Golden leashes
Photo by Don Urban

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 Institutional investor organization asks the SEC to require disclosure of “golden leashes”

Golden leashes
Photo by Don Urban

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 Institutional investor organization asks the SEC to require disclosure of "golden leashes"

Cybersecurity in the cross hairs of the SEC
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 SEC increases focus on cybersecurity

BSA ComplianceGenerally 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 Bank Secrecy Act: Broker-Dealers Must Also Comply

Intrastate offering exemption
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 Don’t cross the border!: Intrastate offering exemption still not useful despite new interpretations

Intrastate offering exemption
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 Don’t cross the border!: Intrastate offering exemption still not useful despite new interpretations

Intrastate offering exemption
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 Don't cross the border!: Intrastate offering exemption still not useful despite new interpretations

HR 3623 does not provide relief
The Great Flood of 1927 by Gil Cohen

In recent weeks, a bill has been reported out of the House Committee on Financial Services promising relief to companies going public.  While I applaud their intentions, this bill will not have much impact, and if anything, is a solution to problems that don’t exist.

On March 14, 2014, the House Committee approved 56-0, a bill titled “Improving Access to Capital for Emerging Growth Companies Act (H.R. 3623).  This purported bipartisan “relief” doesn’t actually provide that much real relief to public companies.  This proposed bill has four major goals.  First, it shortens the period of time that an emerging growth company must publicly file its registration statement before commencing its road show from 21 days to 15 days.  Second, if an issuer loses its emerging growth company status during the registration process, it will be allowed to register as if it had remained an emerging growth company.  Third, an emerging growth company will not be required to include in its registration statement certain historical financial information if the registration statement would be required to be updated to include more recent financial information prior to the registration statement going effective.  And fourth, emerging growth companies will be permitted to submit confidentially registration statements for follow on offerings for up to one year after its initial public offering.

Only one of the goals of HR 3623 is arguably helpful.  In the unusual situation where an issuer was just under $1 billion in revenue when submitting its registration statement and then, due to revenue growth, would no longer qualify as an emerging growth company, it can keep the “benefits” of being an emerging growth company.  It would seem unfair for the issuer to have to lose its status mid-stream, but I don’t know how many issuers this would actually help.

All of the other provisions of HR 3623 are not helpful.  First, not having to include financial information that would otherwise not be required in the final version of the prospectus can reduce some burden of going public; however, because most emerging growth companies voluntarily provide three years of financials rather than two (as permitted) to avoid being perceived as not a “real” public company, this provision is rather meaningless.

Second, shortening the time from which an issuer must publicly file its registration statement until it can commence its road show from 21 days to 15 days will likely be, in practice, meaningless, and potentially dangerous to investors.  There is real value in having the financial press and the public review the public filings of a company going public.  The more people who review the filings, the greater the likelihood that problems with the issuer’s business model or financial statements are discovered.  Most reputable investment banks will likely continue to wait at least three weeks prior to commencing the road show for this reason.

Third, I see very little value in providing an emerging growth company the ability to submit confidentially registration statements for follow on offerings.  The entire value of submitting confidentially is that an issuer can decide not to register its securities before it makes its information publicly available.  In a follow on offering, the issuer will already have made its information public through its initial registration statement and its subsequent periodic reports.

My recommendation is that if Congress truly wants to increase the number of public companies then it should reduce the disclosure obligations of public companies by extending permanently (rather than the current five year maximum benefit) the streamlined disclosure for emerging growth companies (and having it apply to all issuers) and make it more difficult for plaintiffs to recover damages from public companies in securities litigation.  The disclosure burden and litigation risk are contributing much more to the cause of companies not going public than what this bill is attempting to address.

Uniform fiduciary duty standard for broker-dealers
Illustration by Divine Harvester

As we blogged about last August, Section 913 of the Dodd-Frank Act directed the SEC to study the need for establishing a new, uniform, federal fiduciary standard of care for brokers and investment advisers providing personalized investment advice. Recall that, traditionally, broker-dealers and investment advisors are subject to different duties of care: a suitability standard for broker-dealers and a more stringent, fiduciary duty for investment advisors. 

Despite the express mandate given to it by Section 913 of the Dodd-Frank Act, the SEC has made slow progress in determining whether to adopt a uniform fiduciary standard rule. In January 2011, the SEC issued its Section 913 Report, recommending “the consideration of rulemakings” that would establish a uniform fiduciary standard for both broker-dealers and investment advisers. In the wake of issuing its Section 913 Report, in March 2013 the SEC opened its doors comments, requesting data and other information relating to the costs and benefits of implementing a uniform fiduciary standard. While the comment period ended in July of 2013, the SEC has apparently not yet completed its anticipated cost-benefit analysis. Based on the SEC’s regulatory agenda for the 2014 fiscal year, it does not seem to be in much of a rush: in the agenda, the SEC listed the “Personalized Investment Advice Standard of Conduct” as a “long-term action” and as its 40th priority out of 43 items. That said, in a speech at the SEC Speaks Conference in Washington on February 21, 2014, SEC Chair Mary Jo White said she Continue Reading Uniform Fiduciary Standard for Broker-Dealers: An Update

Section 108 of the Jump Start Our Business Startups Actrequired the

Study states more studies required - similar to a punt?
Photo by Duke University Archives

SEC to undertake a study of the disclosure requirements of Regulation S-K. Specifically, the statute mandated that the SEC shall:

conduct a review of its Regulation S-K to—

  1. comprehensively analyze the current registration requirements of such regulation; and
  2. determine how such requirements can be updated to modernize and simplify the registration process and reduce the costs and other burdens associated with these requirements for issuers who are emerging growth companies.

In addition, the JOBS Act required that the SEC report to Congress its specific recommendations on how to streamline the registration process in order to make it more efficient and less burdensome for prospective issuers who qualify as emerging growth companies.

That report was released not too long ago on December 20, 2013. However, it seems like the Commission elected to punt on the second part of the legislative mandate (i.e., to provide specifics), at least for now. Unfortunately, as is so often the case with governmental studies, the primary recommendation by the SEC Staff was to conduct further studies and investigations.  While disclosure reform is complex (and may be politically charged), further studies is not what investors or the capital markets need.  Too much money is spent on preparing duplicative and meaningless disclosures.

The report describes in great detail the history and evolution of the disclosure requirements contained in Regulation S-K – the primary source of disclosure requirements for registration statements and periodic reports filed by public companies with the SEC. All of this is well and good for government regulation historians and SEC buffs, but it provides nothing of real value to companies that are or may become subject to these rules and requirements. However, the report provides no real useful guidance to Congress (which may be the point if the SEC would rather control the reform process itself rather than have Congress control the process). Presumably, Congress had included this section in the JOBS Act for a specific purpose: Continue Reading 4th and 108, SEC elects to punt on Regulation S-K disclosure reform