CURRENT MONTH (September 2018)

Securities Regulation

Elon Musk and Tesla Settle Securities Fraud Charge over Tweet

The Securities and Exchange Commission (the SEC) recently announced that Elon Musk, CEO and Chairman of Tesla, Inc. agreed to settle the securities fraud action brought by the SEC against him in late September.  The SEC also agreed to settle charges brought against Tesla, arising from Musk’s tweet, on August 7, 2018, that he had secured funding for a transaction to take Tesla private at $420 per share. According to the SEC complaint, the potential transaction was uncertain and subject to numerous contingencies and Musk’s misleading tweets caused Tesla’s stock price to jump by over six percent and led to significant market disruption. The SEC alleged that Tesla failed to implement disclosure controls and procedures which would have prevented Musk’s tweet. The settlements, which are subject to court approval, will result in Musk’s removal as Chairman of the Tesla board (with a minimum 3-year bar on re-appointment to this position) and the payment by Musk and Tesla of $40 million in penalties that will be distributed to “harmed investors” under the court’s supervision. Additional remedies covered by the settlements include the appointment to Tesla’s board of two new independent directors, the establishment of a new committee of independent directors and the implementation of “additional controls and procedures to oversee Musk’s communications.”

SEC Denies Applications For ETFs: Will Traditional Wall Street Banks Step In?

By Jennifer Post, Thompson Coburn LLP

In August, the SEC rejected nine separate applications to list Bitcoin exchange-traded funds (ETFs). Proposals by ETF sponsors including Direxion, ProShare and GranitShares, to list the first US-based cryptocurrency ETFs were denied. Each rejection order contained the following language as part of its reasoning:

“…the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.”

The SEC goes on to suggest that the proposed ETFs “…offered no record evidence to demonstrate that bitcoin futures markets are ‘markets of significant size,’” which would justify or demand enhanced surveillance and fraud prevention strategies.

Thematically, the SEC pointed to the difficulty of enforcing market manipulation surveillance and prevention in a Bitcoin ETF. In addition, from the SEC’s point of view, the applications failed to prove the Bitcoin futures markets are large enough to support or establish a means to prevent fraudulent and manipulative acts. The SEC did indicate, however, that the denial of the applications does not rest on an evaluation of whether Bitcoin has value as an investment.

In light of these denials by the SEC, until a sponsor can adequately demonstrate that Bitcoin ETFs are “markets of significant size” or provide alternative methods to protect the markets from fraudulent activities, US-based ETFs may still be in the distance. However, with an increasing appetite among traditional Wall Street banks to enter the cryptocurrency market and offer cryptocurrency products and opportunities to their clients, the time horizon for US-based ETFs and other trading products may be shortened. While many in the cryptocurrency markets may reject the presence of large, traditional banking institutions entering the market, such institutions may be able to convince the SEC that various cryptocurrency products and trading opportunities can be launched in compliance with existing regulations.

SEC Clarifies Effective Date For Disclosure Simplification Rules

By Cam C. Hoang, Dorsey & Whitney LLP

In August, the SEC adopted amendments updating and simplifying disclosure rules. Notable amendments included:

  • the extension of a previously annual requirement to interim periods, to present a statement of changes in shareholders’ equity and to disclose the amount of dividends per share for each class of shares (vs common shares only) (either in a separate statement or a footnote)(revised Rules 8-03(a)(5) and 10-01(a)(7) of Regulation S-X);
  • the elimination of requirements to disclose pro forma information on business combinations in quarterly reports on Form 10-Q, because similar disclosure may be found in Form 8-K filings;
  • the elimination of requirements in business descriptions to disclose financial information broken out by segment (Item 101(b) of Regulation S-K) and geography (Item 101(d)(2)), risks associated with, and dependence of a segment on, foreign operations (Item 101(d)(3)), and amounts spent on R&D (Item 101(c)(1)), because similar discussions may be found in the financial statement footnotes and/or the MD&A, when material; and
  • the elimination of exhibits setting forth the computation of any ratio of earnings to fixed charges disclosed in an SEC report (Items 503(d) and 601(b)(12) of Regulation S-K), because US GAAP already requires the disclosure of components of the ratio.

As of October 1, 2018, the SEC release adopting the various amendments to Regulations S-K and S-X (among others) adopted this August has not been published in the Federal Register.  Because the amendments do not become effective until 30 days after the date of their Federal Register publication, companies now preparing periodic reports for the reporting period ended September 30, 2018 remain uncertain as to whether the amendments apply to such reports in the event the filing deadline precedes the effective date.  That said, there is limited good news on this front -- the SEC’s Division of Corporation Finance has released C&DI 105.09 indicating that application of the amendments relating to presentation of shareholders’ equity may be deferred as explained below.  However, the guidance confirmed that other applicable August amendments nevertheless may apply to Form 10-Qs for the third quarter of 2018 (for calendar-year registrants), if these amendments are published soon in the Federal Register. Given the proximity of the anticipated effective date to the Q3 Form 10-Q filing deadline, however, the staff will not object if companies first present the statement of changes in shareholders’ equity (first bullet above) in the Form 10-Q for the quarter that begins after the effective date, i.e., for the first quarter of 2019 for calendar year-end reporting companies. 

Private Equity and Venture Capital

Court Of Chancery Interprets Preferred Stock Rights

By Edward M. McNally, Morris James LLP

Interpreting the provisions of preferred stock is often a difficult task.  Any preference must be spelled out and any doubts resolved against preferring one class of stock over common stock.  A recent decision holds that the preferred stock must show evidence it was intended to a preference at least when the authorization for that stock is ambiguous. The decision also affirms that stockholder rights to inspect records cannot be taken away by a certificate of incorporation.

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