Category: Corporate law

NetSpend: Delaware Chancery Criticizes Single-Buyer Negotiating, Use of DADW & Revlon Process, But Denies Injunction

GT Law

In a nutshell, plaintiff’s motion to enjoin Total System Services’s $16 per share/$1.4 billion (cash) acquisition of Netspend Holdings was denied because the balance of the equities tipped in favor of the defendants (i.e., the court’s perceived risk to the target’s stockholders of a deal that might fail in the face of a MAC or breach when it was the only deal on the table) even though Vice Chancellor Glasscock concluded that it was reasonably likely that at trial the plaintiff would successfully establish that the Netspend board did not conduct a reasonable Revlon value maximizing process.

The key facts and observations in the case included, among others:

– A single-buyer negotiating strategy employed by the Netspend Board with no formal pre-sign check (although a go-shop was asked for several times in the negotiations and repeatedly rejected by the buyer, the repeated asks appear to have helped obtain the $16 per share price.

– An unaffected 45% premium without giving effect to an immediate pre-sign, positive earnings release by Netspend).

– Netspend had prior bad experience with collapsed sale processes and, therefore, it was queasy about undertaking another formal or elongated process.

– Netspend was not “for sale” and responded to Total System’s initial IOI and commenced discussions mainly because Netspend’s 31% stockholder and 16% stockholder wanted to exit an illiquid and volatile stock (Netspend was content to execute management’s stand-alone operating strategy absent a compelling price).

– Appraisal rights are available under DGCL 262; Vice Chancellor Glasscock questioned whether Netspend’s directors had a “reliable body of evidence” and “impeccable knowledge” of the company’s intrinsic value in the absence of a pre-sign market check and despite Netspend’s prior failed sale processes some years before.

– The fairness opinion obtained by the Netspend board was “weak” under all of the circumstances (putting more pressure on the directors’ understanding of the company’s intrinsic value).

– No interloper surfaced even after the transaction litigation delays (putting maximum pressure on plaintiff’s demand for an injunction); the deal protection package was pretty plain vanilla (the break up fee was in the “northern sector” of the range at 3.9% of total equity value, but certainly not preclusive or coercive; matching rights and other buyer protections were customary).

– A reasonable arms-length negotiating strategy was employed to obtain the $16 per share.

– Netspend’s CEO (who led the negotiations with appropriate Board participation and oversight) was not conflicted (in fact, he was found to be aligned with the non-affiliate stockholders in several respects).

– The nominees of Netspend’s 31% stockholder and 16% stockholder constituted a majority of the Netspend Board (but Vice Chancellor Glasscock found that their interests were aligned with the non-affiliate shareholders).

– Two private equity firms had conducted diligence and looked at buying a significant stake in the company from Netspend’s 31% stockholder and 16% stockholder at a materially lower price than Total System’s initial (and final) bid, but they never indicated a desire to buy 100% of Netspend.

– The support agreements entered into between Total Systems and each of the two large stockholders were coterminous with the merger agreement (but were not terminable upon the Netspend Board’s withdrawal of its declaration of advisability of the merger agreement).

In a noteworthy passage, Vice Chancellor Glasscock faulted the decision of the Netspend Board not to waive the “don’t ask-don’t waive” clauses in the confi-standstills with the two private equity firms at the time discussions commenced with Total Systems and, in the case of any post-sign unsolicited “superior offers” that might arise, he noted the ineffectual fiduciary out to the no-shop covenant in the merger agreement which required Netspend to enforce and not waive pre-existing standstills (thus, the private equity firms were precluded from lobbing in a post-sign jumping bid).

Vice Chancellor Glasscock refers to Vice Chancellor Laster’s In re Genomics decision and to Chancellor Strine’s decision in In re Ancestry pointing up, again, the Court’s sensitivity to, and the highly contextual nature of, DADW provisions in pre-sign confi-standstill agreements and perhaps further underscoring the distinction between using a DADW in a single-buyer negotiating strategy vis a via using one in a formal auction setting or where a full pre-sign market check is conducted.

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Weighing Going Private or Sale to Carl Icahn, Dell Cuts off Info

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As Dell Inc. considers its future after a massive loss in value over the past decade, the question may fundamentally be this: are the company’s problems are the result of poor leadership or a relatively straightforward matter of shedding its stock obligations?

Two proposals are on the table. First, founder Michael Dell has proposed taking the company private by buying out the company’s stock for $24.4 billion through a private equity firm called Silver Lake. Second, business magnate Carl Icahn’s Southeastern Asset Management has offered to buy Dell for $12 in cash per share. Unfortunately, it’s not clear how the buyout negotiations are going.

An unquestioned leader in the personal computer industry in the 90s, Dell had lost some $68 billion in stock market value by 2010, reportedly due to a change in its customer base and inability to respond to Apple’s iPhone and iPad products. Sales at Dell continue to shrink, reportedly showing a 79 percent drop in a quarterly profit report filed last week.

As part of the buyout negotiations, Icahn sent a letter on seeking more detailed information from Dell, including data room access for a certain potential lender This week, however, a special committee of Dell’s board of directors sent Icahn a letter refusing access to that information until it can determine whether his offer is “superior” to Michael Dell’s.

Meanwhile, Dell insisted upon more information from Icahn — such as whether his offer is even serious. In its response, the committee specifically asked Icahn to make “an actual acquisition proposal that the Board could evaluate” as opposed to merely offering the board a backup plan in case Michael Dell’s proposal fails to move forward.

“Please understand that unless we receive information that is responsive to our May 13 letter, we are not in a position to evaluate whether your proposal meets that standard,” the special committee reportedly wrote in response to Icahn’s request.

The question on Wall Street is the same as Dell’s: Is the Southeastern Asset Management offer serious? Icahn reportedly already owns 4.5 percent of Dell’s stock, while Southwest, already Dell’s largest outside shareholder, owns 8 percent.

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Six Ways to do Business Overseas While Reducing the Perils of Future Litigation

Sheppard Mullin 2012

As an executive or in-house counsel, your work likely reaches across the globe.

90% of companies in the United States are involved in litigation—much of it international. American companies have increased overseas business from 49% in 2008 to 72% as late as 2010.

If you work for a medium to large corporation, you are liking working overseas or interacting with colleagues that are. This means that you are likely working around the clock putting out fires, making deals, and juggling regulatory hurdles. Are you worried of running so fast in such unknown territory that you may miss something? Do you wish you had more time to learn everything to minimize your company’s business and litigation risks?

I have good and bad news. The bad—it is nearly impossible to know all of the intricacies of international law, customs, or the unique business challenges facing your company. The good news—you don’t have to. The reality is that ignorance of international law is not what gets you in trouble . . . facts do. Case in point, see Wal-Mart’s bribery scandal in Mexico.

Here are six habits you already know and should put into practice to reduce the risks of bad facts leading to future international litigation:

1. Watch What You Put in Email

You are in charge of an international project and the pressure is mounting. Your foreign counterparts seek written assurances. So, you go on the record via email stating definitively and unequivocally the company’s position. Years later and, with hindsight, you learn you were wrong and it comes back to bite you in litigation. Or maybe you feel especially close to your Brazilian counter-part after a night of food and drinks, so you share information via email about your company’s “issues.” That email is later produced in litigation and becomes evidence against your company.

Remember, emails live on forever and travel . . . fast! Like water leaks, emails go unnoticed until the full impact of their damage emerges years later.

