Corporate law Archives - Page 19 of 32

SEC Whistleblower Awards: Can You Hear Whistles Blow? Valued At More Than $100 Million, You Bet You Can!

Some very loud whistles have been blowing across corporate America since 2011 – whistles valued at $107 million, in fact. The United States Securities and Exchange Commission announced on August 30, 2016, that since its whistleblower program began in 2011, they have awarded more than $107 million total to 33 individuals who voluntarily provided the SEC with original and useful information that led to a successful enforcement action. Whistleblower awards can range from 10 percent to 30 percent of the money collected when the SEC’s monetary sanctions in a matter exceed $1 million.

The SEC encourages employees to report suspected wrongdoing, because they, according to Acting Chief Jane Norberg, “are in unique positions behind-the-scenes to unravel complex or deeply buried wrongdoing.” And, last year alone, employees responded by providing nearly 4,000 tips to the agency. With this kind of incentive from the SEC and other government agencies, as well as a growing number of successes in whistleblower lawsuits, it is more important than ever for companies to get advice on a regular basis. Moreover, companies must be strategic and proactive in their approach to implementing an effective whistleblower protection and anti-retaliation system.

Key elements of an effective whistleblower protection and anti-retaliation system include:

Clear and visible leadership commitment and accountability. This is truly the most important piece of the puzzle. Without sincere support from the top, no internal whistleblower program can succeed.
The creation of a true “speak-up” organizational culture focused on prevention, including encouraging employees to raise all suspicions and issues quickly and insuring the fair resolution of such issues.
Independent, protected resolution systems for employees and third-parties who believe they are experiencing retaliation as a result of raising concerns.
Specific training to educate all employees about their rights and available protections (including both internal and external programs).
Specific training for managers who may receive complaints or information from employees, requiring the manager to be considerate of the employee making the report, to be diligent, and, most importantly, to act on the information with no corporate tolerance of the “just telling me as a friend, not as a manager” excuse.
Internal monitoring and measurement of corporate compliance efforts and the effectiveness of the speak-up and non-retaliation culture, without contributing to the suppression of employee reporting.
Independent auditing to determine if the whistleblower protection and anti-retaliation system is actually working.

Post written by Denise K. Drake of Polsinelli LLP.

Profits Interest as Equity-Based Incentive: Keeping Your Team Motivated

Say you own one-half of an LLC that is taxed as a partnership. You and your partner invested the initial capital that was necessary to get the business up and running, and you both built the business with the help of a few key employees. With the business still in the growth phase, you want to make sure that you motivate and retain these key employees who are helping you grow your company. What should you do? You and your partner might want to consider causing the LLC to issue the key employees a profits interest in the LLC.

What is a Profits Interest?

From a tax-standpoint, an LLC can issue two basic types of membership interests: capital interests and profits interests. A capital interest is an interest in a partnership or LLC taxed as a partnership that entitles the recipient to share immediately in the proceeds of liquidation. A capital interest normally results from a capital investment and provides recipients with participation in current and future equity value, a share of income, and distributions. When someone receives a capital interest in an LLC in exchange for a corresponding capital contribution, this is typically a tax-free event. When someone receives a capital interest in exchange for services, this is taxable compensation to the service provider.

Profits interests are distinct from capital interests, providing no current right to share in the proceeds of liquidation as of the date of grant. Instead, they typically only provide a holder with the right to share in those profits of the business that arise after the recipient acquires the interest. The primary goal of issuing profits interests is typically to give a service provider the ability to participate in the growth of the enterprise without incurring tax on the receipt of the interest, and to enjoy at least some long-term capital gain treatment (instead of ordinary income treatment) on proceeds they receive on a sale of the LLC or similar liquidity event.

Structuring a Profits Interests

Usually, as long as the profits interest is structured properly and capital accounts are booked up on entrance of the profits interest member, the IRS should not treat the grant of a vested or unvested profits interest as a taxable event. Most practitioners design profits interests so that they meet IRS safe harbor standards for ensuring profits interest treatment. These standards include:

The profits interest must not relate to a substantially certain and predictable stream of income from the entity’s assets, such as income from high quality debt securities or a net lease,
The recipient of the profits interest must not dispose of it within two years of receipt, and
The profits interest may not be a limited partnership interest in a publically traded partnership.

The issuing entity’s partnership or operating agreement should be closely examined upon the issuance of a profits interest. Things to consider with respect to newly issued profits interests include whether such recipients should have voting rights similar to that of members who contributed capital to the enterprise. Additionally, the agreement should be updated to clearly define how the profits interests will be valued relative to capital interests under current buy-out or redemption provisions. Oftentimes, practitioners ensure that a profits interest has no right to share in liquidation proceeds on the grant date by valuing the company as of that date, and providing that a profits interest holder will not share in distributions except to the extent a threshold established based on the value is exceeded. Also, booking up capital accounts is generally critical to ensuring that the profits interest does not entitle the recipient to any proceeds of liquidation if the entity was liquidated on the grant date.

