Governance & Compliance Insider

In response to the U.S. government shutdown that began on December 22, 2018, the U.S. Securities and Exchange Commission and its Divisions of Corporation Finance and Investment Management published public guidance regarding the impacts on their operations. Although electronic filings will continue to be accepted in many cases, as described below, nearly all SEC operations, including the review and processing of filings and enforcement and regulatory functions, will be curtailed. Issuers and practitioners should make contingency plans to address the effects upon ongoing or planned securities offerings, filings, and requests for interpretive guidance, among other things. SEC operational status: Government shutdown impact The SEC published its operations plan under a lapse in appropriations and government shutdown (Securities and Exchange Commission, Operations Plan Under a Lapse in Appropriations and Government Shutdown, https://www.sec.gov/files/sec-plan-of-operations-during-lapse-in-appropriations-2018.pdf), which went into effect on December 27, 2018. During the shutdown, the SEC will have limited operations and limited staff. The SEC will retain only an extremely limited number of excepted staff members available to respond to emergencies involving the safety of human life or the protection of property, including law enforcement. Of the approximately 4,400 staff employees, fewer than 300 excepted staff remain in service during the shutdown. In summary, during the shutdown, while SEC systems will continue to accept various electronic filings and submissions, the SEC staff will discontinue: processing and approvals of ‘33 Act filings and registrations, including review and acceleration of effectiveness of registration statements; ongoing enforcement litigation, except for emergency enforcement matters; all non-emergency rulemaking, interpretive advice, and no-action letters; processing new and pending exemptive relief applications; approving applications for registration by investment advisers; processing proposed self-regulatory organization (SRO) rule changes, including NYSE and Nasdaq rule changes; responding to requests for information under the Freedom of Information Act, absent compelling need; responding to tips, complaints, or referrals, although limited staff will attempt to respond to certain critical matters, including allegations of ongoing fraud and misconduct; and responding to complaints, questions, or requests for information. In addition, while the SEC will continue to accept comment letters, the SEC anticipates that there will be delays in posting them to the SEC website. The public reference room will be closed. EDGAR Filings and Rulemaking.  The shutdown will not affect the ability to submit EDGAR filings. Additionally, SEC personnel will be able to process requests for EDGAR access codes and password resets and answer questions about fee-bearing EDGAR filings and other emergency questions regarding EDGAR submissions. The Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations, however, will not process filings, provide non-emergency interpretive advice, issue no-action letters, or conduct any other normal Division and Office activities. The SEC will discontinue all non-emergency rulemaking and processing new or pending applications for exemptive relief. New or pending registration statements and applications for exemptive relief will not be processed regardless of the status of any review of those filings. The Division of Corporation Finance also published a set of Frequently Asked Questions (FAQs), discussed below, regarding Issuers’ options with respect to new and ongoing securities offerings during the shutdown. Division of Corporation Finance FAQs.  The SEC’s Division of Corporation Finance (CorpFin) has posted on its website additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/page/corpfin-section-landing). A limited number of CorpFin staff members are available during the shutdown to answer questions relating to fee calculations for EDGAR filings, but will not generally be available to respond to other questions. Issuers and their representatives seeking assistance in calculating a filing fee for a filing during the shutdown should submit their requests to CFEmergency@sec.gov. CorpFin also provided a series of FAQs containing guidance with respect to ongoing and new offerings of securities during the shutdown: If a company with an effective registration statement determines it must update the information in its prospectus before commencing its offering, it should not go forward with the offering without updating the prospectus. The company must decide whether it can update the prospectus without filing a post-effective amendment because the staff will not be in a position to declare that amendment effective. Similarly, a company with a previously qualified Form 1-A that must be updated should not go forward with its offering before updating its offering statement. The staff will not be in a position to qualify a post-qualification amendment filed on EDGAR. If a company does not price its offering within the 15-day time period provided in Rule 430A, the CorpFin FAQs indicate the company may file post-effective amendments under Rule 462(c), which are automatically effective upon filing, to restart the 15-business-day period so that, at the time of pricing, the registrant will be able to include pricing information in a 424(b) prospectus supplement. As an alternative, at the time of pricing, the registrant could file a post-effective amendment under Rule 462(c), prior to the time confirmations are sent or given, to include the information omitted under Rule 430A. Registrants should note, however, that a Rule 462(c) post-effective amendment may not include substantive changes or additions to the prospectus in the registration statement at the time it became effective. The CorpFin FAQs indicate that a registrant may file