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The SEC Addresses Initial Coin Offerings

All Resources// Cybersecurity// Securities

On July 25, 2017, the Securities and Exchange Commission (SEC) issued a Report of Investigation pursuant to Section 21(a) of the Securities Exchange Act of 1934 (Report) [1] and an Investor Bulletin: Initial Coin Offerings (Bulletin) [2] finally weighing in on whether virtual coins or digital tokens created and disseminated using distributed ledger or blockchain technology may be “securities” under the federal securities laws.

The answer? Maybe, depending on the facts and circumstances.

Virtual Currencies, Initial Coin Offerings, and Tokens – What are They?

Recently, the sale of blockchain-based tokens through initial coin offerings (ICOs) has become an increasingly popular financing technique used by companies to raise capital to fund the development of a digital platform, software, or other project. The sale of such tokens through ICOs has been made possible through the rapid popularization of blockchain technology, the cryptographically-secured, distributed ledger that underpins virtual currencies such as bitcoin and ethereum.

Although the mechanics of ICOs may vary, one popular method of conducting a token sale is to utilize ethereum’s ERC-20 token standard, and issue such tokens through a smart contract deployed to the ethereum blockchain. In this example, individuals may participate in an ICO by sending a certain amount of ether (the token used to transact on the native ethereum blockchain, also known as ETH) to a smart contract. In turn, the smart contract will send a corresponding amount of tokens to the wallet that initiated the transaction. Thus, at the conclusion of the ICO, the company that created the token and deployed the smart contract will likely have received ether in exchange for its own token. Similarly, users who sent ether to the smart contract will typically receive tokens, which may have a number of potential uses.

Tokens purchased through an ICO may be used to, among other things, access the platform, use the software, or otherwise participate in the project. Other tokens may function to confer certain rights on the token holder, such as ownership rights, the right to share in a portion of the organization’s profits, or the right to vote on how the organization should conduct itself.

Tokens are generally fungible. After their issuance they may be sent to other persons in a manner similar to the way ether is transacted between users. Leveraging the same benefits of blockchain technology enjoyed by other virtual currencies, token transactions are recorded on the blockchain, which, through the power of complex mathematics and cryptography, functions as a reliable transaction ledger with verifiably accurate entries.

To provide a medium for the exchange of virtual coins or digital tokens after they have been issued, platforms have developed as a secondary market for trading them. These platforms, known as virtual currency exchanges, consist of persons or entities that exchange virtual currency for a fiat currency (e.g., an underlying physical currency, such as dollars), funds, or other virtual currency. The virtual currency exchanges generally receive a fee for these exchange services.

As a result of the infrastructure described above, the use of virtual coins and digital tokens is becoming a popular method to exchange and store value, manage and exercise ownership rights, and administrate other functions. However, depending on the specific attributes of a given token, it may be considered a security under U.S. law, and therefore subject the issuer to applicable laws and regulations.

Are Virtual Coins and Digital Tokens “Securities” Under U.S. Securities Laws?

Investment Contracts are Securities. Under the federal securities laws, a security is defined to include not only the typical types of instruments that everyone understands to be a security (e.g., stocks, bonds, notes, etc.), but also “investment contracts.” [3] In the seminal case of SEC v. W.J. Howey [4], the Supreme Court defined an investment contract as:

  • an investment of money;
  • in a common enterprise;
  • with a reasonable expectation of profits;
  • to be derived from the entrepreneurial or managerial efforts of others.

The SEC will apply this test to determine whether virtual coin or digital token offerings involve the offer and sale of securities subject to the federal securities laws. The first three prongs of the test generally are easy to apply, especially when the marketing materials or white papers for the offering espouse the benefits of investing in the tokens. However, applying the fourth prong of this test can be problematic and will depend significantly on the specific facts and circumstances of the offering, the function of the token, and the operation of the underlying enterprise.

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California Federal Court Allows Indirect Purchasers of Securities to Sue Issuers for Fraud Under California Statute – Colman v. Theranos, Inc.

All Resources// Securities

A federal magistrate judge in California has allowed a securities fraud suit against a late-stage private company to proceed despite the plaintiff investors holding a security interest only through intermediary, single-purpose investment funds. The opinion in Colman v. Theranos, Inc., 16-cv-06822-NC (N.D. Cal) (Apr. 18, 2017), offers several important lessons for pre-IPO companies and securities practitioners doing business in California.

Theranos, Inc. is a privately held life sciences company that touted how its proprietary technology allowed pharmacies to run highly accurate tests from just a few drops of blood.  According to the complaint, beginning in 2013 the company engaged in an extensive advertising campaign, raised over $700 million from private individual and fund investors, and won a significant contract with Walgreens.

Plaintiffs made their investments in Theranos indirectly, by buying security interests in investment funds that were set up for the sole purpose of making a direct investment in Theranos shares. In October 2015, the Wall Street Journal published an article questioning the viability of Theranos’ technology. By July 2016, the Center for Medicare and Medicaid Services imposed significant sanctions on Theranos and, by that fall, Walgreens had sued Theranos for breach of contract.

Alleging that their investments were now worthless, plaintiffs brought an action for securities fraud under the California Corporations Code and the common law on behalf of all individuals and entities who directly or indirectly purchased Theranos securities. Plaintiffs sued the company, its founder and CEO Elizabeth Holmes, and its former president and chief operating officer Ramesh Balwani. Defendants moved to dismiss.

Defendants argued that plaintiffs could not bring a cause of action under California Corporation Code section 25400(d) and 25500, which together provide a private right of action for false or misleading statements made to induce the purchase or sale of a security, because plaintiffs did not purchase securities directly from Theranos.

In an April 18, 2017 opinion, U.S. Magistrate Judge Nathanael M. Cousins denied the motion in this respect, holding that “the purpose of Section 25400(d) is [to] prevent the manipulation of the market by fraud, and it focuses on the actions of the seller of the securities, not the relationship between the seller and buyer.” Further, the court explained that neither section requires plaintiffs to prove reliance on defendants’ misrepresentations.  However, the court did acknowledge that the reach of these provisions are not unlimited and that the plaintiffs still must prove the defendants’ intent to induce the purchase of securities through the misleading statements.  As a result, this would limit a cause of action to purchasers who are reasonably foreseeable.

