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

On February 18, 2016, the Consumer Financial Protection Bureau (CFPB) finalized a policy that establishes a process for companies developing financial products to apply for a statement from the CFPB, known as a “no-action letter,” regarding the regulatory impact of the proposed product.

According to the CFPB, [t]he new policy was created as part of CFPB’s Project Catalyst initiative and is intended to enhance regulatory compliance in specific circumstances where a product holds the promise for significant consumer benefit and where there may be uncertainty around how the product fits within an existing regulatory scheme.”  Pursuant to the policy, once a company submits an application to the CFPB, and the proposed product passes a review, the CFPB will issue a letter indicating that the CFPB reviewed the application and has no present intention to recommend enforcement or supervisory action with respect to the proposed product.

However, the no-action letters may have more bark than bite.  The policy expressly states that no-action letters “would be non-binding on the Bureau, and would not bind courts or other actors who might challenge a [no-action letter] recipient’s product or service, such as other regulators or parties in litigation.”  Further, although the policy contemplates that company submissions for a no-action letter may contain proprietary or confidential information, there is no guaranty that such information can or will be protected.  In short, the CFPB no-action letter policy falls short of protecting innovative companies seeking regulatory approval of new products.

You can view the CFPB’s no-action letter policy here: http://files.consumerfinance.gov/f/201602_cfpb_no-action-letter-policy.pdf.

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.

Zane Gilmer is a member of the firm’s litigation practice group.  His practice focuses on business litigation and compliance and he is a member of the firm’s CFPB taskforce.  Zane works out of the firm’s Denver office and he can be reached at zane.gilmer@stinson.com or 303.376.8416.

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

The SEC has entered into its first deferred prosecution agreement with an individual in an FCPA case. One interesting fact is it’s hard to figure out what this person allegedly did that was wrong. The FCPA Professor notes the only specific allegation about the individual in the DPA is the first paragraph which merely identifies the person. There is no other specific allegation regarding him including how he caused violations of the FCPA’s books and records and internal controls provisions, and the individual did not admit or deny any of the allegations in the DPA.

The SEC stated it entered into the DPA as a result of significant cooperation the individual provided during the SEC’s investigation.

The Professor also notes his belief that the SEC settlements with the issuer and the individual were not the result of the Yates memo. The investigation commenced years before the Yates memo was authored.

But whether or not the action was influenced by the Yates memo, Matt Kelly has some noteworthy observations on how this enforcement posture will influence the compliance function:

 Even worse, however, is the pall these pressures cast over corporate ethics & compliance programs generally. They are, essentially, forcing compliance programs first and foremost to be surveillance and investigation programs—which nobody likes, including the vast majority of employees who are honest and don’t like the Orwellian behavior any more than you do. If that’s the reality we’re creating, forget all those speeches and best practices about the compliance department as your friend and ally; we’re back to the compliance department as “the Office of No.”

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 alleges that Marrone Bio Innovations, Inc. misstated its revenue. The SEC recently brought a settled enforcement action against its former CFO.  The SEC alleges the CFO received bonuses during the 12-month periods following the filings containing financial results that MBI was required to restate. The settlement requires the former CFO to reimburse MBI for a total of $11,789 pursuant to Section 304(a) of the Sarbanes-Oxley Act of 2002.  The SEC did not allege that the former CFO participated in the misconduct giving rise to the restatement.

Section 304 of SOX requires the chief executive officer or chief financial officer of any issuer required to prepare an accounting restatement due to material noncompliance with the securities laws as a result of misconduct to reimburse the issuer for: (i) any bonus or incentive-based or equity-based compensation received by that person from the issuer during the 12-month periods following the false filings; and (ii) any profits realized from the sale of securities of the issuer during that 12-month periods. According to the SEC, Section 304 does not require that a chief executive officer or chief financial officer engage in misconduct to trigger the reimbursement requirement.

According to the SEC the former CFO violated SOX by not voluntarily tendering a check to MBI.

The settlement also orders the former CFO to cease and desist from committing or causing any violations and any future violations of Section 304 of the Sarbanes-Oxley Act.

The former CFO did not admit or deny the facts in the SEC 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.

