Please find below the July 2019 issue of the US Securities Law Digest. This update is intended to provide a compilation of recent legal news relevant to a capital markets practice in the London and international markets. The news pieces have been collected and summarized from various sources, and links to the original sources are provided.
Please visit the our re-launched website here, where you will find all past Forum content, including past digests, podcasts, and our Capital Markets Glossary (2015). The updated glossary will be published later this year.
Please feel free to forward this email on to any colleagues or contacts who may be interested. We continue to welcome any feedback that you may have about the Digest.
Thanks to Chloe Man of Reed Smith for their help in compiling this digest.
Best regards,
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Daniel Winterfeldt
DWinterfeldt@reedsmith.com
Partner, International Capital Markets & US Securities
Reed Smith LLP
Founder and Co-Chair of the Forum
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Edward Bibko
Ebibko@jefferies.com
General Counsel for EMEA and Asia
Jefferies
Co-Chair of the Forum
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US SECURITIES LAW DIGEST:
JULY 2019
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SEC RULES AND GUIDANCE UPDATES
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SEC Seeks Public Comment to Improve Exempt Offering Process
On June 18, 2019, the Securities and Exchange Commission (the “SEC” or “Commission”) issued a concept release requesting public comment on ways to simplify, harmonize and improve the exempt offering process to expand investment opportunities while maintaining investor protections. The concept release solicits public input on whether changes should be made to improve the consistency, accessibility and effectiveness of the current exemptions from registration for both companies and investors, including identifying potential overlaps or gaps within the framework. In particular, the concept release asks commenters to consider whether:
- The limitations on who can invest in certain exempt offerings, or the amount they can invest, provide an appropriate level of investor protection or pose an undue obstacle to capital formation or investor access to investment opportunities;
- The SEC should take steps to facilitate a company’s ability to transition from one form of exempt offering to another or to a registered offering;
- The SEC should expand companies’ ability to raise capital through pooled investment funds;
- Retail investors should be allowed greater exposure to growth-stage companies through pooled investment funds, such as interval funds and other closed-end funds; and
- The SEC should revise its exemptions for secondary trading of securities initially issued in exempt offerings.
The public comment period for the concept release will remain open for 90 days.
See Mayer Brown’s insight here.
See Katten Muchin Rosenman LLP’s blog post here.
See Sullivan & Worcester LLP’s post here.
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SEC Adopts Rules and Interpretations Related to Standards of Conduct for Broker-Dealers and Investment Advisers
On June 5, 2019, the SEC voted to adopt a package of rules and interpretations related to standards of conduct for broker-dealers and investment advisers, including new rule Regulation Best Interest, new Form CRS, an interpretation of the fiduciary duties of investment advisers and an interpretation of the "solely incidental" clause of the broker-dealer exclusion under the Investment Advisers Act of 1940, as amended (the Advisers Act). The SEC approved these items by a 3-1 vote, with Commissioner Robert Jackson as the sole dissenting commissioner.
See Skadden Arps Slate Meagher & Flom LLP’s update here.
See Kramer Levin Naftalis & Frankel LLP’s alert here.
See Paul Hastings LLP’s alert here.
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SEC Proposes to Improve Disclosures Relating to Acquisitions and Dispositions of Businesses
As part of the Disclosure Effectiveness initiative, the SEC proposed amendments to address the financial disclosure requirements in connection with acquisitions and dispositions. The SEC proposed amendments to the requirements in Rules 3-05, 3-14, and Article 11 of Regulation S-X, as well as related rules and forms, for financial statements of businesses acquired or to be acquired and for business dispositions. The SEC also proposed new Rule 6-11 of Regulation S-X and amendments to Form N-14 for financial reporting of acquisitions involving investment companies. The proposed changes are intended to: improve for investors the financial information about acquired and disposed businesses; facilitate more timely access to capital; and reduce the complexity and cost to prepare the disclosure. The proposed amendments would update the accounting significance tests among other things.
See Mayer Brown’s alert here.
See Cahill Gordon & Reindel LLP’s memoranda here.
See Proskauer Rose’s post here.
See Cooley LLP’s blog post here.
See Weil Gotshal & Manges LLP’s update here.
See the SEC announcement and fact sheet here.