The court further stated that liability is not limited to the corporate entity but extends to “any person who makes false or misleading statements.” Thus, Theranos’ corporate officers alleged to have made misleading statements on behalf of the company for the purpose of inducing purchases of Theranos stock were held to be proper defendants.

In ruling on other portions of the motion, the court dismissed the count under Sections 25401 and 25501 which extends liability to certain negligent conduct because those provisions, in contrast to 25400(d) and 25500, focus on the relationship between the parties and by their terms required privity between seller defendant and purchaser plaintiff. The court refused to dismiss the remaining fraud counts, holding that reliance was adequately alleged because the complaint stated that each plaintiff relied  on newspaper articles quoting Theranos’ officers that “were part of the advertising campaign touting Theranos’ technology.”

The decision has significant implications for growing private companies in the technology sector in California, many of which reside in Silicon Valley or Silicon Beach or seek to raise funds in those areas.

The named plaintiffs each invested in an intermediary that was specially-built for the investment in Theranos, and the intermediary itself held the securities. This arrangement has become common for California late-stage private companies, particularly in the technology industry. This decision should caution issuers and their counsel in pre-IPO offerings to consider taking steps to limit the reasonably foreseeable purchasers  by better reflecting and enforcing  the transfer restrictions on the shares. Additionally, the issuer should take additional steps to inform the investing intermediaries that any further sale or securitization of these shares are prohibited and will be null and void.

Intermediaries themselves should also proceed with caution. The court addressed this as a postscript, requiring additional briefing on the subject of whether adding the intermediaries as “necessary parties” under Rule 19 would disturb venue.

Lastly, it is surprising how little analysis was given to the alleged false statements. The securities laws typically distinguish between corporate advertising to consumers and statements intended to solicit an investment. In this case, the basis for the alleged false statements was the “advertising campaign,” which could have been interpreted as designed to persuade consumers to use Theranos’ products and to win additional wholesale business through new contracts with pharmacies, rather than to solicit investments. But the court accepted plaintiffs’ allegations that statements made in the advertising campaign were for the purpose of raising capital. Late-stage private companies should consider carefully reviewing any advertising and related marketing efforts taking place within a reasonable period of time in advance of any anticipated capital raise with a view to limiting unnecessary hyperbole and any reference to the value of the company or its securities.  Further, private companies also should consider  including appropriate cautionary language and disclaimers on their advertising.

What Every Company’s Board Must Know About Cybersecurity

All Resources// Cybersecurity// Securities

In recent years, data breaches at some of the world’s largest corporations have made news. But smaller companies are just as vulnerable, and must take steps to protect their data. In addition, businesses that serve as vendors to other businesses face increased scrutiny of their cyber preparations. The board of directors plays a critical role in this effort, as Jo Cicchetti, Chair of the Carlton Fields Data Privacy and Cybersecurity Task Force, explained during a recent conversation.

Why is cybersecurity a board concern?

The board’s primary responsibility is to protect the company’s assets and interests on behalf of the shareholder, and cyber risks pose serious threats to the business operations and reputation of the business. So, the board must take into account cybersecurity risks as part of its enterprise risk management duties.

Describe the risks posed by a breach?

If the worst happens, a company could sustain financial and business losses, damage to its infrastructure and reputation. Customers, business partners and regulators could bring legal actions. Class actions from customers could result, and the board could face shareholder derivative suits, alleging that it and its members did not meet their duty of care and/or duty of loyalty to the corporation. Not to mention regulatory enforcement actions that could also result. So, the stakes are high.

What must the board know about cybersecurity?

Board members are not charged with becoming IT specialists—they don’t have day-to-day management responsibility for the issue. But the board needs to know that cyber risks are being handled properly, that the company is taking steps to prepare for any cyberattack, can detect cyber intrusions and when they do happen can respond properly. It must make sure that management has an incident response plan. The board must ask its managers—such as the chief legal officer, chief privacy officer and chief information security officer—particular questions such as: How is the company managing data security? Do we have internal written information security programs [WISPs]? What are the threats particular to the company’s business? What security framework is the company using? Which risks to avoid, accept, or mitigate and what is the plan related to each? How are employees being trained? How do we manage our vendors? What plan is in place for breach response, and who is in charge of that plan?  Those are just some of the questions, but the important thing is that every department of the company—legal, IT, HR, operations—needs to communicate and work together. There can’t be a silo mentality.

How active a role should the board take with respect to cybersecurity?

Board members must take a regular and active role to make sure that cybersecurity and data governance issues are regularly reported to them by management. The topic should appear on the agendas for their quarterly meetings, and someone from either IT or the general counsel’s office should make a report addressing what’s happened in the last quarter—have there been incidents or events, and how have they managed any situations that arose? Vendor compliance should also be discussed, as well as any threats that result from customers’ and third-party access to company information systems, and how to address them. Also, the board needs to know that the right professionals are in place to advise the company.

Who are the right professionals?

A company needs access to technology experts, forensics experts, and privacy counsel. They need not necessarily be on staff, but must be identified and retained in case their services are ever needed. Everybody needs to be prepared and ready to go if a problem develops. You also need to have outside counsel onboard. The first 24 hours are critical. Retaining a public relations professional is also a good idea.

How else can the board help prevent data breaches?

The board cannot prevent data breaches, but there is a lot that can be done, and the board needs to know that the right steps have been taken. For example, employee training programs are critical because data breach situations often arise as a result of employee error or misconduct. There must also be a protocol or plan for incidents, and vendor due diligence and oversight is also important. Protecting against threats requires a multidisciplinary approach that involves the chief legal officer, chief information security officer, and human resources all working together. And, board members need to ask these people the right questions, which might include: What security frameworks are we using? Which company assets are the ‘crown jewels’ that need protection? What are the legal implications of cybersecurity incidents, and how do we avoid them? What risks should we accept? Do we get insurance? How are our employees being trained? What kind of testing do we do?

What role should cyber risk insurance play in a company’s overall plan?

