Tuesday, April 23, 2013

What is Regulation FD and Does it Prohibit the Use of Social Media?

Regulation Fair Disclosure (known as “Regulation FD”) was enacted in 2000 by the Securities and Exchange Commission (the “SEC”) to prohibit selective disclosure of material non-public information by the public companies or persons acting on their behalf to a selected group of outsiders (often market professionals, analysts or major investors) where it is reasonably foreseeable that they would trade on that information before it is made available to the general public. The Regulation requires that if such selective disclosure has been made, then the company must promptly disclose that same information to the public. Public disclosure was typically made by filing Form 8-K with the SEC and/or issuing a press release.

Given the development of the Internet and proliferation of company websites, the SEC said in its 2008 interpretive guidance that it was possible to disseminate the information by posting it on the company’s website, so long as it was viewed as the corporate “recognized channel of distribution.”  This would depend on the “steps that the company has taken to alert the market to its website and its disclosure practices, as well as the use by investors and the market of the company’s website.”   The guidance offered a non-exhaustive list of factors to be considered in evaluating whether the website is a “recognized channel of distribution.”  Mainly, the inquiry focused on the question of whether the company has made its shareholders, investors and the market in general aware that it was going to use its website as its main channel of news distribution.

The advance of technology and social media has continued to test the boundaries of Regulation FD. On July 3, 2012, the Netflix CEO Reed Hastings posted on his personal Facebook page that Netflix monthly viewing exceeded 1 billion hours for the first time. There was no simultaneous press release or Form 8-K filed. Reed Hasting’s Facebook page had over 200,000 followers at the time of the post, including equity research analysts, shareholders, reporters and bloggers. It was the first time that Mr. Hasting’s personal page was used to announce Netflix news and Netflix did not previously inform its shareholders that Hasting’s Facebook page would be used to disclose material information about the company. Previously, Netflix used press releases, its website, Twitter feed and blog to release information about Netflix. So, did this posting violate Regulation FD?

The SEC launched an investigation, and on April 2, 2013 issued a report announcing that it determined not to pursue an enforcement action in this matter given that there was confusion regarding the application of Regulation FD to social media.  In its report, the SEC advised all public issuers that they need to analyze their every single communication, whether it is made through the website, blog, email alert, twitter account or Facebook page, for compliance with Regulation FD. Companies need to identify for their shareholders and investors which communication channels they will use to disseminate material information. For example, companies can do so by simply including the company’s website address (or Facebook page address, etc.) in their periodic reports and press releases. Also, the companies’ websites can identify the steps that the public needs to take to receive important updates (such as subscribing, joining a group, or “liking” a page). The SEC noted, however, that posting material information on a personal Facebook page without prior notice to the public that the page would be used for this purpose is unlikely to pass the Regulation FD muster, regardless of the number of followers. The use of personal Facebook page should not be a channel for the company’s dissemination of material corporate information.

In conclusion, below are a number of steps that public companies may consider taking:
  • Review every single communication for Regulation FD compliance; 
  • Decide which communication channels the company is going to use to disclose its corporate information; 
  • Prepare a short disclosure notice summarizing these communication practices going forward; 
  • Add this notice to the company’s periodic reports, press releases and website in order to provide advance notice to the public; and 
  • In light of the Netflix investigation, avoid using personal websites or personal social media pages to disseminate corporate information.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, April 19, 2013

Accredited Crowdfunding Portals Receive No-Action Relief from the SEC

In my previous blog, I described the FAQs released by the Staff of the Securities and Exchange Commission (the “SEC”) earlier this year addressing the new exemption from broker-dealer registration found in Title II of the JOBS Act (codified as Section 4(b) of the Securities Act). On March 26, 2013, the SEC granted no-action relief to FundersClub, Inc., an operator of a web portal that intends to comply with this new exemption. On March 28, 2013, the SEC granted a similar no-action relief to AngelList. These no-action letters are an excellent illustration of how the new exemption will work in practice.

