Gday

Please join me in welcoming guest blogger Greg Day. 

Greg is a legal studies professor at the Spears School of Business at Oklahoma State University. Greg earned a JD at the University of North Carolina and a PHD in political science (with a focus on international relations) at the University of Mississippi. Before joining the faculty at Oklahoma State, Greg practiced with Morris, Nichols, Arsht & Tunnell LLP, a Delaware-based law firm. His scholarship focuses on the relationship between law and market inefficiencies.

Thanks to Greg for joining us, and I look forward to his posts. 

Here’s something everyone who has ever taken Securities Regulation should know: Section 3(a)(11) of the Securities Act, the intrastate offering exemption, has a safe harbor, Securities Act Rule 147.

As Lee Corso would say, “Not so fast, my friend.”  The SEC is proposing to overturn that longstanding wisdom. If the SEC’s proposed changes to Rule 147 are adopted,Rule 147 would no longer be tied to section 3(a)(11) and section 3(a)(11) would no longer have a safe harbor. The intrastate nature of Rule 147 would be preserved, but the proposed changes would be adopted under the SEC’s general exemptive authority in section 28 of the Securities Act.

Here are the most significant changes that the SEC has proposed:

Tied to State Regulation

The premise of section 3(a)(11) and its Rule 147 safe harbor is to relegate purely intrastate offerings to state regulation. But there’s currently nothing in Rule 147 to enforce that premise; federal exemption does not depend on state regulation of the offering.

The SEC proposal would expressly tie the federal Rule 147 exemption to state regulation. An offering would qualify for the federal exemption only if it was (1) registered at the state level or (2) sold pursuant to a state exemption that imposes investment limits on purchasers and limits the amount of the offering to $5 million in any 12-month period. (This second possibility is clearly aimed at the crowdfunding exemptions that many states have recently enacted.)

Offering Amount

Rule 147 does not currently limit the amount of the offering. The SEC proposal would limit the offering amount to $5 million in any 12-month period, unless the offering is registered at the state level.

State of Incorporation

Rule 147 currently requires that the issuer be incorporated or organized in the state in which the securities are sold. Because of that, even a corporation or LLC with all of its business in a single state cannot use Rule 147 if it happens to be incorporated or organized in another state, such as Delaware.

The SEC proposes to eliminate the focus on state of incorporation or organization, and require instead that the issuer’s “principal place of business” be within the state in which the offering is made. This would be defined as the state where “the officers, partners or managers . . . primarily direct, control and coordinate” the issuer’s activities.

Doing Business in the State

Under the current rule, the issuer must meet four requirements to establish that it is doing business in the state:

  1. It must derive at least 80% of its gross revenues from operations within the state;
  2. At least 80% of its assets must be located within the state;
  3. It must intend to use and actually use at least 80% of the offering proceeds in connection with operations in the state; and
  4. Its principal office must be located in the state.

All four of those requirements must be met.

The proposed rule is much less restrictive. An issuer only has to meet any one of the following requirements:

  1. It derives at least 80% of its gross revenues from operations in the state;
  2. At least 80% of its assets are located in the state;
  3. It intends to use and uses at least 80% of the offering proceeds in connection with operations in the state; or
  4. A majority of its employees are based in the state.

(Notice the addition of the new fourth test.) It will obviously be easier to satisfy a single one of the new requirements that it is to satisfy all four of the requirements under the current rule.

Intrastate Offers and Sales

Rule 147 currently provides that the securities must be offered and sold only to state residents. In other words, it’s not enough to screen out non-residents before sale. You can’t even solicit non-residents.

The SEC proposes to eliminate the restriction on offerees. An issuer could make a general public solicitation to the world, as long as it only sells the securities to state residents. This obviously makes it much easier to make Rule 147 offerings on the Internet.

Reasonable Belief Standard

The current rule requires that all of the purchasers (and offerees) be residents of the state. If one of them is a non-resident, the exemption is lost, even if the issuer thought the person was a resident.

The proposed rule adds a reasonable belief standard. The exemption is protected as long as the issuer had a reasonable belief that the non-resident purchaser was a resident.

Resales and the Issuer’s Exemption

Both the current rule and the SEC’s proposal limit resales to non-residents. However, there’s a crucial difference between the two.

The current rule makes the exemption dependent on meeting all of the terms and conditions of the rule, including the resale limit. Thus, if a purchaser immediately resold to a non-resident, the issuer could lose the exemption.

