A few months ago, a real estate company brought an action against the Securities and Exchange Commission, and apparently the SEC now has been served in the case, known as Platform Real Estate, Inc. vs. United States Securities and Exchange Commission. The federal case was filed in the Southern District of NY. The suit seeks a “declaratory judgment,” or a court’s interpretation of the law as it applies to a particular situation. The plaintiff is asking the court to declare that traditional finders in private securities offerings should not have to be registered as broker-dealers with the SEC. The SEC’s position on the matter, set out in a series of “no-action” letters back in 2001, provides only very limited circumstances where private placement finders would not have to be registered. Prior to that, finders that merely introduced investors to a company and did not engage in negotiations or provide financial advice could earn commissions without registration.
Why does this matter? Many smaller companies, both public and private, struggle to raise money. Traditional investment banks often eschew involvement with smaller companies since the amounts raised are smaller, making their fees smaller. Thus, many of these companies turn to unregistered finders, often individuals who are expert at raising smaller amounts for earlier stage companies. The cost of registering as a broker, maintaining that registration and satisfying net capital requirements is prohibitive for a number of these finders given the size of deals they tend to work on.
Platform’s argument is that the SEC’s position is legally wrong. They point to language in Section 15(a) of the Securities Exchange Act and argue that the language limits the requirement to register to those using securities exchanges or over-the-counter platforms to effect securities transactions. Finders generally do not effect trades through exchanges or OTC platforms. In 2014, the SEC did provide no-action relief for brokers of mergers and acquisitions involving private companies to avoid registration in many circumstances. We will monitor this case for further developments.
Last month, the Nasdaq quietly submitted a proposal to the SEC regarding Regulation A+. It is simple enough to quote: “Any Company listing on Nasdaq in connection with an offering under Regulation A of the Securities Act of 1933 must, at the time of approval of its initial listing application, have a minimum operating history of two years.” On April 18 the SEC published the proposal soliciting comments on the proposed rule change.
Last week I gave a talk at The Reg A Conference entitled, “Where Has Reg A+ Gone Right?” There are a number of good things to list since deal making began in earnest in July 2016 following dismissal of a court challenge to the Reg A+ rules. Almost 125 deals, averaging $10 million per deal, have been completed. About a dozen community banks and tons of real estate investment trusts have successfully gone public using Reg A+. And ten issuers got listed on Nasdaq or the NYSE, though unfortunately their stocks have not fared well generally. The SEC also approved allowing full reporting issuers to use Reg A+, particularly helping smaller OTC companies with an easier path to raising money. Cannabis companies, which generally are not able to list on the big exchanges, also have begun to see the benefit of Reg A+ to raise money in the over-the-counter markets without dealing with state “blue sky” merit review of their IPO.
The NYSE recently decided to pause taking new Reg A+ issuers, and the Nasdaq lately had been slow walking them. This proposed requirement to be operating two years to get a Nasdaq listing makes sense. Some (but not all) of the 10 exchange listed IPOs were pretty new companies. This may partially explain their challenge in building market support for their stocks. Newer companies can list over the counter initially then move up. If this encourages more use of Reg A+ and Nasdaq’s support of these listings, then this can be a positive step in the Reg A+ story, which is only in the first inning.
Last Friday, the Securities and Exchange Commission approved a new Silicon Valley-based national securities exchange, the Long Term Stock Exchange (LTSE), with a unique twist – a focus on earlier stage companies and long term investing. The idea of “venture exchanges” has been around for decades. Canada has long touted the TSX Venture Exchange, effectively launched in 2001, as performing a similar purpose. In 2011, the SEC approved Nasdaq’s BX Venture Market, but that exchange was never ultimately launched. The general idea: a national exchange with lower quantitative listing standards than the larger exchanges, but with more benefits than trading in the over-the-counter markets.
Back in 2015, the head of the SEC’s trading and markets division touted the potential benefits in Congressional testimony thusly: “Venture exchanges potentially could.. [provide] investors a transparent and well-regulated environment for trading the stocks of smaller companies that offers both enhanced liquidity and strong investor protections. As such, they could strengthen capital formation and secondary market liquidity for smaller companies and expand the ability of all investors to participate through well-regulated platforms in the potential growth opportunities offered by such companies.” Current SEC Chairman Jay Clayton also has bemoaned the trend towards fewer and fewer companies going and remaining public.
