Coin Offering Revisited

In December, 2018, I posted an article about proposed Federal legislation to define coin offerings the SEC would NOT treat as securities offerings.  That bill died but has just been re-introduced in modified form, and purports to define tokens which will not be SEC-regulated.  The Token Taxonomy Act, with some bipartisan support, seeks to provide clarity for blockchain-based start-ups issuing coins.

Although blessedly the newly-proposed statute fixes a mandatory national standard (pre-empting  possibly inconsistent State regulation), some commentators claim the new law is too simplistic.  The  appealingly simple part is that the law would exempt digital tokens the histories of which are recorded on a distributed, digital ledger (can you say “blockchain”?)  and do not represent a financial interest in any particular business entity.  The fear is that the dividing line suggested cannot be sharp enough; if the original payment goes into, say, Company X,  and Company X uses the money to finance itself and then affords the Company X product at a discount, is that not like a security (investor pays money, company builds itself on the money, company gives something of economic value to investor such as the product itself, or a discount on the product, or access to the product).

A recent SEC decision suggest such a model will not be SEC-regulated if the tokens cannot be sold to create a currency, but the SEC insists on a case-by-case approach and to date has not commented on the proposed law (filed April 9).

Question: I send a down payment to a company to purchase the company’s widget (let’s say it is a really big, expensive widget).  The company takes my deposit, records it as a down payment, goes out and buys a new widget-maker machine, hires an engineer and and a laborer, builds my widget and ships it to me.  How different is that from a digital token that works the same way?  Why would it matter if my purchase order were sold to another buyer, even for a profit, the transaction being added to a blockchain–or not?

Ever notice how technology is stressing our legal system in search of good analogies where there is no clear precedent?   I keep reminding people that THE seminal case in the definition of a security is a seventy-two year old Supreme decision about an orange orchard.  I fear that it is likely a stretch to say that the law today is asked to compare an apple with an orange– but is that true if, say,  I capitalized the “Apple”?



The New Corporate Activists

Last year, public corporations suffered more than 225 “activist attacks” and more than 160 board seats were won by activists in proxy contests.  But, it seems, this is an incomplete picture; much activity is going on “under the radar.”

According to an expert panel convened this week by National Association of Corporate Directors – New England, many activist approaches are now low key.  This is particularly true with larger targets, where activists can accumulate a substantial block of stock, and thus have leverage, without being required to file a Form 13D (based on percentage ownership) with the SEC.  The new activism often is not designed to create a public conflict, at least initially.

What then does the expert panel suggest to boards:

First, do not react emotionally.  A tactic of activists is to obtain an emotional reaction; the activists are only interested in the money.

Second, be fully prepared before you are approached.  Have your legal and public relations team primed, and identify a board member who might be able to be communicate with the activists.  Ask counsel to review your charter and bylaws.

Third, understand your own business plan.  Are there weaknesses in it?  Address them.  Activists are well prepared, and not necessarily wrong.

Fourth, when executives leave your company, build into their severance agreement a “standstill” which prevents them from assisting an activist attack; activists tend to obtain some of their best information from former senior employees.

Lastly, reach out to the advisory agencies upon which institutional investors often rely (ISS and Glass Lewis), find out what they are thinking and explain your business strategy.

Humor of the day: when a director’s company is approached by an activist, the director is advised to get a dog. “Why?” the director asks.

“Because by the time this is over, your management will hate you, your employees will hate you, you will spend so much time on this that your family will hate you.  At least, when you finally come home exhausted, there ought to be somebody who will give you a friendly welcome.”

Coin Offerings: SEC Flexibility?

Is the SEC softening its reaction to coin offerings?

The literature and the legal hsitory relating to coin offerings defies summarization, let alone in a brief blog post, but the SEC this week issued a no-action letter which permitted a company to effect a coin offering without the usual objection, injunction or fine.  The reason is an update of orange groves to jet planes.

What is a security?  That is the only thing the SEC can regulate.  Per the US Supreme Court in a decision that has stood since 1946, it is an investment in a common enterprise while expecting profit from the efforts of others; that ancient case involved purchasers of orange groves, to be managed by the seller who would do all the work and send back the profits to the “owners” of the land and trees.

