SEC Upends its Own Whistleblower Regulations

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The SEC hands out millions of dollars each year to individuals who alert the Commission (or sometimes other regulatory agencies) of ultimately proven securities fraud.  During the Trump years, the Commission underwent formal procedures under the Administrative Procedures Act (“APA”) to limit these awards in two regards: to give discretion to the SEC to reduce the formula pay-outs in very large cases, and to decline to provide pay-outs where other agencies have similar whistleblower payment programs.

The new Democratic majority intends to reverse these limitations, but also has this week announced that in the interim they will ignore the rules revisions.  This announcement has been criticized by the two remaining Trump-appointed (and now minority) Commissioners as bad policy, creating uncertainty and the precedent that the marketplace can no longer rely on formally adopted rules as governing regulatory action.

However correct that the majority may be, in claiming that the Trump era changes weakened the attractiveness of blowing the whistle against wrongdoing, the dissenting Trump Commissioners seen correct in their criticism.  The APA process for rulemaking is statutory, robust and designed to create knowable, actionable and clear guidance.  Politics aside, seems to me that “the law is the law.”  The SEC always has been politicized at its core, at least at the Commissioner level, where the party in the White House names 3 of the 5 members; but the job of the staff is to enforce what’s on the books today, not what the majority party intends to do in the future.

The professional qualifications of the minority Commissioners are excellent, and so is their argument against the recent policy statement abandoning the law.

Finally, although I readily confess that there is no substantive link between the above legal observations and famous lines by Lauren Bacall in the classic film To Have and Have Not.  I confess that every time “whistleblowing” arises in a professional context, those lines spring inappropriately to mind: “If you want me, all you have to do is whistle. … You know how to whistle, don’t you, Harry?  You just put your lips together and blow.”

Suing Victims over Cyber Attacks

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Monday of this week, in a Texas Federal court, SolarWinds sought to have dismissed a shareholder suit alleging that the company tricked investors by not disclosing in advance company vulnerability to cyber attacks of its software product Orion.  Plaintiffs claimed SolarWinds misled investors by not warning them of the risk; the company replied that there was no suggestion of an intent to mislead, nor of recklessness (which would be the legal equivalent of intent), pointing out that the SolarWinds hack has been generally recognized as highly sophisticated.

The company does make a general observation about the direction of litigation that is worthy of note: any time something bad happens to a public company, a class action is filed against the company for a securities law misstatement harming stockholders.

Interestingly, plaintiffs also claimed against two PE firms because those firms held a large stake in SolarWinds equity.  Seemingly, the PE firms were major investors but not involved in operations.  We do not know all the facts, but mere stockholdings, however large the holdings, better not create liability for actions of the company (absent actual exercise of management control) or else the legal separation between investors and the company in which they invest will be destroyed by mere stock ownership.  That is not the current law,  today the “veil is not pierced” by stock ownership alone, and any change in the law in this regard would have massive market, litigation and insurance consequences.

Finally, while law firms that bring shareholder derivative suits under the securities laws are the traffic cops of the market-place and sometimes do uncover problematic action, the addition of ancillary defendants in litigation, to increase the chances of monetary recovery even on a nuisance suit basis, is unfortunate.

Crypto: Money or Security?

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The problem is: it often is both.

Remarks yesterday by SEC chair Gensler called for Congress to pass legislation making clearer the regulatory powers of the SEC over certain forms of crypto-currency; to date, the SEC has regulated crypto by suing the issuers, which is not, dare I say, best practice.

Many crypto offerings have looked like securities, as they were designed and marketed to provide a thing one could sell and trade at a profit.  Some offerings were more cleverly structured. It is beyond our scope to parse the litigation history, but we can play with the anomalies here:

Clearly, people pay for things with bitcoin and other pseudo-currencies.  Just like with dollars.  Just like with checks that translate to dollars and are so denominated.  But crypto is denominated by the market and so while a check for a dollar always gets you a dollar, a bitcoin unit when issued for a dollar can get you $1.50– or, alas, 75 cents.  SO it is money and an investment.

Let’s say I go out and buy a hundred Euros worth (I am making this up) $125.  When I spend or sell those Euros, I may get $128 of credit, or $1.10 of credit.  But buying Euros, in the form of Euros, is not a securities transaction, clearly.   (What if I am an investment fund and I buy 2.3 billion Euros, in specie, on the assumption that Euros today are underpriced?)

