Regulating Social Media Influencers

The fact that social media influences consumers’ spending decisions should come as no surprise.  Given this power, the Federal government is now applying its rules to the growing phenomenon of online marketing and influencers.

Federal Trade Commission

The Federal Trade Commission, the FTC, is beginning to crack down where social media influencers fail to disclose that their endorsement is paid and often directed, like an advertisement.

For example, the FTC recently settled with Warner Brothers which had used one of the most popular social media personalities, PewDiePie with over 50 million Youtube followers, to promote its new videogame without any indication that Warner Brothers paid for and directed the endorsement.

The FTC wants more clarity for consumers.  A paid endorsement, for example, might include an indication of this fact by including the hashtag #ad early in the copy.

Bloomberg, the online datasource and magazine, carried an interesting story on the FTC’s crackdown which also highlights the growing influence of online content for consumer marketers (click here).

Excerpt

It’s up to the FTC to be more clear and consistent about their policies and enforcement, she said. A lot of influencers think they are following the rules, but in fact are falling short. More than 300,000 sponsored posts on Instagram in July used hashtags like #ad, #sponsored and #sp, up from about 120,000 a year earlier, according to Captiv8. The FTC thinks #ad is okay if it’s at the beginning of a post, but #sp and #spon aren’t.

“If consumers don’t read the words, then there is no effective disclosure,” Ostheimer said. “If you have seven other hashtags at the end of a tweet and it’s mixed up with all these other things, it’s easy for consumers to skip over that. The real test is, did consumers read it and comprehend it?”

Food and Drug Administration

The FTC is not the only Federal agency focusing on online endorsements.  Not long ago, a drug company using Kim Kardashian for a social media promotional post, ran afoul of the FDA, the Food and Drug Administration (click here).

Securities and Exchange Commission

Online promotion of investments, including the new forms of offerings such as crowdfundings and Reg A+ offerings is regulated by the Securities and Exchange Commission, the SEC.

At this time, there appears to be a great deal of experimentation by social media marketers as to what’s effective yet acceptable by regulators.

Monarch Bay is closely following developments in social media marketing especially as applied to the capital markets and the new offering techniques.  For example, Monarch Bay recently posted “Crowdfunding Communication Do’s and Don’ts” (click here).

Please contact Monarch Bay to discuss how these evolving social media marketing techniques might benefit your company’s capital market goals.

New S-1 Registration Provisions

A provision of the recently enacted legislation, known as the FAST Act, makes it easier for smaller public companies to conduct registered offerings.

The reason why this is significant is that smaller public companies face a very unreceptive market when raising capital via private placements, known as PIPE offerings.

Burden to Qualify to Invest in Private Placement

In general, the requirements to qualify as an investor in a private placement leave only a small universe available to consider a private placement offering.

A private placement investor must undergo the paperwork burden to prove the investor qualifies as an accredited investor, with

  • the capability to evaluate the risks of the offering;
  • the willingness to forego immediate liquidity of the securities purchased in the offering; and
  • the ability to sustain the total loss of the investment.

Given the limited universe of investors for private placement offerings, in today’s capital markets, smaller public companies, especially OTC listed companies, typically find only toxic financing available from PIPE investors.  That is, the issuing public company may be able to raise capital but the form of the securities demanded by investors has features which are extremely expensive to the issuer and may, in certain circumstances, result in severe negative impact on the issuer’s stock price, perhaps due to substantial dilution of shares.

In contrast with the limitations of a private placement, an investor in a registered offering:

  • has no paperwork burden to prove eligibility to purchase the securities; and
  • has immediately tradable securities, subject only to the liquidity of the company’s stock.

Given these features of a registered offering, issuers can tap a much broader universe of potential investors for a registered offering which should enable an issuer to obtain better terms than for a private placement.

Why then don’t smaller companies issue shares through registered offerings?

The reasons typically given include:

  • raising capital via a registered offering involves upfront and ongoing costs for legal and accounting work to file an S-1 registration statement without certainty of success in actually raising capital,
  • offering size may be small in relation to the fixed upfront costs noted above; and
  • filing a registered offering is public and would enable a stock short seller to short the issuer’s stock depressing its price then cover the short at a profit with stock purchased on the offering.

