Small public companies are in trouble and they need help now! Once in a while there is a perfect storm forming that can only result in widespread damage and that time is now for small public companies, especially those that trade on the OTC Markets. The trains on track to collide include a combination of (i) the impending amended Rule 15c2-11 compliance deadline (which alone would be and is a clear positive); (ii) the proposed Rule 144 rule changes to eliminate tacking upon the conversion of market adjustable securities; (iii) the SEC onslaught of litigation against micro-cap convertible note investors claiming unlicensed dealer activity; (iv) the OTC Markets new across the board unwillingness to allow companies to move from the Pink to the QB if they have outstanding convertible debt; and (v) the SEC’s unwillingness to recognize the OTC Pink as a trading market and its implications on re-sale registration statements.
Any one of these factors alone would not be catastrophic, and in the case of the 211 overhaul, is extremely beneficial. However, putting together all of these elements will inevitably result in the complete failure of many small public companies and unfortunately, a disproportionate number of those companies will be operated by woman and minorities.
Of course, I am not the only one that realizes this. In late 2020 a group of market participants including small public companies, investors, law firms, and advocates formed the Small Public Company Coalition (SPCC) as a first-in-kind, high-level properly organized advocate and lobbying group to bring the issues in front of those that can make a difference including the SEC and Congress.
The SPCC is a member-driven, federal advocacy coalition consisting of participants in the micro-cap space. The SPCC is the real deal with active involvement from the brightest at Gibson Dunn & Crutcher, an international law firm with over 1,400 lawyers, and organized lobbying efforts led by Polaris Consulting, a top 10 lobbying firm in D.C. The team at Gibson, Dunn wrote an excellent comment letter response to the SEC proposed changes to Rule 144 that was signed by over 60 market participants and includes a complete economic impact analysis prepared by James Overdahl, Ph.D, who is the former Chief Economist for both the SEC and the CFTC. The SPCC has also been actively meeting with groups at the SEC and in Congress in support of the cause. For more information on the SPCC see www.thespcc.com or reach out to info@thespcc.com.
15c2-11 Compliance
On September 26, 2020, the SEC adopted final rules amending Securities Exchange Act (“Exchange Act”) Rule 15c2-11. From a high level, the amended rule will require that a company have current and publicly available information as a precondition for a broker-dealer to either initiate or continue to quote its securities; will narrow reliance on certain of the rules exceptions, including the piggyback exception; will add new exceptions for lower risk securities; and add the ability of OTC Markets itself to confirm that the requirements of Rule 15c2-11 or an exception have been met, and allow for broker-dealers to rely on that confirmation. The new rule will not require OTC Markets to submit a Form 211 application or otherwise have FINRA review its determination that a broker-dealer can quote a security, prior to the quotation by a broker-dealer. For a detailed summary of the new rules, see HERE.
Compliance with the majority of the rule’s requirements, including that all quoted companies have current information in order to remain 211 eligible, is slated for September 28, 2021. For companies that are Alternatively Reporting or intend to be Alternatively Reporting to OTC Markets, the ability to upload information requires access to the OTC Markets OTCIQ system. A company must apply to OTC Markets in order to gain access to the OTCIQ system (and thus publish current information on OTC Markets). If a company has been inactive for a period of time, or if a company goes through a change of control, a new OTCIQ application must be submitted.
Access to the OTCIQ system is the first barrier to entry for companies that wish to publish current information in compliance with the 211 rules, using the Alternative Reporting Standard. OTC Markets is inundated with such applications and has publicly announced that if an application is not submitted before June 30, 2021, it will not be processed in time to allow a company to access the system to upload current information prior to the September 28th deadline. Upon submitting an application, the current processing time is approximately 12 weeks.
