Securities Act

Corp Fin Updates Its Compliance and Disclosure Interpretations; Issues a Statement on WKSI Waivers

by Vanessa Schoenthaler on July 9, 2011

The Division of Corporation Finance added eight new Compliance and Disclosure Interpretations (C&DIs) to the Commission’s website yesterday, addressing four main areas of disclosure:

Notification of Late Filings (Question 107.02)

The first notes that if a company is filing a Notification of Late Filing on Form 12b-25, but doesn’t believe that it will be able to file the required report by the extended deadline, then it shouldn’t check the box in Part II of Form 12b-25 indicating that it will.

This seems obvious enough, but what happens if a company doesn’t check the box and somehow manages to file the required report by the extended deadline? Not to worry, if the deadline is met then the Commission will consider the report to have been timely filed, regardless of the checking of the box.

Notification of Late Filing

Compensation Related Disclosures (Questions 108.01, 117.07, 118.08 and 119.28)

The next three C&DIs address compensation related disclosures:

The first reiterates that Regulation G and Item 10(e) of Regulation S-K apply to any non-GAAP financial disclosures, other than target level disclosures, that are included in a company’s proxy statement. With regard to pay-related non-GAAP disclosures, the Commission notes that it will not object if a company includes the requisite GAAP reconciliations in a prominently cross-referenced annex or by incorporation by reference to the relevant pages of the company’s annual report containing the requisite GAAP reconciliations.

The second specifies that a company may omit disclosure regarding disability plans (as with group life, health, hospitalization, or medical reimbursement plans) that do not discriminate in scope, terms or operation, in favor of its executive officers or directors, and that are available generally to all of its salaried employees.

The third is a little counterintuitive (at least it was at first for me). It notes that the grant date fair value for stock and option awards that are subject to performance conditions must be reported based on the probable outcome of the performance conditions as of the grant date, even if the actual outcome is known as of the disclosure date. (For clarity’s sake you may want to take a look the fact pattern posed by question 119.28)

Disclosure Regarding Departing Directors (Question 116.10)

The next CD&I represents a change in position from question 116.08, which was withdrawn as of yesterday.

Basically it states that if a company incorporates by reference into its annual report disclosure from its proxy statement regarding the identification and business experience of its directors, and the definitive proxy statement is filed within 120 days of the company’s fiscal year-end, then the company may omit from both the proxy statement and annual report disclosure regarding any director whose term will not continue after its annual shareholder meeting.

If, however, a company directly discloses information regarding the identification and business experience of its directors in its annual report (rather than incorporating by reference), it cannot omit disclosure regarding any director whose term will not continue after the company’s annual shareholder meeting.

Disclosures Related to Say on Frequency (Questions 121A.03 and 121A.04)

The final two CD&Is address disclosures related to shareholder advisory votes on the frequency of advisory votes on executive compensation (say on frequency votes):

The first notes that, with respect to the say on frequency vote, a company is not required to disclose the number of broker non-votes; only the number of votes cast for each of the one, two and three-year frequency options and the number of abstentions.

The second notes that a company may disclose the initial voting results from its shareholder meeting in an annual or quarterly report, rather than in a Form 8-K, provided the report is filed within the requisite disclosure period. Thereafter, a company may choose to disclose its board’s decision as to how frequently it will hold the shareholder advisory vote on executive compensation in a new Form 8-K, rather than by amending the annual or quarterly report in which the initial voting results were disclosed. If, however, the initial voting results are disclosed in a Form 8-K the board’s subsequent decision as to how frequently the shareholder advisory vote on executive compensation will be held must be disclosed in an amendment to the original Form 8-K, as opposed to a new Form 8-K.

Statement on Well-Known Seasoned Issuer (WKSI) Waivers

In addition to the new C&DIs, the Division of Corporation Finance also released a statement outlining the framework that it will use when determining whether to grant an “ineligible issuer” waiver to a company that has lost its status as well-known seasoned issuer for having violated the anti-fraud provisions of the federal securities laws. The statement is very brief and if you’re a WKSI worth the quick read.

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The SEC Proposes Rules for Disqualification of Felons and Other Bad Actors from Rule 506 Offerings

by Vanessa Schoenthaler on May 26, 2011

In addition to final rules and forms implementing the whistleblower program, yesterday the Securities and Exchange Commission also voted, by a margin of 3-2, to propose a series of rule amendments designed to implement Section 926 of the Dodd-Frank Act.