The regulatory impetus is the use of the cryptos: if people use them as an investment vehicle then the SEC wants to and should regulate them.  But lots of fine lines need to be drawn. (I am reminded of the question as to whether a promissory note is an SEC-regulated security.  The law specifically and categorically says that a note IS a security.  But the courts and SEC have made clear that only some notes are securities: your mortgage on your house is not a security when you give it to your bank lender, nor is your IOU to your brother when he lends you a thousand dollars.

So today’s reportage quotes Gensler as asserting that a majority of digital assets are under the federal securities laws because their USAGE is speculative. He calls for Congressional power to regulate trading and lending cryptos, particularly on DeFi (decentralized finance) platforms, and seeks to have such platforms register with the SEC much as an exchange.  At the same time, he has just expressed an invitation to register with the SEC an ETF fund dealing in bitcoin trading.

Our grandchildren will open their box of antiquities to marvel at monetary coins and paper; they will do everything financial by electronic credit transfers authorized by fingerprint or iris scan.  Those systems of payment may be by either governmental or private enterprise systems.  We are at the beginning of a journey, the exact twists and turns of which are as unpredictable as the current SEC reaction to cryptos; but the end-point of all this is inevitable.

 

Burgers, Lawyers and Boards– Oh my!!

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A recent article in Law 360 (a service to attorneys) collected a covey of interesting factoids relating to a major hamburger vendor’s legal tangle relating to discrimination and harassment.  Seems Mickey D has been accused of sins in these areas, attracting litigation from shareholders that has ensnared one of the country’s major law firms and the entire board.

First, when accused of discrimination, the company did the right thing in hiring an independent law firm to investigate and report. Now the law firm itself has been sued for aiding and abetting sexual harassment by twice failing to fully uncover its scope, thereby bringing in another presumably solvent and (hopefully) insured defendant.

Second, an investor has sued based on discrimination against Black franchisees and executives, resulting in an alleged 85% decline in Black executives.

Third, another investor has sued the entire Board for breach of fiduciary duty in giving an executive a $56M separation package after termination for an improper relationship with a subordinate.

Without at all suggesting culpability on the part of any of the defendants in these varied litigations, one can nonetheless step back and admire the range of imagination exhibited by plaintiffs’ counsel in asserting various claims against a single enterprise.  It is, however, not necessarily a gravy train for all the lawyers — one firm faces major allegations of its inadequate investigation aiding and abetting its client company in failing properly to respond to harassment allegations.

LIBOR– Interesting Developments

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By now it is common knowledge that calculating commercial interest rates using LIBOR is no longer possible; the disclosure of LIBOR manipulations tolled its death knell.  The influential New York Federal Reserve Bank has proposed a replacement metric (“Term SOFR”), which will permit a transition from LIBOR to a commercially accepted replacement. .

The announced terms of use of Term SOFR, however, bar utilization in certain interest swaps.  The details of the impact of this limitation, and possible work-arounds, are beyond the scope of this post.  Borrowers seeing to hedge future interest rate exposure are going to need to resort to detailed risk analysis, guided by professional input.  To the extent hedges are important financial protections for public registrants, expect some interesting disclosures.  The good news is that it is likely that the marketplace will establish generally accepted instruments to address the present disconnect.

Greater detail is available on my firm’s website. https://duanemorris.com/alerts/libor_term_sofr_formally_recommended_all_done0721.html#start-text

I’ve Been Thinking

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After a wet and tumultuous July, I have gathered my wits again and have begun posting to this blog site on legal matters.  However, on occasion I have written about other subjects when anomalies of life have struck me as– well, anomalous.  Below, my current confusions are catalogued.

My son is off to college and has been in touch with his two future room-mates. How is it possible that an expensive private college that does not give scholarships can attract three students whose politics would suggest that the People’s Revolution is imminent?

People are beating up people requesting the wearing of masks, claiming infringement on constitutional rights.  Whatever the arguments for imperiling everyone else with illness and death, the Constitution is not one of them.  There is a philosophical continuum between the volitional acts of saying “good morning” and shooting a stranger for no reason.  Each is a personal act.  One is protected as a freedom.  One is a felony.  So somewhere in between there is a line that limits freedom, as it is not true that the Constitution does (or should) protect every behavior.