Right now, cyber risk insurance is an evolving area. It is very expensive and doesn’t eliminate a company’s need to have a data security plan and proper implementation. The insurance company underwriting the policy will want to know that the company is taking the right steps before it insures the risk. Ultimately, if a company hasn’t done what it told its insurance company it would do, its coverage could be jeopardized.

How do state breach laws impact a company’s data breach strategy?

There is a patchwork of 50 state laws. A company’s legal department must understand the legal requirements in each of the 50 states. Normally, companies solve to the most difficult jurisdiction, setting up procedures that comply with the most stringent requirements where possible. The process is further complicated by the fact that states also differ in how they define a breach. And the laws are constantly changing. For companies without large internal legal resources, outside experts—such as privacy lawyers and technology consultants—are critical.

Is there any way to eliminate the risk?

There’s no way that anyone—even an organization with all the money and time in the world—can prevent attacks 100 percent of the time. Even the NSA, with its unlimited resources, was hacked. Companies just need to make sure they’re taking reasonable steps to deal with the risks and continue to stay informed. This is an area where it is very important to keep up with the Joneses.

Tips for Effective Succession Planning

All Resources// Securities

Continuing the legacy of successful businesses, and especially privately owned or family owned businesses, is a key value and goal of succession planning. Owners of these businesses, however, who typically spend most of their days worried about gaining market share, hiring and retaining motivated employees, and outrunning the competition, usually fail to give succession planning any thought, much less seek advice about the subject. The reasons for their inattention to succession planning include:

It requires business owners to confront their own mortality—which is the same reason many people defer or delay writing a will. Successful and energetic managers find it hard to imagine letting anyone else take charge, including a family member or key employee. For most business owners, maintaining control is central to their identity.

  • Succession planning, a multi-faceted and complex subject, can appear daunting.
  • Owners know any succession choice will likely alienate those who are passed over, potentially upsetting key people in the organization—who may leave.
  • If employees include the owner’s family members, family dynamics—good and bad—will be involved, making most owners dread succession planning.
  • Most business owners simply don’t know how to approach it.

Benefits of Effective Succession Planning

Succession does not always unfold as the owner envisioned—for example with a trusted successor stepping in once the owner reaches a ripe old age. Instead, the owner may suddenly die, become incapacitated, or receive an employment offer too good to refuse—perhaps to become a university president or take a high-level government post. In these cases, business owners or their families may enter crisis mode, making hasty, and often ill-advised, decisions. Effective succession planning creates a stable and sustainable platform that helps to guide the company forward with a solid management team to assure management succession and an ownership structure that removes uncertainty about ownership succession. As we will see, ownership succession and management succession are two very different matters.

An added benefit of effective succession planning is the stability it offers lenders, investors, suppliers, vendors, and customers. It also preserves and protects one of the most critical, expensive, and often overlooked assets of any business—its people, who possess a wealth of experience, knowledge, and intellect. Partly because effective succession planning can serve as a powerful hiring and retention tool, it can perform double duty by also helping to address challenges that seem more pressing, like growing the business and beating the competition.

Like any other business strategy, succession planning is a tool and a process, not a cure-all. Effective succession plans will not singlehandedly bring a business new customers, greater profitability and market share, or improved employee relationships.

Succession Plan Components

A succession plan must clearly communicate a series of decisions that specify, among other things, how ownership and management will transition when certain events occur. While ownership transition and management succession are usually synonymous, they are not always linked. The owner should not blur the two concepts, which involve separate and distinct considerations.

Other key succession plan components include creating equity or equity-based incentives for key employees and effective evaluation processes—for the plan itself and for personnel.

An effective succession plan for companies that lack outside or independent directors, should consider adding this component to the corporate governance structure. The primary distinction between a succession plan and an effective succession plan is that the latter incorporates most of these components, creating a more holistic solution. Above all, an effective succession plan must be flexible, changing as the business evolves.

The Succession Planning Process

Every owner, business, and situation is unique—there is no such thing as one-size-fits-all succession planning. But effective succession plans share enough elements to suggest basic steps that can be adapted to meet the needs of a given business or owner.

  • Consider the various constituents. To create an effective succession plan, the owner must first set the stage by considering the abilities of present management; the incentives, if any, that exist to hire and retain talent; and whether future leaders are already in place.
  • Identify the main characteristics a successor should possess. No successor can, or should, be the owner’s clone. New skills and ideas contribute to an effective succession plan and help the business progress. Current owners should work with their advisors to determine the talents and qualities most critical in a successor.
  • Determine how to find those most likely to fit the established criteria.Options include an initial search by the company’s board, both within and outside the organization; and the use of a professional search firm. The owner may also identify promising potential successors within the company.
  • Ensure a rigorous and inclusive selection process. Even if the owner wants a particular child or another relative to take over the business, it is crucial to conduct a rigorous examination that assesses the strengths and weaknesses of several potential candidates. Key employees and others with intelligence about the business must be brought into the process, and included in the universe of potential candidates.
  • Make a decision. Once criteria have been set and the search conducted, the owner must make a choice. Many succession plans fail because the owner goes through the process only to decide that no candidate is sufficiently talented, bright, or experienced. So, no decision is made. This demoralizes employees, increasing their sense of being disenfranchised. It also costs the owner credibility, making it extremely difficult to repeat the process.
  • Communicate the decision companywide. This step involves a risk that someone who was passed over may leave. But the risk can be minimized if the plan is effectively communicated and a team approach is taken. For example, the risk of undesired attrition can be reduced by using the equity and equity-based compensation techniques described below.
  • Ensure periodic review of the plan’s components and ultimate succession decision. Simply anointing a successor does not end the process. As business circumstances change, the succession plan and its effectiveness must be reassessed. This is not an opportunity for owners to simply change their minds. Rather, it is a chance to refresh the plan’s vitality and confirm the decisions made. The selection should change only if there is a significant modification in performance or business circumstances.
  • Address ownership succession. The succession plan should include, or at least reference, other strategies the company will implement that go beyond management succession to address ownership succession.
  • Provide for emergencies. Effective succession planning should identify processes or strategies for handling emergency situations, including death, incapacity, or unanticipated departure. Just contemplating these situations will help the owner, or the board, be prepared to make informed decisions as opposed to frantic ones.

