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CROSS BORDER SECURITIES UPDATE
March 2006
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32
Recommendations to Ease Regulatory Burden of MicroCap and SmallCap Companies
in the
US
Psst… Have you heard about the Securities and Exchange
Commission (“SEC”)
Advisory Committee on Smaller Public Companies (“SmallCap
Committee”)? If you are a reporting issuer under the US Securities
Act of 1933 (the “Act”) you may want educate yourself about
the SmallCap Committee and more importantly weigh in on its proposed
recommendations to the SEC. The changes they are recommending could have a
significant impact on your future as a reporting issuer in the US.
In March 2005, the SEC established the SmallCap
Committee to look at the impact of the Sarbanes-Oxley Act of 2002 (“SOX”),
and federal securities laws in general on smaller public companies. On
September 21, 2005, the SEC adopted two of the recommendations the SmallCap
Committee proposed to the SEC regarding microcap and smallcap companies on an
expedited basis:
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(1) postponing for one year the date for non-accelerated
filers to begin complying with section 404 of SOX, and (2) amending the
periodic filing deadlines of non-accelerated filers.
On February 28, 2006, the SmallCap Committee issued a
draft of its
final report for public comment. The draft report contains
thirty-two recommendations. The
149-page report includes parts on scaling securities regulation for
smaller companies, accounting standards, and internal control over financial
reporting. Comments will be received until April 3, 2006 and you may want to
voice your support. To date the report has received some high profile
opposition from the big four accounting firms and former top officials of the
SEC and Federal Reserve.
The SmallCap Committee Recommendations
The recommendations are divided into four categories and
are as follows:
I. Scaling of the Securities Regulation to Size
of Issuer
1.
Establish a new system of scaled or proportional securities regulation
for smaller public companies using the following six determinants to define a
“smaller public company”:
- the total market capitalization of the company;
- a measurement metric that facilitates scaling of
regulation;
- a measurement metric that is self-calibrating;
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- a standardized measurement and methodology for
computing market capitalization;
- a date for determining total market capitalization;
and
- clear and firm transition rules, i.e., small to large
and large to small.
Regulation should be
proportional to the size of the company. “Microcap companies” (those
companies with under $128 million in capitalization) and “smallcap
companies” (those companies with over $128 million and under $787 million in
market capitalization) because their equity market capitalization should not
be treated the same as larger companies and should be considered for scaled or proportional regulation.
II. Internal Control over Financial Reporting
2.
Unless and until a framework for assessing internal control over
financial reporting for such companies is developed that recognizes their
characteristics and needs, provide exemptive relief from Section 404
requirements to microcap companies with less than $125 million in annual
revenue and to smallcap companies with less than $10 million in annual
product revenue that have or expand their corporate governance controls that
include:
a.
adherence to standards relating to audit committees in conformity with
Rule 10A-3 under the Exchange Act;
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32 Recommendations to
Ease Regulatory Burden of MicroCap and SmallCap Companies in the US
(continued)
b.
adoption of a code of ethics within the meaning of Item 406 of
Regulation SK applicable to all directors, officers and employees and
compliance with the further obligations under Item 406(c) relating to the
disclosure of the code of ethics; and
c.
design and maintenance of effective internal controls over financial
reporting.
In addition, as part of this
recommendation, the SmallCap Committee recommended that the SEC confirm, and
if necessary clarify, the application to all microcap companies, and indeed
to all smallcap companies also, of the existing general legal requirements
regarding internal controls, including the requirement that companies
maintain a system of effective internal control over financial reporting,
disclose modifications to internal control over financial reporting and their
material consequences and apply CEO and CFO certifications to such
disclosures. Moreover, management should be required to report on any known
material weaknesses. In this regard, the Proposed Statement on Auditing
Standards of the AICPA, “Communications of Internal Control Related Matters
Noted in an Audit,” if adopted by the AICPA and the PCAOB, would strengthen
this disclosure requirement and provide some external auditor involvement in
the internal control over financial reporting process.
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3.
Unless and until a framework for assessing internal control over
financial reporting for such companies is developed that recognizes their
characteristics and needs, provide exemptive relief from external auditor
involvement in the Section 404 process to the following companies, subject to
their compliance with the same corporate governance standards as detailed in
the recommendation above:
a.
Smallcap companies with less than $250 million in annual revenues but
greater than $10 million in annual product revenue; and
b.
