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

Reuters has an interesting article about a no-action letter the CFTC issued to Southwest Airlines to permit a 15 calendar day delay in reporting oil derivative transactions.  Southwest apparently convinced the CFTC that rapid reporting caused markets to move against it, interfering with its ability to hedge.  According to the Reuters article, Southwest had long sought an exception, and it was the arrival of now CFTC Chair Tim Massad that apparently shook things loose. The article explains that the relief ultimately granted Southwest was narrower than what was originally sought.

You can find the no-action letter here.

So the question now becomes whether others will seek similar relief.

It looks like anyone asking for relief would have a high hurdle to surmount. In the Southwest no-action letter the CFTC noted:

The Division understands that Brent and WTI crude oil swap and swaption market with trading tenors 2 years or longer has few transactions and/or few market participants.

Accordingly, a shorter reporting timeline may increase the risk that the parties’ identities and their business transactions will be released, which may hinder the liquidity providers’ ability to lay off risk. The liquidity providers, in turn, are likely to build that risk into their transactions by imposing additional costs on their counterparties. The Division understands that these contracts are traded by or with Southwest.

The Division further understands that if two commercial end-users trade these contracts with each other, one or both sides to the transaction might be left with residual trades to execute in order to match their desired risk profile with their position. Once information on the original trade is released to the public, it is likely to be difficult for the end-user to execute the remainder of its desired trades. This may increase the costs of hedging to Southwest.

ABOUT STINSON LEONARD STREET

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

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

In November, the Delaware Chancery Court agreed to temporarily bar C&J Energy Services Inc. investors from voting on a proposed merger between C&J and the hydraulic fracturing and well-sealing units of Nabors Industries Ltd.   The court directed C&J to seek out buyers during a 30-day freeze.  The record below was somewhat sketchy, but the court granted the injunction because in “approving the transaction, the board did not consider alternative transactions. The board did not seek out other potential buyers. The board’s review of the merger process was more akin to what one would expect from a board pursuing an acquisition rather than one selling a company.”

The Supreme Court of Delaware reversed the Chancery Court decision.

C&J was acquiring the Nabors CPS business, but to do so after the closing Nabors would own 53% of the post-closing entity. The record reflected that the C&J directors were aware of the Revlon implications of the transaction.  In the negotiations, C&J’s board negotiated several corporate governance provisions, including the power to designate four board members, which included C&J’s CEO as board chair. C&J also bargained for an unusual “buy-side” fiduciary out, allowing for a lengthy and viable post-signing market check, with a termination fee of 2.27% of the deal value.  C&J did not however conduct an active auction process before entering into the merger agreement.

The Delaware Supreme Court noted “Although the record before us reveals a board process that sometimes fell short of ideal, Revlon requires us to examine whether a board’s overall course of action was reasonable under the circumstances as a good faith attempt to secure the highest value reasonably attainable. When that standard is applied to this record, we cannot conclude that the plaintiffs have proven that the majority-independent C&J board acted unreasonably in negotiating a logical strategic transaction, with undisputed business and tax advantages, simply because that transaction had change of control implications.”

The Delaware Supreme Court also noted the following:

  • Revlon involved a decision by a board of directors to chill the emergence of a higher offer from a bidder because the board‟s CEO disliked the new bidder, after the target board had agreed to sell the company for cash. Revlon made clear that when a board engages in a change of control transaction, it must not take actions inconsistent with achieving the highest immediate value reasonably attainable.
  • Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction. There is no single blueprint that a board must follow to fulfill its duties, and a court applying Revlon’s enhanced scrutiny must decide “whether the directors made a reasonable decision, not a perfect decision.”
  • Under Revlon a board can pursue the transaction it reasonably views as most valuable to stockholders, so long as the transaction is subject to an effective market check under circumstances in which any bidder interested in paying more has a reasonable opportunity to do so.   Such a market check does not have to involve an active solicitation, so long as interested bidders have a fair opportunity to present a higher-value alternative, and the board has the flexibility to eschew the original transaction and accept the higher-value deal.  The ability of the stockholders themselves to freely accept or reject the board’s preferred course of action is also of great importance in this context.

