At today’s meeting of the American Bar Association’s Federal Regulation of Securities Committee meeting in Washington, DC, various representatives from the Securities and Exchange Commission provided some comments and updates.
During his presentation, the Director of the Division of Corporation Finance, Keith Higgins, reviewed the Staff’s current priorities, which also had been identified by Chair White in her Congressional testimony earlier in the week. Mr. Higgins noted that the Division continues its work with FASB regarding the types of information required by FASB in notes to financial statements included in registration statements and the requirements under Regulation S-K and Regulation S-X for certain accounting policy related disclosures in order to identify, among other things, possible areas of repetition that could be addressed in connection with the ongoing disclosure simplification review. He noted that work continues in order to address the three remaining executive compensation related rulemakings under the Dodd-Frank Act. Mr. Higgins noted that the accredited investor review is expected to be completed soon (within the next 90 to 120 days). Also, it is anticipated that the Commission will complete the actions required by the JOBS Act relating to the Exchange Act Section 12(g) threshold. Mr. Higgins also briefly reviewed the proposed amendments to Rule 147. He noted that many questions had been received regarding the process or level of Staff review of Regulation A offering statements and noted that the process for review is substantially similar to the process for review of IPO registration statements. Mr. Higgins noted that the Staff always takes into account in its review a sense of scale that is informed by the type of issuer, sophistication of the issuer, risks presented and other similar factors.
David Frederickson, Chief Counsel in the Division of Corporation Finance, reviewed the recent guidance on general solicitation and pre-existing substantive relationships. In this context, he noted that most of the guidance was in the nature of a restatement or clarification of prior Staff guidance and positions. Mr. Frederickson noted that, as a baseline, if an issuer is using the internet and providing information about an offering without password protection, such that the information is generally available, that would be viewed as a general solicitation. However, as noted in the C&DIs (and prior Staff guidance), there are many types of communications, such as ordinary course business communications, that would not be viewed as constituting a “general solicitation.” The guidance regarding pre-existing substantive relationships, he noted, refocuses the analysis on the nature of the relationship. A relationship is substantive if the issuer or an agent acting on its behalf have enough information to evaluate and do in fact evaluate a prospective investor’s financial situation and sophistication. He noted that there is no “magic” period of time that would be viewed as necessary to establish that a relationship is pre-existing (other than a reference in the Lamp Technologies no-action letter). The relationship must have been formed before the offering has commenced as to the individual (when the individual was contacted about the offering). Mr. Frederickson also commented on the recent CitizensVC no-action letter, which extends to an investment adviser the ability to establish a pre-existing substantive relationship. Mr. Frederickson noted that a new issue addressed in the recent C&DIs is a framework for thinking about contact with established networks, such as angel networks. To this end, if the issuer can form a reasonable belief that members of an angel network have the appropriate level of sophistication, communications to the members would not constitute a general solicitation. Of course, these matters are always based on the particular facts and circumstances and a determination as to whether a communication is a general solicitation would be influenced by various factors, including, among others, the number of people contacted, the financial sophistication of offerees, and the nature of the outreach (whether a communication is directed and bilateral or general, not targeted and impersonal). Similarly, depending on the facts and circumstances, communications at demo days may be an offering of securities if such details are discussed.
As is customary for similar public appearances, the regulators reminded audience members that the views expressed reflected those of the individual participants, and not necessarily those of the Commission.
In today’s Congressional testimony, Chair White discussed a number of capital formation related initiatives. She mentioned the Commission’s
- Proposed amendments to modernize Rule 147 for intrastate offerings,
- The tick-size pilot program
- Division of Corporation Finance’s disclosure review initiative,
- Review of the disclosure requirements for smaller public companies, and
- Review of the “accredited investor” definition.
Commenting on the disclosure effectiveness review, Chair White provided some insight on the Commission Staff’s approach. She noted that the “The staff is reviewing the disclosure requirements in phases. In the first phase of the review, the staff is focusing on the business and financial disclosures required by periodic and current reports, Forms 10-K, 10-Q and 8-K, and updates to certain Industry Guides. The staff also will consider whether disclosure requirements should be scaled for certain categories of issuers, such as smaller reporting companies or emerging growth companies, and, if so, how.” The testimony can be accessed here: http://www.sec.gov/news/testimony/chair-white-testimony-sec-agenda-operations-2017-budget.html.
We have revised and republished a summary chart of exempt offering alternatives. You may access the chart here: http://www.mofo.com/~/media/Files/PDFs/151118ExemptOfferingAlternativesChart.pdf
The Division of Economic Research released an updated study regarding capital raised in the United States through unregistered offerings.
The study notes that in 2014 more than $2 trillion in proceeds were raised through exempt offerings, largely through offerings made in reliance on Regulation D. The information was collected principally from Form D filings. Although in reporting data, the study looks at amounts raised in offerings made in reliance on Regulation D, Rule 144A, Regulation S, Regulation A and Section 4(a)(2). By contrast, in 2014, $1.35 trillion was raised in SEC-registered offerings.