This is basic, but often key in litigation. If you are doing business overseas: watch your tone, grammar, use of local colloquialisms, or use of vague undefined terms (e.g. “material” breach). Avoid definitive words like: “always,” “never,” or “definitely.” Give yourself margin for error. If you are assuming, say so in your email. If you still need approval for your written position, note as much in the email. Ask yourself, “is what I am writing something I would be okay having blown up on an overhead projector in court?” If so, send away.

2. Write Facts Down and Do So Clearly

The fear of bad facts or cross-examination should not deter you from writing. Given the language barriers of international work, communication is vital to your success. So, you should write emails and correspondence. But how? The key is clarity of facts.

This means, writing facts, not conclusions or opinions. When you portray facts, be objective and detail-oriented. For example, retell the other side’s position and your company’s response. Don’t assume that the other side will stick to the same story they told you orally, so document it.

However, you are often called to make conclusions or state an opinion. When you do, make sure you identify why, the process leading to the conclusion/opinion, and what factors could change your initial viewpoint.

Litigation is drama and international litigation is drama on a global scale where each side gives their “story.” Take the lead and document the “real story” by writing it down. When you do, and litigation erupts, a litigator like me can clearly and persuasively tell your story.

3. Respect Cultural Sensitivities, But Don’t Be Afraid to Follow Up

You are in meetings with your counter-parts in Asia and essential business issues come up. Yet, you are concerned about being culturally sensitive and not losing “face.” So, you let the issue pass and put it on your to-do list. As the days pass, hundreds of other “to-do” issues join it on your list and you forget.

Respect cultural sensitivities, but always follow-up. Better yet, document it, follow-up over the phone or in person, and document what you did. I have seen clients’ major multi-million dollar litigation matters get sidetracked because an executive failed to follow-up on a legitimate concern and subsequently “waived” the issue.

4. Be a Gatekeeper and Assert Your Contractual Rights

Companies and their executives fly to the moon to strike an international deal that benefits the company. They hire great lawyers to put in all the bells and whistles to protect their business interests. Yet, when the deal meets the reality of daily business life, gravity takes over and the precious rights protected in the contract fall flat to earth.

If you are the executive sent overseas to manage the project or handle the international distribution business, become the gatekeeper. That means: read the previously negotiated contract, understand it, ask questions about it, know it intimately, and then follow the terms of the contract.

If the contract gives you the right to documents from the foreign company, politely, but firmly get your documents. If the contract calls for a delivery schedule, follow it and insist the other side do the same. If the contract requires your foreign counterpart to act a certain way, do a number of things, or behave within the confines of a certain standard, make sure they do.

Your failure to know your contract and follow it, could waive important rights, change the terms of the contract, and create multiple avenues of arguments for the other side. This could come to haunt you later when you are back in the United States and the project you were in charge of heads to litigation.

5. Ask Questions, Look Around, and Gather Information

Maybe the most important and underused tool in your arsenal to reduce the risk of overseas business leading to litigation is to ask questions.

As you undertake your overseas assignment, you will notice that some things don’t make sense. When this happens, ask questions. Who is the foreign executive you are dealing with? What is his role in the company? Why is he asking you to meet with him and a foreign government official at a swanky resort? Could this be a problem? Maybe, but you will never know where you and your company stand unless you ask questions.

While you are asking questions, look around. If you are managing a construction project in Qatar, get on the ground and look at the project site. Don’t rely on others to tell you what is happening, see it for yourself. Open your eyes . . . is anything off? What’s there that shouldn’t be there? What isn’t there that should be there? If you know your contract (as in Tip 4 above), you will know what doesn’t look right.

Gather readily available information. The reality is that international litigation becomes very difficult and expensive from the United States when all of the evidence remains overseas. So, if you hear your foreign counter-part discuss a “regulation,” “policy,” or “contract” that they are relying on, ask to have a copy . . . and actually get it. Doing so will give your company an advantage in discovery if litigation ensues.

In the end, use your senses. What do you see and hear? Does it smell or feel right? If not, take note, ask questions, and gather information as it occurs.

6. Seek Advice

Note, it is wise to seek advice on international law when doing business overseas. Whether you are working on an international investment deal,cross border real estate transaction, want to protect your intellectual property, or are worried about immigration exposure, it is good business to get counsel.

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U.S. Supreme Court Unanimously Upholds Creditability of UK Windfall Tax

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In a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under IRC Section 901.

On May 20, 2013, in a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under Internal Revenue Code (IRC) Section 901.  This decision definitively establishes the principles to be applied when determining whether a foreign tax is creditable under Section 901, expressly favoring a “substance-over-form” evaluation of a foreign tax’s economic impact.

The UK windfall tax was enacted in 1997 as a means to recoup excess profits earned by 32 UK utility and transportation companies once owned by the government.  During the 1980s and 1990s, the UK sold several government-owned utility companies to private parties.  After privatization, the UK Government prohibited these companies from raising rates for an initial period of time.  Because only rates and not profits were regulated, many of these companies were able to greatly increase their profits by becoming more efficient.  The increased profitability of these companies drew public attention and became a hot political issue in the United Kingdom, which ultimately resulted in Parliament enacting a windfall tax designed to capture the excess or “windfall” profits earned by these companies during the years they were prohibited from raising rates.  The tax was 23 percent of any “windfall” earned by such companies, which was calculated by subtracting the price for which the company was sold by the United Kingdom from an imputed value based on the company’s average annual profits.  Both PPL Corporation and Entergy Corporation owned interests in two of these 32 privatized companies and took a U.S. tax credit for the windfall taxes paid to the United Kingdom.

IRC Section 901 grants U.S. citizens and corporations an income tax credit for “the amount of any income, war profits and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.”  Whether a foreign tax is creditable for U.S. income tax purposes is based upon the “predominant standard for creditability” laid out in Treasury Regulation §1.901-2.  Under that approach, a foreign tax is an income tax “if and only if the tax, judged on the basis of its predominant character,” satisfies three tests.  The foreign tax must be imposed on realized income (i.e., income that has already been earned), the basis of gross receipts (i.e., revenue) and net income (i.e., gross receipts less significant costs and expenditures).  See Treas. Reg. §1.901-2(a)(3).

The Supreme Court’s decision resolved a split between the U.S. Courts of Appeals for the Third and Fifth Circuits on how to apply the predominant standard for the creditability test set forth in the regulations.  The Third and Fifth Circuits took opposite views of two U.S. Tax Court decisions, PPL Corp.  v. Commissioner, 135 T.C. 304 (2010), and Entergy Corp.  v. Commissioner, T.C. Memo. 2010-197, which both held in favor of the taxpayers that the practical effect of the UK windfall tax, the circumstances of its adoption and the intent of the members of Parliament who enacted it evidenced that the substance of the tax was to tax excess profits, and therefore was creditable.

In PPL Corp. v. Commissioner, 665 F.3d 60 (3d Cir. 2011), the Third Circuit reversed the Tax Court, refusing to consider the practical effect of the UK windfall tax and the intent of its drafters.  Instead, the court focused solely on the text of the UK statute, which in its estimation was a tax on excess value and not on profits.  In contrast, in Entergy Corp. v. Commissioner, 683 F.2d 233 (5th Cir. 2012), the Fifth Circuit affirmed the Tax Court, finding that the tax’s practical effect on the taxpayer demonstrated that the purpose of the tax was to tax excess profits.  The court explained that Parliament’s decision to label an “entirely profit-driven figure a ‘profit-making value’ must not obscure the history and actual effect of the tax.”

