The JOBS Act in a Nutshell – Part IV Regulation A Redux

by Vanessa Schoenthaler on May 9, 2012

Jumpstart Our Business StartupsRegulation A is a conditional securities exemption allowing for public offers and sales of up to $5 million dollars of securities in a 12-month period. To be eligible to use Regulation A a company must be organized under the laws of the United States or Canada, must not be an investment company or blank check company and must not be subject to the periodic reporting requirements of the Securities Exchange Act.

Conducting a Regulation A offering is somewhat analogous to conducting a registered offering, though much simpler in form and substance, and is often referred to as a “mini-registration”.

In a Regulation A offering a company must prepare and file an offering statement with the Securities and Exchange Commission. An offering statement requires disclosures similar to those made in a registration statement, including disclosures regarding a company’s business and financial condition, its officers, directors and principal stockholders, risk factors, a description of the use of offerings proceeds and so on. An offering statement also requires the filing of certain exhibits and the inclusion of financial statements, which can be unaudited but must be prepared in accordance with generally accepted accounting principles.

Once a company’s offering statement is on file it is reviewed and qualified by the Commission, similar to the process of a registration statement being reviewed and declared effective. After the offering statement is qualified an offering circular, which makes up part of the offering statement, must be delivered to prospective investors prior to any securities being sold.

Thereafter the company must file reports with the Commission detailing the securities sold and the use of proceeds from those sales. The reports must be filed every six months until substantially all of the proceeds from the offering have been applied.

Notwithstanding the sales and use of proceeds reports, and unlike in a registered offering, once a Regulation A offering is complete there are no ongoing reporting obligations; no current, quarterly or annual reports to file (unless of course Exchange Act registration is triggered by some other means, such as by crossing the shareholder threshold required for registration). What’s more, any securities sold in a Regulation A offering are unrestricted and may be freely transferred in a secondary market transaction.

Another way in which Regulation A offerings differ from most other offerings is that Regulation A permits a company to gauge investor interest, or to ”test the waters”, by means of general solicitation or general advertising prior to the filing of an offering statement. Though this ability to test the waters is not without limitation, for example any written documents or scripts of oral presentations must be filed with the Commission prior to their first use. In addition, a company must also comply with the securities laws in each state in which an offer of securities is to be made, some of which do no permit general solicitation or general advertising.

One other item of note, there are also certain instances in which Regulation A can be used for secondary offerings, allowing shareholders resell up to $1.5 million of securities in a 12-month period.

Even though Regulation A does offer a simpler alternative to a full-scale registered offering it’s hardly ever used, in part because of its $5 million dollar offering limitation. In 2010 there were 25 initial Regulation A offerings filed with the Commission, but only 7 of these offerings were qualified.

A Regulation A Redux

The JOBS Act adds a new Section 3(b) to the Securities Act which calls for the Commission to implement an exemption for the public offer and sale of up to $50 million of securities in any 12-month period. There is no required time frame for implementation of this exemption.

The requirements of the new exemption start out much like an enhanced version of Regulation A. The securities, which can be equity securities, debt securities or debt securities convertible into or exchangeable for equity securities, may be publicly offered and sold and will thereafter be freely transferable (they will not be restricted securities). Additionally, subject to any terms or conditions that the Commission may prescribe, companies that wish avail themselves of the new exemption will be permitted to “test the waters” prior to undertaking an offering.

Similar to Regulation A, the new exemption contemplates the preparation and filing of an offering statement, the form and content of which the Commission will prescribed, but which may include a description of the company’s business and financial condition, its corporate governance principles, use of proceeds and audited financial statements. In addition, the exemption requires that companies file audited financial statements with the Commission on an annual basis and provides that the Commission may also require additional periodic disclosures regarding the company’s business and financial condition, its corporate governance principles and use of the offering proceeds.

Unlike Regulation A, if the securities under the new exemption are offered and sold on a national securities exchange or to qualified purchasers then they will be “covered securities” and exempt from the state securities laws.

The Commission also has the discretion to establish disqualification provisions under which the new exemption would not be available to certain companies or their affiliates for reasons substantially similar to the bad actor disqualification provisions to be established under the Dodd-Frank Act (which are themselves based on the disqualification provisions of Regulation A).

Lastly, every two years the Commission will have to review and increase, if appropriate, the $50 million offering limitation, or, if not increased, report to Congress as to why.

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The JOBS Act in a Nutshell – Part III General Solicitation and Private Offering Platforms

by Vanessa Schoenthaler on April 30, 2012

Jumpstart Our Business StartupsThe JOBS Act makes several significant changes to the rules surrounding private capital formation. One such change being the much-discussed elimination of the prohibition on general solicitation and general advertising in certain private securities offerings. Another being the addition of an exemption from broker-dealer registration for platforms that, to a certain extent, facilitate offers and sales of unregistered securities.

