Cross-Border Counselor

On January 24, 2024, the SEC issued new guidance on when a special purpose acquisition company (SPAC) may run afoul of the U.S. Investment Company Act (the Act).  While this guidance was directed at SPACs that register or file reports with the SEC, it is also instructive for other types of shell companies, including Canadian capital pool companies, SPACs, and similar shell companies that do not file reports with the SEC. Why Care About the U.S. Investment Company Act? If a Canadian issuer is deemed to be an investment company that has failed to register under the Act, it is prohibited from engaging in any business in the U.S. or offering or selling any securities in the U.S., its contracts may be voidable to the extent they are subject to U.S. jurisdiction, commonly used securities exemptions such as Regulation S are unavailable to it, and if it violates the Act, persons associated with it may be held criminally liable. Registration is also not generally an option for Canadian issuers. The Act prohibits a non-U.S. entity from registering as an investment company absent special SEC action. Registration is also impractical for an operating company or a company that intends to become an operating company upon completing an acquisition. Accordingly, avoiding investment company status is important for any Canadian issuer that intends to have any connection with the United States. What is an Investment Company? Subject to certain exceptions, the Investment Company Act defines an investment company to include any issuer which: is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of U.S. federal government securities and cash items) on an unconsolidated basis. Operating companies typically avoid investment company status by having a different core business purpose – such as mining, drug development, or making widgets – and by having significant non-cash, non-investment assets. Shell companies that do not have significant non-cash, non-investment assets, and that do not have an operational business, are at greater risk of being deemed an investment company. What to Do? To avoid investment company status, capital pool companies, SPACs, and similar shell companies that have, or intend to have, any connection with the United States should review the SEC’s new guidance* and structure their assets and operations accordingly.  Assuming that the company has the intention to become an operating company as soon as possible through an acquisition of an operating company whose business would become the company’s primary business, it would be prudent for the company to: Describe itself and its intentions in a manner consistent with this purpose. Ensure that the company’s directors, officers, and employees are actively engaged and focused on seeking and completing the transaction that would result in the company being an operating company. Complete its acquisition as quickly as possible. In its new guidance, the SEC stated that “while the duration of a SPAC is not the sole determinant of its status under the Investment Company Act, a SPAC’s activities may become more difficult to distinguish from those of an investment company the longer the SPAC takes to achieve its stated business purpose.” The SEC noted that an exemption under the Act for a transient investment company can be available for up to 12 months, and that escrow accounts of certain blank check companies with a term limited to 18 months were not regulated under the Act, before saying that a “SPAC that operates beyond these timelines raises concerns that the SPAC may be an investment company, and these concerns increase as the departure from these timelines lengthen.” The SEC acknowledged that exchange listing rules contemplate potentially longer SPAC lifespans but said that those rules were adopted for a different regulatory purpose and do not address investment company status concerns. Pending the completion of its acquisition, avoid holding or investing in any assets that would be deemed “investment securities” under the Investment Company Act. This term is quite broad, and includes equity and debt securities, most government bonds, and several common types of term deposits.  For this reason, shell companies should pay very close attention to the types of accounts they create with their banks, and the types of investments they hold pending their transformative acquisition. Cash and U.S. federal government securities are not “investment securities”. Pending the completion of the acquisition, minimize the amount of time spent on managing investments, and do not emphasize to investors the quality or return on such investments. Ensure that its acquisition target is not an investment company, and that it will be an operating company and not an investment company upon completion of the acquisition. The analysis of whether a company is an investment company can be quite complex. The above is only an overview of factors that could be relevant for determining whether a capital pool company, SPAC, or similar shell company is an investment company. Companies should seek legal advice to determine their own status. *The SEC’s new guidance was included in the SEC’s final release adopting new rules for SPACs, beginning on page 360. See Final rule: Special Purpose Acquisition Companies, Shell Companies, and Projections (sec.gov)