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SEC Updates Data Privacy and Cybersecurity Guidance for Registered Firms
On April 16, 2019, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a risk alert, “Investment Adviser and Broker-Dealer Compliance Issues Relating to Regulation S-P – Privacy Notices and Safeguard Policies,” highlighting its data privacy and cybersecurity observations from recent examinations of registered firms.
See Baker & Hostetler LLP’s alert here.
See Kramer Levin Naftalis & Frankel LLP’s article here.
See King & Spalding LLP’s alert here.
See the SEC alert here.
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FCA and SEC Sign Updated Memoranda of Understanding
On March 29, the UK Financial Conduct Authority (FCA) issued a press release announcing that it has signed two updated memoranda of understanding (MOUs) with the SEC. Both MOUs aim to ensure the continued ability of the United Kingdom and the United States to cooperate and consult with each other regarding the effective and efficient oversight of regulated entities across national borders.
See Katten Muchin Rosenman LLP’s digest here.
See Buckley LLP’s blog post here.
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The SEC's release of a new framework to regulate cryptocurrencies and its practical application
In recent years, following the launch of the Bitcoin network, offers of digital assets have been made to investors in the United States. Historically, the SEC has suspiciously viewed and investigated these transactions on the assumption that the offer of digital assets (also known as "tokens") constituted an offer of securities. On several occasions, the SEC found that those offerings had been conducted in violation of U.S. securities laws.
In the past, the SEC viewed cryptocurrencies like Bitcoin and Ether as non-securities in light of the decentralized nature of their networks, which excluded the existence of a central party whose efforts could be a key factor in the enterprise. On April 3, 2019, the SEC, through its Strategic Hub for Innovation and Financial Technology, released a framework (the "Framework") for analyzing whether a digital asset is a security. In particular, this framework provides guidance on whether a digital asset is an investment contract under Section 2(a)(1) of the U.S. Securities Act of 1933.
The Framework has found application in practice already. On April 3, 2019, the SEC released its first "no-action" letter regarding an offering of tokens, requested by TurnKey Jet, Inc., and on April 11, 2019, Blockstack Token LLC filed a preliminary offering circular under Regulation A of the Securities Act for the offering of tokens of its network.
See Baker McKenzie’s alert here.
See Latham & Watkins LLP’s blog update here.
See Kramer Levin Naftalis & Frankel LLP’s article here.
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Think "FAST": SEC Disclosure Modifications Triggered by FAST Act Now Effective
The Fixing America’s Surface Transportation Act, or FAST Act, required the SEC to consider ways to streamline its regulations. Accordingly, the SEC adopted final amendments to its rules in March 2019 to modernize and simplify certain disclosure requirements in Regulation S-K, and related rules and forms, in a manner that reduces the costs and burdens on registrants while continuing to provide all material information to investors. The amendments are also intended to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information.
The majority of the SEC’s final FAST Act rules are effective as of May 2, 2019.
Public companies and their advisors tasked with drafting and finalizing SEC reports and registration statements should carefully consider the substantive and technical changes to the SEC’s forms, rules and regulations triggered by the FAST Act amendments.
See Stinson LLP’s alert here.
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SEC Files Contested Complaint Over Unregistered $100 Million Initial Coin Offering, In Case That Could Clarify Application Of Registration Requirements To Cryptocurrency
On June 4, 2019, the SEC sued Kik Interactive Inc. (“Kik”) for conducting an unregistered offering of $100 million of digital tokens. See U.S. Securities and Exchange Commission v. Kik Interactive Inc.,No. 19-cv-5244 (S.D.N.Y. June 4, 2019). The case has already generated substantial publicity, as Kik previously published a Wells submission it had lodged with the SEC urging against an enforcement action. Kik has argued that the digital tokens it offered were currency, not securities, and that in any event proceeding through enforcement is improper in the face of uncertainty as to how the securities laws apply to initial coin offerings (“ICOs”). The SEC has taken increasingly forceful positions that ICOs require registration, and this case may test the limits of its arguments.
See Shearman & Sterling LLP’s article here.
See McDermott Will & Emery’s article here.
