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Several major publications are reporting that court records indicate that the deadly duck boats were designed decades ago by a businessman who had no engineering experience.

The Wall Street Journal, the Los Angeles Times and USA Today are among those reporting that the designer and entrepreneur, Robert F. McDowell, had completed only two years of college and “had no background, training or certification in mechanics when he came up with the design for ‘stretch’ duck boats” USA Today, “Court Records show duck boat in Missouri disaster was designed by entrepreneur with no engineering training,” by Matt Pearce, July 24, 2018.

The discovery came upon an examination of a lawsuit filed over a roadway disaster in Seattle involving a similar duck boat in 2015.

Investigators are still trying to determine what caused the duck boat to sink on Table Rock Lake near Branson, Missouri, last week. It was carrying 31 people on a sightseeing tour, killing 17 and injuring 14 more people. U.S. Senator Claire McCaskill (D-Mo) called the duck boats a “sinking coffin” and indicated she intends to draft federal legislation proposing stronger safety standards.

Duck boats were originally created during World War II to transport troops and cargo on land and sea. After the war ended, they reportedly became surplus items and were repurposed as pleasure crafts by tour companies across the country. Since then, they have been involved in multiple deadly accidents on the water and on roads, being amphibious vehicles.

USA Today reported that Ride the Ducks Branson vehicles were modified including lengthening the hull and reassembling the craft, according to the National Highway Transportation Safety Administration. These refurbished duck boats allegedly were designed and developed by McDowell who was “self-educated by going to auto parts stores and talking to different people,'” according to the court filing. The court filing goes on to say that engineers were not consulted. McDowell’s father in the 1970s owned the duck boat company in Branson that was then called Ozark Scenic Tours. He sold the company in 2001-02.

Robert A. Clifford, founder and senior partner at Clifford Law Offices in Chicago and a maritime lawyer who has handled numerous cases involving boat tragedies, has been outspoken on the lack of safety and guidelines for these amphibious vessels. Recently, he was quoted in USA Today, ABC News and WGN Radio as well the National Law Journal where he was quoted by reporter Amanda Bronstad saying,

“Lawsuits will inevitably come from this tragic incident.” … It is clear that the owners and operators of the boat were negligent in the decision to take the boat out in the waters, despite clear weather warnings that it was unsafe that day. In addition, surviving witnesses have stated that they were told it was unnecessary to wear life jackets. I view this as similar to wearing seat belts in a car – you are better off with having them on with the likelihood greater that they may help you. Without them, you have less of a chance of survival.

Clifford believes the U.S. Coast Guard should place a 20 knot forecast and/or observed wind limit and no in-thunderstorm operations restriction on all duck boat in-water operations when paying passengers are on board. Clifford also believes that duck boat operators, in order to adhere to the above restrictions, should be required to check all available National Weather Service forecasts and radar sources for the area of operation within 30 minutes of embarking on in-water operations with paying passengers on board.

On 18 July 2018, the German Department of State distributed to associations in Germany, a first ministerial draft of a German Federal Brexit Implementation Act, Brexit-Übergangsgesetz (BrexitÜG), for consultation by 8 August 2018.

The draft Act provides that the UK shall, during the proposed transition period from 30 March 2019 to 31 December 2020, be deemed to be a member state of the EU for all purposes of German Federal Law. However, the BrexitÜG only deals with the Brexit transition on German Federal law level – it does not address the Brexit transition on the level of the state laws of the 16 German states. State-level Brexit transition provisions will need to be adopted by the individual state parliaments.

The BrexitÜG provides for the “grandfathering” of applications by British nationals for German citizenship beyond the end of the transition period, in cases where the application was submitted before the end of the transition period and met all relevant requirements. The purpose of that grandfathering is that British nationals shall not be denied dual citizenship just because of administrative delays. Normally, German law would not allow dual citizenship unless the other citizenship is that from another member state of the EU.

However, the draft BrexitÜG only caters for the “Deal Scenario” and not the “No Deal Scenario”, with the preparatory papers and explanations relating to the draft Act not addressing a situation of “No Deal”, and no subsequent transition period being agreed between the UK and the EU. It remains to be seen if a “No Deal Scenario” will be added to the current draft of the BrexitÜG, or whether this will be postponed until the beginning of 2019.

