Importance of Making Sure Your Corporate Status is Up to Date

On September 8, 2015, the United States Civilian Board of Contract Appeals (CBCA) dismissed a claim for lack of jurisdiction when it determined that a contractor was not in good standing at the time of the filing, and thus it could not file the claim.

Western States Federal Contracting, LLC (Western States) filed a protest seeking damages from the Department of Veterans Affairs (VA). The VA filed a motion to dismiss, asserting that Western States did not have the right to sue because it was not in good standing in its state of incorporation due to unpaid taxes in the amount of $981.

On several occasions, the CBCA ordered Western States to show that it was in good standing and had the right to sue. Although Western States was not in good standing in Delaware, where it was incorporated, Western States first attempted to show it was in good standing in Arizona, where it was conducting business. CBCA rejected this showing and ordered Western States to show it was in good standing in Delaware. Western States was unable to make this showing.

After Western States paid its overdue tax bill, and regained its good standing in Delaware, it argued that its good standing status should be retroactive. The CBCA found that Western States did not have standing to pursue its damages claim because it was not in good standing when it filed its appeal.

In addition to the having the capacity to sue and be sued, here are three other primary reasons why keeping your business in good standing status is good for business.

1. Lenders, Vendors, and Others Might Require a Good Standing Certificate

Lenders sometimes require good-standing status in order to approve new financing. They generally view a loss of good standing status as an increased risk which may increase the cost of financing or even limit the ability to obtain financing. Other businesses might require a Certificate of Good Standing for certain transactions, requests for proposals (RFPs) or contracts. Or, you may need one to sell the business, for real estate closings, or for mergers, acquisitions, or expansions. If a business can’t provide a Certificate of Good Standing, it raises a compliance “red flag” that indicates something’s wrong with the company’s state status.

2. Keeping Your Business Good Standing Often Saves Money in the Long Run

If a business doesn’t maintain its good-standing status, the state likely will make an involuntary adverse status change for the company, labeling it as “delinquent,” “void,” “suspended” or “dissolved,” depending on the state and the compliance problem. The most common reasons for losing good standing include a missed annual report, problems regarding the company’s registered agent-and-office, or unpaid fees or franchise taxes. The cost of fixing these mistakes can add up; preventing these mistakes is not expensive. By simply keeping your LLC or corporation in good standing, you could help:

  • Keep overall operating costs lower—filing on time avoids extra fees and fines from sapping your budget.

  • Prevent a state from administratively dissolving the LLC or corporation (and then having to try for a reinstatement) or worse yet, have to start all over again because your LLC or corporation has been permanently “purged”.

  • Maintain the limited liability protection that an LLC, corporation, or other business entity provides.

  • Preserve your rights to your LLC’s or corporation’s legal name in state records.

  • Keep your business poised for sudden contract opportunities, bids, or deals with other companies that require a Certificate of Good Standing to pursue or seal the deal.

3. Good Standing Helps When You Expand Into Other States

When you form your LLC or corporation, the state generally considers you to be “organizing” a business “entity.” Your business entity (e.g., LLC, corporation) has the right to do business in the state of organization only. If you want to expand and do business in other states, you’ll need to register to transact business in those states, too. Usually, the new state(s) ask for a Certificate of Good Standing from your formation state (or your “domestic” state) before they’ll let you register.

Checking Your Good Standing

Still, it’s not always easy to know which regulations and obligations apply to your corporation or LLC. Compliance can seem complicated or costly at times. Regulations change. And it can be difficult to keep track of the various deadlines your company must meet.  However, compliance can be done easily and inexpensively, relative to the cost of noncompliance.  We recommend that at least annually, you or your legal counsel should confirm that your LLC or corporation is in good standing in its state of formation as well as every state with which you are conducting business.

All states allow steps to be taken for a not-in-good-standing corporation or LLC to restore its standing, and that if good standing is restored, generally it will be as if the corporation or LLC had consistently remained in good standing.

© 2015 Odin, Feldman & Pittleman, P.C.

Taking Control of Cybersecurity: A Practical Guide for Officers and Directors

Foley and Lardner LLP

Major cybersecurity attacks of increased sophistication — and calculated to maximize the reputational and financial damage caused to the corporate targets — are now commonplace. These attacks have catapulted cybersecurity to a top priority for senior executives and board members.

To help these decision makers get their arms around cybersecurity issues, Foley Partners Chanley T. Howell, Michael R. Overly, and James R. Kalyvas have published a comprehensive white paper entitled: Taking Control of Cybersecurity — A Practical Guide for Officers and Directors.

The white paper describes very practical steps that officers and directors should ensure are in place or will be in place in their organizations to prevent or respond to data security attacks, and to mitigate the resulting legal and reputational risks from a cyber-attack. The authors provide a blueprint for managing information security and complying with the evolving standard of care. Checklists for each key element of cybersecurity compliance and a successful risk management program are included.

Excerpt From Taking Control of Cybersecurity: A Practical Guide for Officers and Directors

Sony, Target, Westinghouse, Home Depot, U.S. Steel, Neiman Marcus, and the National Security Agency (NSA). The security breaches suffered by these and many other organizations, including most recently the consolidated attacks on banks around the world, combined with an 80 percent increase in attacks in just the last 12 months, have catapulted cybersecurity to the top of the list of priorities and responsibilities for senior executives and board members.

