What Is Good Corporate Governance? A Commonsense Approach

It seems to be a very simple question that does not always produce a clear-cut response. A group of high profile executives, including CEOs of major US corporations, tried to reach consensus on commonsense principles that are “conducive to good corporate governance, healthy public companies and the continued strength of … public markets.” On July 21, 2016, they released Commonsense Principles of Corporate Governance for public companies to promote further conversation on corporate governance.

These principles do not break new ground in corporate governance – it was not the purpose; these principles serve as a compilation of best practices that provide a “basic framework for sound, long-term-oriented governance.” The authors acknowledge that given the differences among public companies “not every principle … will work for every company, and not every principle will be applied in the same fashion by all companies.” These principles should promote discussions at the executive and board levels. They are a must read for board members, C-suite executives and corporate secretaries. Some of these principles can also be used by private companies and large non-profit organizations. Continue reading

Non-GAAP Financial Measures – Agenda Item for Upcoming Audit Committee Meetings

On June 27, 2016, SEC Chair Mary Jo White delivered a speech, which focused, in part, on non-GAAP financial measures, which have become the new old “hot button” issue for the SEC. Chair White strongly urged companies to carefully consider the SEC’s new Compliance & Disclosure Interpretations (“C&DIs”) that were issued in May 2016 and to “revisit their approach to non-GAAP disclosures.” In addition, Chair White emphasized that appropriate controls should be considered and that audit committees should carefully oversee their company’s use of non-GAAP financial measures and disclosures.

The SEC’s mission with respect to non-GAAP financial measures has been the same since its adoption of non-GAAP rules in 2003 — “to eliminate the manipulative or misleading use of non-GAAP financial measures and, at the same time, enhance the comparability associated with the use of that information.” Although the SEC recognizes that “investors want non-GAAP information,” as Chair White mentioned in her speech, the concern is that instead of supplementing the GAAP information, non-GAAP financial measures have “become the key message to investors, crowding out and effectively supplanting the GAAP presentation.” To make her message crystal clear, Chair White also stated in her speech that the SEC is “watching this space very closely and [is] poised to act through the filing review process, enforcement and further rulemaking if necessary to achieve the optimal disclosures for investors and the markets.”

If a company uses non-GAAP financial measures, then the use of such measures and disclosures in the company’s SEC filings, earnings press releases, earnings calls and other presentations should be an agenda item for upcoming audit committee meetings. On June 28, 2016, the Center for Audit Quality issued a new publication, Questions on Non-GAAP Measures: A Tool for Audit Committees, which is designed to facilitate the conversation between audit committees and management about non-GAAP financial measures. Questions included in this publication focus on transparency, consistency, and comparability of non-GAAP financial measures. The publication also includes a few procedural questions that are important to assess whether appropriate controls exist with respect to the use and disclosure of non-GAAP financial measures.

Five Nutshell Questions about Cybersecurity for the Board of Directors

 

CybersecurityOn April 29, 2016, the Council of Institutional Investors (CII) published its new Special Report, Prioritizing Cybersecurity: Five Investor Questions for Portfolio Company Boards. 

To facilitate effective cybersecurity risk oversight by the board, CII has suggested five questions that a board of directors needs to be able to answer:

  1. How are the company’s cyber risks communicated to the board, by whom, and with what frequency?
  2. Has the board evaluated and approved the company’s cybersecurity strategy?
  3. How does the board ensure that the company is organized appropriately to address cybersecurity risks? Does management have the skill sets it needs?
  4. How does the board evaluate the effectiveness of the company’s cybersecurity efforts?
  5. When did the board last discuss whether the company’s disclosure of cyber risk and cyber incidents is consistent with SEC guidance?

Continue reading

SEC’s Views on Risk Factor Disclosures

On April 13, 2016, the SEC issued a Concept Release, Business and Financial Disclosure Required by Regulation S-K. In this release, which is part of the SEC’s initiative to review and improve its disclosure requirements, the SEC is seeking comments on whether its “business and financial disclosure requirements continue to elicit important information for investors and how registrants can most effectively present this information.” The Concept Release covers a wide range of topics, however, this blog post focuses on the SEC’s concerns about risk factor disclosures. Item 503(c) of Regulation S-K currently requires “disclosure of the most significant factors that make an investment in a registrant’s securities speculative or risky and specifies that the discussion should be concise and organized logically.”