To the extent the profits interest issued is unvested at the time of issuance, most practitioners opt to make an 83(b) election to ensure tax-free treatment upon receipt. When a profits interest is issued, it has no value. If the profits interest is vested, there is no question that it is taxed at the time of receipt, at $0. Unvested property is taxed at the time of vesting, on the property’s value at the time of vesting. Hence, if the profits interest has appreciated in value since the time of grant, then there would be ordinary income at the time of vesting. To avoid this treatment, recipients of profits interests can make an 83(b) election, which is an election to treat the profits interest as vested for tax purposes at the time of grant and to be taxed on the value of the profits interest at the time of grant. There is some IRS guidance that states that an 83(b) election is not necessary. However, that issue is beyond the scope of this article and a so-called “protective 83(b) election” is usually still made to assist in easing the minds of profits interest holders who want to ensure that the interest is not taxable when it vests.

Tax Consequences of a Profits Interest

The recipient of a properly structured profits interest is not taxed on receipt because the IRS views the profits interest’s value as $0. Because the profits interest is treated as having no value, there is no deduction that corresponds to the issuance of the profits interest for the entity. The profits interest will be treated as having a $0 basis, and no capital account. Going forward, the recipient should be treated as an equity owner under the terms of the governing partnership or operating agreement for the entity starting on the date on which the profits interest was granted. The recipient should receive a K-1 and pay taxes on income that is passed through from the entity. Capital accounts should be adjusted accordingly, just as is the case for any other member.

The Future of Profits Interests

The history of how profits interests are taxed is riddled with controversy. In addition, politicians continue to discuss the desirability of profits interests (also sometimes called “carried interests”), in the context of private equity and hedge funds. However, the foregoing analysis reflects the IRS’ stated position on profits interests based on several Revenue Procedures that were issued to address the topic pending additional guidance. Until the IRS or Department of Treasury issues additional guidance, the current rules will generally remain applicable to small businesses and startups who are issuing profits interests.

Overall, profits interests are a unique and creative way to give people who are rendering services to the LLC or partnership a stake in the enterprise. They can generally be viewed as similar to options, except that they also provide the holder with a stake in the losses of the entity. With the increasing use of LLCs for startup operations, the use of profits interests as an incentive compensation mechanism has grown in the past years.

ARTICLE BY Katie K. Wilbur of Varnum LLP

The Effect of “Brexit” on Tax-Qualified Plans

The decision by British voters in a June 23, 2016 referendum to leave the European Union has significantly affected both the equity and debt segments of international financial markets. As with other market dislocations, the decision has also affected US tax-qualified plans, since they invest in those markets as a source of funding and use corporate bond rates for a variety of derivative purposes. The effects differ, however, between defined benefit (DB) and defined contribution (DC) plans.

Potential Effects of Brexit on DB Plans

In the case of DB plans, Brexit potentially has implications for funding levels, lump sum payments, Pension Benefit Guaranty Corporation (PBGC) premiums, and financial accounting results—all of which are the responsibility of the plan sponsor (rather than participants).

Specifically, the vote has triggered a decline in interest rates—including corporate bond rates—that may have at least a short-term adverse effect on the funded status of many DB plans, since (i) corporate bond rates are the proxy used to determine the present value of liabilities for minimum funding purposes, and (ii) a decrease in rates triggers an increase in liabilities (present value inversely goes up as interest rates go down).

This effect will be mitigated somewhat, however, since DB plans generally can use a 25-year average of interest rates (with a 90% floor) for funding purposes, which tends to “smooth out” periodic spikes like Brexit. Still, if interest rates (which are already at historically low levels) decline further or continue to be depressed by the aftershocks of Brexit, more headwinds for DB plans seeking to improve their funded status will be created.

By contrast, DB plans must use a market rate of interest—that is, without “smoothing”—for lump sum, PBGC variable premium, and financial accounting purposes. As a result, any downward trajectory of interest rates triggered by Brexit will more directly affect DB plans for these three purposes. Thus, for example, the dollar amount of lump sums paid to employees will increase as rates fall (that is, lump sum present values grow inversely to interest rates).

This effect on the calculation of lump sum payments may be delayed somewhat, since most plans use a “look back” date for the related interest rates (such as the rate in effect two months before the start of the plan year in which the lump sum was paid). Nevertheless, if interest rates stay low or decline, these lower rates ultimately will roll into effect for lump sum calculation purposes. Plan sponsors that are otherwise so inclined may view this as an impetus to offer lump sum windows or annuity buyouts—sooner rather than later (and before any lower interest rates roll into effect). This is especially true of annuity buyouts, since insurance companies tend to use rates for premium calculations that are even more conservative (i.e., lower) than the corporate bond rates used under ERISA.

Similarly, the PBGC variable rate premium is essentially determined using the same rate as is used for lump sums, but without a lag. This will increase the liabilities that form the basis for determining the amount of the variable premium.

