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OTC Markets Amends Listing Standards For The OTCQX

by Laura Anthony, Esq. on December 29, 2015 in DAD/PAL, OTCQX, OTCQX Listing Requirements, Uncategorized with No Comments

OTC Markets has unveiled changes to the quotations rule and standards for the OTCQX, which changes become effective January 1, 2016. The amended listing standards increase the quantitative criteria for listing and add additional qualitative requirements continuing to align the OTCQX with standards associated with a national stock exchange. Companies already listed on the OTCQX as of December 31, 2015 will have until January 2017 to meet the new ongoing eligibility requirements.

As part of the rule changes, OTC Markets has renamed its U.S. Designated Advisor for Disclosure (DAD) to an OTCQX Advisor. All U.S. companies that are quoted on the OTCQX must have either an attorney or an Investment Bank OTCQX Advisor. A company may appoint a new OTCQX Advisor at any time, provided that the company retains an approved OTCQX Advisor at all times.

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.

All OTCQX Advisors and PALs must be approved by OTCQX after submitting an application. Eligibility to act as an OTCQX Advisor or PAL is limited to experienced and qualified securities attorneys or qualified FINRA member investment banking firms. I am an approved OTCQX Advisor and PAL.

The primary roles of an OTCQX Advisor and PAL include (i) to provide advice and guidance to a company in meeting its OTCQX obligations; (ii) to provide professional guidance to the issuer on creating investor demand as they build long-term relationships with management; (iii) to assist companies in discerning the information that is material to the market and should be disclosed to investors; and (iv) to provide a professional review of the company’s disclosure. The OTCQX puts a great deal of onus on the OTCQX Advisor/PAL to be responsible for the company in which it sponsors, emphasizing the negative impact on the OTCQX Advisor’s reputation for sponsoring companies that are not of acceptable quality. In addition to providing advice and counsel to a company, an OTCQX Advisor/PAL is required to conduct investigations to confirm disclosures. An OTCQX Advisor/PAL must submit a Letter of Introduction and subsequent annual letters confirming their duties and the attesting to the disclosures made by the company.

Summary of Changes

The OTCQX has increased its quantitative initial and ongoing listing standards for U.S. companies including: (i) increase of initial bid price requirement from $0.10 to $0.25 for initial qualification and to $0.10 for ongoing eligibility; (ii) addition of initial minimum market capitalization requirement of $10 million; (iii) addition of continued listing minimum market capitalization requirement of $5 million; (iv) minimum of two market makers with priced quoted on OTC Markets within 90 days of joining; and (v) expands the requirement that the company remain qualified for a penny stock exemption under Rule 3a51-1 or be removed.

The OTCQX has also increased its quantitative initial and ongoing listing standards for international companies including: (i) increase of initial bid price requirement from $0.10 to $0.25 for initial qualification and to $0.10 for ongoing eligibility; (ii) addition of initial minimum market capitalization requirement of $10 million; (iii) addition of continued listing minimum market capitalization requirement of $5 million; and (iv) minimum of two market makers with priced quoted on OTC Markets within 90 days of joining.

The OTCQX has added new qualitative corporate governance requirements for U.S. issuers as well. In particular to list on OTCQX, U.S. companies will be required to (i) have a minimum of 2 independent board members; (ii) have an audit committee comprised of a majority of independent directors; and (iii) conduct an annual shareholders meeting and submit annual financial reports to shareholders at least 15 calendar days prior to such meeting.

The standards for the OTCQX U.S. and International Premier tiers have also increased. The U.S. Premier increases are meant to align such companies with the financial standards recognized by most states for issuer state blue sky exemptions. In particular U.S. Premier companies will require (i) a minimum bid price of $4 for initial qualification and $1 on an ongoing basis; (ii) a minimum market capitalization of $10 million for initial qualification and $5 million on an ongoing basis for companies with a public float of at least $15 million or a minimum market capitalization of $50 million for initial qualification and $35 million on an ongoing basis for companies with a public float of at least $1 million and $750,000 in net income as of the most recent fiscal year end; (iii) stockholders’ equity of $4 million for initial qualification and $1 million for ongoing eligibility; (iv) minimum of 4 market makers with prices quoted on OTC Markets within 90 days of joining; and (v) a minimum of 3 years’ operating history.

The International Premier standards have increased to align with the margin eligibility standards set by the Federal Reserve and SEC. In particular International Premier Companies must have: (i) a global market capitalization of $1 billion for initial qualification and $500 million for ongoing eligibility; (ii) a minimum 5 years’ operating history; (iii) average weekly share volume of 200,000 shares or $1 million for initial qualification and 100,000 shares or $500,000 for ongoing eligibility; and (iv) minimum of 4 market makers with prices quoted on OTC Markets within 90 days of joining.

The annual fee for all companies on the OTCQX has been raised to $20,000.

As part of the changes, the term “OTCQX Advisor” has replaced the current Designated Advisor for Disclosure (DAD) for U.S. companies. I am a qualified approved OTCQX Advisor.

OTCQX

The following is a complete summary of the OTCQX listing standards as they will be in effect on January 1, 2016.

The OTCQX divides its listing criteria between U.S. companies and international companies, though they are very similar. The OTCQX has two tiers of quotation for U.S. companies: (i) OTCQX U.S. Premier (also eligible to quote on a national exchange); and (ii) OTCQX U.S. and two tiers for international companies: (i) OTCQX International Premier; and (ii) OTCQX International. Quotation is available for American Depository Receipts (ADR’s) or foreign ordinary securities of companies traded on a Qualifying Foreign Stock Exchange, and an expedited application process is available for such companies.

Issuers on the OTCQX must meet specified eligibility requirements. Moreover, OTC Markets have the discretionary authority to allow quotation to substantially capitalized acquisition entities that are analogous to SPAC’s.

OTCQX – Requirements for Admission

To be eligible to be quoted on the OTCQX U.S., companies must:

Have $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) $2 million in revenues; (ii) $1 million in net tangible assets; (iii) $500,000 in net income; or (iv) $5 million in market value of publicly traded securities;
Have a market capitalization of at least $10 million on each of the 30 consecutive calendar days immediately preceding the company’s application;
Meet one of the following penny stock exemptions under Rule 3a51-1 of the Exchange Act: (i) have a bid price of $5 or more as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application and as of the most recent fiscal year end have at least one of the following: (w) net income of $500,000; (x) net tangible assets of $1,000,000; (y) revenues of $2,000,000; or (z) total assets of $5,000,000; or (ii) have net tangible assets of $2 million if the company has been in continuous operation for at least three years, or $5,000,000 if the company has been in continuous operation for less than three years which qualification can be satisfied as of the end of a fiscal period or as a result of an interim capital raise; or (iii) have average revenue of at least $6,000,000 for the last three years;
Not be a blank check or shell company as defined by the Securities Act of 1933 (“Securities Act”);
Not be in bankruptcy or reorganization proceedings;
Be in good standing in its state of incorporation and in each state in which it conducts business;
Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;
Be quoted by at least one market maker on the OTC Link;
Have a minimum bid price of $0.25 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX. If (i) there has been no prior public market for the company’s securities in the U.S. and (ii) FINRA has approved a Form 211, then the company may apply to OTC Markets for an exemption from the minimum bid price requirements, which exemption is at the sole discretion of OTC Markets. In the event that the company is a Seasoned Public Issuer (i.e., has been in operation and quoted on either OTC Link, the OTCBB or an exchange for at least one year) that completed a reverse stock split within 6 months prior to applying for admission to OTCQX U.S., the company must have a minimum bid price of $0.25 per share for its common stock as of the close of business on each of the 5 consecutive trading days immediately preceding the company’s application for OTCQX, after the reverse split;
Have GAAP compliant (i) audited balance sheets as of the end of each of the two most recent fiscal years, or as of a date within 135 days if the company has been in existence for less than two fiscal years, and audited statements of income, cash flows and changes in stockholders’ equity for each of the fiscal years immediately preceding the date of each such audited balance sheet (or such shorter period as the company has been in existence), and must include all going concern disclosures including plans for mitigation; and GAAP compliant (ii) unaudited interim financial reports, including a balance sheet as of the end of the company’s most recent fiscal quarter, and income statements, statements of changes in stockholders’ equity and statements of cash flows for the interim period up to the date of such balance sheet and the comparable period of the preceding fiscal year;
Be included in a Recognized Securities Manual or be subject to the reporting requirements of the Exchange Act; and
Have an OTCQX Advisor.

To be eligible to be quoted on the OTCQX U.S. Premier, companies must:

Satisfy all of the eligibility requirements for OTCQX U.S. set forth above;
Meet one of the following: (i) Market Value Standard – have at least (a) $15 million in public float and (b) a market capitalization of at least $50 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; or (ii) Net Income Standard – have at least (a) $1 million in public float; and (b) a market capitalization of at least $10 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; and (c) $750,000 in net income as of the company’s most recent fiscal year end;
Have at least 500,000 publicly held shares;
Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;
Have a minimum of 100 beneficial shareholders owning at least one round lot (100 shares) each;
Have a minimum bid price of $4.00 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX. If (i) there has been no prior public market for the company’s securities in the U.S. and (ii) FINRA has approved a Form 211 and (iii) the bid price is equal to or greater than $1.00, then the company may apply to OTC Markets for an exemption from the 30-day minimum bid price requirements, which exemption is at the sole discretion of OTC Markets. In the event that the company is a Seasoned Public Issuer (i.e., has been in operation and quoted on either OTC Link, the OTCBB or an exchange for at least one year) that completed a reverse stock split within 6 months prior to applying for admission to OTCQX U.S., the company must have a minimum bid price of $4.00 per share for its common stock as of the close of business on each of the 5 consecutive trading days immediately preceding the company’s application for OTCQX, after the reverse split;
Have at least $4 million in stockholder’s equity;
Have a 3-year operating history; and
Conduct annual shareholders’ meetings and submit annual financial reports to its shareholders at least 15 calendar days prior to such meetings.

To be eligible to be quoted as an OTCQX U.S. Acquisition Company, companies must:

Satisfy all of the eligibility requirements for OTCQX U.S. set forth above;
Have a minimum bid price of $5.00 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX; and
Be subject to the reporting requirements of the Exchange Act.

Corporate Governance Requirements for all OTCQX U.S., U.S. Premier and U.S. Acquisition Companies:

Have at least 2 independent board members on the board of directors;
Have an audit committee comprised of a majority of independent directors; and
Conduct annual shareholders’ meetings and submit annual financial reports to its shareholders at least 15 calendar days prior to such meetings.

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 $5 or more as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application and as of the most recent fiscal year end have at least one of the following (w) net income of $500,000; (x) net tangible assets of $1,000,000; (y) revenues of $2,000,000 or (z) total assets of $5,000,000; 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 at least one 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 a shell company or blank check company;
Not be in bankruptcy or reorganization proceedings;
Have a minimum of 50 beneficial shareholders owning at least one round lot (100 shares) each;
Have a minimum bid price of $0.25 per share for its common stock as of the close of business on each of the 30 consecutive calendar days immediately preceding the company’s application for OTCQX. If there has been no prior public market for the company’s securities in the U.S., FINRA must have approved a Form 211 with a minimum bid price of $0.25 or greater. If the company is applying to the OTCQX immediately following a delisting from a national securities exchange, it must have a minimum bid price of at least $0.10.
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;
Have a global market capitalization of at least $10 million on each of the 30 consecutive calendar days immediately preceding its application day;
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); and
Have Principal American Liaison (PAL).

Explanation of 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.

