McCloskey Law PLLC

Wow. The SEC just announced that it settled civil charges with two private companies and one registered investment adviser for failing to timely file Form Ds as required by Rule 503 under the 1933 Act. Civil penalties of $195,000 and $175,000 were imposed on the private companies and the RIA was hit with a civil penalty of $60,000. Cease and desist orders for violations of Rule 503 were imposed on all three. This is a significant development. The firm is not aware of a prior SEC enforcement case based solely on the failure to timely file a Form D. Although Rule 503 requires an issuer relying on Rule 504, Rule 506(b) or Rule 506(c) to file a Form D within 15 days, the filing is not a condition for the 1933 Act exemption (i.e., the failure to file a Form D will not, by itself, cause a Section 5 violation). It is worth noting that all three orders contain findings that the applicable issuer conducted a general solicitation and, as a result, the offerings at issue could not have been conducted as exempt offerings without compliance with Regulation D. The SEC's press release states "[t]oday's orders find that the charged entities deprived the Commission and the marketplace of timely information concerning nearly $300 million of unregistered securities offerings." #securitieslaw #startups #founders

$12,445.44. This is the amount of losses allegedly avoided by the former CEO of a Nasdaq-listed company that resulted in his arrest and indictment yesterday on charges of insider trading, securities fraud and wire fraud. The SEC also announced civil charges. According to the allegations, the defendant placed orders to sell shares (i) shortly after being notified that he was being terminated for cause due to an improper relationship with a subordinate employee and (ii) while he was aware of the company’s yet-to-be announced negative quarterly earnings. Both categories are alleged to have constituted material non-public information (MNPI). The SEC’s complaint further alleges that the defendant was subject to two separate trading blackout periods imposed by the company’s internal compliance policies when he placed the sell orders (one a quarterly blackout period and the other a special blackout period). The defendant was able to sell 8,241 shares from his equity compensation management account resulting in net proceeds of $40,454.54, avoiding losses of $12,445.44. However, the defendant's order to sell 49,400 additional shares from a different brokerage account were never cleared because of the blackout restrictions. Evidently the defendant was able to sidestep the preclearance procedure for the 8,241 shares. According to the SEC’s complaint, had the sale of the additional 49,400 shares gone through, the defendant would have avoided additional losses between $34,580.00 and $110,463.34. The defendant allegedly started logging in and accessing both of his securities accounts hours after he was notified that he was terminated for cause. The indictment and the SEC complaint also reference emails from the defendant instructing his financial advisor to sell the shares. The SEC complaint references a recorded phone call between the brokerage firm and the defendant’s financial advisor, who dialed the defendant into the call. #securitieslaw #securitiesregulation

Here is Monday's NY Court of Appeals decision in favor of Uber, ruling a personal injury plaintiff was bound by a "clickwrap" consent to arbitrate even though she had already commenced a court action. The dissent gave more weight to an alleged violation of NYRPC 4.2 (the so-called no contact rule for represented parties). The majority: "invalidation of the . . . arbitration agreement was not among the sanctions requested by plaintiff for the rule 4.2 violation . . . In any event, there is record support for the Supreme Court's affirmed factual finding that Uber lacked actual knowledge of this litigation at the time it solicited plaintiff's assent to the January 2021 terms, rendering Rule 4.2 inapplicable." The dissent: "[i]n the usual course, Uber's counsel would have had to seek plaintiff's consent to remove the case from court to arbitration . . . Proceeding with arbitration rather than litigation would have entailed a significant change in strategy, decided after consultation with counsel to assess the pros and cons of moving from our public justice system to private dispute resolution. Plaintiff, like any other represented party, would have assumed that all litigation-related communication from defendants--especially one with such significant consequences--would be sent directly to her lawyer. In fact, that is exactly what the rules of professional ethics require. [Quoting NYRPC 4.2 in its entirety] . . . The majority's conclusion: "[f]or essentially as long as there have been written contracts, parties have entered them without first carefully reviewing their terms. That failure can have legal consequences . . . whether the contract is presented on paper or through an electronic pop-up window. Here, the consequence of plaintiff's purported failure to carefully review Uber's updated terms of use is that she must make her arguments regarding Uber's allegedly deceptive and unconscionable conduct to a neutral arbitrator, not the courts." The dissent's conclusion: "Uber should not be able to force plaintiff out of her chosen forum on the specious ground that a reasonable person in her position, having retained counsel, filed a claim, and engaged in motion practice, suddenly decided that arbitration was the better course. Indeed, Uber would have this Court believe that by simply clicking a box on the Uber app while waiting for the car service, plaintiff, without benefit of counsel's advice, forfeited her right to litigate her claims before the judiciary of the state of New York. That is nonsense." #contracts #ethics

On Tuesday the DOJ announced an indictment charging an AI startup founder with securities fraud, wire fraud and aggravated identity theft. Hindsight is 20/20, but this case provides yet another cautionary example that attempts to block or otherwise interfere with direct communications among investors (both prospective and existing) and startup financial personnel should be challenged with suspicion and skepticism. According to the indictment, the founder falsely represented the startup's ARR and customer information in the investor deck for the startup's $8 million Series A round. The founder is also alleged to have personally sold common stock to some of the Series A investors, which included an unnamed NY VC fund (referred to in the indictment as "Investor 1"), in a parallel secondary for proceeds of $750,000. The indictment also alleges that when SVB was placed in receivership in March 2023, the founder informed the board and investors that the startup had $10.1 million on deposit with SVB when the cash amount was only $1.7 million. The founder later countersigned a term sheet with a private equity firm (referred to in the indictment as "Firm 1") for a $35 million Series B round that valued the startup at $135 million. According to the indictment, Firm 1 declined to invest after uncovering issues with the startup's financials, but the founder was successful in getting the managing director of Firm 1 to cancel its scheduled calls with existing investors (including Investor 1) to report that Firm 1 was not investing--asking that Firm 1 only communicate with the founder and the startup's attorneys. Later, the founder allegedly tried to stop an employee at the startup's outside accounting firm from sharing Q1 2024 financials with Investor 1, stating "Please don't. I will." Things evidently unraveled when a different employee at the outside accounting firm sent the Q1 2024 financials to Investor 1, which had a board designee (referred to in the indictment as "Director 1"). After this, the founder allegedly impersonated the startup's outside financial consultant (referred to in the indictment as "Consultant 1") by sending a spreadsheet with false contract data to Director 1 from a startup email account falsely purporting to come from Consultant 1. According to the indictment, during a video conference Director 1 told Consultant 1 that she had received the emailed spreadsheet, but Consultant 1 replied that she had not sent the message and did not have an email account with the startup. About two months later the startup filed for bankruptcy. #securitieslaw #startups #duediligence

Interesting WSJ article reporting that a minority stockholder is suing to enforce its veto under a charter to prevent an IPO. The protective provisions reportedly require a supermajority of two-thirds of the Series C Preferred to increase the number of shares of common and the minority stockholder, which evidently owns more than one-third, has not consented. According to the article, the corporation has countersued, asserting that stockholders do not have the right to veto a "qualified IPO" and that the minority stockholder is trying to block the IPO so it can acquire the company at at cheap price. The minority stockholder reportedly attempted to acquire the corporation before the corporation opted to pursue an IPO. #corporatelaw

SEC Commissioners Peirce and Uyeda dissented from the Commission's recent settlement orders against four respondents for "materially misleading disclosures regarding cybersecurity risks and intrusions." The dissent states, "[t]he common theme across the four proceedings is the Commission playing Monday morning quarterback. Rather than focusing on whether the companies' disclosure provided material information to investors, the Commission engages in a hindsight review to second-guess the disclosure and cites immaterial, undisclosed details to support its charges." The violations cited in the settlement orders included Rules 13a-1 (information required in annual reports), 13a-13 (information required in quarterly reports), 13a-11 (information required in current reports, i.e. 8-Ks) and 12b-20 (information not required but necessary to make the disclosures "not misleading"). Interestingly, each respondent was also found to have violated Section 17(a) of the 1933 Act for having "offered and sold securities to its employees" at the time of the cited material omissions from the applicable reports. This dissent took issue with the SEC's determination that the omission of "the identity of the threat actor" was material (i.e., whether it "would have 'significantly altered the 'total mix' of information about [the respondent] to a reasonable investor in light of the existing public information about the cyberattack."). Another criticism is related the failure of two of the respondents to update their risk factors. This excerpt is noteworthy: "Risk factors are designed to warn investors about events that could occur and materially affect the company. To the extent that an event has occurred and has materially affected the company, it is generally required to be disclosed in another part of a filing, such as the description of the business, management's discussion and analysis, or the financial statements and the notes thereto." A spokeswoman for one of the respondents charged with violating Rules 13a-11 and 12b-20 for deficient Form 8-K disclosures was quoted by the WSJ as stating "[w]e believed that we complied with our disclosure obligations based on the regulatory requirements at that time." The filings at issue were made before the SEC adopted Item 1.05 to Form 8-K (Material Cybersecurity Incidents). #securitieslaw #securitiesregulation

WSJ article on proposed legislation to implement a "test-in" category of accredited investor. "How many questions? How will it stop cheaters? Do you need a sharpened No. 2 pencil? Those are are all open-ended questions for the regulators." A broader debate continues about the net worth and income categories of the accredited investor definition (which SEC Commissioner Mark T. Uyeda recently referred to as "all or nothing" in his published remarks at the Los Angeles Bar Association's Annual Seminar on Securities Regulation). Relatedly, one of the policy recommendations made at the SEC's 2024 Small Business Forum (report published on September 19, 2024) was to: "Expand the accredited investor definition to include additional measures of sophistication, including through an accredited investor certification course or test." An excerpt from the SEC's response: "The Spring 2024 Regulatory Agenda indicates that the SEC's Division of Corporate Finance is considering recommending that the Commission propose amendments to Regulation D, including updates to the accredited investor definition, to improve protections for investors. The Commission will consider this Forum recommendation in connection with this initiative." Back to the WSJ article on the possible test-in component, "[a] Senate aid said it shouldn't be as easy as a driver's learner's permit test, but it also can't be 'impossible'". Stay tuned. #securitieslaw #securitiesregulation

Small securities offerings are not immune from enforcement for antifraud violations. Yesterday the SEC announced settled antifraud charges against a startup and its founder in connection with a Reg CF offering that raised $141,000. As alleged in the SEC's complaint, the offering materials were misleading because, among other things, they touted the endorsement of the lead investor (i.e., the proxy holder for the Crowdfunding SPV), but failed to disclose that the lead investor: (1) was engaged to the founder and (2) had acted as a consultant to the startup in exchange for shares. According to the SEC's press release, the startup and the founder have consented (without admitting or denying the allegations) to be enjoined from violations of Section 17(a)(2) and (3) of the 1933 Act and the founder has offered to pay disgorgement of $12,990.63 plus prejudgment interest of $1,394.06 and a civil penalty of $50,000. The settlement is subject to court approval. #startups #founders #securitieslaw

WSJ article on the SEC's recent enforcement activity related to startup projections. A VC founder says that high-profile scandals have appeared to make the SEC more vocal about policing startups. This quote is telling: "Venture capitalists have gotten used to optimistic, sometimes arrogant, forward-looking projections that could work, and so they may not always scratch as deep as they should . . . That is something scammers take advantage of." #securitieslaw #securitiesregulation #startups

In the SEC's recent enforcement sweep on late Section 13(d)-(g) and Section 16(a) filings, the settlement order against Sunbeam Management, LLC seems a bit circular and somewhat harsh. The SEC found that Sunbeam violated Rule 13d-1 with a late 13D filing because it acquired convertible preferred stock on March 23, 2020 and filed a Schedule 13D reporting 14.1% beneficial ownership more than 10 days later (on May 18, 2020). The conversion right was contingent upon the issuer having enough authorized shares of common stock, but Sunbeam did not disclaim beneficial ownership under Rule 13d-4 based on this contingency. Sunbeam was also cited for a Section 16(a) violation due to a late Form 3 which it filed as a greater than 10% stockholder on May 11, 2020 (i.e., beyond the 10-day deadline). On May 20, 2020, two days after it filed the 13D, Sunbeam's counsel sent a conversion notice. On June 9, 2020 the issuer responded that it would not convert the preferred because there were not enough authorized shares of common. The SEC found that Sunbeam violated Rule 13d-2 because it failed to file an amendment to its 13D to report a "material change" in that it could no longer be deemed a beneficial owner of the underlying common stock. A couple of 13(d) reporting principles are in play here. First, a conversion contingency that is outside of the control of the holder will typically prevent beneficial ownership of the underlying shares until the contingency is satisfied. Second, although statements made in a 13(d) filing may create presumptions of beneficial ownership, they are not dispositive or binding, and that includes any Rule 13d-4 disclaimer (or lack thereof). With these two principles in mind, there seems to be support for the position that Sunbeam never beneficially owned more than 5% (for 13D purposes) or 10% (for Form 3 purposes) of this issuer's common stock and, as a result, no Schedule 13D or Form 3 was required in the first place. In other words, perhaps Sunbeam should not have been cited for a late 13D filing and late Form 3 filing because, from a technical standpoint, these filings were never required. This reasoning would negate the violation for failing to amend the 13D. In addition to being ordered to cease and desist from the cited "violations," Sunbeam was ordered to pay a civil penalty of $40,000. Ouch. Note: the deadline for an initial 13D filing is now five business days (it was 10 calendar days during the events at issue here). #securitieslaw #securitiesregulation