Along comes Turn-Key Jet Inc., a charter service. They convinced the SEC that, under recent SEC Guidance, they should not be required to registered their coin issuance since it was clear that the  coins, regardless of their suspicious character and evil potential upon initial sale,  would be used only to buy air charter services.

Analytically, this slope could be slippery.  You could for example use coins to wholly finance a start-up business, allow use of coins for only the product or service offered by that business, and use the coin to obtain that product or service at a reduced price.  How is that different from investing thru coin offerings in a company to jump-start it, then earning money,  and then spending it on a product from a third party?  Your return is economic value based on the success of the company in which you invested but which was run by others.

Yes it is different of course, but how different?  This is not a new debate.  I had a case involving time shares in a motel in the middle of nowhere to be used as a hunting lodge.  No coins involved (this was perhaps 35 years ago), but the debate was the same: you give me money and I set up a business with it and I give you a sweetheart deal on the rent (or product — or trip on a jet?).

But the evolution of coins with non-speculative elements into something free of SEC interference is a  practical development in the marketplace, and the SEC seems now receptive to applying some logic for the benefit of the marketplace.  The issue may ultimately turn on the express litmus test of  whether there is any de facto trading element to the coins.That is an implicit alteration of the Supreme Court test, however.

Would that be a shocking development from a technical lawyering standpoint?  Depends on your view of whether words that are clear must be read in a policy context.  After all, the statutory definition of a security specifically includes “note” (in the Securities Act it is in fact the very first definition, before the word “stock”), but the mortgage note you sign on your house is not a security.

NACD Program on Cyber/breakfast May 14/Waltham

Just to flag that I am moderating a great panel on what directors and management should be doing about cyber security; this is under the auspices of the National Assn of Corporate Directors–New England, and full information is at

Our panel is pretty powerful: CEO of a major solutions company, former presidential adviser/public director, FBI agent, insurer of cyber risk.  Please consider joining the conversation for breakfast on May 14.

The Fed: Bullish for Now

At this morning’s breakfast presentation in Boston, Federal Reserve Bank of Boston’s President & CEO Eric Rosengren painted a cautiously optimistic US economic picture for the short-term, while identifying known risks which might derail his thinking.

Speaking under the auspices of the National Association of Corporate Directors – New England, Rosengren predicted 2019 economic growth of 2%, 2% of inflation and a reasonably strong domestic economy.  He noted substantive risks which should be considered, including trade with China, Brexit and weakness in European banks and foreign markets.  He also noted that while the stock market has recovered from the fourth quarter of 2018, the debt market and particularly the ten year treasury has not recovered, showing institutional concern and hedging of risk against an economic downturn.

On the positive side, there is no overheating of the economy, inflation rate is within expectation, and economic growth (while down from 3% last year) is reasonable.  A tight employment market also is a positive.

In New England, our education and tech sectors are robust, but an aging local population and public policy against retaining foreign graduate students could be a drag on the regional economy.

Asked about whether continued growth in the current Federal deficit was sustainable, Rosengren advised that you cannot continue to accelerate national debt without advancing productivity, in the face of rising social costs, particularly if those expenditures are not reinvested in the infrastructure (which in turn could drive future growth).

Finally, a reporter from Bloomberg gamely tried for a scoop in asking whether he foresaw a further boost in the Federal discount rate during the balance of the year.  Rosengren obviously but deftly avoided an answer, noting that his view of appropriate policy is to be “patient” to see whether growth continues as anticipated and whether some of the risks he had noted actually arose.  He did state that if the economy continued on its current pace, further fiscal tightening might be on the table.

Absent from his presentation and subsequent questions from the audience:  any mention of wealth disparity in the United States and its possible relationship to fiscal policy.

Impact Investing and M&A

Today’s mailbox brings a meandering article on the above subject from the Law360 news service.  Impact investing is the practice of making investments for profit which also foster some societal benefit, typically related to the target’s business.  Private Equity, obviously a big M&A acquiring cohort, is reported as having a growing interest in societal impact which, if accurate, is by definition admirable.

