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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FATCA Implementation Summit – June 17, 2013

The National Law Review is pleased to bring you information about the upcoming FATCA Implementation Summit.

FACTA

When:

June 17 – 18, 2013

Where:

The Princeton Club
15 West 43rd Street
New York, NY 10036
212-596-1200

The final regulations are out and FATCA implementation dates are closer than ever! The compliance ball is rolling and funds should have their implementation plans already underway. The FATCA Implementation Summit will examine what funds should have done so far, what is next on the list, and what is still unknown. Our expert speaking faculty is prepared to answer all of your FATCA-related questions – including significant changes revealed in the final regulations, timelines, best practices and procedural benchmarks, new and updated forms, and so much more!

This is the ONLY industry event that addresses the unique challenges alternative funds face under the sweeping FATCA regime. We’ll dig deep into questions about how FATCA is playing out in practice – operational challenges, due diligence and on-boarding requirements, responsible parties, outsourcing– and more!

You can’t afford to miss this essential event!

This event is part of a two-day compliance intensive. For information on day two, Preparing for the AIMFD, click here. Register for both events to receive a discounted rate.

Topics at a Glance –

  • FATCA Today: Overview and Timeline of the Final Regulations
  • Who is Affected by FATCA? – Update on Definitions and Classifications
  • Entering into the FFI Agreement: Registering as an FFI with the IRS
  • Managing Your Clients: Due Diligence in Identifying Existing Investors and Developing On-Boarding Processes for New Investors
  • Reporting and Withholding Obligations Under the FATCA Regime
  • Determining FATCA Compliance with IGA Countries
  • Practical Implementation – Putting it all Together
  • Outsourcing – The Risks and the Rewards

Plan for the Worst, Hope for the Best: Why You Must Have a HIPAA (Health Insurance Portability and Accountability Act) Risk Assessment

McBrayer

“The single biggest and most common compliance weakness is the lack of a timely and thorough risk analysis.”

-Leon Rodriguez, head of the U.S. Health and Human Services Office for Civil Rights

When the Office for Civil Rights (“OCR”) auditor drops by your health facility to ensure that you are complying with HIPAA, one thing is for certain: he will be asking to see your Risk Assessment. Do you have one? Is it completed? Has it been used to develop and implement appropriate policies and procedures?

Audit Risks Are Real

The OCR is cracking down on covered entities’ and business associates’ compliance with HIPAA. Audits are becoming commonplace and resulting in more and more providers being hit with fines and sanctions. You may think that even if you are subject to an audit, then penalty will be a slap on the wrist. Think again. The maximum penalty for a HIPAA violation is now $1.5 million. Maybe you are too small of a provider to be the target of an audit? Think again, again. In January of 2013, Hospice of North Idaho agreed to pay the Department of Health and Human Services (“HHS”) $50,000 to settle potential HIPAA violations stemming from a 2010 incident involving a stolen, unencrypted laptop. It was the first HIPAA breach settlement involving less than 500 people. The hospice did not have a risk assessment in place.

Risk Assessments Are Not Optional

A HIPAA risk assessment is a thorough investigation and analysis of areas where there is potential risk of violating HIPAA laws. A risk assessment is not optional and it is not just a checklist. Covered entities, and now business associates, are required to have an assessment done. Specifically, entities must:

Conduct an accurate and thorough assessment of the potential risks and vulnerabilities to the confidentiality, integrity, and availability of electronic protected health information held by the covered entity.

These assessments are critical to compliance with the HIPAA Security Rule. An assessment should include questions addressing administrative, physical, and technical safeguards, and the Breach Notification Rule. Many assessments are created in the form of a table and not only analyze the level of the risk, but also whether there is a policy in place and who should be responsible for ensuring each provision is implemented.

Risk Assessments Are Just the First Step

Once your facility’s risk assessment is complete, then it and any relevant accompanying documents should be kept in your HIPAA security files. Assessing risks is only a first step. You must use the results of your risk assessment to develop and implement appropriate policies and procedures. The use of a privacy officer is highly recommended. Consider offering training to employees where a sign-in sheet is required and certifications are provided once training is complete. This kind of documentation will be very beneficial when the OCR auditor is at your door.

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New Trademark Headaches, But Help is On the Way Re: Internet Corporation for Assigned Names and Numbers’ (ICANN) Expansion of Generic Top-Level Domains (gTLDs)

Neal Gerber

For brand owners that have often struggled to keep up with all the infringement and cybersquatting issues in the 22 existing generic top-level domain name registries, or “gTLDs”, like .com, .org, and .net, life is about to become even more challenging. The Internet Corporation for Assigned Names and Numbers’ (ICANN) planned expansion of gTLDs to potentially almost 2,000 in total has the potential to create major trademark enforcement headaches. In order to address some of those concerns and burdens, ICANN has created the Trademark Clearinghouse, which allows brand owners to submit information regarding their registered trademarks into a single database across all the new gTLDs for an annual fee of approximately $150 per trademark per year.