On January 1, 2024, new direct reporting requirements to the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the United States Department of the Treasury, became effective – known as the Corporate Transparency Act (the “CTA”). Who must file? The CTA, and the regulations promulgated thereunder, apply to corporations, limited liability companies, limited partnerships and similar legal entities either formed in the United States (a “Domestic Reporting Company”) or formed outside the United States but registered to do business in the United States (a “Foreign Reporting Company”). Such entities must identify their natural person beneficial owners and “company applicants” (i.e. the person(s) responsible for the formation or registration of the entity), and disclose certain personal information with respect to each of them. Persons and businesses covered under these new compliance obligations will be confronted with potentially difficult initial reporting and subsequent reporting requirements. Beneficial ownership information (“BOI”) will be reported directly to the federal government. Civil and criminal penalties may apply for non-compliance. Required BOI for each beneficial owner will include, amongst other things, full name, residential address, date of birth, and a photo page of a non-expired U.S. government ID (or, in absence, a foreign passport photo page). When will filing obligations start? For non-exempt Domestic Reporting Companies and Foreign Reporting Companies formed on and after January 1, 2024, an initial report must be filed within 90 days following corporate formation or registration. For non-exempt entities formed or registered prior to January 1, 2024, entities must file an initial report by January 1, 2025. After making an initial report, all entities will be required to file amended reports within 30 days after becoming aware that a previous filing was inaccurate or requires updating (for example, in connection with a change in beneficial ownership). Information disclosed to FinCEN will not be publicly available, but may be obtained by federal agencies engaged in national security, intelligence, or law enforcement activity, certain federal regulators, and certain state, local and tribal law enforcement agencies. Further, certain foreign officials, and certain financial institutions and banks subject to customer due diligence requirements, may also be granted access via submission of a request through a U.S. federal government agency. Who is exempt from the new rules? The intent of the CTA is to collect and compile BOI for legal entities whose ownership and management is not otherwise available. While the CTA provides 23 exemptions to the reporting requirements, most of the available exemptions are limited to regulated entities (e.g., banks and healthcare companies) or large companies with a substantial employee, revenue and operating presence in the United States. Note that most Canadian issuers that conduct business in the U.S. typically do so through a structure that utilizes one or more U.S. subsidiaries. Under this structure, the parent itself typically does not conduct business in the United States and is not qualified to do business in the United States. Accordingly, under this most common structure, the parent would not be a Foreign Reporting Person and therefore would not be subject to the CTA directly. However, its U.S. subsidiaries would need to file if they are not themselves exempt. For most Canadian issuers, the three key exemptions most likely to be relevant are (1) “securities reporting issuers,” (2) “large operating company” and (3) “subsidiary of certain exempt entities.” Securities Reporting Issuer A “Securities Reporting Issuer” is an entity that (i) has a class of securities registered under the U.S. Securities Exchange Act of 1934, as amended (the “34 Act”), and (ii) has a current reporting obligation under the 34 Act. All Canadian issuers that file annual reports on forms 40-F, 20-F and 10-K, including all issuers cross-listed on Nasdaq, NYSE or NYSE American, will qualify as Securities Reporting Issuers. Issuers that are traded on the over-the-counter market in the U.S. (i.e. the OTCQX, OTCQB or OTC Pink) and rely upon an exemption from registration under the 34 Act will not qualify as a Securities Reporting Issuer.           Large Operating Company A “Large Operating Company” is an entity that, in simplified form, has more than 20 full-time employees in the U.S., has gross revenues in excess of $5 million in the U.S. and has a physical operating presence in the U.S. In the typical cross-border structure described above, the Canadian parent would not have a physical presence in the U.S., so the top-tier U.S. subsidiary (if there are multiple entities) would likely be the entity for which the analysis would be applicable. Note that each portion of this test, other than revenue (which may be computed on a consolidated basis), is determined on a separate entity-by-entity basis. Accordingly, some U.S. subsidiaries of Canadian parent companies may be exempt under this test, while others may not be. For some companies, we anticipate that a reevaluation of their subsidiary structure might provide an opportunity to qualify for an exemption from the CTA. Subsidiary of Certain Exempt Entities A Subsidiary of Certain Exempt Entities is any entity that is “controlled or wholly owned, directly or indirectly, by one or more entities” that meet one of the other categories of exemptions under the CTA (although not the exemptions for money services businesses and certain pooled investment vehicles). Notable, however, that FinCEN declined to define “control” in determining the applicability of the subsidiary exemption (although appeared to suggest in its Final Rule that control through majority ownership may not be sufficient for this exemption to apply). All Canadian issuers that are cross-listed in the U.S. will  themselves be eligible for an exemption from the CTA reporting requirements. In addition, their direct and indirect wholly-owned subsidiaries will also be exempt. Less than majority-owned subsidiaries may also be exempt, depending on the circumstances. Other issuers with operations in the U.S. may also be eligible for an exemption, though careful analysis will likely be necessary. Please refer to our long-form update on the CTA HERE. Our attorneys are ready to assist with any questions you may have.

As noted in our post of December 18, Canadian companies with U.S. subsidiaries have been gearing up all year to file beneficial ownership reports with FinCEN pursuant to the Corporate Transparency Act, in advance of a January 1, 2025 deadline for entities that were formed prior to 2024. Many have already completed their analysis and either determined that they qualify for an exemption or filed their initial beneficial ownership reports. On December 3, 2024, the U.S. District Court for the Eastern District of Texas issued a nationwide preliminary injunction against enforcement of the January 1, 2025 deadline. On December 23, 2024, the motions panel of the United States Court of Appeals for the Fifth Circuit granted the government’s emergency motion and stayed the temporary nationwide injunction. Shortly thereafter, FinCEN issued a notice confirming that compliance with the CTA and the FinCEN Regulations was once again effective—but issued new and slightly extended compliance deadlines (for most reporting companies – to January 13, 2025). On December 26, 2024, in order to “preserve the constitutional status quo while the merits panel considers the parties’ weighty substantive arguments”, the merits panel of the United States Court of Appeals for the Fifth Circuit vacated that decision and reinstated the temporary preliminary injunction. On December 27, 2024, FinCEN swiftly confirmed that beneficial ownership information reports were, once again, not currently required, but that reporting companies may continue to submit reports on a voluntary basis. The continued back and forth between the courts (and even within the same court) demonstrates the legal and political tensions (and accompanying confusion) that reporting companies are facing as they continue to grapple with their obligations under the CTA. While this latest development may be welcome relief for many, reporting companies should continue to be prepared to file their BOI Reports on short notice - particularly as the case in issue, Texas Top Cop Shop v Garland et al., is on expedited appeal.

