American Law Institute - American Bar Association Continuing Legal Education
ALI-ABA Course of Study
March 14-16, 2002
Regulation D Offerings and Private Placements
Cosponsored by the Securities Law Committee of the Federal Bar Association
*357 BLUE SKY PRACTICE PART II: SMALL CORPORATE OFFERING REGISTRATION --
FORM U-7
Hugh H. Makens
Warner, Norcross & Judd LLP
Grand Rapids, Michigan
Willie R. Barnes
Musick, Peeler & Garrett LLP
Los Angeles, California
Copyright © 2002 The American Law Institute; Hugh H. Makens and Willie R.
Barnes
*359 TABLE OF CONTENTS
I. BACKGROUND
II. DEVELOPMENT OF THE SMALL CORPORATE OFFERING REGISTRATION FORM
III. PRINCIPAL CONCEPTS OF THE FORM
IV. OTHER FEATURES OF THE FORM
V. ELIGIBILITY TO USE OF FORM U-7
VI. NASAA DEVELOPMENTS AND THE INTERNET
VII. PROBLEMS AND BENEFITS
VIII. USE OF THE SCOR FORM
IX. CONCLUSION
*360 I. BACKGROUND
A. Small business has historically carried the heaviest burden in attempting to comply with state and federal securities laws. Costs are not greatly reduced whether the amount of the offering is $500,000 or $5,000,000, thus making a public offering well beyond the economic ability of most such entities, barring a trip fraught with danger through the rapids of the penny stock market or finding a local underwriter to whom such an offering might be of interest, recognizing that no aftermarket could realistically develop.
With the combination of SEC Rule 504 and a uniform state form acceptable in numerous states, these problems may be largely overcome, at least for companies who are able to find a local underwriter or who can sell the securities through their own contacts.
B. Rule 504 under Regulation D currently exempts limited offerings of up to $1,000,000 by non-public issuers. Until August 1992, Rule 504 specifically exempted such small "public" offerings from registration and permitted general solicitation only if the offering was registered under state securities laws containing a prospectus delivery requirement. The principal benefit of state registration to the issuer was that such registration allowed the issuer to engage in general advertising or solicitations in connection with its offering of securities. From August 1992 until amendments adopted in February 1999, Rule 504 contained no restrictions on general solicitations. However, the issuer had to still comply with a myriad of state securities law requirements even if the offering was exempt from federal registration under Rule 504.
The February 1999 amendments to Rule 504, effective April 7, 1999, have reinstituted the requirement of state registration in a state that requires delivery of a substantive disclosure document or compliance with state exemptions for offerings so long as sales are made to accredited investors in order to obtain unrestricted securities and to engage in general solicitation and advertising.
C. The only significant federal requirement of Rule 504 is the filing of Form D. At the state level, the offering must be registered or offered pursuant to an applicable exemption. To engage in a public offering, i.e., through the use of general solicitations or advertising, the issuer will be required to register the offering in most states or rely on exemptions for public offerings to accredited investors. State prescribed disclosures vary from state to state and, before the Form U-7, therewas no uniform registration form among the states. NASAA has proposed a Model Accredited Investor Exemption that, if available, gives an issuer an option other than registration, albeit without free trading stock.
D. In order to ease the burden on issuers attempting to register a SCOR offering in more than one state, NASAA has sponsored the development of regional review programs. NASAA recommends that state securities regulatory authorities expand coordinated review programs, and a national coordinated equity review program for offerings in amounts over $5,000,000 has been developed. The process of allocating responsibilities between the states and the SEC certainly suggests that these smaller, more local offerings, will be deemed the province of the states.
E. Microcap Fraud has caught national headlines lately, as brokerage firms dealing in thinly traded stocks on the Nasdaq SmallCap Market, the Nasdaq Bulletin Board, or in the Pink Sheets have manipulated the market in their thinly traded securities to drive up prices so personal holdings could be *361 dumped into the market at substantial profits to insiders. The problem appears to arise, however, not from the state review process, but rather from small Rule 504 offerings where the SCOR procedure was not followed. In response to these concerns, the NASD includes in its qualification requirements for the OTC Bulletin Board Section 12(g) reporting status. The SEC has amended Rule 504 as discussed above to limit the use of the Rule 504 exemption to obtain unrestricted securities. Trades are reported to the NASD on the Automated Confirmation Transaction Service.
II. DEVELOPMENT OF THE SMALL CORPORATE OFFERING REGISTRATION FORM [FN1]
A. The Small Corporate Offering Registration Form (SCOR), or Form U-7, was conceived and formulated by the Rule 504 Study Group of the Subcommittee on Private Offering Exemption and Simplification of Capital Formation of the ABA Business Law Section's State Regulation of Securities Committee. Working closely with a committee of the North American Securities Administrators Association (NASAA), the Rule 504 Study Group formulated a uniform question- and-answer registration form, the Form U-7, for small corporate offerings. The SCOR form may be used for state registrations of small corporate offerings which are exempt from federal registration requirements pursuant to Rule 504 of Regulation D under the Securities Act of 1933. The SEC release regarding the adoption of the February 1999 amendments specifically states that the Form U-7 will meet the requirement for a "substantive disclosure document."
B. As of February 2000, forty-six states have adopted the use of Form U-7, either formally or informally. Alabama, Hawaii, Nebraska and New York do not have any SCOR provisions. However, Hawaii has a proposed bill to adopt SCOR provisions. California imposes additional requirements on the use of Form U-7, including limiting the use of the Form to California corporations or to foreign corporations that have a certain presence in California as defined by statute and that have only one class of voting common stock outstanding. Offerings are permitted of voting common stock only.
See Appendix I for citations to the applicable regulation or policy statements in each of the states.
C. SCOR as a concept is reasonably popular on a national basis. A check on the Internet produces many "hits" and the ether is full of attorneys, advisors, consultants, newsletters, purveyors of questionable concepts and others who service or abuse small businesses. Typical of the promos is "Raise Up To $1,000,000 That You Don't Have To Pay Back!" Software promoters proliferate. The Pacific Coast Stock Exchange publishes a SCOR Market Place book. The Missouri Innovation Center, affiliated with the University of Missouri, promotes SCOR through a "Market Maker Program." Stewart-Gordon Associates of Dallas, Texas publishes The SCOR Report, which is designed for issuers and professionals providing services to them. The Direct Stock Market, which creates a market for SCOR offerings, was *362 started in 1997. The Direct Stock Market also runs a website. Prospectuses for SCOR offerings can easily be found on the Internet. The SCOR Report of Stewart-Gordon listed 421 companies whose SCOR offerings had become effective as of May 10, 2000. See Section VI. C. and D. for a further discussion of Internet issues regarding SCOR.
III. PRINCIPAL CONCEPTS OF THE FORM
A. The current version of the Form U-7 Disclosure Document is the version dated September 28, 1999. The form is also referred to as the Small Corporate Offering Registration (SCOR) Form. A revised NASAA Small Company Offering Registration (SCOR) Manual was published on the same date.
B. A central concept in determining the breadth and focus of the Form was simplification.
1. By definition, it will not be complete disclosure when viewed from the perspective of Regulation S-K or Regulation S-B, although it has been accepted by the SEC as Model A to Form 1-A, of Regulation A of the Securities Act of 1933 and is a permitted form of disclosure on Form SB-1 for offerings up to $5 million. The development of SCOR has fashioned a balanced approach between "full" disclosure, as defined by SEC registration forms and rules relating to disclosure, and sufficient information to protect investors under most circumstances by providing a uniform form to reduce the costs of compliance without sacrificing investor protection.
2. The question-and-answer format is intended to streamline the process by which the required disclosure document is prepared while simultaneously increasing the document's readability and comprehensibility. Unlike the traditional prospectus, the question-and-answer format, just by including the question, provides information to the reader, regardless of whether the corresponding answer is affirmative or negative. Following a series of questions on a given subject, SCOR includes notes addressed to investors indicating how the information elicited might be used by the investor in making an analysis leading to an investment decision. Notes addressed to investors are also used to guard against possible misinterpretation of information elicited.
C. A second concept was the emphasis on a business plan.
1. The Form U-7 forces a business to create a business plan in order to effectively meet the disclosure requirements of the Form. Assumptions and weaknesses of the plan are evident when the Form U-7 is completed and those factors can be disclosed as risk factors of the offering.
2. Requests for information are more detailed than on general registration forms so that persons using the Form can more easily understand what information is being sought.
