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August 6, 2018 |
The U.S. Office of the Comptroller of the Currency Will Permit Special Purpose National Bank Charters for Fintech Firms

Click for PDF Last week, the Office of the Comptroller of the Currency (OCC) announced that it would begin accepting proposals from Fintech firms to charter special purpose national banks (SPNBs).  This decision comes over 18 months after the White Paper proposing such charters was issued under President Obama’s Comptroller, Thomas Curry, in his last month in that position.  The OCC accompanied this announcement with a policy statement (Policy Statement) and a supplement to its licensing manual for national banks (Licensing Manual Supplement). This announcement, while expected, is an extremely significant development in federal banking law, and one almost assuredly to be legally challenged, at a time when the Chevron doctrine of administrative agency deference is receiving a fresh look. The OCC’s decision, when considered with its historical approach to preemption under the National Bank Act, could expand the scope of federal banking regulation considerably and provide substantial opportunities.  These opportunities could benefit not merely Fintech firms but investors in many such firms, who would appear to be able to control certain SPNBs and still avoid regulation under the Bank Holding Company Act (BHC Act), including the Volcker Rule. Powers of a Fintech SPNB When former Comptroller Curry introduced his Fintech national bank proposal in December 2016, he noted that “the number of Fintech companies in the United States and United Kingdom has ballooned to more than 4,000, and in just five years investment in this sector has grown from $1.8 billion to $24 billion worldwide.”[1]  The Policy Statement – consistent with the OCC’s traditional approach to the “business of banking” under the National Bank Act – makes clear that the special purpose charter is a response to this development, noting: The OCC recognizes that the business of banking evolves over time, as do the institutions that provide banking services. As the banking industry changes, companies that engage in the business of banking in new and innovative ways should have the same opportunity to obtain a national bank charter as companies that provide banking services through more traditional means.[2] Consistent with its existing regulations, the Policy Statement takes an expansive view of the National Bank Act’s powers provision, 12 U.S.C. § 24(SEVENTH).  Under this provision, a national bank is permitted, when a charter is issued, to: [E]xercise by its board of directors or duly authorized officers or agents, subject to law, all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes . . .[3] Prior to issuing the Policy Statement, the OCC had interpreted this provision to permit it to grant a charter to an institution that engaged in “any of the three core banking functions of receiving deposits, paying checks, or lending money.”[4]  Consistent with this existing regulation, a Fintech firm seeking a SPNB charter must conduct “at least one of these three core banking functions.”[5]  The Licensing Manual Supplement, however, provides greater elasticity to this requirement, as it states that “[t]he OCC views the National Bank Act as sufficiently adaptable to permit national banks to engage in traditional activities like paying checks and lending money in new ways. For example, facilitating payments electronically may be considered the modern equivalent of paying checks.”[6] Depending on the OCC’s ultimate position on “modern equivalence,” a Fintech SPNB charter could be available not only to Fintech firms engaged in lending activities without taking deposits (such as peer-to-peer lending companies), but also to companies engaged in payments broadly understood – including traditional money transmitters, and, in addition, virtual currency exchanges, because such exchanges also engage in money transmission, and indeed many have been licensed by the states as such.  It is noteworthy that the Licensing Manual Supplement states that: Beyond those core activities [deposits, lending, paying checks], the activities of an SPNB are limited to those that are permissible for national banks under a statute, regulation, or federal judicial precedent, or that the OCC has determined to be permissible. See e.g. 12 USC 24(Seventh); 12 CFR 7.5002; NationsBank of North Carolina, N.A. v. Variable Annuity Life Ins. Co., 513 U.S. 251 (1995).[7] In the NationsBank case cited, the Supreme Court, per Justice Ginsburg, “expressly h[e]ld” that “the ‘business of banking’ is not limited to the enumerated powers in § 24 Seventh and that the Comptroller therefore has discretion to authorize activities beyond those specifically enumerated.”[8] OCC Expectations As it indicated in its 2016 White Paper, the OCC is not proposing a “bank-lite” approach to Fintech SPNBs. The OCC expects any charter proposal to have a comprehensive business plan covering at a minimum three years.  The plan should include comprehensive alternative business strategies to address various best-case and worst-case scenarios.  In keeping with its post-Financial Crisis approach to corporate governance, the OCC emphasized the role of an SPNB’s board of directors, who must have a prominent role in the overall governance framework, actively oversee management, provide “credible challenge,” and exercise independent judgment.[9] The OCC also emphasized the importance of capital, minimum and ongoing levels of which need to be commensurate with the risk and complexity of the proposed activities (including on- and off-balance sheet activities).[10]  Where a SPNB’s business activities are principally off-balance sheet, traditional minimum capital requirements may not adequately reflect all risks, and the OCC could therefore require applicants in such circumstances to propose a minimum level of capital that the proposed SPNB would meet or exceed at all times.  In this regard, the OCC noted that other types of limited charter banks often hold capital that “exceeds the capital requirements for other types of banks.”[11]  The OCC would expect a similarly granular presentation with respect to a SPNB’s liquidity, including consideration of planned and unplanned balance sheet changes, varying interest ratio scenarios, and market conditions. Charter applicants would also be expected to demonstrate appropriate systems and programs to identify, assess, manage and monitor risk, including policies and procedures, practices, training, internal control and audit.  Of particular importance is a compliance program for anti-money laundering and OFAC sanctions, as well as a consumer compliance program designed to ensure fair treatment of customers. Two very important criteria for receiving an SPNB charter are financial inclusion and contingency planning.  As to the first, the OCC states: Consistent with the agency’s mission to ensure fair treatment of customers and fair access to financial services, the OCC expects any entity seeking an SPNB charter to demonstrate a commitment to financial inclusion that includes providing or supporting fair access to financial services and fair treatment of customers.  The nature of that commitment will depend on the proposed bank’s business model, and the types of products, services, or activities it intends to provide. An SPNB applicant should describe the proposed bank’s commitment to financial inclusion in its application. The description should include the proposed goals, approaches, activities, milestones, commitment measures, and metrics for serving the anticipated market and community consistent with the bank’s activities, business model, and product and service offerings.[12] On the second, because many SPNBs are likely not to be FDIC-insured, the OCC will be such institutions’ receiver in insolvency.  As a result, the OCC will insist on a detailed contingency plan to be prepared: Before receiving final approval for a charter, an SPNB will be required to develop a contingency plan to address significant financial stress that could threaten the viability of the bank. The contingency plan should outline strategies for restoring the bank’s financial strength and options for selling, merging, or liquidating the bank in the event the recovery strategies are not effective. The format and content of the plan are flexible and should be tailored to the bank’s specific business and reviewed and updated as the bank’s business evolves. As a condition for preliminary approval of a charter, an SPNB will be required to develop the contingency plan during the bank’s organization phase. The OCC’s final approval will require the bank to implement and adhere to the plan. The bank will be expected to review the contingency plan annually and update it as needed. Any significant changes to the contingency plan will require the non-objection of the appropriate supervisory office.[13] As a national banking association, a Fintech SPNB would be subject to the federal statutes applicable to other national banks, such as lending limits, limits on real estate and securities investments, the Bank Secrecy Act and other anti-money laundering laws, OFAC sanctions requirements, and, where applicable, such as with respect to lending, federal consumer law.  A Fintech SPNB would be required to become a member bank in the Federal Reserve System and subscribe for stock in its applicable Federal Reserve Bank in an amount equal to six percent of the bank’s paid-up capital and surplus. Benefits of a Special Purpose Charter to Fintech Firms The principal benefits of the special purpose charter to Fintech firms are national licensing and federal preemption.  Currently, peer-to-peer lending firms, money transmission companies, and virtual currency exchanges are all licensed by the states.  For such firms to carry out a national business, licensing on a state-by-state basis, and ongoing state examination processes, can be burdensome.  The SPNB charter will provide a federal alternative – and one regulator – to the state-by-state approach for qualifying firms. Second, an SPNB will benefit from federal preemption under the National Bank Act.  Such federal preemption is still broad, notwithstanding the Dodd-Frank Act’s attempt to narrow it.  After the Dodd-Frank Act, the OCC may preempt “state financial consumer law” if its application would have a discriminatory effect on national banks in comparison with its effect on state-chartered banks; the state consumer financial law prevents or significantly interferes with the execution by a national bank of its powers (the Barnett standard); or the state law is preempted by a federal consumer financial law other than Dodd-Frank.[14] Significantly, Dodd-Frank left unchanged the ability of a national bank to export interest rates of its home state nationally without regard to state law usury limitations; such interest rate exportation will be a significant benefit to SPNBs engaged in lending activities. Benefits of a Special Purpose Charter to Fintech Investors The SPNB charter may also provide benefits to Fintech investors, who would appear to be able to make controlling investments in certain SPNBs without becoming subject to the BHC Act, including the Volcker Rule.  The BHC Act defines a “bank” as either an FDIC-insured bank or as an institution that both accepts demand deposits and is engaged in the business of making commercial loans.[15]  Under the Policy Statement, the OCC can charter a SPNB that does not accept deposit funding – that is, one that is engaged in making loans or paying checks, or both such activities, as its core banking functions; such a SPNB would not be a BHC Act “bank.”  As a result, such an SPNB may be “controlled” by an investor without that investor becoming a bank holding company. This means that there is now another alternative to the state industrial bank charter available for investors such as private equity firms that wish to obtain the benefits of controlling a banking entity without the burdens of regulation by the Board of Governors of the Federal Reserve System.  In addition, although the OCC can be expected to require some form of capital support from a controlling investor of a non-deposit-taking SPNB, the explicit “source of strength” requirement added by the Dodd-Frank Act for a controlling investor will not apply, because that requirement applies only to controlling shareholders of insured depository institutions.[16] As a result, a Fintech firm that seeks a non-depository SPNB charter may find itself attractive to a wide range of investors. ________________________ It seems highly likely that certain state regulators will challenge the OCC’s Fintech SPNB determination, given its potential to shift a wide variety of firms to federal supervision and examination and preempt areas of state regulation.  Earlier such suits filed after the OCC’s December 2016 White Paper were dismissed as unripe; however, once the chartering process begins, litigation by state regulators could well be expected.  If the OCC’s interpretation of the National Bank Act is upheld by a reviewing court, the Fintech SPNB charter could be the most revolutionary development of regulatory reform in the Trump era, for both Fintech firms and their investors.    [1]   OCC, Exploring Special Purpose National Bank Charters for Fintech Companies (December 2016), at 3-4.    [2]   OCC, Policy Statement on Financial Technology Companies’ Eligibility to Apply for National Bank Charters (July 31, 2018), at 1.    [3]   12 U.S.C. § 24(SEVENTH).    [4]   12 C.F.R. § 5.20.    [5]   OCC, Policy Statement, at 2.    [6]   OCC, Licensing Manual Supplement:  Considering Charter Applications from Financial Technology Companies, at 2 n.5.    [7]   Id. at n.4.    [8]   513 U.S. 251, 258 n.2 (1995).  Given the Valic holding, the OCC would appear to have substantial discretion regarding permissible activities for SPNBs, as long as one core banking function was present.  The degree to which the OCC will exercise such discretion is currently unknown.    [9]   OCC Licensing Manual Supplement, at 16. [10]   Id. at 8. [11]   Id. at 9, n.26. [12]   Id. at 10. [13]  Id. [14]   12 U.S.C. § 25b(b)(1). [15]   Id. § 1841(c)(1). [16]   Id. § 1831o-1. The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long, Jeffrey Steiner and James Springer. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or any of the following: Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 30, 2018 |
2018 Mid-Year Securities Enforcement Update

