Registration of Shares

Companies and shareholders with stock to sell publicly can register their shares with the SEC (or qualify shares through the exemption from registration that is Regulation A+). If a company's first registration is for the public sale of stock by the company, it is called an initial public offering (IPO). Subsequent registrations are called follow‐ons or, sometimes, secondary offerings.

Shareholders whose shares were not registered when they acquired them also can complete a registration known as a resale registration. They may undertake to register the shares when they need liquidity and the ability to sell the shares publicly and cannot wait long enough for an exemption to apply. For example, one exemption, under Rule 144, allows public sale of shares in a company that was never a shell without registration after the shares have been held for either six months or one year, depending on certain circumstances. Another exemption permits public resale without registration if the shares were issued pursuant to a bankruptcy reorganization.

In most private investment in public equity (PIPE) transactions, investors acquire unregistered shares that bear a legend prohibiting transfer except upon registration or an available exemption from registration. They do so with the understanding that the issuing company will effect a resale registration on the investors' behalf, generally within 90 to 120 days. This is usually preferable to a secondary offering because the completion of fundraising can happen more quickly and involves fewer regulatory hurdles.

The resale registration generally is not reviewed by the Financial Industry Regulatory Authority (FINRA) and is subject to a much less stringent state securities law (or blue sky) review than an IPO. Of course, in exchange the company generally raises money in the PIPE at a discount to the stock's trading price, because the investor takes a short‐term liquidity risk.

Registration takes time. Someone must write the public offering prospectus or offering document, which is included as part of the registration statement filed with the SEC, making sure that it includes the information the SEC requires. Much like the offering circular for a Reg A+ offering, a prospectus included in a registration statement must include at least two years of audited financial statements, a year‐to‐year comparison of results, executive compensation, business description, review of litigation, risk factors, a full capitalization chart, a detailed discussion of dilution, disclosure of related‐party transactions, and a whole host of exhibits, including material contracts, corporate charter, and bylaws. Other elements of the registration statement include a summary of prior securities offerings and certain promises the company must make to the SEC in order to complete the registration.

This registration statement (including the prospectus) is filed and then reviewed by the SEC's staff of examiners in the Division of Corporation Finance. The SEC must respond to the filing of an original or amended registration statement within 30 days. It is not unusual to go through three or four iterations of the filing before it is approved, upon which the SEC declares it “effective” and it can be used to sell shares publicly.

In an IPO registration (remember, Reg A+ is an IPO but is exempt from registration and so is distinguished from this), a prospectus must go to the buyer the first time each newly registered share is sold. SEC rules, however, stipulate that shares sold in resale registrations do not have to be accompanied by a prospectus as long as one is publicly available. The registration must be kept current until all shares registered under that registration statement are sold by the selling shareholders. This may require quarterly and other updating, but that is usually not difficult to do.

To make this a little easier, in 2016 the SEC adopted rules permitting smaller reporting companies (as long as they are not considered penny stocks) to “forward incorporate by reference” their future SEC filings into the resale prospectus to keep it current. Therefore, there is typically no longer a need to constantly update, supplement, or amend the registration after effectiveness. The theory is that potential purchasers of the stock being resold should look at all the SEC filings of a company before investing. The SEC was required to adopt these rules under the Fixing America's Surface Transportation (FAST) Act of 2015.

Exemptions from Registration: Rule 144

As mentioned earlier, stock must be registered with the SEC before it can be sold publicly, unless an exemption applies. A number of exemptions are available, depending on the circumstances and facts of a particular situation. For example, as mentioned before, certain issuances in connection with a bankruptcy reorganization are exempt from registration, and shares issued may, in certain circumstances, be immediately resold if there is an existing trading market for them.

The most popular exemption from registration is Rule 144. As previously discussed, shares can become freely tradable without registration as long as they are held for a certain period of time. In general, a nonaffiliate shareholder of a full SEC reporting company must hold unregistered shares for six months. During the following six months the company must remain current in its SEC filings if a Rule 144 sale is to be available. After shares have been held for one year, they are freely tradable by nonaffiliates without these restrictions.

