five business days of participating in an offering for the same stock. That is, you cannot short stock and cover your short by buying the same stock from the underwriter in a public offering. Rule 105 prevents downward pressure on a company’s stock price during the offering process.

The SEC’s current investigation found that 19 firms and one individual trader charged in these latest cases engaged in short selling of particular stocks shortly before they bought shares from an underwriter, broker, or dealer participating in a follow-on public offering. All charged settled with the SEC for a combined $9 million in disgorgement and penalties.

Regulation M

Regulation M was initially adopted in 1996 in an effort to “preclude manipulative conduct by persons with an interest in the outcome of an offering.” Regulation M prevents underwriters, issuers, selling security holders and other participants in a securities offering from engaging in certain trading activity that could (i) artificially raise the price of a security or (ii) create a false appearance of active trading in the market.

Regulation M is comprised of six rules promulgated under the Securities Exchange Act of 1934, as amended (“Exchange Act”). In particular:

Rule 100 – defines terms used in the other five rules.

Rule 101 – regulates bids for and purchases of certain securities by distribution participants and some of their affiliates.

Rule 102 – regulates bids for and purchases of certain securities by issuers, selling security holders and certain of their affiliates in connection with a securities distribution.

Rule 103 – allows passive market making on NASDAQ.

Rule 104 – provides a framework for permitted stabilization activities.

Rule 105 – restricts short selling by prospective investors in certain registered offerings.

Regulation M applies to the distribution of securities. A distribution is not limited to registered offerings. Rather, a distribution is any offering, whether registered or unregistered, which is larger in magnitude than ordinary trading and selling by that issuer and which involves special selling efforts and selling methods. Issuers and selling security holders need to carefully consider whether a particular offering invokes the provisions of Regulation M. In the case of a registered offering, the assumption is that Regulation M applies; however, in a private placement it may not be as clear, especially where it is a private placement limited in distribution but still outside the normal course of business for that issuer. Moreover, Regulation M may be invoked by large volume resales under Rule 144, the exercise of warrants, forced conversions and exchange offers.

The main operative provisions of Regulation M are Rules 101, 102 and 105.

Rule 101 prohibits offering distribution participants from bidding for or purchasing, or attempting to bid for or purchase or inducing a person to bid for or purchase, a security that is covered by the rule. The Rule applies to trading in connection with a distribution or offering and not ordinary trading in a security. Rule 101 prevents manipulative practices from all offering participants other than the issuer or selling security holder in a resale offering. Offering participants include underwriters, prospective underwriters, brokers, dealers and other persons who have agreed to participate or are participating in the distribution of securities.

Furthermore, the Rule extends to affiliates of offering participants. An affiliate includes: (i) any person acting in concert, whether directly or indirectly, with the offering participant; (ii) any person that is directly or indirectly under common control of the offering participant; or (iii) a contractual affiliate.

Rule 101 applies during the restricted period beginning before the pricing of the distribution and ending when the distribution or the party’s participation in the distribution ends. In particular, the restricted period generally begins five business days before the pricing date; however, if any underwriter joins an offering after the 5-day restricted period begins, such underwriter’s restricted period will begin on the day they join the offering. Generally a distribution is complete, or a party’s participation is complete, when all of the subject securities have been distributed and post-offering stabilization arrangements and trading restrictions have been terminated.

In an equity IPO, underwriters commonly have a net syndicate short position created by over-allotments. This means that the underwriters have agreed to sell more shares to investors than they have committed to buy from the issuer. In these circumstances, the issuer typically grants the underwriters an over-allotment option, which is often referred to as the “greenshoe.” It gives the underwriters the option to purchase additional shares from the issuer at the same price as the other shares purchased in the offering. The underwriters then can use those option shares to cover their short position.

Under Regulation M, a distribution is not deemed complete (and the restricted period is not over) if the underwriters exercise their over-allotment option for more shares than the net syndicate short position at the time the option is exercised. Instead, the distribution is deemed to continue until all of the excess shares have been sold. Any bids, purchases or inducements to purchase that the underwriters made before the exercise could violate Rule 101.

Therefore, the deal team should be aware of the issue referred to as “refreshing the shoe.” Underwriters refresh the shoe by increasing the syndicate short position through additional short sales made after the initial syndicate short position has been reduced (or covered). This practice raises a number of potential regulatory considerations and may warrant discussion with senior members of the deal team.

Rule 101 has several exceptions, including: (i) for the distribution of research reports – i.e., such reports will not be considered inducing the purchase of securities; (ii) transactions under Rule 144A; (iii) unsolicited transactions; (iv) de minimus transactions; and (v) NASDAQ passive market making and stabilization.

Regulation M prohibits offering distribution participants from bidding for or purchasing, or attempting to bid for or purchase or inducing a person to bid for or purchase, a security that is covered by the rule. The SEC has identified particular underwriter activities that are manipulative and violate Regulation M as inducing a person to bid for or purchase a covered security. These violating activities include any conduct that could be deemed to request or induce buyers to participate in aftermarket purchases following a distribution. Examples include: (i) limiting distribution or IPO allocations to investors who agree to purchase in the secondary market (“tie-in arrangements”) and (ii) communicating to potential offering participants that they will be able to participate or have increased participation in a distribution if they agree to buy in the secondary market following the distribution.

