On November 1, 2018, the North American Securities Administrators Association, Inc. (“NASAA”) released for public comment proposed updates to the SCOR Statement of Policy and the SCOR Form (Form U-7).  According to the NASAA, the proposed updates are meant to incorporate many of the investor protections that have been put in place under state and federal crowdfunding laws in light of the evolution and availability of methods to raise capital in small offerings.

Changes to the SCOR Statement of Policy (last updated in 1996)

  • Application of SCOR:  The proposed updates amend the types of federal exempt offerings that can be registered at the state level under the SCOR Statement of Policy.  Specifically, SCOR will no longer apply to Regulation A offerings, but will apply to the registration of intrastate offerings exempt under new federal Rule 147A.  Additionally, the proposed updates increase the offering amount limitation from $1 million to $5 million, in line with the Rule 504 offering amount limitation increase.
  • Issuer Eligibility:  The proposed updates remove the existing requirement that the offering price for securities offered be greater than or equal to $1.00 per share or unit of interest.
  • Financial Statements:  The proposed updates revise the financial statement requirements to provide for tiered compilation, review, and audit requirements based on the amount of the offering.  In addition to the tiered approach, the proposed updates require (1) an issuer’s CEO and CFO to certify that annual financial statements are true and complete in all material respects and (2) an issuer provide interim financial statements if annual financial statements are dated more than 120 days prior to the date of filing.  The proposed updates to the financial statement requirements are based on Regulation Crowdfunding.
  • Bad Actor Disqualifications:  The proposed updates revise the bad actor disqualification provisions to merge aspects of federal bad actor provisions applicable to Rule 506 and Rule 504 offerings and to capture individuals materially participating in the offering or the operations of the issuer, as well as events that may include the potential for fraud.  The proposed updates, however, veer from related federal provisions and do not grandfather any bad acts that occurred prior to the adoption of the SCOR Statement of Policy.
  • Investment Limits:  The proposed updates incorporate the individual investment limits set forth in federal Regulation Crowdfunding and require that in each sale of securities in a SCOR offering, an issuer must reasonably believe that the aggregate amount of securities sold to any investor by one or more issuers offering or selling securities under a SCOR offering during the twelve-month period preceding the date of sale, together with the securities sold by the issuer to the investor, does not exceed:
    1. The greater of $2,000 or 5% of the lesser of the investor’s annual income or net worth if either the investor’s annual income or net worth is less than $100,000; or
    2. 10% of the lesser of the investor’s annual income or net worth, not to exceed an amount sold of $100,000, if both the investor’s annual income and net worth are equal to or more than $100,000.
  • Sales Reporting Requirement:  The proposed updates incorporate a sales reporting requirement similar to that contained in intrastate crowdfunding laws and federal Regulation Crowdfunding, which would require an issuer to file a sales report no later than 30 days after the termination or completion of an offering or, if the offering has not been terminated or completed within 12 months, file a sales report containing the information required in Section VIIIA for the initial 12 months.
  • Ongoing Reporting Obligations:  The proposed updates incorporate ongoing reporting requirements based on those required under Regulation Crowdfunding.  An issuer would be subject to the ongoing reporting requirements until the earlier of (1) the securities issued in connection with the SCOR offering are no longer outstanding or (2) the issuer liquidates or dissolves its business.
  • Review Standards:  The proposed updates include a new provision related to review standards and, unlike the proposed updates set forth above, is optional.  In jurisdictions that choose to adopt this provision, offerings will be reviewed for disclosure and for compliance with applicable Statements of Policy with certain modifications incorporated from NASAA’s Coordinated Review Protocol for Regulation A offerings.  Specifically, (1) the Statement of Policy Regarding Promoters’ Equity Investment will not apply and (2) the Statement of Policy Regarding Promotional Shares will apply except that one-half of any promotional shares required to be locked-in or escrowed may be released on the first and second anniversary of the date of completion of the offering, such that all shares may be released from lock-in or escrow by the second anniversary of the date of completion of the offering.

Changes to the SCOR Form (Form U-7) (last updated in 1999)

  • The proposed updates to the SCOR Form are meant to streamline the form by removing duplicative or unnecessary items and to make the form more user friendly.

Comments on the proposed updates to the SCOR Statement of Policy and SCOR Form are due by December 3, 2018.

Over the past year, proxy advisory firms, major index providers, and the SEC’s Investor Advisory Committee have weighed in on the growing number of companies with dual-share classes.  Today, 9% of the S&P 100 and 8% of the Russell 300 are comprised of companies with dual-class structures.  The Council of Institutional Investors has assembled and published a list of public companies with dual-class structures. During a recent program hosted at the Weinberg Center, titled “Snap Judgment: The Legal and Investment Issues Associated with Non-Voting Stock,” participants debated whether courts should step in and consider dual-class structures.

Traditionally, courts will defer to the business decisions of a company with independent directors that act in good faith having undertaken reasonable care.  However, some participants noted that the business judgment rule has been premised on the notion that stockholders could remove a board with which they disagreed.  In instances in which stockholders cannot hold boards of directors accountable by exercising voting rights, participants argued that it might be appropriate for courts to take on greater responsibility for shareholder protection through more active intervention.  Of course, it could be argued that stockholders could simply sell their securities.

The SEC’s Investor Advisory Committee made a number of recommendations to the Division of Corporation Finance, principally aimed at enhanced disclosure requirements, related to dual class structures.  Specifically, Committee recommends that the Division:

  • Require public companies that have dual class or other entrenching governance structures to prominently and clearly disclose: the numerical relationship between the amount of common equity or its equivalent economic beneficial ownership interest held by any person entitled to control or direct the voting of five percent or more of shares entitled to voting rights in the election of directors or the equivalent body (“ownership interests”), and the amount of voting rights held or controlled by such a person (“voting rights”), which the Committee refers to as “wedge” disclosure risks arising from the dual class structure and the inherent conflicts of interest; and risks arising from the exclusion of the stocks of companies with dual class structures from certain broad-based indices;
  • Monitor shareholder disputes arising out of non-traditional governance structures to identify trends, especially those arising from conflicts of interest; and
  • For issuers of non-voting stock, consider adding disclosure requirements to Form 10-K that would provide all information equivalent to that ordinarily included in a Schedule 14A, to the extent of the Commission’s authority.

In the meantime, the FTSE Russell is once again reviewing the inclusion of non-voting or minority voting shares in its indices.  Voting-based bans from index inclusion have generated some controversy with some, including SEC representatives, suggesting that governance by index rules may itself be problematic.