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The Source for Issues Related to Successful Deal Structuring and Corporate Execution

Banishing the General Solicitation Ban!

By Leanna Young on Posted in SEC Regulatory Matters, Securities Issues

The SEC Advisory Committee on Small and Emerging Companies (ACSEC), established in September, 2011, and discussed in the article below made its first recommendation to the SEC on January 6th of this year: immediately relax or modify restrictions on general solicitation and general advertising in private offerings under Rule 506.

 The ACSEC’s perspective showed legislative support.  In November of 2011, the House passed an earlier version of the Jumpstart Our Business Startups Act (“JOBS Act”) by a large and bi-partisan majority of 413-11.  On March 22, 2012, the Senate passed the JOBS Act, but had to send the bill back to the House for approval after making revisions.  The ACSEC recommendation and the JOBS Act created two prospective routes to remove the long-standing general solicitation prohibition:  (i) the SEC could heed the advice of its ACSEC and remove the prohibition through its administrative rulemaking process, or (ii) Congress could mandate the SEC make such changes to its rules through the JOBS Act.  As it turns out, Congress was the route leading to the pot of gold at the end of the rainbow.  Just last week on Tuesday, March 27, 2012, the House, with strong and bipartisan support (380-41), passed the JOBS Act.  Only yesterday, Thursday, April 5, 2012, did President Obama sign the JOBS Act into law.

 Historically, Regulation D transactions restricted general solicitation by limiting transactions to parties with pre-existing relationships.  This restriction significantly reduced the pool of prospective investors and created interesting restrictions around tracking connections between investors and issuers.

 The primary impact on the elimination of the general solicitation ban on Regulation D offerings will be the following:

  • The SEC must revise its rules, within 90 days, to eliminate the general solicitation prohibition for offerings to accredited investors – thereby allowing companies without existing connections to such investors, whose hands were previously tied, to now reach out to such investors and, in return, receive needed capital.
  • Issuers will have the ability to utilize general solicitation, but only for investors who qualify as accredited investors.
  • Issuers must take reasonable steps to verify that purchasers of securities are accredited investors (using such methods as determined by the SEC).
  • Use of general solicitation will come into effect as early as this summer, which means, after a bit of due diligence to establish a reasonable belief that an investor is accredited; issuers can extend offerings to investors with whom they do not have already-established relationships.

 The bottom line: after much grumbling by entrepreneurs and small and emerging businesses, the go-ahead from the ACSEC, some back and forth between Congress, and a little pen and ink from President Obama, the JOBS Act has officially banished the general solicitation ban.

Payroll Tax Cut Extended for Two Months

By William Dornan on Posted in Uncategorized

President Obama signed a two-month extension of the payroll tax cut on December 23, 2011. Both the House and Senate will appoint conferees to negotiate a year-long extension in the coming weeks.

Since 1990, the Social Security tax rate for wages paid has been 12.4%. Both employers and employees pay half of this tax (6.2% each). Pursuant to the Tax Relief Act of 2010, the employee portion of the Social Security tax was reduced to 4.2%; however, the reduced rate was for year 2011 only. Starting in 2012, the employee portion of the Social Security tax rate was set to revert back to the full 6.2%.

DO YOU WANT TO BE THE NEXT FACEBOOK? You shouldn’t…unless…you like distracting lawsuits or the potential loss of your company’s IP.

By Steven N. Levine on Posted in Corporate Securities Issues, Securities Issues

Despite the genius that is Facebook, Mr. Zuckerberg would have saved himself numerous distractions (not to mention millions and potentially billions of dollars) if he only hired a qualified corporate and securities attorney during the start-up phase – like us.  Don’t get me wrong, anyone would be happy to be in Mr. Zuckerberg’s shoes dealing with shareholder lawsuits as a multi-billionaire, however, every start-up is not so fortunate.  All emerging growth companies must be conscious of and comply with securities laws, even during angel and friends and family rounds of financing.   It allows for a solid foundation and shows seriousness about the business.