3. Focus is on specific types of information of special relevance to small and emerging businesses. The types of disclosures required by SCOR are *363 characteristic of the information provided to venture capital and investment banking firms in traditional private placement and venture capital financings. For example, Question 28 requires management to describe those events or "milestones" which the company must reach in order for it to become profitable. It also requires a description of how the company expects to achieve these milestones and the probable consequences of a delay in achieving these goals.
D. Reviewed financial statements can result in substantial cost savings.
1. Form U-7 permits reviewed rather than audited statements if: (a) the offering does not exceed $1,000,000, (b) the company has not previously sold securities by means of an offering involving the general solicitation of investors, (c) the corporation has not previously been required by law to provide audited financial statements, and (d) the aggregate amount of all previous sales of securities by the corporation (excluding debt financings with banks and other commercial lenders) does not exceed $1 million.
2. The cost of requiring an audit is not justified by the additional protection an audit would provide over a review at this dollar amount. Reviewed financial statements can be provided in instances where audited financials are not available. The Study Group believes that for small emerging businesses the procedures undertaken by the accountants in a review provide equivalent disclosure.
3. Many states, however, require audited statements in registrations and this benefit may not be available.
IV. OTHER FEATURES OF THE FORM
A. Distribution.
1. Issuers can place the offering through their officers and directors. Officers and directors who do not receive compensation for selling pose little concern. However, payment to such persons based on stock sales or bonuses for such sales will be prohibited or may be permitted subject to meeting additional testing requirements. See Part III: ULOE and SCOR Ramifications for Broker-Dealers for a discussion of NASAA's "Small Business Sales Agent Guidelines."
2. Use of a registered broker-dealer is an advantage. If local and smaller regional firms will participate in these offerings, they will add a due diligence review to the process.
3. The NASD limitations on brokers' compensation imposed on member firms apply to Rule 504 offerings.
*364 B. "Free-Trading":
1. One element of the Rule 504 structure until the February 1999 amendments was the availability of unrestricted trading privileges under federal regulation for securities sold pursuant to Rule 504. Early abuses in Rule 504 offerings involving "blank check" or "blind pool offerings" and other penny stock issuances have been addressed with the passage of the Securities Enforcement Remedies and Penny Stock Reform Act of 1990, the adoption of Rule 15c2-6, and the adoption of Rule 15g1 through 6. The SEC, however, did not consider those regulations sufficient and proposed amendments to Rule 504 in May 1998 to make all Rule 504 shares restricted. The states had expressed concern that the removal from Rule 504 of the state registration requirement in 1992 increased the opportunity for new abuses. The amendments as adopted in February 1999 reinstated the requirement of state registration or compliance with exemptions for accredited investors to obtain unrestricted shares.
2. Form U-7 avoids many of these problems by prohibiting blank check offerings and by requiring a $1 minimum price. Originally this was set at $5 but was reduced by the states after experience with the form. The Study Group believes that a price limitation coupled with the dollar limitation will inhibit the growth of active trading markets because the amount of the float will be too small.
C. Merit Review:
1. A significant issue in the adoption of SCOR was the scope of the description in the instructions to Form U-7 regarding the existence of substantive fairness or merit standards in many states. After discussion with NASAA representatives over several months, a neutral statement was devised that advises the issuers of the existence of those standards, encourages consultation with the staff of a state's securities division regarding the applicable standards, and advises a practitioner that a state may seek additional information or require that certain terms of an offering be modified to insure compliance with those standards.
2. There is reason to believe, however, that most state securities administrators are aware of the special problems associated with strictly applying traditional merit standards to SCOR offerings and many have been willing to modify their application reviews accordingly. In particular, the Washington Securities Division has relaxed certain of the merit review standards it typically imposes on registered offerings. Arizona by rule has modified the numerical criteria of several of its substantive regulations when applied to SCOR offerings. Michigan has announced a relaxed review standard.
*365 V. ELIGIBILITY TO USE OF FORM U-7
A. The Company must be a U.S. or Canadian corporation or centrally managed limited liability company which engages in or proposes to engage in a business other than petroleum exploration or production or mining or other extractive industries. "Blind pool" offerings, and other offerings for which the specific business or properties cannot now be described, are ineligible to use Form U-7.
B. The securities may be offered and sold only by the Company, and Form U-7 may not be used by any selling security-holder (including purchasing underwriters in a firm commitment underwriting) to register his securities for resale.
C. The offering price for common stock (and the exercise price, if the securities are options, warrants or rights for, and the conversion price if the securities are convertible into, common stock) must be equal to or greater than $1.00 per share. The Company must agree that it will not split its common stock, or declare a stock dividend, for two years after effectiveness of the registration; provided, however, that in connection with a subsequent registered public offering, the Company may upon application and consent of the administrator take such action.
D. The Company may engage selling agents to sell the securities but if commissions, fees, or other remuneration are paid, such persons, if required to be registered, must be appropriately registered in the state. (See Part III: ULOE and SCOR Ramifications for Broker-Dealers.)
E. The Form is not available for the securities of any Company if the Company or any of its officers, directors, 10% stockholders, promoters or any selling agents of the securities to be offered, or any officer, director or partner of such selling agent are subject to various "bad boy" provisions. Disqualifications can be waived. The instructions note that if certain events occurred prior to the time limit set forth, such circumstances should be described in response to the Question regarding Miscellaneous Factors.
F. Use of the Form is available to any offering of securities by a Company, the aggregate offering price of which within or outside this state shall not exceed $1,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of, and during the offering of, the securities under SEC Rule 504 in reliance on any exemption under section 3(b) of the Securities Act of 1933 or in violation of section 5(a) of that act. The Form is not available to a Company that is an investment company (including mutual funds) or is subject to the reporting requirements of § 13 or § 15(d) of the Securities Exchange Act of 1934.
G. The Company must file with the SEC a Form D of Regulation D under the Securities Act of 1933 claiming exemption of the offering from registration under such act pursuant to Rule 504. A copy of the Form D with appropriate state signature pages must be filed with the administrator at the same time as filed with the SEC.
VI. NASAA DEVELOPMENTS AND THE INTERNET
A. On April 28, 1996 NASAA published a Statement of Policy Regarding SCOR. On September 28, 1999, NASAA adopted a revised version of the SCOR (U-7) Form for Rule 504 offerings. Issuers must use this version of the Form for Rule 504 offerings.
*366 B. NASAA also adopted its Issuer's Manual, which is copyrighted by and available from NASAA at 10 G Street NE, Suite 710, Washington, D.C. 20002. (Phone 202-737-0900), or on the internet at nasaa.org. To reach the form, go to the Corporate Finance Section of the main menu. The states have experienced a great deal of difficulty with officers of issuers attempting to fill out the forms without advice of counsel, with the result that the complete form contains such answer to questions as: List in order of importance the factors which the Company considers to be the most substantial risks to an investor in this offering. . . . Answer: NONE. The detailed Issuer's Manual provides an explanation of the thinking underlying the questions and suggests potential areas of disclosure. The explanation of the questions will be helpful even to counsel in preparing a SCOR offering. [FN2]
C. NASAA's website also provides an overview of the SCOR registration process. You may access this information from the Corporate Finance Section by clicking on "Overview" under the "SCOR" heading. Among other things, the overview provides a list of all documents that should be included with a SCOR filing. While several of these documents are self-explanatory, some may cause issuers concern over how to best prepare these documents. NASAA also provides models of several of these documents, including a sample opinion letter, impound of funds agreement, and subscription agreement. To access these model documents, click on "Model Agreements" under the "SCOR" heading in the Corporate Finance Section (see also Appendix III of this outline).
D. NASAA and the individual states are in the process of developing regional review procedures which permit an issuer to file in each state, but to indicate with the filing that regional review is requested. Under those circumstances the issuer will receive only one set of comments, and go effective simultaneously in all states in the region in which filings have been made.
1. To date, the regional system has been set up in the following areas: Western States. Alaska, Arizona, Utah, Nevada, Colorado (SCOR only), Idaho, Oregon, Montana, New Mexico, Washington, and Wyoming. New England States. Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Midwestern States. Illinois, Indiana, Iowa, Kansas, Michigan, Missouri, Nebraska, North Dakota, South Dakota, and Wisconsin. Mid-Atlantic. Delaware, Maryland, New Jersey, Pennsylvania, Virginia, and West Virginia.
2. One state, generally the home state of the issuer, will be appointed as the lead state examiner. The states agree as to the substantive standards to be imposed. The lead examiner is responsible for incorporating each of the states' comments into one comment letter. The primary advantage, therefore, is that the issuer will only have to respond to one comment letter. This reduces both cost and time, valuable commodities to smallcap companies.
