Here’s the results from our recent survey on board approval of the 10-K:
1. When it comes to approving the filing of the Form 10-K with the SEC, our company’s full board:
– Convenes telephonically to approve it – 48%
– Relies on the audit committee to convene telephonically to approve it – 48%
– Management already has the board’s power of attorney to sign the 10-K, so there’s no audit committee or board meeting to approve it – 5%
2. When our directors are given a chance to comment on a draft of the 10-K, we typically receive back:
– No substantive questions or comments – 21%
– 1-2 substantive questions or comments – 43%
– 3-5 substantive questions or comments – 21%
– More than 5 substantive questions or comments – 15%
Dual-Class Structures: Does the Market Already Have a Fix?
Liz recently blogged about the decision of major indices to exclude “dual-class” companies that offer minimal voting rights to public shareholders. The debate about dual-class companies continues to rage – but this recent study suggests that the market may already have a solution, in the form of investors’ demand for a “risk premium” for these stocks. Here’s the abstract:
Critics advocate eliminating dual class shares. We find that founding families control 89% of dual class firms, potentially confounding economic inferences regarding limited voting shares. To identify the impact of dual class structures on outside shareholders, we examine stock price returns; finding that dual-class family firms earn excess returns of 350 basis points more per year than the benchmark.
Institutional owners garner a disproportionate fraction of these returns by holding over 97% of their floated shares. Overall, we show that investors demand a risk premium for holding dual-class family firms, suggesting a market-driven resolution to concerns about limited voting shares.
If the study’s right, these above-market returns may go a long way to explaining why – despite their harrumphing – institutions continue to throw money into these stocks.
Meanwhile, this LA Times article notes that tech companies are not likely to bow to S&P’s new dual-class rules…
Nasdaq to Dual-Class Companies: “We’ve Got Your Back”
The major indices may have “unfriended” dual-class companies like Snap, but this “Institutional Investor” article says that Nasdaq remains happy to provide a home for them. Here’s an excerpt:
Nelson Griggs, head of global listings at the Nasdaq Stock Market, said Nasdaq supports companies that want to go public with a dual-class structure, as long as investors know what they’re getting into. Companies often use multiple share classes – each with different voting rights – to help founders and CEOs maintain control or as a tool to fend off activists. Technology and media companies have been among the biggest users of multiple share classes.
“In the U.S., if companies disclose that they have multiple share classes, then investors can make a decision on whether they want to be a financial owner,” said Griggs. “We think it’s in the best interests of companies to have that option.”
With fewer companies going public, new listings are hard to come by – and companies with dual-class structures represent 10% of Nasdaq’s listings. That’s up from 2% a decade ago. You do the math.
When it comes to changing auditors, it looks like the best advice comes from “Macbeth” – “’twere well it were done quickly.” This Fredrikson & Byron blog flags a new study that says timing matters when it comes to a decision to change auditors – and sooner is a lot better than later:
Companies thinking about changing their auditors should do so before the end of their second fiscal quarter, according to a recent study by researchers at the University of Notre Dame and Ohio University. Although there are legitimate reasons to change auditors having nothing to do with company malfeasance or auditor malpractice, turnover is rare so it can raise questions. In an interview with CFO Magazine, the study’s lead author says that a company announcing the dismissal of its auditor after the second fiscal quarter risks being “lumped in with the bad apples” that want to end the auditor’s engagement to cover up “nefarious” doings.
The study found that companies that dismiss auditors after the 2nd fiscal quarter have “markedly higher rates of future restatements, material weaknesses and delistings” compared to firms that make the change shortly after filing the prior year’s 10-K.
Pre-IPO Companies: Private Liquidity Programs
One reason that some promising companies are electing to defer IPOs may be the growth in private liquidity alternatives for their shareholders. This MoFo blog discusses the Nasdaq Private Market’s recent report on private liquidity programs conducted through its trading platform during the first half of 2017. Here’s an excerpt:
Nasdaq Private Market reports increased activity in private company liquidity programs. Companies that are choosing to stay private longer are using structured and controlled liquidity as a recruitment and retention tool, according to the Nasdaq report. In the first half of 2017, the Nasdaq Private Market Platform had 19 liquidity programs, with a total program volume of $733 million and 1,765 program participants.