On February 16, 2016, the SEC posted an investor bulletin relating to equity crowdfunding intended to educate the public about the process for investing in equity crowdfunding and some of the risks involved. On May 16, 2016, Regulation Crowdfunding will become effective, allowing non-accredited investors to invest limited amounts in private offerings conducted through an online platform.

The bulletin provides some good background regarding equity crowdfunding and includes some helpful tables designed to assist a potential investor in understanding the net worth and investment limitation requirements of Regulation Crowdfunding. The bulletin also includes risk factors that the SEC believes investors should consider before investing in a crowdfunded offering.  In addition to risk factors relating to the illiquidity of the investment, limitations on disclosure, the high degree of speculation, and untestable valuations, which are typical start-up risk factors, the bulletin also includes some risk factors that are non-standard or unique to crowdfunded start-ups, such as (quoting here):

  • Investment in personnel.  An early-stage investment is also an investment in the entrepreneur or management of the company.  Being able to execute on the business plan is often an important factor in whether the business is viable and successful.  You should also be aware that a portion of your investment may fund the compensation of the company’s employees, including its management.  You should carefully review any disclosure regarding the company’s use of proceeds.
  • Possibility of fraud.  In light of the relative ease with which early-stage companies can raise funds through crowdfunding, it may be the case that certain opportunities turn out to be money-losing fraudulent schemes.  As with other investments, there is no guarantee that crowdfunding investments will be immune from fraud.
  • Lack of professional guidance.  Many successful companies partially attribute their early success to the guidance of professional early-stage investors (e.g., angel investors and venture capital firms).  These investors often negotiate for seats on the company’s board of directors and play an important role through their resources, contacts and experience in assisting early-stage companies in executing on their business plans.  An early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.

For more information, you can refer to our prior four-part series covering Regulation Crowdfunding: Capital Raising and Investment Limitations; Issuer Requirements; Intermediary Requirements; and Additional Funding Portal Requirements.

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 approved a Nasdaq rule change to permit Nasdaq to exercise discretion to grant an extension to regain compliance before delisting a company that fails to hold an annual meeting. In determining whether to grant a company an extension to comply with the annual meeting requirement, Nasdaq will consider the likelihood that the company would be able to hold an annual meeting within the exception period, the company’s past compliance history, the reasons for the failure to timely hold an annual meeting, corporate events that may occur within the exception period, the company’s general financial status, and the company’s disclosures to the market. This review will be based on information provided by a variety of sources, which may include the company, its audit committee, its outside auditors, the staff of the SEC and any other regulatory body. The proposed rule change will limit the length of an extension granted by staff, upon review of the plan to regain compliance, to no more than 180 calendar days from the deadline to hold the annual meeting (i.e., one year after the end of the Company’s fiscal 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 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 and the Republic of Estonia have announced that Estonia’s e-Residency platform will be facilitating a blockchain-based e-voting service to allow shareholders of companies listed on Nasdaq’s Tallinn Stock Exchange, Estonia’s only regulated securities market, to vote in shareholder meetings. The country’s e-Residency platform is an electronic identity system used by both Estonian residents and those with business interests in the country to access government services through e-Residency digital authentication.

As part of the program’s pilot, shareholders who are Estonian or Estonian e-residents will be able to participate in the corporate governance of companies more conveniently and securely than ever before. The e-Residency platform vastly improves the ability to authenticate shareholders for the e-voting service, while blockchain technology will allow votes to be quickly and securely recorded, streamlining a proxy voting process that has historically been labor-intensive and fragmented. The pilot is aimed to launch in 2016.

At the end of 2015, Nasdaq announced that an issuer was able to use its Nasdaq Linq blockchain ledger technology to successfully complete and record a private securities transaction – the first of its kind using blockchain technology. Chain.com, an inaugural Nasdaq Linq client and blockchain developer, documented its issuance of shares to a private investor using Nasdaq’s blockchain-enabled technology. Accoding to Nasdaq, the transaction represented a major advance in the application of blockchain technology for private companies.

Nasdaq Linq is a digital ledger technology that leverages a blockchain to facilitate the issuance, cataloging and recording of transfers of shares of privately-held companies on The NASDAQ Private Market. Chain.com describes itself as the leading blockchain infrastructure provider to financial institutions and enterprises. Chain says its platform enables the secure issuance and management of digital assets on a blockchain network.

