Securities Regulation

A Big “Uh-Oh” for the SEC’s ALJs and Administrative Courts

By Ernest Badway, Fox Rothschild LLP

Recently, the United States Supreme Court sent shock waves through the securities industry, as well as the United States Securities and Exchange Commission’s (SEC) enforcement program, when it held that SEC administrative law judges (ALJs) are “Officers of the United States” within the meaning of the Appointments Clause of the United States Constitution. Under this constitutional provision, only the President, a court, or a department head (here, the SEC) may appoint such officers. Because SEC ALJs had been appointed by members of the agency’s staff, the Court deemed the agency’s appointments process to be unconstitutional. Although the Court’s decision centered on a challenge to the authority of the SEC ALJ who presided over a particular SEC administrative enforcement proceeding involving investment adviser Raymond Lucia and his affiliated investment company, it may also have a broader impact not only on other SEC administrative proceedings but also on the use of “in-house” judges by other federal agencies.

The Lucia case involved a former investment adviser, Raymond Lucia, who with his affiliated investment company was found by an ALJ to have violated certain federal securities laws and was sanctioned by an SEC ALJ. The full Commission upheld this determination on appeal and imposed additional sanctions. A panel of the U.S. Court of Appeals for the District of Columbia agreed, rejecting Mr. Lucia’s argument that the ALJ who presided over his case was not constitutionally appointed. The D.C. Circuit panel’s opinion was upheld in a per curiam order issued by the divided en banc court, thus giving rise to a conflict with a contrary decision by the U.S. Court of Appeals for the 10th Circuit. Accepting Mr. Lucia’s request to resolve this conflict, a majority of the Supreme Court determined that the SEC’s ALJs “are ‘Officers of the United States,’ subject to the Appointments Clause.” Writing for the majority, Justice Elena Kagan found that the SEC’s ALJs were “near-carbon copies” of special trial judges of the U.S. Tax Court held by the Court (in Freytag v. Commissioner, 501 U.S. 868 (1991)) to be “inferior officers” rather than employees. To “cure this constitutional error,” the Court reversed and remanded the matter for rehearing either by the SEC itself or by an ALJ other than the judge who had issued the initial decision on the merits.

Now that the Supreme Court has ruled that the SEC’s ALJs are “Officers of the United States” within the scope of the Appointments Clause, many questions remain to be answered. For example, the Court did not indicate whether the SEC’s post hoc ratification of the staff’s previous ALJ appointments fully remediated any constitutional deficiencies, or whether a constitutionally valid appointment necessitates stripping ALJs of removal safeguards established by the Administrative Procedure Act (an issue Justice Breyer raised in a concurring opinion, which the majority expressly declined to address).  Neither is it clear whether other respondents will be able to successfully reopen closed SEC administrative proceedings on the basis of the Lucia opinion in situations where the Appointments Clause argument had not been raised in a timely manner (i.e., in the original proceeding). Finally, the Lucia opinion calls into question what, if anything, will happen to the ALJs at other federal agencies.  Only time will tell.

Ether Is Not A Security: Summary of SEC Division of Corporation Finance Director Hinman’s Remarks

By Michael S. Didiuk, J. Dax Hansen, Jesse P. Kanach, Lowell D. Ness, Keith Miller, Thomas Ahmadifar, Michael S. Selig and Conor O’Hanlon, Perkins Coie LLP

In a recent speech during a crypto conference in San Francisco, a top Securities and Exchange Commission official expressed his view that, at this point, current offers and sales of Ether are not securities transactions. Speaking from prepared remarks, Bill Hinman, Director of the Division of Corporation Finance, said: “Based on my understanding of the present state of Ether, the Ethereum network, and its decentralized structure, current offers and sales of Ether are not securities transactions.” Hinman also said that, given the operational and decentralized nature of the underlying network, Bitcoin likewise is not a security, thus reinforcing what SEC Chairman Jay Clayton stated in his remarks recently on CNBC. The main topic of Hinman’s speech focused on whether a digital asset offered and sold as a security can, over time, become something other than a security. To this point, Hinman noted that where a digital asset is “sold only to be used to purchase a good or service available through the network on which it was created . . . the answer is a qualified ‘yes.’”

