New SEC Guidance on “Bad Actor” Disqualifications from Rule 506 Offerings

On December 4, 2013, the SEC issued new Compliance and Disclosure Interpretations (C&DIs) clarifying the application of the “bad actor” disqualifications from Rule 506 offerings.  Generally, under the new Rule 506(d), an issuer may not rely on a Rule 506 exemption from registering the offering under the Securities Act of 1933 if the issuer or any other person covered by Rule 506(d) has a relevant conviction, judgment, suspension or other disqualifying event that occurred on or after September 23, 2013 (the effective date of Rule 506(d)).  Please see below a summary of some C&DIs issued by the SEC.

When is an issuer required to determine whether bad actor disqualification under Rule 506(d) applies?

An issuer must determine if it is subject to “bad actor” disqualification any time it is offering or selling securities in reliance on Rule 506.  After the initial inquiry, an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to, for example, contractual covenants, bylaw requirements, or an undertaking in a questionnaire or certification.  However, if an offering is continuous, delayed or long-lived, the issuer must update its factual inquiry periodically through bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.

If a placement agent or one of its covered control persons becomes subject to a disqualifying event while an offering is still ongoing, could the issuer continue to rely on Rule 506 for that offering?

Yes, if a placement agent or one of its covered control persons, such as an executive officer or managing member, becomes subject to a disqualifying event while an offering is still ongoing, the issuer could rely on Rule 506 for future sales in that offering if the engagement with the placement agent was terminated and the placement agent did not receive compensation for the future sales.  If the triggering disqualifying event affected only the covered control persons of the placement agent, the issuer could continue to rely on Rule 506 for that offering if such persons were terminated or no longer performed roles with respect to the placement agent that would cause them to be covered persons for purposes of Rule 506(d).

What does it mean to participate in the offering?

Participation in an offering is not limited to solicitation of investors. For example, participation in an offering include participation or involvement in due diligence activities or the preparation of offering materials (including analyst reports used to solicit investors), providing structuring or other advice to the issuer in connection with the offering, and communicating with the issuer, prospective investors or other offering participants about the offering.  However, to constitute “participation,” such activities must be more than transitory or incidental. Administrative functions, such as opening brokerage accounts, wiring funds, and bookkeeping activities, would generally not be deemed to be participating in the offering.

Is disqualification triggered by actions taken overseas?

No, disqualification under Rule 506(d) is not triggered by convictions, court orders, or injunctions in a foreign court, or regulatory orders issued by foreign regulatory authorities.

When does the “reasonable care” exception apply?

The reasonable care exception to new rules applies whenever the issuer can establish that it did not know and, despite the exercise of reasonable care, could not have known that a disqualification existed under Rule 506(d).  This may occur when, despite the exercise of reasonable care, the issuer was unable to determine the existence of a disqualifying event, was unable to determine that a particular person was a covered person, or initially reasonably determined that the person was not a covered person but subsequently learned that determination was incorrect.  An issuer may need to seek waivers of disqualification, terminate the relationship with covered persons, provide additional disclosure under Rule 506(e), or take other remedial steps to address the Rule 506(d) disqualification.

Should Pay Ratio Disclosure Be “Furnished” or “Filed”?

In the recently proposed pay ratio rules, the SEC acknowledged that some commenters had suggested that pay ratio information should be deemed “furnished” and not “filed” for purposes of the Securities Act of 1933 and Securities Exchange Act of 1934, and no commenters had asserted that pay ratio disclosure should be “filed.”[1]  However, the SEC rejected these suggestions based on an extremely literal reading of Section 953(b) of the Dodd-Frank Act, which mandates the SEC to amend Item 402 of Regulation S-K to require disclosure of the pay ratio in any filing of the issuer described in Item 10(a) of Regulation S-K.  The SEC concluded that “the use of the word ‘filing’ in Section 953(b) is consistent with the disclosure being filed and not furnished” and proposed that “the pay ratio disclosure would be considered “filed” for purposes of the Securities Act and Exchange Act and, accordingly, would be subject to potential liabilities under such acts.”[2]  For additional information about the proposed pay ratio rules, see our September blog post.

