The SEC’s Office of Compliance and Inspections (“OCIE”), recently, issued an alert—more like a shot across the bow—to BDs and RIAs regarding its concerns over activities in the industry concerning the challenges encountered by COVID-19.  See https://www.sec.gov/files/Risk%20Alert%20-%20COVID-19%20Compliance.pdf.  As part of its efforts, OCIE made certain recommendations concerning: (1) investor asset protection; (2) personnel supervision; (3) fees, expenses, and financial transactions policies; (4) investment fraud; (5) business continuity plans; and (6) sensitive information protection.

OCIE complained that firms were not doing enough to protect investor assets. OCIE wants firms to make sure they have the appropriate practices in place to guard client assets. OCIE also believes that firms are not doing enough to supervise their personnel given the health issues surrounding COVID-19. OCIE wants firms to ensure that these people are properly supervised since most are not readily capable of oversight and interaction not working at firms.

Similarly, OCIE identified firms having problems with controls relating to their fees, expenses, and financial transactions. Firms, apparently, according to OCIE, have not been informing clients of these items, and possibly creating financial conflicts of interest when certain transactions are made. Coupled with these conflicts, OCIE has found evidence of investment fraud as well.

Firms were also found to have not properly executed their business continuity plans. OCIE was particularly concerned that certain firms were not properly executing critical business functions during the pandemic. Essentially, OCIE was accusing many firms of “dropping the ball.” Finally, OCIE indicated that firms were not protecting sensitive customer information, since, among other things, firms were using remote access and personally-owned devices, as well as personnel creating records away from the firms.

In short, OCIE encourages firms to remain vigilant regarding fraudulent activity, customer information, conflicts of interest, and supervision, among other things. Contacting securities counsel is one way of preparing for an eventual OCIE examination as well compliance before it is too late.

Alerts

Delaware adopted new amendments to its General Corporation Law (DGCL) on July 16, 2020. Amendments to sections 102, 110, 116, 145, 212, 228, 232, 251, 363, 365 and 367 appear to respond to the COVID-19 pandemic, while others modify proxy information exchange, emergency provisions for businesses and the rules regarding public benefit corporations.

We detail these amendments below.

Section 102 – Company Naming and Director Liability

Section 102(a) was amended to add “registered series of a limited partnership” to the list of names from which a corporate name must be distinguishable in the state of Delaware’s records.

Section 102(b)(7) allows a provision in a corporation’s certificate of incorporation to eliminate or limit the liability of directors for monetary damages for certain breaches of fiduciary duties. It also provides that any future amendment, repeal or elimination of such a provision shall not affect a corporation’s application to an act or omission by a director that occurred before the amendment, repeal or elimination, unless the provision states otherwise at the time of the act or omission.

Section 110 – Expanded Emergency Action Measures for Boards of Directors

Section 110(a) was amended to include additional circumstances under which a board of directors can take emergency action, specifically including an epidemic, pandemic or declaration of a national emergency by the U.S. government. The list of triggering events is not exhaustive and includes a catch-all provision for “other similar conditions.”

Additionally, Section 110 was amended to provide that if a quorum cannot readily be convened, a majority of directors present may adopt emergency bylaws. It also permits the board of directors to postpone or change the location of a stockholder meeting and postpone record dates and payment dates of dividends, subject to special rules for publicly traded corporations. Emergency bylaws may contain any provision “practical and necessary” to address the circumstances of the emergency, notwithstanding any different provisions in the DGCL or the corporation’s charter. A corporation that changes the record date or payment date pursuant to this provision is required to provide stockholders with a notice of the change as promptly as practicable (and, in any event, before the original record date). For corporations subject to the reporting requirements of the Securities Exchange Act of 1934, notice must be given by means of a Securities and Exchange Commission filing.

Section 110(i) tracks a prior order by the governor of Delaware permitting the postponement of annual meetings or the transition of annual meetings to remote means. It also allows corporations that had declared a dividend for which the record date had not yet occurred to postpone the dividend to a later date under certain circumstances.

The amendments to this Section 110 are effective retroactively as of Jan. 1, 2020.

