ThomasMoreAI State Merit Review Analysis
Produces pre-filing risk analysis and examiner-ready comment responses for non-covered securities offerings subject to state merit review. Covers cheap stock, promoter equity investment, voting rights, and promoter compensation under NASAA Statements of Policy.
Quick Start
- Confirm offering is NOT a covered security under 15 U.S.C. Section 77r
- Gather intake documents (offering doc, charter, cap table, state list)
- Run analysis steps 1-6 below
- Draft comment response package or pre-filing memo
- Prepare negotiation fallback positions per issue area
Intake (Mandatory)
Gather before analysis unless user says "use defaults" or "just draft":
- Offering document — Form 1-A, prospectus, PPM, or offering circular
- Charter documents — Articles/certificate of incorporation, bylaws, amendments
- Cap table — All issuances with dates, prices, consideration type, vesting, holder identity (Promoter vs. Non-Promoter)
- Issuance chronology — Board consents, subscription agreements, service agreements
- Promoter compensation schedule — Cash, equity, consulting, related-party contracts, loans
- Selling compensation terms — Underwriter/placement agent agreements, warrants
- Historical financials — Balance sheets for promoter equity calculation
- Target state list — Filing pathway per state
- Federal exemption — Reg A Tier 1/2, Rule 504, intrastate, direct registration
- Prior examiner correspondence — Deficiency/comment letters if any
Defaults if user doesn't respond: NASAA SOP standards applied; Rule 405 promoter definition; 10% promoter equity investment benchmark.
Threshold Questions
- Are securities "covered securities" under 15 U.S.C. Section 77r? (If yes, stop — no merit review)
- Shares issued for nominal cash or services within 36 months of filing?
- Promoters received equity disproportionate to cash/tangible asset contributions?
- Voting or control rights deviate from economic ownership?
- Offering proceeds repay insiders?
- State informally flagged issues?
Step 1: Confirm Merit Review Applicability
| Covered (No Merit Review) | Not Covered (Merit Review Applies) |
|---|---|
| Listed on national exchange (NYSE, NASDAQ) | Reg A Tier 1 & 2 in merit states |
| Rule 506(b) / 506(c) | Rule 504 |
| Sold only to "qualified purchasers" | Intrastate offerings |
| Direct public offerings not on national exchange |
Produce short posture memo: pathway, why merit review applies, verified citations. Flag risks to covered status (general solicitation, bad actor, integration).
Step 2: Map Jurisdictional Standards
For each target state, verify:
| Factor | Source |
|---|---|
| Denial standard ("unfair, unjust, or inequitable") | State securities act |
| Registration method and merit review intensity | State regulator website |
| NASAA SOP adoption (Cheap Stock, Promoter's Equity, Unequal Voting) | State admin code |
| Coordinated Review availability (e.g., CR-3(b) for Reg A) | NASAA website |
Key divergences [VERIFY current status]:
- California: Own standards; Cal. Code Regs. Tit. 10, Section 260.140 et seq.
- Texas: Strict merit; arm's-length required for affiliated transactions
- Washington: Heightened scrutiny for development-stage; may require proceeds impoundment
- New York: Generally notice-filing; Martin Act may affect certain types
All cited standards must include verified URLs or [VERIFY] flag.
Step 3: Analyze Cheap Stock
Scope: All equity issued to Promoters below public offering price within 36-month look-back.
Quantitative analysis:
- Identify all Promoters per merit review definition
- Calculate effective price per share (including conversion, warrants, liquidation preferences)
- Compute dilutive effect: promoter price vs. public offering price
- Calculate post-money ownership percentages
Qualitative justification: Early-stage risk, documented services rendered, vesting/lock-up/repurchase rights, milestones.
Common remedies: Escrow until earnings milestones, lock-ups, cancellations/reverse splits, operational use-of-proceeds conditions, enhanced dilution disclosure.
Step 4: Analyze Promoter's Equity Investment
NASAA benchmark: promoter equity >= 10% of total aggregate offering price.
