News from Microcap Strategies

NASDAQ And NYSE American Shareholder Approval Requirement – Equity Based Compensation — 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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NASDAQ And NYSE American Shareholder Approval Requirement – Equity Based Compensation

Nasdaq and the NYSE American both have rules requiring listed companies to receive shareholder approval prior to issuing securities when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants. Nasdaq Rule 5635 sets forth the circumstances under which shareholder approval is required prior to an issuance of securities in connection with: (i) the acquisition of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants; (iii) a change of control (see HERE); and (iv) transactions other than public offerings (see HERE). NYSE American Company Guide Sections 711, 712 and 713 have substantially similar provisions.

In this blog I am detailing the shareholder approval requirements related to equity-based compensation of officers, directors, employees or consultants.  Other Exchange Rules interplay with the rules requiring shareholder approval for equity issuances and for equity compensation issuances in general.  For example, the Exchanges generally require a Listing of Additional Securities (LAS) form submittal at least 15 days prior to establishing or materially amending a stock option plan, purchase plan or other equity compensation arrangement pursuant to which stock may be acquired by officers, directors, employees, or consultants without shareholder approval.

Nasdaq Rule 5635(c)

Nasdaq Rule 5635(c) requires shareholder approval prior to the issuance of securities when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants, except for: (1) warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company (such as a typical dividend reinvestment plan); (2) tax qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans (including foreign plans complying with applicable foreign tax law), provided such plans are approved by the company’s independent compensation committee or a majority of the company’s Independent Directors; or plans that merely provide a convenient way to purchase shares on the open market or from the company at market value; (3) plans or arrangements relating to an acquisition or merger as permitted under IM-5635-1; or (4) issuances to a person not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to the individual’s entering into employment with the company, provided such issuances are approved by either the company’s independent compensation committee or a majority of the company’s Independent Directors. Promptly following an issuance of any employment inducement grant in reliance on this exception, a company must disclose in a press release the material terms of the grant, including the recipient(s) of the grant and the number of shares involved.

NYSE American Company Guide Section 711

Substantially similar to Nasdaq, the NYSE American Company Guide Section 711 requires shareholder approval with respect to the establishment or material amendments to a stock option or purchase plan or other equity compensation arrangement pursuant to which options or stock may be acquired by officers, directors, employees, or consultants, except for: (1)  issuances to an individual, not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to entering into employment with the company provided that such issuances are approved by the company’s independent compensation committee or a majority of the company’s independent directors, and, promptly following an issuance of any employment inducement grant in reliance on this exception, the company discloses in a press release the material terms of the grant, including the recipient(s) of the grant and the number of shares involved; or (2) tax-qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans, provided such plans are approved by the company’s independent compensation committee or a majority of the company’s independent directors; or plans that merely provide a convenient way to purchase shares in the open market or from the issuer at fair market value; or (3) a plan or arrangement relating to an acquisition or merger; or (4) warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company (such as a typical dividend reinvestment plan).

The NYSE American requires a listed company to notify the exchange in writing if it intends to rely on any of the exemptions.

Interpretation and Guidance

                Definition of Consultant

For purposes of this rule, a “consultant” is anyone for whom the company is eligible to use a Form S-8.  Accordingly, shareholder approval would be required for stock awards, plans or arrangements for the issuance of equity to: (i) natural persons; (ii) that provide bona fide services to the company; and (iii) whose services are not in connection with the offer or sale of securities in a capital-raising transaction, and who does not directly or indirectly promote or maintain a market for the company’s securities.

Adoption of Plans

A company may adopt an equity plan or arrangement, and grant options (but not shares of stock) thereunder, prior to obtaining shareholder approval provided that: (i) no options can be exercised prior to obtaining shareholder approval, and (ii) the plan can be unwound, and the outstanding options cancelled, if shareholder approval is not obtained. Companies should be aware of any accounting issues that may arise under these circumstances.

A company that has a plan in place at the time of listing on an Exchange would not be required to obtain shareholder approval for that plan, but would be required to obtain approval for future amendments.