The Supreme Court also noted that the issuance of the mandatory injunction was improper because that can only occur after a trial and making findings of fact or if the injunction is based solely on undisputed facts.  There was also no record to support the judicially ordered infringement of Nabors’ contractual rights because there was no finding that Nabors aided and abetted C&J’s board’s alleged breach of fiduciary duties.  According to the Court, “The decisions in which the Delaware Supreme Court has issued or affirmed the issuance of injunctions targeted to specific deal protection terms all involved viable claims of aiding and abetting against the holder of third party contract rights.”

ABOUT STINSON LEONARD STREET

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

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

The Federal Reserve Board has acted under section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Volcker Rule, to give banking entities until July 21, 2016, to conform investments in and relationships with covered funds and foreign funds that were in place prior to December 31, 2013, which are referred to as legacy covered funds. The Board also announced its intention to act next year to grant banking entities an additional one-year extension of the conformance period until July 21, 2017, to conform ownership interests in and relationships with legacy covered funds.

Section 619 generally prohibits insured depository institutions and any company affiliated with an insured depository institution from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring, or having certain relationships with a hedge fund or private equity fund. These prohibitions are subject to a number of statutory exemptions, restrictions, and definitions.

Section 619 of the Dodd-Frank Act provided banking entities a grace period until July 21, 2014 to conform to its requirements. Section 619 also authorizes the Board to extend the conformance period for one year at a time, and not more than three additional years in total. The Board previously extended the conformance period to July 21, 2015, when the agencies adopted rules to implement section 619. The Board also previously issued a statement in April 2014 indicating that it intended to grant two additional one-year extensions of the conformance period for banking entities to conform ownership interests in and sponsorship activities of collateralized loan obligations (“CLOs”) that are backed in part by non-loan assets and that were in place as of December 31, 2013.

This extension would permit banking entities additional time to divest or conform only legacy covered fund investments. All investments and relationships in a covered fund made after December 31, 2013, must be in conformance with section 619 of the Dodd-Frank Act and implementing rule by July 21, 2015. This extension would not apply to proprietary trading activities, and banking entities must conform proprietary trading activities to the final rule by July 21, 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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

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

In Khazin v. TD Ameritrade the United States Court of Appeals for the Third Circuit held that securities-related retaliation claims brought under Dodd-Frank pursuant to 15 U.S.C. § 78u-6(h)(1)(B)(i) are subject to arbitration agreements.

The analysis isn’t very complex.  The Dodd-Frank anti-arbitration provision only relates to retaliation claims brought under Sarbanes-Oxley, a completely different cause of action.

The only two courts to have addressed the question have concluded that, for the reason outlined above, whistleblowers may be compelled to arbitrate Dodd-Frank retaliation claims. See Murray v. UBS Sec., LLC, No. 12 Civ. 5914 (KPF), 2014 WL 285093, at *10-11 (S.D.N.Y. Jan. 27, 2014); Ruhe v. Masimo Corp., SACV 11-00734-CJC(JCGx), 2011 WL 4442790, at *4 (C.D. Cal. Sept. 16, 2011).

ABOUT STINSON LEONARD STREET

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

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

As mandated by the JOBS Act, the SEC has issued proposed amendments to revise the rules related to the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Exchange Act.

Overview

The proposal would implement the mandate of the JOBS Act by:

  • Amending Exchange Act Rules 12g-1 through 4 and 12h-3 which govern the procedures relating to registration, termination of registration under Section 12(g), and suspension of reporting obligations under Section 15(d) to reflect the new thresholds established by the JOBS Act
  • Revising the rules so that savings and loan holding companies are treated in a similar manner to banks and bank holding companies for the purposes of registration, termination of registration, or suspension of their Exchange Act reporting obligations
  • Applying the definition of “accredited investor” in Securities Act Rule 501(a) to determinations as to which record holders are accredited investors for purposes of Exchange Act Section 12(g)(1).  The accredited investor determination would be made as of the last day of the fiscal year.

