After an issuer completes a Regulation CF crowdfunding offering, it must comply with certain ongoing reporting obligations. Unlike public company SEC reporting requirements, Regulation CF’s ongoing reporting requirements consist of only one filing annually.
Regulation CF Issuers Required to File an Annual Report on Regulation C-AR
An issuer that sold securities in a Regulation Crowdfunding offering must submit an annual report on Form C-AR to the SEC through Edgar no later than 120 days after the end of its fiscal year. Form C-AR must be also be posted on the company’s website. Form C-AR requires information similar to what is required in the Form C offering statement which we discuss here; however, the issuer is not required to obtain an audit or review of its financial statements. Read More
RULE 504 – LIMITED CROWDFUNDING
Securities offerings under Rule 504 of Regulation D of the Securities Act may prove useful to founders of startup and small companies. One of the most difficult times for these companies is when the company is founded. Often the founders will have limited capital with which to fund their new business. Under Rule 504, the company can raise up to $5 million in a 12 month period without filing the offering with the SEC prior to sale. One important limitation of Rule 504 is that it is not available to public companies subject to SEC reporting requirements.
Unlike securities sold in an offering registered with the SEC on Form S-1, companies offering securities in reliance upon Rule 504 submit an SEC filing on Form D 15 days after the first sale of securities. Issuers must still comply with state blue sky requirements. Issuers conducting offerings under Rule 504 should follow the rules below to avoid disqualification of their offering exemption. Read More
The SEC’s Division of Corporate Finance recently provided new COVID-19 related guidance in the form of Frequently Asked questions for issuers using Form S-3 registration statements. The SEC previously provided relief to issuers impacted by coronavirus which are unable to file timely because of “circumstances related to COVID-19 ( the “COVID-19 SEC Order”).
The SEC’s relief included conditional 45-day extensions to submit certain SEC reports and filings that had original deadlines between March 1 and July 1, 2020. The new SEC guidance provides relief to issuers relying on Form S-3 registration statements to register securities. For issuers who qualify, Form S-3 is the most cost- and time-efficient registration statement to prepare because it allows issuers to incorporate certain disclosures previously filed with the SEC. Read More
A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) must file reports (“Public Company SEC Reporting Requirements”) with the Securities and Exchange Commission (the “SEC”). These Public Company SEC Reporting Requirements keep investors and market participants informed about important information about the issuer. Reports and filings made with the SEC can be viewed by the general public without charge on the SEC’s website.
Companies subject to Public Company SEC Reporting Requirements must file Annual Reports on Form 10-K, Quarterly Reports on Form 10Q’s and Current Reports on Form 8-K. As discussed below, certain issuers must file proxy statements and other reports and their officers, directors and certain large shareholders must file beneficial ownership reports with the SEC. Read More
The Securities Exchange Act of 1934, as amended (the “Exchange Act”) authorizes the Securities and Exchange Commission (“SEC”) to issue a trading suspension for up to ten business days. The SEC will order a trading suspension if it determines it is necessary to protect investors. For other securities that are traded in the over-the-counter market, broker-dealers are prohibited from publishing quotes for the security until the company has provided adequate public information. Under most circumstances, the issuer must locate a sponsoring market maker to file a new Form 211 with the Financial Industry Regulatory Authority (“FINRA”).
The reality is an SEC trading suspension is the kiss of death for investors and the issuer. Read More
SEC Provides Rules Allowing Expedited Regulation Crowdfunding Offerings
On May 4, 2020, the Securities and Exchange Commission (the “SEC”) temporary conditional relief for certain companies affected by COVID-19 that may seek to meet their funding needs using Regulation Crowdfunding aka Regulation CF. The rules are designed to expedite the crowdfunding offering process for eligible companies by providing them with relief from certain rules with respect to the timing of Regulation Crowdfunding offerings and the financial statements requirements.
To use the temporary rules, a company must meet enhanced eligibility requirements and provide clear, prominent disclosure to investors about its reliance on the relief. The relief will apply to offerings launched between the effective date of the temporary rules and August 31, 2020. Read More
Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”) provides an exemption from the SEC’s registration statement requirements for transactions by an issuer and do not involve a public offering of securities. Section 4(a)(2) is also known as the private placement exemption and is the most widely used exemption for securities offerings in the U.S. The exemption allows an issuer to raise an unlimited amount of capital in private transactions from sophisticated investors who are able to fend for themselves. Both private and publicly traded companies can rely on the Section 4(a)(2) exemption. Shares sold in reliance upon Section 4(a)(2) are restricted securities and may not be resold by purchasers in the offering absent SEC registration or an exemption therefrom.
