So you listened to your legal advisors, ran the traps, took the plunge, and exited the SEC’s reporting system. You have now “gone dark”. But you probably are wondering, “what now”? What kind of disclosures do you need to give to your shareholders? What sorts of corporate governance policies should you keep in place (for example, with respect to insider trading)? How should your committee charters change? Here are some key considerations you should keep in mind when determining how to adapt to living the life of a private company.
Disclosures to Investors:
Of course, one benefit of exiting the SEC’s reporting system is the reduced cost of compliance with the SEC’s increasingly burdensome disclosure and filing requirements. Nevertheless, companies might want to continue to disclose to investors certain information about the company for a variety of reasons, including:
- Rule 144 Compliance: To ensure that holders can resell the company’s securities under Securities Act Rule 144, the company should make publicly available certain information about the company, including the company’s most recent balance sheet and profit and loss and retained earnings statements.
- Possible Re-Entry into SEC’s Reporting System: As highlighted below, for many companies there is always a risk that it will be required to re-enter the SEC’s reporting system, or the company may wish to voluntarily re-enter for a variety of reasons. Consequently, we have a number of clients who have decided to continue to prepare, and make available, audited annual financial statements and maintain the same level of internal control over financial reporting and disclosure controls and procedures.
Corporate Governance Policies
It is, of course, acceptable to pare back any corporate governance policies that are no longer necessary, including any code of ethics or general corporate governance policy. However, we generally recommend that companies maintain an insider trading policy, especially because a number of companies that have gone dark continue to have their shares quoted on the OTC Bulletin Board or Pink Sheets, where trades occur on a fairly regular basis.
After going dark, many companies welcome the opportunity to pare back or eliminate board committees and certain board and committee requirements that are applicable to public companies traded on a national securities exchange. However, we also have a number of clients who choose to do the opposite and maintain their current board and committee structures, and committee charters, not only to demonstrate to potential investors that they are complying with current corporate governance best practices, but also to ensure that the company is well-prepared to re-enter the public markets if and when the time is right.
Employee Benefits Matters
It is imperative that a company that has gone dark carefully evaluate the Federal and state securities law implications of maintaining employee benefit plans that include stock options, restricted stock or other securities as potential awards under the plan. At the Federal level, a company that has gone dark will, generally, be able to rely on the exemption set forth in Securities Act Rule 701. At the state level, however, because there would generally be no Federal preemption of state securities regulations with respect to the offering of securities under a plan by a company that has gone dark, the company will need to determine the states of residence of each employee/participant under the plan and what exemptions would be available in those states.
Monitoring Broker Kick-Out Risk
Finally, the company will need to closely monitor the number of holders of record of its equity securities to ensure it has not exceeded the threshold for registration, under the Exchange Act, with the SEC.
The general rule for counting holders of record is that you count the ultimate record holders on the company’s books. However, because Cede is often listed as a record holder, and because those shares are generally held on behalf of DTC participants (e.g., brokers or banks), the SEC’s staff has stated that a company should look through Ceded and instead count each DTC participant as a holder of record. Notably, when a company exits the SEC’s reporting system, it runs the risk that brokers and banks kick the shares down to the ultimate beneficial owners, resulting in a significant increase in the number of record holders of the company’s stock.
If you are like most formerly public companies, you would have filed a Securities Act registration statement (for instance, an S-8 or S-1) that the SEC declared effective at one time, which results in you incurring what is called a “Section 15(d) obligation”. The bad news about a Section 15(d) obligation is that it never goes away after you exit the SEC’s reporting system. Instead, at the beginning of each fiscal year, you are required to reassess whether, as of the first day of that fiscal year, you have more than 300 holders of record. If you do, then you are required to re-enter the SEC’s reporting system.
To minimize the risk of broker kick-out and inadvertent re-entry into the SEC’s reporting system, we generally recommend that companies consider complying with the OTC’s requirements to maintain quotation of the company’s securities on the OTC Pink Current Information tier. In addition, after going dark, the company’s management should monitor the number of holders of record and consider whether it should seek board and shareholder approval for a reverse stock split to reduce the number of holders of record.