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

Section 113 of the Dodd-Frank Act authorizes the Financial Stability Oversight Council, or FSOC, to require a nonbank financial company to be supervised by the Board of Governors of the Federal Reserve System and be subject to prudential standards if FSOC determines that material financial distress at the company—or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company—could pose a threat to U.S. financial stability.  FSOC has approved a final rule and interpretive guidance on the FSOC’s authority to require supervision and regulation of certain nonbank financial companies.

FSOC intends to use a three step process to identify nonbank financial companies for supervision.  In Stage 1, FSOC will seek to identify a set of nonbank financial companies that merit company-specific evaluation. In this stage, the Council intends to apply quantitative thresholds to a broad group of nonbank financial companies.  FSOC will evaluate nonbank financial companies using only data available to FSOC, such as publicly available information and information member agencies possess in their supervisory capacities.

After the Stage 2 Pool has been identified, FSOC intends to conduct a robust analysis of the potential threat that each of those nonbank financial companies could pose to U.S. financial stability. In general, this analysis will be based on information already available to FSOC through existing public and regulatory sources, including information possessed by the company’s primary financial regulatory agency or home country supervisor, as appropriate, and information voluntarily submitted by the company. In contrast to the application of uniform quantitative thresholds to a broad group of nonbank financial companies in Stage 1, FSOC intends to evaluate the risk profile and characteristics of each individual nonbank financial company in the Stage 2 Pool based on a wide range of quantitative and qualitative industry-specific and company-specific factors.

In Stage 3, the FSOC, working with the Office of Financial Research, will conduct a review of each nonbank financial company in the Stage 3 Pool using information collected directly from the nonbank financial company, as well as the information used in the first two stages. The review will focus on whether the nonbank financial company could pose a threat to U.S. financial stability because of the company’s material financial distress or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company.

Each nonbank financial company in the Stage 3 Pool will receive Notice of Consideration that the nonbank financial company is under consideration for a proposed determination. The Notice of Consideration likely will include a request that the nonbank financial company provide information that FSOC deems relevant to FSOC’s evaluation, and the nonbank financial company will be provided an opportunity to submit written materials to FSOC.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The Consumer Finacial Protection Bureau, or CFPB, has issued a bulletin in response to several inquiries the CFPB has received regarding the payment of compensation to loan originators under Regulation Z, 12 C.F.R. § 1026.36, which we refer to as the Compensation Rules.  Adoption of the rules was required by the Dodd-Frank Act.

Subject to certain narrow exceptions, the Compensation Rules provide that no loan originator may receive (and no person may pay to a loan originator), directly or indirectly, compensation that is based on any terms or conditions of a mortgage transaction.

The CFPB has received several questions about whether and how the Compensation Rules apply to qualified profit sharing, 401(k), and employee stock ownership plans (collectively, “Qualified Plans”). Specifically, CFPB staff has been asked whether a financial institution can, consistent with the Compensation Rules, contribute to Qualified Plans for employees, including loan originators, if employer contributions to such plans are derived from profits generated by mortgage loan originations.

The Compensation Rules  do not expressly address whether the loan origination provisions apply to contributions made to Qualified Plans. The CFPB recognizes that there has been some confusion on the applicability of the Compensation Rules to Qualified Plans.

Section 1403 of the Dodd-Frank Act contains provisions that also address loan originator compensation. Under the Dodd-Frank Act, the CFPB must adopt final loan originator compensation rules by January 21, 2013, or the provisions are self-effectuating on that date. The CFPB anticipates issuing a proposed rule for public comment in the near future on the loan origination provisions in the Dodd-Frank Act.

Until final rules are adopted by the CFPB, the CFPB believes it is important to clarify how the Compensation Rules apply to Qualified Plans. To provide clarity at this juncture, the CFPB’s view is that the Compensation Rules permit employers to contribute to Qualified Plans out of a profit pool derived from loan originations. That is, financial institutions may make contributions to Qualified Plans for loan originators out of a pool of profits derived from loans originated by employees under the Compensation Rules.

The CFPB has also received questions about how the Compensation Rules apply to profit-sharing arrangements/plans that are not in the nature of Qualified Plans. Many of the questions have been fact-specific and the CFPB does not believe it is practical to provide guidance in this Bulletin about such plans. The CFPB anticipates providing greater clarity on these arrangements in connection with a proposed rule on the loan origination provisions in the Dodd-Frank Act.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

 

 

The Federal Reserve Board has requested comment on a proposed amendment to the Board’s Notice of Proposed Rulemaking, or NPR, issued February 11, 2011, to establish requirements for determining whether a company is “predominantly engaged in financial activities.”

