Equity Market Structure – Musings By The SEC; Rule 15c2-11 And Penny Stocks — Laura Anthony Esq. article republished by Ronald Woessner

See article below of Laura Anthony, Esq. which originally  appeared at this link.

Information about Ms. Anthony and her law firm appears below following the article.

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Equity Market Structure – Musings By The SEC; 15c2-11 And Penny Stocks

In March, SEC Chairman Jay Clayton and Brett Redfearn, Director of the Division of Trading and Markets, gave a speech to the Gabelli School of Business at Fordham University regarding the U.S. equity market structure, including plans for future reform. Chair Clayton begins his remarks by praising the Treasury Department’s four core principles reports. In particular, the Treasury Department has issued four reports in response to an executive order dated February 3, 2017 requiring it to identify laws, treaties, regulations, guidance, reporting and record-keeping requirements, and other government policies that promote or inhibit federal regulation of the U.S. financial system.

The four reports include thorough discussions and frame the issues on: (i) Banks and Credit Unions; (ii) Capital Markets (see my blog HERE); (iii) Asset Management and Insurance; and (iv) Nonbank Financials, Fintech and Innovation (see my blog HERE).

The executive order dated February 3, 2017 directed the Treasury Department to issue reports with the following objectives:

  1. Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
  2. Prevent taxpayer-funded bailouts;
  3. Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
  4. Enable American companies to be competitive with foreign firms in domestic and foreign markets;
  5. Advance American interests in international financial regulatory negotiations and meetings;
  6. Make regulation efficient, effective, and appropriately tailored; and
  7. Restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework.

Chair Clayton and Director Redfearn began with a review of the recently adopted SEC’s initiatives related to market structure. In particular, In 2018, the SEC: (i) adopted the transaction fee pilot; (ii) adopted rules to provide for greater transparency of broker order routing practices; and (iii) adopted rules related to the operational transparency of alternative trading systems (“ATSs”) that trade national market system (“NMS”) stocks. The new rules were designed to increase efficiency in markets and importantly provide more transparency and disclosure to investors.

Clayton and Redfearn then turned to the equity market structure agenda for 2019, which is focused on a review and possible overhaul to Regulation NMS. Regulation NMS is comprised of various rules designed to ensure the best execution of orders, best quotation displays and access to market data. The “Order Protection Rule” requires trading centers to establish, maintain and enforce written policies and procedures designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers. The “Access Rule” requires fair and non-discriminatory access to quotations, establishes a limit on access fees to harmonize the pricing of quotations and requires each national securities exchange and national securities association to adopt, maintain, and enforce written rules that prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross automated quotations. The “Sub-Penny Rule” prohibits market participants from accepting, ranking or displaying orders, quotations, or indications of interest in a pricing increment smaller than a penny. The “Market Data Rules” requires consolidating, distributing and displaying market information.

In recent roundtables on the topics of the market structure for thinly traded securities, regulatory approaches to combating retail fraud, and market data and market access, Chair Clayton and Director Redfearn realized the impact of Regulation NMS on these matters. Each of these topics were then addressed.

Thinly Traded Securities

Regulation NMS mandates a single market structure for all exchange-listed stocks, regardless of whether they trade 10,000 times per day or 10 times per day. The relative lack of liquidity in the stocks of smaller companies not only affects investors when they trade, but also detracts from the companies’ prospects of success. Illiquidity hampers the ability to raise additional capital, obtain research coverage, engage in mergers and acquisitions, and hire and retain personnel. Furthermore, securities with lower volumes have wider spreads, less displayed size, and higher transaction costs for investors.

One idea to improve liquidity is to restrict unlisted trading privileges while continuing to allow off-exchange trading for certain thinly traded securities.  Similar to market maker piggyback rights for OTC traded securities, when a company goes public on an exchange, other exchanges can also trade the same security after the first trade on the primary exchange. This is referred to as unlisted trading privileges or UTP.  Where a security is thinly traded, allowing trading on multiple platforms can exacerbate the issue. If all trading is executed on a single exchange, theoretically, the volume of trading will increase.

Moreover, institutions are particularly hampered from trading in thinly traded securities as a result of Regulation NMS. That is, the Regulation requires that an indication of interest (a bid) be made public in quotation mediums which indication could itself drive prices up. The risk of information leakage and price impact has been quoted as a reason why a buy-side trader would avoid displaying trading interest on an exchange in the current market structure.

Combating Retail Fraud (Rule 15c2-11; Penny Stocks and Transfer Agents)

The SEC has clearly been focused on retail fraud, and in particular with respect to micro-cap and digital asset securities, under the current regime.  The SEC has actively pursued suspected retail fraud and scams in the last few years with the bringing of multiple enforcement actions and imposition of trading suspensions.

In that regard, I was pleased to learn from the speech that the SEC intends to review Rule 15c-211. I’ve written about 15c2-11 many times, including HERE. In that blog I discussed OTC Markets’ comment letter to FINRA related to Rule 6432 and the operation of 15c2-11. FINRA Rule 6432 requires that all broker-dealers have and maintain certain information on a non-exchange traded company security prior to resuming or initiating a quotation of that security. Generally, a non-exchange traded security is quoted on the OTC Markets. Compliance with the rule is demonstrated by filing a Form 211 with FINRA.

The specific information required to be maintained by the broker-dealer is delineated in Securities Act Rule 15c2-11. The core principle behind Rule 15c2-11 is that adequate current information be available when a security enters the marketplace. The information required by the Rule includes either: (i) a prospectus filed under the Securities Act of 1933, such as a Form S-1, which went effective less than 90 days prior; (ii) a qualified Regulation A offering circular that was qualified less than 40 days prior; (iii) the company’s most recent annual reported filed under Section 13 or 15(d) of the Exchange Act or under Regulation A and quarterly reports to date; (iv) information published pursuant to Rule 12g3-2(b) for foreign issuers (see HERE); or (v) specified information that is similar to what would be included in items (i) through (iv).

The 15c2-11 piggyback exception provides that if an OTC Markets security has been quoted during the past 30 calendar days, and during those 30 days the security was quoted on at least 12 days without more than a four-consecutive-day break in quotation, then a broker-dealer may “piggyback” off of prior broker-dealer information.  In other words, once an initial Form 211 has been filed and approved by FINRA by a market maker and the stock quoted for 30 days by that market maker, subsequent broker-dealers can quote the stock and make markets without resubmitting information to FINRA. The piggyback exception lasts in perpetuity as long as a stock continues to be quoted.  As a result of the piggyback exception, the current information required by Rule 15c2-11 may only actually be available in the marketplace at the time of the Form 211 application and not years later while the security continues to trade.

Rule 15c2-11 was enacted in 1970 to ensure that proper information was available prior to quoting a security in an effort to prevent micro-cap fraud.  At the time of enactment of the rule, the Internet was not available for access to information. In reality, a broker-dealer never provides the information to investors, FINRA does not make or require the information to be made public, and the broker-dealer never updates information, even after years and years. Moreover, since enactment of the rules, the Internet has created a whole new disclosure possibility and OTC Markets itself has enacted disclosure requirements, processes and procedures. The current system does not satisfy the intended goals or legislative intent and is unnecessarily cumbersome at the beginning of a company’s quotation life with no follow-through.