As discussed in our Governance & Compliance Insider blog and a recent Dorsey eUpdate, all companies with securities listed on NYSE, NYSE American, or Nasdaq will be required to adopt and comply with updated clawback policies governing the recovery of erroneously awarded compensation by December 1, 2023, pursuant to rules proposed by each stock exchange and approved by the SEC under Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  The new clawback requirements will apply to substantially all listed companies, including foreign private issuers and Canadian MJDS filers.

Current closures at the Internal Revenue Service (“IRS”) have caused significant delays in obtaining an Employer Identification Number (“EIN”) for some U.S. businesses formed by Canadians, including new U.S. subsidiaries formed by Canadian companies. An EIN is a nine-digit number that the IRS assigns to businesses, which is necessary for many essential tasks, including making U.S. federal tax filings, hiring employees, or opening and maintaining a U.S. bank account. Applicants with a “U.S. Responsible Party” (i.e., a CEO, CFO, or President with a U.S. Social Security Number or Individual Taxpayer Identification Number) are generally able to obtain an EIN through the IRS’ online application portal, which remains open. Most applicants lacking a U.S. Responsible Party must submit their applications to the IRS via telephone, fax, or mail. However, due to the COVID-19 outbreak, the IRS has temporarily closed its EIN call center, fax lines, and mail-processing center. Accordingly, applicants lacking a U.S. Responsible Party may not be able to obtain an EIN until the IRS reopens one of these channels. As the IRS has not yet indicated when such reopening might occur, applicants lacking a U.S. Responsible Party are left with only one course of action. These applicants can submit a Form SS-4 via certified mail to the IRS for processing when the IRS reopens its mail-processing center. In doing so, such applicant can attest to having “applied for” an EIN and provide the official date of its application (being the date the application was mailed). While an EIN submitted via certified mail will generally be processed in the order received, the actual processing of the application will not begin until the IRS reopens its mail-processing center. In the ordinary course of business, the EIN-by-mail process can take up to one month. However, given the ongoing uncertainty surrounding COVID-19, the actual processing time of EIN applications submitted via certified mail may be far longer.

The OTC Markets Group published this week proposed amendments to the OTCQX Rules for U.S. Companies, U.S. Banks and International Companies. The rules will become effective on December 12, 2019; comments will be accepted until December 11, 2019. To qualify for the OTCQX, International Companies must, among other qualifications, have a class of securities traded on a Qualified Foreign Exchange (includes the Toronto Stock Exchange, the TSX Venture Exchange and the Canadian Securities Exchange), be an SEC Reporting Company or be a Regulation A Reporting Company. The proposed rules contain several amendments for International Companies, which will be the focus of this update. First, if an International Company applying to trade on the OTCQX is not listed on a Qualified Foreign Exchange, the applicant must meet the following corporate governance requirements: Have a board of directors that includes at least two independent directors, meeting the qualifications in the OTCQX proposed rules; Have an audit committee, a majority of the members of which are independent directors; and Conduct annual shareholders’ meeting and make annual financial reports available to shareholders at least 15 calendar days prior to such meeting. A company must continue to comply with the corporate governance requirements to maintain its eligibility on the OTCQX. International Companies with securities not listed on a Qualified Foreign Exchange that are traded on the OTCQX when the proposed rules become effective will not need to comply with the corporate governance requirements until January 1, 2021. Second, applications to the OTCQX will now include Background Check Authorization Forms. This form will authorize the OTC Markets Group to conduct background checks during the application process on certain persons associated with the companies applying to be on the OTCQX. Third, with some limited exceptions, companies applying to be on the OTCQX must have an OTCQX Sponsor that has been approved by the OTC Markets Group to deliver a Letter of Introduction. Dorsey & Whitney LLP is an approved OTCQX Sponsor. Under the proposed rules, a company that trades on a Qualified Foreign Exchange or that has been an SEC Reporting Company and publicly traded for at least one year might be able to rely on a Letter of Introduction from its primary outside securities counsel under certain limited circumstances. Fourth, Canadian companies that are on the OTCQX must retain a transfer agent that participates in the Transfer Agent Verified Shares Program. This program has been required for U.S. Companies for several months, but the proposed rules extend the requirement to Canadian companies. Many Canadian transfer agents are already part of the program, but it will be important to confirm that the company’s current transfer agent has opted into this program. Finally, the proposed rules modify the initial disclosure obligations. Under the proposed rules, a company will be required to disclose annual reports for the prior three years (or such shorter time as the company has been in existence) and any interim reports released during the prior three years. For Canadian issuers, we would recommend filing annual audited financial statements, the annual MD&A and the Annual Information Form, if applicable, in order to comply with the annual report requirement. Additionally, a company must disclose all other material disclosures made after its last annual report. In addition to the application changes, the OTC Markets Group made one significant change to the ongoing responsibilities of a company to maintain eligibility on the OTCQX. Companies are now required to notify the OTC Markets Group if a Change of Control occurs. A Change of Control is defined as any event that results in: (i) Any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becoming the “beneficial owner” (as defined in Rule 13d-3 of the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the total voting power represented by the Company’s then outstanding voting securities; (ii) The consummation of the sale or disposition by the Company of all or substantially all of the Company’s assets; (iii) A change in the composition of the Company’s board of directors occurring within a two (2) year period, as a result of which fewer than a majority of the directors are directors immediately prior to such change; or (iv) The consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or its parent) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity or its parent outstanding immediately after such merger or consolidation. If a Change of Control occurs, the Company is required, within 20 calendar days of the change, to notify the OTC Markets Group by submitting a Change of Control Notification as well as a new OTCQX Application and application fee. Failure to notify the OTC Markets Group may result in suspension or removal from the OTCQX. If the proposed rules are adopted, OTCQX companies will need to pay particular attention to calculating whether any change in the composition of the board of directors, combined with other changes over the preceding 24 months, constitutes a Change of Control under part (iii) of the test.