62% of the programs were share buybacks and the remaining 38% of the programs were structured as third-party tender offers. These programs had an average size of $40 million. The report notes that most of the 19 programs were employee-focused, where 84% of eligible sellers were current and former employees.
While Nasdaq says that private liquidity programs are appealing to a broader range of companies, most of the companies that have implemented them this year are “unicorns” – with a median valuation of $1.4 billion.
Dividends: NYSE Delays New Timing Requirements
Following up on something we blogged about a few weeks ago, here’s news from Ning Chiu’s blog:
The NYSE has asked the SEC to delay the effectiveness of its recently approved rule requiring listed companies to provide notice to the Exchange at least 10 minutes before making a public announcement about a dividend or stock distribution.
On August 14, when the rule change was approved by the SEC that would require listed companies to provide the Exchange with advance notice, including outside of the hours in which the Exchange’s immediate release policy operates, many assumed that the rule was immediately effective since nothing in the rule filing indicated otherwise.
In its proposal to the SEC, NYSE states that it is asking for the delay to provide listed companies with additional time to prepare and for the Exchange’s new technology systems to provide the necessary support to Exchange staff in reviewing notifications. The Exchange indicates that it will provide reasonable advance notice of the new implementation date to listed companies by emailing a notice to them that will also be posted on nyse.com, and that the new implementation date will be no later than February 1, 2018.
Until then, the text of Rule 204.12 continues to state that notice should be given as soon as possible after declaration of the dividend or stock distribution and in any event, no later than simultaneously with the announcement to the news media.
We decided to release these course materials early since so many are grappling now with the type of issues addressed in this “How to” manual. Just like the upcoming “Pay Ratio & Proxy Disclosure Conference” in October will comprehensively address these – and many more – issues. This comprehensive pay ratio event is one that you can’t afford to miss. Also remember that our third pre-conference webcast is September 27th.
Register Now: This is the only comprehensive conference devoted to pay ratio. Here’s the registration information for the “Pay Ratio & Proxy Disclosure Conference” to be held October 17-18th in Washington DC and via Live Nationwide Video Webcast. Here are the agendas – 20 panels over two days. Register today.
“Token Sales” & ICOs: A Primer
We’ve been blogging a bit about the emergence of initial coin offerings, also known as “token sales,” “app coins” and all sort of other terms (here’s our latest blog). Some members have asked how can a currency be a security. Rather than host a webcast on that topic, I think this 32-minute podcast from “a16z” does a great job of making something fairly challenging to understand seem simple. The brief discussion at the 18:29 mark about how governance works when a “protocol” is monetized sets the table for a fascinating debate…
Steven Clifford on “The CEO Pay Machine”
In this 26-minute podcast, former CEO Steven Clifford discusses the problems with CEO pay – and describes his plan about how to fix it (as noted in his new book “The CEO Pay Machine“), including:
1. Why did you write this book?
2. Can you explain the role of boards in setting pay – and how they might be “collectively” delusional?
3. Why might CEOs not be as important as many think they are?
4. Can you get into the topic of “peer groups” and how CEOs may not be portable?
5. How can excessive pay actually be a de-motivator?
6. I’ve always argued that any pay is “pay-for-performance” by definition. How are most P4P arrangements detrimental to a company’s long-term health?
7. How is “shareholder alignment” not the gold standard that many think it is?
8. What is your plan to fix the “CEO Pay Machine”?
This podcast is also posted as part of our “Big Legal Minds” podcast series. Remember that these podcasts are also available on iTunes or Google Play. Use the “My Podcasts” app on your iPhone and search for “Big Legal Minds”; you can subscribe to the feed so that any new podcast automatically downloads…
This recent WSJ article pointed out a significant decline in penalties levied by the SEC during the first half of 2017:
The SEC levied some $318 million in penalties during the first half of 2017, a search of federal court documents and all publicly available records on the agency’s website and data provided by Andrew Vollmer, a professor at the University of Virginia School of Law, showed. Last year, agency actions yielded $750 million in penalties during the same period, an agency spokesman said.
The article notes that fines & penalties imposed by other financial regulators were also down sharply. It cited a more business favorable climate under the Trump Administration & the winding down of financial crisis cases as contributing factors to a decline in SEC enforcement activity.
