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

Two California-based municipal advisory firms and their executives have agreed to settle SEC charges that they used deceptive practices when soliciting the business of five California school districts.

According to the SEC, an investigation found that School Business Consulting Inc. was advising certain school districts about their hiring process for financial professionals. School Business Consulting was simultaneously retained by Keygent LLC, which was seeking the municipal advisory business of the same school districts.  The SEC stated without permission, School Business Consulting shared confidential information with Keygent, including questions to be asked in Keygent’s interviews with the school districts and details of competitors’ proposals including their fees.  The SEC said the school districts were unaware that Keygent had the benefit of these confidential details throughout the hiring process.  Keygent ultimately won the municipal advisory contracts.

This is the SEC’s first enforcement action under the municipal advisor antifraud provisions of the Dodd-Frank Act. Municipal Securities Rulemaking Board (“MSRB”) Rule G-17 states that, in the conduct of its municipal securities or municipal advisory activities, each broker, dealer, municipal securities dealer, and municipal advisor shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. Section 15B(c)(1) of the Exchange Act requires that municipal advisors shall not act in contravention to any MSRB rule in the provision of advice to or on behalf of a municipal entity, or in undertaking a solicitation of a municipal entity.

School Business Consulting was also charged with failing to register as a municipal advisor.  According to the SEC, School Business Consulting was engaged in the “solicitation of a municipal entity” as that term is defined in Section 15B(e)(9) of the Exchange Act because it received direct compensation from Keygent and the solicitation of school districts on behalf of Keygent was for the “purpose of obtaining or retaining an engagement . . . in connection with . . . the issuance of municipal securities.” Accordingly, the SEC found School Business Consulting should have registered as a municipal advisor pursuant to Section 15B(a)(1)(B) of the Exchange Act from the time it began soliciting for Keygent.

The respondents in the SEC actions did not admit or deny the SEC’s findings.

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 100 largest firms in the U.S., Stinson Leonard Street has 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 13, the final administrative rules implementing the MNvest intra-state crowdfunding exemption were adopted. The MNvest Rules were first proposed back in November of 2015.  Today’s publication in the Minnesota State Register notes that the MNvest Rules were adopted as proposed, other than a few revisions that are shown in blackline format.  The MNvest Rules become effective five working days after publication, meaning they will be available for use next Monday.  You can see our prior coverage of the actual MNvest legislation here and here.

SUMMARY OF MNVEST RULES

Additional Pre-Offering Filing Requirements. Section 80A.461, Subd. 3(11) of the Minnesota Statutes requires that a MNvest issuer file the following information with the Minnesota Department of Commerce at least 10 days prior to the commencement of a MNvest offering: (i) a notice stating that the MNvest exemption is being relied upon, (ii) a copy of the disclosure document that will be provided to prospective investors, and (iii) a $300 filing fee. The MNvest Rules use this notice filing provision in the statute to impose additional disclosure requirements on MNvest issuers.  The pre-offering notice must now include, in addition to the information required by statute:

  • “a written explanation of how the minimum offering amount will be used to implement the MNvest issuer’s business plan.”
  • a written affirmation that the issuer has “reviewed” the bad actor disqualification provisions in Section 80A.461, Subd. 9 and “undertaken the inquiries needed to establish, under [Section 80A.461, Subd. 9(b)(4)], that the issuer has no reason to know that a disqualification exists.” The disqualification provisions include within their scope the issuer and its affiliates, officers and directors, 20% beneficial owners, and promoters.
  • any other information the Commissioner of Commerce may “reasonably require to determine the MNvest issuer’s compliance” with MNvest.

Ongoing Reporting and Record Keeping. The MNvest Rules impose several ongoing reporting and recordkeeping requirements for issuers and portal operators.

Obligation to Update Filings/Registrations. As long as the offering is ongoing, the issuer is obligated to update the information it has filed with the Commissioner of Commerce “as necessary so that the issuer does not make any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in light of the circumstances under which it is made, not misleading.”  In other words, a Rule 10b-5 style disclosure regime applies to MNvest issuer disclosures to the Commissioner of Commerce.  A similar requirement applies to portal operators with respect to the portal operator registration filed with the Department of Commerce (although the obligations persists as long as the portal operator is registered, as opposed to lapsing at the end of an offering).