Under Title 1 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, a company generally can be designated for Board supervision by the Financial Stability Oversight Council only if 85 percent or more of the company’s revenues or assets are related to activities that are financial in nature under the Bank Holding Company Act.  

Some parties providing comments to the February 2011 NPR asked whether conditions imposed on the conduct of financial activities by the Bank Holding Company Act and the Board’s regulations should be considered in defining financial activities for purposes of Title I.  The Board is therefore proposing to amend the NPR to clarify the activities that are financial for purposes of Title I. 

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

All crowdfunding transactions under the JOBS Act must be conducted either through a registered broker or a new type of regulated entity called a funding portal.  While we discuss these obligations in detail below, we have a few preliminary observations based on those obligations and our recent blog post on issuer obligations:

  • Brokers and funding portals apparently will have a role in making risk based disclosures and other fraud minimizing activities.  While the JOBS Act places liability akin to Section 12(a)(2) on issuers, it is silent with respect to liability for brokers and funding portals.  We surmise brokers and funding portals will therefore be subject to at least Rule 10b-5 liability.  The JOBS Act also does not specify the liability of auditors who certify financial statements used in crowdfunding transactions.
  • The Jobs Act places limits not only on aggregate sales by issuers to individual investors during a 12-month period, but also an equivalent aggregate limit for all purchases by individual crowdfunding investors in all crowdfunding issuers during the 12-month period.  Brokers and funding portals must police this limit.
  • Brokers and funding portals may not solicit offers to purchase crowdfunded securities when they are acting as an intermediary.  It is unclear from the JOBS Act who may do so, although there is a reference in new Exchange Act Section 4A(b)(3) to permissible compensation being paid to persons promoting an offering if certain disclosures are made.

The duties of brokers and funding portals under the JOBS Act include:

  • registering with the SEC and self-regulatory organizations, which will most likely be FINRA;
  • providing disclosures, including disclosures related to risks and other investor education materials, as the SEC deems appropriate;
  • ensuring that each investor:
    • reviews investor-education information, in accordance with standards established by the SEC,
    • positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and
    • answers questions demonstrating
      • an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers;
      • an understanding of the risk of illiquidity; and
      • an understanding of other matters as the SEC determines is appropriate;
  • taking such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person;
  • not later than 21 days prior to the first day on which securities are sold to any investor, making available to  potential investors any information the issuer is obligated to file with the SEC and provide to prospective investors;
  • ensuring that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest, in a manner determined by the SEC;
  • making such efforts designated by the SEC to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate, from all issuers, exceed the investment limits permitted under the JOBS Act;
  • taking such steps to protect the privacy of information collected from investors as specified by the SEC;
  • not compensate promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor;
  • prohibiting the intermediary’s directors, officers, or partners from having any financial interest in an issuer using the intermediary’s services; and
  • such other matters as the SEC may determine.

The JOBS Act also specifies what brokers and funding portals cannot do in crowdfunding transactions:

  • offer investment advice or recommendations;
  • solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
  • compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
  • hold, manage, possess, or otherwise handle investor funds or securities; or
  • other matters the SEC may determine.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC staff has issued a report on the implementation of organizational reform pursuant to Section 967 of the Dodd-Frank Act.  The purpose of the report to Congress is to discuss the progress that the SEC staff has made in implementing systemic organizational change to increase efficiency and effectiveness. The staff states it recognizes that meaningful organizational improvement is not a “quick fix”: change will require prolonged effort over several years, and reconsideration of some of the fundamental methods the organization uses to carry out its work. The intent of the report is to communicate the gains in efficiency, effectiveness, cost savings and customer focus over the last six months, and to describe the challenges, strategy and agenda for future organizational improvement, in keeping with the requirements of the Dodd-Frank Act.

The report indicates the SEC has spent $8.5 million to identify costs savings of $13 million through the end of Fiscal Year 2013.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The JOBS Act takes the unprecedented step of permitting crowdfunding.  The statute permits, subject to SEC rulemaking, the ability to offer and sell securities to numerous people that do not have to qualify as accredited investors without registration under the Securities Act.