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SEC settles American Depositary Receipts allegations against international bank subsidiary
On June 14, the SEC announced a $42 million settlement with a wholly-owned subsidiary of an international bank to resolve allegations that certain associated persons on its securities lending desk allegedly improperly pre-released American Depositary Receipts (ADRs), or “U.S. securities that represent shares in foreign companies.” According to the SEC, the subsidiary “improperly obtained pre-released ADRs from depositary banks when [the subsidiary] should have known that neither the firm nor its customers owned the foreign shares needed to support those ADRs.” The SEC asserts that this resulted in an inflated total number of foreign issuer’s tradeable securities and short selling and dividend arbitrage. The SEC alleged that these practices violated the Securities Act of 1933 and claimed that the subsidiary failed to reasonably supervise its securities personnel. The consent order requires the subsidiary to pay more than $24 million in disgorgement, roughly $4.4 in prejudgment interest, and a civil money penalty of approximately $14.3 million. The order acknowledges the subsidiary’s cooperation in the investigation.
See Buckley LLP’s blog post here.
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New York State Department of Financial Services Revokes Crypto Exchange’s Safe Harbor to Operate Without BitLicense
The New York State Department of Financial Services revoked the authority of Bittrex, Inc. to operate a virtual currency business involving New York or a NY resident effective April 11, 2019. The firm had been conducting business in New York pursuant to a “safe harbor” granted by NYSDFS while its application of August 10, 2015, for a NY BitLicense and its application of July 27, 2018, for a NY money transmitter license were pending.
NYSDFS denied Bittrex’s license and revoked its authority to conduct a virtual currency business in New York, saying the firm could not “demonstrate it will conduct its business honestly, fairly, equitably, carefully and efficiently” as required by applicable law and rules.
See Katten Muchin Rosenman LLP’s commentary here.
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DOJ And SEC Announce Resolution Of FCPA Investigation That Spanned Over Fifteen Countries With NPA, Monitor, And Over $231 Million In Disgorgement And Fines
On March 29, 2019, the U.S. Department of Justice (“DOJ”) and the SEC nnounced that they had reached resolution with a German-based major worldwide provider of medical equipment and services (the “Company”), in connection with alleged bribery payments and books and records violations in more than fifteen different countries. See In the Matter of Fresenius Medical Care AG & Co. KGaA,Admin. Proc. No. 3-19126 (Mar. 29, 2019); Press Release, SEC Charges Medical Device Company with FCPA Violations, No. 2019-48 (Mar. 29, 2019). In aggregate, the Company agreed to pay in excess of $231 million in disgorgement and penalties, and also agreed to the imposition of a compliance monitor for two years. And as part of a non-prosecution agreement with the DOJ, the Company admitted responsibility for willfully violating the Foreign Corrupt Practices Act (“FCPA”) and agreed that the facts described by the DOJ were true and accurate.
See Shearman and Sterling LLP’s article here.
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SEC Enforcement Alert: D.C. Circuit Rules Negligent Conduct Is Not “Willful”
On April 30, 2019, the D.C. Circuit issued an important decision in Robare Group, Ltd. v. SEC, Slip Op. No. 16-1453, which rejected the long-standing approach of the SEC that a “willful” violation of the federal securities laws can rest on conduct that is merely negligent. Specifically, the D.C. Circuit held that the Commission could not bring an action alleging “willful” conduct under Section 207 of the Investment Advisers Act of 1940 (“Advisers Act”) based on conduct reflecting only negligence under Section 206(2) of the Advisers Act. Id. at 18.
This decision rejects the Commission’s historical enforcement approach, and its potential impact extends beyond just the Advisers Act. The Commission has long argued that the standard for “willfulness” under the federal securities laws is low, requiring only that the SEC prove that the defendant “knows what he is doing.” See, e.g., In the Matter of Aria Partners GP, LLC, Investment Advisers Act Release No. 4991 (Aug. 22, 2018) (quoting Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000)). The Commission routinely relies on that low “willfulness” standard where the underlying conduct charged is only a negligent violation of the law.