Unlike obtaining EDGAR filing codes from the SEC, access to the OTCIQ system involves a merit review. The application itself requires the disclosure of all officers, directors and 5% or greater shareholders and the submittal of a background check authorization form for each. If there is negative history, either actual or reputational, related to any of the people listed on the form, OTC Markets has the authority to, and will likely, deny the application. In addition, if a company’s stock has been the subject of volatility in recent months (as so many have – see my blog on Gary Gensler’s recent speech on the subject including social media influencing stock prices – HERE), OTC Markets can, and has routinely been, denying the OTCIQ application.
I applaud the efforts to clean up the micro-cap markets but have issue with the discretionary and arbitrary nature of the review and decision-making process. The SEC has clearly defined bad actor rules, which include a shareholder ownership threshold of 20% and does not include a person’s “reputation.” For a detail of the bad actor rules, see HERE. Small and micro-cap companies often go through changes of control including both organic changes and reverse acquisitions. In fact, the new 211 rules give shell companies an 18-month runway to complete an acquisition. As I discuss below, I understand that OTC Markets is in a unique position to witness micro-cap fraud and the dealings of those that give penny stocks a bad name. I also understand that they are trying to find a balance between allowing access and protection of investors and the reputation of the marketplace itself. However, I would advocate for a more prescriptive test that mirrors the SEC bad actor rules with discretionary power only in extreme circumstances.
I am reminded of FINRA’s similar arbitrary use of Rule 6490 back in 2013-2015. Rule 6490 allows FINRA to deny a corporate action (such as name change, reverse split, etc.) if, among other reasons, “FINRA has actual knowledge that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected to the issuer or the SEA Rule 10b-17 Action or Other Company-Related Action are the subject of a pending, adjudicated or settled regulatory action or investigation by a federal, state or foreign regulatory agency, or a self-regulatory organization; or a civil or criminal action related to fraud or securities laws violations; (4) a state, federal or foreign authority or self-regulatory organization has provided information to FINRA, or FINRA otherwise has actual knowledge indicating that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected with the issuer or the SEA Rule 10b-17 Action or Other Company-Related Action may be potentially involved in fraudulent activities related to the securities markets and/or pose a threat to public investors.”
For a period of time, FINRA was relying on “may be potentially involved in fraudulent activities related to the securities markets and/or pose a threat to public investors” to deny corporate actions to companies that had any relationship, no matter how far removed, with a person that FINRA deemed a threat, regardless of any actual legal proceedings. See HERE for more information. Several issuers litigated FINRA’s seemingly expansive and arbitrary use of the rule to deny corporate actions. Although the SEC sided with FINRA and upheld their authority, FINRA adjusted their policy moving forward.
FINRA will still deny a corporate action if there is an actual bad actor involved in the company, and even if there is a significant shareholder or investor, whether debt or equity, that is the subject of a pending SEC or other regulatory proceeding but now the results of a review can be anticipated. FINRA considers actual filed legal proceedings and will even provide a company with an opportunity to explain the circumstances and provide exculpatory information. FINRA no longer considers unsubstantiated anonymous internet trolls in its review process. I hope OTC Markets goes the same route.
I also hope that OTC Markets changes its policy of penalizing a company’s ability to provide current public information, because of recent stock volatility and/or internet chat activity. In January 2021 the equity markets saw unprecedented volatility fueled in part by the use of trading apps such as Robinhood and TD Ameritrade and chat rooms such as on Reddit. Many exchange traded middle market companies, such as GameStop and AMC Theaters, were affected as were multiple OTC Markets entities, many of which lacked current public information. In February 2021 the SEC suspended the trading of several OTC Markets companies as result of social media triggered trading volatility without corresponding public information. Of course, this was a valid response.
However, I do not understand OTC Markets denying the ability to provide current information as a result of third-party social media activity or trading volatility (especially when the whole market was experiencing trading volatility). As OTC Markets pointed out in its comment letter response to the proposed 15c2-11 rules and in its application to the SEC for the formation of an expert market, there are companies that trade without current public information that are legitimate businesses. There are also many companies that are now motivated to provide current information as a result of the impending 211 compliance date. They should be allowed to do so, regardless of trading activity.
