Friday, February 26, 2021

Future Ready Lawyer: The Evolving Role of the Library & Library Staff

By Anne Sherry, J.D.

As the practice of law evolves, so do the research needs of practitioners and the tools they use to understand clients’ business and legal needs. Technology’s role in driving forward movement in the legal profession became ever more critical when the COVID-19 pandemic necessitated remote work. Yet a study commissioned by Wolters Kluwer Legal & Regulatory in 2020 found that while more than two-thirds of lawyers believe their organization will be affected by ten trends in the legal profession, fewer than one-third feel very prepared to address those trends.

Building on that study, which will be repeated in 2021, Wolters Kluwer Legal & Regulatory spoke to prominent law librarians in private practice and academia about the ways in which law libraries help law students, lawyers, and firms adapt to new technology and drive innovation in legal research. Future Ready Lawyer: The Evolving Role of the Library & Library Staff heard from Ronald E. Wheeler, Jr. (Boston University School of Law), Jean P. O’Grady (DLA Piper), and Steven A. Lastres (Debevoise & Plimpton) on the transition to remote work, the law library’s role in diversity and inclusion, and the evolution of research tools.

Use this link to watch a replay of the webinar or click here to read a summary of the discussion.

Thursday, February 25, 2021

Industry groups support/oppose New York’s stock transfer tax proposal

By Jay Fishman, J.D.

Various financial intermediaries have submitted written letters to New York’s state legislative tax committee expressing either support for or opposition to a stock transfer tax bill (STT) James Sanders Jr. introduced in the New York Senate, accompanied by Phil Steck’s corresponding bill in the New York Assembly. The arguments for or against the Sanders-Steck STT seem to stack up evenly but have one thing in common: all the industry groups say that now is the time to act to either retain the 1980-adopted 100 percent repeal of the STT (referred to as a rebate) or reinstate the STT because of COVID-19’s devastating economic impact on New York.

Arguments for retaining the STT rebate. The Investment Company Institution (ICI) and Securities Industry and Financial Markets Association (SIFMA) are two financial intermediaries who’s respective "legislative tax committee letters" favor keeping the rebate. The ICI principally argued that given the current U.S. business and government desire for individuals to ensure their own retirement security, the STT would contradict this belief by depleting middle class investors retirement savings, which has escalated during the pandemic. ICI proclaimed that New York’s legislative and executed branch led by Governor Cuomo should be creating incentives to encourage rather than discourage saving by, among other things, retaining the 100 percent rebate.

The ICI shared some statistics to emphasize the point:
  1. U.S. capital markets have been democratized by publicly offered investment pools that particularly provide middle class individuals with access to a diversified portfolio of stocks, bonds, or other securities that these investors could never replicate efficiently;
  2. Moreover, 39 million U.S. households that own mutual funds, IRAs, or defined contribution accounts have incomes less than $100,000, with 66 million having less than $200,000, respectively representing 50 and 85 percent of all households that own mutual funds, IRAs, or defined contribution accounts; but
  3. The STT, if enacted, would be economically borne by the wealthiest Americans but harm the middle class by depleting the above-mentioned securities these middle class investors could never replicate efficiently; and
  4. Even exempt investors such as retirement accounts and pension funds would be taxed and taxed repeatedly (just like fund investors).
The ICI lastly implored the legislators to adopt an exemption for retirement accounts and 1940 Act registered funds to the extent they are owned by retirement accounts, if the STT becomes law.

SIFMA’s two main arguments for not enacting the STT and for retaining the rebate were that the STT would damage middle class investors more so than it did in the 1970s (before being repealed) in light of the current pandemic, and that the STT would make New York anti-competitive. Extrapolating the devastating findings from a 2020 study of the effects of a hypothetical federal financial transaction taxes (FTT) on investors, SIFMA said the effects of an STT on New York investors would be similar: (1) The STT cost would specifically be passed onto both large and small investors; (2) public and private pensions and retirement funds, charitable organizations, and everyday savers and investors would pay more to save; and (3) any tax on stock transactions would reduce New York savers’ account balances, requiring them to work longer hours to meet their retirement, home ownership, college and other future investment goals.

Regarding the STT rendering New York anti-competitive, SIFMA remarked upon a report that estimates 1 in 10 New York City jobs and 1 in 15 New York State jobs are in the securities industry. Imposing a STT, therefore, could lead financial firms to move their back-office operations and related jobs outside New York, reducing employment and revenue in the state.

Arguments for restating the STT. On February 22, 2021, a coalition of groups representing labor unions, healthcare institutions, environmentalists, social service providers, faith healers and community activists sent New York State’s legislative leaders a letter imploring reinstatement of the STT. Their principal arguments were as follows:

The federal government-released stimulus money distributed throughout the pandemic has provided only a temporary stopgap for essential workers and other middle class New Yorkers who have increasingly struggled throughout 2020 to provide for their families, and others have lost their jobs and unemployment compensation, having to deplete their savings to make ends meet. Moreover, the rebate during the pandemic has so devastated New York that the state government has had to severely cut the budget, thereby threatening the most vulnerable state residents including those who have fought COVID-19 on the front lines as doctors, nurses, school teachers and others, to the detriment of their own health and financial wellbeing; and

The STT would allow New York State to raise an estimated $13-$16 billion annually, reducing reliance on the federal government and providing long-term funding for infrastructure, healthcare, education, housing, and transportation.

Members of the Tax Justice Network (TJN), including James S. Henry, TJN’s Senior Advisor and investigative economist and lawyer, in making points similar to the above-mentioned ones, sharply rebuked the arguments opposing the STT. But first Henry provided three benefits supporting the STT: (1) the STT would raise significant tax revenue, delivering a welcome transfer of wealth from rich to poor; (2) more importantly, the STT would curb excessive and harmful high frequency, speculative trading (which comprises around half of all U.S. stock market trading now) while leaving normal trading and investment intact; and (3) the STT would boost transparency, increasing tax authority financial activity oversight.

Henry then debunked the STT naysayers, including Wall Street as the largest to cry foul. Henry acknowledged that Wall Street would bear having to pay the STT but said the tax would be small, precisely five cents on every share trade valued over $20; hence, for the median Nasdaq share traded, worth $48, the STT would amount to an insignificant 0.1 percent tax. He furthermore proclaimed the STT behaves like a progressive sales tax, vastly lower than the eight percent tax New York residents pay for retail items.

Henry next put to rest SIFMA’s and other industry group assertions that have failed in other countries, particularly Europe, and that an STT would force New York-located companies to flee to non-STT imposing states. He attacked the often-bandied-about argument that Sweden regretted its 1984 FTT because it caused a trading volume decrease. Henry acknowledged that Sweden did lose some trading volumes after FTT implementation but contended this was because of design flaws; specifically, the IMF, in 2011, reported that the FTT was imposed only on trades through Swedish brokers, so "it was easily avoided by using non-Swedish brokers."

Henry then bolstered his argument favoring the STT by stating most European and other countries around the world that have imposed an FTT have had great success because of it. Britain’s economy, on par with New York financially, attained this high rank from its 1694-introduced Stamp Duty on securities, raising $3.5 billion in pounds in 2020, which translates to $4.9 billion U.S. dollars. France and Italy, too, have benefitted economically from their respective FTTs, and a new FTT push in the European Union has begun under Portugal’s leadership. Non-European countries such as China, Taiwan, Thailand, and Turkey have also enjoyed financial success from FTTs.

As for the argument that New York businesses would leave for another state should the STT be adopted, he emphasized that this is just talk that has never panned out in reality. He pointed to New York’s 1905 enacted STT which resulted in the New York Times reporting that all the money would flee to other stock exchanges like Chicago’s or Philadelphia’s, rendering New York one of those "medieval cities that fall out of the course of modern commerce." But three months later, the Times had to retract that opinion because the STT became a great success. Henry speculated that in current times, Wall Street will naturally argue that the STT would ruin middle class lives because Wall Street does not want to give up the immense gravy train it receives on fees extracted from New York pension funds—the STT would curb these extractions to Wall Street’s chagrin.