Click for PDF I.  Significant Developments A.  Introduction For a brief moment in time, after several years with as many as 3 of the 5 commissioner seats vacant, the SEC was operating at full force, with the January 2018 swearing in of newest commissioners Hester Peirce and Robert Jackson.  This situation was short-lived, as Commissioner Piwowar, a Republican appointee with a deregulatory bent who had pulled back on certain enforcement powers, stepped down at the beginning of July.  While the president has named a potential replacement, the Senate has not yet held confirmation hearings; with Democratic Commissioner Kara Stein also set to leave the agency sometime later this year, the Senate may defer consideration until both the Republican and Democratic nominees have been named.  The vacancy could cause the Commission, which has already split on several key rulemakings, to defer some more controversial regulatory initiatives and even some enforcement actions which pose thornier policy questions. Meanwhile, the most noteworthy Enforcement-related event came with the Supreme Court’s Lucia decision, in which the Court held that the agency’s administrative law judges have been unconstitutionally appointed, resolving a technical but significant legal issue which has dogged the SEC’s administrative proceedings for several years.  As discussed further below, the decision throws a wrench in the works for the Enforcement Division, which until the past couple years had been litigating a growing number of enforcement actions in its administrative forum rather than in federal court. In terms of enforcement priorities, the SEC has continued to pursue a relatively small number of significant public company cases; despite a push in recent years to increase its focus on accounting fraud, few new actions were filed in the first half of 2018.  In contrast, the Division filed a surprisingly large number of cases against investment advisers and investment companies, including advisers to individual retail clients, private fund managers, and mutual fund managers. And the SEC’s concentration on all things “cyber” continued to make headlines in the initial months of 2018.  The SEC rolled out guidance on appropriate cybersecurity disclosures, and filed its first (and to date only) case against a public company for allegedly failing to report a data breach to investors on a timely basis.  Additionally, the SEC continues to institute enforcement actions in the cryptocurrency space, though is focus remains primarily on outright frauds, leaving ongoing uncertainty as to the regulatory status of certain digital assets. B.  Significant Legal Developments On June 21, 2018, the Supreme Court ruled in Lucia v. SEC that the SEC’s administrative law judges (ALJs) were inferior officers of the United States for purposes of the Constitution’s Appointments Clause, and that the SEC had failed to properly appoint its ALJs in a manner consistent with the Clause.[1]  (Mr. Lucia was represented by Gibson Dunn before the Supreme Court.)  After several years in which the SEC had increasingly filed contested proceedings administratively rather than in federal district court, the agency reversed course in the face of mounting court challenges to the constitutionality of its ALJs (who had been appointed by a government personnel office rather than by the commissioners themselves).  Even with the reduced number of pending, litigated administrative proceedings, the SEC still faces the prospect of retrying dozens of cases which had been tried before improperly-appointed ALJs.  As this report went to press, the SEC had yet to determine how it would handle these pending cases, or how or when it would go about appointing ALJs to hear litigated administrative proceedings going forward. Even with Lucia resolving the primary legal question which had been floating about in recent years, other questions about the legality of ALJs may continue to complicate administrative proceedings, and thus for the time being the SEC has determined to pursue most litigated cases in court.  (Though the SEC continues to bring settled administrative proceedings, as such settled orders are issued by the Commission itself rather than by an ALJ.) Another Supreme Court decision that curtailed SEC enforcement actions, SEC v. Kokesh, continues to impact the enforcement program.  As detailed previously, in June 2017 the Supreme Court overturned a lower court ruling that required the defendant to disgorge $34.9 million for conduct dating back to 1995.  The Supreme Court found that disgorgement was a form of penalty and was therefore subject to a five-year statute of limitations.[2]  In March 2018, on remand, the Tenth Circuit determined that the statute of limitations still did not bar the SEC’s action since the “clock” restarted with each act of misappropriation.[3]  Moreover, notwithstanding Kokesh, the issue of whether SEC actions seeking injunctive relief or other non-monetary sanctions (such as industry bars) are governed by the five-year statute remains hotly contested.  In a May 2018 speech, Co-Enforcement Director Steven Peiken noted that the SEC continues to maintain that injunctive relief is not subject to the five-year statute of limitations under Kokesh, and admonished parties that the staff would not forgo pursuing actions based on such arguments.[4]  However, the issue is far from settled, and just this month a district court came to a different conclusion.[5] In June, the Supreme Court granted a petition of certiorari filed by Francis V. Lorenzo, an investment banker who copied and pasted his boss’s allegedly fraudulent email into a message to his clients and who the D.C. Circuit found liable for fraud as a result[6].  Mr. Lorenzo has argued that, based on the Supreme Court’s 2011 decision in Janus Capital Group Inc. v. First Derivative Traders, he should not be considered the “maker” of the allegedly fraudulent statements.  Mr. Lorenzo’s petition asserts that the D.C. Circuit decision allows the SEC to avoid the requirements of Janus by characterizing fraud claim as “fraudulent scheme” claims.  A circuit split exists as to whether a misstatement alone can form the basis of a fraudulent scheme claim. C.  Whistleblower Developments The first half of 2018 saw the SEC’s largest whistleblower bounties to date, as well as some related rulemaking proposals which could potentially cap such awards.  As of April, the SEC reported that it had paid more than $266 million to 55 whistleblowers since 2012.[7] In March, the SEC announced its highest-ever whistleblower awards, paying a combined $50 million to two individuals and an additional $33 million to a third.[8]  While the SEC may not disclose the identities of whistleblowers, their counsel subsequently publicly disclosed that the awards were paid in connection with a $415 million SEC settlement with a major financial institution alleged to have misused customer cash.[9]  In its Order granting the awards, the Commission declined to grant awards to additional putative whistleblowers and, in doing so, clarified the standard for finding that a tip “led to” the success of a particular action.[10]  For a tip to “significantly contribute[] to the success of an . . . action” and entitle the whistleblower to an award, the “information must have been ‘meaningful,'” i.e., must “‘make a substantial and important contribution’ to the success of the . . . action.”  The Commission declined to adopt a more flexible standard. In a separate action the following month, the SEC awarded $2.2 million to a former company insider.[11]  The SEC noted that the $2.2 million award was paid under the 120-day “safe harbor” rule, which provides that, when a whistleblower reports to another federal agency and then submits the same information to the SEC within 120 days, the SEC will treat the information as having been submitted on the day it was submitted to the other agency.  A week later, the SEC announced a $2.1 million award to a former company insider whose tips had led to “multiple” successful enforcement actions.[12] In addition to developments relating to award payments, the first half of 2018 also included a Supreme Court decision affecting the rights of whistleblowers pursuant to anti-retaliation protections.  In Digital Realty Trust, the Court overturned the Ninth Circuit’s decision (described in our 2017 Year-End Update) and found that Dodd-Frank’s anti-retaliation measures protect only whistleblowers who report their concerns to the SEC and not those who only report internally.[13] Finally, in a late June open meeting, the Commission voted to propose various amendments to its whistleblower program.[14]  In response to the record-breaking award noted above, the proposed rules would give the SEC discretion to limit the size of awards in cases resulting in monetary sanctions greater than $100 million (which, given a permissible award size of 10-30% of money collected by the SEC, would effectively create a $30 million award cap).  Other proposed amendments include: allowing awards based on deferred prosecution agreements and non-prosecution agreements entered into in criminal cases; permitting awards made when the Commission reaches a settlement outside the context of a judicial or administrative proceeding; allowing the SEC to bar individuals from later seeking awards after they submit false or frivolous claims; and, in response to Digital Realty, requiring a whistleblower to submit information in writing to receive retaliation protection. D.  Cybersecurity and Cryptocurrency In 2017, the SEC touted cybersecurity as a major enforcement priority and created a dedicated “Cyber Unit” to investigate and prosecute cyber-related threats.  The SEC’s cyber-focus continued in the first half of 2018 with its February release of interpretive guidance on public companies’ disclosure obligations regarding cybersecurity risks and incidents.[15]  The Guidance, which reaffirms and expands upon the SEC Division of Corporation Finance’s existing guidance on the topic from 2011, encourages companies to adopt “comprehensive policies and procedures related to cybersecurity,” and to consider how their insider trading policies address trading related to cybersecurity incidents.  While not creating any bright-line rules, it discusses that the “materiality of cybersecurity risks and incidents depends upon their nature, extent, and potential magnitude,” as well as “the range of harm that such incidents could cause,” including “harm to a company’s reputation, financial performance, and customer and vendor relationships, as well as the possibility of litigation or regulatory investigations or actions.”  The SEC further noted that the existence of an ongoing internal or external investigation into an incident “would not on its own provide a basis for avoiding disclosures” of an otherwise material incident.  As discussed further below, the Guidance was followed two months later by the SEC’s announcement of its first enforcement action against a company arising out of a data breach. Regarding the continuing proliferation of digital (or “crypto”) currencies, the staff of the SEC’s Divisions of Enforcement and Trading and Markets issued a statement in March reinforcing that digital platforms that trade securities and operate as an “exchange,” as defined by the federal securities laws, must register as a national securities exchange or operate under an exemption from registration.[16]  The statement also outlines a list of questions that potential investors should consider before deciding to trade on such platforms.  The statement came on the heels of a litigated enforcement action charging a bitcoin-denominated platform, BitFunder, and its founder with operating an unregistered securities exchange, defrauding users by misappropriating their bitcoins and failing to disclose a cyberattack, and making false and misleading statements in connection with an unregistered offering of securities.[17]  In a parallel criminal case, the U.S. Attorney’s Office charged BitFunder’s founder with perjury and obstruction of the SEC’s investigation. The SEC also brought a handful of initial coin offering (ICO) enforcement actions in the first half of 2018.  In January, the SEC obtained a court order halting an ICO it characterized as “an outright scam,” which had raised $600 million in just two months by claiming to be the world’s first “decentralized bank” and falsely representing that it had purchased an FDIC-insured bank.[18]  In April, the SEC charged two co-founders of a financial services start-up with orchestrating a fraudulent ICO by falsely claiming to offer a debit card backed by major credit card companies that would allow users to convert cryptocurrencies into U.S. dollars.[19]  The U.S. Attorney’s Office for the Southern District of New York brought parallel criminal actions against the co-founders, and the SEC later charged a third co-founder with fraud after discovery of text-messages revealing fraudulent intent.[20]  Then, in May, the SEC obtained a court order halting an ICO by a self-proclaimed “blockchain evangelist” who had fabricated customer testimonials and misrepresented having business relationships with the Federal Reserve and dozens of companies.[21] Additionally, in April, the SEC obtained a court order freezing over $27 million in proceeds raised by Longfin Corp. after the company and its CEO allegedly violated Section 5 by issuing unregistered shares to three other individuals so they could sell them to the public right after the company’s stock had risen dramatically due to announcement of acquisition of a cryptocurrency platform.[22] II.  Issuer and Auditor Cases A.  Accounting Fraud and Other Misleading Disclosures In March, the SEC settled charges of accounting fraud against a California-based energy storage and power delivery product manufacturer and three of its former officers.[23]  The SEC alleged that the company prematurely recognized revenue to better meet analyst expectations, that a former sales executive inflated revenues by executing secret deals with customers and concealing them from finance and accounting personnel, and that the former CEO and former controller failed to adequately respond to red flags that should have alerted them to the misconduct.  Without admitting or denying the allegations, the company agreed to pay penalties of $2.8 million; the former CEO and controller agreed to pay a combined total of approximately $100,000 in disgorgement, interest and penalties; and the former sales executive agreed to be barred from serving as an officer or director of a public company for five years and pay a $50,000 penalty. In April, the SEC settled charges of accounting fraud against a Japanese electronics company.[24]  The SEC alleged that the company’s U.S. subsidiary prematurely recognized more than $82 million in revenue by backdating an agreement with an airline and providing misleading information to an auditor.  The matter involved FCPA allegations as well. Also in April, the SEC instituted settled proceedings against a California internet services and content provider.[25]  The SEC alleged that the company failed to timely disclose a major data breach in which hackers stole personal data relating to hundreds of millions of user accounts.  In addition, the SEC alleged that the company did not share its knowledge of the breach with its auditors or outside counsel, and failed to maintain adequate controls and procedures to assess its cyber-disclosure obligations.  Without admitting the allegations, the company agreed to pay a $35 million penalty to settle the charges. In May, the SEC filed a complaint against three former executives of a Houston-based health services company.[26]  The complaint alleged that the executives falsified financial information—including financial statements for three fictitious subsidiaries acquired by the company—to induce a private firm to acquire a majority of the company’s equity.  In a parallel action, DOJ brought criminal charges against the defendants. In June, the SEC filed a complaint against a California-based telecommunications equipment manufacturer and three of its executives.[27]  According to the SEC’s complaint, the executives inflated company revenues by prematurely recognizing revenue on sales and entering into undisclosed side agreements that relieved customers of payment obligations.  The SEC also alleged that the defendants inflated the prices of products to hit revenue targets with the agreement that the company would later repay the difference as marketing development fees.  Without admitting or denying the charges, the defendants agreed to pay penalties totaling $75,000.  In addition, two of the individual defendants consented to five-year officer and director bars; the other individual defendant consented to a bar from appearing or practicing before the SEC as an accountant for five years. B.  Auditor Cases In February, in a case the SEC said underscores its determination to pursue violations “regardless of the location of the violators,” a foreign auditor and his U.S.-based accounting firm, settled charges alleging they providing substantial assistance in a fraudulent shell company scheme by issuing misleading audit reports for numerous companies.[28]  The SEC suspended the auditor and his firm from appearing or practicing before the Commission. In March, the SEC announced settled charges against several foreign firms of the large international accounting networks based on allegations that the firms improperly relied on component auditors that were not registered with the PCAOB, even though the component auditors performed substantial work that should have triggered registration.[29] The SEC alleged violations of PCAOB standards that require sufficient analysis and inquiry when relying on another auditor.  Without admitting or denying the allegations, the four foreign firms agreed to pay roughly $400,000 combined in disgorgement and penalties. Additionally, an auditing firm, two of its partners and a registered financial advisory firm settled charges in May relating to violations of the Custody Rule.[30]  According to the SEC, the auditors failed to meet the independence requirements of the Custody Rule by both preparing and auditing financial statements of several funds and because they had a direct business relationship with the financial advisory firm through a fee-referral relationship.  The SEC also charged the respondents for failing to comply with the requirement of regular PCAOB inspections and cited multiple professional conduct violations, including for failing to design and implement appropriate oversight mechanisms, insufficient quality control and violation of professional due care, among others.  Without admitting or denying the allegations, the defendants were barred from appearing before the Commission and agreed to pay roughly $52,000 combined in disgorgement and penalties. The SEC is also ensuring that firms are not associating with barred auditors. In April, an accounting firm and its sole officer and founder settled charges with the SEC for allegedly violating the Sarbanes Oxley Act of 2012, which prohibits auditors barred by the PCAOB from association with a registered public accounting firm from associating with corporate issuers in an accountancy or financial management capacity.[31]  Without admitting or denying the findings, the company and its founding officer agreed to cease and desist from the association and agreed to pay a $22,500 civil penalty. C.  Private Company Cases While the number of cases against public companies remains low, the SEC has continued to step up its enforcement efforts against private companies. In March, the SEC instituted settled proceedings against a California-based financial technology company.[32]  The SEC alleged that the respondent offered unregistered stock options to its employees without providing the employees with timely financial statements and risk disclosures.  Without admitting the allegations, the company agreed to pay a $160,000 penalty to settle the charges. Also in March, the SEC filed a complaint against a California-based health care technology company, its former CEO, and a former president at the company.[33]  The complaint alleged that the defendants made numerous false statements in investor presentations, product demonstrations and media articles about their flagship product—including misrepresentations regarding expected revenue and the U.S. Department of Defense’s adoption of the product—which deceived investors into believing the product was revolutionary.  Without admitting the allegations, the company and former CEO agreed to settle the charges.  Under the settlement terms, the former CEO agreed to pay a $0.5 million penalty, be barred from serving as an officer or director of a public company for ten years, return 18.9 million shares of the company, and relinquish her voting control by converting her Class B Common shares to Class A Common shares.  The SEC will continue to litigate its claims against the former president in federal court. And in April, the SEC filed a fraud complaint against four parties:  a biotechnology startup formerly based in Massachusetts, its CEO, an employee, and the CEO’s close friend.[34]  According to the SEC, the CEO and the employee made false claims to investors about the company’s finances and the company’s progress in seeking FDA approval for one of its products.  The complaint also alleged that the defendants engaged in a fraudulent scheme to acquire and merge the company with a publicly traded company, manipulated the shares of the new entity, and diverted a portion of the sale proceeds.  The SEC is litigating the case in federal court and seeks to freeze the company’s and CEO’s assets, as well as prohibit the defendants from soliciting money from investors.  In addition, the SEC seeks a permanent injunction, the return of the ill-gotten gains with penalties, and industry and penny stock bars.  The DOJ brought parallel criminal charges against the individual defendants. III.  Investment Advisers and Funds A.  Fees and Expenses In June, a private equity firm settled allegations that it had charged accelerated monitoring fees on portfolio company exits without adequate disclosure.[35]  According to the SEC, the undisclosed receipt of accelerated fees from portfolio companies resulted in negligent violations of various provisions of the Advisers Act.  To settle the matter, the Respondents agreed to pay $4.8 million in disgorgement and prejudgment interest and $1.5 million in penalties. Shortly thereafter, the SEC filed a settled action against a New York-based venture capital fund adviser for allegedly failing to offset consulting fees against management fees in accordance with organizational documents for the funds it advised.[36]  The SEC alleged that the adviser received $1.2 million in consulting fees from portfolio companies in which the funds had invested, and that those fees were not properly offset against advisory or management fees paid by investors, resulting in an overpayment of over $750,000.  The adviser reimbursed its clients, plus interest, and agreed to pay a $200,000 penalty.  Significantly, the SEC’s press release cites to the adviser’s remediation and cooperation, indicating that this was taken into account in determining the appropriate resolution. B.  Conflicts of Interest In March, the SEC instituted settled proceedings against two investment adviser subsidiaries for undisclosed conflicts of interest with regard to the practice of recalling securities on loan.[37]  The SEC alleged that the advisers were affiliated with insurance companies, but also served as investment advisers to insurance-dedicated mutual funds.  The advisers would lend securities held by the mutual funds, and then recall those securities prior to their dividend record dates.  This meant that the insurance company affiliates, as record shareholders of such shares, would receive a tax benefit on the basis of the dividends received.  However, according to the SEC, this recall system resulted in the mutual funds (and their investors) losing income, while the insurance company affiliates reaped a tax benefit.  Without admitting or denying the allegations, the advisers agreed to pay approximately $3.6 million to settle the charges. In April, the SEC instituted proceedings against a New York-based investment adviser in connection with the receipt of revenue sharing compensation from a service provider without disclosing conflicts of interest to its private equity clients.[38]  According to the SEC, the investment adviser entered into an agreement with a company that provided services to portfolio companies.  Pursuant to that agreement, when portfolio companies made purchases, the service provider would receive revenue, and, in turn, the investment adviser would receive a portion of that revenue.  Without admitting or denying the allegations of Advisers Act violations, the investment adviser agreed to pay nearly $800,000 in disgorgement, prejudgment interest, and civil penalties. In early June, the SEC instituted settled proceedings against a New York-based investment adviser in connection with alleged failures to disclose conflicts of interest to clients and prospective clients relating to compensation paid to the firm’s individual advisers and an overseas affiliate.[39]  According to the SEC, this undisclosed compensation, which came from overseas third-party product and service providers recommended by the adviser, incentivized the adviser to recommend certain products and services and a pension transfer.  The SEC also found that the adviser made misleading statements regarding investment options and tax treatment of investments.  In settling the action without admitting or denying the allegations, the investment adviser agreed to pay an $8 million civil penalty and to engage an independent compliance consultant.  In a parallel action, the Commission filed a complaint in federal court in Manhattan against the adviser’s former CEO and a former manager. On the same day, the SEC filed another settled administrative proceeding relating to undisclosed conflicts of interest with a Delaware-based investment adviser.[40]  The settlement order alleges that the adviser negotiated side letters with outside asset managers resulting in arrangements under which the asset managers would make payments to the adviser based on the amount of client assets placed or maintained in funds advised by those asset managers.  This was not disclosed to clients, and contravened the adviser’s agreements with two specific advisory clients.  The SEC also alleged that the adviser failed to implement policies and procedures to prevent conflicts of interest and failed to maintain accurate records relating to the payments from the outside asset managers.  Without admitting or denying the Commission’s findings, the adviser agreed to pay a $500,000 penalty. C.  Fraud and Other Misconduct In January, the SEC filed settled charges against a California-based investment adviser and its CEO and President for failing to adequately disclose the risks associated with investing in their advisory business.[41]  According to the SEC, the firm decided to borrow cash from investors—including its own retail investor clients whose portfolio accounts were managed by the CEO—in the form of promissory notes, in order to fund its business expenses, which exceeded the amount of money received from advisory fees.  In their efforts to market the promissory notes, the CEO and President failed to disclose the true financial state of the firm or the significant risk of default.  In settling the action, the investment adviser agreed to various undertakings, including an in-depth review and enhancement of compliance policies and procedures, and the provision of detailed information regarding noteholders to the staff.  In addition, the firm paid a $50,000 penalty and each principal paid a $25,000 penalty. Also in January, the SEC filed charges in the District of Massachusetts against two Boston-based investment advisers, alleging they engaged in various schemes to defraud their clients, including stealing client funds, failing to disclose conflicts of interest, and secretly using client funds to secure financing for their own investments.[42]  The SEC also alleged that one of the individuals violated his fiduciary duties to clients by obtaining a loan from a client on unfavorable terms to that client and charging advisory fees over 50% higher than the promised rate.  According to the complaint, the pair in one instance misappropriated nearly $450,000 from an elderly client, using the funds to make investments in their own names and to pay personal expenses for one of the individual advisers.  The U.S. Attorney’s Office for the District of Massachusetts also filed criminal charges against the same advisers in a parallel action.  While the SEC action remains pending, the individuals have both pleaded guilty to criminal charges.[43] The SEC also initiated a number of enforcement actions for alleged cherry-picking by investment advisers.  In February, the SEC instituted a litigated action against a California-based investment adviser, its president and sole owner, and its former Chief Compliance Officer for allocating profitable trades to the investment adviser’s account at the expense of its clients.[44]  The SEC’s complaint also alleges that the adviser and president misrepresented trading and allocation practices in Forms ADV filed with the Commission.  The former CCO agreed to settle the charges against him—without admitting or denying allegations that he ignored red flags relating to the firm’s allocation practices—and pay a fine of $15,000; the litigation against the investment adviser and president remains ongoing.  And in March the SEC instituted settled proceedings against a Texas-based investment adviser and its sole principal for disproportionately allocating unprofitable trades to client accounts and profitable trades to their own accounts.[45]  The investment adviser agreed to pay a total of over $700,000 in disgorgement, prejudgment interest, and civil penalties, and the principal agreed to a permanent bar from the securities industry. In April, the SEC filed a settled administrative proceedings against an Illinois-based investment adviser and its president in connection with allegedly misleading advertisements about investment performance.[46]  According to the SEC, the adviser did not disclose that performance results included in advertisements—in the form of written communications and weekly radio broadcasts and video webcasts by its president—were often based on back-tested historical results generated by the adviser’s models, rather than actual results.  The adviser also allegedly failed to adopt written policies and procedures designed to prevent violations of the Advisers Act.  In reaching the agreed-upon resolution, the SEC took into account remediation efforts undertaken by the adviser during the course of the SEC’s investigation, including hiring a new CCO and engaging an outside compliance consultant who conducted an in-depth review of the compliance program and made recommendations which were then implemented by the adviser.  The investment adviser agreed to pay a $125,000 penalty, and the adviser’s president agreed to pay a $75,000 penalty. In May, the SEC charged a California-based individual investment adviser with lying to clients about investment performance and strategy, inflating asset values and unrealized profits in order to overpay himself in management fees and bonuses, and failing to have the private funds audited.[47]  The adviser settled the charges without admitting or denying the allegations, agreeing pay penalties and disgorgement in amounts to be determined by the court. Later that month, the SEC filed settled charges against a Delaware-based investment adviser and its managing member for allegedly making misrepresentations and omissions about the assets and performance of a hedge fund they managed.[48]  According to the SEC, the adviser misrepresented the performance and value of assets in the hedge fund after losing nearly all of its investments after the fund’s trading strategy led to substantial losses.  In addition to making false representations to the fund’s two investors, the adviser withdrew excessive advisory fees based on the inflated asset values.  Without admitting or denying the charges, the adviser and managing member agreed to a cease-and-desist order under which the individual also agreed to a broker-dealer and investment company bar, as well as a $160,000 penalty. In another pair of cases filed in May, the SEC charged a hedge fund and a private fund manager in separate cases involving inflated valuations.  In one case, the SEC alleged that the fund manager’s Chief Financial Officer failed to supervise portfolio managers who engaged in asset mismarking.[49]  The asset mismarking scheme resulted in the hedge fund reaping approximately $3.15 million in excess fees.  The SEC had previously charged the portfolio managers in connection with their misconduct in 2016.  The CFO agreed to pay a $100,000 penalty and to be suspended from the securities industry for twelve months, while the firm agreed to pay over $9 million in disgorgement and penalties.  In the other case, the SEC filed a litigated action in the U.S. District Court for the Southern District of New York against a New York-based investment adviser, the company’s CEO and chief investment officer, a former partner and portfolio manager at the company, and a former trader, in connection with allegations that the defendants inflated the value of private funds they advised.[50]  According to the complaint, the defendants fraudulently inflated the value of the company’s holdings in mortgage-backed securities in order to attract and retain investors, as well as to hide poor fund performance.  This litigation is ongoing. Finally, in late June the SEC announced a settlement with an investment adviser that allegedly failed to protect against advisory representatives misappropriating or misusing client funds.[51]  Without sufficient safeguards in place, one advisory representative was able to misappropriate or misuse $7 million from advisory clients’ accounts.  Without admitting or denying the SEC’s findings, the adviser agreed to pay a $3.6 million penalty, in addition to a cease-and-desist order and a censure.  The representative who allegedly misused the $7 million from client accounts faces criminal charges by the U.S. Attorney’s Office for the Southern District of New York. D.  Investment Company Share Price Selection The first half of 2018 saw the launch of the SEC’s Share Class Selection Disclosure Initiative (SCSD Initiative), as well as several cases involving share class selections.  Under the SCSD Initiative, announced in February, the SEC’s Division of Enforcement agreed not to recommend financial penalties against mutual fund managers which self-report violations of the federal securities laws relating to mutual fund share class selection and promptly return money to victimized investors.[52]  Where investment advisers fail to disclose conflicts of interest and do not self-report, the Division of Enforcement will recommend stronger sanctions in future actions. In late February, a Minnesota-based broker-dealer and investment adviser settled charges in connection with the recommendation and sale of higher-fee mutual fund shares when less expensive share classes were available.[53]  In turn, those recommendations resulted in greater revenue for the company and decreased customers’ returns.  The company, without admitting or denying the allegations, consented to a penalty of $230,000. In April, three investment advisers agreed to settle charges in connection with their failure to disclose conflicts of interest and violations of their fiduciary duties by recommending higher-fee mutual fund share classes despite the availability of less expensive share classes.[54]  Collectively, the companies agreed to pay nearly $15 million in disgorgement, prejudgment interest, and penalties.  The SEC used the announcement of the cases to reiterate its ongoing SCSDC Initiative. E.  Other Compliance Issues In January, the SEC announced settled charges against an Arizona-based investment adviser and its sole principal in connection with a number of Advisers Act violations, including misrepresentations in filed Forms ADV, misrepresentations and failure to produce documents to the Commission examination staff, and other compliance-related deficiencies.[55]  According to the SEC, the adviser’s Forms ADV for years misrepresented its principal’s interest in private funds in which its advisory clients invested.  While the clients were aware of the principal’s involvement with the funds, the adviser falsely stated in filings that the principal had no outside financial industry activities and no interests in client transactions.  Additionally, the SEC alleged that the adviser misstated its assets under management, failed to adopt written policies and procedures relating to advisory fees, and failed to conduct annual reviews of its policies and procedures.  Without admitting or denying the SEC’s allegations, the investment adviser agreed to pay a $100,000 penalty, and the principal agreed to a $50,000 penalty and to a prohibition from acting in a compliance capacity. In April, the SEC filed settled charges against a Connecticut-based investment adviser and its sole owner for improper registration with the Commission and violations of the Commission’s custody and recordkeeping rules.[56]  According to the settled order, the adviser misrepresented the amount of its assets under management in order to satisfy the minimum requirements for SEC registration.  The adviser also allegedly—while having custody over client assets—failed to provide quarterly statements to clients or to arrange for annual surprise verifications of assets by an independent accountant, as required by the Custody Rule, and also failed to make and keep certain books and records required by SEC rules.  Without admitting or denying the allegations, the adviser and its owner agreed to the entry of a cease-and-desist order, and the owner agreed to pay a $20,000 civil penalty and to a 12-month securities industry suspension. A few weeks later, a fund administrator settled cease-and-desist proceedings in connection with the company’s alleged noncompliance in maintaining an affiliated cash fund.[57]  According to the SEC, from mid-2008 to the end of 2012, the firm’s pricing methodology for its affiliated unregistered money market fund was flawed.  The SEC alleged that the deficiencies in the pricing methodology caused the affiliated cash fund to violate Investment Company Act.  To settle the charges, the trust agreed to pay a civil monetary penalty of $225,000. And in June, the SEC announced settlements with 13 private fund advisers in connection with their failures to file Form PF.[58]  Advisers who manage $150 million or more of assets are obligated to file annual reports on Form PF that indicate the amount of assets under management and other metrics about the private funds that they advise.  In turn, the SEC uses the data contained in Form PF in connection with quarterly reports, to monitor industry trends, and to evaluate systemic risks posed by private funds.  Each of the 13 advisers failed to timely file Form PF over a number of years.  Without admitting or denying the allegations, each of the 13 advisers agreed to pay a $75,000 civil penalty. IV.  Brokers and Financial Institutions A.  Supervisory Controls and Internal Systems Deficiencies The SEC brought several cases during the first half of 2018 relating to failures of supervisory controls and internal systems.  In March, the SEC filed a litigated administrative proceeding against a Los Angeles-based financial services firm for failing to supervise one of its employees who was involved in a long-running pump-and-dump scheme and who allegedly received undisclosed benefits for investing her customers in microcap stocks that were the subject of the scheme.[59]  The employee agreed to settle fraud charges stemming from the scheme.  The SEC alleged that the firm ignored multiple signs of the employee’s fraud, including a customer email outlining her involvement in the scheme and multiple FINRA arbitrations and inquiries regarding her penny stock trading activity.  The firm even conducted two investigations, deemed “flawed and insufficient” by the SEC, but failed to take action against the employee.  The SEC previously charged the orchestrator of the pump-and-dump scheme, as well as 15 other individuals and several entities. Also in March, the SEC announced settled charges against a New York-based broker-dealer for its failure to perform required gatekeeping functions in selling almost three million unregistered shares of stock on behalf of a China-based issuer and its affiliates.[60]  The SEC alleged that the firm ignored red flags indicating that the sales could be part of an unlawful unregistered distribution. At the end of June, the SEC charged a New York-based broker-dealer and two of its managers for failing to supervise three brokers, all three of whom were previously charged with fraud in September 2017.[61]  According to the SEC, the firm lacked reasonable supervisory policies and procedures, as well as systems to implement them, and if those systems had been in place, the firm likely would have prevented and detected the brokers’ wrongdoing.  In separate orders, the SEC found that two supervisors ignored red flags indicating excessive trading and failed to supervise brokers with a view toward preventing and detecting their securities-laws violations. B.  AML Cases During the first half of 2018, the SEC brought a number of cases in the anti-money laundering (“AML”) arena.  In March, the SEC brought settled charges against a New York-based brokerage firm for failure to file Suspicious Activity Reports (or “SARs”) reporting numerous suspicious transactions.[62]  The brokerage firm admitted to the charges, and agreed to retain a compliance expert and pay a $750,000 penalty.  The SEC also brought charges against the brokerage firm’s CEO for causing the violation, and its AML compliance officer for aiding and abetting the violation.  Without admitting or denying the charges, the CEO and AML compliance officer respectively agreed to pay penalties of $40,000 and $25,000. In May, the SEC instituted settled charges against two broker-dealers and an AML officer for failing to file SARs relating to the suspicious sales of billions of shares in penny stock.[63]  Without admitting or denying the SEC’s findings, the broker-dealers agreed to penalties; the AML officer agreed to a penalty and an industry and penny stock bar for a minimum of three years. C.  Regulatory Violations In January, the SEC instituted a settled administrative proceeding against an international financial institution for repeated violations of Rule 204 of Regulation SHO, which requires timely delivery of shares to cover short sales.[64]  The SEC’s order alleged that the firm improperly claimed credit on purchases and double counted purchases, resulting in numerous, prolonged fail to deliver positions for short sales.  Without admitting or denying the allegations, the firm agreed to pay a penalty of $1.25 million and entered into an undertaking to fully cooperate with the SEC in all proceedings relating to or arising from the matters in the order. In March, the SEC announced settled charges against a Los-Angeles broker dealer for violating the Customer Protection Rule, which requires that broker-dealers safeguard the cash and securities of customers, by illegally placing more than $25 million of customers’ securities at risk to fund its own operations.[65]  Specifically, the broker-dealer on multiple occasions moved customers’ securities to its own margin account without obtaining the customers’ consent.  The SEC’s Press Release noted that it had recently brought several cases charging violations of the Customer Protection Rule.  Without admitting or denying the allegations, the broker dealer agreed to pay a penalty of $80,000. Also in March, the SEC filed a settled action against a New York-based broker dealer and its CEO and founder for violating the net capital rule, which requires a broker-dealer to maintain sufficient liquid assets to meet all obligations to customers and counterparties and have adequate additional resources to wind down its business in an orderly manner if the firm fails financially.[66]  The SEC found that for ten months, the firm repeatedly failed to maintain sufficient net capital, failed to accrue certain liabilities on its books and records, and misclassified certain assets when performing its net capital calculations.  According to the SEC, the firm’s CEO was involved in discussions about the firm’s unaccrued legal liabilities and was aware of the misclassified assets, but he nevertheless prepared the firm’s erroneous net capital calculations.  As part of the settlement, he agreed to not serve as a financial and operations principal (FINOP) for three years and to pass the required licensing examination prior to resuming duties as a FINOP; the firm agreed to pay a $25,000 penalty. And in a novel enforcement action also arising in March, the SEC filed a settled action against the New York Stock Exchange and two affiliated exchanges in connection with multiple episodes, including several disruptive market events, such as erroneously implementing a market-wide regulatory halt, negligently misrepresenting stock prices as “automated” despite extensive system issues ahead of a total shutdown of two of the exchanges, and applying price collars during unusual market volatility on August 24, 2015, without a rule in effect to permit them.[67]  The SEC also, for the first time, alleged a violation of Regulation SCI, which was adopted by the Commission to strengthen the technology infrastructure and integrity of the U.S. securities markets.  The SEC charged two NYSE exchanges with violating Regulation SCI’s business continuity and disaster recovery requirement.  Without admitting or denying the allegations, the exchanges agreed to pay a $14 million penalty to settle the charges. D.  Other Broker-Dealer Enforcement Actions In June, the SEC settled with a Missouri-based broker-dealer, alleging that the firm generated large fees by improperly soliciting retail customers to actively trade financial products called market-linked investments, or MLIs, which are intended to be held to maturity.[68]  The SEC alleged that the trading strategy, whereby the MLIs were sold before maturity and the proceeds were invested in new MLIs, generated commissions for the firm, which reduced the customers’ investment returns.  The order also found that certain representatives of the firm did not reasonably investigate or understand the significant costs of the MLI exchanges.  The SEC also alleged that the firm’s supervisors routinely approved the MLI transactions despite internal policies prohibiting short-term trading or “flipping” of the products. Later in June, the SEC announced that it had settled with a New York-based broker-dealer for the firm’s violations of its record-keeping provisions by failing to remediate an improper commission-sharing scheme in which a former supervisor received off-book payments from traders he managed.[69]  The SEC also filed a litigated complaint in federal court against the former supervisor and former senior trader for their roles in the scheme.  As alleged by the SEC, the former supervisor and another trader used personal checks to pay a portion of their commissions to the firm’s former global co-head of equities and to another trader.  The practice violated the firm’s policies and procedures and resulted in conflicts of interest that were hidden from the firm’s compliance department, customers, and regulators. E.  Mortgage Backed Securities Cases The SEC appeared to be clearing out its docket of enforcement actions dating back to the mortgage crisis. In February, the SEC announced a settlement against a large financial institution and the former head of its commercial mortgage-backed securities (“CMBS”) trading desk, alleging that traders and salespeople at the firm made false and misleading statements while negotiating secondary market CMBS sales.[70]  According to the SEC’s order, customers of the financial institution overpaid for CMBS because they were misled about the prices at which the firm had originally purchased them, resulting in increased profits for the firm to the detriment of its customers.  The order also alleged that the firm did not have in place adequate compliance and surveillance procedures which were reasonably designed to prevent and detect the misconduct, and also found supervisory failures by the former head trader for failing to take appropriate corrective action.  The firm and trader, without admitting or denying the allegations, agreed to respective penalties of $750,000 and $165,000.  The firm also agreed to repay $3.7 million to customers, which included $1.48 million ordered as disgorgement, and the trader agreed to serve a one-year suspension from the securities industry. Similarly, in mid-June, a large New York-based wealth management firm paid $15 million to settle SEC charges that its traders and salespersons misled customers into overpaying for residential mortgage backed securities (RMBS) by deceiving them about the price that the firm paid to acquire the securities.[71]  The SEC also alleged that the firm’s RMBS traders and salespersons illegally profited from excessive, undisclosed commissions, which in some instances were more than twice the amount that customers should have paid.  According to the SEC, the firm failed to have compliance and surveillance procedures in place that were reasonably designed to prevent and detect the misconduct. V.  Insider Trading A.  Classical Insider Trading And Misappropriation Cases In January, a former corporate insider and a former professional in the brokerage industry agreed to settle allegations that they traded on the stock of a construction company prior to the public announcement of the company’s acquisition.[72]  The insider purportedly tipped his friend, who was then a registered broker-dealer, about the impending transaction in return for assistance in obtaining a new job with his friend’s employer following the merger.  According to the SEC, the broker-dealer traded on that information for a profit exceeding $48,000.  Without admitting or denying the SEC’s findings, both individuals consented to pay monetary penalties, and the trader agreed to disgorge his ill-gotten gains. The following month, the SEC sued a pharmaceutical company employee who allegedly traded in the stock of an acquisition target despite an explicit warning not to do so.[73]  According to the SEC, the defendant bought stock in the other company a mere 14 minutes after receiving an e-mail regarding the acquisition.  Without admitting or denying the SEC’s allegations, the employee agreed to disgorgement of $2,287 and a $6,681 penalty. In February, the SEC charged the former CEO and a former officer of a medical products company with trading on information regarding a merger involving one of their company’s largest customers.[74]  Without admitting or denying the allegations, the two executives agreed to disgorge a total of about $180,000 in trading proceeds and to pay matching penalties. In March, the SEC charged a former communications specialist at a supply chain services company with garnering more than $38,000 in illicit profits after purchasing shares in his company prior to the public announcement of its acquisition.[75]  Without admitting or denying the allegations, the defendant subsequently agreed to $38,242 in disgorgement and the payment of a penalty to be determined following a subsequent motion by the SEC.[76] That same month, the SEC filed suit against the former chief information officer of a company who sold shares of his employer prior to public revelations that that company had suffered a data breach.[77]  In addition, the U.S. Attorney’s Office for the Northern District of Georgia brought  parallel criminal charges.  Both cases are still pending.  Subsequently, at the end of June, the SEC charged another employee at that same company with trading on nonpublic information that he obtained while creating a website for customers affected by the data breach.[78]  The defendant agreed to a settlement requiring him to return ill-gotten gains of more than $75,000 plus interest, and a criminal case filed by the U.S. Attorney’s Office for the Northern District of Georgia remains ongoing. In April, the SEC charged a New York man with tipping his brother and father about the impending acquisition of a medical-supply company based on information that he learned from his friend, the CEO of the company being acquired.[79]  The SEC alleged that the father and brother garnered profits of about $145,000 based on their unlawful trading, and—without admitting or denying the SEC’s allegations—the tipper agreed to pay a $290,000 penalty.  The SEC’s investigation remains ongoing. Also in April, the SEC and the U.S. Attorney’s Office for the District of Massachusetts filed parallel civil and criminal charges against a man accused of trading on a company’s stock based on information gleaned from an unidentified insider.[80]  The man purportedly purchased shares using his retirement savings in advance of eight quarterly earnings announcements over a two-year period, reaping over $900,000 in illicit profits.  The SEC’s complaint also names the man’s wife as a relief defendant, and the matter remains ongoing. Finally, in May, the SEC charged two men with reaping small profits by trading on non-public information in advance of a merger of two snack food companies based on information gained from a close personal friend at one of the merging companies.[81]  Both defendants agreed to settle the lawsuit by disgorging ill-gotten gains and paying penalties. B.  Misappropriation by Investment Professionals and Other Advisors At the end of May, the SEC charged a vice president at an investment bank with repeatedly using confidential knowledge to trade in advance of deals on which his employer advised.[82]  The defendant allegedly used client information to trade in the securities of 12 different companies via a brokerage account held in the name of a friend living in South Korea, evading his employer’s rules that he pre-clear any trades and use an approved brokerage firm.  The trader purportedly garnered approximately $140,000 in illicit profits, and the U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal case.  Both matters are still being litigated. In June, the SEC sued a Canadian accountant for trading on information misappropriated from his client, a member of an oil and gas company’s board of directors.[83]  Based on this relationship, the defendant gained knowledge of an impending merger involving the company.  Without admitting or denying the SEC’s allegations, he agreed to be barred from acting as an officer or director of a public company, and to pay disgorgement and civil penalties of $220,500 each.  The defendant also consented to an SEC order suspending him from appearing or practicing before the Commission as an accountant. Finally, that same month, the SEC charged a credit ratings agency employee and the two friends he tipped about a client’s nonpublic intention to acquire another company.[84]  According to the SEC, the tipper learned the confidential information when the client reached out to the agency to assess the impact of the merger on the company’s credit rating.  Based on the information they received, the friends allegedly netted profits of $192,000 and $107,000, respectively.  In addition, the U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal case against all three individuals.. C.  Other Trading Cases And Developments In February, the Third Circuit Court of Appeals issued a decision in United States v. Metro reversing the district court’s sentencing calculation following the appellant’s conviction on insider trading charges.[85]  The appellant, Steven Metro, was a managing clerk at a New York City law firm, and over the course of five years, he disclosed material nonpublic information to a close friend, Frank Tamayo, concerning 13 different corporate transactions.  Tamayo then transmitted that information to a third-party broker, who placed trades on behalf of Tamayo, himself, and other clients, yielding illicit profits of approximately $5.5 million.  Metro pleaded guilty to one count of conspiracy and one count of securities fraud, and the district court attributed the entire $5.5 million sum to Metro in calculating the length of his sentence.  Metro objected, arguing that he was unaware of the broker’s existence until after he stopped tipping Tamayo. On appeal, the Third Circuit vacated Metro’s sentence after determining that the district court made insufficient factual findings to substantiate imputation of all illicit profits to Metro, holding: “When the scope of a defendant’s involvement in a conspiracy is contested, a district court cannot rely solely on a defendant’s guilty plea to the conspiracy charge, without additional fact-finding, to support attributing co-conspirators’ gains to a defendant.”  The court emphasized that “when attributing to an insider-trading defendant gains realized by other individuals . . . a sentencing court should first identify the scope of conduct for which the defendant can fairly be held accountable . . . .”  Such an inquiry “may lead the court to attribute to a defendant gains realized by downstream trading emanating from the defendant’s tips, but, depending on the facts established at sentencing, it may not,” and the court therefore found that the government erred in propounding a “strict liability” standard. Finally, the first half of this year also saw limited activity by the SEC to freeze assets used to effectuate alleged insider trades.  In January, the SEC obtained an emergency court order freezing the assets of unknown defendants in Swiss bank accounts.[86]  According to the SEC, those unknown defendants were in possession of material nonpublic information regarding the impending acquisition of a biopharmaceutical company, and some of the positions taken in those accounts represented almost 100 percent of the market for those particular options.  The illicit trades allegedly yielded about $5 million in profits.. VI.  Municipal Securities and Public Pensions Cases In the first half of 2018, the SEC’s Public Finance Abuse Unit continued the slower pace of enforcement that began in 2017, pursuing two separate cases against municipal advisors. In January, the SEC charged an Atlanta, Georgia-based municipal advisor and its principal with defrauding the city of Rolling Fork, Mississippi.[87]  The SEC alleged that the municipal advisor had fraudulently overcharged Rolling Fork for municipal advisory services in connection with an October 2015 municipal bond offering and had failed to disclose certain related-party payments.  The related-party payments consisted of an undisclosed $2500 payment made to the advisor by an employee of a municipal underwriter shortly before the advisor recommended that the city hire the underwriter’s firm.  The parties subsequently agreed to settle the case.[88]  Without admitting or denying the allegations against them, the advisor and principal consented to the entry of judgments permanently enjoining them from violating Sections 15B(a)(5) and 15B(c)(1) of the Securities Exchange Act of 1934 and MSRB Rule G-17.  The judgment also requires the defendants to pay a total of about $111,000 in disgorgement, interest, and penalties. In addition, the SEC settled its case against the municipal underwriter.  Without admitting the SEC’s findings, the underwriter agreed to a six-month suspension and to pay a $20,000 penalty. And in May, the SEC brought settled administrative proceedings against another municipal advisor and its owner.[89]  The SEC alleged that, by misrepresenting their municipal advisory experience and failing to disclose conflicts of interest, the advisor and owner had defrauded a South Texas school district and breached their fiduciary duties to that district.  Without admitting to the allegations, the advisor and owner agreed to pay a combined total of approximately $562,000 in disgorgement, interest, and penalties.. [1] Lucia v. SEC, 585 U.S. __ (2018).  For more on Lucia, see Gibson Dunn Client Alert, SEC Rules That SEC ALJs Were Unconstitutionally Appointed (June 21, 2018), available at www.gibsondunn.com/supreme-court-rules-that-sec-aljs-were-unconstitutionally-appointed. [2] See Gibson Dunn Client Alert, U.S. Supreme Court Limits SEC Power to Seek Disgorgement Based on Stale Conduct (June 5, 2017), available at www.gibsondunn.com/united-states-supreme-court-limits-sec-power-to-seek-disgorgement-based-on-stale-conduct. [3] SEC v Kokesh, No. 15-2087 (10th Cir. Mar. 5, 2018); see also Jonathan Stempel, SEC Can Recoup Ill-gotten Gains from New Mexico Businessman: U.S. Appeals Court, Reuters (Mar. 5, 2018), available at www.reuters.com/article/us-sec-kokesh/sec-can-recoup-ill-gotten-gains-from-new-mexico-businessman-u-s-appeals-court-idUSKBN1GH2YK. [4] Adam Dobrik, Unhelpful to Threaten SEC with Trial, Says Enforcement Director, Global Investigations Review (May 10, 2018), available at globalinvestigationsreview.com/article/jac/1169315/unhelpful-to-threaten-sec-with-trial-says-enforcement-director. [5] See SEC v. Cohen, No. 1:17-CV-00430 (E.D.N.Y. July 12, 2018) (holding claims for injunctive relief time-barred). [6] Dunstan Prial, High Court Agrees To Review Banker’s Copy-Paste Fraud, Law360 (Jun. 18, 2018), available at https://www.law360.com/securities/articles/1054568. [7] SEC Press Release, SEC Awards Whistleblower More Than $2.1 Million (Apr. 12, 2018), available at www.sec.gov/news/press-release/2018-64. [8] SEC Press Release, SEC Announces Its Largest-Ever Whistleblower Awards (Mar. 19, 2018), available at https://www.sec.gov/news/press-release/2018-44. [9] Ed Beeson, SEC Whistleblowers Net $83M In Largest Ever Bounties, Law360 (Mar. 19, 2018), available at www.law360.com/articles/1023646/sec-whistleblowers-net-83m-in-largest-ever-bounties. [10] In re Claims for Award in connection with [redacted], Admin. Proc. File No. 2018-6 (Mar. 19, 2018), available at https://www.sec.gov/rules/other/2018/34-82897.pdf. [11] SEC Press Release, SEC Awards More Than $2.2 Million to Whistleblower Who First Reported Information to Another Federal Agency Before SEC (Apr. 5, 2018), available at www.sec.gov/news/press-release/2018-58. [12] SEC Press Release, SEC Awards Whistleblower More Than $2.1 Million (Apr. 12, 2018), available at www.sec.gov/news/press-release/2018-64. [13] Digital Realty Trust, Inc. v. Somers, 583 U.S. __ (2018); see Dunstan Prial, Supreme Court Narrows Definition Of Whistleblower, Law360 (Feb. 21, 2018), available at www.law360.com/securities/articles/1003954. [14] Jennifer Williams Alvarez, SEC Proposes Changes to Whistle-Blower Program, Agenda: A Financial Times Services (Jun. 28, 2018), available at [insert]. [15] SEC Public Statement, Statement on Cybersecurity Interpretive Guidance (Feb. 21, 2018), available at www.sec.gov/news/public-statement/statement-clayton-2018-02-21. [16] SEC Public Statement, Statement on Potentially Unlawful Online Platforms for Trading Digital Assets (March 7, 2018), available at https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading. [17] SEC Press Release, SEC Charges Former Bitcoin-Denominated Exchange and Operator with Fraud (Feb. 21, 2018), available at https://www.sec.gov/news/press-release/2018-23. [18] SEC Press Release, SEC Halts Alleged Initial Coin Offering Scam (Jan. 30, 2018), available at www.sec.gov/news/press-release/2018-8. [19] SEC Press Release, SEC Halts Fraudulent Scheme Involving Unregistered ICO (April 2, 2018), available at www.sec.gov/news/press-release/2018-53. [20] SEC Press Release, SEC Charges Additional Defendant in Fraudulent ICO Scheme (April 20, 2018), available at www.sec.gov/news/press-release/2018-70. [21] SEC Press Release, SEC Obtains Emergency Order Halting Fraudulent Coin Offering Scheme (May 29, 2018), available at www.sec.gov/news/press-release/2018-94. [22] SEC Press Release, SEC Obtains Emergency Freeze of $27 Million in Stock Sales of Purported Cryptocurrency Company Longfin (April 6, 2018), available at www.sec.gov/news/press-release/2018-61. [23] SEC Press Release, SEC Charges Energy Storage Company, Former Executive in Fraudulent Scheme to Inflate Financial Results (Mar. 27, 2018), available at www.sec.gov/news/press-release/2018-48. [24] SEC Press Release, Panasonic Charged with FCPA and Accounting Fraud Violations (Apr. 30, 2018), available at www.sec.gov/news/press-release/2018-73. [25] SEC Press Release, Altaba, Formerly Known as Yahoo!, Charged With Failing to Disclose Massive Cybersecurity Breach; Agrees To Pay $35 Million (Apr. 24, 2018), available at www.sec.gov/news/press-release/2018-71. [26] SEC Press Release, SEC Charges Three Former Healthcare Executives With Fraud (May 16, 2018), available at www.sec.gov/news/press-release/2018-90. [27] SEC Litig. Rel. No. 24181, SEC Charges California Company and Three Executives with Accounting Fraud (July 2, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24181.htm. [28] SEC Press Release, SEC Obtains Bars and Suspensions Against Individuals and Accounting Firm in Shell Factory Scheme (Feb. 16, 2018), available at www.sec.gov/news/press-release/2018-21. [29] SEC Press Release, Foreign Affiliates of KPMG, Deloitte, BDO Charged in Improper Audits (Mar. 13, 2018), available at www.sec.gov/news/press-release/2018-39. [30] In the Matter of Winter, Kloman, Moter & Repp, S.C., Curtis W. Disrud, CPA, and Paul R. Sehmer, CPA, Admin. Proc. File No. 3-18466 (May 04, 2018), available at www.sec.gov/litigation/admin/2018/34-83168.pdf. [31] AP File No. 3-18442, SEC Charges New Jersey-Based Company and Founder for Impermissible Association with Barred Auditor (Apr. 19, 2018), available at www.sec.gov/enforce/34-83067-s. [32] SEC Admin. Proc. File No. 3-18398, Fintech Company Charged For Stock Option Offering Deficiencies, Failed To Provide Required Financial Information To Employee Shareholders (Mar. 12, 2018), available at www.sec.gov/litigation/admin/2017/34-82233-s.pdf. [33] SEC Press Release, Theranos, CEO Holmes, and Former President Balwani Charged With Massive Fraud (Mar. 14, 2018), available at www.sec.gov/news/press-release/2018-41. [34] SEC Litig. Rel. No. 24121, SEC Charges Biotech Start-up, CEO With Fraud (Apr. 24, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24121.htm. [35] In the Matter of THL Managers V, LLC, and THL Managers, VI, LLC, Admin. Proc. File No. 3-18565 (June 29, 2018), available at www.sec.gov/litigation/admin/2018/ia-4952.pdf. [36] SEC Admin. Proc. File No. 3-18564, SEC Charges New York-Based Venture Capital Fund Adviser for Failing to Offset Consulting Fees (June 29, 2018), available at www.sec.gov/enforce/ia-4951-s. [37] SEC Press Release, (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-35. [38] SEC Admin. Proc. File No. 3-18449, SEC Charges a New York-Based Investment Adviser for Breach of Fiduciary Duty (Apr. 24, 2018), available at www.sec.gov/enforce/ia-4896-s. [39] SEC Press Release, SEC Charges Investment Adviser and Two Former Managers for Misleading Retail Clients (June 4, 2018), available at www.sec.gov/news/press-release/2018-101. [40] In re Lyxor Asset Management, Inc., Admin Proc. File No. 3-18526 (June 4, 2018), available at www.sec.gov/litigation/admin/2018/ia-4932.pdf. [41] SEC Admin. Proc. File No. 3-18349, Investment Adviser and Its Principals Settle SEC Charges that They Failed to Disclose Risks of Investing in Their Advisory Business (Jan. 23, 2018), available at  www.sec.gov/enforce/33-10454-s. [42] SEC Litig. Rel. No. 24037, SEC Charges Two Boston-Based Investment Advisers with Fraud (Jan. 31, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24037.htm. [43] Nate Raymond, Ex-Morgan Stanley adviser sentenced to U.S. prison for fraud, Reuters (June 28, 2018), available at www.reuters.com/article/morgan-stanley-fraud/ex-morgan-stanley-adviser-sentenced-to-u-s-prison-for-fraud-idUSL1N1TU28Q. [44] SEC Litig. Rel. No. 24054, SEC Charges Orange County Investment Adviser and Senior Officers in Fraudulent “Cherry-Picking” Scheme (Feb. 21, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24054.htm. [45] SEC Press Release, Investment Adviser Settles Charges for Cheating Clients in Fraudulent Cherry-Picking Scheme (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-36. [46] In re Arlington Capital Management, Inc. and Joseph L. LoPresti, Admin. Proc. File No. 3-18437 (Apr. 16, 2018), available at www.sec.gov/litigation/admin/2018/ia-4885.pdf. [47] SEC Litig. Rel. No. 24142, SEC Charges California Investment Adviser in Multi-Million Dollar Fraud (May 15, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24142.htm. [48] In re Aberon Capital Management, LLC and Joseph Krigsfeld, Admin. Proc. File No. 3-18503 (May 24, 2018), available at www.sec.gov/litigation/admin/2018/ia-4914.pdf. [49] SEC Press Release, Hedge Fund Firm Charged for Asset Mismarking and Insider Trading (May 8, 2018), available at www.sec.gov/news/press-release/2018-81. [50] SEC Press Release, SEC Charges Hedge Fund Adviser With Deceiving Investors by Inflating Fund Performance (May 9, 2018), available at www.sec.gov/news/press-release/2018-83. [51] SEC Press Release, SEC Charges Morgan Stanley in Connection With Failure to Detect or Prevent Misappropriation of Client Funds (June 29, 2018), available at www.sec.gov/news/press-release/2018-124. [52] SEC Press Release, SEC Launches Share Class Selection Disclosure Initiative to Encourage Self-Reporting and the Prompt Return of Funds to Investors (Feb. 12, 2018), available at www.sec.gov/news/press-release/2018-15. [53] SEC Press Release, SEC Charges Ameriprise With Overcharging Retirement Account Customers for Mutual Fund Shares (Feb. 28, 2018), available at www.sec.gov/news/press-release/2018-26. [54] SEC Press Release, SEC Orders Three Investment Advisers to Pay $12 Million to Harmed Clients (Apr. 6, 2018), available at www.sec.gov/news/press-release/2018-62. [55] SEC Admin. Proc. File No. 3-18328, Formerly Registered Investment Adviser Settles SEC Charges Related to Filing False Forms ADV and Other Investment Advisers Act Violations (Jan. 3, 2018), available at www.sec.gov/litigation/admin/2018/ia-4836-s.pdf. [56] SEC Admin. Proc. File No. 3-18423, SEC Charges Investment Adviser for Improperly Registering with the Commission and Violating Several Rules (Apr. 5, 2018), available at www.sec.gov/enforce/ia-4875-s. [57] In re SEI Investments Global Funds Services, Admin. Proc. File No. 3-18457 (Apr. 26, 2018), available at www.sec.gov/litigation/admin/2018/ic-33087.pdf. [58] SEC Press Release, SEC Charges 13 Private Fund Advisers for Repeated Filing Failures (June 1, 2018), available at www.sec.gov/news/press-release/2018-100. [59] SEC Press Release, SEC Charges Recidivist Broker-Dealer in Employee’s Long-Running Pump-and-Dump Fraud (Mar. 27, 2018), available at www.sec.gov/news/press-release/2018-49. [60] SEC Press Release, Merrill Lynch Charged With Gatekeeping Failures in the Unregistered Sales of Securities (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-32. [61] SEC Press Release, SEC Charges New York-Based Firm and Supervisors for Failing to Supervise Brokers Who Defrauded Customers (June 29, 2018), available at www.sec.gov/news/press-release/2018-123. [62] SEC Press Release, Broker-Dealer Admits It Failed to File SARs (Mar. 28, 2018), available at www.sec.gov/news/press-release/2018-50. [63] SEC Charges Brokerage Firms and AML Officer with Anti-Money Laundering Violations (May 16, 2018), available at www.sec.gov/news/press-release/2018-87. [64] Administrative Proceeding File No. 3-18341, Industrial and Commercial Bank of China Financial Services LLC Agrees to Settle SEC Charges Relating to Numerous Regulation SHO Violations That Resulted in Prolonged Fails to Deliver (Jan. 18, 2018), available at www.sec.gov/litigation/admin/2018/34-82533-s.pdf. [65] SEC Press Release, Broker Charged with Repeatedly Putting Customer Assets at Risk (Mar. 19, 2018), available at www.sec.gov/news/press-release/2018-45. [66] Admin. Proc. File No. 3-18409, SEC Charges Broker-Dealer, CEO With Net Capital Rule Violations (Mar. 27, 2018), available at www.sec.gov/enforce/34-82951-s. [67] SEC Press Release, NYSE to Pay $14 Million Penalty for Multiple Violations (Mar. 6, 2018), available at www.sec.gov/news/press-release/2018-31. [68] SEC Press Release, Wells Fargo Advisors Settles SEC Chargers for Improper Sales of Complex Financial Products (June 25, 2018), available at www.sec.gov/news/press-release/2018-112. [69] Lit. Rel. No. 24179, SEC Charges Cantor Fitzgerald and Brokers in Commission-Splitting Scheme (June 29, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24179.htm. [70] SEC Press Release, Deutsche Bank to Repay Misled Customers (Feb. 12, 2018), available at www.sec.gov/news/press-release/2018-13. [71] SEC Press Release, SEC Charges Merrill Lynch for Failure to Supervise RMBS Traders (June 12, 2018), available at www.sec.gov/news/press-release/2018-105. [72] Admin. Proc. File No. 3-18335, Former Corporate Insider and Brokerage Industry Employee Settle Insider Trading Charges with SEC (Jan. 11, 2018), available at www.sec.gov/litigation/admin/2018/34-82485-s.pdf. [73] Lit. Rel. No. 24056,  SEC: Insider Bought Minutes After Warnings Not to Trade (Feb. 28., 2018), available at www.sec.gov/litigation/litreleases/2018/lr24056.htm. [74] Lit Rel. No. 24044, SEC Charges Former Medical Products Executives with Insider Trading (Feb. 12, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24044.htm. [75] Lit Rel. No. 24065, SEC Charges Corporate Communications Specialist with Insider Trading Ahead of Acquisition Announcement (Mar. 8, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24065.htm. [76] Lit Rel. No. 24163, Court Enters Consent Judgment against Robert M. Morano (June 11, 2018), available at https://www.sec.gov/litigation/litreleases/2018/lr24163.htm. [77] Press Release, Former Equifax Executive Charged With Insider Trading (Mar. 14, 2018), available at www.sec.gov/news/press-release/2018-40. [78] Press Release, Former Equifax Manager Charged With Insider Trading (June 28, 2018), available at www.sec.gov/news/press-release/2018-115. [79] Lit Rel. No. 24104, SEC Charges New York Man with Insider Trading (Apr. 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24104.htm. [80] Lit Rel. No. 24097, SEC Charges Massachusetts Man in Multi-Year Trading Scheme (Apr. 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24097.htm. [81] Lit Rel. No. 24134, SEC Charges Two Pennsylvania Residents with Insider Trading (May 4, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24134.htm. [82] Press Release, SEC Charges Investment Banker in Insider Trading Scheme (May 31, 2018), available at www.sec.gov/news/press-release/2018-97. [83] Lit Rel. No. 24165, SEC Charges Canadian Accountant with Insider Trading (June 12, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24164.htm. [84] Lit Rel. No. 24178, SEC Charges Credit Ratings Analyst and Two Friends with Insider Trading (June 29, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24178.htm. [85] 882 F.3d 431 (3d Cir. 2018); see also Tom Gorman, “SEC Disgorgement: A Path For Reform?,” SEC Actions Blog (Feb. 20, 2018), available at http://www.lexissecuritiesmosaic.com/net/Blogwatch/Blogwatch.aspx?ID=32139&identityprofileid=PJ576X25804. [86] Lit Rel. No. 24035, SEC Freezes Assets Behind Alleged Insider Trading (Jan. 26, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24035.htm. [87] SEC Press Release, SEC Charges Municipal Adviser and its Principal with Defrauding Mississippi City (January 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24025.htm. [88] SEC Press Release, SEC Obtains Judgments Against Municipal Adviser and Its Principal for Defrauding Mississippi City (July 2, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24182.htm. [89] SEC Press Release, SEC Levies Fraud Charges Against Texas-Based Municipal Advisor, Owner for Lying to School District (May 9, 2018), available at www.sec.gov/news/press-release/2018-82. The following Gibson Dunn lawyers assisted in the preparation of this client update:  Marc Fagel, Mary Kay Dunning, Amruta Godbole, Amy Mayer, Jaclyn Neely, Joshua Rosario, Alon Sachar, Tina Samanta, Lindsey Young and Alex Zbrozek. Gibson Dunn is one of the nation’s leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators. Our Securities Enforcement Group offers broad and deep experience.  Our partners include the former Directors of the SEC’s New York and San Francisco Regional Offices, the former head of FINRA’s Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California, and former Assistant United States Attorneys from federal prosecutors’ offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force. Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, ourSecurities Litigation Group, and our White Collar Defense Group. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work or any of the following: New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Barry R. Goldsmith – Co-Chair (+1 212-351-2440, bgoldsmith@gibsondunn.com) Laura Kathryn O’Boyle (+1 212-351-2304, loboyle@gibsondunn.com) Mark K. 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Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 12, 2018 |
California Consumer Privacy Act of 2018