Finally, the use of spot fixed income rates for financial accounting purposes will have an adverse effect on a company’s balance sheet to the extent they trigger an increase in reportable plan liabilities. The impact will be much more pronounced than is the case with minimum funding considerations, since the use of spot rates does not allow the impact of currently falling rates to be offset by the prior year increases used in a “smoothing” approach.

Potential Effects of Brexit on DC Plans

In the case of DC plans, participants generally bear the primary risk (and reward) of their investment choices, as allowed by ERISA Section 404(c). Thus, they will bear the risk of both declining bond prices and more volatile financial markets generally. Plan fiduciaries may want to consider alerting participants to the issues raised by Brexit, the possible impact on plan investments, the advisability of staying the course in turbulent markets, diversification considerations, and any other Brexit-related issues relevant to participation in the DC plan, but should be careful to avoid providing specific investment recommendations or advice that may be subject to ERISA’s fiduciary obligations.

Conclusion

In the case of both DB and DC plans, the fiduciary responsible for selecting investments (such as an investment committee) should continue to monitor developments in the financial markets and react as appropriate, in light of the plan’s investment policy statement and the general fiduciary requirements of ERISA. Federal courts and the US Department of Labor have consistently stated that ERISA fiduciaries are not held to a standard of omniscience, but they are required to exercise “procedural prudence” in selecting and monitoring plan investments. This sort of prudence would include adhering to the processes and other mandates established in the fiduciary’s charter or other governing document.

How Will the Exit of the United Kingdom from the European Union (“Brexit”) Affect U.S. Corporations Doing Business in the UK?

On June 23, 2016, the UK voted in a referendum to leave the EU. The UK government will now initiate the procedure under Article 50 of the Lisbon Treaty leading to the UK’s withdrawal from the EU. The UK will be immediately excluded from the European Council and the Council of Ministers, and a negotiation period of two years will commence during which the terms of its withdrawal and of its future relationship with the EU will be determined. No member state has initiated this procedure before, and so it is impossible to predict what this future relationship will be. Furthermore, the UK’s relationships with non-EU states will have to be independently reestablished, as it will no longer be entitled to rely on the bilateral treaties with those states it enjoyed whilst an EU member state.

This Client Alert will focus on the likely impact of Brexit on the laws of the UK influencing key business areas for U.S. corporations doing business in the UK.

M&A

The UK Companies Act 2006, which embodies UK law as it relates to both public and private companies, has been significantly influenced by EU directives, however, it is highly unlikely that Brexit will result in any changes to UK company law, so the basic mechanics of acquisitions and disposals of UK companies will remain the same. The vast majority of M&A transactions in Europe take place between private companies, either by means of an acquisition of shares or of assets, and Brexit will not affect the laws governing such transactions.

The EU Takeover Directive harmonises public company takeovers in the EU and is modelled on the UK Takeover Code, which regulates takeovers of public limited companies in the UK. Brexit is therefore unlikely to have any significant impact on takeovers.

The EU Cross-Border Mergers Directive enables a private or public company in one EU member state to merge with a company in another member state. Brexit means that UK companies will cease to benefit from this regime.

Brexit may possibly affect competition law in the longer term. Currently anti-competitive agreements and abuses of dominant positions in the UK are policed by the Competition and Markets Authority under laws and procedures which mirror EU regulations. In the case of mergers, however, larger transactions are dealt with by the European Commission on a “one-stop-shop” basis to save the parties having to file in several states. Brexit could lead to a decoupling of UK competition law from that of the EU and the end of the “one-stop-shop,” at least for UK mergers.

Commercial Contracts

Existing contracts which continue beyond Brexit could be affected in a number of ways, for example:

Depending on how the contract is drafted, Brexit might constitute a “material adverse change,” entitling the parties to terminate;
Provisions which have EU territorial scope, such as restrictive covenants or exclusive sales rights, will no longer include the UK;
If import duties are imposed as a result of Brexit, contractual pricing mechanisms may operate to shift the burden of such additional costs onto one of the parties making performance more costly.

New contracts should take such matters into account, and now that Brexit is a reality, parties should negotiate how its consequences will be dealt with and who bears the risk.

Debt and Equity Financing

Similar considerations apply to financing transactions on Brexit as apply to M&A deals and commercial contracts. Generally the effect on such transactions will be insignificant.

In the case of loan facility documents, EU territorial clauses may be affected by the UK’s departure from the EU, and Brexit may trigger an event of default in the case of particularly harsh “material adverse change” provisions. The imposition of tariffs and duties and the consequences of market disruption as a result of Brexit might lead to lenders passing on increased costs to borrowers. Brexit might also cause a UK borrower to make an inadvertent misrepresentation (for example, that it is in compliance with EU laws and regulations). It is difficult to see how Brexit would prejudice English law security taken under a security document (with the one exception of intellectual property rights – see below).