                Material Amendments

For purposes of the rule, both Exchanges specifically indicate that a material amendment would include, but not be limited to: (i) any material increase in the number of shares to be issued under the plan, including sublimits (other than as a result of a reorganization, stock split, merger or spin-off); (ii) a material increase in benefits including repricing (such as lowering the strike price of an option) or extensions of duration (though a change in a vesting schedule without more is not material); (iii) a material expansion of the class of participants eligible for the plan; or (iv) an expansion of the types of options or awards under the plan, including value for value exchanges.

If a plan allows for the issuance of stock options, adding stock appreciation rights (SARs) to a plan would not be material as SARs are substantially similar to options. Similarly, if a plan allows for the issuance of restricted stock, adding restricted stock units (RSUs) would not be material.

An amendment to increase tax withholding associated with awards to satisfy tax obligations is not considered a material amendment. Likewise, allowing a recipient to surrender unissued shares to satisfy a tax obligation would not be considered a material amendment. Adding a cashless exercise feature is also not a material amendment.

Neither Exchange will require shareholder approval if the plan, by its own terms, allows for specific actions without further approval, including, for example, the re-pricing of options.  In order to rely on the ability to amend, the plan must be specific in the terms and actions that are allowed. A general authority to amend will not obviate the need for shareholder approval for what would otherwise be considered a material amendment.  Moreover, some pricing changes, such as changing the exercise price from the closing bid price on the day of grant to the average of the high and low market price on the same day, would not require a new approval.

However, if a plan has a formula that allows for automatic increases of the shares available under the plan (“evergreen plan”) or a formula for automatic grants, the plan cannot have a term in excess of ten years unless shareholder approval is obtained every ten years.  Plans that do not contain a formula and do not impose a limit on the number of shares available for grant would require shareholder approval of each grant under the plan.

As the rule specifically only applies to equity grants, awards or compensation and not cash, a company could buy back outstanding awards for cash without first seeking shareholder approval.

                Mergers

Plans or arrangements involving a merger or acquisition do not require shareholder approval in two situations. First, shareholder approval will not be required to convert, replace or adjust outstanding options or other equity compensation awards to reflect the merger transaction. Second, shares available under certain plans acquired in acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval provided the plan had originally been approved by shareholders.

In particular, where a non-listed company is acquired by or merged with a listed company, the listed company may use shares for post-transaction grants of options and other equity awards without further shareholder approval, provided: (i) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (ii) such options and other awards are not granted to individuals who were employed by the granting company or its subsidiaries at the time the merger or acquisition was consummated.

Plans adopted in contemplation of a merger or acquisition will not be considered pre-existing for purposes of this exception. Where an evergreen plan is assumed in a merger, the ten-year period for shareholder approval is measured from the date the target company established the plan.

Any additional shares available for issuance under a plan or arrangement acquired in connection with a merger or acquisition would be counted in determining whether the transaction involved the issuance of 20% or more of the company’s outstanding common stock, thus triggering the shareholder approval requirements under Rule 5635(a) related to mergers and acquisitions.

Source of Shares

A requirement that grants be made out of treasury shares or repurchased shares will not alleviate shareholder approval requirements.

Inducement Exemption

The inducement exemption can only be used for employment, and not consulting, arrangements. However, in some circumstances the exemption may be relied upon to induce a consultant to enter into an employment arrangement. An exchange would consider all facts and circumstances related to the relationship. This exemption can only relied upon in connection with the initial inducement for employment. Accordingly, if an inducement award is materially amended, the amendment would require shareholder approval notwithstanding that the initial award did not.

Likewise, the determination of a “bona fide period of non-employment” requires a facts and circumstances analysis. Generally an exchange will consider: (i) whether there was a relationship between the company and former employee during the time of non-employment; (ii) whether the former employee received payments from the company during the period of non-employment; (iii) the reasons for ending the employment relationship; (iv) whether the former employee was employed elsewhere after leaving the company; and (v) whether there was an agreement or understanding that the employee would return to the company.

