The Herrick Advantage

The SEC recently approved the final crowdfunding rules, which let small businesses raise up to $1 million in a 12-month period through an Internet-based campaign. Crowdfunding issuers will be able to raise capital from individual investors, without regard to their accredited status. Crowdfunding is set to go live in January 2016, following the end of the SEC's 90-day period for public comments. In an effort to prepare you, Herrick corporate partner Patrick Sweeney and associate Marc Shepsman have created this comprehensive primer on the new regulations, which addresses topics such as volume limitations, issuer compliance matters, intermediary requirements, "bad actor" disqualifications and other notable provisions.

On December 3, 2015, Herrick will host Fantasy Sports Outlook, "Rumors, Realities and Regulation," an event that will focus on the fast-changing fantasy sports industry. A lively discussion will be moderated by Matthew Futterman, author and Wall Street Journal senior special writer for sports. Distinguished speakers Don K. Cornwell, partner, PJT Partners; Joey Levy, co-founder and CEO, Draftpot; and Herrick corporate partners Irwin A. Kishner and Daniel A. Etna will discuss recent legal and legislative scrutiny, potential regulatory scenarios and near and long-term market and investment opportunities in fantasy sports, among other topics. To inquire about this event, please email rsvp@herrick.com.

Recent Senate Bill and New York State Guidelines Show Important Cybersecurity Changes to Come for Financial Institutions 

On October 27th, the U.S. Senate passed the much anticipated Cybersecurity Information Sharing Act of 2015 ("CISA") by a bipartisan vote of 74-21. Under CISA, the Department of Homeland Security will share information received from victimized private entities in real-time with the National Security Agency, the Department of Defense, and other federal agencies in order to help other companies defend against similar cyber-attacks. It is a voluntary system under which private entities and the government can share and receive threat indicators, defensive strategies, and other technical information via an automated process. CISA provides private entity participants with significant legal liability protections - which, if not provided, would deter companies from participating due to various concerns such as antitrust violations, loss of trade secrets and proprietary information, and regulatory actions. The bill caused concern in the banking industry with an eleventh-hour addition of language which could prompt new rules for financial institutions. This language, known as "Section 407," would require the Department of Homeland Security ("DHS") to assess the risk level of firms, including banks, designated as critical infrastructure entities, and develop a strategy for mitigating the risk of future attacks. Proponents against Section 407 say such oversight from the DHS makes reporting cyber-attacks seem mandatory, which is not the intention of CISA.

Additionally, States have recently taken matters into their own hands in response to the onslaught of financial sector cyberattacks. For example, the New York Department of Financial Services recently released its plans for new cybersecurity rules which would require firms to hold third-party vendors, such as law firms, data processors and auditors, to strict security contracts that stipulate the encryption of sensitive data. Two-factor authentication would also become mandatory under the new rules. The proposed plan also calls for financial institutions to designate a chief information security officer to oversee and enforce cybersecurity programs. The Department of Financial Services sent the potential new regulations in a letter dated November 9, 2015 to federal and state financial regulators for their feedback, calling cybersecurity "among the most critical issues facing the financial world today."

http://www.dfs.ny.gov/about/letters/pr151109_letter_cyber_security.pdf.

SEC Proposes Amendments to Rule 147 

The SEC recently proposed amendments to modernize Rule 147 promulgated under the Securities Act of 1933. Rule 147 is a non-exclusive safe harbor pursuant to Section 3(a)(11) of the Securities Act that exempts from registration "any security which is a part of an issue offered and sold only to persons resident within a single state or territory, where the issuer of such security is a person resident and doing business within [or incorporated] within such state or territory." Both Section 3(a)(11) and Rule 147 limit both offers and sales to residents of the same state in which the issuer is a resident and doing business. In order to satisfy Rule 147's issuer eligibility requirements, an issuer must, among other things: (i) derive at least 80% of its consolidated gross revenues in-state; (ii) have at least 80% of its consolidated assets in-state; (iii) intend to use and use at least 80% of the net proceeds from an offering conducted pursuant to Rule 147 in connection with the operation of an in-state business or real property; and (iv) have its principal office located in-state.

In discussing the statutory limitation that both the offer and sale take place in-state, the SEC noted that, when combined with the prescriptive threshold requirements with respect to issuers, such limitation "unduly limit[ed] the availability of the exemption for local companies that would otherwise conduct intrastate offerings." More particularly, the SEC received feedback indicating that the current regulatory scheme made it difficult for issuers wishing to avail themselves of newly-enacted state crowdfunding statutes to conduct offerings over the internet, as contemplated by crowdfunding, in compliance with federal securities laws. Accordingly, the SEC is proposing to (i) eliminate the restriction on offers, while continuing to require that issuers sell securities only to residents of the issuer's state or territory, and (ii) amend the threshold tests for an issuer to ease some of the issuer eligibility requirementsSignificantly, the proposed amendments would permit an issuer to engage in any form of general solicitation or general advertising, including the use of the internet, to offer and sell securities so long as (i) all sales occur within the same state as the issuer's principal place of business and (ii) the offering is registered in the state where all of the purchasers reside, or is conducted pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in the aggregate in a twelve-month period and imposes an investment limitation on investors.

http://www.sec.gov/rules/proposed/2015/33-9973.pdf.

