The “Emerging Growth Company”

The JOBS Act created a new category of public company called an “emerging growth company” (“EGC”), which, during a transition period of up to five years, is subject to less IPO restrictions and requirements than other public companies. Only an issuer with total annual gross revenues of less than $1 billion during its most recently completed fiscal year (indexed for inflation every five years) that did not conduct an IPO on or before December 8, 2011 can qualify as an EGC.

An issuer will retain EGC status until the earliest of:

• The first fiscal year after its total revenue as presented on its income statement exceeds $1 billion;
• The first fiscal year following the fifth anniversary of its equity IPO;
• The date on which it has issued more than $1 billion in non-convertible debt during the prior three year period; or
• The date on which it is deemed to be a “large accelerated filer” (i.e., in addition to certain other requirements, an issuer with a non-affiliated public float of at least $700 million as of the end of the second quarter of its most recently completed fiscal year).

Relaxed Disclosure

Under the JOBS Act, EGCs will enjoy less rigorous financial disclosure and audit requirements in connection with, as well as following, their IPO. For example, an EGC’s IPO registration statement only needs to include two years of audited financial statements (down from three years), while the related MD&A and selected financial data sections also will only need to cover two years. In addition, EGCs’ executive compensation disclosure requirements are the same as those of smaller reporting companies (i.e., no requirement to provide Compensation Discussion and Analysis disclosure).

EGCs are also exempt from a number of provisions of Dodd-Frank, including conducting say-on-pay, say-on-frequency or say-on-golden parachute votes or providing, when adopted, pay for performance or internal pay equity disclosure.

While EGCs are required to provide a Sarbanes-Oxley Act (“SOX”) Section 404(a) report on internal control over financial reporting, they are exempt from Section 404(b) of SOX and, therefore, do not need to provide an auditor’s attestation and report on management’s assessment of internal control over financial reporting.

EGCs are not required to comply with any new or revised financial accounting standards until such standards apply, as well, to private companies that are not “issuers” under SOX (non-reporting companies).

Finally, to the extent enacted, EGCs will be exempt from any new PCAOB rules requiring mandatory audit firm rotation or a supplemental auditor discussion and analysis.

Confidential SEC Review of IPO Registration Statements Available:

EGCs, both foreign and domestic, can submit a draft IPO registration statement (in paper or via PDF and not through the EDGAR system) to the SEC for confidential review prior to its “initial public offering date,”[1] provided that the EGC has no more than 21 days before it begins its road show to publicly file its initial confidential submission and all subsequent amendments. Related SEC comment letters and their responses will also maintain confidential treatment, and not be publicly disclosed, until after the EGC’s IPO. As per the SEC, the confidential filing process can also be used by EGCs for pre-IPO offerings of debt securities.

“Testing the Waters” and other Permitted Communications

Historically, companies and their underwriters were subject to “gun jumping” restrictions on their communications with potential investors, inhibiting their ability to maximally gauge interest in the company’s offering. EGCs and their underwriters, however, will be permitted to engage in “test the waters” communications with potential investors that are qualified institutional buyers[2] or institutional accredited investors[3], without concern of such gun jumping prohibitions. Along the same lines, the JOBS Act relaxes restrictions on research analyst coverage and participation in EGC IPOs. While these provisions are effective immediately, SEC and/or Financial Industry Regulatory Authority (“FINRA”) guidance should be expected.

Finally, under the JOBS Act, the SEC and FINRA are prohibited from maintaining or adopting rules which restrict the publication of research on an EGC within any time period after an IPO or before the expiration of any related lock-up arrangement.

The abovementioned provisions are effective immediately and do not require further SEC rulemaking.

Private Placement Publicity

The JOBS Act significantly loosens the restrictions currently in place on private placement publicity.

Regulation D Offerings

Under the JOBS Act, the prohibition on “general solicitation and general advertising,” in Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) will be eliminated by the SEC, where all purchasers in the offering are accredited investors. The SEC is also directed to prescribe the “reasonable steps” issuers must take in order to verify that purchasers are indeed accredited investors. Investment funds relying on Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) are permitted to use broad-based advertising to attract investors under the JOBS Act. While the Investment Company Act will continue to prevent funds from making a “public offering,” the JOBS Act explicitly provides that general advertising or general solicitation under amended Rule 506 will not constitute a public offering for purposes of the federal securities laws.

