Recently, in connection with the Securities and Exchange Commission’s consideration of proposed amendments to the definition of “smaller reporting company,” the Commission had an opportunity to consider including in the adopting release an exemption from the Section 404(b) auditor attestation.  The Commission deferred a decision on the Section 404(b) auditor attestation.  A number of the Commissioners noted that it would be helpful to have the benefit of statistical data regarding the costs associated with the Section 404(b) process and observed that the commenters on the SRC amendments proposed a few years ago included anecdotal commentary on the burdens imposed by Section 404(b) auditor attestation requirements.  Congress also has considered a number of legislative measures that would provide for exemptions for different issuers from the Section 404(b) auditor attestation requirement.  For example, one measure would provide an exemption for low revenue issuers.  A different legislative proposal would extend the period during which emerging growth issuers are exempt from the requirement from five years to ten years.  Against this backdrop, authors Weili Ge, Allison Koester, and Sarah McVay attempt to quantify the benefits and costs of exempting smaller firms from the auditor attestation requirements and under Section 404(b).  In a paper titled “Benefits and Costs of Sarbanes-Oxley Section 404(b) Exemption:  Evidence from Small Firms’ Internal Control Disclosures,” the authors compare the relative increase in audit fees of exempt firms and non-exempt firms from 2003 to 2014.  The authors quantify the benefit of the exemption as a savings of $388 million in Section 404(b)-related audit fee savings for the 5,302 exempt firms sampled.  The authors then consider internal control misreporting, which critics of the exemption point to as the principal concern.  The authors conclude approximately 9.3 percent of the exempt firms that disclose effective internal controls actually have ineffective internal controls.  These are, according the authors, evidence of misreporting.  Section 404(b) compliance lowers misreporting of internal controls from 9.3 percent to 5.8 percent.  The authors also assess the costs of internal control misreporting attributed to the Section 404(b) exemption, lower operating performance due to non-remediation and market values that fail to reflect a firm’s underlying internal control status by looking at changes in future earnings and future stock returns for suspected internal control misreporting.  The authors estimate that the costs of a Section 404(b) exemption for suspected internal control misreporting as $719 million in lower operating performance due to non-remediation and $935 million delay in aggregate market value decline due to the failure to disclose ineffective internal controls.

Time and technology often conspire to make our existing views and approaches seem dated. It’s inevitable, and such is the case with the regulations that address permissible communications by issuers. The securities laws regulating communications by issuers have not undergone many revisions since Securities Offering Reform in 2005 despite the fact that the ways in which issuers communicate with investors and in which investors access information have undergone significant change. The Securities and Exchange Commission (SEC, or the Commission) now is required to propose rules relating to the application of the communications safe harbors under Securities Act Rules 138 and 139 in relation to certain funds. The dialogue relating to measures that may promote capital formation, without sacrificing investor protections, has prompted the Commission to consider extending the ability to “test the waters,” made available by the Jumpstart Our Business Startups (JOBS) Act to emerging growth companies (EGCs), to all companies. While the Commission certainly could limit its rulemaking to acting on these specific matters, it would seem an opportune time for the Commission to undertake a more comprehensive review of all of the communications safe harbors contained in the Securities Act.

Partner Anna Pinedo discusses some of the communications safe harbors that may benefit from amendment in a recently published PLI Current article.

The Securities and Exchange Commission recently published guidance providing some useful clarifications related to the Commission’s recent changes to the definition of “smaller reporting company” (see our prior posts, here and here).  In the guidance, the Commission confirms that foreign issuers can qualify as SRCs; however, investment companies (including BDCs), ABS issuers and majority-owned subsidiaries of non-SRC parent companies cannot. The new definition of SRC becomes effective on September 10, 2018.

Assessing SRC Status.  A company assesses whether it qualifies as an SRC annually as of the last business day of its second fiscal quarter.  If it qualifies as an SRC on that date, it may elect to use the SRC scaled disclosure accommodations in its subsequent filings, beginning with its second quarter Form 10-Q.  A company must reflect its SRC status in its Form 10-Q for the first fiscal quarter of the next year.  Reporting companies calculate their public float annually as of the last business day of their second fiscal quarter. A reporting company that does not qualify under the “public float” test would determine whether it qualifies as an SRC based on its annual revenues in its most recent fiscal year completed before the last business day of the second fiscal quarter.