The proposed rule, like the current rule, requires the issuer to take certain precautions to prevent resales to non-residents, but the prohibition on resales is no longer a condition of the issuer’s exemption. Thus, if the issuer took the required precautions and a purchaser resold to a non-resident anyway, the issuer would not lose the exemption.

Protection from Integration

Rule 147 currently has a provision that protects the Rule 147 offering from integration with sales pursuant to certain other exemptions six months prior to or six months after the Rule 147 offering.

The SEC proposal offers a much broader anti-integration safe harbor, similar to the integration safe harbor included in Regulation A. Offers or sales under the amended Rule 147 exemption would not be integrated with any prior offers or sales. And Rule 147 offerings would not be integrated with subsequent offers or sales that are (1) federally registered; (2) pursuant to Regulation A; (3) pursuant to Rule 701; (4) pursuant to an employee benefit plan; (5) pursuant to Regulation S; (6) pursuant to the crowdfunding exemption in section 4(a)(6); or (7) more than six months after completion of the Rule 147 offering.

There is also some protection against integration when an issuer begins an offering under Rule 147 and decides to register the offering instead.

Section 3(a)(11) Remains Available

As I mentioned earlier, the amended Rule 147 would no longer be a safe harbor for section 3(a)(11) of the Securities Act. But Section 3(a)(11) would remain available. It just wouldn’t have a safe harbor.

An issuer would be free to use the section 3(a)(11) statutory exemption, but I wouldn’t recommend it unless everything is unquestionably intrastate. It was the uncertain interpretations of section 3(a)(11) that led to Rule 147 in the first place.

A Move in the Right Direction

I think the proposed exemption is a move in the right direction. Rule 147, one of the SEC’s earliest surviving safe harbors, was a little long in the tooth. The proposed changes will make it a little more viable.

As you may have heard, the SEC has finally adopted the rules required to implement the crowdfunding exemption. The final release (686 pages) is available here.

But the crowdfunding exemption was not the only item on the SEC’s agenda. At the same meeting, it proposed some rather significant amendments to Rule 504 of Regulation D and to Rule 147, the intrastate offering safe harbor. The release proposing those changes is available here. (It’s only 168 pages.)

The proposed amendment to Rule 504 would increase the dollar amount of the exemption from $1 million to $5 million and would also add bad actor disqualifications similar to those that currently apply to Rules 505 and 506.

The proposed changes to Rule 147 would almost significantly restructure the rule. Here’s a description of the significant changes, taken from an SEC news release:

The proposed amendments would modernize Rule 147 to permit companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level.  The proposed amendments to Rule 147 would, among other things:

  • Eliminate the restriction on offers, while continuing to require that sales be made only to residents of the issuer’s state or territory.
  • Refine what it means to be an intrastate offering and ease some of the issuer eligibility requirements in the current rule.
  • Limit the availability of the exemption to offerings that are registered in-state or conducted under an exemption from state law registration that limits the amount of securities an issuer may sell to no more than $5 million in a 12-month period and imposes an investment limitation on investors.

I think the Rule 147 proposal raise some interesting issues. I will discuss those proposed changes once I’ve had time to work my way through the release.

Pat Haden is the athletic director at the University of Southern California. Until Friday, he was also a member of the College Football Playoff selection committee. And, according to this story in the L.A. Times, he is also a director of at least nine non-profits or foundations and three businesses.

According to the Times, Haden spends an average of 70 hours a week on his U.S.C. job. As a playoff selection committee member, he was expected to spend countless hours watching football games and evaluating teams.

So where does he find the time to serve as a board member? Not a problem, according to Haden. He has “never been to one meeting” of some of the nonprofits he serves. And he spends “very little” time on his board positions.

Haden’s attitude is representative of an earlier era when outside directors merely showed up at meetings and nodded their head to whatever the chairman said. Those days are long gone. Today, board members are expected to spend much more time on their board duties, at the risk of liability if they don’t.

Mr. Haden, a former Rhodes Scholar, is a very bright guy, but even bright guys can say stupid things. I just hope he’s never sued. (At least one of the businesses he serves as a director is a public corporation.) A plaintiff’s lawyer could use quotes like this to mince him.

In the meantime, I suggest he read something on modern corporate governance. He has a law degree, so he shouldn’t have any trouble understanding it.