As reported earlier today on our Cannabis blog, the Delaware Secretary of State’s office is now threatening to prevent the formation of companies that it identifies as having the purpose of being involved in the cannabis industry. For more information, see dorseycann.com/delaware-takes-action-against-formation-of-cannabis-companies/.

Yesterday, the SEC published guidance regarding Inline XBRL. The SEC adopted rules for Inline XBRL in June 2018. For those of you whose first question is “what is Inline XBRL?”, Inline XBRL allows the XBRL data to be embedded directly into an “EDGARized” HTML document. This eliminates the need to prepare a separate XBRL exhibit. The goal of Inline XBRL was to simplify the XBRL process for issuers and to improve the usability of XBRL data for investors. As a reminder, foreign private issuers will be required to comply with Inline XBRL at the following times: Basis of Accounting Filer Status Fiscal Periods Ending On or After: U.S. GAAP Large accelerated filers June 15, 2019 U.S. GAAP Accelerated filers June 15, 2020 U.S. GAAP All other categories June 15, 2021 IFRS All categories June 15, 2021 For foreign private issuers filing on a Form 20-F or Form 40-F, issuers must comply beginning with the Form 20-F or Form 40-F filed for the fiscal year ending on or after the applicable compliance date shown above. For foreign private issuers filing on domestic forms (10-K, 10-Q and 8-K), issuers must comply beginning with their first Form 10-Q for a fiscal period ending on or after the applicable compliance date shown above. For example, for such issuers with the June 30 fiscal year end, issuers must comply with their first Form 10-Q for the period ended September 30. The new C&DIs also provide guidance regarding technical aspects of XBRL, such as: (i) the identification of Inline XBRL on the exhibit index, (ii) voluntary use of Inline XBRL and (iii) how to comply with cover page tagging requirements where the issuer’s name on the cover page differs from its EDGAR-conformed name.

The SEC has proposed revisions to the definition of an “accelerated filer” that would exempt most companies that have both a public float of common equity of less than $700 million and annual revenues of less than $100 million from the requirements of Section 404 of the Sarbanes-Oxley Act (SOX 404). If adopted, these revisions would exempt many Canadian cross-reporting companies from the SOX 404 auditor attestation requirement, thereby reducing the cost of cross-border reporting. The proposal is subject to a 60-day public comment period. Additional information is available in the SEC’s press release regarding the proposed new amendments here: sec.gov/news/press-release/2019-68.

The SEC’s settlement with Tesla and Elon Musk teaches us some important corporate governance lessons on monitoring and vetting executive use of social media. As background, on August 7, 2018, the markets were surprised by a series of tweets initiated by Elon Musk, the CEO of Tesla, Inc., in which Musk mused about taking Tesla private at $420 per share (a significant premium to the then-market price), with funding secured. The stock price jumped, trading in Tesla stock was halted, and Tesla rushed to catch up with official announcements. The deal didn’t happen, and it was questioned whether Musk was really serious, and whether funding was really “secured.” The SEC commenced an investigation. On September 27, 2018, the SEC announced charges against Musk for securities fraud in connection with his tweets, which it said were inaccurate and misleading. Among the remedies sought was a permanent ban on Musk being eligible to serve as a director or officer of any public company, effectively seeking to sever him from Tesla, a company of which he is the heart and soul. Tesla’s stock dropped 14%. If this remedy was included by the SEC as leverage, that leverage worked, and on September 29, 2018, the SEC announced a settlement with Musk, as well as charges against and a settlement with Tesla. Tesla’s stock increased 17%. As part of the settlement, Musk will remain Tesla’s CEO and a director, but Musk and Tesla agreed that: Musk will step down as Tesla’s Chairman for at least three years and be replaced as Chairman by an independent director; Tesla will appoint two additional independent directors; Tesla will establish a committee of independent directors and put in place additional controls and procedures to oversee Musk’s communications; and Musk and Tesla will each pay $20 million to harmed investors under a court-approved process. The SEC alleges that Tesla failed to implement adequate disclosure controls and procedures over Musk’s use of Twitter. Tesla had publicly announced in 2013 that Musk’s Twitter account would be among the means by which Tesla intended to release material information, Musk had amassed 22 million Twitter followers, and important information about Tesla had been released through this account, but the SEC says that Tesla had not adopted any specific policies regarding Musk’s use of Twitter, such as procedures to determine whether proposed tweets were accurate and complete, and whether they contained information requiring disclosure in Exchange Act reports. In effect, the SEC says Tesla had given Musk carte blanche to release material information about Tesla, without subjecting it to the normal controls to which other, more formal, types of disclosures would be subject, and as a result, the market was misled. Investors harmed included short sellers and those who purchased shares after Musk’s announcement temporarily drove up stock prices, only to see those prices drop afterwards. The SEC’s settlement with Tesla and Musk teaches us some important corporate governance lessons: If a public company allows its executives to use Twitter or other social media accounts to disclose material information about the company, it is not enough to notify the public that material disclosures may be made by these means. Companies must ensure that their disclosure controls and procedures adequately cover executives’ use of social media. In deciding what disclosure controls and procedures to implement, consideration should be given to such matters as: what topics are permitted or prohibited; procedures for review and approval of disclosures before they are made; the inclusion of risk factors or other cautionary or explanatory language to help prevent disclosures from being potentially misleading; coordination of social media disclosures with other company disclosures as needed to satisfy public reporting requirements; and monitoring actual disclosures and resulting market and media reactions for any surprises. Companies that do not allow executives to use social media accounts to disclose material information should adopt policies clearly prohibiting such use, and monitor executives’ use of social media for any inadvertent violations of policy.  

