The President today signed the Economic Growth, Regulatory Relief and Consumer Protection Act. Most of the bill is centered around easing some Dodd-Frank restrictions as they apply to smaller banks. But buried in Section 508, called “Improving Access to Capital,” Congress adopted a major change to Regulation A+. Previously, the Reg A+ rules required, in Section 251(b)(2), that a company cannot use Reg A+ if it is subject to the SEC reporting requirements under Section 13 or 15(d) of the Securities Exchange Act immediately prior to the offering. This includes, for example, every company listed on a national exchange such as Nasdaq or the NYSE and many companies that trade over-the-counter. The new law reverses that and orders the SEC to change the rules to permit reporting companies to utilize Reg A+.
In addition, currently, Rule 257 of Reg A+ requires companies completing Tier 2 (raising any amount up to $50 million) offerings to file specified periodic and current reports under what has become known as “light reporting” if they do not become full reporting companies. The new law directs the SEC to amend that to say that a reporting company that conducts a Tier 2 offering going forward will be deemed to have met the periodic and current reporting requirements under that rule if they file what is required of a full permanent SEC reporting company.
What are the implications of this change? Allowing already public and reporting companies to use Reg A+ will provide them access to the unique benefits of this streamlined public offering process. Over-the-counter companies can conduct a Tier 2 public offering free of state blue sky merit review. All companies can use broad “testing the waters” with online or broadcast promotion of their public offering to anyone – this is limited to institutional investors otherwise. The SEC also has been giving much more limited review to these filings, which are completed quickly.
While this is a very positive change it has somewhat limited benefit. Companies trading on national exchanges, as well as over-the-counter companies with market capitalizations in excess of $75 million, can use short registration Form S-3 after they have been public for a year, so long as they have filed all their quarterly filings on time for the prior year. Using S-3 is generally much quicker, cheaper and simpler than even a Reg A+ offering. So as a practical matter this is only likely to help over-the-counter companies with market capitalizations below $75 million, companies that went public less than a year ago and listed companies who missed a filing deadline in the last year. But it is a positive development nonetheless.
In reaction to the growth and popularity of cryptocurrencies and digital tokens, the SEC has recently begun to exercise its authority over the digital asset market. The SEC, which is responsible for oversight of the securities markets in the United States, has determined that most cryptocurrencies and digital tokens are by definition “securities” and therefore subject to its jurisdiction under the federal securities laws. Consistent with that view, the SEC has made public statements, issued investor alerts and carried out enforcement actions addressing digital assets within the traditional legal framework for primary offerings and secondary market trading of securities.
Receiving less attention but no less significant are the activities of investment professionals who are advising others on investing in cryptocurrencies and digital tokens. Digital assets are becoming widely viewed as a distinct asset class which can offer investors additional alpha and diversification strategies, and investment professionals and private hedge funds are quickly becoming active institutional players in the market. Continue reading Investment Advisers and Cryptocurrencies
The Securities and Exchange Commission (SEC) has made it clear that it considers all initial offerings of cryptocurrencies and digital tokens as offerings of securities. The matter is not completely free from doubt, as many cryptocurrency market participants continue to take issue with the SEC’s view. It is not inconceivable that the matter will ultimately end up in court or become the subject of legislation given the breadth of the ICO market, the potential of the underlying blockchain technology and the vast sums of money at stake. The SEC, however, has given all securities lawyers, accountants and underwriters fair warning, that for the present, almost all digital tokens and cryptocurrencies will be treated as securities under the federal securities laws and that any offer or sale of digital assets must be registered with the SEC or qualify for a valid exemption from registration.
The following link is a table that sets forth the terms of the more common methods of conducting securities offerings under federal securities law and SEC rules and regulations. Failure to fully comply with one of the offering alternatives can result in liability for investment losses, investor rescission rights, SEC civil penalties and criminal sanctions.
Click here to access the table “Securities Offering Requirements”: ICO Securities Offerings
Since the release of Bitcoin in 2009, cryptocurrencies and digital tokens powered by blockchain technology have garnered the attention of investors, financial intermediaries and government agencies. Sales of digital tokens representing cryptocurrencies or some other digital asset or utility in so-called initial coin offerings (ICOs) have provided over $10 billion in capital to technology startups, and the aggregate market value of digital coins has surpassed $325 billion. ICOs have been typically open to the public through website platforms that link to white papers describing a startup’s technological proposition. More often than not, ICOs fund little more than concepts and ideas rather than development stage businesses. Staying largely under the radar of financial regulators, many ICOs have been a source of fraud, market manipulation and the financing of illegitimate ventures.
