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Regulation A Roundup

Posted in Regulation A+

This week marks the three-month anniversary of the effective date of Regulation A.  Of course, given this limited experience, it may be premature to comment on market developments.  Instead, below we summarize significant developments.

Small Entity Compliance Guide
Immediately prior to the effective date, the Securities and Exchange Commission published this Small Entity Compliance Guide: http://www.sec.gov/info/smallbus/secg/regulation-a-amendments-secg.shtml.  The guide provides a helpful overview of the regulation, the disclosure requirements and the subsequent reporting requirements.

Compliance and Disclosure Interps
Shortly following the effective date, the Staff of the Commission provided guidance on various aspects of the application of the regulation in the form of Compliance and Disclosure Interpretations, which are accessible here: http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#182.01.

Investor Bulletin
In July, the Commission’s Office of Investor Education and Advocacy issued an Investor Bulletin (see:  http://www.sec.gov/oiea/investor-alerts-bulletins/ib_regulationa.html) that highlights the differences from an investor’s perspective between a Tier 1 and a Tier 2 offering, including the disclosure and ongoing reporting requirements and the investment limitation for Tier 2 offerings.

Reg A Litigation
In the meantime, the litigation by Montana and Massachusetts challenging the Commission’s definition of “qualified purchaser” in the context of Tier 2 Regulation A offerings is proceeding.  The opening brief presents some interesting arguments.  For example, in the brief, petitioners note that the legislative history of NSMIA suggests that state preemption was intended to be limited to qualified purchasers, which were understood to be investors with certain levels of wealth, income and financial sophistication.  The brief further notes that years ago, when the Commission had proposed to define “qualified purchaser,” it had proposed to limit qualified purchaser to “accredited investor.”  This had been premised on the notion that these were investors capable of fending for themselves and who did not require the protections afforded by state securities registration.  Interestingly, this would appear to undercut the arguments being advanced by the states.  If, from a public policy perspective and based on legislative history, the term “qualified purchaser” was intended to identify purchasers that did not require the protections associated with state registration, then, any offeree or purchaser in a Tier 2 would meet this standard.  Offerees and purchasers in Tier 2 offerings have the benefit of an offering statement that must comply with extensive disclosure requirements, including an audited financial statement requirement, and that must be qualified by the Commission.  It stands to reason that such an offeree or purchaser would not need to negotiate for himself or herself with the issuer in order to obtain information about the issuer or the investment.  This information would be publicly available.  The disclosure requirements of a Tier 2 offering serve to level the playing field between the issuer and potential purchasers.  Potential purchasers would not be left to “fend for themselves” in a Tier 2 offering.  The brief points to exempt offerings made pursuant to Section 4(a)(2) and Rule 144A and the investor sophistication requirements in the context of each such exempt offering..  However, there are no disclosure requirements in the case of either a 4(a)(2) or a Rule 144A offering and, of course, no Commission review.  It’s not clear why either would be analogous to a Tier 2 Regulation A offering.  The brief notes that any definition of “qualified purchaser” ought to be consistent with the public interest and the protection of investors.  It would seem that the disclosure requirements, investment limitations (in the case of non-accredited investors), and the transparency afforded by the ongoing reporting requirements provide robust investor protections.

FINRA recently published Regulatory Notice 15-32 on Regulation A Offerings (see:  http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-15-32.pdf).  The Notice reiterates that FINRA’s Corporate Financing Rules apply to Regulation A offers involving the participation of a FINRA member firm.  The Notice also emphasizes that FINRA’s communications rule (Rule 2210) is applicable to materials used in connection with a Regulation A offering and, as such, are subject to content standards (all materials must be fair, balanced, and not misleading), may be subject to registered principal pre-approval and to filing with FINRA.

Given the proliferation of web-based offers or “test-the-waters” type communications purportedly involving Regulation A offerings, the reminder regarding the applicability of the FINRA communications rules is especially timely.