an amendment to a current registration statement to remove the delaying amendment, in which case the registration statement will be effective in 20 days. The CorpFin staff notes, however, that if the SEC’s operating status changes to operational and the registration statement is not yet effective, the staff will consider a request to accelerate to an earlier date or ask the registrant to amend the registration statement to include the delaying amendment. Companies considering this approach should be aware that Rule 430A is not available in the absence of a delaying amendment. As a result, when a company amends a registration statement to remove the delaying amendment, the registration statement and prospectus must also be amended to include all information required by the applicable form, including the price of the securities being offered. A registrant may also file a new registration statement without a delaying amendment during the shutdown. Again, however, the CorpFin staff notes that, if the SEC’s operating status changes during the 20-day period prior to effectiveness, the staff may ask the registrant to amend the document to include a delaying amendment. Investment Adviser Registration Depository (IARD) system.  The SEC’s IARD system will continue to accept filings, including amendments to Form ADV, Form ADV-W, and Form ADV-E filings, but the Office of Compliance Inspections and Examinations will not approve applications for registration by investment advisers and the Division of Investment Management will not provide interpretive advice regarding the Advisers Act, rules or forms or consider applications for exemptive relief under the Advisers Act. As a result, new or pending investment adviser applications will not be processed. Division of Investment Management FAQs.  The SEC’s Investment Management (IM) also posted additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/investment-management). Investment companies can continue to make filings on EDGAR during the shutdown, but the IM staff will not be available to respond to any questions about pending matters, other than answering questions relating to fee calculations for EDGAR filings. The IM guidance notes that a significant percentage of investment companies’ filings, including post-effective amendments to registration statements, become effective automatically either immediately upon filing or following the passage of a certain number of days. These filings will continue to become effective automatically in accordance with the applicable rules. The IM staff will follow the procedures established by Corp Fin, described above, with regard to the acceleration of initial registration statements and other types of filings made by registered investment companies during the federal government shutdown. Questions relating to calculating filing fees should be directed to IMEmergency@sec.gov. Central Registration Depository (CRD) and Transfer Agent Registration Systems.  The CRD system, used for broker-dealer licensing and registration, will continue to accept filings, but the Division of Trading and Markets and the Office of Compliance Inspections and Examinations will not review pending filings, consider new or pending applications or registrations, provide interpretive advice, or issue no-action letters. In addition, the staff will not be available to conduct any other normal Division and Office activities. Electronic Form Filing System (EFFS).  The EFFS will continue to accept submissions by self-regulatory organizations (SROs), but any SRO proposed rule change submitted through EFFS during the shutdown will have as its filing date the next business day after the shutdown has ended and SEC opens for regular business. Days that the SEC is operating under its shutdown plan (i.e. while the lapse in appropriations continues) will not constitute “business days” under Section 19 of the Exchange Act and Rule 19b-4 thereunder. Enforcement/Litigation.  The Division of Enforcement will have only a limited staff, and ongoing litigation, examinations, and investigative work will be suspended, except for limited emergency enforcement matters, including temporary restraining orders and/or investigative steps necessary to protect public and private property, monitoring the SEC’s “tips, complaints, and referrals” system and web-based investor complaint system, and process referrals from SROs and others to identify matters that are emergencies and take follow-up steps relating to such emergencies. The SEC also will continue Market Watch activities and continue to monitor market technology operations and any broker-dealers reported as being in financial distress. Money market fund surveillance and monitoring will also continue. The staff will also continue monitoring any international market developments that might affect the United States. Emergency Contacts.  Page 16 of the SEC’s shutdown plan contains a list of emergency contact telephone numbers and email addresses to reach an extremely limited number of Commission staff members in each office and division who are available to respond to emergency situations.

Earlier this week, Dorsey hosted a webinar panel presentation on the SEC’s recent guidance on cybersecurity disclosures and policies. The webinar provided a detailed walk-through of the SEC’s guidance, including issues related to enhanced disclosure, insider trading, and Reg FD policies. The panel also discussed the impact of the SEC’s guidance within the changing landscape of cybersecurity and current developments in shareholder litigation, SEC enforcement actions, and other regulatory and legislative initiatives such as the GDPR. The Equifax data breach is used as a case study to illustrate how the SEC’s guidance might play out in this broader context. The webinar recording and presentation materials are available on our website at www.dorsey.com/newsresources/events/videos/2018/06/seminar-playback-sec-guidance-on-cybersecurity.