Equity financing documents, such as placing and underwriting agreements and prospectuses, will be similarly affected. In addition, the possible loss of the “passporting” regime for the sale and distribution of securities throughout the European Economic Area (EEA) would adversely affect fundraising outside the UK. On an IPO or bond issue, issuers should consider a Brexit-related risk factor disclosure in their prospectuses, especially if their business is likely to be adversely affected by Brexit.

Funds and Asset Management

Brexit could have potentially significant adverse consequences for funds and asset managers in the UK.

Initially, UK fund managers will be treated as non-EEA alternative investment fund managers and lose their managing and marketing passports into the EU. Currently, thanks to the “passport” regime, under the Alternative Investment Funds Management Directive (AIFMD), both UK and non-UK funds can be managed by UK-regulated fund managers operating out of the UK, and such fund managers can market and distribute the fund throughout the EU. Such fund managers will cease to qualify for a passport on Brexit. Under current rules, they could only market such funds as alternative investment funds to EEA investors under local private placement arrangements, if applicable.

Also, as undertakings for collective investment in transferable securities (UCITS) must be EU domiciled and managed by an EU management company, Brexit could be potentially disastrous for a UK-domiciled UCITS fund.

UCITS funds are subject to strict investment rules, including a maximum investment of 30 percent of their assets in non-UCITS collective investment schemes. Brexit will result in many such funds having to alter their investment mandates to take account of the UK no longer being a member of the EU. Similarly, even non-UCITS funds, whose investment policies are to invest in EU securities, will have to readjust their portfolio investments in UK companies or amend their policies.

Employment

The vast majority of UK employment law is “home grown,” such as protection against unfair dismissal, the right to a payment on redundancy, protection against sex, race, nationality, ethnic origin and disability discrimination, and the right to a minimum wage. EU directives have contributed to UK employment law in areas such as the protection of employment rights on the transfer of undertakings, the obligation to consult with employees in the case of mass redundancies, working time limits and minimum holiday pay.

These EU-derived employment laws have become so integral to UK employment law that it is unlikely that Brexit will affect them.

In fact, previous UK governments have tended to “gold plate” EU directives and regulations (for example, the Working Time Directive allows full-time employees 20 days of paid annual leave, but the UK application of that law allows 28 days). It is possible that, outside the EU, a future UK government will review certain aspects of the legislation which have not sat well with UK businesses since their inception, including in particular, the weekly limit on working hours, regulations relating to agency workers and work councils and even those in respect of collective consultation with employees in general.

As in the case of commercial contracts, employment agreements with EU territorial scope may be affected (for example, in the case of covenants not to compete or solicit customers or employees in the EU after termination of employment).

Brexit may deny the UK access to the “single market” of the EU, including the right of free movement of workers between the UK and the remaining EU member states. This will adversely affect the ability of UK companies to manage a cross-border skilled and experienced workforce.

Trade

Many UK trade laws derive from EU law such as the following:

Product safety
Consumer protection
Laws on unfair contracts
The rights of commercial agents
On-line shopping
Payment services
Laws on hazardous chemicals
Certification of electrical and medical devices

Most of these laws have become enshrined in UK law for many years and are unlikely to be affected by Brexit. However some, which derive from secondary legislation, would lapse unless a post-Brexit government were to preserve them (for example, the regulations governing consumer protection from unfair trading, general product safety, and consumer contracts in respect of “distance” sales of goods and services to consumers).

The withdrawal of the UK from the EU “single market” could entail import duties on the export of products and services from the UK to the EU. Also institutions, such as banks, trading companies and professional firms, such as lawyers and accountants, would cease to enjoy the single market in the provision of services, which could lead to the restructuring or even relocation of their EU-based offices.

Intellectual Property

As one of the largest creators of intellectual property in the EU, the UK and its entrepreneurial innovators could be significantly affected by Brexit.

The Community Trade Mark would cease to apply in the UK. This would require trade marks to be registered both in the UK and as CTMs, incurring additional costs and potentially adversely affecting existing trade mark licenses and security over trade marks.

Currently UK patents are protected and registered under UK legislation, and so Brexit will not affect them (or European patents designating the UK). From 2017, a new EU patent system, the Unitary Patent, is scheduled to be launched, with its new court, the Unified Patents Court, expected to take its seat in London. Brexit would exclude UK patents from this unified system, and London will lose its new court.

Data Protection

The UK law on data protection is based on EU law but dates back to 1998, and so it is unlikely to be significantly affected by Brexit. There are current EU proposals to strengthen the law under the General Data Protection Regulation, and it is likely that the UK will now adopt this.

Post-Brexit cross-border transfers of personal data to the UK are unlikely to be automatically permissible from EU member states. The UK would have to apply to the European Commission for a decision that its data protection standards are adequate to protect the privacy of EU residents (which means the EU standards would have to be met in any event). In the recent case of Schrems, the European Court of Justice held that the United States had not complied with European data protection standards (as Facebook had allegedly transferred consumers’ data to the NSA) and abolished the “safe harbour” rules which had hitherto permitted such transfers from the EU to the United States. If the EC were to deny or restrict the terms of its adequacy decision, the UK could find itself in a similar position to that of the United States after Brexit, which could seriously adversely affect technology providers with UK-based data centres offering services to EU clients.