I teach both Civil Procedure and Business Associations. As a former defense-side commercial and employment litigator, I teach civ pro as a strategy class. I tell my students that unfortunately (and cynically), the facts don’t really matter. As my civil procedure professor Arthur Miller drilled into my head 25 ago, if you have procedure on your side, you will win every time regardless of the facts. Last week I taught the seminal but somewhat inscrutable Iqbal and Twombly cases, which make it harder for plaintiffs to survive a motion to dismiss and to get their day in court. In some ways, it can deny access to justice if the plaintiff does not have the funds or the will to re-file properly. Next semester I will teach Transnational Business and Human Rights, which touches on access to justice for aggrieved stakeholders who seek redress from multinationals. The facts in those cases are literally a matter of life and death but after the Kiobel case, which started off as a business and human rights case but turned into a jurisdictional case at the Supreme Court, civil procedure once again “triumphed” and the doors to U.S. courthouses closed a bit tighter for litigants. 

This weekend, the New York Times published an in depth article about how the corporate use of arbitration clauses affects everyone from small businesses to employees to those who try to sue their cell phone carriers and credit card companies. Of course, most people subject to arbitration clauses don’t know about them until it’s too late. On the one hand, one could argue that corporations would be irresponsible not to take advantage of every legal avenue to avoid the expense of protracted and in some cases frivolous litigation, particularly class actions. On the other hand, the article, which as one commenter noted could have been written by the plaintiffs bar, painted a heartbreaking David v. Goliath scenario.

I see both sides and plan to discuss the article and the subsequent pieces in the NYT series in both of my classes. I want my students to think about what they would do if they were in-house counsel, board members, or business owners posed with the choice of whether to include these clauses in contracts or employee handbooks. For some of them it will just be a business decision. For others it will be a question of whether it’s a just business decision. 

Corporate social responsibility is a perennial topic of interest here at BLPB, and, in particular, the question whether corporations – especially publicly-traded ones – can in fact credibly commit to a non-profit-seeking goal.

Which is why I found this Financial Times column so hilarious.  Lucy Kellaway gathered the “values” statements from 24 different British companies – you know, statements like “We stand for innovation and integrity!” – read them aloud at a conference of the companies’ managers, and asked the managers to identify the statements from their own companies.  Only 5 were able to identify their own company, and in 3 cases, it was because they’d been the ones to draft them in the first place.  The remaining nineteen managers picked the wrong one.

From this, Kellaway concludes that values statements are useless – and she notes that among FTSE100 companies, not having a values-statement is correlated with higher share prices. 

I’d reframe it, though, and say that a values statement – or any corporate declaration of commitment to values – is useless unless it’s backed by real content.  It has to be operationalized in specific terms that are credibly communicated to employees.  The problem with the values statements that Kellaway describes is that they are so generic as to be meaningless – suggesting that the companies themselves were simply using them as PR, to cloak themselves in good feelings without any actual change in the underlying business (and ineffective PR, if you can’t tell one from the other – the companies should at least borrow from Google’s playbook and choose something more memorable, like “Don’t Be Evil”).

And on another note, in honor of the season, here is Sally Richardson, the winner (loser?) of Tulane Law’s Halloween costume drive – the professor with the most student donations has to teach class in costume:

Posted in CSR

Jill Fisch (Penn) recently posted an essay entitled The Mess at Morgan: Risk, Incentives and Shareholder Empowerment.

The entire essay is worth reading, but I think her argument can be summed up with this quote: 

This essay argues that the effort to employ shareholders as agents of public values and, thereby, to inculcate corporate decisions with an increased public responsibility is misguided. The incorporation of publicness into corporate governance mistakenly assumes that shareholders’ interests are aligned with those of non-shareholder stakeholders. Because this alignment is imperfect, corporate governance is a poor tool for addressing the role of the corporation as a public actor. (pg. 651)

Jill Fisch argues that economic regulation may be a better solution to the problem of protecting the public than shareholder empowerment. (pg. 684).

While I acknowledge the essay’s mentioned limitations on shareholder empowerment, I don’t think economic regulation is the only alternative solution to the problem of protecting public values. As Jill Fisch notes “shareholder empowerment might be defended on the basis that it is less intrusive than direct regulation.” Corporate governance mechanisms other than shareholder empowerment may be both less intrusive and more effective than direct regulation. For example, (non-shareholder) stakeholder empowerment may make sense, as I plan to explain in a future article that is currently in its very early stages. 

I recently received information about this social enterprise & nonprofit clinical teaching fellowship position at Georgetown University Law Center. My friend, Georgetown law professor Alicia Plerhoples, is the director of the clinic, and the fellowship sounds like an excellent opportunity.