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;
Have a global market capitalization of at least $1 billion on each of the 30 consecutive calendar days immediately preceding its application day; and
Have one of the following over the prior 6 months: (i) average weekly trading volume of at least 200,000 shares; or (ii) average weekly trading volume of at least $1 million.

Application to the OTCQX

All U.S. companies that are quoted on the OTCQX must submit an application and pay an application fee. The application consists of (i) the application with information related to the company; (ii) the contractual agreement with OTCQX for quotation; (iii) personal information for each executive officer, director and beneficial owner of 5% or more of the securities, except for companies already traded on a foreign exchange or moving from a recognized U.S. exchange; (iv) designation of the OTCQX Advisor; (v) appointment form for the OTCQX Advisor; and (vi) a digital company logo.

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 PAL; and (vii) a copy of the company’s logo in encapsulated postscript (EPS) format.

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

A company must post its initial disclosure documents on the OTC Markets website as a precondition to acceptance of an application for quotation, and such posting must be confirmed with a letter by the company OTCQX ADVISOR/PAL.

Initial disclosure documents include: (i) SEC reports if the company is subject to the Exchange Act reporting requirements; (ii) current information in accordance with OTC Markets disclosure guidelines including financial statements; (iii) if the company is a Regulation A reporting company, it must be current in such reporting requirements; (iii) if the company was an SEC Reporting Company immediately prior to joining OTCQX and has a current 10-K on file with the SEC, or was a Regulation A Reporting Company immediately prior to joining OTCQX and has a current 1-K on file with the SEC, the company is not required to post an information statement through the OTC Markets, but subsequent to joining OTCQX must post all annual, quarterly, interim and current reports required pursuant to the Disclosure Guidelines; and (iv) for international companies 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.

A company must supplement and update any changes to the initial disclosure within 30 days of acceptance of its application for quotation. International companies must follow initial disclosure with a PAL Letter of Introduction.

Requirements for Ongoing Qualification for Quotation on the OTCQX

The following is a summary of the ongoing responsibilities for U.S. OTCQX quoted securities:

Compliance with Rules – OTCQX quoted companies must maintain compliance with the OTCQX rules including disclosure requirements. The company’s OTCQX ADVISOR/PAL is responsible for reporting their/its potential conflicts of interest;
Compliance with Laws – OTCQX quoted companies must maintain compliance with state and federal securities laws and must cooperate with any securities regulators, 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 their Exchange Act reporting requirements;
Retention and Advice of OTCQX ADVISOR – Companies must have an OTCQX ADVISOR at all times and are required to seek the advice of such OTCQX ADVISOR as to their OTCQX obligations;
Duty to Inform OTCQX ADVISOR – As part of its duty to seek advice from its OTCQX ADVISOR, a company has an obligation to provide disclosure and information to the OTCQX ADVISOR, including “complete access to information regarding the company, including confidential and propriety information”; access to personnel; updated personal information forms; and timely responses to requests for information or documents;
Notification of Resignation or Dismissal of OTCQX ADVISOR – A company must immediately notify OTC Markets in writing of the resignation or dismissal of the OTCQX ADVISOR for any reason;
Payment of Fees – a company must pay its annual fees to OTC Markets;
Sales of Company Securities by Affiliates – Prior to transacting in the company’s securities through a broker-dealer, each officer, director or other affiliate of the company shall make its status as an affiliate of the company known to the broker-dealer;
Distribution and Publication of Proxy Statements – The company shall solicit proxies for all meetings of shareholders. If the company is a Regulation A Reporting Company, the company shall publish, on EDGAR through SEC Form 1-U, copies of all proxies, proxy statements and all other material mailed by the company to its shareholders with respect thereto, within 15 days of the mailing of such material. If the company is not an SEC Reporting Company or a Regulation A Reporting Company, the company shall publish, through the OTC Markets, copies of all proxies, proxy statements and all other material mailed by the company to its shareholders with respect thereto, within 15 days of the mailing of such material;
Redemption Requirements – All redemptions must be either by lot or pro rata and require 15 days’ notice;
Changes in Form or Nature of Securities – All changes in form, nature or rights associated with securities quoted on the OTCQX require 20 days’ advance notice to OTC Markets;
Transfer Agent – Companies are required to use the services of a registered transfer agent and authorize such transfer agent to share information with OTC Markets;
Accounting Methods – Any change in accounting methods requires advance notice of such change and its impact, to OTC Markets;
Change in Auditors – All changes in auditor requires prompt notification and a letter from such auditor analogous to Form 8-K requirements;
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) Companies not subject to the Exchange Act reporting requirements must remain current with the annual, quarterly and current reporting requirements of OTC Markets, including posting annual audited financial statements prepared in accordance with GAAP and audited by a PCAOB auditor; (iii) Regulation A reporting companies shall maintain current compliance with their Regulation A reporting requirements and within 45 days of the end of the first and third fiscal quarters shall file quarterly disclosure including all information required in a semi-annual report (i.e., the company shall file quarterly and not just semi-annual reports); (iv) file a notification of late filing when necessary; (v) quickly release disclosure of material news and recent developments, whether positive or negative, through a press release on the OTC Markets website (in addition to SEC filings); (vi) an OTCQX company should also act promptly to dispel unfounded rumors which result in unusual market activity or price variations;
General requirements regarding integrity – OTCQX quoted companies are expected to act professionally and uphold the OTC Markets standards for “high quality,” and to release news and reports that are prepared factually and accurately with neither excessive puffery or conservatism; companies must not report or act in a way that could be misleading; must not inundate with non-material releases; and must not make misleading premature announcements;
Maintain Company Updated Profile – OTCQX quoted companies are required to maintain updated accurate information on their profile page and to verify same every six months;
OTCQX ADVISOR Letter – Within 120 days of each fiscal year end and after the posting of the company’s annual report, every company must submit an annual OTCQX ADVISOR letter;
To remain eligible for trading on the OTCQX U.S. tier, the company’s common stock must have a minimum bid price of $0.10 per share as of the close of business for at least one of every thirty consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $0.10 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $0.10 for ten consecutive trading days;
To remain eligible for trading on the OTCQX U.S. tier, the company must maintain a market capitalization of at least $5 million for at least one of every 30 consecutive calendar days;
To remain eligible for trading on the OTCQX U.S. tier, the company must have at least 2 market makers quote the stock;
To remain eligible for trading on the OTCQX U.S. Premier tier, the company’s common stock must have a minimum bid price of $1.00 per share as of the close of business for at least one of every thirty consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $1.00 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $1.00 for ten consecutive trading days. In the event that the company’s common stock does not regain compliance during the grace period, the company shall have a fast-track option to have its securities traded on the OTCQX U.S. tier.
To remain eligible for trading on the OTCQX U.S. Premier tier, the company must meet one of the following standards: (i) Market Value Standard – have at least (a) $15 million in public float and (b) a market capitalization of at least $35 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; or (ii) Net Income Standard – have at least (a) $1 million in public float; and (b) a market capitalization of at least $5 million, each as of the close of business on each of the 30 consecutive days immediately preceding the company’s application; and (c) $500,000 in net income as of the company’s most recent fiscal year end;
To remain eligible for trading on the OTCQX U.S. Premier tier, the company must have at least $1 million in stockholders’ equity;
To remain eligible for trading on the OTCQX U.S. Premier tier, the company must have at least 4 market makers quoting the stock;
All U.S. companies, whether U.S. standard or U.S. Premier, must maintain corporate governance standards including independent director and audit committee requirements. A company must notify OTC Markets immediately of a disqualification and must regain compliance by its next annual shareholder meeting or one year from the date of non-compliance.

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 with applicable securities laws of their country of domicile and applicable 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 their 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 their 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;
To remain eligible for OTCQX International, the company must maintain a minimum bid price of $0.10 as of the close of business for at least one of every 30 consecutive calendar days. In the event that the minimum bid price for the company’s common stock falls below $0.10 per share at the close of business for thirty consecutive calendar days, a grace period of 180 calendar days to regain compliance shall begin, during which the minimum bid price for the company’s common stock at the close of business must be $0.10 for ten consecutive trading days;
To remain eligible for OTCQX International, the company must maintain a market capitalization of at least $5 million for at least one of every 30 consecutive calendar days;
To remain eligible for OTCQX International, the company must maintain at least 2 market makers;
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; and
To remain eligible for the OTCQX International Premier, the company must have (i) a global market capitalization of at least $500 million for at least one of every 30 consecutive calendar days; (ii) of one following over the prior 6 months (a) an average weekly trading volume of at least 100,000 shares or (b) an average weekly trading dollar volume of at least $500,000; and (iii) at least 4 market makers.

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 $20,000. The annual fee is based on the calendar year and is due by December 1st each year.

OTCQX Advisor (formerly known as Designated Advisors for Disclosure (“DAD”)) and Principal American Liaison (“PAL”) Requirements

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.

The primary roles of an OTCQX Advisor and PAL include (i) to provide advice and guidance to a company in meeting its OTCQX obligations; (ii) to provide professional guidance to the issuer on creating investor demand as they build long-term relationships with management; (iii) to assist companies in discerning the information that is material to the market and should be disclosed to investors; and (iv) to provide a professional review of the company’s disclosure. The OTCQX puts a great deal of onus on the OTCQX Advisor/PAL to be responsible for the company which it sponsors, emphasizing the negative impact on the OTCQX Advisor’s reputation for sponsoring companies that are not of acceptable quality. In addition to providing advice and counsel to a company, an OTCQX Advisor/PAL is required to conduct investigations to confirm disclosures. An OTCQX Advisor/PAL must submit a Letter of Introduction and subsequent annual letters confirming their duties and the attesting to the disclosures made by the company.

Click Here To Print- LC PDF Printout OTC Markets Amends Listing Standards For The OTCQX

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: ADR, DAD, Designated Advisor for Disclosure, OTC Attorney, OTC Attorneys, OTC markets, OTC Pink Market, OTCQX, otcqx advisor, OTCQX Advisor/PAL, otcqx listing standards, OTCQX Obligations, PAL, Principal American Liaison

Title III Crowdfunding

by Laura Anthony, Esq. on December 22, 2015 in Crowdfunding, Intrastate Crowdfunding, JOBS ACT, JOBS ACT and Crowdfunding, Section 4(a)(6), Uncategorized with No Comments

As required by Title III of the JOBS Act, on October 30, 2015, the SEC has published the final crowdfunding rules. Regulation Crowdfunding has been long in the making, with the JOBS Act having been passed on April 5, 2012, and the first set of proposed crowdfunding rules having been published on October 23, 2013. The new rules will be effective 180 days after publication, but the forms for registering a funding portal with the SEC will be effective and available January 29, 2016.

The SEC has dubbed the new rules “Regulation Crowdfunding.” Regulation Crowdfunding provides the rules implementing Section 4(a)(6) of the Securities Act of 1933 (the Securities Act) and the regulatory framework for registered funding portals and broker-dealers that companies are required to use as intermediaries in crowdfunding offerings. In addition, Regulation Crowdfunding exempts securities sold under Section 4(a)(g) from the mandatory registration requirements found in Section 12(g) of the Securities Exchange Act of 1934 (“Exchange Act”).

Background: What is Crowdfunding?

Crowdfunding generally is where an entity or individual raises funds by seeking small contributions from a large number of people. The crowdfunder sets a goal amount to be raised from the crowd with the funds to be used for a specific business purpose. In addition, a crowdfunding campaign allows the crowd to communicate with each other, thus adding the benefit of the “wisdom of the crowd.” Small businesses can particularly benefit from crowdfunding as they are not limited by restrictions on general solicitation and advertising or purchaser qualification requirements. It is intended that crowdfunding offerings will be relatively low-cost and easy to implement; however, I am not sure that particular goal will be achieved.