Robare potentially upends this model going forward (at least in the D.C. Circuit). The Court holds that “[a]ny given act may be intentional or it may be negligent, but it cannot be both.” Robare at 18 (citations omitted). The decision thus suggests that a finding of some intent beyond simple negligence may be required for the Commission to support a violation, or a remedy, that requires “willfulness.” That new paradigm has consequences for both the Commission and for practitioners. Though the Court’s decision may make it harder for the SEC to predicate charges or impose remedies requiring “willful” conduct, the decision could also complicate reaching amicable settlements, particularly where the Commission insists on charges, sanctions, or remedies that contain a “willfulness” component.
See Wilmer Cutler Pickering Hale and Dorr LLP’s alert here.
See Ropes & Gray LLP’s alert here.
See Drinker Biddle & Reath LLP’s post here.
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Post-Cyan Update: Connecticut Trial Court Finds PSLRA Discovery Stay Applies to Securities Act Claims Filed in State Court
In its 2018 landmark decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, the U.S. Supreme Court unanimously held that state courts have concurrent subject matter jurisdiction over class actions that exclusively allege claims under the Securities Act of 1933 (“Securities Act”), and such claims cannot be removed to federal court. Since then, plaintiffs have continued flooding state courts around the country with Securities Act lawsuits in an attempt to circumvent the federal procedural requirements of the Private Securities Litigation Reform Act (“PSLRA” or “Reform Act”), including, in particular, the automatic stay of discovery before a motion to dismiss is decided.
Recently, however, in City of Livonia Retiree Health and Disability Benefits Plan v. Pitney Bowes Inc., the Connecticut Superior Court held that the PSLRA’s automatic discovery stay applies to Securities Act claims filed in both state and federal courts. This decision should be helpful authority for defendants—including public companies, their officers and directors, and underwriters—when seeking to stay discovery during the pendency of a motion to dismiss Securities Act claims brought in state court.
See Paul Hastings LLP’s insight here.
See Shearman & Sterling LLP’s alert here.
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Jander v. IBM: an Aberration or the Start of a Plaintiff-Friendly Trend in ERISA Employer Stock Cases?
The Supreme Court decisions in Dudenhoeffer(2014) and Amgen (2016) made it more difficult, as a practical matter, for plaintiffs to bring ERISA duty of prudence claims involving employer stock. In the ensuing years, every stock drop complaint filed by ERISA plan participants around the country was dismissed for failure to allege facts satisfying Dudenhoeffer – until defendants’ winning streak was broken in December 2018.
In Jander v. Retirement Plans Committee of IBM, 910 F. 3d 620 (2d Cir., Dec. 10, 2018) (cert granted), the Second Circuit held that a complaint against the fiduciaries of an ESOP sponsored by IBM sufficiently pled a claim for violation of ERISA’s duty of prudence in connection with alleged overinflated employer stock, and that it was improper for the lower court to have dismissed the complaint.
This ruling caught many observers by surprise, given that all complaints of this type filed in the past 4-5 years have been dismissed.
See Thompson Hine LLP’s insight here.
See McDermott Will & Emery’s post here.
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Delaware Court Of Chancery Denies Motion To Dismiss Fiduciary Duty Breach Claims Related To Repricing Of Stock Options
In June 13, 2019, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery largely denied a motion to dismiss a derivative action for breach of fiduciary duty and unjust enrichment against directors and officers of a biosciences company in connection with the alleged repricing of stock options shortly before the company announced the issuance of a “key” patent to its subsidiary. Howland v. Kumar, C.A. No. 2018-0804-KSJM (Del. Ch. June 13, 2019). Plaintiff, a stockholder in the company, alleged that the directors and officers were aware of the patent issuance yet delayed the public announcement until after the board’s compensation committee approved the reduction in the strike price of more than 2 million stock options primarily held by defendants. The Court held that pre-suit demand on the board was excused, because a majority of the board was “interested by virtue of having received the repriced options.” Applying an “entire fairness” standard of review, the Court found that it was reasonably conceivable from the pleadings that the process and price were unfair and, therefore, denied the motion to dismiss.
See Shearman & Sterling LLP’s post here.
See Winston & Strawn LLP’s blog post here.
