Cross-Border Counselor

As a result of the partial U.S. government shutdown that began on December 22, 2018, the U.S. Securities and Exchange Commission (SEC), one of nine federal agencies affected, recently published its Operations Plan Under a Lapse in Appropriations and Government Shutdown (sec.gov/files/sec-plan-of-operations-during-lapse-in-appropriations-2018.pdf), which went into effect on December 27, 2018. The Operations Plan offers important guidance regarding the significant impacts of the shutdown on the agency’s activities. Additional guidance is also available from the SEC’s Divisions of Corporation Finance (here: sec.gov/page/corpfin-section-landing) and Investment Management (here: sec.gov/investment-management). Issuers and practitioners should make contingency plans to address the effects upon ongoing or planned securities offerings, filings, and requests for interpretive guidance, among other things. A few important highlights: The EDGAR system is open and accepting filings, including registration statements, periodic filings (such as 6-Ks), and other filings (such as Form Ds). Issuers should continue to make all required filings by the designated due date. During the government shutdown, the SEC staff will not process or review registration statements or accelerate the effectiveness of registration statements. More information can be found on Dorsey’s recent eUpdate here: dorsey.com/newsresources/publications/client-alerts/2019/01/government-shutdown-limits-sec-operations.

The SEC’s settlement with Tesla and Elon Musk teaches us some important corporate governance lessons on monitoring and vetting executive use of social media. As background, on August 7, 2018, the markets were surprised by a series of tweets initiated by Elon Musk, the CEO of Tesla, Inc., in which Musk mused about taking Tesla private at $420 per share (a significant premium to the then-market price), with funding secured. The stock price jumped, trading in Tesla stock was halted, and Tesla rushed to catch up with official announcements. The deal didn’t happen, and it was questioned whether Musk was really serious, and whether funding was really “secured.” The SEC commenced an investigation. On September 27, 2018, the SEC announced charges against Musk for securities fraud in connection with his tweets, which it said were inaccurate and misleading. Among the remedies sought was a permanent ban on Musk being eligible to serve as a director or officer of any public company, effectively seeking to sever him from Tesla, a company of which he is the heart and soul. Tesla’s stock dropped 14%. If this remedy was included by the SEC as leverage, that leverage worked, and on September 29, 2018, the SEC announced a settlement with Musk, as well as charges against and a settlement with Tesla. Tesla’s stock increased 17%. As part of the settlement, Musk will remain Tesla’s CEO and a director, but Musk and Tesla agreed that: Musk will step down as Tesla’s Chairman for at least three years and be replaced as Chairman by an independent director; Tesla will appoint two additional independent directors; Tesla will establish a committee of independent directors and put in place additional controls and procedures to oversee Musk’s communications; and Musk and Tesla will each pay $20 million to harmed investors under a court-approved process. The SEC alleges that Tesla failed to implement adequate disclosure controls and procedures over Musk’s use of Twitter. Tesla had publicly announced in 2013 that Musk’s Twitter account would be among the means by which Tesla intended to release material information, Musk had amassed 22 million Twitter followers, and important information about Tesla had been released through this account, but the SEC says that Tesla had not adopted any specific policies regarding Musk’s use of Twitter, such as procedures to determine whether proposed tweets were accurate and complete, and whether they contained information requiring disclosure in Exchange Act reports. In effect, the SEC says Tesla had given Musk carte blanche to release material information about Tesla, without subjecting it to the normal controls to which other, more formal, types of disclosures would be subject, and as a result, the market was misled. Investors harmed included short sellers and those who purchased shares after Musk’s announcement temporarily drove up stock prices, only to see those prices drop afterwards. The SEC’s settlement with Tesla and Musk teaches us some important corporate governance lessons: If a public company allows its executives to use Twitter or other social media accounts to disclose material information about the company, it is not enough to notify the public that material disclosures may be made by these means. Companies must ensure that their disclosure controls and procedures adequately cover executives’ use of social media. In deciding what disclosure controls and procedures to implement, consideration should be given to such matters as: what topics are permitted or prohibited; procedures for review and approval of disclosures before they are made; the inclusion of risk factors or other cautionary or explanatory language to help prevent disclosures from being potentially misleading; coordination of social media disclosures with other company disclosures as needed to satisfy public reporting requirements; and monitoring actual disclosures and resulting market and media reactions for any surprises. Companies that do not allow executives to use social media accounts to disclose material information should adopt policies clearly prohibiting such use, and monitor executives’ use of social media for any inadvertent violations of policy.  