3. In order to qualify for regional review an issuer must meet the following requirements:
a. The Company must utilize SCOR or Regulation A.
*367 b. The Company must utilize Form U-7 or the Offering Circular Model A of Regulation A.
c. The Company must complete the appropriate Regional Review Application Form to two or more states participating in regional review.
d. All documents must be filed in each state the issuer seeks to register its securities.
E. As the Internet becomes an increasingly popular source of information for investors, issuers and regulators scramble to assess the benefits and deficiencies of the use of the Internet for securities offerings.
1. In January of 1996, NASAA addressed the issue of Internet offerings in its "Resolution Regarding Securities Offered on the Internet." NASAA recommended that the Internet be utilized to raise capital, but cautioned that Internet Offerings must be carefully scrutinized. NASAA therefore resolved to develop a pilot program to monitor Internet offers and made several recommendations to the individual states. Specifically, NASAA encouraged the states to exempt Internet offers where the following conditions apply:
a. The Internet offer indicates, directly or indirectly, that the securities are not being offered to the residents of a particular state.
b. The Internet offer is not otherwise specifically directed to any person in a state by or on behalf of the issuer.
c. No sales of the securities shall be made in any state until the offering has been registered and declared effective and the final prospectus or Form U-7 has been delivered to the investor or the sales are exempt from registration.
2. Entrepreneurs have also sought to assist issuers making offerings through the Internet. DataMerge Inc., a Denver based developer of software, has released a two-volume manual titled, "Self Directed IPO, Raising Capital with SCOR" that guides companies through the SCOR process and then through the process of marketing offerings directly to investors. For example, one section of the manual demonstrates how issuers may utilize their web browser to locate potential investors who match their "optimal investor" profile. The browser also allows the issuer to collect personal information that will assist them in selling the offering to individual investors. Another section of the manual assists the issuer in obtaining a higher web page rating on web page search engines which in turn makes it easier for investors seeking offerings to locate their particular website.
3. Since the successful offering of Springstreet Brewing Company, the first Internet offering, issuers have met with mixed results in their efforts to solicit investors on the Internet. For instance, according to a December 14, 1997 article in the *368 Cincinnati Enquirer, Mr. Jeff Himstreet, former Associate Counsel with NASAA, stated that at least two dozen companies have used the Internet to make their public debuts since the SEC created new rules in 1994 geared to small offerings of $5 million or less. However, many of these offerings have been unsuccessful at raising their target amount of capital. Mr. Himstreet believes that some issuers were blinded by the success of Springstreet Brewing Company. Specifically, Mr. Himstreet speculated that many issuers ignored the intangibles that went into Springstreet's successful offering, which included a plethora of favorable press stories, registration in 20 states, heavy advertising, and a strong stock market. The Cincinnati Enquirer article was written in response to the first Internet offering by an Ohio company, Mountain Forest. At the time of the article, an estimated 300 Internet users had visited Mountain Forest's website in a two week time period. However, only 20 downloaded the offering prospectus. The message apparently is that simply placing your offer on the website will not assure successful investor participation, irrespective of where the offering is placed. The company's fundamentals must be sound, the advertising must be effective, and the states in which you register should be carefully considered. The offering, however, is only costing Mountain Forest about $40,000 which includes accounting, legal and regulatory filing fees as opposed to a traditional initial public offering, which would have cost approximately $120,000. Therefore, when the cost of an offering is a critical consideration, the Internet can be a valuable resource to a small company.
4. One of the more interesting websites promoting Internet offerings is a website run by Direct Stock Market, Inc. (www.directstockmarket.com). One can locate the breakdown of all companies currently using the SCOR form. A variety of articles on small public offerings and use of the Internet are also available. Future services that the Direct Stock Market is attempting to provide, which if approved by the SEC, will allow bulletin board listing and trading of small public company stocks directly between investors who have brokerage accounts on the Internet. The Direct Stock Market is also attempting to implement a virtual roadshow where live video graphical presentations can be scheduled on an event calendar so that viewers may log on for live broadcasts or view a taped version of a previously recorded interview. Furthermore, qualified investor alert notifications are being developed to notify investors interested in specific types of companies or opportunities when they are filed with The Direct Stock Market and joint ventures with bulk E-mail services are being developed to give companies wide exposure to potential customers and potential investors. The primary advantage of The Direct Stock Market will be its ease of access to investors and issuers and a reduction of cost from the traditional public offering and/or traditional trading of securities in small companies. One may also expect that a stronger market for these smaller, securities will develop, thus reducing the dependence on marketmakers.
5. The Model Accredited Investor Exemption that permits general solicitation where sales are limited to accredited investors is a big step forward in establishing viability for matching services over the Internet. The Angel Capital Electronic Network, ACE-NET, created by the Small Business Administration, is *369 an Internet matching service for angels interested in investing in early-stage companies. Thirty-eight states have adopted the Model Accredited Investor Exemption or variations thereof (see Part I: Avoiding Liability Arising from State Private Offerings under ULOE and Limited Offering Exemptions, page 23). The variations include limiting the availability of the exemption to companies in that state to requiring full Form U-7 compliance.
VII. PROBLEMS AND BENEFITS
A. The principal advantage to issuers under Rule 504 is not the availability of free secondary trading, but rather the ability to engage in general advertising or solicitation. This will now be available only for state registered offerings or those limited to accredited investors. Small issuers have a difficult time reaching an adequate audience and the elimination of the restriction provides a far broader potential source of investors. Free trading is realistically a misnomer, since issuers under Rule 504 will not be reporting issuers and likely would not make available sufficient information for a market maker to meet the Rule 15c2-11 1934 Act requirements for information prior to market making activities. Even recommending the security will raise some level of risk because of the absence of information. It is far more likely that the small broker-dealers who initially placed an offering on a best efforts basis will be the source of secondary trading on an unsolicited basis under Section 402(b)(3) of the Uniform Securities Act, or an equivalent exemption in various state laws. Some investors will advise broker-dealers of their interest, and when sellers materialize, trades will occur. Otherwise, even under state law, the broker-dealer cannot find an exemption for secondary trading unless the issuer meets the manual exemption or some other secondary trading exemption under the state securities laws.
B. Perhaps the greatest benefit of the Form U-7 does not lie in its use as a registration document, but rather as a format for small business issuers engaged in private placements. Such issuers have experienced difficulties with the complexities of Regulation D, Rules 505 or 506. Now a format exists for use under Section 402(b)(9) - the state limited offering exemption under the Uniform Securities Act - or under Rule 504 in states which permit reliance on that or an equivalent exemption. Frequently practitioners struggle with disclosure for small offerings, and fall substantially short of the requirements under either Regulation A or Regulation S-K requirements. This format is clearly suitable for such offerings, and probably more so than existing forms. (It remains to be seen whether the new disclosure requirements under Regulation S-B promulgated as part of the SEC's Small Business Initiatives will be easier for small issuers.) Further, it is far easier to use for issuers, advisors and investors. It obviously must be modified for such offerings, but the cost benefits from the use of the Form merit such effort.
The state of Washington has adopted an exemption for sales up to $1,000,000 to no more than 20 purchasers. An accompanying release notes that the Washington equivalent of Form U-7 may be used with proper disclosure in an exempt offering. Iowa, Colorado and Wisconsin have adopted the Form U-7 for certain intrastate offerings.
C. Two states that have adopted Form U-7 provide potential investors with an investor protection brochure to broaden public awareness of the investment risks in start-up ventures. In the State of Washington, the brochure was developed by the Business Assistance Center, a division of the Department of Trade and Economic Development, as part of its consumer awareness program. Practitioners have used the brochure as a supplement to the disclosure form as a means of establishing a defense in the event of investor losses. In Arizona, the Securities Division requires a brochure it developed based on the Washington brochure to be delivered with the Form U-7 to prospective investors. *370 The NASAA "Small Business Sales Agent Guidelines" require the delivery of a "Consumers Guide to Small Business Investments" prior to sale. See Part III: ULOE and SCOR Ramifications for Broker-Dealers, Appendix II.
1. The Arizona and Washington brochures warn of the risks inherent in investing in small businesses and admonish investors not to invest any funds that they cannot afford to lose entirely. After noting that statistically most small businesses fail within a few years, the brochures suggest that an investor who plans to invest large amounts of money in small businesses might adopt the investment diversification strategy of professional venture capitalists.
2. The brochures provide practical hints for analyzing the information disclosed in the Form U-7 Disclosure Document. Investors are cautioned not to over-value companies that lack a history of operations from which an assessment of value can be made. Both brochures also note that inexperienced investors often over-value a glamorous product and do not sufficiently consider management experience, skill and integrity.