Assessing SRC Status in connection with Initial Registration Statement.  A company filing its initial registration statement for shares of common equity will make its initial SRC determination in connection with the filing of its registration statement.  Public float is measured as of a date within 30 days of the date of the filing of the registration statement and is computed by multiplying the aggregate worldwide number of shares of voting and non-voting common equity held by non-affiliates before the registration plus, in the case of a Securities Act registration statement, the number of shares of voting and non-voting common equity included in the registration statement by the estimated public offering price of the shares.  In the case of a determination based on an initial Securities Act registration statement, a company that determined it was not an SRC has the option to re-determine its status under the “public float” test at the conclusion of the offering covered by the registration statement based on the actual offering price and number of shares sold.  A company filing its initial registration statement for common equity that does not qualify under the “public float” test would determine whether it qualifies as an SRC based on its annual revenues in its most recent audited financial statements available on the initial public float calculation date.

Changes in Float/Revenue and Qualification as an SRCThe Commission provides a chart showing how a company can transition and qualify as an SRC depending on changes in its float and/or revenues.

Transitioning to the Amended SRC Definition.  For purposes of the first determination of SRC status after September 10, 2018, a company will qualify as an SRC if it meets the initial qualification thresholds in the revised definition as of the date it is required to measure its public float and, if applicable, had annual revenues of less than $100 million in its most recently completed fiscal year, even if such company previously did not qualify as an SRC.  A company that completed its initial public offering since the end of its most recent second fiscal quarter may elect to determine whether it qualifies as an SRC based on its public float as of the date it estimated its public float prior to filing or as of the conclusion of the offering based on the actual offering price and number of shares sold.  A company newly qualifying as an SRC under the amended definition after September 10, 2018, regardless of whether it qualified under the previous definition, has the option to use the SRC scaled disclosure accommodations in its next periodic or current report due after September 10, 2018, or, for transactional filings without a due date, in filings or amended filings made on or after September 10, 2018.

See the full guidance, including the charts, here.

Neal Newman assesses the success of Regulation A in a paper titled, “Regulation A+:  New and Improved after the JOBS Act or a Failed Revival?”  The author reviews the 267 Regulation A filings made between August 13, 2012 and May 24, 2016 and samples a subset of 48 filings from this period.  Of the sample, 19 were Tier 1 filings (39.6 percent) and 29 were Tier 2 filings (60.4 percent).  For the Tier 1 filings in the sample set, the average minimum offering amount was $829,861 and the average maximum amount was $17,677,397.  Average total assets over the sample were $6,215,061.  Based on the Tier 1 offerings in the sample, the author concludes that very few of the filers sought to raise the maximum $20 million permitted under Tier 1 and few of the Tier 1 issuers were of a size to need $20 million in capital.  It took, on average, 375 days to get qualified.  By contrast, for the Tier 2 offerings in the sample set, the average maximum was just over $23 million.  On average, these Tier 2 offerings took 120 days to be qualified.  Based on the author’s assessment, he notes that the only persuasive rationale for relying on Regulation A rather than on Regulation D would be the ability to sell securities to non-accredited investors.  The author supplemented his quantitative analysis with interviews of issuers that undertook Regulation A offerings.  Contrary to the author’s expectations, the companies that undertook Regulation A offerings were pleased with their financing approach despite the ongoing reporting requirements and the time (and expense) associated with the Regulation A offerings.  The author concludes with a cautionary example, citing an early Regulation A issuer that since has failed to achieve profitability.

Wednesday, August 15, 2018
1:00 p.m. – 2:00 p.m. EDT

PIPE transactions remain an important capital-raising alternative. Whether a public company is seeking to finance an acquisition, effect a recapitalization or restructuring, or facilitate a liquidity opportunity for an existing stockholder, a PIPE transaction may be the most efficient approach.

During this session, Partner Anna Pinedo will discuss:

  • Recent market trends;
  • PIPE documentation and the principal negotiating issues;
  • The securities exchange shareholder approval rules and proposed changes to such rules;
  • Using warrants and structuring approaches;
  • Acquisition-related PIPE transactions; and
  • Selling stockholder PIPE transactions.

For more information, or to register for this complimentary session, please visit the event website.