Except for five specific examples of risk factors suggested by the SEC in Item 503(c) (the company’s lack of operating history, lack of profitable operations in recent periods, financial position, business or proposed business and lack of a market in the company’s securities), risk factor disclosure is principles-based. It is interesting to note that these five factors specified in Item 503(c) have not changed since the SEC published its initial guidance on risk factor disclosure in 1964. Continue reading

Crowdfunding Is Something Worth Explaining to Investors

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On October 30, 2015, the Securities and Exchange Commission (SEC) adopted new Regulation Crowdfunding to implement the requirements of the Jumpstart Our Business Startups Act. Regulation Crowdfunding prescribes rules governing the offer and sale of securities under Section 4(a)(6) of the Securities Act and provides a framework for the regulation of registered funding portals and broker-dealers that issuers are required to use as intermediaries in the offer and sale of securities in reliance on Section 4(a)(6). Regulation Crowdfunding is generally effective May 16, 2016, except for rules related to the registration of funding portals and amendments to Form ID, which became effective on January 29, 2016.

The SEC issued an Investor Bulletin, Crowdfunding for Investors on February 16, 2016 to educate investors about Regulation Crowdfunding and to explain this new investing opportunity — securities–based crowdfunding, which is different from websites raising funds and offering in-kind consideration for financial contributions. Starting May 16, 2016, the general public will have an opportunity to invest in start-ups and early stage companies and receive equity consideration for their investments. Continue reading

EQUITY CROWDFUNDING HAS FINALLY ARRIVED – SEC ADOPTS FINAL RULES ON CROWDFUNDING

On October 30, 2015, the Securities and Exchange Commission (“SEC”), in a 3-1 vote of the SEC Commissioners, approved final rules to adopt Regulation Crowdfunding, which sets forth the framework by which companies can “equity crowdfund” – sell small amounts of securities (typically for a small purchase price) to a large number of investors over the Internet. The final rules, which will become effective 180 days after they are published in the Federal Register, follow the SEC’s adoption of proposed rules in October 2013 (which we previously blogged about). The SEC’s proposed rules were widely criticized as unworkable and elicited more than 480 comment letters that raised a host of concerns regarding, among other things, the effectiveness of the proposed rules in promoting capital formation and protecting investors.

Issuers and investors, particularly in the startup community, have been abuzz about equity crowdfunding since the Jumpstart Our Business Startups Act (“JOBS Act”) was enacted in April 2012.  Title III of the JOBS Act added Section 4(a)(6) to the Securities Act of 1933 (the “Securities Act”) to provide an exemption for equity crowdfunding transactions from the registration requirements of the Securities Act.  After seeing the success of non-equity crowdfunding – the Kickstarter fundraising campaigns of Pebble (~$20M raised) and Pono (~$6M raised) come to mind – it is understandable why issuers and investors have placed so much hope in the promise of equity crowdfunding.  With the SEC’s final rules in place, equity crowdfunding, with its numerous limitations and requirements, will shortly become a reality.

Under the final rules, an issuer may raise up to $1 million in a 12-month period in a crowdfunding offering conducted via a single intermediary – either a broker-dealer or a funding portal registered with the SEC.  An issuer engaging in a crowdfunding offering must complete and file with the SEC a newly-created Form C (similar to the Form 1-A offering statement under Regulation A, but with fewer required disclosures), which will require the disclosure of certain business and financial information including  financial statements of the issuer. Depending on the amount sought in the crowdfunding offering and whether an issuer has previously conducted a crowdfunding offering, the final rules will require that an issuer provide audited or reviewed financial statements.  For example, an offering of more than $500,000 of securities will require reviewed financial statements unless the issuer is not a first time issuer, in which case audited financial statements will be required.