3. The brochures suggest that investors educate themselves about a company's industry or market and competitive factors by reviewing industry research reports in the business press. They also note that a typical marketing mistake made by companies is to assume the ability to reach a particular market share without actually analyzing what is involved to achieve that share.
4. The brochures advocate an "exit strategy" and caution that if the company is not likely to develop a public trading market for its stock or is not likely to be sold, the investor may not be able to realize on his investment.
D. In the often sleazy world of sales of "shell corporations," the SCOR is becoming a popular vehicle to use or pitch after merging a small corporate issuer seeking capital with the infamous "clean" shell. Some of the purveyors of the shells have serious securities regulatory problems in their past or have as their real objective the manipulation of the market for the shell, either for purposes of dumping their stock or for creating an artificial run-up in price from which they can profit before dropping the stock from active trading. Issuers are encouraged to believe that the large list of shell corporation stock shareholders will want to buy their new issue, or that foreign or sophisticated sources want to buy the stock because of its free trading characteristics. Historically those representations have often proved of dubious value.
VIII. USE OF THE SCOR FORM
A. As part of its Small Business Initiatives, the SEC adopted amendments to the Regulation A exemption from the registration requirements of the Securities Act of 1933 that permit the Form and content of the offering circular required under that exemption to be met by the equivalent of Form U-7, known as the Form 1-A, Model A Offering Circular. In addition, the SEC adopted further revisions on April 27, 1993 that would permit small business issuers to register up to $5 million on a new Form SB-1 that includes as one of its disclosure alternatives the Model A Offering Circular under Regulation A. The new *371 rules would also incorporate such disclosure into the forms required for reporting companies under the Securities Exchange Act of 1934.
IX. CONCLUSION
A. The experiences of the states in the forefront of the small business movement have shown that the SCOR program can be an extremely effective tool for attacking the difficult problem of financing small businesses. Professor Mark Sargent, in his article, The SCOR Solution, praises the joint effort of the Business Law Section of the American Bar Association and NASAA for developing a form. He states: "This cooperative effort produced a special registration device that the Bar could regard as helpful and that NASAA could swallow without choking." He continues: "SCOR should actually be useful to the constituency it was intended to benefit - smaller issuers engaged in most offerings and the attorneys advising them." He goes on to praise the use of "plain" English, the relatively simple question-and-answer fill-in-the-blank format, and comments that the document might be actually read and understood by investors.
B. The expansion of the use of the Form U-7 into Regulation A offerings and registrations up to $5 million hopefully will have the effect of encouraging a more user friendly and effective system of raising capital. Its use in meeting the reporting company requirements provides a meaningful transition for a small business entering the "public company" world.
*372 APPENDIX I SCOR CITATIONS
Alabama No SCOR provisions
Alaska Alaska Admin. Code Art. 5, Sec. 3 AAC 08.600-.650
Interpretative Opinion ¶ 8561
Arizona Ariz. Rev. Stat., Sec. 44-1902 Regs. of AZ Corp. Commission,
Sec. R14-4-134
Arkansas Arkansas unofficially allows small business issuers to register
their offerings by qualification Arkansas Regulations Rule
403.02
California Cal. Codes, Sec. 25113 Rule 260.113 and .113.1
Colorado Regs. of the Colo. Division of Securities, Sec. 51-3.2 and
51-3.3
Connecticut Regs. of Conn. State Agencies Sec. 36b-31-18a Admin. Order
¶ 14,553
Delaware Delaware Blue Sky Regulation Sec. 402
Florida Florida Blue Sky Regulation Rules 3E-301.002, 3E-700.028
Georgia Georgia unofficially recognizes SCOR by qualification. Ga. Code
Ann., Sec. 10-5-5
Hawaii SCOR legislation currently under consideration
Idaho Rules and Regs. of Dept. of Finance Rule 161
Illinois Rules of Illinois Securities Department Sec. 130.525
Indiana Ind. Code, Sec. 23-2-1-5.5
Iowa Code of Iowa, Title XII, Sec. 502.207A Rules of Iowa Insurance
Division Sec. 191-50.22(502)
Kansas Kan. Admin. Regs. Sec. 81-4-2
Kentucky Kentucky Admin. Regs. Rule 808 KAR 10:280
Louisiana Louisiana unofficially recognizes SCOR on Form U-7
Maine Rules of the Securities Division of the Bureau of Banking Ch.
525, Sec. 1 through 8
Maryland Code of MD Regs. Rule .12
Massachusetts Gen. Law of Mass., Sec. 13.303(E) Code of Mass. Regs., Sec.
14.412(m) Statement of Policy ¶ 31,634
Michigan Michigan Corp. Laws, Sec. 451.704A. Mich. Admin. Code R
451.803.11
Minnesota Minnesota Stat. Sec. 80A.115
Mississippi Rule 703
Missouri Code of State Regs. Sec. 30-52.271 and Sec. 30-54.240
Montana Mont. Code. Ann. Sec. 30-10-205
Nebraska No SCOR provisions
Nevada Nevada Admin. Code Sec. 90.403
New Hampshire N.H. Rev. Stat. Ann. Sec. 421-B:15-a and Sec. 421-B:20
New Jersey Statement of Policy ¶ 40,604 and ¶ 40,6910
New Mexico New Mexico Adm. Code 11.4.1.1-11.4.6.14; 11.6.2.4
New York No SCOR provisions
North Carolina N.C. Admin. Code Rule .1303
North Dakota Regs. of N.D. Securities Commissioner Sec. 73-02-01-01
Ohio Ohio Admin. Code ¶ 45,738 Rule 1301:6-3-09
Oklahoma Admin. Order ¶ 46,662
Oregon Oregon Admin. Rules Rule 441-65-170, Rule 441-65-220, Rule
441-65-225, and Rule 441-65-110
Pennsylvania Statement of Policy ¶ 48,683G
Rhode Island Regs. of Rhode Island Securities Division Rule 304c-1
South Carolina Statement of Policy ¶ 92-2
South Dakota South Dakota unofficially permits SCOR by qualification
Tennessee Rules of Dept. of Insurance, Division of Securities Rule
0780-4-1.04, Rule 0780-4-2-.02
Texas Texas Admin. Code, Sec. 133.33
Utah Rules of the Securities Commission R164-10-2
Vermont Verm. Stat. Ann. Sec. 4208(3) Regulation S-92-1
Virginia Code of Virginia Sec. 13.1-510 21VAC 5-30-90
Washington WA Admin. Code, Ch. 460-17A WAC 460-17A-010 through 060
West Virginia West Virginia unofficially permits SCOR by qualification Sec.
32-3-304
Wisconsin Wis. Admin Code DFI Sec. 2.028 DFI Sec. SEC 9.01
Wyoming Regs. of Wyoming Securities Division Ch. 7, Sec. 3
*375 APPENDIX II
NASAA RISK DISCLOSURE GUIDELINES
Adopted September 9, 2001
I. INTRODUCTION
A. Background. The risk factor section of the disclosure document presents two purposes that are often in tension with its use as a selling document. First, risk factors alert the potential investor to all of the material risks involved in the offering that bear on the likelihood of business success and financial return to the investor. Second, risk factors protect the issuer from subsequent claims by investors that they were misled by the information in the disclosure document, either by omission or by affirmative misstatements. These guidelines recognize that many variables affect the determination of when disclosure is adequate in the context of a particular offering. Such variables include, but are not limited to, the nature of the offering and the sophistication of the investor.
B. Purpose of These Guidelines. By disseminating a uniform set of the most basic disclosure standards applied by the member jurisdictions of NASAA in reviewing disclosure documents, the reviewing jurisdictions expect to reduce the number and avoid the repetition of deficiency comments issued to applicants. These guidelines attempt to collect and illustrate in a convenient manner, guidelines that in the past have been accessible only by researching securities regulators' laws and regulations, releases, bulletin letters, published no-action positions and industry treatises.
C. Effect of These Guidelines. These guidelines are intended to provide informal guidance to the public and are not intended to create a standard of civil liability in favor of any private party against any person as a result of lack of adherence to them. A disclosure document not complying with these guidelines, however, may be denied effectiveness by the administrator.
II. FORMAT AND USE OF RISK FACTORS
A. The Risk Factors Should Immediately Follow the Cover or the Summary. Consistent with investor protection, a comprehensive listing of the material risks to the potential investor in the offering should be located at the forefront of the disclosure document upon which an investor will make an investment decision. These guidelines recognize that potential investors often focus on the forepart of the document. When comparing potential investment opportunities, consistency in format of often complex disclosure documents further assists the investor.