As a continuation of our August 9 post regarding the deadline for Canadian companies to file a Form D for a private placement in the United States, we now address the questions, “What if our company missed the deadline to file a Form D with the SEC?” And, more importantly, “Have we lost our ability to rely upon the exemption?” The good news is that the exemption provided by Regulation D is not dependent upon the filing of the Form D. So, an issuer that fails to file the Form, or files it late, need not be concerned about the liability associated with a non-exempt offering. However, the failure to file exposes the issuer to risk of administrative action and possible loss of the ability to rely upon Regulation D in the future, and a willful failure to file Form D is a potential criminal violation. Accordingly, a company that discovers it has inadvertently failed to file a Form D with the SEC by the 15th day after the date of first sale of securities in an offering is best served by making the filing late unless counsel can identify an available alternative exemption. Unless the offering is otherwise exempt from state law, a late filed Form D must also be filed with, and a filing fee paid to, any state in which purchasers are located that requires such a filing. States differ in their response to late filings. Some states welcome them, and are happy to get the filing fees. Many states, including Illinois, impose an additional late filing fee when the filing is late. A few states, including Hawaii, have claimed that an exemption from state law is not available if the Form D is filed late, and demanded that the company give investors the right to get their money back. While I believe this view misinterprets federal law, it will usually be worth checking whether the late Form D must be filed in any of the states that take this position or that impose an onerous late filing fee and, if so, whether an alternative exemption is available under state law that would allow the company not to file the Form D in that state.

Canadian companies that sell securities to U.S. investors under Regulation D must file a Form D with the SEC within 15 days after “the date of first sale.” Most people would assume that the closing of the offering is the date of sale. However, in the instructions to Form D, the SEC explains that the date of first sale is “the date on which the first investor is irrevocably contractually committed to invest, which, depending on the terms and conditions of the contract, could be the date on which the issuer receives the investor's subscription agreement or check.” Therefore, the deadline for the Form D will depend on the wording of the agreement and how those words are interpreted under the governing law of the agreement. Companies whose agreements say a subscription is “irrevocable” should consider what that language is intended to mean. If it is intended to mean that the subscriber is contractually obligated to purchase the securities, regardless of whether the company has accepted the subscription agreement, then the receipt of the subscription may begin the 15-day clock and the Form D may be late by the date of closing. This problem can be addressed either by rewording the subscription agreement or by filing a Form D at the start of the offering, covering the maximum amount that may be sold in the offering. If instead, the “irrevocable” language is intended to be effective only upon the company counter-signing the agreement, the company should refrain from counter-signing the agreement until it is ready to begin the 15-day clock for filing of the Form D. Next week we will address the consequences of filing a Form D late.

