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

Independent ChairmanAre the CEO and the Chairman of the Board the same executive at your company?  While there can be very good reasons to have these positions held by the same person, the separation of these posts continues to be a hotly debated topic.  Since the early 1980s, much attention has been paid to corporate boards of directors and how their structures improve (or undermine) organizational performance. In the wake of the recent financial crisis, public corporations have come under scrutiny from activist shareholders, institutional investors, advisory firms and regulators alike.  So naturally, this is the source of the debate over the separation of the CEO and Chairman positions. 

According to the ISS Governance Exchange, in 2012, investors filed 49 independent chair proposals, with more than three-quarters coming to a vote, including three that received majority support.  As of February 1, 2013, this year’s volume of filings now exceeds last year’s total with 53 firms targeted by shareholders seeking a split of the top posts, with additional filings likely at companies meeting later in the year.  Notably, the record for such proposals was set in 2010, with a total of 66. 

Proponents of CEO and Chair independence base their view on the inherent system of checks and balances that the Board, and particularly the Board’s Chairman, is supposed to impose on management.  Essentially, a firm’s Board and Chairman of the Board serves to hire, fire, evaluate and compensate management (including the CEO) based on performance.  Clearly then, these proponents argue, a single CEO and Chairman cannot perform these tasks apart from his or her personal interests, making it more difficult for the Board to perform its critical functions, if and when the CEO is its Chairman.  Accordingly, separation of the Chairman and CEO roles, can lead to better management and oversight because an independent Chairman is able to ensure that the board is fully engaged with strategy and to evaluate how well that strategy is being implemented by management. Importantly, appointment of an independent Chairman can also signal to all stakeholders that the CEO is accountable to a unified Board with a visible leader. 

But while largely helpful from a corporate governance standpoint, one must note that the separation of CEO and Chair positions can impose several costs on a firm.  First, while appointing an outside Chairman can reduce the agency costs of controlling a CEO’s behavior, such an appointment introduces Continue Reading Separating the positions of CEO and Chairman: The debate rages on

Businessman weary of overregulation by SECI understand that the SEC needs to balance having efficient markets and facilitating capital formation with the protection of investors, but sometimes erecting roadblocks with the intent of protecting investors is merely regulation for regulation’s sake.  On February 5, 2013, the Staff of the Division of Trading and Markets of the SEC provided guidance on Title II of the JOBS Act, specifically to help interpret the limited broker registration exemption.  While at first glance, these FAQs are not controversial, a broad interpretation by the Staff nearly eviscerates certain avenues for capital raises for small and emerging companies under Title II.  

To step back a minute, Title II of the JOBS Act exempts certain persons from having to register as a broker if that person merely “maintains a platform or mechanism” that brings together investors and issuers in a Rule 506 offering as long as the person “receives no compensation in connection with the purchase or sale of such security” and doesn’t have possession of customer funds.  Seemed simple enough.  The start-up community was excited about this exemption.  While many start-up companies struggle to raise capital after exhausting their friends and family, many people in the start-up community envisioned this to be a way for for-profit internet portals to develop where issuers could list their offering materials for a monthly subscription fee rather than a transaction-type fee. 

Unfortunately, the Staff has taken a very broad view (and in my opinion an unwarranted view) of the definition of “compensation.”  Question 6 in the FAQ states that in the Staff’s opinion, Congress did not limit the condition to transaction-based compensation (i.e., any compensation based on the actual sale of securities), but to any direct or indirect economic benefit.  Although I don’t think it is possible for anyone to ascertain what Congress’ intent is because the members all vote for different reasons, William Carlton in his Counselor@Law blog provides a nice synopsis of Continue Reading SEC curtails JOBS Act broker registration exemption in recent FAQs

Is ISS claiming pledging is the same as bribery?The answer: when ISS is evaluating a public company’s corporate governance under its revised policies for the 2013 proxy season. We previously blogged about the potential insider trading issues that could theoretically arise when insiders pledge company stock to secure loans. Now, with the implementation of the revised ISS governance standards, there are additional reasons for publicly traded companies to implement antipledging and antihedging policies.

ISS specifically addressed hedging and pledging activity in its 2013 U.S. corporate governance policy updates, which were posted in November of last year.  In these updates, ISS included a footnote to its policy on voting for director nominees in uncontested elections in circumstances where there are perceived corporate governance failures. Under the new policy, ISS will recommend “against” or “withhold” votes for directors (individually, committee members, or, in extreme cases, the entire board) due to “[m]aterial failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company”. The new footnote cites hedging and significant pledging of company stock as examples of activities that will be considered failures of risk oversight. Other cited examples of risk oversight failures include bribery, large or serial fines or sanctions from regulatory bodies, and significant adverse legal judgments or settlements. 

The rationale behind this new update seems to be based on ISS’s belief that pledging any amount of company stock by insiders for a loan is Continue Reading When does hedging or pledging of company stock by insiders equate to bribery?

Cybersecurity legislationSenator Jay Rockefeller (D., West Virginia), the most vocal proponent of cybersecurity legislation, has renewed his focus on cybersecurity legislation. He has sponsored previous cybersecurity-related legislation, but has been unable to implement any meaningful legislation in this area. His prior sponsorship of the proposed Cybersecurity Act of 2012 initially seemed to draw support in the Senate, but it encountered strong opposition from the United States Chamber of Commerce. The Chamber strongly criticized this proposed legislation and went so far as to state that the Chamber would include senators’ votes on this proposed legislation in its annual “How They Voted” survey. In any case, this proposed legislation was not passed in 2012. 

