That was fast. On Friday, Reuters and other sources reported that the SEC rejected the NYSE’s proposed rule change that would have permitted companies to sell newly issued primary shares via a direct listing – which had been submitted the week before.
Broc just blogged last week about the proposal being somewhat controversial. We aren’t sure what aspect of it prompted the rejection – but it’s not uncommon for these types of things to go through a few iterations and this Wilson Sonsini memo speculates that perhaps additional SEC rulemaking is necessary to make primary listings possible. The NYSE says it’s continuing to work with the SEC on a “direct listing product” – so it’s probably not the last we’ll hear of this path to going public.
Direct Listings: Nasdaq’s “Resale” Rule Extended to Its Global & Capital Markets
Last week, the SEC approved this recent Nasdaq proposal that will allow “resale” direct listings on the Nasdaq Global Market and the Nasdaq Capital Market – an extension of an already-existing rule that allows these types of direct listings on the Nasdaq Global Select Market.
This Wilson Sonsini memo summarizes the final rule – and explains how the valuation parameters for companies listing shares on Nasdaq’s Global and Capital Markets differ slightly from what applies to the Nasdaq Global Select Market.
Nasdaq Proposal: Excluding Restricted Shares from “Publicly Held” Calculation
The exchanges have been busy. A couple weeks ago, Nasdaq filed this rule proposal that would require listed companies to provide Nasdaq with info about the number of their non-affiliate shares that are subject to trading restrictions – e.g. due to lockups or standstills, private offering restrictions, etc. – if the exchange observes unusual trading activity that implies limited liquidity.
Under the proposed rule, Nasdaq could also halt trading in connection with the request and could require companies with inadequate “unrestricted public float” to adopt a plan to increase the number of unrestricted shares. Nasdaq already has a similar rule for initial listings, but this would extend the concept to continued listing rules.
The SEC posted the rule for comment last week, so we likely won’t know for at least a couple of months whether this rule will be approved in current form or at all.
Yesterday, Corp Fin unveiled its “Shareholder Proposal No-Action Responses Chart” – and posted the first “informal” no-action response under its new process for Rule 14a-8. DLA Piper’s Sanjay Shirodkar shared this Staff email that accompanied the response:
The staff completed its review of the company’s submission. Our response will be posted after 4:30 PM this afternoon in our 2019-2020 Shareholder Proposal No-Action Responses Chart, which is available on our website at https://www.sec.gov/divisions/corpfin/cf-noaction/14a-8.shtml. Copies of all correspondence relating to this submission will be made available at the same address after a short delay. If you have any questions, please call the Office of Chief Counsel in the Division of Corporation Finance at (202) 551-3520.
We also held a big webcast on this topic just yesterday – “Shareholder Proposals – What Now?” – with Corp Fin’s Chief Counsel David Fredrickson, Davis Polk’s Ning Chiu, Morrison & Foerster’s Marty Dunn and Gibson Dunn’s Beth Ising. If you missed it, the audio archive is already available – and the transcript should be coming a week or so after Thanksgiving.
“Say” Earnings Calls: Not Just For Retail Anymore!
We’ve blogged a couple of times about the “Say” platform that allows shareholders to submit questions during earnings calls, investor days, webinars and annual meetings. Originally, Say focused on increasing retail participation in these events – but it recently announced full access to its Q&A polling for institutional investors as well.
Say also announced that it would collaborate with “Just Capital” on a new type of “shareholder engagement” platform – quarterly calls that allow CEOs to speak with investors about ESG & “stakeholder” value. Last week, Paypal’s CEO broke ground as the first participant.
State “Securities Act” Litigation: Another One Bites the Dust
A few months ago, I blogged about a ’33 Act case being dismissed from state court in New York – offering some hope to companies who are worried about a deluge of state litigation due to the Supreme Court’s 2018 Cyan decision. This D&O Diary blog from Kevin LaCroix recounts another story of hope – this time, a recent dismissal in Connecticut. Here’s the takeaway:
These various dismissal motions rulings are of course themselves without precedential value and are subject to appeal. However, one can hope that these rulings may send a message that the plaintiffs should reconsider whatever perceived advantages they may think they have in proceeding in state court rather than federal court.
