David N. Feldman

Trump’s Order on Reducing Regulations Does Not Apply to the SEC

On January 30, Pres. Trump issued an executive order that for every new regulation proposed, an agency must eliminate two old regulations. The order also requires the net cost of a new regulation to be zero after taking into account cost savings from regulations eliminated. Military and national security regulations are exempt from the order. The head of the Office of Management and Budget also is allowed to make exceptions. In signing the order, the President was surrounded by small business leaders, and said, “We’re cutting regulations massively for small business … that’s what this is about today.”

Many in the capital markets space feared this could hamper the SEC’s rulemaking process, as some “new regulations” can actually reduce regulatory burdens. For example, many have sought to convince the SEC to expand the use of short form registration on Form S-3 to all reporting companies – which would enhance opportunities for capital formation but would require a new regulation. Thankfully, last week the White House issued interim guidance on the order. Among other things, it said the order does not apply to “independent agencies” (ie those that are outside the federal executive departments), which includes the SEC.

A number of liberal groups filed a lawsuit last week to challenge the order, saying it forces agencies to be arbitrary, and that the order was outside the President’s powers. They are seeking an injunction to kill the order. Many, frankly, are scratching their heads over this order. Even those who strongly support easing business regulation are not sure this is the best way to do it. At least the SEC (and most of the finance-related agencies) may move forward in its usual manner.

 

David N. Feldman

First Cannabis Company is Exchange-Listed Amid Uncertainty

In a major positive step for the cannabis industry, the New York Stock Exchange last month listed a new real estate investment trust called Innovative Industrial Properties (NYSE:IIPR), the first cannabis company to be listed on a US national exchange. The company plans to invest solely in real estate intended to be leased out to cannabis growers. In the IPO they raised $67 million, much less than expected. The price has not moved above the IPO price, but it has moved steadily up recently after an initial drop on its first few days of trading.

Other challenges analysts cite: the concentration of investment in one industry, management not experienced in cannabis, and the high uncertainty of the future of federal oversight under President-elect Trump. Trump has said he is fully behind medical marijuana, not a fan of recreational use but believes it should be up to the states, has been against the war on drugs for years and is certainly pro-jobs and pro-taxes coming in. But many are concerned about his nomination of Alabama Senator Jeff Sessions to be the next US Attorney General. As recently as this April, Sessions said, “Good people don’t smoke marijuana” and that it’s “not the kind of thing that ought to be legalized.”

Congress has kept the feds from using money to go after those properly complying with state cannabis laws. But those actions, in appropriation bills, have to be renewed each year, and recent parliamentary changes may make that more difficult. The key question will be whether Trump allows Sessions free rein on the issue. That’s the unknown. But this new listing is still very big for the industry, especially after Nasdaq’s very strong refusal to list MassRoots earlier this year.

David N. Feldman

SEC Issues Encouraging White Paper on Regulation A+ Performance

Following up on positive statements by senior SEC staffers at the recent PLI Securities Law seminar and the SEC small business forum in November, the Commission also recently issued a white paper on how things are going under updated Regulation A, now known as Regulation A+. The white paper can be viewed at http://bit.ly/2ihfssS.

As we have known, the big headline was that, through October 31, just 16 months after the new Reg A+ rules took effect, 20 issuers completed financings raising a total of $189.7 million. That’s an average of $9.485 million raised per deal. The SEC believes this number is understated due to the time frames tested. And the amount per deal is skewed somewhat by some very small financings that we know were completed. But still. As comedian Larry David might say, “Pretty pretty pretty pretty cool.”

Other interesting tidbits: of the 84 Reg A offerings qualified by the SEC since June 2015, a majority, 49, were Tier II and the rest were the smaller Tier I offerings. Probably more important, 85% of the funds sought to be raised in those qualified offerings were in Tier II deals. Issuers are still working to get more of these closed Tier II deals trading on an exchange, and that is expected in the months ahead. Also, equity deals rule, comprising 85% of the Reg A+ offerings. As we also knew, most of the offerings and closed deals were best efforts or self-underwritten.

But my favorite quote from the SEC: “Early signs indicate that Regulation A+ may offer a potentially viable public offering on-ramp for smaller issuers—an alternative to a traditional registered IPO—and either an alternative or a complement to other securities offering methods that are exempt from Securities Act registration.” Here comes 2017!!

David N. Feldman

SEC Approves Important Rule 504 Changes

A little known and little used part of Regulation D under the Securities Act is about to get some new attention. In what appears to be a gift to the states after somewhat eviscerating their power with the Regulation A+ changes, the SEC, on October 26, 2016, approved final changes to Rule 504. This rule now allows raising up to $5 million in an offering exempt from SEC registration, with as many accredited and non-accredited investors as you would like. The prior limit was $1 million.

There are two ways to use Rule 504. First, you can raise money with no advertising or general solicitation, and not be required to seek SEC or state approval; the securities issued will be “restricted, in other words not able to be publicly traded. Second, you can advertise and solicit, and the stock can trade afterwards on the OTC Pink market, if you go through a registration process in the states where you are making offers. In that case, even though the stock trades, the company does so as a non-reporting company (but some basic information is still filed with OTC Markets). In both cases there would be no SEC filings. And for those seeking to trade and offer in multiple states, many states “piggyback” and do not require a separate reviewif another state has already approved; and sometimes a coordinated review process can be applied.

