Monday, January 25, 2016
I was going to blog today about Usha Rodrigues’s article on section 12(g) of the Exchange Act, but my co-blogger Ann Lipton stole my thunder over the weekend. If you’re interested in securities law and you haven’t read Ann’s excellent post on section 12(g), you should. Ann discusses Usha Rodrigues’s article on the history and policy of section 12(g); if you haven’t read it, I strongly recommend it. It’s available here. (Even if you’re not interested in reading about section 12(g), I highly recommend Usha’s scholarship in general. I’ve read several of her articles and blog posts over the last few years; she has become one of the leading commentators on securities and corporate law. She blogs at The Conglomerate.)
Instead of discussing section 12(g), I’m going to talk about exams. I finished grading my fall exams about a month ago and I’ve had time to reflect on them. The main reason students don’t do well on exams is that they don’t know or understand the material. But I’ve been reflecting on the difference between exams that are pretty good and exams that are excellent. Those students all know the material, so that’s not the difference.
One of the major differences between a good exam and an excellent exam is in how well students indicate the level of uncertainty in the law.
Sometimes, the law is clear and the answers to issues are certain. Sometimes, the answer is a little fuzzy, but the available authorities point strongly in a particular direction. Sometimes, the answer is completely unclear.
The best exam answers differentiate among those different possibilities and indicate the certainty of the author’s conclusion as to each issue. Bad answers don’t do that. They provide a definite “yes” or “no” to an issue when an unqualified answer is unwarranted. Or they go through a long list of arguments (“on the one hand, . . . ; on the other hand, . . . ) without reaching a conclusion or even indicating which side has the better argument and why.
I can always tell from reading exams which students I would want to consult as attorneys, and this is one of the clues.
Friday, January 22, 2016
Monday, January 4, 2016
Assume you acquire some nonpublic information about a company that will have no predictable effect on the company’s stock price, but will affect the volatility of that stock price. Is that information material nonpublic information for purposes of the prohibition on insider trading?
That’s one of the issues addressed in an interesting article written by Lars Klöhn, a professor at Ludwig-Maximillian University in Munich, Germany. The article, Inside Information without an Incentive to Trade?, is available here. His answer (under European law)? It depends.
Here’s the scenario: one company is going to make a bid to acquire another company. The evidence shows that, on average, the shareholders of bidders earn no abnormal returns when the bid is announced. There’s a significant variation in returns across bids: some companies earn positive abnormal returns and some companies earn negative abnormal returns. But the average is zero. Of course, the identity of the target might affect the expected return, but to pose the problem in its most complex form, let’s assume that you don’t know the target, just that the bidder is planning to make a bid for some other company.
In that situation, the stock is just as likely to go down as to go up if you buy it. Because of that, Professor Klöhn argues that the information should not be considered material to anyone buying or selling the stock.
However, the information about the bid will make the bidder’s stock price more volatile. The average expected gain is zero, but either large gains or large losses are possible, increasing the risk of the stock. Professor Klöhn argues that, since this risk can be diversified away, it should not affect the bidder’s stock price. However, the increased volatility would allow a trader to profit trading in derivatives based on the bidder’s stock. In other words, the information should affect the value of derivatives. Therefore, the information should be considered material in that context, and anyone using the nonpublic information to trade in derivatives should fall within the prohibition on insider trading.
It’s an interesting article, not very long and definitely worth reading. Professor Klöhn’s focus is on European securities law, but American readers should have no trouble following the discussion.
Monday, December 28, 2015
Andrew Schwartz, a professor at the University of Colorado, has recently published an interesting article discussing how crowdfunding deals with the fundamental problems of startup finance: uncertainty, information asymmetry, and agency costs. His article, The Digital Shareholder, 100 MINN. L. REV. 609 (2015), is available here.
Here’s the abstract:
Crowdfunding, a new Internet-based securities market, was recently authorized by federal and state law in order to create a vibrant, diverse, and inclusive system of entrepreneurial finance. But will people really send their money to strangers on the Internet in exchange for unregistered securities in speculative startups? Many are doubtful, but this Article looks to first principles and finds reason for optimism.
Well-established theory teaches that all forms of startup finance must confront and overcome three fundamental challenges: uncertainty, information asymmetry, and agency costs. This Article systematically examines this “trio of problems” and potential solutions in the context of crowdfunding. It begins by considering whether known solutions used in traditional forms of entrepreneurial finance—venture capital, angel investing, and public companies—can be borrowed by crowdfunding. Unfortunately, these methods, especially the most powerful among them, will not translate well to crowdfunding.
Finding traditional solutions inert, this Article presents five novel solutions that respond directly to crowdfunding’s distinctive digital context: (1) wisdom of the crowd; (2) crowdsourced investment analysis; (3) online reputation; (4) securities-based compensation; and (5) digital monitoring. Collectively, these solutions provide a sound basis for crowdfunding to overcome the three fundamental challenges and fulfill its compelling vision.