B. The Risk Factor Section is a List Identifying the Material Risks Associated with the Offering. The risk factor section should not be a comprehensive discussion of the risks and counterbalancing considerations. Like the summary section, the risk factor section is a summary listing of the material disclosures that are discussed and analyzed in more detail in the appropriate, related sections of the body of the disclosure document. Consistent with this purpose, most risk factors will not be comprehensive discussions of the issues. The risk factor section itself should be limited in length. In order to emphasize the nature of the disclosures as risks, no ameliorative statements should appear in the risk factors.
C. Prioritize. The risk factors that identify risks the potential investor is likely to find most significant should appear at or close to the beginning of the list. Burying factors such as the auditors' "going *376 concern", significant recent losses, or 100% dilution in the middle of a lengthy list of risk factors would be inconsistent with these guidelines.
D. Risk Factor Captions Should Appear in Off-Set Type. As a listing of the material risks of the potential investment, captions should stand out to the eye of the reader. Italicized, bold-face, or underlined type assists the reader to quickly comprehend the scope and nature of the particular risk factors, and permits the reader to focus further on the risk factors of most interest to that reader. For the same reason, issuers should avoid lengthy captions.
III. RISK FACTOR CONTENT
A. Each Caption Succinctly Identifies the Risky Element of the Factor. The caption should avoid the use of general, boiler-plate language. For instance, "Competition" merely identifies the subject of the risk factor. The alternative, "Established Retailers Have Recently Entered The Company's Market", is specifically tailored to the offering, the nature of the competitive risk, and suggests the negative aspect of the risk. As a topic sentence to the factor, the caption can further streamline and shorten the factor.
B. Specific Cross-References Point the Reader to Complete Discussions of the Issue. Consistent with principles of "Plain English" disclosure, risk factors should not merely repeat verbatim disclosure appearing elsewhere in the disclosure document. Where appropriate, the risk factor should be a two or three sentence summary with a cross reference to the discussion appearing elsewhere in the disclosure document. In some cases, there may be no need to repeat the risk factor in the body of the disclosure document. If a risk factor uses multiple cross-references, the references should not then repeat the same disclosure These guidelines recognize that potential investors often focus interest on disclosure that is of most interest to them, and cross-references assist the potential investor in locating this disclosure.
C. Eliminate General, Boiler-Plate Risk Factors. Include only risks that are material to the particular offering or the particular issuer, and, in narrowly drawn cases, particular to the industry segment. Do not include generic risks such as the absence of past dividends or expectation to pay future dividends by a development-stage company. A generic risk factor that the issuer "faces significant competition from established, well-financed companies with greater resources. . ." is an example of an inappropriate risk factor.
D. Forward Looking Statements. Disclosure in the form of boiler-plate legends frequently appears at the beginning of the risk factor section. As the risk factors constitute the "cautionary language" referred to in the legend, these legends are redundant in the risk factor section. They also detract from a "reader-friendly" introduction to the risk factors, and should be moved to follow the risk factors or to some other section of the disclosure document.
IV. GUIDANCE ON SPECIFIC RISK FACTORS OFTEN APPROPRIATE TO A RISK FACTOR SECTION.
Issuers must analyze appropriate risk factors for each offering on a case-by-case basis. Moreover, there is no single acceptable way to draft disclosure for a particular risk factor. You may find it helpful to refer to the SEC Staff Legal Bulletin No. 7 (Corporation Finance), dated September 4, 1998, and its June 7, 1999 update, entitled "Plain English Disclosure," for guidance in writing risk factors. You may also find it helpful to refer to Appendix A of the NASAA Small Company Offering Registration (SCOR) Manual.
*377 APPENDIX III NASAA MODEL AGREEMENTS
*378 SAMPLE IMPOUND OF FUNDS AGREEMENT
This Agreement was entered into _________________________, 20__, between __________________________________________________ (the "Company") and _________________________ (the "Impound Agent"). The Impound Agent is located at _____________.
The Company has applied to register its securities with the Administrator of Securities of the State of __________ (the "Administrator") and, if applicable, with the Administrator of Securities of other states. As a condition of registering the offering, the Administrator required the Company to enter into this Agreement. The Impound Agent represents that it is a financial institution and its deposits are federally insured. The Impound Agent is willing to act as the Impound Agent and to hold the funds under this Agreement.
The Company and the Impound Agent agree as follows:
Deposit of Funds
1. Within 2 business days after the Company receives the monies, the Company will deposit all monies that it receives from the sale of securities (the "Impound Funds") in an impound account with the Impound Agent to be designated the "____________________ Impound Account" (the "Impound Account").
2. The Company and its agents will instruct subscribers to make their checks payable to the Impound Account. The Company will provide the Impound Agent with a copy of the Subscription Agreement together with the Impound Funds. The Company will provide the Impound Agent with the name, address and social security or other tax identification number of each subscriber and the date and amount of each subscription.
3. If the Impound Agent received checks that fail to clear the bank on which they are drawn, the Impound Agent will return those checks, together with the related Subscription Agreement, to the subscriber. The Impound Agent will send a copy of the returned checks and related Subscription Agreements to the Company.
*379 Keeping of Funds
4. The Impound Agent will keep the Impound Funds, segregated in the Impound Account, for investment purposes, until the Impound Agent releases the Impound Funds to the Company or returns them to the subscribers under paragraph 7 or 8, below.
5. Unless the Administrator directs to the contrary, the Impound Agent will invest the funds deposited in the Impound Account as directed by the Company in liquid investments, such as bank certificates of deposit or United States treasury bills, or savings accounts at the Impound Agent.
6. Impound Funds are not assets of the Company and are not subject to judgment or creditors claims against the Company until the Impound Funds are released to the Issuer under this Agreement.
Release or Return of Funds
7. If, by the _____ day of _____, ___ (the "Closing Date"), the funds deposited in the Impound Account amount to or exceed $ __________ (the "Minimum Subscription"), then the Impound Agent will release those funds, and all other funds deposited after that, to the Company provided that
(a) the Impound Agent has provided the Administrator with a letter stating that $_____ has been deposited into the Impound Account before the Closing Date, and
(b) the Administrator has provided the Impound Agent and the Company with written consent to the release of the funds from the Impound Agreement.
8. Unless the Closing Date has been extended under paragraph 10, if, by the Closing Date, the funds deposited in the Impound Account do not equal or exceed the Minimum Subscription, the Impound Agent will
(a) advise the Company and the Administrator in writing that it has not received the Minimum Subscription, and
(b) will return to each subscriber the amount the Impound Agent received on behalf of that subscriber.
9. The Impound Agent will divide any interest earned on the Impound Account between the subscribers based on their subscription and pay that to them.
Extension of Closing Date
10. The Closing Date may be extended, provided that
(a) the Disclosure Document discloses that the offering could be extended for _____ days, and
(b) the Company has delivered to the Impound Agent and the Administrator a written notice of extension.
*380 Revocation or Suspension of Registration
11. If, at any time before the Impound Agent releases the funds as provided in Paragraph 7 or 8 of this Agreement, the Administrator advises the Impound Agent that it has revoked or suspended the registration, the Administrator may direct the Impound Agent
(a) not to release the funds in the Impound Account until further notice by the Administrator, or
(b) to release to each subscriber the amount that the Impound Agent received on behalf of that subscriber together with interest as set out in paragraph 9.
Abandonment of Offering
12. If the Impound Agent receives a letter from the Company stating that the offering has been abandoned, the Impound Agent will return to each subscriber the amount the Impound Agent received on behalf of that subscriber together with interest as set out in paragraph 9.
Termination of Agreement
13. This Agreement will terminate once the Impound Agent has released all funds from the Impound Account in accordance with this Agreement.
Duty of Impound Agent
14. The Impound Agent will act as a depository only, and its sole responsibility will be to act in accordance with the terms of this Agreement.
Records of Impound Agent
15. The Impound Agent will keep records (the "Records") that disclose
(a) the names, addresses, telephone numbers and tax identification numbers of the subscribers,
(b) the amount received on behalf of each subscriber,
(c) the amount and date of the securities purchased,
(d) the date that the Impound Agent released or returned the funds held in the Impound Account
16. The Impound Agent will provide to the Administrator, on request, true, complete and current copies of the Records.
*381 Impound Agent Compensation
17. The Company will pay the Impound Agent reasonable compensation for its services in the amount of $_____.
Scope of Agreement
18. This Agreement will be for the benefit of, and binding on, the Company, the Impound Agent and their successors, the subscribers and their heirs, assignees, beneficiaries, executors, administrators and their legal representatives. If, for any reason, the Impound Agent named in this Agreement is unable or unwilling to continue to act as an impound agent, then the Company may substitute, with the consent of the Administrator, another person to serve as Impound Agent.
