A while back – March 2017, to be exact – I posted a piece entitled “Beware when the legislature is in session”, citing a 19th Century New York Surrogate’s statement that “no man’s life, liberty or property are safe while the legislature is in session.”

It may be time to amend that statement, for Washington seems to be at it regardless of whether the legislature is in session.  A very rough count suggests that there are more than 20 pending bills dealing with securities laws, our capital markets, corporate governance and related matters.  And that does not include other initiatives, such as the President’s August 17 tweet that he had directed the SEC to study whether public companies should report their results on a semi-annual, rather than a quarterly, basis.

Problems with the Approach

I’m not saying that all of the ideas being floated are awful, or even bad.  (One good thing is that our legislators seem to have decided that trying to give every statute a name that can serve as a nifty acronym isn’t worth the effort.)  In fact, some of the ideas merit consideration.  However (you knew there would be a “however”), I have problems with the way in which these bills deal with the topics in question.  (I have problems with some of the ideas, as well, but more on that later.)

  • First, in my experience, far too many legislators do not understand what our securities laws are all about, and some do not want to understand or do not care. I will not cite particular instances of this, but I’ve been surprised several times with the level of ignorance or worse (i.e., cynicism) demonstrated by legislators and their staffs about the matters their proposals address.  At the risk of hearing you say “duh”, this does not lead to good legislation.
  • Second, these bills represent a slapdash approach when what is needed is a comprehensive, holistic one. Even the best of the pending bills and proposals is a band-aid that will create another complication in an already overcrowded field of increasingly counterintuitive and/or contradictory regulations, interpretations, and court decisions.

Problems with the Proposals

As promised (threatened), I also have concerns about a number of the proposals being bruited about, but for the moment I’ll focus on two of them – eliminating quarterly reporting and Senator Warren’s “Accountable Capitalism Act”. Continue Reading Dear Washington: How can we miss you if you don’t go away?

In July 2018, Coinbase – one of the largest cryptocurrency platforms — announced that it had won regulatory approval for a trio of acquisitions. This announcement generated a lot of publicity that Coinbase is on its way to creating the first marketplace on which blockchain-based tokens classified as “securities” can be traded. As it turns out, Coinbase never received regulatory approval for the acquisitions. However, the announcement was nevertheless a potentially significant event for the future of crypto trading.

In order to operate an exchange for securities, an entity must register as a national securities exchange or operate under an exemption from registration, such as the exemption provided for alternative trading systems (ATS) under SEC Regulation ATS. An entity that wants to operate an ATS must first register with the SEC as a broker-dealer, become a member of a self-regulating organization, such as FINRA, and file an initial operation report with the SEC on Form ATS.

Because Coinbase is neither registered as a national securities exchange nor operates under an exemption, it cannot operate an exchange-based trading platform for blockchain-based securities. However, the recently announced acquisitions indicate that Coinbase may be headed in that direction. The three companies acquired by Coinbase were:

  • Venovate Marketplace, Inc. (registered as a broker-dealer and licensed to operate an ATS)
  • Keystone Capital Corp. (registered as a broker-dealer)
  • Digital Wealth LLC (registered as an investment advisor)

By acquiring companies with the proper licenses already in place, Coinbase may be able to speed up its plan to create an exchange-based trading platform for blockchain-based securities as a regulated broker-dealer.

What exactly are blockchain-based securities anyway? Continue Reading Coinbase takes steps toward first blockchain-based token exchange

Since the beginning of this month (July 2018), the SEC has brought two enforcement cases involving perquisites disclosure – one involving Dow Chemical, and one involving Energy XXI.  As my estimable friend Broc Romanek noted in a recent posting, over the past dozen years, the SEC has brought an average of one such case per year.  It’s not clear why the SEC is doubling down on these actions, but regardless of the reasons, it makes sense to pay attention.

The SEC’s complaint in the Dow Chemical case is an important read, as it summarizes the requirements for perquisites disclosure.  Among other things, it’s worth noting the following:

  • While SEC rules require disclosure of “perquisites and other personal benefits”, they do not define or provide any clarification as to what constitutes a “perquisite or other personal benefit.” Instead, the SEC addressed the subject in the adopting release for the current executive compensation disclosure rules, and it has also been covered in numerous speeches and other statements over the years by members of the SEC staff.
  • For those of you who prefer a principles-based approach to rulemaking, you win. Specifically, the adopting release stated as follows:

“Among the factors to be considered in determining whether an item is a perquisite or other personal benefit are the following:

  1. An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties.
  2. Otherwise, an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.”

The SEC has also noted on several occasions that if an item is not integrally and directly related to the performance of the executive’s duties, it’s still a “perk”, even if it may be provided for some business reason or for the convenience of the company.

