CURRENT MONTH (March 2018)

Securities Regulation

Supreme Court Holds That 33 Act Class Claims Stay in State Court

By Cody Wigington, Baker & Hostetler LLP

In a unanimous decision, the United States Supreme Court recently held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) allows class action plaintiffs to pursue alleged violations of the Securities Act of 1933 (the 33 Act) in state court. The Supreme Court also held that defendants are barred from removing the claims to federal court.

In Cyan, Inc. v. Beaver County Employees Retirement Fund, the Supreme Court was faced with the principal question of whether the Private Securities Litigation Reform Act of 1995 (PSLRA)  stripped state courts of jurisdiction over class actions alleging violations of the Securities Act of 1933 (the 33 Act), which applies to securities offerings.  The plaintiffs in that case purchased shares of defendant Cyan, Inc.’s stock in an initial public offering. Following a drop in the price of Cyan stock, the plaintiffs brought a class action alleging that disclosures in the registration statement for the shares was misleading, and seeking damages against Cyan in California Superior Court exclusively for violation of the 33 Act. Cyan moved to dismiss the lawsuit for lack of subject matter jurisdiction, arguing principally that SLUSA stripped state courts of the power to adjudicate 33 Act class actions. In response, the plaintiffs argued that, pursuant to its plain meaning, SLUSA does not strip state courts of jurisdiction over class actions alleging only violations of the 33 Act.  The Supreme Court held the plain language of SLUSA “does nothing to deprive state courts of their jurisdiction to decide class actions brought under the 33 Act.”  The Supreme Court further held that defendants may not remove class action claims alleging violations of the 33 Act to federal court.

In the months leading up to the release of this opinion, some commentators cautioned that allowing state courts to retain jurisdiction over 33 Act claims will reopen the floodgates of securities class actions. While Cyan did not expand the scope of liability under the 33 Act, the number of 33 Act class actions may increase because actions may be brought in each state in which an injury is alleged. However, even if the opinion results in more class actions being filed, it applies only to class actions alleging violations of the 33 Act (i.e., claims related to securities offerings). As the Supreme Court recognized in Cyan, most securities class actions are brought under the Securities Exchange Act of 1934 – which (among other things) governs the trading of securities. Given that, the overall number of securities class actions is unlikely to see a significant rise.

SEC Proposes Targeted Changes to Public Liquidity Risk Management Disclosure

By Michael Sugarman, Orrick, Herrington & Sutcliffe LLP

On March 14, 2018, the Securities and Exchange Commission proposed amendments to public liquidity-related disclosure requirements for certain open-end investment management companies.   Importantly, under the proposed amendments, mutual funds will not have to publicly disclose to shareholders how they score the liquidity of their holdings.  Instead, mutual funds will be required to provide a narrative disclosure discussing the operation and effectiveness of a fund’s liquidity risk management program in the fund’s annual report to shareholders.  The public comment period closes on May 18, 2018.

Securities Regulation

Private Equity and Venture Capital

Spotify Is Bypassing a Traditional IPO in Favor of Direct Listing. Should Other Companies Follow Its Lead?

By Alexandria Kane and Gwenn Barney, White and Williams LLP

First Spotify changed the music industry. Now it might change the way we think about public offerings.

Spotify recently entered the U.S. public securities market through a direct listing of its common stock on the New York Stock Exchange (NYSE).  In a direct stock exchange listing, a company must file a registration statement under Section 12(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act) — typically a Form 10 — but normally does not engage in a capital-raising transaction that would require the filing of a registration statement under Section 5 of the Securities Act of 1933, as amended (the Securities Act).  Spotify was able to file a short-form Exchange Act registration statement on Form 8-A because it incorporated by reference the contents of a statutory prospectus comprising part of an effective Securities Act registration statement on Form F-1, which the company had filed to facilitate resales by certain selling stockholders of Spotify shares originally acquired in private placements or in other exempt transactions.

In going public via a direct listing, a company is able to bypass costs associated with an underwriter and avoids the formal Securities Act roadshow, “testing-the-waters” discussions with potential large investors, and other time-consuming and costly processes associated with traditional IPOs. Because the transaction is not underwritten, investors normally are not subject to the traditional 180 day contractual lockup period customarily associated with an IPO effected pursuant to a Securities Act registration statement. As noted, however, companies going public in this manner still must file an Exchange Act registration statement with the Securities and Exchange Commission (SEC) and become subject to SEC reporting and compliance requirements after obtaining a direct listing.

While the direct listing method had previously been available to companies on NASDAQ and also NYSE under certain circumstances, in early February the SEC approved amendments to the NYSE rules which modify its listing standards in order to facilitate direct listings. Under the new NYSE rules for direct listings, a company must establish that the market value of its publicly-held shares is $100 million in the aggregate. This market value must be evidenced by a third party valuation and the most recent trading price for the company’s common stock in a private market. If the third party valuation judges the publicly-held shares to be worth $250 million in the aggregate, no evidence of a private market price is necessary.

Direct listings have risks associated with them, which is likely why they have not been favored by companies in the past. By not hiring an underwriter to drum up support for the stock before it goes public, the pricing of the stock on the first day of the offering could be volatile. If many stockholders choose to sell off their holdings, the price of the stock could sink, while if too few stockholders sell, the market may struggle to gauge a price for the shares. Additionally, there is no guarantee of the robust aftermarket for trading that an underwriter often creates in the case of an IPO or the promise of a greenshoe to act as a stabilizer should the stock stumble out of the gate.

Spotify will be a test of  how well a larger company can weather these risks. The company’s large shareholder base, robust financial posture and brand recognition could put it in a position to overcome the challenges associated with a direct listing.  We will have to wait and see.

Private Equity and Venture Capital

Venture Capital Firm and Portfolio Company Directors Face Investor Claims

By Lisa R. Stark and Taylor B. Bartholomew, K&L Gates LLP

In Carr v. New Enterprise Associates, Inc., the Delaware Court of Chancery recently declined to dismiss claims that (i) the board of directors of Advanced Cardiac Therapeutics, Inc. (“ACT”) breached its fiduciary duties in connection with a preferred stock financing which allowed venture capital firm, New Enterprise Associates, Inc. (“NEA”), to acquire control of the company, and (ii) the ACT board and NEA breached their respective fiduciary duties in connection with the subsequent sale of an option to purchase ACT to a third party.  According to plaintiff, the preferred stock financing undervalued ACT and was approved by a conflicted board and NEA orchestrated the option transaction on the cheap to optimize the value of its investments in companies other than ACT.  This case highlights the risks faced by venture capital firms and portfolio company directors when engaging in conflict transactions.


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