CROSS BORDER SECURITIES UPDATE

March 2006

32 Recommendations to Ease Regulatory Burden of MicroCap and SmallCap Companies in the US (continued)

2. adoption of a code of ethics within the meaning of Item 406 of Regulation SK applicable to all directors, officers and employees and compliance with the further obligations under Item 406(c) relating to the disclosure of the code of ethics; and
3. design and maintenance of effective internal controls over financial reporting.

In addition, as part of this recommendation, the SmallCap Committee recommended that the SEC confirm, and if necessary clarify, the application to all microcap companies, and indeed to all smallcap companies also, of the existing general legal requirements regarding internal controls, including the requirement that companies maintain a system of effective internal control over financial reporting, disclose modifications to internal control over financial reporting and their material consequences and apply CEO and CFO certifications to such disclosures. Moreover, management should be required to report on any known material weaknesses. In this regard, the Proposed Statement on Auditing Standards of the AICPA, “Communications of Internal Control Related Matters Noted in an Audit,” if adopted by the AICPA and the PCAOB, would strengthen this disclosure requirement and provide some external auditor involvement in the internal control over financial reporting process.

3.     Unless and until a framework for assessing internal control over financial reporting for such companies is developed that recognizes their characteristics and needs, provide exemptive relief from external auditor involvement in the Section 404 process to the following companies, subject to their compliance with the same corporate governance standards as detailed in the recommendation above:

1. Smallcap companies with less than $250 million in annual revenues but greater than $10 million in annual product revenue; and
2. Microcap companies with between $125 and $250 million in annual revenue.

4.     Change the requirements for implementing Section 404’s external auditor requirement to a cost-effective standard, which the SmallCap Committee calls “ASX,” providing for an external audit of the design and implementation of internal controls.

5.    Provide, and request that COSO and the PCAOB provide, additional guidance to help facilitate the assessment and design of internal controls and make processes related to internal controls more cost effective; also, assess if and when it would be advisable to reevaluate and consider amending AS2.

6.    Determine the necessary structure for COSO to strengthen it in light of its role in the standard-setting process in internal control reporting.

III. Capital Formation, Corporate Governance and Disclosure

7.    Incorporate the scaled disclosure accommodations currently available to small business issuers under Regulation S-B into Regulation S-K, make them available to all microcap companies, and cease prescribing separate specialized disclosure forms for smaller companies.

8.    Incorporate the primary scaled financial statement accommodations currently available to small business issuers under Regulation SB into Regulation S-K or Regulation S-X and make them available to all microcap and smallcap companies.

9.    Allow all reporting companies on a national securities exchange, NASDAQ or the OTCBB to be eligible to use Form S-3, if they have been reporting under the Exchange Act for at least one year and are current in their reporting at the time of filing.

10.  Adopt policies that encourage and promote the dissemination of research on smaller public companies.

11.  Adopt a new private offering exemption from the registration requirements of the Act that does not prohibit general solicitation and advertising for transactions with purchasers who do not need all the protections of the Act’s registration requirements. Additionally, relax prohibitions against general solicitation and advertising found in Rule 502(c) under the Act to parallel the “test the waters” model of Rule 254 under that Act.

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32 Recommendations to Ease Regulatory Burden of MicroCap and SmallCap Companies in the US (continued)

12.  Spearhead a multi-agency effort to create a streamlined NASD registration process for finders, M&A advisors and institutional private placement practitioners.

13.  Amend SEC Rule 12g5-1 to interpret “held of record” in Exchange Act Sections 12(g) and 15(d) to mean held by actual beneficial holders.

14.  Make public information filed under Rule 15c2-11.

15.  Form a task force, consisting of officials from the SEC and appropriate federal bank regulatory agencies to discuss ways to reduce inefficiencies associated with SEC and other governmental filings, including synchronizing filing requirements involving substantially similar information, such as financial statements, and studying the feasibility of extending incorporation by reference privileges to other governmental filings containing substantially equivalent information.

16.  Allow companies to compensate market-makers for work performed in connection with the filing of a Form 211, with full disclosure of such compensation arrangements.

17.  Evaluate upgrades or technological alternatives to the EDGAR system so that smaller public companies can make their required SEC filings without the need for third party intervention and associated costs.

18.  Make it easier for microcap companies to exit the Securities Exchange Act of 1934 reporting system.

19.  Increase the disclosure threshold of Act’s Rule 701(e) from $5 million to $20 million.

20.  Extend the “access equals delivery” model to a broader range of SEC filings.

21.  Shorten the integration safe harbor from six months to 30 days.

22.  Clarify SOX Section 402 loan prohibition.

23.  Increase uniformity and cooperation between federal and state regulatory systems by defining the term “qualified investor” in the Act and making the NASDAQ Capital Market and OTCBB stocks “covered securities” under NSMIA.

24.   Clarify the interpretation of or amend the language of the Rule 152 integration safe harbor to permit a registered initial public offering to commence immediately after the completion of an otherwise valid private offering the stated purpose of which was to raise capital with which to fund the IPO process.

