March 31, 2014

General Solicitation: Corp Fin Director Speaks!

On Friday, Corp Fin Director Keith Higgins delivered this speech on Regulation D in an effort to correct any misperceptions out there. For starters, since the general solicitation were relaxed six months ago, 900 new offerings have been conducted, raising more than $10 billion in new capital (but that pales in comparison to 9200 offerings resulting in the sale of $233 billion over the same period in the prior year). Here is a recap of the speech’s main points from Stinson’s Steve Quinlivan’s blog:

1. Reasonable Steps to Verify – Some believe that the reluctance of issuers to use the new Rule 506(c) exemption is because the rule requires that the issuer take “reasonable steps to verify” the accredited investor status of a purchaser. It’s not true that the rule requires that an accredited investor produce his or her tax returns or brokerage statements in all circumstances. There are actually two paths for complying with the rule’s verification requirement. Issuers can rely on one of the four non-exclusive verification methods for a natural person that, if used, would be deemed to satisfy the verification requirement. The other method, however, is the principles-based verification method in which the issuer would look at the particular facts and circumstances to determine the steps that would be reasonable to verify that someone is indeed an accredited investor.

When using the principle-based verification method consider:

– How much information about the prospective purchaser does the issuer already have? The more information the issuer has indicating that the person is an accredited investor, the fewer verification steps that it may have to take to comply with the rule’s requirement.

– How did the issuer find the prospective investor? A person that the issuer located through publicly-accessible and widely-disseminated means of solicitation may need to undergo a greater level of verification scrutiny than a person who may have been pre-screened as an accredited investor by a reasonably reliable third party.

– Are the terms of the offering such that only a person who is truly an accredited investor could participate? The ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors, using their own cash, could reasonably be expected to meet it is relevant in deciding what other steps are needed to verify accredited investor status.

The SEC has had recent inquiries asking whether the staff would provide guidance – presumably on a case-by-case basis – confirming that a specified principles-based verification method constitutes “reasonable steps” for purposes of the rule’s requirement. Mr. Higgins noted the notion of the staff reviewing and approving specific verification methods seems somewhat contrary to the very purpose of a principles-based rule and he is not yet convinced of the need for this type of staff involvement. According to Mr. Higgins, while the staff may not be in a position at this point to provide guidance on what constitutes “reasonable steps” under particular circumstances, he believes the staff will not be quick to second guess decisions that issuers and their advisers make in good faith that appear to be reasonable under the circumstances.

2. Definition of “General Solicitation” – Mr. Higgins noted another commonly-heard criticism is that the definition of a “general solicitation” is too vague, creating so much uncertainty about whether a particular communication or activity is a form of general solicitation that issuers have adopted a very cautious mindset about the new Rule 506(c) exemption. He stated some may even be under the erroneous impression that the Commission has broadened the definition so that activities such as “venture fairs” and “demo days” are now prohibited. The truth of the matter is that the recent rulemaking has not changed any notions of what constitutes a general solicitation.

3. “Overhang” of the 2013 Regulation D Proposal – Mr. Higgins observed that he cannot predict what the Commission will ultimately do on the pending Regulation D rule proposal, but he spoke to a fear the staff has heard expressed that the proposed requirements and penalties might be applied retroactively to offerings conducted before the adoption of the proposal. He pointed to comments of SEC Chair White where she stated that issuers are not expected to comply with any aspect of the rule proposal until such time as the Commission approves a final rule and such rule becomes effective. Ms. White also expressed her expectation that the Commission will consider the need for transitional guidance for ongoing offerings that commenced before the effective date of any final rules, as it did when it adopted Rule 506(c) last summer.

Shareholder Proposals: Commissioner Gallagher Wants Can of Worms Re-Opened

In this speech, SEC Commissioner Gallagher – while discussing the continued federalization of corporate governance – highlighted what he believes are shortcomings of the current shareholder proposal process. Not a new concept, Gallagher pushes for a higher ownership bar – so that only institutional investors can submit proposals – and a longer holding period. He has beefs with other part of the process too (egs. “proposals by proxy,” false & misleading statements, ability to submit same proposals year after year). [Here’s my 90-second video on Corp Fin’s role in the process.]

While many of these ideas might be appealing to corporate factions, the reality is that no area is more challenging to change than the shareholder proposal rule. The fixes are not as easy as some might think (eg. does it matter whose idea it is if a large slice of shareholders support it? how many years is reasonable for a new idea to take hold with a broader shareholder population? the answer certainly is more than one). The last time Rule 14a-8 was revised was in 1998 – and the battle over those changes was intense with a record number of comments at the time. And that was before the true Internet and social media era. Nowadays, I can’t fathom how many comments would be received by the SEC on a proposal (eg. Bebchuk’s mere petition on political contribution disclosures has received over 600k comments).

Of course, controversy is no reason not to tackle a project – but it is a reality that must be confronted. Is this where you want to spend Corp Fin to spend a considerable amount of resources over a period of probably more than several years? Particularly when disclosure reform is not gonna be easy. Too many big projects get started and go nowhere fast. Remember proxy plumbing. Sometimes I feel like we are on a merry-go-round:


Chief Justice Strine’s Take: Dueling Interests of Management & Shareholders

Lot of people are talking about this new 54-page essay by Delaware Chief Justice Leo Strine about “Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologysts of Corporate Law.” It’s intended to “find some common ground between these dueling camps” of corporate manager and shareholder advocates. It’s chock full of analysis of the Bebchuk v. Lipton debate, although Marty is not mentioned except in the footnotes. And there are many Lipton footnotes…

Meanwhile, Berkshire Hathaway Vice Chair – Warren Buffett’s partner – has weighed in on the state of corporate governance in this Stanford article

– Broc Romanek