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.
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.
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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.
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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.
- 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
On September 12, 2016, the United States Chamber of Commerce’s Center for Capital Markets Competitiveness hosted a webinar to discuss the policy recommendations outlined in its report titled “A Plan to Reform America’s Capital Markets” (the “Report”). The Report provides policy recommendations for the next administration and Congress to reform the capital markets in order to address current inefficiencies and inadequacies in the regulation and government oversight of the capital markets. The Report includes a number of recommendations relating to financial services regulation, which are not the subject of this blog post. With respect to capital formation, the Report addresses the following:
Financial reporting, corporate governance, and disclosure effectiveness: The Report recommends establishing consistent definitions of “materiality” and rules of procedure for the SEC, the Financial Accounting Standards Board (FASB), and the Public Company Accounting Oversight Board (PCAOB), and developing a disclosure framework to more clearly present pertinent information to investors. The Report asks that the SEC initiate changes to Exchange Act Rule 14a-8 and modernize shareholder resubmission thresholds. The Report also advocates the repeal of rules unrelated to the SEC’s mission, including the SEC’s conflict minerals rule, resource extraction rule, and pay ratio disclosure rule, and recommends the re-proposal of the SEC’s pay-for-performance rule and clawback rule. In addition, the Report calls for the creation of a Financial Reporting Forum, composed of SEC, FASB, and PCAOB representatives, as well as investors and businesses, tasked with identifying and addressing emerging financial reporting issues.
Capital formation and FinTech: The Report discusses the success of the JOBS Act in enabling more efficient investment for smaller companies and emerging growth companies (EGCs) and recommends passing “JOBS Act 2.0” and related bills that promote capital formation and help increase access to capital for small businesses. The Report also advocates the creation of a congressional bi-cameral committee, comprised of members of the House Committee on Financial Services and the Senate Committee on Banking, Housing and Urban Affairs, to study the current FinTech landscape and provide policy and legislative recommendations to both Houses of Congress.
A copy of the Report is available here.
In the years following the JOBS Act, which created the term “emerging growth company” and made available certain disclosure and other accommodations to companies that qualified as EGCs, there has been renewed focus on scaled disclosure. Today, the Securities and Exchange Commission has proposed amendments to the definition of “smaller reporting company” as used in the SEC rules and regulations. The proposed amendments, which would expand the number of registrants that qualify as smaller reporting companies, are intended to promote capital formation and reduce compliance costs for smaller registrants, while maintaining investor protections. Registrants with less than $250 million in public float would qualify, as would registrants with zero public float if their revenues were below $100 million in the previous year.
Read our client alert here:
See the proposing release here: https://www.sec.gov/rules/proposed/2016/33-10107.pdf.
On May 23, 2016, the House passed H.R. 4139, the Fostering Innovation Act, by voice vote. The bill had passed the House Financial Services Committee on March 2, 2016.
H.R. 4139 proposes to extend the temporary auditing exemption for emerging growth companies for five years, in order for EGCs to comply with Section 404(b) of the Sarbanes-Oxley Act. This bill serves as a way of alleviating the burdensome costs that smaller public companies incur when having to comply with Section 404(b). This would, in turn, allow these companies to focus their resources on growth, rather than on these compliance costs.
Financial Services Committee Chairman Jeb Hensarling commented on the passing of this and other bills and stated: “I believe most of us would agree that our economy works better for all Americans when small businesses can focus on creating jobs rather than navigating bureaucratic red tape.”
While H.R. 4139 passed with strong bipartisan support, Investor Advocate Rick Fleming had urged members of Congress to vote against it. In a letter to Speaker of the House, Paul Ryan, and to Minority Leader, Nancy Pelosi, Fleming warned that passing H.R. 4139 would “chip away” at the protections set in place by Sarbanes-Oxley, ones set in place as a “second set of eyes” in order to prevent another scandal that would affect American investors. Additionally, Fleming states that H.R. 4139 would further compound the complexity of U.S. securities laws/reporting requirements by creating another category of issuer.
At today’s House Financial Services Committee meeting, ten bills relating to facilitating access to capital and the reduction of regulatory burden on smaller reporting companies were approved. Among the bills that passed the committee, the following relate to capital formation:
- HR 4139, The Fostering Innovation Act, passed the committee 42-15. The bills proposes to extend the Sarbanes-Oxley 404(b) exemption for EGCs until the earlier of ten years after the EGC’s IPO, the end of the fiscal year in which the EGC’s average gross revenues exceed $50 million, or when the EGC becomes an accelerated filer ($700 million in public float).
- HR 4498, The Helping Angels Lead Our Startups (HALOS) Act, passed the committee 44-13. The bill establishes a definition of an angel investor for securities law purposes, and clarifies the definition of “general solicitation.”
- HR 4638, The Main Street Growth Act, passed the committee 32-25. The bill would allow for the registration and creation of venture exchanges in order to facilitate a secondary market, including for companies that have undertaken Regulation A offerings.
In his opening remarks, Financial Services Committee Chairman Jeb Hensarling noted that both HR 4498 and HR 4638 would “…help ignite the entrepreneurial spirit by helping small businesses attract investments so they can open their doors even wider.”