Click for PDF On June 28, 2018, Governor Jerry Brown signed the California Consumer Privacy Act of 2018 (“CCPA”), which has been described as a landmark privacy bill that aims to give California consumers increased transparency and control over how companies use and share their personal information.  The law will be enacted as several new sections of the California Civil Code (sections 1798.100 to 1798.198).  While lawmakers and others are already discussing amending the law prior to its January 1, 2020 effective date, as passed the law would require businesses collecting information about California consumers to: disclose what personal information is collected about a consumer and the purposes for which that personal information is used; delete a consumer’s personal information if requested to do so, unless it is necessary for the business to maintain that information for certain purposes; disclose what personal information is sold or shared for a business purpose, and to whom; stop selling a consumer’s information if requested to do so (the “right to opt out”), unless the consumer is under 16 years of age, in which case the business is required to obtain affirmative authorization to sell the consumer’s data (the “right to opt in”); and not discriminate against a consumer for exercising any of the aforementioned rights, including by denying goods or services, charging different prices, or providing a different level or quality of goods or services, subject to certain exceptions. The CCPA also empowers the California Attorney General to adopt regulations to further the statute’s purposes, and to solicit “broad public participation” before the law goes into effect.[1]  In addition, the law permits businesses to seek the opinion of the Attorney General for guidance on how to comply with its provisions. The CCPA does not appear to create any private rights of action, with one notable exception:  the CCPA expands California’s data security laws by providing, in certain cases, a private right of action to consumers “whose nonencrypted or nonredacted personal information” is subject to a breach “as a result of the business’ violation of the duty to implement and maintain reasonable security procedures,” which permits consumers to seek statutory damages of $100 to $750 per incident.[2]  The other rights embodied in the CCPA may be enforced only by the Attorney General—who may seek civil penalties up to $7,500 per violation. In the eighteen months ahead, businesses that collect personal information about California consumers will need to carefully assess their data privacy and disclosure practices and procedures to ensure they are in compliance when the law goes into effect on January 1, 2020.  Businesses may also want to consider whether to submit information to the Attorney General regarding the development of implementing regulations prior to the effective date. I.     Background and Context The CCPA was passed quickly in order to block a similar privacy initiative from appearing on election ballots in November.  The ballot initiative had obtained enough signatures to be presented to voters, but its backers agreed to abandon it if lawmakers passed a comparable bill.  The ballot initiative, if enacted, could not easily be amended by the legislature,[3] so legislators quickly drafted and unanimously passed AB 375 before the June 28 deadline to withdraw items from the ballot.  While not as strict as the EU’s new General Data Protection Regulation (GDPR), the CCPA is more stringent than most existing privacy laws in the United States. II.     Who Must Comply With The CCPA? The CCPA applies to any “business,” including any for-profit entity that collects consumers’ personal information, which does business in California, and which satisfies one or more of the following thresholds: has annual gross revenues in excess of twenty-five million dollars ($25,000,000); possesses the personal information of 50,000 or more consumers, households, or devices; or earns more than half of its annual revenue from selling consumers’ personal information.[4] The CCPA also applies to any entity that controls or is controlled by such a business and shares common branding with the business.[5] The definition of “Personal Information” under the CCPA is extremely broad and includes things not considered “Personal Information” under other U.S. privacy laws, like location data, purchasing or consuming histories, browsing history, and inferences drawn from any of the consumer information.[6]  As a result of the breadth of these definitions, the CCPA likely will apply to hundreds of thousands of companies, both inside and outside of California. III.     CCPA’s Key Rights And Provisions The stated goal of the CCPA is to ensure the following rights of Californians: (1) to know what personal information is being collected about them; (2) to know whether their personal information is sold or disclosed and to whom; (3) to say no to the sale of personal information; (4) to access their personal information; and (5) to equal service and price, even if they exercise their privacy rights.[7]  The CCPA purports to enforce these rights by imposing several obligations on covered businesses, as discussed in more detail below.            A.     Transparency In The Collection Of Personal Information The CCPA requires disclosure of information about how a business collects and uses personal information, and also gives consumers the right to request certain additional information about what data is collected about them.[8]  Specifically, a consumer has the right to request that a business disclose: the categories of personal information it has collected about that consumer; the categories of sources from which the personal information is collected; the business or commercial purpose for collecting or selling personal information; the categories of third parties with whom the business shares personal information; and the specific pieces of personal information it has collected about that consumer.[9] While categories (1)-(4) are fairly general, category (5) requires very detailed information about a consumer, and businesses will need to develop a mechanism for providing this type of information. Under the CCPA, businesses also must affirmatively disclose certain information “at or before the point of collection,” and cannot collect additional categories of personal information or use personal information collected for additional purposes without providing the consumer with notice.[10]  Specifically, businesses must disclose in their online privacy policies and in any California-specific description of a consumer’s rights a list of the categories of personal information they have collected about consumers in the preceding 12 months by reference to the enumerated categories (1)-(5), above.[11] Businesses must provide consumers with at least two methods for submitting requests for information, including, at a minimum, a toll-free telephone number, and if the business maintains an Internet Web site, a Web site address.[12]            B.     Deletion Of Personal Information The CCPA also gives consumers a right to request that businesses delete personal information about them.  Upon receipt of a “verifiable request” from a consumer, a business must delete the consumer’s personal information and direct any service providers to do the same.  There are exceptions to this deletion rule when “it is necessary for the business or service provider to maintain the consumer’s personal information” for one of nine enumerated reasons: Complete the transaction for which the personal information was collected, provide a good or service requested by the consumer, or reasonably anticipated within the context of a business’s ongoing business relationship with the consumer, or otherwise perform a contract between the business and the consumer. Detect security incidents, protect against malicious, deceptive, fraudulent, or illegal activity; or prosecute those responsible for that activity. Debug to identify and repair errors that impair existing intended functionality. Exercise free speech, ensure the right of another consumer to exercise his or her right of free speech, or exercise another right provided for by law. Comply with the California Electronic Communications Privacy Act pursuant to Chapter 3.6 (commencing with Section 1546) of Title 12 of Part 2 of the Penal Code. Engage in public or peer-reviewed scientific, historical, or statistical research in the public interest that adheres to all other applicable ethics and privacy laws, when the businesses’ deletion of the information is likely to render impossible or seriously impair the achievement of such research, if the consumer has provided informed consent. To enable solely internal uses that are reasonably aligned with the expectations of the consumer based on the consumer’s relationship with the business. Comply with a legal obligation. Otherwise use the consumer’s personal information, internally, in a lawful manner that is compatible with the context in which the consumer provided the information.[13] Because these exceptions are so broad, especially given the catch-all provision in category (9), it is unclear whether the CCPA’s right to deletion will substantially alter a business’s obligations as a practical matter.            C.     Disclosure Of Personal Information Sold Or Shared For A Business Purpose The CCPA also requires businesses to disclose what personal information is sold or disclosed for a business purpose, and to whom.[14]  The disclosure of certain information is only required upon receipt of a “verifiable consumer request.”[15]  Specifically, a consumer has the right to request that a business disclose: The categories of personal information that the business collected about the consumer; The categories of personal information that the business sold about the consumer and the categories of third parties to whom the personal information was sold, by category or categories of personal information for each third party to whom the personal information was sold; and The categories of personal information that the business disclosed about the consumer for a business purpose.[16] A business must also affirmatively disclose (including in its online privacy policy and in any California-specific description of consumer’s rights): The category or categories of consumers’ personal information it has sold, or if the business has not sold consumers’ personal information, it shall disclose that fact; and The category or categories of consumers’ personal information it has disclosed for a business purpose, or if the business has not disclosed the consumers’ personal information for a business purpose, it shall disclose that fact.[17] This information must be disclosed in two separate lists, each listing the categories of personal information it has sold about consumers in the preceding 12 months that fall into categories (1) and (2), above.[18]            D.     Right To Opt-Out Of Sale Of Personal Information The CCPA also requires businesses to stop selling a consumer’s personal information if requested to do so by the consumer (“opt-out”).  In addition, consumers under the age of 16 must affirmatively opt-in to allow selling of personal information, and parental consent is required for consumers under the age of 13.[19]  Businesses must provide notice to consumers that their information may be sold and that consumers have the right to opt out of the sale.  In order to comply with the notice requirement, businesses must include a link titled “Do Not Sell My Personal Information” on their homepage and in their privacy policy.[20]            E.     Prohibition Against Discrimination For Exercising Rights The CCPA prohibits a business from discriminating against a consumer for exercising any of their rights in the CCPA, including by denying goods or services, charging different prices, or providing a different level or quality of goods or services.  There are exceptions, however, if the difference in price or level or quality of goods or services “is reasonably related to the value provided to the consumer by the consumer’s data.”  For example, while the language of the statute is not entirely clear, a business may be allowed to charge those users who do not allow the sale of their data while providing the service for free to users who do allow the sale of their data—as long as the amount charged is reasonably related to the value to the business of that consumer’s data.  A business may also offer financial incentives for the collection of personal information, as long as the incentives are not “unjust, unreasonable, coercive, or usurious” and the business notifies the consumer of the incentives and the consumer gives prior opt-in consent.            F.     Data Breach Provisions The CCPA provides a private right of action to consumers “whose nonencrypted or nonredacted personal information” is subject to a breach “as a result of the business’ violation of the duty to implement and maintain reasonable security procedures.”[21]  Under the CCPA, a consumer may seek statutory damages of $100 to $750 per incident or actual damages, whichever is greater.[22]  Notably, the meaning of “personal information” under this provision is the same as it is in California’s existing data breach law, rather than the broad definition used in the remainder of the CCPA.[23]  Consumers bringing a private action under this section must first provide written notice to the business of the alleged violations (and allow the business an opportunity to cure the violations), and must notify the Attorney General and give the Attorney General an opportunity to prosecute.[24]  Notice is not required for an “action solely for actual pecuniary damages suffered as a result of the alleged violations.”[25] IV.     Potential Liability Section 1798.150, regarding liability for data breaches, is the only provision in the CCPA expressly allowing a private right of action.  The damages available for such a civil suit are limited to the greater of (1) between $100 and $750 per consumer per incident, or (2) actual damages.  Individual consumers’ claims also can potentially be aggregated in a class action. The other rights embodied in the CCPA may be enforced only by the Attorney General—who may seek civil penalties not to exceed $2,500 for each violation, unless the violation was intentional, in which case the Attorney General can seek up to $7,500 per violation.[26] [1]   To be codified at Cal. Civ. Code § 1798.185(a) [2]      Cal. Civ. Code § 1798.150. [3]      By its own terms, the ballot initiative could be amended upon a statute passed by 70% of each house of the Legislature if the amendment furthered the purposes of the act, or by a majority for certain provisions to impose additional privacy restrictions.  See The Consumer Right to Privacy Act of 2018 No. 17-0039, Section 5. Otherwise, approved ballot initiatives in California can only be amended with voter approval. California Constitution, Article II, Section 10. [4]   Cal. Civ. Code § 1798.140(c)(1). [5]   Cal. Civ. Code § 1798.140(c)(2). [6]   Cal. Civ. Code § 1798.140(o). The definition of “personal information” does not include publicly available information, and the CCPA also does not generally restrict a business’s ability to collect or use deidentified aggregate consumer information. Cal. Civ. Code § 1798.145(a)(5). [7]   Assemb. Bill 375, 2017-2018 Reg. Sess., Ch. 55, Sec. 2 (Cal. 2018) [8]   Cal. Civ. Code § 1798.100 and 1798.110. [9]   Cal. Civ. Code § 1798.110(a). [10]     Cal. Civ. Code §§ 1798.100(b); 1798.110(c). [11]     Cal. Civ. Code §§ 1798.110(c); 1798.130(a)(5)(B). [12]   Cal. Civ. Code § 1798.130(a)(1). [13]   Cal. Civ. Code § 1798.105(d). [14]   Cal. Civ. Code § 1798.115. [15]   Cal. Civ. Code § 1798.115(a)-(b). [16]   Cal. Civ. Code § 1798.115(a). [17]   Cal. Civ. Code § 1798.115(c). [18]   Cal. Civ. Code § 1798.130(a)(5)(C). [19]   Cal. Civ. Code § 1798.120(d). [20]   Cal. Civ. Code § 1798.135. [21]   Cal. Civ. Code § 1798.150. [22]   Cal. Civ. Code § 1798.150. [23]   Cal. Civ. Code § 1798.81.5(d)(1)(A) [24]   Cal. Civ. Code § 1798.150(b). [25]   Cal. Civ. Code § 1798.150 (b)(1). [26]   Cal. Civ. Code § 1798.155. The following Gibson Dunn lawyers assisted in the preparation of this client alert: Joshua A. Jessen, Benjamin B. Wagner, Christina Chandler Kogan, Abbey A. Barrera, and Alison Watkins. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work or the following leaders and members of the firm’s Privacy, Cybersecurity and Consumer Protection practice group: United States Alexander H. Southwell – Co-Chair, New York (+1 212-351-3981, asouthwell@gibsondunn.com) M. Sean Royall – Dallas (+1 214-698-3256, sroyall@gibsondunn.com) Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com) Christopher Chorba – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Richard H. Cunningham – Denver (+1 303-298-5752, rhcunningham@gibsondunn.com) Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com) Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com) Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com) H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Shaalu Mehra – Palo Alto (+1 650-849-5282, smehra@gibsondunn.com) Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com) Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com) Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com) Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com) Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com) Europe Ahmed Baladi – Co-Chair, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com) James A. Cox – London (+44 (0)207071 4250, jacox@gibsondunn.com) Patrick Doris – London (+44 (0)20 7071 4276, pdoris@gibsondunn.com) Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, bgrinspan@gibsondunn.com) Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com) Jean-Philippe Robé – Paris (+33 (0)1 56 43 13 00, jrobe@gibsondunn.com) Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com) Nicolas Autet – Paris (+33 (0)1 56 43 13 00, nautet@gibsondunn.com) Kai Gesing – Munich (+49 89 189 33-180, kgesing@gibsondunn.com) Sarah Wazen – London (+44 (0)20 7071 4203, swazen@gibsondunn.com) Alejandro Guerrero Perez – Brussels (+32 2 554 7218, aguerreroperez@gibsondunn.com) Asia Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com) Jai S. Pathak – Singapore (+65 6507 3683, jpathak@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 28, 2018 |
India – Legal and Regulatory Update (June 2018)