Growth Capital-backed IPOs

Posted in IPO On-Ramp

In a paper that will be published in The Financial Review, Professor Jay Ritter presents interesting data on “growth capital-backed IPOs” undertaken in the United States from 1980 to 2012.  The paper excludes life science and biotech companies and generally excludes tech companies and instead looks at “growth capital companies,” which are defined to, among other things, focus on growth from the addition of tangible assets or through acquisitions.  In addition, the paper looks at companies that had a financial sponsor.  Based on the criteria and data used, the paper that growth capital-backed IPOs have substantially higher adjusted returns.  This also is true of “rollup” IPOs wherein a financial sponsor has been active.  Interestingly, the paper also considers the performance of VC-backed.  Here, although performance for IPOs in the 1990s was generally positive, the trend reversed subsequently and from 1999 to 2012, VC-backed IPOs suffered from negative returns.  The paper is available here:  https://site.warrington.ufl.edu/ritter/files/2015/09/Growth-Capital.pdf.

Upcoming Advisory Committee Meeting Announced

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

The SEC Advisory Committee on Small and Emerging Companies will hold its next meeting on September 23, 2015 at 9:30 a.m.  The meeting is open to the public and also webcast on the SEC’s website.  The agenda for the meeting includes matters relating to rules and regulations affecting small and emerging companies under the federal securities laws.

Complimentary Teleconference: Final SEC CEO Pay-Ratio Rule

Posted in Events, SEC News

On Thursday, September 10, 2015, Morrison & Foerster Partners David M. Lynn and Scott Lesmes will lead a teleconference entitled “Final SEC CEO Pay-Ratio Rule”.  On August 5, 2015, the Securities and Exchange Commission, in a 3-2 vote, adopted a final CEO pay-ratio rule, which requires public companies to disclose the ratio of the compensation of its chief executive officer to the median compensation of its employees. This session, which will take place from 12:00 p.m. to 1:00 p.m. EDT, will discuss:

  • Disclosure requirements;
  • Covered employees;
  • Identifying the median employee;
  • Calculating median annual compensation;
  • Excepted companies and transition periods; and
  • Preparing for the new rule.

CLE credit is pending.

To register for this session, or for more information, please email tstarer@mofo.com.

Proposed Change to NYSE Shareholder Vote Rule for “Early Stage Companies”

Posted in SEC News

The Securities and Exchange Commission is requesting comments prior to August 31, 2015 regarding whether the Commission should approve or disapprove a proposed change to the NYSE Listed Company Manual Sections 312.03 and 312.04. The NYSE Listed Company Manual contains a number of regulations requiring that a listed company obtain shareholder approval for certain issuances of securities, which provisions are often referred to as the “shareholder vote provisions” or the “20% rule.” In this case, the NYSE proposes to amend the referenced sections in order to provide an exemption pursuant to which an “early stage company” the securities of which are listed on the NYSE may issue shares of common stock (or exchangeable or convertible securities) to certain related parties without shareholder approval. The exemption from the requirement to obtain shareholder approval would be available only to an “early stage company,” which would be defined as a company that has not reported revenues in excess of $20 million in any two consecutive fiscal years since incorporation. The early stage company’s audit committee would be required to review and approve the proposed transaction prior to completion. The exemption would only be available for sales for cash and would not be available for issuances in connection with an acquisition. Many of the securities exchanges’ rules imposing shareholder approval in connection with certain transactions serve to deter companies from raising much-needed capital. This modest positive change would prove beneficial to shareholders.

Does Loyalty Count?

