Securities Law

Archive for August 2017

Posted on Tuesday, August 29 2017 at 8:59 am by

Second Circuit Clarifies its Post-Salman Position, Affirms Insider Trading Conviction

By Paul Foley and John I. Sanders

On August 23rd, the Second Circuit issued its much-anticipated opinion in U.S. v. Martoma, affirming the 2014 insider trading conviction of S.A.C. Capital Advisors portfolio manager Matthew Martoma.[1] In doing so, it clarified an important point regarding what is required to convict a person who trades on a tip received from an insider. We believe this decision will have an immediate impact on how hedge fund portfolio managers and other investment advisers interact with third party resources.

Section 10(b) of the Securities Exchange Act of 1934[2] and Rule 10b-5[3] promulgated thereunder prohibit insider trading. The basic elements of insider trading are: (i) engaging in a securities transaction, (ii) while in possession of material, non-public information, (iii) in violation of a duty to refrain from doing so.

Under the classic theory of insider trading, a corporate insider trades in shares of his employer while in possession of material, non-public information (e.g., advance notice of a merger). In addition to the classic theory of insider trading, case law has extended the liability to persons who receive tips from insiders (i.e., individuals whose duty to refrain from trading is derived or inherited from the corporate insider’s duty). Thus, not only may insiders be liable for insider trading, but those to whom they pass tips, either directly (tippees) or through others (remote tippees) may be liable if they trade on such tips.

The seminal case involving tippee liability is Dirks v. SEC.[4] In Dirks, the U.S. Supreme Court held the following:

In determining whether a tippee is under an obligation to disclose or abstain, it is necessary to determine whether the insider’s “tip” constituted a breach of the insider’s fiduciary duty. Whether disclosure is a breach of duty depends in large part on the personal benefit the insider receives as a result of the disclosure. Absent an improper purpose, there is no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.[5]

The question of what constituted a “personal benefit” was left ill-defined until the Second Circuit gave it shape in U.S. v. Newman.[6] Newman held that a tipper and tippee must have a “meaningfully close personal relationship” and that the insider information be divulged in exchange for “a potential gain of a pecuniary or similarly valuable nature” for the court to find the tipper had breached his fiduciary duty to the source.[7] For a period of time after the Second Circuit issued its opinion in Newman, it seemed that Martoma’s conviction was likely to be overturned.

Unfortunately for Martoma, the U.S. Supreme Court issued its opinion in U.S. v. Salman while Martoma’s appeal was pending.[8] In Salman, the U.S. Supreme Court flatly rejected certain aspects of the Newman holding and called others into question.[9] Accordingly, the Second Circuit held in Martoma that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close relationship’ requirement such that the ‘meaningfully close personal relationship’ requirement is no longer good law.”[10]

In Martoma, the court held that rather than looking at objective elements of the relationship between tipper and tippee, the proper inquiry is now whether the corporate insider divulged the relevant information with the expectation that the tippee would trade on it.[11] This is “because such a disclosure is the functional equivalent of trading on the information himself and giving the cash gift to the recipient.”[12]

Please contact us if you have any questions about the Second Circuit’s opinion in Martoma or the law concerning insider trading generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] U.S. v. Martoma, available at

[2] 15 U.S.C. 78j (2016).

[3] 17 CFR 270.10b-5 (2016).

[4] Dirks v. SEC, 463 U.S. 646 (1983).

[5] Id. at 647.

[6] U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014).

[7] Id. at 452.

[8] Salman v. U.S., available at

[9] Id. at 10.

[10] U.S. v. Martoma, supra note 1, at 24.

[11] Id. at 25.

[12] Id.

Posted on Sunday, August 27 2017 at 9:34 am by

Delaware Encourages Use of “Blockchain” Technology for Corporate Recordkeeping

By: David A. Stockton

Amendments to the Delaware General Corporation Law (“DGCL”) allowing for the use of “distributed ledgers”, or “Blockchain” technology, for corporate recordkeeping, including stock ledgers, became effective on August 1, 2017. These amendments reflect the Delaware bar’s continued efforts to stay at the forefront of corporation law developments.  These innovative changes were promoted by the Delaware Blockchain Initiative, led by a former Delaware governor.  Vice Chancellor J. Travis Laster of the Delaware Court of Chancery has also been actively promoting the use this new technology to “fix the plumbing” of the voting and stockholding infrastructure of the U.S. securities markets.