Offering Reports. Issuers and portal operators are each required to provide to the Department of Commerce, upon request, offering reports containing basic information about MNvest offerings, including the offering minimum and the amount actually raised, the name, address, and amount invested by each investor, and confirmation as to whether investor funds were released from escrow or returned to purchasers.  For portal operators, the offering report must also include the date the portal operator received the certification from each purchaser required by Section 80A.461, Subd. 5 (acknowledgment of risks and certification of Minnesota residency).

Five Year Record-Keeping Requirement. The MNvest Rules impose a five year record keeping requirement on MNvest issuers and prescribe the types of information that must be retained with respect to each MNvest offering, which include “records of all written communications sent to or received from purchasers in a MNvest offering,” as well as all records “used to establish compliance with” the bad actor disqualifications.

Portal Operator Registration Requirements. The MNvest Rules also add the following content to the portal operator’s registration with the Department of Commerce:

  • a written explanation of the portal operator’s “use of a third party’s software program or other services in developing, operating, or maintaining the MNvest portal.”
  • a written explanation of the steps taken by the portal operator to verify the Minnesota residency of each purchaser of securities through the portal.

Cybersecurity. The MNvest Rules require portal operators and MNvest issuers to take “reasonable steps” to maintain the security of financial and personal information of purchasers.  The MNvest Rules note that this requires, at a minimum, that the issuer and the portal operator develop and implement written cybersecurity policies and publish the policies on their websites.  In a change from the proposed rules, the final rules also specify that the cybersecurity policy must address cybersecurity attacks, data breaches, responses to cybersecurity attacks and data breaches.  There is also apparently a requirement that the issuer demonstrate it implemented the policy, although the wording of the final rule is not a font of clarity on this point.  Again, more on that below.

Disqualified Classes of Issuers. The MNvest Rules make MNvest unavailable for certain offerings on the theory that these offerings warrant more detailed disclosure of applicable risks than is appropriate for a securities registration exemption.” These disqualified offerings are comprised of:

  • offerings relating to oil exploration or production, mining activities, or other “extractive industries”
  • offerings relating to investments in digital or crypto currencies (like bitcoin);
  • offerings that are utilizing more than one MNvest portal concurrently;
  • offerings involving investment companies; and
  • offerings by blank check companies.

Restrictions on the Use of the Term “MNvest.” The MNvest rules contain some restrictions on how the term “MNvest” may be used in an effort to avoid investor confusion regarding whether a particular operation is officially-sanctioned in some way by the state of Minnesota.  To that end, a portal operator cannot own a URL containing “MNvest.”  No person can own a URL that contains “MNvest” if the URL automatically directs to a MNvest portal.  In addition, no MNvest portal can purport to be the official or exclusive MNvest portal.

QUESTIONS AND CURIOSITIES

Issuer Bad Actor Affirmation: Not a Beacon of Clarity

Under the as-proposed MNvest Rules, an issuer’s pre-offering filing would have needed to include an affirmation that the issuer had “exercised reasonable care to confirm” that it was not disqualified from utilizing MNvest by reason of the bad actor disqualifications in Section 80A.461, Subd. 9. Presumably, exercising reasonable care would have required some level of due diligence – at least an inquiry of the covered persons as to whether they were subject to any of the disqualifying events.  The reason this matters is because Section 80A.461, Subd. 9(b)(4) states that the MNvest issuer will not lose its exemption if it “establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed.”

In the as-adopted MNvest Rules, the issuer is not required to affirm that it has actually exercised “reasonable care” to investigate its covered persons for purposes of the bad actor disqualifications. Instead the issuer must affirm that it has reviewed the bad actor disqualification provisions, and that it has “undertaken the inquiries needed to establish, under Minnesota Statutes, Section 80A.461, Subdivision 9, paragraph (b), clause (4), that the issuer has no reason to know that a disqualification exists.”

The language of the final rule is less than clear and raises some questions. What problem in the proposed rule does the changed language remedy? Like the proposed rule, the final rule requires an affirmation that the MNvest issuer has taken some action.  Under the proposed rule, that action was the exercise of reasonable care.  Under the final rule, that action is undertaking “the inquiries needed to establish . . . that the issuer has no reason to know that a disqualification exists.”  Is the action described by the final rule representative of a standard of care that is lesser than reasonable care?  It is tempting to read the final language as equivalent to “reasonable care,” but then, if that were the case, why would a confusing change be necessary in the first place?  The original language would have been more accurate, precise, and understandable. Why does the MNvest Rule purport to refer to a standard included in the statute (by the cross reference) but then actually describe a slightly different standard?  Who determines what inquiries are “needed” under the final MNvest Rules?