The final rules also limit the amount of funds that an individual investor may invest in all crowdfunding offerings over a 12-month period, based on an investor’s annual income and net worth. Interestingly, despite criticism on the workability of the investment limitations set forth in the proposed rules, the final rules have more stringent limitations than those included in the proposed rules.  An investor with either annual income or net worth less than $100,000 can invest up to 5 percent of the lesser of annual income or net worth, or $2,000, whichever is greater, every 12 months. An investor with both annual income and net worth greater than $100,000 can invest up to 10 percent of the lesser of annual income or net worth every 12 months, subject to a cap of $100,000 in a 12-month period.   One effect of the limits will be that crowdfunding issuers may end up with numerous investors providing small investments – for example, an issuer raising $1 million would have 500 shareholders if the $2,000 limitation applied to those investors.

Only time will tell whether the regulatory environment created by the final rules will allow equity crowdfunding to reach the heights envisioned by many proponents. Among other reasons, the costs and compliance burden for issuers and the potential returns to investors are difficult to forecast at this time.  Regardless, many issuers, especially startups, now have an additional tool to raise capital in the United States. A more detailed summary of the final rules is provided below.

Sales Limitations

The following sales limitations apply to a crowdfunding offering:

  • An eligible issuer (see below for a description of ineligible issuers) is permitted to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period. In addition, entities controlled by, or under common control, with the issuer are aggregated for purposes of determining compliance with the offering ceiling.
  • Individual investors, over the course of a 12-month period, are permitted to invest in the aggregate across all crowdfunding offerings up to:
    • If either their annual income or net worth is less than $100,000, then the greater of: (1) $2,000, or (2) 5% of the lesser of their annual income or net worth.
    • If both their annual income and net worth are equal to or more than $100,000, then 10% of the lesser of their annual income or net worth, subject to a cap of $100,000 in a 12-month period.
  • The JOBS Act requires that the SEC adjust the issuer sales limitation and investor investment limitations not less than every five years to account for changes in the CPI.

Ineligible Issuers

The following issuers are not eligible to utilize a crowdfunding offering:

  • Non-U.S. companies.
  • Reporting companies under the Securities Exchange Act of 1934 (the “Exchange Act”).
  • Certain investment companies.
  • Companies that are disqualified under Regulation Crowdfunding’s disqualification rules (i.e., bad actors).
  • Companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement (i.e., Form C).
  • Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Disclosure Requirements

An issuer conducting a crowdfunding offering is required to file certain information with the SEC on new Form C and to provide this information to investors and the applicable crowdfunding portal facilitating the offering. Among other things, in its offering documents, the issuer is required to disclose:

  • Information about officers and directors as well as owners of 20 percent or more of the issuer;
  • A description of the issuer’s business and the use of proceeds from the offering;
  • The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the issuer will accept investments in excess of the target offering amount;
  • Certain related-party transactions;
  • A discussion of the issuer’s financial condition; and
  • Financial statements of the issuer that are, depending on the amount offered and sold during a 12-month period:
  • If $100,000 or less, based on information from the issuer’s tax returns and certified by the principal executive officer,
  • If more than $100,000 and but not more than $500,00, reviewed by an independent public accountant, and
  • If more than $500,000, audited by an independent auditor, except that an issuer engaging in a crowdfunding offering for the first time would be permitted to provide reviewed rather than audited financial statements.
  • In any case, if audited financial statements of the issuer are available, then they must be provided.

Issuers are required to amend the offering document during the offering period to reflect material changes and provide updates on the issuer’s progress toward reaching the target offering amount.

In addition, issuers relying on the Regulation Crowdfunding exemption are required to file an annual report with the SEC and provide it to investors.  The reporting requirements will continue until:

  • the issuer is required to file reports under the Exchange Act;
  • the issuer has filed at least one annual report and has fewer than 300 holders of record;
  • the issuer has filed at least three annual reports and has total assets that do not exceed $10 million;
  • the issuer or another party purchases or repurchases all of the securities issued pursuant to the crowdfunding exemption), including any payment in full of debt securities or any complete redemption of redeemable securities; or
  • the issuer liquidates or dissolves in accordance with state law.