For purposes of the required press release disclosure, four days will generally satisfy the “promptly” requirement. A company can aggregate the disclosure of inducements where the inducements were made in connection with a merger or acquisition, or a company regularly offers such awards.  In that regard, a company can adopt a plan that will be used solely for inducements, without the necessity of shareholder approval.  However, inducement grants made to executive officers must always be individually disclosed.

Parallel Nonqualified Plan

parallel nonqualified plan means a plan that is a “pension plan” within the meaning of the ERISA Act that is designed to work in parallel with a qualified tax plan to provide benefits that exceed IRS compensation limitations. A plan will not be considered a parallel nonqualified plan unless: (i) it covers all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess the compensation limits; (ii) its terms are substantially the same as the qualified plan that it parallels except for the elimination of the limitations; and, (iii) no participant receives employer equity contributions under the plan in excess of 25% of the participant’s cash compensation.

Below Market Sales

The private sale of securities to officers, directors, employees or consultants at a price less than market value is considered a form of “equity compensation” and, as such, requires shareholder approval. For purposes of this rule, market value is the consolidated closing bid price immediately preceding the time the company enters into a binding agreement to issue the securities.  Shareholder approval would not be required if the officer, director, employee or consultant was purchasing securities from the company in a public offering.

Issuances to an entity controlled by an officer, director, employee, or consultant of the a company may also be considered equity compensation under certain circumstances, such as where the issuance would be accounted for under GAAP as equity compensation or result in the disclosure of compensation under Regulation S-K.

Broker Votes

Broker-dealers may not vote client proxies on equity compensation plans unless the beneficial owner of the shares has given voting instructions. That is, equity compensation plans are considered “non-routine” items prohibiting broker votes on behalf of their clients.

Foreign Private Issuers

Although the rule applies to foreign private issuers, if such issuer is otherwise following its home country practices in accordance with the Exchange rules, it can do so related to this shareholder approval requirement as well.

Consequences for Violation

This rule is strictly construed and, as such, all plans or material amendments to a plan, regardless of the number of shares under the plan or arrangement, require shareholder approval. Consequences for the violation of any of the Exchange’s rules, including shareholder approval rules, can be severe, including delisting from the Exchange. Companies that are delisted from an Exchange as a result of a violation of these rules are rarely ever re-listed.

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.

 

Capital Raising Made Simple — by Ronald Woessner

Raising money is HARD. It is the hardest task you as a business owner will ever undertake.

Let’s start with some metrics:

  • 57% of startups are funded by founder loans
  • 38% funded by “Friends and Family”
  • 1.43% by banks
  • .91% by angel investors
  • .05% by VC firms
  • Crowdfunding — not yet a significant source of capital for US start-ups, but it’s growing.  According to the article here of StartEngine, one of the largest equity crowdfunding portals, as of February 2019, since crowdfunding inception a few years ago only $176 Million has been raised via crowdfunding.

Even though raising capital is hard, the process is really quite simple. All you need to do are two things:

(1) create the proper tools, and

(2) go looking in the right places for capital.

Relative to point (1), no one would think to build a house without the necessary tools – yet many/most/virtually all inexperienced (and even many experienced CEOs) seek to raise money without the necessary tools.  (More on this topic in later articles.)

Relative to point (2), even though venture capital firms only fund 1/20 of 1% of startups in America, many entrepreneurs automatically think of seeking VC money to fund their start-up.

This is a bad plan, because:

(a) the odds are against you securing VC funding (see metrics above), and

(b) VC firms* are looking for a business that has the potential to become a “unicorn,” and

(c) VC firms* are looking for very specific types of founders and CEOs.

  • typically

Relative to point (b), why are VC firms typically only looking for a business that has the potential to become a “unicorn”?  Because of every 10 deals funded by a VC firm, on average, 3 – 4  deals will go “bust” and the invested capital will be 100% lost; 3 – 4 deals will return only the amount of capital invested or produce a modest return; and, the remaining 2 will produce  phenomenal returns.