The grandfathering provisions in favour of British nationals applying for German citizenship do not apply in favour of German nationals applying for  British citizenship. German citizens only granted British citizenship after the end of the transition period would then cease to be German nationals, due to the German law that does not allow dual citizenship other than where that citizenship is from another member state of the EU.

There are several reasons that a California corporation may want to reincorporate to Delaware. Venture capital funds or other investors may demand a reincorporation to Delaware as a condition to financing. Cumulative voting for director elections, required for California corporations but not required for Delaware corporations, may have become a problem. The corporation may want to take advantage of the flexibility of Delaware’s business laws, the abundance of legal precedent and the availability of the Court of Chancery to resolve corporate disputes.

Whatever the reason, reincorporating from California to Delaware may be more challenging than originally anticipated due to a few complicating factors: (1) California’s long-arm statute, (2) the availability of exemptions from registration and qualification under state and federal securities laws and (3) restrictions under the company’s contracts.^[1]

California’s Long-Arm Statute – CGCL Section 2115

Under California’s long-arm statute, Section 2115 of the California General Corporation Law (“CGCL”), a foreign corporation may be considered a “quasi-California” or “pseudo-foreign” corporation depending on the level of the corporation’s ties to California and, therefore, purportedly subject to certain provisions of the CGCL, including, without limitation, provisions with respect to the following:

• cumulative voting for director elections;

• fiduciary duties of directors;

• dissenters’ rights;

• indemnification of directors, officers and others;

• shareholder approval of mergers and other reorganizations; and

• restrictions on distributions, dividends and share repurchases.

A two-part test is used to determine whether a foreign corporation is subject to CGCL Section 2115:

1. The Voting Shares Test – Are more than 50% of the corporation’s outstanding voting securities held of record by persons having addresses in California appearing on the books of the corporation?

2. The Doing Business Test – Is the average of the corporation’s (a) property factor, (b) payroll factor and (c) sales factor more than 50% during the corporation’s last full income year?^[2] These three factors are defined in Sections 25129, 25132 and 25134 of the California Revenue and Taxation Code, and are calculated by completing Schedule R as part of the corporation’s California state tax returns:

   1. Property Factor – A corporation’s property factor is calculated by dividing (i) the average value of the corporation’s real and tangible personal property owned or rented and used in California during the taxable year by (ii) the average value of all of the corporation’s real and tangible personal property owned or rented and used during the taxable year.

   2. Payroll Factor – A corporation’s payroll factor is calculated by dividing (i) total compensation paid in California during the taxable year by (ii) total compensation paid elsewhere during the taxable year.

   3. Sales Factor – A corporation’s sales factor is calculated by dividing (i) total sales in California during the taxable year by (ii) total sales everywhere during the taxable year.^[3]

If both the “voting shares test” and the “doing business test” are satisfied, then the surviving corporation following the reincorporation merger may subsequently become subject to Section 2115 of the CGCL, potentially frustrating the decision to reincorporate in Delaware, particularly if a primary reason is to escape cumulative voting.

Although CGCL Section 2115 seems problematic as written, its bark may be worse than its bite. California-based Delaware corporations have successfully challenged the enforceability of CGCL Section 2115 in court. For example, in VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005), the Delaware Supreme Court rejected CGCL Section 2115 on grounds that it violated the “internal affairs doctrine” under Delaware law, which provides that the law of the state of incorporation should govern any disputes regarding that corporation’s internal affairs. Moreover, both California and Delaware courts have enforced forum-selection clauses set forth in the charter documents of Delaware corporations, and are even more likely to do so in the future following Delaware’s adoption of Section 115 of the Delaware General Corporation Law (“DGCL”) in 2015. DGCL Section 115 explicitly provides that the certificate of incorporation or bylaws of a Delaware corporation may require that any or all internal corporate claims be brought solely and exclusively in Delaware courts.

