United States: January 2015 Corporate Alert

The Herrick Advantage

On February 11, Herrick will host a Harvard Business School Club of New York (HBSCNY) event with Nina and Tim Zagat, creators of the world-famous Zagat restaurant guides. The Zagats will join us to discuss how they built their guide from a small startup in 1979 to an eventual exit to Google.

For more information, or to register through HBSCNY, please click here.



Newly Enacted Amendments to the New York Uniform Commercial Code

Effective December 17, 2014, several important amendments to the New York Uniform Commercial Code ("NY UCC") were enacted, including amendments to Article 9 of the NY UCC which governs secured transactions.

Security interests in most types of collateral are perfected by filing UCC-1 financing statements.  Financing statements are indexed by debtor name, so using the correct debtor name is integral to perfection. The newly enacted amendments provide guidance regarding the correct way to reference the names of individuals and registered organizations. The names of individuals in particular have been a ripe source of litigation since the NY UCC provided no guidance regarding name references and there are many possible variations (for example, nicknames (e.g., Jon for Jonathan), middle names and/or initials) and sources (e.g., driver's license, passport, social security card, birth certificate). The new amendments provide that for an individual who has a current New York driver's license or non-driver photo identification, the correct name for the financing statement is the name indicated on such license or identification. If a person has no driver's license or identification card or it is expired, the financing statement must indicate (1) the debtor's "individual name" (which is not defined) or (2) the debtor's surname and first personal name.

The correct name of a registered entity for purposes of a financing statement is that indicated on "public record of the debtor's jurisdiction or organization." The new amendments clarify that the public record is "a record initially filed with or issued by a state or the United States to form or organize an organization." The amendments also state that if there is more than one such record, the most recently filed record controls.

Security interests in deposit accounts and security accounts are perfected by control. The new amendments create two new additional methods for a secured party to obtain control over a deposit account: (1) if the account is in the name of the secured party or (2) if the name of the account indicates that the secured party has a security interest therein. The new amendments also state that a secured party will have control over a deposit account if another person has control on behalf of the secured party. In addition, the amendments clarify that a secured party has control over an account even if the obligation of the securities intermediary or bank to comply with the entitlement orders or instructions of the secured party is subject to conditions (other than further consent by the debtor).

2015 Hart-Scott-Rodino Thresholds

The Hart-Scott-Rodino Antitrust Improvements Act requires companies proposing a merger or an acquisition to notify the Federal Trade Commission and the Department of Justice and to observe certain waiting periods before consummating such transaction if the size of the parties involved and the value of such transaction exceed certain thresholds.  The FTC revises the thresholds annually based on the change in gross national product.

For 2015, the size-of-transaction threshold increased from $75.9 million to $76.3 million.  As a result, transactions in which an acquiring person holds an aggregate total amount of voting securities or assets in the acquired person valued at less than $76.3 million will not be required to make a pre-closing filing or to observe the statutory waiting period.  Acquisitions valued between $76.3 million and $305.1 million are reportable based on the size-of-the person thresholds. Generally, a transaction is reportable where one party has sales or assets of at least $15.3 million (increased from $15.2 million) and the other party has sales or assets of at least $152.5 million (increased from $151.7 million).  Transactions which result in the acquiring person holding an aggregate total amount of the voting securities or assets of the acquired person valued in excess of $305.1 million (increased from $303.4 million) will be reportable, absent an applicable exemption.

The new thresholds will take effect on February 20, 2015 and will apply to transactions that close on or after such date.

Delaware Chancery Court Clarifies Duties of Stockholders Petitioning for Appraisal of Shares

In In Re Appraisal of Ancestry.com, Inc. and Merion Capital LP v. BMC Software, Inc., the Delaware Chancery Court held that the record owner of shares seeking appraisal rights under Section 262 of the Delaware General Corporation Law is not required to show that the specific shares for which it seeks appraisal were not voted by previous stockholders in favor of a cash-out merger. This pair of decisions reaffirms the Court's position, previously stated in its 2007 opinion in In Re Appraisal of Transkaryotic Therapies, Inc., that, pursuant to Section 262, the only requirements of the record owner of shares are that it (i) holds the shares on the date it makes its appraisal demand, (ii) continuously holds the shares through the effective date of the merger, (iii) delivers a written demand for appraisal to the company before the stockholder meeting to vote on the merger and (iv) has not itself voted in favor of the merger. In citing the plain language of this statute, the Court held that the record owner seeking appraisal itself must not vote in favor of the merger and refused to read in any requirement that it demonstrate that previous owners of those specific shares did the same. The Court also affirmed its previous stance that investors that acquire target company shares after the record date may assert appraisal rights only if the total number of shares for which appraisal is being sought is less than the total number of shares that either voted no or abstained from voting on the merger. These opinions affirm the viability of the increasingly popular "appraisal arbitrage" strategy whereby investors acquire target company shares after the record date and then assert appraisal rights for those shares which have typically increased in value, a practice which has contributed to the considerable growth of appraisal petitions in recent years.