I note that if any of these companies have engaged in improper stock promotion, pump and dump activity, providing fraudulent or inaccurate public information or misinformation, there are numerous remedies available. The OTC Markets can tag the company with a caveat emptor designation and the SEC can initiate a trading suspension and subsequent enforcement action.
Even once an application for filing code access is granted, all information must be reviewed by OTC Markets prior to receiving current information status or confirmation of 15c2-11 eligibility. Absent actual identifiable bad actors, this seems the best gateway for OTC Markets to exercise its gatekeeper role. Also, in that gatekeeper role, OTC Markets should follow its stated position in its comment letter to the SEC in response to the 211 rule changes and make the review process more objective and efficient. OTC Markets should not review the merits of the information itself. The goal should be to ensure the markets have the information mandated by Rule 15c2-11, that such information is publicly available for the investing community, and that an issuer has the responsibility for the accuracy of the information.
Proposed Rule 144 Rule Changes
On December 22, 2020, the SEC proposed amendments to Rule 144 which would eliminate tacking of a holding period upon the conversion or exchange of a market adjustable security that is not traded on a national securities exchange. Market adjustable securities usually take the form of convertible notes which have become a very popular and common form of financing for micro- and small-cap public companies over the past decade or so but have been under attack in recent years. The reasoning for the attacks range from the dilutive effect of the financing (yes, it’s dilutive); to labeling all market adjustable security investors and lenders as predatory sharks swimming in a sea of innocent guppies; to the SEC’s claim that serial lenders are acting as unlicensed dealers; to no articulated reason at all.
When the rule was first proposed and I blogged about it (see HERE), I saw the rule as adding some clarity to an opaque attack by market participants against a category of investors. In other words, I saw it as adding boundaries to what was otherwise just discrimination. Now I think it is a reactive, under-educated, excessive regulatory response to a perceived issue, fraught with unintended consequences. The hardest hit group from the fallout of this rule will be woman- and minority-majority-owned businesses.
In a standard convertible note structure, an investor lends money in the form of a convertible promissory note. Generally, the note can either be repaid in cash, or if not repaid, can be converted into securities of the issuer. Since Rule 144 allows for tacking of the holding period as long as the convertible note is outstanding for the requisite holding period, the investor would be able to sell the underlying securities into the public market immediately upon conversion. The notes generally convert at a discount to market price so if the converted securities are sold quickly, it appears that a profit is built in. The selling pressure from the converted shares has a tendency to push down the stock price of the issuer. On the flip side, because of the market adjustable feature, the lender can usually offer a lower interest rate and better terms.
The notes also generally have an equity blocker (usually 4.99%) such that the holder is prohibited from owning more than a certain percentage of the company at any given time to ensure they will never be deemed an affiliate and will not have to file ownership reports under either Sections 13 or 16 of the Exchange Act (for more on Sections 13 and 16, see HERE). As a result, there is the potential for a note holder to require multiple conversions each at 4.99% of the outstanding company stock in order to satisfy the debt. Each conversion would be at a discount to the market price with the market price being lower each time as a result of the selling pressure. This can result in a large increase in the number of outstanding shares and a decrease in the share price. Over the years, this type of financing has often been referred to as “toxic.”
Extreme dilution is only possible in companies that do not trade on a national securities exchange. Both the NYSE and Nasdaq have provisions that prohibit the issuance of more than 20% of total outstanding shares, at a discount to a minimum price, without prior shareholder approval. For more on the 20% Rule, see HERE. In addition to protecting the shareholders from dilution, the 20% Rule is a built-in blocker against distributions and as such, the SEC proposed Ruel 144 change only includes securities of an issuer that does not have a class of securities listed, or approved to be listed, on a national securities exchange.
Although on first look it sounds like these transactions are risk-free for the investor and that the proposed legislation makes perfect sense – they are not and it does not. Putting aside the fact that not even the SEC could enunciate the problem they are trying to fix (the SEC does not even mention extreme dilution), and only provided a few sentences on the economic impact of the rule (i.e., the impact is “unclear”), a further review makes it obvious the rule doesn’t make sense.