Exemption from Registration and Qualification under the Securities Laws

Under Rule 145(a)(2), a statutory merger in which the securities of the target corporation will be exchanged for securities of any other person will be deemed to be an offer and sale under the Securities Act of 1933, as amended (the “Securities Act”), unless the “sole purpose of the transaction is to change an issuer’s domicile solely within the United States.” What does “sole purpose” mean in this context? It does not mean that there can be no changes to the rights of shareholders in connection with the reincorporation. The SEC Staff has issued many no-action letters that have permitted changes to be made to shareholder rights in connection with a reincorporation merger while still falling within the Rule 145(a)(2) exception.^[4] However, it is not entirely clear how many changes can be made before one may question whether the “sole purpose” of the transaction is to change domicile, as opposed to some other purpose, such as eliminating important shareholder rights.

If the parties cannot get comfortable that the “sole purpose” of the transaction is to change the California corporation’s domicile, as provided in Rule 145(a)(2), then the reincorporation merger must be analyzed as if it involves the offer and sale of shares by the Delaware corporation to the shareholders of the California corporation. Accordingly, under the Securities Act and applicable “blue sky” laws, the transaction must either be registered or qualified or exempt therefrom. In fact, blue sky laws must also be considered in the Rule 145(a)(2) scenario, because there may not be a similar exception to the definition of offer and sale under state law.

If all of the shareholders of the California corporation are “accredited investors,” as defined in Rule 501(a) of Regulation D promulgated under the Securities Act,^[5] then the analysis is relatively straight-forward.

Under Rule 506 of Regulation D, a safe harbor for establishing that an offer or sale of securities is a transaction not involving a public offering within the meaning of Section 4(a)(2) under the Securities Act, an issuer may offer and sell securities to an unlimited number of accredited investors and for an unlimited dollar value. Additionally, Rule 506 does not require the issuer to provide any particular information to accredited investors regarding the offering, though the issuer still needs to be mindful of anti-fraud rules, such as Rule 10b-5. Rule 506 has some other requirements, including the requirement to prepare and file with the Securities and Exchange Commission (“SEC”) a notice on Form D no later than 15 days after the first sale of securities in the offering, but they are typically “easy bases to tag” for reincorporation transactions.

Securities issued under Rule 506 are “covered securities” under Section 18 of the Securities Act and therefore preempt regulation under state blue sky laws. However, states may require an issuer to file a notice informing the applicable state agency of the Rule 506 offering. For example, CGCL Section 25102.1(d) provides that the issuer must (1) file a copy of the Form D for any Rule 506 offering with the California State Commissioner, (2) file a consent to service of process pursuant to CGCL Section 25165 and (3) pay a filing fee. If the issuer has shareholders in states other than California, then the laws of those states must also be analyzed to see if a notice and/or fee is required.

The analysis gets more complicated if the California corporation has shareholders that do not qualify as “accredited investors.” Although an issuer can still rely on Rule 506 if securities will be issued to fewer than 35 unaccredited investors, the compliance burden increases significantly because the issuer will be required to provide to unaccredited investors in advance of the sale of securities (i.e., before the purchase agreement, merger agreement or similar agreement is signed) certain disclosures meeting the line item requirements of Rule 502(b)(2) of Regulation D. This is true irrespective of whether the unaccredited investors have a “purchaser representative” as contemplated by Rule 506(b)(2)(ii).

The required disclosures for unaccredited investors under Rule 506 can be costly and time-consuming to prepare. These include prescribed financial statement information and non-financial statement information, including the information required by Form S-4 for business combinations. Some relief is given under Rule 502(b) in that such disclosure only needs to be provided “to the extent material to an understanding of the issuer, its business and the securities being offered.”

However, the fact that any disclosure needs to be prepared at all to rely on Rule 506 in an offering to unaccredited investors significantly increases the compliance burden.

In the event that the California corporation has more than 35 unaccredited investors – or if the issuer does not want to prepare the disclosures required by Rule 506 for unaccredited investors – there are alternatives to Rule 506 for an exemption under the Securities Act. For example, if the total value of securities to be issued is less than $5.0 million, then the issuer may be able to rely on Rule 504 of Regulation D for an exemption from registration.^[6]Alternatively, the issuer could conclude that the offer and sale of securities is a transaction not involving a public offering under Section 4(a)(2) of the Securities Act applying the Ralston Purina test.^[7] Neither Rule 504 nor Section 4(a)(2) requires the issuer to provide any particular disclosure to unaccredited investors, though as noted above an issuer must always be mindful of anti-fraud rules.

