In a resounding victory for public companies Friday, the United States Court of Appeals for the District of Columbia Circuit struck down the Securities and Exchange Commission’s rule on proxy access.  The controversial proxy access rule would have permitted shareholders to more easily and more cheaply nominate a minority slate of director candidates for election on an issuer’s board if they held at least 3% of the issuer’s stock for at least three years.  Without reaching the merits of the actual rule, the appeals court struck down the rule because the panel (all three of which were Republican appointees) determined that the SEC had acted “arbitrarily and capriciously for having failed once again . . . adequately to assess the economic effects of a new rule.” 

While we do not believe proxy access is dead, particularly since it was authorized by Congress in the Dodd-Frank Act, we expect that the rule is dead for at least the 2012 proxy season.  Regardless of whether the SEC chooses to appeal to the entire appeals court or the U.S. Supreme Court or rewrite the rule to comply with the decision, it is highly unlikely that any of the choices will lead to the enactment of proxy access by the 2012 proxy season.  Because the SEC is currently inundated with rulemaking from Dodd-Frank, we don’t believe a new rule (with a more thoroughly weighed cost/benefit analysis) will come back until late 2012, at the earliest.

The court did not address the merits of the Business Round Table/ U.S. Chamber of Commerce’s First Amendment argument or their argument that shareholders themselves should vote to determine whether proxy access should be adopted for each issuer.  Thus, even if the SEC did propose a new rule and provided a plausible cost/benefit analysis that passes the court’s muster, the new rule could still be struck down on other grounds.

To read the court decision, click here.

The IRS recently issued proposed regulations under Internal Revenue Code Section 162(m) relating to the deduction limitation for certain employee remuneration in excess of $1,000,000, which if passed, will have a significant impact on the design of equity based compensation plans for existing public companies and privately-held companies that ultimately become publicly held. Under Code Section 162(m), a publicly held corporation is restricted from taking a deduction for compensation paid to a covered employee in excess of $1,000,000. However, the deduction limit does not apply to “qualified” performance-based compensation.

Grants of stock options and stock appreciation rights (SARs) are considered qualified performance-based compensation if, among other things, the plan under which the option or right is granted states the maximum number of shares that may be granted during a specified period to any employee (currently the aggregate number of shares is stated in the plan document). The proposed regulations clarify that qualified performance-based compensation attributable to stock options and stock appreciation rights must specify the maximum number of shares with respect to which the options or rights may be granted to each individual employee. The IRS and the Treasury believe that the individual employee limit is consistent with the broader requirement that a performance goal include an objective formula for determining the maximum amount of compensation that an individual employee could receive if the performance goal were satisfied, and that a third party attempting to make this determination would need to know both the exercise price and the number of options that could be granted.

The proposed regulations apply to taxable years ending on or after the date the rules become final.

Click here for the complete text

When Congress passed the Say-on-Pay provision in Dodd-Frank, there was some concern whether the required vote, even though advisory, would increase the risk for Boards.  As it turns out, the risk is real.  Approximately 35 companies have received a vote of less than 50% in support of their executive compensation programs.  Of these 35 failed votes, five companies were sued by shareholders on a derivative basis.

We believe that the derivative litigation will ultimately fail.  Say-on-Pay is merely advisory – Congress went out of its way to state that the vote would not cause additional liability for directors.  If Congress wanted to make it binding, it could have done so.  Thus, nothing in Dodd-Frank changes the well-established law in all 50 states that a Board has the protection of the business judgment rule when, after deliberating on an issue such as executive compensation, it can exercise its fiduciary duties as it sees fit. 

That said, the Compensation Committee, should seek out advice from its shareholders after a company receives a negative Say-on-Pay vote to understand shareholders’ concerns.  This should be done for obvious public relations reasons, but also to help the directors fulfill their fiduciary duties to determine whether the executive compensation packages need to be adjusted.  However, nothing prevents the Board of Directors from summarily rejecting the shareholders’ contentions after having properly debated the issue.  Based on existing jurisprudence, we do not believe a company would lose a lawsuit as a result of such a decision; however, the costs in defending the litigation should be considered. 