Rule 102 applies to the issuer or selling security holder. Rule 102 is more restrictive than Rule 101 in that it does not include the regular Rule 101 exceptions. Like Rule 101, Rule 102 prohibits offering distribution participants from bidding for or purchasing, or attempting to bid for or purchase or inducing a person to bid for or purchase, a security that is covered by the rule. Rule 102 does except transaction under certain plans including bonus, profit sharing, pension, stock option, retirement and stock appreciation plans and dividend reinvestment programs.

Rule 105

Rule 105 was adopted by the SEC in 1996 and extensively amended in 2007. Subject to limited exceptions, Rule 105 makes it unlawful for a person to purchase equity securities in firm commitment public offerings from an underwriter, broker, or dealer participating in the offering if that person sold short the security that is the subject of the offering during the restricted period defined in the rule, absent an exception. The Rule 105 restricted period is the shorter of the period: (1) beginning five business days before the pricing of the offered securities and ending with such pricing; or (2) beginning with the initial filing of a registration statement or notification on Form 1-A or Form 1-E and ending with the pricing. In other words, Rule 105 imposes a blanket prohibition on participation in a firm commitment offering by persons who have engaged in a short sale during the five-day period prior to the offering.

Rule 105 specifically prohibits “short selling.” The Rule incorporates the definition of a short sale from Regulation SHO. Regulation SHO regulates short sales in general, including locate and close out standards and prohibitions on naked short selling. A full discussion on Regulation SHO will be included in a future blog. Regulation SHO defines a “short sale” as “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.” Account holders should seek advice from their legal counsel and brokers to avoid an inadvertent violation where such account holder is regularly engaged in short selling practices and option trading. For example, a short position that existed prior to the regulated 5-day period may experience a stock dividend during the 5-day period which could result in a violation of the rule.

The Rule 105 prohibition only applies to firm commitment underwritten offerings. A firm commitment underwriting is one where one or more underwriters commit to purchase all of the securities offered by an issuing company, in a particular registered offering, at a negotiated price. The underwriters then sell or attempt to sell the subject securities to the public at price which is an agreed-upon percent markup from the price the underwriter paid. The underwriter assumes the risk of a price decrease from the price paid to the issuer and the price in which they are able to resell the securities. In order to obviate some of this risk, the price paid by the underwriter (and therefore marked-up price that will be paid by the public) is generally not set until the day the offering is to proceed. One of the many factors in determining an offering price is the trading price for the security where the issuing company is already public. Rule 105 helps prevent short sellers from driving down the trading price immediately prior to the setting of an offering price.

Rule 105 does not apply to a best efforts offering, which is where one or more underwriters act as placement agent and use their best efforts to place the registered securities to the public in exchange for collecting a commission.

In addition, Rule 105 only applies to “equity securities.” Accordingly, the rule is not applicable to offerings not involving equity securities, such as debt offerings and derivatives.

The Rule 105 restricted period is the shorter of the period: (1) beginning five business days before the pricing of the offered securities and ending with such pricing; or (2) beginning with the initial filing of a registration statement or notification on Form 1-A or Form 1-E and ending with the pricing. For purposes of the Rule, a business day includes a 24-hour day, and not just market hours. Accordingly, where an offering is priced after the market closes, it would still be considered the same business day. Holidays in which markets are closed are excluded in the 5-days calculation. Moreover, where the period is being determined by the filing of a registration statement, the relevant period begins with the filing of the initial registration statement, not subsequent amendments.

There are three exceptions to Rule 105, including (i) the bona fide purchaser exception; (ii) an exception for separate accounts; and (iii) for investment companies.

The bona fide purchase exception provides that even if a person has sold short during the Rule 105 restricted period, the person can still participate in the offering if a bona fide purchase of the security effectively reversed the effects of the short sales. To qualify as a bona fide purchase, the person must show: (i) a purchase of, or purchases that total to, a number of securities at least equal to the number of securities shorted during the restricted period; (ii) the purchase occurred during regular trading hours; (iii) the trades are reported; and (iv) the purchases occurred after all short sales and no later than the business day prior to the day of pricing. Furthermore, a person relying on the bona fide purchase exception cannot have effected a short sale within the 30 minutes prior to the close of regular trading hours on the business day prior to the day of pricing. The exception is technical and requires careful evaluation.