Since January 1, 2016, the SEC has publicly released its correspondence relating to 60 comment letters sent to Canadian issuers with respect to annual reports filed on Form 40-F pursuant to the Canada-U.S. Multi-Jurisdictional Disclosure System (MJDS). We have analyzed the content and key takeaways from these letters, including: The SEC’s most common areas of focus; Recent trends; and Common errors to be avoided. Background The MJDS system allows Canadian issuers that satisfy certain market capitalization and other requirements to file an annual report with the SEC on Form 40-F. Except for a few items, a Form 40-F does not impose U.S. disclosure requirements upon a Canadian issuer and, instead, includes and relies upon the disclosures contained in the issuer’s annual information form, MD&A, and audited financial statements filed in Canada. The incremental requirements of Form 40-F include that the issuer’s financial statements comply with IFRS as issued by the IASB or be reconciled to U.S. GAAP, that the audit report meet certain requirements, that the auditor be independent, that certain disclosures be included with respect to the issuer’s disclosure controls and procedures and internal control over financial reporting, that certain officer certifications and third-party consents be included, and that certain additional MD&A disclosures be included. While the limited nature of Form 40-F reduces the number of areas in which the SEC may comment, Congress has directed the SEC to review the filings of SEC reporting issuers at least once every three years. For this reason, all companies that report with the SEC, even those that report under the MJDS, should expect their filings to be reviewed from time to time. If upon such review, the SEC has questions or believes that the issuer’s filing is deficient, it may provide comments to the issuer by letter. The issuer must then respond to the SEC’s comments, and may need to amend its filings to address the comments. Industry Breakdown The industry breakdown of the 60 most recent Form 40-F comment letters was: Twenty-four to companies involved in mining, mineral exploration, or the holding of mineral royalties or minerals; Five to energy companies; Five to technology and telecommunications companies; Four to life sciences companies; Four to banking and insurance companies; Three to real estate companies; and Six to companies involved in other industries, including transportation, manufacturing, entertainment, publishing, and professional services. Repeat Letters An issuer’s chance of receiving a comment letter may increase once the SEC has taken an interest in the issuer’s filings. The recipients of the comment letters included nine issuers who received a comment letter in both of the fiscal years covered by our review. Self-Inflicted Wounds Some comments could easily have been avoided. For example: Six letters noted technical problems with the audit report (missing auditor name, signature, date, or entire report; or failed to say financials comply with IFRS “as issued by the IASB”); Four noted technical problems with officer certifications or the internal control attestation report (wrong period, date, or content; or missing entirely); Four noted technical problems with the content of the controls sections of the Form 40-F; Three related to non-IFRS measures that the SEC considered misleading because terms were used inconsistently or the titles of the terms did not match the definitions (e.g., using the term EBITDA but calculating it in a manner inconsistent with market norms); Two noted technical problems with the contractual obligation table; and Two objected to an issuer’s conclusion that disclosure controls were effective when the issuer had disclosed that internal controls were ineffective. Paying Attention The SEC pays attention to an issuer’s website and earnings calls and may comment on inconsistencies between the Form 40-F and these other disclosures or raise other comments based on these disclosures. For example, several comment letters asked issuers about their business activities in sanctioned countries based on disclosures on their website. One letter questioned why management touted improvements in internal controls on the earnings call but disclosed no material change in internal controls in its Form 40-F. Another requested a different presentation of revenues based on sales information disclosed on an earnings call. Most Common Topics By far the most common topic of an SEC comment letter was the issuer’s financial disclosures. Forty-two of the 60 letters included comments relating to the issuer’s financial statements, audit report, auditor, or MD&A. These included, among others: Twenty-four with questions regarding revenue recognition policies, breakout of revenues by product (usually asking why further breakouts of revenue were not provided), methodology and disclosures around asset valuation and capitalization of expenditures, tax assets and rates, depletion/depreciation, or impairment analysis; Thirteen with questions about the accounting treatment of a specific other matter; and Nine requesting improvements to the disclosure of period-to-period changes, a particular accounting analysis, liquidity, cash flow, or other matters. Second-most common was comments relating to technical disclosure requirements for issuers involved in the mining or oil & gas industries, accounting for 13 of the 60 letters. Ten letters addressed mining company technical disclosures, including supplemental requests for copies of technical reports, studies, or other information in support of disclosures (the SEC does not require such reports to be publicly filed, unless also filed in Canada and material), and comments relating to: the issuer’s failure to comply with NI 43-101 (compliance with NI 43-101 is a pre-requisite for not complying with SEC Industry Guide 7); the issuer’s failure to update reserve calculations, for past production or more generally; and inconsistent or unclear disclosures. Three letters related to oil & gas company technical disclosures, all of which requested enhanced disclosures and alleged failures to satisfy FASB disclosure standards. The third-most common topic of the comment letters was comments relating to deficiencies in the officer certifications or disclosures relating to disclosure controls and internal controls. This topic was addressed in eight of the 60 comment letters, most of which related to failures to satisfy the form requirements. Fourth-most common was comments inquiring about the issuer’s business dealings in sanctioned countries (usually Sudan and Syria) or with companies known to operate in those countries and the adequacy of any related disclosures, usually triggered by the SEC’s realization that this may be relevant to the issuer. Seven of the 60 letters included such inquiries. Waves and Trends Comment letters have tended to come in waves. The letters from January 2016 through June 2017 dealt primarily with financial statement and MD&A issues; Two of the three letters issued to real estate companies were issued in the same week of September 2016; All of the letters issued to banks were issued in March 2017; All of the letters dealing with oil & gas technical disclosures were issued in the fourth quarter 2017; and Eight of the 10 letters dealing with mining technical disclosures were issued between June and December of 2017. It’s not yet clear if the shift toward commenting on mining technical disclosures is a trend. Lessons To reduce the likelihood of SEC comments, a Canadian issuer that files SEC annual reports on Form 40-F should attend to the technical compliance of its audit report, officer certifications, controls disclosures, and other Form 40-F mandated disclosures; include a robust and understandable MD&A; avoid the inconsistent or misleading use of non-IFRS terms; and, for resource extraction issuers, comply with the technical disclosure requirements applicable to it under Canadian and U.S. laws.  

With the listing on May 24th of Canopy Growth Corporation (Canopy) on the New York Stock Exchange (NYSE), both NASDAQ and the NYSE have permitted Canadian cannabis companies to trade on their respective exchanges. Canopy, the first Canadian cannabis company to list on the NYSE, follows Cronos Group Inc. (Cronos), which was the first Canadian cannabis company to list on a national stock exchange in the United States when it listed on NASDAQ in February. While neither exchange has formally adopted a policy on the listing of cannabis companies, informally they are willing, on a case-by-case basis, to accept a company with cannabis operations, so long as the company complies with all relevant laws in the jurisdictions where it operates. This is similar to the policies adopted by the Toronto Stock Exchange and TSX Venture Exchange, which prohibit the listing of cannabis companies with U.S. operations. In order to list in the United States, each of Canopy and Cronos filed listing applications with the respective exchange and registered their class of common shares with the United States Securities and Exchange Commission (SEC). A Canadian company that has been a reporting issuer in Canada for at least 12 months and has a public float of at least US$75 million is eligible to take advantage of the Multijurisdictional Disclosure System (MJDS) in order to register with the SEC. The MJDS permits such Canadian companies to file a Form 40-F registration statement, which is essentially a wrap around the company’s Canadian disclosure documents and is not subject to the typical burdensome SEC comment process. This generally permits for a quicker and less costly process for Canadian companies wishing to enter the U.S. markets. For more information on listing in the United States, contact your relationship attorney at Dorsey. For more information about Dorsey's cannabis industry practice, visit www.dorsey.com/services/cannabis.