General Solicitation and General Advertising in Private Offerings

Section 201 of the JOBS Act requires that within 90 days of its enactment, or by July 3, 2012, the Securities and Exchange Commission revise Regulation D to eliminate the prohibition on general solicitation and general advertising in private offerings made in reliance on the safe harbor afforded by Rule 506, provided that only accredited investors participate in the offerings.

In its current form, Rule 506 allows an unlimited amount of capital to be raised from an unlimited number of accredited investors and up to 35 non-accredited investors, provided, however, that whenever non-accredited investors participate in an offering certain information disclosure requirements must be met. In its current form Rule 506 also explicitly prohibits general solicitation and general advertising, regardless of whether participating investors are accredited or non-accredited.

Section 201 of the JOBS Act also requires that the Commission, again by July 3, 2012, revise Rule 144A to provide that securities sold thereunder may be offered to persons other than qualified institutional buyers (QIBs), including by means of general solicitation or general advertising, provided that the securities are ultimately sold only to persons that the seller or anyone acting on the seller’s behalf reasonably believe to be QIBs.

Like Rule 506, Rule 144A is a safe harbor for sales of unregistered securities. Where they differ is that Rule 506 addresses sales of securities by an issuer (akin to a primary offering), whereas Rule 144A addresses resales by persons other than an issuer (akin to a secondary offering). Very generally, the safe harbor afforded by Rule 144A allows for resales of a limited category of qualifying securities to QIBs. Rule 144A resales often follow in close proximity to the private offering in which the securities being resold were originally issued.

So how are these changes going to impact the market for private securities offerings?

Insofar as Rule 506 offerings are concerned, over time we may see a shift from other types of Regulation D offerings to Rule 506 offerings, but lifting the ban on general solicitation and general advertising is not likely to have a significant impact on the type of investors participating in Rule 506 offerings.

Based on a recent report by the Commission’s Division of Risk, Strategy and Financial Innovation (FSHI), Rule 506 is already by far the most popular private offering exemption; used in over half of all the private offerings examined in FSHI’s report. And, even though Rule 506 allows for participation by up to 35 non-accredited investor, almost 90% of all Regulation D offerings (Rules 504, 505 and 506 combined) are made up entirely of accredited investors. So, while we may ultimately see even more Rule 506 offerings, there’s not much room for a shift in the ratio of non-accredited to accredited investors.

As for transactions set up to take advantage of the Rule 144A resale exemption, they only make up a small number of the private offerings conducted each year and they generally involve larger companies that already are, or immediately become, subject to the Exchange Act’s reporting requirements. Compared to Rule 506 offerings, Rule 144A transactions are fairly niche and, while I don’t have anything in the way of stats to back it up, I don’t think that we’re going to see any great shift toward Rule 144A offerings just because general solicitation and general advertising is permitted.

Where lifting the ban on general solicitation and general advertising will undoubtedly have the greatest impact is in the amount of information about private offerings that becomes publicly available. Hopefully this will result in a better understanding of how private capital formation works, as opposed to an overload of information that is of diminishing value or quality.

One other item of note here is that, despite the JOBS Act having taken effect, the current prohibition on general solicitation and general advertising remains in place until the Commission adopts amended or new implementing rules and those rules themselves take effect.

The Platform Exemption to Broker-Dealer Registration

Finally, Section 201 the JOBS Act creates an entirely new exemption from the broker-dealer registration requirements for anyone that maintains a platform or other mechanism that permits offers, sales, purchases or negotiations of securities, or permits general solicitation, general advertising or related activities by an issuer that is offering securities, regardless of whether those activities take place online, in person or by some other means.

What’s more, the exemption is available even if the person maintaining the platform invests in or provides “ancillary services” related to the securities that are made available through the platform. Ancillary services are defined to include due diligence services, provided no compensated investment advice is given, and the provision of standardized documents, provided there is no involvement in the negotiation process and the parties are free to use their own transaction documents if they choose to.

Lastly, the exemption is contingent on there being no transaction related compensation, no possession of securities or customer funds and no involvement by persons subject to statutory disqualification under Section 3(a)(39) of the Exchange Act.

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The JOBS Act in a Nutshell – Part II Research Reports and Communications Related to Emerging Growth Companies

by Vanessa Schoenthaler on April 19, 2012

Jumpstart Our Business StartupsSection 105 of the JOBS Act sets out to improve the availability of information about emerging growth companies by eliminating some of the prohibitions on communications and activities that can take place around a registered offering.

Under the Securities Act of 1933, the offering registration process is divided into three periods:

  • the “pre-filing period” which begins with the decision to publicly offer securities and continues until the filing of a registration statement with the Securities and Exchange Commission;
  • the “waiting period” or “quiet period” which begins with the filing of a registration statement and continues until the Commission declares that registration statement effective; and
  • the “post-effective period” which begins once the registration statement is declared effective.

The kinds of communications and activities that are permissible vary depending on where you are in the registration process. For example, prior to enactment of the JOBS Act, the Securities Act generally prohibited any communications containing oral or written offers of securities during the pre-filing period. During the waiting or quiet period, the Securities Act permitted oral offers as well as written offers made by means of a Section 10 prospectus.

