The U.S. Department of the Treasury issued its second report (of four reports), titled “A Financial System that Creates Economic Opportunities, Capital Markets.”  The Report was issued in response to Presidential Order 137772 setting forth the Core Principles that should guide regulation of the U.S. financial system. The Report addresses various elements of the capital markets, from the equity and debt markets, to the U.S. Treasury securities market, and to derivatives and securitization.  The recommendations relating to the U.S. IPO market and reducing the regulatory burdens for companies seeking to undertake an IPO as well as for smaller public companies may be very familiar to readers of this blog, since many of the measures are included in the Financial CHOICE Act or otherwise addressed in proposed legislation or in rule proposals from the SEC.

See our alert, which may be accessed here.

On October 2, 2017, Congressmen Ted Budd (R-NC) and Gregory Meeks (D-NY) introduced a bipartisan bill, H.R. 3903, in the U.S. House of Representatives.  The bill proposes amendments to the Securities Act of 1933, as amended, to increase initial public offering (“IPO”) and follow-on activity. The proposed legislation extends three JOBS Act provisions currently available to emerging growth companies to all issuers: (1) submission of a draft registration statement for confidential nonpublic review by the SEC prior to the public filing of the IPO registration statement; (2) within the one-year period following an IPO, confidential submission of a draft registration statement for an offering; and (3) the ability to test-the-waters with institutional investors.  The SEC’s Division of Corporation Finance’s policy changes earlier in the year already have addressed confidential submissions for IPOs as well as follow-on offerings undertaken within twelve months of an IPO; however, the bill would ostensibly extend the confidentiality provisions contained in Securities Act Section 6(e)(2) for these draft registration statements.  Currently, those confidentiality provisions are available only for EGCs and confidential submissions made under the new SEC policy must be the subject of a Rule 83 confidential treatment request.  Also, the bill would address the ability to test the waters, which was not addressed by the Division of Corporation Finance.

The text of the bill is available here.

Recently, the Financial Executives Research Foundation (FERF) published a white paper titled, “Growing Past Emerging Growth: Five Years After the JOBS Act,” which highlights areas of focus for emerging growth companies (EGCs) that took advantage of the 2012 JOBS Act and now are losing their EGC status. In particular, the white paper notes the importance of developing a transition plan. Companies ceasing to be EGCs will be required to prepare full compensation disclosures. The more significant hurdle for most companies is addressing Sarbanes-Oxley Section 404 auditor attestation requirements. The white paper provides helpful suggestions on marshalling the requisite resources to prepare for compliance.

The Staff of the Division of Corporation Finance recently posted additional guidance regarding the financial information that an EGC may omit from its draft registration statements, as well as guidance for non-EGC issuers.  See below the Staff’s guidance:

Question 1

Question: What financial information may an Emerging Growth Company omit from its draft and publicly filed registration statements?

Answer: Under Section 71003 of the FAST Act, an Emerging Growth Company may omit from its filed registration statements annual and interim financial information that “relates to a historical period that the issuer reasonably believes will not be required to be included…at the time of the contemplated offering.”  Interim financial information that will be included in a longer historical period relates to that period.  Accordingly, interim financial information that will be included in a historical period that the issuer reasonably believes will be required to be included at the time of the contemplated offering may not be omitted from its filed registration statements.   However, under staff policy, an Emerging Growth Company may omit from its draft registration statements interim financial information that it reasonably believes it will not be required to present separately at the time of the contemplated offering.

For example, consider a calendar year-end Emerging Growth Company that submits a draft registration statement in November 2017 and reasonably believes it will commence its offering in April 2018 when annual financial information for 2017 will be required.  This issuer may omit from its draft registration statements its 2015 annual financial information and interim financial information related to 2016 and 2017.  Assuming that this issuer were to first publicly file in April 2018 when its annual information for 2017 is required, it would not need to separately prepare or present interim information for 2016 and 2017.  If this issuer were to file publicly in January 2018, it may omit its 2015 annual financial information, but it must include its 2016 and 2017 interim financial information in that January filing because that interim information relates to historical periods that will be included at the time of the public offering.  See also Question 101.05 for guidance related to registration statements submitted or filed by non-EGCs. [Aug. 17, 2017]

Question 101.04

Question: What financial information may an Emerging Growth Company omit from its draft and publicly filed registration statements?