Andrew was kind enough to share a draft of this article with me earlier this year, and I’ve been waiting for him to make it publicly available so I could bring it to your attention. I’m not quite as optimistic as Andrew that crowdfunding will solve the problems he identifies, but it’s a good piece and worth reading.
Monday, December 21, 2015
I mentioned back in October that I spoke in Munich on Regulating Investment Crowdfunding: Small Business Capital Formation and Investor Protection. I discussed how crowdfunding should be regulated, using the U.S. and German regulations as examples.
If you’re interested, that talk is now available here. I expect this to be the top-rated Christmas video on iTunes.
If you want to know more about how Germany regulates crowdfunding, I strongly suggest this article: Lars Klöhn, Lars Hornuf, and Tobias Schilling, The Regulation of Crowdfunding in the German Small Investor Protection Act: Content, Consequences, Critique, Suggestions (June 2, 2015).
If you're interested in securities law, there's a new law review symposium issue worth reading. The SMU Law Review has posted an issue honoring the late securities law scholar Alan Bromberg. The symposium includes a number of interesting essays written by leading securities law scholars, including a piece by my co-blogger Joan Heminway. (I also have an article in the issue, so there's also at least one non-interesting article by a non-leading scholar.). Here's a copy of the cover, listing all of the articles:
Here's a PDF copy of the cover, if you can't see the image.
Monday, December 14, 2015
You may have missed the most recent amendments to federal securities law. They were tucked into the Surface Transportation Reauthorization and Reform Act (H.R. 22), which President Obama signed into law on December 4. Where else would you put securities law amendments?
The full Act, which includes a number of changes to securities law, is available here. I don't recommend wading through it, unless you're really into surface transportation. Today, I want to talk about one particular provision, a new exemption for the resale of securities.
As you may know, the Securities Act’s convoluted definition of “underwriter” makes it difficult to know when one may safely resell securities purchased in an unregistered offering (or when an affiliate of the issuer may safely resell any securities, registered or not). The SEC has enacted a couple of safe harbors, Rule 144 and Rule 144A. Rule 144A limits sales to large institutional buyers, so most ordinary resales are structured to meet the requirements of Rule 144. Sellers now have another option.
H.R. 22 adds a new section 4(a)(7) exemption to the Securities Act, as well as new subsections 4(d) and 4(e) to define that exemption.
Section 4(a)(7) exempts resales to accredited investors, as defined in Regulation D. The securities may not be offered or sold through general solicitation or general advertising. And, if the issuer of the securities is not a reporting company, certain information must be made available to the purchaser. There are some other restrictions, including a bad-actor disqualification, but the new exemption gives purchasers of unregistered securities an alternative to Rule 144.
Here’s the full text of sections 4(a)(7), 4(d), and 4(e):
Sec. 4. (a) The provisions of section 5 shall not apply to---
(7) transactions meeting the requirements of subsection (d)
(d) Certain accredited investor transactions.—The transactions referred to in subsection (a)(7) are transactions meeting the following requirements:
(1) ACCREDITED INVESTOR REQUIREMENT.—Each purchaser is an accredited investor, as that term is defined in section 230.501(a) of title 17, Code of Federal Regulations (or any successor regulation).
(2) PROHIBITION ON GENERAL SOLICITATION OR ADVERTISING.—Neither the seller, nor any person acting on the seller’s behalf, offers or sells securities by any form of general solicitation or general advertising.
(3) INFORMATION REQUIREMENT.—In the case of a transaction involving the securities of an issuer that is neither subject to section 13 or 15(d) of the Securities Exchange Act of 1934), nor exempt from reporting pursuant to section 240.12g3–2(b) of title 17, Code of Federal Regulations, nor a foreign government (as defined in section 230.405 of title 17, Code of Federal Regulations) eligible to register securities under Schedule B, the seller and a prospective purchaser designated by the seller obtain from the issuer, upon request of the seller, and the seller in all cases makes available to a prospective purchaser, the following information (which shall be reasonably current in relation to the date of resale under this section):
(A) The exact name of the issuer and the issuer’s predecessor (if any).
(B) The address of the issuer’s principal executive offices.
(C) The exact title and class of the security.
(D) The par or stated value of the security.
(E) The number of shares or total amount of the securities outstanding as of the end of the issuer’s most recent fiscal year.
(F) The name and address of the transfer agent, corporate secretary, or other person responsible for transferring shares and stock certificates.
(G) A statement of the nature of the business of the issuer and the products and services it offers, which shall be presumed reasonably current if the statement is as of 12 months before the transaction date.
(H) The names of the officers and directors of the issuer.