Calculation (NASAA methodology, not GAAP):
- Count: cash, tangible assets at documented fair value
- Exclude: imputed services value, goodwill
- State-specific: verify whether personal guarantees count
Shortfall strategy: Document tangible asset contributions, personal guarantees if permitted. Note: cheap stock + inadequate promoter investment is the highest-risk combination.
Step 5: Review Voting Rights and Governance
NASAA SOP: voting rights proportionate to equity unless compelling justification.
| Issue | Risk |
|---|---|
| Dual-class super-voting shares | High — most merit states reject for retail |
| Blank check preferred stock | High |
| Minority shareholder elects majority of board | High |
| No class vote on mergers/liquidations/asset sales | Medium |
| No sunset on control provisions | Medium |
Mitigation: Sunset provisions, independent directors, class votes on major transactions, plain-English disclosure.
Verify "Description of Securities" matches actual charter/bylaws exactly.
Step 6: Review Promoter Compensation
Build schedule: cash comp, equity grants, consulting fees, bonuses, company loans, related-party leases, IP payments, reimbursements. Connect each to use of proceeds.
Flag if proceeds repay insiders. Promoter definition may be broader than expected — examiners may classify control persons, significant consultants, or paid finders as promoters.
Drafting Comment Response Package
Components:
- Cover letter — point-by-point response to each examiner comment
- Redline of offering document
- Supporting exhibits (revised charter, escrow/lock-up agreements, updated cap table)
Per-comment structure:
- Quote examiner comment verbatim
- Cite applicable NASAA SOP or state admin code
- Explain compliance or justify deviation
- Reference specific redline page/section for remedy
Tone: Respectful, solution-oriented, legally precise. Not a litigation brief.
Consistency: Every factual assertion cites the record. Every legal assertion has verified citation or [VERIFY]. Restrictions promised must appear in binding agreements AND offering document.
Negotiation Strategy
| Issue | Primary Position | Fallback 1 | Fallback 2 |
|---|---|---|---|
| Cheap stock | Dilution disclosure + time-based lock-up | Lock-up + repurchase on bad acts | Milestone-based escrow |
| Promoter investment | Tangible assets + guarantees | Defer insider comp until minimum raise | Restructure founder equity |
| Voting rights | Sunset + independent directors | Reduce super-voting + class vote on majors | Eliminate dual-class |
| Promoter comp | Full disclosure + market comparables | Cap reimbursements + defer consulting | Escrow promotional shares |
Cross-state: concession in one state may require disclosure updates for all states. Don't concede early without knowing other states' positions.
Post-Draft Alignment
After delivering initial analysis, confirm:
- Cap table and issuance chronology reconciled to charter authority?
- Examiner indicated priority concerns or informal guidance?
- Pursue coordinated review (CR-3(b))?
- Concessions client has already decided to accept or reject?
Quality Checklist
- Preemption determination confirmed with verified citation
- NASAA methodology (not GAAP) for promoter equity
- Cap table reconciles to charter authority, matches "Principal Shareholders" and "Dilution" sections
- All promoters identified under merit review definition (broader than typical)
- Cheap stock covers all issuances within 36-month look-back
- Voting rights match actual charter/bylaws, not just offering document
- Every citation verified or flagged
[VERIFY] - Adversarial scrub: would examiner find inconsistencies?
- Negotiation fallbacks prepared per issue area
- Assumptions and open items listed prominently
Pitfalls
- Never fabricate citations. All NASAA policy text, statutory sections, and case citations must be verified via research or flagged
[VERIFY]. - Separate strategy from response. Comment response letters become public records in many states; keep privileged analysis in internal memos.
- Anti-fraud overlay. Never obscure a merit issue — disclose cheap stock, promoter comp, and unequal voting plainly.
- NASAA SOPs are not uniform. Always verify state-specific adoption before citing.
- Recommend CR-3(b) coordinated review where available.
- Cap table errors: Excluding intangible-property shares, not reconciling to charter authority, omitting derivatives, conclusory justifications without documentation.
- Ethics: Model Rules 1.1 (competence), 1.3 (diligence), 1.4 (communicate concession impact), 3.3/4.1 (candor to examiners).
- Attorney review required. All output requires review by a licensed securities attorney before submission.