Unfortunately, despite these rulings, Cyan still creates significant risks for companies. This blog gives a real-life, recent example of a company facing a heap of lawsuits on the heels of its IPO. And because simultaneous state & federal securities lawsuits can’t be consolidated, it’s extra messy. Kevin notes that Congress could fix the problem by making a “simple” tweak to Section 22 of the ’33 Act that eliminates concurrent state court jurisdiction…
I’m very excited to announce that Lynn Jokela has joined us as an Associate Editor for our sites. Lynn has spent the last 11 years in the corporate secretary’s group of a Dow 30 company, following a stint in private practice and a prior career in finance & business. She brings tons of practical experience on all things “corporate & securities” and will be a fantastic addition to our team. Her email address is included in her bio if you want to drop her a line – and she’ll be blogging soon enough!
Transfer Agents: Market Share Leaders
A recent “Audit Analytics” blog highlights current market share leaders among transfer agents. Overall, not much has changed:
Since 2012, the market share for transfer agents engaged by active SEC registrants has remained fairly stagnant. This year proves to be no different; the same five transfer agents we have seen in the top for the past several years still reign. In fact, four of the five have managed to slightly increase their respective market share compared to last year’s results.
The exception, Wells Fargo Bank NA/TA, has shown an expected decrease in market share since our last analysis. As noted last year, Wells Fargo Bank sold its Shareowner Services to Equiniti Trust Co. (part of Equiniti Group plc). This may also explain the increase in market share for the non-top five transfer agents (Other), but only time will tell.
For more color on the industry players – and helpful new offerings by the top transfer agents – check out page 5 of the latest edition of Carl Hagberg’s “Shareholder Service Optimizer.” Carl notes that the market seems ripe for major comparison shopping…
Filing Fees: SEC Unveils New Template
Filing fees: they seem like such an easy task – until one of the 18 people involved in this “game of telephone” drops the ball on the required info. That’s why the SEC recently announced a new pre-populated “FedWire” template.
To make sure all necessary info is included – and avoid filing delays – the Commission is encouraging all companies to use the template when they submit info to their banks to initiate FedWire payments.
We’re very excited to have David Fredrickson – Corp Fin’s Chief Counsel – joining our other esteemed panelists on our webcast tomorrow: “Shareholder Proposals – What Now?” So tune in to hear David – along with Davis Polk’s Ning Chiu, Morrison & Foerster’s Marty Dunn and Gibson Dunn’s Beth Ising – discuss Corp Fin’s new approach for processing shareholder proposal no-action requests, what’s new due to Staff Legal Bulletin 14K and the potential impact of the SEC’s new 14a-8 rulemaking proposal. Don’t miss it!
“ESG” Funds: What’s in a Name?
Regular readers of this blog know that we write more than we want to about the rise of “responsible investing” – e.g. just yesterday. It’s not that we’re opposed to the trend, we just question how meaningful it is. Incidentally, that’s also what’s frustrating people who want it to grow faster.
But here’s the deal: investors want to feel good – but in the end, they also want their returns to match what they’d get by tracking a broad market index. The funds that meet those dual desires end up attracting the most cash, even though some of the “cleaner” funds have significantly outperformed the competition in recent years. This is America! It’s all about marketing.
That’s why, as this WSJ article points out, it’s pretty common for “sustainable funds” to invest in fossil fuel companies (the tagline of the article is that “8 of the 10 biggest US sustainable funds invest in oil & gas companies”). And if that still seems odd to you, the reconciling point is that they invest in the companies with the highest ESG ratings in their sectors – the “most sustainable” fossil fuel companies, if you will.
So when it comes to attracting ESG dollars, the key appears to be outperforming your industry peers – or producing the most information, as Doug Chia suggests. And the Journal explains why that’s unlikely to change any time soon:
Energy shares have often been among the few sectors to reliably produce gains—making them an important group for asset managers. That is especially true for asset managers whose products are aimed in part at institutional investors, which often have less room to miss their target returns. Also, an oil company that scores poorly on one element of ESG—say, the “E”—might do well on the other two elements, meriting its inclusion in a fund.
Transcript: “Sustainability Reporting – Small & Mid-Cap Perspectives”
We’ve posted the transcript for our recent webcast: “Sustainability Reporting – Small & Mid-Cap Perspectives.”