The proposal also would amend the definition of “held of record” to provide that when determining whether an issuer is required to register a class of equity securities with the SEC under Exchange Act Section 12(g)(1), an issuer may exclude securities:

  • Held by persons who received them under an employee compensation plan in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act
  • In certain circumstances, held by persons who received them in exchange for securities received under an employee compensation plan

The SEC also is proposing a non-exclusive safe harbor under which a person will be deemed to have received the securities under an employee compensation plan if the person received them under a compensatory benefit plan in transactions that met the conditions of Securities Act Rule 701(c).

The JOBS Act revised Exchange Act Section 12(g) to raise the threshold at which an issuer is required to register a class of equity securities.  Under the revised threshold, an issuer that is not a bank or bank holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors.  An issuer that is a bank or bank holding company is required to register a class of equity securities if it has more than $10 million of total assets and the securities are “held of record” by 2,000 or more persons.

In addition, the JOBS Act raised the threshold at which a bank or a bank holding company may terminate or suspend the registration of a class of securities under the Exchange Act from 300 to 1,200 persons.

Accredited Investors

As noted, an issuer that is not a bank or bank holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors.  Under the proposed rule “accredited investor” is defined by reference to Securities Act Rule 501(a), the familiar definition used for Regulation D offerings.

The SEC recognizes that issuers may have difficulty determining whether existing security holders are accredited investors for purposes of the threshold in Section 12(g)(1) and that providing a safe harbor or other guidance could help to mitigate costs for issuers seeking to determine accredited investor status.  However, in the release, the SEC rejected a blanket safe harbor where issuers could rely on information gathered during a securities offering. The SEC believes such reliance could result in the use of outdated information that may no longer be reliable.  The practice may be permissible if an issuer can determine, based on facts and circumstances, if it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.

The SEC noted that without guidance from the Commission, when making the determination at fiscal year-end of whether a security holder is an accredited investor for purposes of Exchange Act Section 12(g)(1), issuers would likely use procedures similar to those used when relying on Rule 506.  A footnote then states “The procedures used in a Rule 506 offering may vary depending on a number of factors, including the nature of the purchaser and whether the offering is pursuant to Rule 506(b) or Rule 506(c). Rule 506(c) requires an issuer to take reasonable steps to verify that purchasers of securities sold in such offering are accredited investors. As we previously recognized when we adopted Rule 506(c), “issuers may have to apply a stricter and more costly process to determine accredited investor status than what they currently use.””

Given the difference in making the determination under the Securities Act, which is in the context of an investment decision, and under the Exchange Act, which is for the purpose of determining registration obligations, the SEC is considering whether a different approach than that used under Rule 506 would be appropriate for determining Exchange Act registration obligations.  The release then goes on to solicit comment on how a safe harbor could be established and whether it would be desirable.

Employee Compensation Plans

Exchange Act Section 12(g)(5), as amended by Section 502 of the JOBS Act, provides that the definition of “held of record” shall not include securities held by persons who received them pursuant to an “employee compensation plan” in transactions exempted from the registration requirements of Section 5 of the Securities Act.  By its express terms, this new statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of equity securities under the Exchange Act.   It does not apply to a determination of whether such registration may be terminated or suspended.

Section 503 of the JOBS Act instructs the SEC to amend the definition of “held of record” to implement the amendment in Section 502 and to adopt a safe harbor that issuers can use when determining whether holders of their securities received them pursuant to an employee compensation plan in exempt transactions.  Instead of creating a new definition for the term “employee compensation plan,” the SEC is proposing to revise the definition of “held of record.” Separately, the proposed rules establish a non-exclusive safe harbor that relies on the current definition of “compensatory benefit plan” in Rule 701 and the conditions in Rule 701(c).