It isn’t all profits and using dollars to light cigars for adjustable security investors. First, Rule 144 itself creates some hurdles. In particular, in order to rely on the shorter six-month holding period for reporting companies, the company must be current in its reporting obligations. Also, if the company was formerly a shell company, it must always remain current in its reporting obligations to rely on Rule 144. If a company becomes delinquent, the investor can no longer convert its debt and oftentimes the company does not have the cash to pay back the obligation. Further, over the years it has become increasingly difficult to deposit the securities of penny stock issuers. Regardless of whether Rule 144 requires current information, most brokerage firms will not accept the deposit of securities of a company without current information, and many law firms, including mine, will not render an opinion for the securities of those dark companies.
There are market risks as well. If a company has very low volume and/or an extremely low price, market adjustment will not save the day for the investor. Also, conversion is generally based on a formula over the days prior to the conversion. There is no guarantee that the price will not drop in the time it takes to convert and deposit securities. Of course, there is the time value of money. No matter what, an investor is in for 6 months and would have foregone options on how to put the money to better use.
The problems with the proposed rule go deeper. I urge everyone to read the Comments of the SPCC in response to the rule, the response letter by Michael A. Adelstein, Partner at Kelley, Drye & Warren, LLP and the numerous, almost across the board, comments in opposition to the proposed rule. Whereas the SEC proposed rule contains almost no economic analysis whatsoever, the SPCC’s 187-page response contains an in-depth economic analysis by James Overdahl, Ph.D, who is the former Chief Economist for both the SEC and the . The results are grim, especially for development stage companies with limited capital and revenue.
It is quite possible that the rule’s implementation will bankrupt hundreds of small public companies. As the SEC notes, unlisted small public companies often have one source, and only one source, of quick affordable capital and that is market adjustable convertible securities. Eliminating this source of financing will likely drive these companies out of business (eliminating jobs and investment funds at the same time). As it is undeniably harder for woman and minorities to raise money, especially from traditional sources, they will be the hardest hit. (See my summary of the Annual Report of Office of Advocate for Small Business Capital Formation – HERE.)
The SEC comment letter focuses on the grievous consequences to small businesses as well as the legal legislative issues with the proposed rule (arbitrary and capricious, etc.). The letter also contains an excellent history of Rule 144 including citing the numerous reasons the SEC amended the rule in 1997 to codify the long-standing practice of allowing tacking to the original issue date of a convertible note upon conversion to securities. Likewise, the comment letter contains a thoughtful dissertation that convertible notes are not overly dilutive but rather provide an affordable valuable form of financing and support the SEC’s mission of promoting access to capital for small companies.
Michael A. Adelstein’s comment response letter takes a more analytic approach with a broader market view discussing the different types of issues and investors and even propounding alternative language to the proposed rule. The fact is that the issuers targeted by the proposed rule change are generally not S-3 eligible, cannot rely on the National Securities Market Improvements Act for registrations (i.e., they must comply with state blue sky laws which are arduous) and generally have smaller floats limiting the amount that could be sold in a re-sale registration statement (because it would be considered an indirect primary offering). For these companies’ private placements of public equity or debt (i.e., a PIPE) is the only potential source of meaningful capital. If the company properly uses the capital obtained in PIPE transactions, they will grow out of the need for market-adjustable securities and will move on to registered and underwritten offerings.
Moreover, the SEC does not even consider the impact on small exchange traded companies. If an exchange traded company is struggling financially, under the new rules, it is unlikely that an investor will provide market adjustable convertible sources of capital for fear the company will be delisted and they will lose the ability to tack onto the holding period. As Mr. Adelstein notes, “[A] market-adjustable security can save entire businesses and thousands of jobs, as well as some or all of the value of investments already made into such businesses.”