The separate account exception permits the purchase of the offered securities if the person sold short during the Rule 105 restricted period in a separate account. A separate account is defined as an account that operates without coordination of trading and coordination among or between the accounts. Generally speaking, the separate account exception involves managed money accounts, trustee accounts and other situations where the individual account beneficiary is not involved in the trading activity. The SEC has recognized the following as separate accounts: (i) an account having separate and distinct investment and trading strategies and objectives from the other accounts under management; (ii) personnel for each account do not coordinate trading among or between the accounts; (iii) information barriers separate the accounts, and information about securities positions or investment decisions is not shared between accounts; (iv) each account maintains separate profit and loss statements; (v) there is no allocation of securities between or among accounts; and (vi) persons with oversight or managerial responsibility over multiple accounts in a single entity or affiliated entity do not have authority to execute trades in individual securities of the accounts and do not have the authority to pre-approve trading decisions for the accounts.

The investment company exception allows a registered fund to participate in an offering, even if another series of the registered fund or an affiliated registered fund sold short during the restricted period.

Rule 105 is designed downward pressure on a company’s stock price during the offering process. In enacting the rule, the SEC indicated concern that traders would short sell securities prior to the pricing of a secondary public offering, forcing down the final offering price and reducing proceeds to an issuer.

A violation of Rule 105 does not include an analysis of intent or knowledge. Accordingly, any short sale during a registration period should be carefully examined to avoid an inadvertent rule violation. Even prior to the recent round of enforcement proceedings, the SEC has actively enforced violations of Rule 105. From January 2010 through September 2013, the SEC collected over $42 million from disgorgement, civil penalties and pre-judgment interest arising from Rule 105 enforcement proceedings.

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: Bona Fide Purchase, Equity IPO, Regulation M, Regulation SHO, Rule 101, Rule 105, Rule 144, Securities Exchange Act of 1934

SEC Files Dozens of Charges for Violations of the Section 16 and Section 13 Corporate Insider Reporting Requirements

by Laura Anthony, Esq. on September 15, 2014 in Going Public, Insider Trading, Schedule 13D, Schedule 13G, Section 13, Section 16, Uncategorized with No Comments

Introduction

On September 10, 2014, the SEC filed 28 separate actions against officers, directors and major shareholders and an additional 6 actions against reporting companies, all stemming from violations of the reporting requirements contained in Sections 13 and 16 of the Securities Exchange Act of 1934, as amended (“Exchange Act”). The SEC announced that it had created a task force to investigate violations using quantitative data sources and ranking algorithms to identify repetitive late filers. The SEC settled with all but one of the charged for a total of $2.6 million in penalties.

The actions against insiders and major shareholders were based on direct violations of their individual reporting requirements. The actions against reporting companies were for “contributing to” the violations. In these cases, the companies had contractually agreed to take on the responsibility of making the filings for their insiders, and had been delinquent in doing so.

Historically the SEC has rarely pursued separate actions for violations of Sections 13 or 16; rather, such claims would generally only be included when coupled with other claims. However, in its press release regarding the current actions, the SEC states, “we are bringing these actions together to send a clear message about the importance of these filing provisions” and continues with, “[O]fficers, directors, major shareholders, and issuers should all take note: inadvertence is no defense to filing violations, and we will vigorously police these sorts of violations through streamlined actions.”

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 Sections 13 and 16 filing requirements.

The SEC Enforcement Actions

Each of the individual filings, which appeared as 37 separate administrative proceedings under Section 21C of the Exchange Act, begins with a commentary of the Section 13 and 16 reporting obligations. I discuss such legal obligations in further detail below, as well.

Regarding Section 13, the SEC states:

Section 13(d) of the Exchange Act and the rules promulgated thereunder require any person or group who directly or indirectly acquires beneficial ownership of more than 5% of a Section 12 registered equity security to file a statement with the Commission disclosing certain information relating to such beneficial ownership. Section 13(d) is a key provision that allows shareholders and potential investors to evaluate changes in substantial shareholdings. See 113 Cong. Rec. 855 (1967). The duty to file is not dependent on any intention by the stockholder to gain control of the company, but on a mechanical 5% ownership test.

The SEC notes that under Section 13(d)(1), any person that has acquired more than 5% beneficial ownership of a reporting company’s equity securities must file either a Schedule 13D or 13G within 10 days after the acquisition. The disclosure statement includes among other things, the identity of the beneficial owners, the amount of beneficial ownership, and plans or proposals regarding the issuer. The term “beneficial owner” is defined to include “any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise” has or shares voting or investment power with respect to a registered equity security.” Based on the definition, more than one person can be a beneficial owner of the same security and generally beneficial ownership by an entity includes beneficial ownership by such entities’ beneficial owners.

Regarding Section 16, the SEC states:

Section 16(a) of the Exchange Act and the rules promulgated thereunder require officers and directors of a company with a registered class of equity securities, and any beneficial owners of greater than 10% of such class, to file certain reports of securities holdings and transactions. Section 16(a) was motivated by a belief that “the most potent weapon against the abuse of inside information is full and prompt publicity” and by a desire “to give investors an idea of the purchases and sales by insiders which may in turn indicate their private opinion as to prospects of the company.” H.R. Rep. 73-1383, at 13, 24 (1934). Reflecting this informational purpose, the obligation to file applies irrespective of profits or the filer’s reasons for engaging in the transactions. The Sarbanes-Oxley Act of 2002 and Commission implementing regulations accelerated the reporting deadline for most transactions to two business days and mandated that all reports be filed electronically on EDGAR and posted on the company’s website to facilitate rapid dissemination to the public.

