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SEC Proposes Amendments Revising Section 12(g) Thresholds as Required by the JOBS Act

Posted in JOBS Act News, SEC News

The SEC proposed rules for comment that address the JOBS Act mandate to revise the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Exchange Act. The proposed rules would:

  • Amend Exchange Act Rules 12g-1 through 4 and 12h-3 which govern the procedures relating to registration, termination of registration under Section 12(g), and suspension of reporting obligations under Section 15(d) to reflect the new thresholds established by the JOBS Act;
  • Revise the rules so that savings and loan holding companies are treated in a similar manner to banks and bank holding companies for the purposes of registration, termination of registration, or suspension of their Exchange Act reporting obligations; and
  • Apply the definition of “accredited investor” in Securities Act Rule 501(a) to determinations as to which record holders are accredited investors for purposes of Exchange Act Section 12(g)(1). The accredited investor determination would be made as of the last day of the fiscal year.

The proposed rules also would amend the definition of “held of record” used in determining whether an issuer is required to register a class of equity securities under Exchange Act Section 12(g)(1) to exclude certain securities.

Here is a link to the proposed rule: http://www.sec.gov/rules/proposed/2014/33-9693.pdf

 

 

Securities Regulation Legislation in the Coming 114th Congress

Posted in Crowdfunding, JOBS Act News

If the current 113th Congress is any measure, we can expect the coming 114th Congress to introduce and promote bills seeking, among other matters, to facilitate capital formation, to correct oversights in the original JOBS Act, to make crowdfunded equity offerings a reality and to ease reporting complexity for smaller issuers.  Here is a link to our chart discussing the bills currently pending.  Most of these bills did not progress very far. For example, of the nineteen JOBS Act related bills we tracked, only two — H.R. 4200, “Small Business Investment Company (SBIC) Advisers Relief Act of 2014,” and H.R. 4569, “Disclosure Modernization and Simplification Act of 2013” —  were successfully passed in the House. However, regardless of whether they were passed in one chamber, all bills will need to be re-introduced in 2015  There is a reasonable expectation that the new Congress, which will be majority Republican in both Houses, will be able to pass some of these bills and present them to the President for signing.  We look forward to an interesting 2015 in securities regulation.

Advisory Committee will Consider Accredited Investor Definition

Posted in Accredited Investor Standard, Advisory Committee on Smaller and Emerging Companies, SEC News

The SEC announced that at the December 17th meeting of the Advisory Committee on Small and Emerging Companies, the group will focus on the definition of “accredited investor.”  As we have written in prior posts, the Dodd-Frank Act requires that every four years the SEC consider the definition.  In addition, following the relaxation of the prohibition on general solicitation, consumer groups and state securities regulators have focused on the appropriateness of the definition.  The meeting is webcast on the SEC’s site.  Here is the SEC’s press release:
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543680519#.VIsB5U10xjA.

 

House Approves Various Bills

Posted in Emerging Growth Companies, SBIC

Today the House of Representatives approved several bills including these two, which we have previously commented on:

H.R. 4569, the Disclosure Modernization and Simplification Act, sponsored by Rep. Scott Garrett (R-NJ).  This bipartisan bill will help investors navigate lengthy and confusing company disclosures by allowing public companies to submit a summary page of all material information included in annual Securities and Exchange Commission (SEC) filings.  The bill directs the SEC to also simplify financial reporting requirements for small and emerging growth companies.

H.R. 4200, the Small Business Investment Companies Advisers Relief Act, sponsored by Rep. Blaine Luetkemeyer (R-MO).  H.R. 4200 amends the Investment Advisers Act of 1940 to reduce unnecessary regulatory costs and eliminate duplicative regulation of advisers to Small Business Investment Companies, which are professionally-managed investment funds that finance small businesses.

Waivers of IPO Lock-up

Posted in IPO On-Ramp

We have previously commented on the lock-up requirement in connection with IPOs and noted that it has become somewhat more frequent for underwriters to release issuers and/or their shareholders (including directors and officers) from their lock-up requirements early. Generally, this has been the case where the IPO has performed well and there is interest in selling additional primary or secondary (selling security holder) shares in a follow-on offering before the expiry of the 180-day period. In prior posts, we have noted that the FINRA rules require public disclosure of an early lock up. We also have discussed the importance of disclosing in any prospectus exceptions to the lock-up requirements, and giving thought to which members of the underwriting syndicate will have the authority to release parties from the lock-up.