Microcap companies with between $125 and $250 million in annual
revenue.
4.
Change the requirements for implementing Section 404’s external
auditor requirement to a cost-effective standard, which the SmallCap
Committee calls “ASX,” providing for an external audit of the design and
implementation of internal controls.
5.
Provide, and request that COSO and the PCAOB provide, additional
guidance to help facilitate the assessment and design of internal controls
and make processes related to internal controls more cost effective; also,
assess if and when it would be advisable to reevaluate and consider amending
AS2.
6.
Determine the necessary structure for COSO to strengthen it in light
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III. Capital Formation, Corporate Governance and
Disclosure
7. Incorporate the scaled disclosure accommodations currently available
to small business issuers under Regulation S-B into Regulation S-K, make them
available to all microcap companies, and cease prescribing separate
specialized disclosure forms for smaller companies.
8. Incorporate the primary scaled financial statement accommodations
currently available to small business issuers under Regulation SB into
Regulation S-K or Regulation S-X and make them available to all microcap and
smallcap companies.
9. Allow all reporting companies on a national securities exchange,
NASDAQ or the OTCBB to be eligible to use Form S-3, if they have been
reporting under the Exchange Act for at least one year and are current in
their reporting at the time of filing.
10.
Adopt policies that encourage and promote the dissemination of
research on smaller public companies.
11.
Adopt a new private offering exemption from the registration
requirements of the Act that does not prohibit general solicitation and
advertising for transactions with purchasers who do not need all the
protections of the Act’s registration requirements. Additionally, relax
prohibitions against general solicitation and advertising found in Rule
502(c) under the Act to parallel the “test the waters” model of Rule 254
under that Act.
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32 Recommendations to
Ease Regulatory Burden of MicroCap and SmallCap Companies in the US
(continued)
12.
Spearhead a multi-agency effort to create a streamlined NASD
registration process for finders, M&A advisors and institutional private
placement practitioners.
13. Amend SEC Rule 12g5-1 to interpret “held of record” in Exchange Act
Sections 12(g) and 15(d) to mean held by actual beneficial holders.
14. Make public information filed under Rule 15c2-11.
15.
Form a task force, consisting of officials from the SEC and
appropriate federal bank regulatory agencies to discuss ways to reduce
inefficiencies associated with SEC and other governmental filings, including
synchronizing filing requirements involving substantially similar
information, such as financial statements, and studying the feasibility of
extending incorporation by reference privileges to other governmental filings
containing substantially equivalent information.
16. Allow companies to compensate market-makers for work performed in
connection with the filing of a Form 211, with full disclosure of such
compensation arrangements.
17. Evaluate upgrades or technological alternatives to the EDGAR system so
that smaller public companies can make their required SEC filings without the
need for third party intervention and associated costs.
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18.
Make it easier for microcap companies to exit the Securities
Exchange Act of 1934 reporting system.
19. Increase the disclosure threshold of Act’s Rule 701(e) from $5 million
to $20 million.
20. Extend the “access equals delivery” model to a broader range of SEC
filings.
21.
Shorten the integration safe harbor from six months to 30 days.
22.
Clarify SOX Section 402 loan prohibition.
23. Increase uniformity and cooperation between federal and state
regulatory systems by defining the term “qualified investor” in the Act and
making the NASDAQ Capital Market and OTCBB stocks “covered securities” under
NSMIA.
24.
Clarify the interpretation of or amend the language of the Rule 152
integration safe harbor to permit a registered initial public offering to
commence immediately after the completion of an otherwise valid private
offering the stated purpose of which was to raise capital with which to fund
the IPO process.
IV. Accounting Standards
25.
Develop a “safe-harbor” protocol for accounting for transactions that
would protect well-intentioned preparers from regulatory or legal action when
the process is appropriately followed.
26. In implementing new accounting standards, the FASB should permit
microcap companies to apply the same extended effective dates that it
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27.
Consider additional guidance for all public companies with respect to
materiality related to previously issued financial statements.
28. Implement a de minimis exception in the application of the SEC’s
auditor independence rules.
29.
Together with the PCAOB and the FASB, promote competition and reduce
the perception of the lack of choice in selecting audit firms by using their
influence to include non-Big Four firms in committees, public forums, and
other venues that would increase the awareness of these firms in the
marketplace.
30.