Earlier this week, a panel of Dorsey attorneys presented a webinar on the SEC’s recent guidance on cybersecurity disclosures and policies, which included a detailed walk-through of the SEC’s 2018 guidance, including issues related to enhanced disclosure, insider trading, and Reg FD policies. The panel also discussed the impact of the SEC’s guidance within the changing landscape of cybersecurity and current developments in shareholder litigation, SEC enforcement actions, and other regulatory and legislative initiatives such as the GDPR. The Equifax data breach is used as a case study to illustrate how the SEC’s guidance might play out in this broader context. The webinar recording and presentation materials are available on our website at www.dorsey.com/newsresources/events/videos/2018/06/seminar-playback-sec-guidance-on-cybersecurity.

Canadian companies with U.S. subsidiaries and investments should note upcoming deadlines for filing reports required by U.S. Department of Commerce rules. These mandatory reports are required to be filed with the Bureau of Economic Analysis (“BEA”) within the U.S. Department of Commerce by May 31, 2018, if made by hardcopy, or by June 30, 2018, if made electronically. The affected U.S. subsidiary companies are those in which a non-U.S. person owns or controls, directly or indirectly, 10 percent or more of the company’s voting securities if the U.S. subsidiary company is incorporated, or in which a non-U.S. person holds that same degree of ownership or control through other means if the U.S. subsidiary company is unincorporated. For more detailed information, see our recent eUpdate here: www.dorsey.com/newsresources/publications/client-alerts/2018/05/foreign-owned-us-subsidiaries-federal-survey.

The recent settlement agreement between Kinross Gold Company and the Securities and Exchange Commission is a reminder to Canadian cross-listed companies that it is not enough to adopt a parent-company level anti-corruption policy designed to promote compliance with the Foreign Corrupt Practices Act (FCPA). Effective implementation and monitoring at the operating level is also needed. In Kinross’ case, the SEC charged, in effect, that Kinross had acquired two African mining operations from a third party, was aware of deficiencies in the mines’ controls at the time of acquisition, failed to timely put in place appropriate controls, and then failed to maintain them once implemented. Specifically, SEC alleged that Kinross awarded a logistics contract to a company preferred by Mauritian officials, despite concerns that the awardee exhibited poor performance at high cost without going through Kinross’ own bidding procedures, and engaged in contracts with politically connected consultants without conducting necessary, heightened due diligence. The SEC found these deficiencies constituted a violation of books and records and internal auditing controls provisions of federal securities law. In order to resolve these charges, and without admitting SEC’s findings, Kinross agreed to pay the SEC a penalty of $950,000, comply with a cease-and-desist order, and undertake to report on remedial measures. For more details, see the April 2018 edition of our Anti-Corruption Digest, which is available at  https://www.dorsey.com/newsresources/publications/newsletters/2018/04/anti-corruption-digest-april-2018.