For the Chain.com transaction, Nasdaq enabled the issuer to digitally represent a record of ownership using Nasdaq Linq, while significantly reducing settlement time and eliminating the need for paper stock certificates. In addition to its equity management function, Nasdaq Linq also provides issuers and investors an ability to complete and execute subscription documents online.

Nasdaq’s use of blockchain technology also holds promise for expediting trade settlement for transactions in public markets. Blockchain technology has the potential to assist in expediting trade clearing and settlement from the current equity market standards of three days to as little as ten minutes. As a result, settlement risk exposure can be reduced by over 99 percent, dramatically lowering capital costs and systemic risk. In addition, this technology could allow issuers to significantly lower the risk and the administrative burden of what is largely a manual and multi-step process today.

For more on blockchain technology see our article in the Minneapolis Star Tribune.

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 United States District Court for the District of Columbia recently dismissed Stephen M. Silberstein’s complaint to mandate the SEC to adopt rules regarding disclosure of political contributions. Among other things, the Court found that a claim under § 706(1) of the Administrative Procedures Act can proceed only where a plaintiff asserts that an agency failed to take a discrete agency action that it is required to take. The SEC did not deny the petition; it merely failed to respond to it. Since the SEC did not deny the petition and the plaintiff did not assert that the SEC “failed to act in response to a clear legal duty,” it followed that the plaintiff failed to state a valid APA claim upon which relief can be granted.

Not to be deterred, Mr. Silberstein has filed a complaint seeking a writ of mandamus. Mr. Silberstein seeks to require the SEC to act immediately on his rulemaking petition and issue an explanation of its decision to grant or deny the petition that will permit further judicial review.

According to Mr. Silberstein, the Administrative Procedure Act grants to all interested persons “the right to petition for the issuance, amendment, or repeal of a rule.” 5 U.S.C. § 553(e). The APA places a corresponding duty on agencies receiving such petitions to respond “within a reasonable time.” 5 U.S.C. § 555(b). If an agency fails to respond to a petition, a reviewing court may “compel agency action unlawfully withheld or unreasonably delayed.” 5 U.S.C. § 706(i).

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.

A bill (H.R. 1675) seeking to increase the information disclosure threshold under SEC Rule 701 passed the U.S. House of Representatives on February 3 by a vote of 265 to 159. Rule 701 exempts from registration issuer sales or grants of securities to employees under written compensatory plans.  Pursuant to Rule 701, issuers need only provide a limited amount of disclosure to employees as long as sales are less than $5 million in any twelve-month period.  Once an issuer crosses that threshold, however, it must provide employees with additional disclosures such as risk factors and financial statements identical to those required in Regulation A offerings.

H.R. 1675, or the Encouraging Employee Ownership Act of 2015, proposes to increase the disclosure-triggering threshold of Rule 701 from $5 million to $10 million in any twelve-month period. This would allow companies to issue more securities to employees without having to provide the additional disclosures.

This bill has received some harsh backlash. Congresswoman and Ranking Member of the House Committee on Financial Services Maxine Waters decried the bill as “invit[ing] more Enron-style fraud onto the market.”  Additionally, according to a Statement of Administrative Policy, the White House “strongly opposes” the package of bills to which the proposed amended disclosure threshold belongs.  Two of the other bills included in the package have been the subject of posts earlier this week.  Read my coverage of the proposed XBRL exemption here and my colleague David Jenson’s regarding a potential registration exemption for so-called “M&A brokers” here.

It will be interesting to see how the proposed changes to Rule 701 will be received by the Senate.

The U.S. House of Representatives passed three bills on February 1, 2016 that propose changes to the federal securities laws, including the Securities Act of 1933 (’33 Act) and Securities Exchange Act of 1934 (’34 Act).

The Fair Investment Opportunities for Professional Experts Act (H.R. 2187) passed the House by a vote of 347 to 8.

This bill directs the SEC to revise its definition of “accredited investor” for natural persons by adding to the definition of that term found in Section 2(a)(15) of the ’33 Act.

First, the bill would codify the net worth and income tests largely in their current forms under Regulation D (17 C.F.R. § 230.501(a)(5) and (6), respectively).