The entire industry agrees that 15c2-11 needs an overhaul and so again, I was very pleased that Chair Clayton and Director Redfearn acknowledge the issue. Chair Clayton has directed the Division of Trading and Markets staff to promptly prepare a recommendation to the SEC to update the rules. I hope that the SEC will review and consider the OTC Markets’ suggestions for modification of the rules, including (i) make the Form 211 process more objective and efficient (currently FINRA conducts a merit review as opposed to a disclosure review); (ii) Form 211 materials should be made public and issuers should be liable for any misrepresentations; (iii) Interdealer Quotation Systems should be able to review 211 applications from broker-dealers; and (iv) allow broker-dealers to receive expense reimbursement for the 211 due diligence process.

Chair Clayton and Director Redfearn also hit on penny stocks. Penny stocks are generally defined by Exchange Act Rule 3a51-1 as securities priced below $5.00. The world of penny stocks has taken a hit lately, with Bank of America and its brokerage Merrill Lynch exiting the space altogether (see HERE) and with a slew of enforcement proceedings against clearing firms that accept customer deposits of low-priced securities. Chair Clayton indicates that he has asked the SEC staff to review the sales practice requirements relating to penny stocks. Director Redfearn adds that the staff plans to re-examine the current exceptions from the definition of “penny stock” with a view of providing heightened protections for retail customers.

Unfortunately I think that the SEC groups a stock trading at $.01 with no current information as the same as an OTCQX or Nasdaq Capital Markets security trading at $1.50 that is current in all its SEC Reporting Obligations. Likewise, the SEC groups a zero-revenue OTC Pink no-information company with one with $10 million in annual revenues and consistent yearly growth. I agree 100% that there are companies in the micro-cap space that should not be there and are ripe for scammers and fraudulent activity, but there are also great companies that are supplying the lifeline of American jobs and economic growth. I am concerned about the current regulatory discrimination against all low-priced securities and hope that in its reviews and studies, the SEC staff recognizes the distinctions.

Director Redfearn also has his sights set on transfer agents, mentioning the 2015 Advance Notice of Proposed Rulemaking and Concept Release on Transfer Agents – see HERE.  The goal is to move forward transfer agent rule making and to propose a specific rule related to the transfer agents’ obligations related to the tracking and removal of restrictive legends.

Market Data and Market Access

There are currently two main sources of market data and market access in the U.S. equity markets. The first is the consolidated public data feeds distributed pursuant to national market system plans jointly operated by the exchanges and FINRA. The second is an array of proprietary data products and access services that the exchanges and other providers sell to the marketplace. The second set generally are faster, more content-rich, and more costly than the consolidated data feeds.

The SEC is exploring improving the free data feeds issued by the exchanges and FINRA, including to improve speed, content, order protection and best execution, depth of information, governance, transparency and fair and efficient access to the information.

The Author

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the NasdaqNYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.comCorporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

 

When is a Digital Asset a Security — Laura Anthony Esq. article republished by Ronald Woessner

On April 3, 2019, the SEC’s Division of Corporation Finance published a “Framework for Investment Contract Analysis of Digital Assets,” issued a No-Action Letter to Turnkey Jet, Inc. and made a statement on both. Although all guidance is appreciated, there is really nothing new or different about the analysis, which is firmly based on SEC v. W.J. Howey Co. (the “Howey Test”).  Moreover, as discussed below, even though the SECfound that Turnkey Jet did not need to comply with the federal securities laws in the issuance and sales of its tokens, the opinion and issued guidelines do not go far enough and still leave a great deal of uncertainty.

Framework for Investment Contract Analysis of Digital Assets

The SEC’s framework sets forth facts and circumstances to be considered in applying the Howey Test to determine if a digital asset is an investment contract and thus a security subject to state and federal securities laws in its issuance and subsequent re-sales. The U.S. Supreme Court’s Howey case and subsequent case law have found that an “investment contract” exists when there is (i) the investment of money (ii) in a common enterprise (iii) with a reasonable expectation of profits (iv) to be derived from the efforts of others. See by blog HERE for a general discussion of Howey HERE and HERE being applied to analyze a hypothetical token.

Howey doesn’t just examine the form of the asset or instrument itself (which, in the case of a digital asset, is computer code) but also the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold. The first prong of Howey, an investment of money, is usually easily satisfied as digital assets (or any investments) usually involve the exchange of money or other form of consideration. Case law progeny of Howey has long clarified that the “money” referred to in Howey can be any valid form of consideration or exchange of value.

In its framework analysis, the SEC points out that “bounty programs” also involve the exchange of value. As I discussed in this blog HERE, bounty programs are essentially incentivized reward mechanisms offered by companies to individuals in exchange for performing certain tasks. Bounty programs are a means of advertising and have gained in popularity in ICO campaigns. During a bounty program, an issuer provides compensation for designated tasks such as registering at a website, reading and sharing materials, or marketing and making improvements to aspects of the cryptocurrency framework.

The second prong of Howey, a common enterprise, also typically exists where there is an issuance or sale of a digital asset. That is, investments in digital assets usually involve a common enterprise because the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter’s efforts.

The third element of Howey, a reasonable expectation of profits, involves a more in-depth analysis. Profits can include capital appreciation resulting from the development of the initial investment or business enterprise or a participation in earnings. Price appreciation resulting solely from external market forces impacting the supply and demand for an underlying asset generally is not considered “profit” under the Howey test. In analyzing whether there is a reasonable expectation of profits from an investment in a digital asset, the SEC considers:

  • Whether the digital asset gives the holder rights to share in the enterprise’s income or profits or to realize gain from capital appreciation. This could be from dividends or distributions or capital appreciation from secondary trading markets;
  • The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future (the SEC gives quite a bit of weight to this factor);
  • Purchasers expect the efforts of others to result in capital appreciation;
  • There is little apparent correlation between the purchase/offering price of the digital asset and the market price of the particular goods or services that can be acquired in exchange for the digital asset;
  • There is little apparent correlation between quantities the digital asset typically trades in (or the amounts that purchasers typically purchase) and the amount of the underlying goods or services a typical consumer would purchase for use or consumption;
  • More money is raised than is needed to establish a functional network or digital asset;
  • Money continues to be expended to increase and improve the value of the network or digital asset;
  • The digital asset is marketed, directly or indirectly, using any of the following: (i) the expertise of an Active Participant or its ability to build and grow the network or digital asset value; (ii) that the digital asset is an investment; (iii) intended use of proceeds is to develop the network or the digital asset; (iv) touting the future functionality of the network or asset; (v) the promise to build a future business or operations; (vi) secondary market or transferability; (vii) potential profitability of the network; or (viii) capital appreciation of the digital asset.
  • Related to a re-sale of a digital asset, further consideration should be given to (i) digital assets’ value separate from the continued development of a network; (ii) value of digital assets correlation to the good or service for which it can be exchanged; (iii) trading volume corresponds with level of demand for good or service for which it can be exchanged; (iv) whether network is built out and functionality of the digital asset; (v) whether economic benefit from appreciation is incidental to functionality; (vi) insiders’ access to material non-public information.