In re Appraisal of Ancestry.com, Consol. C.A. No. 8173-VCG (Jan. 5, 2015); and
Merion Capital v. BMC Software, C.A. No. 8900-VCG (Jan. 5, 2015)

SEC Proposes Changes to Exchange Act Registration to Implement JOBS Act

The Securities and Exchange Commission ("SEC") recently proposed amendments to many of the registration requirements under the Securities Exchange Act of 1934 (the "Exchange Act") to implement Titles V and VI of the Jumpstart Our Business Startups Act (the "JOBS Act"). In 2012, the JOBS Act amended and relaxed the registration, termination and suspension of reporting thresholds under the Exchange Act so that an issuer is only required to register a class of equity securities if the issuers: (a) has total assets of more than $10 million; and (b) the class of equity securities is "held of record" by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors. The SEC is proposing to clarify, among other things, how issuers determine record holders who are accredited investors so as to rely on these new, higher thresholds established by the JOBS Act.

Accredited Investors

The SEC is proposing that the definition of "accredited investor" in the Securities Act of 1933 (the "Securities Act") Rule 501(a) apply in making determinations under the Exchange Act Section 12(g)(1). As such, the determination would be made as of the last day of the fiscal year rather than at the time of the sale of the securities. The SEC acknowledged that issuers may have difficulty determining whether existing security holders are accredited investors because issuers are not required to periodically assess an investor's continued status as an accredited investor. Without new guidance, the SEC believed that issuers would likely use procedures similar to those used when relying on Rule 506, i.e. taking appropriate steps to establish a reasonable belief that a prospective investor is an accredited investor. Thus, the SEC is proposing that issuers will need to use due diligence to determine, based on facts and circumstances, whether it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.  However, the SEC is considering whether a different approach may be more appropriate and is soliciting comment with respect to this provision.

Held of Record

As amended by the JOBS Act, Section 12(g)(5) of the Exchange Act provides that the definition of "held of record" does not include securities held by persons who received them pursuant to an "employee compensation plan" in transactions exempt from Section 5 of the Securities Act. Congress further instructed the SEC to adopt a safe harbor upon which issuers may rely when determining whether holders of their securities received them pursuant to an "employee compensation plan" in exempt transactions. Accordingly, the SEC has proposed amending Rule 12g5-1 to include a non-exclusive safe harbor by providing that a person will be deemed to have received the securities pursuant to an employee compensation plan if such person received them pursuant to a compensatory benefit plan that met the conditions of Securities Act Rule 701(c).

Second Circuit Puts New Obstacles in Prosecutors' Way

A recent unanimous decision by the Second Circuit Court of Appeals overturning two major government convictions created new obstacles for insider trading prosecutors. The Court in United States v. Newman and Chiasson held that the government "must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit." In reaching its decision, the Court relied on 31-year-old case, Dirks v. S.E.C., 463 U.S. 646 (1983), and rejected the SEC's theory that a recipient of confidential information (the "tippee"), must refrain from trading whenever he receives inside information from an insider (the "tipper"). Instead, the Court held that the tippee's duty to disclose or abstain from trading on inside information is derived from the tipper's fiduciary duties. Since a breach of an insider's fiduciary duty requires that he will "personally benefit, directly or indirectly from his disclosure," Dirks, 463 U.S. at 662, a tippee may not be held liable in the absence of this benefit.

The Court further noted that for purposes of insider trading liability, the insider's disclosure of confidential information, standing alone, is not a breach of fiduciary duty. Thus, without establishing that the tippee knows of a personal benefit attached to the disclosure of confidential information, a prosecutor cannot meet its burden of showing that the tippee knew of a breach. In accordance with this assessment, the Court found that the defendants were not only unaware that insiders had received a benefit, but that no such benefit ever existed.

Additionally, the court refined the meaning of "personal benefit" in its decision, stating that a tip in exchange for "mere friendship" or "career advice" and such is not sufficient to qualify for "personal benefit." Instead a narrower standard was created by the Court. To meet the "personal benefit" criteria, an exchange that is "objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature" must have occurred.

United States v. Newman and Chiasson 13-1837-cr, 13-1917-cr (Dec. 10, 2014).

Omissions Regarding "Known Trends" May be Actionable Under 10b-5

In a split from the Ninth Circuit's decision a year ago in In re NVIDIA Corp. Securities Litigation, 768 F.3d 1046 (9th Cir. 2014), the Second Circuit recently held that the failure to make a required disclosure under Item 303 of Regulation S-K can serve as an actionable 10b-5 securities fraud claim if certain other requirements are met.  Item 303 imposes obligations on reporting companies to disclose, inter alia, any known trends or uncertainties that the company reasonably expects will have a material impact on revenue or income. The trend must be both "presently known to management and reasonably likely to have material effects on the [company's] financial conditions" to trigger the disclosure requirement.

