There is an attraction for companies to incorporate in Delaware, likely due to the abundance of well-known publicly traded corporations that have chosen to incorporate there. However, it is not necessarily true that the Delaware General Corporation Law (“DGCL”) is better than corporate laws of other states; it is just more developed due to the abundance of case law interpreting it. This usually provides for greater certainty, which is often looked upon favorably by not only directors and management, but investors as well. On the other hand, it is generally more expensive to incorporate and maintain a Delaware corporation. Unless your company has a physical presence in Delaware, you’ll need to pay for a registered agent who is physically located in the state and who can accept service of process on behalf of your company. Delaware also imposes a franchise tax based on a corporation’s capitalization, which is generally higher than similar fees and taxes imposed by other states (for example, Florida’s annual report fee, the only corporate fee that is required to be paid to the state each year to maintain corporate status, is only $150).
Thus, while there may be good reasons for incorporating or reincorporating in Delaware (e.g., because a private equity investor requires it as a condition for investment), the costs of using a Delaware corporation are probably not justified Continue Reading
Illustration by Royce Bair
Accredited investors have long been critical participants in private financing transactions, and the success of most private financings is largely determined by the participation of these investors and the availability of their capital. State and Federal securities laws have been written or amended to foster and facilitate investment by these accredited investors. Based on recent developments, the standards for qualification as an accredited investor may be changing, and these changes could pose problems for companies seeking financing.
The current requirements for accredited investor status are contained in Rule 501(a) of the 1933 Act. The most commonly used standards for individual investors are a $200,000 annual income (or $300,000 combined income with a spouse) or a $1,000,000 net worth (excluding the value of the investor’s primary residence). Other than the exclusion of the investor’s primary residence (which became effective in 2012), these standards have been in place since 1982 without any changes to reflect the effects of inflation during that period.
Based on these current standards, observers estimate that there are approximately 8.5 million accredited investors in the United States. Some critics have asserted that this number is far higher than it should be, and that many of these people only qualify as accredited investors because Continue Reading
Who says Congress isn’t popular? Well, Congress may become much more popular with public company executives if Congressman Patrick McHenry (R-NC) can make good on his recent promise to challenge the power of proxy advisory firms if the SEC doesn’t act. In a recent keynote speech at an American Enterprise Institute conference on the role of proxy advisory firms in corporate governance, Rep. McHenry stated that proxy advisory firms are a significant issue on Capitol Hill.
As I have blogged about before, there are some real questions as to whether proxy advisory firms actually serve investors’ interests. While ISS and Glass Lewis are entitled to create a business model based on providing services to institutional investors, there has been either a market or regulatory failure that has forced public companies to consider corporate governance policies promulgated by two unregulated proxy advisory firms before making business decisions. Public companies should be making decisions based on what makes sense for their company and their shareholders and not based on trying to meet arbitrary policies of ISS or Glass Lewis (policies that seem to be continuously tweaked to keep the proxy advisory firms services relevant). To be fair, ISS and Glass Lewis claim that their policies aren’t arbitrary at all, but rather their policies reflect their clients’ views. Of course, for that to be the case, all of their institutional investor clients would need to have a monolithic view toward corporate governance.
Because institutional investors may own hundreds or even thousands of positions in public companies, institutional investors do not have the ability or the resources to research all of the issues facing each of those holdings. That is where ISS and Glass Lewis step in to provide guidance to these institutional investors. While some institutional investors have robust voting policies and attempt to make educated and informed voting decisions, Continue Reading
Photo by Sharon Drummond
In a case of first impression, the Delaware Supreme Court held that provisions contained in a nonstock corporation’s bylaws, requiring a plaintiff stockholder to reimburse the corporation’s legal expenses if the plaintiff loses on a claim it has brought against the corporation, are facially valid if adopted properly and for a proper purpose (i.e., not for the purpose of deterring meritorious litigation). The court reached its conclusion in its May 8, 2014 decision based on the following factors and analysis:
- the Delaware General Corporation Law (“DGCL”) and other Delaware statutes did not forbid the enactment of fee-shifting bylaws;
- the fee-shifting bylaw related to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees because it related to the allocation of risk in connection with intra-corporation litigation (DGCL § 109(b));
- a provision for fee-shifting was not required to be included in the charter and could therefore be adopted in the bylaws (DGCL § 102(a)); and
- because the Delaware Supreme Court has held that bylaws are treated as contracts among a corporation’s stockholders, it was permissible to modify the American attorney’s fees rule (i.e., that each party in litigation bears its own costs and expenses) by adopting a fee-shifting bylaw.