On February 26, the SEC published interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. The SEC’s new guidance reinforces and expands on its October 2011 guidance, emphasizing the importance of adopting sound cybersecurity policies and procedures and safeguards against insider trading in the event of a potentially material cybersecurity breach. Read more about the new guidance in our recent eUpdate: www.dorsey.com/newsresources/publications/client-alerts/2018/03/sec-issues-new-cybersecurity-guidance.

The SEC is aiming to finalize its new mining disclosure rules within the next year, according to statements made last week by William Hinman, Director of the SEC’s Division of Corporation Finance, at the Securities Regulation Institute. For more details regarding the SEC’s original 2016 proposal to revamp the rules, and reactions by industry, see our summary of the initial proposal (here: www.dorsey.com/newsresources/publications/client-alerts/2016/07/new-mining-disclosure-rules) and our last blog post (here: crossbordercounselor.com/status-check-on-the-secs-proposed-overhaul-of-the-mining-disclosure-regime/).  

About 18 months have passed since the U.S. Securities and Exchange Commission (SEC) published its bold attempt to modernize the disclosure requirements for mining companies that are listed on U.S. stock exchanges or otherwise report to the SEC. With final rules not yet adopted, the fight for a streamlined reporting regime continues. The SEC’s proposed overhaul was spawned by industry request – specifically, a request by the Society for Mining, Metallurgy & Exploration (SME), the leading professional society of mining professionals in the United States, that the SEC bring its disclosure requirements into the modern age and adopt a new disclosure regime based on the Committee for Mineral Reserves International Reporting Standards (CRIRSCO) standards. CRIRSCO-based standards have been adopted in most countries with advanced mining disclosure regimes, including Canada and Australia. Industry was concerned that the existing rules under SEC Industry Guide 7, nearly 35 years old, were hampering the ability of U.S. mining companies and U.S. trading markets to compete by, among other things, prohibiting the disclosure of mineral resources that have not yet been determined to be mineral reserves. As a result, in June 2016, the SEC proposed a new CRIRSCO-based disclosure system that would bring U.S. disclosure requirements more in line with Canada and other jurisdictions. One might think that such a proposal, to modernize rules at the request of industry to benefit American business, would find easy adoption following the election of Donald Trump and the appointment of a Republican Chairman and majority to the SEC, but that hasn’t been the case. Overhauling a system that has been in place for 35 years is a difficult thing to do at any time. The election of Donald Trump likely delayed the process further. The President’s party controls the chairmanship and majority of seats on the SEC, so the election resulted in the resignation of the Democratic Chairman that had overseen the initial proposal. Months of uncertainty passed before her replacement was sworn in. The new Republican Chairman was not appointed until May 2017, seven months ago, without any background on the proposed new mining rules and undoubtedly bringing his own ideas and interests to the table. President Trump also campaigned on a platform of eliminating regulation, and while the proposals were intended to benefit industry, they require passing additional regulations. Finally, but perhaps most importantly, the proposals were not as well-received by the mining industry as the SEC had undoubtedly hoped. Most industry organizations, companies, and law firms that commented on the proposals were supportive of the idea of modernization, but felt that the SEC’s proposals were too prescriptive and varied in too many ways from CRIRSCO standards, thereby imposing an administrative burden on companies, especially those reporting in more than one jurisdiction. Worst of all for many of our Canadian clients, the new rules as proposed would have eliminated the ability of Canadian companies that file SEC reports on non-MJDS forms such as Form 20-F or 10-K from including National Instrument 43-101 (NI 43-101) information in their SEC filings, even if these disclosures were mere supplements to SEC disclosure. The SEC received a lot of feedback to digest. According to the staff, they are continuing to review and consider the comments received. While it’s not a secret, few are aware that the National Mining Association (NMA), the national trade organization of the mining industry, and the SME have teamed up to present the SEC with an alternative proposal for modernizing the SEC’s mining disclosure rules. The NMA and SME have proposed that instead of working from the framework of the SEC’s 2016 proposals, the SEC merely amend the content of Industry Guide 7. The NMA and SME have recommended that Guide 7, as revised, allow companies to disclose estimates of mineral resources in addition to mineral reserves, allow reserves to be established in a pre-feasibility study, not require disclosure to be attributed to a qualified person, limit required disclosures to those that are material, and limit the information required to be disclosed by those holding passive mining interests such as royalties, all without imposing the more detailed, prescriptive requirements contained in the SEC’s 2016 proposals. Of most interest to Canadian companies, the NMA/SME proposal would allow foreign companies that are subject to and required to disclose information in compliance with another CRIRSCO-based standard, such as NI 43-101, to comply with such other standard in lieu of, and in full satisfaction of, the SEC standards, subject only to a requirement to include a reconciliation of any material differences. The NMA/SME proposal includes a specific note that for Canadian companies subject to NI 43-101, reconciliation would generally not be required (due to the lack of material differences between NI 43-101 and the NMA/SME proposed version of Guide 7). If the SEC accepts the NMA/SME proposal, most smaller Canadian companies that do not satisfy the market capitalization requirements of the Multi-Jurisdictional Disclosure System (MJDS) will find it easier and less expensive to file with the SEC than in prior years. Whether the SEC will do so, we cannot say.