Posted in IPO On-Ramp

In recent years, there has been increased focus on “short-termism” within public companies—some speculate that the rise of high frequency trading, activism, and similar developments have exacerbated the focus on short-term returns.  A number of academics, including Patrick Bolton and Frederic Samama, have proposed contractual approaches to reward loyal holders of public companies through the issuance of L-shares or L-warrants.  A stockholder that had held for a specified period (say, three years) would be entitled to receive a warrant to receive additional shares of the public company’s stock.  One could envision any number of other alternative structures designed to reward long-term investors and a number of French and other European issuers already have adopted approaches designed to do just that.  For U.S. investors, the concept may not be all that familiar.  The proposed initial public offering of Ferrari (see http://www.sec.gov/Archives/edgar/data/1648416/000164841615000004/newbusinessnetherlands.htm) may present a fresh opportunity for U.S. investors to consider the loyalty share approach.  The Netherlands-based company will adopt a “loyalty voting program.”  Any holder can opt to participate in the loyalty voting program and, after a three-year holding period, the loyal holder will be entitled to receive one special voting share for each such common share that has been registered.  U.S. IPO investors are fairly accustomed to dual-class and multiple-class voting structures, especially for IPO issuers that use an up-C IPO approach or have insiders that are intent on preserving control; however, they are not so familiar with rewarding loyalty.

House Financial Services Committee Reports on JOBS Act Related Bills

Posted in EGCs, JOBS Act News, SBIC

A flurry of activity was seen last week on the House floor as the Financial Services Committee reported on various bills, many of which JOBS Act related.  These bills propose to change registration and reporting requirements for small reporting companies, Small Business Investment Companies (SBICs) and savings and loan companies, as well as affect the treatment of Emerging Growth Companies (EGCs). On July 14, the House passed the following bills, and on July 15, referred them to the Senate Committee on Banking, Housing and Urban Affairs:

In contrast, plans to consider H.R. 1675 and H.R. 2354 were scrapped by House Republicans, according to CQ News. H.R. 1675 would have directed the SEC to revise regulations relating to compensatory benefit disclosures by issuers. H.R. 2354 planned to reduce the number excessive and costly regulations issued by the SEC by requiring a review of each significant regulation it had issued.

Treatment of “Finders” and Disclosure Effectiveness Discussed at SEC Advisory Committee Meeting

Posted in Advisory Committee on Smaller and Emerging Companies

During their July 15 open telephone meeting, the SEC’s Advisory Committee on Small and Emerging Companies continued discussion on the regulatory treatment of “finders” and disclosure effectiveness relating to small businesses.

The Committee acknowledged the importance of “finders” and other intermediaries in the capital-raising efforts of small businesses, citing limited broker-dealer involvement due to the smaller deal sizes these efforts yield.  It was expressed that although “finders” and similar intermediaries have always been present in our economic system, they currently operate outside regulatory guidance.  In order to legitimize this practice and move forward with any recommendations to the SEC, the Committee agreed that certain issues such as the definition and segmentation of covered persons, scope of activities of “finders,” thresholds, disqualifications and regulation and reporting should first be considered and resolved.

The Committee also announced the SEC’s continued consideration of the recommendations made on February 1, 2013 regarding regulatory relief provided to smaller reporting companies with regard to disclosure.  The Committee discussed expanding this regulatory relief to include relief provided to EGCs under the JOBS Act.  Specific issues and considerations were identified to achieve this proposed expansion, of which the effectiveness of disclosing the ratio of median annual total compensation of all employees to that of CEOs garnered further deliberation, as did mandatory audit firm rotation requirements.  Additionally, the definition of an “accelerated filer” was proposed as a topic of discussion for the upcoming September committee meeting.

A full replay of the meeting webcast will be made available on the SEC website: http://www.sec.gov/news/otherwebcasts/2015/advisory-committee-small-emerging-companies-071515.shtml

2015 BDO IPO Halftime Report — Survey finds decrease in IPO activity and increased positive sentiment towards JOBS Act

Posted in IPO On-Ramp, JOBS Act News

Last week, BDO USA released its 2015 IPO Halftime Report which surveyed capital markets executives from various investment banks on IPO activity and trends for 2015.  The report found that the number of U.S. IPOs and aggregate proceeds are down significantly when compared to the same period in 2014 and notes that predictions point toward a similar volume of offerings in the second half of 2015. While there are many contributing factors to this decrease in number of offerings and proceeds raised, a majority (56%) of the capital markets executives surveyed believe that the availability of private funding at favorable valuations is a principal cause, particularly for technology companies.