Likewise, the SEC focuses only on convertible notes, disregarding the multiple types of market adjustable convertible securities which will also be impacted such as floaters, amorts, resets, forced convertibles and default convertibles. Mr. Adelstein’s comment letter contains an excellent discussion of these different types of instruments and provisions, but the most important point is it is not a one-size-fits-all investment. The SEC must at least consider the use of these different instruments and what impact a broad swipe of the pen can have.
Similarly, not all investors are the same. The SEC lumps together all market-adjustable security investors as pump-and-dump offenders out to take advantage of the marketplace. This simply isn’t true. There are some bad actors, but in my experience the majority are sophisticated investors looking to establish a long-term funding relationship with a client. The dumpers earn a reputation as such very quickly and are not sought after for further investments. I don’t mean to say the good ones are purely altruistic, but it just makes good business sense to establish long-term relationships and trade wisely to support growth. Fundamentals count. It is costly from an administrative perspective (accounting, deposit fees, opinion letters, brokerage fees, etc.) to manage multiple small investments. Also, the profit ratio for small investments is significantly lower than for larger ones. A company that utilizes capital properly and continues to grow will have a higher sustained stock price, more volume and more access to a diverse portfolio of capital only rounding out with market adjustable securities. A sophisticated investor will not just dump but will wait for good news and market changes, trading strategically. In this case, all investors make a larger return on investment dollars and are invited back to participate in future opportunities with even higher potential ROI’s and growth opportunities (every company is a small company in the beginning).
Considering the dramatic negative impact, the proposed rule will have on small and micro-cap companies, it seems obvious that there are many, less intrusive ways in which to approach the perceived problem. The SEC could require shareholder approval for any market adjustable convertible security issuance that could result in 20% or greater dilution, mirroring the current Exchange rules for all public companies. The SEC could also allow for tacking where, in fact, the securities were not issued at a discount to market regardless of market adjustable provisions in the security.
SEC Unlicensed Dealer Litigation
Prior to proposing the amendment to Rule 144, the SEC launched a different attack on investors/lenders of market adjustable securities. In November 2017 the SEC shocked the industry when it filed an action against Microcap Equity Group, LLC and its principal alleging that its investing activity required licensing as a dealer under Section 15(a) of the Exchange Act. Since that time, the SEC has filed approximately four more cases with the sole allegation being that the investor acted as an unregistered dealer. I am aware of several other entities that are under investigation for the same activity, which will likely result in enforcement actions.
The SEC certainly knew of the proliferation of convertible note and other market adjustable securities financings over the years. Rule 415 governs the registration requirements for the sale of securities to be offered on a delayed or continuous basis, such as in the case of the take down or conversion of convertible debt and warrants. In 2006 the SEC issued guidance on Rule 415 that the rule would not be available for re-sale registration statements where in excess of 30% of the company’s float was being registered for re-sale. The SEC indicated it would view such registrations as indirect primary offerings, that could not be priced at the market. The SEC action was in direct response to the proliferation of market adjustable equity line of credit financings during that time. Although there were a few large investors that did the majority of the financings, the SEC did not raise the dealer issue.
As mentioned before the Rule 144, 1997 amendment which specifically allowed tacking of the conversion holding period, spoke in depth as to this kind of financing. Likewise, the 2008 amendments that reduced the holding periods to six months and one year also addressed convertible financing and added a provision to clarify that tacking is also allowed upon the exercise of options and warrants where there is a cashless exercise feature. Again, the SEC did not raise an issue that the most prolific investors could be acting as an unlicensed dealer. To the contrary, the SEC recognized the importance of this type of financing.
On September 26, 2016, and again on the 27th, the SEC brought enforcement actions against issuers for the failure to file 8-K’s associated with corporate finance transactions and in particular PIPE transactions involving the issuance of convertible debt, preferred equity, warrants and similar instruments. Prior to the announcement of these actions, I had been hearing rumors in the industry that the SEC has issued “hundreds” of subpoenas (likely an exaggeration) to issuers related to PIPE transactions and to determine 8-K filing deficiencies. See HERE for my blog at the time. The SEC did not mention any potential violations by the investors themselves.