In SEC v. Ralston Purina Co., 346 U.S. 119 (1953), the U.S. Supreme Court confirmed the position of the SEC that offers and sales to a large number of Ralston Purina’s employees under its stock grant plan did not qualify for the exemption provided by Section 4(a)(2). The Ralston Purina decision provides important factors to consider when relying on the Section 4(a)(2) exemption from SEC registration: Read More
Form 12b-25 and Rule 12b-25 provide relief for issuers unable to meet SEC reporting requirements on time. Rule 12b-25 adopted by the SEC under the Securities Exchange Act of 1934, provides an extension of the SEC’s reporting due dates for certain periodic reports such as Form 20-F, Form 10-K or Form 10-Q.
What must an issuer do if it misses the filing due date for a quarterly or annual report?
Rule 12b-25 requires an issuer that is subject to SEC reporting requirements that is unable to file all or any portion of a quarterly report on Form 10-Q, an annual report on Form 10-K and certain other reports within the prescribed time period to file a Form 12b-25 (informally known as an NT 10-Q, or NT 10-K) with the SEC.
When is the Form 12b-25 due?
The Form 12b-25 must be filed with the SEC no later than one (1) business day after the due date for the late From 10-Q or 10-K report.
How is the Form 12b-25 filed?
The 12b-25 is filed electronically, through the SEC’s EDGAR filing system.
How many days does the Form 12b-25 extend the due date of the issuer’s reports?
Form 12b-25 provides the issuer with 15 additional calendar days to file a late 10-K and five additional calendar days to file a late 10-Q. Moreover, if the late report is filed within the 15-day or five-day extension period, the report is deemed to have been timely filed.
What information must be included in the Form 12b-25?
The issuer must represent that the reason it could not make its filing on Form 10-Q or 10-K timely “could not be eliminated by the registrant without unreasonable effort or expense”; and that the issuer will, in fact, file the report no later than the 15th calendar day following the prescribed due date, in the case of a Form 10-K, or not later than the fifth calendar day following the prescribed due date, in the case of a Form 10-Q. Additionally, the issuer must disclose the reasons for its failure to file in “reasonable detail.” Form 12b-25 requires that the issuer disclose if the failure to file a report timely resulted from the inability of any person other than the issuer–typically, the issuer’s independent public accounting firm–to furnish any required opinion, report or certification. Paragraph (c) of Rule 12b-25 requires the issuer to attach to the Form 12b-25 a statement signed by such person stating the specific reasons why that person was unable to furnish the required opinion, report or certification on time. If the issuer anticipates that any “significant change in results of operations from the corresponding period of the last fiscal year will be reflected in the earnings statements to be included in the report,” then the issuer must disclose the foregoing and attach an explanation of the anticipated changes, both narratively and quantitatively. If appropriate, the issuer must also disclose the reasons that a reasonable estimate of the results cannot be made.
What kinds of reasons for late filings are acceptable? How much detail is “reasonable detail”?
The SEC does not rule on whether an issuer’s stated reasons for a late filing are justifiable or whether the issuer has supplied sufficiently “reasonable” detail of why a report was not timely filed.
Are there negative consequences to filing a Form 12b-25?
As noted, if the conditions of the Rule are met, the issuer is deemed to have made a timely filing even though the report was not filed by the required due date. Issuers have the same duties to be truthful, to disclose all material facts and to avoid material omissions in their Form 12b-25 as they do in any other filings under the federal securities laws. The Form itself states that “Intentional misstatements or omissions of fact constitute Federal Criminal Violations. (See 18 U.S.C. 1001.)”
Can a 12b-25 be renewed by a second filing?
No. Issuers receive only one automatic extension per filing. In the absence of extraordinary circumstances, which are determined in the sole discretion of the SEC’s staff, no further extensions are available.