In its decision, the Supreme Court agreed with both the Fifth Circuit and the Tax Court.  In applying the rules of the Treasury Regulations, the Supreme Court reinforced the three basic principles to determine whether a tax is creditable.  First, a tax that functions as an income tax in most instances will be creditable even if a “handful of taxpayers” may be affected differently.  This means that the controlling factor is the tax’s predominant character.  Second, the economic effect of the tax, and not the characterization or structure of the tax by the foreign government, is controlling on whether the tax is an income tax.  This extends the principle of “substance over form” to the characterization of a foreign tax.  Third, a tax will be an income tax if it reaches net gain or profits.  Applying these principles to the PPL case, the Supreme Court found that the predominant character of the windfall tax was that of an excess profit tax and was therefore creditable.

The PPL decision will likely have far-reaching effects on courts that wrestle with whether certain taxes paid overseas are creditable for U.S. income tax purposes.

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The Jobs Act: Improving Access to Capital Markets for Smaller Companies

GT Law

On April 5, 2012, the Jumpstart Our Business Startups Act or “Jobs Act” was signed into law by President Obama with the stated purpose of increasing American job creation and economic growth by improving access to the public capital markets for emerging growth companies. Specifically, the Jobs Act:

  • creates a new category of “emerging growth company” under the securities laws and reduces certain financial reporting and disclosure obligations on these companies for up to 5 years after their initial public offering;
  • directs the Securities and Exchange Commission to eliminate the prohibition on general solicitations for private offerings under Rule 506 of Regulation D and resales under Rule 144A;
  • legalizes crowdfunding through brokers and “funding portals”;
  • authorizes the SEC to increase the maximum amount permitted to be raised in a Regulation A offering from $5 million to $50 million in any 12-month period; and
  • increases the number of shareholders of record that a company may have before it becomes obligated to file SEC reports.

Creation of the ‘Emerging Growth Company’ Designation

The Jobs Act creates the “emerging growth company” as a new category of issuer under both the Securities Act and the Securities Exchange Act.

Definition of “Emerging Growth Company”

An “emerging growth company” is an issuer that had total annual gross revenues of less than $1 billion during its most recently completed fiscal year. The issuer would continue to be an “emerging growth company” until the earlier of:

  • the last day of the fiscal year during which it had total annual gross revenues of $1 billion or more;
  • the last day of the fiscal year of the issuer following the fifth anniversary of its initial public offering;
  • the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt; and
  • the date on which it is deemed a “large accelerated filer.”

Notwithstanding the foregoing, an issuer that consummated an IPO on or prior to December 8, 2011 will not be eligible to be deemed an emerging growth company. The relief provided to emerging growth companies is available immediately.

Benefits for Emerging Growth Companies

Emerging growth companies will have more lenient disclosure and compliance obligations with respect to executive compensation, financial disclosures and certain new accounting rules. Specifically, an emerging growth company will not be required to:

  • comply with “say on pay” proposals or pay versus performance disclosures;
  • include more than two years of financial statements in the registration statement for its IPO;
  • include selected financial data for any period prior to the earliest audited period presented in connection with its IPO; or
  • comply with new or revised accounting standards that are only applicable to public reporting companies.

In addition, emerging growth companies will be exempt from the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, or SOX, and be given a longer transition period for compliance with new audit standards. Further, SOX has been amended to provide that any rules of the Public Company Accounting Oversight Board, or PCAOB, requiring mandatory audit firm rotation or auditor discussion and analysis will not apply to an emerging growth company. In addition, any future rules adopted by the PCAOB would not apply to audits of emerging growth companies unless the SEC determines otherwise.

The Jobs Act provides that emerging growth companies may start the IPO process by confidentially submitting draft registration statements to the SEC for nonpublic review. Confidentially submitted registration statements would need to be publicly available at least 21 days prior to beginning the road show for the IPO. Emerging growth companies would also be free to “test the waters” with qualified institutional buyers and institutional accredited investors before and during the registration process.

Analyst Reports for Initial Public Offerings of Emerging Growth Companies

The Jobs Act removes some of the restrictions on investment banks underwriting public offerings while simultaneously providing analyst research reports on a particular issuer that was designated as an “emerging growth company.”

Elimination of Prohibition on General Solicitation For Accredited Investors and Qualified Institutional Buyers

The Jobs Act directs the SEC to revise its rules to:

  • provide that the prohibition against general solicitation or general advertising will not apply to offers and sales of securities made pursuant to Rule 506, provided all purchasers of the securities are accredited investors, and
  • provide that the prohibition against general solicitation or general advertising will not apply to offers and sales made under Rule 144A, provided that the seller reasonably believes that all purchasers of the securities are qualified institutional buyers.

It is currently unclear whether these exemptions will apply to offerings exempt from registration under Section 4(2) of the Securities Act to the extent they do not satisfy all of the conditions of Rule 506. The SEC has 90 days from the date of enactment of the Jobs Act to promulgate rules to effect elimination of the specified prohibitions on general solicitation and general advertising.

Creation of a ‘Crowdfunding’ Exemption

Crowdfunding refers to the recent (often internet facilitated) technique of seeking financing for a business through small investments from a relatively large pool of individual investors. Under current securities laws, crowdfunding raises a number of problematic registration exemption issues. The Jobs Act attempts to remedy this by creating a new crowdfunding exemption from the registration requirements of the Securities Act for transactions involving the issuance of securities through a broker or SEC-registered “funding portal,” for which:

  • the aggregate amount of securities sold in the previous 12 months to all investors by the issuer is not more than $1 million; and
  • individual investments by any investor in the securities during any 12-month period are limited to:
    • the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and
    • 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.

Such securities would be considered restricted securities subject to a one-year holding period, with certain exceptions, such as sales to accredited investors or family members. The Jobs Act also provides express securities fraud remedies against the issuer of securities sold under the crowdfunding exemption, which includes extending liability to directors, partners and certain senior officers of the issuer.

Disclosure Requirements

The issuer must file with the SEC, provide to the broker or funding portal, and make available to potential investors at least 21 days prior to the first sale, certain information about the issuer. This information is similar to what many companies currently use in offering memoranda in private offerings and includes:

  • the name, legal status, physical address and website of the issuer;
  • the names of officers, directors and greater than 20% shareholders;
  • a description of the issuer’s current and anticipated business;
  • a description of the financial condition of the issuer, including, for offerings where the aggregate amounts sold under the crowdfunding exemption are:
    • $100,000 or less, income tax returns for the most recently completed fiscal year and financial statements, certified by the principal executive officer of the issuer;
    • more than $100,000, but less than $500,000, financial statements reviewed by an independent public accountant; or
    • more than $500,000, audited financial statements;
  • a description of the intended use of proceeds;
  • the target offering amount and the deadline to raise such amount;
  • the price to the public of the securities, or method to determine the price;
  • a description of the ownership and capital structure of the issuer, including the terms of the offered security and each other security of the issuer and how such terms may be modified, limited, diluted or qualified;
  • risks to purchasers of minority ownership and corporate actions, including issuances of shares, sales of the issuer or its assets or transactions with related parties; and
  • such other information as the SEC may prescribe.

