Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The North American Securities Administrators Association, Inc. (NASAA) has released model rules relating to the use of its Electronic Filing Depository (EFD) system for Form D and state registration and notice filings. The rules have been posted for comment until July 30, 2014 and, in their final form, will be designed to serve as models for adoption by individual states.

Currently, Form D must be filed with the SEC electronically via the EDGAR system, but states typically require that a paper copy of the Form D be filed with the appropriate securities administrator pursuant to notice filing requirements in Regulation D offerings. Similarly, state registration and exemption filings are still largely a matter of paper filing.

The NASAA proposes two alternative model rules – one designed only to implement electronic filing of Form D through EFD, and one designed to implement electronic filing of all state securities registration and notice filings (including all “blue sky” filings) through EFD. Of course, the rules would not become effective until EFD actually has the capability to process these filings. The ability to process Form D filings is expected to become available through EFD in November of 2014.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

GAO issued a report discussing virtual currencies. One example of these is bitcoin, which was developed in 2009. Bitcoin and similar virtual currency systems operate over the Internet and use computer protocols and encryption to conduct and verify transactions. According to GAO, while these virtual currency systems offer some benefits, they also pose risks. For example, GAO notes they have been associated with illicit activity and security breaches, raising possible regulatory, law enforcement, and consumer protection issues.

Federal agencies also have begun to collaborate on virtual currency issues through informal discussions and interagency working groups primarily concerned with money laundering and other law enforcement matters. However, according to GAO, these working groups have not focused on emerging consumer protection issues, and the CFPB—whose responsibilities include providing consumers with information to make responsible decisions about financial transactions—has generally not participated in these groups.  GAO stated  interagency efforts related to virtual currencies may not be consistent  with key practices that can benefit interagency collaboration, such as including all relevant participants to ensure they contribute to the outcomes of the effort.  GAO concludes, as a result, future interagency efforts may not be in a position to address consumer risks associated with virtual currencies in the most timely and effective manner.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

On July 3, 2014, the SEC released six new Compliance and Disclosure Interpretations relating to verification of prospective investors as accredited investors for purposes of Rule 506(b) and Rule 506(c).   Two of these C&DIs are straightforward clarifications; the remaining four relate to two of the safe harbors established by the SEC for purposes of determining when an issuer has taken “reasonable steps” to verify the accredited investor status of a prospective investor in a Rule 506(c) offering.

First, the straightforward clarifications:

  • If prospective investor’s income is reported in a foreign currency, an issuer can rely on either the exchange rate in effect on the last day of the year for which the income was reported, or on the average exchange rate for that year.
  • If a prospective investor owns property or an account jointly with a person other than the prospective investor’s spouse, the value of that property or account can only be counted for net worth purposes to the extent of the prospective investor’s percentage of ownership in the joint property or account.

As for the C&DIs that relate to the safe harbors, the general theme of these questions and answers is that the safe harbor provisions in Rule 506(C) are narrow and should be strictly construed. However, just because an issuer is outside of one of the safe harbors doesn’t mean that the issuer can’t satisfy the “reasonable steps” test based on what the SEC refers to as the “principles-based approach,” with the caveat that more diligence will be necessary if the steps taken by the issuer provide any bases for questioning the quality of the information being supplied or the prospective investor’s accredited investor status.

The safe harbor in Rule 506(c)(2)(ii)(A) allows an issuer to rely on filed IRS forms showing a prospective investor’s income for the two most recent years. Two of the C&DIs relate to this safe harbor:

  • If filed IRS forms indicating a prospective investor’s income are not yet available for the two most recent years (e.g., because the offering is occurring in the first quarter of a year and the prospective investor hasn’t yet filed taxes for the immediately preceding year), then the safe harbor is not available. However, the issuer could still satisfy the reasonable steps test using the principles-based approach by reviewing the filed IRS forms for the two most recently available years and relying on investor representations regarding the year for which filed IRS forms are not yet available (unless this process turns up any red flags, such as income that barely surpasses the threshold amount).
  • Filed tax documents from foreign jurisdiction cannot be used to satisfy this safe harbor. However, tax returns from a foreign jurisdiction that impose penalties for false statements in tax returns that are similar to the penalties imposed in the U.S. could be relied upon in connection with satisfying the reasonable steps test using the principles-based approach (unless those tax documents indicate any red flags).

The safe harbor described in Rule 506(c)(2)(ii)(B) allows an issuer to verify net worth by relying on certain types of documents (such as tax assessments or consumer credit reports issued by one of the three U.S. national credit reporting bureaus) relating to assets and liabilities provided that the documents are dated within the prior three months and the issuer obtains a representation from the prospective investor that all liabilities necessary to make a determination of net worth have been disclosed. Two of the C&DIs relate to this safe harbor:

  • Even though tax assessments are typically only performed annually, a tax assessment older than three months can’t be used to satisfy the safe harbor, even if it is the most recently performed tax assessment. However, it could be possible for an issuer to satisfy the “reasonable steps” test under the principles-based approach by relying on a tax assessment that is more than three months old but shows assets that, after deducting liabilities, result in a net worth well in excess of $1 million (provided there are no red flags).
  • A report from a foreign consumer credit reporting agency analogous to one of the three national credit reporting bureaus in the U.S. cannot be used to satisfy the safe harbor. However, an issuer could satisfy the reasonable steps test under the principles-based approach by relying on a foreign consumer credit report and taking other reasonable steps to be certain that all liabilities have been disclosed (provided there are no red flags).