The new rules enabled by the FAST Act don’t eliminate all these impediments but eliminate one of the costs and risks, which is the requirement to file additional S-1 supplements once the S-1 is declared effective.

Final rules issued by the SEC on January 13th, implementing the FAST Act, enables companies using the S-1 form of registration statement to incorporate by reference required SEC filings after the S-1 is declared effective.

Up until now, S-1 registration statements could only incorporate by reference prior SEC filings. Larger companies, able to use S-3 registrations could incorporate future SEC filings.

Now a smaller company using an S-1 registration statement, which makes the election to incorporate future SEC filings by reference, need not file an update to its S-1 registration when a new SEC filing is required, such as an 8-K or 10-Q, and risk SEC review and comments.

This is a substantial cost and time saving benefit of this provision of the FAST Act.

Interestingly, this is not the feature which got the attention when the FAST Act was passed or the final rules issued.

Please contact us to discuss your capital market plans.

For background reading on this and other capital market provisions in the FAST Act, please click on the following:

Goodwin Procter article

Excerpt:

The amendment to Form S-1 requires smaller reporting companies that make this election to state in the prospectus contained in the registration statement that all documents subsequently filed by the smaller reporting company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act before the termination of the offering shall be deemed to be incorporated by reference into the prospectus.

This amendment will permit smaller reporting companies to eliminate the additional costs and delays of manual updates to “shelf” registration statements on Form S-1 for resale transactions and continuous offerings that commence promptly after effectiveness and continue for a period in excess of 30 days after effectiveness. This amendment does not change the current requirement that companies must conduct delayed offerings under Rule 415(a)(1)(x) under the Securities Act of 1933 using Form S-3 or Form F-3.

In addition, this amendment does not change the eligibility requirements for companies that wish to incorporate documents filed after the effective date of the registration statement under General Instruction VII to Form S-1. The principal eligibility requirements include the following: (1) the company is required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act, (2) the company has filed all reports and other materials required by Sections 13(a), 14 or 15(d) of the Exchange Act during the preceding 12 months or such shorter period as the company was required to file such reports and materials, (3) the company has filed an annual report required under Section 13(a) or Section 15(d) of the Exchange Act for its most recently completed fiscal year, (4) the company is not a blank check company, a shell company or a registrant for a penny stock offering and (5) the company is not registering an offering that effectuates a business combination transaction).

SEC Issues Final Reg A Offering Rules

 

The SEC released its long awaited Final Rules designed to make Reg A offerings a practically useful means for private companies to raise capital.

Reg A defines the conditions under which a private company can raise capital in an offering exempt from the SEC’s registration requirements.

Shares purchased pursuant to Reg A, therefore, are freely tradable post-offering, that is, for securities regulation purposes.  Salability of the shares is still practically limited by the liquidity of the market for the shares.

One of the more attractive features of a Reg A offering is that a company can sell to either non-accredited or accredited investors.  This is a major difference from the restrictions imposed on companies using the 506 exemption from SEC registration.

Under the JOBS Act, the SEC was instructed to update the Reg A rules, now known as Reg A+ rules, which had fallen into disuse.

Reg A+ Offerings

Companies that plan to offer securities under the new Reg A+, must submit an offering statement to the SEC for qualification. 1

The Reg A+ offering statement, however, is far simpler than that required for a registered public offering.2  It will require, however, 2 years of financial statement including balance sheets, income, cash flow and equity statements if the company has been in existence that long.

One of the major changes under Reg A+ is the creation of two tiers of offerings, Tier 1 and Tier 2.

Tier 1 of Reg A+ Offerings

Tier 1 permits offering up to $20 million within a 12 month period.

Tier 1 issuers have essentially no ongoing post-offering disclosure requirements other than reporting on securities sold pursuant to the offering.3

Tier 1 offerings, however, still require state securities regulator review of the offering but under a coordinated review process designed to reduce the state “blue sky” review burden.

Tier 2 of Reg A+ Offerings

Tier 2, in contrast, permits offering up to $50 million within a 12 month period but preempts state securities regulation entirely.