The drawback to using Rule 504 or a “naked” Section 4(a)(2) exemption (i.e., relying on Section 4(a)(2) without the Rule 506 safe harbor) is that the offered securities will not be “covered securities” under Section 18 of the Securities Act and therefore will be subject to regulation under state blue sky laws. In California, because the transaction will involve the exchange of securities incident to a merger, the transaction will need to be qualified under CGCL Section 25120 (not CGCL Section 25110), unless there is an available exemption.^[8]

The two most promising exemptions from CGCL Section 25120 are typically CGCL Section 25103(c) and CGCL Section 25103(h).

CGCL Section 25103(c) is useful if a number of shareholders have addresses of record outside of California. CGCL Section 23103(c) provides that a transaction incident to a merger is exempt from qualification under CGCL Section 25120 if fewer than 25% of shareholders of each class of stock have addresses in California. However, for purposes of this calculation, under CGCL Section 25103(d), any securities held to the knowledge of the issuer in the names of broker-dealers or nominees of broker-dealers or any securities controlled by any one person who controls directly or indirectly 50% or more of the outstanding securities of that class shall not be considered outstanding. It is important to note that the exemption is based on shareholders with “addresses” in California, not “residences” in California, so there is a little room to maneuver there.

CGCL Section 25103(h) provides an exemption from qualification under CGCL Section 25120 if the following criteria are satisfied:

• The transaction, had the exchange transaction involved the issuance of a security in a transaction subject to the provisions of Section 25110, would be exempt from qualification under Section 25102(f); and

• Either:

  • Not less than 75% of shares voted for the transaction, not less than 10% of shares voted against the transaction and shareholders have dissenters’ rights with respect to the transaction; or

  • The transaction is “solely for the purposes of changing the issuer’s state of incorporation or organization” or form of organization, all securities of a similar class are treated equally, and the holders of nonredeemable voting equity securities receive nonredeemable voting equity securities.

Turning to the first prong of the test under CGCL Section 25103(h), the following criteria would need to be satisfied for a transaction to be exempt under CGCL Section 25012(f):

• Sales of the security must not be made to more than 35 unaccredited investors, including persons not in California (no limit on accredited investors);

• Each of the participants in the exchange must have a preexisting business relationship with the offeror or any of its partners, officers, directors or controlling persons, or by reason of his or her business or financial experience could be reasonably assumed to have the capacity to protect his or her own interests in connection with the transaction;

• Each of the participants in the exchange must be purchasing for his or her own account and not with a view to or for the sale in connection with any distribution of the security; and

• The offer and sale of the security must not be accomplished by the publication of any advertisement.

Other potential bars for the applicability of CGCL Section 25103(h) would be if dissenters’ rights do not apply to the transaction. In that case, the Delaware corporation would not qualify for an exemption based on the requirement under CGCL Section 25103(h)(1)(A) that the proposed transaction provide for dissenters’ rights. We note that a potential work-around here could be to contractually provide for dissenters’ rights in connection with the reincorporation transaction.

In addition, whether a reorganization merger would be “solely for the purposes” of changing the state of incorporation, as required under CGCL Section 25103(h)(1)(B), could be challenged to the extent there are differences in shareholders’ rights under the surviving corporation when compared to the disappearing corporation, such as the removal of cumulative voting of directors.

California law lacks helpful precedent on the issue of whether a reorganization merger would be “solely for the purposes” of changing the state of incorporation. As persuasive authority, the SEC has issued some no-action letters that address the issue of whether the “sole purpose” of a transaction is “to change an issuer’s domicile solely within the United States,” in the context of interpreting Rule 145(a)(2). In such letters, the Staff granted no-action relief in certain situations where a change in the state of domicile was accompanied by revisions to the issuer’s charter and bylaws that included provisions that could not have been adopted under the laws of the company’s prior state of incorporation. It is unclear, however, whether California would grant similar relief.

Fairness Hearing

If Rule 506 does not work and you do not qualify for an exemption from qualification under the CGCL, you would need to apply for a permit to qualify the issuance of shares with the California Department of Business Oversight (“DBO”). You would do so through the process of a fairness hearing, which is provided for under CGCL Section 25142.