Lastly, Public Citizen claimed many of the coalition groups arguments for the STT such as raising revenue through investment in infrastructure, tamping down on speculation in the stock market, and FTT success in other countries. But Public Citizen’s Managing Director, Susan E. Harley, advanced two additional reasons for enacting the STT: it would help redistribute U.S. wealth and address racial and economic inequality that has become especially evident during the pandemic. On wealth redistribution, she said that since stocks are primarily owned by the wealthy—the top 10 percent of earners own more than 80 percent of all equities—unlike a sales tax that is regressive, financial transaction taxes are paid by those who are most able to afford it, namely the wealthy stock owners. Applying the above issue to racial inequality, Harley said that the skewed nature of stock ownership is even more pronounced when looking at racial breakdowns of wealth. In terms of overall value, she cited a statistic that Black and Latinx households own only 1 percent and 0.4 percent in corporate equity, respectively. But Harley declared "as our nation confronts generations of policies that systemically kept Black and Brown families from achieving wealth at the rates of white families, any step toward balancing these inequities must be closely examined." The STT would help close this longstanding racial gap.

Wednesday, February 24, 2021

Commissioner Peirce urges regulators and investors to embrace technology

By Mark S. Nelson, J.D.

SEC Commissioner Hester Peirce recently gave a speech in which she touted the benefits of technology and urged listeners to not be afraid of technology while acknowledging that some fintech ideas are not yet feasible, either because of regulatory hurdles or the lack of adequate disclosure. Peirce, who delivered her remarks at the George Washington University Law School Regulating the Digital Economy Conference, said she was motivated in choosing her topic by the market turmoil that arose from the GameStop short squeeze and the attendant legislative fallout, all of which had reminded her of the bubble in uranium markets described in a book she had read.

Fear of technology? According to Peirce, investors and regulators will need to change their "attitude" if regulators and markets are going to accept technological changes that make trading faster or the dissemination of some types of information easier. "Specifically, we tend to look at technological innovation in the markets with deep suspicion, and that mindset has to change," said Peirce. "Attempts to create a good experience using an attractive, easy-to-navigate interface run headlong into a dusty set of regulations written with paper, snail mail, and precise legalese in mind."

But Peirce suggested that some technological changes may have to occur over time. For example, Peirce noted the gradual regulatory shortening of the settlement cycle from three days to two (i.e., T+3 to T+2), despite the calls of some to further shorten the cycle to T+0 or to allow settlement in real time. Peirce said that the current settlement cycle builds in some amount of delay between execution and settlement and that it is this delay that allows the settlement system to function (i.e., delay allows for error correction and human intervention).

"Real-time settlement would address many of the concerns around central clearing and margin calls that we saw late last month," said Peirce. "Widespread adoption of real-time, or at least near real-time, settlement of transactions in equity securities, however, would require a major overhaul in the way equity markets work and could harm liquidity by raising the cost of making markets."

Peirce, however, suggested that a more incremental approach to the settlement cycle might be best, especially an approach focused on modernizing the post-trade settlement process. She said this type of incremental change could still yield "significant" benefits.

The concluding paragraphs of Peirce’s remarks take on the topic of payment for order flow (PFOF) that has generated much discussion after the volatility in GameStop’s stock and the later congressional hearing on GameStop. For Peirce, however, the lesson of GameStop is not to ban PFOF but to mandate better disclosures to investors, whom she suggested are likely to benefit from price improvement associated with PFOF. Said Peirce: "At the same time, critics are correct when they point out the potential for conflicts of interest on the part of the broker, who may be tempted to send trades to a market-maker who offers worse execution pricing (which hurts the investor) but better payment for order flow (which benefits the broker). The way to address this potential conflict, though, is not to ban the practice—which would eliminate a potential conflict at the cost of a likely increase in costs to the investor—but to require better disclosure."

Q&A session. GW later posted a video Q&A session with Peirce. Morenike Saula, Visiting Associate Professor of Law and Business, Finance, and Entrepreneurship Law Fellow at The George Washington University Law School, moderated the first half of the Q&A session following Peirce’s remarks. Saula noted that Nigeria had recently banned trading of virtual currencies and asked Peirce about, among other things, how technology can lead to financial inclusion. Peirce explained that decentralized finance or DeFi can paly a role by removing the human part of interaction through the use of smart contracts. The discussion of smart contract did not directly address the issues that can arise from the fact that humans write the code that runs those same smart contracts.

The second half of the Q&A was moderated by Abraham Bluestone, Class of 2021, and Chair of the Finance Law Conference Committee. The first question came from panelist Carol Van Cleef, Counsel at Bradley, who asked about media reports that regulators were looking into stablecoins. Peirce noted the general market interest in stablecoins arising from Diem (formerly known as Facebook-backed Libra) but she said stablecoins mostly are beyond the SEC’s jurisdiction unless they have features that look like securities. Peirce urged stablecoin developers to talk to SEC staff.

With respect to exchange traded products involving virtual currencies, Peirce replied to a questioner that the number one question is when the SEC might approve an ETP. Peirce noted her prior dissents from SEC disapprovals of virtual currency ETPs and she added that the SEC has in these applications looked more closely at the underlying workings of the Bitcoin market. Peirce said she was hopeful that Gary Gensler, who has been nominated to become SEC chair, and who has experience with virtual currencies, could mean that the agency will take a fresh look at its approach to regulating virtual currencies.

In reply to a question about GameStop, Peirce noted that short selling has a valuable role in the economy, such as providing rewards to those who investigate companies and learn more information about them, including revealing potential fraud. She also said short selling can help to create liquidity. Moreover, without citing a specific research report, Peirce said there was some research that suggests the presence in the market of short sellers can actually cause stock prices to rise over time. But Peirce said there must be a balance between short selling and any further transparency requirements. She also reminded listeners that there are rules for naked short selling that require short sellers to actually borrow the needed shares.

Another questioner wanted to know about regulation of special purpose acquisition companies or SPACs. Peirce acknowledged that SPACs were back in fashion and that SPACs provide a pathway for private companies to go public, although she said the growth of SPACs may raise questions too, such as whether traditional IPOs are too expensive or are otherwise just not working. Peirce added that it is a "positive" that companies have options for going public, but it is important to make sure there is good disclosure associated with those options.

Tuesday, February 23, 2021

Supreme Court rejects petition on extension of broker-dealer registration beyond secondary markets

By Rodney F. Tonkovic, J.D.

The Supreme Court will not hear petitions asking for clarification of the broker-dealer registration requirements and when LLC interests are securities. The first petition accused the SEC of disregarding the language of the securities laws by extending the broker-dealer registration requirements to "underwriters," or so the petitioners claimed. The second sought a uniform standard in the application of the Howey test, arguing that the "label-driven, LLC-only" test employed by the Tenth Circuit ignored the totality of the circumstances in that case. Both petitions were filed in late December 2020, and the respondent in each case waived the right to respond.

Registration for primary markets? The petitioners in Feng v. SEC (20-862) asked the Court to address whether the SEC exceeded its statutory authority by applying broker-dealer registration requirements to the petitioners, who were acting as underwriters. In 2015, the SEC charged attorney Hui Feng with offered and sold EB-5 investments to legal clients while collecting undisclosed commissions from the promoters of the investments. The Commission charged Feng with fraud under the securities laws and with failing to register as a broker-dealer.

In the district court, Feng argued that he was an immigration attorney and not a broker, but the district court held that the evidence established that he acted as a broker and was in violation of the registration requirement. The Ninth Circuit affirmed, agreeing with the lower court's use of the "totality-of-the-circumstances" analysis to find that Feng's work more resembled broker activity than traditional legal work.

The petition argued that the SEC has improperly expanded the Exchange Act's broker-dealer registration requirement to encompass primary offerings of securities. The Exchange Act, the petitioners said, regulates trading in the secondary market, and those operating in the primary market do not trigger the broker-dealer registration requirements of the Act. The petition asserted, however, that the Commission has routinely exceeded this authority by extending the registration requirements beyond secondary markets and over-the-counter trading.