The fourth element of Howey, “derived from the efforts of others,” also involves a more in-depth analysis. When a promoter, sponsor, or other third party (i.e., “Active Participant”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the test is met. A relevant portion of this inquiry is a review of the economic realities of the transaction, including the manner in which the digital asset is offered and sold.

The SEC focuses on two key issues:

  • Does the purchaser reasonably expect to rely on the efforts of an Active Participant?
  • Are those efforts “the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,” as opposed to efforts that are more ministerial in nature?

In answering these two fundamental questions, the SEC guidance lists the following characteristics that support a finding that the purchaser is relying on the efforts of others:

  • An Active Participant is responsible for the development, improvement (or enhancement), operation, or promotion of the network;
  • An Active Participant will perform tasks and responsibilities rather than decentralizing performance to the community. This factor is not eliminated just because some tasks are decentralized, but rather an analysis is made as to the significance of the tasks;
  • An Active Participant creates or supports a market for, or the price of, the digital asset. This can include (i) controlling the creation and issuance of the digital asset; or (ii) taking other actions to support a market price of the digital asset, such as by limiting supply or ensuring scarcity, through, for example, buybacks, “burning,” or other activities.
  • An Active Participant has a lead or central role in the direction of the ongoing development of the network or the digital asset – for example, deciding governance issues, code updates, or how third parties participate in the validation of transactions;
  • An Active Participant has a continuing managerial role in making decisions about or exercising judgment concerning the network or the characteristics or rights the digital asset represents including, for example: (i) determining the compensation for service providers; (ii) determining whether or where the digital asset will trade; (iii) determining the issuance of additional digital assets; (iv) making or contributing to managerial level business decisions; or (v) responsibility for security of the network.
  • Purchasers would reasonably expect the Active Participant to undertake efforts to promote its own interests and enhance the value of the network or digital asset, such (i) the Active Participant retains ownership and has the ability to realize capital appreciation from the digital asset; (ii) the Active Participant distributes the digital asset as compensation or their compensation is tied to the value of the digital asset; (iii) the Active Participant owns or controls intellectual property rights related to the digital asset or network; or (iv) the Active Participant monetizes the value of the digital asset.
  • Related to a re-sale of a digital asset, further consideration should be given to (i) whether or not the efforts of the Active Participant continue to be important to the value of the digital asset; (ii) whether the network is fully functional such that the managerial efforts of an Active Participant are no longer essential; and (iii) whether the efforts of an Active Participant are no longer affecting the enterprise’s success.

In addition to the Howey factors, the SEC provides a list of other relevant considerations, including:

  • Whether the digital asset is offered and sold for use or consumption by its purchasers;
  • Whether the network is fully developed and operational;
  • Whether holders of the digital asset can immediately use its functionality;
  • The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network (for example, limiting use within the network);
  • Prospects for appreciation in the value of the digital asset are limited;
  • With respect to a digital asset referred to as a virtual currency, it can immediately be used to make payments in a wide variety of contexts, or acts as a substitute for real (or fiat) currency;
  • With respect to a digital asset that represents rights to a good or service, it currently can be redeemed within a developed network or platform to acquire or otherwise use those goods or services;
  • There is a correlation between the purchase price of the digital asset and a market price of the particular good or service for which it may be redeemed or exchanged;
  • The digital asset is available in increments that correlate with a consumptive intent versus an investment or speculative purpose; and
  • Restrictions on the transferability of the digital asset are consistent with the asset’s use and not facilitating a speculative market.

Turnkey Jet No-Action Letter

In the first SEC No-Action letter on the question as to whether a particular token distribution would be required to register as a security, the SEC opined that TurnKey Jet, Inc. could offer and sell its token without the need to register under the federal securities laws.  The SEC’s conclusion was supported by the facts that (i) no funds from the sales would be used to develop the network which would be fully operational at the time of any sales; (ii) the tokens would be immediately usable for their intended functionality; (iii) the tokens could not be transferred outside the Turnkey system and thus no secondary market can develop; (iv) the tokens will have a fixed price; (v) if Turnkey repurchases the tokens, it will only do so at a discount to their face value; and (vi) the tokens are marketed for functionality and not investment.

Turnkey’s No-Action Letter is not surprising in its result – it seems from a reading of the company’s letter to the SEC that it checked every box to avoid a finding that it could be considered to be engaged in a securities offering.  The issue is that the letter, together with the SEC guidance, continue to leave questions for those operating tokens that do not “check all the boxes.”

Turnkey’s letter to the SEC made several representations regarding the token including that “[A]t no time will Token sales include a rebate program, rewards program, or similar or otherwise allow for the monetization of an economic benefit or bonus for buying Tokens.” My question is, what if it did include a reward program?  In the SEC guidance it lays out an example of a retail point system, concluding that such a system would weigh in favor of not requiring compliance with the federal securities laws.  In particular, the SEC example is as follows:

For example, take the case of an online retailer with a fully-developed operating business. The retailer creates a digital asset to be used by consumers to purchase products only on the retailer’s network, offers the digital asset for sale in exchange for real currency, and the digital asset is redeemable for products commensurately priced in that real currency. The retailer continues to market its products to its existing customer base, advertises its digital asset payment method as part of those efforts, and may “reward” customers with digital assets based on product purchases.  Upon receipt of the digital asset, consumers immediately are able to purchase products on the network using the digital asset. The digital assets are not transferable; rather, consumers can only use them to purchase products from the retailer or sell them back to the retailer at a discount to the original purchase price. Under these facts, the digital asset would not be an investment contract.

The SEC’s example of a point system and the basis for its opinion in Turnkey does not match with the reality of loyalty or reward points in the consumer world. The fact is that there is a large secondary market for airline and other loyalty points, as I discussed back in June 2018 (see my blog HERE).  Anyone with an American Express card knows they can trade and transfer points among many different award systems and even use the points for cash on Amazon.com, Walmart, Saks Fifth Avenue and a list of other partner providers. Although a particular point provider may fix the value for issuance of the point, the value that same point gets when traded for other points in other systems fluctuates. Points are generally marketed and sold or distributed for consumer consumption and not for their value appreciation, but not completely.

The SEC also puts weight on the fact that Turnkey is not using the tokens to raise working capital, but rather as a form of selling their product (purchasing air charter services); however, the entire loyalty point industry uses the proceeds from the sale of their points for working capital. According to its Form 10-K for the FYE December 31, 2018, Delta Airlines generated $2.651 billion from the sale of loyalty travel awards in 2018, representing approximately 15% of its total passenger revenue.