When a new startup gets underway, there is lots of optimism and an eagerness to get things moving fast, and engagement of proper legal counsel is sometimes placed as a low priority.  Yet a savvy start-up understands that potential lawsuits and other penalties already give founders enough incentive to comply with the law.  However, there’s another consequence – and sometimes forgotten asset – that could result from a breach of securities laws in a non-compliant sale of shares: loss of your company’s IP.  Founders typically contribute IP in exchange for an ownership interest of the company, and any such issuance is a securities transaction.  If this transaction is not executed in compliance with applicable securities laws, then the co-founder who contributed the IP has a right of rescission.  This means that the co-founder has a potential claim in court to have the deal unwound.  In most securities transactions, where stock was issued in exchange for cash or services, this would simply result in a monetary award of damages.  However, if the stock was issued in exchange for IP rights, then a successful lawsuit by the founder who contributed the IP could result in the company losing its rights to the IP, potentially crippling the company.

Facebook has the cash to fight these claims, but can you imagine dealing with a shareholder or founder lawsuit when the company is still in the red?

Even if there are no disputes, potential investors doing due diligence on the company may be scared away because of the potential cloud hanging over the company’s most important assets.

We cannot stress the importance enough of a strong foundation – start-ups should not ignore securities laws in their early rounds of financing, or even in transactions with their co-founders.  Failing to properly create a proper corporate structure and acting diligently about legal matters can threaten a start-up in the future.

SEC To Adopt Form PF Rules

By James Muchmore on Posted in Uncategorized

10.26 SEC Open Meeting 

Please see attached the Opening Statement from SEC Chairman Schapiro regarding Private Fund Systemic Risk Reporting, or more succinctly, Form PF.  Today, it appears the SEC will adopt the final rules regarding private fund reporting on Form PF.  Based on the Chairman’s Opening Statement, it appears Form PF will require the following levels of disclosure:

 Types of Reporting:

Form PF will require “Tiered” reporting from private funds, which information will be distributed to the Financial Stability Oversight Council to assess systemic risk: 

  • Funds with less than $150mm in assets under management will not be required to file Form PF at all.
  • Hedge Funds managing at least $1.5bb will have heightened reporting requirements.
  • Private Equity Funds managing greater than $2bb will have heightened reporting requirements. 

Form PF will require the disclosure of substantially less information from advisers to ”large private equity funds” (to be defined in the final rules) than from advisers to hedge funds and liquidity funds (each type of fund to be defined in the final rules).

Timing of Reports:

  • Larger hedge fund advisers will be required to file Form PF on a quarterly basis no later than 60 days after the end of each quarter.
  • Smaller advisers and private equity advisers will be required to file Form PF on an annual basis no later than 120 days after year end.

The final rules have not yet been posted to the SEC’s website or printed in the Federal Register, so the adoption dates for these new requirements, and the exact language/qualifications in the final rules, are not yet public.  However, when the final rules are released, we will distribute a summary of the rules for your review.

As always, don’t hesitate to contact me if you have any questions regarding this Statement or any other aspect of the Advisers Act or the Dodd-Frank Act.

 

SEC to Hold Microcap Roundtable

By James Muchmore on Posted in SEC Regulatory Matters

On Monday, October 17, 2011, the SEC’s Microcap Fraud Working Group will host a microcap securities roundtable at the SEC’s offices in Washington, D.C.  The roundtable will provide a forum for SEC staff to discuss compliance challenges that issuers face, and changes to the regulatory framework surrounding the execution, clearance and settlement of microcap stocks, which primarily trade in the OTC and OTCBB markets.

The agenda of the roundtable includes three major panel segments: Panel 1 — Compliance Challenges Associated with Microcap Securities, Panel 2 — Anti-Money Laundering Monitoring, and Panel 3 — Potential Changes to the Regulatory Framework Concerning Microcap Securities.  The SEC’s efforts to host this roundtable and explore regulatory issues that affect microcap companies is consistent with the SEC’s recent focus on capital-access challenges facing smaller growing issuers.

SEC to Hoe Easier Road for Small and Emerging Companies’ Access to Capital?

By James Muchmore on Posted in SEC Regulatory Matters

On Sept. 21, 2011 the SEC’s Director of Corporation Finance provided testimony regarding proposals to facilitate small business access to capital. Notwithstanding some arguments that these proposed rule changes are long overdue, in light of the recent economic challenges facing new and growing businesses, it appears the SEC may finally be moving toward helping small and start-up businesses raise capital. Set forth below is a summary of some of the Staff’s suggestions.