Section 116 – Electronic Signatures

Section 116 broadens the definition of “electronic signature and eliminates the carve-out in Section 116(b) for electronic execution of board, stockholder and incorporator consents in lieu of a meeting unless the certificate of incorporation expressly provides otherwise.

Section 145 –Definition of Company “Officer”

Amended Section 145(c) redefines who is deemed an “officer” regarding any act or omission occurring after December 31, 2020. The new definition includes the president, chief accounting officer, chief executive officer, chief financial officer, chief legal officer, chief operating officer, controller and treasurer of a corporation.

The amendments to this section also add a new Section 145(c)(2), which permits a corporation to indemnify any other person who is not a present or former director or officer of the corporation against expenses (including attorneys’ fees) actually and reasonably incurred by such person when they successfully defend claims against them.

The amendments to Section 145(c) take effect after Dec. 31, 2020.

Section 212 – Electronic Execution/Transmission of Proxy Information

Section 212(c) was amended to allow for the electronic execution and transmission of proxy information provided it includes or is delivered with information enabling the corporation to determine the date of delivery and the identity of the stockholder granting the proxy.

Section 228 – Electronic Consent

Section 228 was amended to allow for electronic consent of stockholders or members in lieu of meeting.

Section 232 – Email Notices to Stockholders

Section 232(b) was revised to permit corporations to give notice under Section 232(a) to stockholders by electronic mail to the address of the stockholder set forth in the corporation’s records, without the stockholder’s prior consent.

Section 251 – Domestic Corporation Mergers

Amended Section 251 eliminates, with some limited exceptions, a requirement applicable to certain domestic corporation mergers, that immediately following the effective time of the merger, the organizational documents of the surviving entity contain provisions identical to the certificate of incorporation of the constituent corporation immediately prior to the effective time of the merger.

Section 363 – Voting Requirements for Converting Business to Public Benefit Corporation

The amendment to this section reduces the voting requirement from two-thirds to a simple majority for converting a regular business corporation to a public benefit corporation and vice versa. It also repeals Section 363(b)(2), which applies this change to certain mergers involving conversion of shares to or from a public benefit corporation.

The repeal of Section 363(b)(2) will be effective with respect to a merger or consolidation consummated pursuant to an agreement entered into (or, with respect to a merger consummated pursuant to Section 253, resolutions of the board of directors adopted) on or after July 16, 2020.

Section 365 – Balancing Decisions by Directors

The amended Section 365 clarifies that under Section 365(c), a director will not be considered “interested” for purposes of a balancing decision required by Section 365(a) based solely on his or her ownership of, or interest in, the stock of a public benefit corporation, except to the extent such ownership would create a conflict if the company were not a public benefit corporation. Also, absent a conflict of interest, a failure to satisfy the balancing requirement will not constitute an act or omission not in good faith for the purposes of Section 102(b)(7) or Section 145, unless the certificate of incorporation specifically provides otherwise. This eliminates the need to provide in the certificate of incorporation a provision to protect directors for breaches under Section 365(c) by making this the statutory default.

Section 367 – Pursuing Balancing Lawsuits

The amendment to Section 367 clarifies that any lawsuit to enforce the balancing requirement must be brought by plaintiffs owning at least 2% of the public benefit corporation’s outstanding shares or, in the case of certain listed companies, shares with a value of at least $2 million if that number is lower.

The attorneys of Fox Rothschild’s Corporate Department remain ready to assist companies in navigating these issues with regard to the new provisions of Delaware law and other pandemic- related issues. For questions about this client alert, please contact Jesse Fishman at jfishman@foxrothschild.com or 609-895-6729, or Ankita Patel apatel@foxrothschild.com 609-844-3029 or any member of the firm’s national Corporate Department.

Recently, the United States District Court of the District of Columbia refused to dismiss money laundering charges against a defendant who was allegedly engaged in a darknet cryptocurrency scheme.   See U.S. v. Harmon, Case Number 1:19-cr-00395-BAH (D.D.C. July 24, 2020) .