Unfortunately, a while back, some unsavory types got in trouble for conducting Rule 504 offerings with no information, then getting involved in manipulative trading and the like. But as with other techniques, like reverse mergers, that had been abused, there were and are legitimate quality players in the space. Hopefully they will see this newly increased limit as making Rule 504 much more attractive as they consider the growing panoply of financing options now available for smaller companies.

 

First SEC Staff Comments on Recent Non-GAAP CDIs

As many of us have noticed, the first comment letters from the staff in the SEC’s Division of Corporation Finance, following Corp Fin’s recent issuance of new CDI guidance on the presentation of non-GAAP financial measures, have become available publicly.  The comment letters shed additional useful light on Corp Fin’s views concerning non-GAAP presentations.

One of the comment letters sent to Alexandria Real Estate Equities, Inc. on June 20, 2016, provides a particularly helpful glimpse into Corp Fin’s views about the use of non-GAAP information in the executive summary of MD&A.  The staff’s letter includes the following comment in reference to MD&A in the registrant’s 2015 Form 10-K:

We note that in your executive summary you focus on key non-GAAP financial measures and not GAAP financial measures which may be inconsistent with the updated Compliance and Disclosure Interpretations issued on May 17, 2016 (specifically Question 102.10). We also note issues related to prominence within your earnings release filed on February 1, 2016. Please review this guidance when preparing your next earnings release.

Indeed, the executive summary portion of the MD&A – when initially conceptualized in the SEC’s 2003 release providing interpretive guidance in the preparation of MD&A – was supposed to include an overview to facilitate investor understanding.  The overview was intended to reflect the most important matters on which management focuses in evaluating operating performance and financial condition.  In particular, the overview was not supposed to be duplicative, but rather more of a “dashboard” providing investors insight in management’s operation and management of the business.

Looking back at the release to write this blog entry, I note references, with regard to Commission guidance on preparation of the MD&A overview, explaining that the presentation should inform investors about how the company earns revenues and income and generates cash, among other matters, but should not include boilerplate disclaimers and other generic language.  The Commission even acknowledged that the overview “cannot disclose everything and should not be considered by itself in determining whether a company has made full disclosure.”

Many companies have presented in their MD&A overview those non-GAAP measures used by management to operate the business and otherwise manage the company.  Where appropriate, references typically are made to the information appearing elsewhere in the document, presented to enable compliance with applicable rules and guidance for non-GAAP presentations.  Interestingly, the staff, in its comment, questions the “prominence” of the non-GAAP presentation in the context of the earnings release (noting that the staff provides less specificity in the portion of its comment relating to the MD&A overview).  This focus on prominence – to the extent the staff’s concerns relate to the MD&A overview – is worth further consideration in preparing MD&A disclosure.   In this connection, query whether the staff – in questioning prominence – could be expressing a view that when management analyzes for investors the measures on which it focuses in managing the business, if management relies on non-GAAP measures, it necessarily must focus on (and explain) – with no less prominence – the corresponding GAAP measures.

David N. Feldman

SEC Proposes Expansion of Those Eligible For Scaled Reporting as “Smaller Reporting Companies”

On June 27, 2016, the SEC released a proposal that would increase the number of companies eligible to be “smaller reporting companies.” SRCs get the benefits of reduced disclosure over other public companies, such as two years of financial statements instead of three. To be an SRC, currently you have to have a public trading float value below $75 million, or if your float is zero, then revenues less than $50 million. The SEC is proposing increasing these thresholds to either a public float of less than $250 million, or if no float, then revenues of less than $100 million.

The JOBS Act created “emerging growth companies” (EGCs) which get some of the same benefits as SRCs. But EGC benefits go away with time whereas the SRC benefits do not. Plus, companies that went public before the JOBS Act generally cannot be EGCs. So why is all this cool? Because it was recommended multiple times at the annual SEC small business conference by folks like your humble blogger, and also by the SEC’s advisory committee on small and emerging companies.

Why else is it cool? Because the pool of SRCs has dropped from 42% to 32% of all public companies since the SRC rules were set up. So fewer companies get the benefit. With these proposed changes the SEC projects it would go back to 42%.

David N. Feldman

Analysis of Court Ruling Upholding SEC Regulation A+ Rules

I have now had a chance to read the 23-page, very well-written, clear and concise DC Circuit court opinion on the Reg A+ challenge brought by two states (see entry below). The ruling started with a brief history of securities law, how it started with the states but moved to add federal oversight after the 1929 market crash. Offerings exempt from full SEC registration for smaller companies have been around for a long time, and Reg A actually was first adopted in 1936. In 1996, Congress preempted state oversight of offerings involving “covered securities,” at first essentially those to trade on national exchanges such as Nasdaq or the NYSE. The JOBS Act in 2012 expanded covered securities to include those issued in Reg A+ offerings to “qualified purchasers,” a term the Act said was to be defined by the SEC. The SEC said everyone is qualified because of additional investor protections in the new rules.

