The Securities and Exchange Commission’s Division of Economic and Risk Analysis (DERA) has regularly updated its studies regarding the market for unregistered securities offerings. The most recent study provides data through the end of 2017. Over $3.0 trillion was raised in unregistered securities transactions in 2017. By contrast, registered offerings accounted for approximately $1.5 trillion. Approximately $1.8 trillion was raised in Regulation D offerings, which surpasses the amount of capital raised in public offerings. Of this amount, most was raised in Rule 506(b) offerings and pooled investment vehicles. Some “repeat” issuers have switched to Rule 506(c). Approximately 65% of the Regulation D offerings (by number) involve equity offerings. The data presented in the study is based on information contained in Form D filings and, as a result, may understate the actual level of activity.
Anna Pinedo is a partner in Mayer Brown’s New York office and a member of the Corporate & Securities practice. She concentrates her practice on securities and derivatives. Anna represents issuers, investment banks/financial intermediaries and investors in financing transactions, including public offerings and private placements of equity and debt securities, as well as structured notes and other hybrid and structured products.
A recent paper titled, “Why do firms go public through debt issuance instead of equity?” reviews the characteristics of companies that choose to access the public market through debt issuance. There were approximately 600 initial debt offerings from 1987 to 2016. Public debt issuers tend to be larger companies with higher ratios of operating cash flows to capital expenditure and are often sponsor-backed. There is no industry concentration. A small percentage (16%) subsequently issue equity through an IPO. When companies with public debt eventually do go public, they face lower underpricing than companies in the same industry that undertake traditional equity IPOs.
Since January 2018, the present U.S. administration has imposed a series of tariff policies (U.S. Tariff Policies) that potentially have a wide range of consequences. In this Lexis Practice Advisor® Practice Note, partner Anna Pinedo and associates Martin Estrada and Gonzalo Go discuss disclosure trends related to U.S. Tariff Policies.
The Securities and Exchange Commission recently released its Strategic Plan for fiscal years 2018 to 2022. The plan identifies three goals. The first goal is to focus on the long-term interests of Main Street investors. In order to accomplish this objective, the SEC intends to: enhance its outreach and educational efforts; pursue enforcement initiatives related to retail investor misconduct, including microcap fraud; modernize disclosure requirements and the EDGAR system; and promote investment options for retail investors by expanding the number of companies that are SEC-registered and exchange-listed. The second goal relates to enhancing data security. To further this goal, the SEC will focus on ensuring that market participants are engaged in managing cybersecurity risks. The third goal is to invest in the SEC’s analytical capabilities and human capital development. The SEC intends to continue to expand the use of risk and data analytics in detecting improper behavior and bringing enforcement proceedings.
In recent comments, Commissioner Peirce shared her views on the role of the Securities and Exchange Commission in expressing a view regarding mandatory arbitration provisions. Commissioner Peirce noted that, in her opinion, the SEC does not have grounds to object to mandatory arbitration provisions. She noted that the Federal Arbitration Act “directs federal agencies to respect private contracts that favor arbitration.” To the extent that a corporate charter or bylaws are viewed as private contracts, the Federal Arbitration Act would seem to limit the authority of the SEC to prohibit a mandatory arbitration provision that is otherwise permissible under applicable state law. The Commissioner noted that it has been reported in the past that the Staff of the SEC has not allowed domestic registrants with mandatory arbitration provisions in their charters to have declared effective their IPO registration statements. She notes that if the Staff were to recommend that the SEC prohibit another company from registering an offering because of a mandatory arbitration provision in the future, the Commissioner would want to understand the basis for such view. Despite various statements from Chair Clayton to the effect that the SEC is not actively considering its position on mandatory arbitration, Commissioner Peirce’s comments seem to suggest that mandatory arbitration provisions remain a topic of discussion.
In a recent speech, SEC Commissioner Kara Stein commented on the importance of cybersecurity. The Commissioner noted that encouraging adoption of written policies and procedures, voluntary frameworks and non-binding guidance was not sufficient. She noted that boards of directors have a fiduciary duty to shareholders to monitor and oversee risk, including cybersecurity oversight. She seems to suggest that just as Commission rules require disclosure regarding financial experts, it would be reasonable for there to be some disclosure as to whether boards have an independent director with expert knowledge of technology and cybersecurity. Otherwise, boards should retain experts to provide advice. The Commissioner suggests independent directors meet with the company’s chief information security officer at least twice a year in executive session. She notes that boards should assess company disclosures regarding cyber risks. Finally, she suggests that the board ought to consider how well prepared the company is to respond to a breach, the resiliency of its infrastructure, and the procedures that will be implemented to recover and resume operations.
In a recent paper titled “Unicorn Stock Options – Golden Goose or Trojan Horse?” Anat Alon-Beck analyzes the issues arising in connection with stock-based compensation awarded to employees of unicorns given the trend toward remaining privately held longer and the deferral of IPOs, which traditionally served as the principal liquidity opportunities for employees.
The paper notes that for many Unicorn employees, choosing between exercising their options or forfeiting them is difficult. Valuations for unicorns may be high, so paying the cash exercise price and meeting the tax obligations may be difficult for an employee. Even if the employee were to exercise, the underlying stock would still be illiquid. Moreover, for many employees that choose to leave their companies, the standard option terms provide for a limited period of 90 days or so during which departing employees must make a decision whether to exercise. Given information asymmetries, employees may not have a well-formed view regarding the value of the stock. Many of these factors appear, according to the author, to be contributing to the high turnover among unicorns.