Canadian companies should carefully structure and document loans and advances to their U.S. subsidiaries. If loans to U.S. subsidiaries are not properly structured and documented, such loans may be recharacterized as equity investments for U.S. federal income tax purposes, and important U.S. tax benefits will be lost. Properly structured loans are treated as debt for U.S. federal income tax purposes with favorable tax treatment. The U.S. subsidiary may deduct interest paid in computing taxable income. Such interest payments to its Canadian parent corporation are generally not subject to U.S. withholding tax under the Canada – U.S. income tax treaty. Repayment of the principal amount is generally not subject to U.S. tax for both the U.S. subsidiary and Canadian parent corporation. Loans which are recharacterized as an equity investment do not qualify for favorable tax treatment. The U.S. subsidiary cannot deduct interest paid in computing taxable income. Interest and principal payments will be treated as dividends to the extent of current or accumulated earnings and profits of the U.S. subsidiary. Dividends are subject to U.S. withholding tax of 5% or 15% under the Canada – U.S. income tax treaty. Loans should be properly documented with promissory notes and, in some cases, loan agreements. This documentation should include, at a minimum: an unconditional obligation to pay a sum certain by the U.S. subsidiary, a stated interest rate, the applicable currency (Canadian or U.S. dollars), payment terms (demand or one or more fixed dates), a maturity date, and creditors’ rights provisions. Evidence showing that the U.S. subsidiary has a reasonable expectation of repaying the loan is very important. At a minimum, internal projections should be prepared showing the U.S. subsidiary has the capacity to repay the loan. For larger loans, consideration should be given to obtaining a debt capacity report from a financial advisory or accounting firm. Beginning in 2018, new regulations under Code Section 385 will require that certain loans meet detailed documentation rules to avoid automatic recharacterization as equity. U.S. and Canadian transfer pricing rules will require certain documentation supporting the interest rate charged on the loan. A discussion of the transfer pricing rules is beyond the scope of this summary.

Occasionally, we will see Canadians or Canadian companies assume that they can authorize as many shares for issuance as they want when forming a Delaware corporation, or that they can authorize shares without par value. That’s technically true, but Delaware will make you pay dearly for it, up to $180,000 per company per year. A Delaware corporation must pay the state an annual franchise tax. This tax is initially based on the number of authorized shares. Provided the authorized shares have a stated par value, the tax assessment can be re-calculated on an assumed par value basis using a formula that involves the number of shares authorized for issuance by the certificate of incorporation, the number of shares actually issued and outstanding, the par value of the shares, and the issuer’s total assets. For a properly formed Delaware subsidiary, the annual tax is usually $175. The tax is often more for an operating parent company, but by setting the authorized capital and par value appropriately, the tax can be managed. Unfortunately, we have seen situations where Delaware companies have been formed or acquired without adequate advice, resulting in a $180,000 annual tax. Among other situations, this can occur when no par value shares are authorized, or when the number of shares authorized is a large number compared to a small number of shares actually outstanding, and the franchise tax obligation may fluctuate annually based on the company’s total assets.

As a reminder to all foreign issuers that have a December 31 fiscal year end, the upcoming end of their second fiscal quarter, June 30, 2017, will be the calculation date for their status as a foreign private issuer (“FPI”) for purposes of both the United States Securities Act of 1933, as amended (the “Securities Act”) and the United States Securities Exchange Act of 1934, as amended (the “Exchange Act”). We recommend that issuers begin the analysis early to determine whether actions should be taken prior to the June 30th date to avoid an unintentional loss of FPI status. An early determination of the business nexus test (as described below) is also needed to know whether the issuer needs to request that their transfer agent and depositories provide U.S. resident beneficial shareholder information as of June 30, 2017. As detailed below, the definition of an FPI has two parts, one based on the percentage of the issuer’s U.S. resident shareholdings (the shareholder test), and the other based on its connections with the United States (the business nexus test). As an issuer must meet both of the two parts of the test to lose FPI status, it is often beneficial for an issuer to consider the business nexus test prior to considering the shareholder test. Because many issuers will not meet any of the three elements of the business nexus test (as discussed below), there would be no need to go through the time-consuming and often difficult process of determining the percentage of voting shares held by U.S. resident shareholders. The term “foreign private issuer" is defined by Rule 3b-4 under the Exchange Act and Rule 405 under the Securities Act as any non-U.S. issuer, other than a foreign government, except any issuer meeting the following conditions: (a)   more than 50% of the outstanding voting securities of such issuer are, directly or indirectly, held of record by residents of the United States; and (b)   any one of the following: (i)    the majority of the executive officers or directors are U.S. citizens or residents, or (ii)   more than 50% of the assets of the issuer are located in the United States, or (iii)  the business of the issuer is administered principally in the United States. While the FPI test is a seemingly straightforward calculation, the application of the test in certain circumstances can be challenging. The SEC staff has recently issued guidance that clarifies the application of the tests in certain circumstances and provides comfort for the application of reasonable methodologies that are consistently applied. Our prior blog post on the clarifications can be found here: crossbordercounselor.com/sec-provides-clarification-of-foreign-private-issuer-calculation/. In evaluating the citizenship and residency of executive officers and directors, each test must be separately applied to executive officers as a group and directors as a group. In determining the location from which a business is administered, an issuer must assess, on a consolidated basis, the location from which the issuer’s officers, partners, or managers direct, control, and coordinate the issuer’s business activities. Issuers may look to the geographical segment information determined in the preparation of financial statements for purposes of calculating the location of assets. Alternatively, an issuer may apply any other reasonable methodology on a consistent basis to determine location of assets. If an issuer fails one of more of the business nexus tests, a calculation of the issuer’s U.S. shareholdings is required. For purposes of the shareholder test, each holder identified on the record of security holders counts as a record holder. However, the issuer must look through the record ownership of institutional custodians, such as Cede & Co, CDS, and other commercial depositories, by obtaining the list of accounts for which the securities are held by the depository. In addition, under applicable SEC rules, an issuer must “look through” the record ownership of brokers, dealers, banks, or nominees to the beneficial holders who hold securities through such institutions. The “look through“ provisions of these rules are limited to three jurisdictions: (1) the United States; (2) the foreign company’s home jurisdiction; and (3) the primary trading market for the foreign company’s securities, if different from the foreign company’s home jurisdiction. Foreign private issuer status is of considerable benefit to foreign issuers that access the U.S. markets. Issuers that are in danger of a change in status may find that the recent SEC guidance gives them some additional flexibility in satisfying the FPI test. For those issuers, careful advance planning may make it possible to avoid the loss of the FPI benefits.