Let’s first take a look at the FundersClub letter. The proposed structure looks like this. FundersClub, Inc. is a Delaware corporation and is the sole owner of FundersClub Management LLC, which is the manager of investment funds formed to invest in start-up companies (usually one fund per start-up). The parent entity operates a website portal that provides information about pre-selected start-up companies. Only accredited investors can become members of the club. Once FundersClub Management LLC decides to invest in a start-up, it enters into a non-binding agreement with that company, identifying the target amount of investment. Then, FundersClub posts information provided by the start-up company on its website, www.thefundersclub.com, which is only available to members.  Members submit non-binding indications of interest. Once sufficient interest is reached, FundersClub forms an investment fund (a Delaware LLC) where members invest. All money is kept in a custodial account with a bank or a trust company and later invested into the start-up. FundersClub Management LLC exercises management rights and provides the start-up with strategic and networking assistance. It can vote the investment fund’s shares and can even sell them because the individual members are not record or beneficial shareholders of the start-up company. There may be an initial administrative fee charged by the fund to its members to cover the organizational expenses. The manager intends to be compensated by receiving a carried interest of 20-30% upon the fund’s liquidation. In particular, the waterfall would look as follows: upon liquidation, the proceeds of the fund would (i) first, be used to pay any expenses of the fund and the administrative fee, if not yet paid; (ii) second, to repay the capital contributions of each member; (iii) third, to pay a percentage of profits to the members on a pro-rata basis; and the remainder would be paid to FundersClub Management LLC as carried interest.

The Staff granted the FundersClub entities no-action relief for not registering as broker-dealers pursuant to the exemption found in Section 4(b) of the Securities Act. In arriving at the decision, the Staff noted that (i) the FundersClub entities are advisers solely to venture capital funds; (ii) their compensation (carried interest) is advisory in nature, and is not transaction-based; (iii) the amount of compensation is fully disclosed to the investors at the time of investment; (iv) the administrative fee is used to reimburse third-party expenses and is not paid to the FundersClub entities or their affiliates or principles; and (v) all investment money is kept in a separate custodial account and cannot be accessed by the FundersClub entities for their own use.

Now, let’s take a look at the no-action letter issued to AngelList. Currently, AngelList LLC operates a website angel.co that permits start-up companies to network with angel investors. AngelList provides companies and investors with standard form documents for investments and refers them to Second Market, a registered broker-dealer, to complete the investments. AngelList proposes to form AngelList Advisors LLC as its wholly-owned subsidiary. AngelList Advisors will be a registered investment adviser either with the SEC or in one or more states. AngelList Advisors will establish a separate website (or a portion of the existing website) which will assist investors and start-up companies. All portfolio companies that can participate on the website will have to go through a due diligence process and meet certain criteria. Lead Angel investors (accredited investors leading the deal) will also be subject to due diligence and approval by AngelList Advisors. Upon approval of both the portfolio company and the Lead Angel, AngelList Advisors will form a separate investment vehicle (either an LLC or an LP) for the purpose of investing in that one portfolio company. AngelList Advisors will provide initial capital needed in setting up the fund. Once the fund is formed, AngelList Advisors will make the potential investment opportunity be known to the investors who participate on the platform (only accredited investors are allowed to participate). Interested investors will submit a non-binding request for information, along with a questionnaire certifying that the investor is an accredited person. Investors have to agree to wait at least thirty days from that time to complete the investment. There are two investment models described by AngelList Advisors in the no-action letter. The first model is very similar to the one to be used by FundersClub. The second model is referred to as “Angel Advised”, whereby the Lead Angel takes on an active role in negotiating the investment, provides material managerial assistance to the portfolio company, invests at least 20% of the target amount, and in compensation, shares the carried interest with the AngelList Advisors.