Conclusion

The legal consequences of Brexit are difficult to quantify. Much will depend on the exit terms negotiated between the UK and the remaining EU member states and the status of the continuing relationship between the UK and the EU after Brexit. Such matters will not be known for at least two years. In the interim the status quo will survive.

ARTICLE BY Jonathan Maude, Richard L. Thomas & Sam Tyfield of Vedder Price

Congress Just Says No—to Banking Services for Marijuana Businesses

Yet another attempt has failed to pass legislation shielding banks that provide services to marijuana-related businesses from regulatory action or other penalties. Late last week, the US House of Representatives appeared likely to approve an amendment to the House Financial Services and General Government appropriations bill (the Amendment) that would prevent financial institutions from being penalized if they provided services to state-sanctioned marijuana-related businesses. A similar amendment had already been approved by the Senate Appropriations Committee and appeared likely to be approved by the US Senate.

Under recently passed procedures, the House Committee on Rules must approve all amendments to appropriations bills. On June 20, Representative Denny Heck (D-WA) and Representative Ed Perlmutter (D-CO) filed the bipartisan Amendment with the Committee on Rules. They emphasized that, without banking services, marijuana businesses are forced to conduct business and pay salaries in cash, which increases the risk of money laundering and theft. The Committee on Rules declined to consider the Amendment for a vote, effectively blocking it from further consideration in connection with the appropriations bill.

The Amendment is the latest effort by members of Congress to bring some certainty to banks that wish to provide banking services for marijuana-related businesses. Although both the US Department of Justice and the Financial Crimes Enforcement Network have provided guidance that allows banks to provide services to legal marijuana businesses, marijuana is still illegal under federal law, and banks have been reluctant to rely on such guidance, which they generally have concluded provides insufficient regulatory and law enforcement certainty.

Although marijuana businesses that seek traditional banking services will not see any relief in the current appropriations process, a number of bills that have been introduced in the Senate and House remain that would offer clarity for banks that wish to offer banking services to marijuana businesses. Even though none of those bills have passed the initial stages of the legislative process, these efforts, which are generally bipartisan in nature, are expected to continue and may at some point be successful. In any event, the legal marijuana industry is expected to continue to grow, and more states are likely to authorize recreational and medical use of marijuana. Meanwhile, the issue of providing legal certainty to banks that wish to offer banking services to marijuana business will continue to be debated.

ARTICLE BY Melissa R. H. Hall of Morgan, Lewis & Bockius LLP

Attorneys Facing An Uphill Battle In Litigation Should Consider Option Value When Arguing Valuation

Let me tell you a sad story; Joe owned a marketing company and earned a prosperous living for several years. Joe’s business was growing rapidly and all seemed right with the world. Then a trusted employee left Joe’s firm, taking with him half of Joe’s customers in violation of his non-compete agreement. Joe’s business slowly suffered and lost customers until eventually his firm declared bankruptcy.

Joe sued his former employee and asked for damages related to the value of his firm. Joe’s attorney argued to the court for compensation based on the value of Joe’s firm that was destroyed by the employee. Yet the attorney left out one critical question when arguing the case; how should the law account for the fact that Joe’s business was growing rapidly until the employee left?

Perhaps Joe had several big accounts that he might have been able to sign had the employee not engaged in unfair trade practices. Without taking these factors into account, Joe’s attorney is under-representing the value of Joe’s claim and leaving compensation on the table for no reason.

In finance, this idea of the possibilities that could plausibly occur in the future is called an embedded option or a real option and it is extremely useful in a variety of cases from divorce proceedings and business bankruptcies to merger disputes and matters of economic harm. In the scenario above, Joe’s firm had the ability to potentially continue to grow and become even more successful than it was at the time before Joe’s employee left. Hence the damage done to Joe is greater than simply the lost historical value of the firm. He has also lost the possibility of much more value in the future.

The crux of modern asset valuation is based on a concept called the time value of money. Essentially the idea is that because money received in the future is worth less than money received today, we can value assets or a business based on their associated cash flows and an appropriate discount rate. This approach forms the basis of everything from stock valuation on Wall Street to proper methods for computing interest rates in bankruptcy. This facet of valuation is well understood. But what about the future opportunities or chances of cash flows that are uncertain? That’s what embedded options address.

The concept of embedded options might seem abstract or even too nebulous for many judges to buy into in a court case, but the reality is that real options have significant value and are often a subject of serious financial negotiations. Particularly for small firms, real options are often important and serve as the basis for various types of convertible debt and warrant grants.

