Capital Raising

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SEC Staff issues interpretive advice on Rule 506 offeringsAs more and more companies take advantage of the SEC’s recent rule change allowing general solicitation and advertising in private offerings, lots of interpretative questions on how to apply the new rules have arisen.  Over the course of the last couple of months, the Staff at the SEC has provided some guidance on some of the more frequently asked questions.  To help our readers keep up, I have included the Staff’s advice below with my own commentary.

Question:  An issuer takes reasonable steps to verify the accredited investor status of a purchaser and forms a reasonable belief that the purchaser is an accredited investor at the time of the sale of securities.  Subsequent to the sale, it becomes known that the purchaser did not meet the financial or other criteria in the definition of “accredited investor” at the time of sale.  Assuming that the other conditions of Rule 506(c) were met, is the exemption available to the issuer for the offer and sale to the purchaser?

Answer:  Yes.  An issuer does not lose the ability to rely on Rule 506(c) for an offering if a person who does not meet the criteria for any category of accredited investor purchases securities in the offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor at the time of the sale of securities.  [Nov. 13, 2013]

My Take:  This interpretation should not be a surprise, but it is welcomed anyway.  Rule 506(c) offerings require issuers to take reasonable steps and to form a reasonable belief that each investor is accredited, but Rule 506(c) does not contain an absolute belief standard.  If an offering was to fail simply because an investor committed fraud on the issuer or an issuer relied on an erroneous third party verification of the investor’s accredited investor status, then it would make Rule 506(c) a very unpopular and hardly ever used exemption. 

Question:  An issuer intends to conduct an offering under Rule 506(c).  If all of the purchasers in the offering met the financial and other criteria to be accredited investors but the issuer did not take reasonable steps to verify the accredited investor status of these purchasers, may the issuer rely on the Rule 506(c) exemption?

Answer:  No.  The verification requirement in Rule 506(c) is separate from and independent of the requirement that sales be limited to accredited investors.  The verification requirement must be satisfied even if all purchasers happen to be accredited investors.  Under the principles-based method of verification, however, the determination of what constitutes reasonable steps to verify is an objective determination based on the particular facts and circumstances of each purchaser and transaction.  [Nov. 13, 2013]

My Take:  The Staff is taking a very
Continue Reading SEC provides guidance for new Rule 506 offerings

SEC gets an A+ for proposed Regulation A+ rulesOne of the most anticipated items from the JOBS Act enacted in April 2012 was the so-called Regulation  A+ –  a new and improved exemption that would allow issuers to raise up to $50 million in a 12-month period through a “mini-registration” process that is similar to that of rarely used Regulation A exemption. On December 18, 2013, the SEC issued its proposed rules which were mandated under Title IV of the JOBS Act.

The proposed rules would amend the current Regulation A to create two tiers of exempt offerings. Tier I would become the current Regulation A exemption, which maintains the $5 million offering limitation. Tier II would implement Regulation A+ and would permit offerings of up $50 million in any 12-month period.

Since its implementation years ago, Regulation A has not received widespread use, primarily because it did not provide for preemption of state securities laws and also had a relatively modest dollar limitation on the amount that could be raised. However, Regulation A+ (i.e., Tier II) promises to be a significant improvement over the old Regulation A because of the increased dollar limitation and the other benefits, including the potential preemption of state securities laws and regulations in certain circumstances.

All 387 pages of the proposed rules can be read on the SEC’s website, but a summary of these proposed rules are provided below for those not inclined read the entire release.

Issuer Eligibility

As proposed, Regulation A+ would be available only to United States and Canadian companies that have their principal place of business in the U.S. or Canada. Like the current Regulation A exemption, the Regulation A+ would not be available to certain types of issuers, such as companies that are already SEC reporting companies, registered investment companies and “blank-check companies.” However, under the currently proposed rules, shell companies may avail themselves of the Regulation A+ exemption so long as they are not blank-check companies.

Eligible Securities

The securities that may be offered under Regulation A are limited to equity securities, debt securities and debt  securities convertible into or exchangeable into equity interests, including any guarantees of such securities, but would exclude asset-backed securities.

