At the Practising Law Institute’s Annual Institute on Securities Regulation, a number of updates were provided by the Staff regarding ongoing initiatives within the Office of Small Business.  The Staff reviewed the recently adopted amendments to the definition of “smaller reporting company” (SRC) and directed practitioners to its Small Entity Compliance Guide.  The Staff also noted that a number of Compliance & Disclosure Interpretations were recently updated to address changes brought about by the SRC amendments.  The C&DIs also were recently reorganized and are now grouped by category, making these much easier to navigate.  Below, we highlight a few of the C&DIs relating to SRC status:

Question 104.13
Question: An issuer files its 2019 Form 10-K using the disclosure permitted for smaller reporting companies under Regulation S-K. The cover page of the Form 10-K indicates that the issuer will no longer qualify to use the smaller reporting company disclosure for 2020 because its public float exceeded $250 million at the end of its second fiscal quarter in 2019. The issuer proposes to rely on General Instruction G(3) to incorporate by reference executive compensation and other disclosure required by Part III of Form 10-K into the 2019 Form 10-K from its definitive proxy statement to be filed not later than 120 days after its 2019 fiscal year end. May the issuer use smaller reporting company disclosure in this proxy statement, even though it does not qualify to use smaller reporting company disclosure for 2020?

Answer: Yes, because the issuer could have used the smaller reporting company disclosure for Part III of its 2019 Form 10-K if it had not used General Instruction G(3) to incorporate that information by reference from the definitive proxy statement. [November 7, 2018]

Question 102.01
Question: Could a company with a fiscal year ended December 31, 2018 be both a “smaller reporting company,” as defined in Item 10(f), and an “accelerated filer,” as defined in Rule 12b-2 under the Exchange Act, for filings due in 2019, if it was an accelerated filer with respect to filings due in 2018 and had a public float of $80 million on the last business day of its second fiscal quarter of 2018?

Answer: Yes. A company must look to the definitions of “smaller reporting company” and “accelerated filer” to determine if it qualifies as a smaller reporting company and non-accelerated filer for each year. This company will qualify as a smaller reporting company for filings due in 2019 because on the last business day of its second fiscal quarter of 2018 it had a public float below $250 million. However, because the company was an accelerated filer with respect to filings due in 2018, it is required to have less than $50 million in public float on the last business day of its second fiscal quarter in 2018 to exit accelerated filer status for filings due in 2019, as provided in paragraph (3)(ii) of the definition of “accelerated filer” in Rule 12b-2. This company had a public float of $80 million on the last business day of its second fiscal quarter of 2018, and therefore is unable to transition to non-accelerated filer status. As this example illustrates, a company can be both an accelerated filer and a smaller reporting company at the same time. Such a company may use the scaled disclosure rules for smaller reporting companies in its annual report on Form 10-K, but the report is due 75 days after the end of its fiscal year and must include the Sarbanes-Oxley Section 404 auditor attestation report described in Item 308(b) of Regulation S-K. [November 7, 2018]

Question 102.02
Question: Will a company that does not qualify as a smaller reporting company for filings due in a particular year be able to qualify as a smaller reporting company if its public float or annual revenues later decrease?

Answer: Once a reporting company determines that it does not qualify as a smaller reporting company, it will remain unqualified unless when making a subsequent annual determination either:

  • It determines that its public float is less than $200 million; or
  • It determines that:
    • for any threshold that it previously exceeded, it is below the subsequent annual determination threshold (public float of less than $560 million and annual revenues of less than $80 million); and
    • for any threshold that it previously met, it remains below the initial determination threshold (public float of less than $700 million or no public float and annual revenues of less than $100 million). See Amendments to the Smaller Reporting Company Definition – Compliance Guide for more information.

Example: A company has a December 31 fiscal year end. Its public float as of June 28, 2019 was $710 million and its annual revenues for the fiscal year ended December 31, 2018 were $90 million. It therefore does not qualify as a smaller reporting company. At the next determination date, June 30, 2020, it will remain unqualified unless it determines that its public float as of June 30, 2020 was less than $560 million and its annual revenues for the fiscal year ended December 31, 2019 remained less than $100 million. [November 7, 2018]

The Staff also provided some insights regarding reliance on exempt offering alternatives.  For the twelve months ended June 30, 2018, approximately $1.2 trillion was raised in Rule 506 offerings, of which nearly 97% was raised in reliance on Rule 506(b) offerings.  Most of this was attributable to offerings by funds, although operating company offerings accounted for approximately $175 billion.  The Staff has noted a slow but steady increase in the number of Rule 506(c) transactions.  Regulation A offering activity also has been robust.  For the three years from effectiveness of the amendments to Regulation A through September 30, 2018, there were 257 offerings qualified and nearly $1.3 billion raised in Regulation A offerings.  Real estate and REIT offerings account for the largest percentage of these transactions.  The Staff noted it is currently working on recommendations in order to implement the rulemaking mandate to make Regulation A available to reporting companies.  Finally, the Staff also is working on a review of exempt offering alternatives that would, among other things, seek to harmonize the requirements for various offering exemptions.