. . .Wait, Maybe Penalties Aren’t the Right Thing to Look At?
This CFO.com article by Labaton Sucharow’s Jordan Thomas says “not so fast.” The article claims that enforcement activity shows no signs of easing. Here’s an excerpt:
If the first half of the year was any indication, the SEC is on track to have another record year for enforcement activity in 2017. Looking at data compiled in our SEC Sanctions Database, which tracks a subset of enforcement actions that resulted in monetary sanctions exceeding $1 million, the agency shows no sign of easing its efforts to sanction bad actors.
The largest case thus far in 2017 was brought against Barclays, which agreed to pay $97 million in disgorgement and penalties for overcharging clients for mutual fund sales and advisory fees. Perhaps unsurprisingly, given where major financial firms are headquartered, cases were clustered regionally in the Northeast and West, with nearly half of all actions coming out of the Northeast. But actions coming from the South nearly doubled from last year and the Midwest saw a fivefold increase in the number of cases.
Also for the first half of 2017, more than 40% of cases we studied involved offering fraud. That’s almost double the number of offering fraud cases observed in the first halves of the last three years combined.
The article says that in light of this level of activity, the WSJ’s criticism of the SEC’s enforcement activity during 2017 is misplaced – and that it’s inappropriate to draw conclusions about the agency’s enforcement agenda by looking at 6 months of penalties in a vacuum.
Corp Fin Updates “Financial Reporting Manual”
On Friday, Corp Fin updated its “Financial Reporting Manual” to provide contact information for the Office of the Chief Accountant and to clarify guidance on the omission of financial information from draft & filed registration statements. The latter change adds references to the new CDIs on the same topic issued earlier this month.
Yesterday, the SEC issued this fee advisory that sets the filing fee rates for registration statements for 2018. Right now, the filing fee rate for Securities Act registration statements is $115.90 per million (the same rate applies under Sections 13(e) and 14(g)). Under the SEC’s new order, this rate will rise to $124.50 per million, a 7.4% increase. It could be worse – the current filing fee rate represented a 15% bump over fiscal 2016.
As noted in the SEC’s order, the new fees will go into effect on October 1st like the last five years (as mandated by Dodd-Frank) – which is a departure from years before that when the new rate didn’t become effective until five days after the date of enactment of the SEC’s appropriation for the new year – which often was delayed well beyond the October 1st start of the government’s fiscal year as Congress and the President battled over the government’s budget.
Revenue Recognition: Impact of New Standard on S-3 Financials
This Sidley memo addresses the potential need for some Form S-3 filers to retrospectively revise previously issued financials due to the adoption of the new GAAP revenue recognition standard. The memo addresses the impact of the full retrospective transition method on financial statement requirements in existing and newly filed S-3s, as well as how the timing of the new standard’s adoption could change that result.
Forward-Looking Statements: Does “We’re on Track” Qualify?
Over on “The Mentor Blog,” I recently blogged about a new case holding that you can’t insulate a non-forward looking statement by mixing it into a paragraph of forward-looking statements. Now, here comes this blog from Lyle Roberts about a recent case that illustrates how hard it can be to sort out forward-looking from non-forward looking statements in the first place.
At issue in the case was a remark that makes every securities lawyer cringe whenever it pops out of an executive’s mouth – a statement to the effect that a company is “on track” to meet performance expectations. Courts have reached different conclusions about whether or not this language is protected by the PSLRA safe harbor – and the blog notes a recent decision in which a California federal court said that it didn’t make the cut.
This excerpt summarizes the court’s opinion:
In Bielousov v. GoPro, (N.D. Cal. July 26, 2017), the court considered whether the CFO’s statement “We believe we’re still on track to make [GoPro’s financial guidance] as well” was a forward-looking statement covered by the PSLRA’s safe harbor. The court held that because the CFO included the phrase “we believe” in his statement, it was a statement of present opinion about “his and GoPro’s existing state of mind.” Accordingly, the PSLRA’s safe harbor did not apply and the statement should be examined under the Omnicare standard.