Over the last few years, many Canadian junior resource companies and startup companies have cut back on their legal spend, not necessarily undertaking a legal review of each new private placement of securities, or limiting their review to a Canadian one. Yet over this same time frame, the applicable U.S. rules and relevant interpretations have changed, and previously vetted forms may not be current. Indications that your U.S. law compliance practices in offering and selling securities could use a good scrub include the following: You don’t know the definition of a “foreign private issuer” or whether your company is one; You don’t know if your company has a “substantial U.S. market interest” in the class of securities you are offering; You don’t know what “bad boy disqualifications” are or who they apply to, or you can’t remember the last time the company’s insiders completed disqualification questionnaires; Your U.S. subscription agreements refer to Rule 506 and not Rule 506(b); Your U.S. subscription agreements treat an investor with a net worth of $1 million as an accredited investor, without subtracting certain items relating to the investor’s principal residence; Your warrant exercise forms don’t require all warrant holders to check an appropriate box to help you determine whether U.S. law applies to the exercise and confirm compliance with a U.S. exemption where required; Your offering includes warrants, but your subscription agreements don’t include U.S. provisions relating specifically to the warrants; or You aren’t checking the U.S. legal requirements when you draft your equity compensation plans or when you grant stock options, RSUs, PSUs, ESPP participation, or other types of compensatory equity to a U.S. resident. The risk of non-compliance includes rescission rights for investors, restatement of financial statements, and civil or criminal enforcement actions by regulators, so it’s important to regularly review your forms to ensure they are up to date.

On September 5, 2017, the U.S. House of Representatives overwhelmingly passed (by a vote of 403-3) the Improving Access to Capital Act. The Act directs the SEC to amend Regulation A+ to allow SEC reporting issuers to use Regulation A+ when raising capital, and to deem their SEC periodic reports to satisfy the periodic and current reporting requirements of Tier 2 of Regulation A+. The Act is now being considered by the U.S. Senate. If the Act becomes law, it will increase the alternatives available to SEC reporting companies in seeking additional capital. Smaller public companies that are not listed on Nasdaq or the NYSE, and are therefore subject to state securities regulation in respect of their capital raising activities, may find Regulation A+ especially attractive, because an offering under Tier 2 of Regulation A+ is preempted from state securities regulation other than the potential requirement to make a notice filing, consent to service of process, and pay a filing fee.

Readers listed on the NYSE will want to note a recent rule change. Effective immediately, notification of public announcements regarding dividends or stock distributions must be provided to the NYSE at least ten minutes prior to public release, even after market close. Read more in the post from our partner Jason Brenkert here: https://governancecomplianceinsider.com/nyse-rule-change-requires-ten-minutes-advance-notice-of-public-announcement-of-dividends-or-stock-distributions/

This week the SEC Division of Economic and Risk Analysis published a new report including a wealth of data regarding recent trends in public offerings and private placements of securities. The report includes a number of interesting facts about U.S. private placement practice, including: In the last few years, issuers have raised 2-3 times more capital through Regulation D than through Rule 144A. Rule 506(b) remains the most popular way to raise capital under Regulation D, with 97% of all funds raised under Rule 506 being raised under Rule 506(b), rather than the newer Rule 506(c), with issuers choosing not to take the additional steps required by Rule 506(c) to generally solicit investors. Only 6% of Rule 506(b) offerings in the most recent years have contemplated sales to non-accredited investors. Brokers are more likely to be used in Rule 506(c) generally solicited offerings, at 33% of new offerings compared with only 17% of new offerings under Rule 506(b). The issuer fails to file a Form D in as many of 10% of all unregistered offerings eligible for the Rule 506 exemption. The number of Regulation A offerings qualified by the SEC has taken off, from less than 10 per year before the “Regulation A+” amendments (which increased the maximum offering amount to $50 million) to more than 80 in 2016; however, Regulation A still represents a small fraction of the funds raised under Regulation D or Rule 144A. This is consistent with what we are seeing from our Canadian clients who conduct private placements in the United States. Most issuers that rely on a safe harbor are continuing to rely on Rule 506(b), limiting their offering to accredited investors with no general solicitation, or relying on Rule 144A, to allow for a quicker and more streamlined approach. However, Regulation A+ offerings are becoming more popular where the benefits warrant the extra time and expense. The complete SEC report is available at: www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf.

