The SEC has been busy over the past several weeks rapidly issuing interpretations and procedures to implement the JOBS Act.  Because the JOBS Act is such a fundamental change to securities law, especially for middle market companies, we wanted to spend this blog catching you up to speed on how the JOBS Act looks since we issued our Special Summary White Paper.  While longer than our normal blogs, we think this information is useful and best kept in one place. 

Confidential Submission Process

The SEC has implemented a secure e-mail system that allows a registrant that qualifies as an Emerging Growth Company (as defined in the JOBS Act) to confidentially file draft registration statements with the SEC.  Commencing this past Monday, May 14th, the secure e-mail system will replace the procedures announced on April 5, 2012.  Instructions on how to use the secure e-mail system are fairly easy to follow.

The change to allowing confidential submissions is a fairly radical, and welcome, change to companies filing their initial public offering.  Whether the confidential submission process becomes widely used is still up for debate.  While there are large advantages for keeping initial submissions private (keeping information secret from competitors until you decide to go forward with the IPO, shortening the “in registration” period to better time the markets, and avoiding embarrassing registration statement withdrawals), there are also some potential disadvantages.  For example, often companies filing initial registration statements are simultaneously reviewing other strategic options such as selling the company.  Filing the registration statement publicly effectively alerts the markets that your company is “in play.”  In addition, the initial filing of a registration statement usually prompts potential plaintiffs with claims to file their lawsuits, which gives management time to amend the registration statement to disclose the risks of the lawsuit.  By not filing a publicly available registration statement until 21 days before the road show, Continue Reading JOBS Act update: Keeping current with the SEC’s interpretations

The SEC has been issuing a steady stream of FAQs on the newly enacted JOBS Act.  On Monday, the SEC’s Division of Trading and Markets issued a set of FAQs on the JOBS Act addressing crowdfunding intermediaries.  Last week, the Division of Corporation Finance issued more FAQs on JOBS Act issues such as qualifications for emerging growth companies, confidential submissions of initial registration statements for emerging growth companies, and the extent of relief from disclosure and accounting rules for emerging growth companies.

The SEC Division of Corporate Finance recently issued guidance to smaller financial institutions concerning Management’s Discussion and Analysis and accounting policy disclosures. The guidance can be found in CF Disclosure Guidance: Topic No. 5, dated April 20, 2012 and amounts to rules to follow for future filings that should not be ignored.

The Division focused on the following areas:

  • Allowance for Loan Losses
  • Charge-off and Nonaccrual Policies
  • Commercial Real Estate
  • Loans Measured for Impairment Based on Collateral Value
  • Credit Risk Concentrations
  • Troubled Debt Restructurings and Modifications
  • Other Real Estate Owned
  • Deferred Taxes
  • Federal Deposit Insurance Corporation Assisted Transactions

The Division made it clear that the guidance is not one-size-fits-all so registrants will need to carefully analyze the guidance and how it may apply to them. While the guidance is too lengthy to summarize here, the Division appears to be focused on making the disclosures in the areas above more transparent and meaningful. For example, the Division wants more disclosure on how a registrant calculates the allowance for loan losses and the components of the allowance. Given the financial difficulties facing financial institutions over the past several years, this guidance is not surprising.

The guidance essentially provides a list of issues for each category above that needs to be addressed in a registrant’s Management’s Discussion and Analysis and accounting policy disclosures. This roadmap will be a useful tool for small financial institutions with their future SEC filings. Make sure to consider it when drafting your next registration statement or periodic report to help avoid comments from the SEC.

It is a basic tenant of corporate law that directors of a corporation are not liable for business decisions as long as the directors acted with a reasonable level of care in making these decisions. This is referred to as “the business judgment rule.” Because directors are not guarantors of corporate success, the business judgment rule specifies that a court will not review the business decisions of directors who performed their duties (1) in good faith; (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the directors reasonably believe to be in the best interests of the corporation. As part of their duty of care, directors have a duty not to waste corporate assets by overpaying for property (e.g., 100% of the stock of a target company in an acquisition) or employment services. The business judgment rule is very difficult to overcome and courts will not disregard it absent, among other things, a showing of fraud or misappropriation of corporate funds.

