How to fail at filing

There’s a right way to do everything, even failing to file with the SEC.

We experienced this recently, when one of our Regulation A clients was unable to make its annual 1-K filing covering the year 2016. We’d been watching their progress carefully, and so a few days before this year’s filing deadline of May 1, we picked up the phone and asked the regulators about the best way to handle the situation and to position ourselves to get back into compliance as soon as possible.

First rule of holes: when you are in one, stop digging. In the Regulation A context, this means not making any offers or sales of securities when you don’t have an exemption from SEC registration to rely on. If you are not in compliance with the ongoing reporting requirements of Regulation A, you can’t use Regulation A to make sales or even offers of securities. So you stop making any sales by telling the broker or platform or backend processor you are working with to stop taking money from any investors. And you stop making offers by taking your offering down from any online platform or webpage you are using to host your offering.

Our client, luckily, was not making any online solicitations at the time. Just to make sure, though, and after our conversation with the SEC Staff, we filed a Form 1-Z to signal to the world that we were out of the market. (Funny thing about the Form 1-Z: its signature block is located in the part of the form that says the filer is withdrawing from the reporting system altogether. It’s not the only issue with that form so we expect the Staff will do a technical fix at some time. In the meantime, we intend to file a 1-Z/W to withdraw from our “withdrawal” once we get the 1-K filed.)

Why were we so anxious to make sure that we got this right? Because selling securities publicly without the benefit of an exemption from registration is a violation of Section 5 of the Securities Act. And Section 5 violations are one of the “Bad Acts” that can get the company and the broker it is using disqualified from making any offerings under Regulations A, D and CF.

Last year, the SEC brought a Cease and Desist action against Med-X for failing to file its 1-K. It turned out there was an innocent misunderstanding about the application of the filing requirement. To avoid any such misunderstandings in the future, on May 2 this year the SEC sent out “Dear Issuer” letters to Regulation A filers who failed to file their 1-Ks, reminding them of the obligation and the dangers of continuing to sell securities without an exemption.

This is a new market and it’s sometimes difficult to comply with new rules. But all of us – issuers, the brokers who serve as gatekeepers and service providers such as CrowdCheck – need to make sure we aim for complete compliance with the rules, or risk undermining the reputation of this new market.

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