The term “offer” is broadly defined to encompass “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value” and has been construed by the courts and the Commission to include “the publication of information and statements, and publicity efforts … [that], although not couched in terms of an express offer, may in fact contribute to conditioning the public mind or arousing public interest … ” in a company or its securities.

Pre-Filing and Waiting or Quiet Period Communications

The JOBS Act significantly changes the communications rules is by allowing an emerging growth company, or any person authorized to act on behalf of an emerging growth company, to engage in oral or written communications with potential investors that are qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) in order to gauge their interest in an offering prior to or following the company’s filing of a registration statement (i.e., during the pre-filing and waiting or quiet periods). A practice often referred to “testing the waters”. Unlike many of the other changes addressed below, an emerging growth company’s ability to test the waters is neither limited to its IPO nor offerings of its common equity and, as such, can be used in follow-on offerings and offerings of debt securities.

Again, prior to enactment of the JOBS Act, oral and written offers of securities were generally prohibited during the pre-filing period and while there were no explicit restrictions on oral offers during the waiting or quiet period written offers had to be made by means of a Section 10 prospectus.

Research Reports

Another way the JOBS Act changes the communications rules is by allowing a broker-dealer to publish and distribute research reports about an emerging growth company that proposes to or is in the process of registering its common equity (i.e., during the pre-filing and waiting or quiet periods) without the reports being deemed an offer of securities, even if the broker-dealer will also be participating as an underwriter in the offering.

For purposes of the exclusion the JOBS Act carves out a slightly expanded definition of the term “research report”, which covers oral as well as written and electronic communications that provide information, analysis, opinions or recommendations about an emerging growth company or its securities, whether or not the information is reasonably sufficient to base an investment decision on.

In addition, the JOBS Act prohibits the Commission or any national securities association, FINRA presently being the only one, from adopting or maintaining any rule or regulation that would prohibit a broker-dealer from publishing or distributing a research report or from making a public appearance with respect to the securities of an emerging growth company following the company’s IPO or in advance of the expiration of its IPO related lock-up agreements (i.e., during the post-effective period).

Before the JOBS Act went into effect, a broker-dealer participating as an underwriter in a company’s IPO was prohibited from publishing and distributing research reports and from making public appearances with respect to the company’s securities prior to and for a period of 40 days following the IPO, and for a period of 15 days both prior to and after the expiration of its IPO related lock-up agreements (these rules remain unaffected with respect to IPOs of non-emerging growth companies).

Analyst Communications

The JOBS Act also prohibits the Commission or any national securities association from adopting or maintaining any rule or regulation in connection with the IPO of an emerging growth company’s common equity that would restrict who at a broker-dealer may arrange for communications between a research analyst and a potential investor, or restrict a research analyst from participating in any meetings with the company’s management that non-analyst employees of the broker-dealer also attend.

Before the JOBS Act went into effect, a research analyst was prohibited from directly or indirectly engaging in communications with current or prospective investors in the presence of a company’s management or a broker-dealer’s non-analyst employees, and was prohibited from participating in company road shows or other meetings.

One thing the JOBS Act doesn’t do is relieve broker-dealers of their obligations related to conflicts of interest or research analysts from the disclosure and certification requirements of Regulation AC.

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The SEC Releases the Division of RSFI’s Report on Regulation D Offerings

by Vanessa Schoenthaler on April 11, 2012

Yesterday the Securities and Exchange Commission’s Division of Risk, Strategy and Financial Innovation released a report analyzing information extracted from all Form D filings made with the Commission between January 2009 and March 2011. The report, entitled Capital Raising in the US: The Significance of Unregistered Offerings Using the Regulation D Exemption, coincides with a slide presentation given before the Advisory Committee on Small and Emerging Companies in October 2011. The report looks at the amount of capital raised using the Regulation D exemptions (Rules 504, 505 and 506) as compared to the amount of capital raised using other methods, public and private, and gives us a bit of insight into common Regulation D offering characteristics and the companies that most frequently avail themselves of the Regulation D exemptions.

Common Regulation D Offering Characteristics

Using information reported in response Item 13 of Form D, the report begins by estimating the total amount of capital raised in Regulation D offerings for the 2009 and 2010 calendar years (take a look at the report’s appendix for some of its methodologies and assumptions, including the treatment of Form D amendments). Item 13 of Form D requires that a company specify:

  • the total amount of securities to be offered (Item 13(a)), expressed as a dollar value or as an “Indefinite” amount (indicating that the total offering amount is undetermined or cannot be determined at the time of the Form D filing);
  • the total amount of securities that have been sold as of the time of the Form D filing (Item 13(b)); and
  • the total amount of securities that remain to be sold (Item 13(c)).

Based on a review of these figures the report estimates that, for the 2009 and 2010 calendar years, capital raised through Regulation D offerings ranged from a minimum (calculated using Item 13(b)) of approximately $587 and $905 billion, respectively, to a maximum (calculated using Item 13(a)) of approximately $1.5 and $1.2 trillion, respectively. With the average offering size being approximately $30 million, but the median offering size only being approximately $1 million, suggesting that a large number of smaller offerings took place.