Formally encourage the FASB to continue to pursue objectives-based
accounting standards. In addition, simplicity and the ease of application
should be important considerations when new accounting standards are
established.
31. Require the PCAOB to consider minimum annual continuing professional
education requirements covering topics specific to SEC matters for firms that
wish to practice before the SEC.
32. Monitor the state of interactions between auditors and their clients
in evaluating internal controls over financial reporting and take further
action to improve the situation if warranted.
Where the Focus Is
Commentators and critics have focused on the
recommendations of the SmallCap Committee limiting the
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32 Recommendations to
Ease Regulatory Burden of MicroCap and SmallCap Companies in the US
(continued)
application of SOX to microcap and smallcap companies.
As stated previously the big four accounting firms are against the
recommendations in this area as are a number of the larger US legal firms and
former top officials of the SEC (one being former SEC Chairman Arthur Levitt)
and the Federal Reserve (Reserve Chairman Paul Volker).
The proposals under the “Capital Formation, Corporate
Governance and Disclosure” caption would have a significant impact on
microcap and smallcap companies if adopted by the SEC. Hopefully, these
recommendations won’t be ignored as the SOX debate heats up.
If you support any of the proposed recommendations of
the SmallCap Committee make your voice heard. Those in opposition of these
recommendations have money and power on their side. It is only by
voicing
your support that the SmallCap Committee and the SEC will know that you
believe the proposed changes are a good start in recognizing the importance of small
companies in the competitiveness and future of the North American economy.
Cautionary Note
The Small Cap Committee’s role is an advisor only to the
SEC. The SEC is under no obligation to act upon the
recommendations put
forward by the Small Cap Committee. You should not assume the SEC will
extend its initial waiver to Section 404 of SOX to non-accelerated filers
beyond the July 14, 2007 announced on September 21, 2005.
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Proposal
to Ease Deregistration in the US by Foreign Issuers
On December 27, 2005, the SEC published a
new rule
regarding the termination of US reporting requirements by foreign private
issuers under Section 12(g) US Securities Exchange Act of 1934 (the
“1934 Act”). Rule 12h-6, if adopted, will simplify the process of
deregistration in the US by expanding the options under which a
foreign issuer may terminate its reporting issuer status and truly terminate
its status as a US reporting issuer and not just suspending its reporting
obligations under section 15(d) of the 1934 Act.
Current Deregistration Rules
Under the current 1934 Act rules, Rule 12g-4 only
permits a foreign private issuer to deregister a class of its securities
under section 12(g) of the 1934 Act if the subject class is held by less than
300 U.S. residents or 500 U.S. residents for issuers with less than $10
million in assets, as of the end of its last completed fiscal year. This
number is to be calculated on a "look through" basis by canvassing the record
ownership of brokers, dealers, banks or nominees worldwide and counting the
number of separate accounts of customers residing in the US. If the number of
US residents is under the given threshold, the issuer may deregister the
securities under the 1934 Act. The issuer may also terminate its reporting
obligations under the 1934 Act if the securities had not been registered
under the US Securities Act of 1933 (the “Act”). If, however, the
issuer has registered securities under the Act, under Rule 12h-3 the issuer
may deregister the securities under the 1934 Act but may only suspend, not
terminate, its 1934 Act reporting obligations under section 15(d) of the 1934
Act. At the end of each fiscal year the issuer must check to see if the
threshold has not been exceeded. The issuer must resume its reporting
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Proposed Deregistration Rules
Under
proposed 1934 Act Rule 12h-6, a foreign private
issuer would be able to permanently terminate either or both:
1.
its registration of its securities under Section 12(g) of the 1934 Act
and its corresponding section 13(a) reporting obligations; and
2. reporting obligations under section 15(d) of the 1934 Act.
if it meets the following qualitative and quantitative
conditions:
Qualitative Conditions
(1) The Two-Year 1934 Act Reporting Condition:
The issuer must have been an 1934 Act reporting company for the past two
years, has filed or furnished all reports required for this period and filed
at least two annual reports under Section 13(a);
(2) The One-Year No Sales Condition: The
issuer has not directly or indirectly sold it’s securities in the US in
either a registered or unregistered offering during the preceding 12 months,
other than securities:
·
sold to its employees,
·
sold by selling security holders in non-underwritten offerings,
·
exempt from registration under Section 3 of the Act (except
Section 3(a)(10)), or
·
constituting obligations having a maturity of less than 9
months at the time of issuance and offered and sold in transactions exempted
from registration under Section 4(2) of the Act (i.e., so called "4(2)
commercial paper"); and
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SECURITIES UPDATE: MARCH 2006
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Proposal to Ease
Deregistration in the US by Foreign Issuers (continued)
(3)
The Home Country Listing Condition: The issuer has maintained a
listing of the subject class of securities on an exchange in its home country2
which constitutes the primary trading market for the securities.
