It’s one thing for an issuer to authorize a class of tokenized common stock, but as Commissioner Hester Peirce observed in a recent speech, things get more complicated once tokenized securities are distributed to the public – particularly if somebody other than the issuer of the securities is doing the tokenizing:
Market participants who distribute, purchase, and trade tokenized securities also should consider the nature of these securities and the resulting securities laws implications. For example, depending on the particular facts and circumstances, a token could be a “receipt for a security,” which is itself a security but is distinct from the underlying security held by the distributor of the token.
Alternatively, a token that does not provide the holder with legal and beneficial ownership of the underlying security could be a “security-based swap” that cannot be traded off exchange by retail persons. While blockchain-based tokenization is new, the process of issuing an instrument representing a security is not. The same legal requirements apply to on- and off-chain versions of these instruments.
This Skadden memo digs into some of the legal issues implicated by tokenization by third party distributors, including possible compliance challenges under the Investment Company Act, the potential need for distributors to register as broker-dealers, the possibility that the trading platform for tokenized securities might be a securities exchange, the need to comply with SEC & CFTC rules on swaps, as well as the potential applicability of anti-money laundering and know your customer regulations. So, while the SEC is willing to work with people on the issues associated with tokenization, there appears to be no shortage of issues to work through.
If one of your clients is considering joining a public company board, or if you work with a company that’s looking to add a new director, this Bryan Cave memo offers some helpful advice to prospective directors and companies about some of the areas that should be investigated during the due diligence process. Here’s the intro:
Retired senior executives often receive, or seek out, public company directorships as the next step in their journeys. Before accepting, they should carefully evaluate key areas to make sure they are prepared for the responsibilities and potential risks. Likewise, companies should consider assembling relevant briefing materials for potential candidates to streamline the process, potentially along with an NDA if they intend to share any confidential information, including by making directors or the auditors available for discussions.
Candidates should also be prepared to share relevant information with the company, or its search consultant, including consents to background checks and questionnaires.
Specific areas of inquiry for director candidates include legal and fiduciary duties, company health and reputation, board dynamics and governance, company strategy and outlook, board compensation, and time commitment, skills and experience fit. Topics for companies to explore include biographical data, independence and related party transactions, competitive overlaps, potential conflicts of interest, and legal and regulatory matters.
On Friday, the SEC announced that its Crypto Task Force was hitting the road to get input from people across the country in order to assist it in its efforts to establish a regulatory scheme for digital assets. The SEC’s website has a page devoted to the task force’s road trip, and here’s what it has to say about what it’s hoping to accomplish:
Following five insightful roundtables in Washington D.C. and hundreds of written submissions from industry participants across the country, the SEC’s Crypto Task Force is hitting the road and coordinating opportunities for additional stakeholders to meet with Commissioner Hester Peirce, who leads the Crypto Task Force.
The Crypto Task Force wants to hear from those who weren’t able to travel for the roundtables, and from voices that may have been historically underrepresented in other policymaking efforts. The Crypto Task Force is acutely aware that any regulatory framework will have far-reaching impact, so it wants to ensure that outreach is as comprehensive as possible.
Commissioner Peirce and members of the task force will be visiting several cities in the coming months, and they are particularly interested in hearing from representatives of crypto-related projects that have 10 or fewer employees and are less than two years old.
The page has information on the dates and locations of the various roundtables, as well as instructions on how to make a request to participate in the dialogue. Regrettably, there’s nothing in there about how to purchase tour merchandise. I also think the SEC missed an opportunity by not kicking off its announcement of the task force’s road trip with a classic intro like “It’s 106 miles to Chicago, we have a full tank of gas, half a packet of cigarettes, it’s dark and we’re wearing sunglasses… HIT IT!”
Speaking of SEC task forces, the agency also announced late Friday that it had established a task force to “spearhead the agency’s efforts to enhance innovation and efficiency in its operations through the responsible use of AI.” Valerie Szczepanik, the Director of the SEC’s Office of the Strategic Hub for Innovation and Financial Technology, has been named the SEC’s Chief AI Officer and will lead the task force.
A little over 10 years ago, the SEC adopted major changes in Regulation A in an effort to increase the viability of that exemption. A recent DLA Piper blog took a look at an SEC report issued earlier this year on the past decade’s experience with the revamped Regulation A. The blog says that the results are underwhelming, to say the least:
The SEC’s report on Regulation A covers offerings from June 19, 2015 (the date when the 2015 Reg A amendments went into effect) through December 31, 2024. During that time 1,618 total offerings were filed, which requires a publicly available disclosure, but only 1,426 were qualified by the SEC. This means nearly 15% of the filings did not complete the SEC review process, with most unqualified offerings subsequently abandoned despite being publicly announced. Of the offerings that were qualified, only 817 offerings reported raising money, meaning slightly over 50% of all attempted Regulation A offerings raised nothing, despite the cost of preparing and filing a detailed disclosure document with the SEC.