Financial Advisor's Liability for Aiding and Abetting Directors' Breach of the Fiduciary Duty of Care

In In re Tibco Software Inc. Stockholders Litigation, a stockholder of TIBCO Software Inc. challenged the per share consideration that a private fund agreed to pay to acquire TIBCO in a merger that closed in December 2014. Among other claims, the plaintiff argued that the directors breached their fiduciary duties and that the financial advisor of the company aided and abetted such breach. The defendants moved to dismiss all claims and, last month, the Delaware Court of Chancery granted defendants' motion to dismiss all claims other than the aiding and abetting claim against the financial advisor.

The plaintiff alleged that the directors breached their fiduciary duties to TIBCO by failing to correct, or even approach the buyer in an attempt to correct, the share count error that was discovered after the merger agreement was signed, which error resulted in a $100 million reduction in the purchase price for TIBCO. While the court found that the plaintiff's allegations were sufficient to sustain a claim for a breach of the duty of care against the directors, the court ruled that the directors were exculpated from liability under TIBCO's charter. As a result, the Court dismissed the breach of fiduciary claim. However, the court found that the breach of fiduciary duty by the directors formed the predicate for an aiding and abetting claim against the financial advisor.

In re Tibco Software Inc. Stockholders Litigation, C.A. No. 10319-CB (Del. Court of Chancery, October 20, 2015).

SEC Settles Private Equity Firm Conflict of Interest Charges 

On November 3, 2015, the SEC announced a settlement of charges brought against Fenway Partners, LLC, a private equity firm, and four of its current and former executives, for violations of the Investment Advisers Act of 1940 in connection with their failure to disclose multiple conflicts of interests to Partners Capital Fund III, L.P. (the "Fund"), a private equity fund advised by Fenway Partners, and the Fund's portfolio companies.

First, under Fenway Partners' management services agreement, the portfolio companies were required to pay a management fee to Fenway Partners. However, pursuant to the Fund's organizational documents, these fees were offset against  advisory fees that the Fund paid to Fenway Partners. In late 2011, Fenway Partners and the former executives caused certain portfolio companies to terminate their payment obligations under the management services agreement and enter into new consulting agreements—similar to the terminated management service agreement—with Fenway Consulting Partners, LLC, an affiliate of Fenway Partners and owned by certain former executives. The consulting fees paid to Fenway Consulting were not offset against the advisory fees, resulting in Fenway Partners collecting a higher advisory fee from the portfolio companies. Fenway Partners and the executives never informed the portfolio companies of the conflict of interest from the termination of the management services agreement and their collection of fees pursuant to the consulting agreements. 

Second, in early 2012, Fenway Partners and the executives asked the Fund to provide $4 million in connection with a potential investment, but failed to disclose that $1 million would be used to pay Fenway Consulting.Third, in mid-2012, certain of the executives, including Fenway Consulting employees who were former employees of Fenway Partners, participated in a cash incentive program of a portfolio company and received $15 million in proceeds following the Fund's sale of its interest in the portfolio company, but failed to disclose that they received the payments as compensation for services provided in large part when they were employees of Fenway Partners.

In the SEC press release, Andrew J. Ceresney, Director of the SEC Enforcement Division, noted that "Private equity advisers must be particularly vigilant about conflicts of interest and disclosure when entering into arrangements with affiliates that benefit them at the expense of their fund clients or when receiving payments from portfolio companies."

In re: Fenway Partners, LLC, et al, Release No. 4253 (November 3, 2015), available at http://www.sec.gov/litigation/admin/2015/ia-4253.pdf.

Delaware Chancery Court Decision Sets Limits for the Indemnification of Former Directors and Officers

The Delaware Chancery Court recently held that while former directors and officers may be entitled to indemnification and advancement of legal expenses, they may do so only in connection with actions that have a causal nexus to their former position.

In June 2014, the board of directors of American Apparel unanimously voted to suspend Dov Charney as CEO, revoke his authority to act for or on behalf of the Company, and remove him from his position as Chairman of the board. One month later, Charney entered into a standstill agreement with the Company, which provided that Charney was prohibited from taking certain actions, acting to replace directors and disparaging the Company, among others. Following an investigation, the board terminated Charney's employment with American Apparel in December 2014. American Apparel filed suit six months later, alleging Charney's violation of several specific provisions of the standstill agreement, namely that Charney discussed a takeover of the company, disparaged the company and participated in a lawsuit seeking to replace directors.

In June 2015, Charney filed the suit discussed here, asserting claims for advancement for legal expenses.   The case turned on the court's interpretation of the phrases "related to the fact," and "by reason of," within the context of Charney's actions in relation to his former position. Charney contended that the language should be construed broadly, that the court should adopt the reasoning that but for his former position, he would not have been subject to the standstill agreement, and thus the violations thereof.

The court found Charney's interpretation to lead to "absurd results to which no reasonable person would have agreed." Instead, construing "related to the fact" and "by reason of" as functional equivalents, the court looked for a causal connection between Charney's actions and his former position as a director and officer of the company. Ultimately, the court held that Charney entered into the standstill agreement in his capacity as an individual, and as such, his actions in violation of the agreement were as an individual and did not have a causal connection to his former position as a director and officer.

Charney v. American Apparel, Inc., C.A. No. 11098-CB (Del. Ch. Sept. 11, 2015).

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.