Quantitative Conditions
An eligible foreign private issuer must also meet one of
the following benchmarks:
(4) Public Float and Trading Volume Benchmark:
Foreign private issuers who are also well-known seasoned issuer as defined
under Rule 405 of the Act (“WKSI”) may terminate its obligations as long as
it meets either one of the following benchmarks:
(5) Trading Volume Benchmark: (1) The U.S.
average daily trading volume of the subject class of securities has been no
greater than 5% of the average daily trading volume of that class of
securities in its primary trading market during a recent 12 month period, and
(2) the U.S. residents held no more than 10% of the issuer’s worldwide public
float3 at a date within 60 days before the end of that same period;
or
(6) Public Float Benchmark: U.S. residents
held no more than 5% of the worldwide public float of the issuer’s equity
securities held by non-affiliates for which there is a reporting obligation at
a date within 120 days before the filing date of the Form 15F (described
below), regardless of U.S. trading volume.
If the issuer is not a WKSI, it may only terminate its
obligations if U.S. residents held no more than 5% of the worldwide public
float of the issuer’s equity securities held by non-affiliates for which there
is a reporting obligation at a date within 120 days before the filing date of
the Form 15F (described below), regardless of U.S. trading volume. |
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(7) Alternate
Record Holder Counting Benchmark: If an issuer cannot meet the Public
Float or Trading Volume Benchmark, but satisfies the other qualitative
conditions of the rule, can still terminate its 1934 Act obligations under
proposed Rule 12h-6 if the class of securities is held of record by less than
300 persons on a worldwide basis or less than 300 U.S. residents at a date
within 120 days before the filing date of the Form 15F to deregister.
Debt Securities Registrants
Under proposed Rule 12h-6, a foreign private issuer may
terminate its 1934 reporting obligations under Section 15(d) of the 1934 Act
with respect to a class of debt securities if it meets the following
conditions:
(1) Section 15(d) Reporting Requirement:
The issuer has filed or furnished all required reports under Section 15(d),
including at least one annual report pursuant to Section 13(a) of the 1934
Act; and
(2) Record Holder Counting: Record Holder Counting:
At a date within 120 days before the filing date of the Form 15F, the
class of debt securities is held of record by less than 300 persons on a
worldwide basis or by less than 300 persons resident in the U.S.
Counting Method
Under proposed Rule 12h-6 foreign private issuers would
be allowed to:
Limit its inquiry regarding the amount of securities
represented by accounts of customers resident in the U.S. to brokers, dealers,
banks and other nominees located in (1) the U.S., (2) the foreign private
issuer’s jurisdiction of incorporation, legal organization, or establishment
and, (3) if different, the jurisdiction of the foreign private issuer’s
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·
rely in good faith on the assistance of an independent
information services provider that in the regular course of business assists
issuers in determining the number of, and collecting other information
regarding, their shareholders.
New Form 15F
Under current 1934 Act rules, a foreign private issuer
would have to file a new Form 15 with the SEC certifying that it meets the
conditions for ceasing its 1934 Act reporting obligations. This filing would
automatically suspend the issuer’s reporting obligations. The suspension
becomes a permanent termination if the SEC does not object within 90 days
after the filing. The final rule may include an ability to accelerate the a
permanent termination under Form 15F.
Notice Requirement
Proposed Rule 12h-6 requires a foreign private issuer to
publish a notice in the US to disclose its intent to terminate its 1934 Act
reporting obligations no later than 15 business days prior to filing its Form
15F. A copy of the notice must also be filed under Form 6-K before, or at the
time of, filing the Form 15F or as an exhibit to the Form 15F.
Rule 12g3-2(b)
Proposed Rule 12h6, will allow any foreign private issuer
that terminates its 1934 Act obligations under proposed Rule 12h-6 would
automatically qualify for the Rule 12g3-2(b) exemption. Rule 12g3-2(b)
permits an issuer to avoid registration under Section 12(g) of the 1934 Act.