Hinman also discussed some of the factors to consider in assessing whether a digital asset is offered as an investment contract in a securities transaction. In particular, Hinman focused on the third prong of the “investment contract” test under Section 2(a)(1) of the Securities Act of 1933, originally outlined by the Supreme Court in Howey (SEC v. W.J. Howey, 328 U.S. 293 (1946)), and whether the efforts of an identifiable third party—be it a person, entity, or coordinated group of actors—drives the investor’s expectation of a return. Also noteworthy was Hinman’s comment that the SEC is “happy to help promoters and their counsel work through . . . issues . . . [and] . . . stand prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.” Finally, in a footnote included in the written version of the remarks, Hinman, referencing simple agreements for future tokens, or “SAFTs,” stated his view that a token once offered in a securities offering can, depending on the relevant facts and circumstances, later be offered in a non-securities transaction.

Benefit Plan Disclosure Affected by SEC Staff Compliance and Disclosure Interpretations of Proxy Rules and Schedules 14A/C

By Steve Evans, Jennifer Stokes, Taavi Annus and Mark Stern, Bryan Cave Leighton Paisner LLP

The SEC staff regularly publishes “Compliance and Disclosure Interpretations” (C&DIs) on various securities matters. Recently, the Division of Corporation Finance issued new C&DIs related to the SEC’s proxy rules. Previously, the Division’s interpretations relating to the federal proxy rules were contained in a Manual of Publicly Available Telephone Interpretations, which had not been updated since 1999. Included in the new C&DIs are interpretations that affect compensation and benefit plan disclosure in proxy statements filed on Schedule 14A. Most of the new compensation and benefit plan–related C&DIs carry forward the substance of the prior Telephone Interpretations, but the following C&DI includes a new substantive interpretation:

  • C&DI Question 161.03: If a registrant is required to disclose the New Plan Benefits Table called for under Item 10(a)(2) of Schedule 14A, the table should list all of the individuals and groups for which award and benefit information is required, even if the amount to be reported is “0”. Alternatively, the registrant may choose to use a narrative disclosure accompanying the New Plan Benefits Table to identify any individual or group for which the award and benefit information to be reported is “0”. [This continues the prior Telephone Interpretations as to the requirement to list in the New Plan Benefits Table all of the individuals and groups for which award and benefit information is required, even if the amount to be reported is “0”. The option to use a narrative disclosure is a new interpretation.]

The following compensation and benefit plan C&DIs continue the staff’s prior interpretations that were included in the Telephone Interpretations: Questions 126.01, 161.01, 161.02, and 161.04 to 161.12.

Private Equity and Venture Capital

AICPA Draft Guide Available for Comment: Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds

By Kelley Howes, Morrison Foerster LLP

The AICPA recently released for public comment a working draft of its Accounting and Valuation Guide: Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies.

The Guide is designed to provide investment companies that invest in securities issued by privately held enterprises with an overview of the valuation process and the roles and responsibilities of the various parties involved in the valuation process. It also includes best practice recommendations for complying with FASB ASC 946: Financial Services—Investment Companies and FASB ASC 820: Fair Value Measurement. Investment companies within the scope of FASB ASC 946 include private equity funds, venture capital funds, hedge funds, and business development companies.

Importantly, the Guide does not change existing accounting guidance. The Guide was prepared by the AICPA Private Equity and Venture Capital Task Force and was approved for issuance by the AICPA Financial Reporting Executive Committee. As such, it is non‑authoritative. That said, the Guide seeks to provide funds with interpretive guidance regarding valuation of investments in equity and debt securities issued by privately held enterprises.

In drafting the Guide, the task force considered various accounting and valuation issues that have come up over time. The Guide first provides an overview of the private equity and venture capital industries and related investment strategies. It then summarizes FASB ASC 820 fair value measurement concepts (which updated fair value and measurement disclosures codified in FASB Statement 157: Fair Value Measurements) and provides guidance on market participant assumptions, unit of account, and an overview of valuation approaches (i.e., the market approach, income approach, and asset approach). The Guide also has chapters addressing restrictions on transfer, calibration, back-testing, and factors to consider at or near a transaction date, and includes frequently asked questions and appendices addressing documentation considerations and case studies.

Comments on the working draft are due to the AICPA by August 15, 2018. A final version of the Guide is expected to be released in May 2019.



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