Private Equity and Venture Capital
California Cannabis Regulations May Impact PE/VC Investment
By Melissa Sanders, Fox Rothschild LLP
As states continue to legalize recreational marijuana, private equity and venture capital investment in the cannabis industry has grown rapidly. Investors may be impacted by the proposed revised regulations published by California’s Bureau of Cannabis Control in October. Under the proposed regulations, anyone entitled to 20% or more of the profits of a cannabis business would be considered an “owner” of the business. Further, any entity owning an interest in a cannabis business would be required to disclose its own ownership, with multi-layer entities required to look through all parent entities until reaching individuals.
Securities Regulation
SEC Issues Final Rule to Modernize Property Disclosures for Mining Registrants
By J. Paul Forrester and Robert F. Gray, Jr., Mayer Brown
On October 31, 2018, the US Securities and Exchange Commission (“SEC” or “Commission”) issued a final rule (Final Rule) to modernize required property disclosures for mining registrants. The requirements are currently set out in Item 102 of Regulation S-K and Industry Guide 7. The rule is intended to provide investors with a more comprehensive understanding of a registrant’s mining properties, which should help them make more informed investment decisions. In addition, as the Commission did in 2008 to Industry Guide 2 with respect to oil & gas reporting, the SEC is rescinding Industry Guide 7 and relocating the Commission’s mining property disclosure requirements to a new subpart of Regulation S-K, thereby replacing staff guidance with a Commission Rule.
SEC Reaches First Settlement in connection with an Unregistered Crypto Exchange
By Jim Gatta, Meghan Spillane and Zuzanna Gruca, Goodwin
On November 8, 2018, the U.S. Securities and Exchange Commission announced that it settled charges against Zachary Coburn, the founder of blockchain token trading platform EtherDelta, over operating an unregistered securities exchange. The SEC’s cease-and-desist order to Coburn describes EtherDelta’s website as a user-friendly interface resembling online securities trading platforms. As noted in the order, the SEC advised in the DAO Report that platforms trading in digital assets constituting securities may be “exchanges” under federal securities laws requiring either registration with the SEC or exemption from registration. The SEC determined that during the relevant period, EtherDelta met the criteria of an “exchange” under federal securities laws, but was not registered with the SEC or operating pursuant to a registration exemption. In turn, Coburn’s actions in founding EtherDelta, writing and deploying the site’s smart contract, and overseeing the site’s operations contributed to violations of the federal securities laws.
Without admitting or denying the allegations, Coburn agreed to pay a $75,000 fine and $313,000 in disgorgement and interest. Notably, the order makes no allegation of fraud or misrepresentation. The order, along with recent actions against broker-dealers and a hedge fund in the cryptocurrency markets, reaffirms the SEC’s warning in the DAO Report: the federal securities laws may extend beyond token issuers to market “participants” offering digital assets when U.S. purchasers may be impacted.
Securities Registration Subcommittee of the Federal Regulation of Securities Committee of the ABA Business Law Section: Digital Assets
On November 17, 2018, at a Washington DC meeting of the above-referenced ABA sub-committee, Jonathan Ingram, Deputy Chief Counsel, Division of Corporation Finance, discussed the Division of Corporation Finance’s increasing focus on digital assets, a broad term intended to get beyond labels and cover digital tokens, coins, bitcoin, cryptocurrencies, and similar assets. Mr. Ingram explained Corp Fin’s collaboration and cooperation with other SEC divisions on addressing digital asset questions and related fintech matters and highlighted the SEC’s newly launched FinHub site. The FinHub site is intended to be a “one-stop” resource for innovators, developers, and other parties interested in digital assets, by including information, speeches, and regulatory actions in one place on the SEC’s website. FinHub also facilitates direct engagement with SEC staff.