The SEC notes that under Section 16, every person who is an officer or director or beneficial owner of more than 10% of equity securities of an issuer must file an initial statement on Form 3 within 10 days of the event triggering such filing and continuing changes on Form 4 within two business days following such change. Transactions required to be reported on Form 4 include purchases and sales of securities, exercises and conversions of derivative securities, and grants or awards of securities from the issuer. An annual report on Form 5 is used to report changes and information that should have been, but were not included in prior Forms 3 or 4.

Neither Sections 16 nor 13 require intent or contain subjective standards. The failure to file, regardless of explanation, is a violation. Each of the SEC orders contained a cease-and-desist from committing any future violations and civil penalties.

Refresher on Section 13

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. 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.

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 filed 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% 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.

Refresher on Section 16

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. Moreover, 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 policymaking 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

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. Form 4’s (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.

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.

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.

MATCHING AND REPORTING UNDER SECTION 16 RULES

Event	Report on Form 4 (due within 2nd business day after event)	Report on Form 5 (due within 45 days of end of fiscal year)	Not Required to be Reported (2)
Grant to officer or director under company’s stock option plan	Exempt (1)Code A
Exercise of option	Exemption acquisition of common stock and exempt disposition of optionCode M
Cashless option exercise by officer or director through issuer (by withholding shares or delivering previously held shares)	Exempt acquisition (of gross shares) Code M and exempt disposition (of shares tendered) Code F (1)
Cashless option exercise through broker	Exempt acquisition (of gross shares) Code MMatchable sale (of shares sold) Code S
Expiration of option for no value			Exempt disposition
Acquisition under company’s employee stock purchase plan			Exempt acquisition
Conversion of preferred stock	Exempt acquisition of common stock and exempt disposition of preferredCode C
Stock dividend			Exempt acquisition
Transfer pursuant to domestic relations order			Exempt acquisition or disposition
Distribution from limited partnership to general partner			Exempt change in form of beneficial ownership
Distribution from limited partnership to limited partner	Matchable purchaseCode J
Other acquisition from issuer, including receipt of securities in merger	Exempt acquisition, if by director or officer (1)Code AMatchable purchase if by 10% holderCode P
Acquisition from someone other than issuer	Matchable purchaseCode P
Sale to issuer or tender in connection with merger into another company	Exempt disposition, if by officer or director (1)Code DMatchable sale, if by 10% holderCode S
Sale to someone other than issuer	Matchable saleCode S
Gift		ExemptCode G

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 for at least six months.
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

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Tags: Form 3, Form 4, Form 5, Going Public Transaction, Schedule 13D, Schedule 13G, Section 13, Section 16, Sections 13 and 16, Sections 13(d)

OTCQX Listing and Quotation Eligibility and Requirements for International Companies

by Laura Anthony, Esq. on September 08, 2014 in DAD/PAL, OTC Market, OTC Markets Listing Requirements, OTC Pink, OTC Pink Listing Requirements, OTCBB, OTCQB, OTCQB and OTCQX, OTCQB Listing Requirements, OTCQX, OTCQX Listing Requirements, Section 12, Uncategorized with No Comments

On May 23, 2014, OTC Markets Group, Inc., published its updated OTCQX Rules for International Companies version 6.7. This blog summarizes those rules. A complete copy of the rules is available on the OTC Link website, otcmarkets.com.

Background

The www.otcmarkets.com divides issuers into three (3) levels: OTCQX, OTCQB and OTC Pink.

The OTCQX has two tiers of quotation for U.S. companies: (i) OTCQX International Premier; and (ii) OTCQX International. International issuers on the OTCQX must meet specified eligibility requirements. Quotation is available for American Depository Receipts (ADR’s) or foreign ordinary securities of companies traded on a Qualifying Foreign Stock Exchange.

International issuers on the OTCQB must either be fully reporting and current in their SEC reporting obligations or qualify for the Rule 12g3-2(b) exemption from SEC registration for foreign private issuers. In addition, OTCQB entities must meet minimum price standards, file annual reports and pay annual fees, but do not undergo additional quality review. See my blog HERE for information on OTCQB eligibility requirements for both U.S. and international issuers.

International issuers on the pinksheets are not required to be reporting with the SEC nor are they required to qualify for the Rule 12g3-2(b) exemption from SEC registration for foreign private issuers. Pinksheets are available to ADR’s and foreign ordinary securities of companies traded on a Qualifying Foreign Stock Exchange. However, such issuers are then further qualified based on the level of voluntary information provided to www.otcmarkets.com. Issuers with no information are denoted by a skull and crossbones, issuers with limited financial and business information are classified as “limited information,” and issuers which provide information as set forth in the OTC Markets Pink Alternative Reporting Standard are denoted with a “current information” symbol.