Last month, the House Financial Services Committee unanimously approved the “Improving Access to Capital Act” (H.R. 2864). The bill would eliminate the current provisions of Regulation A that prohibit its use by companies that are already subject to Exchange Act reporting requirements. This Duane Morris blog provides some background:
In implementing rules under the Jumpstart Our Business Startups (JOBS) Act in 2015, the SEC retained the historical restriction that only non-reporting companies could utilize Reg A. There was really no particular reason this could not have been changed.
Now that practitioners have witnessed the closing of well over 30 Reg A+ deals, three of which are now successfully trading on national exchanges, it would seem logical to expand the availability of Reg A+ to reporting companies. They would have a history of full disclosure, and could clearly benefit from utilizing a faster and cheaper option to raise money from the public.
The blog notes that the ability to use Reg A+ could prove particularly useful to reporting companies that don’t qualify to use Form S-3 for primary offerings.
Audit Committees: Proxy Disclosure Trends
In recent years, investors and other constituencies have called for greater disclosure in proxy statements about key audit committee activities – including more detail about decisions to retain independent auditors, auditor independence assessments, & risk oversight. This Deloitte study reviewed audit committee disclosures in 2017 proxy statements filed by the S&P 100.
Disclosures beyond those required by Item 407 of S-K have been trending upward in recent years, and the study says that trend continued – at a somewhat slower pace – in 2017. The most common areas of voluntary disclosure include the committee’s role & responsibilities, risk oversight, topics discussed by the audit committee, and oversight of financial reporting & the internal audit function.
This excerpt reviews the findings on audit committee disclosure of risk oversight:
The role of the board and its committees in overseeing risk continues to be a hot topic. 99% of the S&P 100 companies disclosed the role of the audit committee in overseeing risk. The level of responsibility assigned to the audit committee, however, differed from company to company.
Companies disclosed that the audit committee was responsible for overseeing risks associated with traditional areas such as financial reporting, internal controls, and compliance, and some noted that the audit committee’s role in risk oversight extended beyond these areas. 30% of the S&P 100 companies (versus 27% 2016) disclosed the audit committee’s role in overseeing cybersecurity risk.
Topics that drew the fewest disclosures among the S&P 100 included issues encountered during the audit, as well as matters relating to the committee’s role in determining auditor compensation. Also see this recent blog about a EY report on audit committee disclosures…
Board Diversity: The Pressure is Ratcheting Up
Over on our “Proxy Season Blog,” Liz recently noted State Street’s decision to vote against directors at approximately 400 companies that didn’t satisfy it with their efforts to improve board gender diversity – and we’ve previously blogged about BlackRock’s efforts to prod companies to make progress on the diversity front.
Now this Weil Gotshal blog says that it isn’t just institutional investors that are turning up the heat. As this excerpt points out, here come the politicians:
While these institutional investors are ratcheting up the pressure on public companies, certain members of the US Congress have been pushing the SEC for greater board diversity disclosure. In March, Representative Carolyn Maloney (D-NY) reintroduced her Gender Diversity in Corporate Leadership Act (H.R. 1611), modeled on policies in Canada and Australia, which would instruct the SEC to recommend strategies for increasing women’s representation on corporate boards, and require companies to report their gender diversity policies as well as the proportion of women on their board and in senior executive leadership.
In addition, 29 congressional Democrats have written a letter to SEC Chair Jay Clayton urging the SEC to require more disclosure about board diversity.
Here’s an excerpt from this new study from the “Economic Policy Institute” about relative pay levels:
By this measure, in 2016 CEOs in America’s largest firms made an average of $15.6 million in compensation, or 271 times the annual average pay of the typical worker. While the 2016 CEO-to-worker compensation ratio of 271-to-1 is down from 299-to-1 in 2014 and 286-to-1 in 2015, it is still light years beyond the 20-to-1 ratio in 1965 and the 59-to-1 ratio in 1989. The average CEO in a large firm now earns 5.33 times the annual earnings of the average very-high-wage earner (earner in the top 0.1 percent).
Transcript Now Available: “Pay Ratio Workshop – What You (Really) Need to Do Now”
For those registered for our comprehensive “Pay Ratio & Proxy Disclosure Conference“, we have posted the transcript for our popular webcast: “Pay Ratio Workshop – What You (Really) Need to Do Now.”