(I) The names of any persons registered as a broker, dealer, or agent that shall be paid or given, directly or indirectly, any commission or remuneration for such person's participation in the offer or sale of the securities.
(J) The issuer’s most recent balance sheet and profit and loss statement and similar financial statements, which shall—
(i) be for such part of the 2 preceding fiscal years as the issuer has been in operation;
(ii) be prepared in accordance with generally accepted accounting principles or, in the case of a foreign private issuer, be prepared in accordance with generally accepted accounting principles or the International Financial Reporting Standards issued by the International Accounting Standards Board;
(iii) be presumed reasonably current if—
(I) with respect to the balance sheet, the balance sheet is as of a date less than 16 months before the transaction date; and
(II) with respect to the profit and loss statement, such statement is for the 12 months preceding the date of the issuer’s balance sheet; and
(iv) if the balance sheet is not as of a date less than 6 months before the transaction date, be accompanied by additional statements of profit and loss for the period from the date of such balance sheet to a date less than 6 months before the transaction date.
(K) To the extent that the seller is a control person with respect to the issuer, a brief statement regarding the nature of the affiliation, and a statement certified by such seller that they have no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.
(4) ISSUERS DISQUALIFIED.—The transaction is not for the sale of a security where the seller is an issuer or a subsidiary, either directly or indirectly, of the issuer.
(5) BAD ACTOR PROHIBITION.—Neither the seller, nor any person that has been or will be paid (directly or indirectly) remuneration or a commission for their participation in the offer or sale of the securities, including solicitation of purchasers for the seller is subject to an event that would disqualify an issuer or other covered person under Rule 506(d)(1) of Regulation D (17 CFR 230.506(d)(1)) or is subject to a statutory disqualification described under section 3(a)(39) of the Securities Exchange Act of 1934.
(6) BUSINESS REQUIREMENT.—The issuer is engaged in business, is not in the organizational stage or in bankruptcy or receivership, and is not a blank check, blind pool, or shell company that has no specific business plan or purpose or has indicated that the issuer’s primary business plan is to engage in a merger or combination of the business with, or an acquisition of, an unidentified person.
(7) UNDERWRITER PROHIBITION.—The transaction is not with respect to a security that constitutes the whole or part of an unsold allotment to, or a subscription or participation by, a broker or dealer as an underwriter of the security or a redistribution.
(8) OUTSTANDING CLASS REQUIREMENT.—The transaction is with respect to a security of a class that has been authorized and outstanding for at least 90 days prior to the date of the transaction.
(e) Additional requirements.—
(1) IN GENERAL.—With respect to an exempted transaction described under subsection (a)(7):
(A) Securities acquired in such transaction shall be deemed to have been acquired in a transaction not involving any public offering.
(B) Such transaction shall be deemed not to be a distribution for purposes of section 2(a)(11).
(C) Securities involved in such transaction shall be deemed to be restricted securities within the meaning of Rule 144 (17 CFR 230.144).
(2) RULE OF CONSTRUCTION.—The exemption provided by subsection (a)(7) shall not be the exclusive means for establishing an exemption from the registration requirements of section 5.
Thursday, December 10, 2015
A few days ago, co-blogger Steve Bradford posted on law professor complaints about grading under the title Warning: Law Professor Whine Season. OK. I typically am one of those whiners. But today, rather than noting that grading is the only part of the semester I actually need to be paid for (and all that yada yada), I want to briefly extoll one virtue of exam season: the positive things one sees in students as they consciously and appropriately struggle to synthesize the material in a 14-week jam-packed semester.
My Business Associations final exam was administered on Tuesday. Like many other law professors, I gave my students sample questions (with the answers), held a review session, and responded to questions posted to the discussion board on our class course management site. Sometimes, I dread any and all of that post-class madness. This year, I admit that there were few of the thinly veiled (and, by me, expressly discouraged and disdained) "is this on the exam?" or "please re-teach this part of the course . . ." types of questions or requests in any of the forums that I offered for post-class review and learning. That was a relief.
The students' final work product for my Corporate Finance planning and drafting seminar was due Monday. I met with a number of students in the course about that drafting assignment and about the predecessor project in the final weeks before each was due. I watched them work through issues and begin to make decisions, uncomfortable as they might be in doing so, that solve real client problems. Satisfying times . . . .
In fact, there have been a number of moments over the past week in which I was exceedingly proud of the learning that had gone on and was continuing to go on during the post-class exam-and-project-preparation phase of the semester. I offer a few examples here to illustrate my point. They come from both my Business Associations course, for which students take a comprehensive written final examination, and my Corporate Finance planning and drafting seminar, for which students solve a corporate finance problem through planning and drafting and write a review of a fellow student's planning and drafting project.