Exchange Act Rule 12g3-2(b)

Exchange Act Rule 12g3-2(b) permits foreign private issuers to have their equity securities traded on the U.S. over-the-counter market without registration under Section 12 of the Exchange Act (and therefore without being subject to the Exchange Act reporting requirements). The Rule is automatic for foreign issuers that meet its requirements. A foreign issuer may not rely on the rule if it is otherwise subject to the Exchange Act reporting requirements.

The Rule provides that an issuer is not required to be subject to the Exchange Act reporting requirements if:

(i)the issuer currently maintains a listing of its securities on one or more exchanges in a foreign jurisdiction which is the primary trading market for such securities; and

(ii)the issuer has published, in English, on its website or through an electronic information delivery system generally available to the public in its primary trading market (such as the OTC Market Group website), information that, since the first day of its most recently completed fiscal year, it (a) has made public or been required to make public pursuant to the laws of its country of domicile; (b) has filed or been required to file with the principal stock exchange in its primary trading market and which has been made public by that exchange; and (c) has distributed or been required to distribute to its security holders.

Primary Trading Market means that at least 55 percent of the trading in the subject class of securities on a worldwide basis took place in, on or through the facilities of a securities market or markets in a single foreign jurisdiction or in no more than two foreign jurisdictions during the issuer’s most recently completed fiscal year.

In order to maintain the Rule 12g3-2(b) exemption, the issuer must continue to publish the required information on an ongoing basis and for each fiscal year.

The information required to be published electronically under paragraph (b) of this section is information that is material to an investment decision regarding the subject securities, such as information concerning:

(i) Results of operations or financial condition;
(ii) Changes in business;
(iii) Acquisitions or dispositions of assets;
(iv) The issuance, redemption or acquisition of securities;
(v) Changes in management or control;
(vi) The granting of options or the payment of other remuneration to directors or officers; and
(vii) Transactions with directors, officers or principal security holders.

At a minimum, a foreign private issuer shall electronically publish English translations of the following documents:

(i) Its annual report, including or accompanied by annual financial statements;
(ii) Interim reports that include financial statements;
(iii) Press releases; and
(iv) All other communications and documents distributed directly to security holders of each class of securities to which the exemption relates.

OTCQX Rules for International Companies – Requirements

OTCQX provides an expedited application process for ADRs and foreign ordinary securities of companies traded on a Qualifying Foreign Stock Exchange.

A. To be eligible to be quoted on the OTCQX International, companies must:

Have U.S. $2 million in total assets as of the most recent annual or quarter end;
As of the most recent fiscal year end, have at least one of the following: (i) U.S. $2 million in revenues; (ii) U.S. $1 million in net tangible assets; (iii) U.S. $500,000 in net income; or (iv) U.S. $5 million in global market capitalization;
Meet one of the following penny stock exemptions under Rule 3a51-1 of the Exchange Act: (i) have a bid price of U.S. $5 or more; or (ii) have net tangible assets of U.S. $2 million if the company has been in continuous operation for at least three years, or U.S. $5,000,000 if the company has been in continuous operation for less than three years; or (iii) have average revenue of at least U.S. $6,000,000 for the last three years;
Be quoted by a market maker on the OTC Link (which requires a 15c2-11 application if the company is not already quoted on a lower tier of OTC Markets);
Not be in bankruptcy or reorganization proceedings;
Be included in a Recognized Securities Manual or be subject to the reporting requirements of the Exchange Act;
Have its securities listed on a Qualifying Foreign Stock Exchange for a minimum of the preceding 40 calendar days; provided, however, that in the event the company’s securities are listed on a non-U.S. exchange that is not a Qualified Foreign Stock Exchange, then at the company’s request and subsequent to the company providing OTC Markets Group with personal information forms for each executive officer, director, and beneficial owner of 10% or more of a class of the company’s securities and such other materials as OTC Markets Group deems necessary to make an informed determination of eligibility, OTC Markets Group may, upon its sole and absolute discretion, consider the company’s eligibility for OTCQX International;
Meet one of the following conditions: (i) be eligible to rely on the registration exemption found in Exchange Act Rule 12g-2(b) and be current and compliant in such requirements; or (ii) have a class of securities registered under Section 12(g) of the Exchange Act and be current in its SEC reporting requirements; or (iii) if such company is not eligible to rely on the exemption from registration provided by Exchange Act Rule 12g3-2(b) because it does not (A) meet the definition of “foreign private issuer” as that term is used in Exchange Act Rule 12g3-2(b) or (B) maintain a primary trading market in a foreign jurisdiction as set forth in Exchange Act Rule 12g3-2(b)(ii), and is not otherwise required to register under Section 12(g), be otherwise current and fully compliant with the obligations of a company relying on the exemption from registration provided by Exchange Act Rule 12g3-2(b).

B. To be eligible to be quoted on the OTCQX International Premier, companies must:

Satisfy all of the eligibility requirements for OTCQX International set forth above;
As of its most recent fiscal year end, (i) have (a) revenue of U.S. $100 million; (b) global market capitalization of U.S. $500 million, (c) aggregate cash flow for the three preceding years of U.S. $100 million; and (d) minimum cash flow in each of the two preceding years of $25 million; or (ii) have (a) revenue of U.S. $75 million and (b) global market capitalization of $750 million.