The SEC may enforce an issuer’s reporting requirements by instituting enforcement actions against a delinquent issuer and/or its officers and directors seeking monetary or other penalties, including revoking the issuer’s registration pursuant to Section 12(j) of the Exchange Act. As such, issuers should consult with qualified securities counsel to ensure compliance with SEC reporting requirements.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
After a company becomes subject to SEC reporting requirements by registering a class of equity securities under Section 12(b) or 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), insiders are required to submit certain reports and filings with the SEC. Section 16 is not applicable to companies that have reporting obligations under Section 15(d) because of filing a Form S-1 or other registration statement under the Securities Act of 1933, as amended (the “Securities Act”).
Under Section 16(a) requires certain insiders to report his or her initial ownership of the company’s equity securities on Form 3 after an initial triggering event. Section 16 insiders must report any changes to the amount of securities subsequently owned on Form 4. Section 16 insiders must also file an Annual Statement of Changes in Beneficial Ownership on Form 5 if there are any transactions in the company’s equity securities that the Section 16 insider engaged in during the company’s most recently completed fiscal year that were not previously reported on a Form 4, other than transactions that are exempt from Form 5’s SEC reporting requirements. Read More
Companies going public have a variety of structures for their transactions. Companies can sell shares in reliance upon Rule 506 of Regulation D and file a selling shareholder registration statement with the Securities and Exchange Commission (“SEC”) to register the resale of those shares on Form S-1. A selling shareholder registration statement can be combined with a capital raising transaction to provide capital to offset going public costs.
Item 507 of Regulation S-K of the Securities Act of 1933, as amended sets forth the requirements for selling shareholder disclosures. Read More
The going public process involves a number of steps that vary depending on the characteristics of the private company wishing to go public, and whether it will subject to the reporting requirements of the Securities and Exchange Commission (“SEC”). Even companies that are not subject to SEC reporting requirements must meet certain requirements to have their shares publicly traded. One requirement is that the issuer obtain sufficient stockholders to establish a trading market. These initial investors are commonly referred to as “Seed Stockolders” or “Seed Shareholders”.
Seed Stockholders Requirements in Going Public Transactions
The first step in a going public transaction is most often obtaining the number of Seed Stockholders required by the Financial Industry Regulatory Authority (“FINRA”). The shares issued to them must be unrestricted at the time of the filing of the Form 211 with FINRA, so that a public float will exist when the company’s stock begins trading. Generally, shares in the public float must either be subject to an effective registration statement under the Securities Act of 1933, as amended (the “Securities Act”) or an exemption from such registration must be available.
What Isn’t Wrong With a Form 10 Shell?
Registration Statement (“Form 10 Shell”) under the Securities Exchange Act of 1934, (the “Exchange Act”), are being marketed as a method for private companies to obtain public company status. More often than not, Form 10 Shells are not a timely solution or cost effective method for a private company to obtain public company status.
Most Form 10 Shells are not structured properly for a going public transaction because unlike registration statements filed under the Securities Act of 1933, as amended (the “Securities Act”), a Form 10 cannot be used to create unrestricted shares. A purchaser of a Form 10 Shell may incur the expenses of SEC reporting yet may derive no benefit because the securities are not publicly traded. As a result, the cost of Form 10 Shell exceeds the expenses of a direct public offering and listing. Read More
If you use email in your business, you should be aware of the requirements of the CAN-SPAM Act (“CAN-SPAM”). For years, issuers have hired promoters who use used spam investor relations materials to increase their stock price. Many businesses including investor relations firms may not fully understand what constitutes spam. The definition of spam is much broader than most businesses realize. CAN-SPAM establishes requirements for commercial messages, gives recipients the right to have you stop emailing them, and spells out significant penalties for violations.
Many recipients would agree that most penny stock promotional email does not comply with CAN-SPAM. Issuers should also be cautious of CAN-SPAM’s requirements. Even if an issuer hires another company to handle stock promotion, it remains responsible. The issuer can’t contract away its legal responsibility to comply with the law. Both the issuer whose shares are promoted and the investor relations provider that actually sends the email messages are legally responsible.
Why Should I Care About CAN-SPAM?
