Congress has passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which principally addresses financial regulatory measures.  The legislation also includes a number of securities law related provisions.  For example, Section 503 requires that the SEC review the findings and recommendations of the annual SEC Government-Business Forum on capital formation and address the findings and recommendations publicly.  Section 504 expands the Section 3(c)(1) exception under the Investment Company Act to include venture capital funds that have up to 250 investors and $10 million in aggregate committed capital contributions and uncalled capital.  Section 507 raises the Section 701 threshold to $10 million and indexes the threshold to inflation going forward.  Section 508 allows reporting companies to rely on Regulation A.  Rule 509  provides closed-end funds listed on a national securities exchange and certain interval funds to benefit from the same securities offering and other provisions available to operating companies.  After the Small Business Credit Availability Act was passed modernizing the securities offering and communications related provisions for BDCs, there had been concern that closed-end funds had been forgotten.

See the firm’s Legal Update here.

 

Effective May 11, 2018, the U.S. Treasury’s Financial Crimes Enforcement Network (“FinCEN”) implemented a new customer due diligence requirement.  The requirement applies to certain financial institutions, including banks, broker-dealers and mutual funds, at the time each new account is opened.  The rule enhances the information that financial institutions must collect regarding the identity of individuals (i.e., beneficial owners) who own or control their legal entity customers, which includes any corporation, limited liability company or partnership.  Information must be collected for each owner of 25% or more of the equity interests of a legal entity customer.  As a result of the rule’s recent implementation, financial institutions are devoting significant time and resources to modifying their internal systems and to implementing appropriate procedures to ensure compliance with the rule.  Certain entities are excluded from the definition of “legal entity customer.”  For example,  SEC reporting companies are excluded from the rule because they are subject to public disclosure and reporting requirements that provide information similar to what would otherwise be collected under the rule. Companies listed on foreign exchanges are not excluded from the definition of legal entity customer. Such companies may not be subject to the same or similar public disclosure and reporting requirements as companies publicly traded in the United States and, therefore, collecting beneficial ownership information for them is required. Certain institutions are considering revising some standard form agreements, including underwriting agreements and engagement letters, to include ownership certification representations and covenants to ensure compliance.  FinCEN has provided financial institutions with a certification form that may be used to obtain the required beneficial ownership information.  To read FinCEN’s “Frequently Asked Questions” relating to the new rule, please click here, and to read SIFMA’s memorandum relating to the new rule in the context of certain sales of securities, click here (with attachments providing form certifications at the 25% equity ownership threshold and 10% equity ownership threshold).

In a recent paper, authors Onur Bayar, Thomas J. Chemmaur and Paolo Fulghieri consider whether allowing insiders with nonpublic information to disclose such information prior to selling their securities.  The paper discusses the communications prohibitions applicable prior to, and in close proximity to, securities offerings, as well as some communications safe harbors.  The authors set out a model for disclosures at different points in time prior to a securities offering.  The paper concludes that even in the absence of an agency, like the Securities and Exchange Commission, that regulates disclosures, there are incentives for companies to self-regulate resulting in conservative disclosures.  The authors further conclude that whether allowing disclosures prior to an equity offering is desirable depends on the proportion of Institutional investors who are able to verify the information (compared to retail investors that would not be able to test or verify disclosures).  Finally, the authors also consider the nexus to the rules for bringing private securities lawsuits.  Setting aside the authors’ thesis, it would seem prudent in light of the significant advances in technology since 2005 when securities offering reform last revamped the communications rules to revisit the safe harbors available to issuers.

On January 1, 2018, a European Union law regulating packaged retail insurance-based investment products (“PRIIPs”) went into effect targeting securities offered to retail investors by investment funds.  If a security is considered a PRIIP, the issuer is required to publish a strictly regulated key information document (“KID”) that must be continuously updated during the distribution of the security.  The liability for the content of the KID is assumed by the issuer by operation of law.  The broadly drafted regulation has the potential to impact the ability of investors to purchase securities issued by U.S. exchange-listed real estate investment trusts (“REITs”).  To determine whether the securities of a particular REIT should be considered PRIIPs and thereby subject to the regulation, all relevant operational facts and characteristics of the REIT must be reviewed in an analysis similar to the undertaking by REITs at the time the Alternative Investment Fund Managers Directive (“AIFMD”) was implemented throughout the European Union.  Securities are considered PRIIPs if the amount repayable to the retail investor is subject to: (i) fluctuation because of exposure to reference values or (ii) the performance of one or more assets that are not directly purchased by the retail investor.  Securities issued by REITs that are structured as alternative investment funds under AIFMD are considered PRIIPs.