The blog says that even those companies that did raise money successfully under Reg A didn’t get close to the amount of funding they sought. According to the SEC’s report, the average qualified offering sought just under $20 million but raised only $11.5 million, while the median qualified offering aimed for $10 million and raised just $2.3 million. In light of those results, it’s not surprising that, as the blog points out, most issuers prefer Reg D:
Standing back, in the aggregate companies raised $9.4 billion through Reg A offerings over nearly a decade, for an average of less than $1 billion per year. To put that number into context, in just the year 2019, companies raised $1.5 trillion through just Rule 506(b) (not Section 4(a)(2), Rule 504, Rule 506(c) or other private structures).
The SEC’s Small Business Advisory Committee has been spending a lot of time on Reg A in recent months, and the results of the past decade suggest that a lot more time and attention will need to be devoted to Reg A if the SEC really wants to make it a viable alternative.
We’ve recently posted another episode of our “Understanding Activism with John & J.T.” podcast. This time, J.T. Ho and I were joined by Evercore’s Gloria Lin. We spoke with Gloria on a range of topics relating to the current activism environment. Topics covered during this 34-minute podcast include:
– Current activism environment and key campaign themes
– Evolving activist tactics
– Timing and number of activist settlements
– Director characteristics being targeted by activists
– Key lessons that you have learned from recent proxy fights
– Influence of macroeconomic conditions on recent activist campaigns
– Potential impact of recent events in the Middle East on activism trends
– Tips for vulnerable companies on how to prepare for activism today
This podcast series is intended to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We continue to record new podcasts, and they’re full of practical and engaging insights from true experts – so stay tuned!
To date, the DExit movement has mostly been “all hat and no cattle,” but that changed yesterday, when Andreessen Horowitz, one of Silicon Valley’s biggest names, announced that it was leaving Delaware, and recommended that others follow its lead:
It used to be a no-brainer: start a company, incorporate in Delaware. That is no longer the case due to recent actions by the Court of Chancery, which have injected an unprecedented level of subjectivity into judicial decisions, undermining the court’s reputation for unbiased expertise. This has introduced legal uncertainty into what was widely considered the gold standard of U.S. corporate law. In contrast, Nevada has taken significant steps in establishing a technical, non-ideological forum for resolving business disputes. We have therefore decided to move the state of incorporation of our primary business, AH Capital Management, from Delaware to Nevada, which has historically been a business friendly state with fair and balanced regulatory policies.
We could have made this move quietly, but we think it’s important for our stakeholders, and for the broader tech and VC communities, to understand why we’ve reached this decision. For founders considering a similar move, there is often a reluctance to leave Delaware, based in part on concerns for how investors will react. As the largest VC firm in the country, we hope that our decision signals to our portfolio companies, as well as to prospective portfolio companies, that such concerns may be overblown. While we will continue to fund companies incorporated in Delaware, we believe Nevada is a viable alternative and may make sense for many founders.
The statement goes on to make a tendentious argument in favor of abandoning Delaware for Nevada’s supposedly greener corporate pastures. But the merits of Andreessen Horowitz’s argument don’t really matter. What matters is that a16z is moving, and it’s sounding the clarion call for others to do so as well.
I’ve argued that the real threat to Delaware’s dominance isn’t a mass exodus of public companies, but the possibility that the Andreessen Horowitzs of the world might decide that other jurisdictions offered them a greater ability to control their post-IPO portfolio companies than Delaware does. Andreessen Horowitz’s move is the first example of this, but given the firm’s prominence, it’s unlikely to be the last. The 21st Century’s “race to the bottom” has officially begun.
We’ve previously blogged about some of the big picture issues associated with the use of AI tools in the boardroom, but this Debevoise memo focuses more narrowly on the use of AI to draft minutes, and what companies should consider when deciding whether to use AI tools for that purpose.
The memo discusses, among other things, confidentiality and cybersecurity concerns, state law notice and consent requirements that come into play when meetings are recorded, privilege issues, and implications for document retention policies. In his recent D&O Diary blog on this topic, Kevin LaCroix highlights another topic for consideration:
I have a particular concern here, and that has to do with the kinds of allegations plaintiffs’ lawyers raise in “duty to monitor” type cases. The plaintiffs lawyers will use books and records requests to obtain board minutes and will scour the records to see the extent to which the minutes show that the board discussed a “mission critical” topic.