The JOBS Act also eases broker-dealer registration requirements in connection with the issuance of securities in compliance with Rule 506 by exempting from such registration (i) persons who facilitate offers, sales, purchases or negotiations with respect to such Rule 506 issuance, (ii) persons who permit general solicitations or general advertisements by issuers of such securities, (iii) persons who co-invest in such securities and (iv) persons who provide ancillary services with respect to such securities. Such exemption from broker-dealer registration in only available, however, if no compensation is paid, and if such persons are not in possession of customer funds or securities, in connection with the purchase and sale of the securities.

Rule 144A Offerings

Rule 144A under the Securities Act will also be modified, as per the JOBS Act’s direction to the SEC, to allow the offering of securities sold under Rule 144A, including by means of general solicitation and advertising, to persons other than QIBs, so long as the securities are only sold to persons “reasonably believed” to be QIBs. Note, however, that the JOBS Act does not modify the Regulation S restrictions of “directed selling efforts,” effectively maintaining, to a certain extent, the restrictions of general solicitation and advertising.

The abovementioned changes will become effective only after the SEC adopts implementing rules, which it is directed to do within 90 days of enactment of the JOBS Act.

Crowdfunding Exemption

“Crowdfunding” refers to the raising capital from a large network of small investors, typically via the Internet.  Under the JOBS Act this vehicle becomes more practical and manageable, allowing eligible private companies to offer and sell securities in crowdfunding transactions without registration under the Securities Act or compliance with most state blue sky law requirements so long as not more than $1 million of securities are sold in a rolling 12-month period and the aggregate amount sold to any one investor during that period is capped at a specified level based on the annual income or net worth of the investor as follows (which amounts will be indexed for inflation every five years): (1) the greater of $2,000 or 5 percent of the annual income or net worth of the investor, if either is less than $100,000; or (2) 10 percent of the annual income or net worth of the investor, up to a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.

In terms of offering disclosure, the issuer must file with the SEC and an issuer must provide to investors and the intermediary specified information relating to the issuer, including information concerning its business, financial condition, use of proceeds, target offering amount, directors and officers, ownership and capital structure and certain specified risks to investors. Depending on the offering amount, an issuer must also include (1) its tax returns for its most recently completed year and financial statements certified by the issuer’s CEO (offering amount of $100,000 or less), (2) financial statements reviewed by an independent public accountant (offering amount of more than $100,000 but less than $500,000) or (3) audited financial statements (offering amount of more than $500,000). On an annual basis, issuers must provide investors, and file with the SEC, financial statements and a report of the issuer’s results of operations (as will be established by further SEC rulemaking).

Transfers of crowdfunding offering securities will be restricted for one year after purchase, other than transfers to the issuer, to an accredited investor, as part of a registered offering, to a member of the purchaser’s family or in connection with the death or divorce of the purchaser.

An intermediary broker or “funding portal” registered with the SEC must conduct the crowdfunding transactions. An intermediary may not: (1) offer investment advice or recommendations; (2) solicit purchasers, sales or offers; (3) compensate employees or other persons for the solicitation; (4) hold, manage, possess or otherwise handle investor funds or securities; or (5) engage in other prohibited activities as determined by the SEC. Funding portals will be conditionally exempt from registration as a broker-dealer (pursuant to additional rules to be adopted by the SEC) but will need to be registered with the SEC in order to conduct crowdfunding transactions.

Foreign issuers, SEC reporting companies, investment companies and companies excluded from the definition of investment company by virtue of Section 3(b) or Section 3(c) of the Investment Company Act are not eligible to use the crowdfunding exemption.

Regulation A Transaction Exemption Increased

Pursuant to the JOBS Act, the SEC is directed to adopt new rules to amend Regulation A, a rarely used small offering exemption from registration under the Securities Act, or adopt a new exemption entirely, that will increase the maximum amount raised in a 12-month period under a Regulation A offering from $5 million to $50 million. In addition, if the Regulation A offering securities are offered and sold by an eligible private company on a national securities exchange or to a “qualified purchaser” (as to be defined by the SEC), Regulation A offerings will be exempt from state blue sky laws. Finally, securities offered and sold under the new exemption will not be treated as restricted under the Securities Act with respect to Rule 144 resale purposes.