In this case, the petitioners served to introduce issuers to potential investors for primary market transactions that did not involve an exchange or over-the-counter market transaction. This, they argued, placed them squarely in the category of "underwriter" under the Securities Act, and underwriters are not required to register. Until this case, the petitioners remarked, this "obvious statutory overreach" had gone unchallenged. The SEC waived its right to respond.

LLC interests not securities. In Foxfield Villa Associates, LLC v. Robben (20-868), the petitioners argued that their investments in a real estate venture were "investment contracts" subject to the securities laws. The petitioners alleged that they were fraudulently induced into purchasing owner ship interests in a limited liability company. The district court granted summary judgment to the defendants on the securities fraud claim after concluding that the membership interests were not securities.

At issue on appeal was whether the petitioner's interests fell under the Exchange Act's definition of a "security." The Tenth Circuit panel focused on whether the interests were investment contracts under Howey and allowed that the interests were investments in a common enterprise. The result, then, hinged on whether the profits the investors expected to gain came "solely from the efforts of others." After delving into the six factors used by the Tenth Circuit in analyzing this problem, the facts showed that the petitioners had the requisite access to information and contractual powers to control the profitability of those investments and were not so dependent on the respondents that they could not exercise ultimate control over their investments.

The petition took issue with what it characterized as the Tenth Circuit's use of an "LLC-only test" that ignored the reality of the situation. In this case, the petitioners contended, the entity was nominally titled an LLC, but promoter intended that the investors would "have nothing to do" with the enterprise. A rigid application of the Howey test (and other factors introduced by its progeny) is no longer appropriate as, over time, LLCs and other such entities have been afforded great flexibility in their structure. In reality, the petition said, if the court had looked beyond the formalities of the parties' written agreement, it would have discovered that the promoter had orally promised that he alone would manage the enterprise and that the investors would remain passive. If this case had been brought in circuits that focused on the "totality of the circumstances," such as the Second, Fifth, or Ninth, the result would have been different. The respondents waived their right to respond.

Read the Docket. These cases, and others before the Court may be referenced in the latest version of the Supreme Court Docket, a regular feature of Securities Regulation Daily. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each appeal.

Monday, February 22, 2021

CII urges U.K. not to expand dual-class share offerings

By John Filar Atwood

In comments to the U.K. Treasury in connection with its review of the U.K. listings regime and dual-class structure rules, the Council of Institutional Investors (CII) voiced its opposition to any expansion of dual-class share offerings. CII, which supports the one share-one vote principle, said that expanding dual class strictures would be inconsistent with the London Stock Exchange’s goal of promoting high standards of corporate governance and shareholder rights.

CII believes that every share of a public company’s common stock should have equal voting rights, but has watched over the past 30 years as more companies have gone public with unequal voting rights, thereby eroding corporate governance standards. CII acknowledged that U.S. stock exchanges played a prominent role in that erosion, but asked the U.K. not to yield to this "race to the bottom" pressure.

In the letter, CII said that its primary concern with the expansion of dual-class shares is the principal-agent risk that increases for investors when equity structures skew the alignment of ownership and voting rights. When a company goes to the capital markets to raise money from the public, equity investors with the same residual claims should have equal protections and rights, including the right to vote in proportion to the size of their holdings, CII stated.

CII argued that its concerns over unequal voting rights are supported by research that shows that negative effects of unequal voting rights tend to develop in the medium to long-term. The group noted that in recent years some new companies with dynamic leadership and innovative ideas that have unequal voting rights have attracted capital on public markets with limited apparent valuation discount shortly after the IPO. Over time, however, the valuation of those companies tends to decline, CII noted.

Independent research. The group cited numerous studies that indicate that as the gap between ownership and control widens, the agency costs of insider control and lack of shareholder accountability increase. Moreover, a company’s founders’ entrepreneurial skills and insights that initially propelled a company become dated, and risks change in ways not foreseen by investors at the time of the IPO.

Among the research cited by CII was a study by the European Corporate Governance Institute that shows that even at innovative companies where multi-class structures correlate to a value premium at the time of the IPO, that premium dissipates within six to nine years before turning negative. Similarly, a study by former SEC Commissioner Robert Jackson Jr. found that by seven years after an IPO, perpetual multi-class firms exhibit valuations that are significantly lower than firms with "sunset" provisions.

Time-based sunsets. CII suggested time-based sunsets as a way to mitigate long-term investor risks from dual-class structures. The group recognized that shareholder voting rights can be seen by some founders as creating negative short-term pressure, and that there may be pressures in the U.K. to expand dual-class structures to attract fast-growing new economy companies. If the U.K. decides to go this way, CII recommended that it mandate a time-defined sunset on unequal voting rights of no more than seven years.

In this regard, CII noted that research indicates that any benefits of holding dual-class shares decline over time, with companies with dual-class shares eventually tending to be undervalued as compared to their peers. According to CII, one study found that controlling shareholders have perverse incentives to retain dual-class structures even when those structures become inefficient over time. This makes it difficult for dual-class companies to ever regain alignment of ownership and voting rights unless there are time-based sunsets in place, the group stated.

CII pointed out that its support of reasonable time-based sunsets is backed both by academic studies and by the fact that a growing number of companies that go public in the U.S. with differential voting rights are incorporating time-based sunsets into those structures. Accordingly, CII urged the U.K. to decide that any exchange listing rules that allow dual-class shares must also include mandatory time-based sunsets, regardless of premium or non-premium status.

Friday, February 19, 2021

Organizations weigh in on new ESG reporting and attestation

By Amy Leisinger, J.D.

The Center for Audit Quality and the Association of International Certified Professional Accountants released a roadmap to provide auditors direction in supporting companies seeking to achieve their environmental, social, and governance (ESG) reporting goals. Recently, stakeholders make more decisions based on ESG practices, and, accordingly, companies increasingly report ESG information using established frameworks. Further, the Biden Administration has made climate risk a focus, and investor demand for this information is likely to continue to grow.

Attestation and ESG. The roadmap is designed to help independent auditors inform clients regarding ESG disclosures, as well as to assist clients in determining whether to seek an attestation report on ESG information. While ESG reporting has historically taken place outside of SEC submissions, there are increasing calls for public companies to incorporate ESG information, including the impact of climate change and diversity.

"ESG is a rapidly evolving area of reporting, and while there is no one-size-fits-all approach, independent auditors have an important role as this reporting continues to take shape," said Senior Director of the CAQ’s Professional Practice Dennis McGowan, CPA.

Reporting. The success of comparable and relevant ESG must begin with a foundation of quality reporting, according to the organizations. Companies report ESG information for many reasons but mainly to provide transparency about commitments to identify and manage ESG risks. In 2019, 90 percent of S&P 500 companies voluntarily published sustainability reports, but frameworks and standards differ from company to company.

"Reporting standards provide specific and detailed requirements to assist companies in determining what specific information (i.e. both qualitative and quantitative) to disclose for each topic," the organizations state.

Sustainability reporting has historically taken place outside of SEC submissions, but there is new interest in disclosure of ESG information in SEC submissions. Registrants have begun to refer to attestation in SEC submissions, the groups note, and the SEC Investor Advisory Committee has encouraged the Commission to develop a framework for ESG reporting in submissions. This may require the adoption of standards by which issuers disclose material ESG risks in a manner consistent with the presentation of other financial disclosures.

The organizations urge practitioners to consider the risk and legal considerations relevant to providing attestation services on ESG information, particularly data that may need to be included in an SEC submission. The assessment of the attestation engagement should be informed by required evidence, management objectives, materiality, and expectations of the intended end-users. Materiality should remain top of mind, the organizations conclude.

Thursday, February 18, 2021

SEC, NY state sue to shut down Coinseed app and token

By Anne Sherry, J.D.

The SEC and New York state filed charges against Coinseed, Inc., and its CEO for conducting an unregistered securities offering. The complaint filed by New York also includes Coinseed’s former CFO as a defendant and adds charges of fraud through the misrepresentation of trading fees and the management team’s experience in financial services. Coinseed sold tokens in 2018 to raise money for a mobile app that allows users to round up everyday purchases made on their linked credit and debit cards and invest those round-ups in a choice of virtual currencies (SEC v. Coinseed, Inc., February 17, 2021).

