Friday, March 4, 2016
Presidential candidate Donald Trump has repeatedly stated that he never plans to eat Oreo cookies again because the Nabisco plant is closing and moving to Mexico. Trump, who has starred in an Oreo commercial in the past, is actually wrong about the nature of Nabisco’s move, and it’s unlikely that he will affect Nabisco’s sales notwithstanding his tremendous popularity among some in the electorate right now. Mr. Trump has also urged a boycott of Apple over how that company has handled the FBI’s request over the San Bernardino terrorist’s cell phone.
Strangely, I haven’t heard a call for a boycott of Apple products following shareholders’ rejection of a proposal to diversify the board last week. I would think that Reverend and former candidate Al Sharpton, who called for the boycott of the Oscars due to lack of diversity would call for a boycott of all things Apple. But alas, for now Trump seems to be the lone voice calling for such a move (and not because of diversity). In fact, I’ve never walked past an Apple Store without thinking that there must be a 50% off sale on the merchandise. There are times when the lines are literally out the door. Similarly, despite the #Oscarssowhite controversy and claims from many that the boycott worked because the Oscars had historically low ratings, viewership among black film enthusiasts was only down 2% this year.
So why do people constantly call for boycotts? According to a Freakonomics podcast from January, they don’t actually work. Historians and economists made it clear in interviews that they only succeed as part of an established social movement. In some cases they can backfire leading to a "buycott," as it did for Chik Fil A. The podcast also put into context much of what we believe are the boycott “success stories,” including the Montgomery Bus Boycott with Rosa Parks and the sit in movement related to apartheid in the 1980s.
I have spent much of my time looking at disclosure legislation that is based in part on the theory that informed consumers and socially-responsible investors will boycott or divest holdings (see here, here, and here). In particular, I have focused on the Dodd-Frank conflict minerals corporate governance disclosure and why I don’t think that using name and shame laws work—namely because consumers talk a good game in surveys but actually don’t purchase based on social criteria nearly as much as NGOs and legislators believe.
The SEC was supposed to decide whether to file a cert petition to the Supreme Court on the part of the conflict minerals legislation that was struck down on First Amendment grounds by March 9th but they now have an extension until April. Since I wrote an amicus brief in the case at the lower level, I have a particular interest in this filing. I had planned my business and human rights class on disclosures and boycotts around that cert. filing to make it even more relevant to my students, who will do a role play simulation drafted by Professor Erika George representing civil society (NGOs, investors, and other stakeholders), the electronics industry, the US government (state department, Congress, and SEC), Congolese militia, the Congolese government, and the Congolese people. The only group they won’t represent is US consumers, even though that’s the target group of the Dodd-Frank disclosure. I did tweak Professor George’s materials but purposely chose not to add in the US consumer group. After my students step out of their roles, we will have the honest discussions about their own views and buying habits. I’ll try not to burst any boycott bubbles.
March 4, 2016 in Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, International Business, International Law, Law School, Legislation, Marcia Narine, Securities Regulation, Shareholders, Teaching | Permalink | Comments (1)
Monday, February 29, 2016
Federal and state securities regulation is the personification of what conservatives refer to pejoratively as “big government.” Businesses can’t raise money unless they first get permission from the government and, in many states, that permission turns on a regulator’s determination of whether the offer is fair. The cost of compliance is a serious drag on capital formation, especially small business capital formation. Federal and state securities laws also generate a tremendous amount of plaintiff’s litigation, another conservative bugaboo.
We’ve seen conservative efforts at the federal level to limit securities regulation and litigation—for example, the Private Securities Litigation Reform Act and the JOBS Act. But, unless things are going on at the state level that I’m not aware of, there doesn’t seem to be a corresponding effort at the state level.
That’s surprising, because the Republicans have greater control at the state level than they do at the federal level. There are 31 Republican governors and the Republicans control both chambers of the state legislature in 30 states, plus Nebraska’s unicameral legislature. Republicans control both the governorship and the state legislature in 24 states.
Why hasn’t there been a push to change state securities regulation? Are Republicans satisfied with state regulation? If so, that’s surprising because Rutheford Campbell and others have pointed to state securities regulation as a major drag on small business capital formation. Are politicians at the state level not as anti-government? Or is there something else going on that I’m missing?