Issuers that sell securities in reliance on the exemption must file an offering statement for review with the SEC, disclosing items to be determined by the SEC, as well as annual audited financial statements and such other periodic disclosures as required by the SEC, including items relating to the issuer and its business operations, financial condition and corporate governance principles.

Certain helpful provisions of the current Regulation A will remain in place, including no limitation on the types of securities to be offered or the types of investors that may participate, the ability to “test the waters” and the “unrestricted” character of the securities issued.

Unlike most other aspects of the JOBS Act, the Act does not specify an outside date for the enactment of these rules.

Increase in Exchange Act Registration/Periodic Reporting Threshold

Prior to the enactment of the JOBS Act, a company which at the end of a fiscal year had total assets exceeding $10 million dollars and a class of equity securities held by 500 or more shareholders of record was required to register a class of equity securities under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) within 120 days after the last day of such fiscal year. Such registration also subjected the company to the Exchange Act reporting requirements. The JOBS Act, however, increases the record holder threshold to 2,000 persons or 500 persons who are not accredited investors. This change applies to all companies other than banks and banking holding companies, which have an even more relaxed threshold of 2,000 persons irrespective of the number of non-accredited investors. Note that securities held by persons who received them pursuant to an employee compensation plan or in exempt transactions, including the new crowdfunding exemption, will not be counted in the number of record holders.

The JOBS Act not only makes it harder to become subject to the Exchange Act registration/reporting requirements, but also makes it easier to get out of them – at least for banks and bank holding companies, that may deregister under the Exchange Act if their securities are held of record by less than 1,200 persons, as opposed to the previous threshold of 300 record holders. Final regulations on this item are meant to be implemented following SEC rulemaking within one year.

Stay Tuned

As mentioned, while many of the JOBS Act’s provisions are effective immediately, a good deal of SEC rulemaking remains to fully implement the JOBS Act. The SEC’s approach and details of such rulemaking, as well as public and professional commentary and inquiries (much of which has already begun) will impact the final form and impact of certain JOBS Act provisions, as well as the marketplace, so the final results of this historical legislation remain to be seen.

“Schmidt would have to show evidence that Sun impliedly consented to use of the patent,” William Galkin, Internet attorney at Schwell Wimpfheimer & Associates, told the E-Commerce Times. “However, even an implied license can be subject to termination.”

Click here for the full story.

William Galkin has more than 20 years experience advising companies at all stages of development on entering into, structuring and managing a wide variety of relationships in the areas of information technology, Internet, e-commerce, content, and computer law, including licensing, development, alliance, distribution and outsourcing arrangements.  He can be reached at wgalkin@swalegal.com or at 410 484 2500.  Click here to read his Internet Lawyer Advisor Blog.

• A prospective employee, independent contractor or consultant to a business will be asked to sign one as a condition to being hired.
• Two companies considering doing business with each other will want to protect any confidential information that they share with each other during their courtship, especially in the event that the deal falls through.
• A business that relies on third party vendors, suppliers and sub-contractors who will have access to company secrets will want the service provider to sign one.

Here are some things to think about when you are negotiating a Non-Disclosure Agreement (“NDA”):

Who’s Zoomin’ Who?

Whose secrets are being protected? An NDA can be set up so that it is only protecting the confidential information of one party or it can be a two-way agreement that protects each party’s confidential information in the hands of the other.  When you are asked to either prepare an NDA or sign one, stop for a minute and think about it. Whose information needs to be protected here? Just one side? Or both sides? If only one side to the deal is going to be disclosing secrets, then there may be no need for a mutual NDA. On the other hand, I have seen many situations where a client of mine was asked to sign a one way NDA protecting the other party, but it turned out that in the course of doing business my client would also be sharing confidential information, so we switched to a mutual NDA before going too far down the road.

One other point about mutual NDAs. In theory, they are supposed to protect both sides equally. In practice, the party preparing the NDA often slants the document in its favor. This can come up in any number of places in the contract – how a secret is defined, how long a secret has to be kept, who has to be told to keep their mouth shut, and how a dispute gets resolved, among other things.

What’s protected?