IN WITNESS WHEREOF, the parties have executed this Agreement the ________ day of __________, _____.
COMPANY:_______________
By____________________
President
IMPOUND
AGENT:_______________
By ____________________
Its ____________________
*382 SAMPLE SUBSCRIPTION AGREEMENT FOR
____________________ (Company Name)
If you are interested in purchasing shares ("Shares") of the common stock (the "Common Stock") of ____________________ (the "Company"), you must:
a) complete this Subscription Agreement (the "Agreement");
b) provide a check or money order (unless a wire transfer is being sent) made payable to ____________________ as impound agent for the company;
c) deliver both the Agreement and payment to:
Impound Agent: ____________________
Address: ________________________________________
Attention: ____________________
The Company may accept or reject any subscription you tender, in whole or in part. This means that the Company may allocate to you a smaller number of Shares than you subscribed to purchase. If accepted by the Company, then this Agreement will constitute a subscription for shares of the Company's Common Stock ($_____ par value per share).
The minimum subscription is $_____ for ____ shares. You should pay by check, money order or wire transfer payable to "__________, Impound Account." If the Company rejects your subscription in whole, the Company will return this Agreement and your payment.
If the Company accepts your subscription in whole or in part, a copy of this Agreement will be returned to you as your receipt. This will confirm your subscription and indicate how much of your subscription the Company has accepted. All proceeds of the Offering will be held in an Impound Account at _______________.
When the Company sells its Minimum Subscription, the funds held in the Impound Account will be disbursed to the Company and stock certificates will be issued within _____ days. After that, you will be mailed stock certificates no more than _____ days after the Company mailed written confirmation of the subscription to you. If the Company accepts only part of your subscription, the Company will return the unused portion of your payment to you with interest, if any. If the Minimum Subscription is not sold prior to the Termination Date of the Offering, then all deposits will be returned to subscribers with interest earned, if any.
You irrevocably submit this Agreement for the purchase of _____ Shares at $____ per Share. With this Agreement, you also submit payment in the amount of $_____ ($ per Share) for the Shares subscribed.
*383 In connection with this investment, you represent to the Company that:
a. Before submitting payment for the Shares, you received the Company's Disclosure Document dated __________, 20__.
b. You are a resident of _________________ (State), ____________________ (Country).
(If the Offering has not been qualified or registered in that jurisdiction or is not exempt from the registration requirements in that jurisdiction, your subscription will not be accepted.)
c. The Social Security number or taxpayer identification number that you included in this Agreement is your true, correct and complete identification number.
d. You are not subject to backup withholding of interest or dividends by the Internal Revenue Service.
The Shares should be registered as follows:
Name:______________________________
As (check one):
____ Individual ____ Tenants-in-Common
____ Partnership ____ Joint Tenants
____ Corporation ____ Trust
____ Minor with adult custodian ____ Other
Under the Uniform Gift to Minors Act
Individual(s) Registration:
____________________
Investor No.1 (print name above)
____________________
Street (residence address)
____________________
City State Zip
____________________
Home Phone
____________________
Investor No. 2 (print name above)
____________________
Street (residence address)
____________________
City State Zip
____________________
Home Phone
*384 ____________________
Social Security Number
____________________
Date of Birth
____________________
Signature
____________________
Date
____________________
Social Security Number
____________________
Date of Birth
____________________
Signature
____________________
Date
Entity (Not Individual) Registration:
On behalf of the entity named below, you represent that you have full power and authority to execute this Agreement. You also represent that investment in the Company is not prohibited by any of the governing documents of the entity.
____________________
Name of Entity
By: __________________
Signature of trustee, partner or authorized officer
Title: __________________
____________________
Street Address
____________________
City State Zip
____________________
Date
____________________
Taxpayer ID Number
____________________
Telephone
ACCEPTED BY _________________________ (Company Name) FOR_______________SHARES
By: ____________________
Title: ____________________
Date:____________________
*385 SAMPLE OPINION OF COUNSEL LETTER
[Date of Letter]
Board of Directors
XYZ, Inc.
1221 North Street
Raleigh, North Carolina 27509
RE: Opinion of Counsel regarding legality of Shares
Dear Directors:
In connection with the proposed offer and sale of up to 500,000 shares of the XYZ, Inc.'s (the Company's) Common Stock, we have made such legal examination and inquiries as we have deemed advisable or necessary for the purpose of rendering this opinion and have examined originals or copies of the following documents and corporate records:
1. The Company's Articles of Incorporation, as amended,
2. The Company's Bylaws,
3. The Company's resolutions of the Board of Directors authorizing the issuance of stock, and
4. The application for registration, including the Disclosure Document, as filed by XYZ, Inc. with the Securities Administrator of the State of _______________ on __________, 20___,
Based on our examination and inquiry, we are of the opinion that, upon effectiveness of the registration, and when issued and sold in the manner referred to in the registration and under the applicable subscription agreement, the Shares of Common Stock will be duly authorized, fully paid and nonassessable.
We consent to the filing of this opinion as an exhibit to the application for registration filed with the Securities Administrator.
Very truly yours,
H. Smith, Attorney at Law
*386 SAMPLE PROMOTIONAL SHARES ESCROW AGREEMENT
This Promotional Shares Escrow Agreement ("Agreement") was entered into __________, 20___, among ____________________ (the "Company"), and _______________, _______________, _______________, _______________, (the "Depositors"), and ____________________________ (the "Escrow Agent"). The Company is located at _________________________. The Escrow Agent is located at _________________________, The Company, Depositors and Escrow Agent are collectively referred to as "Signatories" in this Agreement.
The Company has applied to register its Equity Securities with the Securities Administrator of the State of _______________(the "Administrator"), and if applicable, with the Securities Administrator of other states. The Depositors are the owners of the shares of common stock or similar securities and/or convertible securities, warrants, options or rights which may be converted into, or exercised to purchase shares of common stock or similar securities of the Company ("Equity Securities") listed opposite their names on Exhibit A to this Agreement. As a condition to registering the Company's Equity Securities, the Depositors, who are security holders of the Company and who, for the purposes of this Agreement, are deemed to be Promoters of the Company, have agreed to deposit the Equity Securities listed opposite their names on Exhibit A to this Agreement ("Promotional Shares") with the Escrow Agent.
This Agreement is subject to the provisions of the Statement of Policy Regarding Corporate Securities Definitions adopted by the North American Securities Administrators Association, Inc. ("NASAA") on April 27, 1997 and amended September 28, 1999, and the Statement of Policy Regarding Promotional Shares adopted by NASAA as amended November 17, 1997 and September 28, 1999.
The Escrow Agent represents that it is not affiliated with the Company or any Depositors and that it is willing to serve as Escrow Agent and hold the Promotional Shares according to this Agreement.
The Signatories further agree as follows:
Deposit of Promotional Shares
1. The Depositors' Promotional Shares have been deposited into an Escrow Account ("Escrow") with the Escrow Agent, and the Escrow Agent acknowledges receipt of the Promotional Shares as of the date of this Agreement.
Exercise or Conversion of Promotional Shares
2. If the Promotional Shares have exercise rights or conversion rights, the Escrow Agent will, upon receipt of the Company's written request, provide the documents that evidence and/or which are necessary to execute the exercise rights or conversion rights. The exercised or converted Promotional Shares will remain in Escrow subject to the terms of this Agreement.
Term
3. This Agreement and the Escrow begin on the date this Agreement was entered into as indicated above. The Escrow Agent will hold the Promotional Shares until the release conditions of paragraph 4 below are satisfied.
