SEC Continues It’s Crypto Focus

In the 18 months since Gary Gensler expressed his intention to focus on the crypto "wild west," the cryptocurrency industry has faced increasing challenges. The SEC's heightened scrutiny of the crypto space is just one aspect, as the industry has also experienced a crypto winter marked by events like the collapse of the FTX exchange and its FTX Future Fund. Additionally, the anticipated metaverse has yet to materialize, contributing to the challenges faced by the crypto industry.

Financial troubles have further compounded the issues, with bankruptcy filings from prominent crypto entities such as FTX, Blockfi, Celsius, and Voyager. Several others, including Blockchain.com, Coinbase, Crypto.com, and Genesis, find themselves in precarious financial positions.

Apart from the financial crisis within the crypto industry, U.S. regulators, including the SEC, FINRA, and national exchanges, are subjecting any business with even a modest focus on crypto to intense scrutiny. This regulatory environment has made it exceedingly difficult for such businesses to navigate and progress. The collective impact of financial uncertainties and regulatory scrutiny has created a challenging landscape for the crypto industry as a whole.

BACKGROUND

In July 2017, the regulatory landscape for digital assets and cryptocurrencies underwent a significant transformation when the SEC issued a Section 21(a) Report on the DAO investigation. This report, relying on the Howey analysis, established that most cryptocurrencies could be classified as securities. Subsequent to this, the SEC engaged in numerous enforcement proceedings, issued guidance, and delivered speeches, evolving the regulatory framework for the industry.

The Section 21(a) Report used the Howey analysis, which determines when a crypto is a security, leading to the conclusion that the majority of cryptocurrencies at that time were securities. A subsequent announcement in June 2018 by the SEC provided relief by stating that Bitcoin and Ether were likely decentralized enough to no longer be considered securities.

Building on this backdrop, in March 2018, the SEC issued a public statement addressing online platforms trading digital assets. The statement served as both a caution to investors and a warning to platforms, emphasizing that if a platform trades digital assets classified as securities and operates as an "exchange," it must register with the SEC as a national securities exchange or qualify for an exemption.

In April 2019, the SEC's Division of Corporation Finance published a "Framework for Investment Contract Analysis of Digital Assets" and issued a no-action letter to Turnkey Jet, Inc. The guidance reiterated the Howey Test but did not introduce novel perspectives. Despite the guidance, much of the crypto regulation has been enforcement-driven.

Compliance with federal securities laws for cryptocurrencies, given their nature, has proven challenging. Traditional IPOs with S-1 filings are impractical due to general information dissemination and gun-jumping concerns. Traditional exempt offerings are not suitable, as the distribution of cryptocurrencies is not limited to accredited investors.

Regulation A has emerged as a potential avenue; however, completing the offering circular with the SEC is a monumental task. Blockstack was the first in 2019 to qualify an offering circular for issuing a full token with utility token properties. While a few companies have tokenized their equity and completed offerings in the cryptocurrency space, the U.S. has yet to witness the registration or qualification of an offering issuing a cryptocurrency.

As of today, U.S. regulators are approaching anything crypto-related with a presumption of guilt unless proven otherwise. Gary Gensler's August 2021 speech highlighted concerns about fraud, scams, and abuse in the digital asset class. The SEC, through continued enforcement actions and initiatives, is emphasizing its vigilance in addressing crypto-related misconduct and has sought significant funding for this purpose.

SEC Sample Comment Letter

In December 2022, the SEC released a sample comment letter outlining the disclosures it expects from companies directly or indirectly impacted by the collapse of FTX and other crypto company bankruptcies. The SEC emphasizes the need for specific, tailored disclosure about market events, the company's situation in relation to those events, and the potential impact on investors.

The sample comment letter provides 16 comments, starting with a general request for disclosure on significant crypto asset market developments material to understanding the business, financial condition, and results of operations. Under the description of business section, the SEC delves into disclosures related to industry bankruptcies and their impact on a company's business, financial condition, customers, and counterparties.

The comments also extend to the Management's Discussion and Analysis (MD&A) section, with a focus on the effects on financial condition and liquidity, including inquiries about crypto assets serving as collateral for loans or similar activities.

