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.
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.
HR 2864, the “Improving Access to Capital Act,” passed the US House of Representatives on September 5, 2017 with a lopsided bipartisan vote of 403-3. The short bill directs the SEC to permit full Securities Exchange Act reporting companies to use Regulation A+ for a public offering. Previously, only non-reporting companies could utilize the new streamlined approach with unlimited testing the waters capabilities.
Some smaller companies trading in the over-the-counter markets have been contemplating suspending their SEC reporting obligations to be able to move forward with a Reg A+ offering. If this bill passes the Senate and is signed by Pres. Trump, that would no longer be necessary. The bill makes clear that the company would be deemed to satisfy the post-offering reporting obligations under Reg A+ so long as they continue with full quarterly and other reporting required of most Exchange Act reporting companies.
As a practical matter, this change would only help companies trading in the over-the-counter markets with under $75 million market capitalization, companies that went public in the last year or those that have not made recent filings on a timely basis, since all others have some ability to utilize short registration Form S-3, which is a very simple and quick process even compared with Reg A+. It also avoids the limits on the value of shares that can be registered on Form S-3 for smaller exchange listed companies. But help it would.
The House Financial Services Committee recently approved a bill that would permit full SEC reporting companies to use Tier 2 of Regulation A+ to effect a streamlined, lower cost public offering of their securities. The bill now moves to the full House. In implementing rules under the Jumpstart Our Business Startups (JOBS) Act in 2015, the SEC retained the historical restriction that only non-reporting companies could utilize Reg A. There was really no particular reason this could not have been changed.
Now that practitioners have witnessed the closing of well over 30 Reg A+ deals, three of which are now successfully trading on national exchanges, it would seem logical to expand the availability of Reg A+ to reporting companies. They would have a history of full disclosure, and could clearly benefit from utilizing a faster and cheaper option to raise money from the public. OTC Markets, Inc. had submitted a petition several years ago that encouraged this, and Duane Morris submitted a letter to the SEC in support of that petition. Presumably this would only benefit companies that are not eligible for short registration Form S-3, including companies with less than a $75 million market cap and trading over-the-counter.
As noted in Crowdfund Insider, the new Republican-led SEC could, on its own, simply implement this change and avoid the need for Congress to pass a bill. There are some questions to address, however, such as would the relaxed financial reporting requirements apply before the offering is approved by the SEC? Would the testing the waters rules be the same? It will be interesting to see if this develops further.
Purveyors of initial coin offerings (ICOs) received a strong lashing from the SEC recently in declaring that one particular ICO was a securities offering that should have been fully registered with the SEC or met with an exemption from registration. A very new and exploding technique, in ICOs companies issue digital tokens through blockchain technology to investors. It is said over $1 billion has been raised in ICOs just since this January. Several known pending deals seek to raise over $100 million each.
Because the coin purchasers do not invest in the company, some experts claim they are therefore not securities. The SEC disagreed but also said in a press release they would not bring an action against the particular company “in light of the facts and circumstances.” They then issued a warning to all those in the ICO world that many other such offerings might be deemed securities, especially if they become tradeable in a secondary market as many do. In ICOs, very little information is typically provided to investors, and many deals are completed even without attorneys or other advisers.
The SEC investigated the case in question, involving a virtual company known as “the DAO,” because millions of dollars of coins in their ICO were hacked (most were recovered). They also issued an investor bulletin warning the public about potential fraud in ICOs, including bad actors making promises of large returns on investment. ICOs may indeed become a worthwhile investment and method for companies to access capital, especially if promoters accede to the SEC’s warning and conduct a proper IPO or exempt offering such as under Regulation D.
On June 19, 2017, the New York Stock Exchange withdrew its proposal, originally submitted in March, to allow companies to list on the big board through a so-called “self-filing” without an IPO. In a self-filing, a company seeks for previously issued shares of stock to be registered with the SEC so that they can be publicly resold, and this is the method by which the company goes public. No new money is raised in the process.
Shortly after the SEC’s proposal, online music provider Spotify said it might consider a self-filing. The company is flush with cash and does not need to raise money currently, but sees the benefit of being public and in avoiding an expensive underwriting firm.
The NYSE did not indicate why it decided to change its mind. Did they fear the SEC would not approve it for some reason? Did they receive resistance from the investment banking community? One can only speculate. It is disappointing that this legitimate alternative to an IPO will not be available – at least in the near term – to companies seeking the advantages of a public trading stock on the world’s largest stock exchange.