Among the available Regulation D exemptions, Rule 506 was by far the most popular one to be claimed during the period examined. Rule 506 allows you to raise an unlimited amount of capital from an unlimited number of accredited investors, and up to 35 non-accredited investors, provided certain information and other requirements are met.

The data also reveals that during the 2009 and 2010 calendar years the total amount of capital raised in Regulation D offerings was more than twice the total amount of capital raised in public equity offerings. There are, however, other factors that might be influencing these findings, not the least of which being the state of the capital markets during the period in question. It’ll be interesting to see if this trend continues as the environment for public equity improves.

Another interesting bit of information revealed by the data is the number and type of investors that typically participate in a Regulation D offering. Only approximately 10% of investors that participated in offerings during the period examined were non-accredited investors. With approximately 90% of offerings being made up of entirely accredited investors. In addition almost 90% of offerings involved approximately 30 investors or less.

Common Company Characteristics

The report also gives us some insight into the type of companies that most frequently avail themselves of the Regulation D offering exemptions. For example, Item 4 of Form D requires that a company identify its industry group and Item 5 asks that it disclose its revenue range (though companies have the option to “Decline to Disclose”).

Based on a review of the responses to Item 4, nearly one-third, or 29%, of the Form D filers in 2009 and 2010 identified themselves as pooled investments funds (of which approximately half, or 55%, further identified themselves as hedge funds). Of the remaining companies, approximately 15% identified themselves as being in the technology industry, approximately 10% in the health care industry and approximately 8% in the real estate industry.

While approximately half of all companies declined to disclose their revenues, of the companies that did make the disclosure nearly 20% had no revenues at all and another approximately 20% had revenues of $25 million dollars or less (the chart below accounts for a $1.00 – $5 million revenue range and a $1 million – $5 million revenue range, but Form D calls for disclosure in the $1.00 – $1 million and $1 million – $5 million revenue ranges, so it’s unclear to me as to whether there’s overlap in the chart or a typo, though I assume the latter). Finally, less than 4% of all companies raising capital in a Regulation D offering reported revenues in excess of $25 million.

Additionally, during the period examined approximately 25% of all companies that raised capital in a Regulation D offering were foreign companies.

And, of the universe of public companies, approximately 10% raised capital in a Regulation D offering, with those relying on Regulation D tending to be smaller and less profitable then their peers.

A complete copy of the report is embedded below, it’s brief and there are plenty of additional charts to flip through:

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The JOBS Act in a Nutshell – Part I Emerging Growth Companies

by Vanessa Schoenthaler on March 31, 2012

Jumpstart Our Business Startups ActNow that both the House and the Senate have passed the Jumpstart Our Business Startups Act (the “JOBS Act”), and as it awaits President Obama’s signature, let’s take a look at what we actually ended up with. I’m going to break this post down into several parts addressing:

  • the newly created category of emerging growth companies;
  • the crowdfunding exemption;
  • the amendments to Section 12(g) (formerly the 500 shareholder rule).

We’ll start with a straightforward look at what’s in the bill, and then come back to the good, the bad and the ugly.

This first post addresses the newly created category of emerging growth companies:

What is an Emerging Growth Company?

An “emerging growth company” is a company that had total annual gross revenues of less than $1 billion in its most recently completed fiscal year, excluding any company that held an IPO on or before December 8, 2011.

When is a Company No Longer and Emerging Growth Company?

Once a company is an emerging growth company it will remain an emerging growth company until the earlier of the:

  • the last day of the fiscal year in which it has total annual gross revenues of $1 billion or more;
  • the last day of the fiscal year following the fifth anniversary of its IPO;
  • the date on which it has, during the previous three-year period, issued more than $1 billion in non-convertible debt; or
  • the date on which it becomes a large accelerated filer (a company with worldwide non-affiliate market capitalization of $700 million or more, measured as of the last business day of its second fiscal quarter).

How Do Corporate Governance and Disclosure Obligations Differ for Emerging Growth Companies?

IPO Registration Statements

An emerging growth company has the ability to submit an initial draft of its IPO registration statement to the Securities and Exchange Commission for confidential nonpublic review, provided the initial draft and all amendments thereto are publicly filed at least twenty-one days in advance of the emerging growth company’s roadshow.

Financial Statements

An emerging growth company is only required to include two years of audited financial statements in its IPO registration statement (as opposed to two years of audited balance sheets and three years of audited income and cash flows statements).

Selected Financial Data

In any registration statement or periodic or other report filed with the Commission, an emerging growth company is only required to include selected financial data that stems back as far as the earliest period covered by the audited financial statements included in its IPO registration statement (as opposed to selected financial data that stems back five years, or such shorter period as the company may have been in existence).

Note, however, that if an emerging growth company is also a smaller reporting company then it will be exempt from providing any selected financial data at all (as has always been the case for smaller reporting companies under the scaled disclosure requirements).