Nothing in the prior SEC rule making, interpretive guidance, or enforcement actions foresaw the current dealer litigation issue. The SEC litigation put a chill on convertible note investing and has left the entire world of hedge funds, family offices, day traders, and serial PIPE investors wondering if they can rely on previously issued SEC guidance and practice on the dealer question. So far, the SEC has only filed actions for unlicensed dealer activity against investors that invest specifically using convertible notes in penny stock issuers. Although there is a long-standing legal premise that a dealer in a thing must buy and sell the same thing (a car parts dealer is not an auto dealer, an icemaker is not a water dealer, etc.), there is nothing in the broker-dealer regulatory regime or guidance that limits broker-dealer registration requirements based on the form of the security being bought, sold or traded or the size of the issuer.
Specifically, there is no precedent for the theory that if you trade in convertible notes instead of open market securities, private placements instead of registered deals, bonds instead of stock, or warrants instead of preferred stock, etc., you either must be licensed as a dealer or are exempt. Likewise, there is nothing in the broker dealer regime that suggests that if you invest in penny stock issuers vs. middle market or exchange traded entities you need to be licensed as a dealer. Again, the entire community that serially invests or trades in public companies is in a state of regulatory uncertainty and the capital flow to small- and micro-cap companies has diminished accordingly. Although the SEC has had some wins in the litigations, the issue is far from settled.
Importantly, the dealer litigation, together with the proposed Rule 144 rule changes, makes it that much harder for small and developing public companies to obtain financing to execute on their business plans, support job growth and support the U.S. economy.
OTC Markets QB Standards
I mentioned above that most of the comment letter responses to the proposed Rule 144 amendments were in opposition to the rule change. One that was not, is OTC Markets itself. In supporting the proposed rule change, OTC Markets merely suggested that it not discriminate against OTC Markets securities, but rather that the new rule should apply across the board to both OTC Markets and Exchange traded issuers.
OTC Markets is in a unique position to witness the red flags of micro-cap fraud and has valiantly been engaged in an uphill battle to combat that fraud, and earn the respect of the SEC, FINRA and other regulators. To its credit, it has done an amazing job. Nothing is more illustrative of that than the complete dichotomy between the December 16, 2016 SEC White Paper on penny stocks which disregarded OTC Markets as a viable marketplace and showed a complete disinterest in it or its efforts to create a venture market (see HERE) and the new 15c2-11 rule release which hands over the power to determine compliance with the rule to OTC Markets itself.
Moreover, in the years prior to the 2016 White Paper and certainly since, the OTC Markets has consistently implemented new rule and policy changes, all in an effort to deter micro-cap fraud and create a respected market. They have and are succeeding.
But I don’t agree with everything. In recent years, OTC Markets has taken a stance against convertible note lenders and the issuers that rely on their financing. Effective October 1, 2020, OTC Markets formally updated its QB rules to add that it may “[R]efuse the application for any reason, including but not limited to stock promotion, dilution risk, and use of ‘toxic’ financiers if it determines, in its sole and absolute discretion, that the admission of the Company’s securities for trading on OTCQB, would be likely to impair the reputation or integrity of OTC Markets Group or be detrimental to the interests of investors.”
This would be fair enough if, like FINRA, it only denied an application if one of the investors or participants was a bad actor under the SEC rules, or had actual proceedings filed against it. Rather, though, OTC Markets has taken it one step further and has been denying the majority of QB applications where the applicant has convertible securities on the books.
In the past few months, this has become a big topic of conversation among market participants. In addition to clients and potential clients, other attorneys, broker-dealers and transfer agents have reached out to me to discuss insight or guidance. Is one convertible instrument enough to deny a QB application? Is three too many? Why are applications being denied even when the convertible instruments are not market adjustable? Will shareholder approval of the financings solve the problem? What if the total amount of potential dilution is less than 20%? 10% or even 5%?