The recently updated Securities and Exchange Commission agenda (see here and here) provides some insight on what to expect in upcoming months.  The amendments to the smaller reporting company definition, which were widely supported when proposed, remain in the “final rule stage.”  Likewise, the amendments to implement the FAST Act report and disclosure update and simplification (to eliminate outdated, redundant and otherwise repetitive requirements) remain in the final rule stage.  It will be interesting to see whether the Commission takes action on these measures before Commissioner Piwowar’s departure.  Consistent with Corporation Finance Division Director Hinman’s recent Congressional testimony about which we previously blogged, the agenda now includes in the “proposed rule stage” extending the test-the-waters provision to non-EGCs.  Also in the proposed rule stage are changes to Industry Guide 3 (disclosures for banks and other financial institutions), disclosure of payments by resource extraction issuers, and additional changes to the Regulation S-K disclosure requirements.  A new item was added that is referenced as “amendments to financial disclosures for registered debt security offerings.”  It is not clear to what this relates.  Sadly, the changes to various communications safe harbors and other Securities Act rules for business development companies are in the “long-term actions” category.  The long-term actions category also includes a number of measures that have been the subject of recommendations by the Commission’s Investor Advisory Committee, such as disclosures regarding board diversity and changes to the accredited investor definition.  Consistent with recent comments by representatives of the Commission, a measure relating to harmonizing private placement rules is added to the long-term actions list.

On May 11, 2018, the staff of the Division of Corporation Finance of the US Securities and Exchange Commission issued compliance and disclosure interpretations (C&DIs) on proxy rules and related Schedules 14A and 14C. These C&DIs replace the interpretations published in the Proxy Rules and Schedule 14A Manual of Publicly Available Telephone Interpretations and the March 1999 Supplement to the Manual of Publicly Available Telephone Interpretations (collectively, Telephone Interpretations). Generally, the new C&DIs are consistent with the Telephone Interpretations, although several reflect substantive or technical changes from the Telephone Interpretations. Our Legal Update discusses those changes as well as practical considerations for companies.

 

In recent remarks, Commissioner Peirce commented on capital formation, repeating some statistics about the decline in the number of IPOs in recent years and the relatively small number of public companies (about 4,500).  She noted that many companies are able to raise capital in private placements or exempt offerings; however, fewer investors are able to share in the growth of such companies that stay private.  She noted a few regulatory impediments that may make becoming a public company less compelling.  Among these impediments, Commissioner Peirce included the Sarbanes-Oxley Section 404(b) attestation requirement and the burden it places, especially on pre-revenue companies, Dodd-Frank Act-mandated disclosure requirements, such as those on conflict minerals, Dodd-Frank Act executive compensation requirements like the pay ratio rule, and the lack of regulation of proxy advisory firms.  The Commissioner also commented on Regulation A, noting that as of the end of 2017, 185 Regulation A offerings had raised approximately $670 million in offering proceeds, and noting that the current offering threshold for Regulation A offerings may still be too low to be a meaningful stepping stone to an IPO.  The Commissioner also raised a suggestion that has been raised by Commissioner Piwowar from time to time; that is, abandoning the accredited investor standard and allowing all investors to participate in exempt offerings.  The full text of the remarks are available here.

Recently, the Securities and Exchange Commission (the “SEC”) announced a settlement with a registrant relating to the registrant’s failure to disclose the occurrence of a cyber breach.  The breach occurred in 2014 and was disclosed in 2016.  A later discovered breach that took place in 2013 was disclosed in 2017.  The SEC noted that the company did not fully assess the impact of the breach on its business nor whether the disclosures in its public filings, which addressed potential breaches, were rendered misleading by virtue of the actual breach.  The SEC did note that it would not second-guess judgments regarding disclosures made by registrant’s acting in good faith.

The settlement, taken together with statements made by representatives of the SEC regarding the importance of assessing cyber breaches and related risks, and the recent guidance from the SEC regarding cybersecurity disclosures, serve to emphasize, among other things, the importance of disclosure controls and procedures that take into account cyber disclosures.

Over the past year, proxy advisory firms, major index providers, and the SEC’s Investor Advisory Committee have weighed in on the growing number of companies with dual-share classes.  Today, 9% of the S&P 100 and 8% of the Russell 300 are comprised of companies with dual-class structures.  The Council of Institutional Investors has assembled and published a list of public companies with dual-class structures. During a recent program hosted at the Weinberg Center, titled “Snap Judgment: The Legal and Investment Issues Associated with Non-Voting Stock,” participants debated whether courts should step in and consider dual-class structures.

Traditionally, courts will defer to the business decisions of a company with independent directors that act in good faith having undertaken reasonable care.  However, some participants noted that the business judgment rule has been premised on the notion that stockholders could remove a board with which they disagreed.  In instances in which stockholders cannot hold boards of directors accountable by exercising voting rights, participants argued that it might be appropriate for courts to take on greater responsibility for shareholder protection through more active intervention.  Of course, it could be argued that stockholders could simply sell their securities.

Recently, the Ninth Circuit held that only negligence, not scienter, is required to be shown where a violation of the tender offer provisions of Section 14(e) is alleged.  In Varjabedian v. Emulex Corp., the Ninth Circuit court remanded the case for reconsideration of the defendants’ motion to dismiss based on a negligence standard.  The District Court had previously dismissed the complaint for failure to plead a strong inference of scienter in connection with the alleged Section 14(e) violations.  The Ninth Circuit’s conclusion that only a negligence standard applies is at variance with decisions in various other circuits.  In reaching its conclusion, the Ninth Circuit relied on the legislative history of the Williams Act, which it stated is intended to be broad and address the quality of the information provided to stakeholders in a tender offer.  Perhaps the circuit split may at some point be addressed by the Supreme Court.