Who to Involve in the Succession Planning Process

A business owner should consult with a number of resources to help create an effective succession plan. Usually, over time, business owners develop relationships with trusted financial advisors, bankers, legal counsel, accountants, and colleagues. Additionally, the board of directors should play a strong role in creating and implementing the succession plan. However, it is dangerous to involve too many people. The result can be too much noise and not enough action. It is most important to include people with different perspectives so the resulting succession plan reflects a comprehensive approach.

It is also important to ensure that there is a formal method, which includes specific goals, objectives, and defined timelines, that allows the process to be monitored and evaluated as it proceeds. Specific tasks may be delegated to smaller groups. For example, some people may be tasked with determining how other similarly situated companies, perhaps including competitors, handle succession planning. An effective succession planning process must be subject to adjustments, modifications, and revisions as it evolves.

Succession Planning and Incentives

One significant byproduct of the succession planning process is learning that the company may need more depth and experience in certain areas. This realization may require making hires or exerting stronger efforts to retain key people. Creating successful incentives is extremely important for an effective succession plan.

The owner should consider both cash and equity-based incentives. The latter are often used to attract new hires and retain key executives while simultaneously allowing the current owner to effect a gradual change of the organization’s control.

An employee stock ownership plan, or ESOP, might be appropriate for business owners who want to ensure their employees retain a significant stake in the enterprise. A detailed discussion of ESOPs is beyond the scope of these materials. Essentially, ESOP’s are tax-advantaged structures that allow a company’s employees to acquire ownership from the current owner. Numerous issues determine an ESOP’s viability, and ESOPs are not solutions for many businesses. But in the right circumstances, they can be part of an effective succession plan.

Several other equity or equity-based plans can provide incentives to hire and retain key personnel. They include stock options, restricted stock purchases, stock appreciation rights, and phantom stock plans.

With the exception of ESOPs, the incentives described above involve incremental, as opposed to one-time, changes of control. They provide a platform that creates a group of enterprise owners who are presumably vested in the company’s success. Because in most cases their ownership vests over time, these owners develop an increasing stake in the company.

In addition to these plans, which generally prove highly effective, an owner can use other techniques to shift ownership to a designated successor, whether family member or key executive. These strategies usually involve a direct sale of equity over time and with appropriate vesting schedules. As a result, the equity is effectively earned and paid for with cash, services, or both.

There are also numerous estate-planning techniques that involve transfer of ownership to grantor trusts and the use of single member limited liability companies. These are useful as part of an effective succession plan. These sophisticated, complex transactions can provide meaningful and effective strategies for succession planning.

All of these plans can be structured in combination. Many companies employ a variety of them, creating a wide spectrum of equity-based incentives for key employees. Each strategy involves significant legal, tax, and accounting issues. Owners should consult their tax and legal advisors to assure that these plans are structured and implemented in the most efficient and cost effective way.

Evaluation and Documentation

An effective succession plan should be in writing and rigorously referenced during the plan’s implementation phase. This helps those responsible for implementation, keeps the process sustainable, and assists when evaluating the plan’s success.

Senior management and the board should regularly review the plan to determine whether it remains effective or requires revisions. The succession plan itself must be as dynamic as the selection process. It cannot be viewed as an immutable, irrevocable document. Rather, it is an evolving expression of the future needs and goals of the enterprise.

It is equally important that ancillary aspects of the succession plan, especially those addressing ownership transfers, be thoroughly and carefully documented. This results in clarity and mutual understanding of the terms and conditions of ownership transfers. It also enables future beneficiaries to understand the plan’s components, expectations, and mandate. This is especially important when addressing issues like performance criteria and vesting schedules.

When direct equity transfers—as opposed to deferred compensation plans such as stock appreciation rights or phantom stock plans—are involved, it is critical to execute a written shareholders agreement (or operating agreement in the case of a limited liability company). These agreements typically address issues related to management, governance, and equity transferability. They are essential to avoid, or at least minimize, future disputes over ownership, management and control.

Last, if the company lacks an effective personnel evaluation policy, it should consider implementing one as part of its succession plan. These policies help identify potential leaders and successors. They also provide a guide to successfully mentoring talent, and developing a broader, more inclusive management team.

Common Mistakes

Succession plan horror stories abound. Most succession planning mistakes, which can produce a host of unintended consequences, can be attributed to poor planning, lack of foresight, and inattention to detail. Others can be chalked up to owners who lack commitment to the process. They fuel dissension by wavering and failing to follow through.

In many ways, succession planning resembles any other strategic or business plan that companies undertake to identify new customers or markets. All require analysis, planning, commitment to implementation, monitoring, periodic evaluation, and adaptability, as well as buy-in from owners, family members, and key employees. Failed plans lack these components or inadequately focus on them.

An effective succession plan should not be considered an end. Rather, its continued success requires that it be viewed as a beginning.

Conclusion

An effective succession plan can guide a business owner, creating a roadmap for success. It can also help owners attract and motivate successful employees. When owners commit to creating and implementing effective succession plans that embrace comprehensive programs for transferring management responsibility and equity ownership, they can experience the rewards of creating lasting legacies for their businesses. Moreover, in emergency situations, an effective succession plan can literally save the company’s life.

10 Practical Compliance Tips for Growing Companies

All Resources// HR & Employment// Immigration// Securities

Florida companies need to be aware of the high risks and possible penalties, monetary and civil, of failing to comply with the federal laws that govern the documentation of newly-hired employees. Specifically, these laws require employers to complete and maintain Form I-9 (employment verification form). The federal government has increased the number of worksite enforcement actions in the past five years from 250 employers in 2007 to more than 3,000 employers in 2012. Immigration-related audits can lead to significant losses in productivity, criminal fines, and sizable legal expenses. Audits may also lead to unwanted press coverage regarding immigration and hiring practices.

The following practical tips can help keep your company compliant and ready for a possible audit from the U.S. Customs and Immigration Enforcement (ICE), the government agency responsible for the I-9 program.