Ultimately, the best defense against a derivative lawsuit based on a failed Say-on-Pay vote is to prevent the negative vote from occurring.  To the extent companies can make small changes to improve its ISS GRId score, those changes should be made given ISS’s undue influence over the proxy solicitation process.  In addition, if a company expects a significant vote against the executive compensation proposal (greater than 20%), we would strongly encourage reaching out to shareholders before a Proxy Statement is distributed.

 Section 205(a)(1) of the Investment Advisers Act generally prohibits an investment adviser from collecting performance based compensation that is based on a share of capital gains on, or capital appreciation of, a client’s funds or assets under management. The Securities and Exchange Commission (“SEC”) adopted Rule 205-3 to provide exceptions to this prohibition if the client’s assets under management exceeded a certain threshold (the “assets-under-management test”) or if the adviser reasonably believe the client had a certain minimum net worth  (the “net worth test”). Currently, the asset-under-management test and net worth test thresholds are $750,000 and $1.5 million, respectively.

The Dodd-Frank Act (the “Act”), which was signed into law on July 21, 2010, amended Section 205(e) to require the SEC to adjust the dollar amount tests included in the rules issued pursuant to Section 205(e) for inflation by July 21, 2011 and every five years thereafter. Furthermore, the Act required the net worth test dollar amount to exclude the value of a person’s primary personal residence.

On May 10, 2011, the SEC issued a proposed amendment to increase the dollar amounts for the assets-under-management test and net worth test under Rule 205-3 to $1 million and $2 million respectively. These thresholds will be indexed for inflation every five years thereafter. Furthermore, the net worth test will be amended to exclude the value of the investor’s primary personal residence.

To view the SEC’s proposed amendment click here.

Pursuant to Section 417 of the Dodd-Frank Act, the SEC’s Division of Risk, Strategy and Financial Innovation is undertaking two current studies involving short selling. The first study focuses on the state of short selling on national securities exchanges and in the over-the-counter markets. 

The SEC is seeking comments to complete its second study involving the examination of the feasibility, benefits, and costs of real-time reporting of short positions either to the public or solely to the SEC and FINRA and conducting a voluntary pilot program in which public companies will agree to have all trades of their shares designated as ‘‘short’’, ‘‘market maker short’’, ‘‘buy’’, ‘‘buy-to-cover’’, or ‘‘long’’, and reported in real time. 

While short selling is used to benefit from a stock’s expected price decline, to provide liquidity, or to hedge risks, the SEC is seeking input on the existing uses of short selling and the adequacy of the available information regarding short sales. Short selling accounts for almost half of U.S. equities volume, the SEC said, based on data provided by exchanges for June 2010.

The comments are requested over a 45-day period as the agency is preparing its report to Congress mandated by the Dodd-Frank Act, with a deadline of July 21.

To view the request for public comments, click here.

To view comments submitted to date, click here.

To submit your own comment to the SEC, click here.

We have recently experienced some of the worst financial and economic conditions that we (hopefully) will see in our lifetimes. Most of us have been touched personally by these conditions. It appears that economic and financial conditions will continue to get better, but these situations have created some ongoing challenges that will continue to face early stage companies and entrepreneurs even under better conditions. 

The apparent changes in the traditional roles of the venture capital, private equity and angel investing models are some of the changes that will impact early stage companies. This appears to be the “new normal” for the financing of early stage companies.  Financing from venture capital and angel investor sources has historically been a vital source of funding for early stage companies.  Most early stage companies are not able to qualify for bank financing and are too early for private equity financing. Venture capital and angel investor financing traditionally stepped into this gap and gave these companies the critical financing that they needed to survive and expand. Private equity firms tended to remain out of the early stage financing arena until a company had reached a certain level of revenues or profitability.

This traditional financing model has changed.  Many private equity firms have shifted their investment focus to an even more mature class of companies. There has been a concurrent shift in focus by venture capital firms as many of them have also shifted their investment focus to more mature companies and are subjecting target companies to stricter investment criteria.