The first webcast was on July 20th – and the second webcast was on August 15th; transcripts & audio archives are available for both. The third webcast is on September 27th.
It doesn’t matter whether you can make it to DC – because the October 17-18th Conference is available to watch online by video webcast, live on those specific days or by video archive at your convenience. And in addition to the October Conference, you gain access to three pre-conference webcasts – and this set of “Model Pay Ratio Disclosures” in both PDF & Word format.
Register Now: This is the only comprehensive conference devoted to pay ratio. Here’s the registration information for the “Pay Ratio & Proxy Disclosure Conference” to be held October 17-18th in Washington DC and via Live Nationwide Video Webcast. Here are the agendas – 20 panels over two days.
There have been a number of seven-figure awards under the SEC’s whistleblower program, so a recent $2.5 million award wouldn’t merit much attention – that is, if the recipient wasn’t an employee of a government law enforcement organization.
Typically, government law enforcement organization employees aren’t eligible to receive whistleblower awards – but as this Hogan Lovells memo notes, this award indicates the SEC Staff is inclined to read that limitation on eligibility narrowly:
The SEC indicated that although an employee of a law enforcement organization is not normally eligible as a whistleblower, there may be an exception when law enforcement is just one component of the agency’s purposes and the employee does not work for that component of the agency. According to the SEC, employees of law enforcement organizations—defined as organizations “having to do with the detection, investigation, or prosecution of potential violations of law”—are eligible for the award so long as they do not work for the “sub agency components that perform the law enforcement responsibilities.”
The memo points out that the ability of government employees to blow the whistle may complicate the relationship between companies & their regulators:
Personal gain could motivate a government employee to pass along information to the SEC in hopes of receiving an award, especially if the reward encourages competition among government employees to provide information to the SEC. Companies that regularly work and communicate with regulatory agencies should consider the risk of sharing information that could serve as evidence of securities violations, particularly if the likely sanctions could exceed $1 million, which is the threshold required to receive a whistleblower award.
The SEC Staff’s decision to read the law enforcement exclusion from eligibility narrowly also signals that the whistleblower program will continue to feature prominently in its enforcement efforts under the Trump Administration.
SRO Rulemaking: DC Circuit Decision May Slow SEC Action on Rule Proposals
A recent ruling from the DC Circuit may slow down the SRO rulemaking process by effectively raising the standard for SEC review of new rules. This Davis Polk memo explains:
The case, Susquehanna International Group, LLP, et al. v. SEC, decided on August 8, involved a petition by two options exchanges and two broker-dealers (“Petitioners”) for review of an SEC order approving a proposed change by the Options Clearing Corporation (“OCC”) to its rules. The proposed rule set out a plan to bolster its capital by restructuring its capital contribution requirements, fees, rebates and dividends. The proposal was filed by the OCC in 2015 and the SEC issued an order approving the proposal in February 2016.
In reviewing SRO rule changes, the court held that the SEC must undertake its own “reasoned analysis,” not take the SRO’s “word for it” that statutory standards are met, and that SEC approvals may be set aside as being “arbitrary and capricious” unless its determinations are supported by “substantial evidence.” The court reviewed the SEC’s discussion of various aspects of the OCC proposal and found the agency’s analysis concerning the satisfaction of statutory standards to have been insufficiently probing.
The SEC often relies on SRO statements about satisfaction of statutory standards in approving rule changes, and the Court’s insistence on a more probing analysis may slow a process that market participants complain is already too slow and cumbersome.
Links to Exhibits: Remember, Remember! The 1st of September. . .
Sorry for misappropriating & re-dating the famous verse about Guy Fawkes & the Gunpowder Plot – but I wanted to remind everybody that the new rules mandating links to Exhibits in SEC filings go into effect on September 1st. This Sidley blog has an overview of the requirements.
Broc blogged last week that it appears that Corp Fin has provided some informal guidance on how to link to very old exhibits. We continue to post memos in our “Exhibits” Practice Area.