Monday, December 7, 2015
A warning to all of you in the real (non-academic) world: law school exam season has begun. You know what that means: it’s whine time. Time to read blog posts by law professors complaining about the miseries of grading exams. (What you read in the blogs is nothing compared to what you hear in the hallways of law schools.)
Grading law school exams is not a pleasant task. It’s intellectually grinding, but it’s not just the work. I care about my students and I hate to see some of them waste their promise.
But, on a scale of 1 (easy) to 10 (hard), grading law school exams is at most a 3. Some people have to clear septic tanks for a living. Police officers and soldiers put their lives on the line every day. I worked in a pea cannery two summers, and, even compared to that, grading exams is a breeze.
I have it easy, so I promise not to whine this year. I have a well-paying job that mostly allows me to do what I love, so I can tolerate grading. (Don't bother tracking down my old blog posts; I admit I've whined about grading in the past.).
To my students, good luck. I hope you all do wonderfully; nothing would be more fulfilling than to give every one of you an A. And, if you stumble, don't forget the words of Charles Colton: "The greatest fool may ask more than the wisest man can answer."
Wednesday, December 2, 2015
Monday, November 30, 2015
I never thought I would say this, but my favorite book this year is about punctuation. That’s right. Punctuation! The book is Making a Point: The Pernickety Story of English Punctuation, by David Crystal, and it's well worth reading.
It’s an enjoyable romp through the English language, with limited attention to writing in other languages as well. (I just placed something in a German English-language publication and discovered that Germans don’t know how to “correctly” use quotation marks.)
This isn’t a rule book; Crystal talks about current usage, including areas where the “experts” disagree. (Oxford comma, anyone?) But he also covers the history—how the use of punctuation has evolved over time. One of the book's recurring themes is how two functions of punctuation--clarifying the writer's meaning and providing cues to speakers--can sometimes be at odds.
The history is fascinating. I have to admit that, after reading this book and seeing what excellent writers have done in the past, it’s harder to argue for a prescriptive position. I don’t always agree with Crystal’s position on disputed issues, but his case is always cogent.
Crystal covers all the major punctuation marks: , , ;, :, . . . , ., and ( ). (Yes, I did write this sentence just to see what it would look like.) But he also covers other lesser-known punctuation marks that have fallen into disuse, as well as the use of capital letters and spacing. (I was surprised to learn that early Anglo-Saxon writing often didn’t have spacing between words.)
I’m a writing geek, so I love to read books like this. But this book isn’t just for people like me. Anyone who writes for a living or wants to write for a living—and that includes all lawyers and law students—should read this book. Making a Point is entertaining and informative, and the writing is clear. (I almost restrained the urge to write “crystal-clear.”) Check it out.
Thursday, November 26, 2015
It’s Thanksgiving, which means it’s time to do Christmas shopping. No, that’s not it. I’m sure Thanksgiving is supposed to be about more than that. Food? Football? No, there’s something else. It’s on the tip of my tongue; I just can’t quite remember. . . . . . . . .
Oh, yeah: being thankful.
I’m thankful for many things, but I want to use this column to thank some of the people who have touched my professional life.
First, thanks to my co-bloggers (in alphabetical order): Josh Fershee; Joan Heminway; Ann Lipton; Haskell Murray; Marcia Nanine; Stefan Padfield; and Anne Tucker. Their blog posts are always interesting and informative, and usually, I have to admit, better than anything I write. But, if you think their blog posts are good, you ought to see the incredible behind-the-scenes e-mail conversations we share. I have learned a lot from each of them. Believe it or not, I’ve only met two of them in person, but I’m happy to have all of them in my academic life.
Second, I’m thankful for my colleagues here at the University of Nebraska—well, most of them anyway. All of them are deserving of thanks—if for nothing else, just for putting up with me. But I want to pick out one of my colleagues for special mention. My long-time friend and colleague Bill Lyons is retiring at the end of this year (as a colleague; not as a friend, I hope), and I’m really going to miss him. (I never would have thought anyone would miss a tax lawyer, but apparently it's possible.) Bill and I have shared conversations about law school, teaching, children, Monty Python, Star Trek, Babylon 5, Douglas Adams, and a number of equally important matters. I will miss those conversations when Bill retires. Bill has helped keep me sane, or at least as close as I’ll ever get. Thanks, Bill.
I have already publicly thanked two other former colleagues who, sadly, are no longer with us: John Gradwohl and Alan Bromberg. But I can’t thank either of them enough, so I again want to express my thanks for what each of them did for me.
The final person I want to thank is my mother, Bettie Johnston. What's my mother doing on a list of people who touched me professionally? For one thing, I wouldn't be here today but for her. She helped me through the hard times; I don't think I would have survived without her. (And there was that womb thing, too.) But she also taught me to question, and sparked a lifetime love of learning. Our kitchen conversations when I was in junior high and high school started me on the path to be a law professor.