A “smaller reporting company” is a company with a worldwide non-affiliate market capitalization of less than $75 million, measured as of the last business day of its second fiscal quarter, or, in the case of an IPO, measured as of a date within 30 days of the filing of its IPO registration statement. Alternatively, where a company has no market capitalization, it may still qualify as a smaller reporting company if it had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

MD&A

An emerging growth company is only required to provide information in it management’s discussion and analysis of financial condition and results of operations (“MD&A”) that stems back as far as the earliest period covered by the audited financial statements included in its IPO registration statement.

Executive Compensation

An emerging growth company is only required to provide the scaled version of executive compensation disclosure that smaller reporting companies provide.

Accounting Standards

An emerging growth company is not required to comply with any new or revised accounting standards that are applicable to both public and private companies until the date on which private companies are required to comply with the accounting standards.

Auditor Attestations

An emerging growth company is not required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, however is still responsible for establishing, maintaining and assessing internal controls over financial reporting.

Auditing Standards

In the event that the PCAOB adopts rules requiring mandatory audit firm rotation or inclusion of an auditor’s discussion and analysis in a company’s audit report, emerging growth companies will not be required to comply with these requirements.

What’s more, any other rules adopted by the PCAOB after the JOBS Act is enacted will not apply to emerging growth companies unless the Commission determines that their application is necessary or appropriate in the public interest, after taking into consideration investor protection and whether application of such rules would promote efficiency, competition and capital formation.

Say on Pay, Say on Frequency and Say on Golden Parachute Votes

An emerging growth company is not required to hold shareholder advisory votes on executive compensation (“Say on Pay”), shareholder advisory votes on the frequency (“Say on Frequency”) of Say on Pay votes or shareholder advisory votes on golden parachute compensation in connection with a merger, acquisition or other similar transaction (“Say on Golden Parachutes”).

Once a company is no longer an emerging growth company:

  • if it was an emerging growth company for less than two years following its IPO, then it must hold its first Say on Pay and Say on Frequency votes, and, if applicable, Say on Golden Parachute vote, within three years of graduating from emerging growth company status;
  • if it was an emerging growth company for more than two years following its IPO, then it must hold its first Say on Pay and Say on Frequency votes, and, if applicable, Say on Golden Parachute vote, within one year of graduating from its emerging growth company status.

Pay-for-Performance and Pay Equity

An emerging growth company is not required to disclose the relationship between executive compensation and financial performance (“Pay-for-Performance”), or the annual total compensation of it CEO, the median of the annual total compensation of all other employees and the ratio between the two numbers (“Pay Equity”).

Both the Pay-for-Performance and the Pay Equity disclosure requirements were added to the Securities Exchange Act by the Dodd-Frank Act, but the Commission has not yet proposed implementing rules.

Opting In & Out

Finally, other than with respect to the accounting standards, an emerging growth company may elect to forgo some or all of the scaled corporate governance and disclosure provisions and instead comply with the requirements applicable to non-emerging growth companies.

As far as accounting standards are concerned, an emerging growth company must notify the Commission in conjunction with the filing of its initial registration statement as to whether it will take advantage of the extended period for complying with any new or revised accounting standards. When an election is made it is with respect to all new or revised accounting standards (there’s no choosing to comply with some and electing an extension for others). Still, if an emerging growth company initially chooses to take advantage of the extended compliance period, it can always change its mind later. However, after an emerging growth company has elected to forgo the extended compliance period that election is irrevocable.

Update April 18, 2012:

On Monday the Division of Corporation Finance released a set of FAQs discussing the general applicability of the JOBS Act to emerging growth companies.

Update May 3, 2012:

The Division of Corporation Finance released a second set of FAQs discussing the general applicability of the JOBS Act to emerging growth companies.

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SharesPost: The Evolution of a Broker-Dealer

by Vanessa Schoenthaler on March 15, 2012

Yesterday the Securities and Exchange Commission announced that it settled a proposed administrative and cease-and-desist proceeding against SharesPost, Inc., an online private capital marketplace, and its founder and president, Gregg Brogger, for acting as an unregistered broker-dealer.

First, What is a Broker-Dealer?

Under the Securities Exchange Act a “broker” is broadly defined as “any person engaged in the business of effecting transactions in securities for the account of others,” and a dealer as “any person engaged in the business of buying and selling securities for such person’s own account through a broker or otherwise.”

Before a broker-dealer can “effect any transactions in, or … induce or attempt to induce the purchase or sale of, any security …” it must register with the Commission and become a member of FINRA and the SIPC. Additionally, broker-dealers must comply with the registration requirements of the laws of each state in which they intend to operate.

Once a broker-dealer is registered it becomes subject to a number of specific conduct, financial responsibility and reporting requirements, as well as to periodic compliance examinations by the Commission, FINRA and the state securities commissions.

What Does it Mean to be “Engaged in the Business” of Effecting Securities Transactions?