One of the strongest aspects of the Chamber’s resistance to this proposed legislation was the assertion that American companies would be strongly opposed to the legislation.  To confirm the positions of American companies on this issue, Senator Rockefeller sent a letter to the CEOs of all Fortune 500 companies on September 19, 2012. The Senator’s office has now received responses to this letter and the majority staff summarized them in a January 28, 2013 Memorandum. 

Approximately 300 companies responded to the Senator’s letter. The companies that responded were predominantly larger members of the Fortune 500. According to the Staff Memorandum, the overall responses of the companies were favorable to potential cybersecurity legislation (with some important caveats). 

Based on the Staff Memorandum, there appears to be general support from the responding companies for a voluntary cybersecurity compliance program. The companies’ main objections appear to be concern about the Continue Reading Cybersecurity legislation continues to move forward

Regulation FD EnforcementThis is the third 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. 

In the wake of the SEC recommending an enforcement action against Netflix, Inc. and its CEO for social media postings that potentially violate Regulation FD, public companies must increasingly ensure that they understand, and comply with, their obligations under Regulation FD.

So what is Regulation FD?  Adopted by the SEC in 2000, Regulation FD (a/k/a Regulation Fair Disclosure) prohibits companies from selectively disclosing material nonpublic information to analysts, institutional investors, and others. Citing instances of selective disclosure to certain institutional investors and/or securities analysts and the resulting profits or avoidance of loss that come at the expense of those without knowledge of the disclosure, the SEC intended to promote full and fair disclosure of information by issuers.  

Under Regulation FD, when an issuer, or person acting on its behalf, discloses material nonpublic information to certain people (in general, securities market professionals and holders of the issuer’s securities who may well trade on the basis of the information), the issuer must publicly disclose that information.  Importantly, where a disclosure is intentional, the issuer must simultaneously make public disclosure of the nonpublic material information. However, where the disclosure is non-intentional, the issuer must “promptly” make public disclosure.  The required public disclosure may be made by filing or furnishing a Form 8-K, or by another method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public such as press releases disseminated by a wire service. 

Regulation FD does not define what is considered “material,” but Continue Reading Securities Law 101 (Part III): Watch your mouth! Regulation FD’s impact on (selective) disclosure

 

Stock Exchange
Panorama of Wall Street Historic District by Michael Daddino

An SEC advisory committee is likely to recommend that that the SEC support the formation of a new securities exchange designed especially for small cap and micro cap public companies. While this new exchange is a long way from approval and operation, strong SEC support could substantially increase its chances of successful implementation. This securities exchange could reduce costs and create new liquidity and capital raising opportunities for these companies.

It is too early to predict whether this new securities exchange will become a reality or how effective it may be. I believe, however, that this exchange concept is another potentially positive event for small companies and that it could produce significant benefits. This securities exchange, along with certain components of the JOBS Act, could provide significant opportunities for small companies to generate liquidity in their securities and raise additional capital for growth.

The SEC advisory committee that is making this recommendation is the Advisory Committee on Small and Emerging Companies. This Committee is made up of 20 individuals with connections to the small public company space, including business executives, state regulators and, angel investors. Christine Jacobs, co-chair of the Committee, is the CEO of a Theragenics Corp., a small cap medical device manufacturer. The Committee was formed in 2011 to focus on the special needs and dynamics of small businesses and small public companies (see September 13, 2011 formation announcement here). These Committee members are aware of the particular issues that these companies face in the capital raising, corporate governance and securities regulation arenas, and they make the SEC aware of issues and problems in the small company space. You can review information on current Committee members here.

The SEC is not bound by the recommendations of the Committee, but I believe that these recommendations will be taken seriously by the SEC and that some positive action could result. The SEC’s strong support here would substantially increase the chance of this new securities exchange being formed. I was not able to find any indication from the SEC on its possible reaction to the Committee’s recommendation.

The Committee has been reviewing this proposed new securities exchange and its possible positive effects on Continue Reading SEC advisory committee to recommend formation of small company securities exchange

Campaign diclosure rules to create administrative nighmareAs first reported by Professors  Lucian Bebchuk and Robert J. Jackson, Jr. in their recent posting on the Harvard Law School Forum on Corporate Governance and Financial Regulation, the SEC may take action to issue proposed rules on corporate political spending disclosures by public companies as early as the second quarter of this year. This is according to the most recently updated Current Unified Agenda and Regulatory Plan, where the SEC appears to have preliminarily scheduled a notice of proposed rulemaking on this subject for April. Realistically, the fact that these rules are scheduled on this regulatory agenda is probably not very significant and may have gotten there as a means to temporarily appease shareholder rights advocates that have recently been pressing for these disclosures. Additionally, considering that the current four-person commission is equally divided on the political front, it is not likely that anything significant will come out of the SEC in the near future until a replacement for Mary Schapiro is appointed and confirmed. 

If something does miraculously materialize, it would be an interesting move by the SEC considering that rules required to be adopted under the Dodd-Frank Act have yet to be fully implemented almost three years after the bill was signed into law in 2010. This fact was emphasized in Commissioner Gallagher’s recent comments to the U.S. Chamber Center for Capital Markets Competitiveness. In those comments, Commissioner Gallagher specifically noted that “the SEC, like other regulators, is now dealing with the problem of rushed, inadequate rule proposals that were pushed out in a bid to meet arbitrary congressional deadlines.”  With the backlog of Dodd-Frank and JOBS Act rules, why would the SEC even bat an eyelash at a rules proposal with no Congressional mandate? 

In any case, there’s no question that campaign contribution disclosure has been a hot topic, particularly in the wake Continue Reading Proposed campaign contribution disclosure rules may be coming as early as April (but not likely)