The list of people who deserve thanks could go on and on. My students, who have made teaching so fun—and challenging. The many good teachers I had, who molded me into what I am today. (Blame them.) The many people who have used, commented on, and responded to my scholarship. But if I tried to list everyone who positively affected me professionally, this post would go on forever. To all of you, wherever you are, thank you. I haven't forgotten you. (Well, some of your names, but that's an age thing.)
I’ll be back to business law next week. In the meantime, have a happy Thanksgiving. Eat a lot of turkey. Watch a lot of football. And, if you must, do some shopping. But, whatever else you do, don’t forget to thank all of the people who have touched your lives—professionally or otherwise.
Monday, November 23, 2015
Last week was the 30th anniversary of the Delaware Supreme Court’s decision in Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985). In Moran, decided on Nov. 19, 1985, the Delaware Supreme Court upheld what has become the leading hostile takeover defensive tactic, the poison pill.
Martin Lipton, the primary developer of the pill, even makes an appearance in the case—and obviously a carefully scripted one: “The minutes reflect that Mr. Lipton explained to the Board that his recommendation of the Plan was based on his understanding that the Board was concerned about the increasing frequency of ‘bust-up’ takeovers, the increasing takeover activity in the financial sector industry, . . . , and the possible adverse effect this type of activity could have on employees and others concerned with and vital to the continuing successful operation of Household even in the absence of any actual bust-up takeover attempt.”
I’m not sure the takeover world would be that different today if Moran had rejected poison pills. I’m reasonably confident the Delaware legislature would have amended the Delaware statute to overturn the ruling, as they effectively did with another ruling decided earlier that same year, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Shortly after Van Gorkom made it clear that directors might actually be liable for violating the duty of care, the legislature added section 102(b)(7) to the Delaware law, allowing corporations to eliminate any possibility of damages for duty-of-care violations.
As my colleague Joan Heminway has pointed out, 1985 was an incredibly important year for M & A practitioners. In addition to Moran and Van Gorkom, a third major case was also decided that year: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
Van Gorkom was decided in late January of 1985, Unocal in June, and Moran in November. Corporations casebooks and treatises are filled with Delaware Supreme Court decisions, but that has to be one of the most important ten-month periods in Delaware corporate law jurisprudence—especially in the mergers and acquisitions area.
Monday, November 16, 2015
One final post on the SEC’s proposed changes to Rule 147 and I promise I’m finished—for now. Today’s topic is the effect the proposed changes will have on state crowdfunding exemptions. If the SEC adopts the proposed changes to Rule 147, many state legislatures will have to (or at least want to) amend their state crowdfunding legislation.
As I explained in my earlier posts here and here, the SEC has proposed amendments to Rule 147, currently a safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act. If the proposed amendments are adopted, Rule 147 would become a stand-alone exemption rather than a safe harbor for section 3(a)(11). There would no longer be a safe harbor for intrastate offerings.
That creates some issues for the states. Many states have adopted state registration exemptions for crowdfunded securities offerings that piggyback on the federal intrastate offering exemption. That makes sense, because, if the offering isn’t also exempted at the federal level, the state crowdfunding exemption is practically worthless. (An offering pursuant to the federal crowdfunding exemption is automatically exempted from state registration requirements, but these state crowdfunding exemptions provide an alternative way to sell securities through crowdfunding.)
The SEC’s proposed amendments would actually make it easier for a crowdfunded offering to fit within Rule 147. (In fact, the SEC release says that’s one of the purposes of the amendments.) Most importantly, the SEC proposes to eliminate the requirement that all offerees be residents of the state. That change would facilitate publicly accessible crowdfunding sites which, almost by definition, are making offers to everyone everywhere. The securities would still have to be sold only to state residents, but it’s much easier to screen purchasers than to limit offerees.
Problem No. 1: Dual Compliance Requirements
Unfortunately, many state crowdfunding exemptions require that the crowdfunded offering comply with both section 3(a)(11) and Rule 147 in order to be eligible for the state exemption. Here, for example, is the relevant language in the Nebraska state crowdfunding exemption: “The transaction . . . [must meet] . . . the requirements of the federal exemption for intrastate offerings in section 3(a)(11) of the Securities Act of 1933 . . . and Rule 147 under the Securities Act of 1933.” (emphasis added).
Currently, that double requirement doesn’t matter. An offering that complies with the Rule 147 safe harbor by definition complies with section 3(a)(11). That would no longer true if the SEC adopts the proposed changes. Since Rule 147 would no longer be a safe harbor, an issuer that complied with Rule 147 would still have to independently determine if its offering complied with section 3(a)(11). Because of the uncertainty in the case law under 3(a)(11), that determination would be risky. (But see my argument here.) The leniency the SEC proposes to grant in the amendments to Rule 147 would not be helpful unless state legislators amended their crowdfunding exemptions to eliminate the requirement that offerings also comply with section 3(a)(11).