Neither the Exchange Act nor the rules promulgated thereunder define what it means to be “engaged in the business of effecting transactions in securities,” and the courts and the Commission, by means of administrative and enforcement proceedings and through interpretive decisions in the form of no-action letters, have come to construe the phrase broadly to include activities such as:

  • soliciting, structuring or negotiating securities transactions;
  • providing valuation advice;
  • disseminating quotation information;
  • receiving transaction-related compensation;
  • preparing, conveying or collecting transaction-related documentation; or
  • otherwise acting as an intermediary in a securities transaction.

So, What Happened in the SharesPost Case?

SharesPost started out in June 2009 as an online bulletin board for buyers and sellers of private company securities. They charged a flat membership fee for access to their platform and left members to arrange and execute their own transactions. But private sales of securities can be complicated and many members ended up needing “substantial assistance from SharesPost and/or a representative of a registered broker-dealer” in order to complete their transactions. At this point SharesPost probably should have either registered as or merged with a broker-dealer.

Instead, in 2010, SharesPost entered into a series of agreements with registered representatives from various other broker-dealers. The representatives were designated as “Company Specialists” and were each assigned to cover certain categories of companies (e.g., social media, green tech., etc.). Their role was to facilitate transactions between buyers and sellers. As compensation for these services their supervising broker-dealer was paid a transaction based fee. The broker-dealer in turn paid a portion of that fee over to the representative, pursuant to a separate agreement between the broker-dealer and the representative.

To make things a bit more complicated, each representative also entered into an arrangement with SharesPost whereby they agreed to pay 35% of their gross commissions to another broker-dealer to be designated by SharesPost in the future. The only problem is that SharesPost never designated a broker-dealer. It did, however, keep track of the commissions owed and when one of its representatives left SharesPost itself received the accrued commissions (even though it still wasn’t a registered broker-dealer).

By late 2010 SharesPost decided “that maintaining arrangements with multiple registered representatives affiliated with multiple broker-dealers was cumbersome” and so (rather than registering as or merging with a broker-dealer at that point) SharesPost entered into a “Broker-Dealer Independent Affiliate Agreement” with “Broker-Dealer A.”

Pursuant to this latest agreement SharesPost employees who were also registered representatives of a broker-dealer, including its then CEO and other senior executives, facilitated transactions between buyers and sellers on a commissioned basis. Any commissions earned were paid into a compensation pool at Broker-Dealer A. The CEO of SharesPost would then provide Broker-Dealer A with written instructions as to what percentage of funds in the commission pool were to be distributed to each representative and to Broker-Dealer A.

Beyond the creative compensation arrangements SharesPost also engaged in other activities that made it more like a broker-dealer and less like the passive bulletin board that it started out as. Among other things, it made available through its website and suggested that members use its own copyrighted form transaction documents. SharesPost personnel, some of whom were not registered representatives, served as intermediaries between buyers, sellers, companies and transfer agents. It made available free research reports detailing information about the companies whose securities were posted on its bulletin boards and it created a “Venture Index” that aggregated and weighed certain known or estimated data for its most active companies.

Also in late 2010 SharesPost created a series of funds each designed to purchase the securities of one of the companies posted on its bulletin boards. These funds were used to create an auction process. To quote at length from the Commission’s Order:

[P]otential sellers of a company’s stock would set a reserve price for the block of shares they wished to sell. In turn, SharesPost members who posted indications of interest to buy interests in the [fund] were contacted by SharesPost personnel, who were registered representatives of Broker-Dealer A to see if they wanted to participate in the auction. The buyers were bidding on interests in the fund and the fund would in turn purchase the stock. The auction process began to feature prominently on the SharesPost website – thus, at that point, SharesPost was using the website to sell securities (interests in the fund) in which it had a financial interest. The SharesPost subsidiary management company [that oversaw the funds] charged a one-time service fee, which was five percent of the investment and a three percent fee on any distributions to the fund.

Finally, in December 2011, SharesPost acquired a broker-dealer which it also registered with the Commission as an alternative trading system, a development first announced in a press release yesterday.

Overall I think this is a good outcome, SharesPost should have registered or acquired a broker-dealer from the beginning (or at least earlier on) and it’s good to see the Commission reaffirm it’s commitment to both innovation in the market and investor protection. Or as Robert Khuzami noted in the Commission’s press release: “[w]hile we applaud innovation in the capital markets, new platforms and products must obey the rules and ensure the basic fairness and disclosure that are the hallmarks of sound financial regulation.”

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Is it Time to Revisit Earning Guidance?

by Vanessa Schoenthaler on March 13, 2012

Recently NYU professor and author Baruch Lev penned an article in the Wall Street Journal on the perennial subject of earning guidance, arguing that when done “smartly” guidance can benefit investors, companies and management alike.

Professor Lev is of the school of thought that guidance contributes to better overall market data, reduces uncertainty, share price volatility and litigation risk and that it can increase analyst coverage and management credibility.

However, the trend over the last several years has been that of companies moving away from issuing quarterly earnings guidance, many instead offering annualized guidance or non-financial guidance of a general nature, and still others electing to suspend or all together discontinue guidance.