Update: On July 6, 2017, an NYSE representative confirmed, according to www.law360.com, that the proposal was re-submitted in mid-June and is now awaiting SEC approval. The exchange is also seeking accelerated approval from the SEC since their original request was filed in March and received no public comments. This is good news!
Duane Morris client Myomo Inc., a medical robotics company, completed its initial public offering on June 9, 2017 under SEC Regulation A+ created under the Jumpstart Our Business Startups (JOBS) Act of 2012. The historic deal is the first Reg A+ IPO to be listed on a national exchange. In the IPO, Myomo raised a total of approximately $8 million between the public offering and a contemporaneous private offering of investment units. The stock commenced trading with the symbol “MYO” on the NYSE MKT on Monday, June 12, 2017.
For various reasons that have been studied extensively, smaller company IPOs, which proliferated in the 1990s, nearly disappeared starting around 2000. Other alternatives, including reverse mergers, often called “back door listings” because they are completed without advance SEC review, took their place until 2011 when the SEC added significant regulatory burdens to these transactions. A movement to update Regulation A to “reopen the front door” at the SEC started at the annual SEC small business conference in 2010.
Regulation A reforms were then included in Title IV of the JOBS Act. The law significantly increased the amount which a company can raise under what we now call Reg A+ from $5 million to $50 million and fully preempted all state “blue sky” review of those offerings, relieving significant regulatory and cost burdens. The final Reg A+ rules passed by the SEC under the JOBS Act also broadened the ability of Reg A+ issuers to “test the waters” with all potential investors both before and after filing their offering statement with the SEC. In addition, non-listed companies have somewhat scaled disclosure in their IPO as compared to a traditional registration.
The Reg A+ rules also permit non-listed companies a “light reporting” option after their IPO, further reducing costs and burdens as a public company while retaining strong investor protections. The SEC also has given extremely limited review to these filings, and has reported an average of 74 days from initial filing to SEC approval or “qualification.” As a result, companies are reporting a speedier, more cost-efficient and simpler process in completing their Reg A+ offerings than with traditional IPOs.
To date, the SEC has reported that dozens of Reg A+ deals have been consummated and hundreds of millions of dollars raised since the SEC’s final rules were implemented in 2015. Only a handful of these companies, however, have commenced trading their stock. To have completed the first Reg A+ deal to trade on a national exchange, therefore, is a very significant development for those working to redevelop a strong new IPO market for smaller companies.
On May 4, 2017, the House Financial Services Committee, by a vote of 34-26, passed the Financial CHOICE Act of 2017, which now moves to the full House. Most of the bill relates to rollbacks of Dodd-Frank provisions that relate primarily to issues affecting large financial institutions. Among other things it would repeal the Volcker Rule which prohibits banks from doing proprietary trading and sponsoring hedge and private equity funds.
One small section of the summary of the bill is called “Capital Formation.” The Committee’s summary of the bill praises the ideas that come out of the annual SEC small business conference and criticizes the SEC for its slow implementation of the Jumpstart Our Business Startups (JOBS) Act of 2012. But they noted tremendous benefit coming out of the JOBS Act rollout and added more goodies to the bill to enhance capital formation opportunities.
Most important, the bill would allow all SEC reporting companies to use short registration Form S-3, which could be a tremendous help for over-the-counter issuers current in their filings. It also would exempt emerging growth and smaller reporting companies from burdensome XBRL financial reporting rules.
The bill also requires the SEC to formally respond to each recommendation from the small business conference and disclose what action, if any, it is taking in response. It also eliminates the requirement of a broker-dealer or funding portal in JOBS Act Title III crowdfunding under certain circumstances. It is not yet clear whether the bill is likely to pass; we will continue to monitor its progress.
On April 7, 2017, the SEC Division of Corporate Finance issued updated guidance regarding the SEC’s conflict minerals rules, stating that, in light of uncertainties regarding how the SEC will resolve issues relating to its conflict mineral rules, the SEC will not recommend enforcement action with respect to a company – even if it is subject to Item 1.01(c) of Form SD – to comply with the disclosure obligations under the SEC’s conflict minerals rules by only including in its Form SD the disclosures required by Items 1.01(a) and (b) of Form SD.
The SEC was prompted to update its guidance by the April 3, 2017 final judgment of the U.S. District Court for the District of Columbia in National Association of Manufacturers, et al. v. Securities and Exchange Commission, in which the court held that the provisions of Item 1.01(c) of Form SD that require companies to report to the SEC and state on their websites that a product has “not been found to be ‘DRC conflict free’” violates the First Amendment of the U.S. Constitution.
Continue reading SEC Issues Updated Guidance Regarding Conflict Mineral Rules
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!!