Problem No. 2: State-of-Incorporation/Organization Requirements
There’s another potential issue. Many state crowdfunding exemptions include an independent requirement that the issuer be incorporated or organized in that particular state. That’s inconvenient, and reduces the value of the state crowdfunding exemption, because corporations and LLCs are often incorporated or organized outside their home states. But, until now, that state requirement hasn’t mattered because both section 3(a)(11) and Rule 147 also impose such a requirement.
The SEC proposes to eliminate that requirement from Rule 147, so it now matters whether the state crowdfunding exemption independently imposes such a requirement. Issuers won’t be able to take full advantage of the proposed changes to Rule 147 unless states eliminate the state-of-incorporation/organization requirements from their state crowdfunding exemptions as well.
On to More Important Things
That’s the end of my Rule 147 discussion for now. I promise! Now, we can turn to more important questions, such as why your favorite team belongs in the college football playoff. (I know for sure that my college football team won't be there. I would be happy just to have my college football team in a bowl game.)
Monday, November 9, 2015
Once the SEC has created a safe harbor for a statutory exemption, can it ever really get rid of it? That’s one of the issues raised by the SEC’s proposed changes to Rule 147, which I considered in detail last week.
Rule 147 is currently a safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act. Section 3(a)(11) exempts from the Securities Act registration requirement
“Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.”
Rule 147 currently provides that an offering
“made in accordance with all of the terms and conditions of this rule shall be deemed to be part of an issue offered and sold only to persons resident within a single state or territory where the issuer is a person resident and doing business within such state or territory, within the meaning of section 3(a)(11) of the Act.”
In other words, if you meet the requirements of Rule 147, you are within the section 3(a)(11) exemption.
However, as I wrote in my post last week, the SEC is proposing to decouple Rule 147 from section 3(a)(11) and make Rule 147 an independent exemption. As a result, section 3(a)(11) would no longer have a safe harbor. Issuers could still use the section 3(a)(11) exemption, but they would be relegated to the uncertain case law that prevailed under section 3(a)(11) before Rule 147 was adopted.
Or would they?
Consider the nature of a safe harbor. The SEC is saying that, if you comply with the current requirements of Rule 147, you have met the requirements of section 3(a)(11). The SEC is not creating a new exemption or redefining the requirements of section 3(a)(11), merely saying that a particular class of offerings (those that meet all of Rule 147’s requirements) falls within the exemption defined by Congress in section 3(a)(11).
But, if that’s the case, the elimination of the safe harbor should have no effect on offerings that meet the old requirements. If those offerings fell within the exemption created by Congress the day before the safe harbor was eliminated, they should still fall within the congressional requirements the day after the safe harbor is eliminated.
After Rule 147’s amendment, an issuer who meets the old requirements should still fall within the section 3(a)(11) exemption. Why? Because the SEC said an offering like that falls within section 3(a)(11) and, unless the Commission was wrong in the first place, that conclusion should still hold even after the formal rule is eliminated.
Thursday, November 5, 2015
With the recent release of bar results in many states, I have been obsessed of late about the sorry state of bar passage across the country--as well as specific bar passage issues relating to our graduates. So, rather than (as I should and will do soon) responding to Steve Bradford's prompting post on the final JOBS Act Title III crowdfunding rules and the related proposals regarding Rules 147 and 504 under the Securities Act of 1933, as amended (as well as his follow-up post on the Rule 147 proposal), I have decided to focus on bar passage for my few minutes of air time this week. Specifically, I want to begin to explore the question of what we can do, if anything, as business law professors to help more of our students succeed in passing the bar on the first attempt.
At a base level, this means we should endeavor to understand something about the reasons why our individual students fail the bar the first time around. A lot has been written about the national trends (inconclusively, as a general rule). And I am sure every law school is now analyzing the data on its own bar passage shortcomings. But my experience teaching Barbri and my conversations with former students who have not passed the bar indicate a number of possible causes. They include (and these are my descriptions based on that experience and those conversations, in no particular order):
- Failing to state the applicable legal rule(s) and apply them to the facts;
- Difficulty in processing legal reasoning in the time allotted;
- Nerves, sleep deprivation, illness and the like; and
- Engaging insufficiently with study materials and practice examinations.
Assuming that these anecdotal observations are, in fact, causes contributing to bar exam failures for at least some students, how might we be able to help?
Monday, November 2, 2015
Here’s something everyone who has ever taken Securities Regulation should know: Section 3(a)(11) of the Securities Act, the intrastate offering exemption, has a safe harbor, Securities Act Rule 147.