IV. Accounting Standards

25.  Develop a “safe-harbor” protocol for accounting for transactions that would protect well-intentioned preparers from regulatory or legal action when the process is appropriately followed.

26.  In implementing new accounting standards, the FASB should permit microcap companies to apply the same extended effective dates that it provides for private companies.

27.  Consider additional guidance for all public companies with respect to materiality related to previously issued financial statements.

28.  Implement a de minimis exception in the application of the SEC’s auditor independence rules.

29.  Together with the PCAOB and the FASB, promote competition and reduce the perception of the lack of choice in selecting audit firms by using their influence to include non-Big Four firms in committees, public forums, and other venues that would increase the awareness of these firms in the marketplace.

30.  Formally encourage the FASB to continue to pursue objectives-based accounting standards. In addition, simplicity and the ease of application should be important considerations when new accounting standards are established.

31.  Require the PCAOB to consider minimum annual continuing professional education requirements covering topics specific to SEC matters for firms that wish to practice before the SEC.

32.  Monitor the state of interactions between auditors and their clients in evaluating internal controls over financial reporting and take further action to improve the situation if warranted.

Where the Focus Is

Commentators and critics have focused on the recommendations of the SmallCap Committee limiting the

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32 Recommendations to Ease Regulatory Burden of MicroCap and SmallCap Companies in the US (continued)

application of SOX to microcap and smallcap companies.  As stated previously the big four accounting firms are against the recommendations in this area as are a number of the larger US legal firms and former top officials of the SEC (one being former SEC Chairman Arthur Levitt) and the Federal Reserve (Reserve Chairman Paul Volker). 

The proposals under the “Capital Formation, Corporate Governance and Disclosure” caption would have a significant impact on microcap and smallcap companies if adopted by the SEC.  Hopefully, these recommendations won’t be ignored as the SOX debate heats up.

If you support any of the proposed recommendations of the SmallCap Committee make your voice heard.  Those in opposition of these recommendations have money and power on their side.  It is only by voicing your support that the SmallCap Committee and the SEC will know that you believe the proposed changes are a good start in recognizing the importance of small companies in the competitiveness and future of the North American economy.

Cautionary Note

The Small Cap Committee’s role is an advisor only to the SEC.  The SEC is under no obligation to act upon the recommendations put forward by the Small Cap Committee.  You should not assume the SEC will extend its initial waiver to Section 404 of SOX to non-accelerated filers beyond the July 14, 2007 announced on September 21, 2005.

Proposal to Ease Deregistration in the US by Foreign Issuers

On December 27, 2005, the SEC published a new rule regarding the termination of US reporting requirements by foreign private issuers under Section 12(g) US Securities Exchange Act of 1934 (the “1934 Act”).  Rule 12h-6, if adopted, will simplify the process of deregistration in the US by expanding the options under which a foreign issuer may terminate its reporting issuer status and truly terminate its status as a US reporting issuer and not just suspending its reporting obligations under section 15(d) of the 1934 Act.

Current Deregistration Rules

Under the current 1934 Act rules, Rule 12g-4 only permits a foreign private issuer to deregister a class of its securities under section 12(g) of the 1934 Act if the subject class is held by less than 300 U.S. residents or 500 U.S. residents for issuers with less than $10 million in assets, as of the end of its last completed fiscal year. This number is to be calculated on a "look through" basis by canvassing the record ownership of brokers, dealers, banks or nominees worldwide and counting the number of separate accounts of customers residing in the US. If the number of US residents is under the given threshold, the issuer may deregister the securities under the 1934 Act. The issuer may also terminate its reporting obligations under the 1934 Act if the securities had not been registered under the US Securities Act of 1933 (the “Act”). If, however, the issuer has registered securities under the Act, under Rule 12h-3 the issuer may deregister the securities under the 1934 Act but may only suspend, not terminate, its 1934 Act reporting obligations under section 15(d) of the 1934 Act.  At the end of each fiscal year the issuer must check to see if the threshold has not been exceeded.  The issuer must resume its reporting obligations any time the threshold is exceeded.

Proposed Deregistration Rules

Under proposed 1934 Act Rule 12h-6, a foreign private issuer would be able to permanently terminate either or both:

1.     its registration of its securities under Section 12(g) of the 1934 Act and its corresponding section 13(a) reporting obligations; and

2.     reporting obligations under section 15(d) of the 1934 Act.

if it meets the following qualitative and quantitative conditions:

Qualitative Conditions

(1) The Two-Year 1934 Act Reporting Condition: The issuer must have been an 1934 Act reporting company for the past two years, has filed or furnished all reports required for this period and filed at least two annual reports under Section 13(a);

(2) The One-Year No Sales Condition: The issuer has not directly or indirectly sold it’s securities in the US in either a registered or unregistered offering during the preceding 12 months, other than securities:

• sold to its employees,
• sold by selling security holders in non-underwritten offerings,
• exempt from registration under Section 3 of the Act (except Section 3(a)(10)), or
• constituting obligations having a maturity of less than 9 months at the time of issuance and offered and sold in transactions exempted from registration under Section 4(2) of the Act (i.e., so called "4(2) commercial paper"); and

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