As a finance professor and frequent consultant to companies on matters of asset valuation and financial forecasting, I have long taken it for granted that the techniques used in the finance profession were well understood and universally applied across many other industries including the law. I was very surprised to learn when I started doing expert consulting work, this is not the case. Lawyers often neglect to ask for damages based on real options in their cases. This leaves an important tool out of the litigation toolbox.

In discussing real options thus far, it might seem like they are primarily useful for parties alleging damages, yet they can also be useful for defendants as well. In particular, defendants need to understand how real options are valued and also understand the four appropriate metrics for calculating economic harm as it relates to options (compensating variation, equivalent variation, Paasche indices, and Laspeyres indices). I’ll talk more about these in a future column though.

When valuing real options, there are various statistical techniques that can be used. The math is not necessarily important here, but the concepts are. Essentially, real options increase in value in situations where there is greater uncertainty, and when interest rates in the broader economy rise. Those conditions make real options an exciting tool in today’s courts. With the Fed finally starting to raise interest rates, real options should become marginally more valuable. More importantly, situations with significant amounts of uncertainty lead to greater volatility in intrinsic asset prices.

These volatile situations are often the very situations that lead to court cases for attorneys – a business deal that went wrong leads to a bankruptcy but could have led to a hugely successful company, a merger agreement could result in substantial cost savings for both firms or substantial value destruction for investors and is being challenged by shareholders, a wrongful death case for an individual in the prime of their lives leaves so many possible futures unexplored. Thanks to new statistical techniques and greater computing power, these situations and others can be effectively modeled through computer simulations and valued by economists in ways that would have been unimaginable a decade ago.

Representing clients fairly and to the best of one’s ability in court is the foremost duty of an attorney. To do that, attorneys need to understand the tools of business and the cutting-edge techniques being used in asset valuation. Failing to use these tools is not only a disservice to clients, but a severe hindrance to the attorney as well. In a competitive legal market, the Joes of the world will flock to those attorneys that free themselves to position their clients for maximum success in court.

Article By Dr. Michael McDonald of Fairfield University Dolan School of Business

Exclusive Study Analyzes 2015 IPOs

Proskauer’s Global Capital Markets Group presents the third annual IPO Study, a comprehensive analysis of U.S.-listed initial public offerings in 2015 and identification of three-year comparisons and trends of U.S.-listed initial public offerings over the same period.

The study examines 90 U.S.-listed 2015 IPOs with a minimum initial deal size of $50 million, and includes industry analysis on health care; technology, media & telecommunications; energy & power; financial services; industrials and consumer/retail. The study also includes a focus on foreign private issuers. It also makes year-over-year comparisons of extensive data about deal structures and terms, SEC comments and timing, financial profiles, accounting disclosures, corporate governance and deal expenses.

Underlying the study is the global Capital Markets Group’s proprietary IPO database, which is a valuable resource for sponsors and companies considering an IPO as well as for IPO market participants and their advisors.

Download Proskauer’s 2016 IPO Study

Article By Frank Lopez of Proskauer Rose LLP

Private Email Woes Infect The Private Sector in Delaware

email Vice Chancellor J. Travis Laster’s ruling in Amalgamated Bank v. Yahoo!, Inc., C.A. No. 10774-VCL (Del. Ch. Feb. 2, 2016) should sound a tocsin to directors that their “private” emails may not be so private. The ruling addressed Amalgamated Bank’s demand to inspect the books and records of Yahoo! pursuant to Section 220 of the Delaware General Corporation Law. The bank sought to inspect, among other things, documents that reflect discussions or decisions of Yahoo’s full Board or Committee. Documents covered by the demand included emails to and from the directors, from management or the compensation consultant, emails among the directors themselves, and documents and communications prepared by Yahoo officers and employees about the Board‘s deliberations.

Vice Chancellor Laster found that emails were records subject to inspection under Section 220 and that through Delaware’s jurisdiction over a corporation, a court can compel production of documents in the possession of officers, directors, and managing agents of the firm. According to the Vice Chancellor, the court can impose sanctions or other consequences on the firm if the officer, director, or managing agent fails to comply. He further noted that if a personal email account was used to conduct corporate business, the email is subject to production under Section 220. Directors and corporate officers should therefore take heed that emails concerning corporate business may be subject to disclosure even if conducted using a private email address.

Article By Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP

Tax Talk: When Reporting Gifts at Discounted Values, a Qualified Appraisal is Crucial

A common method for transferring wealth from one generation to the next involves contributing assets to a partnership or limited liability company, then transferring minority interests in the partnership or LLC to descendants or other family members. Done correctly, the technique allows donors to reduce their taxable estates by making gifts at reduced values, because of discounts for lack of control and lack of marketability. In so doing, the donor also effectively shifts the tax on any appreciation of the underlying assets to the younger generation.