The issuer must also annually file with the SEC and provide to investors its results of operations and financial statements.

‘Blue Sky’ Pre-emption

Securities sold pursuant to the crowdfunding exemption are “covered securities” for purposes of the National Securities Markets Improvement Act, or NSMIA, and, therefore, are exempt from state securities registration requirements, or “Blue Sky,” laws. This preemption does not prohibit state enforcement actions based on alleged fraud, deceit, or unlawful conduct.

Creation of ‘Funding Portals’

A person acting as an intermediary in an offer or sale of securities under this new crowdfunding exemption will have to register with the SEC as a broker or funding portal and will also need to register with any applicable self-regulatory organizations. Such intermediary will also have to comply with a number of requirements designed to ensure that investors are informed of the possible risks associated with a new venture, including conducting background checks on each officer, director and greater than 20% shareholders of the issuer. Additionally, the Jobs Act instructs the SEC to promulgate rules or regulations under which an issuer, broker or funding portal would not be eligible, based on its disciplinary history, to utilize the exemption.

SEC Rulemaking

The SEC is directed to issue rules as may be necessary or appropriate for the protection of investors to implement the crowdfunding exemption within 270 days after the enactment of the Jobs Act. In addition, the dollar amounts are to be indexed for inflation at least every five years for changes in the consumer price index.

Raising the Regulation A Limit to $50 million

The Jobs Act amends Section 3(b) of the Securities Act to direct the SEC to amend Regulation A so as to increase the aggregate offering amount that may be offered and sold within the prior 12-month period in reliance on Regulation A from $5 million to $50 million. The SEC is required to review the limit every two years and to increase the amount as it determines appropriate or explain to Congress its reasons for not increasing the limit on Regulation A offerings.

No ‘Blue Sky’ Pre-emption

Predecessor bills would have made the Regulation A exemption more appealing by making Regulation A offered securities exempt from “Blue Sky” laws. Although the Jobs Act does not provide that securities offered under Regulation A are explicitly exempt, it does have a provision requiring the Comptroller General to conduct a study on the impact of Blue Sky laws on offerings made under Regulation A. Securities offered and sold to “qualified purchasers,” to be defined under NSMIA, or on a national securities exchange would be “covered securities” and exempt from Blue Sky laws.

Modifying Registration Thresholds

Currently, Section 12(g) of the Exchange Act requires an issuer with assets in excess of $1 million and a class of security held by more than 500 shareholders of record to register such security with the SEC and, therefore, become subject to the reporting requirements of the Exchange Act. The Jobs Act amends the registration thresholds to require registration only when an issuer has:

  • either 2,000 or more shareholders of record, or 500 shareholders of record who are not accredited investors, and
  • assets in excess of $10 million.

Exceptions to “Held of Record” Definition

Further, the Jobs Act amends the definition of “held of record” to exclude securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of the Securities Act. It also directs the SEC to adopt rules providing that securities acquired under the crowdfunding exemption are similarly excluded.

Increased Thresholds for Community Banks

The Jobs Act amends Section 12(g) of the Exchange Act by increasing the shareholder registration threshold in the case of an issuer that is a bank or a bank holding company to 2,000 persons. The bill also makes it easier for banks and bank holding companies to deregister and cease public company compliance requirements by increasing the threshold for deregistration for those entities from 300 persons to 1,200 persons.

Implementation of the Jobs Act

SEC Rulemaking and Studies

The Jobs Act directs the SEC to adopt rules implementing certain provisions of the act as well as to conduct a number of studies and report back to Congress.

SEC Concerns

A number of SEC Commissioners, including Chairman Mary Schapiro, have publicly expressed concerns on the balance between enhancing capital formation and the reduction in investor protections. The Jobs Act does not affect Rule 10b-5 of the Securities Act and adds some additional securities fraud remedies, so issuers should continue to be scrupulous about compliance with their disclosure obligations.

Full Text of the Jobs Act

The Jobs Act was enacted on April 5, 2012. The text of the act is currently available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf.

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California Requires Many Foreign Corporations To Send Annual Financial Statements To Shareholders

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California is a net exporter of corporate charters, but it remains home to many corporations. As a result, the California Corporations Code has a preternatural concern with foreign corporations.

One example is Section 1501(a) which requires the board to cause an annual report to be sent to shareholders.  This report must include a balance sheet as of year end and an income statement and statement of cash flows for the year.  The statute doesn’t require that the statements be audited, but if an independent accountant has issued a report, then that report must be sent along as well.  If there is no report, then the report must include a certificate of an authorized officer that the statements were prepared without audit from the books and records of the corporation.  If the corporation has fewer than 100 holders of record (determined in accordance with Section 605), the financial statements need not be prepared in conformity with generally accepted accounting principles if the statements reasonably set forth the assets and liabilities and income and expense of the corporation and disclose the accounting basis used in their preparation.

The report must be sent not later than 120 days after the close of the fiscal year and must be sent at least 15 days (or, if sent by third class mail, 35 days) prior to the annual meeting of shareholders held during the following fiscal year.  Cal. Corp. § 1501(a)(1) & (2).

This requirement applies to domestic corporations, a term that embraces any corporation formed under the laws of California.  Cal. Corp. § 1501(g).  Thus, it includes corporations not formed under the General Corporation Law. See Cal. Corp. Code § 167.  However, a corporation with less than 100 holders of record (determined in accordance with Section 605) may include a bylaw provision that waives the annual report requirement.

The statute also applies to any foreign corporation if the corporation has its principal executive offices in California or it customarily holds meetings of its board in California.  Cal. Corp. § 1501(g).

Publicly traded companies are not exempted per se from this requirement.  However, corporations with an outstanding class of securities registered under Section 12 of the Securities and Exchange Act of 1934 will satisfy the annual report requirement if they comply with Rule 14a-16 (17 C.F.R. § 240.14a-16).  Cal. Corp. § 1501(a)(4).  [Note that this statute purports to include future amendments and this may give rise to a constitutional problem, see Why Incorporation May Be Unconstitutional.]

Here is a flow-chart describing the application of the statute.  This is probably a good time to remind readers that this blog does not provide legal advice.  There are other requirements in Section 1501 (including possible quarterly reporting requirements) that are not covered in today’s post.  Moreover, there are other nuances that I’ve not mentioned.

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Takeover Code Amendments Extend the Rights of Pension Scheme Trustees

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Amendments include new requirements regarding offerors’ intentions, documents provided to trustees, trustees’ opinions on offers, and publication of agreements between offerors and trustees.

On 22 April, the Code Committee of the UK Panel on Takeovers and Mergers (the Panel) published response statement RS 2012/2 (the Response Statement), which introduces amendments to the City Code on Takeovers and Mergers (the Code).[1] The Response Statement follows a consultation to consider extending the rights of trustees of offeree company pension schemes. Broadly, the amendments to the Code provide the following:

  • An offeror is required to state its intentions with regard to the offeree company’s pension scheme.
  • Certain information is required to be published in the offer document or otherwise provided to pension scheme trustees.
  • Trustees are allowed to provide an opinion on the effects of an offer on the company’s pension scheme.
  • Agreements between an offeror and pension scheme trustees that relate to pension scheme funding may be required to be published if they are material.

