BSA requires broker-dealers to know who you are
Photo by St. Murse

As we blogged about in May, the Bank Secrecy Act (“BSA”), which requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering, applies to entities that we may not traditionally think of as “financial institutions,” including securities broker or dealers. Compliance with the BSA is no easy task. And if a recent notice of new proposed rule by the U.S. Treasury’s Financial Crimes Enforcement Network (also known as FinCEN) becomes law, it’s not about to get any easier.

FinCEN’s stated intent with the proposed rule is to clarify and strengthen customer due diligence requirements for banks, brokers or dealers in securities, mutual funds and futures commission merchants and introducing brokers in commodities. Under current regulations, each of these institutions must establish, document and maintain a Customer Identification Program (or “CIP”) appropriate for its size and business that meets certain minimum requirements, including, among others, the adoption of certain identity verification procedures, and the collection of certain customer information and the maintenance of certain records. The proposed rule adds two (2) new elements to the CIP requirements.

First, the proposed rule
Continue Reading No more secret identities: Broker-dealers may soon be required to identify beneficial owners of legal entity customers

Waiting for the results of the JOBS Act?
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President Obama signed the JOBS Act into law on April 5, 2012 amid much fanfare and optimism. Small and medium sized fast-growing technology companies and their executives were especially sanguine about this new act as it appeared that it would provide access to much-needed additional expansion capital. These companies were still reeling from the recession and the substantial reduction in available venture capital financing, and they saw the JOBS Act as a potentially positive event. A little more than two years later, has this initial optimism proved to be warranted? Let’s take a look at some of the provisions of the Act.

A new regulatory structure for crowdfunding was initially the most anticipated provision of the JOBS Act. I never believed that crowdfunding would be as beneficial as some people did, but I hoped that it could provide some additional access to capital for smaller companies which were starved for funds. Unfortunately we are still waiting for the SEC’s final crowdfunding regulations. The SEC appears to be caught between two complaining factions here – one which thinks the proposed rules are too restrictive and won’t work, and one which thinks
Continue Reading The JOBS Act – Any results yet?

SEC may change identity of angels
Illustration by Royce Bair

Potential Changes.

Accredited investors have long been critical participants in private financing transactions, and the success of most private financings is largely determined by the participation of these investors and the availability of their capital. State and Federal securities laws have been written or amended to foster and facilitate investment by these accredited investors. Based on recent developments, the standards for qualification as an accredited investor may be changing, and these changes could pose problems for companies seeking financing.

The current requirements for accredited investor status are contained in Rule 501(a) of the 1933 Act. The most commonly used standards for individual investors are a $200,000 annual income (or $300,000 combined income with a spouse) or a $1,000,000 net worth (excluding the value of the investor’s primary residence). Other than the exclusion of the investor’s primary residence (which became effective in 2012), these standards have been in place since 1982 without any changes to reflect the effects of inflation during that period.  

Based on these current standards, observers estimate that there are approximately 8.5 million accredited investors in the United States. Some critics have asserted that this number is far higher than it should be, and that many of these people only qualify as accredited investors because
Continue Reading Accredited investors – potential changes and some helpful guidance

Intrastate offering exemption
Photo by Jimmy Emerson

Last week, the SEC issued three new interpretations related to the so-called “intrastate offering exemption,” which is a registration exemption that facilitates the financing of local business operations.  An intrastate offering is exempt because it does not involve interstate commerce, and is therefore, outside the scope of the Securities Act.

We have received a few calls this week from startup companies who mistakenly believed that these new interpretations were creating a new registration exemption.  Largely, the mistaken belief is caused by the confusion stemming from some recent state law changes that allow for intrastate crowd funding.  While the new SEC interpretations were prompted by the recent state law changes, the intrastate offering exemption has been around since 1933, but for many reasons, it is not heavily relied upon.  And, despite the three new interpretations, we still advise against using the intrastate offering exemption.

What is this intrastate offering exemption?

The intrastate offering exemption is actually two separate exemptions, Section 3(a)(11) and a safe harbor Rule 147.  Although the two exemptions differ slightly, generally, if the (i) issuer is incorporated or organized in the same state in which it is offering securities; (2) a substantial portion of the issuer’s business occurs within that state; (3) each offeree and purchaser is a resident of the state; (4) the offering proceeds are used primarily within that state; and (5) the securities come to rest within that state, then your offering would be exempt from federal registration requirements.  The investors do not need to be accredited (unlike Regulation D offerings), there is no limitation on the manner of offering, there are no prescribed disclosures, there is no maximum amount that can be raised (unlike Rule 504, Rule 505, or Regulation A), and the shares are freely transferable to other residents of the state.  In other words, it is a fairly broad exemption that allows a lot of flexibility to issuers, especially to startup companies who need as much flexibility as possible when raising capital.

Ok, so what is such a problem with the intrastate offering exemption?

While there is lots of flexibility with the exemption, the intrastate offering exemption
Continue Reading Don’t cross the border!: Intrastate offering exemption still not useful despite new interpretations

Intrastate offering exemption
Photo by Jimmy Emerson

Last week, the SEC issued three new interpretations related to the so-called “intrastate offering exemption,” which is a registration exemption that facilitates the financing of local business operations.  An intrastate offering is exempt because it does not involve interstate commerce, and is therefore, outside the scope of the Securities Act.