The investigative report of the Securities and Exchange Commission (SEC) on The DAO in July 2017 served as a point of departure for the ICO marketplace. Over a 30-day period in mid-2016, The DAO, a digital decentralized autonomous organization initiated on the Ethereum blockchain, issued digital tokens worth $150 million to fund various “projects” that would be voted on by token holders. Investors in the tokens would share in the earnings from these projects and could sell DAO tokens on the open market over cryptocurrency exchanges. The SEC found that The DAO tokens were in fact securities under longstanding securities law principles and that any offer or sale of the tokens was subject to registration with the SEC unless there was a valid exemption. The SEC applied the Howey test, which dates back to 1946, in its analysis. Under the Howey test, a digital token is a security if it represents an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. The SEC concluded The DAO token squarely met the criteria under the Howey test, and found that the tokens were securities sold without registration or a valid exemption. The SEC also indicated that the platforms that traded The DAO tokens were required to register under a national securities exchange or operate under an exemption. Continue reading Cryptocurrencies and Digital Tokens as Securities
The recent spate of high-profile cybersecurity breaches has not spared public companies, as demonstrated by large data breaches in recent years involving Equifax Inc. (NYSE: EFX) and a multitude of other companies. In response to the proliferation of cybersecurity threats to public companies, on February 21, 2018, the SEC released interpretive guidance to assist companies in preparing disclosures about cybersecurity risks and incidents. The release, which expands upon the staff’s 2011 guidance and addresses several new topics, was adopted unanimously by the full SEC and, therefore, carries significant weight.
As the SEC release makes clear, in order to meet their ongoing disclosure requirements, public companies should adequately and timely disclose any and all material cybersecurity risks and incidents in their registration statements and in their periodic and current reports. Public companies must weigh the potential materiality and likelihood of identified risks and, in the case of cybersecurity incidents, the importance of any compromised information and the impact on their operations. Further, the SEC encourages the use of Forms 8-K and 6-K to promptly disclose cybersecurity risks and incidents, as it will help to reduce the risks of selective disclosure and insider trading. The SEC guidance indicates that, although some time may be needed to discern the scope and implications of a cybersecurity incident, an ongoing internal or external investigation would not, on its own, provide a basis for avoiding disclosures of a material cybersecurity incident. The release includes specific guidance on a number of disclosure elements required by Regulation S-K and Regulation S-X, including risk factors, management discussion and analysis, description of the business, legal proceedings, financial statements and board risk oversight. Continue reading SEC Releases New Guidance on Cybersecurity Disclosures for Public Companies
On Wednesday, February 21, 2018, the United States Supreme Court held, 9-0, in the case of Digital Realty Trust, Inc. v. Somers that the term “whistleblower” under the Dodd-Frank Wall Street Reform and Consumer Protection Act does not include individuals who report violations of securities laws internally to their companies but not to the United States Securities and Exchange Commission.
In Digital Realty Trust, Paul Somers sued his former employer, Digital Realty Trust, alleging that his employment was terminated because he reported certain suspected securities laws violations to Digital Realty Trust’s senior management and that such termination constituted an unlawful retaliation against a whistleblower under the Dodd-Frank Act. The Court held in favor of Digital Realty Trust, stating that the whistleblower anti-retaliation provision under the Dodd-Frank Act does not protect individuals who have reported alleged misconduct internally to their employer, but not to the SEC.
In reaching its conclusion, the Court focused on the actual text of the anti-retaliation provision of the Dodd-Frank Act as well as the Dodd-Frank Act’s purpose. The Court noted that the Dodd-Frank Act defines a “whistleblower” as “any individual who provides…information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission.” Further, the Court stated that the purpose of the Dodd-Frank Act was to aid the SEC’s enforcement efforts by motivating people who know of securities law violations to tell the SEC.
The Court’s ruling overturned the Ninth Circuit’s March 2017 ruling and resolved a split between the Ninth and Fifth Circuits. In March 2017, the Ninth Circuit found that Mr. Somers was entitled to protection under Dodd-Frank Act. In July 2013, the Fifth Circuit ruled in the case of Asadi v. G.E. Energy that whistleblowers must take their complaints to the SEC to be eligible for protection under the Dodd-Frank Act.
Today, Sebastian Abero, the head of the SEC’s Office of Small Business Policy, had some very positive news for those interested in the new Regulation A+. He revealed that, since the Reg A+ rules were adopted by the SEC in June 2015, through September 2017, there have been 69 completed Reg A+ offerings raising a total of $611 million. That’s an average of $8.8 million per deal. As we also know, seven of those companies completed offerings that immediately commenced trading on national securities exchanges.