Background

On 19 September 2011, significant changes were made to the Code, including an extension of the obligations of the offeror and offeree in relation to information to be provided to, and the obligation to publish opinions of, the offeree company’s employees and employee representatives. During the Panel’s consultation on those changes, the pensions industry lobbied significantly for similar provisions to be added to the Code in relation to trustees of pension schemes. Proposed amendments to the Code were published in public consultation paper PCP 2012/2 (the PCP)[2] on 5 July 2012, and a period of consultation followed. The Response Statement sets out the Panel’s response to that consultation and the resulting changes to be made to the Code. Although many of the changes will be adopted as originally proposed in the PCP, certain modifications have been made.

In determining the new regime, the Panel has been mindful that the intended effect of the changes is to create a framework within which the effects of an offer on an offeree company’s pension scheme can become (i) a debating point during the course of the offer and (ii) a point on which the relevant parties can express their views.

Application of New Code Provisions to Defined Benefit Schemes

The new provisions of the Code are limited to funded pension schemes sponsored by the offeree (or any of its subsidiaries) that (i) provide pension benefits (either in whole or in part) on a defined benefit basis—and (ii) have trustees (or managers, in the case of non-UK schemes). The Code provisions are not limited to UK pension schemes and apply to all such schemes, regardless of size or materiality in the context of the offeree’s group.

The new provisions do not apply to pension schemes that provide pension benefits only on a “defined contribution” basis, as the Panel believes that the provisions of the Code granting rights to employees and employee representatives already create an appropriate framework for discussion in relation to the impact of an offer, and the offeror’s intentions, in relation to such schemes.

Publication of Offeror’s Intentions in Relation to Pension Scheme

An offeror will now be required to include in the offer document a statement of its intentions with regard to relevant offeree pension schemes, including with respect to employer contributions and arrangements for deficit funding, benefits accruals for current members, and the admission of new members to the scheme. However, the Panel has not required that the offeror include a statement on the likely repercussions of its strategic plans for the offeree company on relevant pension schemes. Similarly, the Panel has confirmed that such statements do not need to include an assessment of the future ability of the offeree company to meet its funding obligations to its pension scheme.

The Panel also confirmed that the general rule under Note 3, Rule 19.1 of the Code will apply to statements of intention made in respect of pension schemes. This means that an offeror will be considered to be committed by any such statements for 12 months after the offer ends (or such other period of time as is specified in the offeror’s statement), unless there has been a material change of circumstances.

Under the PCP, the Panel originally proposed to require the offeree to include in its offeree circular its views on the effects of the implementation of the offer—and the offeror’s strategic plans for the offeree—on the offeree’s pension schemes. However, following the consultation, the Panel did not make these changes but did confirm that the offeree board may include its views on these subjects in the offeree circular should it wish to do so.

Provision of Information to Pension Scheme Trustees

The amendments to the Code provide that trustees of the offeree company’s pension scheme will be entitled to receive the same documents that offerors and offerees are required to make available to employee representatives. These documents include the following:

  • The announcement that commences the offer period
  • The announcement of a firm intention to make an offer
  • The offer document
  • The offeree board circular in response to the offer document
  • Any revised offer document
  • The offeree board circular in response to any revised offer document

Pension Scheme Trustees’ Opinion on the Offer

Under the revised Code, pension scheme trustees will have the right to require the offeree’s board of directors to publish the trustees’ opinion on the effects of the offer on the pension scheme, and the offeree will be obliged to notify such trustees of this right at the commencement of the offer. As with employee representatives’ opinions, if the trustees’ opinion is received in good time, the opinion must be appended to the offeree board circular. If it is not received in good time, it must be published on a website, with such publication to be announced on a Regulated Information Service.[3] The Panel has confirmed that the trustees’ opinion may cover more than the impact of the offer on the benefits that the scheme provides to members (and other matters to be included in the offeror’s statement in the offer document) and that the opinion may also extend to the trustees’ views on the impact of the offer on the post-offer ability of the offeree company to make future contributions to the pension scheme (i.e., the strength of its funding covenant).

Unlike employee representative opinions, the offeree will only be responsible for the costs incurred in the publication of the trustees’ opinion and not for any other costs incurred in relation to its preparation or verification.

Agreements Entered into Between an Offeror and Pension Scheme Trustees

The revised Code also contains certain provisions relating to any agreements between an offeror and the trustees of an offeree pension scheme, for example, in relation to the future funding of that scheme. Following the consultation, the Panel determined that any such agreements should be treated in the same manner as any other offer-related agreement, with certain variations. As a result, the amendments contain the following requirements for agreements between offerors and pension scheme trustees:

  • Where any such agreement is a material contract for the offeror within the meaning of the Code, it should be published on a website in the same manner as any other material contract.
  • Where such an agreement is not material, but is nevertheless referred to in the offer document, there will be no requirement to publish it on a website.
  • Where such an agreement relates only to the future funding of the pension scheme, it will be excluded from the general prohibition on offer-related agreements contained in Rule 21.2(a).[4]

Pensions Regulator

The Panel has confirmed, following discussions with the UK Pensions Regulator, that there will be no obligation under the Code for the offeror or offeree to send offer-related documentation to the Pensions Regulator, nor will there be any obligation on the Panel to notify the Pensions Regulator of takeover offers. Accordingly, it is for the offer parties (and any other interested parties) to decide whether they wish to engage with, or seek clearance of the offer from, the Pensions Regulator.

Entry into Force

The amendments introduced by the Response Statement will take effect on 20 May 2013, and an amended version of the Code will be published on this date.

[1]. View the Response Statement here.

[2]. View the PCP here.

[3]. The UK Financial Conduct Authority has published a list of information services that are approved Regulated Information Services in Appendix 3 of the Listing Rules, which is available here.

[4]. The Panel, however, emphasised that any obligations or restrictions on the trustees regarding any other offeror or potential offeror would not be permissible.

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The Good Angel Investor (Part 1): Doing the Deal

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At a time when lean startups often require considerably less than $1 million dollars to develop the proverbial minimum viable product and even validate the same with some customers, angel investors are playing an increasingly important role in startup financings.  And that’s a good thing, particularly in places outside of the major venture capital centers, where institutional venture capital is scarce.

Most startups successfully launched with angel capital will want to tap deeper pools of capital later on, often from traditional venture capital investors.  That being the case, entrepreneurs and their angel investors should make sure that the structure and terms of angel investments are compatible with the likely needs of downstream institutional investors.  Herewith, some of the issues entrepreneurs and angels should keep in mind when they sit down and negotiate that first round of seed investment.