The devastating effects that a security breach can have on an enterprise, coupled with the bright global spotlight on the issue, have forever removed responsibility for data security from the sole province of the IT department and CIO. While most in leadership positions today recognize the elevated importance of data security risks in their organization, few understand what action should be taken to address these risks. This white paper explains and demystifies cybersecurity for senior management and directors by identifying the steps enterprises must take to address, mitigate, and respond to the risks associated with data security.

Officers and Directors are Under a Legal Obligation to Involve Themselves in Information Security

The corporate laws of every state impose fiduciary obligations on all officers and directors. Courts will not second-guess decisions by officers and directors made in good faith with reasonable care and inquiry. To fulfill that obligation, officers and directors must assume an active role in establishing correct governance, management, and culture for addressing security in their organizations.

Download This White Paper


The Affordable Care Act—Countdown to Compliance for Employers, Week 1: Going Live with the Affordable Care Act’s Employer Shared Responsibility Rules on January 1, 2015

Mintz Levin Law Firm

Regulations implementing the Affordable Care Act’s (ACA) employer shared responsibility rules including the substantive “pay-or-play” rules and the accompanying reporting rules were adopted in February.  Regulations implementing the reporting rules in newly added Internal Revenue Code Sections 6055 and 6056 came along in March. And draft reporting forms (IRS Forms 1094-B, 1094-C, 1095-B and 1095-C) and accompanying instructions followed in August.

With these regulations and forms, and a handful of other, related guidance items (e.g., a final rule governing waiting periods), the government has assembled a basic—but by no means complete—compliance infrastructure for employer shared responsibility. But challenges nevertheless remain. Set out below is a partial list of items that are unresolved, would benefit from additional guidance, or simply invite trouble.

1.  Variable Hour Status

The ability to determine an employee’s status as full-time is a key regulatory innovation. It represents a frank recognition that the statute’s month-by-month determination of full-time employee status does not work well in instances where an employee’s work schedule is by its nature erratic or unpredictable. We examined issues relating to variable hour status in previous posts dated April 14July 20, and August 10.

An employee is a “variable hour employee” if—

Based on the facts and circumstances at the employee’s start date, the employer cannot determine whether the employee is reasonably expected to be employed on average at least 30 hours of service per week during the initial measurement period because the employee’s hours are variable or otherwise uncertain.

The final regulations prescribe a series of factors to be applied in making this call. But employers are having a good deal of difficulty applying these factors, particularly to short-tenure, high turnover positions. While there are no safe, general rules that can be applied in these cases, it is pretty easy to identify what will not work: classification based on employee-type (as opposed to position) does not satisfy the rule. Thus, it is unlikely that a restaurant that classifies all of its hourly employees, or a staffing firm that classifies all of its contract and temporary workers, as variable hour without any further analysis would be deemed to comply. But if a business applies the factors to, and applies the factors by, positions,  it stands a far greater chance of getting it right.

2.  Common Law Employees

We addressed this issue in our post of September 3, and since then, the confusion seems to have gotten worse. Clients of staffing firms have generally sought to take advantage of a special rule governing offers of group health plan coverage by unrelated employers without first analyzing whether the rule is required.

While staffing firms and clients have generally been able to reach accommodation on contractual language, there have been a series of instances where clients have sought to hire only contract and temporary workers who decline coverage in an effort to contain costs. One suspects that, should this gel into a trend, it will take the plaintiff’s class action bar little time to respond, most likely attempting to base their claims in ERISA.

3.  Penalties for “legacy” HRA and health FSA violations

A handful of promoters have, since the ACA’s enactment, offered arrangements under which employers simply provided lump sum amounts to employees for the purpose of enabling the purchase of individual market coverage. These schemes ranged from the odd to the truly bizarre. (For example, one variant claimed that the employer could offer pre-tax amounts to employees to enroll in subsidized public exchange coverage.) In a 2013 notice, the IRS made clear that these arrangements, which it referred to as “employer payment plans,” ran afoul of certain ACA insurance market requirements. (The issues and penalties are explained in our June 2 post.) Despite what seemed to us as a clear, unambiguous message, many of these schemes continued into 2014.

Employers that offered non-compliant employer-payment arrangements in 2014 are subject to penalties, which must be self-reported. For an explanation of how penalties might be abated, see our post of April 21.

4.  Mergers & Acquisitions

While the final employer shared responsibility regulations are comprehensive, they fail to address mergers, acquisitions, and other corporate transactions. There are some questions, such as the determination of an employer’s status as an applicable large employer, that don’t require separate rules. Here, one simply looks at the previous calendar year. But there are other questions, the answers to which are more difficult to discern. For example, in an asset deal where both the buyer and seller elect the look-back measurement method, are employees hired by the buyer “new” employees or must their prior service be tacked? The IRS invited comments on the issue in its Notice 2014-49.

Taking a page from the COBRA rules, the IRS could require employers to treat sales of substantial assets in a manner similar to stock sales, in which case buyers would need to carry over or reconstruct prior service. While such a result might be defensible, it would also impose costly administrative burdens. Currently, this question is being handled deal-by-deal, with the “answers” varying in direct proportion to the buyer’s appetite for risk.