*387 Release Of Promotional Shares
4. a. Subject to the documentation requirements in paragraph 5 below, the Escrow Agent will release the Promotional Shares in the following manner:
(1) (A) If the Company's Aggregate Revenues are less than $500,000: beginning two years after the completion date of the registered offering, two and one-half percent (2 1/2%) of Promotional Shares held in Escrow may be released each quarter pro rata among the Depositors. All remaining Promotional Shares will be released from Escrow on the fourth anniversary of the completion date of the registered offering; or
(B) If the Company's Aggregate Revenues are $500,000 or more and there is no statement in the Company's financial statements or its auditors' report regarding the Company's ability to continue as a going concern: beginning one year after the completion date of the registered offering, two and one-half percent (2 1/2%) of Promotional Shares held in Escrow may be released each quarter pro rata among the Depositors. All remaining Promotional Shares will be released from Escrow on the second anniversary of the completion date of the registered offering; or
(2) One hundred percent (100%) of the Promotional Shares will be released from Escrow if:
(A) The registered offering has been terminated, and no securities were sold; or
(B) The registered offering has been terminated, and all of the gross proceeds that were received have been returned to investors; or
(C) The Equity Securities did not qualify to be registered by the Administrator.
b. If the Company enters into any merger, reorganization, liquidation, dissolution or other transaction or proceeding with a person who is not a Promoter that results in the distribution of the Company's assets or securities ("Distribution") while this Agreement remains in effect, the Depositors agree that:
(1) All holders of the Company's Equity Securities will initially share on a pro rata, per share basis in the Distribution, in proportion to the amount of cash or other consideration that they paid per share for their Equity Securities (provided that the Administrator has accepted the value of the other consideration), until the shareholders who purchased the Company's Equity Securities in the registered offering ("Shareholders") have received, or have had irrevocably set aside for them, an amount that is equal to one hundred percent (100%) of the offering price per share times the number of shares of Equity Securities that they purchased in the registered offering and which they still hold at the time of the Distribution, adjusted for stock splits, stock dividends recapitalizations and the like;
(2) After a Distribution, all holders of the Company's Equity Securities will participate on an equal, per share basis times the number of shares of Equity Securities they held at the time of the Distribution, adjusted for stock splits, stock dividends, recapitalizations and the like; and
*388 (3) A Distribution may proceed on lesser terms and conditions than the terms and conditions stated in paragraphs 4.b(1) and (2) above if a majority of the Equity Securities that are not held by Promoters, or their Associates or Affiliates, vote, or consent by consent procedure to approve the lesser terms and conditions at a special meeting called for that specific purpose.
c. If the Company enters into any merger, reorganization, liquidation, dissolution or other transaction or proceeding with a person who is a Promoter that results in a Distribution while this Agreement remains in effect, the Depositors' Promotional Shares will remain in escrow subject to the terms of this Agreement.
d. If the securities in Escrow become "Covered Securities," as defined in Section 18(b)(1) of the Securities Act of 1933, all securities held in Escrow will be released.
Documentation Regarding the Release of Promotional Shares:
5. a. A written request for release of the Promotional Shares ("request for release"), based upon paragraph 4 above, will be forwarded to the Escrow Agent;
b. The Company will provide appropriate documentation to the Escrow Agent to show that the requirements of paragraph 4 above have been met; and
c. The Escrow Agent will terminate the Agreement and/or release some or all of the Promotional Shares from Escrow if all the applicable provisions of the Agreement have been satisfied. The Escrow Agent will maintain all records relating to the Agreement for a period of three (3) years following the termination of the Agreement. Copies of all records retained by the Escrow Agent will be forwarded to the Administrator promptly upon written request.
Restrictions on the Transfer, Sale or Disposal of Promotional Shares.
6. While this Agreement is in effect, no Promotional Shares, any interest in Promotional Shares, or any right or title to Promotional Shares may be sold, transferred, hypothecated or otherwise disposed of ("transfer" or "transferred"), except as provided below, and the Escrow Agent will not recognize any transfer that violates the terms of this Agreement. The Promotional Shares may not be transferred until the Escrow Agent has received a written statement, signed by the proposed transferee ("transferee"), which states that the transferee has full knowledge of the terms of this Agreement, the transferee accepts the Promotional Shares subject to the terms of this Agreement, and the transferee realizes that the Promotional Shares will remain in Escrow and subject to the terms of the Agreement until the Promotional Shares are released pursuant to paragraph 4 above. Depositors are prohibited from selling any of their Promotional Shares that are not subject to Escrow during the time that the Company is offering its securities in a self-underwritten registered offering.
a. Promotional Shares held in Escrow may be transferred by will, the laws of descent and distribution, the operation of law, or by order of any court of competent jurisdiction and proper venue.
b. The escrowed Promotional Shares of a deceased Depositor may be hypothecated to pay the expenses of the deceased Depositor's estate, provided that the hypothecated Promotional *389 Shares will remain subject to the terms of this Agreement. Promotional Shares may not be pledged to secure any other debt.
c. Promotional Shares held in Escrow may be transferred by gift to the Depositor's family members, provided that the Promotional Shares will remain in Escrow and subject to the terms of this Agreement.
Voting Rights
7. With the exception of paragraph 4.b above, the Depositors will have the same voting rights as holders of non-escrowed Equity Securities. If the Promotional Shares are registered in the Escrow Agent's name, the Escrow Agent will vote those Promotional Shares in accordance with the Depositors' written instructions.
Dividends, Stock Splits And Recapitalizations
8. All certificates representing stock dividends and shares resulting from stock splits of escrowed shares, recapitalizations and the like, that are granted to or received by Depositors while their Promotional Shares are held in Escrow will be deposited with and held by the Escrow Agent subject to the terms of this Agreement. Any cash dividends that are granted to or received by the Depositors while their Promotional Shares are held in escrow, will be promptly deposited with and held by the Escrow Agent subject to the terms of this Agreement unless such cash dividends are approved by a majority of the Independent Directors of the Company. The Escrow Agent will invest cash dividends as directed by the Depositors. The cash dividends and any interest earned on the cash dividends will be disbursed by the Escrow Agent in proportion to the number of shares released from the Escrow as provided by paragraph 4. above.
Additional Shares
9. Equity Securities that are received by the Depositors as the result of the conversion of the Depositors' convertible securities and/or the exercise of Depositors' options, warrants or rights listed on Exhibit A, while their Promotional Shares are held in escrow, will be promptly deposited with the Escrow Agent as Promotional Shares subject to the terms of this Agreement. These additional Promotional Shares will be released from Escrow as provided by paragraph 4 above.
Duty of Escrow Agent.
10. The Escrow Agent's sole responsibility will be to act in accordance with the terms expressly set forth in this Agreement. In performing its duties under this Agreement, the Escrow Agent will not be liable to anyone for any damage, loss, expense or liability other than for that which arises from the Escrow Agent's failure to abide by the terms of this Agreement.
Escrow Agent's Compensation.
11. The Escrow Agent will be entitled to receive reasonable compensation from the Company for its services as provided in Exhibit B, which is attached to and part of this Agreement. {Drafting Note: the Escrow Agent can specify details of compensation on the Exhibit B, including provisions for services not specified in this Agreement.}
Escrow Agent's Indemnification
12. The Company and the Depositors agree to hold the Escrow Agent harmless from, and indemnify the Escrow Agent for, any cost or liability regarding any administrative proceeding, investigation, litigation, interpretation, implementation or interpleading relating to this Agreement, including *390 the release of Promotional Shares and the disbursement of dividends, interest or proceeds, unless the cost or liability arises from the Escrow Agent's failure to abide by the terms of this Agreement.
Scope
13. This Agreement will be binding upon the Depositors, their heirs and assignees, and upon the Company, Escrow Agent, and their successors.
Substitute Escrow Agent
14. If, for any reason, the Escrow Agent named in this Agreement is unable or unwilling to continue to act as Escrow Agent, then the Company may substitute, with the consent of the Administrator, another person to serve as Escrow Agent under this Agreement.
Termination
15. Except for the compensation and indemnification provisions of paragraphs 11 and 12 above, which will survive until those provisions are satisfied, this Agreement will terminate in its entirety when all of the Promotional Shares have been released, or the Company's Equity Securities and/or assets have been distributed as provided by paragraph 4 above.
The Signatories have entered into this Agreement, which may be written in multiple counterparts and each of which will be considered an original, and have signed this Agreement in the capacities and on the dates indicated below.
____________________
(Print or type the Depositor's name)
____________________
(Signature)
____________________
(Print or type the Depositor's name)
____________________
(Signature)
____________________
(Print or type the Depositor's name)
____________________
(Signature)
Date
_______________
_______________
_______________
*391 Company
By __________________
President
By __________________
Secretary
Date
_______________
_______________
Escrow Agent
____________________
By __________________
Title: _________________
_______________
*392 SAMPLE PROMOTIONAL SHARES LOCK-IN AGREEMENT
This Promotional Shares Lock-In Agreement ("Agreement") was entered into __________, 20___, between ____________________________________________________________ (the "Company"), located at ______________________________________________________________________, and ____________________________________________________________(the "Security Holder"), located at ______________________________________________________________________. Together, the Company and Security Holder are referred to as "Signatories" in this Agreement.