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Georgetown Law Graduate Clinical Teaching Fellowship

Description of the Clinic 

The Social Enterprise & Nonprofit Law Clinic at Georgetown University Law Center offers pro bono corporate and transactional legal services to social enterprises, nonprofit organizations, and select small businesses headquartered in Washington, D.C. and working locally or internationally. Through the Clinic, law students learn to translate theory into practice by engaging in the supervised practice of law for educational credit. The Clinic’s goals are consistent with Georgetown University’s long tradition of public service. The Clinic’s goals are to:

  • Teach law students the materials, expectations, strategies, and methods of transactional lawyering, as well as an appreciation for how transactional law can be used in the public interest.
  • Represent social enterprises and nonprofit organizations in corporate and transactional legal matters.
  • Facilitate the growth of social enterprise in the D.C. area.

The clinic’s local focus not only allows the Clinic to give back to the community it calls home, but also gives students an opportunity to explore and understand the challenges and strengths of the D.C. community beyond the Georgetown Law campus. As D.C. experiences increasing income inequality, it becomes increasingly important for the Clinic to provide legal assistance to organizations that serve and empower vulnerable D.C. communities. Students are taught how to become partners in enterprise for their clients with the understanding that innovative transactional lawyers understand both the legal and non-legal incentive structures that drive business organizations.

Description of Fellowship

The two-year fellowship is an ideal position for a transactional lawyer interested in developing teaching and supervisory abilities in a setting that emphasizes a dual commitment—clinical education of law students and transactional law employed in the public interest. The fellow will have several areas of responsibility, with an increasing role as the fellowship progresses. Over the course of the fellowship, the fellow will: (i) supervise students in representing nonprofit organizations and social enterprises on transactional, operational, and corporate governance matters, (ii) share responsibility for teaching seminar sessions, and (iii) share in the administrative and case handling responsibilities of the Clinic. Fellows also participate in a clinical pedagogy seminar and other activities designed to support an interest in clinical teaching and legal education. Successful completion of the fellowship results in the award of an L.L.M. in Advocacy from Georgetown University. The fellowship start date is August 1, 2016, and the fellowship is for two years, ending July 31, 2018.

Qualifications

Applicants must have at least 3 years of post J.D. legal experience. Preference will be given to applicants with experience in a transactional area of practice such as nonprofit law and tax, corporate law, intellectual property, real estate, or finance. Applicants with a strong commitment to economic justice are encouraged to apply. Applicants must be admitted or willing to be admitted to the District of Columbia Bar. 

Application Process 

To apply, send a resume, an official or unofficial law school transcript, and a detailed letter of interest by December 15, 2015.  The letter should be no longer than two pages and address a) why you are interested in this fellowship; b) what you can contribute to the Clinic; c) your experience with transactional matters and/or corporate law; and d) anything else that you consider pertinent. Please address your application to Professor Alicia Plerhoples, Georgetown Law, 600 New Jersey Ave., NW, Suite 434, Washington, D.C. 20001, and email it to socialenterprise@law.georgetown.edu. Emailed applications are preferred. More information about the clinic can be found at www.socialenterprise-gulaw.org.

Teaching fellows receive an annual stipend of approximately $53,500 (taxable), health and dental benefits, and all tuition and fees in the LL.M. program.  As full-time students, teaching fellows qualify for deferment of their student loans. In addition, teaching fellows may be eligible for loan repayment assistance from their law schools.

Kent Greenfield, Professor of Law and Dean’s Research Scholar at Boston College Law School, recently posted a provocative piece on the CLS Blue Sky Blog (here) in which he argues, among other things, that progressives have “flipped” from supporting “corporate citizenship” pre-Citizens United, to supporting “shareholder primacy” post-Citizens United.  (Kent has stressed to me that he does not believe this characterization extends to progressive corporate law scholars.) The piece is short, so I recommend you go read it before continuing on to my comments below, because I will simply be taking some short excerpts from his post and providing some responses, which will likely benefit from the reader having reviewed Kent’s post first. As just one disclaimer, Kent’s post is based on his article, “Corporate Citizenship: Goal or Fear?” – and I have not yet read that paper. Also, I consider the following to be very much an in-progress, thinking-out-loud type of project, and thus welcome all comments.

1. In 2010, the Supreme Court decided Citizens United v Federal Election Commission, ruling that corporations had a First Amendment right to spend money from general treasury funds in support of political candidates. Though seen as victory for political conservatives, the decision was in some ways based on a progressive view of the corporation. In the Court’s reasoning, corporations act as “associations of citizens” with rights of free speech.

