October 2011

Earlier this month, FINRA proposed new Rule 5123 to regulate private offerings.  Proposed Rule 5123 is a second attempt by FINRA this year to expand the regulatory process  on private offerings.  In January, FINRA had proposed a much more comprehensive set of changes, including proposed regulations affecting private placements not involving a FINRA member firm.  See Gunster’s April Blog for a description of the earlier proposal.  After much criticism of the originally proposed rules, FINRA agreed to repropose rules.

Under the reproposed new Rule 5123, FINRA member firms would be prohibited from participating in a private offering unless a private placement memorandum, term sheet, or other disclosure document is provided to each investor prior to sale that includes detailed information on the intended use of the proceeds and the amount and type of offering expenses and compensation.  The rule would also require notice filings by member firms by requiring member firms to file the private placement memorandum, term sheet, or other disclosure document with FINRA no later than 15 days after the date of first sale.  Certain exemptions to Rule 5123 are available when the offering is made solely to certain qualified investors or when the offering is of certain types of securities.

New Rule 5123 is a significant improvement over the January proposal to amend Rule 5122 because it poses a significantly smaller burden on the capital raising process.  For example, the original proposal required 85% of the proceeds to be used for business purposes as described in the offering document.  In addition, the proposed notice filing is now due no later than 15 days after the date of first sale rather than before commencement of the offering.  Because most offerings involving FINRA member firms already disclose the intended use of proceeds and the amount and type of offering expenses and compensation, we think that the new proposal will not cause any major obstacles to the offering process.

The economic events of recent years have hit small companies particularly hard. While virtually everyone has suffered, small companies endured a double hit as they experienced substantial challenges to sales and profitability as well as a widespread inability to raise capital. This inability to raise capital was made worse by these economic events, but the current capital raising regulatory structure was also a major contributing factor. Fortunately these negative events appear to have generated some potential changes in the small company capital raising arena that could be very beneficial. These changes still face a number of challenges, but momentum appears to be building in their favor.

Small companies have historically faced a number of significant regulatory challenges and compliance requirements when raising capital. Some of these problems are the result of outdated compliance requirements that do not reflect the current small company situation. Other problems have resulted from “one size fits all” compliance requirements that do not contemplate the special needs of small companies and the economic restrictions under which many of them operate. The net result has been that small companies have been restricted in many situations in their ability to raise capital. This has been a particular problem in connection with public securities offerings by small companies.

In response to these concerns, several legislators in both the House and the Senate have submitted legislative proposals that are designed to ease the regulatory burdens on small companies in the capital raising process and to ensure that such regulatory burdens correctly reflect small companies’ situations. One significant proposal would increase the offering limits for Regulation A offerings from the current $5 million level to $50 million. Regulation A has been available as an exemption from registration under the Securities Act of 1933 for a long time, but historically it has not been used very often. This is probably primarily due to the relatively low offering limit. Regulation A contains some fairly substantial benefits for issuers, including the ability to solicit indications of potential interest from investors before an offering by use of several forms of media (although state laws may have an impact here). A substantially increased upper limit on Regulation A offerings could be a significant advantage to small companies’ capital raising efforts. Continue Reading Positive Events in Small Company Capital Raising Arena

Section 951 of the Dodd-Frank Act states that the results of a shareholder say-on-pay advisory vote will not trigger or imply a breach of fiduciary duty. Because Congress went out of its way to be explicitly clear on this point, most legal commentators felt that shareholder derivative suits based on failed say-on-pay votes, without more, would likely never be successful. To further support this position, a number of derivative lawsuits were in fact filed on this very basis in 2011 but none have been successful to date. However, a recent decision by the Federal District Court for the Southern District of Ohio may have breathed new life back into the debate.

In NECA-IBEW Pension Fund v. Cox, the plaintiff shareholders (suing derivatively on behalf of Cincinnati Bell) alleged the company’s board of directors breached its duty by approving and recommending approval of an executive compensation package to the shareholders in its annual proxy statement. The compensation package included significant bonuses and pay increases for executives despite a $61 million decrease in the company’s net income and a drop in earnings per share from $0.39 to $0.07. The plaintiffs alleged that the board-approved executive compensation, which was subsequently rejected by 66% of the shareholders in the say-on-pay vote at the annual meeting, was contrary to the company’s written compensation policy which stated “a significant portion of the total compensation for each of our executives is directly related to the Company’s earnings and revenues and other performance factors” and that at-risk compensation should be “tied to the achievement of specific short-term and long-term performance objectives, principally the Company’s earnings, cash flow, and the performance of the Company’s common shares, thereby linking executive compensation with the returns realized by shareholders.”

The director defendants filed a motion to dismiss the complaint for failure to state a claim for which relief could be granted arguing, among other things, that executive compensation determinations are board decisions protected by the business judgment rule. The business judgment rule generally protects directors that make informed business decisions absent a deliberate Continue Reading Has New Life Been Given to Derivative Suits Based on Failed Say-On-Pay Votes?