What is Blockchain technology?  

According to Don & Alex Tapscott, authors of Blockchain Revolution (2016), “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.” Information held on a blockchain is a shared and continually reconciled database.  The blockchain database isn’t stored in any single location.  Instead, it consists of a distributed system of registers which are accessible to anyone on the internet and are all connected through a secure validation mechanism.

The first and still most popular application of Blockchain technology was the Bitcoin payment network, and its usage has now spread to many other new cryptocurrencies.  The same Blockchain technology can be applied to corporate recordkeeping.  It would theoretically allow for the issuances and transfers of shares without a third-party intermediary, thereby increasing the accuracy of recording such issuances and transfers and minimizing the potential for clerical mistakes.

The Amendments

The specific amendments to Sections 219 and 224 of the DGCL permit (but do not require) the use of “distributed electronic networks or databases”, allowing a corporation’s shares to be recorded and transferred on a decentralized electronic network rather than on a centrally located stock ledger.  This new distributed ledgers technology is by definition only applicable to corporations with uncertificated shares.  Section 224 still requires that records be capable of being converted into a clearly legible paper form within a reasonable time period.

The amendment to Section 224 of the DGCL further requires the blockchain stock ledger to perform three main functions:  (i) to enable the corporation to prepare a list of shareholders, (ii) to record various voting information as required by the DGCL, and (iii) to transfer stock as governed by Article 8 of the Uniform Commercial Code.  The overall effect of these amendments is to validate blockchain technology as a means of complying with all share recordkeeping requirements of the DGCL.

Potential Benefits

Potential benefits from using a blockchain stock registry could be extraordinarily significant.

First and foremost, it has the potential to eliminate the current nominee system for registering ownership of stock, where depositories such as the Depository Trust Company hold stock certificates as owners of record and track transfers using their own electronic book-entry system.  This separation of record ownership by the depository from beneficial ownership by the client was implemented in the 1970’s by the SEC.  It was in response to dramatically increased trading volumes during the 1960’s and 1970’s, which had overwhelmed the traditional system of presenting share certificates for transfer to the issuer or its transfer agent.  The solution was to take the burden of tracking record ownership off of the issuer by allowing most market transactions to be effected in the electronic system of the depository.  DTC was charged with running a centralized electronic book-entry system covering all the shares it owned of record (which today is substantially all shares of most public companies).

In its time the electronic book-entry system was an innovative technology that allowed the markets to continue to function. Forty plus years later, however, it still causes many opportunities for errors and inefficiencies arising from the multiple parties and transactions required for beneficial owners to vote on matters and to transfer shares.  Blockchain technology is thought to have the potential to entirely eliminate the need for such intermediaries and the distinction between record holder and beneficial owner.  It is viewed in effect as the new and improved form of electronic tracking system, replacing the DTC system of record and beneficial owners with a system that operates with only one type of owner, the record owner.

Another potential benefit is that Blockchain technology enables direct transactions without the need for intermediary verification and processing, meaning that settlements could occur immediately rather than in a matter of days or longer, which would also reduce transaction costs.  Plus, comprehensive real-time share ownership information would be continuously available to any participant in the system, i.e., complete transparency.

Finally, because a Blockchain system is an “incorruptible digital ledger”, inconsistencies in corporate records regarding share counts and ownership interests could be reduced or even eliminated.

The Long Path Ahead

Despite these substantial potential benefits, the Delaware amendments are really nothing more than a means of encouraging consideration of Blockchain technology for use in maintaining corporate records.  The amendments make clear that these technologies are consistent with Delaware corporation law, but they do not attempt to address any of the mechanics of how such a system actually would work.  Many practical issues are yet to be addressed and resolved, including:

  • Who will be able to input and access data on the distributed ledgers?
  • How will data be secured?
  • How will the transaction validation process work?
  • Who/what will have organizational control of the distributed ledgers?
  • How can the data be audited?