The majority of the comments fall under the "risk factors" heading, covering a range of risks associated with crypto assets, from redemptions and withdrawals to reputational harm. Notably, the SEC asks companies to describe risks related to potential regulatory developments in crypto assets and markets, even if no pending regulations exist in the U.S. The last risk factor comment seeks insights into the risks associated with stock price depreciation, loss of customer demand, financing risks, legal proceedings, and the impact of price declines or volatility in crypto assets.

Overall, the sample comment letter reflects the SEC's heightened scrutiny of crypto-related disclosures and its focus on ensuring companies provide thorough and comprehensive information to investors in light of recent market events.

Heightened Auditor Scrutiny

The SEC is intensifying its scrutiny not only on company disclosures but also on audit firms working for cryptocurrency companies. Paul Munter, the SEC's acting chief accountant, has emphasized the need for investors to exercise caution regarding claims made by crypto companies. Munter revealed that the SEC is closely reviewing audit reports, audit firms operating in the crypto space, and company financial statements, with the possibility of making referrals to the Division of Enforcement based on their findings. This heightened focus underscores the SEC's commitment to ensuring transparency, accuracy, and compliance in financial reporting within the cryptocurrency industry.

Request for Increased Funding

On March 29, 2023, SEC Chair Gary Gensler presented his annual testimony to the Subcommittee on Financial Services and General Government regarding the SEC's budget request. The SEC has requested a total budget of $2.436 billion, reflecting a substantial 12% increase. A significant portion of this budget is intended for investigating and pursuing noncompliance and wrongdoing within the crypto markets. This emphasis on increased funding underscores the SEC's commitment to addressing and regulating the evolving challenges and complexities within the cryptocurrency industry.

Other Regulators

Companies operating in the crypto space, particularly those trading on OTC Markets, are facing increased scrutiny and challenges in their efforts to uplist to higher OTC tiers such as OTCQB or OTCQX. Processing corporate actions through FINRA, such as name changes or reverse splits, for crypto-related companies has become a prolonged and challenging process, often taking a year or more. National exchanges like Nasdaq and the NYSE also closely scrutinize listing applications from companies involved in the crypto industry.

This heightened regulatory environment has led some crypto companies to actively avoid U.S. capital markets, and in some cases, the U.S. entirely. While these regulatory measures are intended to address concerns and risks associated with the crypto industry, they also pose challenges and potential negative consequences for companies seeking to access U.S. capital markets. The regulatory landscape continues to evolve, and companies operating in the crypto space navigate increased scrutiny and compliance hurdles.

Gayatri GuptaDecember 13, 2023

Nasdaq Compliance

The Nasdaq Stock Market features three tiers of listed companies, namely: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. These tiers are characterized by progressively stringent listing requirements, with the Nasdaq Global Select Market setting the highest standards for initial listings and the Nasdaq Capital Market serving as the entry-level tier, particularly suitable for most small-cap issuers.

To list securities on Nasdaq, a company must fulfill minimum listing requirements, encompassing defined criteria related to financial performance, liquidity, and corporate governance. Nasdaq retains extensive discretion in the listing process and reserves the right to reject an application, even if the technical prerequisites are satisfied, if it deems such denial essential to safeguard the interests of investors and the public.

After securing a listing on Nasdaq, a company is obligated to adhere to ongoing listing standards. To initiate the listing process, a company seeking inclusion on Nasdaq must diligently complete and submit a comprehensive listing application to Nasdaq. This application should include specific documents and information as outlined by Nasdaq's requirements.

Typically, the application process spans a duration of four to six weeks. Once the application is submitted, a Nasdaq analyst is designated as the primary liaison with the company. Within two to three weeks of submission, the company can expect to receive an initial comment letter. The comment and review process persists until a decision is reached on the approval or denial of the application. Similar to filing with the SEC, a meticulously prepared Nasdaq application tends to attract fewer comments and facilitates a more streamlined process. Generally, the company's securities counsel assumes a leading role, serving as the primary contact for preparing the application and engaging in communication with Nasdaq.

