Emerging Markets Law

Showing 6 posts from June 2014.

Supreme Court Makes it Easier for Corporations to Defeat Securities Class Actions

In its decision in Halliburton v. Erica P. John Fund the Supreme court made it easier for corporations to avoid the expense of litigating certain types of class actions brought by unhappy investors.

As I wrote in Out of Balance, one of the key drivers in litigation is the cost of litigation itself.  Litigation is expensive and the U.S. is one of the few industrialized countries where each party bears its own attorneys' fees, even if it prevails in the case.  As a result, a corporate defendant will almost always have to pay its own attorneys' fees, even if the case against is eventually determined to have no merit.

This phenomenon often drives corporate defendants to settle meritless cases.

In the securities litigation arena, because of a case called Basic v. Levinson, potential classes of plaintiffs are able to sue publicly-traded corporations in which the plaintiffs are stockholders based upon a "fraud upon the market" theory.  That legal tactic allows the plaintiffs' lawyers to organize and initiate a class action against a corporation that has suffered a significant decline in stock price without having to prove that any of the potential class members actually relied upon an alleged falsehood or misleading statement made by the defendant corporation.

Defending against a class action lawsuit is difficult and expensive.  Once the lawyers initiating the suit achieve "class certification" the case moves into the discovery stage in which the plaintiffs' lawyers are able to require the defendant corporation to disclose tons of documents and submit to having their officers and directors deposed and so on.  Until now, plaintiffs' lawyers in such cases were not required to show that any of their individual stockholder clients actually relied on the alleged falsehood or misleading statement until after the class certification stage.  Likewise, corporate defendants were not allowed to rebut the presumption that their alleged misstatements were "material" to the price of their stock.

In its ruling in Halliburton this month, the Supreme Court held that corporate defendants could prove - prior to class certification - that any alleged misstatement that might have occurred would not have been "material" and would therefore not have had an effect on the price of the corporation's stock.  Proving that point would allow the trial court to dismiss the case at an early stage, before the expensive and distracting discovery phase would have begun.

While the Halliburton ruling still allows aggrieved investors to sue, it raises the bar for plaintiffs and will likely result in fewer early settlements (and therefore fewer lawsuits overall).

SEC Brings First-Ever Whistle-Blower Retaliation Case

The SEC announced recently a settlement in its first-ever whistle-blower retaliation case.

Retaliation against a whistle-blower is prohibited under various legal theories, including the Sarbanes-Oxley Act and the Dodd-Frank Act each of which contain express prohibitions against whistle-blower retaliation.

The SEC had accused Paradigm Capital Management Inc. and its ownership of punishing a trader for blowing the whistle on allegedly improper transactions.  The SEC alleged that Paradigm punished the trader by demoting him after it learned he was the source of leaks to the SEC about the improper transactions.

According to the SEC, Paradigm agreed to pay about $2.2 million in sanctions to settle the charges without admitting or denying wrongdoing.

The strengthening of whistle-blower protections gives the SEC and other regulators extraordinary powers to sanction firms that might appear to retaliate against employees who cooperate with regulators.  First who are aware of allegations against them are well-advised to act cautiously when dealing with employees in such circumstances.

Data Security: New OpenSSL "Heartbleed" Type Bug

Just when you thought it was safe to go back to OpenSSL, the encryption service affected by the "Heartbleed" bug in April, a new bug has been discovered that further compromises OpenSSL's security.  Although the headlines may become dominated by large companies known to be vulnerable to the bug, you should be aware of the issue if you depend on secure Internet connections for your operations or communications.

OpenSSL is a common Internet encryption tool.  Encryption is designed to protect transmission of sensitive data (such as credit card numbers and passwords) via online services.  The newly discovered bug, which is actually more than a decade old, allows data to be intercepted from an encrypted transmission.  Thus, if a user logs in to a corporate network or email service, his sensitive data might be interrupted and seized mid-transmission without his knowing it.  Following that, the data could be used by the intercepting party for its own unauthorized purposes.  Intercepted information might be used as-is, or it might be used as a tool to exploit other information (by guessing related passwords, for example).