 Information Disclosed in a Filing Does not Have to be Filed with the SEC

 I believe the SEC gave disproportionate weight to the use of the word “filing” in Section 953(b).  “Filings” described in Item 10(a) of Regulation S-K include, without limitation, registration statements under the Securities Act and Exchange Act, annual and other reports under Sections 13 and 15(d) of the Exchange Act, and proxy and information statements under Section 14 of the Exchange Act.  However, some of these filings include disclosures that are considered “furnished” and “not filed”.   For example, a current report on Form 8-K is considered a “filing” described in Item 10(a) of Regulation S-K.  However, information included in a Form 8-K pursuant to Item 2.02 (Results of Operations and Financial Condition) or Item 7.01 (Regulation FD Disclosure) is not “deemed to be ‘filed’ for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section, unless the registrant specifically states that the information is to be considered “filed” under the Exchange Act or incorporates it by reference into a filing under the Securities Act or the Exchange Act.”[3]  Therefore, it seems that the legislative mandate to disclose the pay ratio in any filing described in Item 10(a) of Regulation S-K does not mean that such disclosure cannot be afforded the furnished status.  I believe, Section 953(b) of the Dodd-Frank Act only prescribes the type of documents in which pay ratio disclosure should appear and does not dictate whether such disclosure should be furnished or filed.  

 The Proper Response is the Ballot, not Litigation Challenging the Disclosure

 The proposed pay ratio rules are very flexible and allow a registrant to use (i) a methodology that uses reasonable estimates to identify the median and (ii) reasonable estimates to calculate the annual total compensation or any elements of total compensation for employees other than the PEO. Moreover, in determining the employees from which the median is identified, the registrant may use not only its total employee population, but also statistical sampling or other reasonable methods.  The ability to use various estimates and statistical sampling for a complex analysis required by the proposed pay ratio rules leads to potentially subjective disclosure that may be difficult to verify and that should not serve as potential grounds for shareholder litigation.    

 In contrast, the SEC views the flexibility of identifying the median and the ability to use reasonable estimates as arguments against the pay ratio disclosure being furnished.  The SEC believes that the proposed transition periods, flexibility of identifying the median and the ability to use estimates should mitigate registrants concerns about compiling and verifying the pay ratio disclosure.”[4]  Such argument contradicts the SEC’s original rationale for granting other compensation-related information “not filed” status. In1992, the SEC issued Release No. 33-6962, Executive Compensation Disclosure, which adopted amendments to the executive officer and director compensation disclosure requirements (the “1992 Release”).  The 1992 Release recognized that the newly adopted Compensation Committee Report on Executive Compensation and Performance Graph raised significant concerns about the potential for litigation and increased an issuer’s exposure to liability with respect to these disclosures.  To accommodate these concerns, the SEC stated that the information required by the Compensation Committee Report on Executive Compensation and Performance Graph “shall not be deemed to be ’soliciting material’ or to be ’filed’ with the Commission or subject to Regulations 14A or 14C …, or to the liabilities of Section 18 of the Exchange Act …, except to the extent that the registrant specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act.”[5] 

 The SEC’s reasoning in connection with the “not filed” status of the Compensation Committee Report was that “[i]f shareholders are not satisfied with the decisions reflected in the report, the proper response is the ballot, not resort to the courts to challenge the disclosure.”[6]  This same reasoning should apply to pay ratio disclosures.  Instead of treating the disclosure that most companies will base on subjective estimates and statistical sampling as “filed” and thus subject it to the liability provisions of the Exchange Act and Securities Act, this disclosure should be afforded the “furnished” status and shareholders should use voting as the venue for objecting to a specific ratio.  

 It will be interesting to see whether after the comment process the final SEC release would still support the “filed” status of pay ratio disclosure.  

 


 

[1] See Release No. 33-9452, p. 75 and Note 138.

[2] See id at p. 75.

[3] See Form 8-K, General Instruction B.2.

[4] See Release No. 33-9452, pp 75-76.

[5] See 1992 Release, Item 402(a)(9).  Both the Compensation Committee Report and Performance Graph have retained this “not filed” status in SEC Regulation S-K. See Item 402(e)(5), Instructions to Item 407(e)(5) and Item 201(e), Instruction 8 of Regulation S-K.

[6] See id.

Board Oversight of Political Contributions Is Steadily Rising

In September 2013, the Center for Political Accountability and the Zicklin Center for Business Ethics Research published their third annual index of political accountability and disclosure (2013 Index), which focuses on political spending disclosure of the top 200 companies in the S&P 500 Index. The Index reviews companies’ policies disclosed on their websites and describes:

  • the ways that companies manage and oversee political spending;
  • the specific spending restrictions that many companies have adopted; and
  • the policies and practices that need the greatest improvement.