Answer: Under Section 71003 of the FAST Act, an Emerging Growth Company may omit from its filed registration statements annual and interim financial information that “relates to a historical period that the issuer reasonably believes will not be required to be included…at the time of the contemplated offering.”  Interim financial information that will be included in a longer historical period relates to that period.  Accordingly, interim financial information that will be included in a historical period that the issuer reasonably believes will be required to be included at the time of the contemplated offering may not be omitted from its filed registration statements.   However, under staff policy, an Emerging Growth Company may omit from its draft registration statements interim financial information that it reasonably believes it will not be required to present separately at the time of the contemplated offering.

For example, consider a calendar year-end Emerging Growth Company that submits a draft registration statement in November 2017 and reasonably believes it will commence its offering in April 2018 when annual financial information for 2017 will be required.  This issuer may omit from its draft registration statements its 2015 annual financial information and interim financial information related to 2016 and 2017.  Assuming that this issuer were to first publicly file in April 2018 when its annual information for 2017 is required, it would not need to separately prepare or present interim information for 2016 and 2017.  If this issuer were to file publicly in January 2018, it may omit its 2015 annual financial information, but it must include its 2016 and 2017 interim financial information in that January filing because that interim information relates to historical periods that will be included at the time of the public offering.  [Aug. 17, 2017]

Question 101.05

Question: What financial information may an issuer that is not an Emerging Growth Company omit from its draft and publicly filed registration statements?

Answer: The relief provided by Section 71003 of the FAST Act is not available to issuers other than Emerging Growth Companies. However, under staff policy, an issuer that is not an Emerging Growth Company may omit from its draft registration statements interim and annual financial information that it reasonably believes it will not be required to present separately at the time it files its registration statement publicly. The issuer may not omit any required financial information from its filed registration statements.

For example, consider a calendar year-end issuer that is not an Emerging Growth Company that submits a draft registration statement in November 2017 and reasonably believes it will first publicly file in April 2018 when annual financial information for 2017 will be required. This issuer may omit from its draft registration statements its 2014 annual financial information and interim financial information related to 2016 and 2017 because this information would not be required at the time of its first public filing in April 2018. [Aug. 17, 2017]

The Staff of the Division of Corporation Finance has published these Frequently Asked Questions to assist issuers that are not emerging growth companies that would like to avail themselves of the confidential submission process. The FAQs also clarify that the ability to “test the waters” is limited to EGCs.

See here: https://www.sec.gov/corpfin/voluntary-submission-draft-registration-statements-faqs Continue Reading SEC Staff issues FAQs on Confidential Submissions

The Securities and Exchange Commission yesterday announced a new policy that essentially extends the confidential submission accommodation made available to emerging growth companies (EGCs) to all issuers.  The EGC process will continue unchanged.

Starting on July 10, the Commission will review a draft initial Securities Act registration statement and related revisions on a nonpublic basis subject to the same requirements applicable to EGCs that avail themselves of the confidential submission process.  Similarly, the Commission also will review a draft registration statement of a class of securities under the Exchange Act Section 12(b).  The Commission statement noted in its statement that it will also accept draft registration statements submitted prior to the end of the twelfth month following the effective date of an issuer’s initial Securities Act registration statement or an issuer’s Exchange Act Section 12(b) registration statement for nonpublic review.  A foreign private issuer may choose to rely on the policies applicable to EGCs, to the extent that they qualify, or rely on this new approach.

The full statement is available here.

Read our client alert.

On June 1, 2017, the Public Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, which the PCAOB believes will increase the relevance and utility of auditors’ reports by including additional information regarding the audit process, and other disclosures. Most significantly, the new standard requires inclusion in the audit report of a discussion of critical audit matters (CAMs) identified in the course of the audit. The new standard also contains an auditor tenure disclosure requirement and standardizes the format of the report, among other changes. The new standard retains the pass/fail opinion of the existing auditor’s report.

The new standard and other changes are subject to Securities and Exchange Commission (SEC) approval. Assuming that approval is obtained, the PCAOB expects the provisions, other than those related to CAMs, to take effect for audits for fiscal years ending on or after December 15, 2017. Provisions related to CAMs will take effect for (1) large accelerated filers, in connection with audits for fiscal years ending on or after June 30, 2019, and (2) all other filers, in connection with audits for fiscal years ending on or after December 15, 2020.

Read our client alert.

