The Lebrecht Group, APLC

Update 8/16/10:  I completed a corporate action last week.  While FINRA asked me for a very large amount of supporting documentation, for the pending transaction as well as historical transactions leading up to the pending transaction, they eventually cleared my action in the timeframe requested.   DTC also reviewed the transaction in great detail and eventually agreed not to touch the issuers eligibility.  These situations will be scrutinized on a case-by-case basis, and good supporting documentation is key.

 

In December 2009, FINRA asked the SEC for discretionary power in approving (or disapproving) certain corporate actions for OTC securities.  Their request was granted, and the result is new FINRA Rule 6490.  The SEC Release can be read here.  The types of corporate actions covered include name changes, stock splits, and symbol changes covered by Rule 10b-17.

The new rule outlines five factors that FINRA can consider in determining whether a request to process documentation is deficient: (1) FINRA staff reasonably believes the forms and all supporting documentation, in whole or in part, may not be complete, accurate or with proper authority; (2) the issuer is not current in its reporting obligations, if applicable, to the Commission or other regulatory authority; (3) FINRA has actual knowledge that parties related to the Company-Related Action are the subject of pending, adjudicated or settled regulatory action or investigation by a regulatory body, or civil or criminal action related to fraud or securities laws violations; (4) a government authority or regulator has provided information to FINRA, or FINRA has actual knowledge, indicating that persons related to the Company-Related Action may be potentially involved in fraudulent activities related to the securities market and/or pose a threat to public investors; and/or (5) there is significant uncertainty in the settlement and clearance process for the security.

The new rule also creates a fee schedule, ranging from $200 for a timely request for one of these corporate actions, to $4,000 to appeal a denial by FINRA. 

We have not tested this new rule yet, so we are interested to see how far FINRA intends to take its new discretionary authority.  In the back of my mind, I have a more theoretical legal question looming, and that is this:  if an issuer is not a reporting issuer under the '34 Act, and is not subject to any specific trading-exchange requirements regarding its corporate actions, and the corporate action is approved by all necessary state corporate law actions, what authority does FINRA have over the issuer?  Can FINRA block a corporate action that was validly taken in accordance with state law, such as a name change and stock split?  Given that broker-dealers decide if and when an issuer's stock is traded over-the-counter (to the extent that some issuers may not even be aware that their stock trades over-the-counter), if the action was valid, and completed, and FINRA doesn't recognize it, what value are they adding to their constituency ,the broker-dealer community?

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Finally.  After a journey that would make Schoolhouse Rock proud, President Obama signed the Dodd-Frank Financial Reform and Consumer Protection Act into law giving small public companies (those with a market capitalization under $75 million) a permanent exemption from the auditor attestation requirements of Section 404(b) of Sarbanes-Oxley.  Rarely does something that appeared to be such a long shot nine months ago, actually happen, much less something that is good for the impacted companies and investors.  Stay tuned for information on other provisions of the new law that impact small public companies.
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In this blog, on June 24, 2010, I wrote about the financial reform bill and how the House/Senate reconciliation subcommittees were hammering out differences between the House and Senate version of the financial reform bill, including the determination as to whether the final bill to be put before the House, Senate and President will contain a permanent exemption from Sarbanes-Oxley Section 404(b)'s auditor attestation requirement for small public companies (those with a market capitalization under $75 million).  On June 30, 2010, the House approved the reconciled version of the bill - and it includes the permanent exemption! The next step is approval by the Senate of the reconciled financial reform bill.  Assuming that happens, as most believe it will, then the bill moves to the President for signature, also expected to occur.  Assuming these two things happen (currently on track for about a week to 10 days from now, despite the committee's original intent to present the bill before the 4th of July weekend), then the permanent exemption from 404(b) for small public companies would be law.  But, given the history of this exemption, I won't blame anyone for not wanting to count the chickens before they hatch.  Check back here for the latest updates.
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On Monday, June 28, 2010, the U.S. Supreme Court released its long-awaited decision in Free Enterprise Fund, et al. v. Public Company Accounting Oversight Board.  I wrote a more detailed article about the case here.  The decision was, well, anti-climactic.  The entire decision can be read here, but in summary the Court decided that the President should have the ability to remove PCOAB Board members, who are appointed by the SEC, with or without cause.  Previously, the President could remove Board members only for cause.

While the case raised important constitutional law issues, the decision will have little impact on the way the PCAOB operates and did not invalidate the Sarbanes-Oxley Act in any way.  Both sides are claiming victory.  As an interesting side note, the case was argued back in December 2009 on behalf of the U.S. government by Supreme Court nominee Elena Kagan, whose confirmation hearings started the same day that this decision was released.