In order to benefit from this estate planning technique, however, it is crucial that the gift is adequately disclosed on a gift tax return and its value backed by a qualified appraisal or a detailed description of the method used to determine the fair market value of the transferred partnership or LLC interest. Unfortunately, we have encountered situations recently in which a gift was not supported by a qualified appraisal, leading the Internal Revenue Service to challenge the value claimed by the donor and to propose additional gift tax, penalties and interest. Such challenges can lead to significant uncertainty, stress and legal expense—even if the donor’s valuation ultimately is sustained.

This article describes what constitutes a qualified appraisal and the information that is necessary if no appraisal is provided, and offers some practical advice for donors based on our recent experiences dealing with the IRS in audits and administrative appeals involving disputed gift tax valuations.

IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, requires donors to disclose whether the value of any gift reflects a valuation discount and, if so, to attach an explanation. If the discount is for “lack of marketability, a minority interest, a fractional interest in real estate, blockage, market absorption, or for any other reason,” the explanation must show the amount of, and the basis for, the claimed discounts. Moreover, in order for the statute of limitations to begin running with respect to a gift, the gift must be adequately disclosed on a return or statement for the year of the gift that includes all of the following:

A complete Form 709;
A description of the transferred property and the consideration, if any, received by the donor;
The identify of, and relationship between, the donor and each donee;
If the property is transferred in trust, the employer identification number of the trust and a brief description of its terms (or a copy of the trust);
A statement describing any position taken on the gift tax return that is contrary to any proposed, temporary or final Treasury regulations or IRS revenue rulings; and
Either a qualified appraisal or a detailed description of the method used to determine the fair market value of the gift.

While most of these requirements are straightforward, the last generally requires the donor to provide a more complete explanation. Fortunately, the IRS has published regulations that describe what constitutes a qualified appraisal and what information must be provided in lieu of an appraisal.

With respect to the latter, the description of the method used to determine fair market value must include the financial data used to determine the value of the interest, any restrictions on the transferred property that were considered in determining its value, and a description of any discounts claimed in valuing the property. If the transfer involves an interest in a non-publicly traded partnership (including an LLC), a description must be provided of any discount claimed in valuing the entity or any assets owned by the entity. Further, if the value of the entity is based on the net value of its assets, a statement must be provided regarding the fair market value of 100% of the entity (determined without regard to any discounts in valuing the entity or any assets owned by the entity), the portion of the entity subject to the transfer, and the fair market value of the transferred interest as reported on the return.^[1]

Donors and their counsel will rarely have the expertise needed to provide such a description. While it may be relatively simple to provide some of the factual information, determining the appropriate actuarial factors and discount rates is a highly complex and specialized field. Moreover, even if a donor or his or her counsel happened to have the relevant expertise, a description that is not prepared by an independent expert may be viewed suspiciously by the IRS because of a lack of impartiality. Moreover, if the description (or the appraisal, for that matter) is prepared by the donor’s counsel, it may negate the attorney-client privilege, at least with respect to any work papers prepared by the attorney in connection with the description or appraisal.

For these reasons and others, we strongly recommend that donors obtain an appraisal from an independent, reputable valuation firm before claiming discounts with respect to a gift of a partnership or LLC interest. The applicable Treasury regulations provide that the requirement described above will be satisfied if, in lieu of submitting a detailed description of the method used to determine the fair market value of the transferred interest, the donor submits an appraisal of the transferred property prepared by an appraiser who meets all of the following requirements:

The appraiser holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis;
Because of the appraiser’s qualifications, as described in the appraisal that details the appraiser’s background, experience, education, and membership, if any, in professional appraisal associations, the appraiser is qualified to make appraisals of the type of property being valued; and
The appraiser is not the donor or the donee of the property or a member of the family of the donor or donee or any person employed by the donor, the donee or a member of the family of either.

Further, the appraisal itself must contain all of the following:

The date of the transfer, the date on which the transferred property was appraised, and the purpose of the appraisal;
A description of the property;
A description of the appraisal process employed;
A description of the assumptions, hypothetical conditions, and any limiting conditions and restrictions on the transferred property that affect the analyses, opinions and conclusions;
The information considered in determining the appraised value, including, in the case of an ownership interest in a business, all financial data used in determining the value of the interest that is sufficiently detailed to allow another person to replicate the process and arrive at the appraised value;
The appraisal procedures followed, and the reasoning that supports the analyses, opinions, and conclusions;
The valuation method used, the rationale for the valuation method and the procedure used in determining the fair market value of the asset transferred; and
The specific basis for the valuation, such as specific comparable sales or transactions, sales of similar interests, asset-based approaches, merger-acquisition transactions and the like.^[2]

While there is no firm rule on when or how often appraisals must be obtained, appraisals that are more than a year old may be less reliable—particularly if there is good reason to believe that the value of the underlying assets has changed—and thus more vulnerable to challenge.

An appraisal that meets all of the requirements described above is not unassailable, of course, but if the IRS does choose to challenge a gift tax valuation that is supported by such an appraisal, the donor will be in a significantly stronger position in the resulting examination or proceeding than a donor who failed to obtain a qualified appraisal or opted to rely on a stale appraisal.