If the holder is an affiliate of the company, meaning an officer, director, or other control person (this is generally presumed if one owns over 20 percent of the outstanding shares or has the ability to effect policy change in the company), no shares become freely tradable for six months. After the six‐month period, the affiliate can sell up to 1 percent of the company's outstanding stock (or 1 percent of the average weekly trading volume, whichever is higher) for as long as the holder remains an affiliate, and for 90 days thereafter. If shares are purchased from an affiliate, a new holding period begins (as if the affiliate never started his own holding period). Thus, an affiliate cannot allow a purchaser to tack his holding period.

As mentioned before, these holding periods are adjusted in the case of shells so that sale under Rule 144 is available following a reverse merger, starting the later of six months from acquisition of the shares or one year after the reverse merger and filing of the super Form 8‐K. Also recall the evergreen requirement, which does not permit a sale of stock in a former shell under Rule 144 if the company has not been current in its SEC filings for the 12 months prior to sale. In addition, Rule 144 is generally not available for the resale of shares issued while the company is a shell.

Another Rule 144 wrinkle relates to derivative securities such as warrants or options. If one receives an option on a certain date and holds it for a year, then exercises the option for the cash purchase price, a new holding period begins after that cash purchase. If, however, the option or warrant simply is traded for common stock without any cash payment, an exception in the rule allows what is known as tacking of the holding period from the day the option or warrant was issued. In other words, in so‐called cashless exercise transactions, the holding period relates back to when the original derivative was received.

Cashless transactions work as follows. Imagine a warrant to purchase 100 shares of stock. It has a $3 per share exercise price and was issued on January 2, 2017, when the stock was trading at $2. This warrant is known as being out of the money because the warrant exercise price is above the current market price and it does not make sense to exercise at that time. A year later, on January 2, 2018, the stock moves up to $6 a share, making the warrant in the money, because the holder can exercise the warrant for $3 when the stock is selling in the market at $6.

A holder can exercise the warrant for cash at $3 per share, upon which a new holding period begins. Now he must wait at least another six months under Rule 144 to sell the shares. Alternatively, if permitted by the terms of the security, the holder can exercise a warrant for 50 shares by turning in the warrants for the other 50. In other words, the holder returns 50 warrants, which now have a net value of $3 per share (the $6 market price less the $3 exercise price), which becomes the purchase price for the other 50.

The negative side of the cashless event is that the holder must give up a portion of his holdings. The positive side, besides avoiding the use of cash, is that the holder can tack the holding period and has the immediate ability to sell the underlying shares under Rule 144. PIPE investors typically receive cashless exercise warrants as part of their investment. They like this cashless exercise feature, which protects them from the risk that the company will not succeed in completing the registration of its primary stock holdings purchased from the company. (After a registration, Rule 144 will not be needed.) At least they know that one year after closing the PIPE transaction they will be able to sell some of the shares underlying their warrants, as long as the warrants are in the money and there is a liquid market for the shares.

This same analysis applies to preferred stock or convertible debt. In both cases, the security usually can be exchanged for common stock on some basis, without payment of additional cash. Under Rule 144, because one security is exchanged for another, the holding period relates back to the date of acquisition of the preferred stock or convertible debt. Again, in PIPE transactions involving these securities, an investor utilizing this cashless feature has some protection if the resale registration is not completed.

Private Offerings During Registration

Until 2007, one of the basic no‐no's of a primary offering or resale registration was that, with narrow exceptions, one could not pursue a private offering of company securities when a registration is pending with the SEC (this was also true at the time for Regulation A IPOs). In a famous no‐action letter, the SEC had ruled, again with very few exceptions, that the only private placement one could pursue during a registration was an offering to qualified institutional buyers (QIBs), as defined in SEC Rule 144A.