The SEC alleges that Coinseed and its CEO-founder conducted an unregistered offering from December 2017 to May 2018, whereby it received at least $141,000 in exchange for "CSD tokens." The funds were to be used to develop Coinseed’s crypto-trading mobile app and pay other business expenses. The defendants also told purchasers that they would receive a percentage of Coinseed’s fee revenue. Under Howey, the CSD tokens were securities, the SEC submits: token holders’ fortunes were tied to the defendants’, and reasonable purchasers would expect a profit from the defendants’ efforts because the tokens themselves had no "consumptive use" on the Coinseed platform or elsewhere. The defendants failed to register the offering and deprived investors of the information that would be contained in a registration statement.

Like the SEC, the New York Attorney General also brought a claim for registration violations, in the state’s case under the Martin Act. Not only was the offering itself unregistered, the state alleges, but the defendants acted as an unregistered commodities broker-dealer. (While the SEC’s complaint describes the CSD tokens in terms of their "consumptive use" rather than use the word "currency," the state complaint alleges that the tokens are virtual currencies that in turn are commodities under the Martin Act.) The SEC complaint focuses only on registration violations, but the New York complaint also alleges fraud.

Specifically, New York alleges that in operating as an unregistered commodities broker-dealer, the defendants made material misrepresentations and omissions to investors about fees by charging an undisclosed markup on virtual currencies traded on behalf of investors. Coinseed quoted one price to investors, which was not the same as the price quoted to Coinseed by its third-party trading platforms. Furthermore, in a white paper and other promotional materials, the defendants said that the management team included a blockchain specialist with a financial engineering degree from NYU, a back-end developer with a degree from MIT who worked at Microsoft, and a chief marketing officer who worked for the first VR cinema in the U.S. None of these people were ever employed or contracted by Coinseed, much less vital members of the management team, the complaint alleges.

Announcing the lawsuit, New York Attorney General Letitia James said it lets cryptocurrency traders know that her office will work to protect them against fraud. "Unregulated and fraudulent virtual currency entities, no matter how big or small, will no longer be tolerated in New York. For over three years, Coinseed and its executives flagrantly and illegally violated New York state laws, but the corporate greed perpetrated by Coinseed while committing fraud against thousands of investors ends now." Along with an injunction and bars, the complaint seeks restitution and disgorgement and the full closure of Coinseed’s business operations.

The case is No. 21-cv-01381.

Wednesday, February 17, 2021

Impact of COVID-19 government support measures on credit ratings revealed in new report

By R. Jason Howard, J.D.

The Board of the International Organization of Securities Commissions (IOSCO), has published a report relating to the impact of COVID-19-related government support measures (GSM), on the credit ratings and credit rating methodologies of Fitch, Moody´s and Standard & Poor´s, the three largest credit rating agencies (CRAs).

Report. IOSCO’s Financial Stability Engagement Group conducted the review and used "publicly available information gathered from the CRAs, as well on IOSCO member expertise and analysis," supplemented with roundtable discussions with industry participants and bilateral discussions with each CRA. The report addresses the observed impact of GSMs on credit ratings and credit ratings methodologies across four main asset categories—Sovereigns, Financial Institutions, Non-Financial Corporates, and Structured Finance—and considered the different types of GSMs and their impact on:
  • Fiscal support measures, including tax measures, grants and subsidies, expansion of unemployment benefits, cash to household schemes, and loan programmes;
  • Monetary support measures, including expanded Quantitative Easing programmes, reduction in key rates, and central bank liquidity facilities; and
  • Financial support measures, including easing of regulatory requirements and payment holidays (e.g., on consumer credit products and mortgages).
GSMs, according to the review, played a "significant role in alleviating the downward pressure on credit ratings," but the long-term effectiveness remains uncertain as the timing and pace of GSM withdrawal, the roll-out and effectiveness of vaccination programmes, the potential for a resurgence of coronavirus cases, and the potential need for further government actions, all pose downside risks, especially in emerging markets.

The IOSCO media release notes that the report provides a summary of the GSMs observed impact during the pandemic and that "rating disclosures typically explain the impact of the GSMs where such impact was material to the rating decision," but no material changes to CRA methodologies were observed.

Conclusion. The report concludes that the effects of the GSMs across credit ratings and credit rating methodologies should continue to be considered and, with the COVID-19 health crisis continuing to unfold, the impact of GSMs on credit ratings should be regularly monitored.

Tuesday, February 16, 2021

Senators urge SEC to strengthen and enforce insider trading rule

By Amy Leisinger, J.D.

Senators Elizabeth Warren (D-Mass), Sherrod Brown (D-Ohio), and Chris Van Hollen (D-Md) of the Senate Banking Committee sent a letter to the SEC asking it to review its policies regarding 10b5-1 plans designed to prevent insider trading. Their letter raises evidence indicating that executives are using the plans to obtain windfalls at the expense of ordinary investors. Research suggests that trades often appear to be based on material, nonpublic information, especially in the pharmaceutical industry, they argue.

Is the "safe harbor" safe? The SEC created the 10b5-1 "safe harbor" to allow corporate executives with access to material, nonpublic information to sell their holdings without engaging in insider trading. However, according to the letter, the agency needs to re-examine its policies to improve transparency, enforcement, and incentives to ensure fairness,. The senators argue that Pfizer executives used 10b5-1 plans to sell shares following the announcement of COVID-19 vaccine trial results and earned millions in gains.

When Pfizer announced that its vaccine for COVID-19 was found to be more than 90 percent effective, they note that the CEO sold more than 60 percent of his personal shares in the company under his 10b5-1 plan for a total of approximately $5.6 million.

"These abuses, and the plans’ lack of transparency, damage investors and risk undermining public confidence," wrote the senators.

New approach. Although trades made under 10b5-1 plans are intended to be set in advance, it is not unusual for the plans to be modified before a major announcement. However, the senators state, these short-term trades undermine the purpose of the 10b5-1 provision. Concerns about this use of 10b5-1 plans led the former SEC head to call for a "cooling-off period" of four to six months between the adoption of a 10b5-1 plan and the execution of the first trade. The SEC has yet to take action, the senators note.

The lawmakers call on the SEC to address these "abusive" practices and argue that the content of 10b5-1 plans and related trades should be disclosed to the SEC and the public so that they can evaluate the degree to which stock prices are influenced. The SEC also should enforce existing filing deadlines to keep investors informed; the SEC has a responsibility to ensure adequate, public 10b5-1 disclosures, they explain. The agency should explore options to better align executive incentives with those of shareholders by considering enforcing penalties when executives benefit from short-term windfalls that do not translate into long-term gains.

"In addition to harming ordinary investors, the abuse of 10b5-1 plans and the short-term, windfall profits obtained by insiders through abuses of these plans undermine public confidence in open, fair markets and the products they create," the senators conclude.

The lawmakers requested that the SEC respond by February 22, 2021. Specifically, they seek information regarding the actions the agency has taken regarding 10b5-1 plan compliance with current requirements and enforcement actions. They also ask if the SEC has taken action to require a "cooling off period" and/or additional disclosure.

Monday, February 15, 2021

AFL-CIO and Airbnb take opposing views of SEC’s gig economy proposals

By John Filar Atwood

The SEC’s proposals to address the compensation of gig economy workers have drawn starkly contrasting comments from the AFL-CIO and Airbnb. The AFL-CIO asked the SEC to withdraw the proposals entirely because, among other things, platform workers could see their cash compensation reduced by up to 15 percent in exchange for securities that may be risky and illiquid. Airbnb feels that the rules will finally allow workers that have contributed to its success to benefit from the economic growth of the company.

The rules, proposed in late November, would allow companies, on a trial basis, to provide equity compensation for certain "platform workers" who provide services available through the issuer's technology-based platform or system. The proposals include certain limits and conditions, including that no more than 15 percent of the value of compensation received by a participating worker from the issuer during a 12-month period and no more than $75,000 of such compensation received during a 36-month period will consist of securities.