On April 10, 2017, the SEC’s Division of Enforcement brought enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes. These actions arose when public companies, through promoters or communications firms, hired newsletter writers to generate publicity for their securities without publicly disclosing that the writers were being paid. While it is not illegal to hire newsletter writers, Section 17(b) of the Securities Act of 1933 (Securities Act) requires that newsletter writers fully disclose both the amount and the nature of the compensation received, including the dollar amount of a cash payment, the number of shares issued, or any other compensation. Additionally, newsletter writers and persons who adopt, approve or authorize the content of a publication may be liable for untrue statements of material facts or omissions for misleading investors. The Internet provides a ready means for fraudulent promotion of securities though social media, newsletters, chat rooms, emails, online blogs, press releases, and other media. The SEC’s Division of Enforcement is focusing attention on companies using stock promotion schemes that lead investors to believe that they were reading independent, unbiased analyses in newsletters, social media, stock forums, or other media when writers are secretly compensated for promoting a company’s securities. The SEC can bring charges against companies and promoters for these types of violations under various provisions of the Securities Act and Securities Exchange Act of 1934 (Exchange Act), including: Securities Act Section 17(a)/ Exchange Act Section 10(b) and Rule 10b-5: For, directly or indirectly, using interstate commerce to offer or sale any securities by: - employing any device, scheme or artifice to defraud; or - obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or - engaging in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. Section 17(b) of the Securities Act: For, directly or indirectly, using interstate commerce to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof. Exchange Act Section 20(b):  For aiding and abetting violations of Section 17(a) and Section 17(b) of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act. In addition, violations of securities laws may result in criminal prosecution. Allegations of securities law violations or association with firms that are charged with securities law violations may cause liability and embarrassment to a company and its officers, directors and employees. These violations may result in penalties, fines, imprisonment, or sanctions, including barring persons from serving as an officer or director of a public company or participating in certain securities offerings. Companies may be ultimately responsible for the investor relations work performed by investor relations, communication, social media, marketing, and other firms. Companies can take steps to avoid securities law violations by: Completing due diligence and selecting only reputable investor relations, communication, social media, marketing, and other firms to engage in investor relations activities. Limiting the use of paid newsletter writers and making sure that any compensation paid is properly disclosed. Adopting public communications policies that require authorization of company communications prior to dissemination. Carefully reviewing all materials for accuracy to ensure that the disclosure does not contain untrue statements of a material fact or omissions. Making sure that all content is consistent with the company’s public disclosures filed with regulatory agencies. Including forward looking statement and other disclaimers in all materials that are promotional in nature. Involving legal counsel, auditors and other professionals in the review of investor relations materials. Note: This post was originally published on Dorsey’s Governance & Compliance Insider blog here. 