The 2013 Index demonstrates that of the 195 companies reviewed in both 2012 and 2013, 78% of companies improved their overall scores for political disclosure and accountability.  In particular, data from the 2013 Index indicates that a growing number of companies have some level of board oversight of their political contributions and expenditures.  For example,

  •  62% of companies said that their boards of directors regularly oversee corporate political spending in 2013, compared to 56% in 2012;
  • 57% of companies said that a board committee reviews company policy on political spending in 2013, compared to 49% in 2012; and
  • 56% of companies said that a board committee reviews company political expenditures in 2013, compared to 45% in 2012.

Proposed Pay Ratio Disclosure – Delicate Balancing Act Between Congressional Mandate and Practical Implementation

On September 18, 2013, the SEC proposed the long-awaited and feared pay ratio rules.  The proposed rules embodied in the new Item 402(u) of Regulation S-K implement the mandate of Section 953(b) of the Dodd-Frank Act to disclose the ratio of the median of annual total compensation of all employees (excluding the CEO) to the annual total compensation of the CEO. 

In the proposed rules, the SEC provided registrants with a lot of flexibility in terms of various calculations that should be performed.   However, the SEC conceded that permitting registrants to select a methodology for identifying the median, rather than prescribing a specific methodology, could enable a registrant to “alter the reported ratio to achieve a particular objective with the ratio disclosure, thereby potentially reducing the usefulness of the information.”

Continue reading “Proposed Pay Ratio Disclosure – Delicate Balancing Act Between Congressional Mandate and Practical Implementation”

Companies Listing on the NYSE Can Appoint an Internal Auditor Within a Year after an IPO

On August 22, 2013, the SEC approved the NYSE’s proposal that permits a company listing in conjunction with an IPO to comply with the internal audit function requirement of Section 303A.07(c) of the NYSE Listed Company Manual within one year of the listing date.  NYSE rules now require such company to have an internal audit function in place no later than the first anniversary of its listing date[1].  Previously, NYSE rules only required each listed company to have an internal audit function but did not provide any transition period for companies listing in connection with an IPO.  

The new one-year transition period for compliance with an internal audit function requirement expanded NYSE corporate governance provisions, to which a transition period applies in connection with an IPO.  Such provisions relate to the composition of the board of directors as well as the composition of the nominating, compensation and audit committees (see Section 303A.00). 

The NYSE believes that a transition period for establishing an internal audit function will make the company’s process of implementation of such function more effective and will reduce the costs it faces in its first year as a public company.  The NYSE also expects that this transition period would enable the company’s audit committee to play a significant role in the design and implementation of the company’s internal audit function. 

In case of a company availing itself of a one-year transition period with respect to its internal audit function, the audit committee must:

  • assist board oversight of the design and implementation of the internal audit function; and
  • meet periodically with the company personnel primarily responsible for the design and implementation of the internal audit function.

Once the company establishes its internal audit function, the audit committee must (i) assist board oversight of the performance of the company’s internal audit function, and (ii) meet periodically with internal auditors or other personnel responsible for the internal audit function.

In addition, if the listed company does not yet have an internal audit function because it is using the internal audit function transition period, the audit committee’s review with the independent auditor of any audit problems should include a discussion of management’s plans with respect to the responsibilities, budget and staffing of the internal audit function and its plans for the implementation of the internal audit function.  Once the transition period is over, the audit committee’s review with the auditors should include a discussion of the responsibilities, budget and staffing of the company’s internal audit function.

The audit committee should also discuss with the board management’s activities with respect to the design and implementation of the internal audit function during the transition period, and after the transition period, the audit committee should review with the full board any issues that arise with respect to the performance of the internal audit function.

 Generally, a listed company must maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control, and the company can outsource an internal audit function to a third party service provider (other than the company’s independent auditor).   

 

 

 


[1] It is interesting to note that The NASDAQ Stock Market LLC (NASDAQ) does not have an internal audit function requirement.  Earlier this year, NASDAQ proposed, and later withdrew, an amendment to its listing requirements that each listed company establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control.  The SEC received 42 comment letters on the proposal, and NASDAQ stated in its withdrawal that it was withdrawing the proposal to fully consider such comments and that it intends to file a revised proposal (see SEC Release No. 34-69792).