In its comment letter, the AFL-CIO said that existing rules provide ample opportunity for companies to offer equity compensation to platform workers if they would simply recognize those workers as employees with all the legal rights associated with traditional employment relationships. In the organization’s view, the fact that few platform companies have chosen to classify their platform workers as employees suggests that providing equity compensation to those workers has not been important to their business models.

Risky securities. The proposed rules will effectively treat platform workers as if they are employees for purposes of Rule 701 and Form S-8, the AFL-CIO noted, so platform workers could see their cash compensation reduced by up to 15 percent. In exchange, they would receive company securities that may be highly speculative, illiquid, and inherently risky, the group added. The organization feels that this loophole will increase the economic incentives for platform companies to misclassify their platform workers as independent contractors.

The AFL-CIO pointed out that unlike CEOs and other senior executives, many platform workers are struggling to make ends meet and cannot afford the risks associated with equity compensation. The proposed equity compensation arrangements would be more appropriate for platform workers if their companies would recognize them as employees with all the legal rights and protections that are provided to workers in an employment relationship, the organization stated.

When classified as independent contractors, the AFL-CIO continued, platform workers do not have the right to collectively negotiate the terms of their compensation under the National Labor Relations Act. Unlike employees, independent contractors do not enjoy a variety of legal protections including the minimum wage, overtime, unemployment insurance, workers’ compensation, equal employment opportunity, and family and medical leave, the group said. Moreover, as independent contractors, platform workers do not have access to employer sponsored 401(k) plans or pension plans.

The organization further noted that the majority of platform work is conducted on a temporary or part-time basis for supplemental income. As a result, platform workers do not have the same access to information about the financial condition of their platform company as compared to an employee of a technology startup venture. This information asymmetry increases the risk that platform workers will be defrauded if they are paid in unregistered securities, the AFL-CIO argued.

Arbitrary distinction. The group also opposes the proposed rules’ arbitrary distinction between platform workers and other workers who work as independent contractors. Platform workers would be eligible for equity compensation, it noted, but not other self-employed workers such as free lancers. The AFL-CIO believes the proposed rulemaking provides no justification as to why equity compensation should be permitted simply because independent contractors are hired through technological means.

The group’s final objection is that the proposed rules could lead to unexpected outcomes. The ambiguity in the proposed definition of a platform worker who provides "bona fide services" may result in the use of equity compensation for all sorts of economic transactions that go far beyond the provision of labor services as in a traditional employment relationship, the group said.

Airbnb’s support. Airbnb fully supports the proposed rules because they would make it possible for stakeholders on platforms to more fully benefit from the economic allocations of the public equity markets. In the company’s view, the proposals support President Biden’s call to more equitably share the benefits of capitalism.

The company noted that according to a 2020 Gallup survey, nearly half of all Americans do not own stocks. The company would like to help change that by allowing employees that have contributed so much to its success to participate as company shareholders.

Airbnb said that it has long sought broader pathways for its property hosts to own shares in the company. As part of its IPO, the company included a directed share program for certain eligible hosts. In addition, it previously advocated with the SEC for changes to the federal securities laws that would make it easier for companies to share equity with the people who help power their platforms.

To support its argument that the proposed rules could economically benefit middle-class platform workers, the company noted that in a 2020 survey, 53 percent of its hosts said that their Airbnb income helped them stay in their homes, 18 percent said hosting on Airbnb helped them avoid eviction or foreclosure, 12 percent said they are healthcare workers, and 14 percent said they are teachers or live with a teacher.

Friday, February 12, 2021

SEC issues report on hedge fund, private equity trends

By Amanda Maine, J.D.

The SEC has released the most recent statistics and private fund trends gathered from filings of Forms PF and Forms ADV. The information, which reflects data from the third calendar quarter of 2018 through the second calendar quarter of 2020, includes aggregated data on from Form PF filers with numbers that are rounded or masked to avoid potential disclosure of proprietary information. Only SEC-registered advisers with at least $150 million in private fund assets under management must file a Form PF with the Commission, although SEC-registered advisers with smaller private fund asset numbers report general information regarding the funds they manage on Form ADV.

Numbers and assets. For the quarter ending in spring 2020, private equity funds topped the list in number of funds reported with 14,482, followed by hedge funds with 9,402. Hedge funds edged out private equity funds in the number of advisers advising each fund type by 1,724 to 1,361.

In terms of aggregate assets by fund type over time, the categories of hedge funds and "qualifying hedge funds" (i.e., a hedge fund advised by a large hedge fund adviser that has a net asset value of at least $500 million) came in first and second in both the aggregate private fund gross asset value (GAV) and aggregate private fund net asset value (NAV). Private equity funds and "Section 4 private equity funds" (i.e., a private equity fund managed by a large private equity fund adviser) took the third and fourth spots on the SEC’s chart.

Fund domiciles. The U.S. led the way as the country with the largest percentage of all private fund domiciles as a percentage of NAV at 51 percent. The Cayman Islands came in second with 34.7 percent, and all other domiciles (including Ireland, Luxembourg, the British Virgin Islands, Bermuda, and the U.K.) falling in the single digits.

When separated by type, the Cayman Islands was the most popular domicile for qualifying hedge funds by NAV percentage at 52.5 percent, and the U.S. behind the Cayman Islands at 35.1 percent. Private equity funds in the U.S. came out over the Cayman Islands by 55.1 percent to 31.3 percent.

The report also relayed information on adviser main offices as a percentage of NAV. The U.S. was the overwhelmingly favored location for adviser main offices at 90.4 percent for all private funds. While qualifying hedge funds dipped slightly lower for U.S. adviser main offices at 89.8 percent, it remained the favorite for adviser main office locations of private equity funds at 93.8 percent.

Beneficial ownership. In terms of beneficial ownership for all private funds, other private funds topped the chart at 17 percent of aggregate NAV. The catch-all "other" category came in second at 15.3 percent, followed by state and municipal government pension plans, other pension plans, non-profits, and U.S. individuals.

When broken down by types of funds, private funds were still the top beneficial owners in qualifying hedge funds, followed by non-profits, and the "other" category. State and municipal government pension plans chalked up a beneficial ownership amount of 21.1 percent in Section 4 private equity funds, followed by private funds, sovereign wealth funds, and other pension plans. According to the report, the weighted-average beneficial ownership of top five owners were "other" private funds, real estate funds, hedge funds, venture capital funds, qualifying hedge funds, and private equity funds—all of which came in at 50 to 60 percent.

Other hedge fund industry information. The report also presented tables about other hedge fund information gathered from Form PF. Regarding the number of hedge funds using high frequency trading strategy, over 8,000 reported zero percent of NAV was used for HFT, while 51 reported less than 100 percent and 8 reported 100 percent of NAV or more.

North America dominated large hedge fund adviser exposure by region, followed by the European EEA and Asia. However, when broken down by country, the U.S. remained dominant, with China (including Hong Kong) coming in second, followed by Japan, Brazil, and India.

The report listed the aggregate qualifying hedge fund gross notional exposure by asset type: (1) interest rate derivatives; (2) foreign exchange derivatives; (3) non-financial listed equities; (4) repurchase agreements; and (5) U.S. Treasury securities.

Thursday, February 11, 2021

Board diversity is necessary to grow, petitioner argues

By Amy Leisinger, J.D.

A stakeholder has filed a rulemaking petition regarding the text of proposed rule changes regarding materiality in statements relating to civil rights, diversity, equity and inclusion, equal opportunity, or related topics. The petition argues that more must be done to ensure adequate representation in corporate culture.

Disclosures. According to the petition, under Regulation FD, it is material for listed companies to disclose: (1) their most current EEO-1 report; (2) whether it has been reviewed by its board; and (3) any remedial steps taken consistent with the Civil Rights Act; and (4) whether the firm has voluntarily complied with the Joint Standards of the Federal Financial Institutions Examination Council pursuant to the Dodd-Frank Act. Regulated traded companies often make statements in support of equal opportunity but do not admit deficiencies in this area, the petition explains. Institutions own 80 percent of equity markets, but investors have no standards to evaluate the risk from non-compliance, according to the petitioner.