As Lee Corso would say, “Not so fast, my friend.” The SEC is proposing to overturn that longstanding wisdom. If the SEC’s proposed changes to Rule 147 are adopted,Rule 147 would no longer be tied to section 3(a)(11) and section 3(a)(11) would no longer have a safe harbor. The intrastate nature of Rule 147 would be preserved, but the proposed changes would be adopted under the SEC’s general exemptive authority in section 28 of the Securities Act.
Here are the most significant changes that the SEC has proposed:
Tied to State Regulation
The premise of section 3(a)(11) and its Rule 147 safe harbor is to relegate purely intrastate offerings to state regulation. But there’s currently nothing in Rule 147 to enforce that premise; federal exemption does not depend on state regulation of the offering.
The SEC proposal would expressly tie the federal Rule 147 exemption to state regulation. An offering would qualify for the federal exemption only if it was (1) registered at the state level or (2) sold pursuant to a state exemption that imposes investment limits on purchasers and limits the amount of the offering to $5 million in any 12-month period. (This second possibility is clearly aimed at the crowdfunding exemptions that many states have recently enacted.)
Rule 147 does not currently limit the amount of the offering. The SEC proposal would limit the offering amount to $5 million in any 12-month period, unless the offering is registered at the state level.
State of Incorporation
Rule 147 currently requires that the issuer be incorporated or organized in the state in which the securities are sold. Because of that, even a corporation or LLC with all of its business in a single state cannot use Rule 147 if it happens to be incorporated or organized in another state, such as Delaware.
The SEC proposes to eliminate the focus on state of incorporation or organization, and require instead that the issuer’s “principal place of business” be within the state in which the offering is made. This would be defined as the state where “the officers, partners or managers . . . primarily direct, control and coordinate” the issuer’s activities.
Doing Business in the State
Under the current rule, the issuer must meet four requirements to establish that it is doing business in the state:
- It must derive at least 80% of its gross revenues from operations within the state;
- At least 80% of its assets must be located within the state;
- It must intend to use and actually use at least 80% of the offering proceeds in connection with operations in the state; and
- Its principal office must be located in the state.
All four of those requirements must be met.
The proposed rule is much less restrictive. An issuer only has to meet any one of the following requirements:
- It derives at least 80% of its gross revenues from operations in the state;
- At least 80% of its assets are located in the state;
- It intends to use and uses at least 80% of the offering proceeds in connection with operations in the state; or
- A majority of its employees are based in the state.
(Notice the addition of the new fourth test.) It will obviously be easier to satisfy a single one of the new requirements that it is to satisfy all four of the requirements under the current rule.
Intrastate Offers and Sales
Rule 147 currently provides that the securities must be offered and sold only to state residents. In other words, it’s not enough to screen out non-residents before sale. You can’t even solicit non-residents.
The SEC proposes to eliminate the restriction on offerees. An issuer could make a general public solicitation to the world, as long as it only sells the securities to state residents. This obviously makes it much easier to make Rule 147 offerings on the Internet.
Reasonable Belief Standard
The current rule requires that all of the purchasers (and offerees) be residents of the state. If one of them is a non-resident, the exemption is lost, even if the issuer thought the person was a resident.
The proposed rule adds a reasonable belief standard. The exemption is protected as long as the issuer had a reasonable belief that the non-resident purchaser was a resident.
Resales and the Issuer’s Exemption
Both the current rule and the SEC’s proposal limit resales to non-residents. However, there’s a crucial difference between the two.
The current rule makes the exemption dependent on meeting all of the terms and conditions of the rule, including the resale limit. Thus, if a purchaser immediately resold to a non-resident, the issuer could lose the exemption.
The proposed rule, like the current rule, requires the issuer to take certain precautions to prevent resales to non-residents, but the prohibition on resales is no longer a condition of the issuer’s exemption. Thus, if the issuer took the required precautions and a purchaser resold to a non-resident anyway, the issuer would not lose the exemption.
Protection from Integration
Rule 147 currently has a provision that protects the Rule 147 offering from integration with sales pursuant to certain other exemptions six months prior to or six months after the Rule 147 offering.
The SEC proposal offers a much broader anti-integration safe harbor, similar to the integration safe harbor included in Regulation A. Offers or sales under the amended Rule 147 exemption would not be integrated with any prior offers or sales. And Rule 147 offerings would not be integrated with subsequent offers or sales that are (1) federally registered; (2) pursuant to Regulation A; (3) pursuant to Rule 701; (4) pursuant to an employee benefit plan; (5) pursuant to Regulation S; (6) pursuant to the crowdfunding exemption in section 4(a)(6); or (7) more than six months after completion of the Rule 147 offering.
There is also some protection against integration when an issuer begins an offering under Rule 147 and decides to register the offering instead.
Section 3(a)(11) Remains Available
As I mentioned earlier, the amended Rule 147 would no longer be a safe harbor for section 3(a)(11) of the Securities Act. But Section 3(a)(11) would remain available. It just wouldn’t have a safe harbor.