Because of the statutory basis of the court’s decision, the holding was presumed to also apply to ordinary stock corporations. Thus, a fee-shifting bylaw would likely allow Delaware corporations to require the loser of an intra-corporate lawsuit to pay the corporation’s attorney expenses.
In response to the Delaware Supreme Court’s ruling, the Delaware State Bar Association (with significant plaintiff’s attorney membership) was considering a proposed amendment to the DGCL would amend Section 102(b)(6) and add a new Section 331 to clarify that these costs cannot be borne by stockholders of stock corporations. The proposed legislation was expected to be presented to the Delaware General Assembly before the end of the current session and, if passed, would have become effective on August 1, 2014.
However, in a recent development, Continue Reading
Photo by Josh Turner
The JOBS Act’s crowdfunding provisions were once one of the most eagerly anticipated items contained in that Act. Many companies and their advisors had high hopes that these crowdfunding provisions would open up new arenas for financing smaller companies while easing the costs and challenges associated with securities regulatory compliance. These hopes and dreams have been substantially curtailed as the SEC’s proposed crowdfunding rules (issued in 2013) did not provide the anticipated relief. The SEC received a significant number of comments on these proposed crowdfunding rules, and these comments were predominantly critical due to the perceived regulatory and cost burdens that the proposed Rules seemed to contain.
Hope springs eternal, however, and many people are still eagerly awaiting the SEC’s final crowdfunding regulations to determine if the SEC will adopt a more reasonable position that may be useful to small companies seeking financing. The Federal crowdfunding exemption from registration will not be effective until the SEC issues these final regulations. Many people just want to know what they are actually dealing with here and whether crowdfunding will offer any viable opportunities for small company financing. Somewhat surprisingly given the significant amount of attention and publicity that crowdfunding has generated, the SEC still has not issued those final regulations despite the JOBS Act’s deadline. This situation has caused a significant amount of frustration in the corporate finance community.
Given the uncertainty regarding the status of Federal crowdfunding regulation, some states have seen an opportunity and have taken somewhat bold steps in establishing crowdfunding exemptions on the state level. The states moving ahead of the SEC is somewhat unusual, but it appears that the initial impact of these state crowdfunding initiatives may be economically beneficial to these states.
The predominant model for these state crowdfunding structures is the creation of an intrastate crowdfunding exemption from registration. The states have been very creative in their efforts, as they appear to have used the strong desire for a useful crowdfunding regulatory structure to create state structures that will help to provide economic growth in the states. This is also very compatible with the nature of crowdfunding – since many crowdfunding projects are smaller and localized, they may not be affected by being required to be contained in any one state.
The participating states have mainly modeled their crowdfunding regulations to be Continue Reading
The Foreign Account Tax Compliance Act (“FATCA”) is a US law designed to counter offshore tax avoidance by US persons. Controversial because of its wide-ranging breadth and application to non-US financial institutions, in the most general sense, FATCA imposes a 30% withholding tax on payments of US source income made to foreign financial institutions (“FFIs”) unless they enter into an agreement with the US Internal Revenue Service (“IRS”) and disclose information about their US account holders.
After having revised the timelines for FATCA’s implementation on several occasions (culminating in an implementation delay of over three years from the date of its adoption in March of 2010), FATCA’s official July 1, 2014 implementation date is on the horizon. As a result, FFIs worldwide have made a mad dash in the race toward FATCA compliance over the last few months.
So why does this matter to non-banking/non-financial institutions? Well, as an initial matter, FATCA’s definition of an FFI is broad, including more types of entities than one might expect. As a result, US entities must make sure they have evaluated their corporate structure to determine whether its network includes an FFI. Under FATCA rules, the following types of entities may qualify as FFIs, subject to certain exceptions:
- Non-US retirement funds and foundations
- Special purpose entities and banking-type subsidiaries
- Captive insurance companies
- Treasury centers, holding companies, and captive finance companies
Additionally, even if an organization’s affiliate network does not include an FFI, US-based entities could be Continue Reading
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The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.” The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.
Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”
In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential Continue Reading
Photo by Marina Noordegraaf
The SEC continues to increase its focus on cybersecurity preparedness. As we have reported in prior blogs here and here, we believe that cybersecurity will become an increasingly important element of the SEC’s disclosure and enforcement efforts. Recent events show that the SEC is ramping up its efforts in the cybersecurity area, and we believe that all companies who are potentially affected by these SEC activities should pay special attention to their cybersecurity preparedness and should anticipate possible SEC action in this area.