New SEC Commissioners

In August 2013, Kara Stein and Michael Piwowar were sworn into office as SEC Commissioners.  Ms. Stein and Mr. Piwowar replaced former Commissioners Elisse Walter and Troy Paredes both of whom stepped down in August.  There is a built-in expectation that the new commissioners’ arrival would help the SEC expedite the approval of a number of delayed rules, including unfinalized rule-making under the Dodd-Frank Act and the JOBS Act.  Prior experience of both commissioners has prepared them well for this task. 

From 2009 to 2013, Ms. Stein was Staff Director of the Senate Banking, Housing, and Urban Affairs Committee’s Subcommittee on Securities, Insurance, and Investment.  Ms. Stein was Legal Counsel and Senior Policy Advisor to Sen. Reed from 2007 to 2009 and served as both the Majority and Minority Staff Director on the Banking Committee’s Subcommittee on Housing and Transportation from 2001 to 2006.  Before working on Capitol Hill, Ms. Stein was an associate at the law firm of Wilmer, Cutler & Pickering and an assistant professor with the University of Dayton School of Law.  Ms. Stein received her B.A. from Yale College and J.D. from Yale Law School.

Dr. Piwowar was the chief Republican economist for the U.S. Senate Committee on Banking, Housing, and Urban Affairs.  He worked on the Dodd-Frank Wall Act, the JOBS Act, and on SEC-related issues overseen by the committee.  During the financial crisis, Dr. Piwowar served a one-year term as a senior economist at the President’s Council of Economic Advisers under Presidents George W. Bush and Barack Obama and was a staff economist for the Financial Regulatory Reform Working Group of the President’s Economic Advisory Board.  Dr. Piwowar used to work at the SEC as a visiting academic scholar and senior financial economist in its Office of Economic Analysis, now the Division of Economic and Risk Analysis. Dr. Piwowar received a B.A. in Foreign Service and International Politics from Pennsylvania State University, an M.B.A. from Georgetown University, and a Ph.D. in Finance from Pennsylvania State University.

No Rule 506 Offerings for Bad Boys: Felons and Other “Bad Actors”

On July 10, the SEC revamped the way private placements under Rule 506 of Regulation D can be conducted by permitting general solicitation and general advertising in offerings where all purchasers are accredited investors (see To Use or Not to Use General Solicitation and General Advertising in Private Placements?) and by disqualifying felons and other “bad actors” from all Rule 506 offerings (i.e., irrespective of whether the offering involves or does not involve general solicitation and general advertising).  New SEC “bad actor” rules, effective 60 days after publication in the Federal Register, implement Section 926 of the Dodd-Frank Act and were originally proposed two years ago (May 25, 2011).

Under new Rule 506(d), “Bad Actor” Disqualification, an issuer will not be able to rely on the Rule 506 exemption from registration under the Securities Act of 1933 if the issuer or any other “covered person” is or was involved in a disqualifying event.

Covered Persons

“Covered persons” under Rule 506(d) include:

  • the issuer, any predecessor of the issuer, or any affiliated issuer;
  • directors, executive officers, other officers participating in the offering, general partners or managing members of the issuer;
  • beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • promoters connected with the company at the time of such sale;
  • investment managers of a pooled investment fund;
  • persons compensated (directly or indirectly) for soliciting investors; and
  • directors, executive officers, or other officers participating in the offering, of any such investment manager or solicitor or general partner or managing member of such investment manager or solicitor.

Disqualifying Events

Rule 506(d) “disqualifying events” include the following:

  • criminal convictions, within ten years before the sale of securities (or five years, in the case of issuers, their predecessors and affiliated issuers) in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of an underwriter, broker, dealer, or other financial intermediary;
  • court injunctions and restraining orders, entered within five years before such sale, in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of an underwriter, broker, dealer, or other financial intermediary;
  • final orders of a state securities commission; a state authority that supervises or examines banks, savings associations, or credit unions; a state insurance commission; an appropriate federal banking agency; the U.S. Commodity Futures Trading Commission; or the National Credit Union Administration that: 

     (i)  bar the person from associating with a regulated entity; engaging in the business of  securities, insurance or banking; or engaging in savings association or credit union activities; or

     (ii)  are based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before such sale;