  1. Don’t get hung up on valuation.  Seed stage opportunities are difficult to put a value on, particularly where the entrepreneur and/or the investor have limited experience.  Seriously mispricing a deal – whether too high or too low – can strain future entrepreneur/investor relationships and even jeopardize downstream funding.  If you and your seed investor are having trouble settling in on the “right” price for your deal, consider structuring the seed round as convertible debt, with a modest (10%-30%) equity kicker.  Convertible debt generally works where the seed round is less than one-half the size of the subsequent “A” round and the A round is likely to occur within 12 months of the seed round based on the accomplishment of some well-defined milestone.
  1. Don’t look for a perfect fit in an off-the-shelf world.  In the high impact startup world, probably 95% of seed deals take the form either of convertible debt (or it’s more recent twin convertible equity) or “Series Seed/Series AA” convertible preferred stock (a much simplified version of the classic Series A convertible preferred stock venture capital financing).  Unless you can easily explain why your deal is so out of the ordinary that the conventional wisdom shouldn’t apply, pick one of the two common structures and live with the fact that a faster, cheaper, “good enough” financing is usually also the best financing at the seed stage.
  1. On the other hand, keeping it simple should not be confused with dumbing it down.  If the deal is not memorialized in a mutually executed writing containing all the material elements of the deal, it is not a “good enough” financing.  The best intentioned, highest integrity entrepreneurs and seed investors will more often than not recall key elements of their deal differently when it comes time to paper their deal – which it will at the A round, if not before.  And the better the deal is looking at that stage, the bigger those differences will likely be.
  1. Get good legal advice.  By “good” I mean “experienced in high impact startup financing.”  Outside Silicon Valley, the vast majority of reputable business lawyers have little or no experience representing high impact entrepreneurs and their investors in financing transactions.  When these “good but out of their element” lawyers get involved in a high impact startup financing the best likely outcome is a deal that takes twice as long, and costs twice as much, to close.  More likely outcomes include unconventional deals that complicate or even torpedo downstream financing.  This suggestion is even more important if your deal is perchance one of those few that for some reason does need some custom fitting.
  1. Finally, a pet peeve.  If you think your startup’s future includes investments by well regarded institutional venture capital funds, skip the LLC tax mirage and just set your company up as a Delaware “C” corporation.  If you want to know why, ask one of those “experienced high impact startup lawyers” mentioned in point 4 above.
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Top Five Traps for the Unwary in Spin-Offs

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A wave of corporate breakups has swept through the United States over the last few years as investors have taken notice of the fact that smaller companies focused on a single business tend to outperform their more diversified peers.  A primary vehicle for these breakups has been the spin-off transaction, in which a publicly traded parent company distributes the shares of the spin-off company (spinco) to its own shareholders, creating a new, independent publicly traded entity.  The New York Times, citing Dealogic, reported that there were 93 spin-off transactions worth $128 billion in 2011, and that 2012 kept pace with 85 spin-off transactions worth $109 billion.  The rationale for a spin-off often is to unlock the value in a business or division that is trapped in a larger corporate bureaucracy.  Conglomerates tend to spread capital across all of their divisions rather than focusing on the individual opportunities within each business that are the most promising.  Holding company structures also can make decision-making more cumbersome and equity incentives less incentivizing for division management who feel as though their hard work is being diluted by the underperformance of other divisions or businesses.

Spin-offs, however, are complicated transactions that require a great deal of advance planning.  In many cases, an announcement that a parent company is considering the spin-off of one of its businesses is actually the start of a “dual-track” process wherein the parent company considers and plans for a spin-off while also remaining open to potential bids from third parties to acquire the business.  In even more complicated cases, a parent company agrees to sell a business to an acquirer in connection with a spin-off transaction.

The vast majority of spin-off transactions are designed to qualify under the rules of the Internal Revenue Code as “tax free” to the parent company and the shareholders who receive the spinco stock.

With this in mind, any company considering spinning off a division or business should keep in mind the following five potential traps.

1.  Tax-Free Qualification – Legitimate Business Purpose 

The spin-off must satisfy a legitimate business purpose in order to qualify under both the tax-free rules of the Internal Revenue Code and the Securities Act of 1933.  The tax authorities require that the spin-off be motivated in whole or in substantial part by one or more legitimate corporate business purposes in order to ensure that the purpose of the transaction is not simply “tax avoidance.”  The business purpose requirement is one of many requirements under the tax laws to qualify for a tax-free spin-off.  Because the costs of triggering tax in a spin-off transaction often are very high, most parent companies obtain a legal opinion from outside counsel and obtain a ruling from the Internal Revenue Service as a condition to completing a spin-off transaction.  As discussed in relation to trap number five below, a legitimate business purpose for the spin-off also is required under the securities laws in order for the distribution of the spinco stock to not be treated as a “sale” of securities by the parent company or the spinco requiring Securities Act of 1933 registration and the strict liability standard of care that comes with such a registration.  See the article entitled, “Five Key Tax Considerations for Spin-Off Transactions” for a more in depth discussion of tax issues raised in spin-offs.

2.  Separation of Assets and Liabilities

Before a business or a division can be spun off, both its assets and its liabilities must be separated.  Large companies with long operating histories often find that the process of separating out the spinco business is not straightforward, because the legal entities that house the business might also house other businesses and divisions that share assets, services, products, employees, vendors and customers with the spinco business.  The pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial agreements, financing agreements, intellectual property licensing agreements, collective bargaining agreements, employment contracts, benefit plans, etc.  Often the spinco and the parent company or another legacy business must enter into complex sharing or licensing agreements or joint ventures relating to valuable intellectual property, such as trade names, trademarks or patents, as well as employee matters.  See the article entitled “Trademark, Domain Name and Other IP Considerations for Spin-Offs” for a more in depth discussion of IP issues raised in spin-offs and see the article entitled, “Employee Benefit Issues in a Spin-Off” for a more in depth discussion of employee benefit issues raised in spin-offs.

The sharing of liabilities is often the most complicated endeavour because of the slew of legal obligations that are triggered.  In allocating liabilities to the spinco, the parent company must evaluate the impact such allocation will have on the solvency of the parent and the spinco.  Parent company directors can face personal liability under state corporate law for making an unlawful dividend because the company lacked sufficient capital to make such a dividend or for rendering the parent company insolvent by distributing out the spinco business, and the parent company itself can face claims of constructive fraudulent conveyance—i.e., the parent company received less than equivalent value, and either the parent or spinco was rendered insolvent (assets do not exceed liabilities), the parent and/or spinco was left with unreasonably small capital to run its respective business, or the parent or spinco was left with debts that exceed its respective ability to pay those debts as they become due.  Parent company directors can rely on legal experts and financial advisors to assist them in satisfying their duty of care.  A solvency opinion from a nationally recognized provider of such opinions is often a condition to the consummation of a spin-off transaction.  Such an opinion may be helpful to the directors of the parent company and spinco for a variety of reasons: (i) it can help to show that the directors properly exercised their duty of care in determining to enter into the spin-off transaction; (ii) it can assist in rebutting a fraudulent conveyance claim; and (iii) it can assist in rebutting a claim that the company had insufficient capital to make such a dividend.

3.  Transition Services

While one of the key rationales for spinning off a business or division is to allow the enterprise to operate independently, the reality in most cases is that, at least during the first year or so post-spin, a spinco must rely on its former parent company to provide many key administrative and operational services during the spinco’s transition period to a self-sufficient, independent public company.  During the pre-spin planning period, companies should consider, among other things, which transition services will be required, how they will be provided, for how long and under what pricing terms.  Typical transition services include legal, internal auditing, logistics, procurement, quality assurance, distribution and marketing.  These arrangements often have durations that last between six and 24 months.  Many parent companies agree to provide such transition services purely on a cost basis, while others will use a “cost plus” or “market” rate.

4.  Spinco Management and Board of Directors

Again, while independence from the former parent company is a key benefit for most spincos, having corporate managers with institutional knowledge and history with the enterprise is an important factor in assisting the spinco to successfully transition to independence.  Many spinco management teams include members who have served as executives at the former parent company.  In many cases, these are managers who served as division leaders who reported to the parent company CEO or CFO and are now ready to step into executive roles on their own.  It is also common for between one and three members of the parent company board to agree to take seats on the spinco board to provide the new public company board with a source of the company’s history and culture to ensure a smooth transition.  However, because of the competing fiduciary duties that these directors will face if they hold seats on both the parent and spinco boards, it is important for the spinco board to also have a majority of truly independent directors.  Spinco directors who are former executive officers of the parent also must be aware that the stock exchanges and influential shareholder services firms such as Institutional Shareholder Services will not view them as being truly independent from a corporate governance standpoint for some time after the completion of the spin-off.  This will inhibit their ability to serve on key board committees of the spinco.

