SEC Approves Major New Rule Proposals for Smaller Public Companies

Greetings blogees: This morning I listened in to the SEC's webcast of an open hearing. As predicted, they approved a wide ranging set of rule proposals that positively affect smaller companies. The highlights:

1) Increasing the number of companies that can benefit from the scaled reporting system for smaller companies to those that have a public float of less than $75 million, increasing the number of companies benefiting from this from about 3500 to about 5000. They are also proposing to eliminate all the "SB" forms and separate disclosure system and put everyone back into the "S-K" system of Form 10-K, 10-Q, etc., but still having the scaled reporting and disclosure benefits.

2) Allowing Form S-3 "short form" primary registration (or shelf registration) for all reporting companies once a year for up to 20% of the company's public float in each 12 month period, so long as all filings with the SEC have been timely filed within the last year. This filing will not be available to a company that is a shell company or was one within the one year prior to the filing.

3) Allowing some limited advertising in private offerings for newly defined "qualified purchasers" with at least $2.5 million in investments or $400,000 annual income (or $600,000 income with a spouse). They are also looking to adjust the current Regulation D thresholds for "accredited investor" status for inflation starting in 2012. Form D now will be filed electronically as well, and the form will be redesigned.

4) Reducing the Rule 144 holding period from one year to six months. This period will be tolled, however, if the holder has a short or put equivalent position in the stock, but that tolling would not exceed a total of one year from acquiring the stock. Non-affiliates would be able to sell without volume or other limitations (similar to current Rule 144(k) which is two years) in that same six month period. They also propose eliminating the filing of Form 144 for non-affiliates, and allowing affiliates to file Form 4 (if they are Form 4 filers) in lieu of a Form 144.

The proposals were touted as streamlining regulation while also improving investor protection. The actual details of the written proposals will probably be available within about a week. If these are passed, they are very very significant improvements in the regulatory environment for those involved in small and microcap finance, PIPEs and reverse mergers. I will keep you informed. By the way, another record week for hits last week, thanks!!

Why Listen to Me? S-4 May Work After All

So.....we have done further research following our initial view that S-4 may not be an appropriate form to register shares to be issued in a reverse merger as a primary registration and method possibly to avoid the 415 concerns on a resale under certain circumstances.

Sometimes, well you just don't need to see the sausage getting made. In any event, we now believe that S-4 may indeed be an appropriate form (along with S-1 as also mentioned). We are waiting for some to give it a shot and see what happens. I expect that will happen pretty soon, as a number of my lawyer friends are talking about it.

Why did we have a different impression? Some had suggested the existence of a telephone interpretation which did not allow the resale of shares registered in an S-4 unless a resale registration was filed; this of course would trigger the 415 issue again. As it turns out, the telephone interpretation in question does not deal with this issue. It merely says you can't use S-4 to register already issued shares for resale. Thus, it does not apply to our hope to use S-4 for a primary registration of shares to be issued in a merger.

This is why I end of these legal discussions with "this is not legal advice"!

My Day on the Hill; SEC Will Propose Big Changes on May 23

1. Mr. Feldman Goes to Washington. On Tuesday, May 15, four of us met in the House Majority Leader's office with 7 congresspeople (and their staff) who serve on the financial services committee which is run by Barney Frank (he did not meet with us). This committee oversees the SEC. We talked about working to improve the attitude of some at the SEC with regard to smaller companies while recognizing the hard work of others to help small businesses (see item 2 below). We also spent some time talking about some current challenges in capital formation for small and microcap companies. While we talked about various possible legislative initiatives, it was clear no one is talking about any changes to Sarbanes-Oxley. We ended with pledges for further discussion, additional meetings, an ongoing dialogue, which is great and we thank the legislators for taking the time out of their busy day to join us. We even got a tour of the Capitol!

2. Big (Good) Changes a-Comin..The SEC just announced that on May 23 it is going to consider approving proposals, primarily coming out of the work of the SEC Advisory Committee on Smaller Public Companies (I was honored to testify before this committee as it was doing its work). In addition to some proposals that are intended to ease some of the burden under Section 404 of SOX, there are a number of small business initiatives (some of which happily follow recommendations I made to the committee). Below is the actual agenda from the SEC website:

"The Commission will consider a number of rule proposals addressing the registration and disclosure requirements for smaller companies, as well as private offerings of securities, including whether:

a) to propose amendments to increase the number of companies eligible for the scaled disclosure and reporting requirements for smaller reporting companies;

b) to propose amendments to expand the eligibility requirements of Form S-3 and Form F-3 to permit registration of primary offerings by companies with a public float of less than $75 million, subject to restrictions on the amount of securities sold in any one-year period;

c) to propose exemptions from the registration requirements of the Securities Exchange Act of 1934 for grants of compensatory employee stock options by non-reporting companies;

d) to propose a new Regulation D exemption for offers and sales of securities to a newly defined subset of "accredited investors," as well as to propose revisions to the Regulation D definition of "accredited investor," disqualification provisions, and integration safe harbor and to provide interpretive guidance regarding integration;

e) to propose revisions to Form D and mandate electronic filing of Form D; and

f) to propose amendments to Rule 144 to revise the holding period for the resale of restricted securities, simplify compliance for non-affiliates, revise the Form 144 filing thresholds, and codify certain staff interpretations, as well as to propose amendments to Rule 145."