Recently, courts have been asked to consider claims arising in connection with lock-up releases. For example, in a recent Delaware Chancery Court case, a claim by shareholders for breach of fiduciary duty against an issuer’s board of directors for its waiver of a post-IPO lock-up as to certain existing shareholders survived a motion to dismiss. The court in that particular case dismissed aiding and abetting claim against the underwriters. Noting that the requisite underlying requirements of existence of a fiduciary relationship and its breach existed, the Court held that the element of “knowing participation in the breach by the non-fiduciary defendants” was missing. In waiving the lock-ups, there were insufficient facts alleged to demonstrate that the underwriters knowingly participated in the directors’ (alleged) breach of fiduciary duty or that they extracted “unreasonable” compensation or an “improper side deal” in order to consent to the selective lock-up waivers.

In other instances, where an early lock-up release has permitted a follow-on offering to proceed or has enabled shareholders to sell into the market, shareholders have sought to bring a class action in connection with losses suffered as a result of the drop in the issuer’s stock price.

In planning for an IPO and the capital-raising transactions that inevitably will follow, it will be important for companies and their boards to consider the terms of any lock-up agreement, and, if locked-up shareholders are to be treated differently, the rationale for doing so. If directors are participating in a follow-on transaction occurring during the lock-up period, it will be important to make sure a majority consisting of disinterested directors approves the transaction and their participation. And analyze such disinterestedness on the record. If it is a potentially “hot stock” with or without a disproportionately small public float, consider building in staggered lock-up releases from the beginning. Lock-ups are a lesser concern in follow-on offerings because typically only directors, officers and a select number of larger shareholders will be locked up. And, of course, never assume that stock prices can only go up.

 

Lender-to-thy-Neighbor: P2P Lending in Perspective

Posted in Crowdfunding, P2P Lending

Nigel Glenday is an investment banker at StormHarbour Partners, a global investment banking firm providing strategic advisory, structuring and sales & trading solutions with offices in the U.S., Europe and Asia
Nigel.Glenday@stormharbour.com

Closely related to the crowdfunding phenomenon has been the evolution of the peer-to-peer (P2P) lending model.1 As the early standard-bearers of P2P prepare to enter the public markets, the model itself is poised for greater industry and regulatory visibility. So what has the undoubtedly impressive growth of P2P revealed thus far and what might it portend for a rapidly shifting and decentralized financial sector?

In short, P2P platforms offer lenders, both institutional and retail, the ability to provide credit directly to individual borrowers on a fractional (and, more recently, whole loan) basis. An online portal facilitates the application through funding process for both borrowers and lenders while the platform itself undertakes borrower marketing, credit scoring/underwriting and loan servicing functions. A more streamlined, web-based loan process has appealed to prospective borrowers as the public has grown increasingly comfortable with digital banking channels in general.

The loan funding mechanism, also maintained by the P2P platform, occurs through a marketplace in which institutional and retail investors subscribe to individual loans offered for syndication.2 These marketplaces allocate loans based, essentially, on a first-come-first-served basis, with the interest rate for each loan set by the risk scoring parameters of the platform.3 4 The platforms assess origination and ongoing servicing fees, but otherwise do not retain any credit risk directly.5 The most notable attribute is the extent of the individual borrower- and loan-level data transparency made available (via a website or API) to prospective lenders at the time of origination. The end result is a form of “just-in-time” funding by marketplace participants, many of whom have developed increasingly sophisticated techniques for loan selection.6 Interestingly, this data transparency has attracted several marketplace participants with backgrounds far afield from credit yet who have drawn parallels between the P2P model and other technology-enabled marketplaces (including high frequency stock trading, foreign exchange, digital ad exchanges, among others).

What began as a self-directed retail phenomenon (i.e., individuals extending credit to one another) has given way to an institutional investor base that has found relative value (in an otherwise low interest rate, benign credit environment) in the loans originated through these platforms. Exponential origination volume growth has been fueled by structural shifts in banking and cyclical market forces in the wake of the 2008 crisis. In the U.K. and continental Europe, a more concentrated and weakened banking system has provided even more fertile ground for P2P platforms, alternative lenders and challenger banks.

The P2P model has generated the most traction in relatively simple, homogeneous assets classes amenable to programmatic underwriting. These are asset classes that are in general: i) costly to originate; ii) under-served (or unattractively priced) by existing lenders; or iii) in which risk-based pricing applied to specific borrower segments can supplant “one-size-fits-all” pricing. As such, personal installment loans (largely for debt consolidation or credit card payoff), student loan refinance and, to a lesser extent, small business loans, have generated the most volume for P2P platforms.7

However, the future applicability of the P2P model to other asset classes (for which competitive markets exist today) will come down to platforms sustaining a cost-efficient, defensible origination strategy and the capacity for the marketplace funding mechanism to deliver attractive cost of capital relative to other financing arrangements. Cost-effective origination, even within the core markets of current P2P platforms, may require de-emphasizing direct-to-borrower marketing in favor of natural, captive distribution partnerships (e.g., point-of-sale financing options for consumer loans or online bookkeeping and financial productivity software for small-businesses). Short of this, whether these platforms can be adequately compensated over time for the functions they perform without monetizing credit risk remains an open question.8

The role of traditional banks, short of being displaced, is re-ordered in the daisy chain of intermediation. Traditional banks have provided wholesale funding for P2P loan investors who then retain the residual risk of the loans they fund.9  In fact, many traditional banks are well positioned to do this given that P2P-originated consumer loans are frequently used to refinance credit cards that may have been previously issued by the very same banks. Term ABS remains an attractive end-financing strategy and issuance has picked up, most notably in student loan refinance for which a deep ABS investor base already exists. Even efforts to arrange synthetic exposure and credit protection for P2P loans is growing.