I’m not arguing that state securities laws should be limited (at least, not in this post). I’m just curious why it hasn’t happened.
Wednesday, February 24, 2016
Having just taught a corporate governance seminar class on the proxy process (from a company's perspective), proxy advisory services, and institutional voting, I have the upcoming proxy season on my mind. There are a great collection of resources available for those interested for academic or practice-related reasons. My students found many of these summaries to be a good distillation of the issues and introduction to the nuts and bolts of proxy access. I have provided my list of resources below, in addition to a quick summary of the major governance issues likely to be on the table in 2016.
Major Governance Issues:
- Dodd Frank pay ratio disclosure
- Say on Pay majority voting
- Executive compensation disclosures subject to new SEC interpretations
- Proxy Access Bylaws (see New York campaign)
- Audit Committee Disclosures
- Independent Chair proposals
2016 Proxy Season Resources:
Monday, February 22, 2016
“[T]he effective date of a registration statement shall be the twentieth day after the filing thereof.” That statement, in section 8(a) of the Securities Act of 1933, makes the process seem so reassuringly quick and simple. If I want to offer securities to the public, I file a registration statement with the SEC and, less than three weeks later, I’m ready to go. But, as every securities lawyer knows, it isn’t really that easy.
It can take months for the registration statement in an IPO to become effective. The statutory deadline is circumvented through the use of a delaying amendment, a statement in the registration statement that automatically extends the 20-day period until the SEC has finished its review. See Securities Act Rule 473, 17 C.F.R. § 230.473.
But wouldn’t it be so much more conducive to capital formation if there really was a hard 20-day deadline? I understand that the SEC doesn’t have the staff to complete a full review in that time frame, but it would force them to focus on the important disclosure issues rather than some of the trivialities one sees in the current comment letters.
I’d like to see someone test that automatic 20-day effectiveness—file a complete registration statement without the delaying amendment and wait to see what happens. The issuer would, of course, be stuck with a price set 20 days before sale, because section 8(a) provides that amending the registration statement resets the 20-day clock. But that’s not the biggest problem.
The biggest problem is that the SEC would undoubtedly seek a stop order under section 8(d) of the Act. It’s only supposed to do that if it appears the registration statement contains a materially false statement or omits a material fact required to be included or necessary to keep the registration statement from being misleading. But I have no doubt that the SEC staff would argue that something in the registration statement was materially misleading, no matter how complete and carefully crafted it was.
Still, it would be nice to see someone try, just to see the SEC scramble to deal with such an unprecedented lack of obeisance. Unfortunately, no one would risk it—unless . . . Mr. Cuban?
Wednesday, February 10, 2016
New Scholarship on Hedge Fund Activism Urges Courts to Adopt Enhanced Scrutiny of Boards' Defensive Actions
Bernard Sharfman, in his new article on SSRN, The Tension Between hedge Fund Activism and Corporate Law, argues that hedge fund activism for control of a publicly traded corporation is a positive corrective measure in corporate governance. After asserting that hedge fund activism should be permitted, Sharfman, argues, controversially, that courts should depart from traditional deference to a corporate board's decision making authority under the business judgment rule. Alternatively, Sharfman urges courts to adopt a heightened standard of scrutiny when reviewing defensive board actions against hedge funds.
[Hedge Fund Activism] has a role to play as a corrective mechanism in corporate governance and it is up to the courts to find a way to make sure it continues to have a significant impact despite the courts’ inclination to yield to Board authority. In practice, this means that when the plaintiff is an activist hedge fund and the standard of review is the Unocal test because issues of control are present, a less permissive approach needs to be applied, requiring the courts to exercise restraint in interpreting the actions of activist hedge funds as an attempt to gain control.
If there are no issues of control, then Board independence and reasonable investigation still needs to be the focus. That is, before the business judgment rule can be applied, the courts need to utilize an enhanced level of scrutiny in determining whether the Board is truly independent of executive management or any other insider such as a fellow Board member. As previously discussed, Board independence is critical to maximizing the value of HFA. Moreover, reasonable investigation of the activist hedge fund’s recommendations should be required to justify Board action taken to mute the fund’s influence. Like the Unocal test, the burden of proof for establishing independence and reasonable investigation needs to be put on the Board. In sum, what is required in the court’s review of Board actions to mute the influence of an activist hedge fund is something similar to the first prong of the Unocal test except independence and reasonable investigation is now focused on the Board’s evaluation of the fund’s recommendations, not the threat to corporate policy and effectiveness.