As I talked about back in 2018, online platforms such as www.points.com and www.webflyer.com operate using contractual partnerships with entities that issue loyalty points.  In fact, points.com is owned by Points International Ltd., which trades on the TSX and Nasdaq and refers to itself as “the global leader in loyalty currency management.”  In a 6-K, Points has this to say about the loyalty industry:

Year-over-year, loyalty programs continue to generate a significant source of ancillary revenue and cash flows for companies that have developed and maintain these loyalty programs. According to the Colloquy group, a leading consulting and research firm focused on the loyalty industry, the number of loyalty program memberships in the US increased from 3.3 billion in 2014 to 3.8 billion in 2016, representing an increase of 15% (source: 2017 Colloquy Loyalty Census Report, June 2017). As the number of loyalty memberships continues to increase, the level of diversification in the loyalty landscape is evolving. While the airline, hotel, specialty retail, and financial services industries continue to be dominant in loyalty programs in the US, smaller verticals, including the restaurant and drug store industries are beginning to see larger growth in their membership base. Further, newer loyalty concepts, such as large e-commerce programs, daily deals, and online travel agencies, are becoming more prevalent. As a result of this changing landscape, loyalty programs must continue to provide innovative value propositions in order to drive activity in their programs.

Points’ recent annual report provides that “[T]he Loyalty Currency Retailing segment provides products and services designed to help loyalty program members unlock the value of their loyalty currency and accelerate the time to a reward. Included in this segment are the Corporation’s buy, gift, transfer, reinstate, accelerator and status miles services. These services provide loyalty program members the ability to buy loyalty program currency (such as frequent flyer miles or hotel points) for themselves, as gifts for others, or perform a transfer of loyalty currency to another member within the same loyalty program.”

I also have trouble differentiating loyalty reward programs with bounty programs. Like in a bounty program, a loyalty reward is issued as compensation for an action such as shopping at a retail outlet, using a credit card, or staying at a hotel.

In Vanderkam & Sanders (January 27, 1999), an unnamed operator of an Internet-based auto referral service proposed to issue free stock to anyone who registered at the company’s website or who referred others to it. Visitors would complete a simple registration form and would not be required to provide cash, property or services for their shares. The SEC ruled that “the issuance of securities in consideration of a person’s registration on or visit to an issuer’s Internet site would be an event of sale” and would be unlawful unless “the subject of a registration statement or a valid exemption from registration.”

In Simplystocks.com (February 4, 1999), a web-based provider of financial information proposed to distribute free stock from a pool of entrants who logged in to the company’s website and provided their name, address, Social Security number, phone number and email address and then chose a log-in name and password. Visitors would receive one entry in the stock pool for each day they logged in to the website. After 180 days, the stock would be randomly allocated among the entrants in the stock pool. The SEC stated that the Simplystocks.com stock giveaway would be unlawful unless registered or exempt from registration.

In Andrew Jones (June 8, 1999), the promoter proposed to issue free stock to the first one million people who signed up or referred others to sign up. Shares would be claimed either by sending a self-addressed stamped envelope to the company along with the person’s name, address and email address, or by visiting the company’s website and providing the same information. The company said the information provided by shareholders would be used solely for corporate purposes and would not be sold or given to others or used for advertising purposes. The SEC ruled that “the issuance of securities in consideration of a person’s registration with the issuer, whether or not through the issuer’s Internet site, would be an event of sale” and would be unlawful unless registered or exempt from registration.

Certainly in those cases the companies were issuing common stock which is defined as a security without needing to reference the Howey Test; however, more recently, in the Matter of Tomahawk Exploration LLC, the SEC found that Tomahawk’s issuance of tokens under the Bounty Program constituted an offer and sale of securities because the company provided tokens to investors in exchange for services designed to advance Tomahawk’s economic interests and foster a trading market for its securities. In other words, the services required in the bounty program were a valid consideration. It has long been established that value for securities can be in the form of services, cash, property, or anything that a board of directors reasonably determines as valuable. Tomahawk received value in the form of online marketing and promotion, and by the creation of a secondary public trading market for its token.

I see the need for further guidance from the SEC on tokens vs. rewards as the “token economy” continues to flourish and develop.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journalop-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC’s role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HEREHERE and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

For a review of SEC enforcement driven guidance on digital asset issuances and trading, see HERE.

For information on the SEC’s FinTech hub, see HERE.

The Author

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the NasdaqNYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.comCorporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

 

 

OTC Markets: Community Bank Regulations Should Foster Main Street Growth — republished by Ronald Woessner

See below for an article of OTC Markets that appeared at this link.

Banking regulation tends to be a partisan issue, but there’s one thing lawmakers are certain to agree on: America’s community banks are the backbone of the country’s economy.

Community banks serve a unique purpose. These institutions make over half of all U.S. small business loans, providing capital to entrepreneurs seeking to start businesses, and the financing needed for local businesses to grow. They provide jobs, help families buy homes and serve as the financial core for communities nationwide.

Policymakers and regulators should consider a tailored approach to capital requirements, data reporting and other requirements to keep community banks alive and thriving as the economic engines of U.S. communities. More dramatic changes to regulatory structures would fall harder on small banks, as they don’t have the compliance teams that can rapidly implement changes the way large banks can.

According to a recent survey by the Federal Reserve and Conference of State Bank Supervisors, community bank compliance costs have increased by nearly $1 billion in the past two years to roughly $5.4 billion, or 24% of community bank net income.

The banking industry is thriving and we hope that any regulatory changes considered will take into account a community banks most important customer — Main Street.

The remainder of the article appears  here.

Mr. Woessner’s Linked In bio appears here

 

David Weild: The Collapse of the Small IPO is Undermining Entrepreneurship, Tokenization May Help Fix the Problem | Crowdfund Insider

The article below was originally published by Crowdfund Insider on February 26, 2019, at this link.

This article discusses a recent speech by David Weild, Father of JOBS Act 1.0.  Several other of my published articles discuss the themes of  he disappearing US public companies, lack of capital for smaller-cap companies, the dying of US entrepreneurship, and the consequent loss of upward mobility that appear in Mr. Weild’s published work.

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Last week Crowdfund Insider attended the KoreSummit in Miami – a security token focused event. The opening presentation was delivered by David Weild, a former Vice Chairman of NASDAQ and now CEO of his own firm Weild & Co.

Weild, a staunch proponent of the JOBS Act, has long championed the benefits of entrepreneurship and the smaller initial public offering (IPO) market – a sector that has dramatically declined in recent years. He believes that misguided policy decisions have crushed the small to mid-market IPO and thus undermined access to capital and wealth creation in the US.

Today in the US, much of the innovative entrepreneurship takes place in hotbeds of creativity like Silicon Valley or Silicon Alley – to the exclusion of most of the country. Weild believes this is a shortcoming that must be addressed and the loss of small-cap IPOs have accelerated the decline in entrepreneurship.

Additionally, part of the economic impact due to this concentration of innovation is that the concept of upward mobility has been undermined. For much of the country, it is harder to get ahead. The wealthier get more wealthy while the poor and middle class struggle to make ends meet.  Opportunity and access to capital, is not being equally disseminated across the country. Now, Weild is no social democrat. As he explains:

“I do not begrudge the rich getting rich. I begrudge the people getting left behind.”