  • SEC disciplinary orders suspending or revoking a person’s registration as a broker, dealer, municipal securities dealer or investment adviser; placing limitations on the activities of such person; or barring such person from being associated with any entity or from participating in the offering of any penny stock;
  • SEC cease and desist orders, entered within five years before such sale, that, orders the person to cease and desist from committing or causing a violation of any scienter-based anti-fraud provision of the federal securities laws (e.g., Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 or Section 5 of the Securities Act of 1933).
  • suspensions or expulsions from membership in, or suspension or a bar from association with a member of, a registered national securities exchange for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade;
  • SEC stop orders in connection with a registration statement or orders suspending the Regulation A exemption, issued within five years before such sale; or investigation to determine whether a stop order or suspension order should be issued; or
  • U.S. Postal Service false representation orders, entered within five years before such sale, or being subject to a temporary restraining order or preliminary injunction with respect to conduct alleged by the U. S. Postal Service to constitute a scheme or device for obtaining money or property through the mail by means of false representations.

Exceptions

Rule 506(d) disqualification does not apply if:

  • the triggering event occurred before the effective date of the new rules;
  • the SEC waives the disqualification;
  • before the relevant sale, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing that Rule 506(d) disqualification should not arise as a consequence of such order, judgment or decree; or
  • the company establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed.

 Disclosure of Pre-Existing Disqualifying Events

The company must furnish to each purchaser, a reasonable time prior to sale, a description in writing of any matters that would have triggered Rule 506(d) disqualification but occurred before the effective date of new rules.  The failure to furnish such information timely will not prevent a company from relying on Rule 506 exemption from registration if the company establishes that it did not know and, in the exercise of reasonable care, could not have known of the existence of the undisclosed matter or matters.

Reasonable Care

In connection with “reasonable care” requirements, a company will not be able to establish that it has exercised reasonable care unless it has made a factual inquiry into whether any disqualifications exist. The nature and scope of the factual inquiry will vary based on the facts and circumstances concerning, among other things, the company and the other offering participants.  For example, the SEC anticipates companies to have “an in-depth knowledge of their own executive officers and other officers participating in securities offerings gained through the hiring process and in the course of the employment relationship, and in such circumstances, further steps may not be required in connection with a particular offering.”

The SEC suggested that “factual inquiry by means of questionnaires or certifications, perhaps accompanied by contractual representations, covenants and undertakings, may be sufficient in some circumstances, particularly if there is no information or other indicators suggesting bad actor involvement.”  The SEC also clarified that for continuous, delayed or long-lived offerings, “reasonable care includes updating the factual inquiry on a reasonable basis,” which can be “managed through contractual covenants from covered persons to provide bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.”

Companies that are contemplating a Rule 506 private placement need to establish internal procedures for conducting a factual inquiry into whether “bad actors” may be involved in its offering.

To Use or Not to Use General Solicitation and General Advertising in Private Placements?

The SEC’s July 10th meeting has fundamentally changed the world of private placements by eliminating the blanket prohibition against general solicitation and general advertising in Rule 506 offerings.   The SEC has adopted the rules it proposed almost a year ago (in August 2012) to implement Section 201(a) of the JOBS Act.  Under amended Rule 506, a company will essentially have a choice of using Rule 506(b) to conduct a private placement subject to the current prohibition against general solicitation and general advertising or using new Rule 506(c), pursuant to which securities can be offered through general solicitation and general advertising.  This may not be an easy or straightforward choice for a company contemplating a private placement. 

New Rule 506(c), which will be effective 60 days after publication in the Federal Register, permits a company to offer securities using general solicitation and general advertising, only if it meets all of the following conditions:

  • sales must satisfy all the terms and conditions of Rules 501 (Definitions and Terms Used in Regulation D) and 502(a) and (d) (Integration and Limitations on Resales);
  • all purchasers of securities are accredited investors; and
  • the company takes reasonable steps to verify that purchasers of its securities are in fact accredited investors.

Some companies may choose not to use Rule 506(c) because the determination of whether the steps taken are “reasonable” is based on a facts and circumstances analysis conducted by the company.  A company conducting a private placement under current Rule 506(b) does not need to engage in the verification process described below and can rely on its reasonable belief that the purchaser satisfies one or more accredited investor criteria set forth in Rule 501(a).  In addition, companies may decide not to use the new Rule 506(c), not only to avoid such verification process, but also in order to make private placements to non-accredited investors who meet the sophistication requirements of Rule 506(b).