Investor Limitations

As proposed, investors in a Tier II offering may acquire no more than
Continue Reading The SEC gets an A+ with the proposed “Regulation A+” rules

FDIC Statement of Policy on Bank Stock OfferingsWith the costs of compliance on the rise, we are seeing some significant consolidation in the banking industry, particularly among community banks. In a recent article on www.bankdirector.com, Rick Maroney writes that although bank M&A has been tepid thus far in 2013, some key drivers of M&A activity are starting to emerge and he predicts that we are likely to see increased merger and consolidation activity in the industry as smaller banks need to grow to remain viable. Additionally, the heightened regulatory capital requirements that are expected to be adopted as a result the Basel III accord may be an additional driver of consolidation in the banking sector.

In these merger transactions, it is fairly common for acquiring institutions to offer its common stock to target shareholders as part of the consideration to be paid. Depending on the organizational structure of the acquiring institution, there are a few options for offering stock to target shareholders as merger consideration. If the acquiror is a bank with a holding company structure, the stock portion of the merger consideration is almost always common stock of the holding company. The most significant issue when offering bank holding company stock is that the transaction must either (i) be registered on an S-4 registration statement, which involves substantial time and cost for the acquiror and would subject the acquiror to periodic reporting requirements under the Securities Exchange Act of 1934 or (ii) alternatively, the holding company stock must be issued pursuant to an exemption from registration (typically the Rule 506 safe-harbor for the Section 4(a)(2) private offering exemption). Many smaller banks, to the extent possible, will attempt to avoid registering the transaction due to the high costs and rely on an exemption to registration. If an acquiror considers privately placing holding company securities in a merger transaction, there are a number of considerations to address, some of which may be slightly alleviated by the recent changes under the JOBS Act as described in Kobi Kasitel’s recent blog post regarding stock issuances in M&A transactions after the JOBS Act.

For state-chartered banks regulated by the FDIC that do not have a holding company, the issuance of bank stock in connection with an acquisition may, at first glance, appear simpler. Under section 3(a)(2) of the Securities Act of 1933, securities issued or guaranteed by a bank are exempt securities and may be issued
Continue Reading The FDIC should consider updating its outdated statement of policy on bank stock offerings

What is the right balance between investors and issuers?On the same day that the SEC proposed rules that may make capital raising easier for companies by repealing the ban on general solicitation for private offerings, the SEC also proposed rules that may make it much more difficult to raise capital.  Why would they do this?  The repeal on the ban on general solicitation was required by the JOBS Act, but there is a lot of concern about fraud without the ban in place.  And while the SEC’s mission is to maintain fair, orderly, and efficient markets and facilitate capital formation, the SEC has a third mission: to protect investors.

Here is a highlight (or a lowlight depending on your perspective) of what is being proposed:

  • Require the filing of a Form D at least 15 calendar days in advance of using any general solicitation (rather than the current requirement of 15 calendar days after the first sale of securities);
  • Require the filing of a “closing amendment” to Form D within 30 calendar days after the termination of an offering (there is no current requirement to file a final amendment);
  • Increase the amount of information gathered by Form D such as the number of investors in the offering and the type of general solicitation used in the offering;
  • Automatically disqualify an issuer from using Regulation D for one year if the issuer failed to file a Form D (currently no such harsh consequences);
  • Mandate certain legends on all written general solicitation materials; and
  • Require the filing of general solicitation materials with the SEC (temporary rule for two years)

Now, while these are still only proposed rules and the comment period continues through November 4, 2013, there has been a huge outcry from the startup community.  Critics of these proposed
Continue Reading Proposed changes to Regulation D: Are these really so bad?

Avoid 506 Offering TrapsAs we previously blogged about, the SEC finally adopted final rules to remove the ban on general solicitation and advertising in Rule 506 offerings.  The removal of the ban is a huge change in the way private offerings may be conducted and welcome relief to the thousands of issuers each year who have tapped out their “friends and family,” but yet are too small to attract private equity funds.  With these new changes, however, bring challenges in making sure you conduct a “new” Rule 506 offering (a/k/a Rule 506(c) offering) correctly.

So, with the caveat that best practices are still being developed for Rule 506(c) offerings and issuers and attorneys are still parsing through the new rules, here are five potential pitfalls to avoid:

1.         Being too lenient as to reasonable steps.  Beginning in mid-September, Rule 506(c) offerings will allow general solicitation and advertising as long as you sell securities only to accredited investors and take reasonable steps to verify that the purchasers are accredited.  Issuers are faced with the prospect of defining for themselves what “reasonable steps” are.  That is good and bad.  What issuers can’t do is simply take the easy way out – issuers bear the burden of proving that its offering qualifies for a registration exemption.  The final rules release from the SEC gives a lot of suggestions about what reasonable steps could entail, but each case is fact and circumstance based.  You should also note that the traditional method of self-certification won’t cut it for purposes of Rule 506(c).  Fortunately, the SEC also provided four specific “safe harbors” that are each deemed to be reasonable steps:
Continue Reading Avoiding five potential traps in “new” Rule 506 offerings