"[W]hen companies have to be transparent, it creates external pressure from investors and others who can draw comparisons company to company," the petition states.

This is the goal of the of the disclosure provisions of the federal securities laws, and, as the petitioner states, "pension funds of African-American public employees have little way to prevent themselves from investing in firms which engage in systematic employment, environmental injustice and consumer discrimination against them."

Proposed changes. The Dodd-Frank Act created the Offices of Minority and Women Inclusion to begin to hold the financial industry accountable for diversity and inclusion, but few have offered data voluntarily, according to the petitioner. Regulated entities advertise support for "Black History" and what is being done to level the playing field. However, the petition explains, Bloomberg reports that only 25 of the top100 public firms are willing to disclose their equal opportunity hiring record, and companies regularly enter into settlements, particularly regarding employment discrimination and environmental justice concerns.

"By any analysis, the nation’s publicly-traded companies do not take the Civil Rights Act seriously, even to Congress or financial regulators," according to the petition. "The recent NASDAQ filing on board diversity indicates a growing industry consensus that action is both morally right and good for the bottom line," the petitioner concludes.

Wednesday, February 10, 2021

Industry letter backs Chamber rulemaking petition on COVID-19 lawsuits

By Mark S. Nelson, J.D.

Within months of the onset of the COVID-19 pandemic, several plaintiffs brought lawsuits against cruise ship operators and other businesses alleging the failure to disclose the risk of a pandemic. These early lawsuits prompted the submission of a rulemaking petition in October 2020 signed by Tom Quaadman, Executive Vice President of the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness (CCMC), and by Harold Kim, President of the U.S. Chamber Institute for Legal Reform, asking the Commission to use its exemptive authorities to limit liability for pandemic-related corporate statements. The CCMC and the Chamber Institute for Legal Reform, now joined by a dozen other industry groups, have provided additional comments on their argument for pandemic-related liability exemptive relief.

The original petition had called on the Commission to: (1) assuming sufficient warnings, bar liability for a range of corporate statements, regardless of whether they are forward-looking, regarding a company's ability to recover from the impacts of the pandemic; and (2) limit liability to instances of actual (i.e., subjective) knowledge of a statement's falsity. "Requiring actual knowledge of the falsity of pre-pandemic statements will help ensure that the focus properly remains on the issuer’s knowledge at the time the statement was made, not how well the statement holds up after-the-fact," said the petition.

The more general concern of the Chamber was the rise of event-driven litigation overall, not just the nearly two dozen pandemic-related suits cited by the CCMC’s latest comment letter. The CCMC pointed to suits against companies with businesses not directly related to the response to the pandemic. The CCMC also noted the potential for suits to be brought against companies that receive federal aid and for plaintiffs to target companies’ economic/financial projections and results. The CCMC observed that Australian regulators had taken steps to limit pandemic-driven suits.

In the more than three months since CCMC submitted it rulemaking petition, the Commission has received only one other comment. Linda Moore, President and CEO of TechNet, expressed support for the CCMC petition and reiterated the notion that event-driven securities suits are less carefully investigated before filing and instead rely on more "tenuous" theories of liability. The comment described TechNet as a "national, bipartisan network of technology CEOs and senior executives" whose companies have participated in varied ways to respond to the pandemic.

Tuesday, February 09, 2021

CME launches Ether futures as the cryptocurrency’s spot price soars

By Brad Rosen, J.D.

The CME Group launched its Ether futures contract on February 8, 2021 just as prices in cash markets have been rocketing to all time highs. Ether in the spot market is trading around $1,700 as of press time after seeing a 28 percent jump in price in the prior seven-day period. The cash market price for Ether went as high as $1756.51, according to the widely followed coinmarketcap.com website, before pulling back some.

An expanding crypto-derivative portfolio. According the CME’s release, the introduction of the Ether futures contract represents an expansion of the exchange’s crypto derivatives offerings in this emerging asset class. Tim McCourt, CME Group Global Head of Equity Index and Alternative Investment Products, stated, "As institutional demand for transparent, exchange-listed crypto derivatives continues to increase, we are pleased to launch our new Ether futures contract." He added, "The addition of Ether, along with our liquid Bitcoin futures and options, will create new opportunities for a broad array of clients, whether they are looking to hedge ether positions in the spot market or gain exposure to this cryptocurrency on a regulated derivatives marketplace."

Contract details. CME Ether futures trade under the symbol ETH and each contract represents 50 Ether units. The futures contracts are cash-settled, based on the CME CF Ether-Dollar Reference Rate, which serves as a once-a-day reference rate of the U.S. dollar price of Ether. More information on the contract can be found here.

Growing investor interest and a maturing asset class. Michael Sonnenshein, CEO of Grayscale Investments, a firm involved in digital currency investing, proclaimed, "The launch of CME Ether futures is an exciting addition to the digital assets ecosystem as it evidences the ongoing maturation of the asset class as a whole." Sonnenshein also noted, "At Grayscale Investments, we've seen enormous growth in investor interest for Ethereum and we're excited to see the growing list of financial product offerings expanding access to digital currencies."

Monday, February 08, 2021

SIFMA urges Biden admin to think globally on U.K., China, and data transfer policy

By Lene Powell, J.D.

Emphasizing the importance of international regulatory coordination for the U.S. financial recovery, SIFMA has given the Biden administration a list of priorities for its cross-border financial services agenda. In a statement, Peter Matheson, managing director of international policy & advocacy at SIFMA, said the administration should particularly aim for international regulatory consistency in three areas: redefining the U.S.-U.K. relationship following Brexit, working toward a level playing field in China, and developing a shared understanding on data transfers that avoids aggressive data localization.

Costs of inconsistency. According to Matheson, the financial services industry is perhaps the most globally integrated of all service industries, yet it is still typically subject to regulation at the national level. This causes regulatory inconsistencies that, according to one study, cost the global economy $780 billion per year. Regulatory fragmentation such as capital and liquidity ring-fencing can also undermine global financial stability, said Matheson.

Although there are "well-developed" mechanisms to promote cross-border regulatory cooperation, Matheson believes these can be strengthened and improved. In his view, particular areas deserving focus include sustainable finance and the implementation of the Basel III capital reforms and guidelines around operational resiliency.

Defining a new U.S.-U.K. relationship. Matheson noted that U.S. and U.K. have begun to redefine their bilateral relationship following the exit of the U.K. from the European Union. According to Matheson, this provides an opportunity to establish a new, best standard in cross-border regulatory coordination and supervisory cooperation, and SIFMA has set out a detailed vision describing what that might entail.

Matheson observed that regulatory coordination would also support a future U.S.-U.K. trade agreement that could yield significant and widespread benefits for both countries’ economies.

Promoting a level playing field in China. Given U.S. exports of over $4 billion to China per year, plus another $3 billion supplied by U.S. subsidiaries and affiliates based in China, it remains a priority goal for China to open its financial system to full and fair foreign competition. Matheson noted that the United States and China reached a Phase One trade agreement in January 2020, which cemented landmark commitments by China.

As work progresses in establishing a level playing field with China, it will be crucial for China to fully deliver on its commitments and have processes for robust and regular monitoring and enforcement, said Matheson. To this end, SIFMA’s CEO Ken Bentsen chairs the Engage China Coalition, a group of ten financial services trade associations that work to promote a U.S./China relationship that maximizes benefits to the U.S. economy.

Free-flowing cross-border data. According to a McKinsey estimate, cross-border data flows increased global GDP by 10 percent alone in the decade up to 2014. In Matheson’s view, this underscores the importance for the financial services industry to be able to transfer data across borders and locate servers wherever needed. Yet in recent years, many markets have implemented data localization policies hindering the free flow of data, imposing economic costs both on the industry and on the GDP of countries implementing such regulations.

But trade agreements can help ensure the free flow of data, said Matheson. For example, the United States, Mexico, Canada Agreement (USMCA) was the first trade agreement that included a prohibition on forced data localization, conditioned on regulators retaining access to that data wherever it be stored. Similarly, the U.S. Japan Digital Trade Agreement of October 2019 also ensured that data can be transferred across borders by all suppliers, including financial service suppliers. Moreover, the U.S. and Singapore put forth a shared understanding on data transfers in 2020.