Continue Reading Doubling down (literally) on perquisites disclosure

No, this is not a riff on Hamlet’s soliloquy.  It’s about the current kerfuffle (one of my favorite words) about stock buybacks.  In case you’ve not heard, some (but not all) of the concerns about stock buybacks are as follows:

  • Plowing all that cash into buying back stock means that it’s not going into plant and equipment, R&D or other things that facilitate longer-term growth and job creation.
  • Companies are using the windfall from the 2017 tax act to buy shares back rather than to make investments that will create jobs and longer-term growth.
  • Stock buybacks artificially inflate stock prices and earnings per share, which contributes to or results in additional (i.e., excessive) executive compensation.
  • By reducing the number of shares outstanding, buybacks mask the dilutive effects of equity grants to senior management.

And now there’s another concern.  Specifically, in a recent speech, new SEC Commissioner Jackson announced that stock buybacks are being used by executives to dispose of the shares they receive in the equity grants referred to above.  And one of his proposed solutions is that compensation committees engage in more active oversight – or, rather, that compensation committees should be required to engage in more active oversight – of insider trades “linked” to buybacks.

Continue Reading To buy or not to buy

Photo by Alyse & Remi

Possibly lost in the heat of summer and the false narrative that the Economic Growth, Regulatory Relief, and Consumer Protection Act had somehow repealed the Dodd-Frank Act, the recent Act, which was signed into law on May 24th, has a few provisions impacting the securities laws.  None of these are complete “game changers,” but all could assist earlier stage companies:

  • Investment Company Act. Venture capital funds that have less than $10 million in capital contributions are now deemed to be “qualifying venture capital funds.”  Qualifying venture capital funds can now have up to 250 investors (rather than 100) to remain exempt from being subject to the Investment Company Act of 1940.  This may have the effect of lowering the minimum investment amount in a fund, which may entice more investors to invest in funds.
  • Rule 701 Exemption. Private companies can rely on Rule 701 as a registration exemption to adopt stock option and stock purchase programs for employees, consultants, and advisors.  In any 12-month period, an eligible issuer can issue an amount of securities that is the greater of (i) $1 million; (ii) 15% of the issuer’s total assets; or (iii) 15% of the outstanding securities of the class being issued.  As long as the amount of securities sold during any 12-month period is less than $5 million, the issuer needed to only provide a copy of the compensatory benefit plan to employees, consultants, and advisors.  For larger private companies, the $5 million ceiling was easily exceeded, which then triggered much more burdensome disclosure requirements.  The recent Act increases that disclosure trigger from $5 million to $10 million.
  • Regulation A+. So far issuers and bankers are still warming up to Regulation A+.  I think Regulation A+ will likely become a commonly used registration exemption over the long-term.  The new Act may help.  Previously, issuers that were subject to the periodic reporting requirements under Section 13 or 15(d) of the Securities Exchange Act of 1934 were not eligible to use Regulation A.  The new Act orders the SEC to remove that restriction.

Again, none of these tweaks will by themselves unleash an army of new startups, but we should applaud anytime Congress does anything remotely practical.

If you find the title of this posting confusing, let me explain:  On June 28, the SEC announced revisions to the definition of “smaller reporting company”that will significantly expand the number of companies that fit within that category (i.e., “smaller gets bigger”).  As a result, more public companies will be able to reduce the disclosure they are required to provide under SEC rules (i.e., “which means less”).  The new definition will go into effect 60 days after publication in the Federal Register.

Background

The SEC adopted the reduced disclosure requirements applicable to smaller reporting companies, or SRCs, in 2007. These reduced requirements were intended to ease the costs and other burdens of disclosure for small companies.  The reduced requirements enabled SRCs, among other things, to:

  • present only two (rather than three) years of financial statements and the related management’s discussion and analysis;
  • provide executive compensation for only three (rather than five) “named executive officers”;
  • omit the compensation discussion and analysis in its entirety;
  • present only two (vs. three) years of information in the summary compensation table; and
  • omit other compensation tables, pay ratio disclosure, and narrative descriptions of various compensation matters.

In addition, SRCs that are not “accelerated filers” (companies that must file their Exchange Act reports on an accelerated basis) need not provide an audit attestation of management’s assessment of internal controls, required by the Sarbanes-Oxley Act.  More on this below. Continue Reading Smaller gets bigger, which means less (the new definition of “smaller reporting company”)

Are corporations people? Are they entitled to the same “certain unalienable rights” as human beings – including free speech, as in the Supreme Court’s decision in Citizens United?  These and similar questions struck me as pretty important and presumably interesting. So when I heard about “We the Corporations – How American Businesses Won Their Civil Rights”, I picked it up.

