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

The SEC issued an Investor Alert which says fantasy stock trading for small amounts of money can violate provisions of securities laws implemented by the Dodd-Frank Act.  I bet the Congressional drafters of these provisions who were trying to prevent another financial meltdown are surprised at this result, or at least I would hope so.

According to the SEC, the terms “swap,” “security-based swap,” and “derivative” includes any agreement, contract, or transaction whose value is based upon – or “derivative” of – the value or performance of some other financial product, event, or characteristic.  The SEC stated there are many different ways that virtual games referencing securities could involve a security-based swap.  For example, a website could charge people an entry fee to join an online fantasy stock trading competition in which they would “buy” or “sell” a virtual portfolio of securities and in which they could win a prize.  Although any actual situation would need to be analyzed based on the particular facts and circumstances involved, the SEC thinks the facts presented in this hypothetical suggest that this website may be offering security-based swaps.

The Investor Alert notes that SEC staff have recently observed websites offering many different kinds of financial instruments that may raise concerns under the federal securities laws.  SEC staff continue to investigate other websites, entities, and companies that may be taking investor money without complying with the federal securities laws.

Simultaneously with issuing the Investor Alert, the SEC announced the first settlement with a company that illegally offered complex derivatives products to retail investors.  The Dodd-Frank Act implemented two key requirements for any security-based swaps offering to a retail investor who doesn’t meet the high standard of an “eligible contract participant” defined in the law.  A registration statement must be effective for the offering, and the contracts must be sold on a national securities exchange.  These requirements are intended to make financial information and other significant details about the offering fully transparent to retail investors, and limit the transactions to platforms subject to the highest level of regulation.

The SEC asserted an SEC investigation found that Silicon Valley-based Sand Hill Exchange was offering and selling security-based swaps contracts to retail investors outside the regulatory framework of a national securities exchange and without the required registration statements in effect.  The violations were detected shortly after the offering process began, and with cooperation from the company the platform was shut down before any investor harm occurred.

According to the SEC’s order instituting a settled administrative proceeding against Sand Hill and two individuals:

  • Sand Hill began as two Silicon Valley entrepreneurs creating an online business involving the valuation of private startup companies in the region along the lines of a fantasy sports league.  But Gerrit Hall and Elaine Ou changed their business model multiple times, and earlier this year Sand Hill evolved to invite web users to use real money to buy and sell contracts referencing pre-IPO companies and their value.
  • Sand Hill sought people to fund accounts using dollars or bitcoins.  Hall and Ou did not ask users about their financial holdings or limit the offering to users with any specific amount of assets.  In fact, they wrote on the Sand Hill website: “We accept everybody regardless of accreditation status.”  Hall and Ou intended to pay users who profited from their contracts.
  • Hall and Ou understood that they were buying and selling derivatives linked to the value of private companies, and Ou falsely claimed that they were in the process of seeking regulatory approval for Sand Hill’s contracts.
  • For about seven weeks, Sand Hill offered, bought, and sold contracts through the website in violation of the Dodd-Frank provisions that limit security-based swaps transactions with people who don’t meet the definition of an eligible contract participant.  Hall and Ou exaggerated Sand Hill’s trading, operations, controls, and financial backing.
  • Sand Hill, Hall, and Ou ceased offering and selling security-based swaps following inquiries from the SEC in early April.

The SEC’s order found that Sand Hill, Hall, and Ou violated Section 5(e) of the Securities Act and Section 6(l) of the Securities Exchange Act of 1934.  Without admitting or denying the findings, Sand Hill, Hall, and Ou agreed to cease and desist from committing or causing any future violations of the securities laws.  Sand Hill agreed to pay a $20,000 penalty.

The SEC warns that its Complex Financial Instruments Unit will continue its scrutiny of the retail market for conduct that may violate the Dodd-Frank Act’s swaps provisions, including online competitions creatively monetizing what actually constitute security-based swaps transactions.

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.

Montana and Massachusetts previously filed suit to challenge Regulation A+ adopted by the SEC under the JOBS Act.  On June 5, 2015, Montana requested that the Commission stay the effective date of the amendments to Regulation A+ pending the outcome of the litigation.