5.  Preparation of the Disclosure 

Under the U.S. Securities and Exchange Commission’s rules, a spin-off of the shares of a subsidiary to a parent company’s shareholders does not involve the sale of securities by either the parent company or the subsidiary as long as the following conditions are met: (i) the parent company does not provide consideration for the spun-off shares; (ii) the spin-off is pro rata to the parent company shareholders; (iii) the parent company provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; and (iv) the parent has a valid business purpose for the spin-off.

To meet the adequate public information requirement, parent companies are required to prepare and disseminate detailed “information statements” that effectively look like initial public offering registration statements for the spinco.  These information statements are filed with the spinco’s Form 10 registration statement, which is required in order to register the spinco’s shares under the Securities Exchange Act of 1934 and to permit listing of such shares on a national securities exchange.  The preparation of the spinco information statement can take up to three or four months and requires a great deal of effort and cooperation among the lawyers, the business leaders, the finance department, the human resources/employee benefits department and the auditors.  In addition, under New York law, a spin-off of all or substantially all of a company’s assets may require a vote of such company’s shareholders, while under Delaware law, such a requirement is much less likely.

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Investment Regulation Update – April 2013

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The Investment Regulation Update is a periodic publication providing key regulatory and compliance information relevant to broker-dealers, investment advisers, private funds, registered investment companies and their independent boards, commodity trading advisers, commodity pool operators, futures commission merchants, major swap participants, structured product sponsors and financial institutions.

This Update includes the following topics:

  • SEC Adopts Rules to Help Protect Investors from Identity Theft
  • Increased Attention to Broker-Dealer Registration in the Private Fund World
  • SEC Issues Guidance Update on Social Media Filings By Investment Companies
  • AIFMD — Effect on U.S. Fund Managers
  • SEC Announces 2013 Examination Priorities
  • Reminder — Upcoming Form PF Filing Deadline
  • Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline
  • Are you a Lobbyist?
  • Recent Events

SEC Adopts Rules to Help Protect Investors from Identity Theft

On April 10, 2013, SEC Chairman Mary Jo White’s official first day on the job, the SEC, jointly with the CFTC, adopted rules and guidelines requiring broker-dealers, mutual funds, investment advisers and certain other regulated entities that meet the definition of “financial institution” or “creditor” under the Fair Credit Reporting Act (FCRA) to adopt and implement written identity theft prevention programs designed to detect, prevent and mitigate identify theft in connection with certain accounts. Rather than prescribing specific policies and procedures, the rules require entities to determine which red flags are relevant to their business and the covered accounts that they manage to allow the entities to respond and adapt to new forms of identity theft and the attendant risks as they arise. The rules also include guidelines to assist entities subject to the rules in the formulation and maintenance of the required programs, including guidelines on identifying and detecting red flags and methods for administering the program. The rules also establish special requirements for any credit and debit card issuers subject to the SEC or CFTC’s enforcement authority to assess the validity of notifications of changes of address under certain circumstances. Chairman White stated, “These rules are a common-sense response to the growing threat of identity theft to all Americans who invest, save or borrow money.” The final rules will become effective 30 days after date of publication in the Federal Register and the compliance date will be six months thereafter.

Increased Attention to Broker-Dealer Registration in the Private Fund World

The role of unregistered persons in the sale of interests in privately placed investment funds is an area of great interest for the SEC and the subject of recent enforcement actions. On March 8, 2013, the SEC filed and settled charges against a private fund manager, Ranieri Partners, LLC, one of the manager’s senior executives and an external marketing consultant regarding the consultant’s failure to register as a broker-dealer. The Ranieri Partners enforcement actions are especially interesting for two reasons: (i) there were no allegations of fraud and (ii) the private fund manager and former senior executive, in addition to the consultant, were charged.

On April 5, 2013, David Blass, the Chief Counsel to the SEC’s Division of Trading and Markets, addressed a subcommittee of the American Bar Association. His remarks have been posted on the SEC website. Mr. Blass referenced a speech by the former Director of the Division of Investment Management, who expressed concern that some participants in the private fund industry may be inappropriately claiming to rely on exemptions or interpretive guidance to avoid broker-dealer registration.

In addition, Mr. Blass noted Securities Exchange Act Rule 3a4-1’s safe harbor for certain associated persons of an issuer generally is not or cannot be used by private fund advisers. He suggested that private fund managers should consider how they raise capital and whether they are soliciting securities transactions, but he did acknowledge that a key factor in determining whether someone must register as a broker-dealer is the presence of transaction-based compensation. The Chief Counsel also raised the question of whether receiving transaction-based fees in connection with the sale of portfolio companies’ required broker-dealer registration. He suggested that private fund managers may receive fees additional to advisory fees that could require broker-dealer registration, e.g., fees for investment banking activity.

On a related note, in two recent “no-action” letters, the SEC has established fairly clear rules regarding how Internet funding network sponsors may operate without being required to register as broker-dealers. On March 26 and 28, 2013, the SEC’s Division of Trading and Markets addressed this narrow, fact-specific issue in response to requests from FundersClub Inc. and AngelList LLC seeking assurances that their online investment matchmaking activities would not result in enforcement action by the SEC. The April 10, 2013 GT Alert—SEC Clarifies Position on Unregistered Broker-Dealer Sponsors of Internet Funding Networks is availablehere.

SEC Issues Guidance Update on Social Media Filings by Investment Companies

On March 15, 2013, the SEC published guidance from the Division of Investment Management (IM Guidance) to clarify the obligations of mutual funds and other investment companies to seek review of materials posted on their social media sites. This report stems from the SEC’s awareness of many mutual funds and other investment companies unnecessarily including real-time electronic materials posted on their social media sites (interactive content) with their Financial Industry Regulatory Authority filings (FINRA). In determining whether a communication needs to be filed, the content, context, and presentation of the communication and the underlying substantive information transmitted to the social media user and consideration of any other facts and circumstances are all taken into account, such as whether the communication is merely a response to a request or inquiry from the social media user or is forwarding previously-filed content. The IM Guidance offers examples of interactive content that should or should not be filed with FINRA. The IM Guidance is the first in a series of updates to offer the SEC’s views on emerging legal issues and to provide transparency and enhance compliance with federal securities laws and regulations. You may find a link to the SEC Press Release and IM Guidance here.

On a related note, on April 2, 2013, the SEC released a report of an investigation regarding whether the use of social media to disclose nonpublic material information violates Regulation FD. The SEC has indicated that, in light of evolving communication technologies and habits, the use of social media to announce corporate developments may be acceptable; however, public companies must exercise caution and undertake careful preparation if they wish to disseminate information through non-traditional means. The April 5, 2013 GT Alert—Social Media May Satisfy Regulation FD But Not Without Risk and Preparation by Ira Rosner is available here.