While the article predictably advises that deal structure thus should focus on management composition and compensation, and business planning, post-acquisition, the article also suggests that impact investing will affect deal diligence.  As to that proposition, there is only sparse discussion.  One commentator is cited as suggesting that representations “are likely going to get tailored to the mission and receive greater emphasis in due diligence.”  What changes in our M&A practice can we expect?  Will an acquirer, having gone so far as diligence, then want to delve into past practices in terms of societal impact?  What new is to be asked?  Awareness of disregard for society?  Negligent disregard?  Pursuit of maximum profit, regardless?

Let us assume an M&A target which manufactures widgets.  Standard current reps will ask about labor practices, payroll practices, environmental history, claims made for defective widgets, litigation and governmental actions relating everything.  Asking for an express representation concerning the company’s view of its social impact could be taken as vague, judgmental, not pro-deal.  An acquirer interested in making social impact should be looking to the future.

And assume for a moment that, in fact, the target has manufactured widgets harmful to users while dumping pollutants by action of an underpaid staff chosen based on discriminatory policies, all of which facts are elicited through diligence, and assume further that the diligence questions had been  tweaked with mission in mind to highlight such facts.  Might we want to consider how offended target management will feel about having its practices not just reported in normal course of diligence but also at having their noses rubbed in it by broad policy-related questions.

Seems to me that target past failure is, in the context of doing social good, great news for the acquirer.  The acquirer wants to do social good.  It has a prospective program to do so. It will do greater good by putting better practices in place at a company that until then was terrible on these mission metrics.  Acquirer gets its social return by definition.

And as to companies acquiring targets without a PE involvement, I have not seen sensitivity to social mission beyond that implicit in fixing the issues uncovered by normal due diligence; and, after the deal, the acquirer is in control and calling social benefit shots as it wishes.

Let me know if I am missing something here.

Bylaws Requiring Arbitration

Public companies, particularly those formed in Delaware, sometimes consider including bylaw  provisions requiring shareholder suits for violation of Federal Securities Laws to be brought by arbitration.  The SEC recently was asked if such a proposed provision, strangely presented for proxy statement inclusion through a shareholder proposal, could be excluded from the proxy statement by the company (this is a reversal of positions which one might expect on the issue).

Based on the possibility that such a proposal would violate the law of the State of incorporation (New Jersey), the SEC permitted the exclusion of the proposal from the proxy solicitation, noting that the SEC could not rule on the legality of the provision but on the facts could agree it would take no action if such provision was excluded.

SEC Chair Jay Clayton issued a statement this week that recommended the courts as the proper venue to determine legality and proxy exclusion, and that recommended the Congress address the ground-rules for such bylaw provisions, particularly if included in company bylaws during the IPO process.

Reminder re DE law: by statute it is legal for bylaws to require shareholder suits to be brought only in Delaware, it is generally illegal to shift costs to unsuccessful plaintiffs, and I don’t think there is statutory law addressing mandatory arbitration (please correct me if any of that is in error).

See also

SEC Power Overseas

A couple of weeks ago, a three-judge panel of the United States Circuit Court (for the non-lawyers: the highest Federal courts except for the Supreme Court) decided the case of SEC v Scoville, which in effect held that the SEC has enforcement powers against alleged securities frauds which are primarily extra-territorial.

Attorneys and those wedded to arcane analysis should revert to the case; the facts are complex and the decision arguably does not resolve the question of how far the arm of the SEC reaches.  And, the minority justice on the panel simply said that the Dodd-Frank Act just granted jurisdiction to the SEC, period, a conclusion not clear from statutory history.  Further, a 2010 SCOTUS decision, Morrison, was widely understood to require misconduct connected with US transactions; that understanding seemingly still applies to private lawsuits, but not necessarily to SEC enforcement.  This bifurcated result is defensible based on legal analysis, but perhaps anomalous if your step back and take a logical look.