Qualified institutional buyers are (1) entities that, either acting for their own account or others, own or invest on a discretionary basis at least $100 million in securities of issuers not affiliated with the company selling securities to the QIB, or (2) securities dealers who own and invest at least $10 million in securities not affiliated with the company. Therefore, many usual sources of financing—angels, venture firms, and accredited investors—were unavailable while a registration statement was pending. Occasionally, depending on circumstances, the SEC would allow an exception.

This interpretation prior to 2007, which prohibited most private placements during a pending offering or resale registration, existed to make sure that one of the provisions of Regulation D Rule 506(b) was not violated. The provision, as noted earlier, says that when a company wishes to complete a private placement, it may not engage in a “general solicitation” of investors. The offering documents filed pursuant to the registration are publicly available during the SEC review process.

In 2007, as part of a rule proposal relating to Regulation D that appears to have been otherwise abandoned, the SEC issued immediately effective new guidance that mostly eliminated the restriction previously noted. The new interpretive guidance makes clear, essentially, that any otherwise legitimate private offering of securities may be able to move forward, even while a Securities Act registration is pending, so long as the investor was not solicited using the pending registration, and the investor was not directed to the company as a result of the pending registration. The actual language is more technical, and I urge you to consult with counsel in specific circumstances.

In the final rules on Regulation A+, the SEC confirmed that this same approach applies to public offerings there. A company can complete a concurrent private placement, even if it prohibits general solicitation, so long as investors are not solicited or directed to the company by the Form 1‐A or any testing‐the‐waters materials.

One major benefit of the S‐l, however, is that if a company has many shareholders whose shares would not become publicly tradable under Rule 144 if it went public through Form 10 (which does not register individual shares and relies on enough shareholders being able to sell under Rule 144 without registration), the S‐l effects the removal of all trading restrictions on the shares being registered to be resold.

Engaging Professionals

A cadre of expert professionals is necessary for the timely completion of an S‐l filing. Necessary experts include auditors, legal counsel, a transfer agent, SEC electronic filing services, possibly printers, and others. As stated earlier, it is a good idea to engage an investment banker or other Wall Street veteran to assist you in selecting these professionals. Indeed, the professionals may advise that an S‐l is not the most advantageous route for a particular company.

Identifying Shareholders

The next decision, given that this is a resale registration, is determining which shareholders will have their shares registered. The first question to ask is which of the company's shareholders may already have the ability to sell their shares publicly under Rule 144. (Remember, technically a resale registration is made on behalf of the selling shareholders, not on behalf of the company.) Some shareholders—those who are not affiliates of the company—will have owned their shares for six months. Under Rule 144, in most cases these shares may be traded without prior registration and would not need to be included in the resale registration.

Equally, the company or its investors may wish to restrict which shareholders will have the right to have their shares registered. For example, a key member of management who may have held shares for a short time may wish to have his shares registered, but investors may feel it is not desirable for a member of management to have the ability to cash out his company ownership.

At this time, an analysis of the timing of the financing makes sense. If the company is considering a PIPE or other financing before it goes public, it can include the investors' shares in the S‐l registration and will be tradable as soon as the registration becomes effective. Those who invest early, however, take a risk that the S‐l or other going‐public event will never occur and they will be left with illiquid securities.

The flipside of limiting who gets to register has to do with the float. The larger the number of shares and shareholders available to resell in the public market, the stronger the potential that a robust and liquid trading market will develop, thereby creating a reasonable float in the outstanding shares of the company.

Here it is appropriate to explain how the Reg A+ rules address resale filings. Unfortunately, in most cases these rules do not permit the use of a Form 1‐A to allow the public resale of shares unless there is a concurrent public offering of new shares by the company. The SEC requires that the dollar value of shares being resold cannot exceed 30 percent of shares being sold in a Reg A+ public offering for a company's first Reg A+ filing and for the first year thereafter. This requires a contemporaneous public offering. As an example, in order to publicly resell $10 million in securities there must be an IPO for at least $33.3 million at the same time.

