SEC Disclosure Matters

Securities offerings that are exempt from the SEC’s registration requirements often hinge on whether some or all of the investors are “accredited investors.” There are various categories of accredited investors for business entities, but for individuals, the categories relate to the investor’s annual income, net worth or whether the individual is a director or executive officer of the issuer.

The underlying policy of the current definition of accredited investors is that rich people (a term not used in the actual rules, obviously) can be assumed to have a level of financial sophistication such that they would conduct adequate due diligence before making an investment. Accordingly, accredited investors require less disclosure about proposed securities offerings. This assumption is, shall we say, not attuned to human reality. The obvious group of accredited investors that are not necessarily sophisticated is heirs and spouses of wealthy business people, who may have no background at all in finance and investment matters. But even for those accredited investors who have directly earned the money that grants them that status, plenty are in fields such as sports and entertainment where the particular skill that is remunerative to them has nothing to do with investing. Additionally, many white collar professionals such as doctors, engineers and even some attorneys may be highly educated, but they are not able to make heads or tails of a balance sheet and income statement. …

A Possible Change to the “Accredited Investor” DefinitionRead More »

The SEC’s Division of Economic and Risk Analysis (DERA) recently issued a paper about over-the-counter stocks, i.e., stocks of publicly traded companies that are not listed on a national securities exchange like the New York Stock Exchange or Nasdaq. While the main subject of the paper is on the inadvisability of individual investors purchasing OTC stocks, my focus here, briefly addressed in the paper, is on whether the companies themselves should consider transactions that result in them having OTC stock. For example, companies that are not in a position to complete a traditional IPO may be able to go public via a backdoor method such as merger with a SPAC or a reverse merger.

For these companies, the usual plan is not to remain an OTC company forever, with thinly traded stock and low institutional ownership. Rather, the hope is that, with the capital usually raised concurrently with the transaction that made the company public, it can successfully execute its business plan such that it can meet the listing standards for admission on the NYSE or Nasdaq at a later date. However, this scenario rarely plays out in practice. Studies cited in the DERA paper find that, over a nine-year period, less than 9% of OTC companies became listed on an exchange, and even those that do have a poor average investment return.

Accordingly, any company planning to go public by alternative means has to consider the possibility of remaining in OTC status indefinitely. There are some advantages to being public. It may be easier to attract employees with equity compensation packages, since there is an easier path to eventually selling shares than would be the case with a private company. Also, public company stock can be used to acquire other companies (though a target company may be skeptical about receiving OTC stock). Finally, there are forms of financing like PIPEs that are available only to public companies (though the terms of those transactions are not necessarily any more company-favorable than investments that private companies can secure). …

The Pitfalls of Being an OTC Public CompanyRead More »