Title III of the JOBS Act, called the Crowdfunding Act, amended Section 4 of the Securities Act, adding Section 4(a)(6) to create a new exemption to the registration requirements of Section 5 of the Securities Act. The new exemption allows issuers to solicit “crowds” to sell up to $1 million in securities in any 12-month period as long as no individual investment exceeds certain threshold amounts.

The threshold amount sold to any single investor cannot exceed (a) the greater of $2,000 or 5% of the annual income or net worth of such investor if the investor’s annual income or net worth is less than $100,000; and (b) 10% of the annual income or net worth of such investor, not to exceed a maximum of $100,000, if the investor’s annual income or net worth is more than $100,000. When determining requirements based on net worth, an individual’s primary residence must be excluded from the calculation. Clearly there is a conflict in the language determining threshold amounts; an investor could fall within both categories.

The conflict was pointed out in numerous letters to the SEC and has been addressed in the rule making and in particular (b) has been changed such that both an investor’s annual income and net worth must be in excess of $100,000 to participate in the higher investment amount. In addition, Regulation Crowdfunding limits the total amount any investor can invest to $100,000. Significantly, the investment limitations apply across all crowdfunding issuers during any 12-month period.

Section 302 of the Crowdfunding Act requires that all crowdfunding offerings be conducted through an intermediary that is a broker-dealer or funding portal that is registered with the SEC and a member of a registered self-regulatory organization (SRO). Currently that SRO is the Financial Industry Regulatory Authority (FINRA). Although funding portals will have to register with the SEC and become a member of FINRA, they will not have to register as a broker-dealer. FINRA has also published rules to regulate funding portals.

In addition, the Crowdfunding Act requires that issuers and intermediaries provide certain information to investors, potential investors and the SEC. Regulation Crowdfunding takes the disclosure requirement a step further and requires annual reports from the issuer. The ability to utilize crowdfunding will be subject to bad boy restrictions and other disqualifying events. All crowdfunding issuers must be United States entities. Crowdfunding issuers cannot be subject to the reporting requirements of the Securities Exchange Act of 1934 or an investment company as defined by the Investment Company Act of 1940.

The JOBS Act required the SEC to draft rules implementing the provisions of the Act. On October 30, 2015, the SEC issued a 685-page final rule release.

The SEC Rule Release – Introduction and Background

The SEC begins its rule release with a discussion of the crowdfunding concept and the difficulty of balancing rules that are not unduly burdensome, and thus discourage participation in crowdfunding on the one hand with rules that are too permissive and thus increase the risk for investors. The SEC also recognizes that the SEC staff will need to monitor the practical implementation of the new rules closely and implement amendments and interpretations as necessary as a workable crowdfunding system is created in the U.S.

Summary Breakdown of New Rules – The Crowdfunding Exemption

Issuer Eligibility/Exclusion of Certain Issuers from Eligibility

Regulation Crowdfunding requires that all crowdfunding issuers must be United States entities. In addition, certain issuers are excluded from relying on the exemption, including: (a) companies subject to the reporting requirements of the Securities Exchange Act of 1934; (b) an investment company as defined by the Investment Company Act of 1940, or excluded from such definition under 3(b) or 3(c) of the 1940 Act (i.e., hedge funds and private funds are also not eligible); (c) be subject to bad boy disqualifications as set forth in Rule 503(a) of Regulation Crowdfunding (which rule is substantially similar to the bad actor disqualifications in Rule 506); (d) companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years preceding an offering; and (e) blank check companies (i.e., companies that have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company).

The SEC specifically does not disqualify early-stage or start-up entities, noting that it is these entities that will benefit the most from Regulation Crowdfunding by obtaining “input from the crowd” on business plans and ideas at the inception.

Limitation on Capital Raised/Integration

The exemption from registration provided by Section 4(a)(6) is available to a U.S. issuer provided that “the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under new Section 4(a)(6) during the 12-month period preceding the date of such transaction, is not more than $1,000,000.” This wording opened debate as to which other exempt offerings, if any, would be integrated with the $1,000,000 limit for the new Section 4(a)(6) exemption. The SEC concluded that “the overall intent of providing the exemption under Section 4(a)(6) was to provide an additional mechanism for capital raising for startup and small businesses and not to affect the amount an issuer could raise outside of that exemption.”

In the rule, capital raised through other means does not aggregate or integrate with capital raised under the Section 4(a)(6) Regulation Crowdfunding exemption. Moreover, capital raised through non-equity-based crowdfunding (such as donation or reward offerings) would also not aggregate or integrate in determining the $1,000,000 limit. An issuer could complete an offering made in reliance on Section 4(a)(6) that occurs simultaneously with, or is preceded or followed by, another exempt offering.

However, Section 4(a)(6) offerings conducted by entities controlled by or under common control with the issuer do aggregate and integrate with the issuer’s offering. Securities Act Rule 405 defines “control” as “possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” Offerings by predecessor issuers also integrate and aggregate with the issuer’s offerings.

In addition, caution would need to be taken if the simultaneous offerings were being conducted under an exemption that did not allow advertising.

Investment Limitation

Regulation Crowdfunding limits investment amounts per investor for all crowdfunding offerings by all issuers in any 12-month period as follows: (a) if either annual income or net worth is less than $100,000, the investment limitation is the greater of $2000 or 5% of the lesser of annual income or net worth or (b) if both annual income and net worth are equal to or greater than $100,000, the investment limitation is 10% of the lesser of annual income or net worth. In addition, the final rule provides an overall investment limitation of $100,000 for any investor in any 12-month period. Significantly, the investment limitations apply across all crowdfunding issuers during any 12-month period.

Annual income and net worth are both to be calculated the same as they are calculated in determined accredited investor status under Securities Act Rule 501. Under Rule 501 a person’s residence is not included in the net worth calculation. Annual income and net worth may be calculated jointly with a spouse so long as the aggregate investment amount of both spouses does not exceed the individual limit. The investment limitations apply to all investors, including retail, institutional, accredited, and both U.S. and non-U.S. citizens and residents.

Issuers will be able to rely on the funding intermediaries (i.e., funding portal or broker-dealer) to determine whether investors comply with their investment limits, except where the issuer has actual knowledge otherwise.

Resale Restrictions

Securities purchased in a crowdfunding offering are generally restricted for a period of one year. Such securities may not be transferred by the investor until after a one-year holding period, except that they may be resold back to the issuer, to an accredited investor as defined in Rule 501, as part of a registered offering with the SEC, or to a family member in connection with death or a divorce.

Transactions Conducted Through an Intermediary

Section 4(a)(6)(C) requires that all crowdfunding offerings be conducted through an intermediary that is a broker-dealer or funding portal that is registered with the SEC and a member of a registered self-regulatory organization (SRO). The SEC believes that requiring an issuer to use only one intermediary, rather than multiple intermediaries, to conduct a Regulation Crowdfunding offering helps foster the creation of a crowd and serves the statutory purpose. In addition, from a practical perspective it would be difficult to determine compliance with the $1,000,000 limitation on capital raised and investor investment limitations if multiple intermediaries are allowed. Accordingly, the final rules prohibit an issuer from using more than one intermediary to conduct a 4(a)(6) offering.

In addition, the final rules require that funding platforms conduct Section 4(a)(6) offerings exclusively through their electronic platforms (i.e., no offline transactions). The rules define “platform” to mean an “internet website or other similar electronic medium through which a registered broker or a registered funding portal acts as an intermediary in a transaction involving the offer or sale of securities in reliance on Section 4(a)(6).” To avoid doubt, the SEC specifies that back office and administrative procedures such as document maintenance and preparation of confirmations and notice may be completed offline. To facilitate this requirement, intermediaries will be required to have investors consent to the electronic delivery of all documents and information connected with the offering.

Whether the crowdfunding intermediary is a broker-dealer or new funding portal, they will be subject to the intermediary requirements set out in Section 4A(a) of the Securities Act.

A crowdfunding intermediary must generally provide investors with educational materials, take measures to reduce the risk of fraud, make information about the offering and the issuer available to investors, provide communication channels to permit discussions about the offering on the platform; and facilitate the offer and sale of crowdfund securities.

In particular, a platform must:

(i) Provide disclosures to potential investors, including disclosures related to risks and other investor education materials;

(ii) Ensure that each investor reviews investor education information and positively affirms that they understand that they risk losing their entire investment and can afford such loss;

(iii) Ensure that each investor answers questions demonstrating an understanding of the level of risk generally applicable to investments in start-ups, emerging businesses, and small issuers;

(iv) Ensure that each investor answers questions demonstrating an understanding of the risk of illiquidity;

(v) Take measures to reduce the risk of fraud by establishing rules and procedures, including obtaining background and securities enforcement history checks on each officer, director and person holding more than 20% of the outstanding equity of an issuer and denying access to the platform if any persons are subject to the bad actor prohibitions or the intermediary otherwise believes the issuer is a fraud risk;

(vi) Not later than 21 days prior to the first day securities are sold, file with the SEC and make available to potential investors all disclosure information required and provided by the issuer. (This requirement raises many questions, such as: Who is responsible for the accuracy of the information filed? Will there be a review process with the SEC? Can sales begin if there are open comments with the SEC?)

(vii) Ensure that no offering proceeds are given or available to the issuer until the target offering amount has been raised, and allow investors to cancel their investment during that time;

(viii) Make efforts to ensure that no investor exceeds its allowable investment amount in any 12-month period, including from all issuers and all funding portals;

(ix) Take steps to protect the privacy of information collected from investors;

(x) Not compensate promoters, finders, or lead generators for providing the broker or funding portal with personal indentifying information of any potential investor (the SEC needs to clarify in its rule making whether a funding portal or broker faces any aiding and abetting or other liability for accepting such information that they have not paid for, or whether such practice will be acceptable. In addition, the SEC needs to clarify that brokers and funding portals can indeed compensate promoters, finders and lead generators for directing traffic to their site and other outside promotional activities as long as personal identifying information is not included);

(xi) Prohibit its directors, officers or partners from having any financial interest in any issuer using its service. Moreover, the final rules prohibit these persons from receiving a financial interest in the issuer as compensation for services provided to, or for the benefit of, the issuer in connection with the offer and sale of its securities. However, the intermediary itself does not have the same prohibitions. The intermediary may have a financial interest in an issuer that is offering or selling securities in a crowdfunding offering through the intermediary’s platform provided that: (i) the intermediary receives the financial interest from the issuer as compensation for the services provided to, or for the benefit of, the issuer in connection with the crowdfunding offering on the intermediary’s platform; and (ii) the financial interest consists of securities of the same class and having the same terms as those offered in the crowdfunding offering;

(xii) Have a reasonable basis for believing that the issuer’s offering is in compliance with all the rules and regulations of Regulation Crowdfunding, including satisfying itself that the disclosures and representations of the issuer made to both the intermediary and the potential investors are reliable and accurate; and

(xiii) Have a reasonable basis for believing that the issuer has established means to keep accurate records of the holders of the securities it will offer and sell through its platform which can be satisfied by ensuring that the issuer has engaged the services of an SEC-licensed transfer agent;

Unless such funding portal is also a broker-dealer and subject to certain safe harbor exceptions to facilitate the offering, a funding portal may not:

(i) offer investment advice or recommendations;

(ii) solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;

(iii) compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; or

(iv) hold, manage, possess, or otherwise handle investor funds or securities.

Broker-dealer intermediaries may perform each of the above listed services. Accordingly, broker-dealer intermediaries have a definite monetary advantage over funding portals in the crowdfunding arena. First, a broker-dealer is already licensed, a member of FINRA and versed in abiding by strict regulations and reporting requirements.