CAN-SPAM applies to all commercial messages, which the law defines as “any electronic mail message the primary purpose of which is the commercial advertisement or promotion of a commercial product or service,” including email that promotes content on commercial websites. The law makes no exception for business-to-business email. That means all email – for example, an email message to subscribers to a stock newsletter or website must comply with CAN-SPAM. Each separate email in violation of the CAN-SPAM Act is subject to stiff penalties of up to $43,280.
CAN-SPAM’s requirements relevant to investor relations firms and issuers are as follows:
- Don’t use false or misleading header information. Your “From,” “To,” “Reply-To,” and routing information – including the originating domain name and email address – must be accurate and identify the person or business who initiated the message. In other words, no fake or anonymous emails can be used in investor relations electronic messages.
- Don’t use deceptive subject lines in the promotional email. The subject line must accurately reflect the content of the email message. For example, a subject line claiming the “Cure for Coronavirus Has Been Found” should not be used as bait for an email that contains information about an issuer who sells CBD products even if the body of the email makes no mention of coronavirus.
- Identify the promotional email as an advertisement. The law gives you a lot of leeway in how to do this, but you must disclose clearly and conspicuously that your message is an advertisement. All paid stock promotions are advertisements and must be identified as such. In addition to CAN-SPAM, investor relations providers should be familiar with Section 17(b) which requires publishers of information concerning publicly traded companies to disclose their compensation with specificity.
- Tell recipients of the promotional email where you’re located. The Email message must include a valid physical postal address. This can be your current street address, a post office box registered with the U.S. Postal Service, or a private mailbox registered with a commercial mail receiving agency established under Postal Service regulations.
- Tell recipients how to opt out of receiving future email. Your message must include a clear and conspicuous explanation of how the recipient can opt out of getting email in the future. Any opt-out mechanism must be able to process opt-out requests for at least 30 days after the promo is sent.
Issuers should have compliance programs in place for CAN-SPAM compliance if they intend to engage investor relations providers. Investor relations firms should ensure compliance with CAN-SPAM and other securities laws that apply to their activity included but not limited to Section 17(b) which imposes disclosure obligations on investor relations firms. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
Exchange Act Reporting After SEC Effectiveness of a Registered Direct Public Offering
Upon completion of a registered direct public offering, the Exchange Act imposes periodic reporting obligations. If the issuer is a domestic issuer subject to SEC reporting requirements then it must file an Annual Report on Form 10-K, 10-Q’s for the three quarters following its fiscal year end and current reports on Form 8-K upon the occurrence of certain material events including bankruptcy, and fundamental changes, changes in accounting, changes in the control and departure of officers, and non-reliance on prior financial statements or audit reports. For those issuers who register a class of securities under the Exchange Act, additional reporting obligations apply. These include the SEC’s proxy rules that require disclosures be made on Schedules 14A or 14C and certain procedures for the solicitation of shareholder votes. Additionally, shareholders and management must file beneficial ownership reports of their trading activities in the company’s securities. Read More
Tips For Rule 506(c) Compliance – Direct Crowdfunding Offerings
Rule 506(c) of Regulation D under the Securities Act of 1933, as amended, allows a company to use general solicitation and advertising to raise an unlimited amount of money from accredited investors. Companies can raise the funds themselves or use an intermediary such as an accredited crowdfunding platform. Some companies may choose to crowdfund their own offering without the use of an intermediary by making their own general solicitation and advertising through their corporate website, social media or online advertising or other methods. But there is a catch companies must follow accredited investor verification procedures to ensure that all purchasers qualify for that status. The SEC has suggested several methods for accredited investor verification which can be found at this here. Companies can raise the funds themselves or use broker-dealer or an intermediary such as an accredited crowdfunding platform. Read More
On March 25, 2020, the Securities and Exchange Commission (the “SEC”) issued an order (the “SEC Order”) providing extensions to SEC reporting requirements deadlines for issuers affected by COVID‑19, further extending the deadlines set forth in a March 4, 2020 order. The prior order only granted extensions for SEC periodic reports and filings due on or before April 30, 2020. The new SEC Order grants extensions to issuers that would have been required to submit SEC periodic reports and filings between March 1 and July 1, 2020.
The SEC Order includes the following periodic reports and filings:
- Annual Reports on Form 10-K,
- Quarterly Reports on Form 10-Q,
- Current Reports on Form 8-K, and
- Preliminary and Definitive Proxy Statements.