Recently, the “Governance & Accountability Institute” announced that 60% of the Russell 1000 are now publishing sustainability reports. The top half of that index aligns with the S&P 500 – where sustainability reporting has become mainstream – and 34% of the smaller companies have picked up the practice too. Here’s some other takeaways:
– Of the 60% of Russell 1000® companies that report, 72% were S&P 500® companies – and 28% were from the second half of companies in the index
– Of the 40% of Russell 1000® companies that do not report, 83% were the smaller half of companies by market cap – while only 17% of the non-reporters were S&P 500® companies
Like just about everything, this has become a political issue too. This Stinson blog reports that a right-wing org is asking the SEC to prohibit companies from making “materially false and misleading claims and statements related to global climate change.” Meanwhile, in the more mainstream world, the US Chamber is now focusing on sustainability disclosure – and has now released its own set of “best practices” for voluntary ESG reporting.
“Responsible Investors” Say ESG Isn’t a Fad
You have to wonder what’s driving sustainability reporting by smaller companies. They’re less likely than large companies to be doing it in response to proposals from “activist” shareholders. But there are also shareholders whose attention companies actually want to attract. A recent SquareWell Partners study says that providing ESG info is the “price of entry” for companies of all sizes that want to add big investors to their rosters – or keep them there. Here’s a few key findings:
– Nearly all of the top 50 asset managers (managing $50.6 trillion) are signatories to the UN “Principles of Responsible Investing” – committing to incorporate ESG factors into investment & ownership decisions
– Oddly, the Global Sustainable Investment Initiative reports “only” $30.7 trillion of sustainably invested assets last year – so it’s possible the PRI signatories aren’t following through on the principles
– One-third of the asset managers clearly disclose their approach to integrating ESG factors into fixed income;
– 64% of the asset managers are signatories to the recommendations of the Task Force on Climate-related Financial Disclosure (TCFD);
– Close to 80% of the asset managers engage with portfolio companies on ESG issues;
– 68% of the asset managers use two or more ESG research and data providers;
– Only 20% of the asset managers have a low receptivity to activist demands; and
– A quarter of the asset managers have gone public with their discontent at portfolio companies since January 2018.
For even more on this topic, see Aon’s 28-page report on responsible investing trends. Also check out this recap from Cooley’s Cydney Posner about a recent meeting of the SEC’s Investor Advisory Committee – where reps from AllianceBernstein, Neuberger Berman, SSGA and Calvert discussed how they’re using ESG data for all their portfolios and (for the most part) called for the SEC to guide companies toward more standardized disclosure.
On the debt side, take a gander at this recent PepsiCo announcement about a $1 billion “green bonds” offering where the proceeds will be used to finance the company’s “UN Sustainable Development Goals.” This Moody’s alert says that green bond issues could top $250 billion this year – much higher than what was originally forecast – and walks through some of the global trends. To keep track of memos on this growing trend, we’ve added a new “sustainable finance” subsection to our “Debt Financings” Practice Area.
E&S Risk Factors on the Rise
This NACD blog analyzes the increasing prevalence of “E&S” risk factors. Here’s what’s trending on climate change:
Thirty percent of Russell 3000 companies discussed climate change as a risk in their 10-K statement, with only 3 percent of companies discussing climate change risk in the MD&A section. Predictably, the energy and mining sector had the most disclosure on climate change risk. Retail and consumer sector companies, which are not thought of traditionally for being exposed to climate change risk, also had a high rate of disclosure, citing damage to their supply chain and access to raw materials as risks.
Disclosures for every sector focused on the risk of regulatory and market responses to climate change, including legislative regulation of air emissions, caps, and carbon taxes. Other companies were more detailed in their discussion of climate change risk as it relates to their specific operations, such as Monster Beverage Co.’s 10-K, which states that, “In addition, public expectations for reductions in greenhouse gas emissions could result in increased energy, transportation and raw material costs, and may require us to make additional investments in facilities and equipment. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.”
There’s been some back & forth over “who writes the rules” when it comes to dual-class shares: candidates for that job have included indexes, exchanges and institutional investors (whose objections to an extreme variation of this structure was one of many factors that played a role in the fall of WeWork). In a recent speech, the SEC’s “Investor Advocate” – Rick Fleming – even acknowledged that investors are part of the problem – but also called for heightened SEC disclosure requirements for dual-class shares and intervention from stock exchanges.
