It’s Back (Again): SEC Approves on Accelerated Basis NYSE Proposal Allowing Listing for Certain Non-IPO Offerings
By Ze'-ev Eiger, Morrison & Foerster LLP
On February 2, 2018, the SEC approved on an accelerated basis the NYSE’s proposal, as modified by Amendment No. 3, to change its listing qualifications to facilitate listings for certain non-IPO offerings. Section 102.01B of the NYSE Listed Company Manual (Section 102.01B) currently recognizes that some companies that have not previously registered their common equity securities under the Exchange Act, but which have sold common equity securities in a private placement, may wish to list those common equity securities on the NYSE at the time of effectiveness of a resale registration statement filed solely for the resale of the securities held by selling stockholders. Footnote (E) of Section 102.01B (Footnote (E)) currently provides that the NYSE will exercise its discretion to list these companies by determining that a company has met the $100 million aggregate market value of publicly-held shares requirement based on a combination of both (1) an independent third-party valuation of the company and (2) the most recent trading price for the company’s common stock in a trading system for unregistered securities operated by a national securities exchange or a registered broker-dealer (a Private Placement Market).
The proposal, as modified by Amendment No. 3, was filed on December 8, 2017: (i) eliminates the requirement in Footnote (E) to have a private placement market trading price if there is a valuation from an independent third-party of $250 million in market value of publicly-held shares; (ii) sets forth several factors indicating when the independent third party providing the valuation would not be deemed “independent” under Footnote (E); (iii) amends NYSE Rule 15 to add a reference price for when a security is listed under Footnote (E); (iv) amends NYSE Rule 104 to specify Designated Market Maker (DMM) requirements when facilitating the opening of a security listed under Footnote (E) when there has been no sustained history of trading in a private placement trading market for such security; and (v) amends NYSE Rule 123D to specify that the NYSE may declare a regulatory trading halt prior to opening on a security that is the subject of an initial pricing upon NYSE listing and that has not, immediately prior to such initial pricing, traded on another national securities exchange or in the over-the-counter market.
However, Amendment No. 3 notably revises the proposal, as amended by Amendment No. 2 filed on August 16, 2017, to eliminate proposed changes to Footnote (E) that would have allowed a company to undertake a direct listing (i.e., listing immediately upon effectiveness of an Exchange Act registration statement only, such as Form 10 or Form 20-F, without any concurrent IPO or Securities Act registration). This means that a direct listing will now require a company to either (1) file a resale registration statement for the resale from time to time of securities held by existing securityholders or (2) undertake a primary offering. Although this may limit the efficiency of a direct listing, the rationale for the change might be to ensure that there is a basis for Securities Act Section 11 liability to attach to the direct listing. In contrast, Nasdaq allows a direct listing without a concurrent IPO or Securities Act registration. The SEC has solicited comments on the proposal, as amended by Amendment No. 3, for submission within 21 days of publication in the Federal Register.
U.S. Supreme Court Decides the Scope of Dodd-Frank’s Whistleblower Protections
By Christopher Garcia, Adam Safwat, Agustina Berro and Calvin Lee, Weil, Gotshal & Manges LLP
In a unanimous opinion issued on February 21, 2018, the U.S. Supreme Court narrowed the scope of the anti-retaliation protections of the Dodd-Frank Act, holding that the protections extend only to employees who report alleged misconduct to the SEC and not to employees who report misconduct solely to management. The decision resolves a split between the Second and Ninth Circuits, which held that whistleblower protections apply to internal whistleblowers, and the Fifth Circuit, which limited whistleblower protections to employees who have made reports to the SEC. The Court’s decision is also a rejection of the SEC’s long-standing position that Dodd-Frank protects internal whistleblowers against retaliation.
In reaching its decision, the Court determined that the definition of “whistleblower” under Dodd-Frank “supplies an unequivocal answer” to the question of who is protected: “A ‘whistleblower’ is ‘any individual who provides . . . information relating to a violation of the securities laws to the Commission.’” The Court further concluded that this reading of Dodd-Frank is consistent with the statute’s purpose. The “core objective” of Dodd-Frank’s whistleblower program is “to motivate people who know of securities law violations to tell the SEC.” Thus, the Act’s “text and purpose leave no doubt that the term ‘whistleblower’” in the anti-retaliation provision “carries the meaning set forth in the section’s definitional provision.”