1. Complete an I-9 for every new hire

The 1986 law, Immigration Reform and Control Act (IRCA), mandated that every employer, regardless of the number of employees, complete an I-9 form verifying the employment authorization of each employee who is a new hire. The form must be completed within three days of hire. Failure to complete the I-9 within the three days can lead to civil fines, criminal penalties, or debarment from government contracts. The I-9 form can be printed from the USCIS website. Print all sides of the form and present the list of acceptable documents to all new hires. The most current I-9 form is dated March 8, 2013. Use only that version.

2. Ensure that the employee completes the correct I-9 section

The I-9 form is divided into three distinct sections. Only the employee can complete Section 1 of the form, including the attestation box regarding citizenship status. The employer cannot complete this section under most circumstances. The employee must sign and date the I-9 form.

3. Ensure that the employer (or its agent) completes the correct I-9 section

The employer or its designated agent must complete Section 2 of the form and review the original documents presented by the employee to demonstrate work authorization. The employer is only allowed to accept for review original documents listed on the back side of the I-9 form. Physically examine each original document to determine if it reasonably appears to be genuine and to relate to the person presenting it. The person reviewing must be the person signing Section 2. The only document that need not be an original is a certified copy of a birth certificate.

4. Employers cannot request specific documents from the employee

The employee can choose from among three lists of acceptable documents to present to the employer. They include List A documents that show both identity and work authorization, such as U.S. passports and passport cards; or a combination of documents that establish identity (List B) and authorization (List C), separately. An employer is prohibited by law from requesting specific documents. It is the employee who must select the documents from List A, or List B and List C. Requesting specific documents from a new hire may lead to a charge of discrimination or document abuse. Further, refusing to hire an individual because the document has a future expiration date may also constitute illegal discrimination.

5. Employers should know how long to retain I-9s

Employers need to know when to discard I-9s so as to limit exposure in the event of an audit. ICE may issue fines for improperly prepared or maintained forms even if the employer was no longer obliged to maintain the forms. The rules require the employer to retain I-9s for either three years after the date of hire or one year after termination or departure, whichever is later. Keep current I-9s separate from I-9s for terminated employees for ease of reference in the event of an audit.

6. Employers should timely update forms when necessary and develop a call-up system

Employers must request new documents (re-verify) when employees submit documents with expiration dates. It is critical for employers to review documents at the time of hire, record the expiration dates, and set reminders for future action. Employers should set reminders to call up forms requiring updates 30 days in advance of expiration to allow sufficient time for updating. Rehires (past employees who return to the employer) can either complete a new I-9 form or have an old form updated if rehired within three years of the date of the original I-9 completion. Be aware that U.S. citizens or lawful permanent residents (green card holders) who presented a green card in Section 2 do not have to be updated.

7. Employers should know which employees must complete an I-9 form

Knowing who needs to complete an I-9 form can help prevent charges of discrimination or document abuse. Federal law states that employers are not required to complete I-9 forms for several categories of employees: 1) individuals hired before November 7, 1986; 2) individuals hired after November 7, 1986 who left the job before June 1, 1987; 3) domestic workers at homes or those engaged in sporadic, intermittent, or irregular work; and 4) independent contractors, i.e., leasing companies; or employees not physically present on U.S. soil.

8. Employers should institute and maintain an I-9 completion and maintenance policy

Employers should have a written I-9 completion and maintenance policy and disseminate to all staffing, human resources, or other parties responsible for hiring, particularly those designated to complete and maintain I-9s on the employer’s behalf. The policy should be clear and concise and reviewed periodically to ensure the most current I-9 form is being used.

9. Employers should conduct I-9 training for human resources or designated employer representatives

It is wise and cost effective to hold I-9 trainings at least twice annually, and to make attendance mandatory. Make the USCIS Handbook for Employers: Guidance for Completing I-9 (Employment Eligibility Verification Form)(M274) required reading for employees responsible for I-9 completion. This handbook was updated on April 30, 2013 and can be found online at www.uscis.gov. Additionally, keep color copies of the acceptable documents (found in the handbook) readily available for ease of reference. Always ensure that the most current I-9 is used. Periodically check I-9 Central for updated Form I-9 information.

10. Employers should have experienced and knowledgeable immigration counsel

Employers benefit from having immigration counsel who are trained in I-9 compliance and ready to review documents presented by new hires. These counsel can address I-9 retention issues, issues regarding I-9 completion or maintenance programs, and be available for internal audits or to address and prepare the employer for a possible I-9 audit following a visit from ICE. Immigration counsel can also conduct I-9 training for the employer’s designated employees.

Jobs Act Revamped by Fast Act

All Resources// Crowdfunding// Entrepreneurship// Securities

The Jumpstart Our Business Startup Act of 2012 (the “JOBS Act”) was enacted on April 5, 2012 in an effort to make it easier for certain emerging growth companies (EGCs), generally defined as companies with annual gross revenues of less than $1 billion during their most recent fiscal year, to pursue initial public offerings (IPOs), while also making it easier for companies to raise capital in private offerings and stay privately-held longer. The JOBS Act’s overall goal was to enhance access to the capital markets while reducing the costs to raise such capital and, as a result, enable companies to obtain the funds necessary to expand their businesses and, in turn, hire additional employees.

Specifically, the JOBS Act significantly eased the IPO process for EGCs by, among other things: (1) allowing EGCs to test the waters to determine if there was adequate interest in an investment in the company before filing a registration statement with the Securities and Exchange Commission (SEC) and providing a pre-filing confidential review by the SEC staff of the proposed registration statement, (2) scaling back certain disclosure obligations of EGCs, and (3) phasing in compliance with certain corporate governance provisions of the Sarbanes Oxley Act of 2002.

In addition to easing the burden on EGCs to engage in IPOs and become public companies, the JOBS Act added provisions designed to enhance companies’ ability to raise funds through transactions that are exempt from registration under the Securities Act. In particular, the JOBS Act: (a) eliminated the prohibition against general solicitation or general advertising in connection with certain private offerings under Rule 506 of Regulation D, (b) adopted a crowdfunding exemption from registration (which takes effect May 16, 2016 under the SEC implementing rules), and (c) increased the thresholds to conduct offerings of up to $50 million under Regulation A.