We have received a few calls this week from startup companies who mistakenly believed that these new interpretations were creating a new registration exemption.  Largely, the mistaken belief is caused by the confusion stemming from some recent state law changes that allow for intrastate crowd funding.  While the new SEC interpretations were prompted by the recent state law changes, the intrastate offering exemption has been around since 1933, but for many reasons, it is not heavily relied upon.  And, despite the three new interpretations, we still advise against using the intrastate offering exemption.

What is this intrastate offering exemption?

The intrastate offering exemption is actually two separate exemptions, Section 3(a)(11) and a safe harbor Rule 147.  Although the two exemptions differ slightly, generally, if the (i) issuer is incorporated or organized in the same state in which it is offering securities; (2) a substantial portion of the issuer’s business occurs within that state; (3) each offeree and purchaser is a resident of the state; (4) the offering proceeds are used primarily within that state; and (5) the securities come to rest within that state, then your offering would be exempt from federal registration requirements.  The investors do not need to be accredited (unlike Regulation D offerings), there is no limitation on the manner of offering, there are no prescribed disclosures, there is no maximum amount that can be raised (unlike Rule 504, Rule 505, or Regulation A), and the shares are freely transferable to other residents of the state.  In other words, it is a fairly broad exemption that allows a lot of flexibility to issuers, especially to startup companies who need as much flexibility as possible when raising capital.

Ok, so what is such a problem with the intrastate offering exemption?

While there is lots of flexibility with the exemption, the intrastate offering exemption
Continue Reading Don’t cross the border!: Intrastate offering exemption still not useful despite new interpretations

Intrastate offering exemption
Photo by Jimmy Emerson

Last week, the SEC issued three new interpretations related to the so-called “intrastate offering exemption,” which is a registration exemption that facilitates the financing of local business operations.  An intrastate offering is exempt because it does not involve interstate commerce, and is therefore, outside the scope of the Securities Act.

We have received a few calls this week from startup companies who mistakenly believed that these new interpretations were creating a new registration exemption.  Largely, the mistaken belief is caused by the confusion stemming from some recent state law changes that allow for intrastate crowd funding.  While the new SEC interpretations were prompted by the recent state law changes, the intrastate offering exemption has been around since 1933, but for many reasons, it is not heavily relied upon.  And, despite the three new interpretations, we still advise against using the intrastate offering exemption.

What is this intrastate offering exemption?

The intrastate offering exemption is actually two separate exemptions, Section 3(a)(11) and a safe harbor Rule 147.  Although the two exemptions differ slightly, generally, if the (i) issuer is incorporated or organized in the same state in which it is offering securities; (2) a substantial portion of the issuer’s business occurs within that state; (3) each offeree and purchaser is a resident of the state; (4) the offering proceeds are used primarily within that state; and (5) the securities come to rest within that state, then your offering would be exempt from federal registration requirements.  The investors do not need to be accredited (unlike Regulation D offerings), there is no limitation on the manner of offering, there are no prescribed disclosures, there is no maximum amount that can be raised (unlike Rule 504, Rule 505, or Regulation A), and the shares are freely transferable to other residents of the state.  In other words, it is a fairly broad exemption that allows a lot of flexibility to issuers, especially to startup companies who need as much flexibility as possible when raising capital.

Ok, so what is such a problem with the intrastate offering exemption?

While there is lots of flexibility with the exemption, the intrastate offering exemption
Continue Reading Don't cross the border!: Intrastate offering exemption still not useful despite new interpretations

Last shot for JOBS Act?
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The Jumpstart Our Business Startups (JOBS) Act was enacted on April 5, 2012 with much fanfare and high expectations. The JOBS Act was designed, in part, to help “Emerging Growth Companies” (annual revenues less than $1 billion) gain greater access to growth capital while reducing regulatory restrictions, compliance requirements, and costs. The JOBS Act was welcomed by a business community which was just emerging from a brutal recession and starved for growth capital. The general reaction to the JOBS Act has been disappointment and a feeling that the JOBS Act has failed to live up to its advance billing. With the proposed Regulation A+ still to come, however, the JOBS Act may at last provide some real financing opportunities for private companies seeking growth capital. For background on the JOBS Act see our Emerging Growth Companies Task Force page.

There is no doubt that some good things have come out of the JOBS Act as its various rules have become effective. The elimination of the ban on general solicitation and advertising for some private offerings may prove very helpful to companies trying to find potential investors. The confidential filing of initial public offering documents (which allows a company to file IPO documents and work with the SEC on a confidential basis to resolve problems before the documents become public) has been extremely popular. The maximum number of shareholders that a private company can have before it must register and report as a public company has increased. This allows large private companies to stay private longer, avoiding the dilemma that Facebook and other companies faced. Finally, issuers of securities are now allowed to “test the waters” in some circumstances to determine potential investor interest in an offering before undertaking it. All of these are positive items, but they have not caused a significant increase in successful financing activity.

So what is Regulation A+ and why do we care? This proposed Regulation is one of the last major rulemaking proposals available under the JOBS Act. The SEC voted on December 18, 2013 to propose new rules under the existing Regulation A that would substantially increase the potential for substantial financing transactions conducted under Regulation A. While we haven’t seen the final rules and likely won’t see them for some time, these proposals have been much anticipated in the corporate finance community because of the
Continue Reading Regulation A+: Last gasp of the JOBS Act

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

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?