The LTSE, the brainchild of entrepreneur Eric Ries, will operate without a trading floor, only electronic trading will take place. The SEC noted in its approval release that the LTSE’s listing standards are similar to the Investors Exchange (IEX), another exchange approved by the SEC last year. IEX is focused more on lower listing fees and increased transparency of its processes and trading as opposed to listing earlier stage companies. LTSE governance requirements are similar to the big exchanges, including a majority independent board and fully independent audit committee. But the LTSE will encourage longer-term investing by, among other things, allowing companies to offer greater voting rights to stockholders holding their shares for longer periods, and limiting executive bonuses that are tied to shorter-term goals. The goal of the exchange, according to its website, is that when companies list they “will adopt a set of governing practices that mirror their long-term horizon.”
Given the shutdown of the SEC as part of the wider government shutdown, we are seeing many registration statements being filed with no delaying amendment language and with the language required by Rule 473 to allow automatic effectiveness in 20 days in accordance with Section 8(a) of the Securities Act. In the last two weeks, at least 30 such registration statements have been filed. In all of 2018, there were only three such registration statements, and in all of 2017, there were only two. Obviously, the deals must go on, and corporate issuers and their counsel have seen the Division of Corporation Finance’s FAQs regarding Actions During Government Shutdown and have heeded the answers set forth therein. (For now, the FAQs are posted on the Division of Corporation Finance’s homepage.)
The first of these “automatically effective” registration statements filed in 2019 was on Form S-4 in connection with the pending merger of BSB Bancorp and People’s United Financial, Inc. Since then, issuers have filed these registration statements on Forms S-1, S-3 and S-4 in connection with a variety of transactions. If the government shutdown continues, we should expect to see many more of these filings.
The Securities and Exchange Commission announced on December 19, 2018 that it has adopted final rules that will permit full SEC reporting companies to conduct public offerings utilizing the modern crowdfunding capabilities with Regulation A+. We are still awaiting the details of the new rules, but they will become effective immediately upon publication in the Federal Register, which typically happens within a few weeks of the announcement. The SEC was required to adopt these rules by the Economic Growth, Regulatory Relief and Consumer Protection Act, passed back in May.
Previously, the Reg A+ rules required that a company cannot use Reg A+ if it is subject to the SEC reporting requirements 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 reversed that and now the SEC has changed the rules to permit reporting companies to utilize Reg A+.
While we await the details of the new rules, it is clear that this will benefit full reporting companies that trade over-the-counter, since they can now conduct a public offering preempted by state “blue sky” merit review of their offering. In addition, even listed companies may decide that accessing the ability to “test the waters” with any investor, not permitted with a traditional public offering, is attractive as they market a new public offering. This may also assist companies that are for some reason not eligible for short form registration of public offerings on Form S-3, such as those who went public within the last year or those who had a late SEC filing in the last year. Check this one off the list of desired changes to the already well-designed rules under Regulation A+.
On December 18, 2018, the SEC approved final rules requiring companies to disclose their practices or policies with respect to hedging transactions by officers and other employees as well as directors. The final rules have not yet been published, but the SEC issued a press release (https://www.sec.gov/news/press-release/2018-291) describing the rule it adopted. The new rule implements Section 955 of the Dodd-Frank Act.
New Item 407(i) of Regulation S-K will require a company to disclose in proxy or information statements for the election of directors its practices or policies for officers and other employees, as well as directors, relating to:
- purchasing securities or other financial instruments, or otherwise engaging in transactions,
- that hedge or offset, or are designed to hedge or offset,
- any decrease in the market value of equity securities granted as compensation or held, directly or indirectly, by the officer, other employee or director.
The new item has broad application for affiliated entities and will require disclosure of practices or policies on hedging activities with respect to equity securities of the company, any parent or subsidiary of the company or any subsidiary of any parent of the company.
Companies may either summarize their practices or policies for these types of hedging activities or, alternatively, disclose their practices or policies in full. If a company does not have a practice or policy with respect to hedging activities, it must disclose that fact or state that it permits hedging transactions generally.
Companies will be required to comply with the new disclosure requirements in proxy and information statements for the election of directors during fiscal years beginning on or after July 1, 2019. “Smaller reporting companies” and “emerging growth companies” will have an additional year to comply with the new disclosure requirements. Companies that have adopted policies on hedging may opt to provide the additional disclosure during the 2019 proxy season.