Essentially, the defendant tried to claim that, when he transferred more than 350,000 bitcoins, he was not transferring “money,” and, therefore, not subject to operating an unlicensed money transmitting business, in violation of 18 U.S.C. § 1960(a); and engaging, without a license, in the business of money transmission, D.C. Code § 26-1001(10), in violation of the District of Columbia’s Money Transmitters Act, D.C. Code § 26-1023(c).  The government had alleged that, over a 3 year period, the defendant exchanged over 350,000 bitcoins worth over $300 million.  Further, the government claimed that this was all part of a conspiracy to enrich the defendant as well as allowing the defendant’s customers to facilitate other illicit activities.  The bitcoins allowed these nefarious actions to be hidden.

The federal court rejected that argument indicating that, although the statute did not provide a definition for money, courts provide the statutory term with its ordinary meaning.  As such, the federal court held that the ordinary definition of money as a “medium of exchange, method of payment, or store of value” covered bitcoins, and determined that the defendant was transmitting money from one location to another to hide the bitcoin’s original source.  Thus, the federal court found that these activities qualified as a money transmission, and, as a result, it was an unlicensed money transmitting business.

Accordingly, it is critical that, before engaging in these types of bitcoin transactions, parties should consult with counsel to avoid being the subject of a criminal investigation and potential indictment.

Fox Rothschild’s Securities Industry Group and Labor & Employment Department have updated the firm’s National Survey on Restrictive Covenants, a quick reference guide for in-house counsel and human resource professionals in a variety of industries.

Restrictive covenant law is in a constant state of flux and varies considerably from state to state. Our national survey helps companies keep up with the latest changes to state laws, including increased requirements for creating enforceable restrictive covenants.

In an unexpected to say the least case of first impression, the United States Court of Appeals for the Fifth Circuit, essentially, blew away the privacy doors of the cryptocurrency world when it forced a Bitcoin exchange to disclose user data to the federal government without being served a warrant. See USA v. Gratkowski, Case number 19-50492, (5th Cir. 2020).  This Bitcoin exchange use blockchain technology that records every transaction in a publicly accessible ledger, but the persons owning the actual Bitcoin addresses are not known.

The appellate court found that the government could subpoena a cryptocurrency exchange, and obtain records since there was no violation of the defendant’s Fourth Amendment rights. The court reasoned that users of the digital coin exchanges have no greater privacy rights than those people who have accounts at ordinary banks. The court also held that Bitcoin traders have no expectation of privacy for information published on the public blockchain.

This decision also implicated the United States Supreme Court’s recent decision requiring a warrant to access cellphone records in Carpenter v. United States.  In this case, however, the court said only a subpoena was necessary because it was similar to bank records where there is not necessarily a Fourth Amendment protection.  The court also indicated that no one considered Bitcoins to be as central to someone’s daily life like cellphones.

It would appear that, despite the well-known privacy benefits of blockchain technology, this court apparently believes these exchanges fall under the “third-party doctrine,” whereby there is no expectation of privacy when a party turns over their information voluntarily to a third party, including, but not limited to, banks.  The court found that both traditional banks and cryptocurrency exchanges would be subject to the Bank Secrecy Act of 1970, the statutory authority requiring financial institutions to turn over financial records.

Nonetheless, this decision may have a chilling effect on the blockchain and cryptocurrency industry.  Many participants have been drawn to this medium because it offers high degree of privacy. It is possible that this decision may cause a great deal of anxiety in this area.

As a result, it is more likely that law enforcement authorities—civil and criminal—will be seeking information from Bitcoin exchanges.  Conversely, it is also likely that Bitcoin exchanges will probably publish less information and seek enhanced privacy protections. Accordingly, these issues should be carefully discussed with counsel when proceeding in the future.

The United States Department of Labor (“DOL”) has had a very active summer regulating the securities industry. Yes, you heard it right, the DOL has made certain pronouncements that have considerable effect on the securities industry.

Initially, the DOL allowed 401(k) plans to invest in private equity funds so long as they are managed by an investment professional. The DOL allowed specific types of private equity investments provided the investment professional satisfied its fiduciary obligations. Since these investments are illiquid, the DOL capped these investments at 15%.