Crowdfunding Platforms

Each crowdfunding offering must be conducted exclusively through a single platform operated by an “intermediary” which is either a registered broker or a funding portal – a new type of SEC registrant. The rules require that such an intermediary:

  • Provide investors with educational materials;
  • Take measures to reduce the risk of fraud;
  • Make available information about the issuer and the offering;
  • Provide communication channels to permit discussions about offerings on the platform; and
  • Facilitate the offer and sale of crowdfunded securities.

The rules also prohibit a crowdfunding portal from:

  • Offering investment advice or making recommendations;
  • Soliciting purchases, sales or offers to buy securities offered or displayed on its platform;
  • Compensating promoters and others for solicitations or based on the sale of securities; and
  • Holding, possessing, or handling investor funds or securities.

The final rules provide a safe harbor under which crowdfunding portals can engage in certain activities, consistent with these restrictions.

Miscellaneous Restrictions

Securities acquired in a crowdfunding offering are generally subject to a one year holding period before they can be resold, subject to certain exceptions. Holders of securities acquired in a crowdfunding offering do not count toward the threshold that requires an issuer to register its securities with the SEC under Section 12(g) of the Exchange Act if the issuer is current in its annual reporting obligation, retains the services of a registered transfer agent and has less than $25 million in assets.

Are you a US private company looking for capital? Regulation A+ may be your answer.

The amended Regulation A became effective on June 19, 2015, and the SEC has recently provided helpful guidance about it.  On June 18, 2015, the SEC made available “Amendments to Regulation A: A Small Entity Compliance Guide” summarizing provisions of the new Regulation A, and on June 23, 2015, the SEC issued new Compliance and Disclosure Interpretations (C&DIs) clarifying certain provisions of the new Regulation A.

The new Regulation A mandated by the JOBS Act is often dubbed as Regulation A+, as a sign of significant improvement over the old Regulation A, which was rarely used as a capital-raising vehicle. The new Regulation A+ provides for two tiers of offerings:

  • Tier 1, for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and
  • Tier 2, for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

Under Regulation A+, an entity organized under the laws of the United States or Canada with its principal place of business in the United States or Canada that is not subject to Section 13 or 15(d) of the Securities Exchange Act of 1934 immediately prior to the offering is considered an eligible issuer for the purposes of Regulation A+. The new C&DIs clarify such eligibility requirement and provide that the following companies are eligible to benefit from the provisions of Regulation A+:

  • A company with headquarters located in the United States or Canada, but whose business primarily involves managing operations that are located outside such countries; provided its officers, partners, or managers primarily direct, control and coordinate the issuer’s activities from the United States or Canada.
  • A company that was previously required to file reports with the SEC under Section 15(d) of the Exchange Act, but that has since suspended its Exchange Act reporting obligation; provided the company has satisfied the statutory provisions for suspension in Section 15(d) of the Exchange Act or the requirements of Exchange Act Rule 12h-3.
  • A voluntary filer under the Exchange Act, i.e., a filer that is not obligated to file Exchange Act reports pursuant to either Section 13 or 15(d) of the Exchange Act.
  • A private wholly-owned subsidiary of an Exchange Act reporting company parent; provided such reporting company parent is not a guarantor or co-issuer of the securities of the private wholly-owned subsidiary.

Generally, Regulation A+ has been viewed as a vehicle that private companies can use to raise money to expand their business or to buy out a shareholder. In the new C&DIs, the SEC also clarified that Regulation A+ can be relied upon by an issuer for business combination transactions, such as a merger or acquisition. However, the SEC indicated that Regulation A+ would not be available for business acquisition shelf transactions.

Regulation A+ allows issuers to “test-the-waters” by trying to determine whether there is any interest in a contemplated securities offering. Rule 255 of Regulation A+ requires companies to include certain mandatory cautionary statements in such “test-the-waters” communications. The SEC has previously recognized the issuers interest in using social media (for example, Twitter) to communicate with security holders, and the new C&DIs permits an issuer to “test the waters” in a Regulation A+ offering on a platform that limits the number of characters or amount of text that can be included, and thus technically prevents the inclusion in such communication of the Rule 255 information. The SEC has solved this problem by allowing the use of an active hyperlink to satisfy the requirements of Rule 255 in the following circumstances:

  • The electronic communication is distributed through a platform that has technological limitations on the number of characters or amount of text that may be included in the communication;
  • Including the required statements in their entirety, together with the other information, would cause the communication to exceed the limit on the number of characters or amount of text; and
  • The communication contains an active hyperlink to the required statements that otherwise satisfy Rule 255 and, where possible, prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.