Weild is on a mission. He believes that education, access to capital, company formation, and “exitability” are all essential for upward mobility. Fostering a robust entrepreneurial ecosystem is vital.

He has advocated on behalf of the concept of creating a venture exchange: a marketplace for smaller firms to raise capital, provide liquidity, and create an exit opportunity.

Currently, Weild believes that blockchain technology and tokenization may be the best path forward to take friction out of the innovation ecosystem, lower costs, and reinvigorate entrepreneurship in the US. The technology may streamline primary issuance as well as secondary transactions.

“Instead of us having a one size fits all stock market that is really geared towards trading … and ignores the needs of the companies and intermediaries this would be one that really balances all of the interests.”

Weild believes the problem with the current market structure is that interests are out of balance. He is critical of the existing options. Weild calls OTC Markets efforts to be the US venture market “lunacy” and says we need a complete remake:

“OTC Markets is a stock held exchange. I seriously doubt that any model will work unless it is a member owned exchange.”

He believes the tick size pilot, an experiment launched by the SEC to boost liquidity for smaller cap firms, was flawed due to the participation of the exchanges as they were incentivized by their own profitability. Weild believes that small investment banks and those who make markets and commit capital must be part of the equation.

“You don’t get that optimization, that balancing of interests. Investment banks have to worry about being on the right side of the investors and the right side of the companies they serve and they have to get it right.”

NASDAQ and NYSE just care about their quarterly earnings as public firms, according to Wield. He also believes that the SEC set up the tick pilot to fail from the beginning. In fact, Weild sent a letter to SEC Chair Jay Clayton telling him just that.

Bullish on Entrepreneurs

Weild notes that jobs are created by small businesses – a statement that has been born out in multiple reports. Most innovation takes place in startups and early-stage firms as well. It is vital that policy and regulation support these types of firms – even if many of them inevitably fail.

“You gotta get that right or you don’t have a future,” says Weild.

So what about private markets? Today, there is an ocean of private money looking for great deals. As public markets have declined in relevance and viability, private money has stepped in to fill the void.

Weild believes private markets are not that efficient. He asks the question as to how many entrepreneurs do you run into that are struggling to raise money. This point is buttressed by a slide from his presentation that shows the decline in entrepreneurship that has hit fly-over country.

“They don’t know who to talk to, they can’t find it. It’s a chronic disease of US public markets … there is a have and have not world and the vast majority of the United States is have not … we are in the lowest startup rate in 40 years…”

In effect, venture capital has become a substitute for public markets.

Policymakers need to get ahead of the curve. They need to figure out how to get the heartland back to creating jobs and you cannot do it if you have to be a $500 million company before it is reasonable to take it public.

So where does tokenization fit into all of this? And is the hype getting ahead of reality?

Weild says yes, the hype always gets ahead of the story. But the technological shifts are always overestimated over the short term, or the hype phase, and underestimated in the long term. Weild draws a parallel to the rapid rise of the internet and the first market entrants that largely failed. Inevitably hugely successful companies will arise from the “primordial ooze.”

“Security tokens technologically are really interesting because they can take a lot of cost out of the system. It is not just a token, it is not just a block and general ledger, its this integrated system that includes this software layer that can do whatever, ultimately, they are programmed to do.”

Weild sees a system that is amazingly efficient where you can take out intermediaries – like a bank.

“Look at what JP Morgan just did announcing their own stablecoin.”

Sure. There are plenty of Luddites and naysayers that don’t believe in blockchain tech but in Weild’s experience, we are in the trial and error phase where we are going to work out the kinks. He would be surprised if, at some point in the future, we are not holding securities very differently.

Even DTCC is working on a blockchain project.

Weild says that a lot of the transactional costs will be stripped out of the system.

Securities on blockchain will create a level of innovation we have yet to experience in the past, says Weild. It will transform securities but there will be an interim step where traditional and digital will be interchangeable but eventually, it will all be tokenized.

Weild acknowledges there are still many issues that need to be worked through such as custody. But eventually, major Wall Street firms will be compelled to change and adapt.

Of course, the change is not going to be instantaneous. Weild sees it shifting over the next five years at best.

JUMP Coalition: Jobs Upward Mobility and Making Markets Perform

One of Weild’s newer projects is the Jump Coalition that will be a bi-partisan lobbying group/think tank. The goal is to advocate politically for creating incentives that work for most people. He mentioned both Representative Maxine Waters and former Representative Jeb Hensarling as pursuing supportive legislation in Congress. Representative Waters, now the Chair of the powerful House Financial Services Committee, is on the record supporting the JOBS Act 3.0 – an entrepreneur/small business friendly act of legislation.

Ultimately, Weild wants to see everyone on a path to a better future – not just the lucky few.

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Mr. Woessner  mentors, advises, and helps companies in the start-up and smaller-cap company ecosphere raise capital via Regulation Crowdfunding (CF) and otherwise.  He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. See here for more information on Mr. Woessner’s background.

 

 

Tribute to the Late John Dingell — republished by Ronald Woessner

February 8, 2019 |Washington, D.C. – House Republican Leader Kevin McCarthy (CA-23) honored John Dingell, the longest serving member of the House in history, and his dedication to public service.

“I also rise to commemorate the incredible life and career of John Dingell – the former Dean of this House.

“Few individuals have amassed a record of public service that could rival John’s, and I will bet no one will ever match it – 59 years as an elected representative.

“In fact, his interest in politics began during his time as a Congressional Page, where he personally witnessed FDR’s “A Day That Will Live in Infamy” Speech from this very podium.

“Take one moment to think of the life that this man had witnessed on this floor.

“John taught us that public service is not a sprint, but a marathon. There are many lessons in his life that we can learn from, but I hope we take that lesson every day when we come to work here.

“Another lesson I hope we learn is the one of how I first met John.

“He was an icon before I got here. But I watched the respect, not from his own colleagues in his own party, but the respect from across the aisle.

“They went to John for advice.

“When he walked on the floor, there was many on our side that stood around him – they’d question him where we thought we could go. He believed in this House. He believed in this country.

“He had great passions – passions for his constituents, passion for his committee; energy and commerce. He loved this committee so much he thought there needed no other committee in this House. It wasn’t until his retirement that we got jurisdiction back in other places.

“But he understood an ever-changing world, if you can only imagine serving that long.

“He was able to adapt – which we should learn from too. Yes, the new world of social media, many would think would pass him by because of his age. But he was one of the first I would follow on Twitter.

“This is a lesson this House, in a bipartisan manner, should take. It’s one of my favorite tweets from John.

“It came on the day of July of 2017. He wrote, ‘I’ve been trying to repeal and replace the United States Senate since 1955 […] No luck.’

“Yes we are sad today, but he lived a life we can admire.

“I may have difference in opinion and philosophy with him but I admired his will to fight for what he believed in. I admired the way he treated people who had different beliefs and I admired the way he believed all sides should be heard.

“I speak for everyone on this side of the aisle to convey our deepest sympathies – and to Debbie.