Hence, if the VC firm does not believe that your business has the potential to produce a phenomenal return, you’ll never be funded by a VC firm even though  you otherwise have a good business. For example, most entrepreneurs would think a $3M revenue business that grows 50% a year would be a good (even great) business.  Not so a venture capital firm.

Let’s look at the numbers:

Year 1: $3M revenue

Year 2: $4.5M revenue

Year 3: $6.75M revenue

Year 4: $10.125M revenue …

Year 10: $115.32M revenue

Compare this with Amazon:

Year 1: $0

Year 2: $511,000

Year 3:  $15.75M

Year 4: $147.8M

Year 5:  $1 Billion annualized sales

So, you get the point.

Relative to point (c), VC firms are looking for very specific types of founders and CEOs. For example, if the founder/CEO had a successful “exit” previously in a VC – backed venture, chances are good the founder will secure VC funding again as discussed  here.  If the venture has 100% women founders, the chances of it obtaining VC funding are less than the chances of earth colliding with an asteroid.  See my article here published by equities. com. And, the list goes on and one. Again, if you don’t have the attributes they are looking for, you’ll never be funded by a VC firm.

In sum, the two simple rules of raising capital are:

  1. Create the tools you need to raise capital.
  2. Look for sources of capital that might actually fund your business.

We’ll continue this discussion in later posts.

© Ronald A. Woessner, May 5, 2019

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Mr. Woessner, of Dallas, Texas, is former Senior Counsel to the Financial Services Committee of the US House of Representatives where he was special advisor to the Chairman for capital formation and fintech matters. He has worked in the smaller-cap company ecosphere for 25+ years in the capacity as general counsel to two NASDAQ-listed companies and CEO of an OTC-traded company that he up-listed to NASDAQ, following private law practice. 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, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. Mr. Woessner, a certified Toastmaster, is a frequent contributor to equities.com and speaks and writes about US public and private capital markets matters. For more information on Mr. Woessner’s, see https://www.linkedin.com/in/ronald-woessner-esq-3645041a/.

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

+++++++++++++++++++++++++++++++++++++++++++++++++

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.

 

 

SEC Rules For Disclosure Of Hedging Policies — Laura Anthony Esq. article republished by Ronald Woessner

Smaller reporting companies and emerging growth companies must comply with the new disclosure requirements in their proxy and information statements during fiscal years beginning on or after July 1, 2020. All other companies must comply in fiscal years beginning July 1, 2019. As foreign private issuers (FPI) are not subject to the proxy statement requirements under Section 14 of the Exchange Act, FPIs are not required to make the new disclosures.

New Item 407(i) of Regulation S-K will require a company to describe any practices or policies it has adopted regarding the ability of its employees, officers or directors to purchase securities or other financial instruments, or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of equity securities granted as compensation, or held directly or indirectly by the employee or director. The disclosure requirement may be satisfied by providing a full summary of the practices or policies or by including the full policy itself in the disclosure.

The disclosure requirement extends to equity securities of parent and subsidiaries of the reporting company. The rules regulate disclosure of company policy as opposed to directing the substance of that policy or the underlying hedging activities. The rule specifically does not require a company to prohibit a hedging transaction or otherwise adopt specific policies; however, if a company does not have a policy regarding hedging, it must state that fact and the conclusion that hedging is therefore permitted.

The Senate Committee on Banking, Housing, and Urban Affairs stated in its report that Section 14(j) is intended to “allow shareholders to know if executives are allowed to purchase financial instruments to effectively avoid compensation restrictions that they hold stock long-term, so that they will receive their compensation even in the case that their firm does not perform.”

Background

Currently disclosure requirements related to hedging policies are set forth in Item 402(b) of Regulation S-K and are included as part of a company’s Compensation Discussion and Analysis (“CD&A”). CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. Item 402(b) only requires disclosure of hedging policies “if material” and only for named executive officers. Moreover, CD&A is not required at all for smaller reporting companies, emerging growth companies, closed-end investment companies or foreign private issuers.