These shifts in investment focus are understandable, but they have significantly reduced the availability of crucial funding sources for early stage companies. These shifts happened at a very tough time for most small companies as they tried to recover from bad economic conditions.  This reduction in financing opportunities coupled with the overall slow pace of the economic recovery has caused a dire situation for many early stage companies and entrepreneurs.  Fortunately several events have occurred that should help to fill this financing gap. Continue Reading Financing Early Stage Companies–Dealing With the “New Normal”

In a response letter to Representative Darrell Issa (R-CA) dated April 6, 2011, Mary Shapiro, the Chairman of the Securities and Exchange Commission (“SEC”), indicated that the SEC would be reviewing the feasibility of, among other things, a new exemption from registration for micro-financing or “crowdfunding.” Crowdfunding generally refers to the pooling of small contributions from a large number of people to finance some particular purpose or venture. In an example described to the SEC for the possible exemption, a company would be permitted to conduct an offering of up to $100,000, with a cap on individual investments of $100. Proponents of the proposed exemption view this as a viable way for small start-up companies to raise essential early stage capital at a low cost while minimizing investment risk because of the low cap on individual investment. The SEC is currently soliciting comments from the public on this topic. Public comments are available here. 

To view Chairman Shapiro’s letter click here.

NASDAQ recently filed a proposed rule change with the SEC. Upon taking effect, the rule will change the way total assets and shareholders’ equity are calculated for listing purposes on the NASDAQ Global Select Market. To conform with NYSE’s treatment under their comparable standard, NASDAQ proposes to delete the requirement that total assets be demonstrated as of the close of the most recent fiscal year. Under the proposed Rule, the $80 million total asset threshold for listing on the NASDAQ Global Select Market may be satisfied on the most recent publicly reported financial statements. NASDAQ also proposes to add a definition explaining what adjustments will be made to total assets and shareholders’ equity to reflect the use of proceeds and acquisitions and dispositions. These adjustments are identical to the adjustments specified in the NYSE Listed Company Manual. The proposed rule change was filed on April 1, 2011 and will take effect after the 30-day operative delay period. NASDAQ has asked the SEC to waive the 30-day operative period to allow companies to take advantage of the proposed rule change immediately.

To view the proposed NASDAQ rule amendment, click here.

 Last week, the SEC proposed new rules required by Section 952 of Dodd-Frank Act.  Under the proposal, compensation committees may engage a compensation consultant or other advisor, including legal counsel, only after taking into consideration the following factors, and any other factors determined by the national securities exchanges:

1) provision of other services to the issuer by the person that employs the advisor;

2) amount of fees received from the issuer by the person that employs the advisor, as a percentage of the total revenue of the person that employs the advisor;

3) policies and procedures of the person that employs the advisor that are designed to prevent conflicts of interest;

4) any business or personal relationship of the advisor with a member of the compensation committee; and

5) any stock of the issuer owned by the advisor.

The SEC has not proposed any bright-line tests or numerical thresholds to assist in determining whether a conflict of interest exists.

In addition, each issuer must disclose in any proxy or consent solicitation for an annual meeting at which directors are to be elected, whether (1) the compensation committee has retained or obtained the advice of a compensation consultant or other advisor, including legal counsel, and (2) the work of the advisor has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.  These disclosure rules would apply to all Exchange Act registrants subject to the SEC’s proxy rules.

To review the proposed rules, click here.

Assuming that Congress and the President cannot agree on either a continuing resolution to fund the operations of the United States’ government or a budget prior to midnight, the SEC will immediately suspend most of its operations.  According to the SEC’s contingency plan, of its 3,969 employees only 332 will report to work during the government shutdown.  The employees not furloughed will largely consist of those critical for the safety of human life or the protection of property or to carry out emergency enforcement activities.  No one may volunteer to work without pay.  All law enforcement and litigation matters, except emergency matters, all processing and approvals of filings and registration statements, and all non-emergency rule-making will be suspended.  EDGAR will remain operational; however, the Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations will be unable to process filings, provide interpretive advice, issue no-action letters or conduct any other normal Division and Office activities.

To review the contingency plan, click here.