An issuer would be free to use the section 3(a)(11) statutory exemption, but I wouldn’t recommend it unless everything is unquestionably intrastate. It was the uncertain interpretations of section 3(a)(11) that led to Rule 147 in the first place.
A Move in the Right Direction
I think the proposed exemption is a move in the right direction. Rule 147, one of the SEC’s earliest surviving safe harbors, was a little long in the tooth. The proposed changes will make it a little more viable.
Pat Haden is the athletic director at the University of Southern California. Until Friday, he was also a member of the College Football Playoff selection committee. And, according to this story in the L.A. Times, he is also a director of at least nine non-profits or foundations and three businesses.
According to the Times, Haden spends an average of 70 hours a week on his U.S.C. job. As a playoff selection committee member, he was expected to spend countless hours watching football games and evaluating teams.
So where does he find the time to serve as a board member? Not a problem, according to Haden. He has “never been to one meeting” of some of the nonprofits he serves. And he spends “very little” time on his board positions.
Haden’s attitude is representative of an earlier era when outside directors merely showed up at meetings and nodded their head to whatever the chairman said. Those days are long gone. Today, board members are expected to spend much more time on their board duties, at the risk of liability if they don't.
Mr. Haden, a former Rhodes Scholar, is a very bright guy, but even bright guys can say stupid things. I just hope he’s never sued. (At least one of the businesses he serves as a director is a public corporation.) A plaintiff’s lawyer could use quotes like this to mince him.
In the meantime, I suggest he read something on modern corporate governance. He has a law degree, so he shouldn’t have any trouble understanding it.
Thursday, October 29, 2015
. . . are you sure I qualify?
From a spam email I recently received:
On behalf of The International Women’s Leadership Association, it is my distinct pleasure to notify you that, in consideration of your contribution to family career, and community, you have been selected as a woman of outstanding leadership.
Monday, October 26, 2015
The Second Circuit decision in the Newman case has provoked much discussion of the Supreme Court’s opinion in Dirks and how to interpret the requirements it lays out for tippee liability. But it’s important to remember that Dirks was not writing on a clean slate. This year is the 35th anniversary of the case that preceded Dirks and laid the foundation for the Supreme Court’s insider-trading jurisprudence, Chiarella v. United States.
I realize that this was not the Supreme Court’s first look at insider trading. That honor, arguably, goes to Strong v. Repide, 213 U.S. 419 (1909). But Chiarella was the court’s first discussion of insider trading under Rule 10b-5.
The facts of the Chiarella case are relatively simple. Vincent Chiarella, the defendant in the case, was an employee of Pandick Press, a financial printer. His company was hired to print announcements of takeover bids. Although the identities of the target corporations were concealed in the announcements, Chiarella was able to figure out who they were. He bought stock in the target companies and made a profit of roughly $30,000. He was convicted of a criminal violation of Rule 10b-5, but the Supreme Court overturned his conviction.
It’s important to remember the basic problem Chiarella had to deal with (or perhaps it’s fairer to say the problem as the Chiarella majority constructed it). Rule 10b-5 prohibits securities fraud. People engaged in insider trading don’t usually make false statements and, under the common law, mere silence is not usually fraud. Because of that, the majority in Chiarella rejected the notion that a mere failure to disclose nonpublic information prior to trading violates Rule 10b-5. There’s no fraud.
However, the majority pointed out that a failure to disclose can be fraudulent when the non-disclosing party has a duty to disclose to the other person “because of a fiduciary or other similar relation of trust and confidence between them.” That fiduciary duty, the majority indicated in dictum, does exist in the case of corporate insiders. But Vincent Chiarella was not an insider of the corporations whose stock he traded. Since the government had not otherwise shown that Chiarella violated a fiduciary duty by not disclosing to anyone, he was not liable under Rule 10b-5.
That’s the essence of Chiarella: nondisclosure violates Rule 10b-5 only if there’s a fiduciary duty to disclose. No fiduciary duty, no liability.
Everything that followed—Dirks; O’Hagan; the Second Circuit’s decision in Newman; even the SEC’s Rule 10b5-2—depends on Chiarella. How different things would have been if Justice Blackmun’s dissent had carried a majority. His view was that “persons having access to confidential material information that is not legally available to others” could not trade without liability under Rule 10b-5.
The ultimate irony of Chiarella is that, if the case were tried today, Vincent Chiarella would without a doubt be liable under Rule 10b-5. The Supreme Court’s subsequent decision in United States v. O’Hagan, 521 U.S. 642 (1997) makes it crystal clear that one can be liable for trading on the basis of nonpublic information obtained from one’s employer or client. But the majority in Chiarella refused, on procedural grounds, to reach that question.