As you can see, both no-action letters provide practical guidance to other accredited investor portals on how to avail themselves of the exemption from broker-dealer registration that has become available as part of the JOBS Act. Although the analysis is very fact-specific, there are main overarching factors that are instrumental in structuring the portals: (i) no transaction-based compensation but carried interest is permissible; (ii) no handling of investor money; (iii) all investors must be accredited, and (iv) the offerings must be conducted pursuant to Rule 506.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Thursday, April 4, 2013

The SEC’s Frequently Asked Questions Regarding the Broker-Dealer Registration Exemption

 The legal world is patiently waiting for the Securities and Exchange Commission (the “SEC”) to enact rules implementing Title II of the JOBS Act.  One of the recent developments in this field is the issuance by the SEC Staff of frequently asked questions (FAQs) regarding the broker-dealer registration exemption found in Section 201(c) of Title II of the JOBS Act that adds a new paragraph (b) to Section 4 of the Securities Act. 

Generally, intermediaries are required to register with the SEC as broker-dealers when they are engaging in certain matchmaking activities between the issuers and the investors.  This Guide provides an overview of the activities that may require registration as a broker-dealer.  The JOBS Act introduced an exception to this general rule when it directed the SEC to eliminate the ban on general solicitation and advertising for Rule 506 offers and sales where all investors are accredited.  The exemption is very limited and applies only in Rule 506 offerings and only in the three circumstances listed below.  So, according to the new Section 4(b) of the Securities Act, a person will not be required to register as a broker-dealer solely because:

·         “that person maintains a platform or mechanism that permits the offer, sale, purchase or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person or through any other means;”

·         “that person or any person associated with that person co-invests in such securities”, or

·         “that person or any person associated with that person provides ancillary services with respect to such securities.”  Ancillary services are defined as providing due diligence services (but not investment advice or recommendations for separate compensation) and providing standard deal documents (as long as such person does not negotiate these documents and the issuers are not required to use these documents as a condition of using the service.

Importantly, such person may not receive compensation in connection with the purchase or sale of such securities and may not have possession of customer funds or securities in connection of such transactions, and they are not subject to statutory disqualification.   

What types of entities would be likely to rely on such exemption?  These would most likely be VC funds and their advisers.   Actually, the SEC Staff noted that the compensation prohibition “makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.”  But practical use of this exemption still remains to be seen.
As I have previously written, the SEC had three months from April 5, 2012 to issue rules implementing the elimination of the ban on general solicitation and advertising in Rule 506 offerings.  However, such rules have not yet been implemented, which means that the general solicitation and advertising in Rule 506 offerings to accredited investors are not yet permitted.  Interestingly, the broker-dealer exemption addressed in Section 201 of the JOBS Act went into effect immediately upon adoption of the JOBS Act. 

To clarify the situation, on February 3, 2013 the SEC issued the FAQ regarding this broker-dealer exemption.  It consists of 10 questions.  Below is the summary:

1.       The Staff explained that although the exemption from broker-dealer registration contained in Section 4(b) of the Securities Act is now in effect, the elimination of the ban on general solicitation and advertising in Rule 506 offerings is not.
2.       The scope of the exemption is very narrow: it is only available in connection with the offerings conducted under Rule 506 of Regulation D.
3.       Persons who are eligible for exemption can maintain an Internet website or a social media site and still use the exemption (no need for a more formal portal).
4.       Persons who want to avail themselves of this exemption cannot be compensated in connection with the purchase or sale of these securities.  Here, the Staff interprets “compensation” broadly to include direct or indirect economic benefits. 
5.       The exemption permits co-investing in the securities offered by the platform.  Any economic or financial benefits derived from such investments are not considered impermissible “compensation”.
6.       Someone who is associated with the issuer can maintain a platform to sell the issuer’s securities, as long as no compensation is paid in connection with the purchase or sale of these securities.
7.       The exemption in Section 4(b) does not exempt from state registration requirements.
8.       The exemption is not an exclusion from the definition of the term “broker” or “dealer”, so some federal securities laws would still apply to the exempt persons regardless of registration.

The adoption of the SEC rules regarding the elimination on the ban of general solicitation and advertising, coupled with this exemption from broker-dealer registration, is set to drastically change the way Rule 506 offerings are conducted.  All we have to do now is patiently wait for the enactment of the SEC rules.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.