On January 17, Chair White delivered a speech at The Economic Club of New York, which was titled “The SEC after the Financial Crisis: Protecting Investors, Preserving Markets.”  Chair White commented on the Securities and Exchange Commission’s achievements during the financial crisis era, as well as other areas of focus, such as modernizing the regulation of asset management, addressing equity market structure issues, and related matters.  Chair White noted that an area for further work for the Commission is addressing financial responsibility rules for broker-dealers.  Chair White also noted that the Staff has prepared a public request for comment on Industry Guide 3 for financial institutions, which awaits the approval of the Commission for release.

In these, her last remarks as Chair, she commented on the role of the Commission, “for the SEC to be a strong market regulator, wiser from the experience of the financial crisis, we must be ready to use the full array of tools available to us – not relying on disclosure and enforcement alone.  And we must do so with a fierce independence in applying our expert, best judgment to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate the formation of capital by the companies whose innovation and growth drives the American economy.”

Chair White also addressed the CHOICE Act and other measures designed to address agency rulemaking, noting:

“Another current trend pushing against the independence of the Commission are the legislative proposals from Congress seeking to remake our rulemaking process.  The House passed a bill just last week that would impose conflicting, burdensome, and needlessly detailed requirements regarding economic matters in Commission rulemaking that would provide no benefit to investors beyond the exhaustive economic analysis we already undertake.  These requirements would also prevent the Commission from responding timely to market developments or risks that could lead to a market crisis.  And elements of the CHOICE Act, which could be re‑introduced this session, would similarly undermine agency rulemaking as well as cripple our enforcement capabilities.  The next Commission must continue to challenge these efforts, and so should all of you.”

The full text is available here:  https://www.sec.gov/news/speech/the-sec-after-the-financial-crisis.html.

SEC disclosure requirements have prompted debate among key stakeholders regarding how to strike the right balance, weighing investor protection concerns and regulatory burdens. Partner Anna Pinedo is quoted in MergerMarket’s report on disclosure effectiveness. Read the report here: http://mergermarketgroup.com/wp-content/uploads/2016/12/Vintage-Group_Newsletter-3-2016_Final-LR.pdf.

The Chair of the Securities and Exchange Commission Mary Jo White recently commented on the significance of high-quality accounting standards.  The speech noted the need to support continued work toward the globally accepted accounting standards.  In recent months, representatives of the Office of the Chief Accountant within the Commission had noted that the effort to move toward IFRS was not considered a near-term priority.  Chair White offered compelling statistics.  For example, she noted that U.S. investors invest directly in the securities of many foreign private issuers that apply IFRS in filings with the Commission.  As of September 2016, these companies alone represented a worldwide market capitalization in excess of $7 trillion across more than 500 companies.  As a result, Chair White noted that work toward continued convergence of standards and priorities between the FASB and the IASB should be encouraged.   See the full speech at:  https://www.sec.gov/news/statement/white-2016-01-05.html.

The Division of Economic and Risk Analysis (DERA) of the Securities and Exchange Commission published a study recently that reviews, among other things, the performance of and the returns of investing in OTC stocks.  The study notes that there have been many studies and there is a wealth of data relating to the performance of NYSE- and Nasdaq-listed securities.  These securities tend to be held principally by institutional investors.  By contrast, there has been less analysis undertaken relating to OTC stocks, which tend to be held principally by retail investors.  While the data and analysis included in the study is on its own quite interesting, we find it particularly relevant in light of the many calls for the establishment of a venture exchange.   The Financial CHOICE Act, for example, includes among its many provisions, a section that relates to the establishment of venture exchanges.  The analysis also is relevant in evaluating whether the OTC markets provide a useful market for the securities of companies that undertake Regulation A offerings.

The study confirms that OTC stocks are less liquid than those listed on national securities exchanges.  The study also confirms a correlation between the availability of information about listed companies and their liquidity—with greater liquidity seen for those companies as to which public disclosures are available.  The study seems to indicate that the returns of OTC stocks are typically negative and that often these stocks are subject to alleged market manipulation efforts.  The study notes that “up-listing,” or moving from the OTC markets to a national securities exchange is quite uncommon, with fewer than 9% of companies transitioning during the study period (2001 to 2010) and less than 1% from the Pink Sheets (now OTC Markets) to a national securities exchange.

The study is available here:  https://www.sec.gov/dera/staff-papers/white-papers/White_OutcomesOTCinvesting.pdf.

As year-end approaches, many companies will be focused on preparing their annual reports.  Recent comments from various representatives of the Securities and Exchange Commission accounting staff emphasized the importance of maintaining strong and effective internal control over financial reporting (“ICFR”).  At the American Institute of Certified Public Accountants Conference in Washington, D.C., SEC Chief Accountant Wesley R. Bricker and SEC Deputy Chief Accountant Marc Panucci both addressed ICFR.  Mr. Panucci stated that ICFR remains a significant area of focus for the SEC, including through the coordinated efforts of the SEC’s Office of the Chief Accountant, the Division of Corporation Finance and the Division of Enforcement.  Mr. Panucci also noted that earlier this year, the SEC brought and settled a case against an issuer, members of its management, the audit partner and the issuer’s third-party consultant involving the inadequate evaluation of an identified control deficiency.  Additional takeaways from their remarks include the following:

  • Management, audit committees and auditors should engage in regular dialogue on ICFR assessments, as timely and effective communication among these parties is important for accurate assessments of ICFR and reliable financial reporting that benefits investors.
  • Management has the responsibility to carefully evaluate the severity of identified control deficiencies and to report, on a timely basis, all identified material weaknesses in ICFR. Any required disclosure should allow investors to understand the cause of the control deficiency and to assess the potential impact of the identified material weakness.
  • It is important to maintain competent and adequate accounting staff to accurately reflect the company’s transactions and to augment internal resources with qualified external resources, as necessary.
  • Management has to take responsibility for its assessment of ICFR, and that responsibility cannot be outsourced to third-party consultants. At the same time, third party-consultants can play an important and critical role when assisting management in its evaluation of ICFR.