In addition to the drop in number of IPOs in the first half of 2015, the average size of offerings has decreased as well when compared to 2014. A significant portion (41%) of the executives surveyed attributed this decline in average deal size to fewer large deals coming from private equity and venture capital firms who have already exited many mature businesses. Only 6% of those surveyed believed the JOBS Act contributed to the decrease in average offering size.

Capital markets executives are still divided on the impact of the three-year old JOBS Act on the IPO market. Accordingly, a slight majority (51%) of those surveyed believed the Act has had a positive impact on companies going public. However, when compared to the percentage of bankers who felt this way two years ago (14%), this majority represents a significant change in sentiment towards the JOBS Act. Despite this attitude shift, a majority of executives felt that the JOBS Act’s confidential filing process and corresponding lack of transparency has had a negative impact on their capability to advise clients resulting from a lack of knowledge about competing offerings.

For the second half of 2015, the report indicates an expected increase in healthcare, technology and biotech IPOs and cited private equity firms and venture capital portfolios are cited as the primary source of IPOs.  For these and other findings, the full report can be accessed here.

It’s Not Crowdfunding!

Posted in Regulation A+

Since the Regulation A+ effective date last month, a number of websites have emerged that promote “Regulation A+ crowdfunding” contributing even further to the confusion in the market regarding “crowdfunding.”

Colloquially perhaps any attempt to raise capital through the use of an internet-based platform may be thought of as crowdfunding; however, to a securities lawyer, this usage of the term “crowdfunding” may be misleading.

Title III of the JOBS Act establishes a securities offering exemption for “crowdfunding” (some refer to this as Title III crowdfunding or refer to the new exemption, Section 4(a)(6)), which is available only to certain issuers, and only to raise up to a specified amount of proceeds ($1 million in a twelve-month period).  A Title III crowdfunded offering must be made through a registered broker-dealer or a funding portal.  The SEC has proposed rules for Title III crowdfunding that, among other things, limit advertising and marketing of such offers, prescribe certain disclosure requirements, impose limited ongoing disclosure requirements, and mandate that certain investor educational materials be prepared and disseminated.  At present, Title III crowdfunding is not available to issuers.  The SEC must release final rules.  As we have commented on in prior posts, a number of states have moved forward and have adopted crowdfunding exemptions for intrastate offers.

Title II of the JOBS Act required that the SEC relax the prohibition against general solicitation for certain Rule 506 offerings, and the SEC adopted final rules to do so.  In a Rule 506(c) offering, an issuer may use general solicitation to identify potential investors; provided that investors are verified to be “accredited investors.”  If an issuer enlists the services of a financial intermediary to assist with the offering and the intermediary receives transaction-based compensation, the intermediary generally will be required to be a registered broker-dealer.

Title II also provided greater certainty regarding the activities that a “matchmaking” portal may conduct without being subject to the requirement to register as a “broker-dealer.”  Matchmaking platforms that rely on Rule 506(c) or that, alternatively, rely on pre-JOBS Act no-action letter guidance to make offers to investors with whom a pre-existing substantive relationship has been established and who are determined to be accredited investors prior to any offers being made, may engage in “accredited investor crowdfunding.”

The final rules relating to Regulation A+ permit issuers to “test the waters” subject to compliance with a number of requirements.  Certainly, an issuer that is contemplating a Regulation A+ offering may use internet-based communications to test the waters.  However, the final rules for a Regulation A+ offering have little in common with the proposed rules implementing Title III crowdfunding and, also, little to do with “accredited investor crowdfunding.”  To the extent that offers are made using an internet-based platform and the intermediary expects to receive transaction-based compensation, it generally will be required to be a registered broker-dealer.  The Regulation A+ framework is complex, and requires the preparation of, and review by, the SEC of a disclosure document.  In addition, any “test the waters” materials used after an offering is qualified will need to be updated and filed with the SEC.  The issuer will be required to comply with the investor limitation for individuals.  Issuers considering using a platform should take care to ensure that they will be able to comply fully with applicable regulations.