Cybersecurity Policy Jumble

The proposed MNvest Rules explained that “reasonable steps to ensure that purchasers’ financial information is properly secured” included, at a minimum, “the development and implementation of a written cybersecurity policy that outlines the MNvest issuer’s or portal operator’s policies and procedures for preventing and responding to cybersecurity attacks and data breaches resulting in the disclosure or potential disclosure of purchasers’ confidential or personally identifiable information.”

The as-adopted MNvest Rules alter this to state that reasonable steps must include “at a minimum, a written cyber-security policy that outlines the MNvest issuer’s or portal operator’s policies and procedures for: (1) preventing cybersecurity attacks that result in the disclosure, or potential disclosure, of purchasers’ confidential or personally identifiable information; (2) preventing data breaches that result in the disclosure, or potential disclosure, of purchasers’ confidential or personally identifiable information; (3) responding to a cybersecurity attack or data breach that occurs; and (4) demonstrating the issuer’s implementation of the written cybersecurity policy.”

First, from a drafting perspective, why not combine clauses (1) and (2) by making the single clause apply to both cybersecurity attacks and data breaches? That’s the approach that was taken with clause (3), after all.

Second, what does clause (4) even mean? If you excise clauses (1) through (3) for a moment, the rule reads: “at a minimum, a written cyber-security policy that outlines the MNvest issuer’s or portal operator’s policies and procedures for: (4) demonstrating the issuer’s implementation of the written cybersecurity policy.”  So the written cybersecurity policy must somehow itself demonstrate the issuer’s implementation of that same policy?  Wouldn’t it make more sense to ask the issuer to affirm or demonstrate to the Department of Commerce that it has implemented the written policy?

Third, why leave out portal operators from the scope of clause (4)? As written, a portal operator is required to have a cybersecurity policy, and that cybersecurity policy of the portal operator’s must demonstrate “the issuer’s implementation of the written cybersecurity policy” (my emphasis).  Aren’t we missing something here?  Don’t we need clause (4) to cover implementation of the policy by the portal operator or the issuer, as applicable?

We can only hope for clarifying amendments.

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 100 largest firms in the U.S., Stinson Leonard Street has 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.

Speaking at a conference, Wesley R. Bricker, SEC Deputy Chief Accountant gave his views on appropriate disclosure as public companies approach implementation of the new revenue recognition standard. According to Mr. Bricker:

“Speaking of disclosures, the SEC staff has long advised that a registrant should provide transition disclosures to investors of the impact that a recently issued accounting standard will have on its financial statements when that standard is adopted in a future period.

The preparation of the transition disclosures should be subject to effective ICFR and disclosure controls and procedures. As management completes portions of its implementation plan and develops an assessment of the anticipated impact the standard will have on the company’s financial statements, internal and disclosure controls should be designed and implemented to timely identify relevant disclosure content from the implementation assessments and to ensure, where necessary, that appropriately informative disclosure is made.

Investors should expect the level of transition disclosures to increase as a company progresses in its implementation plans and, when necessary, engage with company management to understand these disclosures.”

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 100 largest firms in the U.S., Stinson Leonard Street has 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 6, 2016, the OTC Markets Group Inc., the entity operating three major over-the-counter marketplaces (“OTC”), submitted a rulemaking petition to the SEC.  The petition asked the SEC to amend Regulation A+ to allow fully reporting companies to utilize the exemption.  OTC argues that such a shift in policy would bring the exemption from registration more in line with congressional intent.

Title IV of the JOBS Act mandated the SEC to amend Regulation A to make it a more viable regime for raising capital, most notably by increasing annual raise limitations and making securities sold pursuant to Regulation A “covered securities” exempt from state blue sky laws.  The old rules under Regulation A prohibited companies subject to the periodic reporting obligations under Sections 13(a) or 15(d) of the Exchange Act from using the exemption. In its final Regulation A+ rules release, the Commission did not alter these eligibility requirements, noting that it that it would prefer to wait until the Regulation A+ market developed before expanding the scope of issuers authorized to conduct Regulation A+ offerings.