While the Court’s decision limits Dodd-Frank protections for whistleblowers, companies still must be cautious in their treatment of employees who report alleged misconduct internally. Employees who report misconduct internally are still protected from retaliation under SOX. Moreover, the decision makes clear that even if a company is unaware that an employee has reported to the SEC at the time it takes an adverse employment action against him or her (or is not motivated by the disclosure), the company may still be found to have violated Dodd-Frank’s whistleblower protections. Accordingly, companies must continue to maintain robust anti-retaliation policies. Finally, companies should be mindful that the Court’s decision likely provides incentive to whistleblowers who might otherwise be inclined merely to report internally to report to the SEC.
The SEC Weighs in on Cybersecurity Disclosure
By Cathy Dixon and P.J. Himelfarb, Weil, Gotshal & Manges LLP
The U.S. Securities and Exchange Commission issued interpretive guidance last week relating to disclosure of cybersecurity risks and incidents amid increasing cybersecurity threats from cybercriminals, competitors, nation-states, and “hacktivists,” and a host of significant breaches that have come to light in the last year (including one involving the SEC’s EDGAR system). The SEC’s guidance is to some extent a repetition of guidance issued in 2011 by the Commission’s Division of Corporation Finance (2011 Staff Guidance), which enhances its authoritativeness, but there are also some new and noteworthy substantive points:
- Focusing on the role of the board of directors, the SEC guidance states that companies should consider board’s oversight of a company’s cybersecurity risks and cybersecurity risk management program in drafting proxy statement disclosure of the board’s role in risk oversight, to the extent cybersecurity risks are deemed material to a particular company’s business.
- The guidance stresses the need for expanded disclosure controls and procedures that function effectively to collect cybersecurity-related information and facilitate its timely analysis by responsible personnel, with a view to determining whether a duty to disclose material non-public information exists.
- The SEC states that a company’s disclosure controls and procedures should cast a wide net to capture information “potentially subject to required disclosure or relevant to an assessment of the need to disclose developments and risks” (emphasis added), and not just information required by specific line items to be disclosed.
- The guidance further stresses that, while “it may be necessary to cooperate with law enforcement [,]” and recognizes “that the ongoing investigation of a cybersecurity incident may affect the scope of disclosure regarding the incident . . . [,] an ongoing internal or external investigation would not . . . on its own, provide a basis for avoiding disclosures of a material cybersecurity incident” (emphasis added). Simply put, the SEC believes that companies can provide investors with the requisite disclosure without revealing sensitive technological and/or investigative information.
- In an apparent highlighting of incidents at Equifax and Intel, involving executives’ sales of securities after discovery but before public disclosure of what, in hindsight, has been viewed as a material cyber breach, the SEC’s guidance is directed at prevention of insider trading when a company has undisclosed, potentially material information about cyber risks and incidents, including vulnerabilities and breaches. More specifically, the guidance:
- reminds companies that information about a company’s cybersecurity risks and incidents may constitute material non-public information, and that directors, officers, and other corporate insiders would violate Securities Exchange Act of 1934 Section 10(b) and Rule 10b-5 thereunder if they were to trade the company’s securities while in possession of such material non-public information; and
- states that companies should “have policies and procedures in place to (1) guard against directors, officers and other corporate insiders taking advantage of the period between the company’s discovery of a cybersecurity incident and public disclosure of the incident to trade on material nonpublic information about the incident, and (2) help ensure that the company makes timely disclosure of any related material nonpublic information.” Recognizing that many companies have implemented “preventative measures” designed to avoid even the appearance of improper trading, the SEC encourages all companies to consider applying such measures in the context of a cyber event.
- The guidance cautions against selective disclosure of cybersecurity information in violation of Regulation FD and encourages companies to use Form 8-K or Form 6-K to report material cybersecurity matters to the investing public.