If a foreign private issuer wishes to maintain this exemption, it is must
provide material home country documents in English under Rule 12g3-2(b) on its
website or through an
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Proposal to Ease
Deregistration in the US by Foreign Issuers (continued)
electronic information delivery system that is generally
available to the public in its primary trading market. This exemption would
remain effective as long as the issuer complies with the availability of
information requirement of the proposed rule, or until either the issuer
registers a new class of securities under Section 12 of the 1934 Act or
incurs reporting obligations under Section 15(d) of the 1934 Act with respect
to securities that were not the subject of the deregistration.
Short
Form Prospectus Now Available to
CNQ and
TSX-V Listed Companies in Canada
National Policy 41-101 Short Form Prospectus
Distributions and its associated form and companion policy (together “NI
41-101”) became effective in all Canadian provinces and territories on
December 30, 2005. NI 41-101 expands the number of issuers who may use the
short form prospectus regime to include a greater number of reporting issuers
in Canada. It also amends the disclosure and other requirements of the short
form prospectus regime to bring it into line with other recent policy
initiatives.
Expanded Eligibility
NI 41-101 simplifies the basic qualification
requirements and eliminates former threshold requirements. Under the new rule
an issuer will be eligible to use the short form prospectus regime if it
meets the following requirements:
·
it must be a reporting issuer and SEDAR filer in at least one
jurisdiction in Canada;
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·
it must have securities listed and posted for trading on the
TSX, TSX-V (Tier 1 or Tier 2) or the CNQ;
· it must have filed a current Annual Information Form (“AIF”),
current annual financial statements and all other required continuous
disclosure documents;
· it must not have ceased its operations and its principal assets
must not be comprised solely of cash, cash equivalents or its exchange
listing (in other words, it is not a shell company or a capital pool
company); and
· it must have filed a one-time notice of intention to be
qualified to file a short form prospectus at least 10 business days prior to
filing its first preliminary short form prospectus.
Each issuer who has a current AIF on December 29, 2005
under Current NI 44-101 will be deemed to have filed a notice on December 14,
2005 declaring its intention to be qualified to file a short form prospectus.
Alternative qualification criteria are available for
issuers of: approved rating non-convertible securities; guaranteed
non-convertible debt securities, preferred shares and cash-settled
derivatives; guaranteed convertible debt securities or preferred shares; and
asset-backed securities.
New Short Form Prospectus
The new short form prospectus is based on the continuous
disclosure filings of the reporting issuer filed pursuant to National
Instrument 51-102 – Continuous Disclosure Obligations. The new form includes
expanded disclosure over the old form with regards to the information
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and information provided regarding: over-allotments;
compensation and options granted to underwriters; use of proceeds; earnings
coverages ratios; recent or proposed significant acquisitions; debt; earnings
coverage ratios; among other items.
The issuer is no longer required to file an auditor’s
comfort letter regarding unaudited financial statements with the final short
form prospectus. However, NI 44-101 still requires the delivery to the
applicable securities commissions, concurrent with the filing of the
pre-short form prospectus, an auditor’s comfort letter if the audited
financial statements included in the preliminary short form prospectus are
accompanied by an unsigned audit report.
NI-44-101 also eliminates the requirement to make all
material contracts available for inspection during the distribution period.
This change reflects the fact material documents are now required to be filed
on SEDAR and therefore available for public inspection on a continuous basis.
Solicitation
of Expression of Interest
NI 44-101 extends the period during which the
pre-marketing of a bought deal can occur from two business days to up to four
business days following the execution of an enforceable agreement between the
issuer and the underwriters.
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CROSS BORDER
SECURITIES UPDATE: MARCH 2006
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The information in this
newsletter is of a general nature only about recent developments of interest
to our clients. You are encouraged to contact legal counsel before acting on
any information provided.
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Author Alixe
Cormick has assisted small and micro cap companies through each stage of
their growth from inception to graduation to junior and more senior trading
forums. |
VENTURE
LAW CORPORATION
618 - 688 West Hastings
Street
Vancouver, British Columbia,
V6B 1P1
Phone: 604-659-9188
Fax: 604-659-9178
Web:
www.venturelawcorp.com
PDF: March 2006 - Cross-Border
Securities Update
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