Advertising and Solicitation

An issuer and funding intermediary may engage in advertising and solicitation subject to certain limitations. Advertisements may not include the terms of the offering (securities offered, price, offering period, etc.) unless the advertisement directs investors to the intermediary’s platform and includes a statement disclosing: (i) a statement that the issuer is conducting an offering pursuant to the crowdfunding exemption, the name of the intermediary and a link to the intermediary’s platform; (ii) the terms of the offering; and (iii) factual information regarding the legal identity and business location of the issuer, including the issuer’s name, address, phone number, website, name and e-mail address of representative and a brief description of the issuer’s business.

The form of advertisement is not limited and can include print- and web-based ads as well as social media. When an issuer is communicating with potential investors through the intermediary’s platform, it must identify itself as the issuer to avoid any misconception that the communication is from the intermediary itself or another unbiased third party using the platform. Moreover, similar to Section 17 of the Securities Act, persons making communications on behalf of the issuer related to the offering or with the intent of selling securities must identify themselves and disclose the compensation received.

Finally, the issuer can continue to publicize information in the ordinary course of business unrelated to the offering, such as related to its products and services.

Disclosure Requirements

Pursuant to the JOBS Act and Regulation Crowdfunding, an issuer who offers or sells securities in a crowdfunding offering must file with the SEC and provide investors and the funding intermediary (whether a funding portal or broker-dealer) and make available to potential investors:

(a) The name, legal status, physical address, and website address of the issuer;

(b) The names of the directors and officers, and each person holding more than 20% of the shares of the issuer;

(d) A description of the financial condition of the issuer, including (i) for offerings of $100,000 or less, income tax returns for the most recently completed year and financial statements certified by the principal executive officer as true and correct; (ii) for offerings of more than $100,000 but less than $500,000, financial statements reviewed by an independent public accountant in accordance with SEC standards and rules for such review; and (iii) for offerings more than $500,000, audited financial statements (note that the offering amount is determined by totaling all Section 4(6) offerings within the preceding 12-month period);

(e) A description of the stated purpose and intended use of the proceeds of the offering;

(f) The target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target;

(g) The price to the public of the securities and the method of determining the price;

(h) A description of the ownership and capital structure of the issuer, including (i) terms of other securities offered and all other classes of securities of the issuer, including details on the differences and potential dilution that could result from a different class (for example, if preferred stock was converted); (ii) a description of how the exercise of rights held by principal shareholders could negatively impact the purchasers of the securities being offered; (iii) name and ownership levels of each existing shareholder owning 20% or more; (iv) how securities being offered are valued and examples of how they may be valued in the future; and (v) risks related to minority ownership and other capital-related risk, such as by the issuance of additional shares, sales of assets, or transactions with related parties.

In addition to the specific disclosure requirements, the issuer must disclose any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.

Detailed Offering Statement Disclosure Requirements

Regulation Crowdfunding requires an issuer to disclose detailed information in relation to a crowdfunding offering. The rule specifically declines to require a specific presentation or format for much of the disclosure; however, the SEC does create a new Form C set up in a streamlined Q&A format. Parts of the Form C are required and others are optional such that the issuer can provide attachments with disclosure information in a different format. The Form C is a fillable form that can be submitted to the SEC with the ability to add attachments as needed.

The Form C must be filed with the SEC prior to commencement of the offering and a copy must be provided to funding intermediaries and investors. The disclosure documents can be delivered to investors by directing them to the intermediary’s platform, through a posting on the issuer’s website or by e-mail.

In addition, an issuer is required to amend and update offering documents if there is a material change. Amendments must be filed with the SEC and provided to funding intermediaries and investors. If the amendment contains a material change, investors must reconfirm their investment within 5 business days or such investment will be deemed canceled.

Issuers must provide updates on their progress in reaching the target offering amount using a Form C-U. Updates must be provided within 5 business days after reaching 50% and then 100% of the target offering amount – provided, however, an issuer can meet the interim Form C-U update requirement by making regular updates publicly available on the intermediary website. All issuers must file a final Form C-U disclosing the total amount of securities sold in the offering within 5 business after reaching the offering deadline.

General Information about the Issuer, Officers and Directors, and Shareholders

Its name and legal status, including form of organization, jurisdiction and date of organization;
Its physical address and website address;
The location on the issuer’s website, and time of availability, of its ongoing annual reports under Regulation Crowdfunding, as well as any failure to comply with ongoing reporting requirements;
The names of the directors and officers, including any person holding a similar position or providing a similar function, all positions and offices held by such person, the period of time they have served such position and a description of their business experience during the past three years, including their principal occupation and employment and the name of the business entity in which such occupation or employment took place;
The name of persons, as of the most recent practicable date, who are the beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power; and
Disclosures related to disqualifying events and other bad actor disclosures.

Description of the Business

The rules require issuers to disclose information about their business and business plan; however, the final rules specifically decline to set out the parameters of such disclosure. Issuers must determine the proper disclosure for their business based on their stage of development, industry and the offering size. Moreover, the SEC declined to provide a non-exclusive list of the types of disclosure as they rightfully believe such list would be viewed as a de facto disclosure requirement.

Use of Proceeds

As required by the JOBS Act, the final rules require a description of the use of the proceeds from the offering. The SEC notes that it expects the disclosure to “provide a sufficiently detailed description of the intended use of proceeds to permit potential investors to evaluate the investment.” Examples of possible specific line items include specific acquisitions, repayment of affiliated or non-affiliated debt, intermediary compensation and commissions, employee compensation, repurchase of outstanding securities and general working capital. Moreover, it is suggested that the working capital line item disclose the amount of time such working capital is expected to last. If an issuer indicates that it will allow an oversubscription of the target offering amount, it will be required to provide a separate use of proceeds for the excess proceeds.

Target Offering Amount and Deadline

As required by the JOBS Act, the rules require issuers to disclose the target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target. In addition, the rules require disclosure as to whether the issuer will allow an oversubscription from the target amount and an absolute maximum amount it will accept: “For example, if the issuer sets a target amount of $200,000 but is willing to accept up to $750,000, the issuer would be required to disclose both the $200,000 target offering amount and the $750,000 maximum offering amount that it will accept.” Disclosure as to how oversubscribed shares will be allocated will be required.

The rules require issuers to describe the process to cancel a subscription or investment commitment or to complete and close the investment once the target amount has been achieved, including the following statement:

Investors may cancel an investment commitment until 48 hours prior to the deadline identified in the issuer’s offering materials;
The intermediary will notify investors when the target offering amount has been met;
If an issuer reaches the target offering amount prior to the deadline identified in its offering materials, it may close the offering early if it provides notice about the new offering deadline at least five business days prior to that new deadline (absent another material change that would require an extension of the offering and reconfirmation of the investment commitment); and
If an investor does not cancel an investment commitment before the 48-hour period prior to the offering deadline, the funds will be released to the issuer upon closing of the offering and the investor will receive securities in exchange for his or her investment.

The rules also require issuers to disclose that if an investor does not reconfirm their investment decision following a material change, the investment will be canceled and the committed funds will be returned. A reconfirmation cannot be had through negative response. Finally, if the target amount is not achieved by the offering deadline, the offering will be canceled and all funds will be returned.

Offering Price

As required by the JOBS Act, the final rules require an issuer to disclose the offering price or the formula for determining the offering price, provided that if only a formula is disclosed, prior to the sale, each investor must be provided in writing with a final price. Moreover, the issuer must disclose the deadline to reach the target offering amount and whether the issuer will accept investments in excess of the target offering amount.

Ownership and Capital Structure

Regulation Crowdfunding requires disclosure of:

The terms of the securities being offered and each other’s class of security of the issuer, including the number of securities being offered and/or outstanding ones, whether or not such securities have voting rights, any limitations on voting rights, how the terms of the securities can be modified and a summary of the differences between the different classes of securities of the issuer, and how the rights of the securities can be limited, diluted, or qualified.
A description of how the exercise of the rights held by the principal shareholders of the issuer could affect the investor’s securities;
The name and ownership level of persons who are 20% or more beneficial owners;
How the securities being offered are valued and examples of methods that the issuer may use to value securities in the future;
The risks to the purchasers of the securities related to minority ownership in the issuer and the risks associated with corporate actions, including additional issuances, issuer repurchases, a sale of the issuer or of assets or transactions with related parties; and
A description of the restrictions on the transfer of the securities.

Additional Disclosure Requirements

In addition, Regulation Crowdfunding also requires:

Disclosure of the name, commission file number and CRD number of the intermediary conducting the offering;
Disclosure of the amount of compensation paid to the intermediary, including the amount of any referral or other fees associated with the offering and any other financial interest of the intermediary;
Disclosure of certain legends to be included in the offering statement, including regarding ongoing reporting requirements of the issuer;
Disclosure of the current number of employees of the issuer;
A discussion of the material risk factors;
A description of the material terms of any indebtedness of the issuer, including the amount, interest rate and maturity date;
Disclosure of exempt offerings conducted within the past three years;
Disclosure of certain related party transactions, including by and between the issuer and any officer, director, promoter, or 20% or more beneficial owner or immediate family members of the foregoing; and
Management, discussion and analysis on the issuer’s financial condition, including to the extent material, a discussion of liquidity, capital resources and historical results of operations.

Financial Disclosure

Regulation Crowdfunding requires a tiered financial disclosure, including a description of the financial condition of the issuer, as follows:

(i) for offerings of $100,000 or less, the issuer must provide (x) the amount of total income, taxable income and total tax (or equivalent line items) as reported on the U.S. federal income tax returns filed by the issuer for the most recently completed fiscal year, if any, and (y) the financial statements of the issuer, in both cases certified by the principal executive officer of the issuer to be true and complete in all material respects;

(ii) for offerings of more than $100,000 but less than $500,000, he issuer must provide financial statements reviewed by a public accountant that is independent of the issuer; and

(iii) for offerings of more than $500,000, audited financial statements from an independent PCAOB auditor. However, the SEC has provided a limited one-time exclusion from the audit requirements for issuers conducting their first Regulation Crowdfunding offering provided that the issuer does not have audited financial statements available at the time. Such issuers may provide reviewed financials instead.

In determining the threshold offering amount for disclosure, the rules require that an issuer aggregate any amounts offered and sold (rather than all offered amounts, including those not sold) under Regulation Crowdfunding in the preceding 12-month period. In addition, possible oversubscriptions must be added and included.

The rules require all issuers to file with the SEC, provide to investors and the intermediary and make available to potential investors a complete set of their financial statements (a balance sheet, income statements, statement of cash flows and states of changes in ownership equity), prepared in accordance with U.S. GAAP covering the shorter of the two most recent fiscal years or the period since inception.

Financial statements must cover the two most recently completed fiscal years or the period since incorporation, if shorter. For the first 120 days following the end of a fiscal year, an issuer can rely on the prior year’s financial statements so long as the issuer was not otherwise required to provide updated financial statements as a result of ongoing reporting obligations, or if the current year financial statements were, in fact, complete and available.

Regardless of the age of financial statements, an issuer must include a discussion of any changes in financial condition subsequent to the statements.

As required in the JOBS Act, the rules require an issuer that is conducting an offering of $100,000 or less to provide its filed income tax returns for the most recently completed fiscal year, if any, and its financial statements certified by its principal executive officer. The rules require issuers to redact personal identifiable information such as Social Security numbers. If tax returns are not completed and filed as of the date of the offering, the prior year’s returns can be provided with a discussion of any changes. The SEC has created a form of certification for executive officers to sign attesting to the truth and accuracy of financial statements.