For ongoing Rule 506 offerings that commence before the effective date of Rule 506(c), a company may choose to continue the offering after the effective date under either Rule 506(b) or Rule 506(c).  If a company chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date, as permitted under such rule, will not affect the exempt status of offers and sales of securities that occurred under Rule 506(b) prior to the effective date.

A significant part of the SEC’s adopting release is focused on the analysis that a company must conduct to verify that a purchaser of securities in a Rule 506(c) offering is an accredited investor.  The SEC has specifically stated in the adopting release that a company will not be deemed to have taken reasonable steps to verify accredited investor status if it only required an investor to check a box in a questionnaire or sign a form (which is an acceptable practice now under the current “reasonable belief standard” applicable to offerings under Rule 506(b)), in the absence of other information indicating accredited investor status of the purchaser.  The SEC has embraced a principles-based method of verification and believes that a company should consider the following factors in its analysis:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the company has about the purchaser; and
  • the nature of the offering (e.g., the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount).

These factors are interconnected and the SEC stated that “[a]fter consideration of the facts and circumstances of the purchaser and the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify the accredited investor status.”  To illustrate this, the SEC produced the following example: “if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party.”

A company may rely on a third party that has verified a person’s status as an accredited investor (assuming the company has a reasonable basis to rely on such third-party verification) or on publicly available information in filings with a federal, state or local regulatory body (e.g., proxy statement disclosing the compensation of a purchaser who is a named executive officer of a public company or IRS Form 990 disclosing total assets of a Section 501(c)(3) organization with $5 million in assets). 

The means used by the company to solicit purchasers may be relevant in determining the reasonableness of the steps that a company should take to verify accredited investor status.  The SEC has pointed out that “[a]n issuer that solicits new investors through a website accessible to the general public, through a widely disseminated email or social media solicitation, or through a newspaper, will likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party.”

Recognizing the difficulty of determining what steps would be reasonable to verify an accredited investor’s status of a natural person and in response to comments, the SEC has provided the following examples of non-exclusive and non-mandatory methods that a company may use to verify that a natural person purchasing its securities in a Rule 506(c) offering is an accredited investor (assuming that the company does not have knowledge that such person is not an accredited investor):

  • reviewing any IRS form that reports the purchaser’s (or with the purchaser’s spouse in the case of a person who qualifies as an accredited investor based on joint income with that person’s spouse) income for the two most recent years (including, but not limited to, Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser (or with the spouse) that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;
  • reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser (or with the purchaser’s spouse in the case of a person who qualifies as an accredited investor based on joint net worth with that person’s spouse) that all liabilities necessary to make a determination of net worth have been disclosed:
    • with respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
    • with respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; or
  • obtaining a written confirmation from one of the following persons or entities that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor:
  • a registered broker-dealer;
  • an investment adviser registered with the SEC;
    • a licensed attorney who is in good standing under the laws of the jurisdictions in which he or she is admitted to practice law; or
    • a certified public accountant who is duly registered and in good standing under the laws of the place of his or her residence or principal office.
  • in regard to any person who purchased securities in a Rule 506(b) offering as an accredited investor prior to the effective date of 506(c) and continues to hold such securities, for the same issuer’s Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

Given the facts and circumstances analysis that a company has to perform in order to determine whether the purchaser of its securities in a Rule 506(c) offering is an accredited investor, on the one hand, and the privacy concerns of individual investors, on the other hand, it’s unclear whether general solicitation and general advertising in Rule 506 private placements will become a mainstream trend.

Corporate Governance Will Play an Important Role in Swaps

The Commodity Exchange Act (CEA), as amended by the Dodd-Frank Act, provides that it will be unlawful for any person to engage in a swap unless that person submits such swap for clearing to a derivatives clearing organization, provided the swap is required to be cleared.  The CEA delegates the authority to determine which swaps are required to be cleared to the Commodity Futures Trading Commission (CFTC).  The CFTC has determined that, starting on September 9, 2013, an entity will not be able to engage in certain classes of credit default swaps and interest rate swaps unless the entity submits the swaps for clearing.  However, this clearing requirement does not apply if one of the counterparties to the swap qualifies for and elects to rely on the “end-user exception.”

An entity will be eligible to claim the end-user exception if the entity:

  • is not a financial entity[1];
  • is using swaps to hedge or mitigate commercial risk; and
  • provides certain information to the CFTC or a swap data repository.