The JOBS Act also increased the minimum thresholds that trigger the registration requirements under the Securities Exchange Act of 1934 (“Exchange Act”) and, as a result, provided more flexibility for companies to avoid such registration.

However, just three and one half years after enactment, Congress determined that the JOBS Act needed updating. Consequently, as a part of the Fixing America’s Surface Transportation Act (the “FAST Act”), which became law on December 4, 2015,  Congress updated the JOBS Act in five primary ways: (1) reducing further the burdens on EGCs to pursue IPOs; (2) revising the Form S-1 registration statement to make it easier for smaller reporting companies to use, (3) establishing a new private resale exemption from registration;  (4) requiring the SEC review and make recommendations on the modernization and simplification of disclosure requirements under Regulation S-K; and (5) revising the Exchange Act to clarify that the registration thresholds established for bank holding companies apply to savings and loan holding companies.

With the exception of the changes to Form S-1 and the review of Regulation S-K to be undertaken by the SEC, these FAST Act provisions are self-executing. In response to the enactment of the FAST Act, the SEC’s Division of Corporation Finance (the “Division”) issued an announcement on December 10, 2015 containing certain of its views on the application of the FAST Act under certain situations (the “Announcement”), issued and updated certain of its interpretative guidance on December 21, 2015 (“Interpretative Guidance”), and on January 13, 2016 adopted interim rules implementing the mandated changes to registration statements on Forms S-1 and F-1.

Reduced Burdens For IPOs of EGCs

The FAST Act amended the JOBS Act to provide EGCs with additional flexibility to raise capital in three primary ways:

  • Reduced Waiting Period Prior to a Public Offering: Previously, an EGC was required to publicly file its registration statement and all previously submitted drafts with the SEC no later than 21 days before the date on which the EGC conducted a road show. The FAST Act amended Section 6(e)(1) of the Securities Act of 1933 by reducing the waiting period from 21 to 15 days. Consistent with its JOBS Act interpretations of Section 6(e), the Division stated in the Announcement its view that if an EGC does not conduct a road show, the non-public drafts must be filed at least 15 days before the effectiveness of the registration statement. This revision permits an EGC to bring its offering to the market in a shorter period of time and correspondingly reduce the risks associated with changing markets during the waiting period.
  • Grace Period for Change of Status of EGC: Previously, an issuer would lose its status as an EGC if it had over $1 billion in revenue in the preceding fiscal year. Under certain circumstances, due to the length of the IPO process, an issuer that had originally qualified as an EGC when it commenced the IPO process could and would lose its EGC status on January 1 of the following year if it exceed more than $1 billion in revenue in the prior year. Consequently, an issuer that lost its EGC status would have to make additional disclosures, incur additional costs in connection with its IPO, and be burdened by additional regulatory compliance requirements. To rectify that situation, under the FAST Act, an issuer that is qualified as an EGC at the time it submitted a draft confidential registration (or publicly files a registration statement) statement will continue to be treated as an EGC through the earlier of (1) the date on which the issuer consummates its IPO or (2) the end of the one year anniversary of the issuer losing its EGC status. In the Announcement, the Division stated that EGCs with registration statements pending at the time of enactment of the FAST Act may rely on the provision.
  • Omission of Certain Financial Information: Prior to the FAST Act, the SEC would not review an IPO registration statement unless the historical financial statements provided were for the period of time required by SEC rules. Under the FAST Act amendments, EGCs may omit historical financial information for an IPO if (1) the omitted financial information relates to a historical period the EGC reasonably believes will not be required at the time of offering, and (2) prior to the distribution of a preliminary prospectus to investors, the registration statement is amended to include all financial information required. This provision was to become effective 30 days after the date of enactment of the FAST Act. However, the Division stated in the Announcement that it would not object if EGCs applied this provision immediately.

Additionally, on December 21, 2015, as part of its Interpretative Guidance, the Division issued two interpretations:

  • The Division clarified that the interim financial information referenced in the statute “relates” to both the interim period and to any longer period (either interim or annual) into which such financial information has been or will be included. An EGC issuer may not omit interim financial statements from its filing or submission that will be included within required financial statements covering a longer interim period or annual period at the time of the offering, even though the shorter period will not be presented separately at the time of filing. The Division provided the following example:

[C]onsider a calendar yearend EGC that submits or files a registration statement in December 2015 and reasonably expects to commence its offering in April 2016 when annual financial statements for 2015 and 2014 will be required. This issuer may omit its 2013 annual financial statements from the December filing. However, the issuer may not omit its nine-month 2014 and 2015 interim financial statements because those statements include financial information that relates to annual financial statements that will be required at the time of the offering in April 2016.

  • An EGC issuer may omit financial statements of other entities from its filing or submission if it reasonably believes those financial statements will not be required at the time of the offering.

The revised financial statement requirements will eliminate the need to include (and pay for) an audit of a fiscal year that will not need to be included at the time the registration statement is expected to be declared effective. The EGC also will not need to prepare unaudited quarterly financial statements for periods that will not be included in the final prospectus.

These statutory changes were effective upon enactment of the FAST Act.

Revisions to Form S-1 to Reduce Registration Costs for  Smaller Reporting Companies

The FAST Act seeks to reduce the costs for smaller reporting companies (SRCs) using the Form S-1 registration statement (which is the primary form used by SRCs for IPOs and resales by selling securities holders) by permitting SRCs to incorporate by reference filings made with the SEC after the date that the registration statement has been declared effective. SRCs generally are companies that have a public float of less than $75 million on the last business day of the company’s second quarter or, if there is no public float, had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

Prior to this provision’s implementation, SRCs were only permitted to incorporate by reference filings made with the SEC before the date that the registration statement has been declared effective. As a result, SRCs using a Form S-1 registration statement were required to continually update the registration statement by filing supplements or post-effective amendments with the SEC. This process imposed a costly financial burden on such issuers and slowed down the offering process, especially in instances where the offering involved shelf registration or resales by selling securities holders. By permitting SRCs to incorporate SEC filings by in the future in a Form S-1, the shelf offerings and secondary sales process will become less cumbersome because the Form S-1 registration statement may be automatically amended through the filing of certain periodic reports under the Exchange Act.