Now, CII is also moving the issue to the state level – via this letter to the Delaware State Bar Association. Here’s an excerpt (and here’s a Wilson Sonsini blog that responds to CII’s proposal):
A proposed new Section 212(f) of the DGCL is attached as Annex A to this letter. Pursuant to that language, no multi-class voting structure would be valid for more than seven years after an initial public offering (IPO), a shareholder adoption, or an extension approved by the vote of a majority of outstanding shares of each share class, voting separately, on a one-share, one-vote basis. Such a vote would also be required to adopt any new multi-class voting structure at a public company. The prohibition would not apply to charter language already existing as of a legacy date.
Non-GAAP: How to Avoid Staff Scrutiny
Last month, I blogged that this year’s “Top 10 List” for Corp Fin comments continues to include non-GAAP – no surprise there. This PwC memo highlights the 5 most common non-GAAP issues that draw Staff scrutiny:
1. GAAP measure not given enough prominence
2. Reconciliation between GAAP and non-GAAP measures is missing or does not start with the GAAP measure
3. Non-GAAP measure is not presented consistently between periods or the reason for changing a non-GAAP measure is not disclosed
4. Management’s explanation of why a non-GAAP measure is useful to investors is inconclusive
5. Use of an individually–tailored accounting principle (a company cannot make up its own GAAP)
We’ve blogged before about that last one – it’s a newer area of comment so there’s still some confusion about what it means. For those who subscribe to “The Corporate Counsel” print newsletter, we’ll take a deep dive into this topic in the forthcoming November-December Issue.
“Investors’ Exchange”: RIP
Three years ago, John blogged about a new national securities exchange, “IEX” – which was unique in that it wasn’t operated by Nasdaq or NYSE. Its run was short-lived – this WSJ article reports that it decided to exit the business after its only listed company went back to Nasdaq. But other new competitors remain optimistic – there are at least three hoping to break into the market next year…
In other “exchange” news, last week Nasdaq filed a rule change to modestly increase annual listing fees. Starting January 1st, fees for most equities will go up by about $1-$3k…
The gloves are off. Yesterday, ISS announced that it had filed this lawsuit against the SEC – which challenges the Commission-level guidance that was issued back in August. As Broc blogged earlier this week, CII had already sent a couple of comment letters to the SEC to complain about that guidance. This lawsuit also comes on the heels of the SEC announcing that it will hold an open Commission meeting next week to propose rule changes for proxy advisors.
These are the ISS allegations (also see this Cooley blog – and this Twitter thread from Wharton Prof David Zaring that speculates this case may be used as part of the bigger picture pushback on regulatory guidance that we’ve been seeing):
– The guidance exceeds the SEC’s statutory authority under Section 14(a) of The Securities Exchange Act of 1934 and is contrary to the plain language of the statute; the provision of proxy advice is not a proxy solicitation and cannot be regulated as such
– The guidance is procedurally improper because it is a substantive rule that the SEC failed to promulgate pursuant to the notice-and-comment procedures of the Administrative Procedure Act
– The guidance is arbitrary and capricious because, even though it marks a significant change in the regulatory regime applicable to proxy advice, the SEC has denied that it is changing its position at all. The agency has thus flouted the basic requirement of reasoned decision-making that it at least display awareness that it is changing its position
Director Survey: “Collegiality” & “ESG” Can Go Too Far
PWC is out with its annual survey of 700 directors. The main theme is that “collegiality” remains highly valued and important – but it can go too far if it keeps directors from speaking up or pursuing necessary refreshments. Here’s the key findings:
– 49% of directors (privately) say that one or more colleagues should be replaced (a record number)
– 43% of directors say it’s difficult to voice a dissenting view in the boardroom
– 72% of boards are conducting performance assessments (up from 49% in 2016) – but most focus on adding expertise or diversity, rather than counseling or not re-nominating underperforming incumbents
The survey also says that some directors are growing weary of diversity & ESG attention:
– After years of steadily climbing, the number of directors saying board diversity is “very important” fell by 10%
– 83% of directors say they don’t support state law diversity mandates – but around half say they support policies of including diverse candidates in recruitment slates
– 56% of directors say that investors devote to much attention to E&S issues (however, part of the frustration is that there’s still a lot of confusion among directors about what issues fall into this category)
– An increasing number of directors say that the board has a role in corporate culture (but still not as much as upper & middle management)
See this HBR article for a take on working with the “5 archetypes” of director approaches to ESG – the deniers, the hardheaded, the superficial, the complacent, and the true believers.