Hedging transactions themselves may be disclosed in other SEC reports. For example, Form 4 filings by officers, directors and greater than 10% shareholders would include disclosures of hedging transactions involving derivative securities. Hedging transactions involving pledged securities would be included in disclosures related to the beneficial ownership of officers, directors and greater than 5% shareholders in SEC reports such as a company’s annual report, registration statements or proxy materials. However, there is currently no rule that specifically requires the disclosure of hedging policies and that encompasses all reporting issuers.

New Item 407(i) of Regulation S-K

The SEC determined that disclosure of hedging policies constitutes a corporate governance disclosure and, as such, should be contained in Item 407, keeping all corporate governance disclosure requirements in one rule. As indicated above, the final new Item 407(i) of Regulation S-K will:

• require the company to describe any practices or policies it has adopted, whether written or not, regarding the ability of employees, officers, directors or their designees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds), or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities granted to the employee, officer, director or designee or held directly or indirectly by the employee, officer, director or designee;
• a company will be required either to provide a fair and accurate summary of any practices or policies that apply, including the categories of persons covered and any categories of hedging transactions that are specifically permitted and any categories that are specifically disallowed, or to disclose the practices or policies in full;
• if the company does not have any such practices or policies, require the company to disclose that fact or state that hedging transactions are generally permitted. Likewise, if a company only has a practice or policy that covers a subset of employees, officers or directors, they would need to affirmatively disclose that uncovered persons are permitted to engage in hedging transactions;
• specify that the equity securities for which disclosure is required include equity securities of the company or any parent, subsidiary, or subsidiaries of the company’s parent. Moreover, the disclosure is not limited to registered equity securities, but rather any class of securities;
• require the disclosure in any proxy statement on Schedule 14A or information statement on Schedule 14C with respect to the election of directors. Disclosure is not required in a Form 10-K even if incorporated by reference from the proxy or information statement; and
• clarify that the term “employee” includes officers of the company.

The essence of Item 407(i) is to disclose any allowable transactions that could result in downside price protection, regardless of how that hedging is achieved (for example, purchasing or selling a security, derivative security or otherwise). Accordingly, the rule specifically does not define the term “hedge” but rather is meant to cover any transaction with the economic effect of offsetting any decrease in market value.

Similarly, the Rule does not define the term “held directly or indirectly” but rather will leave it to a company to describe the scope of their hedging practices or policies, which may include whether and how they apply to securities that are “indirectly” held. To the extent that it is undefined or a person may not be covered based on the definition, again, a company would disclose that hedging is permitted as to those that are not covered.

The new Rule only requires disclosure of policies and practices and not hedging transactions themselves. CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. The new Rule adds an instruction to Item 402(b) related to CD&A such that the required disclosure can be satisfied by the new disclosure required by Item 407(i).

Section 14(j) specifically referred to any employee or member of the board of directors. The final rule clarified that officers are also covered in the disclosure. The Rule covers all employees, regardless of the materiality of their position. As the disclosure is about policies and practices, and does not mandate required policy or practice, the SEC saw no benefit in limiting the disclosure requirement to only certain covered persons. Consistently with the concept of allowing a company to define terms and scope in their adopted policies and practices, the definition and scope of “held directly or indirectly” will be left to a company to describe in its policy, if any, and associated disclosure.

The Author

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

+++++++++++++++++++++++++++++++++++++++++++++++++

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.

 

 

Why Is Austin Such a Promised Land for Food Entrepreneurs? — republished by Ronald Woessner

Article originally published by the Austin Chronicle here.

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Why Is Austin Such a Promised Land for Food Entrepreneurs?

The land of milk and honey and consumer packaged goods

Daniel Barnes (Photo by John Anderson)

 

It’s not the picturesque Hill Country views, or Austinites’ penchant for patio cocktails, or even the gushing venture capital streams that are driving the local consumer packaged goods industry, explains Leigh Christie, senior vice president of Global Technology and Innovation at the Austin Chamber of Commerce.  So what exactly is it that makes Austin an oasis for sought-after consumer packaged goods (CPG) companies?

