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Orange County Securities Law Blog

New Accredited Investor Verification Under 506(c) of Regulation D

Reasonable Steps to Verify Accredited Investor Status. Rule 506(c) of Regulation D as adopted contains both a general requirement that issuers take "reasonable steps" to verify that purchasers are accredited investors, as well as a non-exclusive list of methods that can be used to satisfy this requirement. As originally proposed, Rule 506(c) of Regulation D did not mandate a particular verification process or even identify a set of "safe harbor" procedures that would be deemed to be "reasonable." Instead, the proposing release identified certain factors that issuers would need to consider in determining whether their verification process is "reasonable." In the release adopting the final rules, the SEC retained the "principles-based" method of determining whether the verification steps taken by an issuer were reasonable, but supplemented it with four specific verification methods that will be deemed to constitute "reasonable steps" to verify a purchaser's status unless the issuer or its agent has knowledge that the particular purchaser is not an accredited investor. Under the "principles-based" method, the extent to which an issuer needs to verify the accredited investor status of a proposed purchaser is to be determined based on the facts and circumstances of the particular purchaser and transaction. The adopting release identifies the following as among the factors that an issuer should consider in determining whether the verification steps taken in any particular case were "reasonable." 

Why Some "Finders" May Not Be Keepers

Firms may regret their decision to hire finders that are not registered broker-dealers, or individuals that are not associated with registered broker-dealers, to connect them with potential investors. Section 15(a)(1) of the Securities and Exchange Act of 1934 states that non-registered persons who use any "instrumentality" to "induce" the purchase or sale of a security are unlawful.

It may seem a fine line between finding individuals or companies to purchase a security as opposed to actually selling the security. Courts will look at the following factors to determine whether the party is a seller and not just a finder:

  • The involvement the finder has with the negotiations of the security sale.
  • Discussing details and making recommendations.
  • Compensation based on the amount of securities sold, or other structures that appear to be more of a transactional compensation.
  • The finder's previous history with effecting security sales.

Changes in OTCQB Eligibility Standards

As an overview, an over-the-counter (OTC) equity security is generally considered to be any equity security that is not traded on a national securities exchange under the National Market System.

The OTC Markets Group ("OTC Markets") is a privately owned company that permits market participants to quote OTC equity securities and provides a public trading platform for around 10,000 U.S. and global securities.[1] OTC Markets offers three tiered marketplaces, which are summarized below[2]:

  • OTCQX: Companies must meet financial standards (including annual revenue of at least $2 Million and total assets of at least $2 Million), be current in providing disclosures to the market, and be sponsored by a professional third party advisor.
  • OTCQB: While companies must be current in periodic reporting requirements, there are no financial standards, so this marketplace includes many smaller or developing companies.
  • OTCPink: Companies may, but are not required to, make filings publicly available through the OTC Disclosure and News Service. No financial standards apply.

Curing Delinquent Securities Filings: The Super 10-K

During the aftermath of the great recession, many companies have become delinquent in their periodic quarterly ("10-Q") and annual ("10-K") securities filings because they could not raise enough capital to pay the multitude of professionals involved with their public company reporting. As manycommentators have noted, the Securities and Exchange Commission ("SEC") generally requires later filers to cure individual 10-Q's and 10-K's.

A delinquent filer can simply file all of the required Forms 10-Q and Forms 10-K and become current. However, this usually demands extraordinary fees and effort, particularly on the audit side.

Consequently, the SEC has established a method by which delinquent filers can request permission from the SEC's Office of Chief Accountant at the Division of Corporation Finance to combine several periods of Forms 10-Q and Forms 10-K into one report, commonly known as a "Super 10-K."

The SEC gives guidance regarding an accommodation request in Section 1320.4 of the Division of Corporation Finance's Financial Reporting Manual.

The Silent IPO: The "Not So Public" Initial Public Offering

The Jumpstart Our Business Startups Act ("JOBS Act") has created what is known as the Confidential Initial Public Offering ("IPO"), also referred to as the "quiet" or "silent" IPO.

As part of the JOBS Act, this option is available only to smaller companies called Emerging Growth Companies ("EGCs"). EGCs are companies that have annual revenues of $1 billion or less.

EGCs that qualify and choose to go public by means of a Confidential IPO can work with the SEC without being exposed to public scrutiny for a certain time period.

A company doing typical IPO has to file with the SEC several months before it conducts its roadshow and markets its shares, but an EGC pursuing a Confidential IPO only has to file three weeks before it conducts its roadshows.
When EGCs do file with the SEC, the registration drafts and correspondence can be kept private. Once public registration statements are filed, which are done with either type of IPO, the previously private documents are then attached as exhibits and can be viewed by the public.

Confidentiality Agreements Work!

n Florida a man ("Mr. Snay") sued his employer for age discrimination. They settled (like most lawsuits do), and pursuant to a confidentiality agreement the employer paid Mr. Snay $80,000.

Enter Mr. Snay's teenage daughter, who writes her 1,200 Facebook friends, stating "Mama and Papa Snay won the case against Gulliver. Gulliver is now officially paying for my vacation to Europe this summer. SUCK IT."

In finding that Mr. Snay had to disgorge the $80,000 settlement, the court stated that "Snay violated the agreement by doing exactly what he had promised not to do. His daughter then did precisely what the confidentiality agreement was designed to prevent."
Read more here

Dropbox v. Box: Is a Private Placement Better than an IPO?

Dropbox and Box are two rival cloud-storage companies that are raising large amounts of capital lately, but they are doing it in different ways under the securities laws. Success and failure in an emerging industry is often determined by which competitor has more cash. The big question is which company will emerge the strongest: the company that raised private capital or the one that raised public capital?

Dropbox filed a Form D with the SEC on February 24th, 2014, which indicated a private investment of approximately $325 million. A Form D is filed when a company is selling securities that is exempt from the normal securities in a transaction registration process.

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