 

On September 6, 2018, House Committee on Financial Services Chairman Jeb Hensarling and Representative John Delaney released a discussion draft of the Bipartisan Housing Finance Reform Act (the “Act”).  The Act would require eligible private credit enhancers (as approved by the Federal Housing Finance Agency, “PCEs”) to engage in approved credit risk transfer transactions.  PCEs would be new entities in the secondary mortgage market that would be required to provide eligible private insurance for conventional mortgage loans financed through Ginnie Mae.  In order to encourage investment in the credit risk transfer securities issued by the PCEs, the Act would expand the current Section 3(c)(5)(C) exemption to include all risk-sharing transactions and the investment in any other products created pursuant to the Act with an aim of diversifying risk away from the current government housing finance system.

The current Section 3(c)(5)(C) exemption generally excludes from the definition of “investment company” any entity primarily engaged in, among other things, purchasing or otherwise acquiring mortgages and other interests in real estate.  In order to qualify for this exemption, a mortgage REIT must comply with strict asset tests, including having at least 55 percent of its assets consist of mortgages and other liens on, or interests in, real estate that are the functional equivalent of mortgage loans, referred to as “qualifying assets,” and at least 80 percent of its assets consist of qualifying assets and real estate-related assets.  The Act would expand the exemption’s qualifying asset definition to expressly include any financial instrument that transfers credit risk on mortgage loans.

Neither Chairman Hensarling nor Representative Delaney is planning to run for re-election to Congress in 2018.  We will continue to track the progress of the draft Act as it is considered by the House Committee on Financial Services.

A summary of the draft Act is available here.

 

A paper titled, “The Impact of Exchange Listing on Corporate Governance Evidence from Direct Listing,” written by Dan French, Andrew Kern, Thibaut Morillon, and Adam Yore, considers the impact on corporate governance policies attributable to the listing of a class of securities on a national securities exchange.  The authors focus on direct listings and challenge the notion that companies that undertake direct listings may not adopt investor protections and governance practices due to the absence of underwriters that typically act as gatekeepers.  The authors examine public non-listed REITs that undertake a listing, or “transitioning REITs.”  By doing so, the authors attempt to demonstrate the value of a listing without an offering, or a direct listing.  The authors consider various data points, including board size, board independence, nominating and compensation committee independence, etc., in order to draw comparisons between public non-listed REITs and transitioning REITs.  Transitioning REITs even before listing on a securities exchange already meet many of the governance standards of the securities exchanges.  This suggests that the REITs that undertake direct listings already have characteristics associated with public companies.  In addition, once listed on exchanges they ave significant institutional stockholders, and this serves to reinforce the heightened governance standards.  The authors conclude that even without the benefits of the traditional IPO process, companies that undertake direct listings have comparable governance standards.  The authors note that “changes in corporate governance occur gradually through time as opposed to abruptly just after the listing event.”

On January 1, 2018, a European Union law regulating packaged retail insurance-based investment products (“PRIIPs”) went into effect targeting securities offered to retail investors by investment funds.  If a security is considered a PRIIP, the issuer is required to publish a strictly regulated key information document (“KID”) that must be continuously updated during the distribution of the security.  The liability for the content of the KID is assumed by the issuer by operation of law.  The broadly drafted regulation has the potential to impact the ability of investors to purchase securities issued by U.S. exchange-listed real estate investment trusts (“REITs”).  To determine whether the securities of a particular REIT should be considered PRIIPs and thereby subject to the regulation, all relevant operational facts and characteristics of the REIT must be reviewed in an analysis similar to the undertaking by REITs at the time the Alternative Investment Fund Managers Directive (“AIFMD”) was implemented throughout the European Union.  Securities are considered PRIIPs if the amount repayable to the retail investor is subject to: (i) fluctuation because of exposure to reference values or (ii) the performance of one or more assets that are not directly purchased by the retail investor.  Securities issued by REITs that are structured as alternative investment funds under AIFMD are considered PRIIPs.