Most NDAs have a long section at the beginning defining what is considered to be “Confidential Information” that must be kept secret if disclosed. It usually starts with a long laundry list of items such as trade secrets, customer lists, pricing information, patents and patent applications, software source documents, and the like.

Do I have to label it?

Some NDAs require the disclosing party to label any information that it wants to protect as “Confidential” before sharing it. Otherwise, it’s fair game. If you are the one wanting to protect your information, a clause like this could be a trap, especially if you are part of a large organization and many different people handle your secrets. Better to go the other way and say that confidential information means any information “that would reasonably be expected to be considered confidential” by the disclosing party.

Word of mouth

Confidential information can be transmitted in many different ways. It can be in a written document. It can be sent by email. It can be disclosed verbally during a conversation. If you are the disclosing party, make sure that your NDA covers all of these scenarios.

What’s not protected?

A typical NDA will list certain categories of information that do not have to be kept secret. They include information that becomes generally available to or known by the public through no fault of the receiving party, or that was disclosed to the receiving party by someone else who had a right to do so.

Harmonic Convergence

If you are the receiving party, one category that you want to be sure and include is any information that is independently developed by you without resort to the other party’s confidential information. Of course, you have to be able to prove that it was independently developed.

“They made me do it”

Often included in the categories of information that is deemed not to be confidential is information that a party is required to disclose because of judicial action or a government regulation. Technically, that’s not true. The information is still confidential. Its just that someone is forcing you to spill the beans. Make sure that the party being forced to disclose is required to give the other party as much advance notice as possible in order to provide an opportunity to go to court and stop the disclosure if deemed necessary.

How long does it last?

Whether or not it is obvious from the language, most NDAs set in motion two different clocks. One clock measures the period of time during which information that is disclosed is considered to be secret. The other clock measures how long that information must be kept secret – usually for the duration of the relationship and for some period of time after it ends. It is best to have the language clarify both periods of time. I have seen NDAs that are so focused on what happens after the relationship ends that they forget to say that the information is secret during the relationship itself. Watch out for this omission.

If you are the receiving party, you want a clear, objective time that both clocks stop ticking. Phrases like “three years from the initial disclosure” or “as long as trade secrets are protected by law in this jurisdiction” make it hard to figure out when the confidentiality obligation ends. Better for you if the parties can agree on an actual calendar date.

What else are they trying to protect?

If you are the receiving party, watch out for clauses that have nothing to do with protecting secrets but are just thrown in for good measure or left over from another deal without having been carefully edited.

In particular, watch out for language stating that you will not solicit the other party’s customers for a period of time, or you will not solicit their employees, or that you will not compete with the other party. If the only point of the NDA is to keep a secret, then none of these should be included.

Similarly, watch out for language stating that any ideas that you contribute to the interaction between you and the other side are considered to be “work for hire” or in some way owned by the other party.

These might be legitimate negotiating points for your deal. But then again, they might not.

Think before you sign.

Tuvyah (Terry) Aronoff chairs the Corporate Practice Group at Schwell Wimpfheimer & Associates and specializes in Entertainment law. He has over 25 years of experience representing public and private companies in both traditional and innovative markets, as well as entertainment clients and individual performing artists. He can be reached at taronoff@swalegal.com or 646 328 0781.

This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Tuvyah (Terry) Aronoff . The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

The notice must include the following information:

• Rate of pay: by hour/shift/day/week/month, commission (if applicable), and whether overtime applies
• Regular payday
• Official name of the employer and any other names used for business
• Address and phone number of the employer’s main office
• Allowances (tips, meal and lodging deductions) taken as part of the minimum wage (if relevant)

Please note that:

1. The notice must be written in the employee’s primary language.
2. The employee should sign and date the notice, and should be given a copy of the signed and dated notice.
3. The employer must retain the original signed notice for a period of 6 years.

The Department of Labor has posted notice forms that may be used for different types of employees. To download forms that are relevant to your New York employees, click on the following link: http://www.labor.ny.gov/formsdocs/wp/ellsformsandpublications.shtm.