The General Rule

The SEC is proposing to amend the definition of “held of record” to provide that when determining whether an issuer is required to register a class of equity securities with the SEC pursuant to Exchange Act Section 12(g)(1) an issuer may exclude securities that are either:

  • held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act; or
  • held by persons eligible to receive securities from the issuer pursuant to Exchange Act Rule 701(c) who received the securities in a transaction exempt from the registration requirements of Section 5 of the Securities Act in exchange for securities excludable under proposed Rule 12g5-1(a)(7).

The SEC notes that the proposal goes beyond what is required by the JOBS Act.  Specifically a number of companies issue securities to employees without Securities Act registration on the basis that the issuance is not a sale under Section 2(a)(3) of the Securities Act and therefore do not trigger the registration requirement of Securities Act Section 5, which applies only to the offer and sale of securities. While securities issued to employees in transactions that do not involve a sale under Section 2(a)(3) are not technically “transactions exempted from the registration requirements of section 5,” they are similar to other compensatory issuances to employees in exempt transactions in that the issuer provides the awards to employees for a compensatory purpose. The SEC is therefore proposing to exclude such “no sale” issuances from the definition of “held of record” in Rule 12g5-1 for purposes of determining an issuer’s obligation to register a class of securities under the Exchange Act.

Another area goes beyond what is required by the JOBS Act — the proposed rule would also permit an issuer to exclude holders who are persons eligible to receive securities from the issuer pursuant to Rule 701(c) and who acquired the securities in exchange for securities excludable under the proposed definition.  The proposed exclusion is intended to facilitate the ability of an issuer to conduct restructurings, business combinations and similar transactions that are exempt from Securities Act registration.  If the securities being surrendered in such a transaction would not have been counted under the proposed definition of “held of record,” the securities issued in the exchange also would not be counted under this definition.  The securities issued in the exchange would be deemed to have a compensatory purpose because they would replace other securities previously issued pursuant to an employee compensation plan.

Non-Exclusive Safe Harbor

The SEC is proposing a non-exclusive safe harbor under proposed Rule 12g5-1(a)(7) that would provide that a person will be deemed to have received the securities pursuant to an employee compensation plan if such person received them pursuant to a compensatory benefit plan in transactions that met the conditions of Securities Act Rule 701(c).

An issuer would be able to rely on the safe harbor for determining the holders of securities issued in reliance on Securities Act Rule 701, as well as holders of securities issued in transactions otherwise exempted from, or not subject to, the registration requirements of the Securities Act that satisfy the conditions of Rule 701(c).  This applies even if all the other conditions of Rule 701, such as issuer eligibility in Rule 701(b)(1), the volume limitations in Rule 701(d) or the disclosure delivery provisions in Rule 701(e), were not met. Thus, the safe harbor would be available for holders of securities received in other employee compensation plan transactions exempted from, or not subject to, the registration requirements of Section 5 of the Securities Act, such as securities issued in reliance on Securities Act Section 4(a)(2), Regulation D of the Securities Act, or Regulation S of the Securities Act, that meet the conditions of Rule 701(c).

The safe harbor would be available for the plan participants enumerated in Rule 701(c), including employees, directors, general partners, trustees, officers and certain consultants and advisors.  The safe harbor also would be available for permitted family member transferees with respect to securities acquired by gift or domestic relations order, or securities acquired by them in connection with options transferred to them by the plan participant through gifts or domestic relations orders.

The safe harbor would be limited to holders who are persons specified in Rule 701(c) who received the securities under specified circumstances.  Once these persons subsequently transfer the securities, whether or not for value, the securities would need to be counted as held of record by the transferee for purposes of determining whether the issuer is subject to the registration and reporting requirements of Exchange Act Section 12(g)(1).

ABOUT STINSON LEONARD STREET

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

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

The Financial Stability Oversight Council, or FSOC, voted on December 18, 2014 to release a notice seeking public comment regarding potential risks to U.S. financial stability from asset management products and activities, including hedge funds.  FSOC is seeking input from the public about potential risks associated with liquidity and redemptions, leverage, operational functions, and resolution in the asset management industry.