5.  Reporting

That the ACA employer reporting rules are in place, and that the final forms and instructions are imminent should give employers little comfort. These rules are ghastly in their complexity. They require the collection, processing and integration of data from multiple sources—payroll, benefits admiration, and H.R., among others. What is needed are expert systems to track compliance with the ACA employer shared responsibility rules, populate and deliver employee reports, and ensure proper and timely delivery of employee notices and compliance with the employer’s transmittal obligations. These systems are under development from three principal sources: commercial payroll providers, national and regional consulting firms, and venture-based and other start-ups that see a business opportunity. Despite the credentials of the product sponsors, however—many of which are truly impressive—it is not yet clear in the absence of actual experience that any of their products will work. It is not too early for employers to contact their vendors and seek assurances about product delivery, reliability, and performance.

Business and Economic Incentives Primer

Womble Carlyle

Competition among jurisdictions to recruit and retain companies is intense. To attract business to their communities, both state and local governmental authorities will often offer discretionary economic incentives for projects that generate substantial tax revenues or create significant employment opportunities. Companies requiring new or larger facilities or facing lease expirations for their existing operations should assess whether they might qualify for an “incentives package” from the various jurisdictions they are considering for their projects. The potential benefits will typically vary depending upon the project’s key capital expenditures, job creation potential and the company’s corresponding wage parameters and associated commitments. Companies with potentially qualifying projects should evaluate how to best leverage their unique strengths to negotiate all available incentive benefits and to maximize those benefits once they are secured.

Business and economic incentives are the tax, cash and in-kind benefits offered by state and local governments to induce a company to relocate to a new community or remain in its existing jurisdiction primarily to create or retain jobs and increase tax revenue. Incentives help businesses mitigate upfront capital and ongoing operating costs for its required projects. Tax incentives include a variety of income and sales/use tax credits, exemptions, reductions and abatements. These can also include other tax-related investment incentives, such as investment and tax credits, research and development tax incentives, and accelerated depreciation of industrial equipment. The Enterprise Zone (EZ), a special kind of tax incentive program (also known as Empowerment Zones and Empowerment Communities), has been used by the federal government and even more widely by many states.

Cash incentives include monetary grants, reimbursements of transportation or infrastructure costs and other financial incentives including alternative financing subsidies. One of the most common benefits in this category is the Industrial Development Bond (IDB) that is used by jurisdictions to offer low-interest loans to firms. A variation on the IDB is the Tax Increment Financing (TIF) districts that are used by many states. A TIF allows governments to float bonds to help companies based on their anticipated future tax impact. In-kind incentives include expedited permitting by the state, county and local municipality and customized worker training programs. Some jurisdictions also offer other in-kind benefits such as watered-down environmental regulations and “right to work” laws that inhibit union organizing. Some states also have federal grant monies they are empowered to allocate towards different programs and projects depending on a project’s possible “public” infrastructure needs and other specific criteria.

In offering incentives, cities and counties are typically driven more by investments that increase the tax base while states focus more on jobs that pay above average wages. Some jurisdictions will provide incentives only for manufacturing projects or for specific statutory lists of facilities such as manufacturing, distribution facilities, air cargo hubs, multimodal facilities, headquarters facilities and data centers. Other states will not provide incentives for retail or hospitality facilities. In general, cities and counties have more flexibility than states in the kinds of projects for which they will provide incentives. Some states have wage tests and require that health care insurance and benefits be provided at the employer’s cost or that at least a portion of the cost be subsidized.

Whether for a corporate expansion or relocation, it is critical for a company to initiate its incentive identification and negotiation efforts early in the site-selection process for its project. Specifically, to achieve the greatest negotiating leverage, a company should begin the pursuit of economic incentives at the same time it is are undertaking its site selection efforts, since it is at this point in the process that competition readily exists between the cities, counties and/or states interested in enticing the company to relocate or remain in their jurisdictions. Since the success of this process is, in part, dependent upon “competing” the relevant state and local jurisdictions, it is important for a company to make it clear to all who are acting for the company that no decision or no public announcement may be made about the company’s plans until the company has evaluated all relevant factors.

To begin the process, a company should form a project team that will work with various economic development representatives from the relevant jurisdictions to achieve the optimal incentives package. The project team should develop a formal incentives negotiation strategy that would include some if not all of the following components:

  • Identifying and analyzing all incentive opportunities available for the project.
  • Determining the company’s short and long term capital and operating costs as well as job creation estimates.
  • Preparing a preliminary “incentives” pro forma.
  • Outlining the plan for securing the incentives and evaluating the related commitments that will be necessary from the company.
  • Identifying and integrating important components of the company’s corporate culture into the negotiation requests and strategy.
  • Determining the essential needs of the project to be included as the non-negotiable points of the company’s business case.
  • Defining the “business case” for why a jurisdiction would benefit from the company’s relocation to that state/county, such as tax (income and sales) revenues to be generated and the jobs to be created by the company.
  • Identifying how to formulate the most productive partnership between the company and the community.
  • Determining how to work creatively within the state and local framework.
  • Considering the use of a third party economic impact study to create an effective business case showing the jurisdiction how to fund the incentives.