  • Modify the definition of “Holders of Record” under the Exchange Act
    Registration is generally required by issuers with total assets over $10 million and securities held of record by 500 or more persons. In some cases, a public issuer’s securities may be held in street name by a broker, who is counted as a singular holder of record, notwithstanding the fact that the broker may hold such shares on behalf of a large number of individual shareholders. In contrast, a private issuer typically has shareholders who hold shares directly, which results in each shareholder counting toward the 500 person “holder of record” limit. As a result, many smaller companies get caught up in the SEC reporting requirements based on the manner in which their shareholders hold stock. To combat this issue, the SEC is considering expanding the “holders of record” definition to pierce the street name broker and count beneficial owners as record holders. Other proposals seek to raise the shareholder threshold or create an accredited investor exclusion.
  • Review the restriction on general solicitation in private offerings
    Small companies frequently rely on Section 4(2), which exempts from registration transactions “not involving any public offering.” The SEC noted that this prohibition often prevents a small business from raising money from third parties in a Series B round. To ease issuers’ ability to raise capital after a friends and family round, the SEC is considering easing the public offering process to accommodate small businesses, and perhaps permitting a larger class of issuers to use a free writing prospectus before a substantially complete prospectus is filed.
  • Modification of Capital-Raising Strategies
    The SEC is considering modifying its regulations to permit new types of capital raising.  For example, “crowdfunding,” a relatively new strategy whereby groups of people pool small, individual contributions to invest, is a potential strategy that may be helpful for smaller businesses looking to raise capital.  The Staff noted that Representative Patrick McHenry (R – NC) has introduced a bill (H.R. 2930) that would exempt crowdfunding capital raises, within specified limitations, from registration, which may result in easier capital access for smaller businesses.  Additionally, the SEC indicated it is considering revising Regulation A to increase the $5 million non-registered offering ceiling.

Chairman Schapiro has requested that the SEC Staff review, including undertaking a robust study and working with the Advisory Committee on Small and Emerging Companies, ways to lift regulatory burdens that stand in the way of capital access.  However, notwithstanding this directive, don’t be surprised if any rule proposals easing access to capital brushes up against counterbalancing SEC concerns of investor protection.

At least it’s a baby-step in the right direction…..

SEC Announces Formation of Committee on Small and Emerging Companies

By James Muchmore on Posted in SEC Regulatory Matters

On Sept. 13, 2011, the SEC announced the formation of an Advisory Committee on Small and Emerging Companies (the “Committee”). The Committee was established to focus on interests and priorities of small businesses and smaller public companies, and is intended to provide a formal mechanism through which the SEC can receive advise and recommendations specifically related to privately held small businesses and publicly traded companies with less than $250 million in public market capitalization. When the SEC announced the formation of the Committee, SEC Chairman Mary Shapiro noted in part that “[t]his new advisory committee will increase the input we receive from the small business community.”

The Committee will advise and consult the SEC on such issues affecting emerging privately-held small businesses and publicly traded companies with less than $250 million in public market capitalization as:

• Capital raising through private placements and public securities offerings.
• Trading in the securities of small and emerging small publicly traded companies.
• Public Reporting requirements of such companies.

Rule 206(4)-2: Don’t Forget About Your Mandatory Surprise Audit!

By James Muchmore on Posted in Investment Management Topics

In discussions with several fund managers recently, the topic of the application and obligations under Rule 206(4)-2 under the Investment Advisers Act of 1940 was discussed. Rule 206(4)-2, or the Custody Rule, requires generally that registered investment advisers who have custody of client funds or securities to engage an independent public accountant to conduct an annual surprise audit to verify the assets over which the adviser has custody.

Under the Rule, if a qualified custodian maintains a client’s funds and securities, then the adviser must notify the client of the qualified custodian’s name, address and the manner in which the funds or securities are maintained, and the adviser must have a reasonable basis for believing that the qualified custodian sends an account statement to each client at least quarterly identifying the assets in the account and the transaction that occurred during the subject period. Additionally, unless an exception applies, an adviser is required to engage an independent public accountant to conduct a surprise audit at least once during each calendar year, pursuant to which the accountant agrees to perform an audit at a time that is chosen by the accountant without prior notice or announcement and that is irregular from year-to-year. The engagement agreement must require the accountant to file a certificate on Form ADV-E with the SEC within 120 days of the time that the engagement begins, and must notify the SEC upon the discovery of any material discrepancy during the course of the engagement.