Entrepreneurs seriously considering crowdfunding will need to carefully think through the implications:

  • The JOBS Act requires certain financial and other information be filed with the SEC.  We assume anything filed with the SEC will be publicly available.  Therefore, entrepreneurs need to be comfortable that their relatives, neighbors, friends, vendors, customers and present and potential competitors will have this information available.
  • The JOBS Act specifies the type of financial information that must be given to investors.  Any entrepreneur anticipating raising substantial amounts through crowdfunding would be well advised to have audited financial statements prepared, or at the very least, reviewed financial statements.
  • Crowdfunding under the JOBS Act has long term implications which need to be evaluated, including filing annual financial information with the SEC and providing it to investors.  Therefore, it may not be advisable to use crowdfunding to bridge short-term funding needs.
  • Acquiring numerous shareholders through crowdfunding can have unintended consequences.  It likely will make investments by venture capital groups impossible and can significantly complicate or block an exit.  An entrepreneur can lose control of his or her company.  It will require an entrepreneur to function as an investor relations officer and respond to numerous inquiries from shareholders.  Lastly, the likely impersonal nature of crowdfunding increases the possibility of attracting disruptive investors.

Specific information on the requirements for issuers are discussed below.

Limitations on Sales

The statute limits sales as follows:

  • Not more than $1,000,000 in sales may be made in the preceding 12-month period.  It is important to note that this refers to all sales, not just those in reliance on the crowdfunding exemption.
  • The aggregate amount sold to any investor (no matter what exemption is relied upon) in  the preceding 12-month period cannot exceed:
    • the greater of $2,000 or 5 percent of the annual income or net worth of such investor, if either the annual income or the net worth of the investor is less than $100,000, and
    • 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.

The income and net worth tests are calculated in the same manner as that used for an accredited investor.  As a result, the value of the primary residence of an individual investor cannot be included when calculating net worth.

Limitations on Who Can Sell the Securities and How

Only brokers, or a new type of regulated entity, called a “funding portal,” can “conduct” the transaction.

Issuers may not advertise the terms of the offering, except for notices that direct investors to the funding portal or broker.  In addition, issuers cannot compensate any person to promote its offerings through communication channels provided by a broker or funding portal, without taking such steps as to ensure that such person clearly discloses the receipt of such compensation, as determined by SEC rules.

Limitations on What Type of Entities Can Raise Money Using Crowdfunding

The following types of entities cannot use the crowdfunding exemption:

  • entities not organized under the laws of any state or territory of the United States;
  • entities which are public;
  • “investment companies” and those entities that are not investment companies under Section 3(b) and 3(c) of the Investment Company Act. What this means in plain English is you cannot use the crowdfunding exemption to start a private equity or hedge fund.
  • other types of entities the SEC may designate.

In addition, the SEC is directed to issue rules containing “bad boy disqualifiers” that will preclude disqualified issuers from using the crowdfunding exemptions.  These disqualifiers are expected to look through the issuer to directors, officers, general partners and 10% owners for certain matters.

Information that Must be Filed With the SEC and Given to Others Prior to Sale

Certain information must be filed with the SEC and given to brokers, funding portals, investors and potential investors.

Financial Information

The financial information that must be filed with the SEC and disseminated to designated persons includes a description of the financial condition of the issuer, which means:

  • for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of
    • $100,000 or less–
      • the income tax returns filed by the issuer for the most recently completed year (if any); and
      • financial statements of the issuer, which must be certified by the principal executive officer of the issuer to be true and complete in all material respects;
    • more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures established by the SEC, and
    • more than $500,000 (or such other amount as the SEC may establish), audited financial statements.

Other Information

Other information which must be filed with the SEC and given to brokers, funding portals, investors and potential investors includes:

  • the name, legal status, physical address, and website address of the issuer;
  • the names of the directors and officers and each person holding more than 20 percent of the shares of the issuer;
  • a description of the business of the issuer and the anticipated business plan of the issuer;
  • a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount;
  • the target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
  • the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities; and
  • a description of the ownership and capital structure of the issuer that meets certain specific requirements.

Information that Must be Filed With the SEC Annually and Given to Investors

The JOBS Act provides that not less than annually, crowdfunding issuers must file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as the SEC determines by rule.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters. 

Some publications have predicted widespread changes in the way hedge funds and private equity funds are marketed.  The speculation is based on the JOBS Act elimination of previous prohibitions on general solicitation, or advertising, in connection with Rule 506 private placements on which hedge funds and private equity funds rely when selling securities.  Prior to the JOBS Act, the prohibition on general solicitation prevented hedge funds and private equity funds from advertising or contacting potential investors that the fund or the placement agent did not have a preexisting relationship.  After the JOBS Act, advertising and general solicitations are permitted, so long as sales are made only to accredited investors.