SECTION 4(A)6 OF THE SECURITIES ACT
Section 4(a)(6) of the Securities Act of 1933, as amended (the “Securities Act” is also known as Regulation CF. These rules have made it easier for companies to raise money from a wider range of investors than ever before. Traditional crowdfunding models may or may not involve the offer and sale of a security, but if so, the issuer must comply with federal and state securities laws, which we discuss in this section. Like offerings under Tier 2 of Regulation A and Rule 506(c), one notable benefit of Regulation CF is that state blue-sky laws are preempted.
Regulation CF provides an exemption from the registration requirements of the Securities Act for certain crowdfunding transactions. To qualify for this exemption, the transactions must meet specific requirements, including limits on the dollar amount of the securities that may be sold by an issuer and the dollar amount that may be invested by an individual in a 12-month period. It also must be conducted through a registered intermediary that complies with specified requirements. These intermediaries are called “funding portals.” Title III also provides limitations on who may rely on the exemption and establishes specific liability provisions for material misstatements or omissions in connection with Section 4(a)(6)-exempt transactions. Read More
Regulation A, also known as Regulation A+, provides investors with more investment choices and issuers with more capital raising options during their going public transactions. The rules adopting Regulation A+ are mandated by Title IV of the Jumpstart Our Business Startups (JOBS) Act. The Regulation A exemption provides for two distinct offering exemptions. Tier 1 provides an exemption from SEC registration for offerings of up to $20 million. Tier 2 exempts offerings up to $50 million. One of the most notable differences between the two Regulation A+ tiers is that issuers that conduct a Tier 2 offering will become subject to ongoing Regulation A reporting obligations, though such obligations are significantly less burdensome than those that apply to SEC reporting issuers filing Form S-1 Registration Statements.
Regulation A can be used in combination with direct public offerings and initial public offerings as part of a Going Public Transaction. The exemption simplifies the process of obtaining the seed stockholders required by the Financial Industry Regulatory Authority while allowing the issuer to raise initial capital. Read More
The SEC recently granted issuers using Regulation A and Regulation Crowdfunding known as Regulation CF have been granted extensions to their SEC reporting obligations. Last month, the SEC published new temporary final rules extending the due dates for certain ongoing SEC reporting requirements imposed by Regulation Crowdfunding also known as Regulation CF and Regulation A under the Securities Act of 1933 (the “Securities Act”). The SEC’s rules were created due to potential disruptions of COVID-19 which could prevent issuers and other filers from complying with their SEC filing deadlines.
An issuer may only rely on the SEC’ extended due dates if its failure to comply with the original due date relates to circumstances arising from COVID-19. The SEC’s new temporary rule does not relieve issuers from their obligation to evaluate and comply with their obligations to make true and complete disclosures to investors under federal securities laws. Read More
“Accredited Crowdfunding” under Rule 506(c) of Regulation D of the Securities Act of 1933, as amended allows an issuer to use general solicitation in connection with its private placement of securities. Rule 506(c) requires the issuer to take reasonable steps to verify that all of the investors in its private placement are accredited investors. This verification requirement is in addition to the requirement that sales only be made to accredited investors.
Since Rule 506(c) was adopted and Accredited Crowdfunding has grown in popularity, third party service providers have popped up offering accredited-investor verification services. In order for verification to be comply with the Securities and Exchange Commission’s requirements, a third party service provider must review sensitive financial information about the investor’s financial condition. This review and the lack of regulation concerning third party verification providers has raised significant concerns among market participants. The accredited investor third-party verification segment is still relatively new and there are few if any, barriers to entry. It is no surprise to find that there are numerous third-party verification providers readily available through the internet who tout their services but fail to provide meaningful background information. Read More
Crowdfunding Offerings in the Time of Coronavirus
In the past few months, the COVID-19 outbreak has caused quarantines and closures, and has restricted the movement of people and goods between countries and within the United States. It has devastated certain industries and economies at home and abroad. Uncertainty about the duration of the crisis has roiled the financial markets, leading to worries about a global recession to come. Large businesses like Boeing will survive, as in 2008, because they’re “too big to fail,” but the small businesses that are the real backbone of the U.S. economy may face hardship. Some—the lucky ones—will need to raise capital to respond to increased demand for their crisis-related products; others will need additional cash to keep their businesses viable during the pandemic.