The SEC denied Montana’s request for stay. It noted:

  • Montana has not demonstrated a strong likelihood of success on the claim that the Commission’s definition is contrary to the statute.
  • Montana has not demonstrated a strong likelihood of success on the merits of the claim that the Commission failed to adequately analyze the economic consequences of the rule as it relates to investor protection.
  • Montana has failed to show irreparable harm if the rule is not stayed.
  • The public interest is not served by granting a stay because doing so would cause harm and contravene Congress’s will.

There is nothing I can see on the docket in the District of Columbia that would delay the effective date of Regulation A+ this coming Friday, June 19 2015.

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 Northern District of Georgia, Atlanta Division, entered a preliminary injunction preventing the SEC from conducting an administrative proceeding in an insider trading matter.  In the Hill case, the Court found the plaintiff has a substantial likelihood of success on the merits of his claim that the SEC administrative proceeding violates the Appointments Clause of the United States Constitution.

In Hill the ruling, the Court noted  the matter could be easily cured by having the SEC Commissioners issue an appointment or preside over the matter themselves.

In a subsequent filing, the SEC stated it intends to ask the Court to stay the proceedings so that it can appeal the Court’s ruling.  According to the SEC, “any further proceedings in this Court could prove largely superfluous and a waste of the parties’ and the Court’s resources.”

Now, in a separate case in which the same issue has arisen, the Department of Justice informed the United States District Court for the Southern District of New York that:

“Because appellate guidance on the propriety of the Hill injunction may be forthcoming if the Solicitor General approves the appeal, the government believes that the Commission should not act precipitously to modify its ALJ scheme. This is particularly the case when the SEC has over 100 litigated proceedings at various stages of the administrative process and the ALJ scheme has been in use for seven decades and is grounded in a highly-regulated competitive service system that Congress created for the selection, hiring and appointment of ALJs in the Executive Branch.”

Finally, the Gray Financial case, which presents issues identical to the Hill case, has been transferred to the same judge that issued the preliminary injunction in Hill.  That judge has scheduled a hearing on a preliminary injunction for July 13 in the Gray Financial case.

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 Northern District of Georgia, Atlanta Division, entered a preliminary injunction preventing the SEC from conducting an administrative proceeding in an insider trading matter.  The Court found the plaintiff has a substantial likelihood of success on the merits of his claim that the SEC violated the Appointments Clause of the United States Constitution.

When the order was entered, the Court directed the parties to confer on a timetable for conducting discovery and briefing the remaining issues.  The parties were unable to agree, and the SEC submitted one timetable and the plaintiff submitted another timetable.

The SEC’s filing states it intends to ask the Court to stay the proceedings so that it can appeal the Court’s ruling.  According to the SEC, “any further proceedings in this Court could prove largely superfluous and a waste of the parties’ and the Court’s resources.”

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.

Minnesota has adopted an intrastate crowdfunding exemption referred to as “MNvest.”  The legislation is meant to work in tandem with the federal exemption for intrastate offerings under Section 3(a)(11) of the Securities Act of 1933 and related guidance issued by the SEC in Rule 147.

The exemption is available only to “MNvest issuers,” which generally means:

  • the entity is organized under the laws of Minnesota, and is not a general partnership;
  • the principal office of the entity is located in Minnesota;
  • as of the last day of the most recent semiannual fiscal period of the entity, at least 80 percent of the entity’s assets were located in Minnesota; and
  • at least 80 percent of the entity’s gross revenues for the prior fiscal year or trailing 12 month period (depending on the timing of the offering) were derived from the operation of the business in Minnesota.

Because the legislation implements an intrastate offering exemption, offers and sales may be made only to Minnesota residents, and at least 80 percent of the net proceeds of the offering must be used for the operation of the issuer’s business in Minnesota.

The offering must be conducted exclusively through a “MNvest portal” which is an internet web site managed by a “portal operator.” A “portal operator” is an entity, including an issuer, that:

  • is authorized to do business in Minnesota;
  • is a broker-dealer registered with the State of  Minnesota or otherwise registers with the Minnesota Commissioner of Commerce as a portal operator in accordance with the new legislation; and
  • satisfies such other conditions as the Minnesota Commissioner of Commerce may determine.

