ABA Journal’s 10th Annual Blawg 100
On December 18, 2014, the SEC published proposed rule amendments to implement portions of Title V and Title VI of the JOBS Act by amending rules promulgated under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”). The proposed amendments will revise the Section 12(g) rules to reflect the new, higher shareholder thresholds for triggering registration requirements and for allowing the voluntary termination of registration or suspension of reporting obligations. The proposed rules also make similar changes related to banks, bank holding companies, and savings and loan companies.
The proposed rules establish the time for determining accredited status for purposes of calculating shareholders of record and the corresponding application of the registration and deregistration rules. In particular, the proposed rules set the last day of the fiscal year as the relevant calculation moment effectively imposing an obligation on issuers to obtain, and investors to give, updated representations following an initial investment into the company. Such an obligation has not previously existed.
Finally, the proposed rules revise the definition of “held of record” in Exchange Act Rule 12g5-1 to exclude securities held by persons who received them pursuant to employee compensation plans.
JOBS Act Background
Prior to enactment of the JOBS Act on April 5, 2012, the Exchange Act required companies with greater than $10 million in total assets and greater than 500 record holders of any class of equity security to register and file periodic reports with the SEC. This requirement was burdensome for companies aspiring to raise capital and grow but that were not yet ready to become publicly reporting.
Section 12(g) of the Exchange Act and the rules promulgated thereunder allow a company to deregister and relieve itself of the reporting requirements of the Exchange Act if it has fewer than 300 shareholders, or fewer than 500 shareholders and less than $10 million of assets.
Title V and Title VI of The JOBS Act amended Section 12(g) and Section 15(d) of the Exchange Act as follows. Each of these amendments went effective automatically without further action by the SEC.
- Section 501 of Title V amended Section 12(g) of the Exchange Act to increase the holders of record threshold for triggering Section 12(g) registration for issuers with total assets of more than $10 million (other than banks and bank holding companies) from 500 or more persons to either (1) 2,000 or more persons or (2) 500 or more persons who are not accredited investors.
- Section 601(a)(1) of Title VI amended Section 12(g)(1)(B) to increase the holders of record threshold for triggering Section 12(g) registration for banks and bank holding companies, as such term is defined in the Bank Holding Company Act of 1956, as of any fiscal year end after April 5, 2012 from 300 or more persons to 2,000 or more persons.
- Section 601(a)(2) of Title VI amended Section 12(g)(2) of the Exchange Act to increase the holders of record threshold for Section 12(g) deregistration and suspension of reporting under Section 15(d) for banks and bank holding companies from 300 to 1,200 persons.
In addition, the JOBS Act requires the SEC to exempt, by rule, conditionally or unconditionally, securities acquired pursuant to an offering made under Title III Crowdfunding, from the registration provisions of the Exchange Act. Moreover, the SEC was required to enact rules that exclude persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of Section 5 of the Securities Act, in calculating the number of holders of record.
The New Proposed Rules
Although the above amendments went effective upon passage of the JOBS Act, the automatic amendments did not include a change to the deregistration provisions under Section 12(g). Accordingly, since April 2012, a company would not be required to register until it had 2,000 shareholders of record or 500 or more persons who are not accredited investors, but could not de-register unless it had fewer than 300 shareholders, or 500 shareholders for those companies with less than $10 million in assets.
The new proposed rules align the deregistration provisions under Section 12(g) with the registration threshold requirements. In addition, the new proposed rules unify the rules related to bank and bank holding companies to include saving and loans and savings and loans holding companies. Further, the new proposed rules establish a non-exclusive safe harbor that companies may follow to exclude persons who received securities pursuant to employee compensation plans when calculating the shareholders of record for purposes of triggering the registration requirements under Section 12(g).
The proposed rules amend Exchange Act Rule 12g-1 through 12g-4 and 12h-3 to reflect the $10 million in total assets and 2,000 person thresholds across the board for requirements related to registration, termination of registration and suspension of reporting obligations.
Furthermore, though the registration requirement automatically went into effect with the JOBS Act, the language of the Section 12(g) rules remained outdated. The new proposed rules update the language to reflect the state of the law and remove any outdated remaining references. Also, the proposed rules modify the Rule 12g-4 to clarify that a bank or bank holding company issuer that files a Form 15 may automatically and immediately suspend its reporting obligations, rather than be subject to a 90-day waiting period as currently procedurally delineated.