Sharfman uses Third Point LLC v. Ruprecht, the 2014 Delaware case invovling Sotheby's poison pill, to illustrate how the traditional (deference) standard of review leads to boards being able to defeat hedge fund activists.
An interesting comment published in the Yale Law Journal by Yale Law Student Carmen X.W. Lu, Unpacking Wolf Packs, offers an alternative view of the Third Point case emphasizing the coalition of hedge funds acting in that case and the court's skepticism of wolf pack activist investors.
Thursday, February 4, 2016
For the past four weeks I have been experimenting with a new class called Transnational Business and Human Rights. My students include law students, graduate students, journalists, and accountants. Only half have taken a business class and the other half have never taken a human rights class. This is a challenge, albeit, a fun one. During our first week, we discussed CSR, starting off with Milton Friedman. We then used a business school case study from Copenhagen and the students acted as the public relations executive for a Danish company that learned that its medical product was being used in the death penalty cocktail in the United States. This required students to consider the company’s corporate responsibility profile and commitments and provide advice to the CEO based on a number of factors that many hadn’t considered- the role of investors, consumer reactions, the pressure from NGOs, and the potential effect on the stock price for the Danish company based on its decisions. During the first three weeks the students have focused on the corporate perspective learning the language of the supply chain and enterprise risk management world.
This week they are playing the role of the state and critiquing and developing the National Action Plans that require states to develop incentives and penalties for corporations to minimize human rights impacts. Examining the NAPs, dictated by the UN Guiding Principles on Business and Human Rights, requires students to think through the consultation process that countries, including the United States, undertake with a number of stakeholders such as unions, academics, NGOs and businesses. To many of those in the human rights LLM program and even some of the traditional law students, this is all a foreign language and they are struggling with these different stakeholder perspectives.
Over the rest of the semester they will read and role play on up to the minute issues such as: 1) the recent Tech Terror Summit and the potential adverse effects of the right to privacy; 2) access to justice and forum non conveniens, arguing an appeal from a Canadian court’s decision related to Guatemalan protestors shot by security forces hired by a company incorporated in Canada with US headquarters; 3) the difficulties that even best in class companies such as Nestle have complying with their own commitments and certain disclosure laws when their supply chain uses both child labor and slaves; 4) the Dodd-Frank conflict minerals debate in the Democratic Republic of Congo and the EU, where students will play the role of the State Department, major companies such as Apple and Intel, the NGO community, and socially-responsible investors debating some key corporate governance and human rights issues; 5) corporate codes of conduct and the ethical, governance, and compliance aspects of entering the Cuban market, given the concerns about human rights and confiscated property; 6) corporate culpability for the human rights impacts of mega sporting events such as the Super Bowl, World Cup, and the Olympics; 7) human trafficking (I’m proud to have a speaker from my former company Ryder, a sponsor of Truckers Against Traffickers); 8) development finance, SEC disclosures, bilateral investment treaties, investor rights and the grievance mechanisms for people harmed by financed projects (the World Bank, IMF, and Ex-Im bank will be case studies); 9) the race to the bottom for companies trying to reduce labor expenses in supply chains using the garment industry as an example; and 10) a debate in which each student will represent the actual countries currently arguing for or against a binding treaty on business and human rights.
Of course, on a daily basis, business and human rights stories pop up in the news if you know where to look and that makes teaching this so much fun. We are focusing a critical lens on the United States as well as the rest of the world, and it's great to hear perspectives from those who have lived in Europe, Africa, Asia, and South America. It's a whole new world for many of the LLM and international students, but as I tell them if they want to go after the corporations and effect change, they need to understand the pressure points. Using business school case studies has provided them with insights that most of my students have never considered. Most important, regardless of whether the students embark on a human rights career, they will now have more experience seeing and arguing controversial issues from another vantage point. That’s an invaluable skill set for any advocate.