While P2P-originated loans remain a small fraction of the $3.2 trillion in U.S. non-mortgage consumer credit outstanding, its exponential growth may very well the “tail wagging the dog” for traditional banks. Many are now emulating the online borrower experience characteristic of P2P platforms with some setting up their own online consumer lending portals. Others are seeking out new non-traditional credit scoring models to improve loan rejection rates (particularly for small business). If anything, P2P is simply accelerating a longer standing shift away from “brick-and-mortar” banking channels.

P2P platforms today still offer a limited set of credit products for specific market segments and cross/up-sell initiatives are just beginning to take shape. The model takes part in wider theme of bank disaggregation and decentralization that includes innovations in payments, mobility, crypto-currencies and all manner of “big data”. But, the lifetime value of multi-product customer relationships beyond credit (including deposit taking, cash/treasury management, wealth management, among many others) just might compel P2P platforms to re-create the very traditional financial institutions they sought out to dis-intermediate in the first place.


1 Also commonly referred to as online direct or marketplace lending; or crowdlending

2 Many platforms use a third-party sponsor bank to act as a lender of record upon loan origination after which economic interest in the loan is issued by the P2P platform (or a special purpose vehicle) to the end-investor through an SEC-registered security

3 Earlier attempts at auction-based pricing proved problematic in the absence of sufficiently sophisticated lenders experienced in pricing credit risk (a circumstance that may be changing as institutions become the principal investor base for these platforms).

4 Many platforms have been using a wider set of non-traditional borrower credit metrics, including social media, web-scraped credit data, internet browser behavior and other “big data” sources

5 Other non-bank lenders, frequently included under the P2P umbrella, rely on wholesale funding sources (e.g., accumulation facilities, term ABS, etc) and do retain residual credit risk

6 Distinct from, but related to, the “originate-to-sell” model in which the originator may retain some loan warehousing risk

7 A growing variety of asset classes are being pursued through the P2P model, including real estate, invoice finance and project finance (notably renewable energy). Insurance has also been suggested as a possible extension of this model.

8 Monetization through retaining credit risk on-balance sheet or through an auction-based, gain-on-sale model

9 Some banking institutions and finance companies also purchase loans directly from P2P platforms

2014 SEC Government-Business Forum on Small Business Capital Formation Considers Adding Qualitative Requirements to the Standards for an “Accredited Investor” and Steps Needed to Make Exchanges More Hospitable to Smaller Companies

Posted in Accredited Investor Standard, SEC News

On Thursday, November 20th, the 2014 SEC Government-Business Forum on Small Business Capital Formation met at the SEC headquarters in Washington, D.C. The forum was attended by SEC Chairwoman Mary Jo White, Commissioner Gallagher, SEC staff (the “Staff”) and featured presentations by lawyers, an Arkansas state securities regulator, and the SEC’s Senior Financial Economist, among others. Stanley Keller, a partner at Edwards Wildman Palmer led the panel, “Secondary Market Liquidity for Securities of Small Businesses.”  He stressed the importance of liquidity in promoting capital formation, permitting the redeployment of capital, providing benefits to employees and giving companies more time grow. Mr. Keller noted that while the emergence of secondary market trading platforms has led to increased liquidity, there are concerns about investor protections and the adequacy of information provided by such platforms, which affects both investors and the transparency of the trading markets. Michael Zuppone, a partner at Paul Hastings, discussed the need to create specialized exchanges hospitable to smaller companies that would permit reduced reporting requirements and have lower fees than those of national exchanges. He stated that the need for such exchanges is likely only to increase upon the implementation of Regulation A+ and the increase in smaller company IPOs that he believes is likely to follow. Mr. Zuppone further proposed that the Staff should allow companies that are currently listed on national exchanges to be able to “migrate” to Regulation A+ reporting requirements. The Staff was receptive Mr. Zuppone’s proposal, with Stephen Luparello, the Director of the Division of Trading and Markets, agreeing that “one size does not fit all—especially in equity.”