Austin, an entrepreneurial mecca, finds itself at the delta of a national phenomenon in consumer preference: Consumers are demanding more traceability and simplicity in their products but also more convenience and innovation. People across the country are dreaming up new food-centric products in response, with high hopes of hitting the CPG jackpot, and an uncanny number of the success stories hail from right here in River City: EPIC Provisions, creator of all-natural meat/fruit bars, was born here and then acquired by General Mills; Amplify Snack Brand, which makes SkinnyPop Popcorn, is an Austin native and was acquired by Hershey; Chameleon Cold Brew and Briggo, the on-demand coffee bar, are also local brands. Siete Family Foods, a Mexican-American food brand created by the local Garza family, makes grain-free chips and tortillas, hot sauces, and dairy-free cashew queso, and just received a $90 million investment in February.

Daniel Barnes – mastermind behind Treaty Oak Brewing and Distilling, Waterloo Sparkling Water, and Mighty Swell – suggests that it’s mostly the community’s spirit that’s driving the scene: “I believe that a lot of it stems from a creative base and the creative culture in Austin, and that to me is more important than the VCs that are here.”

Leigh Christie (Photo by John Anderson)

 

In fact, many of the VCs, or venture capitalists, that fund Austin-based companies are only just beginning to invest their capital into packaged goods. “We’re seeing more VC and active investors wanting to learn about CPG because it’s not something they’ve invested in previously,” says Christie. “We’ve got more and more CPG companies who are relocating to Austin” – thereby raising awareness about the industry and its potential.

The city of Austin’s Economic Development Department calculated the food industry’s total economic impact in Austin to be $4.1 billion, or 0.45% of the city’s GDP, and food manufacturing only makes up $738 million of this industry. Still, “we have a strong need in the market, [and] we’re seeing that grow,” explained the department’s Global Business Expansion Manager David Colligan. Both the city of Austin and the Austin Chamber of Commerce have made the consumer packaged goods industry a target market for economic development, which basically means their goal is to bring more food companies to town.

James Brown (Photo by John Anderson)

 

So why is it not happening faster? Simple: There are no active incentives from the city for CPG companies looking to move to Austin. Still, the lack of state income tax and oft-lauded “affordable” standard of living make it an attractive place to settle in and build a business. According to James Brown, Barton Springs Mill owner/founder, there are quite a few grants and incubators around town willing to assist upstart companies. “We just won the Austin Food and Wine Alliance Grant,” he explained. “They usually give away half a dozen grants every year to local and regional food and beverage enterprises, ranging from $5,000 to $15,000.” Whole Foodsand Wheatsville also add to the allure, and coupled with the Food+City Challenge Prize and SKU, one of the nation’s leading CPG accelerators, Austin is quite a nurturing environment for introducing innovative products to the public.

South by Southwest in particular has played a unique role in creating buzz around Austin’s growing CPG scene. With every conceivable kind of creator making an appearance during those 10 Festival days, Brown says, “It’s an amazing experience to behold and to see the cross-pollination of all of these different thoughts and ideas. It does certainly have a huge effect on the food scene at that time.”

Barnes agrees, saying, “There’s no denying that SXSW has played some sort of a role in that [growth].” He also maintains that it’s the wealth of imagination, not the money, flowing through the Festival that makes it so influential on local companies. “When you’re constantly surrounded by inspiration and innovation, it just pushes you to drive your own creativity further and further,” he explained.

Creativity culture does not stop when SXSW ends, though. The Clayton Christophers (Sweet Leaf Tea; Deep Eddy Vodka) and the Tito Beveridges (Tito’s Vodka) of the food world greatly influence the development of companies by making themselves accessible. “They still go out of their way to have meetings with people who are on their way up. That responsiveness and that family mentality toward creating products here is remarkable,” said Barnes. Christie echoed his thoughts and explained that the chamber has seen a similar ecosystem being built around these companies because success begets success. “The CPG industry in town seems to support each other very well,” she said. “They seem to mentor, fund, and support one another.”