Offerings under Tier 2, require the company to make post-offering filings with the SEC including annual and semi-annual financial statements as well as other material current events. 3

A Tier 2 offering also triggers the requirement that the financial statements in both the offering statement and subsequent annual filings be audited.

Each of Tier 1 and Tier 2 offerings have other limitations, including limitations on secondary selling,  which are explained in the SEC’s press release (click here) and Final Rules (click here).

Final Rules Pg. 143

Final Rules Pg. 118

Final Rules Pg. 160

Morrison Foerster, the law firm, has also posted a useful and readable recap (click here).

The NY Venture Hub also posted a readable article (click here).

SEC’s New “Broken Window” Policy

Applying a phrase from street cop law enforcement, a “broken window” policy, the SEC’s new enforcement zeal for what were considered minor infractions sends a signal which companies need to heed or suffer the consequences.

The SEC now has tools to enable it to identify and pursue a range of issues as described in a recent post on this site (click here).

This has resulted in enforcement actions against companies, board members and executives for:

Stock transaction and ownership reporting rule failures

Audit committee chair reporting failures, and

Corporate officer certification errors.

Failure to heed the message risks you and your firm becoming the next example.

Winston Strawn, the law firm, produced a podcast and slide deck on the SEC’s “broken windows” policy which is worth the review (click here).

Public Company SEC Topics Webinar

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Board members and corporate executives of public companies will find this webinar a valuable discussion of key issues about the new energized SEC enforcement approach.

Latham & Watkin’s webinar covers many issues and examples including:

  • SEC’s greater use of technology to permit investigation and enforcement of infractions previously unobserved;
  • Increasing use of whistleblower incentives to discover and prosecute infractions;
  • Greater coordination between SEC Divisions including Corporation Finance and Enforcement.

It’s better to be forewarned than to remain unaware and vulnerable.

Click on this link to go to the sign-up page for Latham & Watkin’s “Securities and Exchange Commission: Critical Issues Facing Public Companies” (Duration: 60 minutes)

SEC Charges Two Audit Committee Chairs

In another shot across the bow, the SEC has charged two companies’ Audit Committee Chairs for failing to act on obvious red flags of fraudulent accounting and financial reporting.  Both of the companies were primarily operating in China but the Audit Committee Chairs are US citizens.

While some might be inclined to discount this warning signal because of the China connection, Daniel Goelzer, a partner with law firm Baker & McKenzie and former SEC general counsel and former member of the Public Company Accounting Oversight Board suggests otherwise.

Click here to read the article from Baker & McKenzie from which this excerpt is drawn:

“During the past year, the SEC chair and staff have announced a new focus on gatekeepers, such as attorneys, accountants, and directors, and these cases seem to illustrate how the Commission intends to apply its gatekeepers program to audit committee members,”

Coming on the heels of the SEC charging company executives for false certification (click here), this seems to signal the SEC’s serious intent to enforce its rules rather than look the other way.

Below are links to a Compliance Week article and two SEC documents describing the circumstances and charges of the two cases mentioned.

Compliance Week article: http://www.complianceweek.com/blogs/accounting-auditing-update/sec-charges-two-audit-committee-chairs-for-blind-eye#.VAODSWx0wdU

Agfeed’s SEC Complaint: http://www.sec.gov/litigation/complaints/2014/comp-pr2014-47.pdf

L&L Energy Cease and Desist Order: http://www.sec.gov/litigation/admin/2014/34-71824.pdf

SEC Charges Company Exec’s with False Certification

In a rare case, the SEC has charged the CEO and CFO of Quality Services Group, a computer equipment company, with falsely certifying its financial statements.

The charge stems from an SEC review of the company procedures which revealed that company management misrepresented the state of its internal controls over financial reporting to its auditors, and not from a misstatement of financial results.

Excerpt from SEC Press Release

The Sarbanes-Oxley Act of 2002 requires a management’s report on internal controls over financial reporting to be included in a company’s annual report. The CEO and CFO must sign certifications confirming they’ve disclosed all significant deficiencies to the outside auditors, reviewed the annual report, and attest to its accuracy.

“Corporate executives have an obligation to take the Sarbanes-Oxley disclosure and certification requirements very seriously. Sherman and Cummings flouted these regulatory requirements and misled investors and external auditors in the process,” said Scott W. Friestad, associate director in the SEC’s Enforcement Division.