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No, not the big purple dinosaur, in this case its Barney Frank (although some may argue the difference, that is not the topic here), but more on Mr. Frank in a minute.  Back in March this year I wrote an article updating the status of Section 404(b) of Sarbanes-Oxley as it applies to small public companies.  As a reminder, Rule 404(b) requires ’34 Act reporting companies to get an attestation from their independent auditors regarding the effectiveness of the company’s internal control over financial reporting.   Without reciting the entire article (you can read it here:  http://www.thelebrechtgroup.com/index.php/publications/tlg-publications/184-smaller-reporting-companies-and-section-404b-where-are-we) the article discussed the U.S. House Financial Services Committee’s vote to approve the “Investor Protection Act of 2009” in November 2009, which if approved by Congress and signed by the President would provide a permanent exemption from Section 404(b) for small public companies (those with less than $75 million in market capitalization).  In that article I concluded, despite my belief that 404(b) was a terrible burden and any benefits not worth the costs for smaller public companies, that I did not believe there was sufficient time for Congress to act the President to sign a bill exempting small public companies from 404(b) before they would be forced to comply (fiscal years after June 15, 2010).  However, much to my surprise, my conclusion may have been completely wrong.  In May 2010, the Senate passed a version of the Investor Protection Act that did not include a permanent exemption from 404(b) for small public companies.  That is obviously not the part that might make my conclusion in the article incorrect.  However, currently a House subcommittee and Senate subcommittee are meeting to hammer out the differences between their two versions of the Investor Protection Act to try and get something in front of the President to sign (allegedly by July 4, 2010).  Most believe the bill will pass, the big question is what provisions will make the final bill?   This brings us back to Barney and friends.  While it is anyone’s guess as to whether the final bill will include the 404(b) exemption for small public companies, the best indication as to whether it will has come from Barney Frank.  Mr. Frank, the chairman of the House Financial Services Committee, recently stated that he expected the final version of the bill will contain the permanent exemption.  If Mr. Frank, a regular critic of Wall Street, believes the permanent exemption will be in the final version of the bill, then I believe there is hope for small public companies.  While companies should move forward with putting 404(b) compliance measures in place until word that the permanent exemption is signed into law.  Keep a close eye to this blog and/or our newsletter, The Isolated Offering, for the latest developments. 
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      On May 17, 2010, the SEC denied a No-Action request from a Virginia law firm to be exempt as a finder from the registration requirements of a broker-dealer.  The letter can be read here.

      The law firm wanted to act as a finder so that it could help one of its clients find investors in a private placement.  The law firm proposed to have a very limited role in the private placement, but did propose to be paid a transaction-based fee tied to successful investments by investors introduced by the law firm.  This is where the SEC took issue, stating "[t]he staff believes that the receipt of compensation directly tied to successful investments in [the client's] securites by investors introduced by [the law firm] would give [the law firm] a 'salesman's stake' in the proposed transactions and would create the heightened incentive for [the law firm] to engage in sales efforts.  Accordingly, the staff believes that [the law firm's] proposed activities would require broker-dealer registration."

      This is a more restrictive position than that historically taken by the SEC.  Historically, the SEC has looked at a variety of factors, including whether the finder was involved in the negotiations, solicited investors, made recommendations to prospective investors, and the frequency of the finder's involvement in the sale of securities.  But in this no-action denial, the SEC focused squarerly on transaction-based compensation.

      While there has been a variety of recommendations for the SEC and/or individual states to regulate finders at a lower level than broker-dealers, at this time the SEC is not considering any formal actions to exempt finders.

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As most public company officers and directors are aware, forward-looking statements made in a company’s public filings are protected by certain safe harbor provisions.  The rule is that the statements are protected if the forward-looking statements are: (i) accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement;” (ii) is immaterial; or (iii) a plaintiff fails to prove that the statement was made with actual knowledge the statement was false or misleading.  In most companies’ filings they rely on a combination of all three of these factors for protection in making forward looking statements related to their business.   

A recent court case decision (Slayton v. American Express Company et al., No. 08-5442-cv (2d Cir. 2010)), has shed some light on how these factors are reviewed by courts in determining if the forward-looking statements are protected by the safe harbor.  Although the decision discusses all three factors, the most pertinent part of this decision for our purposes relates to the first factor - what should be contained in a company’s cautionary statement.  This is likely due to the fact that if the forward-looking statement is either immaterial or is made with the knowledge the statement is false, then other factors are at play, either irrelevant statements are being made (immateriality) or the statements are fraudulent (knowingly making a statement that is false), and the company’s disclosure should be modified to ensure these two factors are not in play.   

