SEC Rule 701 exempts non-reporting companies from registering securities offered or sold to employees, officers, directors, partners, trustees, consultants, and advisors under compensatory benefit plans or other compensation agreements. As discussed in an earlier post, under the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) passed by Congress in 2018, the threshold for the aggregate sales price of securities sold during any consecutive 12-month period that triggers additional disclosure requirements under Rule 701 was increased from $5 million to $10 million.   What may have gone unnoticed was that the SEC has adopted final rules to implement EGRRCPA and has published a concept release “soliciting comment on possible ways to modernize rules related to compensatory arrangements in light of the significant evolution in both the types of compensatory offerings and the composition of the workforce since the Commission last substantively amended these rules in 1999.”

Continue Reading The SEC modernizes exempt compensatory offerings (with more changes in the works)

On February 19, 2019, the Securities and Exchange Commission voted to propose a new rule that would expand the availability of the “testing-the-waters” provisions that enable eligible companies to engage in certain communications to gauge institutional investor interest in a proposed IPO. Currently, only companies that qualify as “emerging growth companies” or “EGCs” are eligible to test the water. The new rule and related amendments would expand the availability of the provisions to all types of issuers, including investment companies.

The purpose of the testing-the-waters provisions is to allow potential issuers to gauge market interest in a possible initial public offering or other registered securities offering by discussing the offering with certain investors, including qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”), prior to filing a registration statement. SEC Chairman Jay Clayton said that “[t]he proposed rules would allow companies to more effectively consult with investors and better identify information that is important to them in advance of a public offering.” The proposed rules and related amendments are intended to give more issuers a cost-effective and flexible means of communicating with institutional investors regarding contemplated offerings and evaluating market interest.

Continue Reading Testing-the-waters provisions to be available to bigger fish

As securities lawyers know, disclosure is generally regarded as the best disinfectant.  However, in a recent enforcement action, the SEC determined that disclosure is not always enough.  Specifically, when it comes to internal controls over financial reporting, or ICFR, companies need to actually fix the problems they disclose.

In the action, the SEC cited four companies for failing to maintain ICFR for periods ranging from seven to 10 consecutive annual reporting periods.  While each of the companies disclosed material weaknesses in ICFR, it took them months or years to remediate the weaknesses – even after being contacted by the SEC!  (I don’t usually use exclamation points in my postings, but this calls for an exception to my usual policy.)  As noted in the SEC’s press release on the action, “[c]ompanies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation.”

Others have noted that the cases in question are outliers.  That’s undoubtedly true — at least I hope so, because it’s hard to imagine hearing from the SEC and doing nothing about it, much less over a period of years).  However, the moral of the story remains unchanged: if you’re going to disclose an ICFR problem, you better fix it, too.

In case you think that corporate minutes and other corporate formalities are for sissies, think again.  And read the opinion in the case of KT4 Partners vs. Palantir, decided by the Delaware Supreme Court in January 2019.

KT4 had submitted a demand under Section 220 of the Delaware General Corporation Law, seeking to inspect Palantir’s books and records.  Because such an inspection must be for a “proper purpose,” KT4 noted that, among other things, Palantir had failed to hold stockholder meetings and to give proper notice under stockholder agreements.

The demand ended up in the Delaware Court of Chancery, which granted some of KT4’s demands but rejected demands for emails exchanged among directors and officers relating to an investor rights agreement.  KT4 appealed to the Delaware Supreme Court, which reversed that rejection.

Continue Reading Minutes count (as do other formalities)

On December 19, 2018, the SEC adopted final rules allowing reporting companies to rely on the Regulation A exemption.

How did we get here?

The SEC adopted a new – and greatly improved – Regulation A, known as Reg A+, in 2015.  As noted in previous posts (see here and here) Reg A, provides an exemption from registration under the Securities Act for smaller public offerings, but for many years was seldom used due to cost restraints and small financing caps.  The 2015 amendments, adopted in response to the JOBS Act, remedied these shortcomings, updating Reg A to make it a more viable capital-raising tool.

The main benefits of Reg A+ include the following:

  • Companies can raise up to $50 million every 12 months via two overlapping tiers.
    • Tier 1: offerings of up to $20 million in a 12-month period.
    • Tier 2: offerings of up to $50 million in a 12-month period.
  • Insiders can sell their shares in a Reg A+ offering.
  • Investors in a Reg A+ offering have immediate liquidity – they can sell their shares once the offering is completed and don’t have to hold them for a period of time.
  • Some Reg A+ offerings are exempt from state securities or “blue sky” laws.
  • Some Reg A+ offerings are easier to list on an exchange.
  • Reg A+ can be used for merger and acquisition transactions.

What’s new? Continue Reading Hip, hip, Reg A! — Reporting companies can now use Reg A+ and may find it a viable capital raising alternative

Each January, I depart from my admittedly nerdy focus on SEC and governance matters to communicate with you on one of my other admittedly nerdy pursuits – reading – by providing a list of my 10 favorite books of the prior year, five works of fiction and five of non-fiction.  As always, the list is comprised of books I read during the year gone by, rather than books published during the year.

By way of an overview, much of the fiction I read last year was just so-so, and while I really liked the works of fiction listed below, it was an easier choice than has been the case for the last couple of years (e.g., The Underground Railroad or A Gentleman in Moscow).  In the non-fiction category, I seem to have focused on biographies and memoirs even more than last year, as four of my five non-fiction works were in this category.