FierceCFO, the online newsletter noted

Indeed, many companies and executives are likely taking a careful look at internal controls, given the charges the Securities and Exchange Commission levied recently against Quality Services Group, a computer equipment company in Florida.

Click here to read the SEC press release.

Click here to read the FierceCFO article.

SEC Trends for Public Companies

This webinar will include practical tips to help your company avoid SEC trouble.

Latham & Watkins, the law firm, has produced valuable webinars which are well worth the time (which is not universal with webinars, in my opinion).

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Please join Latham & Watkins for a complimentary webcast discussing SEC trends for public companies in the areas of accounting and financial fraud.

Click here to go to the webinar.

Topics

• The Re-Tooled SEC – A smarter SEC takes on big data analytics

• The New Era of Creative and Aggressive Enforcement – The “broken windows” approach to enforcement and the lower bar for SEC actions

• Hitting and Avoiding the SEC’s Radar Screen – Practical tips for avoiding compliance issues and enforcement action

Speaker
John Sikora, Partner, Latham & Watkins LLP (Chicago), former SEC Assistant Director in Enforcement and the Asset Management Unit

Sponsor
Latham & Watkins LLP is a leading global law firm dedicated to working with clients to help them achieve their business goals and overcome legal challenges anywhere in the world. The firm has earned considerable market recognition based on a record of landmark matters and a unified culture of innovation and collaboration. From a global platform of offices covering the world’s major financial, business and regulatory centers, the firm’s lawyers help clients succeed. For more information, visit www.lw.com.

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Unintended Consequences for Bond Market Liquidity

Regulatory changes under the Dodd-Frank Act designed to reduce the risk of another financial market downturn may have the reverse effect so suggests an article in “FierceCFO”, the online magazine.

My takeaway from the article is that new regulations forcing large banks out of proprietary bond trading and concentrating it in the hands of hedge funds will increase the risk of illiquidity in the event of another period of instability.

The article suggests that in the event of another period of economic uncertainty, hedge funds will quickly step away from the market accelerating illiquidity.  Regulators have much less leverage over hedge funds to maintain some level of liquidity than they have over the banks.

Click here to read the article on “FierceCFO”.

“FierceCFO” article summary

Liquidity: How regulators are fueling the next crash

We’re not fans of deregulation, but the opposite does have unintended consequences. And TABB Group just released a report that suggests the changes brought about by Dodd-Frank and other regulatory moves made in response to the last financial crisis may set the stage for the next one. How so? By shifting bond trading from banks to hedge funds, which have more freedom to pull in their horns just when the market needs the opposite. In other words, liquidity could dry up at just the wrong time. The money quote comes from Colin Teichholtz, co-head of fixed income trading at Pine River Capital Management: “These new liquidity providers can just turn off the machine in bad times,” Teichholtz said. “Illiquidity can beget illiquidity and there is no obligation on these players to make market. The danger is that the dealers won’t be around to pick up the slack. The optimum business model won’t be to warehouse risk.”

In an interesting development on this topic, Liquidnet, an equity trading “dark pool” is expanding into bond trading to provide an additional trading venue for the bond market.  As the article above stresses, the trading activity conducted by hedge funds through “dark pools” can dry up at any time if parties step to the sidelines.

Click here to read the article on FierceFinanceIT about Liquidnet entering bond trading.

 

SEC Charges IR Exec. With Selective Disclosure

As a timely reminder to those of us who work with public companies, the SEC just charged an investor relations person at a public company with selective disclosure of what was material non-public information.

Those of us who’ve worked with public companies for many years recall the outrageous abuses which prompted Reg FD in order to promote full and fair disclosure of material financial information.

Even after Reg FD, however, occasionally company executives forget or get sloppy about following the disclosure rules strictly.

This case, then, is a valuable reminder to us all.  Please click here to take you to the article by Holland & Knight which describes the circumstances of the case.

http://www.jdsupra.com/legalnews/sec-charges-former-head-of-investor-rela-32855/?utm_source=jds&utm_medium=twitter&utm_campaign=securities
Post by Dennis McCarthy
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