Regarding the first factor, the court makes clear that the forward-looking statement disclaimer protection will not apply unless the language contained therein is specifically tailored to the risks involved based on the forward-looking statements being made.  Based on this decision, now is a good time for companies to review their forward-looking statement disclaimer to ensure the disclaimer is not merely boilerplate language that is repeated in each filing period after period, as the court makes clear that such boilerplate disclaimers, in the face of changing factual situations and forward-looking statements, will not provide protection for the statements.  The other two prongs will still be available to protect such statements, but companies should use all that is available to them to protect such statements.  Therefore, make sure you review your disclaimers with your legal counsel in conjunction with your next public filing that contains forward-looking statements.

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Back in September 2009, I blogged on the impact of the SEC's enforcement action against Moore & Associates Chartered, and more specifically, the impact on issuers who were relying on Audit Reports issued by Moore.  You can read that blog here.

Last week, I sat in on a webinar about the PCAOB's inspection and enforcement programs.  You can watch an archive of the webinar here.And I have to tell you, it scared me a little.  Not because auditors were being inspected, or that enforcement actions were being brought against unscrupulous auditors.  Those things are, of course, good for the industry.  I couldn't help but continue to think about the impact on one of our issuers if their independent auditor was the subject of a PCAOB enforcement action. 

First, the cost to the auditing firm is tremendous.  This can result in distractions, reduced staffing, and an overall degredation in the level of service to the issuer.  Some audit firms will have an insurance policy that covers this type of enforcement action, which might be short term relief until the renewal cost comes on that policy and is passed on to the issuer.

Second, the reputation of the issuer, and specifically of the issuers financial statements, might be brought into question by investors.  This could cause a financing transaction to be cancelled, or the cost of financing to increase.

Third, and most dramatically, the financial statements filed by the issuer with the SEC could be deemed to be unreliable.  This triggers an immediate 8-K filing, and potentially renders the issuer out of compliance with its reporting obligations under the Securities Exchange Act.

The impact that a PCAOB enforcement action has on the issuer raises the question.  Are these enforcement actions helping, or hurting investors?  The PCAOB's Mission Statement says they are to, among other things, "protect the interests of investors."  Are they doing so by bringing an enforcement action against an auditor that is extremely expensive and potentially damaging to the issuer? 

As a result of these and other potential risks, you should periodically check up on your auditor.  You can read the PCAOB's inspection reports on their website.  Don't be afraid to start an open dialogue with your auditor about their standing with the PCAOB.

Finally, I have blogged several times about the United States Supreme Court's still-pending case questioning whether the PCAOB is constitutional.   Again, I raise the question, or they doing more harm than good?

 

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In the course of networking locally here in Orange County, CA I have recently been introduced to numerous local banks that specialize in offering small business loans guaranteed by the U.S. Small Business Association (SBA Loans).  According to many of these employees of these banks the opportunities for small businesses to get approved for an SBA Loan have greatly increased over the last six or so months, especially in the range up to $1,000,000, showing vast improvement over one year ago during the massive credit crisis.  However, I have not personally heard of any small companies that have successfully been approved for an SBA Loan, but I thought that was maybe just a coincidence with the companies I have come across.  However, last week I had the opportunity to present at the SEC Roundtable Series sponsored by Haskell & White, LLP.  The topic was “Structuring Your Next Capital Raise” and most of the attendees were public companies interested in learning more about alternate financing methods, such as PIPES, equity lines, and registered direct offerings.  Since this topic will be the subject of an upcoming article in our monthly newsletter, The Isolated Offering, I will not recite the entire topic here, but wanted to touch on one important point.   In speaking with the attendees at the SEC Roundtable Series it became apparent that many of these smaller, public companies, which were not ones I had met with previously, were also not meeting the lending requirements for an SBA Loan (hence their interest in alternative financing methods).  I am not sure where the disconnect is occurring between those working for banks who believe that SBA loans are increasing and many companies are qualifying, versus the 30+ smaller private and public companies I have spoken with recently that believe the access to conventional lending remains closed to them and is evidenced by their inability to qualify for an SBA Loan.  I plan to continue to look into this issue and will report back here.  In the meantime, keep a lookout for the Structuring Your Next Capital Raise article that will be in an upcoming issue of The Isolated Offering.

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