Yesterday, on June 7, 2021, OTC Markets published some guidance on dilution risk associated with an OTCQB or OTCQX application. OTC Markets is focusing on:
- Whether an issuer has recent or currently outstanding convertible notes with conversion features that provide significant discounts to the current market price and whether such notes are held by company officers, directors and control persons;
- Whether an issuer has other classes of outstanding securities that are convertible into common stock at largely discounted rates and are not held by officers or directors;
- A capital table and/or “toxic financing” structure that will substantially reorganize the share ownership of the company;
- Whether an issuer has had a history of substantial increases in the amount of its outstanding shares;
- Whether an issuer has had a history of multiple or large reverse stock splits; and
- Whether an issuer has engaged lenders that have been the subjects of regulatory actions regarding “toxic financing” and related concerns.
The OTC Markets guidance indicates that an application can be renewed if a company takes corrective measures including enhancing corporate governance, providing additional disclosure, changing capital structure or adding protections for minority investors.
Although we appreciate all guidance, it is still opaque. It comes down to effectively identifying and solving a problem. The guidance indicates “substantial discount to market” but in my experience, even convertible notes at a fixed conversion price have been problematic. I know OTC Markets wants to allow listings on the QB and QX and is also trying to be a good steward and fiduciary to the marketplace. It is clear that we are in a period of transition.
In addition to the existence of convertible debt, like the OTCIQ application, OTC Markets has been doing a deep-dive merit review on all companies that apply to the QB and has been quick to deny an application, often without articulating the reasons or in perfunctory emails with a high-level reason that has been the source of some frustration for applicants.
Trading on the QB is not merely for optics. It has a definitive regulatory and capital raising impact.
The OTC Pink is not a Recognized Marketplace
A company that trades on the OTC Pink market may not rely on Rule 415 to file a re-sale registration statement whereby the selling shareholders can sell securities into the market at market price. That is, all registration statements, whether re-sale, primary or indirect primary, must be at a fixed price unless the issuer is trading on the OTCQB or higher.
Rule 415 sets forth the requirements for engaging in a delayed offering or offering on a continuous basis. Under Rule 415 a re-sale offering may be made on a delayed or continuous basis other than at a fixed price (i.e., it may be priced at the market). It is axiomatic that for a security to be sold at market price, there must be a market. There was a time when the SEC refused to recognize any of the tiers of OTC Markets, as a “market” for purposes of at-the-market offerings. On May 16, 2013, the SEC issued a C&DI recognizing the OTCQB and OTCQX as market for purposes of filing and pricing a re-sale registration statement.
However, OTC Pink is still not a recognized market. As there is no actual rule that identifies what is a market for purposes of Rule 415, the SEC has looked to Item 501(b)(3) of Regulation S-K. Item 501 provides the requirements for disclosing the offering price of securities on the forepart of a registration statement and outside front cover page of a prospectus. Item 501 requires that either a fixed price be disclosed or a formula or other method to determine the offering price based on market price. The SEC uses this rule to require a fixed price where a company trades on the OTC Pink since there is no identifiable “market” to tie a price too.
In light of the SEC dealer litigation and proposed Rule 144 amendments, many companies are engaging with investors for registered offerings. Even though the SEC is a proponent of exempt offerings (thus the redo of the entire exempt offering structure in November 2020), it seems that encouraging companies to register offerings will reduce micro-cap fraud and should be supported by OTC Markets. However, in order to properly utilize registration statements for capital market financing transactions, a company must trade on the OTCQB or better. A company’s added difficulty in being accepted to trade on the QB is just another notch on the tightening noose of OTC Markets companies.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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Lawcast is derived from the term podcast and specifically refers to a series of news segments that explain the technical aspects of corporate finance and securities law. The accepted interpretation of lawcast is most commonly used when referring to LawCast.com, the securities law network. Example: “LawCast expounds on NASDAQ listing requirements.”
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