Securities Regulation

New Act Takes A Few Small Steps to Encourage Capital Formation

By Cydney Posner, Cooley LLP

While the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was just signed into law, is focused primarily on providing regulatory relief to banks under Dodd-Frank, there are a few provisions of more general interest in Title V, “Encouraging Capital Formation”:

  • Requires the SEC, not later than 60 days after enactment of the new Act, to revise Section (e) of Rule 701, the exemption for issuances to employees, to increase the threshold to trigger the requirement for delivery of additional disclosure to investors from $5,000,000 to $10,000,000 in aggregate sales price or amount of securities sold during any consecutive 12-month period. The amount will be indexed for inflation every five years to reflect the change in the Consumer Price Index for All Urban Consumers, rounding to the nearest $1,000,000.
  • Requires the SEC to amend Reg A/A+ to allow public companies to use the exemption by eliminating the eligibility requirement in Section 251 that the issuer not be subject to Section 13 or 15(d) of the Exchange Act immediately before the offering. For Reg A+ offerings, the provision also amends Section 257 to deem any issuer that is subject to, and current under, those public reporting requirements to have met the periodic and current reporting requirements of Section 257.
  • Provides parity among national securities exchanges by changing the definition of “covered security” for purposes of federal preemption of state blue sky laws under NSMIA. The provision eliminates the specific references to particular named exchanges and instead refers to “a security designated as qualified for trading in the national market system pursuant to section 11A(a)(2) of the Securities Exchange Act of 1934 that is listed, or authorized for listing, on a national securities exchange (or tier or segment thereof).”
  • Requires the SEC to submit a report to Congress on the effect of algorithmic trading on the markets, along with recommendations for any necessary regulations.
  • Requires the SEC to review annually the findings and recommendations of the Government-Business Forum on Capital Formation and disclose the actions the SEC intends to take with regard to those findings or recommendations.
  • Amends the Investment Company Act of 1940 to exempt from the definition of “investment company,” for purposes of specified limitations applicable under the 1940 Act, a qualifying venture capital fund that has no more than 250 investors (an increase from 100 investors) and less than $10 million in aggregate capital contributions and uncalled committed capital. 

In the First Application of the Whistleblower “Safe Harbor” Rule, SEC Awards More Than $2.2 Million to Whistleblower Who First Reported Information to Another Federal Agency

By Mary Beth Schluckebier, Saul Ewing Arnstein & Lehr LLP

On April 5, 2018, the SEC announced an award of more than $2.2 million to a former company insider who voluntarily provided critical information to another federal agency before reporting it to the SEC, and whose report led to a significant SEC enforcement action. The SEC’s award is the first of its kind paid under the “safe harbor” provision of Exchange Act Rule 21F-4(b)(7).

The safe harbor provision of the Rule provides a 120-day grace period for reporting to the SEC, offering assurance to whistleblowers who report information to other federal agencies before submitting the same information to the SEC. For purposes of evaluating award applications in such cases, the SEC will now treat the information as though it had also been submitted to the SEC on the date of the original disclosure to the other federal agency. This is important because ordinarily, in order to be treated as a whistleblower under 17 C.F.R. § 240.21F-4, an individual must voluntarily report original information to the SEC. Under the safe harbor provision, however, a whistleblower who first reports to a federal agency other than the SEC is not disqualified from SEC whistleblower award eligibility, as long as he or she reports the same information to the SEC within 120 days. Thus, the other agency’s use of the information in a referral that prompts the SEC to open an investigation is credited to the whistleblower for purposes of making an award determination.

In this case, after the whistleblower reported the information to another federal agency, the agency referred the matter to the SEC, which then opened an investigation. Within 120 days of the initial report, the whistleblower provided the same information to the SEC. Even though the whistleblower’s SEC report came after the SEC had already opened its investigation, which would typically preclude the reporter from being treated as a whistleblower, the SEC treated the report as though it had been made directly to the SEC at the same time the whistleblower provided the information to the other agency.