The second panel featured a discussion of the standards for an “Accredited Investor,” under Regulation D. Chairwoman Mary Jo White explained that the SEC’s goal is to “assess whether we are properly identifying the population of investors who should be able to purchase securities in a securities offering without the protection afforded by the registration requirements of the Securities Act.” Commissioner Gallagher stated that he’s “baffled by continued insistence from some quarters that we need to significantly revise” the Accredited Investor definition, and that he felt the Dodd-Frank Act’s removal in 2010 of the equity value of one’s primary residence for the purposes of the net worth test “was already a significant change to the accredited investor definition.”. He asked, “Why should we spend limited Commission resources protecting the wealthiest 2%-3% of investors in this country? This obsession with protecting millionaires — potentially at the cost of hindering the wildly successful and critically important private markets — strains logic and reason. Millionaires can fend for themselves.” Panelists considered adding qualitative provisions to allow investor to qualify based on their “financial sophistication” and/or educational requirements, and not just their net worth. Panelists believed that this alternative could potentially expand the pool of investors that would qualify as “Accredited Investors” and promote capital formation. However, Jean Peters of the Angel Capital Association said she does not believe the definition should be changed “as far as financial thresholds” and only agreed with adding a sophistication element in addition to current financial threshold requirements.

An archive version of the webcast of the forum is expected to be available shortly on the SEC’s website.

The program and slide presentations from the forum can be accessed here.

Opening remarks from Chair Mary Jo White can be accessed here.

A Closer Look at Regulation D: OfferBoard Finds Rule 506(c) Offerings Have Lowest Percentage of Funds Committed at Time of Filing; Revenue Disclosure More Frequent in 506(c) Offerings

Posted in Regulation D, Rule 506 Rulemaking

In “Equity Crowdfunding Under Title II of the JOBS Act: The First Year,” OfferBoard reveals many interesting findings regarding offerings under Regulation D. The white paper finds that offerings under Rule 506(c) of Reg. D (“506(c)”) have the lowest percentage of funds committed at the time of filing—15.9% as compared to 73.2% for Rule 506(b) (“506(b)”) offerings. Possible explanations include the gradual nature of the publically-advertised fundraising process or the fact that issuers are registering these offerings earlier in the process because they collect funds immediately, rather than waiting to collect funds once there is a critical mass, as is typical in the 506(b) process.

The paper also finds that companies using the 506(c) exemption more frequently disclose the amount of revenue they are earning than companies utilizing other exempt offerings, with 78% of 506(c) offerings disclosing revenue, compared to 70% of companies disclosing revenue under other exemptions. The public nature of 506(c) offerings is a likely explanation for this discrepancy in revenue disclosure, as a greater amount of information must be available to the public to allow for general solicitation.

Also, the paper finds that the average number of investors per offering varies widely by industry; however, certain industries seem to be experiencing a surge in the number of investors they attract due to the 506(c) exemption. Biotechnology, business services and telecommunications companies had more investors under 506(c) than other exemptions. According to OfferBoard, possible explanations for this include these industries being better served by investment platforms and intermediaries than others or that market conditions have made certain industries more desirable to investors than others.

You can sign up to download the White Paper here.

Meeting of the Advisory Committee on Small and Emerging Companies

Posted in SEC News

The SEC announced the next meeting of the Advisory Committee on December 17th, beginning at 9:30 a.m. The committee will focus on the interests and priorities of emerging and smaller public companies. Meetings are open to the public. Please see the notice for additional details: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543499940#.VG5iVk10xpB.

SEC Commissioners on Capital Formation

Posted in Capital Formation, SEC News

Recently, various SEC Commissioners, including Commissioner Stein and Commissioner Gallagher, have addressed issues related to capital formation in their public remarks.

At a Los Angeles County Bar Association conference, both noted that one of the Commission’s most important objectives remains facilitating capital formation, while, of course, preserving important investor protections. In her remarks, Commissioner Stein addressed the transformational changes that have occurred to the “capital formation continuum.” She focused her remarks for the first time on how an issuer might use Regulation A+ as a financing alternative or a stepping stone, and how Rule 506 offerings might continue to provide the flexible financing option that has proven a reliable source of capital for companies at all stages of their growth. She called for “a comprehensive review and rationalization of our capital formation tools…” and suggested that a starting point might be tackling Regulation A+ and making the exemption a flexible option for issuers. In a more recent speech, at the “Live from the SEC” conference, Commissioner Stein acknowledged that “the continuum of capital formation has changed dramatically” and considered the international aspects of crowdfunded and Regulation D offerings. It is encouraging that the Commissioners are discussing the future of Regulation A+ (it’s been nearly a year since the Commission released its very thorough Regulation A+ proposed rules), and discussing financing options as existing on a continuum. Most issuers carefully weigh the costs and benefits of various financing alternatives available to them, and take into account restrictions on resales, disclosure requirements, the ability to use general solicitation or general advertising, and investor comfort or familiarity with the offering format. Rather than considering each exemption (whether existing or proposed) in isolation, taking a more holistic approach is likely to lead to a more robust range of capital formation alternatives.