The MNvest portal must take steps to limit web site access to the offer or sale of securities to only Minnesota residents when conducting MNvest offerings.  MNvest offerings may not be viewed on a MNvest portal by a prospective purchaser until the portal operator verifies, through its exercise of reasonable steps, such as using a third-party verification service or as otherwise approved by the administrator, that the prospective purchaser is a Minnesota resident and the prospective purchaser makes certain acknowledgements.

In any 12-month period the MNvest issuer cannot raise more than:

  • $2,000,000 if audited or reviewed financial statements are supplied to prospective purchasers; and
  • $1,000,000 if the financial statements are not audited or reviewed.

The MNvest issuer must require the portal operator to provide or make available to prospective purchasers through the MNvest portal a copy of the MNvest issuer’s balance sheet and income statement for the MNvest issuer’s most recent fiscal year, if the issuer was in existence. For offerings beginning more than 90 days after the issuer’s most recent fiscal year end, or if the MNvest issuer was not in existence the previous calendar year, the MNvest issuer must provide or make available a balance sheet as of a date not more than 90 days before the commencement of the MNvest offering and certain year-to-date and other information.

In addition:

  • no single purchaser may purchase more than $10,000 in securities of the MNvest issuer under the crowdfunding exemption in connection with a single MNvest offering unless the purchaser is an accredited investor;
  • all payments for the purchase of securities must be held in escrow (by a financial institution) until the aggregate capital deposited into escrow from all purchasers is equal to or greater than the stated minimum offering amount;
  • a disclosure document that includes certain required information must be made available through the portal (in the nature of a streamlined private placement memorandum);
  • purchasers must make representations regarding Minnesota residency prior to purchase;
  • the issuer must provide the Department of Commerce with at least 10 days advance notice of its intention to conduct a MNvest offering, which must include a copy of the offering documents and payment of a $300 fee.

The legislation permits limited advertising and solicitation if certain required disclaimers and statements are made.

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 New York man has agreed to pay almost $4.5 million to settle charges by the SEC that he violated Section 15(a) of the Exchange Act by acting as an unregistered broker-dealer. According to the SEC, starting in 2010 Joshua A. Yudell entered into numerous arrangements that he marketed to securities owners as a “private shareholder secondary offering.”  Pursuant to a written agreement, the securities owners (usually of stocks with very low market capitalization) would cause their securities to be re-registered in the name of a Yudell-controlled entity.  Yudell would then deposit* the securities into a brokerage account with a registered broker-dealer and attempt to sell the securities into the market at or above agreed upon price floors.  Yudell would then return the proceeds to his customer after deducting his fee, which ranged from 10% to 35%.  Yudell also created receipts representing the trades and provided the receipts to his customers. Yudell is alleged to have engaged in at least 88 of these transactions through a number of different companies that he was using as alter egos.  Over the course of these transactions, Yudell was never registered as a broker-dealer or as a registered representative of a broker-dealer, and none of his alter ego companies were registered as broker dealers.  As such, the SEC claimed that Yudell’s conduct violated Section 15(a)(1) of the Exchange Act.

*Curiously, the SEC’s complaint notes that Yudell would “attempt to deposit,” perhaps indicating that in some cases the registered broker-dealer refused to participate in the arrangement.  The SEC has not provided any information with respect to the registered broker-dealer(s) used by Yudell.

The Yudell settlement fits within a broad pattern of increased attention by the SEC to the activities of those acting as unregistered broker-dealers.  In an April 2013 speech, David Blass cautioned investment advisers to private funds to carefully examine their practices to determine whether they ought to be registered as broker-dealers, an area of compliance (and enforcement) that had largely been overlooked prior to the passage of the Dodd-Frank Act and the changes that it brought to the investment adviser registration regime. Although we have not seen any high profile cases against private fund advisers for violations of Section 15(a), the SEC has highlighted its increased focus on unregistered broker-dealer activity in several enforcement actions against individuals.  On May 16, 2014, an individual agreed to pay more than $22 million to settle an enforcement action for violations of Section 15(a), and on March 26, 2015, the SEC settled an action against 22 parties relating to Section 15(a) violations, resulting in over $6 million in penalties.  The Yudell settlement continues the trend of the SEC highlighting cases in which the penalties are high and there is no allegation of fraud by any of the parties involved.  The message seems to be that the SEC will not be taking a “no harm no foul” approach to broker-dealer enforcement actions.