In 2014, based on these filings, there were 33,429 Regulation D offerings. Foreign issuers accounted for 20% of the total amount raised during 2014 and came principally from Canada, Cayman Islands and Israel. This information is, in our experience, quite incomplete. Most non-U.S.-domiciled issuers access the U.S. institutional investor market through cross-border debt placements and these are made in reliance on Section 4(a)(2). These transactions, which are often referred to as “insurance private placements” or “cross-border privates” are substantial.
The study notes that since September 2013 (effectiveness date), the amounts raised in reliance on 506(c) offerings through 2014 was only 2% of the total amount cited above, or $33 billion
The study contains many useful charts segmenting data and findings. It can be accessed here: https://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10-2015.pdf.
PwC recently released a study on the effect of disclosing material weaknesses (MWs) during an issuer’s initial public offering. Disclosing material weaknesses, which are defined by the SEC as “a deficiency, or a combination of deficiencies in Internal Control over Financial Reporting (ICFR) such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis,” has often had negative consequences for new companies whose performance is not yet well known. PwC’s study found, however, that many companies that disclose MWs in conjunction with their IPOs do not experience the same unfavorable consequences during their first few years as a public company.
The study notes that the percentage of companies disclosing material weaknesses in US IPOs has risen from 18% in 2012 to 31% in 2015, to date. 88% of all companies reporting material weaknesses had less than $500 million in revenue, which PwC attributes to the fact that smaller companies are more vulnerable to MWs than larger companies with better accounting and reporting resources. Of the companies that disclosedMWs during their IPOs, PwC’s research showed 33% of these companies were tech companies and 31% were healthcare companies. The industry representation may not be meaningful since the majority of IPOs have been undertaken by companies in these two industry sectors.
The most common MW disclosed was the “lack or shortage of accounting personnel”, which accounted for 24% of all MWs, followed by “inappropriate reconciliation of complex or non-routine transactions,” which accounted for 19%.
Although the effects of disclosing MWs for pre-IPO companies might be minimal for the first few years oflife as a public company, investors are interested in remediation steps. PwC found that 92% of companies disclosing MWs were including remediation language in their registration statements. Of the remediation solutions, the most popular solutions were to hire additional personnel, used by 65% of companies in PwC’s research, and 61% would hire a Chief Financial Officer.
We have a variety of regulations that set forth different standards of eligibility for different types of instruments. These can be found under both the U.S. securities laws and the commodities laws. It’s not always easy to remember who is who. To help keep things straight, we have prepared a summary table, which you can access here.
On November 16, 2015 at 12:00 p.m. EST, Morrison & Foerster Partners David Lynn and Anna Pinedo will lead a teleconference on exempt offering choices available to issuers. Now that the final Regulation Crowdfunding has been released, all of the new offering formats contemplated by the JOBS Act will be available to issuers. Of course, issuers also may choose to rely on traditional private placements conducted under Section 4(a)(2) and Rule 506(b). We will discuss some of the motivations for using one approach over another, in addition to the following:
- An overview of Regulation Crowdfunding;
- Choosing between Regulation A, crowdfunding, and a Rule 506(c) offering;
- Tier 2 of Regulation A compared to an IPO;
- Life after the offering and ongoing reporting;
- Good-old 4(a)(2) and Rule 506(b); and,
- Offerings in close proximity to one another.
CLE credit is pending.
To register for this session, or for more information, please click here.
At the same time the Securities and Exchange Commission (the “SEC”) adopted rules implementing Regulation Crowdfunding pursuant to Title III of the Jumpstart Our Business Startups Act (the “JOBS Act”), the agency proposed rule changes that could potentially facilitate intrastate and regional offerings that are subject to state blue sky regulation. In particular, the SEC proposed to modernize Rule 147 under the Securities Act of 1933, as amended (the “Securities Act”), and establish a new exemption to facilitate offerings relying upon recently adopted intrastate crowdfunding exemptions under state securities laws. The SEC also proposed amendments to Rule 504 of Regulation D under the Securities Act to increase the aggregate amount of securities that may be offered and sold in any twelve-month period from $1 million to $5 million and to disqualify certain bad actors from participating in Rule 504 offerings. The SEC indicated in the proposing release that these proposals are “part of the Commission’s efforts to assist smaller companies with capital formation consistent with other public policy goals, including investor protection.
Read our client alert here.
Today, the House Financial Services Committee voted 53-4 in favor of HR 3868 sponsored by Congressman Mulvaney (see text: https://www.govtrack.us/congress/bills/114/hr3868/text). Among other things, the bill would make needed changes to the Securities Act that would bring the offering related and communications related provisions of the Act into parity for BDCs.
Chairman Hensarling offered an amendment to a transportation and transportation bill, which includes a number of JOBS Act and other capital formation related bills that had received bipartisan support. The capital formation related bills include HR 2064, the Improving Access to Capital for Emerging Growth Companies Act, HR 1525, the Disclosure Modernization and Simplifications Act, HR 432, the SBIC Advisers Relief Act, HR 1839, the Reforming Access for Investments in Startup Enterprises Act, HR 1723, the Small Business Freedom and Growth Act, and HR 1334, the Holding Company Registration Threshold Equalization Act. We previously reported on these bills.