Securities Regulation, Private Equity and Venture Capital
Securities and Exchange Commission Adopts Final Rule That Provides New Exemptions From Investment Adviser Registration for Advisers to Small Business Investment Companies
By: Edward Eisert, Orrick, Herrington & Sutcliffe LLP
On January 5, 2018, the SEC adopted amendments to Rule 203(l)-1 under the Investment Advisers Act of 1940 (the Advisers Act) that defines a “venture capital fund” and Rule 203(m)-1 under the Advisers Act that implements the private fund adviser exemption under the Advisers Act. These amendments were adopted to reflect changes made by title LXXIV, sections 74001 and 74002 of the Fixing America’s Surface Transportation Act of 2015 (the FAST Act). That legislation amended sections 203(l) and 203(m) of the Advisers Act. The amendments are effective on March 12, 2018.
In particular, Title LXXIV, section 74001 of the FAST Act amended the exemption from investment adviser registration for any adviser solely to one or more “venture capital funds” in Advisers Act § 203(l) by deeming “small business investment companies” to be “venture capital funds” for purposes of the exemption. Accordingly, the SEC amended the definition of a “venture capital fund” in Rule 203(l)-1 to include “small business investment companies.”
Title LXXIV, section 74002 of the FAST Act amended the exemption from investment adviser registration for any adviser solely to “private funds” with less than $150 million in assets under management, set forth in Advisers Act section 203(m), by excluding the assets of “small business investment companies” when calculating “private fund assets” towards the registration threshold of $150 million. Accordingly, the SEC amended the definition of “assets under management” in Rule 203(m) to exclude the assets of “small business investment companies.”
Private Equity and Venture Capital
Chancery Court Holds Stockholder Consent Removing and Replacing CEO and Director Ineffective under Stockholders Agreement
By Lisa R. Stark and Taylor B. Bartholomew, K&L Gates LLP
In an unpublished order, Schroeder v. Buhannic, C.A. No. 2017-0746-JTL (Del. Ch. Jan. 10, 2018) (ORDER), the Delaware Court of Chancery held that a stockholder consent that purported to remove and replace the CEO of TradingScreen, Inc. in his capacity as an officer and a director of the company was ineffective under Delaware law and granted judgment on the pleadings to plaintiffs under Section 225 of the Delaware General Corporation Law. The Court held that the stockholders’ attempt to remove and replace the CEO-director in his capacity as an officer was invalid because the bylaws provided that the power to hire and fire officers was vested in the Board. The Court also held that the removal of the CEO in his capacity as a director was invalid. Under the stockholders agreement, the stockholders agreed to elect and maintain certain persons to the Board, including “three (3) representatives designated by the holders of a majority of the Common Stock, one of whom shall be the Chief Executive Officer.” Plaintiffs contended that the provision required the stockholders to maintain the board seat with the Board-selected CEO. Defendants argued that this provision allowed them to appoint anyone to the board seat and constrained the Board’s ability to choose a CEO to one of the directors nominated by the stockholders. The Court concluded that the plaintiffs’ interpretation of the disputed provision of the stockholders agreement was the only reasonable interpretation when considered in the context of, among other things, (i) the Company’s bylaws, which provided that the Board must select the CEO and that the CEO need not be a director, (ii) parallel provisions of the stockholders’ agreement which suggested that the language “one of whom shall be the Chief Executive Officer” in Section 7.2(b) of the stockholders’ agreement restricted the holders of common stock in their designation of directors to the board, and (iii) Delaware law, which holds that the appointment of the CEO is a core board function that can only be limited by the certificate of incorporation or the bylaws, not a stockholders agreement. This case serves as reinforcement of the cardinal principle of Delaware law that the board of directors manages the business and affairs of the corporation, including the appointment of the CEO, and provides an interpretation of a standard provision of a stockholders agreement.
Stock Issued in Violation of a Stockholders Agreement Is Void
Edward M. McNally, Morris James LLP
A recent decision underscores the importance under Delaware law of the difference between when a stock issuance is void and when the issuance is only voidable. A corporate act is void when it violates a statute or a corporation’s governing instrument such as its certificate of incorporation. An action that violates equitable principles is only voidable. Void acts cannot be ratified, but voidable acts may be ratified by stockholders or upheld by a court if the equities permit that form of relief. This decision explains this distinction and holds that when stock is issued in violation of a stockholder agreement, the issuance is “void.”