The SEC’s most recent activity in the cybersecurity area involves registered broker-dealers and registered investment advisers. These entities are logical choices for a cybersecurity focus because of the large volume of confidential and very sensitive customer information that they hold. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced this cybersecurity focus in an April 15, 2014 Risk Alert which stated that the SEC plans to mount an initiative to assess cybersecurity preparedness in the securities industry. The SEC had previously laid the groundwork for this initiative during a March 26, 2014 Cybersecurity Roundtable when Chair White stressed the vital importance of cybersecurity to our market system and consumer data protection. She also called for more public/private cooperation in strengthening cybersecurity preparedness. Other SEC participants at this Roundtable stressed the importance of gathering data and information regarding cybersecurity preparedness so that the SEC could determine what additional steps it should take in this area.
The OCIE’s cybersecurity initiative will assess cybersecurity preparedness in the securities industry and obtain data and information about the securities industry’s recent experiences with cyber threats and cybersecurity breaches. As part of this initiative, the OCIE announced that it will conduct examinations of more than 50 registered broker-dealers and registered investment advisers to obtain cybersecurity data and information and to assess the preparedness of these entities to defend against cyber threats. According to the Risk Alert, this investigation will focus on such things as Continue Reading
Generally speaking, the Bank Secrecy Act (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. But while anyone can imagine that the BSA and its implementing regulations apply to those entities we typically classify as “financial institutions” such as banks and other depository institutions, it is important to note that the BSA Rules also apply to other entities that we may not traditionally think of as “financial institutions” including securities broker-dealers.
The BSA rules require brokers-dealers to, among other things, develop and implement BSA compliance programs. In accordance with the BSA rules, FINRA Rule 3310 sets forth minimum standards for broker-dealers’ BSA compliance programs. First, the rule requires firms to develop and implement a written BSA compliance program. The program has to be approved in writing by a member of senior management and be reasonably designed to achieve and monitor the firm’s ongoing compliance with the requirements of the BSA Rules. Additionally, and consistent with the BSA Rules, the rule also requires firms, at a minimum, to:
- establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of suspicious transactions;
- establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the BSA and implementing regulations;
- provide for annual (on a calendar-year basis) independent testing for compliance to be conducted by member personnel or by a qualified outside party. If the firm does not execute transactions with customers or otherwise hold customer accounts or act as an introducing broker with respect to customer accounts (e.g. engages solely in proprietary trading or conducts business only with other broker-dealers), the independent testing is required every two years (on a calendar-year basis);
- designate and identify to FINRA (by name, title, mailing address, e-mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program. Such individual or individuals are associated persons of the firm with respect to functions undertaken on behalf of the firm. Each member must review and, if necessary, update the information regarding a change to its BSA compliance person within 30 days following the change and verify such information within 17 business days after the end of each calendar year.
Compliance with the BSA Rules is no easy task. To effectively address these rules, Continue Reading
Photo by Jimmy Emerson
Last week, the SEC issued three new interpretations related to the so-called “intrastate offering exemption,” which is a registration exemption that facilitates the financing of local business operations. An intrastate offering is exempt because it does not involve interstate commerce, and is therefore, outside the scope of the Securities Act.
We have received a few calls this week from startup companies who mistakenly believed that these new interpretations were creating a new registration exemption. Largely, the mistaken belief is caused by the confusion stemming from some recent state law changes that allow for intrastate crowd funding. While the new SEC interpretations were prompted by the recent state law changes, the intrastate offering exemption has been around since 1933, but for many reasons, it is not heavily relied upon. And, despite the three new interpretations, we still advise against using the intrastate offering exemption.
What is this intrastate offering exemption?
The intrastate offering exemption is actually two separate exemptions, Section 3(a)(11) and a safe harbor Rule 147. Although the two exemptions differ slightly, generally, if the (i) issuer is incorporated or organized in the same state in which it is offering securities; (2) a substantial portion of the issuer’s business occurs within that state; (3) each offeree and purchaser is a resident of the state; (4) the offering proceeds are used primarily within that state; and (5) the securities come to rest within that state, then your offering would be exempt from federal registration requirements. The investors do not need to be accredited (unlike Regulation D offerings), there is no limitation on the manner of offering, there are no prescribed disclosures, there is no maximum amount that can be raised (unlike Rule 504, Rule 505, or Regulation A), and the shares are freely transferable to other residents of the state. In other words, it is a fairly broad exemption that allows a lot of flexibility to issuers, especially to startup companies who need as much flexibility as possible when raising capital.
Ok, so what is such a problem with the intrastate offering exemption?
While there is lots of flexibility with the exemption, the intrastate offering exemption Continue Reading