Section 926 requires the adoption of rules disqualifying an offering from reliance on Rule 506 of Regulation D when certain felons or other “bad actors” are involved in the offering. Rule 506 is by far the most widely claimed exemption under Regulation D. For the 12 month period ended September 30, 2010 the Commission received 17,292 initial filings for offerings under Regulation D, of those 16,027 claimed a Rule 506 exemption.

The Actors

As proposed the rule amendments would add a new subsection (c) to Rule 506 entitled “Bad Actor Disqualification”, and would apply to bad acts committed by:

  • the company or any predecessor or affiliated company;
  • the company’s officers, directors, general partners or managing members;
  • beneficial owners of 10% or more of a company’s equity securities;
  • any promoter connected to the company in any capacity at the time of sale;
  • any person that has been or will be paid, directly or indirectly, for the solicitation of purchasers in connection with an offering; and
  • any officers, directors, general partners or managing members of a compensated solicitor.

The Bad Acts

The bad acts triggering disqualification would include:

  • criminal convictions in connection with: the purchase or sale of securities; the making of false filings with the Commission; or the business of an underwriter, broker-dealer, municipal securities advisor or paid solicitor of securities, that have occurred within 10 years of the offering (or 5 years in the case of the company, or a predecessor or affiliated company);
  • being subject to a court injunction or restraining order within 5 years of the offering that, at the time of the offering, prohibits a person from engaging in: conduct in connection with the purchase or sale of securities; the making of false filings with the Commission; or the business of an underwriter, broker-dealer, municipal securities advisor or paid solicitor of securities;
  • being subject to a final order by certain state or federal regulators that, at the time of the offering, bars a person from: association with an entity regulated by the Commission; engaging in the business of securities, insurance or banking; engaging in savings association or credit union activities; or is based on a violation of law or regulation that prohibits fraudulent, manipulative or deceptive conduct entered within 10 years of the offering;
  • certain Commission disciplinary orders related to broker-dealers, municipal securities dealers, investment advisers and investment companies and their associated persons;
  • suspension or expulsion from membership in, or suspension or bar from associating with, a member of a securities self-regulatory organization;
  • being subject to a refusal order, stop order or order suspending a Regulation A exemption within 5 years of the offering; and
  • being subject to a U.S. Postal Service false representation order within 5 years of the offering.

One Exception

The proposed rule amendments contain a reasonable care exception which provides that a company would not lose the benefit of the Rule 506 exemption, regardless of the existence of a disqualifying bad act, if the company can show that it did not know and, in the exercise of reasonable care, could not have know of the disqualification. Establishing reasonable care requires doing your diligence, i.e., conducting a factual inquiry into whether any disqualification exists; the nature and scope of the inquiry will depend on the facts and circumstances of the offering.

The Controversial Provision

At the Commission’s open meeting, one of the more controversial aspects of the proposed rule amendments was the inclusion of disqualifying events that pre-date enactment of the Dodd-Frank Act in the look-back period for bad acts under the rule.

In other words, as currently proposed, if an actor covered by the new rule amendments entered into a negotiated settlement agreement with a federal or state regulator prior to enactment of the Dodd-Frank Act that settlement agreement will still disqualify the actor from participating in Rule 506 offerings, even if they might not have settled had they known at the time that it would have resulted in disqualification.  For a complete discussion of the issue take a look at pages 44-49 of the Commission’s proposing release.

Both Commissioners Casey and Paredes took issue with this provision and ultimately voted against the proposed rules and amendments.

The Commission is soliciting public comments on the proposed rules and amendments, which are due on or before July 14, 2011.

 

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The Proposed Amendments to the Definition of Accredited Investor and Other Odds and Ends

by Vanessa Schoenthaler on February 1, 2011

Last week the Securities and Exchange Commission issued proposed amendments to conform the definition of accredited investor to the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As amended, the definition would read:

Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.

An interesting tidbit from the footnotes of the proposing release: in fiscal year 2010 the Commission received 17,593 initial Form D filings, of those 16,856, or 96%, claimed an exemption that relies on the definition of an accredited investor.