In the instant case, Stratte-McClure v. Morgan Stanley, the Plaintiffs alleged that Morgan Stanley and six of its current and former officers made material misstatements and omissions between June and November 2007 in an effort to conceal Morgan Stanley's exposure to the subprime mortgage market. Particularly, the action arises out of what the Second Circuit describes as a "massive propriety trade" executed in December 2006: a $2 billion short position (the "Short Position"), in which Morgan Stanley purchased credit default swaps ("CDSs") on collateralized debt obligations ("CDOs") backed by mezzanine tranches of subprime residential mortgage-backed securities, and a $13.5 billion long position (the "Long Position") in which Morgan Stanley sold CDSs that referenced more senior tranches of CDOs. The Plaintiffs contended that Morgan Stanley made material omissions on their 10-Q filings by failing to disclose the existence of the Long Position, that Morgan Stanley had sustained losses on that position in 2007, and that Morgan Stanley was likely to incur additional significant losses on the Long Position in the future.

An omission under securities laws is actionable only when the "corporation is subject to a duty to disclose the omitted facts." Accordingly, the Second Circuit maintained that, due to the "obligatory nature of [Form 10-Q], a reasonable investor would interpret the absence of an Item 303 disclosure to imply the nonexistence of [material known trends or uncertainties]." The Court found that that Morgan Stanley had not satisfied their Item 303 requirements through the use of generic cautionary language "spread out over several different filings."  The Court did not go so far as to say that Morgan Stanley had a duty to disclose the particulars of its trading positions, but only that "it faced deteriorating real estate, credit and subprime mortgage markets, that it had significant exposure to those markets, and that if the trends came to fruition, the company faced trading losses that could materially affect its financial condition.

The Court, however, dismissed the suit for failure to state a claim because it found that the Plaintiffs did not adequately plead scienter - in the present case, an allegation that Morgan Stanley was at least consciously reckless - under the Private Securities Litigation Reform Act's heightened pleading standards.

Stratte-McClure v. Morgan Stanley, 2015 WL 136312 (2d Cir. 2015)

SEC's 2015 Examination Priorities

The Securities and Exchange Commission (the "SEC") recently identified its examination priorities for 2015. With a view towards protecting investors and the integrity of the capital markets, the SEC will focus on three themes during its examinations:

  • Examining matters of importance to retail investors and investors saving for   retirement;
  • Assessing issues related to market-wide risks; and
  • Using data analytics to identify and examine registrants that may be engaged in illegal activity.

Protection of Retail Investors and Investors Saving for Retirement

The SEC noted that financial professionals are increasingly choosing to operate as investment advisers.  In its attempts to protect retail investors and investors that must save for their retirement, the SEC intends to focus on:

  • examining fee arrangements offered by such investment advisers and focusing on recommendations of account types and whether they are in the best interest of clients;
  • assessing whether registered entities are using improper or misleading practices when recommending that investors move retirement assets from employer-sponsored plans into other investments and accounts;
  • evaluating registered entities' recommendations or determinations to invest retirement assets in structured products and higher yield securities, including whether due diligence was conducted, whether disclosures were made, and the suitability of the recommendations;
  • examining registered entities' supervision of branch offices to determine when branch offices are not adhering to the home office policies;
  • assessing funds offering alternative investments and using alternative investment strategies, with a particular focus on leverage, liquidity, and valuation policies and practices, internal controls and marketing; and
  • reviewing fund disclosures made by fixed income investment companies.

Assessing Market-Wide Risks

The SEC aims to monitor the financial markets for structural risks and trends that may involve multiple firms or entire industries. Specifically, the SEC will focus on (i) the largest broker-dealers and asset managers, (ii) clearing agencies, (iii) examining broker-dealers' and investment advisers' cyber-security compliance and controls and (iv) whether firms are violating their best execution duties by revising trade order flows.

Use of Data Analytics

In order to prevent and combat fraudulent and illegal activity in the marketplace, in 2015 the SEC will also increasingly use data analytics to:

  • identify persons with a track record of misconduct and examine firms that employ such individuals;
  • examine broker-dealers and transfer agents for indications that they may be engaged in, or aiding and abetting, pump-and-dump schemes or market manipulation;
  • examine clearing broker data to identify introducing brokers and registered representatives that engage in excessive trading; and
  • examine clearing and introducing broker-dealers' anti-money laundering programs, with a special focus on firms that have not filed or not timely or completely filed suspicious activity reports and on broker-dealers that allow customers to deposit and withdraw cash and/or provide customers direct access to the markets from higher-risk jurisdictions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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