A company that is well positioned to benefit from business and economic incentives should engage a seasoned professional who has a successful track record in achieving incentive benefits from the jurisdictions relevant to its business. Working in coordination with the governmental authorities, the right advisor can assist the company in establishing timelines for critical dates, administering applications to secure the incentives, and obtaining formal jurisdictional approvals to ensure compliance is implemented and negotiated incentives are realized. The advisor will also participate, as requested, in presentations for internal and governmental board approval and provide ongoing information and updates to the company during key phases of the incentive pursuit process.

After the final incentives package has been negotiated, the company and the jurisdiction will prepare and negotiate the required incentives agreements and then pursue the formal final governmental approvals. Public relations personnel for the company and the governmental authority are typically involved at this stage to prepare supporting media releases and project announcements. Once all necessary approvals are obtained, the company must establish internal documentation and processes to satisfy the compliance requirements to realize the negotiated incentives, which typically takes the form of a compliance manual.

Business and economic incentives can be valuable tools for a company to reduce costs, increase savings and manage risks as they pursue a signature lease transaction, building acquisition or facility development. To achieve the optimal result, the incentives process must be carefully managed from inception to completion, toward the ultimate goal of creating a meaningful partnership between the company and the community in which the company will conduct its business.

This article originally was published in the August 2013 edition of “Focus on WMACCA,” the newsletter of the Washington Metropolitan Area Corporate Counsel Association

This article was written with Scott R. Hoffman with Cushman & Wakefield.

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Investment Management Legal and Regulatory Update – October 2013

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SEC Issues Guidance Update for Investment Companies that Invest in Commodity Interests and Announces New Risk and Examinations Office

The staff of the Division of Investment Management has issued a Guidance Update that summarizes the views of the Division regarding disclosure and compliance matters relevant to funds that invest in commodity interests. The staff also announced the creation of a Risk and Examinations Office within the Division of Investment Management that will accompany the SEC’s Office of Compliance Inspections and Examinations (OCIE) on exam visits.

Disclosure of Derivatives and Associated Risks. Any principal investment strategies disclosure related to derivatives should be tailored specifically to how a fund expects to be managed and should address those strategies that the fund expects to be the most important means of achieving its objectives and that it also anticipates will have a significant effect on its performance. In determining the appropriate disclosure, a fund should consider the degree of economic exposure the derivatives create, in addition to the amount invested in the derivatives strategy. This disclosure also should describe the purpose that the derivatives are intended to serve in the portfolio (e.g., hedging, speculation, or as a substitute for investing in conventional securities), and the extent to which derivatives are expected to be used. Additionally, the disclosure concerning the principal risks of the fund should similarly be tailored to the types of derivatives used by the fund, the extent of their use, and the purpose for using derivatives transactions.

Prior Performance Presentation. A newly registered fund that invests in commodity interests and that includes in its registration statement information concerning the performance of private accounts or other funds managed by the fund’s adviser is responsible for ensuring that such information is not materially misleading. Specifically, a fund that includes the performance of other funds or private accounts should generally include the performance of all other funds and private accounts that have investment objectives, policies, and strategies substantially similar to those of the fund.

Legend Requirement. Rule 481 under the Securities Act requires a fund to provide a legend on the outside front cover page that indicates that the SEC has not approved or disapproved of the securities or passed upon the accuracy or adequacy of the disclosure in the prospectus and that any contrary representation is a criminal offense. The staff will not object if a fund that invests in commodity interests includes in the legend language that also indicates that the CFTC has not approved or disapproved of the securities or passed upon the accuracy or adequacy of the disclosure in the prospectus.

Compliance and Risk Management. Day-to-day responsibility for managing a fund’s portfolio, including any commodity interests and their associated risks, rests with the fund’s investment adviser. In addition, the fund’s board generally oversees the adviser’s risk management activities as part of the board’s oversight of the adviser’s management of the fund. The staff expects that funds and their advisers would adopt policies and procedures that address, among other things, consistency of fund portfolio management with disclosed investment objectives and policies, strategies, and risks.

Each fund should have in place policies and procedures that are sufficient to address the accuracy of disclosures made about the fund’s use of derivatives, including commodity interests, and associated risks, as well as consistency of the fund’s investments in these derivatives with the fund’s investment objectives. For example, these policies and procedures should be reasonably designed to prevent material misstatements about a fund’s use of derivatives, including commodity interests, and the associated risks.

New Risk and Examinations Office. The update notes that a Risk and Examinations Office has recently been created within the Division of Investment Management to analyze and monitor the risk management activities of investment advisers, investment companies, the investment management industry and new products. The group will work closely with OCIE to make onsite visits to investment management firms.

Source: SEC Division of Investment Management Guidance, August 2013, 2013-05.

SEC Approves Registration Rules for Municipal Advisors

State and local governments that issue municipal bonds frequently rely on advisors to help them decide how and when to issue the securities and how to invest proceeds from the sales. Prior to passage of the Dodd-Frank Act in 2010, municipal advisors were not required to register with the SEC. This left many municipalities relying on advice from unregulated advisors. After the Dodd-Frank Act became law, the SEC established a temporary registration regime for municipal advisors that prohibited any municipal advisor from providing advice to, or soliciting, municipal entities or other covered persons without being registered. More than 1,100 municipal advisors have since registered with the SEC. The SEC recently adopted final rules that establish a permanent registration regime for municipal advisors.