The Commission is soliciting comments on a number of aspects of the new definition, which are due on or before March 11, 2011. Of particular note, at the Commission’s January 25, 2011 open meeting, both Commissioners Casey and Paredes expressed interested in hearing comments on whether the amended definition should “grandfather” existing investors who were accredited at the time of their initial investment, but who may no longer be accredited under the new definition, to allow those investors to make follow-on investments.

An Extension of Comment Periods

On Friday the Commission announced that it was extending the comment period for its proposed rules on disclosures related to conflict minerals, mine safety and payments made in connection with resource extractions through March 2, 2011. The original comment period was set to expire on January 31, 2011. The extension is being issued in response to several requests for additional time to “allow for the collection of information and improve the quality of responses” by interested persons. Each of the extending releases, available here, here and here, references a representative sample of letters that have made a request for additional time.

The Cost of Implementing Dodd-Frank

Also on Friday Representatives Randy Neugebauer, Chairman of the Subcommittee on Oversight and Investigations, and Spencer Bachus, Chairman of the House Financial Services Committee, issued a joint letter to the Commission, and several other federal agencies, seeking information regarding the estimated costs associated with implementing and executing the Dodd-Frank Act. The Commission has until February 10, 2011 to respond.

(Download File)

The Commission continues to suffer from budgetary constraints and is currently operating on the basis of a continuing resolution that temporarily extends its fiscal year 2010 budget through March 4, 2011. As a result, the Commission has been forced to scale back or delay a number of Dodd-Frank initiatives, among other things.

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Will Facebook be Forced to IPO by Spring?

by Vanessa Schoenthaler on December 30, 2010

Looks like those exorbitant transfer fees weren’t enough to put a damper on the growing market for shares of companies like Facebook and Zynga.

The New York Times and The Wall Street Journal have been reporting that the Securities and Exchange Commission has launched an inquiry into the trading of shares of Facebook,  Zynga, Twitter and LinkedIn in secondary markets like SecondMarket and SharesPost.com.

The Commission declined to comment on the matter, but that’s to be expected as inquires are always conducted confidentially unless an administrative proceeding or legal action are filed.

Both articles also note that the inquiry appears to be focused, in part, on certain investment funds set up to purchase the companies’ shares (Bloomberg did a piece on three such funds back in November) and both question whether the inquiry could ultimately force Facebook into filing for an IPO.

But how do you force a company to IPO?

Companies with an excess of $10 million in assets and a class of equity securities held of record by 500 or more persons are required to register that class of equity securities under Section 12(g) of the Securities Exchange Act of 1934.  The required registration statement must be filed within 120 days of the end of the first fiscal year in which a company meets both the asset and shareholder tests.

As an aside, registering under the Exchange Act isn’t the same as filing for an IPO.  Exchange Act registration only requires that a company comply with applicable disclosure requirements, such as the filing of quarterly and annual reports.  When a company files for an IPO it does so by registering securities for sale to the public under the Securities Act of 1933.  What frequently happens when a company is forced to register under the Exchange Act is that it will simultaneously file for an IPO under the Securities Act.  This was the case in the often cited example of Google, which filed for registration under both the Securities Act and Exchange Act on April 29, 2004.

Each of Facebook,  Zynga, Twitter and LinkedIn have already surpassed the asset requirement of Section 12(g), so the deciding factor in whether they will be forced into registration under the Exchange Act is whether their securities are held of record by 500 or more shareholders.  As currently defined, the holder of record is the person identified in a company’s records as the owner of the securities in question.  Meaning that securities held in the name of an entity, like one of the investment funds being set up to purchase shares of Facebook, are only counted as being held by one person, regardless of how many investors make up the funds.  There is an exception to this rule, however: if Facebook knows or has reason to know that the investment funds are primarily being used to avoid Exchange Act registration the Commission can count the beneficial owners of the securities as the holders of record, meaning, in our example, the investors that make up the funds.  This may be where Facebook and other companies run the risk of being forced into Exchange Act registration.

If this is the case, and assuming Facebook uses the calendar year for its fiscal year, then if the Commission finds that Facebook had 500 or more shareholders of record on the last day of its fiscal year end on December 31, Facebook would be required to file a registration statement under the Exchange Act by April 30, 2011.