During the fairness hearing, the DBO will examine all relevant factors in determining whether the transaction is fair and equitable, with the following factors considered to be the most material:

• the primary reasons for the reincorporation;

• whether there are any significant objections to the reincorporation;

• how shareholders are treated in connection with the reincorporation;

• whether adequate notice of the reincorporation was provided to shareholders; and

• whether the reincorporation was approved by shareholders.

If the DBO determines that the transaction is fair, the Commissioner will issue a permit allowing the Delaware corporation to issue shares to the California corporation’s shareholders in connection with the reincorporation merger. As an added bonus, the transaction would then qualify for an exemption under Section 3(a)(10) of the Securities Act based on the DBO approving the issuance of shares through the fairness hearing process, so the reincorporation would also be covered on the federal side.

Other State Exemptions

As noted above (in the context of offerings to accredited investors), if some shareholders are located in states other than California, you would need to look at securities regulations in those states to determine whether the merger transaction would qualify for a securities exemption or would need to be registered and qualified in those states.

Contractual Approvals

Aside from procedural and securities law requirements of reincorporating a California corporation in Delaware, you need to consider the effect of the merger on the corporation’s contracts.

As part of the merger transaction, the California corporation would be assigning its assets and liabilities by operation of law to the newly-formed Delaware corporation, including its existing contracts with customers, suppliers, landlords, lenders and other counterparties. To the extent that any of your agreements contain language restricting assignment – by operation of law or otherwise – reincorporating would constitute a technical breach of these agreements. As a result, before deciding to reincorporate, it is advisable to review your material contracts to confirm whether the merger transaction would require notice or consent, constitute an event of default, or otherwise constitute a breach. If so, it may be worth requesting counterparty consent for any material contracts prior to reincorporating.

_{[1]  The basic process for reincorporating your California corporation in Delaware is relatively straightforward. The first step is organizing a new corporation in the State of Delaware by submitting a Certificate of Incorporation with the Delaware Secretary of State. In conjunction with filing the Certificate of Incorporation, the Delaware corporation would adopt bylaws to establish the governing rules of the corporation in the reincorporation merger. Next, the California and the Delaware corporations would merge, with the California corporation as the disappearing corporation and the Delaware corporation as the surviving corporation.}

_{To complete the merger, you would be required to comply with the requirements under both California and Delaware corporate law. Under California law, both board and shareholder approval must be obtained. Although CGCL Section 1201(b) provides that shareholder approval is not required if the shareholders of the disappearing corporation possess more than five-sixths of the voting power of the surviving corporation, CGCL Section 1201(d) states that the principal terms of the merger must be approved by shareholders if the shareholders receive shares of the surviving corporation having different rights, preferences, privileges or restrictions than the shares surrendered. CGCL Section 1201(d) also states that shares in a foreign corporation received in exchange for shares in a domestic corporation are necessarily considered to have different rights, preferences, privileges or restrictions.}

_{After board and shareholder approval of the merger is obtained, the California corporation would file a Certificate of Ownership with the California Secretary of State. The filing would be accompanied by a resolution or plan of merger adopted by the board of the California corporation, authorizing the merger and setting forth its terms. As a final step, upon receipt of the Certificate of Ownership and Merger from the Delaware Secretary of State, the California corporation would submit a certified copy of the Certificate of Ownership and Merger to the California Secretary of State to complete the merger filings in California.}

_{In Delaware, only board approval and Secretary of State filings are required. To complete the merger in Delaware, the Delaware corporation would file a Certificate of Ownership with the Delaware Secretary of State as well as the merger authorizing resolutions adopted by its board. Shareholder approval would not be required because, under DGCL Section 253(a), the California corporation would own more than 90% of the outstanding shares of the Delaware corporation upon its formation.}

_{[2] Because the “doing business test” calculations are dependent on the availability of year-end financial information, the requirements of CGCL Section 2115(b) become applicable only upon the first day of the first income year of the corporation commencing on or after the 135th day of the income year immediately following the latest income year with respect to which the “voting shares test” and the “doing business test” have been met, per Section 2115(d) of the CGCL.}

_{[3] Schedule R and its accompanying instructions can be located on the California Franchise Tax Board’s website (Schedule R for 2017; instructions for Schedule R for 2017).}

_{[4] For example, Russell Corp. (March 18, 2004) (https://www.sec.gov/divisions/corpfin/cf-noaction/russellcorp031804.pdf).}

