A recent action where the SEC focused on the presumably conservative undervaluation of assets suggests that it is more than willing to use valuation as a hook to deter “smoothing” of returns. As we previously noted, while the SEC consistently announces that valuation is a “key area of focus,” it is uncommon for regulators to second guess valuation determinations in the absence of other potential violations. However, failure to adhere to stated valuation policies/procedures is one situation that may lead to heightened regulatory exposure and disputes.
The SEC, in conjunction with the Colorado Bar Association and Colorado Society of Certified Public Accountants, recently sponsored the 51st Annual Rocky Mountain Securities Conference featuring SEC officials and corporate experts from across the nation. Sam Waldon, partner at Proskauer and former Assistant Chief Counsel in the SEC’s Division of Enforcement, moderated a panel of expert practitioners on developments in securities enforcement and white collar defense. The following topics were discussed:
1. Current Commission and Division of Enforcement
The Panel generally agreed that commentators have largely overstated the extent to which the current Enforcement program has changed under the current administration. However, they agreed that the types of cases being brought today, and the current case mix, is somewhat different than the immediately preceding Enforcement program, with a greater emphasis on cases involving retail investor harm. And the Panel agreed that the single biggest factor impacting the Enforcement program today has been the prolonged hiring freeze.
2. Sharing results of internal investigations
The Panel discussed recent experiences with having to decide whether and how to share the results of an internal investigation with staff, highlighting the challenge of balancing the desire to gain meaningful cooperation credit, against the value of preserving privilege. The speakers also discussed how it can often be prudent to share with staff the findings of an investigation generally, but not share memoranda memorializing witness interviews. Such an approach reduces the risk of waiver of the attorney-client privilege and/or attorney work product immunity covering the internal investigation as a result of disclosure to the SEC. Continue Reading
The DC Circuit recently released an opinion addressing the SEC’s administrative findings against registered investment adviser The Robare Group (TRG) for failure to disclose alleged conflicts of interest. Although the court affirmed the SEC’s finding of a violation of Section 206(2) of the Advisers Act, it held that Commission could not find willful violations under Section 207 based on the same negligent conduct.
The court’s analysis of 206(2) of the Advisers Act, the key negligence-based antifraud provision for investment advisers, is instructive. The court affirmed that, as a fiduciary to its clients, the adviser was required to make full and fair disclosure of all material facts, including conflicts of interest. Continue Reading
There’s a new unicorn in town, and this time, it isn’t just another tech company. Rent the Runway, also known as RTR, is now officially valued at over $1 billion after its most recent funding round which raised $125 million.
The high-end rental clothing brand was launched in 2009 by female founders, including co-founder and CEO Jennifer Hyman. Rent the Runway’s third and largest round of funding took place during Hyman’s ninth month of her pregnancy term – a fact that surprises some and empowers all. The company has been sky-rocketing in value since it introduced its subscription rental service which now makes up 60% of the company’s revenues. One of the best parts – the consumer base is 100% female.
Of course, with success comes attention, and not always welcome attention. The same week Rent the Runway reached unicorn status, LA startup FashionPass filed a lawsuit accusing Rent the Runway of monopolizing the high-end clothing rental market. In its lawsuit, FashionPass alleges that RTR conspired with other labels to demand exclusivity in the rental relationship. FashionPass’s complaint alleges in “excess of $3 million” in damages and claims it is entitled to recover treble damages. Continue Reading
Last week the SEC announced a settlement of fraud claims against the founder of Jumio, Inc, a private mobile payments company, for misstating the company’s financial results and using those financials to sell his company shares on the secondary market. This case is a reminder that privately negotiated securities transactions and private, VC-funded companies are not exempt from regulatory scrutiny. As we observed in a number of settlements last year, the SEC will pursue suspected investor fraud involving privately-held companies, whether in fundraising or sales by insiders, or even in disclosures to a company’s own employees in connection with stock options.
The SEC settlement involving Jumio alleged a variety of misconduct by the founder, such as entering into round-trip transactions designed to inflate revenue. Interestingly, the alleged scheme was apparently designed so that the founder could sell shares on the secondary market in privately negotiated transactions, rather than in a funding round.
According to the SEC press release, Jumio’s founder agreed to a settlement ordering him to disgorge profits from the sales as well as to pay a penalty, and agreed to be barred from serving as an officer or director of a publicly traded company in the U.S. The SEC also negotiated a settlement with Jumio’s former CFO/General Counsel for failure to exercise reasonable care in connection with the matter. Jumio itself filed for bankruptcy in 2016 after the company restated its financial results.
Looking ahead, we see this type of case as a microcosm of what may be in store when the next economic downturn hits the current stable of unicorns. Misconduct involving privately held companies, or even exits that are below recent valuations, may give rise to similar disputes. Meanwhile, recent experience – most prominently with Theranos – suggests that the failure of one or more unicorns is likely to attract both regulatory scrutiny and private litigation.
A recent decision by the Delaware Chancery Court suggests that a litigant might forego the ability to file a books and records request if it waits to do so until after the lawsuit is filed. Last month the Delaware Chancery Court dismissed just such an action, characterizing the request for a books and records inspection after the filing of a lawsuit as “inherently contradictory” and an improper attempt to “sue first, ask questions later.”
Section 220 of the Delaware General Corporation Law allows stockholders to inspect books and records of a Delaware corporation for any proper purpose and to compel inspection if such inspection is refused. Section 220 is typically used prior to the filing of a lawsuit as a means to develop information to support a plaintiff’s claims before it has access to discovery rules. The corollaries to a Section 220 demand in the limited partnership and limited liability company contexts are known as a Section 17-305 demand and a Section 18-305 demand, respectively. Continue Reading
An increasingly sophisticated and active OCIE division, innovative market disruptors, a maturing credit cycle, and a philosophical change in how the private fund industry views and utilizes litigation are likely to lead to increased regulatory scrutiny and litigation risk for advisers (and their funds) in 2019. With that backdrop, we are pleased to present our Top Ten Regulatory and Litigation Risks for Private Funds in 2019. Continue Reading