Second, and more importantly, the bill proposes two additional classes of persons to the definition of accredited investor, regardless of the level of that person’s income. The first additional class is straightforward: all brokers or investment advisors currently licensed or registered with any of the SEC, FINRA, or an equivalent SRO.  The second added class, on the other hand, is broader.  It would include persons the SEC determines by regulation to have “demonstrable education or job experience to qualify . . . as having professional knowledge of a subject related to a particular investment, and whose education or job experience is verified by FINRA or an equivalent SRO.”  Based on this somewhat amorphous language, exactly how broad this second class could potentially be is not entirely clear.  Nonetheless, taken as a whole, these two new classes of accredited investors have the potential to open up a broad swath of capital to private placements offered pursuant to Regulation D (particularly capital held by financial services professionals).

You can read the full text of the bill here.

The SEC Small Business Advocate Act of 2016 (H.R. 3784) was passed by the House by a voice vote.

This bill proposes to amend Section 4 of the ’34 Act by adding a new office housed within the SEC. The proposed Office of the Advocate for Small Business Capital Formation (the “Small Business Advocate”) would be charged with, among other things, assisting small businesses and small business investors in resolving problems posed by the SEC and SROs, advocating changes to Congressional legislation, SEC regulations, and SRO rules, conducting outreach to small businesses in order to solicit views on relevant capital formation issues, and advising the Investor Advocate on issues related to small businesses and small business investors.  Also, the Small Business Advocate would be responsible for producing an annual report to each of the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives regarding its activities and recommendations.

The bill also proposes to establish within the SEC a Small Business Capital Formation Committee (the “Small Business Committee”). This committee would be responsible for advising the SEC on its regulations, rules, and policies regarding (i) capital-raising by, (ii) trading in the securities of, and (iii) public reporting and corporate governance requirements of, emerging, privately-held small businesses and publically-traded companies with less than $250 million in public market capitalization.  The Small Business Committee would not advise the SEC with regard to enforcement matters.

You can read the full text of the bill here.

The Small Business Capital Formation Enhancement Act (H.R. 4168) passed the House by a vote of 390 to 1.

This bill seeks to amend Section 503 of the Small Business Investment Incentive Act of 1980 to require the SEC to review the findings and recommendations of the annual government-business forum on capital required to be held pursuant to that statute. In addition, the bill would require the SEC to issue a public statement assessing the findings or recommendations and disclosing the action, if any, the SEC intends to take with respect to the findings or recommendations.

You can read the full text of the bill here.

The Delaware Court of Chancery has issued an opinion on a Section 220 demand made against Yahoo! No complaint has yet been filed, and although Vice Chancellor Laster speculates on some inferences that can be drawn, no one has proven anyone has done anything wrong.

The allegations in the case have eerie parallels to the Disney compensation litigation. The Vice Chancellor notes:

 Mark Twain is often credited (perhaps erroneously) with observing that history may not repeat itself, but it often rhymes. The credible basis for concern about wrongdoing at Yahoo evokes the Disney case, with the details updated for a twenty-first century, New Economy company. Like the current scenario, Disney involved a CEO hiring a number-two executive for munificent compensation, poor performance by the number-two executive, and a no-fault termination after approximately a year on the job that conferred dynastic wealth on the executive under circumstances where a for-cause termination could have been justified. Certainly there are factual distinctions, but the assonance is there.

While noting the decision does not hold the Yahoo directors breached their fiduciary duties, the Vice Chancellor observed:

Based on the current record, the Yahoo directors were more involved in the hiring than the Disney directors were, but the facts still bear a close resemblance to the allegations in Disney III. The directors‘ involvement appears to have been tangential and episodic, and they seem to have accepted Mayer‘s statements uncritically. A board cannot mindlessly swallow information, particularly in the area of executive compensation: ―While there may be instances in which a board may act with deference to corporate officers‘ judgments, executive compensation is not one of those instances. The board must exercise its own business judgment in approving an executive compensation transaction.‖ Haywood v. Ambase Corp., 2005 WL 2130614, at *6 (Del. Ch. Aug. 22, 2005). Directors who choose not to ask questions take the risk that they may have to provide explanations later, or at least produce explanatory books and records as part of a Section 220 investigation.

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.