Many cross-border loan transactions involve subsidiaries that are organized in the United States and/or U.S. based collateral. To the extent that the underlying loan is made to a Canadian borrower by a Canadian lender, these transactions are typically documented with loan agreements governed by Canadian law (often under the law of the Province where the primary Canadian borrower is organized, but sometimes based on the law of a Province selected by the Canadian lender). In many of these transactions, in addition to the Canadian law governed documents, the Canadian lenders will also require the use of U.S. law governed documents for guarantees provided by U.S. organized subsidiaries and Security Agreements for collateral owned by U.S. subsidiaries or otherwise located in the United States. Whether or not the requirement to add these additional U.S. law governed documents is prudent and cost effective often depends on several factors, including: 1) the total amount of the loan, 2) the importance of the U.S. subsidiary guarantor to the consolidated balance sheet of the Canadian borrower, 3) the value of any U.S. based collateral, and 4) the nature of the U.S. based collateral. It is also important to understand the reason a Canadian lender would request the additional documentation when the Canadian law governed documents already cover any U.S. based subsidiaries and any U.S. based collateral. Primarily, the additional U.S. law governed documents aid a Canadian lender if and when the lender needs to realize on the U.S. based collateral or otherwise collect against the U.S. organized subsidiary in U.S. courts. As a general matter, U.S. courts should typically give effect to and recognize Canadian law as a valid choice of law, absent fraud or some other public policy concern. Therefore, Canadian law loan documents should be sufficient regardless of the jurisdiction of the subsidiary or the location of the collateral. Canadian borrowers can therefore argue that adding U.S. law governed documents in addition to the Canadian law documents is unnecessary. While there is merit to this argument, the reality is that while U.S. courts should give effect to and recognize Canadian law and they should be able to interpret and impose Canadian law in any proceeding brought in a U.S. court, many lenders simply don’t want to take the risk that a U.S. court would look for an opportunity to negate or invalidate a guaranty or security agreement simply because of the choice of Canadian law when a viable alternative is available. The other argument that is sometimes proffered is that it is better to have a U.S. law governed document if a filing under the Uniform Commercial Code (“UCC”) will be made in the United States for U.S. based collateral or for a U.S. organized subsidiary. Fundamentally, the reasonableness of the request hinges on the cost to draft and negotiate the additional documents vs. the likelihood that they would ever be used and if so the value of any U.S. based subsidiaries as guarantors or the value of any U.S. based collateral. Assuming the borrower is willing to agree to use additional U.S. law governed guarantees and security agreements, lenders will often request that the U.S. law governed documents be “typical” or “market” for similar transactions governed under U.S. law. While this request may be reasonable, in an effort to make the documentation and negotiation as efficient as possible, Canadian borrowers may counter that any U.S. law governed documents simply mirror all of the provisions of their Canadian law counterparts – other than the choice of law provisions and other truly jurisdiction-specific provisions (e.g., referencing the UCC instead of the Personal Property Security Act (“PPSA”)). In addition, because most lenders require legal opinions as to the enforceability of loan documents, most borrowers will need to engage separate U.S. counsel to negotiate the documents and provide the necessary legal opinions. Ultimately, the best approach to the form of the documentation and the scope of any opinions will again depend on the cost to draft and negotiate the additional documents vs. the likelihood that they would ever be used and if so the value of any U.S. based subsidiaries as guarantors or the value of any U.S. based collateral. As with any loan transaction, the costs associated with additional U.S. law governed documents needs to be balanced with the reality that there are some advantages to a lender in having different options in the event they need to enter U.S. courts to enforce their loan documents, while at the same time keeping in mind the value of the guarantees and the U.S. based collateral relative to the total value of the loans.

