Securities Law

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Posted on Wednesday, March 27 2013 at 2:04 pm by

This is the short link.">What’s Up With the Dodd-Frank Whistleblower Bounty Program?

You might be wondering what happened to the Whistleblower Bounty Program that was announced with great fanfare as part of the Dodd-Frank Act in the middle of 2010. In the almost three years since that Act was passed, only one bounty has actually been paid–a not very impressive $50,000 payment. But this belies the fact that many more, and likely much larger, bounty payments are just over the horizon.

The Dodd-Frank Bounty Program requires the SEC to pay a bounty of from 10% to 30% of any monetary recovery greater than $1 million that is attributable to original information received from the whistleblower. The Office of the Whistleblower within the SEC was established in early 2011, and it was soon fully-staffed and busily at work, receiving over 3,000 tips in the 12 months ended June 30, 2012. The single payout was made in August 2012.

The reason there has only been one award made so far is the long lead time required to get to an actual payment to a whistleblower. After a tip has been received, it must result in the company being required to pay monetary payments of greater than $1 million, whether through a settlement or administrative proceedings. Of course, finalizing these type proceedings can take many years, and would rarely be complete in as little as one year. Only after a $1 million plus monetary sanction is finalized does the whistleblower submit an application to the SEC for a bounty payment. This then commences a whole new administrative process where the SEC determines if a bounty payment is called for under the statutory conditions and, if so, in what amount.

So, not even the tip of the iceberg has been seen to this point; and there are many more cases winding their way through the administrative process, which will ultimately wind up paying bounties. These will almost certainly include some big, multimillion dollar bounty payments, which are going to get a lot of public attention. Governmental officials should be expected to use that platform to encourage even more tips.

The Chief of the Office of the Whistleblower already has been quoted as saying “We are open for business and ready to pay people who bring us good, timely information.” You can bet that these type statements will be made even more vigorously in conjunction with future multimillion dollar bounty payment announcements. As a result, public awareness of the bounty program, and enthusiasm for becoming a part of it, will increase substantially in the coming months and years. So the bounty program is hardly in a hiatus; to the contrary, the posse is riding hard and the excitement is about to begin!

Posted on Thursday, March 14 2013 at 1:49 pm by

This is the short link.">Nasdaq’s Proposed New Internal Audit Function Requirement

On March 4, 2013, Nasdaq issued a proposed new rule that, if approved by the Securities and Exchange Commission (“SEC”), will require listed companies to establish and maintain an internal audit function.  The proposed rule is open for public comment until 21 days after publication in the Federal Registrar, but it is expected to be approved by the SEC.  It would make this Nasdaq listing requirement similar to that of the NYSE, which already has an internal audit function requirement. 

By requiring an internal audit function, Nasdaq seeks to ensure that a company’s management and audit committee receive ongoing assessments of the company’s risk management processes and system of internal control that are provided independently from the company’s routine accounting and financial reporting regimes.  A company will be allowed to outsource the internal audit function to any third party (other than its independent auditor), but the audit committee must maintain sole responsibility for oversight, and it may not allocate or delegate that responsibility to another board committee.

The proposed rule does not prescribe many other specifics for the implementation of an internal audit function, and it does not indicate how Nasdaq will assess compliance with the requirement, beyond certain matters implicit in Nasdaq’s statement of the audit committee’s oversight responsibility.  That statement makes clear that the audit committee will be expected to arrange periodic meetings with the personnel engaged in the internal audit function (whether they are company employees or personnel of an outsource provider) and with the company’s independent auditors, as a way to ensure both (a) receipt of the types of assessments the rule is targeting and (b) more generally, that the assigned responsibilities, budget, staffing and other aspects of the internal audit function are adequate for it to be effective. 

The proposed rule seems unlikely to impose substantial additional effort on most issuers, and Nasdaq noted that many of its listed companies already have an internal audit function.  However, there are no special provisions to modulate requirements for Smaller Reporting Companies, so those issuers will be subject to the same requirements as all other issuers. 