Similarly to the SEC review process, Nasdaq conducts a thorough examination of publicly accessible information pertaining to a company. This encompasses, but is not limited to, SEC filings, the company's website, management communications and speeches, as well as press releases. The iterative nature of the review process typically doesn't necessitate a formal protocol, and communication is commonly facilitated through email correspondence and phone calls.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria:

Specific Initial Requirements:
- Quantitative Standards: Meeting defined thresholds for both quantitative and qualitative factors.
- Qualitative Standards: Fulfilling certain qualitative benchmarks.
Continuing Requirements:
- Quantitative Criteria: Adhering to ongoing quantitative benchmarks.
- Qualitative Criteria: Maintaining specified qualitative standards.

The initial quantitative thresholds are typically set at a higher level than those required for continued listing. This distinction aims to ensure that companies achieve a sufficient level of maturity before being listed. Additionally, Nasdaq imposes rigorous corporate governance standards that listed companies must adhere to throughout their tenure on the exchange.

Before formally submitting a comprehensive listing application, a company has the option to pursue a preliminary listing eligibility review. In this stage, the Listing Qualifications Staff conducts a thorough examination of the company's public filings to assess its compliance with numerical listing requirements. Additionally, the team evaluates the company's adherence to corporate governance requirements outlined in the Marketplace Rules ("Rules"). This preliminary review provides valuable insights into the company's eligibility for listing on Nasdaq before committing to the full application process.

Upon completion of the preliminary review, the Listing Qualifications Staff will make an assessment regarding whether the company meets the numerical listing criteria. Additionally, any corporate governance or regulatory concerns raised during this phase will be considered to determine their impact on the listing approval. It's important to note that while the preliminary review provides insights, final approval necessitates the submission of a formal listing application. This application undergoes a thorough examination by the NASDAQ Listing Qualifications Staff. Furthermore, the final approval process involves satisfactory compliance with specific qualitative reviews. This includes an examination of the regulatory history of the company's officers, directors, and significant shareholders. Meeting these criteria is integral to obtaining the final approval for listing on Nasdaq.

Financial And Liquidity Requirements

    Requirements

    Equity Standard
    Market Value of Listed Standard
    Net Income Standard

    Listing Rules

    5505(a)
and
5505(b)(1)
    5505(a)
and
5505(b)(2)
    5505(a)
and
5505(b)(3)
    
    Stockholders Equity

    	$5 million
    	$4 million
    	$4 million
    
    The market value of publicly held shares

    $15 million
    $15 million
    $
      5 million
    
    Operating History

    	Two years
    N/A
    N/A
    
    The market value of listed securities

    N/A
    $50 million
    N/A
    
    Net income from continuing operations (in the latest fiscal
a year or in two of the last three
fiscal years)

    N/A
    N/A
    $750,000
    
    Publicly held shares

    	1 million
    	1 million
    	1 million
    
    Bid Price

    	$4
    	$4
    	$4)
    
    Closing Price

    	$3
    	$2
    	$43
    
    Corporate Governance

    Yes
    Yes
    Yes
    
    Total Shareholders

    300
    300
    300

Corporate Governance Requirements

Across all three tiers of the Nasdaq Stock Market, corporate governance requirements remain largely consistent. The categories encompassing corporate governance standards include:

Distribution of Annual or Interim Reports
Independent Directors
Audit Committee
Compensation Committee
Nomination of Directors
Code of Conduct
Annual Meetings
Solicitation of Proxies
Quorum
Conflict of Interest
Shareholder Approval
Voting Rights

These governance elements play a crucial role in ensuring transparency, accountability, and ethical conduct within listed companies, irrespective of the specific tier within the Nasdaq Stock Market.

Companies seeking listing on Nasdaq must adhere to specific corporate governance standards, including the following:

Compensation Committee with Independent Directors:
- The company is required to establish a compensation committee comprised of independent directors.
- The committee must consist of at least two members.
- Rule 5605(d)(2)(A) introduces an additional independence test for compensation committee members.
Responsibility for Executive Compensation:
- The compensation committee is tasked with determining or recommending to the entire board the compensation of the chief executive officer (CEO) and all other executive officers.

These standards are designed to ensure a level of independence and scrutiny in the decision-making processes related to executive compensation within the company.