We get asked from time-to-time whether it is advisable for issuers to pay fees to unregistered “finders” for introducing potential investors in the United States to the issuer in connection with securities offerings. The short answer is “no.” Most finders are engaged by issuers under finder’s, advisory, or other arrangements, which typically require payment of “success fees” upon completion of a financing transaction. While these arrangements are sometimes structured to try to hide or disguise the true intent of the arrangement, payment of transaction-based compensation is treated by U.S. securities regulators as a nearly-conclusive indication that a person is engaged in the securities business and should be registered as a broker-dealer. The relevant U.S. federal broker-dealer laws that should be of concern to an issuer using an unregistered finder include: Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act), which makes it unlawful for a person to “effect a transaction in securities” or “attempt to induce the purchase or sale of, any security” unless they are registered as a broker or dealer under the rules and regulations of the Financial Industry Regulatory Authority, Inc. (FINRA). FINRA is the regulatory organization designated by the Securities and Exchange Commission (SEC) to license and regulate broker-dealers. Section 29(b) of the Exchange Act, which provides that every contract made in violation of any provision of the broker-dealer registration requirements “shall be void” as to rights of persons who made or engaged in the performance of such contract. It results in the underlying purchase of securities becoming a voidable transaction that gives the investor a right of rescission, effectively granting a put right to the investor or purchaser. Section 20(e) of the Exchange Act, under which the SEC may impose aiding-and-abetting liability on any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act. The theory behind broker-dealer registration is to provide a gatekeeper to protect investors in the marketplace. FINRA members are required to “observe high standards of commercial honor and just and equitable principles of trade” in the conduct of its business, including determining if an investment is "suitable" for its customer. Finders assisting in transactions rarely make such determinations and view themselves simply as middlemen in making introductions to potential investors. Because unregistered broker-dealers may not adhere to these high commercial standards, the SEC broadly construes the broker-dealer laws and narrowly construes the few permitted exceptions. Under SEC guidance derived from no-action letters, the SEC requires all intermediaries effecting transactions in securities to be licensed, subject to a few limited exceptions. Effecting a securities transaction may include, among other factors, receiving transaction-based compensation, recommending a company or the purchase of its securities, negotiating terms of a securities offering or purchase, attending meetings or presentations where the merits of the investment are discussed, performing or accommodating due diligence efforts, providing valuations or estimates of value, and other activities that facilitate a securities transaction. The consequences of engaging an unlicensed finder can be troublesome: Finder Risks:  Any unlicensed person engaging in activities designed to effect a transaction in securities may violate broker-dealer laws. The SEC or state securities regulators may seek to enjoin the unlawful activities or seek monetary penalties or criminal sanctions. Issuer Risks:  Retaining and permitting an unlicensed intermediary to effect a securities transaction may be a violation of federal and many state laws, and may subject the issuer to possible civil and criminal penalties. Any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act may be subject to aiding-and-abetting liability. Rescission Risks:  A violation of broker-dealer laws creates a right of rescission under federal and/or state securities law. The SEC or state securities regulators may require the issuer to offer investors rescission rights, and the issuer may be required to return the investment. State Securities Violations:  Many states have begun reviewing state notice filings on Form D (which report transactions exempt from registration under Regulation D) and actively monitoring finder’s fees paid in connection with securities transactions. Some states have required issuers to provide additional information related to unlicensed broker-dealers and, in some cases, to certify that finder’s fees or commissions have only been paid in compliance with broker-dealer laws. Accounting Liability Risk:  Auditors may raise accounting issues resulting from paying finder’s fees to unregistered broker-dealers and may require an issuer to account for potential liability arising from rescission rights. Bad Actor Consequences:  An issuer or finder that is convicted of any felony or misdemeanor, is subject to any order, judgment, or decree of any court, or is subject to any order of certain regulators may be ineligible to participate in certain types of securities offerings, including Rule 506 of Regulation D offerings and Regulation A offerings. Using an unlicensed finder can result in broker-dealer law violations. Many times the issue arises in the context of state notice filings and direct inquiries from state securities regulators where finder’s fees or commissions are paid in connection with an offering. Other times, they arise from a failed investment where the investor may assert claims related to broker-dealer law violations to establish a right of rescission. Issuers should use caution in determining whether to engage a finder to assist in financing transactions.   Note: This post was originally published on Dorsey's Governance & Compliance Insider blog here. 

Many cross-border loan transactions involve subsidiaries that are organized in the United States and/or U.S. based collateral. To the extent that the underlying loan is made to a Canadian borrower by a Canadian lender, these transactions are typically documented with loan agreements governed by Canadian law (often under the law of the Province where the primary Canadian borrower is organized, but sometimes based on the law of a Province selected by the Canadian lender). In many of these transactions, in addition to the Canadian law governed documents, the Canadian lenders will also require the use of U.S. law governed documents for guarantees provided by U.S. organized subsidiaries and Security Agreements for collateral owned by U.S. subsidiaries or otherwise located in the United States. Whether or not the requirement to add these additional U.S. law governed documents is prudent and cost effective often depends on several factors, including: 1) the total amount of the loan, 2) the importance of the U.S. subsidiary guarantor to the consolidated balance sheet of the Canadian borrower, 3) the value of any U.S. based collateral, and 4) the nature of the U.S. based collateral. It is also important to understand the reason a Canadian lender would request the additional documentation when the Canadian law governed documents already cover any U.S. based subsidiaries and any U.S. based collateral. Primarily, the additional U.S. law governed documents aid a Canadian lender if and when the lender needs to realize on the U.S. based collateral or otherwise collect against the U.S. organized subsidiary in U.S. courts. As a general matter, U.S. courts should typically give effect to and recognize Canadian law as a valid choice of law, absent fraud or some other public policy concern. Therefore, Canadian law loan documents should be sufficient regardless of the jurisdiction of the subsidiary or the location of the collateral. Canadian borrowers can therefore argue that adding U.S. law governed documents in addition to the Canadian law documents is unnecessary. While there is merit to this argument, the reality is that while U.S. courts should give effect to and recognize Canadian law and they should be able to interpret and impose Canadian law in any proceeding brought in a U.S. court, many lenders simply don’t want to take the risk that a U.S. court would look for an opportunity to negate or invalidate a guaranty or security agreement simply because of the choice of Canadian law when a viable alternative is available. The other argument that is sometimes proffered is that it is better to have a U.S. law governed document if a filing under the Uniform Commercial Code (“UCC”) will be made in the United States for U.S. based collateral or for a U.S. organized subsidiary. Fundamentally, the reasonableness of the request hinges on the cost to draft and negotiate the additional documents vs. the likelihood that they would ever be used and if so the value of any U.S. based subsidiaries as guarantors or the value of any U.S. based collateral. Assuming the borrower is willing to agree to use additional U.S. law governed guarantees and security agreements, lenders will often request that the U.S. law governed documents be “typical” or “market” for similar transactions governed under U.S. law. While this request may be reasonable, in an effort to make the documentation and negotiation as efficient as possible, Canadian borrowers may counter that any U.S. law governed documents simply mirror all of the provisions of their Canadian law counterparts – other than the choice of law provisions and other truly jurisdiction-specific provisions (e.g., referencing the UCC instead of the Personal Property Security Act (“PPSA”)). In addition, because most lenders require legal opinions as to the enforceability of loan documents, most borrowers will need to engage separate U.S. counsel to negotiate the documents and provide the necessary legal opinions. Ultimately, the best approach to the form of the documentation and the scope of any opinions will again depend on the cost to draft and negotiate the additional documents vs. the likelihood that they would ever be used and if so the value of any U.S. based subsidiaries as guarantors or the value of any U.S. based collateral. As with any loan transaction, the costs associated with additional U.S. law governed documents needs to be balanced with the reality that there are some advantages to a lender in having different options in the event they need to enter U.S. courts to enforce their loan documents, while at the same time keeping in mind the value of the guarantees and the U.S. based collateral relative to the total value of the loans.