Last week, Corp Fin issued updated guidance on processing procedures for draft registration statements. The new guidance clarifies how the IPO offering date will be determined & the ability of companies with registration statements on file to switch to the non-public review process for future amendments. Here’s the text of the new language:
The nonpublic review process is available for Securities Act registration statements prior to the issuer’s initial public offering date and for Securities Act registration statements within one year of the IPO. In identifying the initial public offering date, we will refer to Section 101(c) of the JOBS Act. The nonpublic review process is available for the initial registration of a class of securities under Exchange Act Section 12(b) on Form 10, 20-F or 40-F.
An issuer that has a registration statement on file and in process may switch to the nonpublic review process for future pre-effective amendments to its registration statement provided it is eligible to participate in the nonpublic review process and it agrees to publicly file its amended registration statement and all draft amendments in accordance with the time frame specified above.
Language was also added indicating that companies may submit eligibility questions to CFDraftPolicy@sec.gov. See this Gibson Dunn blog.
EGC Registration Statements: 3 New & Updated CDIs on Financial Info
At the same time, Corp Fin updated “FAST Act” CDI #1 addressing the financial information that ECGs may omit from draft & publicly-filed registration statements (new “Securities Act Forms” CDI 101.04 provides the same):
Question: What financial information may an Emerging Growth Company omit from its draft and publicly filed registration statements?
Answer: Under Section 71003 of the FAST Act, an Emerging Growth Company may omit from its filed registration statements annual and interim financial information that “relates to a historical period that the issuer reasonably believes will not be required to be included…at the time of the contemplated offering.” Interim financial information that will be included in a longer historical period relates to that period. Accordingly, interim financial information that will be included in a historical period that the issuer reasonably believes will be required to be included at the time of the contemplated offering may not be omitted from its filed registration statements. However, under staff policy, an Emerging Growth Company may omit from its draft registration statements interim financial information that it reasonably believes it will not be required to present separately at the time of the contemplated offering.
For example, consider a calendar year-end Emerging Growth Company that submits a draft registration statement in November 2017 and reasonably believes it will commence its offering in April 2018 when annual financial information for 2017 will be required. This issuer may omit from its draft registration statements its 2015 annual financial information and interim financial information related to 2016 and 2017. Assuming that this issuer were to first publicly file in April 2018 when its annual information for 2017 is required, it would not need to separately prepare or present interim information for 2016 and 2017. If this issuer were to file publicly in January 2018, it may omit its 2015 annual financial information, but it must include its 2016 and 2017 interim financial information in that January filing because that interim information relates to historical periods that will be included at the time of the public offering. See also Question 101.05 for guidance related to registration statements submitted or filed by non-EGCs.
New “Securities Act Forms” CDI 101.05 provides that non-EGCs may also omit annual & interim financial information that will not be required to be presented separately at the time of its first public filing.
Revenue Recognition: SEC Updates Guidance & Issues New SAB
On Friday, the SEC issued two interpretative releases & the Staff issued a Staff Accounting Bulletin updating guidance on revenue recognition – all related to FASB’s “ASC Topic 606 – Revenue from Contracts with Customers.” Here’s the press release (and Steve Quinlivan’s blog). This interpretive release addresses accounting for “bill and hold arrangements” – while the other release covers sales of vaccines to the federal government for certain stockpiling programs.
New SAB 116 is intended to bring existing guidance into conformity with ASC Topic 606.
In response to my recent blog about “initial coin offerings” (also known as “token sales”), Margaret Rosenfeld of Smith Anderson sent me this interesting note:
1. It’s Real – The crypto-economy is a reality and this is not fringe anymore – but frontier. I can remember when I practiced outside the U.S. before Regulation S was adopted. As practitioners, we had to grapple with how to fit into the SEC regulation regime. There were many cowboys, there were many conservatives and there were many of us right down the middle, which is where Regulation S ended up being.
2. Bankers Are “In” – There are many people taking advantage of the crypto-economy. Bankers that will do an accredited investor ICO for you in exchange for 50% of the raise are using the SEC’s Section 21(a) Report to tell people that the SEC is coming down hard on ICO’s and everything done will be considered a “security.” Why are they promoting this so strongly? Very obvious.
3. Millennials Love It – The driver of the crypto-economy is the millennial generation, which now has purchasing power. They want disruptive, socially conscious ways that differ from their elders.