Notably, the implementation of this provision required rulemaking by the SEC and, on January 13, 2016, the SEC issued interim rules that permit SRCs to use the incorporation by reference of future filings made with the SEC in Form S-1, commencing January 18, 2016.

New Private Resale Exemption From Registration

Securities of a private company acquired in private investment transactions or held by control persons of the private company often are illiquid for a period of time because there is no applicable specific exemption under the Securities Act of 1933 (“Securities Act”) for the resale of securities by securities holders. The primary exemptions under Sections 4(a)(1) [transactions other than by an issuer, underwriter, or dealer] and 4(a)(2) [transactions by an issuer not involving a public offering] of the Securities Act do not provide a specific exemption from registration for resales by private investors.

Under Section 4(a)(1), an investor reselling shares acquired in a private investment transaction (“restricted shares”) may be deemed an “underwriter” if the shares were purchased from the issuer with a view to further distribution. Because this standard relates to a state of mind at the time of purchase, it is difficult for an investor to become comfortable that his or her motives will not be second guessed in hindsight. Although Rule 144 was established as a safe harbor for resales of such shares (and under which the selling shareholder will not be deemed an “underwriter”), this rule establishes a holding period and has other requirements that must be satisfied as a condition to reliance thereupon. Section 4(a)(2), the so-called private placement exemption, is only applicable to issuers and not to selling shareholders.

Prior to FAST Act, a common-law and industry practice was developed whereby private resales of restricted securities were considered exempt from registration so long as the private resales followed the same sales practices used in connection with private placements by issuers pursuant to Section 4(a)(2) of the Securities Act. This was often referred to as the “Section 4(a)(1½) Exemption.”

To address the potential illiquidity of securities acquired in private investment transactions, which may impede private investment in growing companies, the FAST Act, in essence, codified the Section 4(a)(1½) common law exemption by adopting a new exemption from registration under Section 4(a)(7) of the Securities Act.

Section 4(a)(7) provides that private resales of restricted securities will be exempt from registration if the following specific requirements are met:

  • Each purchaser is an accredited investor;
  • No general solicitation or advertisement is used;
  • If the transaction involves non-reporting issuers, such issuers must make available to the prospective purchaser and to the seller certain general information about the issuer, the securities being sold, and certain financial information of the issuer;
  • Issuer of the securities must be engaged in the business and must not be in the organizational stage or in bankruptcy, or be a blank check, blind pool or shell company with no specific business plan or purpose;
  • The security to be resold is not part of an unsold allotment to, or a subscription or participation by, an underwriter of the securities;
  • The transaction is not be conducted by the issuer or a subsidiary of the issuer;
  • Neither the seller nor any person that has been or will be paid in connection with the transaction is disqualified as a bad actor under Regulation D or is subject to statutory disqualification;
  • If the seller is a control person of the issuer, it must provide a brief statement regarding the nature of the affiliation and a certification that the seller has no reasonable grounds to believe that the issuer is in violation of any securities laws or regulations; and
  • The security must be of a class that has been authorized and outstanding for at least 90 days prior to the date of the transaction.

By meeting the above described criteria and certain other requirements, the securities will be considered “covered securities” under Section 18 of the Securities Act, and will be exempt from registration under state blue sky regulations. However, securities sold under Section 4(a)(7) exemption will be deemed restricted securities within the meaning of Rule 144.

This statutory exemption from registration may be useful for holders of restricted shares and affiliates of the issuer holding shares (“control shares”) who: (1) wish to sell the shares before the expiration of the holding period set forth in Rule 144, and (2) are affiliates and want to sell shares in excess of the 1 percent limitations of Rule 144. Although this exemption is available for resale of shares issued by either public or privately-held companies, it may be more difficult to use if the issuer is not a reporting company because the seller will need the issuer’s cooperation to provide the required information to the purchasers.

These provisions were effective upon enactment of the FAST Act.

Disclosure Modification And Simplification

Building on the JOBS Act mandate that the SEC undertake a study to simplify and modernize the disclosure requirements of Regulation S-K, the FAST Act requires the SEC to revise Regulation S-K as follows by June 1, 2016:

  • promulgate regulations that permit issuers to present a summary page on Form 10-K, so long as they include cross-references to the material contained in Form 10-K to which it relates.
  • scale or eliminate duplicative, overlapping, outdated, or unnecessary requirements of Regulation S-K for all issuers in order to reduce the burden on EGCs, accelerated filers, SRCs and other small issuers.

The FAST Act also requires the SEC to conduct a study to assess the requirements contained in Regulation S-K, with the goal of: (1) determining how to best modernize and simplify such requirements in a manner that reduces costs and burdens on issuers while still providing all material information, (2) emphasizing a company by company approach that allows relevant and material information to be disclosed to investigators without boilerplate language or static requirements while preserving completeness and comparability of information across registrants, and (3) evaluating methods of information delivery and presentation, and exploring methods for discouraging repetition and disclosure of immaterial information.

Savings And Loan Holding Companies

The FAST Act also amended Sections 12(g) and 15(d) of the Exchange Act to provide equal treatment of savings and loan holding companies to bank holding companies as follows:

  • Savings and loan holding companies will have a Section 12(g) registration obligation if there is a class of equity security held of record by 2,000 (rather than 500 non-accredited investors) or more persons and there are $10 million in assets.
  • The threshold for Section 12(g) deregistration and for suspension of reporting under Section 15(d) is increased to 1,200 persons from 300 persons.

In response to the enactment of these amendments, the Division issued an Interpretative Guidance which provides that:

  • Savings and loan holding companies will be treated in a similar manner as bank holding companies for purposes of registration, termination of registration, or suspension of Exchange Act reporting requirements.
  • If a savings and loan holding company has filed an Exchange Act registration statement and the registration statement is not yet effective, then it may withdraw the registration statement. However, if a saving and loan holding has registered a class of equity securities under Section 12(g), it will need to continue that registration unless it is qualified for deregistration under Section 12(g).
  • If a class of securities of a savings and loan holding company is held of record by less than 1,200 persons, it a may file a Form 15 to terminate a Section 12(g) registration. The Division further advised that the savings and loan holding company should include an explanatory note in its Form 15 filing indicating that it is relying Exchange Act Section 12(g)(4) to terminate its obligation to file reports. Importantly, since Form 15 terminations are effective 90 days after the date of filing, the savings and loan holding company should continue to file all applicable reports required under the Exchange Act until the termination is effective.
  • A savings and loan holding company may suspend its obligation to file reports under Section 15(d) of the Exchange Act with respect to any class of securities held of record by less than 1,200 persons as of the first day of the current fiscal year, and such suspension would be deemed to have occurred at the beginning of the fiscal year. (unless that savings and loan holding company has a registration statement that has become effective or is updated during the current fiscal year (other than updating pursuant to Section 10(a)(3) of the Exchange Act and no sales have been made under the registration during the current fiscal year)).

These amendments were effective upon enactment of the FAST Act.

Guide to Equity & Deferred Compensation Plans

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The following summary is intended as general information and not specific legal advice. It serves as a basic guide to equity plans and deferred compensation plans for privately-owned businesses.

Direct Equity

This form of award or reward involves the actual issuance of stock (or membership interests in the case of an LLC) to a participant. Usually, the grant is structured as a sale and the securities vest over time to assure continued service or employment. In some cases, the participant signs a promissory note to pay for the securities and the note is amortized through bonus payments over the life of the note. In other cases, the note is forgiven over time depending upon performance. The characterization of the payments can result in different tax consequences to the participant. Often, if income tax liability attaches, bonuses are often given on a grossed up basis to absorb the tax cost and results in no cash out of pocket to the employee.

In the event of a sale of the company or an IPO where the participant sells his/her securities, the resulting gain is usually capital gain. In addition, in order to reward employees for their efforts in positioning the company for a sale or an IPO, all unvested shares typically will vest at the time of the transaction.

The securities are “restricted,” meaning that they cannot be transferred or sold and if the participant leaves the company, there are usually buy-back provisions that assure return of the securities to the company. There are a variety of means for accomplishing this. For example, if the participant is terminated for cause, then the repurchase price might be book value, which could be less than the original purchase price.

This type of securities program is typically known as a restricted stock purchase plan.

Another type of direct equity program is one that permits eligible employees to purchase a certain number of company securities each year at then current value through payroll deductions. Again, the ownership of these securities typically vests over time to assure continued employment. This type of program also typically includes buy-back rights.

In all of these cases, because stock or membership interests are actually issued to the participant, then to the extent ownership has vested, the participant can vote the securities – if they are voting securities – and he/she is also entitled to a pro-rata share of any dividends or distributions. In some cases, the restricted stock is issued into escrow thereby allowing for voting rights and dividend participation.

Options

Another form of equity programs involves the issuance of stock options to eligible participants. These options typically take two forms. The first type is known as an ISO or Incentive Stock Option. These options have certain income tax advantages and do not constitute compensation to the employee, either at the time of grant or at the time of exercise. An ISO gives the employee the right, but not the obligation, to purchase securities at a fixed price over a certain time period (no more than 10 years). To qualify as an ISO, the exercise price must equal the fair market value of the securities at the time of grant. If the employee exercises an ISO, he/she will be issued the number of shares covered by the option upon payment of the exercise price. In some plans, the purchase price can be evidenced by a promissory note. Typically, an employee does not recognize taxable income at the time of grant or at the time of exercise and upon sale of the underlying securities any gain on the securities is treated as capital gain.

The second type of option is known as a non-qualified stock option, or NQSO. These options may be issued at exercise prices less than then current fair market value, but if so, there can be adverse tax consequences to the participant including tax penalties under some circumstances. Also, an NQSO can be exercised over a longer period than 10 years. Upon exercise, the difference between the exercise price and the market value of the securities at the time of exercise usually constitutes additional ordinary income for the participant and a corresponding deduction for the company for compensation paid.

There are many nuances and complex tax issues relating to stock options. This is merely a very brief outline of some of the basic points.

Deferred Compensation and Equity-Based Programs

The two most often used forms of equity-based compensation programs are known as stock appreciation rights and phantom stock plans. Although they may seem to involve a form of equity, in reality they are forms of deferred compensation.

Stock appreciation rights, or SAR’s, grant to a participant the right to share in future value of a security. For example, if a security is worth $10 per share when an employee is granted an SAR, and the value of that security grows to $20 per share, then at the time the SAR becomes payable – which is usually at retirement or upon the occurrence of a liquidity event such as a merger or sale of the company – the employee would receive $10 per share.

SAR’s are not equivalent to actual securities. The holder of an SAR is not entitled to vote any shares or interests and usually is not entitled to be paid dividends or other distributions.

Phantom stock plans are similar to SAR’s. An eligible employee is awarded a certain number of units, usually based on some performance metrics, and those units are equivalent to a certain number of shares. When and if a liquidity event occurs, the employee will receive the value of those phantom shares. That value is not necessarily limited to the increased value since the date the phantom shares or units were issued and can relate back to a benchmark price or value from an earlier period of time. As with SAR’s, holders of phantom stock units have no voting, dividend or distribution rights.

Because these types of plans do not involve the actual issuance of securities, they do not result in the issuance of equity in the company. And the employees typically do not pay anything to receive SAR’s or phantom stock units. As a result, the amounts paid to employees holding these types of performance-based awards will be treated as ordinary income, as opposed to capital gains, when and if they receive any cash for their units.

The foregoing is a very basic overview of equity awards and equity-based compensation. The tax, accounting and securities laws issues that are involved with each of these programs are complex and intricate. For example, it is highly likely that a company may want to combine one or more of these types of programs and that is often done. However, that takes careful planning and analysis. This summary is intended only to give the reader a very broad-based outline of these types of programs. Please consult with your financial and legal advisors to discuss any specific programs.

IRS Circular 230 Notice: Any tax advice provided herein (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed on any taxpayer.