Attention Brokers – FINRA Wants to “Friend” You!

FINRA is apparently upset that state legislatures have been granting employees the right to maintain privacy over their Facebook pages and Twitter accounts. Since FINRA requires all forms of digital communication to be monitored by broker-dealers, these new laws may actually grant registered persons privacy rights that conflict with FINRA regulations. So FINRA has asked for an exemption.

Five states have enacted laws barring employers from requesting access to social media accounts of job applicants and employees, while similar legislation is either pending or contemplated in 27 other states and Congress.  FINRA has sought an exemption from such laws to enable securities firms to comply with their requirements under FINRA rules to monitor and supervise communications with the public. Most securities firms have policies either prohibiting the use of social media, such as Facebook, Twitter and LinkedIn, or requiring strict approval and oversight of their use, including pre-approval of all content by a supervisor.

Registered representatives have increasingly turned to social media to reach a larger audience of potential clients and promote themselves. FINRA Rule 2210 which governs communications with the public, sets out certain review procedures and content standards for all registered persons in communication with the public, which includes social media. FINRA is concerned that new state or federal privacy laws will affect firms’ ability to carry out their supervisory functions and hinder FINRA’s  performance of its regulatory  oversight of the industry.   

It will be interesting to see how FINRA fares with their lobbying efforts and whether industry groups will oppose any exemption.

For more information on social media issues with the SEC and FINRA, feel free to contact the authors of this post, Rob Rabinowitz (rrabinowitz@becker-poliakoff.com) and Victor DiGioia (vdigioia@becker-poliakoff.com).

YES, Social Media Posts May Satisfy Regulation FD, if Investors Know to Look There

Following up on my previous article concerning how the SEC would handle the infamous Facebook post made by Reed Hastings, the CEO of Netflix – you know, the post where he decided to disclose that Netflix had streamed 1 billion hours of content in June without previously disclosing through a press release, Netflix’s website (or Facebook page), or Form 8-K – it appears that the SEC saw a fork in the road and decided to go straight.

The Investigation Report, available here, states that the SEC will not pursue an enforcement action in this matter.  As discussed in the previous article, under Regulation FD a company makes public disclosure when it distributes information “through a recognized channel of distribution.”  Recognizing that the use of social media as a means of communicating and distributing information has “proliferated,” the SEC seized the opportunity to clarify how a company can comply with Regulation FD while still utilizing social media.

The SEC emphasized that the critical issue is not the vehicle or medium by which the information is disclosed, rather it is whether the market is aware that information will be disclosed via that vehicle or medium.

So what does that mean?

Simply put, companies or issuers must provide investors with appropriate notice specifying the channels they will use to disseminate material, nonpublic information.  As suggested by the SEC, this can be accomplished by identifying the social media channels that a company intends to use to broadcast material non-public information.

If you’re thinking that Hastings might have slipped one past the goalie on this, you’re not alone, although arguments remain as to whether the information he disclosed was material.  As the SEC stated,

Disclosure of material, non-public information on the personal social media site of an individual corporate officer, without advance notice to investors that the site may be used for this purpose, is unlikely to qualify as a method ‘reasonably designed to provide broad, non-exclusionary distribution of the information to the public’ within the meaning of Regulation FD.

In other words, investors would not usually think to look at an officer or C-level executive’s personal social media profile as a medium for obtaining material information about the company, and therefore such a medium is insufficient as a means of publicly disclosing information under Regulation FD, UNLESS the company has previously disclosed to investors that medium would be used to disseminate information.

Helen Chaitman Won't Let Citibank Get Away With Turning a Blind Eye

Becker & Poliakoff attorney Helen Chaitman continues to advocate on behalf of former Dewey & LeBoeuf partners.  You can read more about the case here.

No Certificate No Cry: Perfecting Security Interests In Uncertificated LLCs

The limited liability company (“LLC”) is the preferred structure for startup companies but unlike traditional corporations, members (the owners and investors) generally do not receive anything akin to a stock certificate.  LLC membership interests are generally not considered securities under the Uniform Commercial Code (the “UCC”) and such interests are treated as general intangibles under UCC Article 9.    So if possession is nine-tenths of the law, creditors are left with the other tenth to secure their loan.  What’s a lender to do?

There is a solution.  An LLC may make an affirmative election, in its organization documents, to have its interests treated as securities for purposes of UCC Article 8, and thus investment property under UCC Article 9.  By making such an election, a secured party may perfect its interest via control or possession, thereby achieving higher priority and simplifying the procedure for foreclosing on its interest in the event of a default by the debtor.  It is important to note that the secured party should carefully describe the collateral that is the subject of its security interest in its security agreement.  More specifically, the security agreement should stipulate as to whether the security interest in the LLC includes merely economic rights, or also includes governance rights, akin to ownership of voting stock.

To further complicate the issue, yet narrow the available options, a security interest in uncertificated interests cannot be perfected via possession – there is nothing to physically posses. Rather, possession of uncertificated interests must be accomplished via control.  This will require an agreement between the debtor and the creditor/secured party, by which the debtor agrees to comply with the creditor/secured party’s instructions regarding the ownership interests.  Again, this will require the debtor to affirmatively opt-in to UCC Article 8.

