September 2022 in Brief: Securities Law

Securities Regulation

SEC Adopts JOBS Act Inflation Adjustments

By Marissa Dressor, Mayer Brown

On September 9, 2022, the Securities and Exchange Commission (SEC) announced amendments to its rules in order to implement inflation adjustments mandated by the JOBS Act. The SEC’s amendments increase the annual gross revenue threshold for emerging growth companies and raise certain dollar amounts contained in Regulation Crowdfunding. Pursuant to the JOBS Act, the SEC is required to make inflation adjustments to various JOBS Act rules at least once every five years.

Title I of the JOBS Act added Securities Act Section 2(a)(19) and Exchange Act Section 3(a)(80) that define the term “emerging growth company.” Pursuant to the statutory definition, the SEC is required to index to inflation the annual gross revenue amount used in determining EGC status. The SEC therefore adopted amendments to Securities Act Rule 405 and Exchange Act Rule 12b-2 to adjust the EGC threshold from $1.07 billion to $1.235 billion.

Title III of the JOBS Act added Securities Act Section 4(a)(6), which provides an exemption from the registration requirements of Section 5 of the Securities Act for certain crowdfunding transactions. Sections 4(a)(6) and 4A of the Securities Act set forth dollar amounts to be used in connection with the crowdfunding exemption. The SEC implemented inflation adjustments for Rules 100 and 201(t) of Regulation Crowdfunding, which cover offering maximum and investment limits, and financial statement requirements, respectively. The SEC noted, due to increases it made in March 2021 to Regulation Crowdfunding’s offering limit contained in Rule 100(a)(1), it is declining to further increase the $5 million offering limit. Please see the Fact Sheet for the specific dollar amounts in Rules 100 and 201(t), as adjusted for inflation.

The new thresholds became effective on September 20, 2022. See Press Release here. See Final Rule here.

SEC Adds New Industry Offices

By Jason Hyatt, Latham & Watkins

On September 9, 2022, the Securities and Exchange Commission (SEC) announced its plan to add two new industry offices to its Division of Corporation Finance’s Disclosure Review Program (DRP). The two new offices are the Office of Crypto Assets and the Office of Industrial Applications and Services. The two new offices will join the seven existing focused offices under the DRP.

The Office of Crypto Assets will review filings involving crypto assets and will allow the SEC to focus its attention and resources on the unique and evolving filing issues related to crypto assets.

The Office of Industrial Applications and Services will be responsible for the non-pharma, non-biotech, and non-medicinal products companies currently assigned to the Office of Life Sciences. In recent years, the number of companies assigned to the Office of Life Sciences has significantly increased. The SEC believes that transitioning some companies to this new office will allow the DRP staff to better build specialized expertise in this space.

The DRP expects the new offices will be established later this fall.

SEC Chief Accountant Addresses Use of Non-Local Auditors to Avoid HFCAA

By Thomas W. White, Retired Partner, WilmerHale

Acting Chief Accountant Paul Munter of the Securities and Exchange Commission (SEC) recently warned China- and Hong Kong–based issuers about attempting to avoid the strictures of the Holding Foreign Companies Accountable Act (HFCAA) by using auditors other than local China- or Hong Kong–based registered public accounting firms.

As discussed in prior notes on the HCFAA, foreign issuers will be subject to US trading prohibitions if their auditors are not subject to full inspection and investigation by the Public Company Accounting Oversight Board (PCAOB), due to positions taken by the auditors’ home country regulators, for three consecutive years. At present, the potential trading prohibitions apply to companies whose auditors are headquartered in mainland China or Hong Kong, though the PCAOB and Chinese regulators recently reached an agreement that, if implemented to the PCAOB’s satisfaction, could result in lifting the threatened trading prohibitions.

In a recent statement, Mr. Munter noted that some China- and Hong Kong–based issuers have begun attempting to structure audit engagements not with local China- or Hong Kong–based accounting firms, but with accounting firms located in the US or elsewhere. Mr. Munter described structures in which issuers with multiple locations or business units might choose to retain a lead auditor that is already able to be inspected and investigated completely by the PCAOB (i.e., headquartered somewhere besides China or Hong Kong) and that (1) uses, and assumes responsibility for, the work or reports of other independent auditors, or (2) directly engages another independent accounting firm or other individual accountants to participate in the audit under the direction of the lead auditor. Mr. Munter stressed that PCAOB auditing standards impose significant responsibilities on the lead auditor under either structure, notably including the requirement that audit documentation be retained by or be accessible to the lead auditor. He also noted that issuers seeking to change auditors to remediate an HCFAA problem have responsibilities regarding communications with the predecessor auditor, which also include access to the predecessor auditor’s documentation. (Although unstated, Mr. Munter’s comments appear to presuppose that non-local lead auditors may have difficulties meeting their responsibilities, because the local auditors will be restricted by local regulations in their ability to satisfy the lead auditor’s requirements.)