February 4, 2016 in Business Associations, Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, International Business, International Law, Investment Banking, Law School, Lawyering, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (0)
Wednesday, January 27, 2016
As many of you know, I teach both traditional doctrinal and experiential learning courses in business law. I bring experiential learning to the doctrinal courses, and I bring doctrine to the experiential learning courses. I see the difference between doctrinal and experiential learning courses as a matter of emphasis. Among other things, this post explores the intersection between traditional classroom-based law teaching and experiential law teaching by analogizing business law drafting to yoga practice principles. This turned out to be harder than it "felt" when I first started to write it. So, the post may be wholly or partially unsuccessful. But I persevere . . . .
I begin by noting that we are, to some extent, in the midst of a critical juncture with respect to experiential learning in legal education. Some observers, including both legal practitioners and faculty, criticize the lack of experiential learning, noting that legal education is too theoretical and policy-oriented, resulting in the graduation of students who are ill-prepared for legal practice. Yet, other commentators note that too great an emphasis on experiential learning leaves students without the skills in theory and policy that they need to make useful interpretive judgments and novel arguments for their clients and to participate meaningfully in law reform efforts. Of course, different law schools have different programs of legal education (something not noted well enough, or at all, in many treatments of legal education). But even without taking that into account, many in and outside legal education (including, for example, in articles here and here) advise a law school curriculum that merges the two. I think about and struggle with constructively effectuating this all merger the time.
Now, about the yoga . . . . Most of you likely do not know that, in addition to teaching law, being a wife and mom, and other stuff, I enjoy an active yoga practice. As I finished a yoga class on Sunday afternoon, I realized that yoga has something to say about integrating doctrinal and experiential learning, especially when it comes to instruction on legal drafting in the business law area. Set forth below are the parallels that I observe between yoga and business law drafting. They are not perfect analogs, but they are, in my view, instructive in a number of ways important to the teaching mission in business law. The first two bullet points are, as I see it, especially important as expressions of the idea that law teaching is more complete and valuable when it holistically integrates doctrine, policy, theory, and skills. The rest of the bullets principally offer other insights.
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.
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 3, 2015
Earlier this month, the DC Circuit denied a petition for rehearing on the conflict minerals disclosure, meaning the SEC needs to appeal to the Supreme Court or the case goes back to the District Court for further proceedings. At issue is whether the Dodd-Frank requirement that issuers who source minerals from the Democratic Republic of Congo label their products as “DRC-conflict free” (or not) violates the First Amendment. I have argued in various blog posts and an amicus brief that this corporate governance disclosure is problematic for other reasons, including the fact that it won’t work and that the requirement would hurt the miners that it’s meant to protect. Congress, thankfully, recently held hearings on the law.
I’ve written more extensively on conflict minerals and the failure of disclosures in general in two recent publications. The first is my chapter entitled, Living in a material world – from naming and shaming to knowing and showing: will new disclosure regimes finally drive corporate accountability for human rights? in a new book that we launched two weeks ago at the UN Forum on Business and Human Rights in Geneva. You’ll have to buy the book The Business and Human Rights Landscape: Moving Forward and Looking Back to read it.
My article, Disclosing Disclosure’s Defects: Addressing Corporate Irresponsibility for Human Rights Impacts, will be published shortly by the Columbia Human Rights Law Review and is available for on SSRN. The abstract is below:
Although many people believe that the role of business is to maximize shareholder value, corporate executives and board members can no longer ignore their companies’ human rights impacts on other stakeholders. Over the past four years, the role and responsibility of non-state actors such as multinationals has come under increased scrutiny. In 2011, the United Nations Human Rights Council unanimously endorsed the “UN Guiding Principles on Business and Human Rights,” which outline the State duty to protect human rights, the corporate responsibility to respect human rights, and both the State and corporations’ duties to provide remedies to parties. The Guiding Principles do not bind corporations, but dozens of countries, including the United States, are now working on National Action Plans to comply with their own duties, which include drafting regulations and incentives for companies. In 2014, the UN Human Rights Council passed a resolution to begin the process of developing a binding treaty on business and human rights. Separately, in an effort to address information asymmetries, lawmakers in the United States, Canada, Europe, and California have passed human rights disclosure legislation. Finally, dozens of stock exchanges have imposed either mandatory or voluntary non-financial disclosure requirements, in sync with the UN Principles.