Advertising rules may still limit selling securitiesAlthough the SEC recently finalized rules that will remove the ban on general solicitation and advertising for certain private offerings under Rule 506 of Regulation D, it does not mean that issuers will have free reign and complete discretion over their use of advertisements. That is, issuers looking to locate potential investors through advertising after the new rules become effective in September may still be subject to other laws that will restrict the manner in which they advertise or solicit investments.

For example as Keith Bishop over at the California Corporate & Securities Law Blog points out in a recent post that certain other state laws may be implicated with these types of advertisements. According to the post, in California, Rule 260.302 of the California Code of Regulations states, in part, that:

 An advertisement should not contain any statement or inference that an investment in the security is safe, or that continuation of earnings or dividends is assured, or that failure, loss, or default is impossible or unlikely.”

Thus, it is possible that states could use advertising laws and regulations to regulate, to some extent, private offerings under the new Rule 506. However, the question remains, as to how far these types of state laws and regulations can go? The answer to this question is
Continue Reading Removal of ban on general solicitation and advertising won’t be a license for issuers to say anything they want

506 offerings to raise moneyThe SEC issued Final Rules last week that effectively eliminate the ban on the use of general solicitation and general advertising in connection with certain securities offerings performed under Rule 506 of Regulation D. This is a major shift that will allow issuers to use general solicitation and advertising to promote certain private securities offerings. Rule 506 is widely used by many startup and early stage companies to provide a safe harbor from registration under the 1933 Act. The elimination of this ban should have very positive effects for startup and early stage companies. Hopefully it will facilitate capital raising for these companies and thus begin to allow some of the long-awaited positive impacts that we all expected from the JOBS Act. These Final Rules will become effective in mid-September of this year.

The SEC also issued a Press Release and a Fact Sheet that contain helpful information on the Final Rules.

These Final Rules provide amendments to Rule 506 and Rule 144A under the 1933 Act. I will focus on the Rule 506 amendments since they are most relevant to startup and early stage company financing situations. These Rule 506 amendments allow an issuer to engage in general solicitation and advertising in connection with the offering and sale of securities under Rule 506 provided that all purchasers of the securities are accredited investors under the Rule 501 standards and that the issuer takes “reasonable steps” to verify each investor’s accredited investor status. The Rule 506 amendments provide a non-exclusive list of methods that issuers can use to verify the accredited investor status of natural persons. These amendments also amend Form D to require issuers to tell the SEC whether they are relying on the provision that permits general solicitation and advertising in a Rule 506 offering. The Final Rules also contain some very interesting economic and statistical data on Rule 506 offerings and participation by accredited investors.

In a related development, the SEC issued a Final Rule on July 10, 2013 that amended
Continue Reading By removing ban on general solicitation SEC finally moves the JOBS Act forward

New platform for private companiesNasdaq OMX Group, Inc. announced today that it will enter into a joint venture with SharesPost, Inc. to form a marketplace for the trading of shares of unlisted companies. This is an interesting and cutting edge move that solves some problems for both Nasdaq and SharesPost. This new marketplace should be very positive for rapidly growing and large private companies which want to allow some trading in their shares but which are not ready to become publicly traded companies. It will also give investors opportunities to buy the shares of large private companies before the shares of these companies become publicly traded. According to a Nasdaq press release issued today this new marketplace, which will be called The Nasdaq Private Market, will “provide improved access to liquidity for early investors, founders and employees while enabling the efficient buying and selling of private company shares”. 

Nasdaq will own the majority of and will control this joint venture, but the joint venture will use SharesPost’s existing trading platforms and infrastructure. The joint venture will be run by SharesPost founder Greg Brogger. Depending on the speed of regulatory approval, this new market for unlisted shares could be operational later this year. 