AIFMD – Effect on U.S. Fund Managers

New European Union legislation that regulates alternative asset managers who manage or market funds within the EU comes into force on July 22, 2013. The Alternative Investment Fund Managers Directive (AIFMD) will have a significant impact on U.S. fund managers if they actively fundraise in Europe after July 21, 2013 (or if they manage EU-domiciled fund vehicles). Historically, U.S. private equity firms raising capital in Europe have relied on private placement regimes that essentially allowed marketing to institutions and high net worth investors. Beginning July 22, 2013, U.S. fund managers may continue to rely on private placement regimes in those EU jurisdictions that continue to operate them; however, they will now be under an obligation to meet certain reporting requirements and rules set out in the AIFMD relating to:

  • transparency and disclosure, and
  • rules in relation to the acquisition of EU portfolio companies.

The transparency and disclosure rules require, for the most part, the disclosure of information typically found in a PPM; however, additional items are likely to be required such as the disclosure of preferential terms to particular investors and level of professional indemnity cover. The rules also require reports to be made to the regulator in each jurisdiction in which the fund has been marketed. The reports will need to include audited financials, a description of the fund’s activities, details of remuneration and carried interest paid, and details of changes to material disclosures. Acquisitions of EU portfolio companies also lead to reporting obligations on purchase – an annual report – and a rule against “asset stripping” for 24 months after the acquisition of control. Firms with less than €500 million in assets under management are exempt from the reporting requirements and reverse solicitation is potentially an option, as the directive does not prevent an EU institution from contacting the U.S. fund manager, but in practice it may be difficult to apply systematically.  Fund managers may choose to register in the EU on a voluntary basis from late 2015. This will allow marketing across all EU member states on the basis of a single registration. However, registration will come with a significant compliance burden. If you plan to market in the EU after July 23, 2013, ensure that you review your marketing materials, evaluate your likely reporting obligations and consider how the portfolio company acquisition rules are likely to impact your transactions.

SEC Announces 2013 Examination Priorities

On February 21, 2013 the SEC’s National Examination Program (NEP) published its examination priorities for 2013. The examination priorities address issues market-wide, as well as issues relating to particular business models and organizations. Market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and technology controls.  Priorities in specific program areas include: (i) for investment advisers and investment companies, presence exams for newly registered private fund advisers, and payments by advisers and funds to entities that distribute mutual funds; (ii) for broker-dealers, sales practices and fraud, and compliance with the new market access rule; (iii)for market oversight, risk-based examinations of securities exchanges and FINRA, and order-type assessment; and (iv) for clearing and settlement, transfer agent exams, timely turnaround of items and transfers, accurate recordkeeping, and safeguarding of assets, and; (iv) for clearing agencies, designated as systemically important, conduct annual examinations as required by the Dodd-Frank Act. The priority list is not exhaustive. Importantly, priorities may be adjusted throughout the year and the NEP will conduct additional examinations focused on risks, issues, and policy matters that are not addressed by the release.

Reminder—Upcoming Form PF Filing Deadline

SEC registered investment advisers who manage at least $150 million in private fund assets with a December 31st fiscal year end should be well underway in preparing their submissions for the approaching April 30, 2013 deadline. Filings must be made through the Private Fund Reporting Depository (PFRD) filing system managed by the Financial Industry Regulatory Authority (FINRA). As a reminder, advisers to three types of funds must file on Form PF: hedge funds, liquidity funds and private equity funds. Hedge funds are generally defined as a private fund that has the ability to pay a performance fee to its adviser, borrow in excess of a certain amount or sell assets short. Liquidity funds are defined as a private fund seeking to generate income by investing in short-term securities while maintaining a stable net asset value for investors. Private equity funds are defined in the negative as not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not generally provide investors with redemption rights. When classifying its funds, advisers should carefully read the fund’s offering documents and definitions on Form PF and should seek assistance of counsel. Particularly, we have seen the broad definition of hedge fund cause a fund considered a private equity fund by industry-standards to be a hedge fund for purposes of Form PF, thus subjecting the fund to more expansive reporting requirements. As is the case with filing Form ADV through IARD, the $150 Form PF filing fee is paid through the same IARD Daily Account and must be funded in advance of the filing. FINRA recently updated their PFRD System FAQs. The SEC has also posted new Form PF FAQs, which should be referred to for upcoming filings.

Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline

All entities, including private funds, engaged in swap transactions must adhere to the ISDA Dodd-Frank Protocol no later than May 1, 2013 in order to engage in new swap transactions on or after May 1. Adherence to the Dodd-Frank Protocol will result in an entity’s ISDA swap documentation being amended to incorporate the business conduct rules that are applicable to swap dealers under Dodd-Frank.  Adherence to the Protocol involves filling out a questionnaire to ascertain an entity’s status under Dodd-Frank (e.g., pension plan, hedge fund and corporate end-user).  Further information on adherence to the Protocol can be obtained at ISDA’s website by clicking here.

Are you a lobbyist?

Over the last decade, many state and municipal governments have enacted new laws regarding how businesses may interact with government officials. These laws often establish new rules expanding the activities that are deemed to be “lobbying,” who is required to be registered as a lobbyist and what information must be publicly disclosed. Approximately half of the states, and countless municipalities, now define lobbying to include attempts to influence government decisions regarding procurement contracts – including contracts for investment advisors and placement agents – and impose steep penalties for companies that fail to register and disclose their “lobbying” activities and expenditures. Although some lobbying laws include exceptions for communications that occur as part of a competitive bidding process, the rules are inconsistent and not always clear. For example, although New York City’s lobbying law long included procurement lobbying, in 2010 the City’s Corporation Counsel and the City Clerk issued letters warning businesses that “activities by placement agents and other persons who attempt to influence determinations of the boards of trustees by the City’s . . . pension funds” are likely to be considered lobbying activity that requires registration and disclosure. Similarly, California’s lobbying law was expanded in 2011 to expressly include persons acting as “placement agents” in connection with investments made by California retirement systems, or otherwise seek to influence investment by local public retirement plans. Greenberg Traurig’s Investment Regulation Group, in conjunction with our Political Law Compliance team, is available to assist clients with questions regarding how to navigate increasingly complex lobby compliance laws and rules across the country and beyond. GT has a broad range of experience in advising to some of the world’s leading corporations, lobbying firms, public officials and others who seek to navigate lobbying and campaign finance laws.

Recent Events

On April 18, 2013, GT hosted the seminar, “The Far Reaching Impact of FATCA Across Borders and Across Industries” as both a webinar and live program in NY and Miami. The seminar explored the latest FATCA regulations and key intergovernmental agreements as well as their applications to a variety of industries. Click here to view the presentation.

On April 10, 2013, GT sponsored Artisan Business Group’s EB-5 Finance seminar at our NYC office. The program exposed participants to a unique alternative financing opportunity for projects that lend themselves to the EB-5 immigrant investor program and featured several GT speakers, including Steve Anapoell and Genna Garver, Co-Chair of the Investment Regulation Group, who provided a securities law update and considerations in the EB-5 area. Guest speakers included Jeff Carr from EPR, Phil Cohen from the EB-5 Resource Center, and Reid Thomas from NES Financial.

On April 2, 2013, GT co-hosted a Global Compliance seminar with Dun & Bradstreet on Foreign Corrupt Practices Act (FCPA) issues. The program included an overview of the FCPA, with a specific emphasis on the Department of Justice’s recently released Resource Guide to the FCPAand recent enforcement activities. A link to the Resource Guide can be found here.

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