OTC, in its rulemaking petition now asks the Commission to revisit this position. Under the current Regulation A+ eligibility requirements, OTC notes:

Fully reporting issuers seeking to take advantage of the streamlined Regulation A+ offering process face an unfortunate choice: (i) deregister as a fully reporting company and then file Form 1-A, in the process ceasing their more frequent and detailed periodic reporting; or (ii) elect other available options, e.g., a costly full Form S-1 or S-3 registration or a private placement under Regulation D, the latter of which would shut out many of the important individual investors Regulation A+ was designed to include. For those issuers that do not meet the minimum thresholds for Exchange Act deregistration, the Regulation A+ window is completely shut.

The petition also characterizes other capital-raising options available to fully reporting companies (namely PIPEs and the streamlined process available under Form S-3) as sub-optimal choices for small reporting companies.

The entire petition is worth a read for those interested. It is available here. As the number of issuers conducting Regulation A+ offerings increase, it will be interesting to see whether the SEC is persuaded by OTC’s arguments.

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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 100 largest firms in the U.S., Stinson Leonard Street has 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.

In Beacom v. Oracle America, Inc., the United States Court of Appeals for the Eight Circuit considered retaliation claims under Sarbanes-Oxley and Dodd-Frank.

The essence of the matter was a business unit of Oracle switched revenue projection methods from a “bottoms-up” method to a “top-down” method. Plaintiff Beacom claimed he repeatedly voiced concerns to his supervisor about the new projection method. Beacom testified he was concerned that “the wrong, incorrect, non-fact-based expectations were being sent up through the management chains, which would be the foundation of an expectation sent to” Wall Street, and that these inaccurate projections contributed to Oracle’s decline in stock value.

The truth of the matter, according to the Court, is the business unit was only a few sales away from meeting projections.

In January 2012, Beacom and his supervisor attended a conference in New York City. The supervisor told Beacom he had increased his projection from $25 million to $30 million. Beacom then “challenged” the supervisor’s practice of “intentionally forecasting false revenue commitments.” Soon after, Beacom met with an HR representative to express concerns that the forecasts were setting the wrong expectation for shareholders.

The supervisor and the HR representative decided to fire Beacom in March (to avoid interrupting Oracle’s fiscal quarter). On March 5, 2012, Oracle terminated Beacom on the basis of poor performance and insubordination.

Beacom sued Oracle under the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act, alleging Oracle wrongly terminated him in retaliation for his complaints about Webster’s revenue projections. The district court granted Oracle’s motions for summary judgment. Beacom appealed.

Sarbanes-Oxley prohibits a publicly traded company from discharging an employee in retaliation for providing information to a supervisor or another person in the company with investigative authority about any conduct which the employee reasonably believes constitutes a violation of certain provisions of securities laws or any provision of Federal law relating to fraud against shareholders.

The 8th Circuit found that Beacom must establish that a reasonable person in his position, with the same training and experience, would have believed Oracle was committing a securities violation. According to the Court, the business unit missed its projections by no more than $10 million. The Court said Beacom—an Oracle salesperson and shareholder—would understand the predictive nature of revenue projections. And, he would understand that $10 million is a minor discrepancy to a company that annually generates billions of dollars. The Court found these facts compel the conclusion that Beacom’s belief that Oracle was defrauding its investors was objectively unreasonable. As a result, the district court did not err in granting summary judgment to Oracle on the Sarbanes-Oxley claim.

The 8th Circuit further stated Dodd-Frank prohibits an employer from discharging a whistleblower for “making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002.” The 8th Circuit held since Beacom did not make a disclosure protected under Sarbanes-Oxley, his claim under Dodd-Frank failed.

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 100 largest firms in the U.S., Stinson Leonard Street has 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.

House Financial Services Committee Chairman Jeb Hensarling (R-TX) unveiled details of the Financial CHOICE Act – the Republican plan to replace the Dodd-Frank Act and promote economic growth. CHOICE stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs.

It included the expected verbiage about ending “too big to fail and bank bailouts.” Some specifics are retroactively repealing the authority of the Financial Stability Oversight Council (FSOC) to designate firms as systematically important financial institutions (SIFIs).  The proposal also calls for fundamental reforms of the CFPB, including renaming it the Consumer Financial Opportunity Commission.