Additionally, the DOL has now proposed a new fiduciary advisor rule to replace the previous rule that was abandoned by the current administration. Ironically, the current Secretary of Labor led the legal attack that scuttled the previous rule. The “new” rule adopts the previous test if a registered investment advisor or broker-dealer constitutes an “investment advice fiduciary”: (1) securities value advice; (2) regularity; (3) agreement; (4) investment decisions’ basis; (5) and individualized. This “investment advice fiduciary” must also satisfy the SEC’s new best interest standard, provide sufficient disclosure, and have appropriately implemented compliance policies as well as reviews.

In sum, the DOL’s pronouncements indicate that it will be looking very closely at the actions of securities professionals. As such, it would be important for securities professionals to be prepared for those inquiries by consulting with counsel at the earliest convenience.

By Jesse Fishman and Laura Holm

In Quarterly Reports on Form 10-Q, companies are required to disclose any material changes to risk factors that were included in their most recent Annual Report on Form 10-K.  Many companies do not update risk factors in their first quarter 10-Q filing because no material changes have occurred since the filing of the Form 10-K.  However, the world changed drastically in the first and second quarters of 2020 and many companies have felt that impact of COVID 19.

Companies need to consider whether additional risk factor disclosure in their 10-Q filings is appropriate to address material risks exacerbated or introduced in connection with COVID-19.  Some risk factors that companies may wish to consider are:

Risks related to changes to in demand;

  • Risks related to cybersecurity issues;
  • Risks related to supply chain disruption;
  • Risks related to financial markets and economic conditions; and
  • Risks related to general uncertainty.

Some special considerations should be made by those in the travel industry where stay at home orders and corporate restrictions on travel have greatly affected their revenues in Q1 and may affect their revenue projections in the coming months.  Additionally, because of stay at home orders, more employees are working from home.  This situation presents unique opportunities for cyber criminals and exposure to phishing attacks.

SEC’s guidance stresses companies to tailor the risks to their company and to avoid generic risk factors that could apply to any issuer or offering.  If the company has experienced a situation which requires risk factor disclosure, the company should be careful to avoid posing that situation as a hypothetical.

Reviewing peer companies and companies who have the same SIC code as your company are important practices.  You can also look at risk factors for companies in industries who have been severely impacted by the pandemic, such as the travel, restaurants and retail industry.

 

Join our colleagues, Jon Heyl and Alex Kerzhner, in what is sure to be an important review of the challenges facing the PE/HF industry during the pandemic.   The webinar will take place on Thursday, June 4, 2020 at 2 p.m. (EDT)/ 11 a.m. (PDT).

Please register (or click) at this site:  https://foxrothschild2.webex.com/mw3300/mywebex/default.do?nomenu=true&siteurl=foxrothschild2&service=6&rnd=0.520498216233004&main_url=https%3A%2F%2Ffoxrothschild2.webex.com%2Fec3300%2Feventcenter%2Fevent%2FeventAction.do%3FtheAction%3Ddetail%26%26%26EMK%3D4832534b00000004a042107c2af537d531b2ac872f843c41108c4da97db0231303c011bd8277765f%26siteurl%3Dfoxrothschild2%26confViewID%3D161131266161257810%26encryptTicket%3DSDJTSwAAAASqE0ZuyzNd7jcvQfkqx3mqfGmPjA6SK9Z5v54tVs7LwQ2%26

 

 

Sadly, the hackers of the world have not let the pandemic get in the way of their nefarious activities.  In particular, BDs and RIAs have been primary targets.   In our prior blog postings, we discussed business continuity plans and the requirement these plans include cybersecurity provisions.   We believe that the SEC, FINRA, and the various states could begin to review these firms for cybersecurity issues as early as this summer.  Thus, the old adage– be prepared– has never been more true.  We strongly recommend that these firms consult with securities counsel to prepare for this regulatory onslaught.

Oksana Wright and Charles DeMonaco discuss the management and corporate compliance measures for the companies to prioritize during the time of cost-cutting and uncertainty:

https://www.corporatecomplianceinsights.com/corporate-compliance-during-covid-19/