ABOUT STINSON LEONARD STREET

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

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

 

On October 22, 2014, ISS published a note on the financial consequences for shareholders to vote “NO” to a proposed hostile takeover (see article here).   ISS claimed to have demonstrated that those shareholders who voted “No” to a proposed takeover of their company would have been better off financially if they had they agreed to the takeover.

According to a recent paper, the ISS note does not support such a blanket statement. The author’s take on the ISS paper highlights what they believe are many debatable aspects of ISS’ analysis. According to the authors the ISS analysis is marred by dubious analytical choices, questionable metrics and the remarkable absence of a key investment parameter, the risk/return relationship.

ABOUT STINSON LEONARD STREET

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

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

The swap pushout rule was originally embodied in Section 716 of the Dodd-Frank Act.  Among other things, it prohibited “federal assistance” to any “swaps entity.”  Insured depository institutions were subject to this prohibition, subject to a couple of exceptions.  One exception was for hedging activities of the insured depository institution.  The other more significant exception exempted swaps tied to interest rates, foreign exchange, precious metals such as gold and silver and credit default swaps that are centrally cleared.  So there was already a hole in the law a mile wide.

But Section 630 of Title V of the Consolidated and Further Continuing Appropriations Act, 2015, also known as Cromnibus, changed the mile-wide exception to basically read “acting as a swaps entity for swaps or security-based swaps other than a structured finance swap.” So everything is basically permitted other than structured finance swaps, which are swaps or security-based swaps based on an asset-backed security (or group or index primarily comprised of asset-backed securities).  And even structured finance swaps are permitted if each asset-backed security underlying the structured finance swaps is of a credit quality and of a type or category with respect to which the prudential regulators have jointly adopted rules authorizing swap or security-based swap activity by covered depository institutions.

So the swap pushout rule was not repealed.  Just amended to remove all teeth. Whether this is good or bad remains to be seen.

Another Study

Section 202 of Title II of Cromnibus provides that within 90 days after enactment the Director of the Office of Management and Budget will submit a report to the Committees on Appropriations of the House of Representatives and the Senate on the costs of implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The report is to include:

  • the estimated mandatory and discretionary obligations of funds through fiscal year 2017, by Federal agency and by fiscal year, including:
    • the estimated obligations by cost inputs such as rent, information technology, contracts, and personnel;
    • the methodology and data sources used to calculate such estimated obligations; and
    • the specific section of such Act that requires the obligation of funds; and
  • the estimated receipts through fiscal year 2017 from assessments, user fees, and other fees by the Federal agency making the collections, by fiscal year, including:
    • the methodology and data sources used to calculate such estimated collections; and
    • the specific section of such Act that authorizes the collection of funds.

SEC Gets Nicked

Section 629 of Title VI of Cromnibus rescinds $25 million of the unobligated balances available in the Securities and Exchange Commission Reserve Fund established by Section 991 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Subject to some limitations, that provision of Dodd-Frank allows the SEC to keep registration fees collected under Section 6(b) of the Securities Act and Section 24(f) of the Investment Company Act.

ABOUT STINSON LEONARD STREET

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

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

On December 15, 2014, the North American Securities Administrators Association, Inc. (NASAA) unveiled its Electronic Filing Depository (EFD) for use in connection with state Form D filings in Rule 506 offerings.  The NASAA has been pursuing initiatives to streamline the state blue sky filing process for some time. In July of 2014, we reported on the NASAA’s proposed model rules that could be enacted by states to require electronic filings in connection with Rule 506 offerings. The EFD system dovetails with that initiative. While the availability of the EFD is an interesting and welcome development, there are a few important limitations to note:

  • Limited to Form D Filings. Although it is anticipated that additional state notice filings will be possible in the future, for now the EFD’s functionality is limited to filing a Form D and paying a filing fee in connection with a Rule 506 offering. If a state’s applicable statutes or regulations require any additional filings or information in connection with Rule 506 notice filings (such as a separate consent to service of process or supplemental information about securities sold within the state), that information will still need to be provided directly to the state.  
  • Not All States Are Participating. Currently, 37 states plus the District of Columbia, Puerto Rico, and the U.S. Virgin Islands are accepting Form D filings through EFD. States that want to accept filings through EFD have to opt in by whatever means the applicable state securities administrators feel is necessary. That may involve adopting new rules or legislation. As noted above, the NASAA has developed model rules to assist states in this regard. Minnesota is not among the states that are currently accepting filings through EFD.
  • Interaction with Other Systems. Over the past few years, several states have invested in their own online platforms for facilitating securities filings. California’s Self-Service DOCQNET Portal, administered by the California Department of Business Oversight, comes to mind. DOCQNET currently allows for several types of state notice filings. California is not one of the states that currently accepts EFD filings. States that have invested in their own systems will have to make decisions about whether to continue developing those systems or whether to rely on EFD going forward.

While the launch of EFD is subject to several limitations, nevertheless its development and launch is a positive step towards streamlining state notice filings in connection with Regulation D offerings.

ABOUT STINSON LEONARD STREET

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

The SEC recently rendered an opinion in an enforcement action against two persons, John P. Flannery and James D. Hopkins, associated with an investment adviser.  In so doing, it sought to limit the Supreme Court’s holding in Janus and offered an expansive view of Rule 10b-5(a) and (c).  Commissioners Gallagher and Piwowar dissented from the Commission action.

In Janus, the Supreme Court interpreted Rule 10b-5(b)’s prohibition against “mak[ing] any untrue statement of a material fact.”  After concluding that liability could extend only to those with “ultimate authority” over an alleged false statement, the Court held that an investment adviser who drafted misstatements that were later included in a separate mutual fund’s prospectus could not be held liable under Rule 10b-5(b).

According to the SEC,  Rule 10b-5(a) and (c) are different.  Those provisions do not address only fraudulent misstatements. Rule 10b-5(a) prohibits the use of “any device, scheme, or artifice to defraud,” while Rule 10b-5(c) prohibits “engag[ing] in any act, practice, or course of business which operates or would operate as a fraud or deceit.”  The SEC noted the very terms of the provisions “provide a broad linguistic frame within which a large number of practices may fit.”

Accordingly, the SEC concluded that primary liability under Rule 10b-5(a) and (c) extends to one who (with scienter, and in connection with the purchase or sale of securities) employs any manipulative or deceptive device or engages in any manipulative or deceptive act.  Per the SEC, as various courts have recognized, that standard certainly would encompass the falsification of financial records to misstate a company’s performance, as well as the orchestration of sham transactions designed to give the false appearance of business operations.

It is the SEC’s view that Rule 10b-5(a) and (c) extend even further than many courts have suggested.  In particular, the SEC concluded that primary liability under Rule 10b-5(a) and (c) also encompasses the “making” of a fraudulent misstatement to investors, as well as the drafting or devising of such a misstatement. Such conduct, in the SEC’s view, plainly constitutes employment of a deceptive “device” or “act.”

The SEC does not believe Janus requires a different result. In Janus, the Court construed only the term “make” in Rule 10b-5(b), which does not appear in subsections (a) and (c); the decision did not even mention, let alone construe, the broader text of those provisions.  And the Court never suggested that because the “maker” of a false statement is primarily liable under subsection (b), he cannot also be liable under subsections (a) and (c).

The SEC did not suggest that the outcome in Janus itself might have been different if only the plaintiffs’ claims had arisen under Rule 10b-5(a) or (c). As Janus recognizes, those plaintiffs may not have been able to show reliance on the drafters’ conduct, regardless of the subsection of Rule 10b-5 alleged to have been violated. Thus, the SEC interpretation would not expand the “narrow scope” the Supreme Court “give[s to] the implied private right of action.”

The SEC also noted that in contrast to private parties, the Commission need not show reliance as an element of its claims.  Thus, even if Janus precludes private actions against those who commit “undisclosed” deceptive acts, it does not preclude Commission enforcement actions under Rule 10b-5(a) and (c) against those same individuals.

ABOUT STINSON LEONARD STREET

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

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