Therefore, while a potential Reg A+ issuer could conduct a Reg D offering before its IPO and promise public resale as part of the IPO process, it cannot complete a Reg D offering and go public solely through the resale as is possible with a Form S‐1. Therefore we would not tend to call these filings “self‐filings” since they would merely accompany an IPO.

In its release, the SEC stated that they did not want to encourage allowing the use of Reg A+ when no new funds are being raised. If the interest in self‐filings grows, however, so might the drumbeat for the Commission to reconsider this restriction. If the prospect of a Reg A+ resale filing helps raise money in a Reg D private placement prior to filing, the same goal is achieved.

Preparing and Filing the Document

The preparation of the contents of the S‐1 filing is similar to the preparation of a super Form 8‐K following a reverse merger. Usually, the attorneys, with help from management, take the lead in putting the document together. The basis of the filing is a well‐written business plan prepared by management, which is then transformed into a prospectus.

The auditors must complete their two‐year audit, as well as assisting management in preparing the MD&A. In this section, management must describe, line item by line item, what changed from year to year and from quarter to quarter (if it is the middle of a year), and why it changed.

Once the filing is ready, it is sent for “Edgarization” under the SEC's Electronic Data Gathering, Analysis, and Retrieval system (EDGAR). As we have discussed, EDGAR is the electronic filing system that the SEC fully implemented in 1996.

Once all the approvals of the Edgarized version of the filing are obtained, a company authorizes the EDGAR service to push the button and file. The filing date is the same as the day the files were sent, as long as this occurs before 5:30 P.M. Eastern time. The filing date can be important, as the financial information in the filing must be current, in most cases no more than 135 days old. If the financials go stale, it may be necessary to input updated information and then file.

The FAST Act in 2015 added another helpful change. It provides, essentially, that if at the time of your initial SEC filing you reasonably expect that certain financial statements will not need to be included in the final effective filing, then you can exclude those financial statements from the initial filing. If, for example, your initial filing is made in early January 2018, you would have had to include full annual audited financial statements for 2015 and 2016 (assuming your fiscal year is a calendar year).

However, after mid‐February 2018 in this scenario, you would have to include annual audited financials for 2016 and 2017, and you no longer would need 2015. Since it is likely that you will not complete the SEC review process by mid‐February, the new law allows you to exclude the 2015 audit from that initial filing since it will not be required at the end of the process.

We should note that the SEC has confirmed that this flexibility also applies to Reg A+ filings even though the law technically limits itself to registration statements. This change has provided some helpful relief in allowing companies to avoid wasting time on preparing financial information that ultimately will not be needed.

SEC (and FINRA) Comments and Revisions

After filing comes waiting. Sometimes the response from the SEC arrives in less than 30 days, but not usually. The company typically receives a formal comment letter from the SEC examiner who reviewed the filing. FINRA may need to review the document as well, to determine if any interest held by those individuals or entities who are selling shares violates the limits on underwriting compensation. FINRA's review has no specific time frame and can take quite a bit of time.

Most professionals rank SEC comment letters by the number of comments received. “We only got forty comments” is a common happy response to a first filing. I think, though, that quality of comments is more important than quantity. I once received 72 comments on an initial filing, and felt very unhappy. But as I went through the comments, it was clear that very few of them were substantive, and the great majority were cosmetic or minor. That, to me, is better than receiving 40 difficult comments to address. In contrast, recall that recent Reg A+ filings generally have received fewer than 10, almost always very minor, comments. It should be noted that the SEC examiners, in recent years, generally have been giving fewer comments to S‐1s than before 2010.

An S‐l allows a reasonable and flexible amount of response time (unlike a Form 10 filing, which, as will be discussed later, comes with a ticking 60‐day clock); however, a response to the SEC is mandatory. If they do not receive a response, the SEC will eventually decide, after a warning first, that the registration has been withdrawn and abandoned.