I was hopeful it would include a repeal of the onerous Dodd-Frank provisions imposed upon public issuers that have nothing to do with securities laws, such as conflict minerals reporting. I was not disappointed.  It provides for the repeal of “non-material specialized disclosures.”  However there is nothing in there about getting rid of pay-ratio disclosures.

Other securities laws topics include:

  • Make all financial regulatory agencies subject to the REINS Act, bi-partisan commissions, and place them on the appropriations process so that Congress can exercise proper oversight.
  • Impose an across-the-board requirement that all financial regulators conduct a detailed cost-benefit analysis of all proposed regulations.
  • Reauthorize the Securities and Exchange Commission (SEC) for a period of five years with funding, structural, and enforcement reforms.
  • Institute significant due-process reforms for every American who feels that they have been the victim of a government shakedown.
  • Repeal the so-called Chevron deference doctrine.
  • Impose enhanced penalties for financial fraud and self-dealing and promote greater transparency and accountability in the civil enforcement process.
  • Allow the SEC to triple the monetary fines sought in both administrative and civil actions in certain cases where the penalties are tied to the defendant’s illegal profits. Give the SEC new authority to impose sanctions equal to investor losses in cases involving “fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement” where the loss or risk of loss is significant, and increase the stakes for repeat offenders.
  • Increase the maximum criminal fines for individuals and firms that engage in insider trading and other corrupt practices.
  • All fines collected by the Public Company Accounting Oversight Board and Municipal Securities Rulemaking Board will be remitted to the Treasury for deficit reduction.
  • Impose enhanced penalties for financial fraud and self-dealing and promote greater transparency and accountability in the civil enforcement process.
  • Allow the SEC to triple the monetary fines sought in both administrative and civil actions in certain cases where the penalties are tied to the defendant’s illegal profits. Give the SEC new authority to impose sanctions equal to investor losses in cases involving “fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement” where the loss or risk of loss is significant, and increase the stakes for repeat offenders.
  • Increase the maximum criminal fines for individuals and firms that engage in insider trading and other corrupt practices.
  • All fines collected by the Public Company Accounting Oversight Board and Municipal Securities Rulemaking Board will be remitted to the Treasury for deficit reduction.
  • Incorporate more than two dozen Committee or House-passed capital formation bills.

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 100 largest firms in the U.S., Stinson Leonard Street has 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.

 

Nasdaq recently extended the comment period for its proposed disclosure requirements on golden leash arrangements. Some may wonder why the proposal is controversial.  For an answer, please see the post submitted by in-house counsel at a 34 Act reporting company set forth below.

Nasdaq Golden Leash Proposal

In January 2016, the Nasdaq issued proposed rules that would require companies listed on its exchange to publicly disclose compensation arrangements between third parties and director nominees or directors. The proposal indicates that such compensation arrangements are often structured so that the director receives certain amounts from a third party [think “activist hedge fund”] if the company’s stock price increases by a certain amount over a specified time period.  The concern of course is that arrangements like these raise conflicts of interest and could interfere with those directors fulfilling their fiduciary obligations because they are incented to focus on short-term stock price results at the expense of long-term sustainable growth.  Hence the (legitimate) desire to make sure stockholders are aware of these arrangements.

SEC Disclosure Rules re: Director Compensation

The problem is that the SEC already has broad, comprehensive rules requiring disclosure of director compensation matters, including arrangements with third parties.   From where I sit, it was pretty bizarre (disingenuous) that the Nasdaq’s January proposal was devoid of any discussion about the SEC’s rules on director compensation. Then, in March 2016, Nasdaq re-issued its proposal, acknowledging to some degree that there are relevant SEC rules but not addressing the elephant in the room – i.e. whether or not those SEC rules require the same disclosure that would be required by the Nasdaq proposal.  There has been a spirited debate on this in the corporate and securities community, with many practitioners concerned that a stock exchange is now trying to regulate disclosure on a subject matter adequately covered by the SEC’s rules.  Said differently, many corporate attorneys believe that the Nasdaq proposal may be substantively unnecessary and — if it is necessary – it’s coming from the wrong regulator.  The logic is that if any action is necessary with regard to this subject matter, it would be in the best interests of companies and their investors if the SEC just clarifies that its existing rules regarding disclosure of director compensation cover these third arrangements.  Under this approach, investors reading the proxy statements for NYSE- or NASDAQ-listed companies would be receiving comparable information when it comes to director compensation matters.