Principal American Liaison

All International companies that are quoted on the OTCQX must have either an Attorney Principal American Liaison (“PAL”) or an Investment Bank PAL, provided however, if the company’s OTCQX traded security is an ADR, the international company may have an ADR PAL. All PAL’s must be approved by OTC Markets Group. A company may appoint a new PAL at any time provided they maintain a PAL at all times.

Application to the OTCQX for International Companies

All international companies that are quoted on the OTCQX must submit an application and pay an application fee. The application consists of (i) OTCQX application for international companies; (ii) the contractual agreement with OTCQX for international companies; (ii) the OTCQX application fee; (iv) the OTCQX Agreement for international companies; (v) an application for the international company’s desired PAL if such PAL is not already pre-qualified; (vi) an appointment form for the DAD/PAL; and (vii) a copy of the company’s logo in encapsulated postscript (EPS) format.

The company and its PAL will receive confirmation of the application submittal within approximately five business days. The application is subject to review and comment by OTC Markets. OTC Markets may require additional conditions or undertakings prior to admission. Moreover, the application may be denied if, in the opinion of OTC Markets, trading would be likely to impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors.

Initial Disclosure Obligations

An international company must post its initial disclosure documents on the OTC Markets website within 90 days of submission of its application to quote on the OTCQX and such posting must be confirmed with a notice by the company PAL. The filing of the initial disclosure is a precondition to acceptance of an application for quotation. Initial disclosure documents include: (i) SEC reports if the company is subject to the Exchange Act reporting requirements; or (ii) if the company is not subject to the SEC reporting requirements, all information required to be made public pursuant to Exchange Act Rule 12g3-2(b) for the preceding 24 months, which information must be posted in English.

PAL Letter of Introduction

After the initial disclosure has been posed, the company must submit a PAL Letter of Introduction to OTC Markets Group.

Requirements for Ongoing Qualification for Quotation on the OTCQX

The following is a summary of the ongoing responsibilities for OTCQX International quoted securities:

Eligibility Criteria – The International company must meet the above eligibility requirements as of the end of each most recent fiscal year;
Compliance with Rules – OTCQX quoted companies must maintain compliance with the OTCQX rules, including disclosure requirements. Officers and directors of the company are responsible for compliance and are solely responsible for the content of information;
Compliance with Laws – OTCQX quoted companies must maintain compliance applicable securities laws of its country of domicile and application U.S. federal and state securities laws. The company must comply with Exchange Act Rule 10b-17 and FINRA rule 6490 regarding notification and processing of corporate actions (such as name changes, splits and dividends). The company must cooperate with any securities regulators, whether in its country of domicile or in the U.S., including self-regulatory organizations;
Blue Sky Manual Exemption – Companies must either properly qualify for a blue sky manual exemption or be subject to and current in its Exchange Act reporting requirements;
Retention and Advice of PAL – Companies must have a PAL at all times and are required to seek the advice of such PAL as to their OTCQX obligations;
Notification of Resignation or Dismissal of PAL – A company must immediately notify OTC Markets in writing of the resignation or dismissal of the PAL for any reason;
Payment of Fees – a company must pay its annual fees to OTC Markets;
Responding to OTC Markets Group Requests – OTCQX quoted companies are required to respond to OTC Markets comments and amend filings as necessary in response thereto;
Ongoing Disclosure Obligations – (i) Companies subject to the Exchange Act reporting requirements must remain current in such reports; (ii) A company that is not an SEC Reporting Company must remain current and fully compliant in its obligations under Exchange Act Rule 12g3-2(b), if applicable, and in any event shall, on an ongoing basis, post in English through the OTC Disclosure & News Service or an Integrated Newswire, the information required to be made publicly available pursuant to Exchange Act Rule 12g3-2(b); (iii) provide a letter to its PAL at least once a year, no later than 210 days after the fiscal year end which states that the company (y) continues to satisfy the OTCQX quotation requirements; and (z) is current and compliant in its obligations under Exchange Act Rule 12g3-2(b) and that the information required under such rule is posted, in English, on the OTC Markets website or that the company is subject to the SEC reporting requirements and is current in such reporting requirements.
PAL Letter – Within 225 days of each fiscal year end and after the posting of the company’s annual report, every company must submit an annual PAL letter.

Removal from OTCQX International

A company may be removed from the OTCQX if, at any time, it fails to meet the eligibility and continued quotation requirements subject to a 30-day notice and opportunity to address them. In addition, OTC Markets Group may remove the company’s securities from trading on OTCQX immediately and at any time, without notice, if OTC Markets Group, upon its sole and absolute discretion, believes the continued inclusion of the company’s securities would impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors. In addition, OTC Markets can temporarily suspend trading on the OTCQX pending investigation or further due diligence review.

A company may voluntarily withdraw from the OTCQX with 24 hours’ notice.