Reporting from the Practising Law Institute’s Annual Institute on Securities Regulation here in New York City. I was honored to serve on a panel next to Jennifer Zepralka, head of the SEC’s Office of Small Business Policy. Jennifer provided a very positive report on Regulation A+. Here are the highlights:
- Since the new Reg A+ rules went effective in June 2015 and through September 2018, 123 public offerings were completed raising a total of $1.3 billion. That’s an average of about $10 million raised per deal since 2015.
- These numbers compare to the report from a year ago that 69 deals had been completed by September 2017 raising an aggregate of $612 million or $8.8 million per deal. Doing the simple math, this means there were 54 new deals in the last year – close to double the number of deals compared to the two plus years before.
- Doing more math: total funding in the last year more than doubled the total amount raised though Reg A+ offerings from the two years before. In other words, $612 million raised between June 2015 and September 2017 and another $688 million raised just in the one year ended September 2018.
- Doing more more math: the average deal size increased notably to $12.7 million in the year ended September 2018 vs. $8.8 million in the two years ended September 2017. That’s a 44% increase in the average deal size.
Jennifer also reported on the SEC’s Congressional mandate, under the Improving Access to Capital Act, to adopt rules to allow full SEC reporting companies to utilize Reg A+. She said the SEC is “taking steps” toward that regulatory initiative but offered no timeline on when it would be completed. She also made clear that current SEC reporting companies cannot go ahead and use Reg A+ until those rules are fully adopted.
Despite some of the reports (and my own commentary at times), Reg A+ is achieving its purpose – to help smaller companies raise capital and create jobs. And the fact that the number of deals, total funding and average deal size are all strongly increasing also is very encouraging. The “shakedown cruise” continues for exchange-listed Reg A+ issuers, but many believe this ship has many more years of successful dealmaking ahead.
A few weeks ago the President renewed discussion of the possibility of eliminating quarterly reporting by US public companies and moving back to semi-annual reports. In a tweet on August 17, he said, “In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. ‘Stop quarterly reporting & go to a six-month system,’ said one. That would allow greater flexibility & save money. I have asked the SEC to study!” He later indicated the idea came primarily from the CEO of Pepsi. Later that day SEC Chairman Jay Clayton said that the SEC “continues to study public company reporting requirements, including the frequency of reporting.”
This is not a new drumbeat. It was reported about 3 years ago that some leading attorneys, including Marty Lipton of M&A law firm Wachtell Lipton, were making just such an argument. Why is less reporting potentially good? As was noted in 2015, because it allows companies to focus less on short-term results, which can help encourage capital investment and strategic thinking, especially in this era of activist investing. Who else agrees? Al Gore. The European Union eliminated mandatory quarterly reporting for listed companies in 2013. It is only since 1970 that the SEC required quarterly reporting for US public companies.
Those who counter this argument believe six months is too long to spot trends that are developing. They also argue that shareholder activists help shine a light on bad managers. Interestingly, Clayton’s response to the President’s tweet did not seem to suggest he considered the tweet a mandate requiring him to commence a formal review of the issue. Under recent legislation, the SEC currently is examining a variety of steps to simplify and update disclosure requirements. It will be interesting to see if the Commission takes a more serious look at reducing compliance obligations and pressure to beat quarterly earnings expectations.
The SEC Commissioners voted unanimously on June 28, 2018 to expand the definition of “smaller reporting company.” This change has been requested as a key recommendation for a number of years at the annual SEC small business conference. Companies with SRC status have somewhat relaxed disclosure and reporting obligations, such as providing two rather than three years of financial information, as well as relief from some of the more costly aspects of the Sarbanes-Oxley Act of 2002. The change is effective 60 days after publication in the Federal Register, which should happen fairly soon.
The revised definition raises the value of a company’s public float to qualify as an SRC from $75 million to $250 million. If a company does not have public float (such as at the time of its IPO), it previously was an SRC unless revenues exceeded $50 million. The new rule says any company is an SRC if it has less than $100 million in revenues and either no public float or a public float of less than $700 million.
Many of the benefits of SRC status also are available if the company is an “emerging growth company” under the Jumpstart our Business Startups (JOBS) Act of 2012. Those are generally companies with less than $1.07 billion in revenues who had not completed an SEC registration of securities prior to passing the JOBS Act. EGC status, however, is terminated over time.
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.