While we expect the JOBS Act will have some effect on marketing of hedge funds and private equity groups, we do not believe there is a high likelihood of fundamental near-term change.  There are several reasons for this:

  • As a result of the Dodd-Frank Act, many larger hedge fund and private equity sponsors were required to register with the SEC as investment advisers under the Investment Advisers Act.  Section 206 of the Investment Advisers Act contains an anti-fraud provision, and related SEC Rule 206(4)(1) governs advertising conduct by investment advisers. Those provisions were not changed by the JOBS Act.
  • When adopting JOBS Act regulations, the SEC may foresee a waive of inappropriate marketing and take steps to further bolster prohibitions on advertisements by sponsors of hedge funds and private equity funds.
  • The SEC has publicly stated that they are going to scrutinize performance claims made by hedge fund and private equity sponsors, so moderation will be the key.
  • Sponsors that use FINRA registered placement agents to aid in raising funds will find those placement agents have to comply with FINRA rules.
  • Hedge fund and private equity sponsors that are required to register with various state authorities because they do not qualify for SEC registration will have to consider restrictions on advertising imposed by states.
  • If a hedge fund is also a “commodity pool,” CFTC and National Futures Association Rules must be considered.

The JOBS Act also increases the threshold for registration under the Exchange Act for becoming a public reporting company from more than 500 shareholders to 2,000 persons, or 500 persons who are not accredited investors.  We believe this will have minimal impact on the structuring of funds.  Many funds rely on the 3(c)(1) exemption from registration under the Investment Company Act, which separately limits the number of investors in a fund to not more than 100 owners.  Other funds, however, rely on the Section 3(c)(7) exemption to avoid registration under the Investment Company Act.  That Section requires owners of a fund to be “qualified purchasers,” which means investors  that have significant funds to invest (i.e., natural persons who own$5,000,000 in investments and others who hold $25,000,000 in investments).  While the Section 3(c)(7) exemption is not dependent on the number of investors, we have found that the previous 500 person threshold for  Exchange Act registration was only a concern of very few funds.

The JOBS Act also includes simplifications for the registration of securities, such as the so-called “IPO On-Ramp” and an expanded Regulation A type of exemption which will permit offers and sales of securities of up to $50 million.  Private equity groups may find that these simplifications make it somewhat easer to use the equity markets as an exit strategy.  However, so called “crowdfunding” will not be available to raise funds for a private equity group or hedge funds under the terms of the JOBS Act.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The House of Representatives has passed the Senate version of the Jumpstart Our Business Startups Act, or JOBS Act, and President Obama is expected to sign the legislation.  While the long-term impact of the provisions is at this time unknown, some promise to have a more immediate and useful impact than others.

Elimination of Prohibition on General Solicitation for Rule 506 Offerings and Rule 144A Sales.  I think this provision will have the most immediate and direct impact, but may disappoint some.  Basically this means some form of wide solicitation akin to advertising of securities sales will be permitted, so long as the ultimate sale is made only to accredited investors.   An entrepreneur going it alone may be disappointed that he or she is unable to raise money by putting up a web site and advertising the sale of securities.  But for more organized and professional offerings, this provision will allow placement agents to reach out and contact more people more quickly.

Increase in Threshold for Exchange Act Registration.  The JOBS Act increases the threshold for registration under the Securities Exchange Act to 2,000 persons, or 500 persons who are not accredited investors.  Perhaps more importantly, the JOBS Act provides that record holders of securities who received the securities pursuant to an employee compensation plan that was exempt from Securities Act registration are not counted when determining if the foregoing threshold is met.

Elimination of Exchange Act registration for growing companies obviously results in a huge reduction in regulatory burdens.  The provision is not without its challenges.  For instance, how will a company determine how many of its shareholders are not accredited investors?

Smaller companies are likely to find a large shareholder base unruly to manage as well.  In a worst case scenario, founders and management could find themselves ousted from the company or otherwise losing control.  Taking on numerous shareholders can also complicate a venture capital funding or a private equity exit at a later date.  So make sure you really want all those shareholders before you go down this path.