The good news is that the history of corporate civil rights is interesting, and Adam Winkler (a professor at UCLA Law School) does a decent job of telling it.  The bad news is that his negative views regarding corporations infect the narrative and make me question the impartiality, if not the accuracy, of much of the book.

Early on, Professor Winkler discusses the monopolistic practices of Standard Oil and other late nineteenth- and early twentieth-century trusts.  So far, so good.  However, he then discusses the “migration” of Standard Oil from Ohio to New Jersey due to the increasingly pro-corporate laws of the Garden State.  He characterizes this development as a “race to the bottom” in corporate law.  Again, so far, so good – maybe.  But then he goes on to state that Delaware has become the jurisdiction of choice for so many corporations because it favors corporations, presumably to the detriment of their constituencies – possibly including society at large.  To be fair, that may have been an accurate characterization in the past.  However, to really be fair, Professor Winkler should have acknowledged that in recent decades Delaware has become far more judicious (all puns intended) as to the exercise of corporate rights than most states.  And he also should have acknowledged that a (the?) major reason so many corporations organize under Delaware law is the existence and wisdom of and predictability afforded by its corporate judicial system – i.e., its Court of Chancery and Supreme Court – rather than its lax laws.  (Ironically, the book ends with a lengthy discussion and citation of Delaware Supreme Court Chief Justice and former Chancellor Leo Strine, who strongly disagrees with the Citizens United decision.  One wonders if Chancellor Strine was aware of Professor Winkler’s views of his state’s laws.)

Continue Reading Interesting issue, weak execution: a review of “We the Corporations”, by Adam Winkler

A few weeks ago, I attended the “spring” meeting of the Council of Institutional Investors in Washington (the quotation marks signifying that it didn’t feel like spring – in fact, it snowed one evening).  These meetings are always interesting, in part because over the 15+ years that I’ve been attending CII meetings, their tone has changed from general hostility towards the issuer community to a more selective approach and a general appreciation of engagement.

So what’s on the mind of our institutional owners?  First, an overriding concern with capital structures that limit or eliminate voting rights of “common” shareholders.  CII’s official position is that such structures should be subject to mandatory sunset provisions; that position strikes me as reasonable (particularly as opposed to seeking their outright ban), but it’s too soon to tell whether it will gain traction.

Continue Reading News from the front

Wyoming Blockchain
Photo by Kenneth Vetter

While Bitcoin initially paved the way for the introduction of blockchain and distributed ledger technology in the mainstream, most would agree that the potential applications of this relatively new technology goes far beyond just cryptocurrencies.

Blockchain technology, at its core, is merely a set of linked records that form an immutable ledger. Information is added in “blocks” which are linked to the prior information on the block by a cryptographic hash of all of the prior information. The information on the blockchain is secure because any attempts to change information in an earlier block would result in a different “hash” that would be easily detected by the network, which would reject that version of the blockchain as being unauthentic (there are several articles about how cryptographic hash functions work, but at the most basic letter, these functions take an input of any size and convert it to an alphanumeric output of a specified length). Furthermore, because the blockchain is distributed among multiple computers, each operating as a node running the underlying software, there is no single centralized entity or system responsible for maintaining the blockchain. Rather, the collective nodes maintain the blockchain pursuant to the underlying software code.

The potential applications of blockchain technology are seemingly endless. For example, digital representations of shares of stock of a corporation could be tokenized and traded on a blockchain, which would allow companies to maintain a corporate stock ledger without the need for a transfer agent. These shares of stock could also be traded on a decentralized exchange that would provide liquidity to shareholders without the burden of applying to be listed on a national securities exchange.

Several states have taken steps to facilitate these kinds of applications for blockchain technology. For example, Continue Reading Wyoming leads the way on facilitating blockchain technology

On February 21 the SEC issued a  “Commission Statement and Guidance on Public Company Cybersecurity Disclosures”. The Release contains new guidelines and requirements regarding public companies’ disclosure responsibilities for cybersecurity situations. No new rules or regulations have been issued at this point, but the Release contains some valuable guidance. It is also clear that cybersecurity is a hot button for the SEC and for Chair Clayton, and I believe that cybersecurity disclosure issues will be subject to more rigorous scrutiny going forward. All public companies should carefully review the Release and evaluate their disclosure obligations in connection with cybersecurity.

The Release updates the SEC’s position on cybersecurity. The SEC’s previous guidance in this area was primarily a Corporation Finance Division Release issued in 2011 that did not contain specific disclosure requirements. The cybersecurity landscape has changed radically since then. The substantial increases in the number and severity of cybersecurity incidents, coupled with the growing dependence of businesses on cyber systems and the associated problems that arise in a cybersecurity incident, have clearly convinced the SEC that additional disclosure is required. Continue Reading SEC issues guidance on cybersecurity disclosure obligations (and more)