On the other side of the debate, those critical of the practice of issuing earnings guidance argue that preparation and delivery of guidance is a drain on management’s time and a company’s resources, that guidance encourages short-termism and that it distorts incentives.

But in his article Professor Lev dismisses many of these criticisms, and offers up a few tips on the “right … ways to do guidance,” including to: “guide when you are a better prognosticator than analysts … if most of your industry peers release guidance regularly … when uncertainty about your company’s prospects are high … [and] when forthcoming earnings will disappoint … .” Professor Lev also argues that guidance “should be part of a wider strategy of regularly disclosing fundamental information about [your] company and its business model … .”

Whether or not to provide guidance and, if you do, the type of guidance to provide, is a company specific choice, one that should be made by management together with the audit committee, and in some cases the entire board of directors. But let’s assume for a moment that you’re in agreement with Professor Lev and that your company has decided to provide guidance, what then should you consider when developing (or revisiting and updating) your guidance policy?

What Kind of Guidance Will You Provide?

One of the first things to address is what kind of guidance to provide. There are any number of metrics for you to choose from, both quantitative and qualitative. For example, many companies provide guidance on factors like revenues, net income, margins and of course earnings per share, as well as on non-GAAP measures* like adjusted net income, adjusted EBIT or EBITA and adjusted earnings per share.

The myriad of possibilities notwithstanding, you should only provide guidance in metrics that you feel you can accurately forecast. Additionally, once you’ve selected an appropriate set of metrics, you need to consider whether you are best suited to offer guidance in terms of a single number (e.g., “we expect earnings of $9.30 a share on sales of $37 billion”), in a range of numbers (e.g., “we expect net income to be between $144 million and $150 million”) or as a percentage (e.g., “we expect our adjusted EBIT margin to increase to around 13% and adjusted earnings per share by about 10%”).

Guidance can also come in the form of non-financial metrics, such as guidance about market conditions, trends in your industry or your long-term vision and strategy. Non-financial guidance can take just about any form you can think of (e.g., “we plan to open approximately 100 new stores” or “we anticipate market conditions to remain challenging due to the economic environment”) and can be useful in adding context to a forecast.

How Often Will You Provide Guidance?

Closely related to the matter of form is the question of how often to provide guidance, with most companies doing so on an annual or  quarterly basis, and occasionally on a selective basis in between periods. The appropriate interval is again a company specific choice. It depends in part on internal considerations, like the resources that you’re willing to devote to the preparation of guidance and the interval at which you feel you can accurately forecast in the metrics you’ve chosen, and to a certain extent on external considerations, like the norms in your industry.

For example, if you’re a regulated utility you can likely forecast earning per share on a quarterly basis with less effort and more accuracy than say an airline carrier or a bank holding company can. In addition, if a majority of companies in the utility industry, or even just a majority of your peers, provide quarterly earnings per share guidance you should factor that into your own analysis of whether to provide similar guidance.

How Will You Present Your Guidance?

Whenever you present guidance it must be delivered in a manner that is compliant with both the requirements of the federal securities laws, the anti-fraud provisions and Regulation FD in particular, and the disclosure and reporting requirements of the exchange on which your securities are listed. Accordingly, most companies that provide guidance do so as part of their annual or quarterly earnings calls, with many still making guidance a part of their earnings release (as was required of NYSE listed companies prior to May 2009).

Still you can provide guidance at just about any other time, but doing so at odd intervals or in between periods requires a bit of careful planning. Let’s say, for example, that you decide to provide additional guidance in between your regularly scheduled quarterly earnings calls. Best practices for written guidance might include the issuance of a press release or a written statement coupled with a Form 8-K filing. Similarly, best practices for oral guidance might include the prior issuance of a press release or a written statement coupled a Form 8-K filing, which either sets forth the guidance to be presented orally or announces your intention to provide oral guidance by a means readily accessible to the general public, such as on a conference call or in a webcast. What’s more, whenever presenting oral guidance you have to be mindful that you only address forward-looking information. Any discussion of or updates regarding material non-public information from a previously completed fiscal period will trigger additional disclosure requirements under Item 2.02 of Form 8-K.

In addition, regardless of how you choose to present your guidance, it should always be preceded by an appropriately fashioned cautionary statement on forward-looking information, one that is up-to-date and addresses material risks specifically related to the guidance. Any presentation should also set forth the key assumptions on which your guidance is based and note that actual results may differ from projections.

What’s In Your Guidance Policy?

In the end, you should put it all together in a written guidance policy, whether a stand alone policy or as part of your overall disclosure policies. Your guidance policy should at least sets forth when and how you will provide guidance and whether you will update previously issued guidance. Your guidance policy should also be amended any time your practices change and everyone responsible for providing guidance should be familiar with its terms.

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*Remember that if you provide guidance in a non-GAAP financial measure you also have to comply with the requirements of Regulation G.