In sum, obtaining a qualified appraisal is a crucial step in any estate planning or gifting strategy that involves making gifts of assets valued at a discount. Although donors may occasionally balk at the time and expense of preparing a reliable appraisal, it is almost certainly less time-consuming and costly than battling the IRS in an examination, administrative appeal or in litigation and should give donors confidence that their gifts are unlikely to be successfully challenged by the IRS.

Article By Ivan H. Gold of Schiff Hardin LLP

_{[1] Treas. Reg. § 301.6501(c)-1(f)(2)(iv).}

_{[2] Treas. Reg. § 301.6501(c)-1(f)(3).}

Proxy Advisory Firms Release Policy Updates for 2016

Institutional Shareholder Services (ISS) and Glass Lewis, two leading proxy advisory firms, recently published their 2016 proxy voting guidelines, which include updates applicable to the 2016 proxy season.

Institutional Shareholder Services

Key policy updates for US companies reflected in ISS’s 2016 proxy voting guidelines include:

Overboarding: Beginning in 2017, ISS will issue negative vote recommendations for non-CEO directors who sit on more than five public company boards (down from six under the current policy). For CEOs, the outside directorship limit will remain at two. In 2016, ISS will note in its analysis whether a director is serving on more than five public company boards.

Unilateral Board Actions: For established public companies, ISS will continue its policy of generally recommending that shareholders withhold votes (in uncontested elections) from directors who have unilaterally adopted a classified board structure, implemented supermajority vote requirements to amend the bylaws or charter or otherwise adopted charter or bylaw amendments that diminish the rights of shareholders. The negative recommendation would continue in subsequent years until the unilateral action is reversed or approved by stockholders. For newly public companies that have taken action to diminish shareholder rights prior to or in connection with an IPO, directors may be subject to negative vote recommendations under the updated policy, determined on a case-by-case basis (with significant weight given to shareholders’ ability to change the governance structure in the future through a simple majority vote and their ability to hold directors accountable through annual director elections).

Compensation of Externally Managed Issuers: The updated “Problematic Pay Practice” policy provides that an externally managed issuer’s failure to provide sufficient disclosure for shareholders to reasonably assess the compensation practices and payments made to executive officers on the part of the external manager will be deemed a problematic pay practice, and will generally warrant a recommendation to vote against the issuer’s “say-on-pay” proposal.

For a complete overview of the 2016 updates to ISS’s proxy voting guidelines, click here. ISS also recently updated both its Equity Plan Scorecard frequently asked questions (FAQs) and QuickScore 3.0. The updated 2016 US Equity Plan Scorecard FAQs, effective for meetings on or after February 1, 2016, can be found here, and QuickScore 3.0 can be found here.

Glass Lewis

Significant policy updates to Glass Lewis’s 2016 proxy season guidelines include:

Conflicting Management and Shareholder Proposals: Going forward, Glass Lewis will consider the following factors when it is analyzing and determining whether to support conflicting management and shareholder proposals: (1) the nature of the underlying issue; (2) the benefit to the shareholders from implementation of the proposal; (3) the materiality of the differences between the management and shareholder proposals; (4) the appropriateness of the provisions in light of the company’s shareholder base, corporate structure and other relevant circumstances; and (5) a company’s overall governance profile and, specifically, its responsiveness to previous shareholder proposals and its adoption of “progressive” shareholder rights provisions.

Exclusive Forum Provisions: Glass Lewis will no longer automatically recommend a “withhold” vote against the chairman of the nominating and corporate governance committee of a company that adopts exclusive forum provisions in connection with its initial public offering. Instead Glass Lewis will weigh exclusive forum provisions in a newly public company’s governing documents with other provisions that Glass Lewis believes unduly limit shareholder rights (e.g., supermajority vote requirements, classified board and/or a fee shifting bylaw). Glass Lewis will continue, however, to recommend voting against the chairman of the nominating and corporate governance committee when a company adopts an exclusive forum provision without shareholder approval outside of an IPO, merger or spin-off.

Nominating Committee Performance: Glass Lewis may consider recommending shareholders vote against the chair of the nominating committee where the board’s failure to ensure the board has directors with relevant experience––either through periodic director assessment or board refreshment––has contributed to a company’s poor performance. Notably, Glass Lewis does not define “poor performance.”

Overboarding: Beginning in 2017, consistent with ISS’s policy update described above, Glass Lewis will generally recommend voting against (1) any director who serves on more than five public company boards and (2) any executive officer of a public company who serves on a total of more than two public company boards. Like ISS, during 2016, Glass Lewis may note a concern where a director serves on (x) more than five total boards for directors who are not also executives, and (y) more than two boards for a director who serves as an executive officer of a public company.

For a complete overview of Glass Lewis’s 2016 proxy voting guidelines, click here.

Article By Jonathan D. Weiner, Mark J. Reyes & Andrew S. Herrington-Gilmore of Katten Muchin Rosenman LLP

Category: Corporate law

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