Matheson urges that the U.S. must build on this foundation, begun in the Obama administration and continuing in the Trump administration, and protect financial services from policies that constrain the free flow of data or necessitate locating servers in particular jurisdictions. This should include ensuring the WTO Joint Statement Initiative (JSI) negotiations on digital trade also discipline unnecessary or discriminatory data localization mandates and data transfer restrictions, said Matheson.

In conclusion, Matheson believes that as governments around the world look to innovate and recover from the COVID-19 crisis in a sustainable, equitable way, they should recognize the cross-border nature of the financial services industry in shaping policy. Strengthening the competitiveness of U.S. financial services through policies on regulatory cooperation, data, and relationships with major trade and investment partners will help accelerate the rate of recovery and help establish a stronger foundation for the economic future of the U.S., said Matheson.

Friday, February 05, 2021

SEC seeks comment on potential money market fund reform measures

By Brad Rosen, J.D.

The Securities and Exchange Commission is seeking comment on potential reform measures for money market funds, as highlighted in a recent report of the President’s Working Group on Financial Markets (“PWG”). As noted in the agency’s request, public comments on the potential policy measures will help inform consideration of reforms to improve the resilience of money market funds and broader short-term funding markets.

The President’s Working Group Report. As indicated in the SEC’s press release, the PWG studied the effects of the growing economic concerns related to the COVID-19 pandemic in March 2020 on short-term funding markets and, in particular, on money market funds. Moreover, the PWG report provided an overview of prior money market fund reforms in 2010 and 2014, as well as how different types of money market funds had evolved since the 2008 financial crisis.

In reviewing the events of March 2020, the report discussed significant outflows from prime and tax-exempt money market funds that occurred and how these funds experienced, and began to contribute to, general stress in short-term funding markets before the Federal Reserve, with the approval of the Department of the Treasury, established facilities to support short-term funding markets, including money market funds. The PWG report also observed that these events occurred despite prior reform efforts to make money market funds more resilient to credit and liquidity stresses and, as a result, less susceptible to redemption-driven runs.

Vulnerabilities and potential reforms. As a result of the vulnerabilities discovered with respect to money market funds, the PWG report concluded that the events of March 2020 demonstrated that more work is needed to reduce the risk that structural vulnerabilities in prime and tax-exempt money market funds will lead to or exacerbate stresses in short-term funding markets.

The report also identified various reform measures that policy makers could consider to improve the resilience of prime and tax-exempt money market funds and broader short-term funding markets. The report noted that many of these measures could be implemented by the SEC under its existing statutory authority, while others may require coordinated action by multiple agencies or the creation of new private entities.

Leadership weighs in. SEC Acting Chair Allison Herren Lee observed “Money market funds play a significant role in our short-term funding markets, and they are utilized by both large institutions and individual retail investors.” She added, “Comments received will assist the SEC and other relevant financial regulators in further analysis of potential reforms.”

SEC request for comments. The SEC is requesting public comment on the report, including the effectiveness of the previously enacted money market fund reforms and of implementing the potential policy measures described in the report. Commenters also are invited to discuss other topics that are relevant to potential money market fund reforms, including other approaches to reform. The SEC encourages commenters to submit empirical data and other information in support of their comments.

The public comment period will remain open for 60 days following publication of the comment request in the Federal Register.

Thursday, February 04, 2021

DOJ amicus sees no reason to revisit Basic, says Goldman case should be remanded

By Rodney F. Tonkovic, J.D.

The Department of Justice has filed an amicus brief urging that the Supreme Court vacate and remand the petition in the Goldman Sachs petition concerning the rebuttal of the Basic presumption. The DOJ generally takes the position that the Second Circuit was correct in upholding class certification in this matter. The brief argues for remand, however, to clarify whether the appellate court held that the generic nature of the alleged misstatements is legally irrelevant to a court's determination of price impact.

Background. The petition asks the court to reverse a decision upholding class certification in a suit alleging that Goldman Sachs Group, Inc., falsely represented its ability to remain conflict-free despite participating in a conflicted collateralized debt obligation. At issue is whether a defendant in a securities class action may rebut the presumption of classwide reliance recognized in Basic Inc. v. Levinson by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality. The Court granted certiorari on December 11, 2020.

The petition argues that a court should not reject price-impact evidence simply because it may also have implications for merits issues. In this case, a divided Second Circuit panel rejected Goldman Sach's position, stating that a contrary rule would permit a defendant to smuggle materiality into a Rule 23 price-impact inquiry at the class-certification stage. A dissenting judge suggested that a reviewing court should be able to consider misrepresentations for their price impact, even if it looks like the court is assessing materiality. In the instant case, the dissent said no reasonable investor would have been moved by Goldman Sachs’ "generic statements."

DOJ urges vacate and remand. The DOJ's brief concludes that the case should be remanded for further consideration. The brief agrees with the Second Circuit's position that there is no categorical rule that misstatements phrased in general terms are legally incapable of affecting a security's price. On the other hand, the brief continues, one reading of the decision is that it holds that the generic nature of the alleged misstatements is legally irrelevant to a court's determination of price impact. This position is incorrect, the DOJ says in agreement with Goldman Sachs, because evidence of the nature of the alleged misstatements may be important in determining whether the alleged violations more likely than not affected the market price. It is unclear, however, whether the court erroneously treated evidence about the nature of the alleged misstatements as legally irrelevant or simply found the evidence insufficient to establish clear error in the district court's assessment of price impact. So, the brief concludes, the Court should vacate the Second Circuit's judgment and remand for further proceedings on this point.

The DOJ also notes that the Second Circuit correctly held that a defendant seeking to rebut the presumption of reliance by showing a lack of price impact bears the burden of persuasion to show that the alleged misstatements had no impact on price. But, to overcome the Basic presumption, a defendant must prove a lack of price impact. Goldman Sachs maintains that once it introduced evidence suggesting a lack of price impact, the burden of persuasion shifted to the respondents. This position lacks any support, the brief says, in either the Rules of Evidence or Court precedent, and to hold otherwise would negate Halliburton II's recognition (in Justice Ginsburg's words) that "it is incumbent on the defendant to show the absence of price impact." There is no reason, the brief says in sum, for the Court to revisit the framework set forth in Basic.

SEC officials support. The DOJ's brief is just one of many amicus briefs filed in this matter on February 1, 2021. A septet of briefs filed by various amici in support of Goldman Sachs argues that the Second Circuit's decision should be reversed, or at least vacated and remanded. Among these, a brief filed by a group of former SEC officials and law professors argues that the Second Circuit has precluded consideration of the generic nature of the challenged statements when assessing price impact; as the DOJ noted, this essentially nullifies the decision in Halliburton II. The brief observes that corporations routinely include generic statements of principle similar to those at issue in this case and that such statements can be "weaponized by plaintiffs." The brief also posits that a defendant seeking to rebut the Basic presumption only bears the burden of production, arguing that Rule 301 of the Rules of Evidence states that the party against whom a presumption is directed only bears "the burden of producing evidence to rebut the presumption," while the burden of persuasion remains with the original party. Other briefs made similar arguments concerning claims based on generic statements.

Wednesday, February 03, 2021

Exchanges say smaller public companies can thrive on trading venues

By Amanda Maine, J.D.

Members of the SEC’s Small Business Capital Formation Advisory Committee have heard from representatives of smaller companies on a number of topics, including private offering exemptions, the definition of accredited investor, funding gaps that impede entrepreneurs, issues related to the COVID-19 pandemic, and challenges minority communities face accessing capital. At its most recent meeting, the committee heard from representatives of national exchanges who discussed how their organizations seek to include smaller companies and the challenges they face.

LTSE: Focus on long-term over short-term. Martin Alvarez, chief commercial officer of the Long Term Stock Exchange (LTSE), focused on LTSE’s emphasis on the long-term. LTSE was approved as a national stock exchange in May 2019 and was officially launched in September 2019. According to Alvarez, LTSE aims to address "chronic short-termism" in the stock market and spearheading innovation to further this goal. According to Alvarez, other exchanges encourage companies to sacrifice long-term value for short-term expectations, or they simply decide to opt out of the public market entirely. He also decried the rise of private market capital raising as bringing greater inefficiencies and opacities.