4. SEC’s Position Is Howey Test Applies – Most of the law firm memos written about the SEC’s Section 21(a) Report note that it didn’t state that every ICO is a securities offering. The Howey test applies. Many digital assets are being sold primarily for non-economic purposes. Note that many of us active in the crypto-economy are working to use consistent nomenclature and call these “Tokens” and “Token Sales” rather than “Coins” and “Initial Coin Offerings.”
By the way, here’s an example of a Token Sale that is trying to do it the right way after the SEC’s Section 21(a) Report.
5. Game Theory Involved – There is a lot of “game theory” involved in this economy. Millennials grew up on gaming.
6. The Securities Law Question – This is the most important question facing the cryptoeconomy right now on the regulator front: If the primary purpose for someone’s purchase of a Token is for a non-investment reason – but the Token’s value can increase or decrease, does that make it a security?
Think of Chuckie Cheese, a millennial breeding ground. Kids put money into machines to play the games. They got tickets. They compete with their friends to get tickets and to see who is the best at the game and has the most tickets at the end. The tickets end up having a value because they can be traded in for cheap trinkets. Are the kids putting the money into the machines to play the games, to compete and be the big winner or for the trinkets (which shows value)? My kids often went home with tickets in their pockets. My son actually stockpiled his tickets.
In the case of tokens, the Buyer is primarily buying for something other than a potential investment. For example, the Buyer may get a right to participate in a future event to vet and approve projects of the company (I purposefully use those words rather than voting). As a company builds a community of tokenholders and grows more successful, those tokens can increase in value. If there is a limited supply of tokens and a demand builds to have those tokens to join the community, a market develops to trade those tokens. So, will the SEC take the view that those tokens, which a buyer bought for a non-investment purpose, is a security because their value can increase?
Think of it this way. I buy a house in a nice community. It has a HOA and I have a vote to decide where HOA money is being spent and other HOA matters. If it is a good HOA, arguably the right I have to vote (my Token) and participate in community activities may be increasing the value of that community and my token. If my house goes up in value, is that a security?
7. Moving Outside the US Probably Doesn’t Solve – Does incorporating your company in the Caymans and stating that “US citizens cannot participate” work? Law firms out there are advising this and allowing securities to be offered. Really? These websites are not blocking ISP addresses in the US. Putting your company offshore and allowing offering materials flow into the US does not mean you are not subject to the US securities laws (uh, Regulation S anyone?).
Individuals may think they are protecting themselves – but if you are physically on the ground in Florida and doing this, I expect the SEC Staff will be calling you.
Six Possible Approaches
AND, the people participating in this economy from the beginning are trying to be disruptive. They want to make changes to the world and create a global currency that helps all. They don’t want to limit things to “accredited investors.” So here are six approaches that I see:
– Structure it as a true utility sale – a Token Sale. It must be a product that has real rights and not a primary purpose for investment. And you must say that clearly and often in your disclosure.
– When you launch your pre-sale, you must already know clearly what those rights are and state them. You can add to those rights, but you must analyze before the pre-sale (which is a right to be converted into the eventual token sold at a discount) whether it is a utility or a security. Pretty obvious but many out there are diving in without doing this and being advised that it is okay.
– Don’t fuss around with the offshore and limits. Pillar did this and found that the limits killed its raise. It restructured. Folks are smart and wonder why are you putting this in the Caymans.
– If it is not a utility, structure is as a security. Do it right. And let’s as a community try to find bankers who will not gouge the companies with crazy fees.
– Right now, 506(c) approach is what is being done for the private placements. This is good. BUT I would like to work with the SEC to see if we can use Form 1-A to come up with a standard ICO approach. I think it could work but the SEC has to be willing to be nimble about review on this.
I have been around a bit – practicing securities law since 1997 – and seen many trends. This is a paradigm shift in the economy. I was in Jakarta a month ago and watched a waiter pull out his phone so that he could buy into an ICO. I got to talking with him and learned that the stability of cyber-currency was a huge attraction for Indonesians.
I am usually a debunker of trends – but I predict in 10 years there will be a global crypto-currency that dominates. Remember how we grew up and there were just three channels on TV! Could you imagine sitting in front of a TV with 300 when you were 10? The future is now. Believe it or not, there are already 10 token/coin offerings that are targeted to be announced at Burning Man at the end of the month…