But while there’s no shortage of great ideas, raising capital is another story. Kirstin Ross, managing director of SKU, explained that convertible notes and angel networks are some of the limited options for companies looking to grow. Familiar names in venture capital firms like Cavu and LiveOak rarely offer financial support to businesses with less than $5 million in revenue, but with more Austin companies attracting the attentions of Fortune 100 companies, some industry insiders are taking it upon themselves to bridge the gap and give more CPG startups a chance. Genevieve Gilbreath recently launched Springdale Ventures, a VC fund that is dedicated to writing $500,000 checks to help companies through the bootstrapping stage. One of their first investments was Mason Arnold’s Cece’s Veggie Co. The hope, she explained, is to give burgeoning companies another option as they scramble to grow during the difficult stage between $500,000 and $1.5 million in sales.

Stephanie McClenny (Photo by John Anderson)

 

Plenty of Austin companies aren’t looking for explosive growth, though. Brown has turned down offers for investment in Barton Springs Mill and his “exit strategy” is something along the lines of “I don’t know, I’m going to die at some point?” Stephanie McClenny, owner of beloved local jam brand Confituras, created a small, but stable company that is able to weather the fickle winds of consumer taste: “We are a small, quiet company, and we work hard on building community and rely on word of mouth to strengthen our support rather than purchasing it.”

But with consumers’ short attention spans and social media driving people to constantly scour the landscape for the next best thing, Austin must continue to nourish upstart CPG entrepreneurs’ ideas. That’s a surefire way to satisfy taste buds while also boosting the city’s industry growth. After all, as Barnes put it, “The big guys aren’t ever going to be as good at innovation as the smaller guys are.”

Keep up with all our SXSW coverage at austinchronicle.com/sxsw. Sign up for our South By-specific newsletter at austinchronicle.com/newsletters for news, reviews, and previews delivered to your inbox every day of the Fest. And for the latest tweets, follow @ChronSXSW.

A note to readers: Bold and uncensored, The Austin Chronicle has been Austin’s independent news source for almost 40 years, expressing the community’s political and environmental concerns and supporting its active cultural scene. Now more than ever, we need your support to continue supplying Austin with independent, free press. If real news is important to you, please consider making a donation of $5, $10 or whatever you can afford, to help keep our journalism on stands.

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VC Funding Is Hard to Come by If You’re a Female Founder — republished by Ronald Woessner

Article originally published by Barrons +++++++++++++++++++++++++++++++++++++++++++++

OTC Markets: OTCQX Community Banks Virtual Investor Conference — republished by Ronald Woessner

Invitation to webcast by OTC Markets Group appears below:

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OTC Markets Group invites you to join us Thursday, March 14, 2019 at VirtualInvestorConferences.com for a series of live webcast presentations featuring CEOs and senior executives of OTCQX Community Banks.

Register now to hear from some of our 2019 OTCQX® Best 50 OTCQX regional and community Banks. Tune in as these OTCQX banks speak to their future growth plans and engage with industry leaders during a live Q&A session.

Presentation Agenda:
March 14, 2019 (EST)

Register Here

Not able to Attend?

The event, including presentations, will be available for on-demand replay following the conclusion of the conference.

About Virtual Investor Conferences 
Virtual Investor Conferences is the leading proprietary investor conference series that provides an interactive forum for publicly-traded companies to meet and present directly with investors.

A real-time solution for investor engagement, Virtual Investor Conferences is part of OTC Market Group’s suite of investor relations services specifically designed for more efficient Investor Access.  Replicating the look and feel of on-site investor conferences, Virtual Investor Conferences combine leading-edge conferencing and investor communications capabilities with a comprehensive global investor audience network.

Questions, please contact:   

John M. Viglotti
SVP | Investor Access
T +1 (212) 220-2221
johnv@otcmarkets.com

 

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.