One of the landmark cases in this area of law was Smith v. Van Gorkam, which was decided by the Delaware Supreme Court in 1985. In that case, the board of directors of TransUnion approved a merger with Marmon Group without consulting outside experts as to the fairness of the price to be paid to TransUnion shareholders, rather, the board relied on the recommendations company’s CEO and CFO, neither of whom made any substantive attempt to determine the actual value of TransUnion. Additionally, the board did not inquire as to the process used by the CEO and CFO in determining the merger consideration. As a result, the Delaware Supreme Court found that the directors of TransUnion were grossly negligent in carrying out their fiduciary duties to the company. Because of this, the board was found not to have satisfied their duty of care and were therefore not entitled to the presumptions and protections of the business judgment rule. Ultimately, the TransUnion board agreed to pay $23.5 million in damages resulting from their fiduciary duty breaches.

The facts of Facebook’s recently announced acquisition of Instagram (as reported by the Wall Street Journal) are strikingly similar to the Van Gorkam case. Allegedly, Facebook’s CEO Mark Zuckerberg and Instagram’s CEO Kevin Systrom worked out the details of the acquisition privately over the course of 3 days at Mr. Zuckerberg’s home. Once the details were finalized for the $1 billion acquisition, the deal was presented, without notice, to the Facebook board of directors who approved the deal, likely without outside expert advice as to the fairness of the transaction. According to several reports, the board vote was largely symbolic because Zuckerberg has control of 57% of the voting power of the company. Facebook directors were likely put in a precarious Continue Reading Could directors be personally liable if Facebook paid too much for Instagram?

On April 16th, the Securities and Exchange Commission’s Division of Corporation Finance issued 17 Frequently Asked Questions pertaining to Title I of the JOBS Act.

The FAQs address some of the threshold questions on how to apply the JOBS Act to emerging growth companies such as how to determine if your company is deemed an “Emerging Growth Company” and how to interpret the scaled disclosures permitted under the JOBS Act.

One of the most well-known and popular Internet companies, Groupon, Inc., has again encountered significant accounting problems. These problems appear to be potentially severe. This situation is very negative for Groupon, but it also has troubling ramifications for the entire technology industry and especially for technology companies that have recently gone public. There is also some doubt about Groupon’s ability to successfully maintain and grow its business model. Only time will tell if Groupon can successfully fix these problems and move forward, but it is clear that the company needs to do a much better job of managing its accounting and public company reporting functions and its internal controls processes as well as the way in which it responds to related crisis situations.

The focus of Groupon’s recent problems is the substantial restatement of its operating results for the fourth quarter of 2011. This was a critical reporting period for the company as it was the first full reporting period since the company’s IPO in November 2011. This revision reduced the company’s fourth quarter revenues by $14.3 million and increased its net loss by $22.6 million. These revisions also affected the company’s 2011 annual financial statements. While these revised numbers alone would be cause for concern, Groupon also disclosed in its press release on these issues that it had identified a material weakness in its internal controls systems. This is a major red flag for any company, and it was made worse by Groupon’s past history of accounting problems and restatements of financial results.

The effects of this situation were magnified since the company’s IPO had only occurred about five months ago, and that process had been marred by substantial changes to the company’s financial results. Under pressure from the Securities and Exchange Commission during the IPO process, Groupon was forced to abandon a strange accounting metric that attempted to exclude certain significant marketing expenses. Use of this metric substantially increased the company’s revenues. When the company’s calculations were revised to incorporate these marketing expenses, its total revenues were reduced by about 50%. This situation was also made worse by its timing – it occurred right in the middle of the IPO review process. Groupon’s IPO prospectus can be found here.

The timing of this accounting problem made it even more critical that Groupon “get it right” in connection with its accounting and financial reporting. To have yet another significant accounting problem surface in the very next quarter’s results is a huge blow to the company. The situation became much more serious when it became evident that problems existed with its internal controls system – this was no longer just a numerical mistake, but had extended to a deeper accounting process problem.

Groupon’s management and public relations professionals have made these situations worse by not responding well. Management made optimistic statements about the company’s potential, even during the IPO “quiet period”. Management’s attitude and responses on the current accounting problems have been viewed by some commentators as flippant and dismissive. Management did not seem to understand the gravity of these problems and their possible ramifications, seemingly conveying that Groupon is a young, fast growing company, and that problems like this are going to happen. This is clearly not the response that the investment community was expecting, and this confluence of accounting and public relations problems has substantially damaged the company’s reputation and credibility. Groupon is regarded in some circles as not ready for the rigors and responsibilities of public company life.