SEC Offers Compliance Guidance and Highlights Recent Enforcement Actions Involving Blockchain Technologies
By Parris M. Bell, Burr & Forman
In a November 16, 2018 Statement on Digital Asset Securities Issuance and Trading, the Securities and Exchange Commission (SEC) announced its current position on regulation of blockchain and other distributed ledger technologies. In its Statement, the SEC emphasized that “market participants must still adhere to our well-established and well-functioning federal securities law framework when dealing with technological innovations, regardless of whether the securities are issued in certificated form or using new technologies, such as blockchain.”
The Statement relied on five recent enforcement actions to underscore the continued importance of compliance with federal securities laws. The SEC lumped the issues raised by recent enforcement actions into the following three categories: “(1) initial offers and sales of digital asset securities (including those issued in initial coin offerings (“ICOs”)); (2) investment vehicles investing in digital asset securities and those who advise others about investing in these securities; and (3) secondary market trading of digital asset securities.”
In discussing offers and sales of digital asset securities, the SEC highlighted two settlement orders it had issued earlier that day against entities AirFox and Paragon in connection with their unregistered token offerings, requiring the companies to pay monetary penalties and register their tokens as securities under Section 12(g) of the Securities Exchange Act of 1935 (Exchange Act), in addition to filing periodic reports with the SEC. With regard to investment vehicles investing in digital asset securities, the SEC advised all involved to be “mindful of registration, regulatory and fiduciary obligations under the Investment Company Act and the Advisers Act.” On the issue of exchange registration, the SEC recommended that entities using blockchain or distributed ledger technology for trading digital assets “carefully review their activities on an ongoing basis to determine whether the digital assets they are trading are securities and whether their activities or services cause them to satisfy the definition of an exchange.” Finally, addressing broker-dealer registration, the SEC cautioned entities which facilitate the issuance of digital asset securities in ICOs and secondary trading that they may qualify as “brokers” or “dealers” which are required to register with the SEC and maintain membership in a self-regulatory organization. Specifically, the SEC emphasized that pursuant to Section 15(a) of the Exchange Act, “absent an exception or exemption, it is unlawful for any broker or dealer to induce or attempt to induce the purchase or sale, of any security unless such broker or dealer is registered in accordance with Section 15(b) of the Exchange Act.” In conclusion, the Statement stressed that companies using new blockchain technologies should consult with legal counsel to ensure that their practices comply with federal securities laws.
Law and Accounting, Audit Responses and Federal Regulation of Securities Committees of the ABA Business Law Section “Critical Audit Matters: What Lawyers Need to Know About the PCAOB’s New Auditor Reporting Standard.”
By Rani Doyle, Vice-Chair, Law and Accounting Committee, American Bar Association Business Law Section
On November 16, 2018, the above-referenced committees presented a CLE program entitled "Critical Audit Matters: What Lawyers Need to Know About the PCAOB’s New Auditor Reporting Standard." The panelists reviewed the final PCAOB standard, focusing on the determination and communication of critical audit matters or CAMs. As to how audit firms were preparing for the standard, Josh Jones of Ernst & Young explained that his group addressing CAMs was working with about 1,000 audit teams and issuing guidance, providing training and practicing compliance with the new standard. He discussed “dry runs” with companies intended to allow them and their teams and audit committees to get a feel for the process and timing involved with auditor compliance and to provide feedback to improve process. Potentially common CAMs were suggested as being in the areas of valuation, M&A, significant unusual transactions, tax reform and uncertain tax positions. Karen Wiedemann of the PCAOB explained that the PCAOB was preparing to review and monitor initial reports, that it would perform a post-implementation review a couple of years after initial effectiveness. Panelists discussed the challenges in determining how to appropriately tailor CAM disclosures. The panel also discussed what the average number of CAMs might be for any given company, stating that dry runs to date indicate a range of 2-4. Panelists suggested that lawyers ask their clients about participation in a dry run, and engage with and obtain feedback from audit committees and companies that can be provided to audit firms and the PCAOB. Materials from the program are available here.