However, if an electronic communication is capable of including the entire required statements, along with the other information, without exceeding the applicable limit on number of characters or amount of text, the SEC considers the use of a hyperlink to the required statements to be inappropriate. This approach is consistent with the SEC’s position on other communications with shareholders under the Securities Act and Exchange Act rules.

Under Regulation A+, state securities (Blue Sky) registration requirements are not preempted for Tier 1 offerings, but such preemption exists for primary offerings of securities by the issuer or secondary offerings by selling security-holders in Tier 2 offerings. The new C&DIs make it clear that Blue Sky registration and qualification requirements are not preempted with respect to resales of securities purchased in a Tier 2 offering. Resales of securities purchased in a Tier 2 offering must be registered, or offered or sold pursuant to an exemption from registration, with state securities regulators.

Sec Proposes Anticipated Rules on Pay-Versus-Performance Disclosure

On April 29, 2015, the SEC, in a 3-2 vote of the SEC Commissioners, approved proposed rules (the “pay-versus-performance disclosure”) that would require an issuer to disclose the relationship between the issuer’s executive compensation and the issuer’s financial performance. The proposed rules would implement a disclosure obligation required under Section 953(a) of the Dodd-Frank Act. Chair White noted, in the SEC press release announcing the proposed rules, that the pay-versus-performance disclosure “would better inform shareholders and give them a new metric for assessing a company’s executive compensation relative to its financial performance.”

In particular, the proposed rules would amend Item 402 of Reg. S-K by adding a new Item 402(v) which would require issuers to disclose, in each proxy or information statement requiring executive compensation disclosure under Item 402 of Reg. S-K, the following:

  • the executive compensation “actually paid” to the issuer’s principal executive officer (“PEO”);
  • the executive compensation “actually paid” to the issuer’s named executive officers (“NEOs” ), expressed as an average for all such NEOs;
  • the issuer’s total shareholder return (“TSR” ); and
  • the TSR of a peer group of issuers.

Like all disclosures required under Item 402 of Reg. S-K, the pay-versus-performance disclosure would be subject to the say-on-pay advisory vote.

Compensation Actually Paid

Under the proposed rules, the executive compensation “actually paid” by an issuer means the total compensation for a particular executive disclosed in the summary compensation table adjusted by certain amounts related to pensions and equity awards. The adjusted disclosure represents an attempt by the SEC to reflect the compensation awarded to, or earned by, such executive officer in a particular year of service. In order to calculate the compensation “actually paid” to a particular executive officer, the total compensation disclosed for such executive officer in the summary compensation table would be adjusted to:

  • deduct the aggregate change in the actuarial present value of all defined benefit and actuarial pension plans reported in the Summary Compensation Table;
  • add back the actuarially determined service cost for services rendered by the executive officer during the applicable year;
  • exclude the grant date value of any stock and option awards granted during the applicable year that are subject to vesting; and
  • add back the value at vesting of stock and option awards that vested during the applicable year, computed in accordance with the fair value guidance in FASB ASC Topic 718.

An issuer would need to include footnotes to the pay-versus-performance summary table (see below for the form table) which describes the amounts excluded from and added to the total compensation reported in the summary compensation and the issuer’s vesting date valuation assumptions used (if materially different from the grant date assumptions disclosed in the issuer’s financial statements).

In addition to the required disclosure, an issuer would be permitted to make disclosures to capture the issuer’s specific situation and industry, provided that any supplemental disclosure is not misleading and not presented more prominently than the required pay-versus-performance disclosure. Examples of supplemental disclosure provided in the proposed rules include the disclosure of “realized pay” or “realizable pay” or additional years of data beyond the time periods required.