Mr. Munter raised the specter of enforcement action if lead auditors do not comply with their responsibilities under PCAOB rules and standards: “The failure of the retained lead auditor to meet any of its legal or professional obligations with respect to PCAOB inspection and investigative demands, or the failure of the lead auditor to comply with all applicable audit standards can result in significant liability for not only the auditor and its personnel, but also for the issuer.” He also warned of potential liability not only for accounting firms and their associated persons, but also issuers, their audit committees and officers and directors, if they engage in what he calls “an efficient breach”—thinking that avoiding the uncertainty of HCFAA is worth the potential costs of violating other legal and audit requirements.

SEC’s Acting Chief Accountant Releases a Statement on Critical Points to Consider When Contemplating an Audit Firm Restructuring

By Kimberly Ayudant, Mayer Brown

The Acting Chief Accountant of the Securities and Exchange Commission (SEC), Paul Munter, recently released a statement regarding critical points to consider when contemplating an audit firm restructuring. In recent years, audit firms have been increasingly involved in complex business arrangements, such as selling a portion of their business to a third party while retaining an equity interest in that business or divesting the accounting firm’s consulting practice, in whole or in part, to a third party. These business arrangements can increase the challenges associated with an audit firm’s maintenance of its independence, both in fact and appearance, with respect to its audit clients. In particular, Mr. Munter points to the importance of considering the definition of “accounting firm” in Rule 2-01 of Regulation S-X when entering into these transactions. An “accounting firm” includes “the organization’s departments, divisions, parents, subsidiaries and associated entities [emphasis added], including those outside of the United States.” The SEC has not defined “associated entity,” but when making a determination as to whether a third-party investor or purchaser would be considered an associated entity, it is the view of the staff of the Office of the Chief Accountant (“OCA Staff”) that the following be considered: (i) the third party’s financial interest in the accounting firm; and (ii) the third party’s ability to influence the accounting firm’s operating or financial decisions.

These considerations are of particular importance in transactions involving private equity firms. Private equity structures can be complex and include entities that have influence over portfolio companies. Therefore, each entity within the contemplated structure should be evaluated to determine if the entity is an “associated entity” and if so, whether the entity would be considered a part of the accounting firm and be subject to auditor independence requirements. In addition to determining which entities meet the definition of accounting firm, the accounting firms need to comply with Rule 2-01(b) Regulation S-X (the general standard of auditor independence). It is the OCA Staff’s view that it would be a “high hurdle” for an accounting firm to comply with this rule if it provides any audit, review, or attestation services to any entities within the private equity structure. Auditor independence may also be at risk due to private equity firms generally having a “continuously evolving universe of entities.”

In addition to these private equity investment concerns, Mr. Munter notes the potential for auditor independence violations when an individual investor is involved in a transaction. If an individual, other than an audit firm partner, directly invests in the accounting firm, then such investor’s interests would need to be evaluated to determine if they fall under the “covered person” definition of Rule 2-01. If so, the investor must also comply with auditor independence rules. Last, Mr. Munter notes the OCA Staff’s expectations regarding divestitures. If an accounting firm divests all or part of its business and the divested entity is no longer part of the accounting firm post-transactions, the OCA Staff expects certain actions to be taken to maintain independence. This includes, but is not limited to, adopting separate corporate and financial structures, terminating all interests between the accounting firm and the divested entity, and not having any profit sharing between the accounting firm and the divested entity.

See the full text of the Acting Chief Accountant’s remarks here.

Small Business

Congress Reauthorizes the Small Business Innovation Research Program

By Jelena Tasic and Margaret M. Cassidy, Cassidy Law

The U.S. Government’s Small Business Innovation Research Program (SBIR) provides competitively awarded contracts to small, U.S. businesses to foster innovation by funding research and development. The program awards contracts so that small businesses with innovative ideas have R&D funding and funding to develop their R&D into a solution for the government and for the commercial market.

Generally speaking, SBIR contracts do not include many of the regulatory requirements of typical federal government contracts, so small businesses that do not pursue federal government contracts find it easier to comply with the contract terms.

Congress has funded SBIR since its inception in 1982. But until recently, SBIR funding was set to expire on September 30, 2022. Some members of Congress have shown reluctance to fund SBIR because of the potential for waste, fraud, and abuse in the program, such as persons or businesses misrepresenting their qualifications for the program, particularly non-U.S. persons or entities being involved in what should be a U.S. business. Senator Rand Paul raised concerns about the potential for businesses to use SBIR contracts as their only source of work, which runs afoul of the idea that business grow out of SBIR.

Congress’s most recent reauthorization bill added provisions addressing the primary concerns about the program by including performance benchmarks and requiring disclosure of connections to “foreign countries of concern,” particularly China, which can be the basis of denying an award under the SBIR program in some circumstances.

After the reauthorization bill passed in the Senate, the revised bill passed with little opposition in the House on September 29 and was signed into law on September 30. The SBIR program is reauthorized for another three years—just in the nick of time.