David N. Feldman

And So it Goes…The Year in Smallcap Regulation

What a year this was! So much has happened in our smallcap world this year. Here are my top 10 highlights (and lowlights):

•Regulation A+ rules were finalized, dramatically improving the range of options for capital formation for smaller companies. Unfortunately, two states challenging the new requirements have led some to hold off on utilizing the new rules.

•The FAST Act got us easier transfers of interests in private companies, S-1 forward incorporation by reference, reducing financial disclosure and a longer confidentiality period for IPOs.

•The SEC made it easier to demonstrate a pre-existing substantive relationship with an investor in a Regulation D offering.

•Proposed changes to Rule 504 under Regulation D could offer expanded crowdfunding opportunities.

•One well known smallcap attorney goes to jail for 18 months for pump and dump schemes, another arrested in an alleged market manipulation scheme, the same alleged scheme in which yet a third attorney in our space was arrested in 2014.

•The SEC approved final Title II JOBS Act crowdfunding rules, with hope to help start-up companies raise money from large numbers of folks. In-state crowdfunding has also become more and more popular.

•The Supreme Court made proving insider trading more difficult, leaving many in jail to seek release.

•The SEC still does not seem ready to act on allowing private placement broker/finders to act without or with limited SEC registration as they have for M&A brokers. Same with allowing smaller companies the right to opt out of XBRL, even though the House passed it.

•PIPE funds are resurfacing and raising money. And..

•I joined the awesome firm of Duane Morris LLP as a partner in NY!

Too all a happy, healthy and prosperous 2016!!!

David N. Feldman

OTCQX Strengthens Listing and Governance Requirements

The OTCQX, owned by OTC Markets, Inc., announced last week that they are increasing their listing and governance requirements effective January 1. The QX is the highest tier of trading among the OTC options. There will now be a higher initial bid price of $0.25 to trade on the OTCQX U.S. tier.  US companies on the QX will have to keep a price above $0.10. International companies will be required to meet new initial and ongoing minimum bid prices of $0.25 and $0.10 to trade on the OTCQX International tier. Both US and international companies will have higher initial and ongoing market capitalizations of $10 million and $5 million, respectively.  All companies now will be required to have at least two market makers.

In addition, there are new minimum corporate governance requirements for American companies on the QX. These are: a minimum of two independent directors on the board of directors; an audit committee composed of a majority of independent directors; and they must conduct annual shareholders’ meetings and submit annual financial reports to shareholders at least 15 calendar days prior to such meetings. They also added even more stringent new requirements for the higher level “premier” tier on the QX.

In their announcement, OTC Markets CEO Cromwell Coulson acknowledged the purpose of these changes is to strengthen the legitimacy of the QX and get more attention from investors, Wall Street firms and analysts for these companies. My take: good stuff!

David N. Feldman

Flash: Obama Signs New Small Business Initiatives Into Law

They got tucked into a transportation bill (Fixing America’s Surface Transportation Act or the FAST Act), but with a deft set of amendments the Reforming Access for Investments in Startup Enterprises Act of 2015 (or the RAISE Act) and other small business initiatives were signed by the President on December 4, 2015 and are now law. The new law also includes a direction to the SEC to change Form S-1 to allow forward incorporation by reference in filings by smaller reporting companies. This is a big and positive change for companies not eligible to use short form registration on Form S-3.

The RAISE Act assures an exemption from SEC registration for a resale of a security to an accredited investor who has access to certain information from the company, no bad actors or shells allowed, no general solicitation or advertising, no start-up companies and the class of stock being sold has to have existed for at least 90 days. This eliminates the old awkward invented Securities Act Section 4(1-1/2) exemption which was used in practice and accepted by the SEC but actually nowhere in the statute. This could help add comfort to secondary market folks who help people buy pre-IPO stocks like Facebook and Twitter before they go public. It could also help PIPE (private investment in public equity) investors who wish to transfer their shares more confidently in a private transaction before they would otherwise be eligible to sell the shares publicly.