NYC Bar Association Securities Regulation Committee Letter

Another not insignificant concern about the Nasdaq’s proposal is that it’s getting no meaningful attention from stakeholders that could be significantly impacted. One of the few comment letters submitted is from the NYC Bar Association Securities Regulation Committee, and it’s worth a read. The letter specifically notes several SEC rules that require disclosure of director compensation matters, including compensation from third parties.  The letter recommends that the Nasdaq proposal not be adopted and that, instead, it should be determined whether the SEC’s existing rules requiring disclosure of director compensation, including compensation paid by third parties, cover the disclosures in the Nasdaq proposal.  The bar association reasons that the SEC’s Disclosure Effectiveness Project would be the more effective and appropriate way to address any new disclosure requirements in this regard – in order to promote comparable disclosures to investors, regardless of the exchange on which the company is listed, and also notes that the SEC process would be more likely to ensure meaningful input from the wide range of stockholders that could be impacted by this proposal.

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 100 largest firms in the U.S., Stinson Leonard Street has 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 author and not those of Stinson Leonard Street or any client.

 

Earlier today, the SEC issued an interim final rule amending Form 10-K pursuant to section 72001 of the FAST Act.  That section required the SEC to allow issuers to include summary sections in their annual reports on Form 10-K as long as each summary item included a cross-reference (electronic or otherwise) to the complete discussion located elsewhere in the report.

The SEC decided to adopt a flexible principles-based rule rather than proscribing a specific format for issuers to follow.  Any summary is permissible as long as the information is presented “fairly and accurately” and each item includes a hyperlink to the related full discussion located elsewhere in the report.

The SEC decided that the “cross-reference” requirement may only be satisfied with a live hyperlink (rather than a textual reference). The hyperlink must direct the reader to the specific section of the 10-K where the detailed description appears or, if the relevant information appears in a document incorporated by reference, to the relevant section in the incorporated document.

The summary rule is completely voluntary and I suspect it will take a few brave registrants next year before (and if) Form 10-K summaries become common.  The amended Form 10-K will now include new Item 16:

______________________________

Item 16. Form 10–K Summary.

Registrants may, at their option, include a summary of information required by this form, but only if each item in the summary is presented fairly and accurately and includes a hyperlink to the material contained in this form to which such item relates, including to materials contained in any exhibits filed with the form.

Instruction: The summary shall refer only to Form 10-K disclosure that is included in the form at the time it is filed. A registrant need not update the summary to reflect information required by Part III of Form 10-K that the registrant incorporates by reference from a proxy or information statement filed after the Form 10-K, but must state in the summary that the summary does not include Part III information because that information will be incorporated by reference from a later filed proxy or information statement involving the election of directors.

______________________________

Before the amendment is finalized, the SEC is seeking public input regarding further revisions.  Additionally, the interim final rule poses the following specific questions that provide some insight into the Commission’s thinking about some potential issues with the new rule:

  1. Are companies and investors likely to find a Form 10-K summary useful? If so, should we propose mandating a summary?
  2. Would it be helpful to EDGAR users for the Form 10-K summary or a link to the summary to be displayed on a registrant’s EDGAR search results landing page?
  3. Should we impose a length limitation on the summary? If so, what limitation would be appropriate (e.g., a page limit, word limit, character limit)?
  4. Should we provide further guidance on preparation of the summary? For example, should we include language similar to Item 503(a) of Regulation S-K, which covers a prospectus summary?
  5. Should we require that the summary appear at the beginning of the Form 10-K? Should we require certain content or a specific format for the Form 10-K summary? For example, should we propose to require registrants choosing to prepare a summary to include specified Form 10-K items, such as the MD&A? Are there some items that registrants should not be permitted to include in a summary? If so, which items should be required to be included in, or excluded from, the summary?
  6. Should we require registrants that cannot include a summary of the Part III information (because that information will be incorporated by reference from a later filed proxy or information statement involving the election of directors) to file a Form 10-K amendment to update the summary to reflect the Part III information when that information is filed with the proxy or information statement?
  7. Are there other cross-reference methods that we should allow in lieu of, or in addition to, hyperlinks?
  8. Should we propose to amend other annual reporting forms, such as Form 20-F18 filed by foreign private issuers, or Form 1-K filed by issuers that have conducted a Regulation A offering, to expressly allow a summary similar to the approach we are adopting for Form 10-K? Would such revisions be useful given that our rules do not prohibit such registrants from voluntarily including a summary in their annual reports?