_{[5]  “Accredited investor” is defined in Rule 501(a) of Regulation D, and includes the following main categories:}

1. _{Directors, executive officers, and general partners of the issuer.}

2. _{Any natural person whose net worth either individually or jointly with their spouse equals or exceeds $1 million.}

3. _{Natural person investors who have income in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in current year (or $300,000, jointly with their spouse).}

4. _{Any trust not organized for the specific purpose of acquiring the securities offered, in which case each beneficial owner of the security is counted separately.}

_{[6] As with an offering exempt from registration under Rule 506 of Regulation D, Form D must be filed in connection with an offering that relies on Rule 504 of Regulation D for an exemption from registration.}

_{[7] Under the Ralston Purina test, an offering is exempt from registration if it would be considered a “private offering” as opposed to a “public offering,” with a balancing of four factors: (a) the number of offerees and their relationship to each other and the issuer, (b) the number of securities offered, (3) the size of the offering and (4) the manner of the offering. The relationship of the offerees to the issuer is significant, where an offering to members of a class who should have special knowledge based on their relationship to the issuer being less likely to be a public offering than an offering to members of a class who do not have that advantage.}

_{[8] Transactions subject to CGCL Section 25120 are not also subject to CGCL Section 25110. Per Section 4.5 of the Guide to California Securities Law Practice, Corporations Committee of the Business Law Section of the State of California, “by its express terms, [CGCL Section] 25110 applies only to those issuer transactions that are not subject to [CGCL Section] 25120. If an issuer transaction is subject to [CGCL Section] 25120 et seq., then [CGCL Section] 25120 and the regulations related thereto, and not [CGCL Section] 25110, apply to the transaction.”}

Health care data breaches cost health care entities an average $408 per record– the highest of any industry for the eighth straight year, according to IBM and the Ponemon Institute’s 2018 Cost of a Data Breach Report, and three times higher than the cross-industry average of $148 per record. The cost for a health care data breach increased from last year’s reported average of $380 per record. Contributing factors to the high costs include compliance with laws and regulations and abnormally high churn rates due to consumer mistrust.

The report was comprised of data collected from interviews with over 2,000 IT, data protection, and compliance professionals across 477 companies around the world that experienced data breaches in the last year. Some of the most significant findings from the report include the following:

• Notification costs for organizations are the highest in the United States at $740,000, due in part to costs associated with determining regulatory requirements. In contrast, India had the lowest notification costs at $20,000.
• Hackers or criminal insiders cause 48 percent of all data breaches analyzed in the report. The cost per record to resolve such attacks was $157, compared to $131 per record for data breaches caused by system glitches, human error, or negligence.
• Third party involvement in a data breach and extensive cloud migration at the time of the breach increases the cost by more than $13 per compromised record.
• For the fourth year in a row, the report showed that the faster a data breach can be identified and contained, the lower the costs for the breach. The average time to identify a data breach for the sample of 477 companies was 197 days, and the average time to contain a data breach was 69 days. Companies that identified a breach in less than 100 days saved more than $1 million as compared to those that averaged longer than 100 days. Likewise, companies that contained a breach in less than 30 days saved over $1 million as compared to those companies that took longer than 30 days.
• Incident response teams reduce the cost of a data breach by as much as $14 per compromised record and extensive use of encryption reduces the cost by $13 per capita.
• Organizations that lose 1 percent of customers due to a data breach result in an average total loss of $2.8 million. Organizations that lose 4 percent or more customers average a total cost of $6 million.

While the costs of data breaches continue to rise for health care as well as other industries, the study showed signs of cost savings through the use of newer technologies, such as automation tools, artificial intelligence, and machine learning to support or replace human intervention in data breach identification and response.

Cavalry Portfolio Services is defending two nearly-identical putative TCPA class actions in California, and recently obtained a stay in one of those cases, pending a forthcoming ruling on ATDS functionality in the other.

In Krejci v. Cavalry Portfolio Servs., No. 3:16-cv-0211-JAH-WVG, 2018 U.S. Dist. LEXIS 122904 (S.D. Cal. July 17, 2018), Cavalry moved for a stay of the action until the court in the related case of Horton v. Calvary Portfolio Services, LLC, 13-cv-0307-JAH (WVG) (S.D. Cal.) rules on the parties’ cross-motions for summary judgment concerning whether the Aspect dialing system used by Cavalry “is an ATDS within the meaning of the TCPA.”  Krejci, supra at *5.