In sum, an issuer can use methods analogous to those outlined in the safe harbors to satisfy the reasonable steps test under the principles-based approach, but only if the issuer is actually analyzing the information and performing further follow up when there is reason to question the materials being relied upon, and not simply completing the steps by rote.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The Government Accountability Office, or GAO, has issued a report noting the SEC  issued a rule in 2012 requiring certain companies to disclose the source and chain of custody of necessary conflict minerals in their products.  However, the report notes the Department of Commerce has not yet compiled a list of all conflict minerals processing facilities—smelters and refiners—known worldwide, required by January 2013 pursuant to the Dodd-Frank Act. Commerce cited difficulties with, for example, tracking conflict minerals operations but told GAO that it had completed outreach efforts with the majority of stakeholders. According to GAO Commerce did not have a plan of action, with associated time frames, for developing and reporting on the list of conflict minerals processing facilities worldwide. The GAO said standard practices in program and project management include, among other things, developing a plan to execute specific projects needed to obtain defined results within a specific time frame. The GAO thinks an action plan with timeframes could better position Commerce to report on the status of its efforts to produce a final list to Congress and to hold its personnel accountable for completing activities.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

On June 23, 2014, the Securities Industry and Financial Markets Association (SIFMA) published a memo outlining several specific methods for verifying accredited investor status that SIFMA believes would satisfy the requirement, in a Rule 506(c) offering involving general solicitation, that the issuer take “reasonable steps” to verify the accredited investor status of each purchaser in the offering.

As a quick refresher (full summary of the rule here), Rule 506(c) allows issuers, for the first time since the advent of the securities laws, to publicly advertise private offerings of securities, provided that are number of requirements are met. Sales in a Rule 506(c) offering can only be made to accredited investors and the issuer must take “reasonable steps” to verify that each purchaser is in fact an accredited investor. This is in contrast to a traditional Rule 506 offering (now a Rule 506(b) offering) in which the issuer may rely on a representation from the purchaser that the purchaser is an accredited investor. In a Rule 506(b) offering, it is enough that the purchaser checks a box to indicate the purchaser is an accredited investor; the SEC has stated that, in a Rule 506(c) offering, relying on a purchaser to check a box is not enough to satisfy the “reasonable steps” requirement. The SEC has attempted to mitigate the uncertainty provided by the “reasonable steps” requirement by providing four safe-harbor verification methods for complying with the standard. However, the safe harbor methods outlined by the SEC may be of limited utility because three out of the four methods require natural persons to, for example, disclose sensitive personal financial information to the issuer or other third party such as a broker-dealer or lawyer.

SIFMA is attempting to bridge the gap by setting forth several specific methods that broker-dealers and investment advisers could use to verify the accredited investor status of individuals, as well as some examples aimed at verifying the accredited investor status of certain entities.   The memo contains an example questionnaire for use in verifying accredited investor status of natural persons and an example of a written verification that could be provided to an issuer by a broker-dealer, investment adviser, or law firm certifying that a purchaser is an accredited investor (which is one of the four SEC safe harbors).

I’ll summarize the methods outlined by SIFMA for verifying the accredited investor status of natural persons in a moment, but first, it’s worth putting the SIFMA guidance in context. This is not SEC guidance on satisfying the “reasonable steps” test, and there is no guarantee that complying with the methods described in the SIFMA memo would be deemed sufficient by the SEC. The memo only represents “examples of the types of methods that [SIFMA] believe[s] can constitute reasonable steps to verify in light of the facts and circumstances outlined [in the memo].” Having said that, these methods have been endorsed by SIFMA and 20 prominent law firms, and an issuer that relied upon the SIFMA guidance, in the absence of specific SEC guidance, would have a strong case that the issuer was taking “reasonable steps” to verify the accredited investor status of each purchaser in an offering.

For registered broker-dealers and investment advisers seeking to verify the accredited investor status of a natural person the SIFMA memo provides the Account Balance Method and the Investment Amount Method.

Account Balance Method:

  • The purchaser has been a client of the firm for at least six months;
  • The purchaser has, individually or with a spouse, unpledged marketable securities in excess of $2 million in accounts with the firm;
  • The purchaser has made representations regarding status as an accredited investor (by completing the questionnaire attached to the SIFMA memo); and
  • The firm is not aware of any facts that call the into question the status of the purchaser as an accredited investor.

Investment Amount Method:

  • The purchaser has been a client of the firm for at least six months;
  • The purchaser invests at least $250,000 in the offering;
  • The purchaser has made representations regarding status as an accredited investor and that the $250,000 investment represents less than 25% of the purchaser’s net worth (by completing the questionnaire attached to the SIFMA memo); and
  • The firm is not aware of any facts that call the into question the status of the purchaser as an accredited investor.