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This 91-page report from EY – and the related 7-page summary – say that Corp Fin issued 34% fewer comment letters last year. While that was partially due to the long-lasting government shutdown, it follows a 25% drop in the prior year – so there appears to be a trend. Not surprisingly, revenue recognition & non-GAAP were the most frequent comment topics. Here’s the full top 10 (see the report for example comments in each category):
1. Revenue recognition
2. Non-GAAP financial measures
3. MD&A (in order of frequency: (1) results of operations (20%), (2) critical accounting policies and estimates (10%), (3) liquidity matters (8%), (4) business overview (6%) and (5) contractual obligations (2%) – many companies received MD&A comments in more than one category)
4. Fair value measurements (including comments on fair value measurements under Accounting Standards Codification 820 – as well as fair value estimates, such as those related to revenue recognition, stock compensation and goodwill impairment analyses)
5. Intangible assets and goodwill
6. Income taxes
7. State sponsors of terrorism
8. Segment reporting
9. Acquisitions and business combinations
10. Signatures/exhibits/agreements (new to this year’s “Top 10”)
Foreign Nations Might Be Delaware’s New Competition
While you may think of Nevada – or even federal law – as Delaware’s primary competitor in the “corporate law” space, a forthcoming law review article says that non-US jurisdictions are the real threat. Here’s an excerpt:
While Delaware continues to dominate the market with 48.1% of US-listed companies, foreign nations now account for 13.4% of incorporations – more than double the 5.5% of US-listed companies incorporated in Nevada, which has been identified as the only other state besides Delaware actively vying to draw corporations that physically operate outside of its borders.
As this Article will show, offshore incorporation havens in recent decades have built sophisticated legal infrastructures that enable them to compete with Delaware. For one, they have attracted a network of elite foreign lawyers who help lawmakers in these jurisdictions draft “cutting edge” corporate law statutes. These lawmakers also rely heavily on incorporation fees for government revenues, allowing them to credibly commit to retaining laws that are attractive to the private sector.
Because the population of offshore incorporation havens tends to be a fraction of even sparsely populated states in the United States (for instance, as of 2019, the population of the Cayman Islands is 59,613 compared to 961,939 in Delaware and 2,998,039 in Nevada), these jurisdictions can enact legislation swiftly in response to private sector demand. They also do not confront the type of democratic accountability facing large nation states (or large states like New York or California), in part because they specialize in producing laws for corporations that do not physically operate within their territories.
Delaware’s judicial system is often pointed to as a competitive advantage over other states. These jurisdictions compete not by carbon copying Delaware’s judiciary, but rather by offering dispute resolution for a functionally similar to modern commercial arbitration. Like arbitration, courts in offshore incorporation havens swiftly resolve disputes without juries. Judges serving in these courts, like arbitrators, are credentialed business law jurists including partners at major international law firms who fly in from overseas to preside over cases ad hoc. Many legal proceedings take place in secret, and full-length opinions are frequently unpublished or available only to insiders.
I’m admittedly biased due to interning in Wilmington for a Delaware Justice back in the day, but isn’t transparency & predictability still a pretty big advantage? I guess if you can opt out of derivative suits & fiduciary duties, which is the case with many of these incorporation havens, that may matter less.
Although we haven’t yet seen a Sunshine Act notice from the SEC, the Financial Times is reporting that the SEC could propose new rules for proxy advisors & shareholder proposal thresholds as soon as next Tuesday. For now, here’s what’s being reported as part of the proposal:
– Proxy advisors would be required to give companies two chances to review proxy voting materials before they are sent to shareholders
– Shareholder proposal resubmission threshold would increase to 6% approval in year one, 15% in year two and 30% in year three – if a shareholder proposal doesn’t hit those thresholds, companies would be able to exclude proposals on the same subject matter for the next three years
These things are always very speculative – both the substance & timing could change, and nothing’s certain till we see the proposal. The FT article emphasizes that too:
The Commission is expected to vote to put the changes out for comment on November 5, according to the people, who cautioned that the plans and the timing were still in flux and could change before the vote next month.