Another potential explanation for the inquiry is that the Commission may be considering amending the definition of “held of record”, the current version of which was adopted in 1965.  In 2003 a group of investment funds petitioned the Commission to revise the definition to count the beneficial owners of securities held in street name as the holders of record.  Interested parties have been commenting on the proposal since its introduction, with the most recent comment letter being submitted in April 2009.

With the growth of secondary markets for illiquid assets and the increased use of alternative investment vehicles, perhaps the Commission is reconsidering how it tallies up shareholders and whether a company the size of Facebook should be required to disclose certain information to its investors.

Update: January 10, 2011

At this point this topic has pretty much been covered to death. Rapper 50 Cent has opined on Facebook’s reported $50 billion valuation and there was even a rumor floating around that Mark Zuckerberg was going to shutter the company by March 15, because it was just too stressful for him to run.  With that kind of competition, I don’t think there’s much for me to add.  In the interest of being complete, however, I did want to include a few links to round out the story.  So, in summary:

Facebook did not have 500 shareholders as of its December 31, 2010 fiscal year end, so no IPO until next spring; the Commission is still investigating the trading of private company shares in the secondary markets (and I’ll probably have something more to say on the subject if, and when, we get details); some of Facebook’s financial information was leaked; and it looks like the Goldman Sachs offering was a success; but not everyone thinks that’s a good thing.

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The Commission May Not Be So Quick to Grant Your Next Confidential Treatment Request

by Vanessa Schoenthaler on November 3, 2010

The Office of Inspector General has been conducting an audit of the Securities and Exchange Commission’s processes and procedures for handling confidential treatment requests under Securities Act Rule 406 and Exchange Act Rule 24b-2.  In September OIG released its final report containing eight recommendations designed to improve these processes and procedures; the Commission has agreed, or partially agreed, with seven of them and will provide OIG with a written action plan to address the agreed upon recommendations by November 12, 2010.

A Brief Overview of Confidential Treatment Requests

There are generally two types of confidential treatment requests, those made pursuant to:

  • Securities Act Rule 406 or Exchange Act Rule 24b-2 with respect to information required to be filed with the Commission, such as a material agreement filed as an exhibit to a registration statement or periodic report; and
  • Rule 83 of the Commission’s Rules of Practice with respect to information not required to be filed with the Commission, such as supplemental information provided in the context of the comment and review process.

Requests Made Pursuant to Securities Act Rule 406 or Exchange Act Rule 24b-2

When making a request for confidential treatment pursuant to Securities Act Rule 406 or Exchange Act Rule 24b-2 the request must:

  • be sufficiently narrow, so that only information eligible for exemption under the Freedom of Information Act is covered;
  • contain legal and factual analyses substantiating the exemption;
  • contain an affirmative representation as to the confidentiality of the information; and
  • set forth the duration for which the exemption is being sought;

The Commission will not generally grant a request for confidential treatment with respect to information that is specifically required to be disclosed under applicable securities laws or information that is material to investors.

Requests Made Pursuant to Rule 83 of the Commission’s Rules of Practice

As with a request for confidential treatment made pursuant to Securities Act Rule 406 or Exchange Act Rule 24b-2, a request made pursuant to Rule 83 of the Commission’s Rules of Practice must be sufficiently narrow so as only to include information eligible for exemption under the FOIA.  However, it is not necessary to substantiate a request for confidential treatment made pursuant to Rule 83 until such time as a FOIA request is made.  Additionally, it is possible to request that the Commission return any supplemental materials, thus rendering them unavailable for production in a FOIA request.  The Commission will generally do so provided returning the materials is consistent with the protection of investors and the provisions of the FOIA. Any request for confidential treatment that is granted under Rule 83 will expire after 10 years, unless renewed prior to its expiration.

How the OIG’s Recommendations Might Apply

Two of the OIG’s eight recommendations focus on the processes and procedures for the Commission’s initial screening and selective full review of requests for confidential treatment that are based on the required disclosures causing competitive harm and not being necessary for the protection of investors.  Specifically, that such requests are overly broad, use conclusory statements and contain boilerplate language.  The Commission has agreed, or partially agreed, to address these recommendations by revising its internal processes and procedures.  So as to avoid delay, or even further review, issuers should also consider whether they have fully addressed these concerns in their next confidential treatment request.

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