Further, if an adviser serves as the qualified custodian, or a person related to the adviser serves as the qualified custodian for an adviser’s clients, then the independent public accountant retained to perform the surprise audit must be registered with the Public Company Accounting Oversight Board. Additionally, under these circumstances an adviser must obtain, or receive from the related qualified custodian, a written internal control report at least once each calendar year indicating whether internal controls exist to safeguard the funds and securities held by the adviser.

However, there are exceptions to an adviser’s obligation to engage an accountant to perform a surprise audit on an annual basis, two of which are most frequently utilized by advisers.  First, an adviser is not required to engage an accountant to conduct a surprise audit for the accounts of limited partnership, limited liability company or other pooled investment vehicles that are subject to an annual audit by a PCAOB-registered firm, and that distributes audited financial statements in accordance with GAAP to all limited partners within 120 days of its fiscal year end. Second, an adviser is not required to perform an annual surprise audit if a related person maintains custody of client assets, and that person is “operationally independent” of the adviser.

Note however, that there is no exception for the account of a client that is not a pooled investment vehicle (i.e., an endowment, an individual, or a pension fund). As a result, if an adviser maintains custody over both pooled investment vehicles and separately managed accounts, then the adviser must retain an independent accountant to perform a surprise audit with respect to the separately managed accounts, notwithstanding the fact that the adviser may qualify for an exemption from the surprise audit requirement with respect to its pooled investment vehicles.

 

Senate Bill 1483 Proposes Disclosure of Beneficial Owners of Private Corporations

By James Muchmore on Posted in Corporate Securities Issues

On Aug. 6, 2011, Senator Carl Levin (D-Michigan), and Senator Chuck Grassley, (R-Iowa), introduced Senate Bill 1483 — “Incorporation Transparency and Law Enforcement Assistance Act.” This Act would require states to obtain the names of beneficial owners of corporations or limited liability companies formed under a state’s laws, require this information to be updated, and provide the information to law enforcement authorities upon the receipt of a subpoena or summons. Further, states would be required to collect information regarding beneficial owners’ names, addresses, and a U.S. driver’s license or passport number. Effective one year after a state amends its incorporation system to comply with the proposed Act, any entity formed under the laws of the subject state before the Act would be considered a corporation or limited liability company unless such entity qualified for an exemption. Under the proposed Act, a “beneficial owner” would include a natural person who, directly or indirectly, “exercises substantial control over a corporation or limited liability company,” or “has a substantial interest in or receives substantial economic benefits from the assets of a corporation or limited liability company.”

Under the proposed Act, entities would be obligated to make periodic and annual updating filings in connection with a change in the beneficial ownership of an entity, and, perhaps most significantly, the provision of false information, or the failure failing to provide complete or updated beneficial ownership information to a State, would subject persons to potential civil penalties and/or imprisonment.

The Bill does include some limited reporting exemptions for certain regulated entities, such as publicly traded corporations, banks, broker-dealers, insurers and registered investment funds, as well as for companies that have greater than 20 employees on a full time basis, U.S. tax returns reflecting gross sales greater than $5,000,000 and an operating presence at a physical location in the United States. However, the disclosure exemptions are affirmative “opt-in” exemptions, pursuant to which entities will have to formally identify and confirm the exemption that they qualify for, rather than simply determining independently that they qualify for an exemption and thereafter operating without making an affirmative disclosure.

In the event this bill is passed, the identification of every beneficial owner of every privately-held corporation and limited liability company that exists or is created in the United States would need to be disclosed. Entrepreneurs and investors would be wise to monitor the status of this bill, and if passed, monitor their compliance with their disclosure obligations under this Act, particularly in light of the severe consequences resulting from the failure to comply with the Act In addition, passage of this Act may affect the willingness of angel investors and/or venture capital funds from funding start-up entities, since certain investors may be reluctant to take a position in a start-up entity in order to avoid being identified as a beneficial owner thereof.