As readers of this blog know, the SEC has — at least recently — made clear that it believes that most digital assets are a “security” under the Howey test. But, as Liz noted earlier this year, it has been waiting on a ruling (or settlement) in its case against Ripple Labs, where it alleged that Ripple raised over $1.3 billion through unregistered sales of its XRP cryptocurrency token. Last Thursday, a SDNY judge issued the long-awaited order, which found that XRP both was and was not a security.
The court found that Ripple’s initial sales of XRP to institutional buyers satisfied the last prong of Howey but sales through exchanges and algorithms did not. Citing statements in promotional brochures and market reports for XRP, the court distinguished the Institutional Sales from the Programmatic Sales as follows:
From Ripple’s communications, marketing campaign, and the nature of the Institutional Sales, reasonable investors would understand that Ripple would use the capital received from its Institutional Sales to improve the market for XRP and develop uses for the XRP Ledger, thereby increasing the value of XRP.
[…] Here, the record establishes that with respect to Programmatic Sales, Ripple did not make any promises or offers because Ripple did not know who was buying the XRP, and the purchasers did not know who was selling it. In fact, many Programmatic Buyers were entirely unaware of Ripple’s existence. […] There is no evidence that a reasonable Programmatic Buyer, who was generally less sophisticated as an investor, shared similar “understandings and expectations” and could parse through the multiple documents and statements that the SEC highlights, which include statements (sometimes inconsistent) across many social media platforms and news sites from a variety of Ripple speakers (with different levels of authority) over an extended eight-year period.
If you’re confused, you’re not alone. So is Twitter and Tulane securities professor Ann Lipton, who has this to say:
The purchasers may not have known they were supplying capital to Ripple, but they knew what the institutional investors knew about Ripple’s intentions. They knew Ripple was making efforts to expand the business, promote the token, and develop it as an asset. They almost certainly were motivated to buy it for that reason; Ripple made statements encouraging them to do so. That they didn’t know their particular moneys would assist that effort isn’t really …. relevant. Moreover, as I said, the cross border system depended on a liquid market for XRP – of course Ripple would promote one.
What it looks to me is going on is that the court kind of stealthily accepted defendants’ “contract” argument after all, in a way. The judge held that it was a security for the buyers who had a direct relationship with Ripple and knew where their money was going. For buyers who had no such relationship, there was no security.
She also addresses the other thing we’re all thinking:
Let’s just get out of the way that it’s perverse that sales to institutions are treated as securities because institutions are sophisticated. That’s backwards; it subverts the purpose of the securities laws (to protect less sophisticated investors) and contradicts other tests for whether assets are securities (the Reves test often weights investor sophistication against finding the presence of a security).
I should note, as Bloomberg’s Matt Levine points out in his column, that the argument “an investment contract is only an investment contract when you buy it from the issuer” is not new to crypto enthusiasts and, in fact, is a key argument made by Coinbase, but this opinion “goes way beyond” the argument Coinbase is making.
Crypto may be calling this a victory, but I’m not so sure. The SEC’s win here seems solid; Ripple’s less so. I guess we’ll have to wait a little longer for the answer to crypto. I don’t know about you, but this reminds me of The Hitchhiker’s Guide to the Galaxy, where a supercomputer takes millions of years to answer the meaning of “life, the universe and everything” and eventually responds with “42”.
Broadridge surveyed 2,000 randomly selected (self-identified) crypto market participants in Canada, the U.K., and the U.S. from March to June 2023. The goal of the survey was to better understand what holders of crypto assets think is important when purchasing a crypto asset. In a 23-page report, Broadridge summarizes the results of the survey and, as Keir Gumbs, Broadridge’s CLO, notes on LinkedIn, the report “sheds light on the activity and process on how crypto market participants track performance of digital assets, and what avenues they seek out to find that information.”
Here are two of the key findings from the report’s overview:
Long-term investment Over 65% of respondents suggested their holdings represented a long-term investment, suggesting that, contrary to popular perception, most participants are not speculators.
Additionally, 46.7% of respondents answered that their investments in the space were being used to educate themselves, indicating a “learning by doing” approach by holders.
Traditional metrics prioritized over native crypto metrics When asked about what type of disclosure information is most important in their decision making, respondents consistently selected traditional investment metrics including financials, risk and security, and information about the management team over native crypto metrics such as tokenomics and network / platform activity. While not surprising given the novelty of crypto assets, this suggests possible underappreciation of items critical to pricing and understanding the attractiveness of a crypto asset.
The study also found that studying crypto markets will continue to be important, with survey respondents signaling a persistent interest in the space despite the challenges and setbacks currently facing the industry.
In a recent WSJ OpEd, Jay Clayton, SEC chair from 2017-20, and Timothy Massad, CFTC chair from 2014-17, argue that both agencies must take steps beyond enforcement to move closer to the end goals of integrity and investor protection in crypto markets. They point to the limited utility of litigation — it won’t address critical questions like whether laws need to be adjusted for the features of tokens and how the federal government can oversee the trading of tokens, like bitcoin, that aren’t securities.