Heartbleed could log keystrokes of any user regardless whether there was an open connection active with another user.  The new bug requires an active communication between two users in order to be effective and is, therefore, harder to exploit.  Note, however, that common applications such as VPNs (which have a live connection at each end) may be vulnerable to this new form of potential attack.

If you use secure online services such as a VPN, cloud storage, communications or financial/payment tools, you may want to do the following things:  (1) verify that your own network devices and software are up to date/patched and that no data have been compromised; (2) confer with your vendors to see whether they have done the same; (3) review what your privacy policy and standard agreements say about your security practices, and consider whether they should be revised or updated.

Wisconsin Beer Brewer First to Use Intrastate Crowdfund Law

Posted In Crowdfunding

Wisconsin craft beer brewery, MobCraft, is the first issuer to use Wisconsin's recently-adopted intrastate crowdfund law.

As its name suggests, MobCraft has been using the power of the crowd since its inception.  The brewery has been polling its fans about its latest brews as of way of testing the market to see which flavors will be the most popular.

Wisconsin's recently adopted intrastate crowdfunding law simply allowed the firm to take the power of the crowd to the next level by allowing Wisconsin residents to buy a stake in the company.

One of the twists in the Wisconsin law is that it exempts only intrastate offerings that are presented on licensed intrastate crowdfunding portals.  The MobCraft offering is being hosted on CraftFund's portal, as that firm claims to be the first to have been licensed under the Wisconsin law.

Possible New Equity Crowdfunding Law

Congressman Patrick McHenry (R-NC) is quoted to say that he hopes to iron out the details of a new equity crowdfunding bill next month.

Congressman McHenry, of course, was one of the principal authors of the JOBS Act and has been especially vocal in his criticism of the SEC's stalled attempts to implement the crowdfunding provisions of the JOBS Act.

ABA Comments on Regulation Crowdfunding

Posted In Crowdfunding

The American Bar Association's Business Law Section has submitted a lengthy comment letter on the SEC's proposed Regulation Crowdfunding.

The comment letter is well-constructed and well-reasoned, as you would expect from a committee-written letter from a bunch of lawyers.  What I found especially noteworthy was the number of points on which the ABA committee provided significant pushback.  ABA committees, since they tend to represent a consensus view of practicing lawyers, tend to be conservative a non-controversial, tending to avoid confrontations with regulators.  While this comment letter gives the usual praise to the regulators for their "reasonable" approach, the actual points of difference belie that praise.

One of the key points of push-back concerns the SEC's requirement that certain crowdfunded offerings under Title III of the JOBS Act (sometimes also called Section 4(a)(6) offerings by reference to the applicable provision of the Securities Act of 1933) involves the SEC's requirement that the issuer provided a full set of financial statements, prepared in accordance with GAAP, as well as audited financial statements (for offerings of $500,000) or more.

As the comment letter points out, the Congressional intent in the JOBS Act was to make it possible for small business start-ups to raise capital by appealing to the crowd.   Start-ups NEVER have audited financial statements.  (Just imagine, if you were starting up a new business, would you hire an accounting firm to conduct an audit of last year's activity?)

And yet, in its proposed Regulation Crowdfunding, the SEC has taken upon itself to require crowdfunding issues to purchase and provided audited financial statements to prospective investors.  As the comment letter points out, these same issues could raise funds under Regulation D without audited financial statements.  Why would any issuer incur the cost of an audit when it can avoid that cost by utilizing Regulation D?

The SEC in recent years has emphasized its role as the protector of investors.   If accredited investors under Regulation D can purchase securities in issuers that lack audited financial statements, does the SEC really believe that the addition of audited financial statements will truly benefit the unaccredited investors who will be permitted to participate in Section 4(a)(6) offerings under Regulation Crowdfunding?  What additional information does the SEC expect will find its way into the audited financial statements that will be capable of discernment by unaccredited investors in contrast to what the accredited investors would discern without the same audited financial statements?

The SEC has gone a long way towards making Title III crowdfunding unworkable because of the audited financial statement requirement.  The ABA's Business Law Section's comment letter calls them on it.

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