U.S. small businesses are left unsure whether they’ll survive without an injection of cash. While government relief is in the works, many businesses won’t qualify, or the resources available to them will not be enough to address their needs. But some industries will not be impacted, and may even experience growth during the coronavirus crisis. Companies in these industries that need capital to meet rising demand should consider crowdfunding a securities offering as an option. Read More
A short sale transaction can be part of a legitimate trading strategy. It is often endorsed for its beneficial effects on the securities markets, which include increasing liquidity. Short selling is also criticized. Short sellers profit by identifying companies that are weak or overvalued, and companies whose shares have been manipulated to rise to artificially high share prices. The most widely misunderstood aspect of short selling is under what circumstances it becomes illegal. This post addresses the most common questions we receive about Short Sales. Read More
The SEC Addresses COVID-19 Disclosure Requirements
Earlier this month, the Securities and Exchange Commission (the “SEC”) addressed COVID-19 disclosure requirements in a release reminding companies subject to the SEC’s reporting requirements of their disclosure obligations regarding their assessment of, and plans for addressing, material risks to their business and operations. Issuers are encouraged to keep investors and the markets informed about how they’re affected by the current crisis, and how they plan to deal with it. The SEC also granted extensions to deadlines for certain filings and reports including Form 10-K, Form 20-F and Form 10-Q by issuers impacted by COVID-19.
Companies engaged in fund raising should consider the impact of COVID-19 Disclosure Requirements in their offering materials. All issuers should consider COVID-19 disclosure requirements in their SEC filings and reports, and in communications to shareholders as well. Because the extent and severity of the COVID-19 outbreak is not yet known and is rapidly evolving, public companies must monitor and consider on an ongoing basis their SEC and investor disclosures, in light of the latest developments, and their potential impact on business and operations. Read More
The Coronavirus Preparedness and Response Supplemental Appropriations Act (the “Act”), passed with near unanimous support in both the House and Senate and was signed into law on March 6, 2020. The Act provides $20 million for the Small Business Administration (“SBA”) disaster loans program to support SBA’s administration of loans to entities financially impacted as a result of COVID-19 (coronavirus). Individual businesses may apply for up to $2 million of working capital loans.
There are 30.2 million small businesses in the United States, and they employ 47.5 percent of the nation’s workforce. The top three industries for small business employment are healthcare and social assistance, accommodation and food services, and retail trade. All of these sectors will be affected by the intensification of the coronavirus crisis. The last two have already been hit hard, as many states have ordered the closing of all “non-essential” businesses. Only groceries, gas stations, healthcare providers, drugstores, banks, and restaurants offering takeout or delivery services can remain open. Read More
Accredited Investor Verification – Accredited Crowdfunding Under Rule 506(c)
Accredited investor verification is a critical part of the Rule 506(c) also known as the Accredited Crowdfunding exemption. Rule 506(c) of Regulation D of the Securities Act of 1933, as amended allows issuers to engage in general solicitation and advertising of their exempt offering if specific requirements are met. One such requirement is that the issuers comply with accredited investor verification procedures because sales under the rule can only be made to purchasers who are “accredited investors“. Even one sale to a non-accredited investor in a Rule 506(c) offering will prevent the issuer from relying upon the exemption.
Rule 506(c) Generally
Both public and private companies can rely upon Rule 506(c) for their securities offerings. The exemption is commonly used in going public transactions to raise initial capital and obtain a shareholder base. Rule 506(c) allows issuers to raise an unlimited amount of capital and there are no limitations on the number of non-accredited investors who can invest. Issuers may only advertise their Rule 506(c) offering if they verify that sales are made only to accredited investors. One method of doing this is by hiring a third party accredited investor verification provider. Read More
When a manipulated stock’s price declines, it has become common practice for penny stock issuers and their disciples to scream foul play and claim their company is the victim of a naked short seller working with nefarious clearing firms to send their stock price downward. These same issuers also complain vociferously about the Securities and Exchange Commission (“SEC”) failure to pursue illegal short sale activities.
It has become common practice for issuers and some stock promoters or stock touts hired to increase an issuer’s stock price, to point to the Threshold Security List as evidence of illegal short sale activity that supposedly explains their declining stock prices. The internet is flooded with misinformation about what the Threshold Security List reveals about a security.