Judge John A. Houston of the Southern District of California granted Cavalry’s motion, finding a stay was appropriate for three reasons: (1) Plaintiff had failed to demonstrate any potential harm that would result from a limited stay; (2) Cavalry’s burden in having to litigate the same issue over again; and (3) “a determination as to whether or not Cavalry’s Aspect system qualifies as an ATDS,” in Horton would have a “substantial impact” on the Krejci case.

This was a prudent exercise of discretion by Judge Houston, and his ruling illustrates the importance of every unpublished District Court decision on key issues like ATDS functionality.  As we’ve covered on the Ramble in past episodes, every one of these lower court decisions has the potential to cause significant ripples throughout TCPAland.  And that’s part of what makes this place special.

Oral argument on the Horton cross-summary judgment motions is scheduled for August 13, 2018.  We wait on the edge of our seats to provide you with our reporting and analysis on this next upcoming episode in the ATDS functionality saga.

On June 28, 2018, the SEC issued a proposed new rule under the Investment Company of 1940 (the 1940 Act)— Rule 6c-11—that would permit exchange-traded funds (ETFs) that satisfy certain conditions to launch and operate without first obtaining an individualized exemptive order from the SEC. In connection with proposed Rule 6c-11, the SEC proposed to rescind certain exemptive orders that have been granted to ETFs that could rely on the proposed rule. The SEC also issued proposed amendments that would require additional prospectus and/or website disclosure of information concerning ETF trading costs, including as to bid-ask spreads and premiums and discounts from the ETF’s net asset value. At present, ETFs require specific exemptive relief from various provisions of the 1940 Act to operate. To date the SEC has granted more than 300 such orders, many with inconsistent terms and conditions. According to the proposing release, the proposed rule and amendments are “designed to create a consistent, transparent, and efficient regulatory framework for ETFs and to facilitate greater competition and innovation among ETFs.”

Highlights of the SEC’s ETF rule proposal and amendments are as follows:

• Custom baskets permitted. In order to facilitate efficient ETF operation and, in view of differences in exemptive order terms among ETF sponsors, to level the playing field, Rule 6c-11 would provide flexibility with respect to the use of “custom baskets,” i.e., baskets that are composed of a non-representative selection of the ETF’s portfolio holdings (e.g., baskets that do not reflect a pro rata representation or representative sampling of the ETF’s portfolio holdings), or different baskets used in transactions on the same business day. The proposed rule would provide an ETF with the option of using custom baskets if it has adopted and implemented policies and procedures that “(i) set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (ii) specify the titles or roles of the employees of the ETF’s investment adviser who are required to review each custom basket for compliance with those parameters.”
• No distinction between index-based and actively managed ETFs. As part of the effort to simplify the regulatory framework governing ETFs, ETFs that are able to rely on Rule 6c-11 would be subject to the same conditions, regardless of whether the ETF is index-based or actively managed. The SEC stated that it believes index-based and actively managed ETFs that comply with the proposed rule’s conditions function similarly with respect to operational matters, despite different investment objectives or strategies, and do not present significantly different concerns under the provisions of the 1940 Act from which the proposed rule grants relief.
• Full portfolio transparency required. The proposed rule would require an ETF to disclose prominently on its website the portfolio holdings that will form the basis for the next calculation of its net asset value per share. This disclosure must be made each business day before the opening of regular trading on the primary listing exchange of the ETF’s shares and before the ETF starts accepting orders for the purchase or redemption of creation units. In this regard, the SEC is seeking comment on whether it should consider exemptions for ETFs with non-transparent or partially transparent portfolios in connection with the proposed rule.
• Additional disclosure requirements. In addition to the portfolio holdings information, the SEC is proposing to require ETFs to disclose on their websites information regarding a published basket that will apply to orders for the purchase or redemption of creation units each business day, the median bid-ask spread for the ETF’s most recent fiscal year and certain historical information about the extent and frequency of an ETF’s premiums and discounts. In addition, proposed form amendments would require additional specific disclosure regarding ETF trading information and related costs formatted as a series of questions and answers.
• No Intraday Indicative Value requirement. One of the standard conditions currently required for operation of an ETF is dissemination of Intraday Indicative Value (IIV).¹ However, the SEC is not proposing to require the dissemination of an ETF’s IIV as a condition of the proposed rule because, as stated in the proposing release, the SEC understands that IIV is no longer used by market participants when conducting arbitrage trading. Moreover, the proposing release notes that “IIV also may not reflect the actual value of an ETF that holds securities that do not trade frequently.” In view of the foregoing, as well as the condition under proposed Rule 6c-11 requiring daily disclosure of portfolio holdings, the SEC stated that it did not believe an IIV requirement would be necessary.
• Effect of proposed Rule 6c-11 on prior exemptive orders. The SEC is proposing to amend and rescind the exemptive relief issued to ETFs that would be permitted to rely on the proposed rule. The proposed rescission of orders would be limited to the portions of an ETF’s exemptive order granting relief with respect to an ETF’s formation and operation.
• Leveraged and inverse ETFs and ETFs organized as UITs or as a share class of an open-end fund not covered by proposed rule. ETFs that seek to provide returns that exceed the performance, or returns that have an inverse relationship to the performance, of a market index by a specified multiple over a fixed period—i.e., leveraged and inverse ETFs—would not be permitted to operate under the proposed rule. Similarly, ETFs organized as unit investment trusts (UIT ETFs) would not be able to rely on the proposed rule; rather, proposed Rule 6c-11 would be available only to ETFs that are organized as open-end funds.² In addition, ETFs that are structured as a share class of a multiple-class open-end fund would not be included in the scope of the proposed rule.