Registered municipal advisors will also likely be subject to additional new regulation from the Municipal Securities Rulemaking Board (MSRB). In September 2011, the MSRB withdrew several rule proposals pertaining to municipal advisors pending adoption by the SEC of a permanent registration regime for municipal advisors. Among the proposals was a rule regulating political contributions by municipal advisors. The MSRB had previously indicated that it would resubmit the withdrawn rule proposals once a final definition of the term “municipal advisor” was adopted by the SEC.

Proposed Rule

In 2010, the SEC proposed a rule governing the permanent registration process. The proposal defined “municipal advisor” broadly and would have required municipal advisor registration of appointed board members of municipalities and people providing investment advice on all public funds. The SEC received more than 1,000 comment letters on the proposal, most of which raised concerns about the broad reach of the proposal.

Final Rule

The final rule requires a municipal advisor to register with the SEC if it:

  • provides advice on the issuance of municipal securities or about certain “investment strategies” or municipal derivatives; or
  • undertakes a solicitation of a municipal entity or obligated person.

The rule clarifies who is and is not a “municipal advisor” and offers guidance on when a person is providing “advice” for purposes of the municipal advisor definition. The rule exempts employees and appointed officials of municipal entities from registration and limits the type of “investment strategies” that will result in municipal advisor status. Additionally, instead of the proposed approach that would have required individuals associated with registered municipal advisory firms to register separately, the final rule requires firms to furnish information about these individuals.

Defined Terms

Advice. A person is providing “advice” to a municipal entity or an “obligated person” based on all of the relevant facts and circumstances, including whether the advice:

  • involves a recommendation to a municipal entity;
  • is particularized to the specific needs of a municipal entity; or
  • relates to municipal financial products or the issuance of municipal securities.

Advice, however, does not include providing certain general information.

An “obligated person” is an entity such as a non-profit university or non-profit hospital that borrows the proceeds from a municipal securities offering and is obligated by contract or other arrangement to repay all or some portion of the amount borrowed.

Investment Strategies. A person providing advice to a municipal entity or an “obligated person” with respect to “investment strategies” only has to register if such advice relates to:

  • the investment of proceeds of municipal securities;
  • the investment of municipal escrow funds; or
  • municipal derivatives.

Exemptions from the Municipal Advisor Definition

The following persons conducting the specified activities would not be required to register as a municipal advisor:

Registered Investment Advisers. Registered investment advisers and associated persons do not have to register if they provide investment advice in their capacities as registered investment advisers, such as providing advice regarding the investment of the proceeds of municipal securities or municipal escrow investments.

This exemption does not apply to advice on the structure, timing, and terms of issues of municipal securities or municipal derivatives. The SEC considers advice in these areas as outside the focus of investment adviser regulation.

Independent Registered Municipal Advisor. Persons who provide advice in circumstances in which a municipal entity has an independent registered municipal advisor with respect to the same aspects of a municipal financial product or issuance of municipal securities do not have to register, provided that certain requirements are met and certain disclosures are made.

Banks. Banks do not have to register to the extent they provide advice on certain identified banking products and services, such as investments held in deposit accounts, extensions of credit, funds held in a sweep account or investments made by a bank acting in the capacity of bond indenture trustee or similar capacity.

This exemption does not apply to banks that engage in other municipal advisory activities, such as providing advice on the issuance of municipal securities or municipal derivatives, in part because municipal derivatives were a source of significant losses by municipalities in the financial crisis.

Underwriters. Brokers, dealers and municipal securities dealers serving as underwriters do not have to register if their advisory activities involve the structure, timing and terms of a particular issue of municipal securities.

Registered Commodity Trading Advisor. Registered commodity trading advisors and their associated persons do not have to register if the advice they provide relates to swaps.

Swap Dealers. Registered swap dealers do not have to register as municipal advisors if they provide advice with respect to swaps in circumstances in which a municipal entity is represented by an independent advisor.

Public Officials and Employees. Public officials do not have to register to the extent that they are acting within the scope of their official capacity. This exemption addresses an unintended consequence of the proposed rule that generated significant public comment and created the impression that public officials and municipal employees would be covered if they provided “internal” advice.

This exemption covers persons serving as members of a governing body, an advisory board, a committee, or acting in a similar official capacity as an official of a municipal entity or an obligated person. For instance, it covers:

  • members of a city council, whether elected or appointed, who act in their official capacity; and
  • members of a board of trustees of a public or private non-profit university acting in their official capacity, where the university is an obligated person by virtue of borrowing proceeds of municipal bonds issued by a state governmental educational authority.

Similarly, this exemption covers employees of a municipal entity or an obligated person to the extent that they act within the scope of their employment.

Attorneys. Attorneys do not have to register if they are providing legal advice or traditional legal services with respect to the issuance of municipal securities or municipal financial products.

This exemption does not apply to advice that is primarily financial in nature or to an attorney representing himself or herself as a financial advisor or financial expert on municipal advisory activities.

Accountants. Accountants do not have to register if they are providing accounting services that include audit or other attest services, preparation of financial statements, or issuance of letters for underwriters.