We get asked from time-to-time whether it is advisable for issuers to pay fees to unregistered “finders” for introducing potential investors in the United States to the issuer in connection with securities offerings. The short answer is “no.” Most finders are engaged by issuers under finder’s, advisory, or other arrangements, which typically require payment of “success fees” upon completion of a financing transaction. While these arrangements are sometimes structured to try to hide or disguise the true intent of the arrangement, payment of transaction-based compensation is treated by U.S. securities regulators as a nearly-conclusive indication that a person is engaged in the securities business and should be registered as a broker-dealer. The relevant U.S. federal broker-dealer laws that should be of concern to an issuer using an unregistered finder include: Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act), which makes it unlawful for a person to “effect a transaction in securities” or “attempt to induce the purchase or sale of, any security” unless they are registered as a broker or dealer under the rules and regulations of the Financial Industry Regulatory Authority, Inc. (FINRA). FINRA is the regulatory organization designated by the Securities and Exchange Commission (SEC) to license and regulate broker-dealers. Section 29(b) of the Exchange Act, which provides that every contract made in violation of any provision of the broker-dealer registration requirements “shall be void” as to rights of persons who made or engaged in the performance of such contract. It results in the underlying purchase of securities becoming a voidable transaction that gives the investor a right of rescission, effectively granting a put right to the investor or purchaser. Section 20(e) of the Exchange Act, under which the SEC may impose aiding-and-abetting liability on any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act. The theory behind broker-dealer registration is to provide a gatekeeper to protect investors in the marketplace. FINRA members are required to “observe high standards of commercial honor and just and equitable principles of trade” in the conduct of its business, including determining if an investment is "suitable" for its customer. Finders assisting in transactions rarely make such determinations and view themselves simply as middlemen in making introductions to potential investors. Because unregistered broker-dealers may not adhere to these high commercial standards, the SEC broadly construes the broker-dealer laws and narrowly construes the few permitted exceptions. Under SEC guidance derived from no-action letters, the SEC requires all intermediaries effecting transactions in securities to be licensed, subject to a few limited exceptions. Effecting a securities transaction may include, among other factors, receiving transaction-based compensation, recommending a company or the purchase of its securities, negotiating terms of a securities offering or purchase, attending meetings or presentations where the merits of the investment are discussed, performing or accommodating due diligence efforts, providing valuations or estimates of value, and other activities that facilitate a securities transaction. The consequences of engaging an unlicensed finder can be troublesome: Finder Risks:  Any unlicensed person engaging in activities designed to effect a transaction in securities may violate broker-dealer laws. The SEC or state securities regulators may seek to enjoin the unlawful activities or seek monetary penalties or criminal sanctions. Issuer Risks:  Retaining and permitting an unlicensed intermediary to effect a securities transaction may be a violation of federal and many state laws, and may subject the issuer to possible civil and criminal penalties. Any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act may be subject to aiding-and-abetting liability. Rescission Risks:  A violation of broker-dealer laws creates a right of rescission under federal and/or state securities law. The SEC or state securities regulators may require the issuer to offer investors rescission rights, and the issuer may be required to return the investment. State Securities Violations:  Many states have begun reviewing state notice filings on Form D (which report transactions exempt from registration under Regulation D) and actively monitoring finder’s fees paid in connection with securities transactions. Some states have required issuers to provide additional information related to unlicensed broker-dealers and, in some cases, to certify that finder’s fees or commissions have only been paid in compliance with broker-dealer laws. Accounting Liability Risk:  Auditors may raise accounting issues resulting from paying finder’s fees to unregistered broker-dealers and may require an issuer to account for potential liability arising from rescission rights. Bad Actor Consequences:  An issuer or finder that is convicted of any felony or misdemeanor, is subject to any order, judgment, or decree of any court, or is subject to any order of certain regulators may be ineligible to participate in certain types of securities offerings, including Rule 506 of Regulation D offerings and Regulation A offerings. Using an unlicensed finder can result in broker-dealer law violations. Many times the issue arises in the context of state notice filings and direct inquiries from state securities regulators where finder’s fees or commissions are paid in connection with an offering. Other times, they arise from a failed investment where the investor may assert claims related to broker-dealer law violations to establish a right of rescission. Issuers should use caution in determining whether to engage a finder to assist in financing transactions.

In a recent case, Wadler v. Bio-Rad Laboratories, Inc. case number 3:15-cv-02356 (2016), the federal court in the Northern District of California ruled that the plaintiff and former general counsel of Bio-Rad Laboratories could use attorney-client privileged information to support his claim of whistleblower retaliation. The court determined that the Sarbanes-Oxley Act’s whistleblower protections preempt the state ethical rules against disclosure of attorney-client privileged information. In reaching its determination, the court noted that this ruling reflects “a reasonable balancing of conflicting policies to the extent that it protects attorney whistleblowers from retaliation even as it requires them to report violations.” The jury awarded the plaintiff $8 million, including $5 million in punitive damages, finding that the plaintiff’s report of suspected payments in violation of the Foreign Corrupt Practices Act was a substantial motivating factor in Bio-Rad’s decision to terminate him in 2013 after serving as Bio-Rad’s general counsel for nearly 25 years. The SEC filed an amicus brief in support of the plaintiff’s claim, arguing that the federal whistleblower scheme would be “seriously undermined” if attorney-client privilege prevents attorney-whistleblowers from using their reports of potential violations as evidence in anti-retaliation litigation. The Wadler decision may signal a shift in judicial attitude toward the protections afforded in-house attorneys who act as whistleblowers. Previously, courts have not permitted attorney whistleblowers to use attorney-client privileged materials in litigation against their former employers. For example, in 2013, the Second Circuit Court of Appeals ruled that a former general counsel violated New York Rules of Professional Conduct when he used attorney-client privileged materials as evidence in a whistleblower retaliation suit (United States ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Inc.). The SEC has indicated a willingness to consider the extent of retaliation that a whistleblower suffers when determining the amount of the whistleblower award. In 2015, the SEC announced a maximum whistleblower award payment of 30% of the amounts collected in connection with In the Matter of Paradigm Capital Management, Inc. and Candace King Weir, File No. 3-15930 (June 16, 2014) because the whistleblower was retaliated against as a result of reporting to the SEC. If other courts follow the precedent established in Wadler, employees in general, and in-house attorneys in particular, may find it easier to support claims of whistleblower retaliation.