Other very exciting changes in the law:

  • mandating the SEC look to ease disclosure burdens on smaller companies, to study ways to improve and simplify disclosure rules, and reduced disclosure for emerging growth companies.
  • lengthening the time you can keep your IPO filing confidential under the JOBS Act to 15 days before the first road show (from 21 days)
  • permitting a JOBS Act IPO filing to exclude financials that are likely to go stale by the time of the actual offering.
  • allowing an emerging growth company to still be treated like one through its JOBS Act IPO even if it stops being an EGC during the process.

Thanks House Financial Services Committee for pushing these through the “I’m Just a Bill” process!

Dell/EMC Merger Highlights the Return of Tracking Stock and the Associated Corporate Governance and Shareholders Rights Issues

Tracking Stocks Are Now Relics,” declared the Wall Street Journal in January 2008.  Tracking stocks had been the hot trend during the dot-com boom of the late 1990s, when companies sought to take advantage of wild valuations of internet business that they owned.  Recently, however, tracking stock has returned to the news due to its role in the Dell/EMC merger.  Dell, to help pay for the merger, plans to issue tracking stock to track EMC’s interest in VMWare.  Because that tracking stock will be a form of Dell common stock, Dell in essence is returning to the public markets, as noted by UC Berkeley professor Steven Davidoff Solomon in this NYTimes DealBook column.

A tracking stock is a form of common stock that “tracks” or depends on the financial performance of a specific business unit or operating division of a company – rather than the operations of the company as a whole.  Tracking stocks trade as separate securities. Thus, if the unit or division fares poorly, the value of the tracking stock would fall, even if the company at large was doing well.  And vice versa.

Interesting corporate governance and shareholders’ rights issues arise in connection with tracking stock as a result of the limitations inherent to tracking stock:

  • Tracking stock does not entail ownership of the tracked entity’s assets. Rather, for financial reporting purposes the company allocates consolidated assets, liabilities, revenue, expenses and cash flow between the entire company and the tracked entity.  That allocation, however, does not change the legal title to any assets, which remain with the company.
  • It does not confer voting rights on its shareholders, typically.
  • The tracked entity does not have its own board of directors. The board of directors operates the entire company, of which the tracked entity is but one division or business.  The board could make decisions which are good for the company overall, but not necessarily for the owners of the tracking stock.  As a result, conflicts may arise between the board of the company and the shareholders of the tracked entity
  • The tracking stock holders have no right to participate in a tender offer for the common shares of the company (unless the tender also was directed to the tracking shareholders).
  • As a result of the foregoing, owners of tracking stock may lose out on takeover bids and other activity by activist investors. In that sense, a tracking stock resembles the stock of a spinoff with a permanent anti-takeover provision.

A case arising out of the dot com era illustrates some of these issues.  In Sedighim v. Donaldson, Lufkin & Jenrette, Inc., 167 F. Supp. 2d 639, 644-45 (S.D.N.Y. 2001), DLJ had offered tracking stock in its online brokerage business, DLJdirect, in 1999.  The following year, Credit Suisse made a tender for all outstanding common shares of DLJ – but not for DLJdirect.  So while the DLJ shareholders obtained a nice premium, the DLJdirect shareholders missed out.

DLJdirect shareholders asserted claims under Sections 11 and 12 of the Securities Act of 1933, alleging the DLJdirect prospectus misrepresented the rights that DLJdirect shareholders would have in a merger.  They claimed, for instance, that statements such as that “DLJdirect shareholders would be subject to all the risks of an investment in DLJ” suggested DLJdirect shareholders would be entitled to participate in the tender for DLJ common shares.  The plaintiffs also asserted they were entitled to participate in Credit Suisse’s tender under the SEC’s “All Holders, Best Price” rule (Rule 14d-10), which requires that a bidder make its tender available to all holders of the same “class” of securities subject to the tender.  DLJdirect shareholders asserted that because the prospectus described the tracking stock as a part of the common stock of DLJ, they were entitled to participate along with DLJ’s common shareholders. The court rejected this argument, holding that the DLJdirect shares were “vastly different securities with different rights, and trade at significantly different prices in the market.” Id. at 651.  The rule could not be used to “erase distinctions of different types of securities.” Id.

The Sedigham decision highlights the different rights of tracking stock.  In essence, DLJ’s board could properly ignore the interest of the shareholders of DLJdirect in the context of the merger between DLJ and Credit Suisse.  These issues were spelled out in the IPO prospectus for the DLJdirect tracking stock, and despite claims to the contrary its shareholders had no reasons to believe otherwise.  The court granted defendants’ motion to dismiss.