Peer Group

The peer group utilized for the TSR comparison would be the same peer group used by the issuer in its stock performance graph or in describing the issuer’s benchmarking compensation practices in its CD&A.

Format

The pay-versus-performance disclosure must be provided in tabular form as set forth below.

Year(a) Summary Compensation Table Total For PEO(b) Compensation Actually Paid to PEO(c) Average Summary Compensation Table Total for non PEO Named Executive Officers(d) Average Compensation Actually Paid to non PEO Named Executive Officers(d) Total Shareholder Return(f)

Peer Group Total Shareholder Return

(g)

Following the pay-versus-performance disclosure table, the issuer would be required to describe the relationship between the issuer’s executive compensation actually paid and the issuer’s TSR and the relationship between the issuer’s TSR and the peer group’s TSR.

Issuers will generally need to make the pay-versus-performance disclosure for its five (or three years, in the first applicable filing following the effectiveness of the proposed rule) most recently completed fiscal years.  However, smaller reporting companies will only need to make the disclosure for three years (or two years, in the first applicable filing following the effectiveness of the proposed rule).  In addition, a smaller reporting company would not be required to (i) disclose amounts relating to pensions (consistent with current executive compensation disclosure obligations); nor (ii) present the TSR of a peer group in its pay-versus-performance disclosure.

XBRL

Companies would be required to tag the pay-versus-performance disclosure using XBRL.  Smaller reporting companies would not be required to comply with the tagging requirement until the third filing in which the pay-versus-performance disclosure is provided.

Companies to which Disclosure Requirement Applies

The proposed pay-versus-performance disclosure rules would apply to all reporting companies, except registered investment companies, foreign private issuers and emerging growth companies.

Conclusion

It is unclear whether the pay-versus-performance disclosure will be adopted (and in effect) in time for the 2016 proxy season.  The SEC is seeking comments on the proposed rules for 60 days following their publication in the Federal Register.

The Alphabet Soup of Raising Capital: Regulation A or Regulation D — What Would You Prefer?

On June 19, 2015, amended Regulation A recently adopted by the SEC will become effective. The new Regulation A, mandated by the JOBS Act and often dubbed as Regulation A+, is a significant improvement over the old Regulation A, which was rarely used as a capital raising vehicle. The old Regulation A permits unregistered offerings of up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by security holders of the company. Permissible thresholds of Regulation A+ are much higher. It provides for two tiers of offerings: “Tier 1, for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and Tier 2, for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.”

However, will Regulation A+ become a more popular choice for smaller companies than Regulation D in raising capital? Is Regulation A+ a workable compromise between the company’s need to have access to capital and the SEC’s goal of investor protection?

Rule 506 of Regulation D is one of the most widely used capital raising exemptions under the US securities laws. The main reason of its popularity is its flexibility. Although Rule 506 does not provide an opportunity for selling security holders to participate in the offering as Regulation A+ does, Rule 506 does not have any caps on the dollar amount that can be raised. In addition, any company: public or private, US or foreign can raise capital under Rule 506. However, only a US or Canadian issuer that is not (i) a reporting company under the Securities Exchange Act of 1934 immediately prior to the offering, (ii) an investment company, or (iii) a blank check company is considered an “eligible issuer” under Regulation A+. Note that “bad actor” disqualification applies to both Rule 506 and Regulation A+ offerings. Also, a company that had its registration revoked under Section 12(j) of the Exchange Act within five years before the filing of the offering statement or that has been delinquent in filing required reports under Regulation A+ during the two years before the filing of the offering statement (or for such shorter period that the issuer was required to file such reports) is not eligible to do an offering under such Regulation.

In some instances, Regulation A+ appears to be more accommodating than Rule 506. For example, Rule 506 allows an unlimited number of accredited investors as purchasers (with Rule 506(b) also permitting up to 35 non-accredited investors), and Tier 1 of Regulation A+ does not have any limitation on the number or type of investors. Tier 2 also does not have any limitations on the number of investors, but imposes a per-investor cap for non-accredited investors (unless the securities are listed on a national exchange) of the aggregate purchase price to be paid by the purchaser for the securities to be no more than 10% of the greater of annual income or net worth for individual investors or revenue or net assets most recently completed fiscal year for entities.  In addition, Regulation A+ allows issuers to “test-the-waters” by trying to determine whether there is any interest in a contemplated securities offering (assuming such practice is allowed under applicable blue sky laws for Tier 1 offerings), while the traditional Rule 506(b) does not allow for general solicitation and advertising (Rule 506(c) permits general solicitation and advertisement).