This move makes good sense for Nasdaq because it should help them to begin to rebuild their credibility with up and coming companies and the technology industry. These market segments have traditionally been Nasdaq’s strength, but Nasdaq has been losing company listings (even from technology companies) to the NYSE and other exchanges. Nasdaq’s problems in attracting new technology company listings may be due to the significant negative issues that occurred in the initial public offering of Facebook’s shares last year. Nasdaq took a huge hit to its credibility as it was roundly blamed and criticized for the technical glitches that occurred with the Facebook offering. Some estimates say that major market makers and broker dealers lost more than $500 million in the Facebook IPO because of Nasdaq’s technical glitches. Nasdaq will also soon feel the economic effects of this matter as it reportedly offered as much as $62 million to settle associated claims and it now faces a possible $5 million fine from the SEC. For a good discussion of the current status of Nasdaq’s Facebook offering woes, see Charlie Osborne’s post on ZDNet. 

This new relationship should also be very beneficial to SharesPost. SharesPost, which began operations in 2009, experienced substantial success in facilitating trading of shares of unlisted companies. The company provided the platform for trading in unlisted securities of high visibility technology companies such as LinkedIn and Facebook before these companies’ securities became publicly traded. SharesPost eventually encountered regulatory scrutiny, however, and the SEC brought an action against the company for failure
Continue Reading Potential good news for growth companies: Nasdaq to set up new private market for unlisted stocks

Businessman weary of overregulation by SECI understand that the SEC needs to balance having efficient markets and facilitating capital formation with the protection of investors, but sometimes erecting roadblocks with the intent of protecting investors is merely regulation for regulation’s sake.  On February 5, 2013, the Staff of the Division of Trading and Markets of the SEC provided guidance on Title II of the JOBS Act, specifically to help interpret the limited broker registration exemption.  While at first glance, these FAQs are not controversial, a broad interpretation by the Staff nearly eviscerates certain avenues for capital raises for small and emerging companies under Title II.  

To step back a minute, Title II of the JOBS Act exempts certain persons from having to register as a broker if that person merely “maintains a platform or mechanism” that brings together investors and issuers in a Rule 506 offering as long as the person “receives no compensation in connection with the purchase or sale of such security” and doesn’t have possession of customer funds.  Seemed simple enough.  The start-up community was excited about this exemption.  While many start-up companies struggle to raise capital after exhausting their friends and family, many people in the start-up community envisioned this to be a way for for-profit internet portals to develop where issuers could list their offering materials for a monthly subscription fee rather than a transaction-type fee. 

Unfortunately, the Staff has taken a very broad view (and in my opinion an unwarranted view) of the definition of “compensation.”  Question 6 in the FAQ states that in the Staff’s opinion, Congress did not limit the condition to transaction-based compensation (i.e., any compensation based on the actual sale of securities), but to any direct or indirect economic benefit.  Although I don’t think it is possible for anyone to ascertain what Congress’ intent is because the members all vote for different reasons, William Carlton in his Counselor@Law blog provides a nice synopsis of
Continue Reading SEC curtails JOBS Act broker registration exemption in recent FAQs

Stock Exchange
Panorama of Wall Street Historic District by Michael Daddino

An SEC advisory committee is likely to recommend that that the SEC support the formation of a new securities exchange designed especially for small cap and micro cap public companies. While this new exchange is a long way from approval and operation, strong SEC support could substantially increase its chances of successful implementation. This securities exchange could reduce costs and create new liquidity and capital raising opportunities for these companies.

It is too early to predict whether this new securities exchange will become a reality or how effective it may be. I believe, however, that this exchange concept is another potentially positive event for small companies and that it could produce significant benefits. This securities exchange, along with certain components of the JOBS Act, could provide significant opportunities for small companies to generate liquidity in their securities and raise additional capital for growth.

The SEC advisory committee that is making this recommendation is the Advisory Committee on Small and Emerging Companies. This Committee is made up of 20 individuals with connections to the small public company space, including business executives, state regulators and, angel investors. Christine Jacobs, co-chair of the Committee, is the CEO of a Theragenics Corp., a small cap medical device manufacturer. The Committee was formed in 2011 to focus on the special needs and dynamics of small businesses and small public companies (see September 13, 2011 formation announcement here). These Committee members are aware of the particular issues that these companies face in the capital raising, corporate governance and securities regulation arenas, and they make the SEC aware of issues and problems in the small company space. You can review information on current Committee members here.

The SEC is not bound by the recommendations of the Committee, but I believe that these recommendations will be taken seriously by the SEC and that some positive action could result. The SEC’s strong support here would substantially increase the chance of this new securities exchange being formed. I was not able to find any indication from the SEC on its possible reaction to the Committee’s recommendation.

The Committee has been reviewing this proposed new securities exchange and its possible positive effects on
Continue Reading SEC advisory committee to recommend formation of small company securities exchange