Fees

Upon application for quotation on the OTCQX, companies must pay an initial non-refundable fee of $5,000. In addition, companies must pay an annual non-refundable fee of $15,000.

Click Here to Print OTCQX Listing and Quotation Eligibility and Requirements for International Companies- LC OTCQX Listing and Quotation Eligibility and Requirements for International Companies

The Author

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

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

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

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Tags: DAD/PAL, OTC Markets Group, OTC Markets Listing Requirements, OTC Pink, OTC Pink Listing Requirements, OTCQB Listing Requirements, OTCQX, OTCQX Listing Requirements, PAL, Rule 12G3-2(b), Rule 3a51-1, Section 12

Public Company and Affiliate Stock Buyback Rules; Rule 10b-18

by Laura Anthony, Esq. on September 02, 2014 in Regulation FD, Regulation S-K, Rule 10b-18, Uncategorized with No Comments

The SEC allows for limited methods that an issuer can utilize to show confidence in its own stock and assist in maintaining or increasing its stock price. One of those methods is Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Exchange Act Rule 10b-18 provides issuers with a non-exclusive safe harbor from liability for market manipulation under Sections 9(a)(2) and 10(b) and Rule 10b-5 under the Exchange Act when issuers bid for or repurchase their common stock in the open market in accordance with the Rule’s manner, timing, price and volume conditions. Each of the four main conditions of Rule 10b-18 must be satisfied on each day that a repurchase is made.

Sections 9 and 10 of the Exchange Act are the general anti-fraud and anti-manipulation provisions under the Act. Section 9(a)(2) of the Exchange Act makes it unlawful for any person to, directly or indirectly, create actual or apparent active trading in a security or raise or depress the price of such security for the purpose of inducing the purchase or sale of such security by others.

Section 10(b) of the Exchange Act makes it unlawful for any person to, directly or indirectly, “use or employ, in connection with the purchase or sale of any security… any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” Rule 10b-5, promulgated under Section 10(b), provides that “[I]t shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

Although Rule 10b-18 provides a safe harbor from the liability provisions of Section 9(a)(2), 10 and Rule 10(b)(5), like most securities rules, the rule does not provide protection from liability where it is utilized as part of a plan or scheme to evade the securities laws. In addition, an issuer must consider the interaction of other basic securities laws when attempting to rely on Rule 10b-18, such as whether it is in possession of material non-public information.

Rule 10b-18

Prior to relying on Rule 10b-18, the issuer’s board of directors must approve the plan. The board minutes should include the purpose of the plan and disclose the benefits to the corporation and its shareholders in proceeding with the repurchase program.

The issuer should also consider whether it will publicly announce the program. Rule 10b-18 does not specifically require announcement, but the issuer must consider overall public disclosure requirements. Generally, if the issuer is embarking on a repurchase program, it should be announced, as the failure to announce could be deemed material non-public information preventing the program itself. Moreover, likewise if a program is announced and subsequently terminated, the termination should be announced. An announcement would be in the form of a press release and Regulation FD Form 8-K filing with such release.

The material portions of Rule 10b-18 are as follows:

Definition. A “Rule 10b-18 purchase” is generally defined as an open market purchase or any bid or limit order of an issuer’s common stock by or for the issuer or any of the issuer’s affiliated purchasers. The Rule is limited to common stock and does not cover other forms of securities such as warrants, options, debt or preferred stock.

To be able to rely on Rule 10b-18 in making repurchases, the following four (4) conditions must be met.

Time of Purchase. The Rule restricts issuers from making repurchases that constitute the opening transaction in the security on a trading day, or subject to exceptions, that occur during the last 30 minutes before the scheduled close of trading. However, the limitations on purchases at the close vary depending on the average daily trading volume (“ADTV”) and public float. Issuers with more liquid securities (i.e., issuers with an ADTV of $1 million or more and a public float value of $150 million or more) would not be restricted from bidding for or purchasing their securities during any of the following periods: (1) in the 10 minutes before the scheduled close of the regular trading session in the principal market for the security; (2) the 10 minutes before the scheduled close of the regular trading session in the market where the purchase is made; and (3) after the termination of the period in which last sales prices are reported in the consolidated system.

Price of Purchase. The purchase price cannot exceed the higher of the highest independent bid or the last independent transaction price. For after-hours trading, the price must not exceed the lower of the closing price of the primary trading session or principal market and the price of any other reported subsequent transactions. The price restrictions do not apply provided that (i) the purchase otherwise complies with the Rule; (ii) the security is an actively traded security as defined in Regulation M (i.e., issuers with an ADTV of $1 million or more and a public float value of $150 million or more); (iii) the purchase is entered into or matched before the opening of the regular trading session; (iv) the execution price of the VWAP purchase based on regular trades meets specified conditions; (v) the purchases do not exceed 10% of the issuer’s ADTV; (vi) the purchase is not for the purpose of creating an actual or apparent active trading market; (vii) the VWAP calculation is in accordance with the Rule; and (viii) the purchase is recorded using a special VWAP code (so as not to sway the independent market).