What is the impact of this decision?  First, we have not heard from other Circuit Courts and they may disagree with Scoville, setting up an ultimate Supreme Court resolution of differing Circuit decisions.  Second, certainly the SEC, long seeking authority to chase off-shore frauds, at least for now will be more aggressive in selecting the cases they bring.

In the late 60s and early 70s I recall arguing to the First Circuit Court of Appeals that US-based brokerages were not liable for acts outside the United States, period, even if involving US securities and even involving US citizens. Claimants replied that protecting US investors when they were living or just traveling overseas, and keeping US-based firms generally ethical, were valid exercises of SEC power (and indeed also a basis for civil liability on behalf of injured investors, which was a viable argument pre-Morrison).  The law today still bars private rights of action in most offshore cases, but Scoville clarifies a rationale for SEC activity and, thus, at least some recourse for the allegedly defrauded.

Talking Diversity and the SEC

Diversity is a huge issue in constructing boards of directors, and never is it so focused as for reporting companies.

Extant SEC disclosure rules contained in Regulation S-K already required disclosure of diversity information, to the extent consent from a director or director candidate agrees, including race, gender, ethnicity, religion, nationality, disability, sexual orientation or cultural background.  New guidance requires a statement as to HOW these characteristics were considered by the nominating committee or board.

Extant SEC disclosure also required a description of the process of nomination, whether it considers diversity and how.  New guidance requires an explanation of how it blended in consideration of other factors within scope of its diversity policy, including work history, military service or socio-economic characteristics.

Boards do discuss these issues, of course; one is compelled to if there is any sort of diversity program.  It is not clear to me what this new granularity has to add beyond eliciting an obvious response.  Perhaps the goal is to dig for detail to eliminate a suspected practice in some cases of tokenism?  Will we see disclosure other than a formulaic kind of recitation (“we aim for a board that is diverse, we needed a cyber expert, and  X turned out to be a widely recognized cyber expert and X also turned out to be a [pick a diverse category]!”).  Sharing the goals of diversity and preaching it in my own practice need not require government guidance on the obvious, and no board is going to say that they failed to look at all attributes of a director candidate.  Much SEC disclosure in response to ever-refined disclosure regimes results in a longer document but no increase in true qualitative data.

Today’s  Boston Business Journal carries an article about local company general counsel decrying lack of diversity in law firms while suffering lack of diversity on their own boards.  Aside from highlighting the intense topicality of board diversity, the article suggests an approach to disclosure: simple head count.  Should you care about process, or bottom line results.  As they say: “If you cannot measure it, you cannot achieve it.”

Stock Buybacks and the Wealth Gap

Most public observers note the wealth gap in the United States.  Liberal Democratic politicians for the past two years have suggested legislation to narrow it, and one theme is to prevent public corporations from buying back their own stock unless they have acted to close the wealth gap.

Bernie Sanders is re-introducing legislation that would ban buy-backs unless companies increase pay to a $15 minimum wage and provide paid sick-leave.  Similar controls would impact dividends.  The theory is that buy-backs enrich investors and executives, already wealthy enough.  A recent Times op-ed piece by Bernie and a California Rep was to the same effect.

Elizabeth Warren’s was more subtle, barring executive sale of shares for three years after a stock buy-back, although other provisions were more far-reaching (employees would name 40% of a public company board, a proposal so disruptive from a governance perspective as to be structurally unworkable even putting aside being a political non-starter.)

It is not my job here to engage in the ongoing un-civil political war we are now experiencing.  It does, however, strike me that the proposals of both Senators are very far from the mainstream of historical American social and political thought, as well as sure to create enormous resistance from business interests and business theorists.  To the extent one identifies and wishes to address wealth disparity, which indeed can be an existential risk to any government (at some point we cannot easily define for the US), a more limited practical approach in increments certainly seems more viable if you really want to see actionable legislation get passed and signed by someone living at 1600, Republican or Democrat.

Disclosure:  Bernie and I were classmates (class of ’59), and both writers for the James Madison High School Magazine, but at the time Bernie was writing about his track team and not about politics.  Same school attended by Chuck Schumer and Ruth Bader Ginsberg….