Click for PDF The Indian Market The Indian economy continues to be an attractive investment destination and one of the fastest growing major economies. After a brief period of uncertainty, following the introduction of a uniform goods and services tax and the announcement that certain banknotes would cease to be legal tender, the growth rate of the economy has begun to rebound, increasing to 7.7 percent in the first quarter of 2018, up from 6.3 percent in the previous quarter. In the World Bank’s most recent Ease of Doing Business rankings, India climbed 30 spots to enter the top 100 countries. This update provides a brief overview of certain key legal and regulatory developments in India between May 1, 2017 and June 28, 2018. Key Legal and Regulatory Developments Foreign Investment Compulsory Reporting of Foreign Investment: The Reserve Bank of India (“RBI“) has notified a one-time reporting requirement[1] for Indian entities with foreign investment. Each such entity must report its total foreign investment in a specified format (asking for certain basic information such as the entity’s main business activity) no later than July 12, 2018. Indian entities can submit their reports through RBI’s website. Indian entities that do not comply with this requirement will be considered to be in violation of India’s foreign exchange laws and will not be permitted to receive any additional foreign investment. This one-time filing requirement is a precursor to the implementation of a single master form that aims to integrate current foreign investment reporting requirements by consolidating nine separate forms into one single form. Single Brand Retail: The Government of India (“Government“) has approved up to 100% foreign direct investment (“FDI“) in single brand product retail trading (“SBRT“) under the automatic route (i.e., without prior Government approval), subject to certain conditions.[2] Previously, FDI in SBRT entities exceeding 49% required the approval of the Government. The Government has also relaxed local sourcing conditions attached to such foreign investment. SBRT entities with more than 51% FDI continue to be subject to local sourcing requirements in India, unless the entity is engaged in retail trading of products that have ‘cutting-edge’ technology. All such SBRT entities are required to source 30% of the value of goods purchased from Indian sources. The Government has now relaxed this sourcing requirement by allowing such SBRT entities to count any purchases made for its global operations towards the 30% local sourcing requirement for a period of five years from the year of opening its first store. The Government has clarified that this relaxation is limited to any increment in sourcing from India from the preceding financial year to the current one, measured in Indian Rupees. After this five year period, the threshold must be met directly by the FDI-receiving SBRT entity through its India operations, on an annual basis. Real Estate Broking Service: The Government has clarified that real estate broking service does not qualify as real estate business and is therefore eligible to receive up to 100% FDI under the automatic route.[3] Introduction of the Standard Operating Procedure: In mid-2017 the Government abolished the Foreign Investment Promotion Board – the Government body responsible for rendering decisions on FDI investments requiring Government approval. Instead, in order to streamline regulatory approvals, it has introduced the Standard Operating Procedure for Processing FDI Proposals (“SOP“).[4] The Government has designated certain competent authorities who are to process an application for FDI in the sector assigned to them. For example, the Ministry of Civil Aviation is responsible for considering and approving FDI proposals in the civil aviation sector. Under the SOP, the competent authorities must adhere to time limits within which a decision must be given. Significantly, the SOP mandates a relevant competent authority to obtain the DIPP’s concurrence before it rejects an application or imposes conditions on a proposed investment. Mergers and Acquisitions Relaxation of Merger Notification Timelines: Previously, parties to a transaction, regarded as a combination within the meaning of the [Indian] Competition Act, 2002 were required to notify the Competition Commission of India (“CCI“) within 30 days of a triggering event, such as execution of transaction documents or approval of a merger or amalgamation by the board of directors of the combining parties. Now, the CCI has exempted parties to combinations from the 30 day notice requirement until June 2022.[5] This move will provide parties involved in a combination sufficient time to compile a comprehensive notification and will possibly lead to faster approvals by easing the burden on CCI’s case teams. Rules for Listed Companies Involved in a Scheme: The Securities and Exchange Board of India (“SEBI“)’s listing rules requires listed companies involved in schemes of arrangement under the [Indian] Companies Act, 2013 (“Companies Act“), to file a draft version of the scheme with a stock exchange. This is in order to obtain a no objection/observation letter before the scheme can be filed with the National Company Law Tribunal. In March 2017, SEBI issued a revised framework for schemes proposed by listed companies in India. In January 2018, SEBI issued a circular[6] amending the 2017 framework. As a part of the 2018 amendments, SEBI clarified that a no objection/observation letter is not required to be obtained from a recognized stock exchange for a demerger/hive off of a division of a listed company into a wholly owned subsidiary, or a merger of a wholly owned subsidiary into its parent company. However, draft scheme documents will still need to be filed with the stock exchange for the purpose of information. The stock exchange will then disseminate the information on their website. Companies Act Action Against Non-Compliant Companies: Registrars of companies (“RoC“) in various Indian states, acting on powers granted under the Companies Act, have initiated action against companies which have either not commenced operations or have not been carrying on business in the past two years. In September 2017, the Government announced that over 200,000 companies had been struck-off from the register of companies based on the powers described above.[7] Further, the director identification numbers for individuals serving as directors on the board of such companies were cancelled, resulting in their disqualification to serve on the board of any company for a period of five years. The striking-off was targeted at Indian companies that failed to fulfill regulatory and compliance requirements (such as filing annual returns) for three years.[8] Notification of Layering Rules: The Government has notified a proviso to subsection 87[9] of Section 2 of the Companies Act along with the Companies (Restriction on Number of Layers) Rules, 2017 (the “Layering Rules“).[10] The effect of these notifications is that an Indian company which is not a banking company, non-banking financial company, insurance company or a government company, is not allowed to have more than two layers of subsidiaries. For the purposes of computing the number of layers, Indian companies are not required to take into account one layer consisting of one or more wholly owned subsidiaries. Further, the Layering Rules do not prohibit Indian companies from acquiring companies incorporated outside India which have subsidiaries beyond two layers (as long as such a structure is permitted in accordance with the laws of the relevant country). Provisions of Companies Act Extended to all Foreign Companies: India has enacted the Companies (Amendment) Act, 2017 in order to amend various sections of the Companies Act. The provisions of the amendment act are being brought into effect in a phased manner. Recently, the Government has notified a provision in the Companies (Amendment) Act, 2017[11] which extends the applicability of sections 380 to 386 and sections 392 and 393 of the Companies Act to all foreign companies which have a place of business in India or conduct any business activity in the country. Prior to this amendment, these provisions were only applicable to foreign companies where a minimum of fifty percent of the shares were held by Indian individuals or companies. These provisions of the Companies Act include a requirement to (a) furnish information and documents to the RoC, such as certified copies of constitutional documents, the company’s balance sheet and profit and loss account; and (b) comply with the provisions governing issuance of debentures, preparation of annual returns and maintaining books of account. Notification of Cross Border Merger Rules: The Government had notified Section 234 of the Companies Act and Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules 2016. Please refer to our regulatory update dated May 1, 2017 for further details. In this update, we had referred to the requirement of the RBI’s prior permission in order to commence cross border merger procedures under the Companies Act. On March 20, 2018, the RBI issued the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (the “Cross Border Merger Rules“).[12] The Cross Border Merger Rules provide for the RBI’s deemed approval where the proposed cross-border merger is in accordance with the parameters specified by it. These parameters include, where the resultant company is an Indian company, a requirement that any borrowings or guarantees transferred to the resultant entity comply with RBI regulations on external commercial borrowings within a period of two years from the effectiveness of the merger. End-use restrictions under the existing RBI regulations do not have to be complied with. However, where the resultant company is an offshore company, the transfer of any borrowings in rupees to the resultant company requires the consent of the Indian lender and must be in compliance with Foreign Exchange Management Act, 1999 and regulations issued thereunder. In addition, repayment of onshore loans will need to be in accordance with the scheme approved by the National Company Law Tribunal. Currently, these provisions apply only to mergers and amalgamations, and not to demergers. Labour Laws States Begin Implementing Model Labour Law: In mid-2016, the Government introduced the Model Shops and Establishments (Regulation of Employment and Conditions of Service) Bill (“S&E Bill“). The S&E Bill, as is the case with other shops and establishments legislation in India, mandates working hours, public holidays and regulates the condition of workers employed in non-industrial establishments such as shops, restaurants and movie theatres. States in India can either adopt the S&E Bill in its entirety, superseding existing regulations, or choose to amend their existing enactments based on the S&E Bill. The S&E Bill seeks to update Indian laws, adapting them to current business requirement for non-industrial establishments. For example, the S&E Bill (a) enables establishments to remain open 365 days in a year, and (b) allows women to work night shifts, while containing provisions for employers to ensure safety of women workers. Registration provisions under the new legislation have also been eased. In late 2017, the State of Maharashtra notified a new shops and establishments statute based on the S&E Bill.  Other states in India are expected to follow suit. Start–ups Issue of Convertible Notes by Start-ups: The Government had eased funding for start-ups in India in January 2016. Please refer to our regulatory update dated May 18, 2016, for an overview of this initiative. In January 2017, the RBI had permitted start-ups to receive foreign investment through the issue of convertible notes.[13] The revised FDI Policy issued in 2017 now incorporates these provisions. The provisions allow for an investment of INR 2,500,000 (approx. USD 36,700) or more to be made in a single tranche. These notes are repayable at the option of the holder, and convertible within a five year period. The issuance of the notes is subject to entry route, sectoral caps, conditions, pricing guidelines and other requirements that are prescribed for the sector by the RBI.[14] Capital Gains Tax Charging of Long Term Capital Gains Tax: An important amendment to Indian tax laws introduced by the Finance Act, 2018[15] is the levy of tax at the rate of 10% on capital gains made on the sale of certain securities (including listed equity shares) held at least for a year. The tax is levied if the total amount of capital gains exceeds INR 100,000 (approx. USD 1,448). This amendment came into effect on April 1, 2018. However, all gains made on existing holdings until January 31, 2018 are exempt from the tax.  In all such ‘grandfathering’ cases, the cost of acquisition of a security is deemed to be the higher of the actual cost of acquisition and the fair market value of the security as on January 31, 2018. Where the consideration received on transfer of the security is lower than the fair market value as on January 31, 2018, the cost of acquisition is deemed to be the higher of the actual cost of acquisition and the consideration received for the transfer.[16] [1] RBI Notification on Reporting in Single Master Form dated June 7, 2018. Available at https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/NT194481067EB1B554402821A8C2AB7A52009.PDF [2] Press Note No. 1 (2018 Series) dated January 23, 2018, Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, Government of India. [3] Id.  [4] Standard Operating Procedure dated June 29, 2017. Available at http://www.fifp.gov.in/Forms/SOP.pdf  [5] MCA Notification dated June 29, 2017. Available at http://www.cci.gov.in/sites/default/files/notification/S.O.%202039%20%28E%29%20-%2029th%20June%202017.pdf  [6] SEBI Circular dated January 3, 2018. Available at https://www.sebi.gov.in/legal/circulars/jan-2018/circular-on-schemes-of-arrangement-by-listed-entities-and-ii-relaxation-under-sub-rule-7-of-rule-19-of-the-securities-contracts-regulation-rules-1957-_37265.html. [7] Press Information Bureau, Government of India, Ministry of Finance, “Department of Financial Services advises all Banks to take immediate steps to put restrictions on bank accounts of over two lakh ‘struck off’ companies”, http://pib.nic.in/newsite/PrintRelease.aspx?relid=170546 (September 5, 2017). [8] Live Mint, “Govt blocks bank accounts of 200,000 dormant firms”, http://www.livemint.com/Companies/oTcu9b66rZQnvFw6mgSCGK/Black-money-Bank-accounts-of-209-lakh-companies-frozen.html (September 6, 2017).  [9] MCA Notification vide S.O. No. 3086(E) dated September 20, 2017.  [10] Notification No. G.S.R. 1176(E) dated September 20, 2017. Available at http://www.mca.gov.in/Ministry/pdf/CompaniesRestrictionOnNumberofLayersRule_22092017.pdf[11] MCA Notification dated February 9, 2018. Available at http://www.mca.gov.in/Ministry/pdf/Commencementnotification_12022018.pdf [12] FEMA Notification dated March 20, 2018. Available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/CBM28031838E18A1D866A47F8A20201D6518E468E.pdf  [13] RBI Notification of changes to RBI regulations dated January 10, 2017. Available at https://rbi.org.in/scripts/NotificationUser.aspx?Id=10825&Mode=0 [14] Consolidated FDI Policy Circular of 2017. Available at http://dipp.nic.in/sites/default/files/CFPC_2017_FINAL_RELEASED_28.8.17.pdf [15] Section 33 of the Finance Act, 2018. Available at http://egazette.nic.in/writereaddata/2018/184302.pdf [16] CBDT Notification No. F. No. 370149/20/2018-TPL. Available at https://www.incometaxindia.gov.in/news/faq-on-ltcg.pdf Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team: Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com) Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com) Prachi Jhunjhunwala (+65.6507.3645, pjhunjhunwala@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 25, 2018 |
Gibson Dunn Transaction Named Private Equity Deal of the Year by The Deal

The Deal named “Kindred Healthcare Inc. – Humana Inc.; TPG Capital LP & Welsh, Carson, Anderson & Stowe” as its Private Equity Deal of the Year. Gibson Dunn was counsel to Guggenheim Securities, financial advisor to Kindred Healthcare in its sale to TPG Capital; Welsh, Carson, Anderson & Stowe; and Humana. The Gibson Dunn team included New York corporate partners Barbara Becker and Dennis Friedman.  The awards list was published on June 25, 2018.

May 17, 2018 |
Gibson Dunn Strengthens Private Equity and M&A Practices With Four Corporate Partners

Gibson, Dunn & Crutcher LLP is pleased to announce that George Stamas, Mark Director, Andrew Herman, and Alexander Fine have joined the firm as partners.  Stamas will work in the firm’s New York and Washington, D.C. offices, while Director, Herman and Fine will be based in the Washington, D.C. office and also will work regularly in the New York office.  They all join from Kirkland & Ellis, continuing their corporate, mergers and acquisitions and private equity practices. “We are delighted to add this distinguished team to the firm,” said Ken Doran, Chairman and Managing Partner of Gibson Dunn.  “George, Mark, Andrew and Alex are talented, highly regarded lawyers and energetic business developers.  They have strong contacts in the legal and business communities in D.C., New York and internationally.  Their addition will significantly strengthen our M&A, private equity and corporate practices not just on the East Coast but across the firm worldwide.” “Many of us here at Gibson Dunn have worked opposite of this group in a number of transactions, and we have the utmost respect for them,” said Stephen Glover, a partner in the Washington, D.C. office and Co-Chair of the M&A Practice Group.  “Our combined practice will create a D.C. corporate powerhouse that will firmly establish our position as a leader in high-end corporate and M&A.  In addition, their private equity and public company M&A experience will complement and expand our national and international practice.” “We are excited about the opportunity to join the firm,” said Stamas.  “We have long admired Gibson Dunn’s culture and collaborative approach to servicing clients.  We are committed to joining the team and further developing our practice together.  We wish the very best to our former colleagues, who we hold in high regard.” About George Stamas Stamas served as a senior partner in Kirkland & Ellis’ corporate practice group since 2002 and will continue to serve as a senior partner in Gibson Dunn’s New York and Washington, D.C. offices.  He focuses on public company and private equity M&A and corporate securities transactions.  He also counsels C-level executives and board of directors on corporate governance matters. Stamas has previously served as Vice Chair of the Board of Deutsche Banc Alex Brown, Inc.; as a founding board member of FTI Consulting (NYSE); as a venture partner of international venture capital firm New Enterprise Associates; and as a member of numerous public and private corporate boards. He is an executive board member of New York private equity firm MidOcean Partners.  He also is a board member of the Shakespeare Theatre Company and on the National Advisory Council of Youth Inc.  He is a co-founder of The Hellenic Initiative and a member of The Council on Foreign Relations. Stamas is also is a partner of Monumental Partners, which controls the Washington Capitals and Washington Wizards and is a partner of the Baltimore Orioles. He graduated in 1976 from the University of Maryland Law School, where he was a member of the International Law Review, and from 1977 to 1979, he served as special counsel to Stanley Sporkin in the Enforcement Division of the Securities and Exchange Commission. About Mark Director Director represents public companies and private equity sponsors and their portfolio companies in a broad range of transactions, including M&A, leveraged buyouts, spin-offs, minority investments and joint ventures.  He also advises boards of directors and corporate executives on corporate governance, public disclosure, securities reporting, and compliance and risk management matters. He is a member of the Society for Corporate Governance and the Board of Directors of Everybody Wins! DC, a children’s literacy organization.  He serves as Vice President and a member of the Board of Directors of Washington Hebrew Congregation. Director was a partner with Kirkland & Ellis since 2002.  Before that he served as Executive Vice President and General Counsel of publicly traded US Office Products Co. and of a private equity-owned telecommunications company.  He graduated cum laude in 1984 from Harvard Law School, where he was a member of the Journal on Legislation and worked with the Hon. Douglas H. Ginsburg (then a professor at Harvard) to co-author a casebook on the regulation of the electronic mass media. About Andrew Herman Herman’s practice focuses on advising private equity sponsors and their portfolio companies on leveraged buyouts, growth equity investments and other transactions.  He also advises public companies on M&A transactions, securities law compliance and corporate governance.  He is experienced in advising on the acquisition and sale of sports franchises. Herman joined Kirkland & Ellis in 2002 and became a partner in 2004.  He graduated in 1995 from Columbia University School of Law, where he was a Harlan Fiske Stone Scholar and the submissions editor of the Journal of Transactional Law.  He received a master’s degree with honors in accounting from the University of North Carolina, Chapel Hill in 1992.  Herman serves on the Board of Directors and chairs the Finance Committee at Adas Israel Congregation. About Alexander Fine Fine’s practice focuses on advising private equity sponsors and public companies on a wide range of transactional matters, including strategic M&A, leveraged buyouts, minority investments, and joint ventures.  He also advises clients on corporate governance and securities law matters. Fine was previously a partner with Kirkland & Ellis since 2010, and before that served as Executive Vice President and Corporate Counsel of Allied Capital Corporation. He graduated in 2000 from the University of Virginia School of Law where he was a member of the Order of the Coif and of the Editorial Board of the Virginia Law Review.

April 23, 2018 |
5 Factors Driving Private Equity In Asia

Hong Kong partner Scott Jalowayski and Hong Kong associate James Jackson are the authors of “5 Factors Driving Private Equity In Asia,” [PDF] published by Law360 on April 23, 2018.

April 5, 2018 |
M&A Report – AOL and Aruba Networks Continue Trend of Delaware Courts Deferring to Deal Price in Appraisal Actions

Click for PDF Two recent decisions confirm that, in the wake of the Delaware Supreme Court’s landmark decisions in Dell and DFC, Delaware courts are taking an increasingly skeptical view of claims in appraisal actions that the “fair value” of a company’s shares exceeds the deal price.[1] However, as demonstrated by each of these recent Delaware Court of Chancery decisions—In re Appraisal of AOL Inc. and Verition Partners Master Fund Limited v. Aruba Networks, Inc.—several key issues are continuing to evolve in the Delaware courts.[2] In particular, Delaware courts are refining the criteria in appraisal actions for determining whether a transaction was “Dell-compliant.” If so, then the court will likely look to market-based indicators of fair value, though which such indicator (unaffected share price or deal price) is the best evidence of fair value remains unresolved. If not, the court will likely conduct a valuation based on discounted cash flow (DCF) analysis or an alternative method to determine fair value. The development of these issues will help determine whether M&A appraisal litigation will continue to decline in frequency and will be critical for deal practitioners.[3] DFC and “Dell-Compliant” Transactions In DFC, the Delaware Supreme Court endorsed deal price as the “best evidence of fair value” in an arm’s-length merger resulting from a robust sale process. The Court held that, in determining fair value in such transactions, the lower court must “explain” any departure from deal price based on “economic facts,” and must justify its selection of alternative valuation methodologies and its weighting of those methodologies, setting forth whether such methodologies are grounded in market-based indicators (such as unaffected share price or deal price) or in other forms of analysis (such as DCF, comparable companies analysis or comparable transactions analysis). In Dell, the Court again focused on the factual contexts in which market-based indicators of fair value should be accorded greater weight. In particular, the Court found that if the target has certain attributes—for example, “many stockholders; no controlling stockholder; highly active trading; and if information is widely available and easily disseminated to the market”—and if the target was sold in an arm’s-length transaction, then the “deal price has heavy, if not overriding, probative value.” Aruba Networks and AOL: Marking the Boundaries for “Dell-Compliant” Transactions In Aruba Networks, the Delaware Court of Chancery concluded that an efficient market existed for the target’s stock, in light of the presence of a large number of stockholders, the absence of a controlling stockholder, the deep trading volume for the target’s stock and the broad dissemination of information about the target to the market. In addition, the court found that the target’s sale process had been robust, noting that the transaction was an arm’s-length merger that did not involve a controller squeeze-out or management buyout, the target’s board was disinterested and independent, and the deal protection provisions in the merger agreement were not impermissibly restrictive. On this basis, the Court determined that the transaction was “Dell-compliant” and, as a result, market-based indicators would provide the best evidence of fair value. The Court found that both the deal price and the unaffected stock price provided probative evidence of fair value, but in light of the significant quantum of synergies that the parties expected the transaction to generate, the Court elected to rely upon the unaffected stock price, which reflected “the collective judgment of the many based on all the publicly available information . . . and the value of its shares.” The Court observed that using the deal price and subtracting synergies, which may not be counted towards fair value under the appraisal statute,[4] would necessarily involve judgment and introduce a likelihood of error in the Court’s computation. By contrast, AOL involved facts much closer to falling under the rubric of a “Dell-compliant” transaction, but the Court nonetheless determined that the transaction was not “Dell-compliant.” At the time of the transaction, the target was well-known to be “likely in play” and had communicated with many potential bidders, no major conflicts of interest were present and the merger agreement did not include a prohibitively large breakup fee. Nonetheless, the Court focused on several facts that pointed to structural defects in the sale process, including that the merger agreement contained a no-shop period with unlimited three-day matching rights for the buyer and that the target failed to conduct a robust auction once the winning bidder emerged. In addition, and importantly, the Court took issue with certain public comments of the target’s chief executive officer indicating a high degree of commitment to the deal after it had been announced, which the Court took to signal “to potential market participants that the deal was done, and that they need not bother making an offer.” On this basis, the Court declined to ascribe any weight to the deal price and instead conducted a DCF analysis, from which it arrived at a fair value below the deal price. It attributed this gap to the inclusion of synergies in the deal price that are properly excluded from fair value. Parenthetically, the Court did take note of the fact that its computation of fair value was close to the deal price, which offered a “check on fair value analysis,” even if it did not factor into the Court’s computation. Key Takeaways Aruba Networks and AOL provide useful guidelines to M&A practitioners seeking to manage appraisal risk, while also leaving several open questions with which the Delaware courts will continue to grapple: Whether market-based indicators of fair value will receive deference from the Delaware courts (and, correspondingly, diminish the incentives for would-be appraisal arbitrageurs) depends upon whether the sale process could be considered “Dell-compliant.” This includes an assessment of both the robustness of the sale process, on which M&A practitioners seeking to manage appraisal risk would be well-advised to focus early, and the efficiency of the trading market for the target’s stock, to which litigators in appraisal actions should pay close attention. For those transactions found to be “Dell-compliant,” the best evidence of fair value will be a market-based indicator of the target’s stock. Whether such evidence will be the deal price, the unaffected stock price or a different measure remains an open question dependent upon the facts of the particular case. However, for those transactions in which synergies are anticipated by the parties to be a material driver of value, Aruba Networks suggests that the unaffected share price may be viewed as a measure of fair value that is less susceptible to errors or biases in judgment. For those transactions found not to be “Dell-compliant,” DCF analyses or other similar calculated valuation methodologies are more likely to be employed by courts to determine fair value. As AOL and other recent opinions indicate, however, there is no guarantee for stockholders that the result will yield a fair value in excess of the deal price—particularly given the statutory mandate to exclude expected synergies from the computation. [1] Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017); DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017). See our earlier discussion of Dell and DFC here. [2] In re Appraisal of AOL Inc., C.A. No. 11204-VCG, 2018 WL 1037450 (Del. Ch. Feb. 23, 2018); Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL, 2018 WL 922139 (Del. Ch. Feb. 15, 2018). [3] It is worth noting that, after DFC and Dell, the Delaware Supreme Court summarily affirmed the decision of the Court of Chancery in Merlin Partners, LP v. SWS Grp., Inc., No. 295, 2017, 2018 WL 1037477 (Table) (Del. Feb. 23, 2018), aff’g, In re Appraisal of SWS Grp., Inc., C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. May 30, 2017). The Court of Chancery decided SWS Group prior to the Delaware Supreme Court’s decisions in DFC and Dell. Nonetheless, it is clear that the court would have found the transaction at issue in SWS Group not to be “Dell-compliant,” as the transaction involved the sale of the target to a buyer that was also a lender to the target and so could exercise veto rights over any transaction. Indeed, no party to the SWS Group litigation argued that the deal price provided probative evidence of fair value. See our earlier discussion of the SWS Group decision by the Delaware Court of Chancery here. [4] See 8 Del. C. § 262(h) (“[T]he Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . .”); see also Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507 (Del. Ch.) (“The entity must be valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself must be disregarded.” (internal citations omitted)), aff’d, 11 A.3d 214 (Del. 2010). The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Eduardo Gallardo, Jonathan Layne, Joshua Lipshutz, Brian Lutz, Adam Offenhartz, Aric Wu, Meryl Young, Daniel Alterbaum, Colin Davis, and Mark Mixon. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Jonathan Corsico – Washington, D.C. (+1 202-887-3652), jcorsico@gibsondunn.com Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 20, 2018 |
Supreme Court Approves Deferential Review of Bankruptcy-Court Determinations on “Insider” Status

Click for PDF On March 5, 2018, the U.S. Supreme Court issued a decision in U.S. Bank N.A. Trustee, By and Through CWCapital Asset Management LLC v. Village at Lakeridge, LLC (No. 15-1509), approving the application of the clear error standard of review in a case determining whether someone was a “non-statutory” insider under the Bankruptcy Code. We note that the Court’s narrow holding only addressed the appropriate standard of review, leaving for another day the question of whether the specific test that the Ninth Circuit used to determine whether the individual was a “non-statutory” insider was correct. The ruling is significant, however, because without the prospect of de novo review, a bankruptcy court’s ruling on whether a person is a “non-statutory” insider will be very difficult to overturn on appeal—which may have significant impact on case outcomes. The Bankruptcy Code “Insider” The Bankruptcy Code’s definition of an insider includes any director, officer, or “person in control” of the entity.[1] This definition is non-exhaustive, so courts have devised tests for identifying other, so-called “non-statutory” insiders, focusing, in whole or in part, on whether a person’s transactions with the debtor were at arm’s length. Background In this case, the debtor (Lakeridge) owed money to two main entities, its sole owner MBP Equity Partners for $2.76 million, and U.S. Bank for $10 million. Lakeridge submitted a plan of reorganization, but it was rejected by U.S. Bank. Lakeridge then turned to the “cramdown” option for imposing a plan impairing the interests of non-consenting creditors. This option requires that at least one impaired class of creditors vote to accept the plan, excluding the votes of all insiders. As the debtor’s sole owner, MBP plainly was an insider of the debtor, within the statutory definition of Bankruptcy Code §101(31)(B)(i)–(iii), so its vote would not count. Therefore, to gain the consent of the MBP voting block to pass the cramdown plan, Kathleen Bartlett (an MPB board member and Lakeridge officer), sold MPB’s claim of $2.76 million to a retired surgeon named Robert Rabkin, for $5,000. Rabkin agreed to buy the debt owed to MBP for $5,000 and proceeded to vote in favor of the proposed plan as a non-insider creditor. U.S. Bank, the other large creditor, objected, arguing that the transaction was a sham and pointing to a pre-existing romantic relationship between Rabkin and Bartlett. If Rabkin were an officer or director of the debtor, Rabkin’s status as an insider would have been undisputed. But because Rabkin had no formal relationship with the debtor, the bankruptcy court had to consider whether the particular relationship was close enough to make him a “non-statutory” insider. The bankruptcy court held an evidentiary hearing and concluded that Rabkin was not an insider, based on its finding that Rabkin and Bartlett negotiated the transaction at arm’s length. Because of this decision, the Debtor was able to confirm a cramdown plan over the objection of the senior secured lender. The Ninth Circuit affirmed the bankruptcy court’s ruling, holding that that the finding was entitled to clear-error review, and therefore would not be reversed. The Supreme Court Holds That the Standard of Review Is Clear Error On certiorari, the Supreme Court, in a unanimous opinion, took pains to emphasize that the sole issue on appeal was the appropriate standard of review, and not any determination of the merits of the “non-statutory” insider test that the Ninth Circuit had applied to determine whether Rabkin was an insider. The Supreme Court held that the Ninth Circuit was correct to review the bankruptcy court’s determination for “clear error” (rather than de novo). The Court discussed the difference between findings of law—which are reviewed de novo—and findings of fact—which are reviewed for clear error. The question in this case—whether Rabkin met the legal test for a non-statutory insider—was a “mixed” question of law and fact. Courts often review mixed questions de novo when they “require courts to expound on the law, particularly by amplifying or elaborating on a broad legal standard.”[2] Conversely, courts use the clearly erroneous standard for mixed questions that “immerse courts in case-specific factual issues.”[3] In sum, the Court explained, “the standard of review for a mixed question all depends on whether answering it entails primarily legal or factual work.”[4] Choosing between those two characterizations, the Court chose the latter. The basic question in this case was whether “[g]iven all the basic facts found, Rabkin’s purchase of MBP’s claim [was] conducted as if the two were strangers to each other.”[5] Because “[t]hat is about as factual sounding as any mixed question gets,”[6] the Court held that the clear error standard applied. The Supreme Court Avoids Adjudicating a Potentially Significant Circuit Split on Tests Used to Determine Non-Statutory Insiders All nine of the justices joined Justice Kagan’s opinion. However, the concurring opinion from Justice Sonia Sotomayor (joined by Justices Anthony Kennedy, Clarence Thomas and Neil Gorsuch) suggests grave doubts about the coherence of the Ninth Circuit’s standard for assessing non-statutory-insider status. Nevertheless, Justice Sotomayor agreed that resolving the propriety of that standard is not a task that warranted the Supreme Court’s attention. Impact of US Bank While this case does not break new ground, it firmly establishes the bankruptcy courts’ authority to make these determinations and limits appellate review. This opinion may embolden appellants (and bankruptcy courts) to push the envelope in the future. Debtors may be emboldened to seek to use a variety of affiliate-transaction structures as they seek the keys to confirming cramdown plans over the objections of senior lenders.    [1]   11 U.S.C. § 101(31)(B)(i)–(iii).    [2]   Decision at p. 8.    [3]   Ibid.    [4]   Id. at p. 2.    [5]   Id. at p. 10.    [6]   Ibid. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com) Daniel B. Denny – Los Angeles (+1 213-229-7646, ddenny@gibsondunn.com) Sara Ciccolari-Micaldi – Los Angeles (+1 213-229-7887, sciccolarimicaldi@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 5, 2018 |
Supreme Court Settles Circuit Split Concerning Bankruptcy Code “Safe Harbor”

Click for PDF On February 27, 2018, the U.S. Supreme Court issued a decision in Merit Management Group, LP v. FTI Consulting, Inc. (No. 16-784), settling a circuit split regarding the “safe harbor” provision in § 546(e) of the Bankruptcy Code.  That section bars the avoidance of certain types of securities and commodities transactions that are made by, to or for the benefit of covered entities including financial institutions, stockbrokers and securities clearing agencies. Circuits had split regarding whether the safe harbor protects a transfer that passes through a covered entity, where the entity only acts as a conduit and has no beneficial interest in the property transferred.  In Merit Management, the Court held that the safe harbor does not apply when a covered entity only acts as a conduit, and that the safe harbor only applies when the “relevant transfer” (i.e., the “overarching” transfer sought to be avoided) is by, to or for the benefit of a covered entity.  As a result, the Court held that the safe harbor did not protect a private securities transaction where neither the buyer nor the seller was a covered entity, even though the funds passed through covered entities. The Bankruptcy Code “Safe Harbor” The Bankruptcy Code permits a trustee to bring claims to “avoid” (or undo) for the benefit of the bankruptcy estate certain prepetition transfers or obligations, including claims to avoid a preference (11 U.S.C. § 547) or fraudulent transfer (11 U.S.C. § 548(a)).  Section 546(e) limits those avoidance powers by providing that, “[n]otwithstanding” the trustee’s avoidance powers, “the trustee may not avoid a transfer that is” (1) a “margin payment” or “settlement payment” “made by or to (or for the benefit of)” a covered entity, or (2) “a transfer made by or to (or for the benefit of)” a covered entity “in connection with a securities contract . . . or forward contract.”  11 U.S.C. § 546(e).  The sole exception to the safe harbor is a claim for “actual fraudulent transfer” under § 548(a)(1)(A).  Id. Background Merit Management involved the acquisition of a “racino” (a combined horse racing and casino business) by its competitor.  To consummate the transaction, the buyer’s bank wired $55 million to another bank that acted as a third-party escrow agent, which disbursed the funds to the seller’s shareholders in exchange for their stock in the seller.  The buyer subsequently filed for Chapter 11 bankruptcy protection and a litigation trust was established pursuant to the buyer’s confirmed reorganization plan.  The trustee sued one of the selling shareholders that received $16.5 million from the buyer, alleging that the transaction was a constructive fraudulent transfer under § 548(a)(1)(B) because the buyer was insolvent at the time of the purchase and “significantly overpaid” for the stock. The district court held that the safe harbor barred the fraudulent transfer claim because the transaction was a securities settlement payment involving intermediate transfers “by” and “to” covered entities (the banks).  The Seventh Circuit reversed, holding that the safe harbor did not apply because the banks only acted as conduits and neither the buyer nor the shareholder was a covered entity.  In so holding, the Seventh Circuit diverged from other circuits that had applied the safe harbor to transactions consummated through a covered entity acting as a conduit.[1]  Those circuits interpreted the disjunctive language in the safe harbor that protects transfers “by or to (or for the benefit of)” a covered entity to mean that a transfer “by” or “to” a covered entity is protected even if the transfer is not “for the benefit of” the covered entity.  The Supreme Court granted certiorari to settle the circuit split. The Supreme Court Holds That the Safe Harbor Does Not Protect a Transfer When a Covered Entity Only Acts as a Conduit   The Supreme Court affirmed the Seventh Circuit’s decision, holding that the safe harbor does not protect a transfer when a covered entity only acts as a conduit.  The crux of the decision is that a safe harbor analysis must focus on whether the “relevant transfer,” meaning the “overarching” or “end-to-end” transfer that the trustee seeks to avoid, was by, to or for the benefit of a covered entity.  Whether an intermediate or “component” transfer was made by or to a covered entity is “simply irrelevant to the analysis under § 546(e).”[2]  The Court reasoned that, as an express limitation on the trustee’s avoidance powers, § 546(e) must be applied in relation to the trustee’s exercise of those powers with respect to the transfer that the trustee seeks to avoid, not component transfers that the trustee does not seek to avoid.[3]  In the case before it, because the trustee sought to avoid the “end-to-end” transfer from the buyer to the shareholder, and neither was a covered entity, the safe harbor did not apply. The Court Avoids Adjudicating a Potentially Significant Defense The shareholder did not argue in the lower courts that the buyer or the shareholder was a covered entity.  In its briefing in the Supreme Court, the shareholder argued that the buyer and seller were both covered entities because they were customers of the banks that facilitated the transaction, and the definition of “financial institution” in 11 U.S.C. § 101(22)(A) includes a “customer” of a financial institution when the institution “is acting as agent or custodian for a customer.”  During oral argument, Justice Breyer indicated that he might have been receptive to that potentially dispositive argument.  However, the decision expressly avoids adjudicating the argument on the basis that the shareholder raised the point “only in footnotes and did not argue that it somehow dictates the outcome in this case.”  Id. at n. 2.  As a result, the “customer-as-financial-institution defense” will likely be litigated in the lower courts going forward. Impact of Merit Management As a result of Merit Management, parties to securities and commodities transactions should expect that, in the event of a bankruptcy filing, the safe harbor will not protect a transaction unless the transferor, transferee or beneficiary of the “overarching” transfer is a covered entity.  Routing a transfer through a covered entity will no longer protect the transaction.  Given the increased importance placed on whether a party to the overarching transfer is a covered entity, Merit Management may lead to a new wave of litigation regarding the scope of the covered entities, including the circumstances in which the customer of a financial institution constitutes a covered entity, and related planning strategies to fall within such scope.    [1]   See, e.g., In re Quebecor World (USA) Inc., 719 F. 3d 94, 99 (2d Cir. 2013); In re QSI Holdings, Inc., 571 F. 3d 545, 551 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F. 3d 981, 987 (8th Cir. 2009); In re Resorts Int’l, Inc., 181 F. 3d 505, 516 (3d Cir. 1999); In re Kaiser Steel Corp., 952 F. 2d 1230, 1240 (10th Cir. 1991).    [2]   Decision at p. 14.    [3]   See id. at pp. 11-14 (“If a trustee properly identifies an avoidable transfer . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer, as is the case with §546(e). . . .”). Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Oscar Garza – Orange County, CA (+1 949-451-3849, ogarza@gibsondunn.com) Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Douglas G Levin – Orange County, CA (+1 949-451-4196, dlevin@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 1, 2018 |
To Form an Entity or Not to Form an Entity, That Is the Question; Deciding Between an Entity Joint Venture and a Contractual Strategic Alliance

Click for PDF People often speak of forming a joint venture as if the meaning of the term “joint venture” is self-evident.  However, the term “joint venture” can be used to describe a wide array of arrangements between two or more parties.  The universe of these arrangements can be divided into two broad categories: joint ventures that are implemented solely through contractual arrangements, which we refer to as “Contractual JVs,” and those in which the parties jointly own one or more entities, which we refer to as “JV Companies.”  Therefore, one of the first questions that the parties and their counsel should consider when developing the joint venture structure is “Will the joint venture be solely contractual or will the parties each own a stake in one or more legal entities that conduct the joint venture business?” A JV Company Is a Substantial Undertaking Establishing a JV Company offers a number of advantages that may be difficult to achieve through a Contractual JV.  For example, a JV Company may make it easier for the parties to share assets to be used in the venture business, manage liability risks associated with the business and establish a management team that is focused solely on the venture.  But establishing a JV Company may also be significantly more complex than forming a Contractual JV; this complexity may make a JV Company more expensive and burdensome for the venture parties than a Contractual JV. Some of the reasons for the additional complexity include the following: Additional Negotiation and Documentation: In addition to agreeing on the economic terms of the joint venture, the parties have to negotiate and document the governance arrangements of the JV Company, their obligations to make contributions to, and rights to receive distributions from, the JV Company, and the terms and conditions under which a party may exit the joint venture, such as through a transfer of joint venture company equity or a sale of the JV Company. Operational Burdens: Operating a JV Company imposes burdens on the parties that they may not have in connection with a Contractual JV.  Among other requirements, the JV Company may have to obtain required licenses and permits, design and implement internal controls and procedures, produce its own financial statements, maintain its corporate existence and books and records separate from those of the parties and, as noted below, employ a workforce, appoint officers and retain a managing board.  These burdens will increase both the time and expense required to run the joint venture. Governance Issues: Depending on the governance structure of the JV Company, the management decision-making process can also be much more involved than in a Contractual JV.  The parties must develop and implement mutually agreeable governance arrangements, potentially at the board and senior management levels, and each party must devote time to overseeing the venture.  Procedural requirements, for example, requirements for calling and conducting board or member meetings and taking board or member action, must be complied with or waived.  As the number of members of the joint venture with governance rights increases, so does the potential complexity of the JV Company’s governance arrangements as well as the potential for disputes about decisions the board and/or the members must make. Issues Associated with Terminating and Unwinding the Venture:  Terminating a joint venture structured as a JV Company may be more complicated than terminating a Contractual JV.  Unless the JV Company will be sold to a third party, the venture parties must decide what to do with the JV Company itself, how to provide for its liabilities and how any remaining JV Company assets will be distributed among the parties.  For example, will tangible assets be returned to the party that contributed them to the JV Company? Who will receive and/or be entitled to use any JV Company intellectual property? If the venture business will not be continued by one of the parties, they must wind it down and take any related required actions, such as terminating the JV Company’s employees, notifying the JV Company’s creditors, etc. It is important to note that the factors outlined above are generalizations, and this discussion is not intended to suggest that Contractual JVs are inevitably simpler than JV Companies, or that formation and structuring issues arising in connection with Contractual JVs are more easily resolved than those involving JV Companies.  Contractual JVs may present issues and impose burdens on the venture parties similar to those described above.  For example, the various contractual arrangements necessary to manage a complex Contractual JV can look like, and be just as difficult as, governance of a JV Company, with each party appointing representatives to a managing board that oversees the venture business.  Similarly, terminating a Contractual JV can raise issues like those implicated by terminating a JV Company if the parties’ business operations are significantly intertwined. Deciding between a JV Company or a Contractual JV The following list of questions is intended to help potential venture parties evaluate whether a JV Company or a Contractual JV is the best way to achieve their joint venture goals.  It may also help the parties identify areas where they have differing views about the proposed joint venture.  It is neither an exhaustive list nor one that can always be ticked through in a linear fashion as many of these considerations are related and/or address overlapping issues. Scope of the joint venture: Will the joint venture operate a stand-alone, self-sustaining business with many moving parts, such as designing, manufacturing and selling products all over the world, or will it have a simpler purpose, such as supplying a particular product or service to one of the parties?  Will the venture business be large in scope, or relatively small? The more complicated and expansive the enterprise, the more likely it is that a JV Company structure will be appropriate.  The simpler the purpose of the joint venture, the more likely it is that it can be structured as a Contractual JV. Need for significant investment:  Will the joint venture require significant capital expenditures or investment to be funded by contributions from both parties, for example, to conduct research, build facilities or purchase equipment?  If yes, it may make sense for a JV Company to own the assets that are created with this investment. New line of business, products or markets:  Do the parties plan to pool their respective resources and/or combine complementary assets to develop a new business (i.e., one that no party currently engages in)?  As was discussed above in “Need for Significant Investment,” if joint efforts are required to create a new business, it may make sense to establish a JV Company through which the parties can jointly own the venture business. Role of the parties:  Do both parties expect to have significant input into management decisions regarding the joint venture business?  If yes, it may be easier for the parties to provide such input if the venture business is run by a JV Company, rather than by one of the parties in a Contractual JV. Need for dedicated management team:  Will the venture business be sufficiently complex that it should be managed by a separate team focused only on the venture business, rather than by managers who are juggling responsibilities to the joint venture and one of the parties?  Will the joint venture benefit from a separate compensation structure tied to performance of the venture business to incentivize the management team?  If the answer to either question is yes, then this would support a decision to establish a JV Company. Need for separate employee base:  Will the joint venture need employees who are focused solely on the venture business?  Or can the venture business be run just as, or more, efficiently by employees of one or more parties?  If the former, this fact would support establishing a JV Company.  If the parties are contemplating transferring employees to the JV Company, they should also consider the willingness of their employees to work for the JV Company.  Employees may be reluctant to leave an established company to work for an unproven one. Intellectual property considerations:  Will the joint venture develop intellectual property to be used primarily in its business, such as new product designs or trademarks, and/or will the parties contribute certain existing intellectual property to the joint venture?  If yes, the parties may wish to form a JV Company to control these intellectual property assets, maintain applicable intellectual property registrations and otherwise protect the joint venture’s intellectual property rights.  However, a JV Company may not be required if new intellectual property is not needed for the joint venture business, or if the intellectual property to be used in the joint venture will be owned and controlled solely by one party. Liability concerns:  Will the joint venture business generate significant liability risk?  If yes, the parties may want to own the business through a JV Company to help develop a liability shield. Foreign law concerns: Will the joint venture operate in a jurisdiction that curtails foreigners’ rights to conduct certain businesses or own property?  For example, Canada restricts the ability of non-Canadians to own and control Canadian telecommunications carriers.  China limits the percentages of businesses in the financial sector, such as banks, securities firms and insurers, that foreigners may own.  If such restrictions will prevent one of the parties from owning the venture business, a Contractual JV may be the more attractive option. Ability to transfer assets to the venture:   If the venture business requires the use of assets owned by the parties, can these be transferred easily?  If there are encumbrances preventing the transfer of these assets, such as pledges to creditors, a Contractual JV may be a better choice. Regulatory issues:  Is the venture business in a highly regulated industry?  Does it require licenses that cannot be transferred, specialized employees and/or substantial infrastructure designed to ensure compliance with applicable laws?  If yes, and one of the parties already has such licenses, employees and/or infrastructure, it may be desirable for that party to continue to run the business, rather than transfer it to a new company. Strategic objectives:  What are the parties’ respective strategic objectives?  Does the venture represent an opportunity for one party to learn about a new business?  Or for a party to gain access to new funding, technology or markets?  In some cases, it may be easier for a party to achieve a strategic goal if a JV Company is established.    For example, let’s assume that the venture will be the sole supplier of raw materials to one of the parties.  That party may want the venture business to be contributed to a JV Company so the party can exercise more control over the business and have the option to buy out the other party in the event of any dispute between them.  Another example is an arrangement under which one party will adapt technology developed by the second party for use in the first party’s business.  In this context, it may make sense for the first party and the second party to form a JV Company, because joint ownership of the enterprise may make it easier for the first party to learn about the technology and control its commercialization. Term of the joint venture:  Do the parties expect the joint venture to have an extended or indefinite life?  Or is the venture being formed to take advantage of a short-term opportunity?  If the joint venture is expected to have an extended life, a JV Company may be the better choice. Exit plans:  Do the parties have a specific plan for how they will exit or terminate the joint venture?  For example, do they envision growing the venture business for several years and then selling it to a third party or taking the business public?  Is one party hoping that it can eventually buy out the other party’s interest?  Is the other party hoping that it can exit the business after participating in the joint venture for a period of time?  In these circumstances, it may be easier to develop exit plans if the parties establish a JV Company. Tax Considerations Tax planning is a critical element of venture planning, and parties would be well-advised to involve tax counsel as early as possible in the venture planning process.  Parties that form a Contractual JV should be aware of the risk that a Contractual JV may be treated as a separate entity for federal income tax purposes.  Generally, an arrangement under which the participants jointly conduct a business and share profits and losses will be treated as a partnership under the Internal Revenue Code.  (If a Contractual JV is such an arrangement, the parties can elect to treat the arrangement, i.e., the Contractual JV, as a corporation instead of a partnership for federal income tax purposes.)  Factors that courts consider when evaluating whether a Contractual JV is a partnership for federal income tax purposes include, among others, each party’s contributions to the venture, who controls income and withdrawals, if the venture is conducted in the joint names of the parties and if the parties have mutual control over the venture.  Significantly, if a Contractual JV is treated as a separate entity for federal income tax purposes, there is also a risk that a party’s activities that the parties do not consider to be part of the venture are nonetheless treated as part of the Contractual JV for federal income tax purposes.  These risks may result in unintended tax consequences.  In contrast, forming a JV Company provides certainty about what activities will be treated as part of the venture, and such certainty will make tax planning easier. By bringing more certainty to the taxation of the venture, the creation of a JV Company may also offer more opportunities for tax planning than a Contractual JV.  This is particularly the case in the cross-border context; if the venture will involve operations in multiple countries, it may be advisable to form multiple local-country entities to manage their tax liability.  Moreover, recent changes to the tax law, particularly those changes impacting the taxation of non-US income earned by US taxpayers, require particular attention.  Conclusion The decision whether to establish a JV Company or a Contractual JV is not always easily made.  There is no formula that can be applied to produce the right result.  Although the answers to the questions posed above do not invariably dictate whether a JV Company or a Contractual JV will be the best structure, they may provide valuable insight.  In some instances, one approach will have clear advantages over the other.  However, in most situations, the parties will be able to be accomplish their objectives through either a JV Company or a Contractual JV.  In these cases, the parties must balance a number of potentially competing considerations, and then make a judgment call. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert: Stephen I. Glover – Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com) Alisa Babitz – Washington, D.C. (+1 202-887-3720, ababitz@gibsondunn.com) Please also feel free to contact any of the following practice group leaders: Mergers and Acquisitions Group: Barbara L. Becker – New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Private Equity Group: Sean P. Griffiths – New York (+1 212-351-3872, sgriffiths@gibsondunn.com) Steven R. Shoemate – New York (+1 212-351-3879, sshoemate@gibsondunn.com) Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com) Charlie Geffen – London (+44 (0)20 7071 4225, cgeffen@gibsondunn.com) Scott Jalowayski – Hong Kong (+852 2214 3727, sjalowayski@gibsondunn.com) Tax Group: Art Pasternak Washington, D.C. (+1 202-955-8582, apasternak@gibsondunn.com) Jeffrey M. Trinklein – London/New York (+44 (0)20 7071 4224/+1 212-351-2344), jtrinklein@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 14, 2018 |
Compliance Reminders for Private Fund Advisers – 2018

Click for PDF Private fund advisers are subject to a number of regulatory reporting requirements and other compliance obligations, many of which need to be completed on an annual basis.  This Client Alert provides a brief overview. 1.         Regulatory Filing Obligations under the Advisers Act A private fund adviser that is either a registered investment adviser (“RIA“) or an exempt reporting adviser (“ERA“) under the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act“), must comply with a number of regulatory reporting obligations.  Chief among these is the obligation to update the adviser’s Form ADV and Form PF filings with the SEC on an annual basis.  The following is a brief summary of those filing obligations and the applicable deadlines (assuming a fiscal year end of December 31, 2017): Form ADV Annual Update (3/31/2018 deadline).  Each RIA and ERA has an ongoing obligation to update the information provided in its Form ADV no less frequently than annually.  This annual update must be filed within 90 days of the end of the adviser’s fiscal year.  An RIA must update the information provided in both the “check the box” portion of its Form ADV (Part 1A) and in its “disclosure brochure” (Part 2A).  An ERA is only required to update the information reported in its abbreviated Part 1A filing.  This year, most private fund advisers will be filing for the first time on the amended Part 1A that went into effect on October 1, 2017.[1]  We strongly recommend that each private fund adviser build extra time into its annual Form ADV updating process for this year in order to assess and address any changes to its reporting obligations.All such updates must be filed with the SEC electronically through IARD.  To avoid last minute delays, we recommend that each RIA and ERA check its IARD account early to ensure that its security access codes are up-to-date and that it has sufficient funds in its IARD account to cover all Federal and state filing fees. Each RIA is also required to update the information provided in its “supplemental brochures” (Part 2B) no less frequently than annually.[2]  Although an RIA is not required to publicly file its supplemental brochures with the SEC, up-to-date supplemental brochures must be kept on file at the RIA’s offices. Disclosure Brochure Delivery (4/30/2018 deadline).  An RIA is also required to deliver an updated version of its Part 2A disclosure brochure to all clients within 120 days of the end of its fiscal year.[3]  An RIA may comply with this requirement either by mailing a complete copy of its updated brochure to its clients or by sending a letter providing a summary of any material changes that have been made to the brochure since its last annual update and offering to provide a complete copy of the updated brochure upon request free of charge.[4] Forms PF and CPO-PQR (4/30/2018 deadline).  An RIA with regulatory assets under management attributable to private funds exceeding $150 million is required to provide a report on Form PF to the SEC regarding its private funds’ investment activities.  For most private fund advisers, the Form PF is required to be filed once a year within 120 days of the end of the RIA’s fiscal year.  However, a private fund adviser with assets under management exceeding certain thresholds may be required to file more frequently and/or on shorter deadlines.[5]  In addition, the information that such a large private fund adviser must provide to the SEC is significantly more extensive.An RIA that is also registered under the Commodity Exchange Act (“CEA“) as a Commodity Pool Operator (“CPO“) or Commodity Trading Adviser (“CTA“) should consider its reporting obligations under Form CPO-PQR, a Commodity Futures Trading Commission (“CFTC“) form that serves the same purpose as, and requires the reporting of similar types of information to, Form PF.  In theory, a dual registrant may comply with its reporting obligations under both the Advisers Act and the CEA by filing a single Form PF.  However, the CFTC still requires certain information to be provided in a Form CPO-PQR filing in order to take advantage of this feature. 2.         Annual Compliance Program Review Rule 206(4)-7 under the Advisers Act (the “Compliance Program Rule“) requires an RIA (but not an ERA) to review no less frequently than annually the adequacy of its compliance policies and procedures and the effectiveness of their implementation.  Although the Compliance Program Rule does not require that these reviews be in writing, the SEC’s examination staff has a clear expectation that an RIA will document its review.  SEC examiners routinely request copies of an RIA’s annual compliance program review reports as part of the examination process. Producing an annual compliance program review report need not be overly burdensome.  Although an RIA may consider engaging a third party to conduct a comprehensive audit of the firm’s compliance program from time to time, under normal circumstances an RIA can take a more risk-based approach to the process.  For example, an RIA might build a review around the following three themes where potential compliance risks may be most acute: Compliance policies and procedures that may be affected by changes in the RIA’s business or business practices since the last review was conducted; Any areas where SEC examiners have identified deficiencies or where the firm has experienced compliance challenges; and Any changes in applicable law, regulation, interpretive guidance or regulatory priorities. In addition, a CCO should document in the annual review report any incremental improvements that have been made to the firm’s compliance program throughout the year, not just as part of a formal annual review process. 3.         Notable Regulatory Developments  The following is a brief summary of the more notable regulatory developments for 2017 that a private fund adviser may want to consider when conducting its annual compliance program review: Fees and Expenses.  The SEC continues to focus on industry practices concerning the collection of non-investment advisory fees from portfolio companies and on the allocation of certain of the adviser’s expenses to funds.  This past year, in continuation of a line of enforcement actions against private fund advisers dating back to 2015, the SEC’s Enforcement Division settled several enforcement actions against private equity firms in which violations of fiduciary duties were found with respect to the collection of non-advisory fees and/or the allocation of expenses.[6]  Examples of the types of practices that could trigger SEC scrutiny (particularly if not the subject of clear prior disclosure and/or a contractual basis in the applicable fund governing documents) include: re-characterizing non-investment advisory fee revenue in a manner intended to avoid triggering management fee offsets; charging accelerated monitoring or similar fees to portfolio companies; allocating expenses related to the adviser’s overhead and/or back-office services to its funds; allocating broken deal expenses to funds without allocating a portion of those expenses to other potential co-investors (especially affiliated co-investors); and negotiating discounts on service provider fees for work performed on behalf of the adviser without also making the benefit of those discounts available to the adviser’s funds. We continue to encourage private fund advisers to review their financial controls with respect to fee collection, management fee offsets and expense allocation to ensure that their practices are consistent with their funds’ governing documents (including any disclosure documents) and in line with SEC expectations.  We also encourage private fund advisers to periodically review their policies regarding fee collection and expense allocation practices to make sure that they are up-to-date and comprehensive. Cybersecurity.  The SEC continues to make cybersecurity a high priority for the entire financial services industry.  In the past three years, OCIE has published five “Risk Alerts” relating to cybersecurity and identified cybersecurity as one of its examination priorities in 2015, 2016, 2017 and 2018.[7]  In addition, the SEC’s Division of Enforcement has formed a “CyberUnit” to focus on combatting cyber-related threats.  In light of this regulatory focus, we recommend that each private fund adviser review its information security policies and practices thoroughly and implement enhancements to address any identified gaps promptly. Custody Rule.  One two occasions in February 2017, the staff of the SEC’s Division of Investment Management issued interpretive guidance on Rule 206(4)-2 under the Advisers Act (the “Custody Rule“). In a no-action letter, the staff was asked to affirm that an adviser did not have custody under the Custody Rule in circumstances where an investment adviser was authorized to instruct a custodian to transfer client funds to a designated third party account pursuant a standing letter of instruction from the client to both the adviser and the custodian.  The staff refused, stating that “an investment adviser with power to dispose of client funds or securities for any purpose other than authorized trading” has access to the client’s assets and is therefore subject to the Custody Rule.  However, the staff did grant relief from the surprise audit requirements under the Custody Rule in circumstances where a standing letter of instruction meeting certain conditions is in place.[8] In a separate “IM Guidance Update,” the staff also cautioned investment advisers that, even in circumstances where the adviser’s investment management agreement with a client prohibits the adviser from gaining access to the client’s assets, the adviser may still “inadvertently” be subject to the requirements of the Custody Rule in circumstances where the client’s custodian agreement purports to grant the adviser broader access to the client’s assets.[9] Together, both interpretations demonstrate that the SEC continues to take a broad view of what constitutes “custody” under the Custody Rule.  Advisers may wish to review their custody arrangements in view of this interpretive guidance to ensure that they are in strict compliance with the Custody Rule. OCIE “Frequent Findings” Reports.  OCIE issued two Risk Alerts in 2017 in which it summarized the most frequent findings from its compliance examinations of investment advisers.  The first report focused on OCIE’s exam findings generally and identified the following topics as the five most frequently cited deficiencies:   failure to adopt or implement adequate compliance policies and procedures in accordance with Compliance Program Rule or to perform adequate annual reviews of such compliance policies and procedures; failure to submit accurate or timely regulatory filings; failure to comply with the Custody Rule; failure to comply with Rule 204-1 under the Advisers Act (the “Code of Ethics Rule“); and failure to maintain proper books and records in compliance with Rule 204-2 under the Advisers Act (the “Books and Records Rule“).[10] The second report focused more specifically on OCIE’s findings with respect to investment adviser advertising practices, and identified a number of topics as frequently cited deficiencies, including the use of misleading performance results, misleading one-on-one representations, misleading claims of compliance with voluntary performance standards, cherry-picked profitable stock selections, misleading selection of recommendations, and inadequate compliance policies and procedures.  The staff also identified several common deficiencies as a result of its “touting initiative” focusing on the use of “accolades” in advertising materials, including the misleading use of third-party rankings or awards, and the misleading use of professional designations and testimonials.[11] Other Conflicts.  Finally, private fund advisers should remain vigilant for any other practices or circumstances that could present actual or potential conflicts of interest.  Several recent enforcement actions serve to emphasize the SEC’s view that the failure to properly address and disclose potential conflicts of interest is a breach of an investment adviser’s fiduciary duties under the Advisers Act, even in the absence of clear harm to investors.[12]   4.         Compliance Program Maintenance Each private fund adviser should (and in some cases must) perform certain annual maintenance tasks with respect to its compliance program.  The following is a list of mandatory and recommended tasks that should be completed: Code of Ethics Acknowledgements.  Each RIA is required under the Code of Ethics Rule to obtain a written acknowledgement from each of its “access persons” that such person has received a copy of the firm’s Code of Ethics and any amendments thereto.  As a matter of best practice, many RIAs request such acknowledgements on an annual basis.  In addition, each access person must provide an annual “securities holdings report” at least once every 12 months and quarterly “securities transactions reports” within 30 days of the end of each calendar quarter.  We recommend that each RIA review its records to ensure that each of its access persons has complied with these acknowledgement and personal securities reporting requirements, as the failure to maintain such documentation is a frequent deficiency identified by the SEC’s examiners.[13] Custody Rule Audits.  Compliance with the Custody Rule generally requires a private fund adviser to prepare annual audited financial statements in accordance with US GAAP for each of its private funds and to deliver such financial statements to each fund’s investors within 120 days of the fund’s fiscal year end (180 days in the case of a fund-of-funds). Disclosure Documents/ Side Letter Certifications.  In addition to the updates to an RIA’s disclosure and supplemental brochures on Form ADV Parts 2A and 2B discussed above, private fund advisers whose funds are continuously raising new capital (e.g., hedge funds) should review the offering documents for their funds to ensure that the disclosure in these documents is up-to-date.  A private fund adviser should also check to see that it has complied with all reporting, certification or other obligations it may have under its side letters with investors. Privacy Notice.  An investment adviser whose business is subject to the requirements of Regulation S-P (e.g., because it maintains records containing “nonpublic personal information” with respect to “consumers”) is required to send privacy notices to its “customers” on an annual basis.  As a matter of best practice, most private fund advisers simply send privacy notices to all of their clients and investors, often at the same time they distribute the annual updates to their disclosure brochures on Form ADV (see above).  We recommend that each adviser review its privacy notice for any updates to reflect changes in its business practices and for compliance with the applicable safe harbor provided in Regulation S-P. Political Contributions.  For a firm whose current or potential investor base includes state or local government entities (e.g., state or municipal employee retirement plans or public universities), we recommend that the political contributions of any of the firm’s “covered associates” be reviewed for any potential compliance issues under Advisers Act Rule 206(4)-5 (the “Pay-to-Play” rule). 5.         Other Potential Compliance Obligations Depending on the scope and nature of a private fund adviser’s business, numerous other regulatory reporting requirements and other compliance obligations may apply.  For example: Rule 506(d) Bad Actor Questionnaires.  For a private fund adviser whose funds are either continuously raising capital (e.g., hedge funds), or where the firm anticipates raising capital in the next twelve months, we recommend that the firm ensure that it has up-to-date “Bad Actor Questionnaires” under Regulation D Rule 506(d) on file for each of its directors, executive officers and any other personnel that are or may be involved in such capital raising efforts.  Firms that are or are contemplating engaging in general solicitations under Rule 506(c) of Regulation D should also review their subscription procedures to ensure that they are in compliance with the enhanced accredited investor verification standards required under that Rule. ERISA.  Funds that are not intended to constitute ERISA “plan assets” (e.g., because the fund is a “venture capital operating company” or because “benefit plan investors” own less than 25% of each class of equity of the fund) are typically required to certify non-plan asset status to their ERISA investors annually.  Thus, a private fund adviser should confirm that its funds have continued to qualify for a plan asset exception and prepare the required certifications.  In addition, investment advisers to funds that are ERISA plan assets sometimes agree to prepare an annual Form 5500 for the fund as a “direct filing entity.”  This approach allows underlying ERISA plan investors to rely on this Form 5500 with respect to the investment and have more limited auditing procedures for their own Forms 5500.  If this approach is used, Form 5500 is due 9-1/2 months after year-end (i.e., October 15 for calendar year filers).  Alternatively, if the fund does not itself file a Form 5500, it will need to provide ERISA investors the information they need to complete their own Forms 5500. CFTC Considerations.  A private fund adviser that is registered as either a CPO or a CTA, or which relies on certain exemptions from registration as a CPO or CTA, is subject to certain annual updating and/or reaffirmation filing requirements under the CEA and the rules adopted by the CFTC thereunder. Exempt Advisers.  Many advisers and general partners of private funds that trade in a de minimis amount of commodity interests (i.e., futures, options on futures, options on commodities, retail forex transaction, swaps) are not required to register under the CEA as a CPO, but need to qualify for, and rely on, an exemption from CPO registration.  CFTC Regulation 4.13(a)(3) provides an exemption for advisers and general partners of private funds that engage in a de minimis amount of commodity interests (the “De Minimis Exemption“) pursuant to a test found in that regulation.  Other exemptions from registration as a CPO or a CTA may be available to advisers or general partners of private funds.  An adviser or general partner must claim an exemption from CPO registration with respect to each fund that invests in commodity interests by filing an initial exemption through the National Futures Association (“NFA“) website and must reaffirm its exemption filing within 60 days after the end of each calendar year or else the exemption will be deemed to be withdrawn. Registered CPOs and CTAs.  If a private fund does not qualify for the De Minimis Exemption or another exemption, the adviser or general partner of that private fund may be required to register with the CFTC as a CPO or a CTA, resulting in annual fees, disclosure, recordkeeping and reporting requirements.  Notably, a registered CPO must file an annual report with respect to each relevant commodity pool that it operates and update disclosures to investors (unless a limited exemption under CFTC Regulation 4.7 applies).  A registered CPO should also consider reporting obligations under Form CPO-PQR, which would need to be filed with the NFA within 60 days of the end of each calendar quarter (depending on AUM).  Similarly, registered CTAs must consider reporting obligations under Form CTA-PR, which must be filed with the NFA within 45 days after the end of each calendar quarter.  If a manager or general partner is dually-registered as both a CPO and a CTA, it must complete Form CTA-PR and Form CPO-PR with respect to the relevant private funds. Other Considerations – Clearing, Trading and Uncleared Margin.  Regardless of whether an adviser or general partner claims an exemption from CPO registration with respect to a private fund, the simple fact that the private fund invests in commodity interests makes the private fund a “commodity pool” and the adviser and general partner CPOs (even if they are exempt from registration).  The designation as a commodity pool has some practical implications for private funds as commodity pools are considered “financial entities” under Section 2(h)(7)(C)(i) of the CEA and are therefore subject to mandatory clearing, trade execution and margin requirements with respect to their swaps activities.  Notably, rules requiring commodity pools to exchange variation margin for uncleared swaps came into force on March 1, 2017. Exchange Act Reporting Obligations.  A private fund adviser that invests in “NMS securities” (i.e., exchange-listed securities and standardized options) is reminded that such holdings may trigger various reporting obligations under the Securities Exchange Act of 1934 (the “Exchange Act“). For example: Schedules 13D & 13G.  An investment adviser that exercises investment or voting power over more than 5% of any class of a public company’s outstanding equity securities must file a holdings report on Schedule 13G if it qualifies as a passive institutional investor.[14]  Schedule 13G filings must be made within 45 days of the end of the calendar year and within 10 days after the end of any calendar month in which the adviser’s holdings in the applicable equity security exceeds 10%.  A Schedule 13G filer is also required to file an amended report on Schedule 13G within 10 days after the end of any calendar month in which its holdings in an NMS security exceeded 10% and within 10 days after the end of any calendar month after that in which such holdings changes by more than 5%.  An investment adviser that does not qualify as a passive institutional investor must file a report on Schedule 13D within 10 days of acquiring more than 5% of any class of an issuer’s outstanding equity securities and “promptly” (typically within 24 hours) after any material change in the information provided in the Schedule 13D (including any change in such adviser’s holdings of more than 1% or a change in the adviser’s investment intent with respect to such holdings). Form 13F.  An institutional investment adviser who exercises investment discretion over accounts holding publicly-traded equity securities[15] having an aggregate fair market value in excess of $100 million on the last trading day of any month in a calendar year must report such holdings to the SEC on Form 13F within 45 days after the end of such calendar year and within 45 days after the end of each of the first three calendar quarters of the subsequent calendar year. Form 13H.  A private fund adviser whose trading activity in NMS securities exceeds certain “large trader” thresholds[16] is required to file a report on Form 13H “promptly” (within 10 days) after exceeding the threshold.  In addition, such filings must be amended within 45 days after the end of each calendar year and promptly after the end of each calendar quarter if any of the information in the Form 13H becomes inaccurate. Section 16.  A private fund adviser that holds a greater than 10% voting position in a public company or whose personnel sit on the board of directors of a public company may also have reporting obligations under Section 16 of the Exchange Act and be subject to that Section’s restrictions on “short swing profits.” Regulation D and Blue Sky Renewal Filings.  A private fund that engages in a private offering lasting more than one year may be subject to annual renewal filing requirements under Regulation D and/or State blue sky laws. State Pay-to-Play and Lobbyist Registration Laws.  A private fund adviser that is soliciting state or local government entities for business may be subject to registration and reporting obligations under applicable lobbyist registration or similar state or municipal statutes in the jurisdictions where the adviser is engaged in such activities. Cross-Border Transaction Reporting Requirements.   A private fund adviser that engages in cross-border transactions or which has non-US investors in its funds may be subject to various reporting requirements under the Department of Treasury’s International Capital System (“TIC“) or the Bureau of Economic Analysis’ (“BEA“) direct investment survey program.  In general, investments that take the form of investments in portfolio securities are subject to TIC reporting requirements, while investments that take the form of direct investments in operating companies are subject to the BEA’s reporting requirements. A direct investment is generally defined by the BEA as an investment that involves a greater than 10% voting interest in an operating company.  For purposes of applying this definition, general partners are the only entities considered to have a voting interest in a limited partnership.  Limited partner interests are not considered voting securities.  The BEA’s reporting requirements apply to any direct investment that exceeds $3 million in size (whether by a US investor overseas or by a non-US investor in the US), even if the BEA has not provided notice to the applicable investor that a reporting obligation applies.  Which BEA Form applies, and the extent of the reporting person’s reporting requirements, depends on the size and nature of the direct investment.  This year, the BEA will conduct a 5-year “benchmarking survey” of all foreign direct investment into the United States.  As of the date of this Client Alert, the BEA had not yet published the version of Form BE-12 that it will use to conduct the survey, but a private fund adviser that is either domiciled outside the U.S. or that makes direct investments into the U.S. through offshore funds should keep track of developments in this area. In general, any cross-border investment (whether by an investor in a fund or by a fund in a portfolio security) that does not meet the BEA’s definition of a direct investment is reportable under TIC.  Again, the form to be used and the frequency and scope of the reporting obligation depends on the size and nature of the investment.  In general, however, unless an investor receives written notice from the Federal Reserve Bank of New York to the contrary, an investor is only required to participate in the TIC’s “benchmark surveys”, which are conducted once every five years.[17]  In addition, the reporting requirement generally falls on the first (or last) US financial institution in the chain of ownership at the US border, which means that in many cases for private fund advisers, the actual reporting obligations applies to the fund’s custodian bank or prime broker, and not to the private fund adviser itself. European Regulatory Reporting Requirements.  Private fund advisers that are either registered as alternative investment fund managers (“AIFMs“) or authorized to manage or market alternative investment funds (“AIFs“) in the European Economic Area (“EEA“) are required to regularly report information (referred to as transparency information) to the relevant regulator in each EEA jurisdiction in which they are so registered or authorized (“Annex IV Reports“).  The process of registering to market an AIF is not consistent across jurisdictions.  Registration of some type (which can range from mere notice to a formal filing-review-approval process lasting many months) is generally necessary before any marketing of the AIF may take place. Once registered, the AIFM must begin making Annex IV Reports in each relevant jurisdiction.  The transparency information required by the Annex IV Reports concerns the AIFM and the AIFs it is managing or marketing in the EEA.  The AIFM must provide extensive details about the principal markets and instruments in which it trades on behalf of the AIFs it manages or markets in the EEA, as well as a thoughtful discussion of various risk profiles.  Preparing Annex IV Reports, therefore, can be a challenging exercise.  Further, while Annex IV Reports are conceptually analogous across jurisdictions, the precise reporting requirements imposed by each regulator differ. The reporting frequency will depend on the type and amount of assets under management of the AIFM, as well as the extent of leverage involved, but will be yearly, half-yearly, or quarterly. The reports must be filed within one month of the end of the annual (December 31st), half yearly (June 30th and December 31st) or quarterly (March 31st, June 30th, September 30th and December 31st) reporting periods, as applicable.  Furthermore, AIFMD requires the AIF to prepare annual reports for its European investors, covering a range of specified information. We generally recommend that firms assess reporting requirements on an on-going basis in accordance with any changes to assets under management, and in consultation with reliable local counsel. As well as requiring the submission of Annex IV reports, AIFMD also imposes other requirements on AIFMs for information to be given to investors and regulators on an on-going basis (including in relation to the acquisition of control of EU companies by the AIF).  Consequently, we have seen an increase in the number of firms choosing to adopt a “rent-an-AIFM” approach, effectively outsourcing the compliance function to a local service vendor.  This removes the need to continually monitor shifts in local regulations, but not the need to do the internal collection and analysis of investment data required to complete the filings. EU General Data Protection Regulation.  The European Union General Data Protection Regulation (“GDPR”) is a replacement for the current Data Protection Directive in the EU.  Notably, the scope of the GDPR has been broadened and now extends to data controllers and processors outside the EU whose processing activities relate to the offering of goods or services (even if for free) to, or monitoring the behavior of, data subjects within the EU.  Non-EU funds that are subject to the GDPR may be required to appoint an EU-based representative in connection with their GDPR obligations. The GDPR makes existing data protection obligations more onerous, and introduces a raft of new obligations. For example, the GDPR expands the information that must be provided to data subjects about how their data is processed, and introduces more stringent consent requirements.  In addition, the GDPR places onerous accountability obligations on data controllers and data processors to demonstrate compliance with the GDPR.  This includes requiring them to appoint data protection officers in certain instances and: (i) maintain and develop records of processing activities, (ii) conduct a data protection impact assessment (this applies only to data controllers), prior to data processing that is inherently “high risk” (e.g. a systematic monitoring of a publicly accessible area on a large scale), and (iii) implement data protection, including by not repurposing data (subject to limited exceptions, including consent) and through data minimization (which refers to the principle that personal data must be adequate, relevant and limited to what is necessary in relation to the purposes for which it is processed). Breaching the GDPR carries serious reputational and financial risk. A range of sanctions may be imposed for non-compliance, including fines of up to the greater of EUR 20,000,000 or 4% of total worldwide annual revenue for the preceding financial year, whichever is higher.[18] The Markets in Financial Instruments Directive II (“MiFID II”).  MiFID II came into force on January 3, 2018.  The impact of MiFID II on a firm will depend upon the relevant firm’s regulatory classification.  The MiFID II framework will continue to apply directly to EU discretionary portfolio managers conducting MiFID activities (“MiFID AIFMs“), but has now been extended to apply directly to management companies of undertakings for the collective investment in transferable securities (“UCITS“) and EU AIFMs which manage separate discretionary accounts.  MiFID II also harmonizes the EU’s regulatory approach to non-EU investment firms by introducing a passport regime for the provision of services to eligible counterparties and professional clients in the EU.  In order for a country to be eligible for a third country passport, the EU Commission will have to assess whether the relevant firm is subject to equivalent supervision in its home jurisdiction.  A MiFID third country passport may offer UK firms currently passporting their services to other EU countries under MiFID access to EU markets post-Brexit. MiFID AIFMs have needed to update their systems, controls, policies and procedures to address the following regulatory changes introduced by MiFID II: Best execution:  MiFID II has raised the best execution standard from an obligation to take “all reasonable steps” to an obligation to take “all sufficient steps consistently”, to achieve the best possible result for the customer. In addition, firms are now subject to more onerous disclosure obligations regarding best execution (including a requirement to publish annually information relating to the firm’s top five execution venues (including brokers, regulated markets, multi-lateral trading facilities and organized trading facilities) by volume, and on the execution quality provided by each (by reference to each different class of instrument). Client Categorization:  As a result of mis-selling concerns connected to the sale of complex products to local government authorities, under MiFID II firms are no longer permitted to treat such investors as eligible counterparties or as per se professional clients.  Under MiFID II, local authorities are now automatically deemed to be retail clients, with the ability to request an “opt-up” process in order to become elective professional clients.  If local authorities are unable to satisfy the opt-up criteria, firms will need to assess whether their existing permissions allow them to continue providing services to such entities or if additional retail permissions are necessary. Inducements and Investment Research:  MiFID II imposes additional restrictions affecting how discretionary investment managers may pay for research. Under MiFID II, firms carrying out MiFID business comprising portfolio management are restricted from how they may accept fees, commissions, or any monetary or non-monetary benefits paid or provided by a third party (e.g. research from an investment bank) in relation to the provision of services to clients.  Such firms may, nonetheless, continue to receive third party research without contravening the inducements rules, provided that they pay for research either directly from their own resources or from a separate research payment account controlled by the firm but charged to its clients (the latter will need to satisfy a number of requirements, including as to transparency). Product Governance:  A new regime has been introduced which imposes requirements on firms that manufacture and distribute financial instruments to act in the clients’ best interests during the lifecycle of the relevant products (for PE firms, the product is the fund itself).  The granular rules include requirements to ensure the clear identification of a target market, the review of existing products and their suitability for the target market, and review the risks for new products. Scope of Transaction Reporting Rules:  Prior to MiFID II, MiFID’s reporting rules applied to financial instruments admitted to trading on EU regulated markets and assets that derive their value from such investments (e.g. OTC derivatives). MiFID II extends the scope of the transaction reporting requirements to all financial instruments traded, or admitted to trading, on EU trading venues (this will expand the reporting regime to cover instruments traded on, inter alia, multi-lateral trading facilities and organized trading facilities). This is aimed at providing greater  transparency and ensuring that the MiFID II reporting requirements mirror the scope of the Market Abuse Directive. Telephone Recording:  Prior to MiFID II, the majority of private equity firms were exempt from the requirements to record calls and other electronic communications, under an exemption for discretionary managers. However, this exemption has now been removed and recording requirements under MiFID II apply to all communications that relate to activities such as arranging deals in investments, dealing in investments as agents, managing investments and in certain circumstances, managing AIFs.  The requirements cover communications that were intended to result in a transaction, even if the communication does not, in fact, result in a transaction.  Telephone recording is required to be carried out on a best endeavors basis and the recordings must be retained for 5 years.  UK Exemptions for Non-MiFID AIFMs.  In the UK the Financial Conduct Authority (“FCA”) has granted a number of exemptions from the above requirements to AIFMs that are not MiFID AIFMs.  For example: the scope of the Telephone Recording obligations is limited to activities which involve financial instruments being traded on a trading venue or for which a request for admission has been made; the Inducements and Investment Research obligations do not apply to an AIF or collective investment scheme, which generally invests in issuers or non-listed companies in order to acquire control over such companies; and the Best Execution obligations do not apply, but AIFMs that are not MiFID AIFMs will nonetheless still need to comply with the best execution rules under the AIFMD Level 2 Regulations. However, it is also worth noting that these exemptions will not be available if and when an AIFM is carrying on MiFID business. In practice, our experience has been that firms managing collective funds and segregated accounts have chosen to apply common standards across their MiFID and non-MiFID business activities. Tax.  Depending on the structure and nature of a private fund adviser’s investment activities and/or client base, certain tax filings or tax compliance procedures may need to be undertaken.  Examples include: Investments by U.S. persons in non-U.S. entities may need to be disclosed on IRS Form 5471 (ownership in non-U.S. corporation), IRS Form 8865 (ownership in non-U.S. partnership) and IRS Form 8858 (ownership in non-U.S. disregarded entity), which forms are required to be filed together with such U.S. persons’ annual U.S. federal income tax returns. Investments by non-U.S. persons in U.S. entities may need to be disclosed on IRS Form 5472 (25% ownership in a U.S. corporation).  For tax years beginning on or after January 1, 2017, a U.S. disregarded entity that is wholly owned by a non-U.S. person is treated as a U.S. corporation for purposes of determining any reporting obligations on IRS Form 5472. Transfer of property by a U.S. person to a foreign corporation may require the U.S. person to file an IRS Form 926. Ownership of interests in or signature authority over non-U.S. bank accounts and similar investments, may need to be disclosed under foreign bank and financial accounts reporting regime (FBAR) on Form FinCEN 114, the due date of which has been moved to April 15th for initial filings, with an automatic extension available to October 15th. Managers may need to report the existence of certain accounts to the U.S. IRS or their local jurisdiction under FATCA or the OECD Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard. Managers should be aware that IRS Forms W-8 provided by non-U.S. investors generally expire after three years from the execution date of the form and they may need to collect updated IRS Forms W-8 from their non-U.S. investors. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.   [1]   See Significant Amendments to Form ADV go into Effect on October 1, 2017, Gibson Dunn Client Alert (Sept. 25, 2017) https://www.gibsondunn.com/significant-amendments-to-form-adv-go-into-effect-on-october-1-2017/.  The most significant changes to Form ADV include the formalization of the SEC’s practice of permitting so-called umbrella registration of multiple private fund advisers operating as a single firm and the expansion of reporting requirements for advisers of separately managed accounts.   [2]   An RIA is required to prepare a supplemental brochure for each supervised person that (i) formulates investment advice for and has direct contact with a client, or (ii) has discretionary investment power over client assets (even if such person does not have direct client contact).  As a practical matter, most private fund advisers prepare supplemental brochures for each member of their investment committees and/or each of their portfolio managers.   [3]   As a technical matter, investors in a private fund are not considered “clients” of the fund’s investment adviser.  As a matter of best practice, however, most private fund advisers make updated copies of their disclosure brochures available to the investors in their funds.   [4]   Such letters must also provide a website address (if available), e-mail address (if available) and telephone number by which a client may obtain a copy of the RIA’s current disclosure brochure, as well as the website address through which a client may obtain information about the adviser through the SEC’s Investment Adviser Public Disclosure (IAPD) system.   [5]   In particular, a hedge fund adviser with more than $1.5 billion in regulatory assets under management attributable to its hedge funds is required to report on Form PF on a quarterly basis within 60 days of the end of each calendar quarter and to complete an additional section of the Form (Section 2).  A private liquidity fund adviser with more than $1.0 billion in combined regulatory assets under management attributable to both registered money market funds and private liquidity funds is required to report on Form PF on a quarterly basis within 15 days of the end of each calendar quarter and to complete an additional section of the Form (Section 3).  A private equity fund adviser with more than $2.0 billion in regulatory assets under management attributable to its private equity funds is only required to file on an annual basis within 120 days of the end of its fiscal year, but is required to complete an additional section of the Form (Section 4).   [6]   See TPG Capital Advisers, Advisers Act Release No. 4830 (Dec. 21, 2017); and Platinum Equity Advisers, Advisers Act Release No. 4772 (Sept. 17, 2017).  See also Apollo Management V, L.P., et. al.¸ Advisers Act Release No. 4493 (Aug. 23, 2016); Blackstreet Capital Management, LLC, et. al., Exchange Act Release No. 77957, Advisers Act Release No. 4411 (Jun. 1, 2016); Equinox Fund Management, LLC, Securities Act Release No. 10004, Exchange Act Release No. 76927, Advisers Act Release No. 4315 (Jan. 19, 2016); Cherokee Investment Partners, LLC, et. al., Advisers Act Release No. 4258 (Nov. 5, 2015); Fenway Partners, LLC, et. al., Advisers Act Release No. 4253 (Nov. 3, 2015); Blackstone Management Partners L.L.C., et. al., Advisers Act Release No. 4219 (Oct. 7, 2015); Kohlberg, Kravis Roberts & Co., Advisers Act Release No. 4131 (Jun. 29, 2015); and Alpha Titans, LLC, et al., Exchange Act Release No 74828, Advisers Act Release No. 4073, Investment Company Act Release No. 31586 (Apr. 29, 2015).   [7]   See OCIE Cybersecurity Initiative, National Exam Program Risk Alert, Vol. IV, Issue 2 (Apr. 15, 2014); Cybersecurity Examination Sweep Summary, National Exam Program Risk Alert, Vol. IV, Issue 4 (Feb. 3, 2015); OCIE’s 2015 Cybersecurity Examination Initiative, National Examination Program Risk Alert, Vol. IV, Issue 8 (Sept. 15, 2015); Cybersecurity: Ransomware Alert, National Exam Program Risk Alert, Vol. VI, Issue 4 (May 17, 2017); and Observations from Cybersecurity Examinations, National Exam Program Risk Alert, Vol. VI, Issue 5 (Aug. 7, 2017).  See also, Examination Priorities for 2015, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 13, 2015); Examination Priorities for 2016, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 11, 2016); Examination Priorities for 2017, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 12, 2017); and 2018 National Exam Program Examination Priorities, National Exam Program, Office of Compliance Inspections and Examinations (Feb. 7, 2018).   [8]   Investment Adviser Association, SEC No-Action Letter (pub. avail. Feb. 21, 2017).   [9]   Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority, IM Guidance Update No. 2017-01 (February 2017). [10]   The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers, National Exam Program Risk Alert, Vol. VI Issue 3 (Feb. 7, 2017). [11]   The Most Frequent Advertising Rule Compliance Issues Identified in OCIE Examinations of Investment Advisers, National Exam Program Risk Alert, Vol. VI Issue 6 (Sept. 14, 2017). [12]   See, e.g., Centre Partners Management, LLC, Advisers Act Release No. 4604 (Jan. 10, 2017) and New Silk Road Advisors, Advisers Act Release No. 4587 (Dec. 14, 2016). [13]   See Footnote 10 above and accompanying text. [14]   To qualify as a passive institutional investor, an investment adviser must be an RIA that purchased the securities in question “in the ordinary course of business and not with the purpose or effect of changing or influencing the control of the issuer nor in connection with or as a participant in any transaction having such purpose or effect.” [15]   The SEC maintains a definitive list of securities subject to Form 13F reporting at http://www.sec.gov/divisions/investment/13flists.htm. [16]   A “Large Trader” is defined as any person that exercised investment discretion over transactions in Regulation NMS securities that equal or exceed (i) two million shares or $20 million during any single trading day, or (ii) 20 million shares or $200 million during any calendar month. [17]   The next 5-year benchmark survey will cover foreign investment in U.S. securities and is scheduled to be conducted in 2019. [18]   For a further discussion of the requirements of the GDPR, see The General Data Protection Regulation: A Primer for U.S.-Based Organizations that Handle EU Personal Data, Gibson Dunn Client Alert (Dec. 4, 2017) https://www.gibsondunn.com/the-general-data-protection-regulation-a-primer-for-u-s-based-organizations-that-handle-eu-personal-data/. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com) Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com) Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com) Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com) Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com) Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 29, 2018 |
2017 Year-End Activism Update

This Client Alert provides an update on shareholder activism activity involving NYSE- and NASDAQ-listed companies with equity market capitalizations above $1 billion during the second half of 2017, as well as a look back at trends for the 2017 calendar year. Activism activity declined modestly during the second half of 2017, similar to the trend we found in the second half of 2016, which can be partially attributed to the passing of the proxy season. Overall, activist activity rose slightly in 2017 from 2016. In 2017, Gibson Dunn’s Activism Update surveyed 98 public activist actions involving 82 companies and 63 activist investors, compared to 90 public activist actions involving 78 companies and 60 activist investors in 2016. Our survey covers 46 total public activist actions, involving 36 different activist investors and 39 companies targeted, during the period from July 1, 2017 to December 31, 2017. Six of those companies faced advances from multiple investors, including three companies that faced coordinated actions by activist groups. Equity market capitalizations of the target companies ranged from just above the $1 billion minimum covered by this survey to approximately $235 billion. By the Numbers – 2017 Full Year Public Activism Trends *Includes data compiled for both 2017 Mid-Year and Year-End Activism Update publications. **All data is derived from the data compiled from the campaigns studied for the 2017 Year-End Activism Update. Additional statistical analyses may be found in the complete Activism Update linked below. In the second half of 2017, activists most frequently sought to influence target companies’ business strategies (63.0% of campaigns), while changes to board composition and M&A-related issues (including pushing for spin-offs and advocating both for and against sales or acquisitions) were sought in 41.3% and 34.7% of campaigns, respectively. Changes to corporate governance practices (including de-staggering boards and amending bylaws) (23.9% of campaigns), changes in management (10.9% of campaigns), and requests for capital returns (10.9% of campaigns) were relatively less common. Seven campaigns involved proxy solicitations during the second half of 2017, five of which reached a vote. Finally, activism was most frequent among small-cap companies (64.1% of companies targeted had equity market capitalizations below $5 billion). More data and brief summaries of each of the activist actions captured by our survey follow in the first half of this publication. The most notable change from prior periods surveyed is the decrease in publicly filed settlement agreements, as our survey captured only four such agreements in the second half of 2017, compared to 12 in the first of 2017 and 13 in the second half of 2016. The decline in publicly filed agreements may be partially attributable to the decrease in the percentage of actions in which activists sought board seats. Though certain key terms of settlement agreements, including standstills, voting agreements, ownership thresholds and non-disparagement agreements, remain nearly ubiquitous, we think it is notable, despite the small sample size, that all four agreements covered in this edition of Activism Update included expense reimbursement provisions, which had been on the decline during prior periods. We hope you find Gibson Dunn’s 2017 Year-End Activism Update informative.  If you have any questions, please do not hesitate to reach out to a member of your Gibson Dunn team. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm’s New York office: Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com) Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com) Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com) Eduardo Gallardo (+1 212.351.3847, egallardo@gibsondunn.com) Adam J. Brunk (+1 212.351.3980, abrunk@gibsondunn.com) Please also feel free to contact any of the following practice group leaders and members: Mergers and Acquisitions Group: Jeffrey A. Chapman – Dallas (+1 214.698.3120, jchapman@gibsondunn.com) Stephen I. Glover – Washington, D.C. (+1 202.955.8593, siglover@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310.552.8641, jlayne@gibsondunn.com) Securities Regulation and Corporate Governance Group: Brian J. Lane – Washington, D.C. (+1 202.887.3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, rmueller@gibsondunn.com) James J. Moloney – Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com) Lori Zyskowski – New York (+1 212.351.2309, lzyskowski@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 9, 2018 |
Recent Developments in UK Public Takeover Regulation – A Brief Summary of Recent Rule Changes and the Landmark Decision in The Panel on Takeovers and Mergers v King

Click for PDF Enforcement of Panel Rulings A few weeks ago, the Court of Session in Edinburgh (the Court)[1] delivered its landmark judgement in the case of The Panel on Takeovers and Mergers v David Cunningham King[2] – the first case in which the UK Takeover Panel (the Panel) applied to court for an enforcement order pursuant to its rights under the Companies Act 2006 (the Act). On 13 March 2017, the Takeover Appeal Board (TAB) published its decision that Mr King had acted in concert with other persons to acquire more than 30% of the voting rights in Rangers Football Club (Rangers) and in consequence had incurred an obligation under the Code to make a mandatory offer at a price of 20 pence per Rangers share for all the shares not already held by King and his concert parties. TAB directed that King make this mandatory offer by 12 April 2017. As previously written about[3], King failed to comply with the direction of TAB and on 13 April, the Panel commenced proceedings in the Court seeking  an order requiring Mr King to comply with its rulings. The Court acknowledged that whilst “in nearly all cases, if asked by the Panel to enforce its decision by granting an order”, it would do so, nonetheless it confirmed that there may be rare cases where it may not do so and that the wording of the legislation allowed for this inherent discretion to refuse to grant an order. The Court went on to find in favour of the Panel, helpfully noting “the Panel is the body which is charged with the duty of evaluating the evidence and making findings of fact” – the court is not acting in this context as a court of appeal. Earlier this week, a number of changes to the City Code on Takeovers and Mergers (the Code) were introduced. Significant Asset Sales in Competition with Offers The first set of changes, which the Panel consulted on earlier last year, principally relate to the situation where a target company is considering a “significant” asset sale with a view to distribution of the company’s cash balances including the asset sale proceeds to its shareholders, in competition to an offer or possible offer[4]. The Panel has introduced a set of changes to: (i) prevent asset buyers in such cases from circumventing certain provisions of the Code; and (ii) ensure that shareholders have the benefit of competent independent advice and comprehensive information from the target company board on the competing asset sale. We have previously commented on some of the proposed changes put forward by the Panel[5]. The key change following the consultation process[6] is that the Panel has raised the threshold for asset sales which would normally be regarded as significant from 50% to 75% having regard to relative values ascribed to consideration, assets and profits. The first set of rule changes also cover the use and supervision (by financial advisers) of social media for the publication of information by parties to an offer. Bidder Statements of Intention and Code Timetable Changes The second set of changes which the Panel consulted on in autumn 2017[7] principally related to: (i) the enhanced scope and timing of statements of intention by bidders in relation to a target company; and (ii) a new rule prohibiting bidders from publishing their offer document in the first 14 days from publication of the announcement of the firm intention to make an offer, other than with the consent of the target board. Following the recent Code changes, bidders will now be required to make statements of intention with regard to the target’s: (a) research and development functions (if any); (b) material changes to the balance of skills and functions of the target company’s employees and management; and (c) location of the target company’s headquarters and headquarter functions – first in the firm intention offer announcement and also in its offer document. These changes present yet another challenge for bidders or possible bidders of UK Code companies. First, bidders will now in practice be required to undertake more comprehensive diligence and analysis at a much earlier stage by bidders with respect to the new matters outlined above. Whilst the Panel conceded following feedback during the consultation process[8] that there may be circumstances where the bidders intentions may change during an offer and that in such circumstances the bidder would be required to announce any new intentions promptly, the Panel pushed back against the ability of a bidder to satisfy these new intention statement requirements by stating that it would undertake a review of the target’s business following an offer. Second is the new important change to the takeover timetable and offer document posting date. In practice, the change means that a hostile bidder will no longer be able to launch and close  a so-called “bullet offer” – that is, a bid where the firm intention offer and offer document are announced and posted on the same day with a view to closing the offer on the 1st closing date (21 days later). The tide has turned yet again against bidders of UK companies.    [1]   The Court of Session is Scotland’s supreme civil court which is divided into the Outer House and Inner House. This case was heard at first instance by one Lord Ordinary sitting in the Outer House.    [2]   Panel on Takeovers and Mergers v King [2017] CSOH 156    [3]   https://www.gibsondunn.com/uk-public-ma-learnings-from-some-recent-contested-cases-before-the-uk-takeover-panel/    [4]   Panel Consultation Paper: “Asset Sales and Other Matters” – PCP 2017/1 – http://www.thetakeoverpanel.org.uk/wp-content/uploads/2017/07/PCP.192957_1.pdf    [5]   https://www.gibsondunn.com/uk-public-ma-when-is-a-final-offer-not-final-part-2/    [6]   See Response Statement – RS 2017/1 – http://www.thetakeoverpanel.org.uk/wp-content/uploads/2017/12/RS2017-1.pdf    [7]   Panel Consultation Paper: “Statements of Intention and Related Matters” – PCP 2017/2 – http://www.thetakeoverpanel.org.uk/wp-content/uploads/2017/09/PCP-re-statements-of-intention-September-2017.pdf    [8]   See Response Statement – RS 2017/2 – http://www.thetakeoverpanel.org.uk/wp-content/uploads/2017/12/FinalRS2017-2.pdf If you require further information on the Code changes outlined above or guidance on these recent developments, please contact the author of this note, Selina Sagayam (ssagayam@gibsondunn.com), the Gibson Dunn lawyer with whom you normally work, or the following partners in the firm’s London office.  We would be pleased to assist you. Nigel Stacey (+44 (0)20 7071 4201, nstacey@gibsondunn.com) Charlie Geffen (+44 (0)20 7071 4225, cgeffen@gibsondunn.com) Patrick Doris (+44 (0)20 7071 4276, pdoris@gibsondunn.com) Jonathan Earle (+44 (0)20 7071 4211, earle@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 13, 2017 |
M&A Report – Two Sides to Working Capital Adjustments

Click for PDF Buyers and sellers often agree that a target company’s valuation assumes that the target will be sold on a cash-free, debt-free basis, with a normalized level of working capital.  With respect to working capital, which is typically defined as current assets minus current liabilities, the buyer wants to ensure that the target has a sufficient amount of working capital to operate in the ordinary course after closing without requiring an infusion of capital. Accordingly, the buyer and seller will typically agree upon a target for the amount of working capital the acquired company should have at closing.  Prior to closing, the seller will deliver an estimate of the amount of working capital it believes the acquired company will actually have at closing.  If the seller’s estimate exceeds the working capital target, the seller will receive an amount equal to such excess as an increase in the purchase price.  If, however, the seller’s estimate is less than the working capital target, the buyer will receive the shortfall as a purchase price reduction.  In the period immediately following closing, the buyer will perform its own calculation to determine the amount of working capital the acquired company actually had at closing.  If the amount resulting from the buyer’s calculation differs from the amount of the seller’s estimate, the purchase price will be further adjusted.  This process is often referred to as a “true-up.” Occasionally disputes between the parties regarding the working capital calculation will arise in the true-up process.  Often in these disputes the buyer’s and seller’s differing viewpoints regarding the purpose of the working capital adjustment are revealed.  On the one hand, sellers often argue that working capital must be calculated consistently with the methodology used to calculate the working capital target amount.  In other words, the seller will argue that the purpose of the working capital adjustment is to compensate for deviations from the target working capital amount, and in order for such changes to be calculated equitably, the closing amount of working capital must be calculated using the same methodology that was used in calculating the working capital target amount. On the other hand, the buyer may argue that the purpose of the working capital adjustment is to ensure that the acquired company is delivered at closing with sufficient working capital, and that determination should be made by calculating working capital in accordance with GAAP (i.e., if the closing working capital amount, calculated in accordance with GAAP, results in a deviation from the target and the estimate, which were not calculated in accordance with GAAP, then the GAAP-compliant calculation should control).  Both of these divergent viewpoints sometimes make their way into the M&A purchase agreement in the form of convoluted and unclear language regarding how working capital is to be calculated.  In contrast, at times, one side’s preferred viewpoint may be reflected in the purchase agreement without the other side’s realizing the full implications of the language. At first blush, a recent Delaware case, Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC, 2017 WL 2774563 (Del. June 27, 2017), would seem to provide support for the seller’s viewpoint.  However, the case had highly unusual facts that ultimately limit its utility at the negotiating table for either the buyer or seller.  In the case, the Delaware Supreme Court reversed the decision of the Chancery Court, which had upheld the right of Westinghouse, as buyer, to use the post-closing working capital true-up process to claim that the financial statements of Chicago Bridge, as seller, were not based on a proper application of GAAP.  The Delaware Supreme Court stated that the true-up process is a “narrow, subordinate, and cabined remedy” only intended to account for changes in the target’s business between signing and closing of the transaction.[1] In October 2015, Chicago Bridge and Westinghouse entered into a purchase agreement pursuant to which Westinghouse agreed to acquire a wholly owned subsidiary of Chicago Bridge, CB&I Stone & Webster Inc. (“Stone”).[2]  Chicago Bridge agreed to sell Stone to Westinghouse for, inter alia, a purchase price of zero dollars and certain limitations on liability that were intended to give Chicago Bridge a clean break from the spiraling costs of the nuclear projects in which Stone was principally involved.[3]  The parties agreed that Westinghouse’s sole remedy, in the absence of actual fraud, for Chicago Bridge’s breach of the agreement’s representations and warranties was to refuse to close the transaction.[4]  In other words, for example, Westinghouse agreed that it would have no recourse for a breach of Chicago Bridge’s representation in the purchase agreement that Stone’s financial statements complied with GAAP.  Westinghouse also agreed to broad indemnification of Chicago Bridge for all future claims related to Stone and to obtain liability releases, for the benefit of Chicago Bridge, from the power utilities that would ultimately own the nuclear plants being built by Stone.[5] The agreement also contained a post-closing purchase price adjustment true-up process whereby the parties would reconcile a working capital estimate with the actual working capital of Stone at closing.[6]  This multi-step true-up process required Chicago Bridge to deliver an estimate of working capital to Westinghouse at least three days prior to closing and, subsequently, Westinghouse to deliver a similar statement to Chicago Bridge no later than 90 days after closing.[7]  The agreement required the statements to be “prepared and determined from the books and records of [Chicago Stone] and in accordance with United States [GAAP] applied on a consistent basis throughout the period indicated and with the [agreed principles].”[8]  At the conclusion of the true-up process, Westinghouse alleged that Chicago Bridge’s historical financial statements, from which Chicago Bridge’s true-up estimates were based, were not GAAP compliant and, as a result, Chicago Bridge owed it a working capital adjustment of over $2 billion.[9] The agreement also contained a dispute resolution mechanism to address disputes in the true-up process which referred the parties to an independent auditor.[10]  Prior to Westinghouse invoking the independent auditor to arbitrate its working capital adjustment claim, Chicago Bridge filed a claim with the Court of Chancery seeking a declaration that Westinghouse’s claim was not appropriate for the true-up dispute resolution mechanism because it was based principally on the allegation that Chicago Bridge’s historical financial statements were not GAAP compliant and, therefore, was barred by the limitation on liability contained in the agreement.[11]  The Court of Chancery held in favor of Westinghouse, holding that the dispute resolution mechanism established a mandatory path for resolving the parties’ disagreements over the post-closing purchase price adjustment, including disagreements as to whether Stone’s historical financial statements were GAAP compliant.[12] The Delaware Supreme Court reversed the Court of Chancery’s decision and held that the Court of Chancery must enjoin Westinghouse from submitting claims to the independent auditor or continuing to pursue already-submitted claims regarding Chicago Bridge’s historical financial statements because such claims were barred by the limitation on liability contained in the agreement.[13]  In his decision, Chief Justice Strine leaned heavily on the facts, including the limitation on liability, which he described as “unusual.”[14]  The opinion began with the declaration that “[i]n giving sensible life to a real-world contract, courts must read the specific provisions of the contract in light of the entire contract” and later stated that, although the true-up process has an important role to play, its role is “limited and informed by its function in the overall Purchase Agreement.”[15]  Chief Justice Strine further justified his decision by arguing that a ruling to the contrary would “render the [limitation on liability] meaningless and eviscerate the basic bargain” struck by the parties.[16] This decision leaves open the question of whether the Delaware courts would view the true-up process contained in traditional agreements, where the buyer is not subject to a liability bar, in the same limited way.  Some buyers will be tempted to argue that this case represents a narrow holding that does not preclude buyers in the traditional context from bringing claims regarding GAAP compliance in the post-closing purchase price adjustment true-up process.  In contrast, some sellers will be tempted to argue that Chief Justice Strine’s pronouncement that the true-up process is only intended to account for changes in the target’s business between signing and closing forecloses buyers from asserting that the working capital calculation was not performed in accordance with GAAP.  Certainly the deal terms at issue in this case were unusual, and the imposition of a liability bar seems to have weighed heavily on the outcome.  It is unclear whether a purchase agreement without a liability bar, and with unambiguous language subjecting the working capital calculation to a GAAP standard, would lead to a different result. In any event, this case should serve as a reminder that, even in a traditional acquisition agreement, post-closing purchase price adjustments should be drafted with specificity and with the buyer’s and seller’s divergent viewpoints on the purpose of the working capital adjustment in mind.    [1]   Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC, 2017 WL 2774563 at *3 (Del. June 27, 2017) (“Chicago Bridge“).    [2]   Id. At *1.    [3]   Id.    [4]   Id. at *2.    [5]   Id.    [6]   Id. at *4.    [7]   Id. at 7-8.    [8]   Id. at *8.    [9]   Id. [10]   Id. at *9. [11]   Id. [12]  Id.; Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC and WSW Acquisition Co., LLC, 2016 WL 7048031 at *1 (Del. Ch. Dec. 5, 2016). [13]   Chicago Bridge at 16. [14]   Id. at *5-*6. [15]   Id. at *1, *11. [16]   Id. at *14. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert: Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com) Eric B. Pacifici – Dallas (+1 214-698-3401, epacifici@gibsondunn.com) Please also feel free to contact any of the following practice group leaders: Mergers and Acquisitions Group: Barbara L. Becker – New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Private Equity Group: Sean P. Griffiths – New York (+1 212-351-3872, sgriffiths@gibsondunn.com) Steven R. Shoemate – New York (+1 212-351-3879, sshoemate@gibsondunn.com) Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com) Charlie Geffen – London (+44 (0)20 7071 4225, cgeffen@gibsondunn.com) Paul Harter – Dubai (+971 (0)4 318 4621, pharter@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 10, 2017 |
An Expert’s View: Current Developments in Commitment Letter Negotiations

​New York partner Janet Vance is the author of “An Expert’s View: Current Developments in Commitment Letter Negotiations,” [PDF] published by Practical Law Finance on November 10, 2017.

October 27, 2017 |
10 Considerations When Selling to Private Equity Consortium

New York partner John Pollack and associate Daniel Alterbaum are the authors of “10 Considerations When Selling to Private Equity Consortium,” [PDF] published by Law360 on October 27, 2017.

October 2, 2017 |
Private Equity JVs: Part 1 – DrillCos

​Houston partners Justin Stolte and Michael Darden are the authors of “Private Equity JVs: Part 1 – DrillCos,” [PDF] published by Oil & Gas Financial Journal on October 2, 2017.

September 25, 2017 |
Significant Amendments to Form ADV Go into Effect on October 1, 2017

Investment advisers that file Form ADV with the Securities and Exchange Commission ("SEC") either as registered investment advisers ("RIAs") or as exempt reporting advisers ("ERAs")[1] are reminded that significant amendments to Part 1A of Form ADV ("Part 1A") go into effect on October 1, 2017.  For most investment advisers having a fiscal year end of December 31st, the amendments will first impact their annual updating filings that will be due on April 2, 2018. The following Client Alert provides a brief summary of the changes that have been made to Part 1A.  Investment advisers would be well-advised to begin considering how these changes will impact their Form ADV filing requirements for 2018 and how they will capture the additional data they will need to complete amended Part 1A.[2] 1.   Enhanced Reporting Regarding Separately Managed Accounts. One of the most significant changes to Part 1A is the addition of new reporting requirements for RIAs[3] with respect to their separately managed accounts ("SMAs").[4]  Specifically, new Item 5.K has been added to Part 1A that will require an RIA to identify (i) whether it has any regulatory assets under management ("RAUM") attributable to SMAs ("SMA Assets"), (ii) whether it engages in borrowing transactions on behalf of SMAs, (iii) whether it engages in derivatives transactions on behalf of SMAs, and (iv) whether any single custodian holds more than 10% of the RIA’s SMA Assets.  A "yes" answer to any of these questions will trigger a requirement to complete the applicable parts of new Section 5.K of Schedule D to Form ADV. New Section 5.K of Schedule D requires an RIA to report certain data on an aggregated basis with respect to its SMA Assets.[5]  In particular: Section 5.K(1) will require an RIA to report the percentage of SMA Assets it manages in each of twelve separate asset categories.[6]  An RIA with $10 billion or more in SMA Assets must report this data as of the end of its second fiscal quarter and as of the end of its fiscal year.  An RIA will less than $10 billion in SMA Assets is only required to report this data as of the end of its fiscal year. Section 5.K(2) will require an RIA with $10 billion or more in SMA Assets that engages in borrowing or derivatives transactions on behalf of its SMAs to report the amount of SMA Assets it manages in three ranges of "gross notional exposure:" (i) less than 10%, (ii) between 10% and 149%, and (iii) 150% or more.  For each range, the RIA is further required to report the aggregate dollar amount of all borrowings on behalf of the SMAs in such range, and the gross notional value of all derivatives held in such accounts, broken down into six categories of derivative instruments.[7]  This information must be presented on a semi-annual basis as of the end of the RIA’s second fiscal quarter and as of the end of its fiscal year.  For purposes of calculating this data, an RIA may (but is not required to) exclude SMAs with less than $10 million in RAUM.  An RIA with between $500 million and $10 billion in SMA Assets will be required to report the amount of SMA Assets it manages in each of the three ranges of gross notional exposure as of the end of its fiscal year only. Such RIAs will also be required to report the aggregate dollar amount of borrowings on behalf of its SMAs within each range of gross notional exposure, but will not be required to provide a breakdown of the derivative instruments held in such accounts.  An RIA with less than $500 million in SMA Assets will not be subject to this reporting requirement. Finally, Section 5.K(3) will require an RIA to identify each custodian that holds more than 10% of the RIA’s SMA Assets. 2.   Enhanced Reporting of Certain Information Regarding the Investment Adviser and its Business. A number of amendments have been made to Part 1A that will increase the level of detail an investment adviser is required to provide relating to itself and the nature of its business.  In particular: Item 1 of Part 1A has been amended to require an investment adviser to identify any publicly available social media sites whose content is controlled by the adviser.  In addition, the adviser will be required to report the total number of branch offices it has and identify each of its 25 largest branch offices by number of employees, including (i) the number of employees in such branch office engaged in performing investment advisory functions, (ii) any other business activities conducted by the investment adviser at the branch office, and (iii) a brief description of the investment-related activities conducted from the branch office.[8]  Further, an adviser who outsources its chief compliance officer ("CCO") function to a third party will be required to provide the name and IRS employer identification number of the CCO’s employer.  Finally, a large investment adviser with $1 billion or more in assets on its own balance sheet will be required to identify whether such assets fall within one of three ranges.[9] Item 5 of Part 1A has been amended to significantly change the manner in which RIAs report information relating to their client base.[10]  Specifically, an RIA will be required to complete a new table identifying the number of clients it has in each of thirteen enumerated classes of clients[11] and the amount of the RIA’s RAUM attributable to each class of clients.  RIA’s will also be required to identify approximately how many clients it has that do not have RAUM attributable to them (i.e., client accounts for which the RIA does not provide "continuous and regular supervisory or management services"),[12] the approximate percentage of its clients that are non-U.S. persons and the amount of its RAUM that is attributable to such non-U.S. person clients.  An RIA that manages registered investment companies or who participates in wrap fee programs will also be subject to additional reporting requirements with respect to those activities. Finally, Section 7.B(1) of Schedule D to Part 1A, under which an investment adviser is required to provide detailed information with respect to the private funds it manages, has been revised to require an investment adviser to provide the PCAOB number, if any, of the auditor of each of its private funds, and to report whether the investors in any 3(c)(1) funds it manages are required to be "qualified clients." 3.   Relying Advisers. The amendments to Part 1A also codify certain no-action relief granted by the SEC in 2012[13] permitting certain registered private fund advisers ("Filing Advisers") to register multiple entities ("Relying Advisers") under the Advisers Act using a single Form ADV filing ("Umbrella Registration").  For the most part, these amendments to Part 1A follow the already existing no-action letter precedent and do not impose significant additional reporting or other compliance burdens on a Filing Adviser that is already using Umbrella Registration.  However, as discussed below, in adopting the amendments the SEC has clarified certain interpretations of its requirements pertaining to Umbrella Registration that may result in some unexpected results for private fund advisers.  The conditions for qualifying to register Relying Advisers pursuant to an Umbrella Registration under amended Part 1A have not changed in substance.  A Filing Adviser and its Relying Advisers must operate as a single private fund investment advisory business where: (i) the firm’s only clients are private funds or SMAs for qualified clients that invest in parallel with such private funds, (ii) the principal place of business for the firm is located in the U.S., (iii) all personnel are subject to the Filing Adviser’s supervision and control, (iv) the investment activities of each Relying Adviser are subject to the Advisers Act and SEC examination, and (v) the Filing Adviser and all Relying Advisers are subject to a single compliance program and code of ethics administered by a single CCO. A Filing Adviser relying on Umbrella Registration will now be required to complete a new Schedule R to Form ADV for each Relying Adviser covered by the Umbrella Registration.  For the most part, the information that is required to be reported in Schedule R is as one would expect.  It should be noted, however, that new Schedule R will require a Filing Adviser to separately identify the basis upon which each Relying Adviser independently qualifies to register under the Advisers Act.[14]  In addition, a Filing Adviser will be required to separately report the complete ownership structure for each Relying Adviser in such Relying Adviser’s Schedule R to the same degree of detail as is required for the Filing Adviser in Schedules A and B of Form ADV.  Despite numerous requests in comment letters to do so, the SEC declined to expand the availability of Umbrella Registration beyond U.S. based RIAs whose business is limited exclusively to managing private funds.  In particular, Umbrella Registration is still not available to non-U.S. based advisers or to ERAs.  The SEC did state in the Adopting Release, however, that certain no-action relief permitting ERAs to rely on a somewhat different form of Umbrella Registration will still be available.[15] 4.   Other Changes. In addition to the changes summarized above, the SEC adopted two amendments to Rule 204-2 under the Advisers Act (the "Books and Records Rule") that expand an RIA’s record-keeping obligations with respect to written communications containing performance data.[16]  In particular: First, the SEC amended Rule 204-2(a)(16) such that RIAs will be required to maintain records to support performance claims in communications sent to any person.  Under the current rule, RIAs are only required to maintain such records for performance claims in communications sent to ten or more persons. In addition, the SEC added a new requirement to Rule 204-2(a)(7) that will require RIAs to maintain records of all written communications sent or received by the RIA relating to the performance or rate of return of any or all managed accounts or securities recommendations. Both of these amendments go into effect on October 1, 2017. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.   [1]   RIAs and ERAs are referred to collectively herein as investment advisers.   [2]   Complete copies of the revised instructions to Form ADV and amended Part 1A can be found on the SEC’s website using the following links: General Instructions:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-a.pdf Instructions for Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-b.pdf Glossary of Terms:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-c.pdf Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-d.pdf In addition, a copy of amended Part 1A, marked to show changes against the current version, can also be found on the SEC’s website at https://www.sec.gov/rules/final/2016/ia-4509-form-adv-summary-of-changes.pdf.   [3]   ERAs will not be subject to these new reporting requirements.   [4]   An SMA is defined for this purpose as any client account other than a registered investment company, business development company or other pooled investment vehicle (including private funds).    [5]   The reporting requirements are somewhat akin to reporting obligations under Form PF that apply to an RIA with respect to any private funds it manages.  Unlike the data provided under Form PF, however, the data provided in response to Schedule D, Section 5.K, will be publicly available on the SEC’s website.   [6]   The asset categories are (i) exchange-traded equity securities, (ii) non exchange-traded equity securities, (iii) U.S. government/agency bonds, (iv) U.S. state and local government bonds, (v) sovereign bonds, (vi) investment grade corporate bonds, (vii) non-investment grade corporate bonds, (viii) derivatives, (ix) securities issued by registered investment companies or business development companies, (x) securities issued by other pooled investment vehicles, (xi) cash and cash equivalents, and (xii) other.   [7]   The six categories of derivative instruments are (i) interest rate derivatives, (ii) foreign derivatives, (iii) credit derivatives, (iv) equity derivatives, (v) commodities derivatives and (vi) other derivatives.   [8]   Unlike most of the information provided in Item 1 (which must be promptly updated on an other-than-annual basis if the information provided becomes inaccurate in any respect), the information with respect to an investment adviser’s branch offices will only need to be updated once a year as part of the investment adviser’s annual updating amendment to its Form ADV.   [9]   The ranges are (i) from $1 billion to $10 billion, (ii) from $10 billion to $50 billion, and (iii) more than $50 billion. [10]   ERAs, which are not required to complete Item 5 of Part 1A, will not be subject to these requirements. [11]   The enumerated classes of clients are (i) individuals (other than high net worth individuals), (ii) high net worth individuals, (iii) banking or thrift institutions, (iv) business development companies, (v) registered investment companies, (vi) other pooled investment vehicles, (vii) pension and profit sharing plans (other than government pension plans), (viii) state and municipal government entities (including government pension plans), (ix) other investment advisers, (x) insurance companies, (xi) sovereign wealth funds and foreign government institutions, (xii) corporations and other businesses, and (xiii) other clients.  [12]   In the Adopting Release, the SEC cites nondiscretionary accounts or one-time financial plans as examples of situations where, depending on the facts and circumstances, an adviser may provide investment advice but does not have RAUM.  See SEC Adopting Release, Form ADV and Investment Advisers Act Rule, Release No. IA-4509, File No. S7-09-15 (Aug. 25. 2016), https://www.sec.gov/rules/final/2016/ia-4509.pdf, at footnote 144.  [13]   See SEC No-Action Letter, Investment Advisers Act of 1940 – Sections 203(a) and 208(d) American Bar Association, Business Law Section (Pub. avail. Jan. 18, 2012), https://www.sec.gov/divisions/investment/noaction/2012/aba011812.htm. [14]   This will not be a problem for any Relying Adviser that has the same principal place of business with the Filing Adviser.  However, Relying Advisers whose principal place of business is not the same as the Filing Adviser will need to identify a separate grounds for claiming SEC jurisdiction under the Advisers Act, such as by having $100 million or more in RAUM or by having its principal place of business located outside of the U.S. [15]   See SEC Staff Interpretive Guidance, Frequently Asked Questions on Form ADV and IARD (June 12, 2017), https://www.sec.gov/divisions/investment/iard/iardfaq.shtml at "Reporting to the SEC as anExempt Reporting Adviser." [16]   ERAs are not subject to these record-keeping requirements. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com)Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com)Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com)Marc J. Fagel (+1 415-393-8332, mfagel@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 6, 2017 |
UK Public M&A – UK Public Companies Up for Sale: ‘Strategic Reviews’, ‘Auctions’, ‘Formal Sale Processes’ – Does It Matter? New Guidance

When the board of a public company decides to undertake a strategic review, this may involve putting itself or some of its assets up for sale. These options may in turn be run as a formal auction or might involve (or be preceded by) more informal private discussions with a small number of parties to gauge market interest. These steps may be run as distinct ordered stages and in other situations may develop iteratively, often being regarded by the company itself as a continuum or variation of one and same process. Under UK takeover rules and practice, however, entering into these different stages can have markedly different consequences of strategic importance to the company. The Executive body of the UK Panel on Takeovers and Mergers (Executive) recently published new guidance in the form of a Practice Statement[1] 31 on "Strategic reviews, formal sale processes and other circumstances in which a company is seeking potential offerors"[2] (PS 31) . This alert summarises the substance of the guidance and draws out some practical considerations for companies and their advisers in these situations. Different scenarios discussed in the Practice Statement 31 PS 31 seeks to draw a distinction between the following key announcement scenarios: General strategic review announcements by target companies Strategic review announcements by companies which specifically refer to an offer, or a formal sale process (FSP), a merger or the search for a buyer for the company, as one or some of the options under consideration Announcements by companies that the board is seeking one or more potential offerors by means of a FSP Private discussions between a target company with one or more potential offerors where subsequently the target company wishes to announce a FSP. Each of the scenarios above address voluntary announcements scenarios. It should be noted there are a number of other scenarios provided for under the Code where a target company or an offeror may be required to make an announcement about a possible offer e.g. in the event of rumour or speculation, untoward target share price movement or where private discussions by a target company with potential offerors exceeds more than a very restricted number of potential offerors. These mandated situations are not addressed in PS 31 nor in this alert. Rule 2 of the Code sets out the framework for announcements (voluntary and mandated) and the Executive has also set out further guidance on this in Practice Statement 20[3] on "Secrecy, Secrecy, possible offer announcements and pre-announcement responsibilities". Why does it matter? From a target company’s perspective, it is important to understand and ideally to pre-plan for the implications under the Code, if any, of any of the announcement scenarios listed above. Entering into an offer period: First, the company will want to know if the result of the announcement is to bring it into an "offer period" under the Code. If a company enters into an offer period, a number of different requirements and restrictions will arise, many impacting the target company itself and others impacting possible offerors and third parties. With respect to the target company, these include the imposition of certain restrictions on dealings, disclosure requirements, compliance with regimes regarding circulation of information about the target company and restrictions on actions which are regarded as "frustrating actions" under the Code. In addition, whenever a company enters into an offer period, this generally attracts market and stakeholder pressures which inevitably arise from the public scrutiny and enquiry of a company (seen to be) "in play". Public identification of potential offerors and PUSU: Second, an announcement by a target company which commences an offer period must identify any potential offeror it is in talks with or from which an approach has been received (and not unequivocally rejected). This "outing" of potential offeror(s) is important as, in addition to the public revelation of interest by any such potential offeror(s) prior to any firm conclusion of any discussions with the target company (which generally operates against the interests of the offeror and in some circumstances may not also be in the interests of the target), the potential offeror then becomes subject to the so-called "put up shut up" (PUSU) 28 calendar day deadline. The PUSU deadline (which can only be extended with the consent of both the Panel and the target) requires the potential offeror to announce a firm intention to make an offer within 28 days of the announcement "outing" it or to announce that it does not intend to make an offer, in which case it will be "off-side" with respect to an offer for the target, for a number of months. The Code does however, on request of the target,  allow the Panel to grant a dispensation to the "outing" of potential offerors in the case of FSPs and the imposition of the PUSU period. Consultation with the Panel is required. Offer-related arrangements and equality of information: Thirdly, depending on the nature of the scenario in which a company is classified for purposes of the Code, the following additional restrictions may be imposed on it and the parties (including possible offerors) that it is in discussions with or wishes to commence discussions with: Restrictions on entering into any "offer-related arrangements" during an offer period: There is a general restriction under the Code from a target entering into such arrangements which are broadly defined to include any agreement, arrangement or commitment in connection with an offer including any inducement fee "or other arrangement having a similar or comparable financial or economic effect". The Code does however envisage granting a dispensation to allow a target company to enter into an inducement fee arrangement in situations where the company has announced a FSP Equality of information to subsequent bona fide offerors or potential offerors without conditions save as to conditionality and non-solicitation: In order to place all bona fide offerors or potential offerors (whether welcome or unsolicited) on an equal footing, the Code requires the target, to provide equally and promptly, on request, any information given to one (potential) offeror to another bona fide (potential) offeror. The Code also states that the passing of such information should not be made subject to any conditions other than those relating to confidentiality, reasonable non-solicitation provisions and requirements as to use of information solely in connection with an offer. Importantly, this restriction only applies in respect of information requested by a (potential) offeror where that information has already been provided to an earlier (potential) offeror but does not seek to regulate the terms imposed by a target company on the "first" offeror or potential offeror. The question then arises as to who is regarded as the "first" offeror(s) in the context of an auction sale or FSP or similar – this is important for a target company to ascertain as it sets the framework within which it may choose to run an auction process, FSP or strategic review. How does PS 31 address the different scenarios? The table below sets out the requirements and guidance set out in PS 31 with respect to the different sale scenarios identified above.   Conclusions Companies (board members, controlling shareholders and their advisers) who are considering a strategic review, running an auction process or putting the company up for sale should give due consideration to the guidance issued by the Executive in PS 31. With an increase in public-to-private activity, initiated by PE backed owners and otherwise, running an effective sale process is important and necessitates a real understanding of the dynamics of public offers, the implications and strategic options available under the Code including with respect to outing of bidders, access to information and freedom to enter into offer-related arrangements. When the Code Committee of the Panel introduced the FSP regime in 2011 which was in conjunction with, inter alia, the general prohibition on offer-related arrangements, there was an expectation that this regime would be attractive to target companies undergoing a strategic review, given the greater flexibility/ dispensations available to companies (and bidders) participating in this process. The statistics however have been uninspiring (both in terms of the numbers of FSPs launched and the success in concluding in an offer) until more recently when FSPs have gradually developed increased interest. In H1 2017, 27 firm offer intention announcements for Code companies were announced. Of these seven were FSPs – this included three main market and three AIM listed companies with offer periods commencing with a FSP announcement. In four of the six, the FSPs were part of a wider strategic review and dispensations from ‘outing’ and imposition of the PUSU deadline were sought. With this backdrop of increasing prevalence of strategic reviews and FSPs, companies and their advisers should take particular note of the guidance of the Executive in PS 31. [1] Practice Statements are issued by the Executive to provide informal guidance to companies involved in takeovers and practitioners as to how the Executive normally interprets and applies relevant provisions of UK’s City Code on Takeovers and Mergers (Code) in certain circumstances. The statements do not form part of the Code and are not binding on the Executive or the Panel. They have however been relied upon and referred to in cases where evidence of certain Executive practice on particular provisions has been in question. [2] http://www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/PDF-of-Practice-Statement-No.31.pdf [3] http://www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/PDF-of-Practice-Statement-No.20.pdf If you require further information or guidance on these developments, please contact the author of this note, Selina Sagayam (ssagayam@gibsondunn.com), the Gibson Dunn lawyer with whom you normally work, or the following partners in the firm’s London office.  We would be pleased to assist you.     Charlie Geffen (+44 (0)20 7071 4225, cgeffen@gibsondunn.com)Nigel Stacey (+44 (0)20 7071 4201, nstacey@gibsondunn.com)Jonathan Earle (+44 (0)20 7071 4211, jearle@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.