For offerings of more than $100,000 but less than $500,000, the issuer must file with the SEC and provide potential investors and intermediaries with financial statement reviewed by an independent public accountant. To qualify as independent, an accountant will need to comply with the SEC’s existing independence rules as set out in Rule 2-01 of Regulation S-X. Moreover, the financial statements must be reviewed in accordance with the Statements on Standards for Accounting and Review Services (“SSARS”) issued by the Accounting and Review Services Committee of the American Institute of Certified Public Accountants (“AICPA”). These are the most widely used review standards, and the SEC did not see any reason to modify them for purposes of Regulation Crowdfunding. The issuer will be required to provide the SEC, investors and intermediaries with a copy of the accountant’s review report.

For offerings of more than $500,000, the issuer must file with the SEC and provide potential investors and intermediaries with audited financial statements together with the audit report. The auditor must be independent, and the audit must be conducted in accordance with the AICPA or PCAOB standards. The rule does not require that the auditor be PCAOB registered. The receipt of a qualified audit opinion would not discount the audited financial statements; however, an adverse opinion or disclaimer of opinion by the auditor would render the audited financial statements unusable for purposes of the rule. However, the SEC has provided a limited one-time exclusion from the audit requirements for issuers conducting their first Regulation Crowdfunding offering provided that the issuer does not have audited financial statements available at the time. Such issuers may provide reviewed financials instead.

The Offering Process

As indicated above, the offering must be completed using an intermediary and a Form C must be filed with the SEC prior to commencement of the offering. The Form C and all disclosure documents must be provided to funding intermediaries and investors.

An investor can cancel an investment commitment for any reason until 48 hours before the offering deadline and during that 48 hours only if there is a material change to the terms of the offering and upon receipt of such material change disclosure from the issuer.

In addition, an issuer is required to amend and update offering documents if there is a material change. Amendments must be filed with the SEC and provided to funding intermediaries. Funding intermediaries must in turn provide the amendments to investors and (i) describe the material change; and (ii) inform the investor that the investment will automatically be canceled if not confirmed within 5 days. That is, if the amendment contains a material change, investment must reconfirm their investment within 5 business days or such investment will be deemed canceled. If the material change occurs within five business days of the offering deadline, the offering must be extended to allow five business days for the investor to reconfirm.

An offering must be kept open for a minimum of 21 days. An offering can be closed early if the targeted offering amount is met as long as the offering has been kept open for the 21-day minimum and each investor and potential investor is given a minimum of 5 days’ notice of the new deadline and such notice must include a statement that the investor or potential investor has the right to cancel commitments until 48 hours prior to the new deadline and whether the investor will continue to accept new investments during that 48-hour window. Moreover, the issuer must continue to meet the targeted offering amount at the new earlier deadline.

If the target offering amount is not reached by the stated offering deadline, or the issuer otherwise terminates the offering prior to completion, the intermediary must notify all investors of the termination and return investor funds within 5 business days of such termination.

Post-offering Reporting Requirements

Issuers must file an annual report with the SEC on Form C-AR and provide a copy to investors within 120 days after the issuer’s fiscal year end. The annual report must include substantially the same information as the offering statement except that information related to the terms of the offering itself may be omitted (the offering results are not omitted). In addition, in lieu of the financial information required in the offering statement, the issuer may provide financial statements covering the two most recently completed fiscal years certified by the principal executive officer of the issuer to be true and correct in all material respects rather than audited or reviewed financial statements (unless any such reviewed or audited financial statements are available, in which case those must be provided instead) and a description of the financial condition of the issuer with respect to the period covered by the financial statements.

The annual report must also be posted on the issuer’s website. Any amendments to the annual report may be filed in Form C-AR/A.

The issuer must continue to file annual reports until the earliest of the following:

The issuer becomes subject to the reporting requirements of the Securities Exchange Act;
The issuer has filed at least one annual report since the completion of its most recent Regulation Crowdfunding offering, and has fewer than 300 shareholders of record;
The issuer has filed at least three annual reports since the completion of its most recent Regulation Crowdfunding offering, and has less than $10 million in assets;
The issuer, or another party, has repurchased all of the securities issued in the Regulation Crowdfunding offering; or
The issuer has liquidated or dissolved its business in accordance with state law.

The issuer must file an exit Form C-TR (termination of reporting) upon becoming eligible to cease filing annual reports.

Although the failure to file required reports will not destroy the crowdfunding exemption for completed offerings, it does effect the eligibility to complete any additional crowdfunding offerings while delinquent. Moreover, the failure to file reports subjects the issuer to the potential of an SEC enforcement action.

Conditional Exclusion from Section 12(g) of the Exchange Act

Exchange Act Section 12(g) requires that an issuer with total assets exceeding $10,000,000 and a class of equity securities held of record by either 2,000 persons or 500 persons who are not accredited register with the SEC, generally on Form 10, and thereafter be subject to the reporting requirements of the Exchange Act.

Regulation Crowdfunding exempts securities in crowdfunding offerings from the Section 12(g) registration requirements if the issuer meets all of the following conditions:

The issuer utilizes an SEC-registered transfer agent;
The issuer remains subject to the crowdfunding reporting obligations; and
The issuer has less than $25 million in assets.

Moreover, even if a crowdfunding issuer is not eligible for the Section 12(g) registration exemption as set forth above, that issuer will have a two-year transition period prior to being required to having to register under the Exchange Act, as long as during that two-year period, the issuer continues to file all of its ongoing reports in a timely manner with the SEC.

Issuer and Intermediary Liability

Regulation Crowdfunding gives a private cause of action to a crowdfunding investor for rescission if they still own the security (return of their money plus interest in exchange for giving back the stock) or for damages if they no longer own the security.

Regulation Crowdfunding imposes liability for making an untrue statement of a material fact or omitting to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading, provided the purchaser did not know of such untruth or omission. The liability standard is the same as is set out in Section 12(a)(2) of the Securities Act of 1933. The pertinent “moment of time” for considering liability is the time the investor makes a commitment for purchase. Section 12 requires that the investor prove causation—that is, that they relied on the misleading information and, as a result of relying on such information, they were damaged.

Regulation Crowdfunding defines the issuer, for purposes of liability, as the issuer’s directors or partners, the principal executive officer or officers, principal financial officer and controller or accounting officer, and any other person that is part of the issuer that offers or sells the securities in the crowdfunding offering, including the intermediary. In layman’s terms, in addition to the intermediary, all of the key officers, directors and employees of an issuer in a crowdfunding offering can face personal liability for untrue statements or omissions.

The issuer (and the individuals) can raise several defenses, such as proof that the investor had actual knowledge of the information or should have been aware of the information if they had taken reasonable care and inquiry. The rules also specifically allow the issuer to raise the defense that they did not know, and in the exercise of reasonable care, could not have known of such untruth or omission.

Bad Boy Disqualification

The Crowdfunding Act required that the SEC create disqualification rules for both issuers and funding portals and intermediaries and lists certain provisions to be included in the disqualification provisions. “Bad actor” disqualification requirements, sometimes called “bad boy” provisions, prohibit issuers and others (such as underwriters, placement agents and the directors, officers and significant shareholders of the issuer) from participating in exempt securities offerings if they have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws.

The Crowdfunding Act disqualifies any offering or sale of securities by a person that:

(i) is subject to a final order of a state securities commission or agency or other state authority that (a) bars the person from associating with an entity regulation by such agency; (b) bars the person from engaging in the business of securities, insurance or banking; or (c) bars the person from engaging in savings associations or credit unions;

(ii) constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within the 10-year period ending on the date of the filing of the offering; or

(iii) has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the SEC.

The disqualification events that must be disclosed in the offering statement are substantially similar to the existing “bad actor” disqualification events with respect to Rule 506 of Regulation D under the Securities Act, and include certain criminal convictions, court injunctions and restraining orders, regulatory agency orders, SEC disciplinary, cease-and-desist and stop orders, suspension or expulsion from membership in self-regulatory organizations and U.S. Postal Service false representation orders.

Regulation Crowdfunding/State Law Pre-emption

In addition to federal securities laws, each state has its own securities laws and governing body which oversees and enforces such laws. The individual state securities statutes are not uniform; every state is different. However, many aspects of federal securities law pre-empt state securities laws. Still, pre-emption is never complete pre-emption. Although the federal securities laws may pre-empt the state securities laws in the areas of form and procedure of an offering, state regulators are always empowered to investigate and prosecute violations of their state anti-fraud securities provisions. Moreover, state regulators can require certain disclosure filings (such as a copy of the Form D) and the payment of fees.

In an offering under the Crowdfunding Act, which is Internet-based, investors will come from any or all of the 50 states. It would be incredibly difficult and expensive for a company to learn about and abide by the laws of each of these states. Section 305 of the Crowdfunding Act amends Section 18 of the Securities Act of 1933 to include securities sold in a crowdfunding offering as “covered securities” for purposes of federal pre-emption of state law. Consistent with general pre-emption law, Congress specifies that Section 305 relates “solely to State registration, document and offering requirements… and shall have no impact or limitation on other State authority to take enforcement action with regard to an Issuer, funding portal, or any other person or entity using the exemption from registration provided by Section 4(6) of the Act.”

Under Regulation Crowdfunding, states are pre-empted from regulating certain aspects of crowdfunding conducted in accordance with the new rules, including state registration, documentation and offering requirements with respect to crowdfunded securities. In addition, no notice filings and fees may be required with respect to offers and sales of crowdfunded securities except as may be required by the securities commission of the state of the principal place of business of the issuer or any state in which purchasers of 50 percent or greater of the aggregate amount of the issue are residents.

Specific Provision as to Issuer’s Filing and Fee Requirements

In addition, the Crowdfunding Act specifically prohibits states from requiring a filing or charging a fee in connection with notice requirements, except for the home state of the issuer and any state in which more than 50 percent of all the investors reside.

Specific Provision as to Funding Portal’s Registration Requirements

The Crowdfunding Act amends Section 15 of the Securities Exchange Act of 1934 (Registration and Regulation of Broker Dealers) to prohibit any state from enforcing any law, rule or regulation against a registered funding portal for operating as such. In layman’s terms, a state cannot require a funding portal to register as a broker-dealer in that state, nor can they prosecute a funding portal for acting as an unregistered broker-dealer. States can still investigate and prosecute funding portals for fraud.

Click Here To Print- LC PDF Printout Title III Crowdfunding

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: Crowdfunding, Crowdfunding Act, Crowdfunding Offerings, JOBS ACT, Regulation Crowdfunding, sec, Section 4(a)(6)

The Fast Act (Fixing American’s Surface Transportation Act)

by Laura Anthony, Esq. on December 15, 2015 in Form S-1, IPO, S-1 Registration Statement, Section 3(a)(39), Section 4(a)(7), The FAST Act, Uncategorized with No Comments

On December 4, 2015, President Obama signed the Fixing American’s Surface Transportation Act (the “FAST Act”) into law, which included many capital markets/securities-related bills. The FAST Act is being dubbed the JOBS Act 2.0 by many industry insiders. The FAST Act has an aggressive rulemaking timetable and some of its provisions became effective immediately upon signing the bill into law on December 4, 2015.

In July 2015, the Improving Access to Capital for Emerging Growth Companies Act (the “Improving EGC Act”) was approved by the House and referred to the Senate for further action. Since that time, this Act was bundled with several other securities-related bills into a transportation bill (really!) – i.e., the FAST Act.

In addition to the Improving EGC Act, the FAST Act incorporated the following securities-related acts: (i) the Disclosure Modernization and Simplifications Act (see my blog HERE ); (ii) the SBIC Advisers Relief Act; (iii) the Reforming Access for Investments in Startup Enterprises Act; (iv) the Small Business Freedom and Growth Act; and (v) the Holding Company Registration Threshold Equalization Act.

