In June 2017, the Financial Choice Act of 2017 1 (the “Choice Act”) was passed by the U.S. House of Representatives with all but one Republican voting in support of the Choice Act, a bill designed to substantially restructure the post-crisis regulatory framework of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The Choice Act is premised on the concept that regulatory reforms in the post-crisis era under Dodd-Frank was a blunt instrument that did not achieve its purpose and has impeded economic growth. As a result, the majority of the Choice Act aims to revise certain banking and financial regulatory provisions of Dodd-Frank, however there are a number of provisions aimed at capital markets reform for smaller issuers to ease their regulatory burden of compliance and capital raising and administrative law changes that would affect SEC rulemaking.
While the Choice Act covers a broad range of regulatory reforms, this article will focus specifically on the proposed changes affecting public companies and other capital market participants, including:
- Public Offerings
- Registration Exempt Offerings and Transactions
- Public Company Compliance
- Repealed Provisions of Dodd-Frank
- Expanded Form S-3 Eligibility: Expansion of the availability of Form S-3 for companies that cannot meet the $75 million public float requirement as long as it has at least one class of common equity securities listed on a national securities exchange. The Choice Act does not mandate a similar change to Form F-3, the analogous short form registration used by foreign private issuers.
- Regulation A+: Increasing the maximum allowable offering amount under Regulation A+ from $50 million to $75 million, with indexing for inflation every two years.
- Testing the Waters Expansion: Extending the Jumpstart Our Business Startups Act provisions to allow any issuer, not just emerging growth companies, to engage in “testing the waters” communications with potential investors prior to filing its initial public offering registration statement; and, permitting the confidential submission of draft registration statements for confidential non-public review by the staff of the SEC by all first time registrants.
- Elimination of Automatic Disqualifications: Eliminating the automatic disqualification for issuers the subject of certain judicial, administrative or governmental orders or decrees being deemed an “ineligible issuer”2 under Rule 405 of the U.S. Securities Act of 1933, as amended (the “1933 Act”), unless the SEC, by order, on the record after notice and an opportunity for a hearing, makes a determination that such issuer should be disqualified or otherwise deemed an ineligible issuer.
- Venture Exchanges: Allowing for the creation of venture exchanges that would list the securities of smaller issuers and exempt such exchanges from certain federal and state regulatory requirements.
Registration Exempt Offerings and Transactions
- Micro-Offerings: Amending Section 4 of the 1933 Act to create a new exemption from registration for “micro-offerings.” A micro-offering is an offering of up to $500,000 in a 12 month period and sold to no more than 35 purchasers, each of which have a substantial pre-existing relationship with an officer or director of the issuer or is an existing 10% shareholder. Importantly, the Choice Act would also deems any securities issued in a micro-offering to be “covered securities,” thus pre-empting such transactions from state blue-sky registration provisions.
- Expanded Section 4(a)(7) Resale Exemption: Expanding the scope of the Section 4(a)(7) exemption for certain private resales of public and private company securities, implemented as part of the Fixing America’s Surface Transportation Act. The Choice Act would revise Section 4(a)(7) to allow for general solicitation and general advertising so long as all sales are made through a platform available only to accredited investors and would remove certain issuer information requirements.
- Revisions to Filings Under Regulation D: Revising the Form D filing requirements so that an issuer relying on Rule 506 is only required to file a single notice of sales containing the information required by Form D not earlier than 15 days after the date of first sale of securities. In addition, the Choice Act would prohibit the SEC from conditioning the availability of any exemption under Rule 506 on the issuer’s filing of a Form D and prevents the SEC from requiring issuers to submit written general solicitation materials to the SEC for a Rule 506(c) offering.
- Clarification of General Solicitation and Advertising: Directing the SEC to revise the definition of “general solicitation” and “general advertising” in Regulation D to exclude certain presentations or other communications made by or on behalf of an issuer at certain events, including meetings sponsored by venture or angel investor groups, governmental organizations, educational institutions or non-profit organizations, so long as (i) the event sponsor does not provide investment advice, charge for attendance, or engage in activities or receive compensation that would require registration as a broker-dealer under U.S. Securities Exchange Act of 1934 Act, as amended (the “1934 Act”) or Investment Advisers Act of 1940, (ii) advertising for the event does not reference a specific securities offering, and (iii) limited information about the issuer and its securities offering is communicated at the event.
- Accredited Investor Definition: Amending the definition of “accredited investor” in Section 2(a)(15) of the 1933 Act to include the Regulation D income test of $200,000 per year (or $300,000 including spouse’s income) and net worth test of $1 million, which would be adjusted for inflation every five years. In addition, it would also expand the categories of natural persons under the statutory definition considered to be accredited investors to include registered brokers or investment advisers and certain other persons deemed by the SEC to have demonstrable education or job experience to qualify such person as an accredited investor, irrespective of salary or net worth.