SEC comments tend to be divided between financial and non‐financial topics and, therefore, must be reviewed with auditors as well as company officials. The team then responds to the comments. In some cases, agreeing with a comment is no problem (such as when it suggests that a risk factor is too generic and must be removed). In some cases, responding to a comment requires a project, such as making changes to the financial statements or altering a business description.

In other cases, the company simply disagrees with a comment and wishes to express its view. For example, occasionally the examiner misunderstands a disclosure of some kind or the SEC is requesting disclosure that is not required and that the company prefers not to make.

After reviewing the comments and, occasionally, discussing them with the SEC staff, an amendment is filed, along with responses to the comments, and then the SEC enters another round of review and provides another comment letter, ideally with fewer comments than the previous letter. This continues, essentially, until they are out of comments. The number of rounds of filings this takes is a function of the company's willingness to play ball with every SEC comment, the capability of the SEC examiner, and, frankly, the SEC's apparent comfort level with the filing or transaction in question.

Once the SEC has completed its comments, it declares the registration statement effective and it can be used to resell the securities that were registered through that process. Typically, effectiveness is accelerated by a formal request asking for a certain effective date.

FINRA can be more difficult, and some filings cannot go ahead without its approval. There is simply no way to predict how long a FINRA review will take. Comments in the third round of communications can be brand‐new and of the type that should have been raised in the first round. It can take 45 or 60 days to get one round of comments.

Establishing a Trading Market

Once the S‐l is effective, the company is public—no IPO, no reverse merger with a shell with the lingering evergreen problem and seasoning issues. Financing has been obtained either before or right after the filing becomes effective, or carefully while it is pending under the 2007 interpretation.

There are now enough shares in the public float to qualify for, say, the OTCQB or OTCQX. FINRA and these platforms unofficially require at least 35 to 40 nonaffiliate shareholders with at least 100 tradable shares apiece. This requirement is not on any official list of rules, but as a practical matter the regulators will bury your application to trade if you do not meet this criterion.

All that is missing is a quotation or listing on an exchange or market, without which the shares may not be traded through brokers. Most companies going through a self‐filing do not yet qualify for the higher exchanges, so broker‐dealers serving as market makers will be needed to get trading going since that is required in the over‐the‐counter markets. I generally recommend that a company encourage market makers to start the application process while the S‐l or other filing is pending, so as not to waste time. The process of obtaining approval can take a few months, so the sooner the process starts the better.

In general, the over‐the‐counter platform will begin reviewing an application for a company that is not yet public as long as the company has initiated the process. Running these two processes in parallel gives the company the best chance of having a listing by the time the SEC clears the registration so that the shares can begin trading.

Form 10 versus Form S‐1 (Exchange Act versus Securities Act)

Form 10 is remarkably similar to the S‐l, except it does not describe a securities offering. The company description and other sections are basically the same as those on an S‐l or any public offering document.

S‐l is a form created under the Securities Act of 1933 (as is Form 1‐A for a Reg A+ offering), and Form 10 is a form under the Securities Exchange Act of 1934. Following the great stock market crash of 1929, Congress sought to regulate the ailing securities markets. The '33 Act, as it is often called, or the Securities Act, as we will call it here, established guidelines for companies conducting public offerings, requiring them to register any such offering with the SEC.

The '34 Act, also referred to as the Exchange Act, officially established the SEC and set up the integrated disclosure system and series of periodic and current reports required of reporting companies, among other things. If a company is subject to the reporting requirements of the Exchange Act, it may be able to list its securities on the OTCQB or OTCQX or any national exchange. Non-reporting companies' stock may only trade on the OTC Pink. As we have noted, the QB and QX recently amended their rules also to permit Reg A+ issuers to have their stock quoted there, with certain limitations, even if they are in the light reporting system.