On June 1, 2017, the Public Company Accounting Oversight Board (PCAOB) adopted a new standard for auditor’s reports that requires a description of “critical audit matters,” for purposes of providing investors with information regarding the most challenging, subjective or complex aspects of the audit. Under the new standard, critical audit matters are defined as any matter arising from the current period’s audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex auditor judgment. If no critical audit matters arose from the audit, the auditor’s report must state that there were no critical audit matters. The communication of each critical audit matter in the auditor’s report must include: (a) the identification of the critical audit matter; (b) a description of the principal considerations that led the auditor to determine that the matter was a critical audit matter; (c) a description of how the critical audit matter was addressed in the audit; and (d) a reference to the relevant financial statement accounts or disclosures. Additional changes to the auditor’s report under the new standard include items that are intended to clarify the auditor’s role and responsibilities, provide additional information about the auditor and make the auditor’s report easier to read for investors. Under the new standard, the auditor’s report will still retain the pass/fail opinion of the existing auditor’s report.

The new standard will apply to audits conducted under PCAOB standards, but communication of critical audit matters will not be required for audits of: (1) broker-dealers reporting under Exchange Act Rule 17a-5; (2) investment companies other than business development companies (BDCs); (3) employee stock purchase, savings and similar plans; and (4) emerging growth companies (EGCs) as defined under Exchange Act Section 3(a)(80). The new standard is still subject to approval by the SEC. If approved, all provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after December 15, 2017. The provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019 for large accelerated filers and for fiscal years ending on or after December 15, 2020 for all other companies subject to such provisions.

A copy of the PCAOB’s fact sheet on the new standard is available at: https://pcaobus.org/News/Releases/Pages/fact-sheet-auditors-report-standard-adoption-6-1-17.aspx.

A copy of the PCAOB’s release on the new standard is available at: https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf.

Amongst other limitations, an issuer will cease to be considered an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act and unable to take advantage of the accommodations for such issuers set forth in the Jumpstart Our Business Startups Act if it has issued more than $1.0 billion of non-convertible debt securities over a rolling three-year period (not limited to completed calendar or fiscal years).  In general, all non-convertible debt securities issued over the prior three-year period, whether outstanding or not, are required to be counted against the $1 billion debt limit.  “Non-convertible debt” in this context means any non-convertible security that constitutes indebtedness, whether issued in a registered offering or not.  In calculating whether an issuer exceeds this $1 billion debt limit, the SEC Staff has interpreted all non-convertible debt securities issued by an issuer and any of its consolidated subsidiaries, including any debt securities issued by such issuer’s securitization vehicles, to count against the $1 billion debt limit.  As a result, asset-backed securities that are considered non-recourse debt and consolidated on a parent issuer’s financial statements for accounting purposes should be included when calculating the applicability of the $1 billion debt limit.  However, the SEC Staff does not object if an issuer does not count debt securities issued in an A/B exchange offer, as these debt securities are identical to (other than the fact that they are not restricted securities) and replace those issued in a non-public offering.

In March 2017, the Public Company Accounting Oversight Board, or PCAOB, released a white paper detailing certain characteristics and trends of emerging growth companies, or EGCs, based on its review of available data through November 15, 2016.  The White Paper highlights the following notable trends:

  • A Sizeable Number of Companies Identified Themselves as an EGC. There were 1,951 companies that identified themselves as EGCs in at least one SEC filing since 2012. This number excludes companies that were EGCs and since have transitioned and become large accelerated filers. As of November 15, 2016, the 742 exchange-listed EGC filers had $350 billion in market capitalization. EGC filers represent:
    • 15% of the 4,797 total companies listed on a U.S. national securities exchange; and
    • approximately 1% of total market capitalization of all exchange-listed companies.

Growth in Number of EGCs

Market Cap EGC

  • Characteristics of EGCs. The assets reported by EGC filers ranged from zero to approximately $19.4 billion. The average assets were approximately $245.9 million, while half of EGC filers reported assets of less than $5.9 million.  The annual revenue reported by EGC filers ranged from zero to approximately $978.5 million. The average revenue was approximately $56.6 million, while half of EGC filers reported revenue of less than $140,000.
  • Going Concern. Approximately 51% of EGC filers included a going concern paragraph in their financial statements.
  • The Majority of EGC Filers Provided a Management Report on Internal Control Over Financial Reporting. Approximately 65% of EGC filers (or 1,262 of 1,951) provided a management report on internal control over financial reporting in their most recent annual filing. Almost half (approximately 47%) of those EGC filers reported material weaknesses.

A copy of the White Paper is available here: http://business.cch.com/srd/PCAOBWhitePaperEGCs.pdf