Registration in the Trademark Clearinghouse provides two primary benefits:

  • First, it allows brand owners priority access for registering their trademarks as domain names in any new gTLD that is available to the general public as it launches.1 For example, if Acme Car Sales owns a trademark registration covering the term ACME in any jurisdiction worldwide, as the anticipated .cars registry launches, Acme Car Sales would be able to register acme.cars before others have that opportunity.
  • Second, Clearinghouse registrants will receive notice if anyone tries to register domain names that match their marks. Thus, to take the prior example, if Acme Car Sales decides not to register acme.cars, but a third party proceeds to do so, Acme Car Sales will receive notice of the registration and then can contest it if appropriate.

Although this sounds promising, be aware that the Clearinghouse is not perfect—if Acme Car Sales’ only trademark registration is for “ACME,” the Clearinghouse does not provide any benefits pertaining to domain name registrations that differ even slightly from the trademark registration, such as acmesales.cars, or acmechicago.cars. Additionally, individual registries are permitted to determine on their own how to handle situations where multiple entities own trademark registrations for the same mark.

Despite these shortcomings, the Trademark Clearinghouse presents a good first step toward brand protection in the new gTLD space, and most brand owners will benefit from registration. Registration is now open, and will remain open as long as new gTLDs are being released.

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America’s Claims Event 2013 – June 19-21, 2013

The National Law Review is pleased to bring you information about the upcoming 17th Annual America’s Claims Event:

American Claims Act June 19-21 2013

America’s Claims Event 2013

June 19-21, 2013

Austin, Texas

We have Every Angle of the Claims Process Covered with Expertise

The 17th Annual America’s Claims Event is the ONLY industry event where senior managers, practitioners & experts involved with claims operations can get the insight they need to implement effective and tactical strategies for their claims handling process. More than 400 professionals and decision-makers from mid-size to large Fortune 500 companies attend the event to engage in idea exchanging and peer-to-peer learning. Attendees gain deep insight from the experts and obtain unparalleled access to proven solutions to confront their operational challenges.

Strategic and Tactical Intelligence YOU Can Immediately Employ in YOUR Claims Process:

  • Make better business decisions with accurate information from industry experts
  • Realize attainable goals with streamlined operations: learn how to maximize employee productivity and adapt to market trends
  • Department control: manage operations through sophisticated workflow and data-decision solutions
  • Improved customer and agent relations: easy-to-implement changes can make a significant difference on resolution time of claims

New Focuses Explore:

  • The growing talent problem; tackling recruitment, retention, competencies & organizational knowledge transfer across claims
  • Organizational branding & Market PR; harnessing the power of new & developing media to engage the client base
  • Engaging & communicating with the Customer base
  • The latest in Fraud Prevention, Preparedness & Mitigation

Keynote sessions and focused panels will tackle real world issues involving modernization, process simplification, streamlining, business growth, claims strategy, tactical efforts applications and a holistic exploration of the property casualty market in its short, medium and long term projections.

The 17th Annual America’s Claims Event is produced by Summit Business Media and presented by Claims, Tech Decisions, National Underwriter’s Property & Casualty magazines, and FC&S.

The Stockton Saga Continues: Untouchable Pensions on the Chopping Block?

Sheppard Mullin 2012

Judge Christopher M. Klein’s decision to accept the City of Stockton’s petition for bankruptcy on April 1, 2013 set the stage for a battle over whether public workers’ pensions can be reduced through municipal reorganization.

Stockton’s public revenues tumbled dramatically when the recession hit, leaving Stockton unable to meet its day-to-day obligations. Stockton slashed its police and fire departments, eliminated many city services, cut public employee benefits and suspended payments on municipal bonds it had used to finance various projects and close projected budget gaps. Stockton continues to pay its obligations to California Public Employees’ Retirement System (“CalPERS”) for its public workers’ pensions. Pension obligations are particularly high because during the years prior to the recession, city workers could “spike” their pensions—by augmenting their final year of compensation with unlimited accrued vacation and sick leave—in order to receive pension payments that grossly exceeded their annual salaries.

When Judge Klein accepted Stockton’s petition April 1, 2013, he reasoned that Stockton could not perform its basic functions “without the ability to have the muscle of the contract impairing power of federal bankruptcy law.” Judge Klein noted that his decision to “grant an order for relief … is merely the opening round in a much more complicated analysis.” The question looming is whether the contract-impairing power of federal bankruptcy law is strong enough to adjust state pension obligations.