Abero was speaking at the annual SEC Government-Business Forum on Small Business Capital Formation, this year being held in Austin, TX. Other speakers included SEC Chairman Jay Clayton. Mr. Clayton’s remarks focused on helping what he called “Mr. and Ms. 401(k)” obtain opportunities to invest in growth companies. He acknowledged that a “one size fits all regulatory structure does not fit all” as he talked about the benefits of scaled disclosure for smaller issuers. He acknowledged there is room for improvement in the regulations to remove some of the “speed bumps” in the path to capital formation. He also hinted at expanding which companies can benefit from reduced disclosure as “smaller reporting companies.”
Investment banker Mark Elenowitz also spoke this morning at the Forum and pushed to increase the maximum that can be offered in Reg A+ deals to $75 million (a bill is working its way through Congress to do that). Nasdaq Vice President AnneMarie Tierney agreed with increasing the cap. She also talked about the challenges of best efforts underwritings in Reg A+ deals. The best efforts deals can garner less aftermarket support than in firm commitment underwritings. Panelists also suggested that the resales of Reg A+ securities should be exempt from SEC registration when trading in the over-the-counter markets. Currently issuers have to rely on certain somewhat cumbersome exemptions.
At this week’s Practising Law Institute’s Annual Institute on Securities Regulation, SEC Chairman Jay Clayton commented, among other things, on initial coin offerings, or ICOs. As we know, this year alone billions of dollars have been raised in ICOs, where cryptocurrency in the form of a “token” or coin is sold to investors to raise money for a company or other business endeavor. The tokens often trade on an online platform. Previously the SEC had issued a warning saying that the tokens may be securities and to be careful. Prior to that players were assuming securities laws did not apply. They also last week issued a warning to celebrities about risks of endorsing ICOs.
Chairman Clayton went a bit further today, going off his script to say that he has yet to see an ICO that doesn’t have “sufficient indicia” of being a securities offering. He also mentioned that the trading platforms could face SEC scrutiny and might have to either register as national securities exchanges or make clear they have an exemption from doing so.
While there may well be circumstances in which structures can be implemented to avoid being deemed securities, it seems there could be an exciting opportunity for ICO promoters to conduct their offerings under the securities laws, and allow trading of tokens on proper SEC approved exchanges. There would still be real benefits, including not diluting insiders’ ownership of their company. This could reduce the risk of fraud and still encourage capital formation.
In a HUGE announcement last week, Nasdaq, Inc., the parent company of the various stock exchanges bearing that name, decided the exchanges should no longer be called NASDAQ. Instead, they are “re-branding” as just plain Nasdaq, i.e. initial cap then lower case.
Why? Well, the name had been upper case because it stood for the National Association of Securities Dealers Automated Quotation system. The NASD no longer exists since it was merged in 2007 with the NYSE’s regulatory arm to form the Financial Industry Regulatory Authority (FINRA). So they’re acknowledging that people just know “Nasdaq” and it doesn’t need to stand for anything anymore.
The NYSE also recently re-branded its lower tier market from NYSE MKT to NYSE American, harkening back to the exchange’s prior history as the American Stock Exchange before the NYSE bought it. Does this stuff matter to anyone? Do these changes result from big high level strategy meetings? As a former marketing major, I would love to know. But alas likely we shall not. You are now free to continue going about your day.
The Regulation A+ rules adopted by the SEC in 2015 included scaled reporting obligations to assist in reducing issuers’ offering costs as against a traditional IPO. However, if a company is seeking to become a full Securities Exchange Act reporting company, which is required if it is planning a national exchange listing, its disclosure must follow traditional IPO Form S-1 level disclosure, without the benefit of scaling. The one exception: even these companies may utilize financial statements that are up to nine months old. Normally in a Form S-1 your financials cannot be more than 135 days “stale.” Last month, the SEC and Nasdaq permitted Chicken Soup for the Soul Entertainment Inc. to go public, trade on Nasdaq and complete its Reg A+ offering with no financial information from 2017. The other three Reg A+ issuers that have completed IPOs onto national exchanges utilized financials that were no more than 135 days old.
The unanswered question, however, was this: is a company that does not have “current” financials in its Regulation A+ offering documents immediately out of compliance with reporting obligations right after it becomes a full reporting company upon completion of the IPO? The SEC answered this in a positive way last week with several Compliance and Disclosure Interpretations (C&DIs). The answer: if you have missing quarterly reports on Form 10-Q when you finish your IPO, you are given 45 days from then to file them. If you are missing an annual report on Form 10-K, you have 90 days to complete that.
This small piece of guidance adds another substantial cost-saving benefit to Reg A+. The ability to defer the preparation and reporting of four and one-half months of financial information beyond what Form S-1 would require allows a company to deal with that cost after it raises money in its IPO, if it is comfortable that the scaled disclosure will not impede the ability to complete the fundraising and IPO.