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The Net Worth Standard Under the Definition of Accredited Investor Went Into Effect Today

by Vanessa Schoenthaler on February 27, 2012

The Securities and Exchange Commission’s final rules and amendments conforming the net worth standard under the definition of accredited investor to the requirements of the Dodd-Frank Act went into effect today, causing the Division of Corporation Finance to withdraw and archive C&DI Questions 179.01 and 255.47, which addressed how to determine the value of an investor’s primary residence for purposes of calculating net worth. Any such future determinations should be made in accordance with the final rules.

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Should There Be Uniform Disclosure Requirements Regarding Political Contributions?

by Vanessa Schoenthaler on February 27, 2012

Two years ago, in its landmark Citizens United v. FEC decision, the U.S. Supreme Court ruled that government imposed restrictions on corporate political speech–prohibiting corporations and other associations from using treasury funds to make independent political expenditures–were a violation of the First Amendment.

Following Citizens United there was a tremendous uptick in election spending and a great deal of debate around what kind of disclosure corporations should make about political expenditures.

In April 2010 Congressman Chris Van Hollen introduced the DISCLOSE Act in the House of Representatives. It was later introduced in the Senate in July 2010.  The DISCLOSE Act sought to amend the Federal Election Campaign Act of 1971 to require, among other things, that corporations, unions and other associations make certain disclosures regarding political expenditures. The bill passed in the House, but not in the Senate.

Earlier this month Congressman Van Hollen again introduced legislation to amend the Federal Election Campaign Act to require additional disclosure regarding political expenditures, though the text of this latest bill is not yet available.

Taking a different route, in August 2011, the Committee on Disclosure of Corporate Political Spending (the “Committee on Disclosure”), a group made up of ten prominent securities law professors, petitioned the Securities and Exchange Commission to develop uniform disclosure rules for corporate political spending. That petition remains pending.

This past Friday Commissioner Aguilar, in his remarks before PLI’s SEC Speaks in 2012 program, also called for the Commission to enact uniform disclosure rules related to corporate political spending, noting the large number of comment letters received in support of the Committee on Disclosure’s petition for rulemaking (64,790 in total as of this writing; 42,439 of which the Commission has characterized as a variant on the form of Letter A and 22,118 as a variant on the form of Letter B).

However, according to Reuters, at the same PLI program Chairman Shapiro told reporters that while the Commission will address the rule-making petitions that it receives “at some point” shareholders already have a means of requiring more disclosure. “Companies that receive a shareholder proposal asking them for disclosure about political contributions have been required to put those shareholder proposals in the proxy, so there is a mechanism for shareholders to directly represent to the companies they own to have that issue put forward for a shareholder vote.”

In his remarks Commissioner Aguilar noted that, according to the Committee on Disclosure’s rulemaking petition, out of a total of 465 shareholder proposals that made it into company proxy statements in 2011, 50 addressed disclosure of political expenditures (10.7% of all proposals). A quick search on the outcome of those proposal shows that at least 10 (of the 10 I looked at) failed to garner a sufficient vote to pass.

The success rate of shareholder proposals notwithstanding, there are a number of companies that are making voluntary disclosures about direct and, to a lesser extent, indirect political expenditures on their websites (e.g., Time Warner Inc. and Merck & Co Inc.).

In October 2011, the Center for Political Accountability released an index of corporate political accountability and disclosure policies in S&P 100 companies. The index will be updated annually and expanded to include S&P 500 companies in 2012.

While it doesn’t appear that uniform disclosure rules regarding corporate political expenditures will be a priority, unless Congress suddenly decides to allocate enough funds for the Commission to get through its Dodd-Frank rulemaking and still have something left, the number of companies making voluntary disclosures, at least in the S&P 100, is encouraging. Though the disclosure is sometimes difficult to find and certainly not uniform.

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SEC’s New C&DI: How to Describe A Say on Pay Proposal on Your Proxy Card

by Vanessa Schoenthaler on February 13, 2012

The Division of Corporation Finance issued new a Compliance and Disclosure Interpretation (C&DI) today (Exchange Act Rule Question 169.07), addressing how shareholder advisory votes on executive compensation should be presented on proxy cards and voting instruction forms:

Question: On its proxy card and voting instruction form, how should a company describe the advisory vote to approve executive compensation that is required by Exchange Act Rule 14a-21?

Answer: The following are examples of advisory vote descriptions that would be consistent with Rule 14a-21’s requirement for shareholders to be given an advisory vote to approve the compensation paid to a company’s named executive officers, as disclosed pursuant to Item 402 of Regulation S-K.

  • To approve the company’s executive compensation
  • Advisory approval of the company’s executive compensation
  • Advisory resolution to approve executive compensation
  • Advisory vote to approve named executive officer compensation

The following is an example of an advisory vote description that would not be consistent with Rule 14a-21 because it is not clear from the description as to what shareholders are being asked to vote on. Shareholders could interpret this example as asking them to vote on whether or not the company should hold an advisory vote on executive compensation, rather than asking shareholders to actually approve, on an advisory basis, the compensation paid to the company’s named executive officers.

  • To hold an advisory vote on executive compensation
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