But all these issues have been addressed and adequately resolved in the Bitcoin application, so there is reason to believe that they can be worked out in the context of corporate recordkeeping as well.

These amendments are just the opening salvo in the effort to apply a very innovative technology to the very traditional world of corporate recordkeeping, which will no doubt be a long and difficult path.  But they are a promising beginning which should encourage issuers, investors and financial market professionals to begin the process of investigating the use of Blockchain technology to maintain stock ledgers.

Posted on Thursday, August 24 2017 at 11:48 am by

SEC Expands Confidential Review of IPO Registration Statements

By: David M. Eaton

The SEC announced earlier this summer (and supplemented that announcement late last week with additional information) that it has expanded the availability of its popular procedure for confidential non-public review of, and comment on, draft initial public offering registration statements.  This procedure was originally mandated by 2012’s JOBS Act.

In its pre-existing iteration, the procedure allows “emerging growth companies” (EGCs) to submit draft registration statements confidentially to the SEC for review, provided that (1) the issuer has not yet sold common stock in an SEC-registered IPO and (2) the draft registration statements and all amendments thereto are publicly filed at least 15 days prior to any “road show”.  This process is available not just for a common stock IPO registration statement, but also for any pre-IPO registration statement an EGC might file.  An EGC is a company with annual gross revenues of less than $1.07 billion during its most recent fiscal year.

Now, in addition to the confidential review process for EGCs which remains in effect, the SEC announced that it will review, on a confidential basis, draft submissions of the following registration statements filed by any issuer (including foreign private issuers)—not just EGCs:

  • IPOs.  Securities Act IPO registration statements (or other initial Securities Act registrations)—again, from any issuer.  This will permit larger pre-public companies to take advantage of the confidential submission process.
  • Listings, But No OfferingsSpin Offs.  Securities Exchange Act registration statements that relate to an initial direct listing on a stock exchange without a concurrent public offering.  This will be useful to companies going public via a “spin off” from another public company.
  • Follow-On Offerings.  Securities Act registration statements for an offering within a year of the company’s initial Securities Act or Securities Exchange Act registration statement.  This should prove useful to companies conducting a “follow-on” stock offering in the wake of a successful IPO.  In addition to raising additional capital for the company, follow-ons have traditionally allowed pre-public shareholders to sell some of their holdings in the common situation where underwriters were reluctant to let them “piggy back” on the IPO registration statement (although often the follow-on registration statements are not selected for SEC review, as the recent IPO registration statement would have received a full inspection).

As with the EGC process, IPO and direct listing registration statements and amendments must be filed at least 15 days prior to any IPO roadshow, or 15 days prior to the requested effective date of the registration statement if there isn’t a road show.  One difference for follow-on offering registrations is that the SEC will only review the first draft submission confidentially, not subsequent amendments.

The confidential submission process has several advantages for issuers.  It allows the company to keep the registration statement and its exhibits out of the public domain until the company decides that it is ready to move forward with the offering, if at all.  If it abandons the offering before committing to a road show, its submission remains confidential.  In this manner, the company can avoid the risk of being perceived by the market as “damaged goods” by dint of abandoning its IPO.  It also facilitates pursuing “dual track” exit strategies for founders and/or venture investors—that is, exploring a sale of the company and an IPO simultaneously.

Even if the company goes forward with the offering, and consequently makes its confidential submissions publicly available, there is value to companies in not having to endure, in real time, the intense microscope of the media on the sometimes painful SEC review process. (On the other hand, some would probably say that undergoing that process in the open is beneficial to investors).

While the expansion of the useful confidential submission review process is a welcome development, it can fairly be characterized as an incremental improvement, not a transformational one.  Such “baby steps” may not be enough to reverse the continuing reduction in the overall number of U.S. publicly traded companies, a trend which is attracting growing concern.

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