March 2013

Pitfalls issuing securities to employeesThis is the fourth part of our Securities Law 101 series.  Because capital raising is such a critical function for middle market companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams make.  We will periodically publish posts examining different aspects of securities law.

For startup companies, cash is almost always tight.  Despite the cash crunch, startups need to be able to attract qualified employees to get their business off the ground.  So, a question I get all the time from founders of startups is: Can’t I just give my employees some shares?  The answer, of course, is “yes, as long as there is an exemption from registration.”

So, what is this “exemption from registration”?

Well, as a reminder every time you issue securities the securities must be registered with the SEC and each state’s securities commission unless there is an exemption from registration.  When you are issuing securities to employees, the exemption that you would most likely rely on is “Rule 701.”  To be able to rely on Rule 701, you need to meet the following conditions:

Pitfalls issuing securities to employeesThis is the fourth part of our Securities Law 101 series.  Because capital raising is such a critical function for middle market companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams make.  We will periodically publish posts examining different aspects of securities law.

For startup companies, cash is almost always tight.  Despite the cash crunch, startups need to be able to attract qualified employees to get their business off the ground.  So, a question I get all the time from founders of startups is: Can’t I just give my employees some shares?  The answer, of course, is “yes, as long as there is an exemption from registration.”

So, what is this “exemption from registration”?

Well, as a reminder every time you issue securities the securities must be registered with the SEC and each state’s securities commission unless there is an exemption from registration.  When you are issuing securities to employees, the exemption that you would most likely rely on is “Rule 701.”  To be able to rely on Rule 701, you need to meet the following conditions:

Say-on-pay lawsuitsWhy doesn’t the plaintiffs’ bar believe Congress means what it says? The Dodd-Frank Act could not have been more clear that the outcome of the mandatory say-on-pay advisory vote for public companies does not create or imply any change to the fiduciary duties of board members. However, as we have discussed in previous blog posts, this fact hasn’t stopped lawsuits in the wake of failed say-on-pay votes that allege, among other things, breaches of fiduciary duty by the boards of directors and management of public companies related to such failed votes. The vast majority of these cases have been dismissed at the early stages of proceedings, usually for failing to make a proper demand on the board of directors as required by most state corporate law statutes, but this has only lead to a shift in strategies. 

As the old saying goes, if you fail, try and try again. That is exactly what the plaintiffs’ bar is doing. The current tactic du jour seems to involve filing suits to enjoin the annual meeting. Most of these complaints seeking an injunction have typically alleged that directors and/or management breached their respective fiduciary duties by not providing adequate disclosure in the annual proxy statement to enable shareholders to make informed voting decisions, usually as it relates to proposals seeking to approve (i) executive compensation, (ii) a new or amended compensation plan, or (iii) an amendment to the charter to increase the number of authorize shares. Some of the most common allegations include: 

  • “The Proxy fails to disclose the fair summary of any expert’s analysis or any opinion obtain[ed] in connection with the [equity incentive plan]”; 
  • “The Proxy fails to disclose the criteria” used by the compensation committee “to implement the [stock purchase plan] and why the [equity incentive plan] would be in the best interest of shareholders”; 
  • “The Proxy fails to disclose the dilutive impact that issuing additional shares may have on existing shareholders”; and 
  • “The Proxy fails to disclose how the Board determined the number of additional shares requested to be authorized.” 

The timing of these lawsuits is less than ideal for companies as many are only a few weeks away from their scheduled meeting. This, of course, creates increased pressure to Continue Reading Say-on-pay litigation: Round 2

New platform for private companiesNasdaq OMX Group, Inc. announced today that it will enter into a joint venture with SharesPost, Inc. to form a marketplace for the trading of shares of unlisted companies. This is an interesting and cutting edge move that solves some problems for both Nasdaq and SharesPost. This new marketplace should be very positive for rapidly growing and large private companies which want to allow some trading in their shares but which are not ready to become publicly traded companies. It will also give investors opportunities to buy the shares of large private companies before the shares of these companies become publicly traded. According to a Nasdaq press release issued today this new marketplace, which will be called The Nasdaq Private Market, will “provide improved access to liquidity for early investors, founders and employees while enabling the efficient buying and selling of private company shares”. 

Nasdaq will own the majority of and will control this joint venture, but the joint venture will use SharesPost’s existing trading platforms and infrastructure. The joint venture will be run by SharesPost founder Greg Brogger. Depending on the speed of regulatory approval, this new market for unlisted shares could be operational later this year. 

This move makes good sense for Nasdaq because it should help them to begin to rebuild their credibility with up and coming companies and the technology industry. These market segments have traditionally been Nasdaq’s strength, but Nasdaq has been losing company listings (even from technology companies) to the NYSE and other exchanges. Nasdaq’s problems in attracting new technology company listings may be due to the significant negative issues that occurred in the initial public offering of Facebook’s shares last year. Nasdaq took a huge hit to its credibility as it was roundly blamed and criticized for the technical glitches that occurred with the Facebook offering. Some estimates say that major market makers and broker dealers lost more than $500 million in the Facebook IPO because of Nasdaq’s technical glitches. Nasdaq will also soon feel the economic effects of this matter as it reportedly offered as much as $62 million to settle associated claims and it now faces a possible $5 million fine from the SEC. For a good discussion of the current status of Nasdaq’s Facebook offering woes, see Charlie Osborne’s post on ZDNet

This new relationship should also be very beneficial to SharesPost. SharesPost, which began operations in 2009, experienced substantial success in facilitating trading of shares of unlisted companies. The company provided the platform for trading in unlisted securities of high visibility technology companies such as LinkedIn and Facebook before these companies’ securities became publicly traded. SharesPost eventually encountered regulatory scrutiny, however, and the SEC brought an action against the company for failure Continue Reading Potential good news for growth companies: Nasdaq to set up new private market for unlisted stocks