This makes it difficult for many investors to differentiate between legitimate short selling and unlawful manipulative short selling, and often causes investors to believe a stock’s price has dropped because of short selling rather than because of selling by insiders or the issuer itself.
The Creation of the Threshold List
A “failure to deliver” is the outcome of a transaction where one of the parties in the transaction fails to meet his respective obligations. When failure to deliver occurs, either the party with the long position does not have enough money to pay for the transaction, or the party in the short position does not own the underlying assets that are to be delivered.
Regulation SHO, promulgated by the SEC in 2005, created the Threshold Security List to address failures to deliver in an orderly manner. It was not created to punish short sellers or reveal short positions. Regulation SHO was designed to clean up open failures to deliver in certain securities when they reached a relatively low aggregate level without creating a short squeeze. Failures to deliver may result from either a short or a long sale.
There may be legitimate reasons for a failure to deliver. For example, human or mechanical errors or processing delays can result from transferring securities in physical certificate rather than book-entry form, thus causing a failure to deliver on a long sale within the normal three-day settlement period. A failure to deliver may also result from lawful naked short selling. Despite the mounds of contrary information on the internet, there are numerous circumstances in which naked shorting is legal.
The Definition of a Threshold Security
A security will be placed on the threshold list if it has a significant fail to deliver position for at least 5 business days. This list includes failures to deliver for both long and short positions. The standards are different for SEC reporting issuers and non-SEC reporting issuers. The definition of a threshold security for a reporting issuer is set forth in Regulation SHO and for non-reporting issuers is set forth in Rule 4320.
Regulation SHO defines threshold securities as any equity security of an issuer that is registered under Section 12 of the Securities Exchange Act of 1934, or that is required to file reports pursuant to Section 15(d) of the same Act, and where, for five consecutive settlement days:
♦ there are aggregate failures to deliver at a registered clearing agency of 10,000 shares or more per security; and
♦ the level of failures to deliver is equal to at least one-half of one percent of the issuer’s total shares outstanding.
FINRA Rule 4320 defines threshold securities as any equity security of an issuer that is not an SEC reporting security and, for five consecutive settlement days, has:
♦ aggregate failures to deliver at a registered clearing agency of 10,000 shares or more; and
♦ a reported last sale during normal market hours for the security on that settlement day that would value the aggregate failure to deliver position at $50,000 or more.
Each Self Regulatory Organization (“SRO”), including the stock exchanges, must publish a daily list of the issuers with a significant delivery failures. This list is known as the Threshold List, and is based on information reported to the SROs by theNational Securities Clearing Corporation (NSCC), the clearing arm of the DTCC. It is published every night at around 11 p.m.
What the Threshold List Does Not Reveal
The Threshold List is simply a list of the companies which, for that particular day, qualified for threshold status. The Threshold List does not:
♦ reflect the short position in a particular security, but failures to deliver for long and short positions; ♦ reflect the number or total amount of failures to deliver for the day;
♦ mean that any improper short sale or long sale activity has occurred or is occurring for the securities listed; and
♦ reflect only failures to deliver because (i) a security may remain on the Threshold List longer than 13 days after broker-dealers close-out all delivery failures, since the security stays on the threshold list for five consecutive days; (ii) new delivery failures resulting from long or short sales that crossed the threshold, keeping the security on the SRO’s threshold securities list; or (iii) the delivery failures may have been occurred prior to a security’s appearance on the Threshold List, and may be grandfathered on the list from the close-out requirement of Regulation SHO.
It should also be borne in mind that since the threshold list is in part based on the number of shares any company has issued and outstanding, unreported stock issuances can and will land the stock on the SHO list when in reality there are no significant failures to cover.
How the Threshold List Is Misunderstood
Issuers sometimes build entire promotional campaigns around the Threshold List. These issuers assert that the Threshold List proves a particular stock’s decline is temporary and the result of short sellers. The Issuers tell their shareholders to buy the stock to create a “short squeeze”. A short squeeze generally refers to the sharp price increase or unavailability of a security to borrow to cover a short position. If a squeeze occurs, short sellers must purchase the stock to cover their positions.