The SEC requests comment on all aspects of the proposed rule and disclosure amendments, including with respect to, among other things, the scope of the proposed rule (e.g., whether leveraged or inverse ETFs should be covered by the rule) and whether the SEC should create a new registration form specifically designed for ETFs.

Members of Vedder Price’s Investment Services Group plan to publish a detailed analysis of the SEC’s ETF rule proposal and amendments in the near future.

Comments on the proposal and amendments will be due 60 days after the date of publication of the SEC’s proposing release in the Federal Register.

The SEC’s proposing release is available at: https://www.sec.gov/rules/proposed/2018/33-10515.pdf

_{1 As noted in the proposing release, exchanges, such as NYSE Arca, have their own requirements for dissemination of an ETF’s IIV.}

_{2 Under the SEC’s proposal, UIT ETFs would continue to be regulated pursuant to their exemptive orders, rather than a rule of general applicability. The proposing release noted that the “vast majority of ETFs currently in operation are organized as open-end funds.”}

With its decision in South Dakota v. Wayfair, the U.S. Supreme Court substantially eliminated the distinction between brick-and-mortar business and e-commerce, for purposes of state laws obligating sellers to collect and remit sales taxes. In response to that ruling, remote sellers into the 25 states (and counting) that have adopted laws requiring them to collect and remit sales taxes might be tempted to consider moving some of their operations into those states. After all, they might reason, if they have to collect sales taxes anyway, it might be more efficient to move parts of their supply chain closer to the customer, particularly in states with lots of customers.

Before making such a decision, however, businesses would be wise to look beyond sales taxes to the entire range of taxes they might have to pay. In particular, despite all of the recent focus on sales taxes, businesses should not lose sight of the potential state and local income tax bills they could face should they establish a physical presence in any particular state.

In 1959, Congress enacted a law that severely restricts the power of states to impose income taxes on businesses that make sales into a state, but lack a permanent presence there. Public Law 86-272 (codified in 15 U.S.C. §381) prohibits states or localities from imposing a net income tax on income derived from interstate commerce into that state if: (1) the only activity of the seller involves solicitation of orders for tangible personal property, (2) those orders are approved or rejected outside the state, and (3) the property is shipped from outside the state. The Supreme Court has ruled that this law prohibits states from imposing income taxes on sales made by a business’ salespeople who do not maintain an office in the state, and whose only role is soliciting orders. Wisconsin Dep’t of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992).

In considering how best to respond to Wayfair, businesses should consider whether any savings they might realize from moving operations to a state might be offset by their potential liability to pay state and local income taxes on sales made into that state. After all, it’s not just about the sales taxes.