Not all of the SEC’s actions in the area of broker-dealer registration and enforcement in the past couple of years have adhered to a strict interpretation of Section 15(a); in a January 31, 2014 no-action letter, the SEC provided assurance that it would not take enforcement action against an M&A broker, providing some clarity in a historically gray area of broker-dealer enforcement.

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 CFPB adopted a final that allows the agency to supervise larger nonbank auto finance companies for the first time. The CFPB also released the examination procedures that its examiners will use.

Currently, the Bureau supervises auto financing at the largest banks and credit unions. The new rule extends that supervision to any nonbank auto finance company that makes, acquires, or refinances 10,000 or more loans or leases in a year. Under the rule, those companies will be considered “larger participants,” and the Bureau may oversee their activity to ensure they are complying with federal consumer financial laws, including the Equal Credit Opportunity Act, the Truth in Lending Act, the Consumer Leasing Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition on unfair, deceptive, or abusive acts or practices.

Under the final rule, which was proposed in September 2014, the Bureau estimates that it will have authority to supervise about 34 of the largest nonbank auto finance companies and their affiliated companies that engage in auto financing. These companies together originate around 90 percent of nonbank auto loans and leases, and in 2013 provided financing to approximately 6.8 million consumers. The final rule also defines additional automobile leasing activities for coverage by certain consumer protections of the Dodd-Frank Act.

The Bureau is finalizing the rule largely as proposed, with minor changes. The final rule broadens the category of transactions involving asset-backed securities that are not counted toward the 10,000 transaction threshold. It also makes a minor modification to the definition of refinancing for the purpose of the threshold.

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 October 2014, Compliance Week noted that SEC Chair Mary Jo White indicated a concept release on Audit Committees would be forthcoming.   James Schnurr, Chief Accountant, SEC Office of the Chief Accountant gave an update on the status of the release.

Mr. Schnurr noted the staff has been actively developing a recommendation to the Commission in the form of a concept release intended to seek feedback regarding how investors currently use the information provided in audit committee disclosures as well as feedback on the usefulness of potential enhancements, including additional disclosures. He anticipates being in position to recommend that the Commission publish the release for public comment in the near future.

As envisioned by Mr. Schnurr, the value of public comment would be to aid in the SEC’s understanding of audit committee disclosures that investors would find useful in informing their investment or voting decisions. As part of its review, the staff is also giving consideration to current trends in audit committee reporting. For example, many companies and their audit committees are currently providing disclosure beyond that which is required by the Commission’s requirements.

Mr. Schnurr is particularly interested in learning more from investors, audit committees, auditors, and others regarding current audit committee disclosures related to oversight of the independent auditor and whether the disclosures should be refined to provide more insight into the information the audit committee used and the factors they considered in executing their oversight of the external auditor.

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 Northern District of Georgia, Atlanta Division, has entered a preliminary injunction preventing the SEC from conducting an administrative proceeding in an insider trading matter.  The Court found the plaintiff has a substantial likelihood of success on the merits of his claim that the SEC violated the Appointments Clause of the United States Constitution.

Among other things, the Appointments Clause requires that “inferior officers” be appointed by the President, department heads or courts of law.  SEC administrative law judges are not appointed by the SEC – they are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions and the Office of Personnel Management.  The Court looked to the powers of the administrative law judge which are functionally comparable to that of a judge in making its decision.

The Court noted that the matter could be easily cured by having the SEC Commissioners issue an appointment or preside over the matter themselves.

The Court also rejected the plaintiff’s claims that:

  • The administrative proceeding violates his Seventh Amendment right to a jury trial.
  • The Dodd-Frank Act violates the Constitution because it gives the SEC unfettered discretion to select its forum.

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.

Traditionally the SEC has released correspondence related to its review of registration statements.  Now the staff will also release “no review” letters for filed registration statements that are not reviewed. It doesn’t add much, because after the passage of time it wasn’t hard to tell when a registration statement was declared effective without any review correspondence entering the public domain.  If you’ve read one “no review” letter you pretty much have read them all. But any increase in transparency by the SEC is welcome.

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.