At least in the context of a report to another federal agency, the safe harbor provision provides would-be whistleblowers with incentive and protection. Awards like the one described above are likely to attract the attention of company insiders (and, at a minimum, the plaintiff whistleblower bar), further encouraging the reporting of alleged misconduct to the government.

Securities Regulation; Private Equity and Venture Capital

Cryptocurrency Debit Card Startup Founders Indicted

By Linn Foster Freedman, Robinson+Cole LLP

The U.S. Attorney’s Office in the Southern District of New York has announced that a federal grand jury has returned an indictment against three Florida men who co-founded the cryptocurrency company Centra Tech, Inc. The indictment alleges that the founders defrauded investors of $25 million through conspiracy and securities and wire fraud, and that the founders lied to investors prior to the initial coin offering.

According to the announcement, the three co-founders allegedly lured investors into buying unregistered securities by falsely advertising that (1) the company had hired a team of executives, including a CEO with superior qualifications and credentials, (2) the company had licensing agreements with major credit card companies, including Mastercard and Visa, and (3) the company had licenses in 38 states. The announcement also states that the CEO was fictitious.

According to the U.S. Attorney’s Office, the men sought to “capitalize on investor interest in the burgeoning cryptocurrency market.” Following the arrest of the three men, the FBI seized 91,000 units of Ether, which was culled from investors who participated in the initial coin offering. Although the Ether was worth $25 million at the time of the initial coin offering, it is reported to be worth $60 million now.


Open Market CLO Managers Are Not ‘Securitizers’

By Jamie Kocis, Kramer Levin Naftalis & Frankel LLP 

On April 5, 2018, in accordance with the mandate issued by the District of Columbia Circuit on April 3, 2018, and the opinion of the D.C. Circuit issued on Feb. 9, 2018, the U.S. District Court for the District of Columbia ordered that the Credit Risk Retention Rule, adopted pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, be vacated insofar as it applies to open market CLO managers.

A CLO is a type of securitization backed by loans made to corporate borrowers. Balance sheet CLOs are typically sponsored by large institutions, securitizing loans originated by such institutions. In contrast, in an open market CLO, a collateral manager directs the purchase of loans through a special purpose vehicle in the open market. After loans are selected for the CLO, the collateral manager operates and manages the loan portfolio.

The Credit Risk Retention Rule requires any “securitizer” of asset-backed securities—defined as including a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer—to retain at least 5% of the credit risk of the securitized assets. Open market CLO participants have expressed concern with the application of the Credit Risk Retention Rule to a CLO manager who is unaffiliated with the origination of the loans and purchases loans on the open market.

In 2016, the Loan Syndications and Trading Association (LSTA), representing members participating in the syndicated corporate loan market, brought an action against the SEC and the Federal Reserve challenging the applicability of the Credit Risk Retention Rule to open market CLOs. The District Court granted summary judgment to the defendant agencies. The Court of Appeals, ruling de novo, reversed.

On appeal, the LSTA renewed its argument that, given the nature of the transactions performed by open market CLO managers, the extension of the Credit Risk Retention Rule to open market CLOs lacked a statutory basis. The appellate court agreed, concluding that open market CLO managers are not “securitizers” for purposes of the Credit Risk Retention Rule because open-market CLO managers typically do not own the assets underlying the CLO and therefore do not transfer them to the issuer.

It is now the law that open market CLO managers do not have to comply with the Credit Risk Retention Rule. Many CLO managers have invested a lot of time and money in creative structures to ensure compliance with the Credit Risk Retention Rule and to enable securitizers to leverage their retained piece of the CLO structure. It remains to be seen whether managers will abandon the new structures or whether they will use them as a selling point to distinguish themselves in the market. Deals may continue to be structured as risk retention compliant, but without the formal disclosure requirements and filings.

Also, smaller market participants that did not have the resources to comply with the Credit Risk Retention Rule, and therefore exited the business, may now re-enter the market, and new participants may enter as well.



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