February 02, 2018

MONTH-IN-BRIEF: Securities Law

Cathy Dixon, Lisa R. Stark

Securities Regulation

SEC Nixes 1940 Act Registration of Cryptocurrency-Related Funds for Now

By Steven Quinlivan, Stinson Leonard Street LLP

In a letter to representatives of the Investment Company Institute and the Securities Industry and Financial Markets Association, the SEC staff indicated it would not be receptive to 1940 Act registration of cryptocurrency-related funds until significant outstanding questions concerning how funds holding substantial amounts of cryptocurrencies and related products would satisfy the requirements of the 1940 Act and its rules. Some of the issues raised by SEC staff include:

  • How would funds develop and implement policies and procedures to value, and in many cases “fair value,” cryptocurrency-related products?
  • How would funds’ accounting and valuation policies address the information related to significant events relevant to cryptocurrencies? For example, how would they address when the blockchain for a cryptocurrency diverges into different paths (i.e., a “fork”), which could result in different cryptocurrencies with potentially different prices?
  • What steps would funds investing in cryptocurrencies or cryptocurrency-related products take to ensure that they would have sufficiently liquid assets to meet redemptions daily?
  • In a recently issued statement, Chairman Jay Clayton noted that concerns have been raised that cryptocurrency markets, as they are currently operating, feature substantially less investor protection than traditional securities markets, with correspondingly greater opportunities for fraud and manipulation. How have these concerns informed your responses to the foregoing questions concerning, for instance, valuation and liquidity?
  • Have you discussed with any broker-dealers who may distribute the funds how they would analyze the suitability of offering the funds to retail investors in light of the risks discussed above?

SEC Staff Publishes Important Accounting and Disclosure Guidance Relating to the Tax Cuts and Jobs Act of 2017

By Cathy Dixon, Weil, Gotshal & Manges LLP

With the December 22, 2017, enactment of the federal Tax Cuts and Jobs Act (Tax Act), which became effective on January 1, 2018, came numerous questions for preparers of the financial statements that comprise a critical component of periodic reports and other documents filed with the SEC. The uncertainty arising from complicated statutory tax provisions that (among other things) reduce the corporate tax rate to 21 percent, create a territorial tax system, and impose a mandatory, one-time tax on foreign earnings (“deemed repatriation”) has been amplified for many calendar year-end companies by the speed with which the legislation was signed into law and the proximity of the enactment date to the December 31 fiscal year-end. To assist companies grappling with the immediate accounting and disclosure consequences of the Tax Act under considerable time pressure, the SEC staff published the following, two-pronged guidance on December 22, 2017:

Staff Accounting Bulletin (SAB) No. 118. Available here, SAB 118 addresses the application of relevant U.S. GAAP by companies preparing an initial accounting of the income tax effects of the Tax Act, under circumstances where a particular company “does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting under ASC Topic 740” by the time the financial statements for the reporting period that includes the December 22, 2017, enactment date are issued. In these situations, SAB 118 allows companies to use a more flexible “measurement period” approach that will expire on the first anniversary of the Tax Act (December 22, 2018).

New Form 8-K Compliance and Disclosure Interpretation (C&DI) 110.02. New Form 8-K C&DI 110.02, available here, clarifies how companies relying on the SAB 118 “measurement period” approach to income tax accounting should analyze the Form 8-K, Item 2.06 “material impairment” disclosure obligation relating to tax assets whose value may be affected under the new federal tax regime. In brief, a company’s re-measurement of a deferred tax asset to incorporate the effects of the Tax Act pursuant to SAB 118 does not constitute an “impairment” for purposes of ASC Topic 740 that would trigger a duty to disclose under Item 2.06. As noted in C&DI 110.02, however, those companies applying SAB 118 that conclude that a material impairment of a tax asset has (or may have) occurred during the reporting period solely as a result of the Tax Act’s enactment may defer disclosure of this impairment (or a provisional amount relating to a possible impairment) until the filing of its next periodic report, in reliance upon an instruction to Form 8-K. Put another way, this means that a similarly situated company could wait to disclose such impairment until it files its next annual report on Form 10-K or quarterly report on Form 10-Q (depending on when its fiscal year ends).