The Company has applied to register its Equity Securities with the Securities Administrator of the State of_______________ (the "Administrator"), and if applicable, with the Securities Administrators of other states. The Security Holder is a Promoter of the Company and owns the following Equity Securities issued by the Company that are Promotional Shares as defined in the Statement of Policy Regarding Corporate Securities Definitions (the "Definitions SOP") adopted by the North American Securities Administrators Association, Inc. ("NASAA") on April 27, 1997 and amended September 28, 1999 (describe the type and number of Equity Securities owned): _____________(the "Promotional Shares").
Other capitalized terms in this Agreement that are not defined within the Agreement have the meanings specified in the Definitions SOP.
As a condition to Registering the Company's Equity Securities, the Signatories agree as follows:
Promotional Shares are Restricted Securities
1. The Security Holder agrees not to sell, pledge, hypothecate, assign, grant any option for the sale of, or otherwise transfer or dispose of, whether or not for consideration, directly or indirectly, the Promotional Shares and all certificates representing stock dividends, stock splits, recapitalizations, and the like, that are granted to, or received by the Security Holder during the term of this Agreement (the "Restricted Securities"), except as allowed by this Agreement.
Exercise or Conversion of Restricted Securities
2. If the Restricted Securities under this Agreement have exercise or conversion rights, the Security Holder may execute the rights, but the exercised or converted Equity Securities will also be Restricted Securities and subject to Lock-In during the term of this Agreement.
Term
3. This Agreement became effective on the date the Agreement was entered into as indicated above and will terminate when the release conditions of paragraph 4 are satisfied.
Release of Restricted Securities
4. a. Subject to the documentation requirements in paragraph 5 below, the Restricted Securities may be released from Lock-In provisions of this Agreement in the following manner:
*393 (2) (A) If the Company's Aggregate Revenues are less than $500,000: beginning two years after the completion date of the registered offering, two and one-half percent (2 1/2%) of the Restricted Securities may be released each quarter pro rata among all Security Holders subject to Lock-In Agreements. All remaining Restricted Securities will be released on the fourth anniversary of the completion date of the registered offering; or
(B) If the Company's Aggregate Revenues are $500,000 or more and there is no statement in the Company's financial statements or its auditors' report regarding the Company's ability to continue as a going concern: beginning one year after the completion date of the registered offering, two and one-half percent (2 1/2%) of the Restricted Securities may be released each quarter pro rata among all Security Holders subject to Lock-In Agreements. All remaining Restricted Securities will be released on the second anniversary of the completion date of the registered offering; or
(2) One hundred percent (100%) of the Restricted Securities will be released if:
(A) The registered offering has been terminated, and no securities were sold; or
(B) The registered offering has been terminated, and all of the gross proceeds that were received have been returned to investors; or
(C) The Equity Securities did not qualify to be registered by the Administrator.
b. If the Company enters into any merger, reorganization, liquidation, dissolution or other transaction or proceeding with a person who is not a Promoter that results in the distribution of the Company's assets or securities ("Distribution") while this Agreement remains in effect, the Security Holder agrees that:
(1) All holders of the Company's Equity Securities will initially share on a pro rata, per share basis in the Distribution, in proportion to the amount of cash or other consideration that they paid per share for their Equity Securities (provided that the Administrator has accepted the value of the other consideration), until the shareholders who purchased the Company's Equity Securities in the registered offering have received, or have had irrevocably set aside for them, an amount that is equal to one hundred percent (100%) of the offering price per share times the number of shares of Equity Securities that they purchased in the registered offering and which they still hold at the time of the Distribution, adjusted for stock splits, stock dividends recapitalizations and the like;
(4) After a Distribution, all holders of the Company's Equity Securities will participate on an equal, per share basis times the number of shares of Equity Securities they held at the time of the Distribution, adjusted for stock splits, stock dividends, recapitalizations and the like; and
(5) A Distribution may proceed on lesser terms and conditions than the terms and conditions stated in paragraphs 4.b(1) and (2) above if a majority of the Equity Securities that are not held by Promoters, or their Associates or Affiliates, vote, or *394 consent by consent procedure to approve the lesser terms and conditions at a special meeting called for that specific purpose.
c. If the Company enters into any merger, reorganization, liquidation, dissolution or other transaction or proceeding with a Promoter that results in a Distribution while this Agreement remains in effect, the Security Holder's Restricted Securities will remain subject to the terms of this Agreement.
d. If the Restricted Securities under this Agreement become "Covered Securities," as defined in Section 18(b)(1) of the Securities Act of 1933, the Restricted Securities will be released.
Documentation Regarding the Release of Restricted Securities
5. The following will be required as evidence of compliance with the conditions for release of Restricted Securities from this Lock-In Agreement under paragraph 4 above:
a. A written notice to the Administrator with a copy of this Agreement to advise that the release conditions have been satisfied;
d. Appropriate supporting documents that demonstrate compliance with paragraph 4 above will be maintained for a period of three (3) years after termination of the Agreement and will be sent to the Administrator promptly upon request; and
e. If the Administrator does not request additional documents or object to the release of Restricted Securities within ten (10) business days after the notice specified above has been filed, this Agreement will terminate and the Restricted Securities will be released.
Exceptions from Restrictions
6. The following types of transfer, hypothecation or disposition of Restricted Securities are allowable under this Agreement:
a. Restricted Securities may be transferred by will, the laws of descent and distribution, the operation of law, or by order of any court of competent jurisdiction and proper venue.
b. The Restricted Securities of a deceased Security Holder may be hypothecated to pay the expenses of the deceased Security Holder's estate, provided that the hypothecated Restricted Securities will remain subject to the terms of this Agreement. Restricted Securities may not be pledged to secure any other debt.
c. Restricted Securities may be transferred by gift to the Security Holder's family members, provided that the Restricted Securities will remain subject to the terms of this Agreement.
Voting Rights
7. With the exception of paragraph 4.b above, the Security Holder will have the same voting rights as holders of Equity Securities that are not Restricted Securities.
Restrictive Legends on Stock Certificates
8. a. A notice will be placed on the face of each stock certificate of the Restricted Securities covered by the terms of this Agreement stating that the transfer of the stock evidenced by the *395 certificate is restricted in accordance with the conditions set forth on the reverse side of the certificate; and
b. A typed legend will be placed on the reverse side of each stock certificate of the Restricted Securities covered by this Agreement which states that: the sale or transfer of the shares evidenced by the certificate is subject to certain restrictions pursuant to anagreement between the Security Holder (whether beneficial or of record) and the Company; the agreement is on file with the Company and the stock transfer agent; and a copy of the agreement is available upon request without charge.
Modifications of Agreement
9. This Agreement may be modified only with the written approval of the Administrator.
Other Requirements of the Company
10. The Company will:
a. File an executed copy of this Agreement with the Administrator before the effective date of the registered offering;
b. Provide copies of this Agreement and a statement of the initial public offering price to the Company's stock transfer agent;
c. Place appropriate stock transfer orders with the Company's stock transfer agent against the sale or transfer of the shares covered by this Agreement, except as otherwise provided in this Agreement;
d. Place the stock restriction legends described above on the periodic statement sent to the registered owner if the securities subject to this Agreement are uncertificated securities.
The Signatories have entered into this Agreement, which may be written in multiple counterparts and each of which will be considered an original, and have signed the Agreement in the capacities, and on the dates, indicated below.
____________________
(Print or type the Security Holder's name)
____________________
(Signature)
Company
By __________________
President
By __________________
Secretary
Date
_______________
_______________
_______________
[FN1]. For additional articles on the development of the SCOR project, see generally Harris, Keller, Stakias & Liles, Financing the "American Dream"-- Small Business and the ULOR Project, 43 Bus. Law. 757(1-988); Harris, Keller, Stakias & Liles, Financing the "American Dream": A Beginning, 44 Bus. Law. 625(1989); Harris, Keller, Stakias & Liles, Financing the "American Dream": ULOR SCOR[E]S, 45 Bus. Law. 1343(1990); Sargent, The SCOR Solution, 18 Sec. Reg. L.J. 93(1990); Harris & Makens, Uniform Form For Small Offerings: SCOR, 23 Rev. of Sec. & Com. Reg. 219(1990); Harris, Keller, Stakias & Liles, Developments in the Use of Form U-7 (SCOR), 47 Bus. Law 273(1991); Stakias & Harris, Simplifying Registration of Small Corporate Offerings: Form U-7 'SCORs', 6 Insights 13 (July 1992).
[FN2]. In addition to the Issuer's Manual, NASAA has specifically addressed risk disclosure in its "NASAA Risk Disclosure Guidelines," adopted September 9, 2001 (see Appendix II).
END OF DOCUMENT
GB+ND+C |