In any event, many Nasdaq issuers with an existing internal audit function, particularly smaller companies, might benefit from a review of their processes and procedures to make sure this function will operate properly under the new requirement.  Among other things, issuers may want to:

  • Formally designate the individuals (and their requisite qualifications) who comprise the issuer’s internal audit function, whether they are existing or new employees of the issuer or personnel provided by an outsourced arrangement.
  • Consider whether titles or job descriptions of any of the issuer’s employees who have been performing de facto the internal audit function (and who will continue that role) should be updated and expanded to better reflect the Nasdaq requirement.
  • Consider whether lines of reporting responsibility need to be clarified, revised and/or formalized.  (Important issues often arise in integrating or balancing procedures for the requisite independence of personnel who are involved in the internal audit function with a company’s procedures for its routine accounting and financial reporting functions.)
  • Check the Audit Committee’s charter to assure that it reflects the oversight and other responsibility envisioned by the new rule.

If the new rule is approved as proposed, companies listed on Nasdaq on or prior June 30, 2013 will need to comply with the new listing requirement by December 31, 2013. Companies listed on Nasdaq after June 30, 2013 will be required to establish an internal audit function prior to listing.

Posted on Monday, September 17 2012 at 7:55 pm by

This is the short link.">SEC Issues Proposed Rules Regarding Elimination of General Solicitation Ban

The Securities and Exchange Commission (the “SEC”) has issued proposed rules that would permit certain forms of “general solicitation” in private offerings made in reliance on Rule 506 of Regulation D or Rule 144A under the Securities Act of 1933 (the “Securities Act”).

Rule 506 Offerings

Rule 506 of Regulation D provides a non-exclusive safe harbor that permits the sale of securities in private placements to certain persons, including purchasers who the issuer reasonably believes are accredited investors and up to 35 other purchasers subject to certain conditions. In addition, offerings made pursuant to Rule 506 are not subject to any state securities registration requirements. Currently, Rule 506 prohibits any form of general solicitation or general advertising in connection with a sale of securities under Rule 506.

The JOBS Act directed the SEC to amend Rule 506 by July 4, 2012, to permit general solicitation or general advertising in Rule 506 offerings, provided the only purchasers of the securities are accredited investors.

The proposed rules would permit general advertisements in connection with Rule 506 offerings if the issuer takes “reasonable steps to verify that the purchasers of the securities are accredited investors” and “all purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities”. However, issuers that do not engage in a general solicitation may to continue to adhere to Rule 506 as it currently exists and sell to up to 35 non-accredited investors if general solicitation is not employed.

While the proposed rules require issuers to take “reasonable steps” to verify that purchasers of the securities are accredited investors, they do not specify the methods necessary to satisfy this requirement. The SEC specifically avoided providing specifics in order to provide sufficient flexibility to accommodate different types of transactions and changes in market practices and to avoid the market giving unnecessary weight to any factors the SEC may have otherwise provided. It should be recognized, however, that this approach by the SEC is likely to create uncertainty among issuers as to what steps will be sufficient to comply with the proposed rules.

The proposed rules instead provide that whether the steps taken are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction. The proposed rules do, however, provide that an issuer should consider the following factors when evaluating the reasonableness of the steps taken to verify that a purchaser is an accredited investor:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

With regard to the last factor, the proposed rules indicate that an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer. In the case of website offerings, the SEC does not believe that an issuer would have taken reasonable steps to verify accredited investor status if it required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status. In the case of a widely disseminated email or social media solicitation, the SEC believes that an issuer would be entitled to rely on a third party that has verified a person’s status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification. Additionally, the SEC also believes that a purchaser’s ability to meet a high minimum investment amount could be relevant to whether an issuer’s verification steps would be reasonable. For example, the ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors could reasonably be expected to meet it, with a direct cash investment that is not financed by the issuer or by any other third party, could be taken into consideration in verifying accredited investor status.

Regardless of the particular steps taken, issuers will need to retain adequate records that document the steps taken to verify that a purchaser was an accredited investor. Any issuer claiming an exemption from the registration requirements of Section 5 has the burden of showing that it is entitled to that exemption. However, if a person who does not meet the criteria for any category of accredited investor purchases securities in a Rule 506(c) offering, we believe that the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

Effect on Sections 3(c)(1) and 3(c)(7) under the Investment Company Act

Privately offered funds, such as hedge funds, venture capital funds and private equity funds, typically rely on Section 4(a)(2) and the Rule 506 safe harbor to offer and sell their interests without registration under the Securities Act. In addition, privately offered funds generally rely on exclusions from the definition of “investment company” under Section 3(c)(1) and Section 3(c)(7) the Investment Company Act, which enables them to be excluded from the regulatory provisions of that Act. Privately offered funds are precluded, however, from relying on either of these two exclusions if they make a public offering of their securities. The proposed rules provide that SEC believes the effect of the proposed rules is to permit privately offered funds to make a general solicitation without losing either of the exclusions under the Investment Company Act.