And I ask that we lift up in our prayers to God for his soul to rest peacefully and to remember what he truly believed:

“Public service matters. This country matters – and the ability to work together so all Americans will have a better tomorrow.”

An IPO Without The SEC — Laura Anthony Esq. article republished by Ronald Woessner

On January 23, 2019, biotechnology company Gossamer Bio, Inc., filed an amended S-1 pricing its $230 million initial public offering, taking advantage of a rarely used SEC Rule that will allow the S-1 to go effective, and the IPO to be completed, 20 days from filing, without action by the SEC.  Since the government shutdown, several companies have opted to proceed with the effectiveness of a registration statement for a follow-on offering without SEC review or approval, but this marks the first full IPO, and certainly the first of any significant size. The Gossamer IPO is being underwritten by Bank of America Merrill Lynch, SVB Leerink, Barclays and Evercore ISI. On January 24, 2019, Nasdaq issued five FAQ addressing their position on listing companies utilizing Section 8(a).  Although the SEC has recommenced full operations as of today, there has non-the-less been a transformation in the methods used to access capital markets, and the use of 8(a) is just another small step in a new direction.

Section 8(a) of the Securities Act

Section 8(a) of the Securities Act of 1933 (“Securities Act”) provides for the effectiveness of registration statements and amendments.  In particular, the statute provides that a registration statement shall automatically go effective on the 20th day after its filing or such earlier date as the SEC may determine.  Section 8(b) gives the SEC the power to issue a stop order to prevent a registration statement from going effective in accordance under Section 8(a) if the registration statement is “on its face incomplete or inaccurate in any material respect.”

In practice, companies avoid the Section 8(a) effectiveness by adding language to their registration statements known as the “delaying amendment.”  The typical language for a delaying amendment is similar to the following:

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted.

… and with that provision, Section 8(a) is avoided.  A company then goes through a comment, review and amendment process with the SEC which ultimately results in the SEC informing the company that it has cleared comments.  A company then files a letter with the SEC, relying on another rule (Rule 461) requesting that the registration statement become effective.  Technically the request is that the SEC accelerate the effectiveness of the registration statement so that a company does not have to file a final amendment removing the “delaying amendment” language and adding Section 8(a) language and then waiting 20 days for the registration statement to go effective.

The reasons that Section 8(a) is not used in practice are twofold. The first is that a company and its attorneys, auditors and underwriters believe that there is too much risk of litigation associated with forgoing SEC review. If the registration statement disclosures are later shown to have shortcomings, the unusual lack of SEC review adds fuel to the plaintiff’s lawyer’s claims. However, the SEC does not conduct a merit review, but rather just reviews to determine if the disclosures comply with the rules and regulations. Not only does the SEC not pass on whether a deal is good or bad, but making a statement to the contrary is a criminal offense and Item 501 of Regulation S-K specifically requires a disclaimer on the subject with suggested language, to wit:

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

It seems that if a company has competent counsel and the underwriter has competent counsel, they can together review the disclosures to determine if they are accurate and complete. Moreover, the fact is that if the stock price goes way down, the company is likely to face an investor lawsuit anyway, regardless of what the SEC reviews or doesn’t review. Besides, risk factors are designed to warn investors of potential issues, and Gossamer did so with its newest SEC filing adding the following risk factor:

As a result of the shutdown of the federal government, we have determined to rely on Section 8(a) of the Securities Act to cause the registration statement of which this prospectus forms a part to become effective automatically. Our reliance on Section 8(a) could result in a number of adverse consequences, including the potential for a need for us to file a post-effective amendment and distribute an updated prospectus to investors, or a stop order issued preventing use of the registration statement, and a corresponding substantial stock price decline, litigation, reputational harm or other negative results.

The registration statement of which this prospectus forms a part is expected to become automatically effective by operation of Section 8(a) of the Securities Act on the 20th calendar day after the most recent amendment of the registration statement filed with the SEC, in lieu of the SEC declaring the registration statement effective following the completion of its review. Although our reliance on Section 8(a) does not relieve us and other parties from the responsibility for the adequacy and accuracy of the disclosure set forth in the registration statement and for ensuring that the registration statement complies with applicable requirements, use of Section 8(a) poses a risk that, after the date of this prospectus, we may be required to file a post-effective amendment to the registration statement and distribute an updated prospectus to investors, or otherwise abandon this offering, if changes to the information in this prospectus are required, or if a stop order under Section 8(d) of the Securities Act prevents continued use of the registration statement. These or similar events could cause the trading price of our common stock to decline substantially, result in securities class action or other litigation, and subject us to significant monetary damages, reputational harm and other negative results.

The second is that the S-1, which will go effective after 20 days, must be totally complete, including pricing information.  In a traditional IPO or follow-on offering, the company does not file the final amendment with pricing information until the day it goes effective.  This allows a company to judge the market at the moment of sale to choose the best price, which is especially important in a firm commitment underwritten deal where the underwriter buys all the company’s registered stock in the IPO and immediately resells it to customers and syndicated broker-dealers.  A company also may get feedback during its roadshow, which typically occurs in the 10-15 days prior to effectiveness that affects pricing decisions.

Interestingly, Gossamer has decided to ignore these market factors and let the world know its believed value up front.  I’m actually not surprised at all.  This is just another way that capital markets are shifting.  There has been a recent rise in different methods of going public including direct public listings without an IPO (see HERE).

Nasdaq FAQ

On January 24, 2019, Nasdaq issued five FAQ addressing the listing of new companies during the government shutdown and the impact on already listed companies.  Nasdaq will list companies that had cleared comments, but whose registration statement had not yet been declared effective at the time of the shutdown.  Likewise if a company has substantially cleared comments, Nasdaq is willing to proceed with the listing under certain circumstances.  In particular, the company will have had to clearly address the outstanding comments and Nasdaq will require a representation from the company’s counsel and auditor that they believe all disclosure and accounting comments have been fully addressed.  Nasdaq will not list a company that has not yet received SEC comments or that first filed for its IPO during the shutdown.  Gossamer announced that it has applied for the Nasdaq Global Select Market and so it will likely amend its S-1 to allow SEC review.

Nasdaq will also allow certain up-listings from the OTC Markets to proceed as long as the company satisfies the listing requirement.  In particular, if the company only needs to file a registration statement under the Securities Exchange Act of 1934 (“Exchange Act”), such as a Form 10 or Form 8-A, Nasdaq will allow it to continue. Keep in mind a registration statement under the Exchange Act does not involve the offer or sale of any securities.  However, if the up-listing involves an offering and the filing of a registration statement under the Securities Act, Nasdaq will review the application the same as a new IPO. That is, if the company has already cleared or substantially cleared comments, they may continue, if not, they will need to complete the SEC review process.

If a company is already listed on Nasdaq, they may proceed with a follow-on offering without SEC review.

Although the SEC is again operational, they will be backlogged, so presumably Nasdaq is still willing to proceed with certain companies without SEC action.  Companies that have already filed a registration statement without the delaying amendment and with the appropriate Section 8(a) amendment will likely proceed.  For those that had one or two unsubstantial comments left, they will need to assess which route will be the quickest, wait for the SEC to review the final comments or file a new fully completed registration using Section 8(a).  Of course, Nasdaq may issue updated FAQ altering their position on accepting these applications.