If the proposal is issued, you can bet we’ll be covering it in our upcoming webcast – “Shareholder Proposals: What Now” – on Thursday, November 21st. In that program, Davis Polk’s Ning Chiu, Morrison & Foerster’s Marty Dunn and Gibson Dunn’s Beth Ising will also be discussing Corp Fin’s new approach for processing shareholder proposal no-action requests and the expected impact of Staff Legal Bulletin 14K.
“Harmonization” of Private Offerings: NASAA Comments on SEC’s Concept Release
Right now, a “requirement” for relying on the Reg D private placement exemption is to file a Form D within 15 days of the date that securities are first sold under the exemption. “Requirement” is in quotes because filing a Form D isn’t a condition to the availability of the federal exemption – but it could disqualify the company from using the exemption in the future, and some state enforcement agencies say that a delinquent Form D kills the preemption the company would otherwise enjoy from state law registration requirements.
So it’s interesting that in its recent comment letter to the SEC’s “Concept Release on Harmonization of Securities Offering Exemptions,” the North American Securities Administrators Association – otherwise known as NASAA, the organization that represents state securities regulators – is recommending an amendment to Regulation D that would require pre-issuance as well as post-closing Form D filings. This Allen Matkins blog gives more details (and here are all the comments the SEC has received so far):
NASAA argues that a pre-issuance filing requirement will “alert regulators that the offering is forthcoming and to provide an opportunity for regulators to investigate the offering if any information in the Form D raises concern”. Form D was originally presented as a tool to “collect empirical data which will provide a basis for further action by the Commission either in terms of amending existing rules and regulations or proposing new ones”. It has evolved, however, into an enforcement tool for securities regulators. See “Is Form D Afflicted With Mission Creep?“
NASAA is also recommending amendments to the definition of “accredited investor” that would raise individual net worth & income requirements, and preserving Rule 504 in its current form. Our “Reg D Handbook” covers all the ins & outs of the current exemption – including the current Form D filing requirements and related “Blue Sky” impact.
“Climate-Change Accounting”: Not Adding Up?
Last week, as this WSJ article reports, Exxon began defending itself in New York state court about whether it improperly accounted for the cost of climate change regulations (they were also sued in Massachusetts). The NY suit was brought under New York’s sweeping Martin Act and arises out of a 4-year investigation – so of course there’s some controversy. According to the article, Exxon has denied wrongdoing – and said a reasonable investor wouldn’t expect to know these details. But then there’s this unrelated Reuters article about how investors want more transparent “climate-change accounting” so they can better understand & price risks. Here’s an excerpt:
Using a broad measure, global sustainable investment reached $30.1 trillion across the world’s five major markets at the end of 2018, according to the Global Sustainable Investment Review. This equates to between a quarter and half of all assets under management, due to varying estimates of that figure.
Condon said most investors were still more focused on returns than wider sustainability criteria but were becoming concerned that companies may expose them to possible future climate-related financial losses.
To try to price risk, the world’s biggest financial service providers are investing in companies which provide ESG-related data. This year alone, Moody’s bought Vigeo Eiris and Four Twenty Seven, MSCI bought Carbon Delta and the London Stock Exchange bought Beyond Ratings. S&P acquired Trucost in 2016. Independent climate risk advisors Engaged Tracking say they attracted two-thirds of their clients in the past year. All six companies provide data, assessments and consulting on the climate exposure of companies or bonds.
To reiterate, these investors weren’t reacting to Exxon’s disclosure specifically, or its court case. And we obviously don’t know what’ll happen there. But if there’s a scale weighing the pros & cons of a more standard disclosure framework for environmental costs & risks, the specter of this type of litigation – and investor appetite – seem to drop in on the “pro” side…
When I first saw this announcement from the SEC’s Enforcement Division about an emergency action to halt an unregistered ICO, I brushed it off as a takedown of yet another fraudulent “crypto” company. But this column from Bloomberg’s Matt Levine points out that this one is different.