- Crowdfunding: Revising the current crowdfunding rules with a new exemption including: (i) no apparent caps or limits on aggregate offering amounts or investment limits; (ii) no financial statement or specific disclosure requirements; (iii) no investor financial qualifications, permitting crowdfunding offerings without use of an intermediary; and (iv) no requirement for intermediaries to be registered as broker dealers. Additionally, crowdfunding investors would be excluded from the calculation under Section 12(g) of the 1934 Act for the purpose of triggering registration thereunder.
- Employee Plans: Amending Rule 701 under the 1933 Act, which is often relied upon by foreign private issuers for issuances of securities to employees and others pursuant to written compensatory benefit plans. Rule 701(e) requires the issuer to provide specified disclosure, including financial statements, if the issuer has sold more than $5 million of securities during any consecutive 12-month period. The Choice Act would increase this threshold to $20 million.
- M&A Brokers: Exempting from SEC broker-dealer registration brokers engaged in mergers and acquisitions of “eligible privately-held companies”, which are non-SEC reporting company with pre-tax earnings of less than $25 million and/or gross revenues less than $250 million.
- Qualifying Venture Capital Funds: Amending Section 3(c)(1) under the Investment Company Act of 1940, as amended (the “1940 Act”) to create a new exemption from registration for privately offered qualifying venture capital funds with up to 500 beneficial owners and no more than $50 million in capital commitments. This would allow these venture funds to have more than 100 beneficial owners and accept investors who are not “qualified purchasers” and yet avoid registration under the 1940 Act.
Public Company Compliance
- Say-On-Pay: Amending the Section 14A requirement of the 1934 Act that companies hold an advisory, nonbinding shareholder vote on executive compensation (say-on-pay vote) at least once every three years, irrespective of the materiality in changes to executive compensation, to require say-on-pay votes only those years in which there has been a material change to the compensation of executives of an issuer from the previous year. Currently, there is no guidance as to what a “material change” is, but if the Choice Act is enacted the SEC may provide further guidance on this point. In addition, the Choice Act would also eliminate the requirement to hold a “say-on-frequency” vote at least once every six years.
- Shareholder Proposals: The Choice Act would significantly modify the rules governing shareholder proposals in the following ways:
- Submission Requirement: removing the requirement that a shareholder own at least $2,000 of an issuer’s shares for at least one year and replacing it with the requirement that the shareholder own at least 1% (or such greater percentage as determined by the SEC) of the issuer’s outstanding common shares for at least three years;
- Resubmission Requirement: currently, if a shareholder proposal deals with substantially the same subject matter as one or more shareholder proposals previously included in an issuer’s proxy materials within the previous five calendar years, the issuer may exclude it from its proxy materials for any meeting held within three calendar years of the last time it was included if the previously submitted proposals received less than the following levels of shareholder support: (i) less than three percent of the vote if voted on once within the preceding five calendar years, (ii) less than 6% of the vote if voted on twice within the preceding five calendar years, or (iii) less than 10 percent of the vote if voted on three times or more within the preceding five calendar years. The Choice Act would increase the resubmission thresholds to 6%, 15% and 30% respectively; and
- Proposals by Proxy: permitting an issuer to exclude a shareholder proposal from its proxy materials if such proposal is submitted by a person as proxy, representative of on behalf of a shareholder.
- Universal Proxy: Prohibiting the SEC from adopting a universal proxy rule that would require an issuer to include in its proxy materials on a single ballot both issuer and dissident shareholder nominees in a proxy contest.3
- Clawback of Executive Compensation: Replacing the Dodd-Frank clawback policy requiring an issuer to recover incentive-based compensation received by any current or former executive officer in the three-year period preceding an accounting restatement if such compensation was based on financial metrics that are subsequently restated, to limit such clawback to only those executive officers that had control or authority over the financial reporting that resulted in the accounting restatement.
- SOX Auditor Attestation Relief: Providing relief for issuers that have ceased to be an emerging growth company and had average annual gross revenues over the preceding three years of less than $50 million to continue to take advantage of the emerging growth company exemption from the auditor attestation requirement until the earliest of (i) the last day of the fiscal year of the issuer following the 10th anniversary of the first sale of registered common equity securities, (ii) the last day of the fiscal year of the issuer during which the average annual gross revenues of the issuer exceeds $50 million, or (iii) when the issuer becomes a large accelerated filer. The Choice Act also provides an exemption from the auditor attestation requirement for any issuer with a total market capitalization of less than $500 million or any issuer that is a depository institution and has less than $1 billion in assets.
- XBRL Relief: Providing an exemption for emerging growth companies and companies with total annual gross revenues of less than $250 million from the SEC XBRL filing requirements in their registration statements and periodic and current reports.