LTSE is designed to offer a listing option for both large and small companies, Alvarez said. LTSE eschews a one-size-fits-all perspective approach and instead embraces five main principles companies can mold to their own vision. As implied by its name, the principles emphasize serving the interests of a broad group of stakeholders, measuring success over long time horizons, rather than short-term gains. Company compensation plans for officers and executives should reward long-term performance and they should prioritize engagement with long-term shareholders.

Over-the-counter: Where small companies can thrive. Cass Sanford, associate general counsel of OTC Markets Group, touted the OTC market as a place where smaller companies can thrive and "graduate" to an exchange listing. While the OTC market trades thousands of securities, from large international companies to small domestic companies, Sanford said that smaller companies use the OTC market as a venture market. Its disclosure rules are streamlined towards the type of business involved, and compliance costs are lower than the big national exchanges, she said. According to Sanford, between 60 to 80 companies "graduate" from the OTC exchange to an exchange listing every year.

Sanford outlined the three market tiers on the OTC Markets Group: OTCQX, OTCQB, and Pink. Sanford said that OTCQX and OTCQB have securities of over 1,400 trading, a "good chunk" of which are small public companies based in the U.S. She also noted that these two exchanges represent a variety of different industries, from financial services to technology to health to industrial manufacturing. Small U.S. public companies on OTCQX and OTCQB markets have an average $48 million market cap, with $65 million in revenue and 197 employees, she remarked.

Nasdaq and NYSE. Representatives from Nasdaq and NYSE told the committee that while the financial press has been focused on the impressive number of special purpose acquisition company (SPAC) IPOs, the big exchanges still have room for smaller companies, and healthcare and biotechnology companies in particular. Caroyln Saacke, chief operating officer of NYSE Capital Markets, said, that excluding SPACs, there have 175 IPOs with a market cap of $250 million or less since 2016, most of which were in the healthcare sector.

Saacke also said that investing in smaller companies wishing to go public is sometimes perceived as speculative because there are fewer financial controls and less experienced management. She said that NYSE provides many services to newly public companies, including up to four years of investor relations services (which, in addition to jumpstarting the "public company life" also improves investor relations), investor access services, educational forums, and relief programs.

NYSE senior vice president Jeff Thomas offered his own thoughts about how to encourage smaller companies to list on exchanges. The cost of director and officer (D&O) insurance can be a hindrance for smaller businesses, he said. There is also a push for more disclosure on environmental, social, and governance (ESG) factors, and companies are asking for more guidance on this topic, Thomas advised. One aspect of ESG is board recruitment for companies that wish to have a more diverse board of directors, he added, which can be difficult with smaller companies. Thomas also praised the SEC’s recent proxy reform efforts, including requiring more transparency for proxy advisory firms and changes to the shareholder proposal process, as a way to encourage more small companies to go public.

Tuesday, February 02, 2021

SEC names CorpFin Acting Director and Senior Policy Advisor for Climate and ESG

By Lene Powell, J.D.

The SEC announced that John Coates will serve as Acting Director of the Division of Corporation Finance. In addition, Satyam Khanna will serve as Senior Policy Advisor for Climate and ESG in the office of Acting Chair Allison Herren Lee. Coates joins the SEC from Harvard Law and is a member of the SEC Investor Advisory Committee, while Khanna rejoins the SEC after a stint at NYU Law and on the Biden-Harris transition team for banking and securities regulation.

CorpFin Acting Director. John Coates replaces former Director Bill Hinman, who departed the SEC last December. Shelly Parratt served briefly as Acting Director, then retired from the agency in January after 35 years of service.

Among other positions, Coates currently is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School, where he teaches corporate governance, M&A, finance, and related topics. Coates has served on the SEC Investor Advisory Committee for four years and is also a fellow of the American College of Governance Counsel and the European Corporate Governance Institute. Before joining Harvard, Coates was a partner at Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and financial institutions, and in helping companies register and sell more than $10 billion of securities.

"John is widely recognized as an expert on corporate governance, corporate transactions, and compliance and disclosure processes," said Acting Chair Allison Herren Lee. "He has spent the last three decades deeply engaged with our capital markets as a scholar, practitioner, and member of the SEC’s Investor Advisory Committee. I am confident that the SEC and all the market participants we serve will benefit greatly from his expertise."

Climate and ESG policy. In a new role in the office of Acting Chair Allison Herren Lee, Satyam Khanna will return to the SEC to serve as Senior Policy Advisor for Climate and ESG. In this capacity, Khanna will advise the agency on environmental, social, and governance matters and advance related new initiatives across its offices and divisions.

Most recently, Khanna was a resident fellow at NYU School of Law’s Institute for Corporate Governance and Finance and served on the Biden-Harris Presidential Transition’s Federal Reserve, Banking, and Securities Regulators Agency Review Team.

Khanna previously served at the SEC as counsel to SEC Commissioner Robert J. Jackson Jr., and was also previously a member of the SEC’s Investor Advisory Committee, where he served on the Investor-As-Owner Subcommittee and was a senior advisor to the Principles for Responsible Investment. Prior to that, Khanna was staff member of the Financial Stability Oversight Council at the U.S. Treasury Department and was a litigation associate at the law firm McDermott Will & Emery.

"I am thrilled that Satyam is returning to the SEC to oversee and coordinate the agency’s efforts related to climate risk and other ESG developments, issues of great significance to investors and the capital markets," Acting Chair Allison Herren Lee stated. "Having a dedicated advisor on these issues will allow us to look broadly at how they intersect with our regulatory framework across our offices and divisions. Satyam’s experience, insight, and resourcefulness will help ensure our efforts in this space are thoughtful and effective."

Monday, February 01, 2021

Delaware cedes to California on deciding plaintiff’s fraud claim

By Jay Fishman, J.D.

The Delaware Court of Chancery denied the defendants’ motion to have Delaware deemed the choice of law for deciding the plaintiff investor’s fraud claim under the California Securities Act. The court determined that even though the parties contract stipulated Delaware as the choice of law for deciding disputes between the plaintiff-buyer and defendant-sellers, California should rule on this claim because: (1) California has a materially greater interest in applying the California Securities Act than Delaware does; (2) California law would, in fact, apply to part of the buyer’s fraud allegations; and (3) any buyer’s waiver of its right to assert a claim under the California Securities Act would be contrary to California’s public policies (Swipe Acquisition Corporation v. Krauss, January 28, 2021, Fioravanti, P.).

Defendants contend that Delaware law should apply. The defendants contended that Delaware law should apply to the plaintiff’s California Securities Act claim because the plaintiff waived its right to assert the claim by contractually agreeing with the contract that Delaware law would apply to all claims arising out of the contract, including statutory claims.

Court determines California law should apply. The court acknowledged that the contract could be reasonably construed to waive the plaintiff’s right to assert any non-Delaware law claims, which would include California statutory law. But, said the court, accepting the above choice of law does not end the inquiry. From precedent, the court gleaned that a choice of law provision is unenforceable if it would be "contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which…would be the state of the applicable law in the absence of an effective choice of law by the parties."

The court determined that in this case, California had a materially greater interest in deciding the plaintiff’s fraud claim in violation of California securities law because: (1) the plaintiff is physically located in California; (2) the injury to the plaintiff is alleged to have occurred in California; and (3) a key meeting between the parties concerning the agreement is alleged to have occurred in California.

Moreover, the record indicated that all of the contract negotiations took place in California, and that the only connection to Delaware is that one of the defendants is incorporated there. Lastly, the court justified its decision from a California Court of Appeals holding in the 1983 Hall v. Superior Court case: "the right of a buyer of securities in California to have California law…apply to any future dispute arising out of the transaction is a ‘provision’ within the meaning of [California Securities Act] section 25701 which cannot be waived or evaded by stipulation of the parties to a securities transaction."

The case is No. 2019-0509-PAF.