One thing that Rule 506 has taught us is that SEC safe harbors tend to become minimum thresholds in practice; will the same thing happen with respect to this SIFMA guidance? Will law firms advise issuer clients that failing to follow one of the SEC safe harbors or the SIFMA guidance in a Rule 506(c) offering is simply too risky? Obviously, Rule 506(c) is still in its infancy and much remains to be seen regarding how it will be utilized by issuers and interpreted and enforced by the SEC, but the SIFMA memo is certainly an interesting step in fleshing out the meaning of the Rule.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

SEC Chair Mary Jo White recently gave a speech on a number of important matters, including the role of directors as gatekeepers, her views of self-reporting of violations and the SEC’s whistleblower program.  In the speech she noted “You may well have doubts about the bona fides of a particular whistleblower – perhaps because his or her prior nine tips have not proven to be true or management tells you that the would-be whistleblower is a disgruntled employee.  But always think – because it is so – that her tenth tip may be right on target.  The bottom line is that it is a mistake not to take all tips from whistleblowers seriously.”

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The SEC has ordered registered securities exchanges and FINRA to submit a tick size pilot program within 60 days.  The order specifies that the control group will be quoted at the current tick size increment, $0.01 per share, and trade at the increments currently permitted.   The first test group would be quoted in $0.05 minimum increments and trading could continue to occur at any price increment that is permitted today. There are two other test groups with a $0.05 minimum with different trading rules.  The pilot program would be in effect for a year.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

The SEC charged two firms with failing to register as investment advisers because their operations were integrated (SEC orders are here and here) and charged one of the entities with violating pay-to-play rules.

Failure to Register and Integration

The integrated entities did not qualify for an exemption from registration with the Commission under Rule 203(m)-1 under the Investment Advisers Act because the combined operations exceeded $150 million in regulatory assets under management in the U.S.  The entities did not admit or deny the findings, except for jurisdictional matters.

Alleged facts the SEC looked at in determining integration included:

  • On their exempt reporting adviser reports filed with the Commission, both entities reported that they are under common control with each other. In addition, various employees and associated persons of one entity held ownership stakes in that entity  and in the general partner and management company of the other entity.
  • The entities had several overlapping employees and associated persons, including individuals who provided investment advice on behalf of both entities.
  • The entities had significantly overlapping operations without any policies and procedures designed to keep the entities separate. Marketing materials for one entity made reference to both entities as being a “partnership.”  In addition, Managing Directors of one entity solicited potential investors for the other.  Moreover, neither adviser had adequate information security policies and procedures in place to protect investment advisory information from disclosure to the other. Also, employees and associated persons of one entity routinely used email addresses associated with the other entity to conduct business and communicate with outside parties.

In arriving at its conclusion, the order noted the SEC has stated that it will treat as a single adviser two or more affiliated advisers that are separate legal entities but are operationally integrated, which could result in a requirement for one or both advisers to register. Based upon the facts and circumstances, the SEC found the entities were operationally integrated and, therefore, were not eligible to rely on the claimed exemptions from registration. The SEC pointed to guidance in Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, Investment Advisers Act Release No. 3222 at 125, as support for its conclusion..

Pay-to-Play Violations

The SEC investigation found that one of the private equity firms violated pay-to-play rules by continuing to receive compensation from two public pension funds within two years after an associate made a $2,500 campaign contribution to a mayoral candidate and a $2,000 campaign contribution to a governor.  The mayoral and governor positions could influence the hiring of investment advisers for the public pension funds for which the private equity firm managed money.  After the contributions, the private equity firm  improperly continued to receive compensation from the pension funds for those advisory services.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

Daniel K. Tarullo of the Board Of Governors of the Federal Reserve System delivered a speech on the intersection of corporate governance and prudential regulation.  Some of the points he noted were (emphasis added):

“While regulators should have clear expectations for boards, we need to make sure that we are creating expectations that lead to boards spending more time overseeing the risk-management and control functions I have emphasized this afternoon. There are many important regulatory requirements applicable to large financial firms. Boards must of course be aware of those requirements and must help ensure that good corporate compliance systems are in place.”

“Specifically, the question arises as to whether the fiduciary duties of the boards of regulated financial firms should be modified to reflect what I have characterized as regulatory objectives. Doing so might make the boards of financial firms responsive to the broader interests implicated by their risk-taking decisions even where regulatory and supervisory measures had not anticipated or addressed a particular issue. And, of course, the courts would thereby be available as another route for managing the divergence between private and social interests in risk-taking.”

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The United States District Court for the Eastern District of Wisconsin refused to allow a plaintiff to amend his complaint where the plaintiff claimed he was terminated because he complained internally and to the FTC and the FDIC about the defendants’ regulatory violations. The plaintiff sought to file an amended complaint where he sought to add a claim for violation of the whistleblower-protections of the Dodd-Frank Act.

The court did not allow the plaintiff to amend the complaint because the Dodd-Frank anti-retaliation protections only apply to disclosures related to violations of “securities laws.” The court said the “banking laws” the defendants were alleged to have violated were not “securities laws.”

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.