Groupon had been extremely successful as a private technology company. It offered reduced price deals on a significant number of popular products and services at local levels. Consumers liked the discounts and price cuts that they could receive through the use of Groupon. Merchants and service providers accepted this process as a way to stimulate business and to introduce new potential customers to their products and services. Groupon has also historically offered a generous refund or cancellation right to purchasers of its services. The company’s business model has expanded, however, and it now includes discount coupons for much more highly priced goods and services. Where the original business model mainly focused on items such as meals, haircuts and similar low-priced items, the new and expanded model includes items with much higher prices, such as vacations and medical and surgical procedures. Groupon apparently extended the same generous cancellation or return policies on these higher priced items, but did not increase the amounts held in reserve to cover the refunds required in connection with the cancellation of these higher priced items. This led to the significant restatement of financial results and to the identification of the material weaknesses in the company’s financial controls discussed above.

One other factor that is concurrently hurting Groupon is the stated perception by some analysts that the company’s business model may not be sustainable or able to be successfully expanded to include bigger and higher-priced situations. It is too early to determine if this analysis is valid, but these accounting problems may have supported this negative business perception.

Groupon has also experienced some external negative events from these situations. The SEC has apparently instituted a preliminary probe into Groupon’s situation. This is troubling, especially after the controversy that resulted in the massive reduction (mandated by the SEC) of the company’s revenues during its IPO. It is unclear at this time whether the SEC’s involvement will extend further, perhaps to a full investigation of Groupon and its accounting and financial controls processes. A number of shareholder lawsuits have also been filed against the company. Regardless of the ultimate resolution of this SEC probe and these shareholder lawsuits, they are expensive and they divert management’s attention at a time when all hands need to be totally focused on business issues.

To Groupon’s credit, it now appears to be working on the remediation of these problems and the improvement of its internal controls processes. It has hired a large global accounting firm (in addition to its regular auditing firm) to specifically work on the improvement of its internal controls. This situation may be able to be fixed, but it will take a substantial amount of time and effort to rebuild Groupon’s credibility in the investment community. Groupon’s stock price is currently well below its IPO price, and further deterioration in the company’s market value will likely occur if the problems identified in this post are not fully acknowledged and corrected.

Groupon’s problems also quickly become problems for the entire technology community, and especially for web-based companies that have gone public. Since Groupon is such a recognizable company in this industry, anything it does (positive or negative) will have an effect on the entire technology industry. If many analysts conclude that Groupon is not ready to successfully operate as a public company because of its inability to manage its accounting processes or its failure to effectively acknowledge and respond to associated crisis situations, inevitably some of these negative consequences will affect other technology companies. Groupon needs to ensure that it clearly understands the gravity of these situations and that it develops and quickly executes mature and effective solutions to these problems. It also needs to ensure that such solutions are clearly communicated to the investment community in order to try to rebuild its credibility.

Although this was a news story that hit about six months ago, we saw very little coverage on, what we think, is a very novel alleged hostile takeover bid by organized crime. 

On October 26, 2011, a federal grand jury indicted Nicodemo S. Scarfo, an alleged member of the Lucchese crime family, Salvatore Pelullo, an alleged associate of the Lucchese and Philadelphia LCN families, and 11 other people, including five practicing lawyers and an accountant for allegedly taking over FirstPlus Financial Group, Inc. (OTC Markets: FPFX), a publicly traded mortgage company in Texas. 

According to the indictment, the men used both explicit and implicit threats of economic and physical harm to seize control of FirstPlus by replacing its existing board of directors and management with members who would further their interests. 

Based on the facts from the indictment, in 2007, the defendants falsely accused a director of financial improprieties, and threatened a lawsuit against the director unless the director agreed to persuade the existing directors and management to turn over control to the defendants.  Over the course of 2007 and 2008, according to the indictment, the men looted the company through various acquisitions of entities controlled by the defendants at inflated prices.  The defendants were indicted for securities fraud, wire fraud, money laundering, extortion, and obstruction of justice. 

No mention of whether the defendants ever filed a Schedule 13D.