So how close is infecting someone who dies to: saying “good morning”;  and, how close to shooting a stranger for no reason?

COVID fatigue will cause offices to open more rapidly this Fall even though statistics in some areas will show, as today, greater infections than at the alleged original height of the pandemic.

I tried to commute into Boston the other day for a rare, masked visit to my office.  Although the commuter rail schedule has been slashed, that did not stop the scheduled 8:15 from Wellesley Farms to post on the screen as up to 45 minutes late due to late equipment arrival.  Can’t they get the few trains still running to run reliably, avoiding human error or sloth?

They are building a fifty story building across the street from my office in town, split between residences and offices.  Someone just bought a two-bedroom apartment on the Boston waterfront for $13M.  You cannot afford a home in a Boston suburb because everyone is moving out of the City due to a permanent change of lifestyle and work habits.  Uh, wait– let’s think about this paragraph again….

My beloved Red Sox have fallen out of first place and refused to add real strength at the just-concluded trading deadline.  I do not understand John Henry and Chiam Bloom.

I bought an on-line ticket to a Sox-Yankee game the other day, at Fenway (having deferred my season seats due to COVID for a second year).  Beautiful day.  Sox blew the game in the 8th, to the delight of the Yankee fan family sitting next to me, on tour of various big league parks as a summer vacation for their seven year old; that night they flew to Chicago.  When I was seven, my parents for summer celebration gave me a dixie cup with a wooden spoon….

Changes at Fenway.  Just about all beer is of limited choice and canned, at over $11 each; no dark.  Food choices greatly curtailed.  El Tiante Cuban treat stand reduced to selling Italian sausage.  No chowdah!  Still a sell-out with almost no masks (in fairness, was before CDC recent advice to mask up).

When the “Yankees Suck” chant arose from the bleachers near the end of the game, the seven year old did not seem to notice.  At least there were no street vendors selling anti-Yankee Ts with obscene comments.

Oh, yes.  As a local sport writer sometimes is wont to say, this is the time for a shameless personal plug.  In the last two months I have published two new non-lawyer books, each available at Amazon and Barnes and Noble.  A book of short stories entitled Noir Ain’t the Half of It.  A book of new poetry entitled Laertes in America.  Please order; I need the ego boost of a royalty check.  If Grisham can sell books, so can I.

Further deponent sayeth not.

Weathering the Storm–SEC Dispute

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While most businesses acknowledge the potential impact of climate on their operations, and many people see first-hand the potential for disruption due to climate change, there is a dispute as to the role of the SEC in disclosing climate factors in public company filings.

SEC Chair Gensler is gung-ho in favor of his staff establishing mandatory reporting standards for discussing climate risk, a position supported by 75% of comment letters to the SEC.  However, many major corporation are on record as being opposed to inclusion of such reporting in officially filed SEC documents.  What’s worrying Amazon, Alphabet, eBay, Facebook, Salesforce and other business giants?

These companies are on record of having disclosures sent by separate reports to the SEC, but not included in official filings such as annual reports on 10-Ks.  The practice of unofficial filings would avoid law suits against registrants based on climate disclosures, which is appropriate because “climate disclosures … involve inherent uncertainty” which would subject companies to private lawsuits.  And one Commissioner opposes formal disclosure requirements as the SEC is not “well-suited to make judgments about … climate metrics….”

Reporting on climate should be a priority for public companies, as investors are interested both in economic impact and in ESG compliance as a policy matter.  The fact that the SEC is not expert in climate issues should not be an argument — the SEC is not expert in a very wide range of issues upon which it requires formal disclosure from registrants.  The point is that the registrants need to be expert regarding climate, not the Commission.  Cushioning companies from untoward litigation based on climate is the ability of registrants to make clear the range of possible impacts so that registrant is not tied to a single analysis of future uncertain events.

With half the West on fire, portions of the East and of mainland Europe flooded, and record temperatures everywhere in the world, there is no reason to require registrants to take a pass on disclosing the planning that they must by definition be performing inside the board room, so that investors can evaluate corporate intentions.

SPACs Revisited

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In my May 5 post, I predicted that the SEC’s animosity to SPACs would not fade away.  It was easy prophesy and of course it has come to pass.