Kent argues that the historical divide between progressives and conservatives can be viewed as one of “shareholder primacy” versus “corporate citizenship,” with progressives advocating for corporate citizenship while conservatives advance the cause of shareholder primacy. A couple of caveats are in order here. First, we must distinguish “shareholder primacy” as an assertion that shareholders should have the dominant (or at least more) controlling power within the corporation, from “shareholder wealth maximization,” which posits that the goal of corporate control is shareholder wealth maximization, independent of where the decision-making power resides. Second, we should keep in mind the competing corporate personality theories: aggregate theory, artificial entity (concession) theory, and real entity theory. I have argued in the past (see, e.g., here) that both aggregate theory and real entity theory tend to view the corporation as more private than public, with aggregate theory equating the relevant “association of citizens” with shareholders, while real entity theory looks to the board of directors – in either case positing a group of natural persons who can assert constitutional rights against government regulation. Artificial entity theory, on the other hand, views corporations as more public, at least in part because it is essentially impossible to mimic the corporate form solely through private contracting, and thus the state is entitled to more leeway in regulating corporations than natural persons acting in their purely private capacity. In light of all this, it may be better to view progressives as opposing shareholder wealth maximization as the sole goal of corporate governance, while being flexible as to the means used to achieve that end – be it shareholder primacy, director primacy, or “state primacy.” (I am not suggesting that a shift to shareholder primacy as the favored means of achieving the ends of progressive corporate governance is insignificant. Rather, I argue merely that a shift in means is less dramatic than a shift in ends, and thus less appropriately characterized as an ideological flip.) To the extent Citizens United is viewed as having merely strengthened the associational, private view of corporations without challenging the shareholder wealth maximization norm – it is hard to view it as advancing a progressive view of the corporation. In fact, it arguably stands simply as an opinion that gives more political power to corporations to pursue shareholder wealth maximization (or for managers to use shareholder wealth maximization as a justification for self-dealing) at the expense of other stakeholder concerns.

2. The biggest impediment to using the Citizens United moment to change corporate governance for the better is the progressive left.

In light of my comments above, I think there is a stronger argument to be made that the biggest impediment to changing corporate governance for the better is the continuing identification of corporations as purely private entities. It has been said that the greatest trick the devil played was convincing the world he didn’t exist. In this context, we might say the greatest trick played on progressives was convincing them their only viable choices are contractarian.

3. Justice John Paul Stevens’s dissent in Citizens United …. (perhaps unwittingly) bolsters shareholder supremacy by arguing that corporate speech should be limited in order to protect shareholders’ investments.

It may be better to view this part of Justice Stevens’s dissent as challenging the majority’s view that opening the corporate political contribution floodgates is not problematic because “corporate democracy” will address any problems. Meanwhile, Justice Stevens quotes Dartmouth College approvingly, and states that “corporations have been ‘effectively delegated responsibility for ensuring society’s economic welfare,’” both of which place him squarely in the concession theory camp – despite his protestations to the contrary.

4. The irony runs the other way as well. In the 2014 Hobby Lobby case, the Court granted corporations the statutory right under the Religious Freedom Restoration Act to object to otherwise applicable regulations on religious grounds. Writing for the Court, Justice Samuel Alito recognized that corporations need not maximize the bottom line ….

Go here for my take on whether Hobby Lobby changed anything in terms of the ability of those who control corporations to pursue “socially responsible” ends.  It is worth noting that a corporation’s ability to pursue “socially responsible” ends as part of an overall shareholder-wealth-maximizing strategy in light of the business judgement rule is not necessarily the same thing as concluding corporations will pursue some optimal level of “corporate citizenship,” which may rather require recognizing state power to require such activity or prohibit related harmful activity.

5. The world is flipped. Progressives are championing shareholder rights. Conservatives are planting their ideological flag on the summit of corporate citizenship.

As noted above, to the extent one views progressives as seeking more corporate social responsibility, and being willing to consider alternative methods to that end – be it shareholder primacy, director primacy, or state primacy – I do not see a significant flip here. Meanwhile, to the extent conservatives can be viewed as having supported shareholder wealth maximization as the optimal, but not sole, means to the end of lifting all ships via a rising tide, in addition to being consistently united against government regulation, there is also arguably nothing here that constitutes a significant “flip.”

Of course, generalities like “progressive” and “conservative” typically suffer from significant amounts of imprecision, and it may be that the “flip” characterization is more or less appropriate given the strand of progressive or conservative one is considering.