What the subsequent trade is actually reflecting is not a purchase by a short desperate to cover its position, but a purchase by a naive investor who is buying the stock of other shareholders, sometimes insiders who are selling. Short squeezes are quite uncommon in penny stocks; covers or close-out buys of short positions rarely impact the price of the security even when the security is on the Threshold List.
By blaming short sellers for a decline in stock price, issuers cause investors to hold their positions enabling the seller to get a higher price for his shares.
Stock promoters and their clients invariably dump into their own pump, and their object it to persuade retail traders to help them do so. Anyone who takes the trouble to make a call to FINRA will be advised that the list to follow is the bi-monthly short interest report they publish. The Reg SHO list records only persistent fails to deliver.
The short interest report records actual short positions as of the day of the report. Almost always, the short interest is very low. While some short sellers engage in manipulative techniques most do not. Jumping on the “naked shorting” bandwagon is a mistake. Falling for the fantasy of gigantic naked short positions is the stuff of fairy tales; it does not lead to the longed-for short squeeze, particularly where stocks are the subject of aggressive stock promotion. The stock in question may rise temporarily, as a self-fulfilling prophecy, but in the end it will succumb to selling on the part of the stock promoters and the insiders who hired them.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal advice on any specific matter, nor does this message create an attorney-client relationship. FPlease note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
Form 10 is a type of registration statement used to register a class of securities under Section 12(g) of the Securities Exchange Act of 1934 (“Exchange Act”). Both public and private companies can register a class of securities on Form 10. Form 10 is also used by shell purveyors to create inventory for reverse merger transactions that take a company from private to public company status. These shells are subject to SEC reporting requirements. This blog post addresses the most common questions we receive about Form 10 registration statement during the going public process.
A. Companies with more than $10 million of total assets and over the applicable minimum number of holders of their equity securities must register that class of equity securities under the Exchange Act. For companies that are banks or bank holding companies, there must be more than 2,000 holders of record of the class of equity securities. For companies that are not banks or bank holding companies, there must be either more than 2,000 holders of record of the class of equity securities or more than 500 record holders of the class of equity securities that aren’t accredited investors. If a company meets these thresholds it will be required to register a class of securities under the Exchange Act even if it does not seek to list on the NYSE or NASDAQ. Read More
If a company files a registration statement on Form 10 under Section 12 of the Exchange Act, it becomes an SEC reporting company and the company becomes subject to the same annual, quarterly, and current reporting obligations that result from Securities Act registration.
Additionally, the company’s shareholders and management become subject to various requirements discussed below upon effectiveness of the company’s Form 10 registration statement. A company whose Form 10 has been declared effective must comply not only with the SEC’s periodic reporting requirements, it must also comply with the SEC’s proxy rules whenever its management submits proposals to shareholders that will be subject to a shareholder vote, usually at a shareholders’ meeting. As explained below, Form 10 is often used in connection with going public transactions. Read More
The JOBS Act includes provisions to allow crowdfunding intermediaries known as “Crowdfunding Portals”, or “Crowdfunding Platforms” to assist companies with raising capital using the internet. Crowdfunding Portals will serve as attractive capital raising centers for private companies seeking to go public in need of seed capital. Crowdfunding Portals are not subject to the extensive registration requirements applicable to brokers, but they must register with FINRA and applicable Self Regulatory Organizations (“SRO”).
SEC and FINRA Regulation of Crowdfunding Portals and Intermediaries
Restrictions on Crowdfunding Portals include prohibitions from offering investment advice, soliciting transactions in securities offered or sold, compensating any employees or agents for soliciting transactions, holding, managing or collecting investor funds or securities, and engaging in activities prohibited by the SEC. Crowdfunding Portals must be either registered brokers or SEC approved Crowdfunding Portals. FINRA can enforce and examine rules specifically written for Crowdfunding Portals.
One requirement of Regulation CF is that the issuer cannot conduct the offering itself. The offering must only be conducted through a crowdfunding intermediary commonly referred to as a “funding portal.” Crowdfunding intermediaries must be registered with the SEC as a broker-dealer or as a funding portal and become a member of FINRA. An issuer is required to use only one intermediary to conduct an offering in reliance on Section 4(a)(6). The SEC has stated that it believes this helps foster the creation of a “crowd” and better serves the purpose of the statute. Read More