Stockton will have the opportunity to present a plan of adjustment, which must be approved through the confirmation process. No plan of adjustment can be confirmed over rejection by a particular class of creditors unless the plan (1) does not discriminate unfairly, and (2) is fair and equitable with respect to each class of claims that is impaired under or has not accepted a plan. Judge Klein said that if Stockton “makes inappropriate compromises, the day of reckoning will be the day of plan confirmation.”

Stockton’s plan of adjustment will likely propose periods of debt service relief and interest-only payments for some municipal bonds, followed by amortization. Stockton intends to actually impair other municipal bonds, potentially paying only cents on the dollar. However, Stockton does not intend to reduce its pension obligations to CalPERS under the plan. Provisions of the California Constitution and state statutes prohibit the reduction of public workers’ pensions, even in bankruptcy proceedings. These California state law provisions were thought to make public pensions virtually untouchable. Yet, the plan may not be confirmable if it impairs Stockton’s obligations to bondholders but not its obligations to CalPERS. Bondholders and insurers will surely vote against and object to the plan, claiming it unfairly discriminates against them, and Judge Klein will have to decide whether the treatment constitutes unfair discrimination. The unfair discrimination claim may have merit, because an overarching goal of federal bankruptcy law is to equitably allocate losses among competing creditors. Federal bankruptcy law often trumps state laws, but there is no precedent for how federal bankruptcy law applies to California’s pension provisions.

For now, cash-strapped municipalities around the country—and their creditors—are watching to see just how Stockton will restructure its obligations.

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Law Firm Tornado Relief Drive

CLEVELAND, OH – May 22, 2013 – Benesch has announced that it will donate $1 for every “like” on its Facebook page (up to $5,000) to the American Red Cross Disaster Relief Fund to aid the victims of the May tornados in Oklahoma and neighboring states. This online drive will begin immediately and run until Wednesday, May 29.

“As a firm and as a community, we are deeply saddened by the losses and devastation caused by the recent tornados, especially yesterday’s tornado in Moore, Oklahoma,” said Ira C. Kaplan, Benesch’s Managing Partner. “We want to do our part to help the people in that area as they begin to rebuild in the days ahead.”

Benesch’s Facebook page can be accessed at: www.facebook.com/Benesch.Law

Department of State Releases June 2013 Visa Bulletin

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EB-2 category for all chargeable areas other than China and India remains current, with considerable forward movement—but continued backlog—in the EB-3 category for a second month in a row.

The U.S. Department of State (DOS) has released its June 2013 Visa Bulletin. The Visa Bulletin sets out per country priority date cutoffs that regulate the flow of adjustment of status (AOS) and consular immigrant visa applications. Foreign nationals may file applications to adjust their status to that of permanent resident or to obtain approval of an immigrant visa at a U.S. embassy or consulate abroad, provided that their priority dates are prior to the respective cutoff dates specified by the DOS.

What Does the June 2013 Visa Bulletin Say?

EB-1: All EB-1 categories remain current.

EB-2: Foreign nationals in the EB-2 category from all countries other than China and India remain current. A cutoff date of July 15, 2008, reflecting minor forward movement, has been imposed for foreign nationals in the EB-2 category from China. A cutoff date of September 1, 2004 remains in effect for foreign nationals in the EB-2 category from India.

EB-3: There is continued backlog in the EB-3 category for all countries, with considerable forward movement for EB-3 individuals chargeable to countries other than India and the Philippines.

The relevant priority date cutoffs for foreign nationals in the EB-3 category are as follows:

China: September 1, 2008 (forward movement of 275 days)

India: January 8, 2003 (forward movement of 17 days)
Mexico: September 1, 2008 (forward movement of 275 days)

Philippines: September 22, 2006 (forward movement of 7 days)

Rest of the World: September 1, 2008 (forward movement of 275 days)

Developments Affecting the EB-2 Employment-Based Category

Mexico, the Philippines, and the Rest of the World

In November 2012, the EB-2 category for individuals chargeable to all countries other than China and India became current. This meant that EB-2 individuals chargeable to countries other than China and India could file an AOS application or have the application approved on or after November 1, 2012. The June Visa Bulletin indicates that the EB-2 category will continue to remain current for these individuals through June 2013.

China

The June Visa Bulletin indicates a cutoff date of July 15, 2008 for EB-2 individuals chargeable to China. This means that EB-2 individuals chargeable to China with a priority date prior to July 15, 2008 may file an AOS application or have the application approved on or after June 1, 2013.