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FINRA Proposes New Rules for Firms with a Significant History of Misconduct
On May 2, 2019, the Financial Industry Regulatory Authority (“FINRA”) proposed new Rules that would impose financial and other obligations on member firms with significant levels of risk-related disclosures as compared to similarly sized firms. See Regulatory Notice 19-17, available [here]. http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-19-17.pdf
Under the new Rules, FINRA would perform an annual calculation of each firm based on six categories of firm-level and individual-level disclosure events. Firms that exceed pre-determined thresholds would be deemed “Restricted Firms” and subject to a review process that could result in the firm being required to deposit funds in a restricted account and comply with other conditions specific to the firm’s suspect areas of operation. Based on historical data, FINRA expects between 60 and 98 member firms to qualify as “Restricted Firms” each year.
See Bressler, Amery & Ross PC’s alert here.
See Troutman Sanders LLP’s update here.
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FINRA Issues New Anti-Money Laundering Red Flag Guidance For Broker-Dealers
On May 6, 2019, FINRA issued Regulatory Notice 19-18 providing guidance to broker-dealers on potential red flags to help identify suspicious activity that may be reportable under the Bank Secrecy Act (“BSA”) and FINRA rules (the “Notice”).
FINRA Rule 3310 requires broker-dealers to develop and implement written anti-money-laundering (“AML”) programs reasonably designed to comply with the BSA and to detect and cause the reporting of suspicious activities under the Treasury Department’s Suspicious Activity Reporting rule (“SAR Rule”). Red flags have long been used to assist broker-dealers in identifying such suspicious activity.
The Notice is important and merits particular attention because it is the first significant guidance providing such detailed potential red flags since the self-regulatory organization issued Special Notice to Members 02-21 in April 2002.
In addition, the Notice provides a better sense of regulatory expectations beyond those already set forth in FINRA AML enforcement actions issued throughout the years. Indeed, the guidance provides some insight into the regulator’s view on what it deems necessary for broker-dealers to look for when trying to identify suspicious activity.
In particular, the Notice provides significant clarity in the kinds of activity that may trigger additional review or investigation. However, it also reminds broker-dealers to be aware of emerging areas of risk for suspicious activity such as risks associated with digital assets. The Notice makes clear that BSA/AML requirements, including SAR filing requirements, apply to digital assets irrespective of whether they are securities. As a result, broker-dealers should consider the relevant risks around these assets, monitor for suspicious activity and make reports as appropriate.
In light of this Notice, broker-dealers should review the identified red flags and consider incorporating into their AML program those appropriate to, among other things, their client base and business model.
See Sidley Austin LLP’s insight here.
See McGuireWoods LLP’s blog update here.
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SEC Requests Comments on New Listing Requirements for Nasdaq Offerings Under Tier 2 of Regulation A
In April, the SEC announced that it is soliciting comments on a proposed rule change submitted by The Nasdaq Stock Market LLC (the “Nasdaq”) that will impose additional requirements for companies listing in connection with offerings under Tier 2 of Regulation A under the Securities Act. The rule would require any company listing on the Nasdaq in connection with a Regulation A offering to have a minimum operating history of two years at the time of the approval of its listing application.
The SEC has previously expressed concern that companies seeking to list in conjunction with Regulation A offerings have less developed business plans and may not be as prepared to operate as public companies when compared with other companies seeking to list on the Nasdaq. Additionally, the SEC has raised concerns that investors may be exposed to greater risk of fraud from less mature companies. In response to these concerns, the Nasdaq has proposed the rule change, stating that it believes the two-year minimum operating history requirement will help ensure that companies seeking to list under Regulation A have an established business plan and history of operations that investors can more predictably rely on.
See Mayer Brown’s alert here.
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OFAC Publishes “A Framework for Compliance Commitments”
On May 2, 2019, the US Office of Foreign Assets Control (“OFAC”) published A Framework for OFAC Compliance Commitments (the “OFAC Framework”). This long-awaited document sets out OFAC’s expectations for effective sanctions compliance programs (“SCPs”). While the broad elements of the OFAC Framework should be familiar to seasoned compliance practitioners, the details highlight the specific significance that OFAC attaches to SCPs in resolving enforcement actions. Indeed, we are already seeing OFAC settlements conditioned on compliance enhancements reflected in the OFAC Framework.
Key points include the need for SCPs to be risk-based and continually evolving, the importance of root cause analysis upon identification of potential violations, and details on the metrics that OFAC will apply in assessing the adequacy of a company’s remedial response to violations.