When a company goes public through a public offering by it or its shareholders, for example, on Form S‐l, it is automatically subject to the reporting requirements through the end of its first fiscal year after the offering. (This is pursuant to Section 15 of the Exchange Act.) After that, continuing to be a reporting company is by choice (pursuant to Section 12 of the Exchange Act). Some companies simply cease reporting after this one year and their stock trades on the OTC Pink.

Most companies completing a public offering immediately become reporting companies through a very simple filing known as Form 8‐A. If this is filed within the first full fiscal year after the offering, a company automatically becomes permanently subject to the reporting requirements. As discussed, Reg A+ issuers must file their Form 8‐A much closer to the time of completion of the offering.

After this time, or if a company has not yet conducted a public offering, if it wishes to become a permanent reporting company, it must file a more complex form, known as Form 10, in order to have a class of its securities, typically its common stock, registered with the SEC, rather than individual shares. No offering is involved and no shares become tradable by virtue of this filing unless an exemption from registration, like Rule 144, applies.

Form 10 typically is used in two situations. One is when a company has conducted a public offering, its stock is trading, and it is beyond its Section 15 mandatory filing period. Now it seeks to become a reporting company either to complete a merger or move up to a higher exchange.

In another case, a company goes public through a Form 10 filing. This is how the form is used within the context of a self‐filing. A private company wants voluntarily to subject itself to the SEC's reporting requirements. Trading can commence, even if no shares individually are registered, in one of two ways. Either enough shareholders have held their shares long enough under Rule 144 to allow them to become tradable without being registered once the company is reporting and has a ticker symbol, or the company intends to file an S‐l resale registration to release some shares from restriction immediately following the day when the Form 10 filing is completed and effective.

The question then becomes, why file an S‐l after a Form 10 rather than just going public through an S‐l? The answer, as mentioned earlier, is restrictions on financing. If a company needs to complete private placements and raise money while waiting to become public, it may be concerned it cannot satisfy the SEC's requirement to ensure that an investor was not solicited with the S‐l nor did the investor learn about the company or the offering through the Form S‐l. Using the Form 10 eliminates this concern.

If it seems a little tedious to deal with two different filings, consider that the second filing, taking place right after the first, is likely to get much less SEC scrutiny (assuming the SEC has carefully reviewed the Form 10 before its effectiveness, which is likely). In this way, a company is able to finance itself while waiting to go public without concerns about the 2007 interpretation, can close a PIPE when the Form 10 is effective, and can then file the S‐l resale registration with its money already in the bank and likely a speedy SEC review.

Filing Form 10 and Automatic Effectiveness

The process of preparing the Form 10 and getting it filed basically is the same as that for an S‐l. The difference comes into play after the filing is made. Under SEC rules, Form 10 is automatically effective 60 days after it is filed. In other words, if the SEC chooses not to comment, the form is effective after the 60 days have elapsed and the company is thereafter public and subject to the Exchange Act reporting requirements.

If the SEC does comment, the form still becomes effective 60 days after its original filing date, provided the amendments have been filed and all comments have been cleared before 60 days pass. Miss this deadline and the SEC will either allow the form to go effective and treat future responses to the comments as a so‐called post‐effective amendment, or insist that the form be withdrawn and refiled, starting another 60‐day period.

Developing a Market After Filing a Form 10

As mentioned earlier, the process of obtaining a ticker symbol and getting trading started is a little more complex with a Form 10 approach. Hopefully, the company has at least 35 to 40 nonaffiliated shareholders with more than 100 shares each that have been held a sufficient time to be tradable under Rule 144. If so, trading on the over‐the‐counter markets can commence immediately upon the form's being declared effective. If not, an S‐l needs to be filed and brought to effectiveness before trading on the OTC markets can begin. In the meantime, if there are some shareholders with tradable shares, a ticker can be obtained and trading can commence on the OTC Pink.