In addition to enforcement efforts, they believe the SEC and CFTC should, either directly or through an SRO, create basic standards for investor and market protections, preferably with Congress mandating them. They argue that these standards could avoid sticky classification issues that exist today, focus on major issues (like “wash trading”), address existing information asymmetry problems without requiring a rewrite of existing laws and, if an SRO was used, wouldn’t cost taxpayers anything to implement.
As the Broadridge report I blogged about above notes, “developing disclosure principles for a novel industry is not entirely a linear process.” But the data from Broadridge’s survey could be useful input if the agencies ever went down this path.
I blogged just last month about the 9th Circuit’s decision to uphold an exclusive forum bylaw that effectively extinguished a shareholder derivative suit brought under Section 14 of the Exchange Act, on the basis of allegedly misleading proxy statement disclosure. That case created a circuit split with the 7th Circuit.
Now, a federal district court in the 5th Circuit has upheld a forum selection clause at SolarWinds that kicks a Section 10(b) derivative claim to Delaware Chancery Court – which, again, does not have jurisdiction to hear that federal claim. The anti-fraud allegations stem from the company’s 2020 cyber breach.
Alison Frankel analyzes the case in this Reuters article. Here’s an excerpt, which pulls in thoughts from Tulane’s Ann Lipton:
Pitman’s SolarWinds decision breaks new ground, said law professor Ann Lipton of Tulane University, because it extends forum selection enforcement to derivative 10(b) claims.
Shareholder derivative suits accusing board members of violating Section 10(b) are rare, Lipton said, so the ruling may not foreclose many cases. (Plaintiffs lawyers filed a spate of 10(b) derivative suits in the early 2000s against directors and officers of companies engaged in stock options backdating. More recently, shareholders alleged derivative 10(b) claims against Wells Fargo executives after revelations about fake bank accounts.)
But what Pitman’s decision signals, Lipton said, is the creeping effect of forum selection clauses. Companies first adopted them to channel M&A breach-of-duty suits to Delaware so businesses would not be forced to litigate the same claims in multiple courts. Then, after the U.S. Supreme Court confirmed in 2018 that shareholders can file Securities Act suits in either state or federal court, corporations used forum selection clauses to mandate federal court jurisdiction for litigation over allegedly misleading disclosures in offering documents.
Now the clauses have become a weapon to kill Exchange Act derivative claims — whether shareholders are alleging proxy violations or, as per Pitman’s new decision, 10(b) fraud claims.
This writeup from Cooley’s Cydney Posner provides even more context. It’s worth noting that there are strong views that derivative Exchange Act claims don’t provide any remedy that isn’t already available via a direct federal claim or a derivative state law claim. For companies, the bottom line is that it’s probably worthwhile right now to have an exclusive forum bylaw…
There’s a lot happening right now. Plus, if you’re like me, the summer season throws a big wrench in your ability to keep track of complicated details like which month it is. If you’re looking for a comprehensive update on “where things stand,” look no further than this 106-page Freshfields memo, which covers:
– Proxy season takeaways;
– Board, committee and director trends;
– Diversity at the leadership and workforce levels;
– Updates to SEC rules, including proposed rules; and
– Updates on institutional investors and proxy advisors.
Here are the latest stats on a few key governance topics covered in the memo:
– 71% of S&P 500 companies have one additional committee beyond their standing audit, compensation and nominating and governance committees
– The average number of committees is 4, which is basically unchanged for the past decade
– Over half of S&P 500 companies in 2022 elected at least one new director
– 33% of new S&P 500 directors are active or retired corporate executives, excluding CEOs but including line or functional leaders and division or subsidiary leaders, the same as 2021
– 14% of S&P 500 new independent directors are active CEOs or employed as chairs, presidents or COOs and an additional 12% are retired CEOs, chairs, presidents or COOs
– 37% of newly appointed directors have prior public director experience
– Average age of all independent directors is 63, unchanged since 2021
– Average tenure of S&P 500 directors is 7.8 years
– 70% of S&P 500 boards disclose a retirement age policy
– 7% of S&P 500 boards impose mandatory term limits, with most of those set at 15-20 years
In this 19-minute episode of the “Women Governance Trailblazers” podcast, Courtney Kamlet & I interviewed Fenwick’s Dawn Belt. Among other roles, Dawn is a Partner in Fenwick’s corporate group, co-leader of the firm’s Startup & Venture Capital Practice Area, co-author of Fenwick’s annual board diversity report, and spends significant time working to enhance diverse leadership at top tech companies. Listen to hear:
1. Predictions on where board diversity practices and disclosures will go in the next 5 years, in light of the current discourse on diversity and ESG
2. Diversity trends at executive and management levels
3. Common traits among women who are successfully leading Silicon Valley companies
4. The most important governance risks that tech companies are facing right now
5. What Dawn thinks women in the corporate governance field can add to the current conversation on the role of corporations in society
If there are “women governance trailblazers” whose career paths and perspectives you’d like to hear more about, Courtney and I always appreciate recommendations! Shoot me an email at liz@thecorporatecounsel.net.