- Registration and Deregistration Thresholds: Revising the registration threshold of Section 12(g) of the 1934 Act to remove the existing 500 holder requirement, resulting in a revised Section 12(g) that requires registration where a company has $10 million in assets and at least 2,000 holders of record. The Choice Act would also require the asset test to be indexed to inflation on a five-year cycle. The Choice Act would also amend the requirements under Section 12(g)(4) and 15(d) of the 1934 Act, permitting issuers to terminate registration or suspend its 1934 Act reporting obligations if it has holders of record of less than 1,200 persons, which has been increased from the old 300 person threshold.
- Wells Notices: Creating a new procedure to allow recipients of a Wells4 notice to have the right to make an in-person presentation before staff of the SEC concerning the Wells notice and to be represented by counsel at such presentation.
- Officer and Director Bars: Repealing the SEC’s authority in administrative proceedings to bar individuals from serving as an officer or director of a reporting company. The SEC could however ask a federal court to implement the bar on serving in either capacity.
Title II of the Choice Act proposes to increase the existing maximum penalties under the 1933 Act, the 1934 Act, the 1940 Act and Investment Advisers Act of 1940, including:
- creating new maximum penalty amounts for violations involving fraud, deceit, manipulation, reckless disregard of a regulatory requirement and result in, or create the risk of, substantial losses to others, or substantial pecuniary gains to the wrongdoer at the greater of: (i) $300,000 for a natural person or $1,450,000 for any other person; (ii) three times the gross amount any pecuniary gain; or (iii) the amount of losses incurred by victims;
- creating a new maximum penalty limit for recidivists, defined as those criminally convicted of securities fraud or subject to a regulatory order related to an allegation of fraud within the preceding 5 year period, of three times the otherwise applicable limit;
- doubling the maximum penalties for violations by registered public accounting firms and associated persons under the Sarbanes-Oxley Act, the rules of the Public Company Accounting Oversight Board, or securities laws relating to the preparation and issuance of audit reports and other auditor obligations and liabilities. There is an exception to the penalty for intentional/knowing conduct by entities other than “natural persons,” where the Choice Act would increase the maximum civil penalty from $15 million to $22 million;
- increasing the maximum penalty under the 1934 Act for “controlling person” liability in connection with insider trading from $1 million to $2.5 million. However, the Choice Act would maintain the existing limitation that the penalty shall not exceed the greater of $2.5 million or three times the amount of the profit gained or loss avoided as a result of such controlled person’s violation; and
- increasing the maximum penalty available under Section 32 of the 1934 Act for willful violations of any rules or regulations of the 1934 Act from $5 million to $7 million, including significant increases to the fines available under the anti-bribery provisions under Section 30A of the 1934 Act from $2 million to $4 million against issuers and from $100,000 to $250,000 against officers, directors and other employees an agents of an issuer.
Repealed Provisions of Dodd-Frank
The Choice Act would repeal the following provisions of Dodd-Frank:
- Pay Ratio Disclosure: The requirement to disclose the median of the annual total compensation of all employees, the annual total compensation of the CEO and the ratio of median annual compensation of all employees and compensation of the CEO.
- Hedging Policy Disclosure: The requirement to disclose whether an issuer’s directors and employees are permitted to engage in hedging transactions of the issuer’s securities.
- Chairman/CEO Structure: The requirement to disclose in annual proxy statements why an issuer has chosen the same or different individuals to serve as chairman of the board of directors and chief executive officer.
- Conflict Minerals: The requirement to examine supply chains and provide certain disclosure annually regarding conflict minerals.
- Mine Safety Disclosure: The requirement for issuers that operate a mine, or have a subsidiary that operates a mine, to disclose certain health and safety information in its periodic reports.
- Resource Extraction Issuer Rules: The requirement for issuers engaged in commercial development of oil, natural gas, or minerals to disclosure annually certain payments made to the United States or foreign governments.
- Proxy Access: The ability of the SEC to adopt proxy access rules.
The Choice Act in its omnibus form is not likely to have any bipartisan support in the U.S. Senate. However, the U.S. Senate may be willing to support a bill that is more limited in scope or pass discrete parts of the Choice Act that are more palatable. Until the Choice Act makes its way through the U.S. Senate, Nauth LPC recommends that issuers and other capital market participants continue to comply with existing securities law and disclosure requirements but start to prepare for the possible upcoming changes.
If you have questions regarding the Choice Act or how it may affect your company, please contact Daniel D. Nauth at 416-477-6031 or firstname.lastname@example.org.
1 The full text of the Choice Act can be found here. The House Financial Services Committee prepared an executive summary of the Choice Act which can be found here and a comprehensive summary which can be found here.
2 An ineligible issuer is generally unable to use free writing prospectus’ and ineligible issuer that is a “well known seasoned issuer” loses that status for a period of three years and cannot benefit from automatic shelf registrations.
3 In October 2016 the SEC proposed rule requiring the use of universal proxies. The proposed rule remains pending. The SEC proposal can be found here.
4 A Wells notice is a letter sent by the SEC informing individuals or organizations that the SEC is planning to bring an enforcement action against them.