The Application And Documents

The Nasdaq application package encompasses several key components:

Symbol Reservation Form:
- Used to request the reservation of a specific trading symbol for the company.
Listing Application:
- Requires supplemental documents and details about the company's financials, operations, and other pertinent information.
Listing Agreement:
- A formal agreement outlining the terms and conditions of the listing on Nasdaq.
Corporate Governance Certification:
- A certification affirming the company's commitment to meeting Nasdaq's corporate governance standards.
Initial Application Fee:
- Payable via check or wire transfer, this fee is a prerequisite for initiating the listing process.
Logo Submission Form:
- Used for submitting the company's logo for use in Nasdaq's materials.

These application forms are completed through the Nasdaq website listing center, utilizing the online platform to facilitate the submission of supplemental and supporting documents. It is advisable to thoroughly review all required paperwork in advance, ensuring that the necessary information is readily available before initiating the application process.

Symbol Reservation Form

The symbol reservation form is a concise, one-page electronic form where applicants input information for Nasdaq's consideration. Nasdaq symbols, limited to 1-5 characters, adhere to guidelines established by the Intermarket Symbols Reservation Authority (ISRA). The ISRA system is designed to organize symbols efficiently, prevent duplication, and reduce programming and operational complexities. The ISRA operates within the framework of the NMS Symbology Plan, a plan utilized by Nasdaq.

Key details about the symbol reservation process:

Symbol Choices:
- The form allows applicants to propose three symbol choices in order of preference.
- While Nasdaq generally honors the first choice if available, it retains the authority to assign, rescind, or reassign a trading symbol at its discretion.
ISRA and Nasdaq Authority:
- The ISRA and Nasdaq have overarching authority in managing the assignment of symbols.
Additional Information:
- The form captures essential details about the issuer and the planned public offering.
- Information may include the name of the attorney, lead underwriter (if applicable), CEO and CFO names, yearly revenues, company website, and the sector in which the company operates.

Completion of this symbol reservation form initiates the process of securing a trading symbol on Nasdaq, and it's essential to provide accurate and comprehensive information to facilitate this stage of the listing application.

The Application

The Nasdaq listing application process is comprehensive and varies based on the circumstances surrounding the listing sought. There are twelve distinct listing applications catering to different situations, including changes of control, switches from other exchanges or markets, spin-offs, and initial public offerings (IPOs). Each application, spanning approximately seven pages, collects detailed information about the company, covering areas such as address, contact and billing details, securities attorney and auditor information, transfer agent particulars, and the company's officers and directors. Specific information on the company's securities, including type, par value, and cusip number, is also required.

Furthermore, the application mandates disclosure of legal proceedings involving the company, its officers or directors, or significant shareholders over the past ten years. This encompasses inquiries, investigations, lawsuits, litigation, arbitrations, and other legal and administrative proceedings. Documents supporting the backup and final disposition of these matters must be provided.

Regarding private offerings within the prior six months, including bridge financings, shelf registrations, and Regulation S offerings, the company is required to disclose such activities. Additionally, the application delves into the company's background, posing questions to ensure compliance with seasoning rules.

While Nasdaq retains the right to request relevant supporting documents, specific documents are mandatory based on the application type. For an uplisting from an existing U.S. market, the application must include letters from three market makers confirming their commitment to making a market in the subject securities. Other required documents include a listing agreement, a logo submission form, a corporate governance certification form, regulatory correspondence over the past 12 months, and shareholder confirmation documents. Nasdaq often seeks confirmation from the company's transfer agent regarding the eligibility of the security for the direct registration program (DRS).

During the review of an up listing application, Nasdaq may request additional information, such as a Broadridge share range analysis and NOBO list, a certified shareholder list, details about mitigating any going concerns or opinions, income statement and/or balance sheet projections for the next 12 months, and confirmation of Sarbanes Oxley Section 302 and 906 certifications by the company, among other inquiries related to compliance and financial matters.