There are creative ways to give creditors rights akin to a perfected security interest without having to jump through the hoops of perfection.  If you would like to discuss them, contact Michael De Biase (mdebiase@becker-poliakoff.com) or Victor DiGioia (vdigioia@becker-poliakoff.com). 

Securities Brokerage Firms Obtain Landmark Ruling in Class Action Disputes

On February 21, 2013, a panel of the Financial Industry Regulatory Authority (FINRA) denied FINRA the ability to bar securities brokerage firms from including in customer agreements a mandatory waiver of the right to participate in class actions. The action involved a conflict between FINRA’s rules and the Federal Arbitration Act.

In its February 1, 2012, complaint brought against Charles Scwab & Company, Inc., FINRA claimed (complaint can be read here)  that the language used by Charles Schwab violated NASD Rule 3110 (f)(4)(A) and FINRA Rule 2268(d)(1). FINRA stated in its complaint that the language used by Charles Schwab incorrectly led customers to believe that they could not bring or participate in securities class actions. The objectionable language, according to FINRA was:

"You and Schwab hereby waive any right to bring a class action, or any type or representative action against each other or any Related Third Parties in court. You and Schwab waive any right to participate as a class member, or in any other capacity, in any class action or representative action by any other person, entity or agency against Schwab or you."

The panel determined that the Federal Arbitration Act prohibited FINRA from enforcing its interpretation of its rules.  FINRA can appeal the ruling to its National Adjudicatory Council.

What will be the impact of this decision?

We believe this ruling, if not overturned, will have a significant impact on the industry and its customers.  Brokerage firms and clearing firms can be expected to change their account forms to include similar language as was approved by the panel.  We would advise our brokerage industry clients to review their client forms and include similar language.

The decision would substantially limit, if not completely prohibit, customers of brokerage firms from bringing actions against their brokerage firms.  FINRA arbitration panels do not entertain class actions.   This would leave customers who believe they have been the victims of securities fraud or similar activities with claims that must be brought solely with respect to their singular claims.  The plaintiff’s bar would see a vast change in the economics of bringing such suits.  We expect that the private securities bar, as well as other regulatory agencies such as state level government authorities, the plaintiff’s securities bar and certain members of Congress will seek to overturn or override the panel’s decision.

In a second ruling in the same case with Schwab, the hearing panel upheld FINRA’s complaint that the brokerage firm cannot require customers to agree that the arbitration panel in customer disputes cannot consolidate more than one party’s claims.        

To further discuss this post, or the ruling discussed herein, please contact the author of this post, Brian Daughney (bdaughney@becker-poliakoff.com).       

Becker & Poliakoff's Own Helen Davis Chaitman and Peter Smith Compel Dewey's Former Executive Director to Appear and Testify

Helen Davis Chaitman and Peter Smith of Becker & Poliakoff's New York office represent two former Dewey partners, Andrew Fawbush and Elizabeth Sandza, in connection with a dispute over a $71.5 million partner settlement.  Fawbush and Sandza, former Dewey partners, have alleged that the settlement intentionally favors certain partners, and are objecting to the proposed liquidation plan.

You can read more here.

Season 4, Episode 13: Joulies and Ice Cream and Bears, Oh My!

This episode started piping hot.  Everyone wanted in, causing a four-on-one battle slating Mark Cuban against the rest of the Sharks.

The product was Coffee Joulies – essentially a metal apparatus in the shape of a large coffee bean that keeps coffee at the perfect temperature.  It was made out of a proprietary material that captures and releases energy (heat). I am a Starbuck’s freak and I love hot coffee.  I would have bought it on the spot.

The obvious first question:  Who owns the rights to the product?  Although the company did not own the proprietary material, they obtained a design patent and applied for a utility patent on the Joulies.  A big plus but somehow the entrepreneurs were unprepared for this question and fumbled through the answer.  They should have scored big on this point but suffered the first hit of the evening.  Proprietary rights and intellectual property protections, such as patents, are critical, because they provide barriers to entry and limit competition.

The next issue was revenue and valuation.  It is to be expected that the Sharks would take a bite out of the entrepreneur’s valuation of their own company.  The entrepreneurs valued the company at about $3MM based on previous year’s revenues of $575,000, and profits of $50,000.  However, they included one shot expenses such as legal fees, research and development, etc. as ordinary operating expenses.  BIG MISTAKE!  The Sharks were drooling.  They were already calculating the cash flow (EBITDA) and doing their own evaluations.

When it came time for the Sharks to make their offers, two different offers were presented:  1) $150,000, no equity, but with a $6 royalty on online sales, $3 royalty on wholesale sales, and a $1 royalty in perpetuity; and 2) $250,000 for 12% equity (Mark Cuban).  To the surprise of all of the Sharks, the entrepreneurs went with the royalty offer.  Rookie mistake!  As Mark Cuban pointed out, the company was ripe for a liquidity event and new investors will not invest if cash is going out the door, especially to prior investors.  The second round will force the owners to renegotiate the royalty and that will cost them equity – probably much more than Mark Cuban was demanding.

This deal was a solid “4-4.5” and they took an offer suited for a “3.”  Although the entrepreneurs thought the got what they wanted, in the end they became Shark Meat.

We would love to hear your thoughts.  Feel free to contact Victor DiGioia, Esq. (vdigioia@becker-poliakoff.com) or Michael De Biase, Esq. (mdebiase@becker-poliakoff.com), and give us your "two-cents".