Despite various forms of disclosure mandates, these efforts do not work. The conflict lies within the flawed premise that, armed with specific information addressing human rights, consumers and investors will either reward “ethical” corporate behavior, or punish firms with poor human rights records. However, evidence shows that disclosures generally fail to change behavior because: (1) there are too many of them; (2) stakeholders suffer from disclosure overload; and (3) not enough consumers or investors penalize companies by boycotting products or divesting. In this Article, I examine corporate social contract theory, normative business ethics, and the failure of stakeholders to utilize disclosures to punish those firms that breach the social contract. I propose that both stakeholders and companies view corporate actions through an ethical lens, and offer an eight-factor test to provide guidance using current disclosures or stakeholder-specific inquiries. I conclude that disclosure for the sake of transparency, without more, will not lead to meaningful change regarding human rights impacts.
December 3, 2015 in Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Law, Marcia Narine, Securities Regulation | Permalink | Comments (0)
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.
Wednesday, November 4, 2015
The Department of Labor issued new interpretive guidelines for pension investments governed by ERISA. A thorny issue has been to what extent can ERISA fiduciaries invest in environmental, social and governance-focused (ESG) investments? The DOL previously issued several guiding statements on this topic, the most recent one in 2008, IB 2001-01, and the acceptance of such investment has been lukewarm. The DOL previously cautioned that such investments were permissible if all other things (like risk and return) are equal. In other words, ESG factors could be a tiebreaker but couldn't be a stand alone consideration.
What was the consequence of this tepid reception for ESG investments? Over $8.4 trillion in defined benefit and defined contribution plans covered by ERISA have been kept out of ESG investments, where non-ERISA investments in the space have exploded from "$202 billion in 2007 to $4.3 trillion in 2014."
The new guidance admits that previous interpretations may have
"unduly discouraged fiduciaries from considering ETIs and ESG factors. In particular, the Department is concerned that the 2008 guidance may be dissuading fiduciaries from (1) pursuing investment strategies that consider environmental, social, and governance factors, even where they are used solely to evaluate the economic benefits of investments and identify economically superior investments, and (2) investing in ETIs even where economically equivalent."
Under the new interpretive guidelines, the DOL takes a much more permissive stance regarding the economic value of ESG factors.
"Environmental, social, and governance issues may have a direct relationship to the economic value of the plan's investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary's primary analysis of the economic merits of competing investment choices. Similarly, if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote. Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors."
In other words, ESG factors may be economic factors and such investments are not automatically suspect under ERISA fiduciary duty obligations.
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.
Wednesday, October 28, 2015
I had the honor of being invited to speak at the annual symposium for the Wayne Law Review two weeks ago. The event, which focused on Corporate Counsel as Gatekeepers, was well organized and attended--and also very stimulating. Speakers included Tony West as a keynote, a few of us academics, and a bunch of current and former practitioners--prosecutors, in-house counsel, and outside counsel.
My presentation focused on a story that bugs me--a story built on an experience I had in practice. In the story (which modifies the true facts), an executive flagrantly violates a securities trading compliance plan that I drafted in connection with a subsequent transaction that I worked on for the executive's firm. Specifically, the executive informs a friend about the transaction the day before it is announced, believing that the friend will never trade on the information. The friend trades. The incident results in a stock exchange and Securities and Exchange Commission (SEC) inquiries. No enforcement is undertaken against the firm. However, the executive signs a consent decree with--and pays a cash penalty to--the SEC and, together with the firm, suffers public humiliation via a front-page article in the local newspaper (since the SEC would not agree to forego a press release). This fact pattern gnaws at me because I wonder whether there is anything more legal counsel can do to prevent an executive from violating a compliance policy to the detriment of himself and the firm . . . .
Tuesday, October 27, 2015
This hit my mailbox this morning. If the report is correct, we'll know in a few days whether we have a path to unregistered, broad-based securities crowdfunding in the United States. More as news is reported . . . .
[Additional information: Based on the link to the SEC's notice of meeting in Steve Bradford's comment to this post, it also appears that the SEC is considering amendments to Rules 147 (intrastate offerings) and 504 (limited offerings under Regulation D of up to $1,000,000).]