A number of the provisions in the FAST Act that were not self-executing and effective immediately require SEC rulemaking within 30-45 days. This timeline is not realistic for many reasons, including that it would be impossible to comply with the provisions of the Administrative Procedures Act and its requirements related to proposing rules and receiving comments, in that short period of time, not to mention the realities of the holiday season schedule. However, I do expect a quick turnaround from the SEC on drafting, publishing and enacting final rules.

On December 10, 2015, the SEC Division of Corporate Finance addressed the FAST Act by making an announcement with guidance and issuing two new Compliance & Disclosure Interpretations (C&DI). As the FAST Act is a transportation bill that rolled in securities law matters relatively quickly and then was signed into law even quicker, this is the first SEC acknowledgement and guidance on the subject. I suspect more in the near future.

Summary of Securities Law Related Matters Included in the FAST Act

The Improving Access to Capital for Emerging Growth Companies Act

The Improving the EGC Act became Sections 71001-71003 and Section 85001 of the FAST Act. The Improving the EGC Act is a very short bill with specific provisions designed to help smooth the IPO and follow-on offering process for companies qualifying as an EGC, which is most companies completing an IPO in today’s market. The short provisions carry a big impact.

Effective immediately, the Improving EGC Act allows a company to exclude certain historical financial statements from its initial confidential S-1 filing as long as all required financial statements are included in the S-1 filing that will be distributed or available to potential investors. In particular, the Improving EGC Act specifically provides that a confidential registration statement may “omit financial information for historical periods otherwise required by regulation S-X as of the time of filing (or confidential submission of such registration statement, provided that: (A) prior to the issuer distributing a preliminary prospectus to investors, such registration statement is amended to include all relevant periods required at the date of such amendment; and (B) the issuer reasonably believes such financial disclosure will no longer be required to be included in the Form S–1 at the time of the contemplated offering.”

This provision will greatly assist issuers that are timing and planning IPO’s late in their fiscal year. For example, under today’s rules an issuer with a FYE of December 31 that begins to plan an IPO after September 30, 2015, must decide whether to audit the two prior fiscal years (i.e., December 31, 2013 and 2014) and review September 30, 2015, for the filing or wait until the first quarter of 2016 and only audit December 31, 2014 and 2015. In addition to the excess cost of auditing 2013 in this scenario, the issuer must consider that the September 30 financials go stale after 135 days (mid-February), and that taking into account the 3-4 month S-1 review process, it will likely need to update for the 2015 audit prior to going effective in any event. Adding to the considerations is that most issuers do not close out their books until approximately 30 days post FYE (in this case, the end of January to close out books) and an audit takes at least 4 weeks.

Under the new FAST Act in this fact scenario the issuer could file its registration statement with just the 2013 audit and September 30, 2015 reviewed stub period. The stub period would still need to be included even though at the time of effectiveness it is contemplated that this stub period would be replaced with the full 2015 audit.

This timing creates a difficult dilemma on the timing of filing an S-1 for a first or early second quarter IPO. In my office, I feel like we are “doing the timing math” every week for new or contemplated IPO’s. The amendment proposed in the Improving EGC Act will provide real-world assistance to EGC’s and their deal team in preparing for and launching an IPO. Again, this provision became effective immediately on December 4, 2015.

Both of the two issued C&DI’s is on this subject. In particular, the SEC clarifies that you cannot omit stub period financial statements even if that stub period will ultimately be included in a longer stub period or year-end audit before the registration statement goes effective. The SEC clarified that the FAST Act only allows the exclusion of historical information that will no longer be included in the final effective offering. The C&DI clarifies that “Interim financial information “relates” to both the interim period and to any longer period (either interim or annual) into which it has been or will be included.”

The second C&DI clarifies the allowable exclusion of financial statements for other entities if the issuer reasonably believes that those financial statements will not be required in the final registration. The SEC confirms that: “Section 71003 of the FAST Act is not by its terms limited to financial statements of the issuer. Thus, the issuer could omit financial statements of, for example, an acquired business required by Rule 3-05 of Regulation S-X if the issuer reasonably believes those financial statements will not be required at the time of the offering. This situation could occur when an issuer updates its registration statement to include its 2015 annual financial statements prior to the offering and, after that update, the acquired business has been part of the issuer’s financial statements for a sufficient amount of time to obviate the need for separate financial statements.”

The Improving EGC Act also reduces the number of days prior to the road show or effectiveness of an S-1 that confidentially submitted S-1 filings must be made public from 21 days to 15 days. The change shortens the time that a company has to wait launch the road show. In particular, An EGC that has used a confidential submission process must publicly file its registration statement and all previously submitted drafts no later than 15 days (rather than 21 days) before conducting a road show. In offerings that do not involve a road show, the public filing must occur at least 15 days before the registration statement goes effective. This provision became effective immediately upon signing of the FAST Act on December 4, 2015. EGCs with initial public offerings pending before the FAST Act became law or at any time thereafter may take advantage of the provision.

Also effective immediately, the Improving EGC Act also allows an issuer that has filed a confidential S-1 as an EGC, but thereafter ceases to be an EGC, to continue to be treated as an EGC until the earlier of: (i) the completion of its initial public offering for which the confidential S-1 was filed; or (ii) one year from the date it ceased being an EGC.

The Improving EGC Act has an equally short and potentially helpful provision effecting follow-on offerings for an EGC. In particular, the Improving EGC Act provides “FOLLOW-ON OFFERINGS.—An emerging growth company may, within 1 year of the company’s initial public offering, confidentially submit to the Commission a draft registration statement for any securities to be issued subsequent to its initial public offering, for confidential nonpublic review by the staff of the Commission prior to publicly filing a registration statement, provided that the initial confidential submission and all amendments thereto shall be publicly filed with the Commission not later than 2 days before the date on which the emerging growth company issues such securities.”

Although I can think of benefits for all market levels, in the small cap market space in particular, follow-on offerings often include an uplisting to a national exchange or higher tier of such exchange. Allowing confidential submission and review will ease the pressure on the follow-on offering deal team as it works through exchange applications such as NASDAQ or NYSE MKT. On the other hand, a one-year time frame for a follow-on is very short and only high-growth companies will be in a position to take advantage of this new benefit if passed.

As a reminder, the Jumpstart our Business Startups Act (JOBS Act) enacted in April 2012 created a new category of company: an “Emerging Growth Company” (EGC). An EGC is defined as a company with annual gross revenues of less than $1 billion that first sells equity in a registered offering after December 8, 2011. In addition, an EGC loses its EGC status on the earlier of (i) the last day of the fiscal year in which it exceeds $1 billion in revenues; (ii) the last day of the fiscal year following the fifth year after its IPO; (iii) the date on which it has issued more than $1 billion in non-convertible debt during the prior three-year period; or (iv) the date it becomes a large accelerated filer (i.e., its non-affiliated public float is valued at $700 million or more).

EGC status is not available to asset-backed securities issuers (“ABS”) reporting under Regulation AB or investment companies registered under the Investment Company Act of 1940, as amended. However, business development companies (BDCs) do qualify.

The Disclosure Modernization and Simplifications Act

In early December 2014, the House passed the Disclosure Modernization and Simplification Act of 2014, following which it was bundled into the FAST Act and now passed into law. I previously wrote on this Act HERE ). The Disclosure Modernization and Simplification Act of 2014 became Sections 72001-72003 of the FAST Act.

The Disclosure Modernization and Simplification Act of 2014 requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K (Section 72001); and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for EGCs, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K (Section 72002). In addition, the SEC is required to conduct yet another study on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information (Section 72003).

In particular, Section 72001 of the FAST Act requires the SEC to issue regulations within 180 days permitting issuers to submit a summary page on Form 10-K if each item identified in the summary includes a cross-reference to the relevant information. Section 72002 related to amendments to Regulation S-K has the same 180-day deadline.

Section 72003 requires that the SEC conduct a study of Regulation S-K and provide a detailed report within 360 days.

The bill requests that the SEC emphasize a “company by company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static requirements while preserving completeness and comparability of information across registrants” and “evaluate methods of information delivery and presentation and explore methods for discouraging repetition and the disclosure of immaterial information.”

The Reforming Access for Investments in Startup Enterprises Act

The FAST Act incorporates the new Reforming Access for Investments in Startup Enterprises Act (the “RAISE Act”). The Raise Act is included in Section 76001 of the FAST Act. The RAISE Act is meant to codify the so-called Section 4(a)(1 ½) exemption. See my blog on the Section 4(a)(1 ½) exemption and the SEC Advisory Committee on Small and Emerging Companies recommendation for codification HERE.

The RAISE Act, through the FAST Act, creates a new Section 4(a)(7) of the Securities Act. The new Section 4(a)(7) exemption allows for the resale of securities by shareholders for transactions that meet the following requirements:

Each purchaser is an accredited investor as defined in the Securities Act;
Neither the seller nor any persons acting on the seller’s behalf engages in any form of general solicitation or advertising;
In the case of a non-reporting issuer or an issuer exempt from the reporting requirements pursuant to Rule 12g3-2(b), at the request of the seller, the issuer must provide reasonably current information to the seller and a prospective purchaser;
Current information includes: (i) The issuer’s exact name (as well as the name of any predecessor); (ii) The address of the issuer’s principal place of business; (iii) The exact title and class of the offered security, its par or stated value, and the current capitalization of the issuer; (iv) Details for the transfer agent or other person responsible for stock transfers; (v) A statement of the nature of the issuer’s business that is dated as of 12 months before the transaction date; (vi) The issuer’s officers and directors; (vii) Information about any broker, dealer or other person being paid a commission or fee in connection with the
sale of the securities; (viii) The issuer’s most recent balance sheet and profit and loss statement and similar financial statement for the two preceding fiscal years during which the issuer has been in business, prepared in accordance with GAAP or, in the case of a foreign issuer, IFRS. The balance sheet will be reasonably current if it is as of a date not less than 16 months before the transaction date, and the profit and loss statement shall be reasonably current if it is as of a date not less than 12 months preceding the date of the issuer’s balance sheet. If the balance sheet is not as of a date less than six months before the transaction date, it must be accompanied by additional statements of profit and loss for the period from the dates of such balance sheet to a date less than six months before the transaction date; and (ix) If the seller is an affiliate, a statement regarding the nature of the affiliation accompanied by a certification from the seller that it has no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.

The new Section 4(a)(7) exemption is not available in the following circumstances:

In a transaction where the seller is a direct or indirect subsidiary of the issuer;
If the seller or any person that will be compensated as part of the transaction, including a broker-dealer, is subject to the bad actor disqualifications in Rule 506 of Regulation D or under Section 3(a)(39) of the Exchange Act;
If the issuer is a blank check, blind pool, shell company, SPAC or in bankruptcy or receivership;
Where the transaction relates to a broker-dealer or underwriter’s unsold allotment; or
Where the security being sold is part of a class of securities that has not been authorized and outstanding for at least 90 days prior to the transaction date.

The securities sold in a Section 4(a)(7) resale transaction will be considered “restricted securities” for purposes of Rule 144. Securities sold will be “covered securities” under the NSMIA and therefore will pre-empt state law. A transaction pursuant to this exemption will not be deemed to be a “distribution” under the Securities Act.

Incorporation by Reference in Form S-1 by Smaller Companies

A significant change included in the FAST Act is in Section 84001 that requires the SEC to revise Form S-1 to allow smaller reporting companies to incorporate by reference to both prior and future Exchange Act filings. This is significant as currently smaller reporting companies are specifically prohibited from incorporating by reference and must prepare and file a post-effective amendment to keep a resale “shelf” registration current, which can be expensive. A shelf registration is one that allows continuous sales over a period of time.