The risk is that the minutes do not show the topic being discussed, allowing the plaintiffs’ lawyers to make the argument that “the board didn’t even discuss” the critical topic. The possibility of overly terse board minutes omit discussion of key topics is always present. I fear that with AI-generated minutes this risk is increased. Even if humans review the minutes, they may not spot the omission (as it is always harder to spot an omission than an error). This type of litigation risk highlights the need for heightened vigilance with respect to board use of AI tools.
Kevin cautions that all decisions concerning the use of AI tools in the boardroom should be informed by the need to ensure that boards are in the appropriate position to defend themselves in the event they face a subsequent lawsuit. As for me, when it comes to using AI to draft minutes, I think I’m aligned with the analog version of Bartleby the Scrivener – “I prefer not to.”
Check out our latest “Timely Takes” Podcast featuring Cleary’s J.T. Ho & his monthly update on securities & governance developments. In this installment, J.T. reviews:
– The SEC’s “Executive Compensation” Roundtable
– Director Interlocks Study
– PwC Board Study
– DEI Executive Order Updates
– DExit Scorecard Study
This month’s podcast includes a “bonus round” featuring J.T.’s thoughts on potential disclosure implications of the Iran conflict.
As always, if you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share in a podcast, we’d love to hear from you. You can email me and/or Meredith at john@thecorporatecounsel.net or mervine@ccrcorp.com.
The PCAOB recently issued a new Audit Focus report on engagement acceptance by accounting firms. Like most PCAOB publications targeted toward auditors, this one is also worth reading by public company audit committees and their advisors. The report covers a variety of issues that auditors should consider before accepting particular engagements. This excerpt lays out questions that auditors should consider in connection with any new engagement:
– Were there any recent changes in ownership, company management, the board of directors, or the composition of the audit committee related to the prospective engagement? What were the reasons for the changes?
– What are the qualifications of the company’s current management team and the audit committee associated with the prospective engagement, and do these qualifications enable them to execute their roles and responsibilities effectively?
– Has the audit firm considered any previous restatements or material weaknesses (e.g., nature of restatements, nature of deficiencies, whether they are long-standing, etc.)?
– Were there any risk factors that indicate that company management and those charged with governance lack integrity?
– Has the audit firm thoroughly considered whether its personnel are free from any obligation to, or interest in, the prospective engagement, company management, or the company’s owners?
– Is the audit firm independent or will the audit firm be able to become independent for the audit and professional engagement period?
– Does the audit firm have sufficient knowledge and experience or appropriate access to subject matter experts, including relevant industry expertise, to undertake the work?
– Was the company’s management or audit committee aware of any improper activities conducted by the former auditor during interim reviews or annual audits, including activities related to the supervision of the audit or to the engagement quality review?
– Was the company’s management or audit committee aware of any illegal acts identified by the predecessor auditor and not reported to the U.S. Securities and Exchange Commission or any other relevant regulators?
The report also addresses inquiries that an audit firm must make if a company is changing auditors and reviews certain responsibilities of successor auditors. Audit committees and their advisors likely will find the report helpful in identifying potential areas of concern to a new auditor in connection with its engagement and in developing strategies to address those concerns.
Last week, in Hanna v. Paradise and Skillz Inc., (Del. Ch.; 7/25), the Delaware Chancery Court refused to dismiss insider trading allegations against corporate insiders arising out of their sales of company stock in a public offering conducted during a blackout period. mandated by the company’s insider trading policy. The plaintiff alleges that the company failed to disclose material negative information about its performance of which the board was aware until after the offering, which permitted insiders to sell their shares in the offering at an inflated price.
This case doesn’t involve a 10b-5 claim; instead, it’s a so-called “Brophy claim” alleging that the defendants’ actions involved a breach of fiduciary duty. The lawsuit was filed as a derivative action, so this decision focuses on issues like demand futility and director independence and does not address the substance of the plaintiff’s allegations. Chancellor McCormick declined to dismiss the case, so the possibility exists that she may address some of the more interesting issues raised by the case in subsequent proceedings.
Even if the Chancellor doesn’t address those issues, the case gives me an excuse to plug our upcoming “Securities Offerings During Blackout Periods” webcast – which I assure you will focus on the substantive issues surrounding a decision to move forward with a public offering during a blackout period.