Here goes: Continue Reading My 10 Best Books of 2018

Lest you think that the SEC’s focus on the use of non-GAAP financial metrics is so, well, 2018, think again.  On December 26, the SEC issued a cease-and-desist order against a company based entirely on the company’s use of non-GAAP metrics without giving “equal or greater prominence [to] the most directly comparable financial measure or measures calculated and presented in accordance with GAAP…”, as required by Item 10(e)(1)(i)(A) of Regulation S-K.

According to the SEC order, the company in question – ADT, the security company based in Boca Raton, Florida – issued earnings releases for fiscal 2017 and the first quarter of fiscal 2018 that prominently included such non-GAAP metrics as adjusted EBITDA, adjusted net income, and free cash flow before special items, without giving equal or greater prominence to the comparable GAAP data.  For example, the order states: Continue Reading Ho, Ho, Uh-Oh: The SEC continues to focus on non-GAAP disclosures

Following a tweet from the President last August, the SEC has begun the process of reviewing the existing quarterly reporting regime and will be further exploring possible changes that may ease administrative and other burdens on public companies. Specifically, the President “asked the SEC to study!” whether less frequent reporting for publicly traded companies would “allow greater flexibility and save money.” This is not a new issue on the SEC’s radar screen, but it has recently regained traction– the SEC issued a concept release in 2016 soliciting public comments more specifically on reporting frequency and the current quarterly reporting process.

The request for comments, which can be viewed here, asks for public input on several questions related to the existing reporting regime. One of the more interesting questions on which the SEC is seeking input is whether the practice of public companies issuing forward earnings guidance places undue pressure and focus on short-term results and negatively impacts long-term results. Several commentators have expressed concern on this issue over the years and believe management teams with a longer-term view would be better stewards of investor capital. Many of the other specific questions asked by the SEC in its request for comments relate directly to the current reporting process and whether changes could be made that balance the interests of investors while making the reporting process more efficient, including, among other things: Continue Reading SEC seeks public comments on quarterly reporting for public companies

As we approach the end of 2018, it’s only natural to look back on some of the year’s events – and some non-events.  For my money, one of the most significant non-events was the inauguration of CEO pay ratio disclosure, one of the evil spawn of Dodd-Frank.

In the interest of brevity, I’ll skip the background of the disclosure requirement, except to say that it seemed intended to shame CEOs – or, more accurately, their boards – into at least slowing the rate of growth in CEO pay.  Some idealists may have actually thought that it would lead to reductions in CEO pay.  Poor things; they failed to realize not only that all legislative and regulatory attempts to reduce CEO pay have failed, but also that such attempts have in every single instance been followed by increases in CEO pay.

So the 2018 proxy season, and with it pay ratio disclosures, came and went.  Sure, there were media outcries about some of the ratios, but they failed to generate any traction.  Companies may have incurred significant monetary and other costs to develop the data needed to prepare the disclosures, but their concerns about peasants storming the corporate gates with torches and pitchforks proved needless.  Few, if any, investors – and certainly no mainstream investors – seemed to care about the pay ratios.  Employees making less than the “median” employee didn’t rise up in anger.  Even the proxy advisory firms seemed to yawn in unison.

So that’s that.  Or so you’d think.

Continue Reading To pay ratio advocates, nothing succeeds like excess

The SEC recently settled charges against two prominent celebrities in connection with the promotion of initial coin offerings. Boxer Floyd Mayweather Jr. and music producer and social media star DJ Khaled were charged in separate incidents with failing to disclose that they had received payments for promoting ICOs. While the SEC has provided prior guidance and warnings regarding the ICO and cryptocurrency markets, I believe that these are the first situations in which the SEC has actually brought enforcement actions and levied substantial monetary penalties in connection with such promotional activities.

Mayweather and Khaled each made endorsements of ICOs, primarily through their social media platforms. This allowed them to immediately convey their endorsements to their numerous social media followers. Each individual was paid a fee for making these ICO endorsements, but neither individual disclosed that he was being compensated for these promotional activities. The SEC charged each individual with violating Section 17(b) of the Securities Act of 1933, which prohibits anyone from promoting a security without fully disclosing that they are being compensated for such endorsement and the amount of the payment.

The SEC’s prime concern here appeared to be that investors who are unaware of these compensation arrangements might think that Mayweather’s and Khaled’s endorsements were independent and were not influenced by this compensation. In its November 29, 2018 press release regarding this matter, the SEC stressed the “importance of full disclosure to investors” and said that “investors should be skeptical of investment advice posted to social media platforms and should not make decisions based on celebrity endorsements”. For further discussion of the SEC’s positions in the ICO and cryptocurrency areas, you can access SEC Release No. 81207 (July 25, 2017) here.

The SEC is right in its actions in these situations.  It’s clear that athletes like Mayweather and music industry leaders like Khaled exert significant influence over their fans, and this is magnified on social media. For example, Khaled is a well-known and powerful social media influencer who is sometimes called the “King of Snapchat”. When such powerful social media influence enters the securities offering and disclosure area, it’s important for the SEC to take the steps necessary to ensure that the correct investor safeguards are in place even though the investor context is not the traditional one.

Neither Mayweather nor Khaled admitted or denied the SEC’s charges in this matter, and I’m not imputing bad motives to either man. Each agreed, however, to pay fairly substantial amounts for disgorgement, penalties and interest. Mayweather paid over $600,000, while Khaled paid over $150,000, and each agreed to not promote any securities (digital or otherwise) for three years (Mayweather) and two years (Khaled).

This situation demonstrates the SEC’s commitment to carefully regulate the ICO and cryptocurrency areas and its willingness to take firm and swift action when it discovers problem situations. ICO issuers and promoters should carefully plan their actions and strategies to ensure that they comply with SEC laws and regulations.