In December 2015, the Canadian Securities Administrators (CSA) announced an amended regime for a prospectus-exempt rights offering in Canada. This amended regime allows certain public companies in Canada to conduct a prospectus-exempt rights offering without prior CSA review of the rights offering circular, and using a greatly simplified rights offering circular that assumes, without incorporation by reference, that the shareholder is familiar with the issuer’s other continuous disclosures. While the new regime revitalized the market in Canada for rights offerings, it raised several questions regarding the extension of the rights offering to U.S. shareholders. Form F-7 under the Multi-Jurisdictional Disclosure System (MJDS) has historically provided a means for eligible Canadian issuers to register securities issued in a rights offering under the U.S. Securities Act of 1933, as amended (the 1933 Act). Based on the SEC’s determination that Canadian disclosure requirements are adequate, Form F-7 allows the offering document (whether prospectus or rights offering circular) to comply principally with Canadian requirements, imposing only a few additional SEC requirements. Unlike most SEC registration forms, conducting an offering on Form F-7 does not subject the issuer to ongoing SEC reporting requirements. However, because the securities are treated as having been issued in a registered offering, the issuer is liable under the 1933 Act for any material misstatement or omission in the offering document, as it is in other registered public offerings. Following the passage of the December 2015 amendments, it was unclear whether the SEC would allow the use of Form F-7 under the new, abbreviated Canadian regime. Preliminary verbal guidance received from the SEC’s staff suggested that the staff was not, at that time, sufficiently comfortable with the new regime to give any assurance of Form F-7’s availability in such circumstances. It was also unclear how, if such registration was permitted, an issuer would protect itself from liability under the 1933 Act for material misstatements or omissions, given the limited amount of disclosure that is required or permitted under the new Canadian regime. As a result, since December 2015, Canadian issuers have not extended rights offerings under the new regime into the United States on Form F-7, and have often prevented U.S. shareholders from participating in the rights offering. Last week, the SEC published a no action letter allowing the use of Form F-7 for rights offerings by eligible Canadian issuers under NI 45-106, as amended by the CSA. The no action letter was issued following the receipt of an acknowledgment from the law firms submitting the request that: “When so registering securities on Form F-7, an issuer would need to assure that the registration statement and the prospectus satisfied the antifraud and liability provisions under the [1933 Act]”, and assurances that: “To do so, for purposes of the offering materials made available to U.S. holders, the issuer could provide a brief description of its business, risk factors, discussion of results of operations and capital resources and such other matters as it deemed material or otherwise in the offering circular.” Therefore, it appears that the SEC will allow the use of Form F-7 for rights offerings extended under NI 45-106, as amended by the CSA; however, a Canadian issuer taking advantage of this form of registration must include in the offering document sufficient information to protect itself from liability under the 1933 Act for material misstatements or omissions. It remains to be seen how the market will react to the SEC’s no action letter, including (1) the amount of disclosure that issuers will be comfortable including, and omitting, from a rights offering circular that is filed on Form F-7, knowing that the offering will be subject to U.S. prospectus liability, and (2) how frequently issuers will decide to follow this approach.