India

Since October 2012, the cutoff date for EB-2 individuals chargeable to India has been September 1, 2004. The June Visa Bulletin indicates no movement of this cutoff date. This means that EB-2 individuals chargeable to India with a priority date prior to September 1, 2004 may file an AOS application or have the application approved through June 2013.

Developments Affecting the EB-3 Employment-Based Category

The May Visa Bulletin announced that the cutoff dates for EB-3 individuals chargeable to most countries had advanced significantly in an attempt to generate demand and fully utilize the annual numerical limits for the category. The June Visa Bulletin indicates that the cutoff dates for EB-3 individuals chargeable to most countries have advanced significantly for a second month in a row. The June Visa Bulletin notes that this forward movement is not indicative of what can be expected in the future, and that rapid forward movement in cutoff dates is often followed by a dramatic increase in demand for numbers within the following three to six months. If such demand materializes, such movement in cutoff dates may slow, or stop, for a period of time.

China

The May Visa Bulletin indicated a cutoff date of December 1, 2007 for EB-3 individuals chargeable to China. The June Visa Bulletin indicates a cutoff date of September 1, 2008 for these individuals, reflecting forward movement of 275 days. This means that EB-3 individuals chargeable to China with a priority date prior to September 1, 2008 may file an AOS application or have the application approved on or after June 1, 2013.

India

Additionally, the May Visa Bulletin indicated a cutoff date of December 22, 2002 for EB-3 individuals chargeable to India. The June Visa Bulletin indicates a cutoff date of January 8, 2003 for these individuals, reflecting forward movement of 17 days. This means that EB-3 individuals chargeable to India with a priority date prior to January 8, 2003 may file an AOS application or have the application approved on or after June 1, 2013.

Rest of the World

The May Visa Bulletin also indicated a cutoff date of December 1, 2007 for EB-3 individuals chargeable to the Rest of the World. The June Visa Bulletin indicates a cutoff date of September 1, 2008 for these individuals, reflecting forward movement of 275 days. This means that individuals chargeable to all countries other than China and India with a priority date prior to September 1, 2008 may file an AOS application or have the application approved on or after June 1, 2013.

How This Affects You

Priority date cutoffs are assessed on a monthly basis by the DOS, based on anticipated demand. Cutoff dates can move forward or backward or remain static. Employers and employees should take the immigrant visa backlogs into account in their long-term planning and take measures to mitigate their effects. To see the June 2013 Visa Bulletin in its entirety, please visit the DOS website here.

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Patent Exhaustion Rejected: Patented Seed Purchaser Has No Right to Make Copies

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The Supreme Court in Bowman v. Monsanto Co. ruled unanimously that a farmer’s replanting of harvested seeds constituted making new infringing articles.  While the case is important for agricultural industries, the Supreme Court cautioned that its decision is limited to the facts of the Bowman case and is not a pronouncement regarding all self-replicating products.

In a narrow ruling that reaffirms the scope of patent protection over seeds, and possibly over other self-replicating technologies, the Supreme Court of the United States held that a purchaser of patented seeds may not reproduce them through planting and harvesting without the patent holder’s permission.  Bowman v. Monsanto Co., Case No. 11-796 (Supreme Court May 13, 2013).

In this case, Monsanto had asserted two of its patents that cover genetically modified soybean seeds that are resistant to herbicide (Roundup Ready® seeds).  Monsanto broadly licenses its Roundup Ready® soybean seeds under agreements that specify that the farmer “may not save any of the harvested seeds for replanting, nor may he supply them to anyone else for that purpose.”  Vernon Hugh Bowman is a farmer who purchased soybean seeds from a grain elevator.  Bowman replanted Roundup Ready® seeds in multiple years without Monsanto’s permission.  The district court granted summary judgment of patent infringement against Bowman, and the U.S. Court of Appeals for the Federal Circuit affirmed.  Bowman appealed to the Supreme Court, which granted certiorari.

On appeal, Bowman heavily relied on the “patent exhaustion” doctrine, which provides that the authorized sale of a patented article gives the purchaser or any subsequent owner a right to use or resell that article.  Bowman argued that the authorized sale of the Roundup Ready® seeds exhausted Monsanto’s patent rights in the seeds, because “right to use” in the context of seeds includes planting the seeds and reproducing new seeds.