It will be interesting to see whether tracking stocks return in any significant number, and any corporate governance issues that develop – in particular, the nature and scope of the duties owed by a company’s board of directors to owners of tracking stock.

The Comverge Case: Fiduciary Duties and Break-up Fees in M&A

Our partner Richard Renck in Wilmington recently posted an entry on our Delaware Business Law Blog regarding the Comverge case decided last month by the Delaware Court of Chancery.   Among other things, the Court’s opinion provides practitioners and clients with insight regarding break-up fees as well as a road map of  how the Court of Chancery reviews challenges to third-party sale transactions, approved by a disinterested board, under the enhanced scrutiny of Revlon.  Please see Richard’s post here.

Recent Federal Court Decisions Revitalize the Government’s Civil Enforcement Power Under FIRREA

Our partner Marvin G. Pickholz recently co-authored Recent Federal Court Decisions Revitalize the Government’s Civil Enforcement Power Under FIRREA, which appeared in the July/August issue of the Financial Fraud Law Report.

Continue reading Recent Federal Court Decisions Revitalize the Government’s Civil Enforcement Power Under FIRREA

SEC Ends Losing Streak; Conflict Minerals Rule Upheld

The SEC scored a victory in the U.S. Court of Appeals for the District of Columbia Circuit in a case filed in October 2012 by the U.S. Chamber of Commerce, the Business Roundtable, and the National Association of Manufacturers. The plaintiffs challenged the SEC’s rule on disclosure of the use of conflict minerals on grounds that aspects of the rule were arbitrary and capricious under the Administrative Procedure Act and claiming that the disclosures required by the SEC and by Congress run afoul of the First Amendment. In a 63-page decision in favor of the SEC, the Court found no problems with the SEC’s rulemaking and disagreed that the “conflict minerals” disclosure scheme transgressed the First Amendment.

Continue reading SEC Ends Losing Streak; Conflict Minerals Rule Upheld

Fifth Circuit to Dodd-Frank Whistleblowers: Call the SEC First

The U.S. Court of Appeals for the Fifth Circuit’s decision last week in Asadi v. G.E. Energy (USA) has been hailed as a triumph for employers because it requires whistleblowers who bring retaliation claims under the Dodd–Frank Wall Street Reform and Consumer Protection Act to show that they suffered retaliation because they reported potential violations to the U.S. Securities and Exchange Commission. The Fifth Circuit rejected the position adopted by the SEC in its regulations implementing Dodd-Frank and by the few district courts that have addressed the issue. That rejected approach interprets Section 922 of Dodd-Frank to apply its enhanced protections to certain whistleblowers even if they had not reported their concerns to the SEC. Although this decision narrows the category of employees who can seek the enhanced protections of Dodd-Frank, it will likely increase the number of whistleblowers who report their concerns to the SEC.

Our firm’s client alert regarding the case can be found here.

FTC Revises Hart-Scott-Rodino Thresholds

The Federal Trade Commission announced yesterday that it has made its annual adjustments to the thresholds for determining whether a transaction is reportable under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the amount of the related filing fee. The new thresholds were published today in the Federal Register. Under HSR, certain transactions may not be completed until a waiting period (generally 30 days unless extended by a request for additional information or terminated early upon request) has expired after the required notifications are filed.

Continue reading FTC Revises Hart-Scott-Rodino Thresholds

New York Comptroller Seeks Qualcomm’s Records on Political Giving; SEC Contemplating Political Contribution Disclosure Rules

A “books and records” action brought by New York’s comptroller to determine how Qualcomm Incorporated “is spending corporate funds in the political arena” may create a precedent for shareholders seeking to force corporate disclosure of political contributions.

The suit was brought last week in Delaware Chancery Court by Comptroller Thomas DiNapoli as trustee of the New York State Common Retirement Fund, a shareholder of Qualcomm. The complaint cites to recent studies concluding that “corporate political spending is negatively correlated with enterprise value” and may indicate “more widespread control and governance deficiencies.”

Continue reading New York Comptroller Seeks Qualcomm’s Records on Political Giving; SEC Contemplating Political Contribution Disclosure Rules