In Matt’s words, the company here was doing the “best-practices-y thing” that had been blessed by several law firms. Its offering was structured as a “Simple Agreement for Future Tokens” – as John blogged last year, that’s an approach – based on the popular “SAFE” template for startup financing – that was starting to take off for Reg D token deals. Matt’s explanation of how it works:
1. Sell something—call it a “pre-token”—to accredited investors (institutions, venture capitalists, etc.) to raise money to build your platform. Concede that the pre-token is a security.
2. When the platform is built, it will run on a token, a cryptocurrency that can be used for transactions on the platform and that is not a security.
3. At some point — at or after the launch of the platform — the pre-token (the security) flips into the token (the non-security), and all the people who bought pre-tokens to finance the platform now have tokens to use on it. (Or to sell to people who will use them.)
This seems to honor the intention of securities law—you’re not selling speculative investments to retail investors to fund the development of a new business—while also honoring the intention of the ICO: Your platform is financed (indirectly, eventually) by the people who use it; the people putting up the money do so not in exchange for a share of the profits but for the ability to participate in the platform itself. In this model the pre-token will be called something like a “Token Purchase Agreement” or “Simple Agreement for Future Tokens”: It’s a security wrapper for the eventual utility token.
Unfortunately, the SEC’s complaint took issue with the fact that when the “pre-tokens” here were scheduled to flip into tokens, there would be no established ecosystem for them to trade as currency. Which would seem to be an obvious side-effect of financing a new form of cryptocurrency?
We’re not really sure what to make of this yet – there were some reports that early investors in this offering were flipping their tokens right away, which would be a problem in the SEC’s view. Matt also suggests that maybe the SEC would be more amenable if the pre-tokens didn’t flip until the ecosystem is running robustly. But probably not. John blogged recently on “The Mentor Blog” about how to do a Reg A token offering. So perhaps anyone considering an ICO should take a look at that…
“Reg D” ICOs: What’s the Harm in Trying?
This MarketWatch article notes there’s been a steep drop-off in the number of Reg D token offerings this year. If the Enforcement Division taking issue with a SAFT isn’t enough to put companies off that approach, keep in mind that the remedies in these actions go beyond just halting the current offering:
Until September 30, 2019, SEC enforcement actions in the crypto industry conveyed a consistent message: most crypto is a security, and if a token issuer does not follow the registration requirements of the 1933 Act, the issuer would face significant consequences in the form of substantial penalties, a mandated rescission offer to US investors, a requirement to register the tokens under Section 12(g) of the 1934 Act, and bad actor disqualifications preventing the issuer from future Regulation A and Regulation D offerings.
That’s the intro from this Wilson Sonsini memo – but it does note a recent “aberration” on the remedies front:
On September 30, the SEC announced a settlement with Block.one that did none of these things. Despite finding that Block.one issued tokens that were securities in the United States without complying with registration requirements of the 1933 Act, the SEC: imposed a financial penalty on Block.one that was minor in the context of the total size of Block.one’s capital raise; did not require Block.one to make a rescission offer to investors; did not require Block.one to register its tokens under the 1934 Act; and did not impose bad actor disqualifications under Regulation A and Regulation D.
And, as discussed below, the Block.one Settlement Order omitted any mention of key factual information necessary to support the SEC’s conclusion that the tokens were in fact securities. Equally surprising, the SEC did not address, in any respect, whether new tokens issued being used on a blockchain supported by Block.one are securities, and the SEC took no action (and offered no discussion) with respect to the issuance of those tokens.
What are we all to make from these mixed messages? This Eversheds Sutherland memo says that the most we can take away is that the SEC is evaluating facts in settlement proceedings on a case-by-case basis. If you’re doing an unregistered token offering right now, go document some good facts!
We just wrapped up “Lynn, Borges & Romanek’s 2020 Executive Compensation Disclosure Treatise” — and it’s been sent to the printers. This Edition includes updates to disclosure examples, info about the evolving link between ESG topics & executive pay, and a brand new chapter on hedging policy disclosure. All of the chapters have been posted in our “Treatise Portal” on CompensationStandards.com.
How to Order a Hard-Copy: Remember that a hard copy of the 2020 Treatise is not part of a CompensationStandards.com membership so it must be purchased separately. Act now to ensure delivery of this 1710-page comprehensive Treatise as soon as it’s done being printed. Here’s the “Detailed Table of Contents” listing the topics so you can get a sense of the Treatise’s practical nature. Order Now.