Patent Implications

Speaking through Justice Kagan, the Supreme Court unanimously affirmed the Federal Circuit’s decision that Bowman’s activities amounted to making new infringing articles.  The Supreme Court held that “the exhaustion doctrine does not enable Bowman to make additional patented soybeans without Monsanto’s permission.”  Specifically, the exhaustion doctrine restricts a patentee’s rights only as to the particular article sold, but “leaves untouched the patentee’s ability to prevent a buyer from making new copies of the patented item.”  The Supreme Court noted that if Bowman’s replanting activities were exempted under the exhaustion doctrine, Monsanto’s patent would provide scant benefit.  After Monsanto sold its first seed, other seed companies could produce the patented seed to compete with Monsanto, and farmers would need to buy seed only once.

In rebuffing Bowman’s argument that he was using the seed he purchased in the manner it was intended to be used, and that therefore exhaustion should apply, the Supreme Court explained that its ruling would not prevent farmers from making appropriate use of the seed they purchase—i.e., to grow a crop of soybeans consistent with the license to do so granted by Monsanto.  However, as the Supreme Court explained “[A]pplying our usual rule in this context . . . will allow farmers to benefit from Roundup Ready, even as it rewards Monsanto for its innovation.”

Tying the Supreme Court’s decision in this case narrowly to seed (as opposed to other self-replicating technologies), Justice Kagan noted that the decision is consistent with the Supreme Court’s 2001 decision in J.E.M. Ag. Supply, Inc. v. Pioneer Hi-Bred Int’l, Inc., in which the Supreme Court concluded that seeds (as well as plants) may simultaneously be subject to patent protection and to the narrower protection available under the Plant Variety Protection Act (PVPA).  PVPA protection permits farmers who legally purchase protected seed to save harvested seed for replanting.  However, reconciling the two forms of protection, Justice Kagan explained, “[I]f a sale [i.e., of a patented seed] cut off the right to control a patented seed’s progeny, then (contrary to J.E.M.) the patentee could not prevent the buyer from saving harvested seed.”

Other Self-Replicating Technologies

The Supreme Court’s decision in Monsanto is, of course, important for agricultural industries.  If extended to other self-replicating technologies, it may also prove important for biotechnology companies and others  that rely on self-replicating technologies, including, for example, companies that own patent rights over viral strains, cell lines, and self-replicating DNA or RNA molecules.  If subsequent cases extend the “no exhaustion” holding of Monsanto to these technologies, patent protection would extend to copies made from the “first generation” product that is obtained through an authorized sale.

However, the Supreme Court cautioned that its decision is limited to “the situation before us” and is not an overarching pronouncement regarding all self-replicating products.  The Supreme Court suggested that its “no exhaustion” ruling might not apply where an article’s self-replication “occur[s] outside the purchaser’s control” or is “a necessary but incidental step in using the item for another purpose,” citing computer software (and a provision of the Copyright Act) as a possible example.  As explained by Justice Kagan, “We need not address here whether or how the doctrine of patent exhaustion would apply in such circumstances.”  In this regard, the Supreme Court particularly noted that “Bowman was not a passive observer of his soybeans’ multiplication.”  Instead, Bowman “controlled the reproduction” of seeds by repeated planting and harvesting.  Thus, the Supreme Court suggests that a purchaser’s “control” over the reproduction process likely will be a key inquiry in considering the patent exhaustion doctrine as it relates to other self-replicating technologies.  Of course, it remains to be seen how broadly lower courts will interpret the Supreme Court’s ruling.

Antitrust Implications

By holding that Monsanto’s restriction on replanting was within the scope of its patent rights, the Supreme Court effectively immunized that restriction from antitrust scrutiny.  Other court decisions have called into question other license restrictions viewed as going beyond the scope of patent protection as being potentially susceptible to an antitrust or patent misuse challenge.

The Supreme Court highlighted its application of the exhaustion doctrine last addressed in Quanta, which held that “the initial authorized sale of a patented item terminates all patent rights in that article.”  This boundary line conventionally demarcated the end of a patent’s protection and the beginning of a potential antitrust minefield.  Some commentators may interpret the Monsanto decision to push that line further out.  Importantly, however, the Supreme Court deemed the seeds at issue to be a “new product.”  So construed, Monsanto’s restriction on replanting did not affect the product’s use, as in Quanta and Univis Lens, but rather came within the well-settled principle that “the exhaustion doctrine does not extend to the right to ‘make’ a new product.”

The Supreme Court not only was doctrinally conservative in its Monsanto decision, it was also careful to explain that its holding is a narrow one.  Monsanto never exhausted its patent rights in the “new” seeds; indeed, it never truly “sold” them.  Rather, Bowman created new seed from seeds that Monsanto had sold.  The decision therefore may not portend a more general inclination to construe the scope of patent protection more broadly.  In fact, the Supreme Court went so far as to clarify that it could reach a different outcome were it presented with a different technology.

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

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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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