This 144 change could be huge. If the current one year holding period before public sales can begin without registration is reduced (say to six months), much of the Rule 415 brouhaha will be ameliorated. Also I am hopeful that "codify certain staff interpretations" refers in part to Worm/Wulff and that they take a hard look at providing some relief to allow non-affiliate, non-promoters in shells the right to sell under Rule 144 at some point.

Looking forward to hearing more details, and I'll be back to you as soon as we hear.

Milestones

Dear blogees: It's that time of year, graduations, weddings, award dinners, reunions. From whence we came...

I'm lucky enough to be enjoying three amazing such things this season. First, a charity on whose board I have served for over 15 years, Youth Renewal Fund (www.youthrenewalfund.org), celebrated its 18th anniversary with an amazing dinner fundraiser at the NY Museum of Natural History. For you non-Jews, anything 18 is a meaningful number, so that was quite a feat, and we raised $1.3 million in one night.

Second, I'm here at the University of Pennsylvania this weekend celebrating my 25th college reunion. I'm on campus often as I am Chair Emeritus of the Wharton School's worldwide alumni association board, but this is a special weekend and many old friends are gathering for a great time. Having also attended law school at Penn, I have incredible memories of a very special time in my life, that my daughter, 17, will soon embark upon.

Which brings me to the third, but actually best, great thing. My daughter Sammi, who among other things in her spare time in high school runs her own charity, Kidzz4Kidzz, Inc. (www.kidzz4kidzz.org), had a special honor this week. Back in 5th grade, she received a special award as the most outstanding kid in her elementary school orchestra. She was presented the award by the then-11th grader who had won the award herself six years earlier. At the time we laughed at the notion of Sammi coming back in six years, and how far away that was. This week she came back, now the 11th grader, speech in hand (which she did not even use), to present the award to a 5th grader. She was beautiful and was wonderfully articulate, speaking from the heart about what music means to her and how it can bring people together. My wife and I (and her five-year old brother) are so proud of her we could just burst.

As in some prior posts, I am clearly off the RM message today. But the purpose, I suppose, is to remember, as we rush and do deals and run around the country, what's really important. Luckily I get to love not only what I do, but what I do when I'm not doing what I do. Great week to all.

A Shell or Not a Shell?

As discussed in my book, in its June 2005 rulemaking on reverse mergers, the SEC created a new defined term "shell company." Any company that is a shell company is subject to the enhanced disclosure requirements which were adopted in that rulemaking, including the "super 8-K" to be filed within four business days of closing a reverse merger with a shell including audited financial statements and prospectus-like disclosure about the merged company.

One big change adopted as part of all this was a "check the box" requirement on the cover of every periodic filing by every single public company, from General Motors to the smallest reporting company on the OTC Bulletin Board. Every company must indicate whether it is or is not a shell company.

Shell company was defined as any SEC reporting company that has no or nominal assets (other than cash) and no or nominal operations. At the time of proposing the rule, the SEC invited comment as to whether they should be more specific about what nominal means. One of the comments I provided was to request that indeed they provide more clarity on this. In the end, however, the staff did not change the language and felt that setting a threshold would encourage fraudsters to design things with $1 more, etc.

It was a little confusing to the market that another definition, "blank check company," was also in use by the SEC under Rule 419 adopted in 1992. A blank check is subject to numerous restrictions on its ability to register shares to become publicly tradable under the Securities Act of 1933, and is subject to the Worm/Wulff letters which do not allow shareholders to avail themselves of certain exemptions from registration such as Rule 144. Rule 419 defined blank check as a company with no business plan, or whose business plan is to acquire another business.

There are clearly companies that qualify as blank checks but not public shells, and vice versa. The shell definition, I believe, was intended to make life a little more difficult for questionable players putting small businesses into companies and taking them public claiming that they are not blank check companies. Under the new definition these tiny companies usually qualify as shell companies.

Indeed in the famous footnote 32 (see earlier posts) to the rulemaking, the SEC said they are targeting people that do an improper end around Rule 419's restrictions when they put a small business into a company to take it public but with an undisclosed intention to strip out the company upon a merger.

In my practice I have encountered a number of entities being marketed as shells but they do not "check the box." The control people of the shell generally claim they either have assets or operations that are not nominal. The question we constantly wrestle with is, what is nominal? If a public company obtains royalties from a license agreement, what is the agreement worth as an asset? If the company is engaged in research and development, how much spending is necessary for it not to be nominal? Does a company need revenues to avoid having nominal operations, or are expenses enough? What if the company is spending money on finding an acquisition? Does that constitute "operations"?

As we see, there are more questions than answers here. As indicated in my book, it seems that either assets (other than cash) or operations (whatever that means) in excess of $1 million is probably not nominal. Short of that, we have to apply a facts and circumstances analysis to the situation. If you are unsure, it never hurts to contact the SEC and see if they can provide general guidance based on your situation. Or hire me to help!

Have a great week all.