Registration Forms

The final rule requires municipal advisory firms to file the following through EDGAR:

  • Form MA to register as a municipal advisor; and
  • Form MA-I for each individual associated with the firm who engages in municipal advisory activities.

The temporary registration regime will remain in place until December 31, 2014. The new rule requires municipal advisors to register on a staggered basis beginning July 1, 2014. The expiration date of the temporary rules will be extended in order to allow municipal advisors to continue to remain temporarily registered during the staggered compliance period.

Sources: SEC Approves Registration Rules for Municipal Advisors, SEC Press Release 2013-185 (September 18, 2013); Registration of Municipal Advisors, SEC Release No. 34-70462 (September 18, 2013).

SEC Eliminates the Prohibition on General Solicitation and General Advertising in Certain Private Offerings to Accredited Investors

As we reported in our July Client Alert, the SEC amended Regulation D to implement a Jumpstart Our Business Startups Act (JOBS Act) requirement to lift the ban on general solicitation and general advertising for certain private offerings.


Congress passed the JOBS Act in 2012, which directed the SEC to remove the prohibition against general solicitation and general advertising for securities offerings relying on Rule 506, provided that sales are limited to accredited investors and an issuer takes reasonable steps to verify that all purchasers are accredited investors.

While issuers will be able to widely solicit and advertise for potential investors, the JOBS Act required the SEC to adopt rules that “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” In other words, there is no restriction on who an issuer can solicit, but an issuer faces restrictions on who is permitted to purchase its securities.

Rule 506(c)

The addition of 506(c) to the existing Rule 506 permits issuers, including hedge funds and other private funds, to use general solicitation and general advertising to offer their securities provided that:

  • all purchasers of the securities are accredited investors (as defined in Rule 501);
  • the issuer takes reasonable steps to verify that the investors are accredited investors;
  • all other conditions of the Rule 506 exemption are met; and
  • Form D is completed and the box is checked indicating that Rule 506(c) is being relied upon.

Verification of Accredited Investor Status

Under the new rules, the issuer will need to take reasonable steps to verify that each investor is accredited. Whether the steps taken are “reasonable” will be a principles-based determination by the issuer, in the context of the particular facts and circumstances of each purchaser and transaction. The SEC noted that the issuer should consider the nature of the purchaser and the amount and type of information that the issuer has about the purchaser; the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering; and the terms of the offering, such as a minimum investment amount.

In response to comments received with respect to the SEC’s original rule proposal, the amendment to Rule 506 also includes a non-exclusive list of methods that issuers may use to verify that purchasers are accredited investors. The methods described in the final rule include the following:

  • Verification of Income. Review IRS forms filed for last two years and obtain a written representation of expected income for the current year.
  • Verification of Net Worth. Review documentation related to assets (bank and brokerage statements, CDs and independent appraisal reports) and liabilities (credit reports).
  • Third Party Verification. Obtain a written confirmation that a person is an accredited investor from a broker-dealer, investment adviser, attorney or CPA.
  • Existing Accredited Security Holder. For any investor who invested in an issuer’s prior Rule 506 offering as an accredited investor and remains an investor, obtain a written certification (at the time of a Rule 506(c) sale) that he or she still qualifies as an accredited investor.

Preservation of Existing Rule

The existing provisions of Rule 506 as a separate exemption are not affected by the final rule. Issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren’t subject to the new verification rule.

Form D

In connection with these changes, Form D has been amended to require issuers to indicate whether they are relying on 506(c), which permits general solicitation and advertising in a Rule 506 offering.

The rule amendments became effective September 23, 2013.

Sources: SEC Approves JOBS Act Requirement to Lift General Solicitation Ban, Commission Also Adopts Rule to Disqualify Bad Actors from Certain Offerings and Proposes Rules to Enable SEC to Monitor New Market and Bolster Investor Protections, SEC Press Release 2013-124 (July 10, 2013); Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, SEC Release No. IA-3624 (July 10, 2013).

SEC Adopts Rule to Disqualify “Bad Actors” from Rule 506 Offerings

The SEC recently approved amendments to Rule 506 to set forth the “bad actor” (commonly known as “bad boy”) provisions that could disqualify issuers from relying on the rule. The Dodd-Frank Act directed the SEC to adopt the amendments in order to prevent issuers from relying on the Rule 506 safe harbor if certain “bad actors” were involved in the offering.

As required by the Dodd-Frank Act, the SEC approved disqualifications under Rule 506 that are substantially similar to the disqualifications found in other securities regulations. Persons covered by the bad boy provisions include: issuers; directors, executive officers, other officers participating in the offering, general partners or managing members of issuers; beneficial owners of 20% or more of the issuer’s voting equity securities; investment managers to an issuer that is a pooled investment fund and directors, executive officers, other officers participating in the offering, general partners or managing members of the investment manager; promoters connected with the issuer; persons compensated for soliciting investors as well as the directors, officers, general partners or managing members of any compensated solicitor. The disqualifying events include:

  • securities-related criminal convictions;
  • securities-related court injunctions and restraining orders;
  • final orders of a state securities commission, state insurance commission, state or federal bank, savings association or credit union regulator or the CFTC barring an individual from association with regulated entities or from engaging in securities, insurance or banking business or finding a violation of any law pertaining to fraudulent, manipulative or deceptive conduct;
  • SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers and investment companies and their associated persons;
  • SEC cease-and-desist orders related to violations of certain anti-fraud provisions and registration requirements of the federal securities laws;
  • suspension or expulsion from membership in, or suspension or bar from associating with a member of, a securities self-regulatory organization; and
  • SEC stop orders pertaining to the filing of a registration statement or the suspension of an exemption.