The author notes that stock-based compensation models were premised on the fact that most entrepreneurial companies had a lifetime of four years or so to IPO. With an extended timeline to IPO, the author suggests that it may be necessary to formulate a new approach to compensation. Possible alternatives may include: longer vesting periods, longer periods in which to exercise when an employee departs, back-end loaded options and greater reliance on RSUs. However, each such alternative has its limitations. As a result, the author contends that regulatory reform is needed. First, the author calls for changes to the Exchange Act Section 12(g) threshold to include employees in the holder count and more rigorous information requirements for companies under Rule 701. Given that the SEC’s Concept Release relating to Rule 701 and Form S-8 generally reflects a predisposition for less disclosure and greater flexibility, the article provides an interesting counterpoint. As the author notes, current regulations did not contemplate the growth of unicorns and, while increased flexibility for stock-based compensation grants may be useful, it does not address the information disparities or the lack of liquidity for employees and other optionholders.
Authors Zhaoxin Lin, Travis R.A. Sapp, Jackie Rees Ulmer, and Rahul Parsa examine insider trading data in order to assess the significance of this issue.
In their article, “Insider Trading Ahead of Cyber Breach Announcements,” the authors report on their review of stock price responses following 258 announced cyber breaches that occurred from 2011 to 2016. Based on historical insider sales, the authors catalogue sales as routine or opportunistic, to the extent data is available. The authors identify a statistically significant sample of sales prior to announcements of breaches. Opportunistic sales, or sales occurring in close proximity to a cybersecurity breach announcement by insiders that do not have an established trading program, produced significant abnormal savings for the insider sellers. Of course, the study cannot confirm that such trades were made in violation of the securities laws, but perhaps does suggest that companies reviewing their cybersecurity-related policies and procedures ought to give thought to information handling.
In a recent paper, author Brian Cheffins contends that the concerns about the death of the US public company are overstated. Although there has been a decline in the number of public companies since 2000, public companies continue to play an important role in the US economy. In assessing the role of public companies, Cheffins considers the ratio of aggregate market capitalization of publicly traded stocks to gross domestic product. The ratio is now near an all time high. Public companies are now larger than in prior periods. For example, he notes that in 2017, the market capitalization of listed US companies averaged almost $7 billion, which is more than ten times as much on an inflation-adjusted basis as the 1976 average.
Cheffins attributes the decline in the number of US IPOs (measured against historical levels) to market factors rather than regulatory burdens. The author notes that promising companies are exiting through M&A transactions, rather than IPOs. Unless the availability of private capital and M&A opportunities dry up, he notes that the current trend should be expected to continue. While his thesis may be accurate, the concerns expressed by representatives of the Securities and Exchange Commission that a smaller percentage of American investors now has the opportunity to benefit from the periods of the most significant growth of promising emerging companies also is true.
Speaking at a session at the American Bar Association’s annual meeting, a representative of the Securities and Exchange Commission’s Division of Corporation Finance (Michael Seaman) provided guidance for attendees regarding areas of focus in the coming months. After reviewing some of the Commission’s recent rulemaking initiatives, including the Concept Release regarding Rule 701 and Form S-8, the recent changes to Regulation S-K to address outdated, duplicative and other similar rules, and the proposed amendments to the disclosures required by Regulation S-X Rule 3-10 and Rule 3-16, Mr. Seaman commented on ongoing and upcoming priorities. He noted that the staff is working on proposed rules that would address the statutory change that permits Exchange Act-reporting companies to undertake Regulation A offerings. There appears to be significant interest on the part of smaller public companies in relying on the exemption. Mr. Seaman cautioned that the exemption is not available to such companies until the Commission adopts final rules. He noted that the staff continues its work on proposed changes to Industry Guide 3 for financial services companies. Guide 3 requirements may be simplified in light of the disclosures required of regulated financial institutions as a result of Basel III and other standards, as well as disclosures otherwise already contained in financial statements and the accompanying notes. Consistent with remarks made by other Commission representatives, Mr. Seaman noted that the staff also is working on a concept release related to private offering exemptions intended to harmonize conditions for such exemptions. When asked whether there would be additional rulemaking in furtherance of the Commission’s disclosure-effectiveness initiative, Mr. Seaman noted that the staff continues to review other aspects of the Regulation S-K requirements, including those on which comment was sought in the Concept Release on Business and Financial Disclosure required by Regulation S-K.
As far as areas of staff comment, Mr. Seaman noted that the staff was reviewing issuer disclosure related to cyber breaches and cybersecurity and commenting on risks that were generic and did not address issuer-specific facts and circumstances, as well as on disclosures related to incidents of breaches. He also noted that the staff was reviewing dispute-resolution provisions in governing documents that may have the effect of limiting investors’ rights, such as provisions requiring mandatory arbitration, waiver of jury trial provisions, provisions related to class-action waivers, and provisions requiring a minimum ownership threshold in order to bring certain claims. In this regard, the staff was commenting on issuer disclosures related to the inclusion of such provisions in the governing documents with a focus on ensuring that such provisions are clearly explained and investors understand the risks associated with such provisions, including the limitations on remedies, as well as ensuring that issuers are addressing in their disclosures whether such provisions are enforceable and comply with the securities laws.
Mr. Seaman also mentioned a new initiative, led by the Chief Counsel’s office, with the support and involvement of other groups, to review all of the Compliance & Disclosure Interpretations for any required updates, as well as to eliminate any C&DIs that may no longer be relevant or applicable. He encouraged practitioners to provide their views regarding any C&DIs that may be confusing or problematic, as well as any areas or topics that may be appropriate to address in new C&DIs.