Amendment to Rule 144A

Rule 144A provides a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain “restricted securities” to qualified institutional buyers (“QIBs”). In order for a transaction to come within existing Rule 144A, a seller must have a reasonable basis for believing that the offeree or purchaser is a QIB and must take reasonable steps to ensure that the purchaser is aware that the seller may rely on Rule 144A. The proposed rules revise Rule 144A to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under the proposed rules, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are limited to QIBs.

If you have any questions regarding the matters addressed above, please contact us.

Posted on Monday, June 25 2012 at 8:37 pm by

This is the short link.">Social Media Usage Can Have Reg FD Implications

A recent news headline provided another reminder of both the power of social media to disseminate information, and the dangers of its casual use by public company employees. In this case, a cryptic twitter message led to the firing of a senior executive, perhaps because the tweet raised Regulation FD concerns, or perhaps because it reflected very poor judgment.

In mid-May 2012, Francesca’s Holdings Corporation announced the termination of its CFO after an internal investigation determined that he had improperly communicated company information over twitter. News reports at the time said the CFO posted a tweet that said “Board meeting. Good numbers = Happy Board” during a quiet period prior to the company’s planned earnings release. There is no report of involvement in the matter by the SEC at the time or since.

The exploding popularity of social media – with its temptations to make flippant and less than thoughtful comments, even though they are blasted out to a universe of recipients – should make public companies and their employees leery of using such channels to say anything about their companies. In addition to general concerns about the imprecision and potentially misleading nature of many such communications, there is the potential applicability of Regulation FD (fair disclosure), or Reg FD as it is commonly known. Reg FD prohibits the selective disclosure of material nonpublic information by senior executives and most other company representatives.

The SEC has brought actions under Regulation FD against 11 companies and 12 associated individuals since 2000. Only one of these actions resulted in a judicial decision: SEC v. Siebel Systems Inc., 384 F. Supp. 2d 694 (S.D.N.Y. 2005). In Siebel, the SEC alleged that private statements made by Siebel executives to investors at dinner meetings contained nuanced differences from existing public statements of the company and that this conduct constituted selective disclosure of material nonpublic information.

The U.S. District Court for the Southern District of New York dismissed the entire action on the grounds that the conduct of the Siebel officials did not constitute selective disclosure of material nonpublic information. The court explained that “[t]o be deemed to be material, the statements must contain information of reasonable specificity to impart a definite indicia of performance; and a statement is not material if it constitutes nothing more than a vague assertion on which no reasonable investor would rely.” Id. at 709 n.15.

It is an interesting question whether this, or any other, court would have interpreted the Francesca’s CFO’s brief message as specific enough to support a finding of liability. It seems that the CFO’s message of “Good Numbers,” given the timing and the source, would have been clear enough to cause a reasonable investor to rely on it.

On the other hand, it might be argued that the broad reach of twitter (and many other social media channels) prevents a communication via such media, regardless of its materiality, from being “selectively” disclosed. The practical reach of such channels may be greater than that of a press release or an official SEC filing. Legal recognition of that possible practical reality is not here yet, however. Reg FD defines “public disclosure” as either being included in an 8-K filing with the SEC or dissemination by “another method that is reasonably designed to provide broad non-exclusionary distribution of the information to the public.” Whether social media might satisfy this disclosure requirement has not been the subject of serious public debate to this point.

It is not known if the proactive termination by Francesca of its CFO was prompted by fear of a Reg FD investigation by the SEC or by a more generalized perception of very poor judgment for a company executive to casually disseminate confidential company information to the world. In either case, those in possession of a public company’s material inside information are well advised to guard that information closely, and to recognize that blasting it out via any social media channel is imprudent, at best.

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