Continued Shifting Capital Markets

The rise of decentralized platforms and imminent change in how the capital markets function as a whole and the role of intermediaries in the process has opened the market’s view to relying less on the SEC’s input in their disclosures.  tZero is scheduled to launch its security token platform this week, introducing a new way in which securities, or fractional ownership interests in a company, can be bought and sold.  tZero is starting with launching its own securities tokens on the platform but will soon open up to third-party companies and reportedly already has applications from over 60 companies. tZero may be the first to launch, but it will not be the only and soon we will have independent markets competing with Nasdaq and the NYSE.  Moreover, the securities token markets will have sectors for private company markets and public company markets, blurring the current private equity silo with public trading.

Much more significantly, though, is that this is the first step in a retooling and complete change in how the clearing and settlement of securities functions (for more on the current clearing and settlement, see HERE and HERE).  The new blockchain technology will allow for instantaneous clearing and settlement, a big change from the current t+2 and sometimes t+3 settlement of today (thus the name tZero).  Notably, blockchain eliminates the need for a trusted intermediary, thus opening up the question as to the future role of DTC and its custodial arm, Cede & Co.

No regulator, the SEC or FINRA included, is ready for a complete disruption of the capital markets system, but they have been thinking about it for a while.  FINRA published a report on the implications of blockchain for the securities industry back in January 2017 (see HERE).  Furthermore, the SEC has reportedly told tZero, and presumably others following in their lead, that they will allow incremental changes in the market system.

This is a small concession considering that they will have no choice as the proverbial train has left the station.  tZero is launching a joint venture with Boston Options Exchange, which is one of 12 SEC-listed security exchanges which together comprise the National Market System network. The joint venture seeks to launch a marketplace able to deal in both public securities and digital tokens.  Nasdaq Financial Framework, a software company owned by the exchange, just closed a $20 million Series B funding round into Symbiont which is working to “give Nasdaq the ability to originate a financial instrument and the smart contract to custody it on a blockchain, to allow trading to occur with their matching engine, to allow surveillance to occur across the network using Nasdaq technology and then to perform settlement on a blockchain.”

Meanwhile, the SEC is clearly not against forgoing the comment and review process and relying on Section 8(a).  As it was shutting down, the SEC posted an FAQ on its website reminding companies that they can proceed to rely on Section 8(a) to effectuate their registration statements, and even providing the exact language that needs to be included in order to accomplish this.  In particular: “This registration statement shall hereafter become effective in accordance with the provisions of Section 8(a) of the Securities Act of 1933.”   Even with the re-opening of the SEC, CorpFin will be exponentially backlogged compared to the time it was shutdown.  It will be interesting to see how the SEC handles the workload – perhaps in addition to simply foregoing comments on many filings, the SEC will continue to support the use of 8(a) on others, especially follow-on offerings completed for a company that has had a full review in the last few years.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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Mr. Woessner of Dallas, Texas is former Senior Counsel to the US House Financial Services Committee where he served as special advisor to former Committee Chairman  Jeb Hensarling on capital formation and fintech issues. He currently mentors, advises, and helps start-up and smaller-cap companies raise capital through Regulation Crowdfunding (CF) and other means. He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. Mr. Woessner, a certified Toastmaster, speaks and writes about US public and private capital markets topics and his articles are published by equities.com and elsewhere. You may contact him about a speaking engagement at Linked In here.

 

 

Who is Ronald Woessner?

Mr. Woessner of Dallas, Texas has worked in the smaller-cap company ecosphere for 25+ years in the capacity as general counsel to two NASDAQ-listed companies and advisor to others.  He currently mentors, advises, and helps start-up and smaller-cap companies raise capital through Regulation Crowdfunding (CF) and other means. He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. Mr. Woessner, a certified Toastmaster, speaks and writes about US public and private capital markets topics and his articles are published by equities.com and elsewhere. You may contact him about a speaking engagement at Linked In here.

SEC Updates CDI Related to Smaller Reporting Company Definition — Laura Anthony, Esq. article republished by Ronald Woessner

See article below of Laura Anthony, Esq. which originally  appeared at this link.  Information about Ms. Anthony and her law firm appears below following the article.

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SEC Updates CDI Related to Smaller Reporting Company Definition

On June 28, 2018, the SEC adopted the much-anticipated amendments to the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K.  For more information on the new rules, see HERE

Among other benefits, it is hoped that the change will help encourage smaller companies to access US public markets. The amendment expands the number of companies that qualify as a smaller reporting company (SRC) and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The SEC estimates that an additional 966 companies will be eligible for SRC status in the first year under the new definition.

As proposed, and as recommended by various market participants, the new definition of a SRC will now include companies with less than a $250 million public float as compared to the $75 million threshold in the prior definition. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million and only included companies with no ascertainable public float. Once considered a SRC, a company would maintain that status unless its float drops below $200 million if it previously had a public float of $250 million or more. The revenue thresholds have been increased for requalification such that a company can requalify if it has less than $80 million of annual revenues if it previously had $100 million or more, and less than $560 million of public float if it previously had $700 million or more.

The SEC also made related rule changes to flow through the increased threshold concept. In particular, Rule 3-05 of Regulation S-X has been amended to increase the net revenue threshold in the rule from $50 million to $100 million. As a result, companies may omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 if the net revenues of that business are less than $100 million.

The new rules did not change the definitions of either “accelerated filer” or “large accelerated filer.” As a result, companies with $75 million or more of public float that qualify as SRCs will remain subject to the requirements that apply to accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chair Clayton has directed the SEC staff to make recommendations for additional changes to the definitions to reduce the number of companies that would qualify as accelerated filers.

Furthermore, the conforming changes include changes to the cover page for most SEC registration statements and reports including, but not limited to, Forms S-1, S-3, S-4, S-11, 10-Q and 10-K.  On November 7, 2018, the SEC made conforming changes to its Compliance and Disclosure Interpretations (C&DI).

In particular, the SEC issued four new C&DI to reflect the impact of the larger size threshold for SRC status and withdrew four C&DI addressing transition issues for SRCs and two additional obsolete C&DI which still referred to the old Regulation S-B.

New C&DI 102.01 illustrates that, under the new amendments, companies can now be both accelerated filers and SRCs, which means that, as SRCs, they can use the scaled disclosure rules but, as accelerated filers, their periodic reports are due under the time frames for accelerated filers and they must provide Sarbanes-Oxley Section 404(b) auditor attestation reports in their 10-Ks. In an example, a company was an accelerated filer with respect to filings due in 2018 and had a public float of $80 million on the last business day of its second fiscal quarter of 2018. Because its public float at that measurement date was below $250 million, the company would qualify as an SRC for filings due in 2019; however, it would also need to file its 10-K within 75 days as an accelerated filer and would need to comply with Section 404(b).  Since the company was an accelerated filer with respect to filings due in 2018, it would be required to have less than $50 million in public float on the last business day of its second fiscal quarter in 2018 to exit accelerated filer status for filings due in 2019.