The Listing Agreement

The Listing Agreement is a concise document, spanning two pages, serving as a formal affirmation of the company's commitment to adhere to all rules and regulations set forth by the Nasdaq Stock Market. It includes provisions for indemnifying and holding Nasdaq harmless from liability. Notable points in the agreement include:

Compliance Assurance:
- The company explicitly agrees to comply with all rules and regulations stipulated by the Nasdaq Stock Market.
Indemnification Clause:
- The company indemnifies Nasdaq, meaning it undertakes to compensate or reimburse Nasdaq for any losses or damages incurred. This includes harm resulting from third-party trademark infringement claims related to the company's symbol and logo, as well as Nasdaq's use of the same.
Disclaimer of Warranty and Liability:
- The agreement contains a disclaimer of warranty and liability against Nasdaq for trading issues, with the exception of those resulting from gross negligence or willful misconduct.

This agreement establishes a clear framework for the relationship between the listed company and Nasdaq, emphasizing the company's commitment to regulatory compliance while providing indemnification for certain specified matters and delineating the scope of Nasdaq's liability.

Corporate Governance Certification Form

The corporate governance certification form certifies compliance with the governance requirements related to an audit committee, director nomination process, compensation committee, board composition, executive sessions, quorum, and codes of conduct. Where an exemption applies, the form requires specification of the exemption terms. The document specifies the different rules and exceptions in a check-the-box format.

Logo Submission Form

The logo submission form contains the guidelines for the logo and affirms Nasdaq’s rights to use the same. Nasdaq uses company logos in its marketing materials, on the MarketSite Video Wall and Tower, and websites.

Fees

Entry fees are based upon the aggregate number of shares to be listed at the time of initial listing, regardless of class, with a maximum cap of $75,000. Fees are assessed on the entry date in The Nasdaq Capital Market, except for $5,000, representing a non-refundable application fee. This fee must be submitted with the company’s application.

Nasdaq does not charge application or entry fees for any securities transferred from a national securities exchange.

Benefits Of Trading On An Exchange

There are many benefits to trading on an exchange instead of the OTC Markets. The most significant benefits to a business are the ability to attract analyst coverage and institutional investors and the corresponding increase in liquidity that comes with both. Stocks that trade on Nasdaq tend to have a lower bid/offer spread — again encouraging trading volume and liquidity. Exchange-traded securities are exempt from the penny stock definition, allowing more market maker and broker-dealer participation. As further explained below, a broker-dealer cannot recommend a penny stock transaction to its retail clients. Therefore, no analysts, financial advisors, or institutional investors make recommendations for purchases of penny stocks.

As an aside, this is one of the reasons that OTC Markets created the OTCQX market tier, which does not list penny stocks. It is also why the small-cap industry is pushing for a supported valid venture exchange (for further reading.

In today’s world, depositing stock and/or trade-in non-exchange traded securities is increasingly difficult. Despite the congressional efforts and SEC rulemaking in support of small-cap capital formation (for example, the JOBS Act, including the emerging growth company regulations, new Regulation A+ and Title III Crowdfunding and the new FAST Act), through enforcement and investigative proceedings, both the SEC and FINRA continue to apply pressure on broker-dealers, clearing firms and transfer agents to reduce the secondary trading and free flow of penny stocks. For more information on difficulties in depositing stocks.

Further On Penny Stocks

NASDAQ and NYSE MKT traded securities are exempted from the definition of a “penny stock” due to the initial and ongoing listing standards. Penny stock rules focus on broker-dealers’ activity in effectuating trades in penny stocks. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) prohibits broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The rules promulgated thereunder, particularly Exchange Act rules 15g-1 through 15g-100 (the “penny stock rules”).

Section 15(h) of the Exchange Act provides that no broker or dealer may effectuate a customer’s purchase or sale of any penny stock unless such broker or dealer.

Approves the customer for the specific penny stock transaction and receives a written agreement to the transaction from the customer.
Furnishes the customer a risk disclosure document describing the risks of investing in penny stocks.
Discloses to the customer the current market quotation, if any, for the penny stock, including the bid and ask prices and the number of shares that apply to such bid and ask prices.
Discloses to the customer the amount of compensation the firm and its broker will receive for the trade.

In addition, after executing the sale, a broker-dealer must send its customer monthly account statements showing the market value of each penny stock held in the customer’s account.

Moreover, brokers and dealers subject to the penny stock rules are subject to additional disclosure requirements outlined in Rules 15g-2 through 15g-9. For my information on penny stocks and the rules affecting broker-dealer activity.

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