In an announcement issued yesterday, the SEC’s Office of Investor Education and Advocacy surely set out to warn investors of the risks of investing in SPACs– four single-spaced pages of cautionary text.  While the explanation of SPAC transactions was both clear and helpful, it is a little hard to understand all the criticism when SPACs are valuable market entities; and, they are already so closely regulated by the Commission in terms of detailed disclosure requirements.  Surely there is no evidence proving pervasive fraud experiences justifying an intense campaign of warnings.

You might conclude that the SPAC process, whereby a funded holding company acquires a private operating company and thus makes it public, annoys the staff as it interferes with the historical IPO process which has been part of the SEC’s fundamental regulatory system for almost a hundred years.

Among the warnings: read the deal carefully;  you are relying on the judgment of the management of the SPAC as to what entity is acquired; if you paid more for your SPAC shares on the open market, they may deteriorate in value below the share value held in cash for purposes of buying a target; there may be shrinking targets to acquire as SPACs proliferate; often SPACs also issue warrants and their terms vary among deals; shareholder approval of an acquisition may be voted upon by the sponsors of the SPAC if they and their cohorts have controlling shares; original investors in SPACs likely will have paid less per share than the public investor; future funding may come from sponsors of the SPAC and the terms of such financing may create sponsor business interests not congruent with public investor interests.

No doubt the above all are risks, but are they not covered by disclosure?  Are many not common in nature and impact with issues faced by companies offering shares by a traditional IPO?  Is there a market study showing in fact that SPACs create greater risk of fraud or deception of investors?  I am a believer in strong regulation of the markets, having seen so much illegality and deception over my years of practice, but free markets are important also. So far, this pronouncement comes as “education.”  Not sure where this is all heading….

Insider Trading Revisited

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Everyone knows that insider trading is illegal and can create liability for the person who gives the “tip” and the person who trades based on the “tip.”  So why did the US House of Representatives enact the Insider Trading Prohibition Act a week or so ago? And, wonder of wonders, with strong bipartisan support?

As of this moment, there actually is no law prohibiting insider trading per se.  Rather, the illegality arises from the Securities Exchange Act prohibition against fraud.  Without here tracing the complex case law that has arisen in trying to define the “fraud” involved in the myriad fact patterns we call insider trading, suffice it to say that the elements of proof have wavered over time, most recently focusing on whether the tipper received any benefit from the “tip.”  (A curious side-trip, as the harm to free trading markets does not turn on that fact.)

The new bill abandons the idea of fraud and focuses on “wrongful use” of insider information. It also bans wrongful gathering, which would cover theft and hacking.

As the bill moves to the Senate, note a last-minute amendment to the House bill which re-inserted the requirement that there be personal benefit provided by the tippee to the tipper.  Per the bill’s draftsperson, Columbia Law professor John Coffee, Jr., this “major concession to the Republicans” ignores that in tipping cases the parties are “like members in an old boys club” and the reciprocity of access to information is normative and ingrained.   Let’s see what happens in the Senate.

 

Life Science Update

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A week ago, panelists at an ambitious program mounted by the Boston Bar Association took a broad look at major trends in life science deals and risks.  Some interesting highlights follow.

Did COVID hurt or help life science dealmaking?  Both; people became more accessible via Zoom, but the lack of personal contact impeded ability to benefit from establishing personal rapport and trust.  Bottom line, deal flow did not slow down though deals were harder to make.

Lack of scientific conferences hurt.  Ability to discuss presentations with companies impeded recognition of deal synergy.

Obvious intense interest in bio-tech drew capital, but also fear of regulation of drug profits and of FDA regulation and of heightened anti-trust focus dampened interest in the eyes of some.  So did “frothy” price premiums being sought during a “hot” market.  Some of the froth came from VCs raising larger funds, as well as SPAC interest (see immediately prior post).

Near the end of program, a deeper visit to SPAC-land.  Life science SPACs were said to be a small percentage of SPAC activity.  75% of all life science SPACs are today trading within 5% up or down from issuance price.  It was suggested that the best SPAC promoters are serial sponsors because they have a list of reliable investors.

Interesting technical discussion of how to frame patent claims, particularly with the tension between maximizing patent protection today with specific claims vs. seeking protection over time in face of rapid innovation.  Patents are written today, examined in three years, litigated in ten years.  Do you articulate your claims narrowly or reach for protection by making functional claims?