Rapidly moving legislation dubbed the Jumpstart Our Business Startups Act (JOBS Act) was passed today by the U.S. Senate, which fundamentally alters the securities laws.  The business world is buzzing about the pros and cons of this Act.  The Act is designed to invigorate the IPO market by removing restrictions on capital raising that many of the detractors of the Act believe are important for investor protection.  The JOBS Act:

Permits “crowd funding” (raising capital in small amounts from many people usually via the Internet to finance a start up);

  • Eliminates the ban on public solicitation of investors by companies seeking financing in a private offering;
  • Raises the offering ceiling for so called “Regulation A Offerings” from $5 million to $50 million;
  • Raises the threshold for required registration as a public company from 500 to 2,000 shareholders (1,500 of whom must be “accredited investors” under the Regulation D standard);
  • Raises the threshold for required registration as a public company for community banks from 500 to 2,000
  • Creates a new category of securities issuer called an “emerging growth company,” defined as companies with annual gross revenues of less than $1 billion.; and
  • Provides for a “securities on-ramp” to phase in costly SEC reporting and compliance requirements such as internal controls audits, Say-On-Pay votes, etc over a five-year period for “emerging growth companies”.

The JOBS Act was passed in the House by a wide, bipartisan margin (390 to 23) on March 8th, and by the Senate by a narrower, but bipartisan margin (73 to 26) today.  Because the Senate adopted the House version with a slight amendment, the bill will be sent back to the House to be reconciled.  We expect the JOBS Act to be signed by President Obama by the end of the month.

Recent comments from SEC commissioner Luis Aguilar indicate that the SEC may consider new rules that would require public companies to disclose political expenditures. In his recent speech from February 24, 2012, Commissioner Aguilar informally called on the SEC to adopt political spending disclosure rules in light of the landmark U.S. Supreme Court Case, Citizens United v. Federal Election Commission, which struck down federal restrictions on corporate political spending as unconstitutional. Although public companies are still restricted from directly contributing corporate funds to political candidates, they are permitted to contribute funds for campaign advertisements that support or oppose political candidates. Additionally, companies may contribute to independent organizations that engage in political advertising or lobbying.

We previously blogged about a petition which was submitted by a group of ten law professors in response to the Supreme Court’s opinion in Citizens United asking the SEC to consider adopting rules that would require public companies to make disclosures about their political contributions. The petition was prompted by, among other things, the Court’s assertion that procedures of corporate democracy would be a means by which shareholders could monitor the use of corporate assets for political purposes and also effect corporate change where such political purposes were inconsistent with shareholder interests. As the petitioners pointed out, the Court’s reasoning is partially based on the assumption that shareholders have access to information concerning a company’s political spending. While certain companies voluntarily make political spending disclosures in their public filings with the SEC, there are currently no rules or regulations that require a company to make such disclosures. Continue Reading Are more disclosure requirements for public companies in the works?

As mentioned on Brock and Dave’s Blog and a recent article by Bloomberg, the conflict minerals disclosure required by the Dodd-Frank Act appears to be close to final.  These proposed rules are highly controversial because of the estimated high costs for public companies to comply with the new rules compared to the small perceived benefit to investors.  In fact, we have previously blogged regarding the likelihood that the SEC has grossly underestimated the compliance costs.

Under the proposed conflict minerals rules, companies must disclose whether certain minerals used in production chains originate from the Democratic Republic of the Congo or its neighboring countries.  Minerals sourced from these areas of central Africa often fund militia and other military groups’ operations which have exacerbated internal conflicts and human rights violations.   Congress believes that by requiring these disclosures public companies may be encouraged to seek alternative sources, materials, or suppliers to project a more socially responsible image to consumers.

In a letter to the SEC, Senator Leahy and other members of Congress have taken issue with the proposed final rules apparently circulating around the Capitol.  In the letter, the Senator and his colleagues have informed the SEC that they believe the proposed final rules contravenes Congress’s legislative intent by allowing the conflict mineral reports to be “furnished” rather than “filed.”  The difference, of course, is not just semantics.  Items “filed” in periodic reports are subjected to liability under the Securities Act of 1933, including Section 11 and Section 12(a)(2), because the information is incorporated by reference into Securities Act registration statements.  Items “furnished” are subject only to liability under the Securities Exchange Act of 1934, primarily Rule 10b-5.  Because Section 11 liability presents essentially “strict liability” for issuers, it would be much easier for a plaintiff to win a judgment against an issuer for faulty conflict minerals disclosure if the disclosure is “filed” rather than “furnished.”

Whether or not the legislative intent espoused by Senator Leahy in his letter is correct, we believe the foundation of the entire law is flawed.  As we have blogged before, we strongly disagree with the increasing frequency in which social policy has been weaved Continue Reading Conflict minerals rule may be reaching a conclusion