Reasonable Care Exception. Under this exception, an issuer would not lose the benefit of the Rule 506 safe harbor if it can show that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.

Disclosure of Pre-Existing Disqualifying Events. Disqualification applies only for disqualifying events that occur after September 23, 2013, the effective date of this rule. Matters that existed before the effective date of the rule and would otherwise be disqualifying are subject to a mandatory disclosure requirement to investors.

Sources: SEC Approves JOBS Act Requirement to Lift General Solicitation Ban, Commission Also Adopts Rule to Disqualify Bad Actors from Certain Offerings and Proposes Rules to Enable SEC to Monitor New Market and Bolster Investor Protections, SEC Press Release 2013-124 (July 10, 2013); Disqualification of Felons and Other Bad Actors from Rule 506 Offerings, SEC Release No. 33-9414 (July 10, 2013).

SEC Proposes Amendments to Private Offering Rules (Regulation D and Form D)

In partial response to the many comments that the SEC received with respect to its proposed JOBS Act amendments to Rule 506, the SEC recently proposed the following amendments to the private offering rules.

Advance Notice of Sale. Under the proposal, issuers that intend to engage in general solicitation as part of a Rule 506 offering would be required to file the Form D at least 15 calendar days before engaging in general solicitation for the offering. Also, within 30 days of completing an offering, issuers would be required to update the information contained in the Form D and indicate that the offering has ended.

Additional Information about the Issuer and the Offering. Under the proposal, issuers would be required to provide additional information such as:

  • types of general solicitation used;
  • methods used to verify accredited investor status;
  • publicly available website;
  • controlling persons;
  • industry group;
  • asset size;
  • breakdown of investor types (accredited/non-accredited and natural person/entity) and amounts invested; and
  • breakdown of use of proceeds.

Disqualification. Under the proposal, an issuer would be disqualified from using the Rule 506 exemption in any new offering if the issuer or its affiliates did not comply with the Form D filing requirements in a Rule 506 offering.

Legends and Disclosures. Under the proposal, issuers would be required to include certain legends or cautionary statements in any written general solicitation materials used in a Rule 506 offering. The legends would be intended to inform potential investors that the offering is limited to accredited investors and that certain potential risks may be associated with such offerings.

In addition, if the issuer is a private fund and includes information about past performance in its written general solicitation materials, it would be required to provide additional information in the materials to highlight the limitations on the usefulness of this type of information. The issuer also would need to highlight the difficulty of comparing this information with past performance information of other funds. The proposal also requests public comment on whether other manner and content restrictions should apply to written general solicitation materials used by private funds.

Submission of Written General Solicitation Materials to the SEC. Under the proposal, issuers would be required to submit written general solicitation materials to the SEC through an intake page on the SEC website. Materials submitted in this manner would not be available to the general public. As proposed, this requirement would be temporary, expiring after two years.

Guidance to Private Funds about Misleading Statements. In its current form, Rule 156 under the Securities Act provides guidance on when information in mutual fund sales literature could be fraudulent or misleading for purposes of the federal securities laws. Under the proposal, the rule would be amended to apply to the sales literature of private funds.

Comments on the proposal originally were due on September 23, 2013. However, “in light of the public interest,” the SEC re-opened the comment period until October 30, 2013.

Sources: SEC Approves JOBS Act Requirement to Lift General Solicitation Ban, Commission Also Adopts Rule to Disqualify Bad Actors from Certain Offerings and Proposes Rules to Enable SEC to Monitor New Market and Bolster Investor Protections, SEC Press Release 2013-124 (July 10, 2013); Amendments to Regulation D, Form D and Rule 156, SEC Release No. IC-30595 (July 10, 2013).

SEC Charges Investment Adviser for Misleading Fund Board About Algorithmic Trading Ability

The SEC charged an investment adviser and its former owner for misleading a mutual fund’s board of directors about the firm’s ability to conduct algorithmic currency trading so the board would approve the adviser’s contract to manage the fund.

The case arises out of an initiative by the SEC Enforcement Division’s Asset Management Unit to focus on the “15(c) process” – a reference to Section 15(c) of the Investment Company Act that requires a fund’s board to annually evaluate the fund’s advisory agreements. Advisers must provide the board with truthful information necessary to make that evaluation.

“It is critical that investment advisers provide truthful information to the directors of the registered funds they advise,” said Julie M. Riewe, Co-Chief of SEC Enforcement Division’s Asset Management Unit. “Both boards and advisers have fiduciary duties that must be fulfilled to ensure that a fund’s investors are not harmed.”

The SEC’s Enforcement Division alleged that Chariot Advisors LLC and Elliott L. Shifman misled the fund’s board about the nature, extent, and quality of services that the firm could provide. In two presentations before the board, Shifman misrepresented that his firm would implement the fund’s investment strategy by using a portion of the fund’s assets to engage in algorithmic currency trading. Chariot fund’s initial investment objective was to achieve absolute positive returns in all market cycles by investing approximately 80% of the fund’s assets under management in short-term fixed income securities, and using the remaining 20% to engage in algorithmic currency trading.