OFAC pointedly directs its guidance not only to persons subject to US jurisdiction, but also to foreign entities that conduct business in or with the United States, with US persons, or involving US-origin goods or services. All companies should therefore look to the OFAC Framework as a useful checklist when designing, implementing and updating SCPs in general and, in particular, when remediating identified compliance weaknesses.
See Baker McKenzie’s blog post here.
See Quarles & Brady LLP’s alert here.
See Eversheds Sutherland (US) LLP’s alert here.
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DOJ Issues Detailed Guidance on Evaluating Corporate Compliance Programs
On April 30, 2019, the DOJ released an updated version of its “Evaluation of Corporate Compliance Programs” (the “Guidance”). The DOJ has previously published guidance on the same topic, most recently in February 2017. The Guidance, while building on prior principles, offers significantly more detail about how prosecutors will evaluate compliance programs. Specifically, the Guidance now directs that prosecutors should ask three fundamental questions:
- Is the corporation’s compliance program well designed?
- Is the program being applied earnestly and in good faith?
- Does the corporation’s compliance program work in practice?
Under this framework, the Guidance provides 12 specific factors over 18 pages (double the 2017 version’s length) for prosecutors to consider. Along with re-organizing the material and adding an additional factor, the Guidance now also includes contextual notes introducing each topic. As with previous materials, the factors and questions in the Guidance are not meant to be a checklist or a “rigid formula.” Rather, the DOJ encourages prosecutors to evaluate compliance programs in the context of a company’s business and to make individualized determinations.
See Drinker Biddle & Reath LLP’s publication here.
See McDermott Will & Emery’s insight here.
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Final Regulations on Section 956 and “Deemed Dividends” from Controlled Foreign Corporations
On May 22, 2019, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) released final regulations (the “Final Regulations”) under Section 956 of the U.S. Internal Revenue Code of 1986, as amended (the “Code”) that generally adopt the proposed regulations that were released on October 31, 2018 (the “Proposed Regulations”), with some modifications […].
Under the Final Regulations, there will often no longer be a U.S. federal income tax impediment to a controlled foreign corporation (“CFC”) providing credit support with respect to debt issued by its parent U.S. corporate borrower. As noted in the Prior Memorandum, however, other considerations, including non-U.S. local law issues and limitations on the extent to which lenders can access foreign subsidiary guarantees and asset-level pledges, will continue to be a factor and could raise non-tax difficulties. Moreover, potential guarantee fees to CFCs could have non-U.S. and U.S. tax consequences that should be considered.
The Final Regulations apply only to U.S. corporate borrowers and U.S. partnership borrowers to the extent owned by U.S. corporations, and do not apply to individual borrowers or U.S. partnership borrowers to the extent owned by individuals (for which Section 956 continues to apply as it did before). In addition, the Final Regulations make certain technical corrections, noted below. There are also certain situations discussed below where the Final Regulations do not apply.
The Final Regulations will apply to taxable years of a CFC beginning on or after May 23, 2019; but these rules have essentially been effective since the release of the Proposed Regulations, as the Proposed Regulations provided that a taxpayer can generally rely on the rules for taxable years of a CFC beginning after December 31, 2017.
See Paul, Weiss, Rifkind, Wharton & Garrison LLP’s article here.
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Income Inclusions from a Controlled Foreign Corporation or Passive Foreign Investment Company are “Good” Income for a Regulated Investment Company, Even if Not Distributed
Recently-finalized, regulations provide that, in determining whether a corporation is a regulated investment company (RIC), amounts the corporation is required to include in income as a result of its investment in foreign corporations will qualify as “good income” even if those amounts are not distributed to the corporation. This represents a reversal of the position taken by Treasury and the IRS in 2016 proposed regulations, and reinstates the position the IRS had taken in private letter rulings issued to RICs beginning in 2006. This is a favorable result not only for RICs that invest in wholly-owned foreign subsidiaries to gain exposure to commodity-related or other assets that they cannot hold directly, but also for RICs that invest in foreign corporations where they cannot control the amount or timing of distributions of the corporation’s income.
See Kramer Levin Naftalis & Frankel LLP’s insight here.
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