Mr. Bricker’s speech is available at: https://www.sec.gov/news/speech/keynote-address-2016-aicpa-conference-working-together.html.  Mr. Panucci’s speech is available at: https://www.sec.gov/news/speech/panucci-2016-aicpa.html.

On November 2, 2016, FINRA terminated the FINRA registration for UFP, LLC (“UFP”), making UFP the first crowdfunding portal to be expelled from FINRA.   UFP ran an online funding portal, uFundingPortal.com, where it acted as an intermediary in debt and equity crowdfunding offerings conducted in reliance on SEC Regulation Crowdfunding rules.  FINRA’s investigation into UFP alleged that from May through September 2016, UFP violated various SEC Regulation Crowdfunding rules and FINRA Funding Portal Rules. As a result of FINRA’s investigation, UFP pulled its website and submitted a Letter of Acceptance, Waiver and Consent (the “AWC”) in order to settle these alleged rule violations with FINRA.  The AWC is available at: http://disciplinaryactions.finra.org/Search/ViewDocument/67004.

FINRA alleged that UFP violated Rule 301(a) and Rule 301(c)(2) under SEC Regulation Crowdfunding.  Rule 301(a) requires funding-portal intermediaries like UFP to have a reasonable basis for believing that issuers using its crowdfunding portal comply with applicable regulatory requirements, and Rule 301(c)(2) requires that access to funding portals be denied to issuers that present the potential for fraud or otherwise raise investor protection concerns. FINRA found UFP to be in violation of Rule 301(a) because 16 of the issuers on UFP’s portal had failed to file certain requisite disclosures with the SEC and, in each case, UFP had reviewed these issuers’ SEC filings and therefore had reason to know that these filings were incomplete.  In addition, FINRA found UFP to be in violation of Rule 301(c)(2) by failing to deny access to its portal when it had a reasonable basis to believe these issuers and/or their offerings presented the potential for fraud. For example, FINRA found that these 16 issuers all had impracticable business models and oversimplified and unrealistic financial forecasts; 13 of these issuers disclosed identical amounts for their funding targets, maximum funding requests, price per share of stock, number of shares to be sold, total number of shares and equity valuation; three of these issuers had identical language in the “Risk Factors” sections of their websites; and two issuers listed identical officers and directors even though they had vastly different business plans.  Additionally, UFP had reason to know that four of these issuers either had officers or directors who owed back taxes or had not filed an annual tax return for 2015.   FINRA also alleged that UFP violated Funding Portal Rule 200(c)(3), which prohibits funding portals from including any issuer communication on its website that it knows or has reason to know contains any untrue statement of material fact or is otherwise false or misleading.

On December 8, 2016, the Securities and Exchange Commission’s (“SEC”) Division of Corporation Finance (the “Staff”) released several new compliance and disclosure interpretations (“C&DIs”) clarifying the definition of “foreign private issuer” (an “FPI”) under Rule 405 (“Rule 405”) under the Securities Act of 1933, as amended (the “Securities Act”), and Rule 3b-4(c) (“Rule 3b-4(c)”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). On the same day, the Staff issued additional C&DIs, which provide explanations on the permitted use of an F-Series registration statement and Form 20-F by an FPI (and its subsidiaries) in certain contexts. This alert provides a brief summary of these C&DIs.

Read our client alert.

On December 8, 2016, the staff of the Division of Corporation Finance provided additional guidance in the form of Compliance and Disclosure Interpretations (“C&DIs”) related to the types of securities that may be counted toward the Rule 144A $100 million threshold.  For example, the C&DIs confirm that securities purchased and held on margin may be counted as “owned” for purposes of calculating whether the entity meets the $100 million threshold, provided that the securities are not subject to a repurchase agreement.  (Question 138.05).  Similarly, an entity may count securities that have been loaned to borrowers.  (Question 138.06)   However, the entity cannot count securities that it has borrowed, since these securities are not “owned.”  (Question 138.07)  An entity also cannot count short positions in securities for the same reason—these do not represent an ownership interest.  (Question 138.08)

The Staff guidance also addressed aggregation with respect to fund families in the context of determining whether these entities are QIBs.  The Staff has clarified that, when assessing QIB status for a family of funds, the investments held by funds that are not registered investment companies cannot be aggregated with the investments held by registered investment companies in the fund family.  (Question 138.09)

Finally, the Staff addressed assessing equity ownership of limited partnerships for purposes of Rule 144(a)(1)(v).  In this context, the Staff notes that the limited partners are the equity owners of a limited partnership.  The general partner, unless that person is also a limited partner, need not be considered in determining whether a limited partnership is a QIB.  (Question 138.10)

The C&DIs are accessible here: