On February 13, 2012, the Securities and Exchange Commission issued a No-Action Letter to the Fenwick & West LLP law firm. This No-Action Letter is good news for private companies that are approaching the statutory 500 shareholder limit (which would generally require them to register as public reporting companies under Section 12(g) of the Securities Exchange Act of 1934). Exceeding this limit can be very painful for a company, as it may be forced to register its class of shares under the Securities Exchange Act of 1934, which would require significant disclosures of information (the same as if it had undertaken an initial public offering) without realizing any of the benefits of public company status. The No-Action Letter will allow private companies to issue certain equity-based compensation to employees, directors and some consultants without triggering the reporting requirements of the 500 shareholder limit. Fenwick’s original request for the No Action Letter (which describes the background of this situation) can be found here.

Fenwick is the law firm that represents Facebook in its current initial public offering. Fenwick had previously sought and obtained similar relief specifically for Facebook in 2008. In this No-Action Letter, however, Fenwick obtained a much broader exemption from the SEC on this issue. Since the No-Action Letter was issued to the law firm rather than to a single company, the relief from these public reporting requirements should be very broad and should be applicable to any company whose situation is close enough to that described by Fenwick in its request for the No-Action Letter.

The situation that Fenwick used here involved “restricted stock units” (“RSUs”). RSU’s as described by Fenwick in the No Action Letter are equity compensation vehicles that generally entitle the holder to receive shares of a company’s common stock if certain future conditions are met before the RSUs expire. These RSUs are widely used by some companies, but there was a question regarding whether the issuance of an RSU caused the recipient to become a shareholder of the company, thus increasing the number of total shareholders and potentially causing the company to exceed the 500 shareholder limit. Continue Reading SEC’s No-Action Letter is good news for pre-IPO companies

When someone refers to a company as being “publicly traded” we normally understand that to mean that it has sold shares to the public through an initial public offering (or “IPO”) and is listed on a national securities exchange (like the NYSE or Nasdaq) and makes periodic filings with the SEC. However, some smaller companies that are not listed on a national exchange and that have never filed any documents with the SEC are coming to find out that they may in fact be “publicly traded” and may not even realize it. Moreover, being classified as “publicly traded,” under certain circumstances, can impose requirements on the company to provide notice for certain corporate events and pay associated fees.

Rule 10b-17 and FINRA Rule 6490

Section 10(b) of the 1934 Securities and Exchange Act (the “Exchange Act”) is one of the anti-fraud provisions of the Exchange Act and imposes liability on persons engaged in the use of “manipulative or deceptive devices or contrivances”  in connection with the purchase or sale of a security. Pursuant to its rule making authority, the SEC has enacted a number of rules (the most well-known of which is Rule 10b-5) which regulate these manipulative and deceptive devices and contrivances in order to protect investors.

Less well-known among these rules is Rule 10b-17 which relates to untimely announcements of record dates. Specifically, Rule 10b-17 states that failure by an issuer of a class of securities publicly traded to give 10-days’ prior notice to FINRA of the establishment of record dates relating to dividends, distributions, stock splits, or rights or other subscription offerings, constitutes a “manipulative or deceptive device or contrivance” for Section 10(b) purposes.

FINRA Rule 6490 (effective as of September 27, 2010) codified the Rule 10b-17 notification requirements and requires issuers subject to the rule to pay the applicable fees in connection with their submission of the required notice. Most notably, notifications which are late can trigger a late fee of up to $5,000.

Our company is privately-held so why should we care?

At first glance, the rules above seem to only apply to companies who have securities which are publicly traded. In fact, the rule Continue Reading Your company may be ‘publicly traded’ without your knowledge – and there may be a price to pay

As reported in the Wall Street Journal, Facebook, Inc. filed a registration statement with the SEC late Wednesday to register to go public.  This continues the recent trend of established technology companies going public since the beginning of last year.  Whether the stock price ultimately supports its expected lofty valuation remains to be seen.

While the IPO has been long-expected, it is important to remember the reason why Facebook decided to go public: it was required.  Section 12(g) of the Securities Exchange Act of 1934 requires companies that have at least $10,000,000 in assets and at least 500 shareholders as of the end of its fiscal year to register with the SEC.  This shareholder limit has not been adjusted since its adoption in 1964, and causes companies that need to raise capital to face two equally unappealing choices: limit the number of investors to ensure the 500 limit is not breached or register with the SEC regardless of whether being a public company is in the company’s best interests once the limit is met.  While a recent proposed bill in the House has attempted to lessen the burden on private companies looking to raise capital by increasing the shareholder limit from 500 to 1000, to date no legislation has been enacted into law.  The SEC is also reviewing the shareholder limit.

Until Congress or the SEC acts, private companies should consider taking a few safeguards to avoid the requirement to register with the SEC.  First, adopt a shareholders’ agreement that restricts the transferability of the shares.  The transfer restriction will prevent shareholders from subsequently transferring their shares to multiple new shareholders which could cause the company to exceed the limit.  Second, issue stock options to employees rather than shares of stock.  Stock options are considered a separate class of equity security, and since 2007, the SEC has exempted companies from having to register under Section 12(g) because there were more than 500 option holders.  Third, private companies can adopt an insider trading policy that prohibits any employee from reselling their shares.  Facebook adopted such a policy, which effectively eliminated the secondary distribution of its shares.  Fourth, companies can implement high transfer fees to restrict the distribution of its shares similar to the fees Continue Reading Missed in Facebook IPO frenzy: they had to go public. Here are 6 ways private companies can remain private

Earlier this month, the S.E.C. changed its long standing practice of allowing defendants of securities violations to “neither admit nor deny” criminal wrongdoing.  This change is effectively the S.E.C.’s response to critics that say that the agency should not let criminal defendants simply pay a fine and avoid an admission of guilty.  The new policy will generally require that defendants having a parallel criminal conviction, entering into a non-prosecution agreement or signing a deferred prosecution agreement no longer be allowed to sidestep admitting their guilt in a settlement with the S.E.C.

While this change seems more just, it is limited to only a small number of cases.  Thus, the change should help ease the concerns of the critics, but will not change S.E.C. policy for most situations.  This will help the S.E.C. look more tough on certain securities violations while still allowing the agency to negotiate settlements by allowing defendants to “neither admit nor deny” wrongdoing in most situations.  It remains to be seen whether the new policy will provide the right balance between the benefit of more easily negotiating settlements without requiring an admission of guilt and punishing criminals to the satisfaction of the critics.

See the recent article in the New York Times

Risks of Cyber Attacks

If you are an executive for a public company, new SEC guidance requires you to consider cybersecurity in your ongoing periodic reports.  As evidenced by the barrage of news reports over the past couple of years, cyber incidents have become very significant events for all types of companies.  A recent example was the data breach of Sony Corporation’s Playstation Network.  These cyber incidents can cause companies to spend substantial amounts of money and time to attempt to reduce or correct the associated damage, including significant reputational damage.  All companies must make significant capital investments for systems and measures designed to prevent future cyber incidents or at least mitigate their harmful effects. Unfortunately, the number of cyber incidents will continue to increase, and the tactics used by hackers will become more sophisticated and harder to prevent and control.

Congress Gets Involved

Last year, a group of U.S. senators recognized that cybersecurity incidents and the associated costs were a major risk for many companies and that many public companies were not adequately disclosing these events. The Senators also recognized the growing risks of cybersecurity and cyber incidents, and that there was very little guidance for public companies on their disclosure responsibilities in connection with cybersecurity. These senators wrote a letter to SEC Chairman Shapiro asking for some interpretative guidance on how to address disclosure of cybersecurity and cyber incidents and the associated risks and economic effects.

SEC Sets Expectations

In response to the Senate inquiry, the SEC recently issued CF Disclosure Guidance:  Topic No. 2 (the “Disclosure Guidance”), which set forth the SEC’s expectations of public company cybersecurity disclosure. Public companies of all sizes and industries should Continue Reading New Cybersecurity Disclosure Obligations for SEC Filings

Last Friday, the SEC’s Division of Corporate Finance issued its fourth topic in its CF Disclosure Series, which periodically provides the SEC’s views on various topics.  This time, the SEC addressed, what it believes to be, inconsistent disclosures on European sovereign debt holdings.  The SEC reminds registrants, particularly bank holding companies, of their obligations to identify known trends or known demands, commitments, events, or uncertainties in their MD&A.  Generally, the SEC expects supplemental disclosure to be provided by country, segregated between sovereign and non-sovereign exposure, and financial statement category.  Registrants must focus on countries that are “experiencing significant economic, fiscal and/or political strains such that the likelihood of default would be higher than would be anticipated when such factors do no exist.”  In addition, the SEC expects to see additional risk factors addressing European sovereign debt exposure and heightened disclosures in the market risk discussion.

For a more detailed outline of what disclosure is relevant and appropriate, click here to view the SEC’s complete guidance.

Some of the best known names in technology were able to conduct initial public offerings during 2011. These included technology companies like LinkedIn, Pandora, Groupon, Zillow, Demand Media and others. This will likely continue tomorrow as one of the most highly anticipated technology company offerings of the year (Zynga, a developer of online games for Facebook) is scheduled to price its IPO tonight.

The markets remained fairly receptive to these technology IPOs throughout 2011. This is impressive given the general poor state of the capital markets and the high degree of skepticism that greeted many transactions in other industries. Companies from many other industries found themselves either shut out of the capital markets or unable to easily access capital.

Many of these high profile technology companies have been able to maintain or show an increase from their IPO price. Based on recent information, LinkedIn, Groupon and Zillow are all trading well above their IPO prices. This is again impressive given the overall status of the capital markets. Not all technology companies have been successful in the public arena, however, as Pandora, Demand Media and others currently trade well below their IPO prices. The general feeling among investors seems to be that they are satisfied with most of these technology companies for now, but there is also an undercurrent of skepticism.

Of course, the most highly anticipated technology IPO (and one of the most highly anticipated IPOs in history) may occur in 2012 if Facebook elects to proceed with its offering. There is no way to tell if this will happen, but there have been an increasing number of signs that Facebook is going in this direction.

All of these public technology companies face some serious fundamental questions and issues, and the resolution of these questions and issues will determine the long-term success or failure of these technology companies as public entities. The questions surrounding these companies mainly relate to basic business issues such as the long-term viability of their business models and their ability to establish and maintain sustainable and profitable business operations over time. Even though investors Continue Reading Technology IPOs – Where Do We Go From Here?

If the U.S. House of Representatives has its way, big changes are on the horizon for private offerings.  In an effort to enhance the ability of small businesses to raise capital, the House has now passed four bills that reduce some of the restrictions.  The bills are as follows:

1)  Entrepreneurial Access to Capital Act (HR 2930) – This bill would allow businesses to accept and pool donations of up to $1 million (or $2 million in some instances) without requiring SEC registration.  This concept is known as crowdfunding, which involves the pooling of small contributions in an effort to help others attain a specific goal. If this bill were to become law, it would preempt state law, would permit access to capital sources that previously were untapped, and would prevent the new shareholders from being counted toward the SEC’s 500 shareholder limit for non-public companies.

2)  The Access to Capital for Job Creators Act (HR 2940) – This bill would remove the general solicitation and advertising ban from SEC Rule 506 under Regulation D.  This change would permit small businesses to solicit investments from accredited investors throughout the U.S. and globally.  Like the crowd funding bill, HR 2940 would provide greater access to capital sources.  It would also modernize the way Regulation D offerings are conducted by allowing businesses to directly advertise to accredited investors.

3)  HR 1965 – This bill with no name would increase the number of shareholders bank holding companies and banks may have before requiring SEC registration.  Currently, companies are required to go public if they have 500 or more shareholders and have $10 million or more in assets.  The bill would allow community bank holding companies to have up to 2,000 investors before requiring registration.  As such, community banks would have greater access to capital without requiring added SEC regulation. Continue Reading House Votes to Make Capital Raising Easier

Late last week, a shareholder activist filed, what is believed to be, the first proxy access resolution for this proxy season.  The target of the proposal, MEMC Electronic Materials, Inc., is an S&P 500 company that manufactures and sells wafers and related products to the semiconductor and solar industries.  As discussed in a previous blog post, while the U.S. Court of Appeals for the D.C. Circuit vacated the SEC proxy access rules, the Business Round Table and the U.S. Chamber of Commerce did not challenge the amendment to Rule 14a-8, which will allow shareholders to propose a process for the nomination of directors by shareholders. 

Beginning this proxy season, issuers will begin to receive proxy access proposals, which if passed by the shareholders, would allow for a shareholder nominating process beginning in 2013.  Unlike the process access rules proposed by the SEC, which would have limited nominations to shareholders who have held at least 3% of the issuer’s stock for at least three years, Rule 14a-8, as recently revised, allows activist shareholders to determine the requirements and the nominating process to be voted upon.  A nonprofit organization called the U.S. Proxy Exchange has published a model proxy access proposal to make it easier for activist shareholders to propose the required bylaw changes to allow for proxy access.  The MEMC shareholder proposal is based on that model proposal.  The model proposal urges an issuer’s board to adopt a proxy access bylaw that would permit director nominees from: any party of one or more shareholders that has held continuously, for two years, 1% of the issuer’s securities eligible to vote for the election of directors, and/or any party of shareholders of whom 100 or more satisfy SEC Rule 14a-8(b) eligibility requirements (i.e., those who have held at least a $2,000 stake for at least one year). The model proposal would also allow any such party to make one nomination or, if greater, a number of nominations equal to 12% of the current number of board members, rounding down.

While other issuers will likely receive proxy access proposals for this proxy season, we expect the over all number to be relatively low this year.  We would, however, expect the number of proxy access proposals to increase for the 2013 proxy season once the few “test cases” in this proxy season are resolved.

Section 1502 of the Dodd-Frank Act mandates the SEC to adopt rules requiring reporting companies to 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. The goal of the recent legislation is to provide transparency to consumers to allow them to make certain choices with respect to the products that they purchase from public companies. Moreover, the disclosure requirements may encourage public companies to seek alternative sources, materials, or suppliers to project a more socially responsible image to consumers.

The SEC estimated approximately 1,200 companies would be affected by the new disclosure rules and would result in an increase in aggregate compliance costs of approximately $71 million. However, a recent Tulane University study argues that the SEC woefully underestimated this cost and that the actual cost is almost $8 billion. The study indicates that some of the reasons for the SEC’s underestimation include a flawed calculation of the number of affected companies, failure to account for the impact on suppliers or privately-held companies in an issuer’s supply chain, and inadequate estimates of costs for internal due diligence reform. Although final conflict mineral disclosure rules have not yet been promulgated, a bi-partisan congressional group has openly urged the SEC to promptly do so.

To view the SEC’s proposed conflict mineral disclosure rules, click here. To view the study conducted by Tulane University, click here. For more information, view Gustav Schmidt’s contact information by clicking here.