Canadian companies should be aware that if they engage in certain “organizational actions” that affect the tax basis of shares held by U.S. persons (including many types of acquisitions and business combinations where shares are issued to U.S. persons), they are required by the U.S. tax laws to evaluate the effect of the action on the U.S. holder’s tax basis and disclose this information in a completed Form 8937 promptly following the action. Internal Revenue Code Section 6045B and IRS From 8937 require corporations to report an “organizational action” that affects the tax basis of its shares held by U.S. individuals and certain other tax entities. Canadian residents who are U.S. citizens or green card holders are treated as U.S. individuals for this purpose. The required reporting may be satisfied by filing Form 8937 with the IRS within 45 days of the organizational action (or if earlier, by January 15th of the following year) and also providing the Form 8937 to the impacted shareholders by January 15th of the following year. In the alternative, a corporation may satisfy the reporting requirements by timely posting the Form 8937 on its public website and maintaining it there for 10 years. Many public companies choose to post the Form 8937 on their public websites because this is administratively easier. “Organizational actions” include tax-deferred mergers and acquisitions under Code Section 368, contributions of property to controlled corporations under Code Section 351, contributions to capital without the issuance of additional shares, tax-free stock distributions, share consolidations, tax-free spin-offs, distributions that are treated as a return of capital (i.e., a distribution in excess of earnings and profits), taxable liquidations under Code Section 331 which involve more than one distribution in liquidation, recapitalizations and conversions under Code Section 368 and modifications of certain debt instruments. The instructions to Form 8937 specifically provide that reporting with respect to a corporation’s stock is required only if an organizational action impacts the tax basis of all holders of the issuer’s stock or all holders of a class of stock. A non-U.S. corporation is subject to the same rules as a U.S. domestic corporation, provided it has at least one shareholder who is a U.S. individual or partnership. For this purpose, a corporation includes any business entity that is treated as a corporation for U.S. federal income tax purposes. For example, a Canadian unlimited liability company which elects to be treated as a corporation for U.S. federal income tax purposes is treated as a corporation for Form 8937 reporting purposes. Penalties apply for failure to properly report an organizational action.

For Canadian issuers and their advisers, compliance with U.S. securities laws generally begins with the question: Is the issuer a “foreign private issuer”? The FPI definition, which is set out in Rule 405 under the Securities Act and 3b-4(c) of the Exchange Act, involves the following four inquiries: Are more than 50% of the issuer’s outstanding voting securities held of record, directly or indirectly, by residents of the United States? Are a majority of the issuer’s executive officers and directors citizens or residents of the United States? Are a majority of the issuer’s assets in the United States? Is the issuer’s business principally administered from within the United States? While the FPI test is a seemingly straightforward calculation, the application of the test in certain circumstances can be challenging.  The SEC staff has recently issued guidance that clarifies the application of the tests in certain circumstances and provides comfort for the application of reasonable methodologies that are consistently applied. Multiple Classes of Voting Securities.  Issuers that have multiple classes of outstanding voting securities with different voting rights may choose to make the calculation on the basis of voting power or the number of outstanding securities, provided that the methodology is applied on a consistent basis. United States Residency.  A person who has permanent resident status in the United States (a “Green Card” holder) is presumed to be a U.S. resident.  For purposes of other holders, an issuer may select other reasonable criteria, and apply them consistently, such as tax residency, nationality, mailing address, physical presence, location of financial or legal relationships, or immigration status. Officers and Directors.  In evaluating the citizenship and residency of executive officers and directors, each test must be separately applied to executive officers as a group and directors as a group. Administration of Business.  No single factor or group of factors is determinative of the location from which a business is administered.  An issuer must assess, on a consolidated basis, the location from which the issuer’s officers, partners or managers direct, control and coordinate the issuer’s business activities.  Absent other factors, shareholder meetings or occasional meetings of the board of directors in the United States would not indicate that the issuer’s business was administered in the United States. Location of Assets.  Issuers may look to the geographical segment information determined in the preparation of financial statements for purposes of calculating the location of assets.  Alternatively, an issuer may apply any other reasonable methodology on a consistent basis to determine location of assets. Foreign private issuer status is of considerable benefit to Canadian issuers that access the U.S. markets.  Issuers that are in danger of a change in status may find that the recent SEC guidance gives them some additional flexibility in satisfying the FPI test.  For those issuers, careful advance planning may make it possible to avoid the loss of the FPI benefits.

Most non-underwritten private placements of securities by Canadian companies to U.S. investors are made in reliance upon Rule 506 of Regulation D. Since September 2013, this exemption has been subject to “bad boy disqualifications.” Generally speaking, a company is prohibited from relying on Rule 506 if the company, any of its predecessors, any of its affiliated issuers, or any of its directors, officers, general partners, managing members or promoters has been subject to certain convictions, orders, judgments, decrees in the United States or suspension or expulsion of membership from certain organizations in the United States. In addition, if any person has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in the Rule 506 offering, then the offering will generally not qualify for Rule 506 if the person being paid, any general partner or managing member of such person or any director or officer of any of the foregoing has been subject to any such disqualifying events. A limited exception exists if the event occurred prior to September 2013 and is appropriately disclosed to prospective purchasers prior to the sale. Canadian companies that want to ensure the availability of Rule 506 should ask their directors, officers, 20% beneficial shareholders, general partners, managing members and promoters to periodically complete an appropriate Rule 506 bad boy questionnaire. We recommend that companies obtain a completed questionnaire from such persons at least annually, and that a questionnaire be completed by any person who newly becomes subject to the requirements (e.g., a newly appointed officer or a shareholder who first becomes a 20% beneficial shareholder). An appropriate form of questionnaire is available to clients upon request. In addition, Canadian companies should not agree to pay any person any remuneration or commission (directly or indirectly) for soliciting purchasers in a Rule 506 offering (e.g., an underwriter, agent or “finder”), unless it is first confirmed that the person is a U.S. registered broker-dealer that is legally permitted to receive such a commission and the parties enter into an appropriate contract in which the person confirms that no bad boy disqualifications are applicable. Companies should seek U.S. counsel’s advice on the appropriate language.