Expansion of Regulation A. Regulation A provided for a simplified registration process for offerings not exceeding $5 million.  It has not been widely used, perhaps because of the size limitation and sometimes onerous requirements under state blue sky laws.    The JOBS Act directs the commission to revise Regulation A by increasing the size of permitted offerings to amounts not exceeding $50 million in any 12 month period.  Benefits in addition to a simplified registration process include the ability to “test the waters” before filing a registration statement and potentially simplified post-sale reporting requirements.

Importantly, the Commission is authorized to eliminate burdensome blue sky regulation if offers and sales are made to “qualified purchasers.”  The SEC has never defined the term “qualified purchaser” in a useful way (outside of the arena of credit default swaps, if you consider that useful).  In 2001, the SEC proposed defining the term “qualified purchaser” in a manner akin to the definition of “accredited investor,” but the rules were never finalized.

The utility of this portion of the JOBS Act rests squarely in the hands of the SEC adopting user-friendly implementing regulations.

Simplifications for Emerging Growth Companies – the IPO On-Ramp.  The JOBS Act simplifies Securities Act registration and subsequent Exchange Act compliance for “emerging growth companies.”  An emerging growth company is almost anyone that was not public in December 2011 and does not have revenues in excess of $1 billion.

While the simplifications are welcome, an issuer will still need to be an exciting company that an underwriter wants to take public, and a company  that will have a public float that allows for ready trading to attract the attention of investors.  The JOBS Act does nothing to solve that problem.  Smaller IPOs may occur, but the business must still be of a size to bear the costs of still significant regulation.  And management and shareholders must still determine that they wish to operate the business under public company scrutiny.

Crowdfunding.  One would think this provision would rank towards the top of the list because of its novelty.  Crowdfunding however, can be conducted only through certain intermediaries – a registered broker or a “funding portal.”  It remains to be seen how many broker-dealers will be interested in transactions under $1,000,000, which is the annual crowdfunding limit imposed by the JOBS Act.  The exact utility of a “funding portal” remains to be seen, but the moniker imposes significant restrictions, such as not being able to solicit sales, compensate employees or agents based on sales and other matters to be determined by the SEC.

Entrepreneurs will be faced with the necessity of filing designated information with the SEC prior to sale and annual SEC filings thereafter.  The broker or funding portal will have to perform a background check on each officer, director and more than 20% owner.  Reviewed financial statements are required if raising more than $100,000 but not more than $500,000, and audited financial statements are necessary for transactions exceeding $500,000.

The likely impersonal nature of raising capital through crowdfunding heightens the risk of accepting funds from disruptive shareholders. Entrepreneurs may not be appreciative of inquiries and complaints from numerous shareholders, whether warranted or unwarranted.  There are risks here as well with respect to loss of control by founders and management, and having numerous shareholders makes venture investments or an exit difficult.

With all of this regulation, crowdfunding may not be a useful source of capital for a small business.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The House of Representatives has passed the Senate version of the Jumpstart Our Business Startups Act ,or JOBS Act, and President Obama is expected to sign the legislation.

Some principal components of the JOBS Act include:

  • Provide an exemption for crowdfunding by permitting sales of not more than $1,000,000 in any twelve month period.
  • Facilitate initial public offerings and subsequent Exchange Act compliance for “emerging growth companies.”
  • Eliminating the prohibition on general solicitation (a/k/a advertising) for Rule 506 Regulation D offerings and sales under Rule 144A.
  • Increasing the Regulation A threshold to $50,000,000.
  • Increase the threshold for registration under the Securities Exchange Act to 2,000 persons or 500 persons who are not accredited investors.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The OECD has issued a  “Supplement on Gold” which  forms an integral part of the OECD Due Diligence Guidance for Minerals from Conflict-Affected and High-Risk Areas.  According to the OECD, the supplement provides specific guidance on supply chain due diligence of gold from conflict-affected and high-risk areas according to the different positions of companies in the gold supply chain.  The guidance distinguishes between the roles of and the corresponding due diligence recommendations addressed to “upstream companies” and “downstream companies” in the supply chain.

“Upstream companies” include miners (artisanal and small-scale enterprises or medium and large-scale gold mining companies),11 local gold traders or exporters from the country of gold origin, transporters, international gold traders of Mined/Recyclable Gold and refiners.  “Downstream companies” include refined gold traders and gold markets, bullion banks and exchanges or other entities that do their own gold vaulting, jewellery manufacturers and retailers, and other companies using gold in the fabrication of products (e.g. manufacturers and retailers of electronics or medical devices). 

You can find further information about the OECD project here.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.