Earlier this year, the Delaware Chancery Court allowed a claim to proceed against an officer that was premised on alleged oversight failures that caused a breach of their duty of loyalty. This is a big deal because it’s the first time the court has applied Caremark duties to an officer.
This Sidley memo suggests action items for companies & officers to ensure that those individuals are aware of their duties – as agents & as fiduciaries – so that they are getting info to the board that allows directors to perform their own roles effectively, and also so that the officers aren’t acting (or failing to act) in a way that could result in personal liability. Here are the suggested action items for companies:
– Consider providing officer training covering officer fiduciary duties and officer responsibilities as agents of the corporation.
– Include real-world scenarios and Q&As to help officers understand their duties in practice.
– Ensure officers know when and how to report up regarding “red flags.”
– Because officers’ duty of oversight is context-driven, ensure that roles and responsibilities are clearly defined and understood, both by the board and by management.
– Consider whether the processes for developing board materials is sufficiently robust to cover major areas of potential risk and which officers should regularly report to the board.
– Ensure that board materials and minutes reflect that the board has been informed of potential risks, how they are addressed and which officers are responsible.
– If permitted under applicable law (as in Delaware since 2022), consider amending the corporate charter to provide for officer exculpation.
Accounting is the latest profession where “nobody wants to work anymore.” That’s according to this WSJ article, which says that the shortage of good help is starting to show up in corporate disclosures as a material weakness. Here’s an excerpt:
Nearly 600 U.S.-listed companies of a total 7,359 reported material weaknesses related to personnel, typically in accounting or information technology, this year through June, down 5.2% from the prior-year period, but up 40.6% from the 2019 period, according to a review of filings by research firm Bedrock AI.
The article says that, while strained resources aren’t unusual at smaller companies, the difference now is that even large companies are affected – and it’s because they’re having trouble filling the roles, not because they’ve decided to eliminate positions. US-listed companies that are based in other countries are having a particularly difficult time retaining accounting personnel who are qualified to handle their complex issues. The article also predicts that the material weaknesses could lead to a wave of restatements.
On a somewhat related note, make sure to mark your calendar for our webcast, “Non-GAAP Developments: Enhancing Your Policies and Procedures” – next Thursday, July 20th, at 2pm Eastern. Hear from Honigman’s Mike Ben, Deloitte’s Pat Gilmore, Faegre Drinker’s Amy Seidel, and Covington’s Matthew Franker about non-GAAP developments and how you should be revamping your related disclosures, policies, procedures and controls. If you’re not already a member with access to this webcast, sign up online for a no-risk trial or email sales@ccrcorp.com.
Late last week, Nasdaq announced that its “Nasdaq 100” index will undergo a “special rebalance” – i.e., outside of its regular rebalancing schedule. The specific changes will be announced tomorrow and will take effect prior to the market open on Monday, July 24th.
This is the first-ever special rebalance for this particular index, which tracks 100 of the largest Nasdaq-listed domestic & international non-financial companies. As you might guess, this includes a lot of “Big Tech.” Here’s more detail from Reuters:
A special rebalancing, which is part of Nasdaq 100’s methodology to maintain compliance with a U.S. Securities and Exchange Commission rule on fund diversification, has taken place twice before, in 2011 and 1998, said Cameron Lilja, global head of index product and operations at Nasdaq.
The special rebalancing may be conducted at any time if the aggregate weight of companies, each having more than 4.5% weight in the index, tops 48%, according to Nasdaq. During the rebalancing, it is capped at 40%.
Nasdaq says that no companies will be added or removed from the index at this time – the rebalance will just adjust the relative weightings of companies in the index. The impact to companies in the index is that funds will need to buy & sell shares of the companies whose weighting changes. There’s some speculation that other indices will need to follow suit so that their customers don’t run afoul of the SEC’s diversification rule, but no announcements yet.
Earlier this week, I shared sample disclosures that could be used as a starting point for the new Item 408(a) info that will be required in the next Form 10-Q for most companies. Several interpretive questions are coming up as companies begin to apply this rule to their real-world circumstances. Here are a few common scenarios that our members have asked about on our Q&A Forum (#s 11,370, 11,514, and 11,715):
1. Would an ESPP would be considered a non-rule 10b5-1 trading arrangement that triggers disclosure under the new line item?
2. Would natural expiration of a 10b5-1 plan during the most recent quarter constitute a “termination” of a plan or arrangement that requires disclosure?
3. During the most recent quarter, an executive officer retired and subsequently adopted a Rule 10b5-1 trading plan. Does the disclosure apply only to plans adopted or terminated at a time when an individual was a current executive or director?
For each of these items, my educated guess – with significant assists from John and K&L Gates’ Ali Nardali – is that the SEC did not intend for the rule to pick these up (unless, as John noted in his response to #3, the facts and circumstances suggest that the timing of the plan’s adoption was intended to evade the disclosure obligation that would otherwise arise). However, the Staff hasn’t publicly weighed in. I am keeping my fingers crossed for “Christmas in July” – CDIs!