Application of the Increased Threshold for Accredited Investors
Knowing whether an investor or shareholder is accredited has always been a basic premise in determining the availability of an exemption from the registration requirements and the disclosure delivery requirements applicable to such an exemption. The new registration and deregistration thresholds now extend the importance and timing of knowing the accredited status of shareholders beyond what was ever previously required.
Identifying accredited investors for purposes of the registration, and especially deregistration, requirements could be problematic. Suggestions in this regard included: (i) allowing issuers to rely on annual affirmations from record shareholders; (ii) reliance on information obtained at the time of an initial investment or most recent sale of securities to such investor; or (iii) third-party verification.
For the time being, the new proposed rules rely on the current definition of “accredited investor” enumerated in Securities Act Rule 501(a) and require that the “accredited investor” determination be made as of the last day of the fiscal year rather than at the time of the sale of securities. This provides a dramatic change for issuers who currently have no obligations to assess accredited status after a sale of securities is completed.
In rejecting the ability to rely on representations made at the time of a sale of securities to a particular investor, the SEC stated that “[W]e believe such reliance could, however, result in the use of outdated information that may no longer be reliable. Instead, an issuer will need to determine, based on facts and circumstances, whether it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.”
The SEC recognizes the difficulties this requirement can create and is considering an alternative approach and has requested comments on the subject. It seems to me that issuers will now need to obtain contractual agreements from investors to provide updated representations; however, determining fair and reasonable consequences for a breach of such an agreement is problematic. Direct damages will be hard to determine. I doubt an issuer could claim that the shareholders’ refusal to provide updated information results in the issuer having to register, or continue reporting, and seek damages in the amount of reporting costs. Likewise, investors will balk at consequences directed toward their share ownership, such as a restriction on voting or dividend rights, though remedies along these lines seem the most workable.
As the proliferation of rules centered on a distinction between accredited and non-accredited investors continues, the definition of accreditation has become the subject of much debate. The Dodd-Frank Act specifically requires the SEC to review the definition no less than every four years.
Although the new proposed rules do not change the current definition (or create a new specific-purpose definition), the SEC has been requesting comment and input and has held committee meetings on this topic. I expect a new global definition, or possibly several specific-purpose definitions, of “accredited” to be implemented in 2015.
Employee Compensation Plans
The new proposed rules establish a non-exclusive safe harbor that companies may follow to exclude persons who received securities pursuant to employee compensation plans when calculating the shareholders of record for purposes of triggering the registration requirements under Section 12(g). Exchange Act Section 12(g)(5), as amended of the JOBS Act provides that the definition of “held of record” shall not include securities held by persons who received them pursuant to an “employee compensation plan” in exempt transactions. By its express terms, this new statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of equity securities under the Exchange Act and does not apply to a determination of whether such registration may be terminated or suspended.
The proposed rule implements the JOBS Act by establishing a statutory exclusion for security holders who received their stock in unregistered employee stock compensation plans, and provides a safe harbor for determining whether holders of their securities received them pursuant to an employee compensation plan in exempt transactions.
The SEC declines to add a new definition of “employee compensation plan”; rather, the SEC incorporates Rule 701(c) and the guidance under that rule for issuers to rely in their Section 12(g) analysis. The proposed safe harbor allows an issuer to conclude that shares were issued pursuant to an employee compensation plan in an unregistered transaction as long as all the conditions of Rule 701(c) are met, even if other requirements of Rule 701, such as 701 (b) (volume limitations) or 701(d) (disclosure delivery requirements), are not met.
The proposed Rule amends the definition of “held of record” such that for purposes of Section 12(g), an issuer may “exclude securities that are either:
•held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act; or
•held by persons eligible to receive securities from the issuer pursuant to Exchange Act Rule 701(c) who received the securities in a transaction exempt from the registration requirements of Section 5 of the Securities Act in exchange for securities excludable under proposed Rule 12g5-1(a)(7)” (such as a merger, acquisition or other combination).
The SEC also proposes to exclude securities issued under the “no-sale” exemption to registration theory from the “held of record” definition, including shares issued as a dividend to employees.
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.
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