Section 12(g) Correction

Section 85001 of the FAST Act amends Section 12(g) of the Securities Exchange Act to add savings and loans to the class of entities subject to the higher threshold registration requirements. Now, both savings and loan companies and banks are not required to register under the Exchange Act unless they have, at the end of the most recent fiscal year, at least $10 million in assets and a class of equity securities held of record by at least 2,000 shareholders. The prior omission of saving and loans was thought to be an inadvertent error in the JOBS Act.

Click Here To Print- LC PDF Printout The Fast Act (Fixing American’s Surface Transportation Act)

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: EGC Act, FAST ACT, Filing an S-1, Fixing American’s Surface Transportation Act, Form S-1, IPO, section 4(a)(7), The Fast Act

SEC Guidance on Shareholder Proposals and Procedural Requirements

by Laura Anthony, Esq. on December 08, 2015 in Proxy Statement, Schedule 14A, Shareholder Proposals, SLB 14H, Uncategorized with No Comments

In late October the SEC issued its first updated Staff Legal Bulletin on shareholder proposals in years – Staff Legal Bulletin No. 14H (“SLB 14H”). The legal bulletin comes on the heels of the SEC’s announcement on January 16, 2015, that it would no longer respond to no-action letters seeking exclusion of shareholder proposals on the grounds that the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders and the same meeting, as further discussed herein. SLB 14H will only allow exclusion of a shareholder proposal if “a reasonable shareholder could not logically vote in favor of both proposals.” As a result of the restrictive language in SLB 14H, it is likely that the direct conflict standard will rarely be used as a basis for excluding shareholder proposals going forward. With the publication of SLB 14H, the SEC will once again entertain and review no-action requests under the “direct conflict” grounds for exclusion.

SLB 14H also provides guidance on the allowable exclusion related to proposals that request actions or changes in ordinary business operations, including the termination, hiring or promotion of employees.

Background

The regulation of corporate law rests primarily within the power and authority of the states. However, for public companies, the federal government imposes various corporate law mandates including those related to matters of corporate governance. While state law may dictate that shareholders have the right to elect directors, the minimum and maximum time allowed for notice of shareholder meetings, and what matters may be properly considered by shareholders at an annual meeting, Section 14 of the Securities Exchange Act of 1934 (“Exchange Act”) and the rules promulgated thereunder govern the proxy process itself for publicly reporting companies. Federal proxy regulations give effect to existing state law rights to receive notice of meetings and for shareholders to submit proposals to be voted on by fellow shareholders.

All companies with securities registered under the Exchange Act are subject to the Exchange Act proxy regulations found in Section 14 and its underlying rules. Section 14 of the Exchange Act and its rules govern the timing and content of information provided to shareholders in connection with annual and special meetings with a goal of providing shareholders meaningful information to make informed decisions, and a valuable method to allow them to participate in the shareholder voting process without the necessity of being physically present. As with all disclosure documents, and especially those with the purpose of evoking a particular active response, such as buying stock or returning proxy cards, the SEC has established robust rules governing the procedure for, and form and content of, the disclosures.

The underlying premise of an annual or special meeting is that the company is soliciting the shareholders to vote in favor of particular matters, such as particular directors or particular corporate actions. Accordingly, the proxy is prepared by the company, presenting matters the company’s board of directors have already approved or recommended for approval and has an underlying goal of getting the shareholder to return a proxy card with a “yes” vote. However, Rule 14a-8 allows shareholders to submit proposals and, subject to certain exclusions, require a company to include such proposals in the proxy solicitation materials even if contrary to the position of the board of directors, and is accordingly a source of much contention.

Rule 14a-8 in particular allows a qualifying shareholder to submit proposals that meet substantive and procedural requirements to be included in the company’s proxy materials for annual and special meetings, and provide a method for companies to either accept or attempt to exclude such proposals. State laws in general allow a shareholder to attend a meeting in person and, at such meeting, to make a proposal to be voted upon by the shareholders at large. In adopting Rule 14a-8, the SEC provides a process and parameters for which these proposals can be made in advance and included in the proxy process.

As shareholder activism in general has increased, Rule 14a-8 has been the subject of much debate and controversy. This debate and controversy has expanded exponentially since the SEC adopted amendments to the rule to require a company to include in its proxy materials any proposals from qualifying shareholders that would amend, or request an amendment to, a company’s director nomination procedures in its charter documents, as long as such amendment would not conflict with or violate applicable law.

Over the years the SEC has issued guidance on the rule, including Staff Legal Bulletin No. 14 published on July 13, 2001. An entire treatise could be written on Rule 14a-8, including SEC guidance and court interpretation, and this blog is limited to a high-level review. In late October the SEC issued its first updated Staff Legal Bulletin on shareholder proposals in years – Staff Legal Bulletin No. 14H. The legal bulletin comes following and was likely motivated by the SEC’s announcement on January 16, 2015, that it would no longer respond to no-action letters seeking exclusion of shareholder proposals on the grounds that the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders and the same meeting. SLB 14H will only allow exclusion of a shareholder proposal if “a reasonable shareholder could not logically vote in favor of both proposals.”

Shareholder Proposals – Rule 14a-8

Rule 14a-8 of Regulation 14A permits qualifying shareholders to submit matters for inclusion in the company’s proxy statement for consideration by the shareholders at the company’s annual meeting. The rule itself is written in “plain English” in a question-and-answer format designed to be easily understood and interpreted by shareholders relying on and using the rule. Other than based on procedural deficiencies, if a company desires to exclude a particular shareholder process, it must have substantive grounds for doing so.

Shareholder Qualification and Procedure

Procedurally to qualify to submit a proposal, a shareholder must:

Continuously hold a minimum of $2,000 in market value or 1% of the company’s securities entitled to vote on the subject proposal, for at least one year prior to the date the proposal, is submitted and through the date of the annual meeting;
If the securities are not held of record by the shareholder, such as if they are in street name in a brokerage account, the shareholder must prove its ownership by either providing a written statement from the record owner (i.e., brokerage firm or bank) or by submitting a copy of filed Schedules 13D or 13G or Forms 3, 4 or 5 establishing such ownership for the required period of time;
If the shareholder does not hold the requisite number of securities through the date of the meeting, the company can exclude any proposal made by that shareholder for the following two years;
Provide a written statement to the company that the submitting shareholder intends to continue to hold the securities through the date of the meeting;
Clearly state the proposal and course of action that the shareholder desires the company to follow;
Submit no more than one proposal for a particular annual meeting;
Submit the proposal prior to the deadline, which is 120 calendar days before the anniversary of the date on which the company’s proxy materials for the prior year’s annual meeting were delivered to shareholders, or if no prior annual meeting or if the proposal relates to a special meeting, then within a reasonable time before the company begins to print and send its proxy materials;
Attend the annual meeting or arrange for a qualified representative to attend the meeting on their behalf – provided, however, that attendance may be in the same fashion as allowed for other shareholders such as in person or by electronic media;
If the shareholder or their qualified representative fail to attend the meeting without good cause, the company can exclude any proposal made by that shareholder for the following two years;
The proposal, including any accompanying supporting statement, cannot exceed 500 words. If the proposal is included in the company’s proxy materials, the statement submitted in support thereof will also be included.

A proposal that does not meet the procedural requirements may be excluded by the company. To exclude the proposal on procedural grounds, the company must notify the shareholder of the deficiency within 14 days of receipt of the proposal and allow the shareholder to cure the problem. The shareholder has 14 days from receipt of the deficiency notice to cure and resubmit the proposal. If the deficiency could not be cured, such as because it was submitted after the 120-day deadline, no notice or opportunity to cure must be provided.

Company Response to Shareholder Proposal

Upon receipt of a shareholder proposal, a company has many options. The company can elect to include the proposal in the proxy materials. In such case, the company may make a recommendation to vote for or against the proposal, or not take a position at all and simply include the proposal as submitted by the shareholder. If the company intends to recommend a vote against the proposal (i.e., Statement of Opposition), it must follow specified rules as to the form and content of the recommendation. A copy of the Statement of Opposition must be provided to the shareholder no later than 30 days prior to filing a definitive proxy statement with the SEC.

If included in the proxy materials, the company must place the proposal on the proxy card with check-the-box choices for approval, disapproval or abstention.

The company may seek to exclude the proposal based on procedural deficiencies, in which case it will need to notify the shareholder and provide a right to cure as discussed above. The company may also seek to exclude the proposal based on substantive grounds, in which case it will may file a no-action letter with the SEC seeking confirmation of its decision and provide a copy of the letter to the shareholder as further discussed below. The company may also seek to exclude the proposal on the grounds of conflict if it follows the procedures set out in the new SLB 14H also as discussed below.

Finally, the company may meet with the shareholder and provide a mutually agreed upon resolution to the requested proposal. According to the 2014 Annual Corporate Governance Review released by Georgeson, Inc., approximately 43% of the proposals submitted by shareholders in 2014 were later withdrawn or omitted from the proxy statement and not considered at the annual meeting as a result of these negotiations.

Substantive Requirements and Grounds for Exclusion

If a company seeks to exclude a proposal based on most of the substantive grounds (other than direct conflict under Rule 14a-8(i)(9)), it must seek concurrence from the SEC by utilizing the SEC no-action letter process. That is, the company must submit a no-action letter to the SEC explaining the reasons for excluding the proposal and seeking confirmation that the SEC will not consider the exclusion a violation of Rule 14a-8. The letter must be submitted no later than 80 days prior to filing a definitive proxy statement with the SEC. The shareholder must be provided a copy of the no-action letter submittal and such shareholder has the opportunity to reply to the company and the SEC. The SEC may require agreement with the company’s request to exclude the proposal, require unconditional inclusion of the proposal, or provide for shareholder revision of the proposal as a condition to requiring its inclusion.

The company faces the burden of proving that a particular shareholder proposal may be excluded from the proxy materials. In the no-action process, the SEC will only consider the facts, arguments and information submitted by the company, so it is very important that a company work with company counsel to ensure a comprehensive submittal. Like the registration process, the SEC bases its determination on the disclosure and ultimate information that will be provided to shareholders in proxy statements, as opposed to the underlying merits of the requested shareholder proposal. Moreover, the decision by the SEC in the no-action process is as to whether they would pursue enforcement against the company for a violation of Rule 14a-8 for an exclusion of the proposal, but is not otherwise binding on the company or shareholder.

On January 16, 2015, the SEC announced that it would no longer respond to no-action letters seeking exclusion of shareholder proposals on the grounds that the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders and the same meeting. With the publication of SLB 14H, the SEC will once again entertain and review no action requests under the “direct conflict” grounds for exclusion.

Rule 14a-8 provides many substantive grounds in which a company may exclude a proposal from the proxy, including if:

The proposal is not a proper subject for shareholder vote in accordance with state corporate law;
The proposal would bind the company to take a certain action as opposed to recommending that the board of directors or company take a certain action;
The proposal would cause the company to violate any state, federal or foreign law, including other proxy rules;
The proposal would cause the company to publish materially false or misleading statements in its proxy materials;
The proposal relates to a personal claim or grievance against the company or others or is designed to benefit that particular shareholder to the exclusion of the rest of the shareholders;
The proposal relates to immaterial operations or actions by the company in that it relates to less than 5% of the company’s total assets, earnings, sales or other quantitative metrics;
The proposal requests actions or changes in ordinary business operations, including the termination, hiring or promotion of employees, provided, however, that proposals may relate to succession planning for a CEO (I note this exclusion right has also been the subject of controversy and litigation and is discussed in SLB 14H);
The proposal requests that the company take action that it is not legally capable of or does not have the legal authority to perform;
The proposal seeks to disqualify a director nominee or specifically include a director for nomination;
The proposal seeks to remove an existing director whose term is not completed;
The proposal questions the competence, business judgment or character of one or more director nominees;
The company has already substantially implemented the requested action;
The proposal is substantially similar to another shareholder proposal that will already be included in the proxy materials;
The proposal is substantially similar to a proposal that was included in the company proxy materials within the last five years and received fewer than a specified number of votes;
The proposal seeks to require the payment of a dividend; or
The proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.