You can read the SEC’s interim final rule here (starts automatic pdf download).

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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 100 largest firms in the U.S., Stinson Leonard Street has 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 charged a registered private equity fund adviser and its principal for receiving transaction-based compensation for the provision of brokerage services in connection with the acquisition and disposition of portfolio companies, while not being registered as a broker.

There is not much more detail provided in the SEC order. The order states that although the limited partnership agreement expressly permitted the adviser to charge transaction or brokerage fees, the advisor has never been registered with the SEC as a broker nor has it ever been affiliated with a registered broker. Rather than employing investment banks or broker-dealers to provide brokerage services with respect to the acquisition and disposition of portfolio companies, some of which involved the purchase or sale of securities, the adviser performed these services in-house, including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions.

The private equity advisor and its principal did not admit or deny the findings in the settlement order.

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 100 largest firms in the U.S., Stinson Leonard Street has 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.

Robb Mandelbaum has a nice piece up at Forbes that digs into the advertising limitations that are imposed by Regulation Crowdfunding. The whole piece is worth a read, and it sparked reactions in me in a couple of spots.

CEOs and founders of startups are likely to have lots of trouble with the rules. The impetus for the article was Mandelbaum’s realization that a prior piece on the newly effective Regulation Crowdfunding, a company founder put his crowdfunded offering at risk of violating Regulation Crowdfunding by even agreeing to talk to Mandelbaum about the offering.  Indeed, the SEC’s C&DIs released May 16, 2016 state that a news story is subject to Regulation Crowdfunding’s advertising rules to the same extent as communications by the issuer if the issuer was directly or indirectly involved in the creation of the content. Many CEOs and journalists are likely not going to be aware of nuances of Regulation Crowdfunding’s advertising rules and may inadvertently violate them. We already run into this issue from time to time working on Rule 506(b) offerings, which do not permit any general solicitation.  CEOs and founders of startups are successful in part because they are good at selling a company’s story, and when they have an opportunity to tell the press about all of the great things that are going on, they rightfully seize on it.  But including discussions of the company’s ongoing fundraising that will allow it to do even more great things can be fatal to a Rule 506(b) offering.  Crowdfunded offerings present an even greater risk – the Regulation D prohibition on general solicitation is a font of clarity compared to Regulation Crowdfunding’s advertising rules.

Mandelbaum’s piece includes a quote from Darren Marble, CEO of CrowdfundX, a digital advertising agency that has advised on the successful Elio Motors Regulation A+ offering:

“The best way to raise money for equity crowdfunding is to sell your vision, mission, and values,” says Marble. “It’s the story. Think about it: you have an unsophisticated investor, who maybe isn’t really an investor to begin with, but is now able to invest. The average American wants to invest in companies that they believe in and entrepreneurs who have the same world view as they do.”

I think Mr. Marble has effectively stated the case for why the SEC is so concerned with equity crowdfunding in the first place – unsophisticated investors may make emotional decisions based on slick sales pitches rather than decisions that are based on a more fulsome understanding of the risks inherent in the investment.   The SEC wants investors to invest after reviewing information about the company’s history, capital structure, market and competitive position, financial history, sales data, debt load, litigation risk, and all of the other factors typically addressed in a full PPM through a funding portal; the SEC does not want investors to make the decision to invest based a professionally produced five minute marketing video delivered through Facebook.

I think the bottom line is that Regulation Crowdfunding suffers from a public misperception that has not been helped by the enthusiasm of its supporters. There is a perception that the SEC’s crowdfunding rules enable kickstartr type fundraising; there is a lack of understanding that, due to the numerous limitations and requirements of the rules, offerings under Regulation Crowdfunding are fundamentally different from what most people understand as “crowdfunding.”

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 100 largest firms in the U.S., Stinson Leonard Street has 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.