According to the SEC’s order instituting administrative proceedings, Chariot Advisors did not have an algorithm capable of conducting such currency trading. This was particularly significant because in the absence of an operating history the directors focused instead on Chariot Advisors’ reliance on models when the board evaluated the advisory contract. Even though Shifman believed that the fund’s currency trading needed to achieve a 25 to 30% return to succeed, Shifman allegedly did not disclose to the board that Chariot Advisors had no algorithm or model capable of achieving such a return.

The SEC alleges that for at least the first two months after the fund was launched, Chariot Advisors did not use an algorithm model to perform the fund’s currency trading as represented to the board, but instead hired an individual trader who was allowed to use discretion on trade selection and execution. According to the order, the trader used a technical analysis, rules-based approach for trading that combined market indicators with her own intuition.

The SEC further alleges that the misconduct by Shifman and Chariot Advisors caused misrepresentations and omissions in the Chariot fund’s registration statement and prospectus filed with the SEC and viewed by investors.

A hearing will be scheduled before an administrative law judge to determine whether the allegations contained in the order are true and whether any remedial sanctions are appropriate.

Sources: SEC Charges North Carolina-Based Investment Adviser for Misleading Fund Board About Algorithmic Trading Ability, SEC Press Release 2013-162 (August 21, 2013); In the Matter of Chariot Advisors, LLC and Elliott L. Shifman, Investment Company Act Release No. 30655 (August 21, 2013).

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New Federal Communication Commission (FCC) Rules to Protect Telephone Consumers from Autodial/Robocalls

Lewis & Roca

On October 16, 2013, new Federal Communication Commission rules took effect to further protect consumers under the Telephone Consumer Protection Act of 1991 (TCPA). See 47 U.S.C. § 227; 47 C.F.R. § 64.1200. The changes ordered by the FCC are designed to protect consumers from unwanted autodialed or pre-recorded telemarketing calls, also known as “telemarketing robocalls.” The new TCPA rules accomplish four main things: (1) require prior written consent for all autodialed or pre-recorded telemarketing calls to wireless numbers and residential lines; (2) require mechanisms to be in place that allow consumers to opt out of future robocalls even if during the middle of a current robocall; (3) limit permissible abandoned calls on a per-calling campaign basis in order to discourage intrusive calling campaigns; and (4) exempt from TCPA requirements calls made to residential lines by health care related entities governed by the Health Insurance Portability and Accountability Act of 1996. None of the FCC’s actions change the requirements for prerecorded messages that are non-telemarketing, informational calls such as calls by or on behalf of tax-exempt organizations, calls for political purposes, and calls for other non-commercial purposes including those to people in emergency situations.

Under the FCC’s new rules, “prior written consent” will require two things: a clear and conspicuous disclosure that by providing consent the consumer will receive auto-dialed or prerecorded calls on behalf of a specific seller, and a clear an unambiguous acknowledgement that the consumer agrees to receive such calls at the mobile number. The content and form of consent may include an electronic or digital form of signature such as the FTC has recognized under the E-SIGN Act. See Electronic Signatures in Global and National Commerce Act, 15 U.S.C. § 7001 et seq. However, prior written consent may be terminated at any time. In addition, the written agreement must be obtained “without requiring, directly or indirectly, that the agreement be executed as a condition of purchasing any good or service.” 16 C.F.R. § 310.4(b)(v)(A)(ii).

Read the full rule here.

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A Tip For Dealing with Automatic Gratuities in 2014

McBrayer NEW logo 1-10-13

A new Internal Revenue Service (“IRS“) rule, set to take effect in January 1, 2014, may eliminate a common practice in the restaurant industry. Often, an automatic gratuity, normally 18%, is added to the bill of large parties. Automatic gratuities were adopted by restaurant employers as a means for ensuring that servers do not get stiffed on expensive bills. Servers heavily rely on tips to supplement a salary that is often times lower than the federal minimum wage.

Traditionally, automatically-added gratuities have been classified as employee tips. As such, it is up to the employees to report the money as income. Starting in January, automatic gratuities will be categorized as “service charges” – making them regular wages and subject to payroll tax withholdings. Employers will have to track and report any automatic tips and will be required to include the “service charge” payments in employees’ W-2 wages. Further, employers will no longer be able to count these tips as a credit to reduce their minimum wage obligation. It is a lose-lose situation because servers will not see their automatic gratuity money until payday; making it more difficult to survive on a small salary.

Many major chains, like Olive Garden and Red Lobster, have eliminated automatic gratuities in response to the approaching deadline. For restaurants that opt to keep the automatic gratuity system, payroll accounting will become much more complicated. Tips from automatic gratuities will have to be factored into hourly pay rates, which means hourly rates could vary based on how many large parties are served in any given hour.

It would be wise for smaller restaurants to follow the chain restaurants’ lead by eliminating automatic gratuities altogether. Doing so will not only to lessen compliance requirements and tax burdens, but will also keep employees happy by ensuring that the tips they earn can immediately be pocketed.

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