Private Equity and Venture Capital

Directly to a National Securities Exchange: Direct Listings Are an Attractive Alternative for Unicorns to a Traditional IPO

By Anna T. Pinedo, Morrison & Foerster LLP

The SEC’s Division of Corporation Finance’s new policy that essentially extends the confidential submission process to all issuers, while keeping the emerging growth company process unchanged, makes direct listings an attractive alternative to a traditional IPO for unicorns. The new policy also permits an issuer to submit for confidential review a registration statement filed for a class of securities under the Securities Exchange Act of 1934, such as one on Form 10 for a U.S. issuer or on Form 20-F for a foreign private issuer. An Exchange Act registration statement must be filed at least 15 days before it becomes effective. For certain large, privately held companies that have undertaken various rounds of private financings and may not have an immediate need to raise additional capital, a “direct listing” may be an attractive alternative to a traditional IPO.

Historically, there have not been many issuers that have undertaken a “Form 10 IPO” or “backdoor IPO,” but market dynamics have changed. However, for a unicorn, which has been able to raise capital in the private markets at attractive valuations, a direct listing may be a good alternative. A listing on a national securities exchange will provide much-needed liquidity for employees, early investors, and even venture capital and private equity sponsors. A unicorn, advised by financial intermediaries acting as financial advisers (not underwriters), likely will be able to attract the attention of additional or new institutional investors that might purchase its securities in the secondary market. These same financial intermediaries, or others familiar with the company, might provide research coverage following the listing of its stock on a securities exchange.

One cautionary note: At the 45th Annual Securities Regulation Institute held January 22–24, 2018, Division of Corporation Finance Director William Hinman said that the staff was considering whether some IPOs via stock exchange listings pursuant to the Securities Exchange Act of 1934 might be distributions for purposes of the Securities Act of 1933.

Chancery Court Finds that Founders and Venture Capitalists Are Not a Control Group

By Sophia Dai, Stroock, Stroock, & Lavin LLP and Lisa Stark, K&L Gates LLP

In van der Fluit v. Yates, C.A. No. 12553-VCMR (Del. Ch. Nov. 30, 2017), the Delaware Court of Chancery rejected the application of the entire fairness standard of review to plaintiff’s challenge to Oracle’s acquisition of Opower, Inc., a venture-backed company, which the plaintiff contended was an unfair deal orchestrated by a controlling stockholder. The acquisition was structured as a tender offer followed by a back-end merger. Although Opower had recently conducted an IPO, the company’s early venture-capital investors and founders collectively, but not individually, owned a controlling position in the company. Plaintiff sought the application of the entire fairness standard of review to the court’s review of the transaction on the basis that the company’s co-founders and two VC firms were a control group which extracted non-ratable benefits from the transaction. 

Plaintiff’s argument that the VC firms and founders constituted a collective control group relied on the argument that these early investors were connected in a legally significant manner because they were parties to an investor rights agreement and tender and support agreements. Because the investor rights agreement contained no voting, decision-making, or other agreements that bore on the transaction challenged, and the tender and support agreements merely reflected a “concurrence of self-interest” among the investors, the court declined to find the existence of a control group. However, the court also declined to find that the deferential business judgment standard of review applied to its review of the transaction under the Delaware Supreme Court’s decision in Corwin, due to material omissions in the tender offer documents. Accordingly, the court found that Revlon applied to plaintiff’s claims for breach of fiduciary duty, but dismissed plaintiff’s complaint for failure to plead non-exculpated claims against the Opower board.

Cathy Dixon

Partner; Weil, Gotshal & Manges LLP

Catherine Dixon is a partner in Weil’s Washington, D.C. office and a recognized authority on the federal securities laws, as amended over the past decade by the JOBS Act of 2012, the Dodd-Frank Act of 2010, and the Sarbanes-Oxley Act of 2002. Her practice encompasses public and private company disclosure advice, capital markets transactions (including public and private offerings), mergers and acquisitions, corporate governance and compliance-related matters. Ms. Dixon is a member of Weil’s Public Company Advisory Group.

Lisa R. Stark

Counsel, K&L Gates

Lisa Stark advises boards of directors, board committees, and significant stakeholders on fiduciary and statutory obligations and corporate governance and M&A related matters. She has over 15 years of experience in mergers and acquisitions, strategic investments, initial public offerings, proxy contests, and hostile takeovers. Ms. Stark also advises private equity and venture capital funds in connection with their investments in Delaware corporations.