New C&DI 102.02 recaps the circumstances under which a reporting company that fails to qualify as an SRC can later re-qualify if its revenues or public float decreases. Once a reporting company determines that it does not qualify as a smaller reporting company, it will remain unqualified unless, when making a subsequent annual determination, either:

  • It determines that its public float is less than $200 million; or
  • It determines that:

(i) for any threshold that it previously exceeded, it is below the subsequent annual determination threshold (public float of less than $560 million and annual revenues of less than $80 million); and

(ii) for any threshold that it previously met, it remains below the initial determination threshold (public float of less than $700 million or no public float and annual revenues of less than $100 million).

The C&DI provides an example where the company had exceeded one of the caps, but not the other: “A company has a December 31 fiscal year end. Its public float as of June 28, 2019 was $710 million and its annual revenues for the fiscal year ended December 31, 2018 were $90 million. It therefore does not qualify as a smaller reporting company. At the next determination date, June 30, 2020, it will remain unqualified unless it determines that its public float as of June 30, 2020 was less than $560 million and its annual revenues for the fiscal year ended December 31, 2019 remained less than $100 million.”

New C&DI 202.01 provides that in calculating annual revenues to determine whether a company qualifies as a SRC as defined in Regulation S-K, the company should include all annual revenues on a consolidated basis.  As such, a holding company with no public float as of the last business day of its second fiscal quarter would qualify as a smaller reporting company only if it had less than $100 million in consolidated annual revenues in the most recently completed fiscal year for which audited financial statements are available.

New C&DI 104.13 confirms that a company that is transitioning from an SRC (in the example, the company qualifies as an SRC in 2019 but will no longer qualify in 2020 based on its public float on the last day of its 2019 second quarter) may still rely on General Instruction G(3) to incorporate by reference executive compensation and other disclosure required by Part III of Form 10-K into the 2019 Form 10-K from its definitive proxy statement to be filed not later than 120 days after its 2019 fiscal year-end.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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Mr. Woessner  mentors, advises, and helps companies in the start-up and smaller-cap company ecosphere raise capital.  He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. See here for more information on Mr. Woessner’s background.

 

 

Chairman Hensarling Urges Senate Action on JOBS Act 3.0 on US House Floor — republished by Ronald Woessner

WASHINGTON – Financial Services Committee Chairman Jeb Hensarling (R-TX) delivered the following speech on the House Floor today, urging the Senate to pass the “JOBS & Investor Confidence Act of 2018,” otherwise known as the JOBS Act 3.0:

“I come here today, Mr. Speaker, and I picked up a copy of this morning’s edition of the Wall Street Journal. Many Americans would consider it to be the most influential newspaper in America; but certainly at least on economic matters, I think, most would agree.

I just happened to read the lead editorial today, Mr. Speaker, and it says that the House, this body, “has done yeoman’s work shepherding bipartisan bills to expand access to capital.” Most influential paper in America. There’s a lot in between but let me go to the last sentence where it says, “The Senate shouldn’t scuttle what could be one of this congress’s better achievements.” That’s in today’s Wall Street Journal, Mr. Speaker, and the Journal’s talking about JOBS 3.0. It’s a bill that came out of this body 406-4, and its purpose, Mr. Speaker, is to promote small business, to promote entrepreneurial capitalism, to promote venture capital. Again, Mr. Speaker, it came out of this body 406-4. We couldn’t get 406-4 votes on a Mother’s Day resolution. And yet it languishes on that side of the Capitol.

So I’ve been in this body for 16 years, Mr. Speaker, and I’ve learned a few things. One of the things I’ve learned is never underestimate the Senate’s capacity to do nothing. And unfortunately, so far, the United States Senate has done nothing on a bill that passed 406-4.

Mr. Speaker, thanks to the leadership of President Donald Trump, thanks to the leadership of Speaker Paul Ryan, thanks to the leadership of Chairman Kevin Brady, we have what for most Americans – not all, but for most Americans – is the greatest economy they have had in their entire lifetime. Unemployment at a 50-year low. Cutting across all socioeconomic groups. Small business optimism, consumer optimism, off the charts. We are seeing more people come back into the labor force, and this is all great news.

But we cannot be blinded by the fact that as good as the economy is of today, we still have to concentrate on the economy of tomorrow. And we need to know, can we ensure that the seed capital is there? Can we make sure that our public policy nourishes the drivers of tomorrow’s economy, the next Amazons, the next Googles, the next Ubers; where are they going to come from?

So unfortunately, Mr. Speaker, what we have seen is that as recently as 2016, as recently as 2016, startups in America have been cut in half. And oh, incidentally the securities regulatory burden has increased by over 50% in the last 10 years, and by over 80%. It now costs, Mr. Speaker, twice as much to go public today as it did 10 years ago.

And what do we see? We see half the number of companies going public. They don’t seem to have that problem in China, Mr. Speaker, because China has over 1/3 of the world’s I.P.O.’s or initial public offerings.

Yet the United States, our I.P.O.’s have been cut in half. That’s why it’s so important that every Congress, every Congress we go back and we ensure that our securities laws are written in such a way that we make sure that entrepreneurial capitalism can’t just survive in America, but absolutely thrive. So I come to this floor again to ask that our colleagues on the other side of the Capitol, and I have many friends in that body, but I am often confused why, why they cannot act on something that has received incredible, incredible support in the House.

Mr. Speaker, November is National Entrepreneurship Month. There’s only two days left in the month. So I hope that my voice can be heard on the other side of the Capitol, and I would ask the United States Senate to immediately take up the JOBS 3.0 Act, and make sure that the economy of tomorrow for our children and grandchildren is as healthy and thriving as the economy of today.”

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See the link here for Mr. Woessner’s bio.

This is a reprint of a posting at the link here.

 

 

 

 

h

SEC Proposed Rule Regarding Covered Investment Fund Research Reports – Summary by Ronald Woessner

On May 23, 2018, as directed by Congress pursuant to the Fair Access to Investment Research Act of 2017, the SEC proposed a new rule under the Securities Act of 1933.

If adopted, the proposal would establish a safe harbor for an unaffiliated broker or dealer participating in a securities offering of a “covered investment fund” to publish or distribute a “covered investment fund research report.” If the conditions for the safe harbor are satisfied, this publication or distribution would be deemed not to be an offer for sale or offer to sell the covered investment fund’s securities for purposes of sections 2(a)(10) and 5(c) of the Securities Act of 1933.

The SEC also proposed a new rule under the Investment Company Act of 1940. This proposal would exclude a covered investment fund research report from the coverage of section 24(b) of the Investment Company Act (or the rules and regulations thereunder), except to the extent the research report is otherwise not subject to the content standards in self-regulatory
organization rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.

Public comments on the proposal were required to be submitted to the SEC on July 9, 2018.

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This is a reprint of an earlier posting at ronaldwoessner.com.

See Mr. Woessner’s biography at the link here.