In addition, if the party electing this exception is a public company, then to qualify, the company’s board or an appropriate committee[2] of the board needs to review and approve the decision to enter into swaps that are exempt from the clearing requirements under the end-user exception.  This approval can be done either on a general basis or on a swap-by-swap basis.  The board or committee approval should specifically state that the board or committee, as applicable, has approved the decision to enter into swaps that are not being cleared and are not executed on a designated contract market or swap execution facility and that the company will rely on the end-user exception. 

The CFTC also expects public company boards to set appropriate policies governing the company’s use of swaps subject to the end-user exception and to review those policies at least annually and, as appropriate, more often upon a triggering event (e.g., implementing a new hedging strategy that was not contemplated in the original board approval).

Public companies that intend to rely on the end-user exception should, prior to September 9, 2013, adopt (i) appropriate board or committee approvals, and (ii) policies regarding the company’s use of swaps.

 

[1] The CFTC exempts from the definition of ‘‘financial entity’’ an entity that: (i) is organized as a bank or a savings association, among others, and the deposits of which are insured by the Federal Deposit Insurance Corporation; and (ii) has total assets of $10 billion or less on the last day of such entity’s most recent fiscal year.

[2] If a company intends to delegate this responsibility to a committee, the committee should be specifically authorized, either by charter amendment or board resolution, to review and approve the company’s decision to enter into swaps, including swaps subject to the end-user exception.

NYSE Proposes to Move to Only Website Disclosure of Listing Application Materials and to Otherwise Streamline its Listing Application Process

It has been a long-standing practice of the NYSE to post on its website the forms of the documents required to be submitted in connection with the NYSE listing applications. On April 30, 2013, the NYSE filed proposed rule changes to its Listed Company Manual (Manual), which, if adopted, will result in the Manual sections containing the listing application materials being deleted, and updated listing application materials will be posted only on the NYSE’s website. 

Although the NYSE amends its Manual from time to time, forms of listing agreements contained in the Manual have not always been amended to reflect changes made to the NYSE listing documents.  Some provisions in the listing agreements contained in the Manual are obsolete. The NYSE proposes to remove from the Manual (i) each of the agreements set forth in Sections 901.01 through 901.05, (ii) the form of original listing application contained in Section 903.01, and (iii) the form of supplemental listing application contained in Section 903.02. 

In the event that in the future the NYSE makes any substantive changes to those documents that are being removed from the Manual, it will submit a rule filing to the SEC to obtain approval of such changes, except for typographical or stylistic changes. The NYSE also plans to maintain all historical versions of those documents on its website after changes have been made, so that it will be possible to review how each document has changed over time. 

In addition, the NYSE proposes to state certain requirements, which it has been imposing as a matter of practice, in the Manual to add transparency to the listing process.  For example, the NYSE proposes to include in the Manual a new Section 107.00, Financial Disclosure and Other Information Requirements, which will contain the following requirements, among others:

  • Section 107.03 (SEC Compliance): No security shall be approved for listing if the issuer has not for the 12 months immediately preceding the date of listing filed on a timely basis all periodic reports required to be filed with the SEC or Other Regulatory Authority or the security is suspended from trading by the SEC pursuant to Section 12(k) of the Exchange Act.
  •  Section 107.04 (Exchange Information Requests): The NYSE may request any information or documentation, public or non-public, deemed necessary to make a determination regarding a security’s initial listing, including, but not limited to, any material provided to or received from the SEC or Other Regulatory Authority. A company’s security may be denied listing if the company fails to provide such information within a reasonable period of time or if any communication to the NYSE contains a material misrepresentation or omits material information necessary to make the communication to the NYSE not misleading. 

The NYSE also proposes to no longer require the following supporting documents in connection with an original listing application (see Section 702.04):

  •  Stock Distribution Schedule (the stock distribution schedule requirement is obsolete because the NYSE obtains the distribution information it needs from the applicant’s public filings and from its transfer agent). 
  • Certificate of Transfer Agent/Certificate of Registrar (the information that the NYSE needs about the applicant’s outstanding shares is available in its prospectus or periodic SEC reports, as well as the report of the applicant’s outstanding shares that will be required to be delivered to the Exchange once a quarter after listing). 
  • Notice of Availability of Stock Certificates (all transactions in listed securities in the national market system are conducted electronically through DTCC). 
  • Prospectus (final prospectuses are publicly available on the SEC’s website). 
  • Financial Statements (financial statements are included in the applicant’s SEC filings which are publicly available on the SEC’s website).