The biggest downside of Regulation A+ structure is that blue sky registration requirements are not preempted for Tier 1 offerings, which significantly limits the use of Tier 1 for offerings in multiple states. Such preemption exists for Rule 506 offerings as well as Tier 2 of Regulation A+ offerings. But the welcomed flexibility of doing nationwide offerings under Tier 2 comes with a heavy price tag of ongoing reporting. After a Tier 2 offering, an issuer must file with the SEC annual reports on Form 1-K, semi-annual reports on Form 1-SA and current reports on Form 1-U (within 4 business days of the event). The SEC also noted that companies may “voluntarily” file quarterly financial statements on Form 1-U, but the practical effect of desired compliance with Rules 15c2-11 and Rule 144 to maintain placement of quotes by market makers and resales of securities, will lead to “voluntary” quarterly reporting becoming essentially mandatory.

Rule 506 offerings are usually accompanied by private placement memoranda, or PPMs, (even when offerings are solely to accredited investors) to protect issuers from Rule 10b-5 liability under the Exchange Act. There is no prescribed format for such PPMs and they are not reviewed by the SEC. In connection with Regulation A+ offerings, an issuer must file Form 1-A (a “mini” registration statement) through EDGAR with the SEC (first-time issuers are eligible to initially do a non-public submission of a draft of Form 1-A). Such Forms 1-A are subject to the SEC review and comment process, which increases the cost of the transaction and extends the time from the beginning of the transaction and the closing.

The good news is that Regulation A+ provides a new way for smaller companies to raise capital and get some liquidity in their securities. However, if a company is confident that it can raise money through the traditional Rule 506 private placement, it may still want to avoid the SEC review process, the hassle of blue sky compliance under Tier 1 or ongoing reporting obligations of Tier 2 introduced by Regulation A+.

Beware of Confidentiality Agreements with Employees; Make Sure They Don’t Stifle Whistleblowing

On April 1, 2015, the SEC announced its first enforcement action against a company for utilizing language in a confidentiality agreement which could discourage whistleblowing.

The SEC charged KBR, Inc., a Houston-based global technology and engineering firm, with violating Rule 21F-17 of the Exchange Act. Rule 21F-17, adopted pursuant to the Dodd-Frank Act, provides that “[n]o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. . .with respect to such communications.”

As part of its compliance program, KBR regularly receives allegations from its employees of potential illegal or unethical conduct by KBR or its employees. In looking into such matters, KBR would typically conduct an internal investigation which would include interviewing KBR employees.   In connection with such internal investigation interviews, KBR required witnesses to sign confidentiality statements which provided that such witnesses could face disciplinary action and even be fired if they discussed the matters discussed in the interview with outside parties without the prior approval of KBR’s legal department.  Because such investigations could involve violations of securities laws, the SEC claimed that the restrictive language in the KBR confidentiality statements violated Rule 21F-17. Notably, the SEC was not aware of any instance where (i) this restrictive language prevented a KBR employee from communicating with the SEC about potential securities violations, or (ii) KBR took any action to enforce such language in its confidentiality statements.

In order to settle the enforcement action, without admitting or denying the SEC’s charges, KBR (i) agreed to pay a $130,000 penalty, (ii) agreed to make reasonable efforts to contact KBR employees in the U.S. who had signed the confidentiality statement since August 21, 2011 to clarify that such employees are free to report possible violations of federal law or regulation to governmental agencies without obtaining the permission of KBR’s general counsel, and (iii) amended its confidentiality statement to include the following language:

“Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.”

In light of the above enforcement action, companies should review agreements that they have with their employees, as well as Company policies, to make sure that such documents do not contain language that would potentially stifle whistleblowing.