To succeed in their challenge, the states would have had to prove 1) that the Act “unambiguously foreclosed” the opportunity for the SEC to write the rules the way they did or 2) that the rules were “arbitrary and capricious” and serving no valid economic purpose. The states actually tried to argue that the JOBS Act was not clear in preempting state review of Reg A+ offerings. The Court clearly and strongly disagreed and made clear it was Congress, not the SEC, preempting the states. They also stated firmly that the SEC was given very broad power in the Act to write the definition of qualified purchaser almost entirely as they wished, regardless of prior proposals on other matters and even regardless of the plain meaning of the words. And it also noted that they added further protections such as the limit on investments by non-accredited investors and the enhanced disclosure and reporting obligations, as well as clearly demonstrating the economic benefits of the new rules (um it’s called the JOBS Act!). So, said the Court, they were not foreclosed by the law to act as they did and they did not act in an arbitrary or capricious fashion.

There is a broader legal discussion about the breadth of powers of administrative agencies to implement statutory edicts, but that is for another day and probably a legal journal in any event. Let us hope that the states that brought this and their supporters accept the ruling, take their licks and move on. One assumes they would not want to appeal just to be even further rebuked by a full appeals panel. So….let’s do some deals!

David N. Feldman

Flash: Court Shoots Down State Challenge to Reg A+ Rules

Very good news: the DC Circuit today rejected the effort by two states (Massachusetts and Montana) to invalidate the SEC’s rules enacted to implement Regulation A+ and Title IV of the Jumpstart Our Business Startups (JOBS) Act of 2012. We are waiting to review the actual decision, but the court’s decision, written by Judge Karen L. Henderson, said the SEC made rules that were not arbitrary or capricious, the grounds on which they were being challenged.

As I understand it, the states’ only choice at this point would be to appeal directly to the US Supreme Court. The Supremes take a very small percentage of cases seeking their involvement, though one cannot predict what MA and MO will seek to do. As we know, the states were supported and backed by the North American Securities Administrators Association (NASAA) which represents the securities regulators of all the states.

More to come after we review the decision. But this is a critically positive development for the continuing acceptance, growth and use of new Regulation A+ to help smaller companies grow, raise capital and create jobs.

David N. Feldman

How to Modernize “Accredited”?

The SEC’s Advisory Committee on Small and Emerging Companies, co-led by Sara Hanks, met the other day to talk about how to update the definition of “accredited investor” following a detailed report issued by the SEC back in December. As we know, only accrediteds are permitted to invest in certain types of securities offerings.

The 1982 thresholds in SEC Regulation D say you’re accredited with $200,000 annual income or a $1 million net worth (now excluding your primary residence). I know my friends will be mad at me, but if you go to www.dollartimes.com, it tells you that $200,000 in 1982 dollars is worth $503,244 today after inflation. Luckily it doesn’t appear anyone at the SEC is proposing increasing the amount that much. And they are also considering letting you be accredited if you have certain types of licensing, such as an accountant or financial planner. They also are considering not increasing the thresholds but limiting the amount you can invest if you make over $200,000 but less than some other level. They’re even considering developing an exam to show you are sophisticated regardless of income.

So I don’t think it’s whether but when these changes will be made, and how severe they will be. I like expanding it to knowledgeable folks even if not meeting income standards. Reg D offerings have been the bulwark of the investment community for decades. Let’s hope the staff and Commissioners (including the two new ones who are coming, having been approved by the Senate Banking Committee today) don’t jigger with it too much.

David N. Feldman

SEC Completes JOBS & FAST Act Rulemakings

Last week the SEC proudly announced the completion of its rulemaking obligations under the Jumpstart Our Business Startups (JOBS) Act of 2012 and the mini-JOBS Act 2.0 tacked onto the Fixing America’s Surface Transportation (FAST) Act. The last rules had to do with implementing the increase in the number of shareholders triggering an obligation to become a full SEC reporting company. They also spent lots of time on the Regulation A+ rules and new Regulation CF for “statutory” crowdfunding which are also complete. CF is just days away from being effective, the Reg A+ rules have been in effect almost a year now.

There is other work still pending under JOBS. For example, the SEC recently put out a 300+ page concept release talking about ideas to modernize some of the disclosure requirements in SEC Regulation S-K. The JOBS Act mandates that they examine this and hopefully implement some changes. One of the most interesting, which I’ve been pushing for years: let’s allow smaller public companies to eliminate burdensome disclosure requirements if they are not material to an investor’s understanding of the company. This is similar to SEC rules for disclosure in private companies to non-accredited investors. But this is still developing.

The last rule change? Per the SEC release, “As a result of JOBS Act and FAST Act changes, an issuer that is not a bank, bank holding company or savings and loan holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are ‘held of record’ by either 2,000 persons, or 500 persons who are not accredited investors.  An issuer that is a bank, bank holding company or savings and loan holding company is required to register a class of equity securities if it has more than $10 million of total assets and the securities are ‘held of record’ by 2,000 or more persons.” This is good.