Staff Legal Bulletin No. 14H

SLB 14H addresses the controversial “direct conflicts” standard for excluding shareholder proposals and provides guidance on the “ordinary business operations” exclusion.

SLB 14H – Direct Conflicts Standard for Exclusion

Beginning in 2009 there has been a substantial increase in proposals and company counterproposals that conflict. In particular, for example, a shareholder could request that the company amend its bylaws to permit shareholders holding 10% of the outstanding stock to hold a special meeting and a company could counter with its own proposal setting a 25% or some other threshold. The company could then seek to exclude the shareholder proposal as conflicting with its own on the same subject.

Last year Whole Foods sought to exclude a shareholder proposal that would allow shareholders owning at least 3% of the outstanding stock for at least 3 years to nominate up to 20% of the directors but no fewer than 2. Whole Foods responded with its own proposal allowing any shareholder that owned at least 9% of the outstanding stock for at least 5 years to nominate 10% of the directors but no fewer than 1. The SEC supported Whole Foods and the shareholder sought reconsideration. The SEC then decided not to address any exclusion requests related on conflicting proposals, including that of Whole Foods. In other words, the SEC bowed out of the fight altogether and spent some time considering its policy. SLB 14H articulates that consideration.

The SEC will only allow exclusion “if a reasonable shareholder could not logically vote in favor of both proposals.” With the publication of SLB 14H, the SEC will once again entertain and review no-action requests under the “direct conflict” grounds for exclusion, with no-action relief only being granted if a reasonable shareholder could not logically vote in favor of both proposals.

The SEC’s view is that the “direct conflict” right to exclude a shareholder proposal is intended to prevent shareholder proposals that, if voted on along with a management proposal, “could present alternative and conflicting decisions for the shareholders and create the potential for inconsistent and ambiguous results.” SLB 14H continues to state that “…we believe that a direct conflict would exist if a reasonable shareholder could not logically vote in favor of both proposals, i.e., a vote for one proposal is tantamount to a vote against the other proposal.” The SEC admits that the burden to exclude proposals articulated in SLB 14H is likely higher than they had historically been requiring in the no-action process. As a result of this higher burden, it is generally believed by practitioners that the direct conflict basis for exclusion will rarely be used.

However, the bulletin does give four examples of application of the new standard for review of such direct conflicts. In particular, a direct conflict would exist where: (i) a company seeks shareholder approval of a merger, and a shareholder proposal asks shareholders to vote against the merger; and (ii) a shareholder proposal that asks for the separation of the company’s chairman and CEO would directly conflict with a management proposal seeking approval of a bylaw provision requiring the CEO to be the chair at all times. Conversely, examples of where no direct conflict would exist include: (i) “a company does not allow shareholder nominees to be included in the company’s proxy statement, a shareholder proposal that would permit a shareholder or group of shareholders holding at least 3% of the company’s outstanding stock for at least 3 years to nominate up to 20% of the directors would not be excludable if a management proposal would allow shareholders holding at least 5% of the company’s stock for at least 5 years to nominate for inclusion in the company’s proxy statement 10% of the directors” and (ii) “a shareholder proposal asking the compensation committee to implement a policy that equity awards would have no less than four-year annual vesting would not directly conflict with a management proposal to approve an incentive plan that gives the compensation committee discretion to set the vesting provisions for equity awards.”

The SEC provides guidance on how a company can manage potentially confusing and conflicting proposals that do not rise to the high standard of a direct conflict to support exclusion. In particular, footnote 22 to SLB 14H states: “[W]here a shareholder proposal is not excluded and companies are concerned that including proposals on the same topic could potentially be confusing, we note that companies can, consistent with Rule 14a-9, explain in the proxy materials the differences between the two proposals and how they would expect to consider the voting results. As always, we expect companies and proponents to respect the Rule 14a-8 process and encourage them to find ways to constructively resolve their differences.”

SLB 14H – “Ordinary Business Operations” Standard for Exclusion

SLB 14H provides guidance on the “ordinary business operations” exclusion. Rule 14a-8(i)(7) allows the exclusion of a shareholder proposal where the proposal requests actions or changes in ordinary business operations, including the termination, hiring or promotion of employees, provided, however, that proposals may relate to succession planning for a CEO. The “ordinary business operations” basis for exclusion has also been the subject of debate and adversarial proceedings.

In the recent Trinity Wall Street v. Wal-Mart Stores, Inc. ruling by the U.S. District Court in Delaware, the shareholder proposal requested that the board assign a committee the responsibility of “overseeing the formulation, implementation, and public reporting of policies that determine whether the company should sell a product that especially endangers public safety and well-being, has the potential to impair the company’s reputation, or would be considered offensive to the values integral to the company’s brand.” The SEC supported the company’s exclusion of the proposal as being the subject of ordinary course of business matters; however, the court sided with the shareholder and concluded that the proposal was improperly excluded.

The court found that “because the proposal merely sought board oversight of the development and implementation of a company policy, leaving day to day aspects of implementation of this policy to the company’s officers and employees, the proposal itself did not have the consequence of dictating what products Wal-Mart could sell.” The SEC, in contrast, had considered whether the underlying issue involved ordinary business matters and determined in this case that it did. The company appealed the court decision and the court of appeal overruled the Delaware court, supporting both the SEC’s no-action decision and Wal-Mart’s right to exclude the proposal.

The appellate court agreed with the SEC and Wal-Mart that the proposal’s subject matter related to Wal-Mart’s ordinary business operations – specifically, “a potential change in the way Wal-Mart decides which products to sell.” SLB 14H reiterates that the SEC analysis related to the request to exclude proposals under the ordinary business exclusion focuses on the underlying subject matter of a proposal. The SEC recognizes that it is not always easy to determine if a proposal transcends ordinary business operations and actually relates to significant policy issues, and thus cannot be excluded under the ordinary course of business exclusion rule. That is, even though a shareholder may present a proposal as being one that addresses a significant policy issue, including social policies, the SEC will look beyond that presentation to determine if the proposal is in fact related to ordinary business operations. Summarizing its position, the SEC quotes the court “whether a proposal focuses on an issue of social policy that is sufficiently significant is not separate and distinct from whether the proposal transcends a company’s ordinary business. Rather, a proposal is sufficiently significant ‘because’ it transcends day-to-day business matters.”

I note that although SLB 14H may be attempting to provide further guidance on the subject, the distinction and interrelationship between significant policy decisions and daily business operations remains complex and will continue to be subject to difficult interpretation.

Click Here To Print- LC PDF Printout SEC Guidance on Shareholder Proposals and Procedural Requirements

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: proxy materials, Proxy Process, Rule 14a-8, sec, Section 14, SLB 14H, Staff Legal Bulletin 14H

SEC Proposes Amendments Related To Intrastate And Regional Securities Offerings- Part II- Rules 504 And 505

by Laura Anthony, Esq. on December 01, 2015 in Intrastate Offering, Rule 147, Rule 504, Rule 505, Rule 506, Uncategorized with No Comments

On October 30, 2015, the SEC published proposed rule amendments to facilitate intrastate and regional securities offerings. The SEC has proposed amendments to Rule 147 to modernize the rule and accommodate adopted state intrastate crowdfunding provisions. In addition, the SEC has proposed amendments to Rule 504 of Regulation D to increase the aggregate offering amount from $1 million to $5 million and to add bad actor disqualifications from reliance on the rule. The SEC has also made technical amendments to Rule 505 of Regulation D.

In Part I of the blog, I discussed the Rule 147 amendment, and in this Part II will discuss the changes to Rules 504 and 505. I have never really written about either Rules 504 or 505 in the past, the simple reason being that they are rarely used exemptions. Perhaps with the current proposed changes, Rule 504 will have a new life. I do not think Rule 505 will gain favor, and in fact, as part of the rule release the SEC is seeking comment as to whether Rule 505 should simply be eliminated.

Overview

Currently Rule 504 of Regulation D provides an exemption from registration for offers and sales up to $1 million in securities in any twelve-month period. Current Rule 504, like Regulation A/A+, is unavailable to companies that are subject to the reporting requirements of the Securities Exchange Act, are investment companies or blank check companies. Moreover, current rule 504 prohibits the use of general solicitation and advertising unless the offering is made (i) exclusively in one or more states that provide for the registration of the securities and public filing and delivery of a disclosure document; or (ii) in one or more states that piggyback on the registration of the securities in another state and they are so registered in another state; or (iii) exclusively according to a state law exemption that permits general solicitation and advertising so long as sales are made only to accredited investors (i.e., a state version of the federal 506(c) exemption).

Rules 504, 505 and 506 together comprise Regulation D. Rule 506 is promulgated under Section 4(a)(2) of the Securities Act and preempts state law. Rules 505 and 506 are promulgated under Section 3(b) of the Securities Act and do not preempt state law. Currently Rules 505 and 506 have bad actor disqualification provisions but Rule 504 does not.

The vast majority of states require the registration of Rule 504 offerings. Rule 504 is similar to the Intrastate Offering found in Section 3(a)(11) in that on the federal level it defers to state legislation and oversight. In fact, of the 29 states that have recently passed state-based crowdfunding exemptions, Maine specifically allows an issuer to rely on Rule 504 in utilizing its crowdfunding provisions.

As Rule 504 is in essence a deferral to the states for small offerings, the SEC is of the position that it does not warrant imposing extensive regulation on the federal level. I agree. As stated by the SEC, the purpose of Rule 504 is to assist small businesses in raising seed capital by allowing offers and sales of securities to an unlimited number of persons regardless of their level of sophistication – provided, however, that the offerings remain subject to the federal anti-fraud provisions and general solicitation and advertising is prohibited unless sales are limited to accredited investors.

Proposed Amendments

The SEC has proposed to increase the amount of securities that may be offered and sold in reliance on Rule 504 to $5 million in any 12-month period, and to add bad actor disqualification provisions to the rule. The SEC believes the change will help facilitate capital formation and give states greater flexibility in developing state-coordinated review programs for multi-state registrations. The proposed rule also corrects the technical reference to Section 3(b) of the Securities Act in the current Rules 504 and 505 to Section 3(b)(1), which change was made by the JOBS Act in 2012.

The proposed bad actor disqualification provisions are substantially the same as those in place for Rule 506 offerings. For a review of the Rule 506 bad actor disqualification provisions, see my blog HERE.

Click Here To Print- LC PDF Printout SEC Proposes Amendments Related To Intrastate And Regional Securities Offerings- Part II- Rules 504 And 505

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: Intrastate Offering, rule 147, rule 504, rule 504 offerings, rule 505, rule 506, Rule 506 bad actor disqualification provisions, section 3(a)(11)

Monthly Archives: December 2015

OTC Markets Amends Listing Standards For The OTCQX

Title III Crowdfunding

The Fast Act (Fixing American’s Surface Transportation Act)

SEC Guidance on Shareholder Proposals and Procedural Requirements

SEC Proposes Amendments Related To Intrastate And Regional Securities Offerings- Part II- Rules 504 And 505

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