Volume of Purchase. The Rule limits the amount of securities an issuer may repurchase on the market on a single day to 25% of the four-week average daily trading volume in its shares (that is, the average daily trading volume during the four calendar weeks prior to the week in which the 10b-18 purchase is to be made). However, issuers are permitted to make one block purchase of its common stock per week outside of the volume restrictions. Issuers have to include block purchases in applying the 25% volume limitation. However, issuers would also be permitted to include block purchases in calculating the ADTV for their securities, thereby increasing the amount of stock able to be purchased within the safe harbor. The Rule defines a “block” as a quantity of stock that (1) has a purchase price of $200,000 or more, (2) is at least 5,000 shares and has a purchase price of at least $50,000, or (3) is at least 20 round lots of the security and totals 150% or more of the ADTV of that security. As an alternative to the 25% volume limitation, issuers are allowed purchase up to a daily aggregate amount of 500 shares regardless of the ADTV of the security. Thus, an issuer’s purchases, on any single day, may not exceed the higher of 25% of the ADTV for the issuer’s security or a daily aggregate amount of 500 shares.

Manner. The Rule requires an issuer to use only one broker or dealer per day to bid for or purchase its common stock. The issuer may utilize a different broker on different days, as long as they only use one per day. The issuer’s direct use of an electronic trading platform or alternative trading system will be considered using a broker for purposes of applying the rule. Moreover, an issuer is not prohibited from closing unsolicited private transactions involving the repurchase of a shareholder’s securities in addition to its open-market purchases.

Benefits of a stock repurchase program

There are many reasons why an issuer or an affiliate of an issuer may want to purchases its stock in the open market. In particular, (i) the repurchase of stock in the open market shows confidence and a belief in the value of the stock; (ii) like all purchases, can tend to drive up the stock price; (iii) can reduce the cost of capital for the issuer; (iii) supports liquidity for all shareholders; (iv) can be used to signal a belief that the stock is undervalued; (iv) reduce dilution after an acquisition or other large issuance; and (v) is a way to return cash to shareholders.

State law and other considerations

Prior to embarking on a repurchase program, the issuer must review its charter, bylaws and material contracts and, in particular, financing contracts. Each of these documents could contain provisions that directly or indirectly prohibit or otherwise affect an issuer’s ability to repurchase its own securities.

Stock repurchase programs do not pre-empt state law. Many states have provisions related to the issuer’s ability to repurchase its own stock. For example, Delaware law provides that a company may not purchase shares of its stock when the purchase “would cause any impairment of the capital of the corporation.” A repurchase is often considered analogous to a dividend under state law (by purchasing stock from shareholders, the issuer is providing cash to such shareholder). The dividend provisions of the state of incorporation should always be reviewed for compliance. Many states prohibit a dividend, including through the repurchase of securities, in the event the company is technically insolvent or fails to meet certain basic balance sheet tests such as the ratio of assets to liabilities or the amount of retained earnings.

General creditors’ rights should be considered as well. For example, a creditor could attack a repurchase program when such a program leaves the issuer without available cash to meet its obligations or is seen to otherwise impair such creditor’s ability to be repaid, or its security under a security agreement. It is fairly common for complex financing transactions to prohibit or otherwise limit such stock repurchases, including indirectly through limits on the use of excess cash.

Reporting requirements related to repurchases

All issuers that are subject to the Exchange Act reporting requirements must report their stock repurchases in their Forms 10-Q and 10-K. Item 703 of Regulation S-K requires that an issuer disclose in tabular form (a) the period of purchases, by month; (b) the total number of shares repurchased during the past quarter, separated by month; (c) the average price paid per share; (d) the number of shares that were purchased as part of a publicly announced repurchase plan; and (e) the maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs.

For publicly announced repurchase plans, the issuer is also required to disclose (by footnotes to the table) the following information: (a) the announcement date; (b) the share or dollar amount approved; (c) the expiration date (if any) of the plans or programs; (d) each plan or program that has expired during the period covered by the table; and (e) each plan or program terminated prior to expiration or the program.

Repurchase programs should also be discussed under the issuer’s management discussion and analysis (MD&A) disclosures. The reasons for embarking on the program are material and relevant to the issuer’s plans of operations and belief in the value of the company. In addition, the use of cash for such a program is material to the liquidity discussion.

The Author

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

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

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

Download our mobile app at iTunes.

Tags: 10-b18, Regulation FD, Regulation S-K, Rule 10b-18, Section 10(b)(5) of the Exchange Act, Section 9(a)(2), Stock Repurchase Programs

Monthly Archives: September 2014

The ECOS Matter; When Is A Reverse Split Effective?

SEC Filed Actions Against 19 Firms and One Individual Trader for Violation of Rule 105 of Regulation M

SEC Files Dozens of Charges for Violations of the Section 16 and Section 13 Corporate Insider Reporting Requirements

OTCQX Listing and Quotation Eligibility and Requirements for International Companies

Public Company and Affiliate Stock Buyback Rules; Rule 10b-18

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