Meira Ferziger is the head of the labor and employment practice at Schwell Wimpfheimer & Associates and has significant experience in drafting policies, agreements, employee handbooks and guidelines in compliance with U.S. federal and state law.  Meira functions as an integral part of the day to day operation of corporate clients by counseling them through their employment-related practices and decisions, and also advises clients as to employment issues that arise from corporate transactions, such as restructurings or acquisitions. She can be reached at meira@swalegal.com or at 646 328 0794.

This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Meira Ferziger. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

As discussed in SWA’s Issuing Securities in U.S. Private Offerings – New Higher Standard for “Accredited Investors” (August 22, 2010) the “accredited investor” is a key component of a limited offering of securities qualifying for exemption from registration under Regulation D of the United States Securities Act of 1933 (the “Securities Act”).

An individual can qualify as an “accredited investor” if his or her individual net worth, or joint net worth with his or her spouse, at the time of his or her purchase, exceeds $1 million. Under the amended rules, the $1 million net worth standard now excludes the value of the individual’s primary residence. In addition, in an effort, as per the SEC, to prevent manipulatory inflation of the net worth standard by borrowing against home equity shortly before participating in an exempt securities offering, the amended net worth calculation, other than as described in the next sentence, excludes indebtedness secured by the primary residence, up to the estimated fair market value of the primary residence, as a liability. However, if the borrowing is not in connection with the acquisition of the primary residence and occurs within the 60 days preceding the purchase of securities in the offering, the net worth calculation treats the debt secured by the primary residence as a liability. Indebtedness secured by a person’s primary residence in excess of the property’s estimated fair market value, on the other hand, is treated as a liability in calculating net worth.

The amended rules grandfather certain individuals who qualified as “accredited investors” prior to the enactment of the Dodd-Frank Act, allowing them to use the prior net worth standard, provided that (i) the individual held a right to purchase the securities prior to July 20, 2010, (ii) the individual qualified as an “accredited investor” on the basis of net worth when they acquired such right and (iii) the individual held securities of the issuer (other than the right to purchase) on July 20, 2010.

The Dodd-Frank Act requires the SEC to review the “accredited investor” definition in its entirety and to engage in further rulemaking to the extent it deems appropriate beginning in 2014, and every four years thereafter. For now, however, additional rule making is likely far off, as the SEC has determined that additional modifications are not necessary at this time.

The amended rules become effective 60 days after publication in the Federal Register.

Craig Tzvi Gherman is a member of the Corporate and Securities practice groups at Schwell Wimpfheimer & Associates.  His clients range from individuals and start-ups to Fortune 500 public companies.  His practice focuses on public and private company stock and asset based acquisitions and sales, mergers, tender offers, joint ventures and corporate governance/Sarbanes-Oxley compliance.  He can be reached at cgherman@swalegal.com or 646 328 0788.

Jan S. Wimpfheimer is Co-Managing Partner and head of the private equity and investment funds practices at Schwell Wimpfheimer & Associates.  He practices general corporate and transactional law, with a focus on representing sponsors and investors in all types of private investment funds and handling international mergers and acquisitions and other corporate transactions for financial institutions, multi-national businesses, and other clients.  He can be reached at jan@swalegal.com or 646 328 0670.

The information contained in this publication is not intended as legal advice or as an opinion on specific facts. For more information about these issues, please contact Craig Tzvi Gherman or  Jan S. Wimpfheimer. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

• a foreign government registering its debt securities;
• a foreign private issuer that is listed or is concurrently listing its securities on a non-U.S. securities exchange;
• a foreign private issuer that is being privatized by a foreign government; or
• a foreign private issuer that can demonstrate that the public filing of an initial registration statement would conflict with the law of an applicable foreign jurisdiction.

The Staff also indicated that shell companies, blank check companies and issuers with no or substantially no business operations will not be eligible for non-public submission of their registration statements. It is important to note, as the Staff cautioned, that under certain circumstances, even those companies which otherwise fall into one of the four qualifying categories above may not receive non-public confidential treatment. The Staff did not provide any specific guidance, but does give the examples of a competing bid in an acquisition transaction or publicity about a proposed offering or listing.

Although the new policy is effective immediately, non-public submissions that do not fall within one of the qualifying categories and that were received by the Staff prior to December 8, 2011 will continue to be reviewed by the SEC without a public filing. However, those companies should be aware that any subsequent amendment to the registration statement will not enjoy the non-public treatment and must be filed on the EDGAR system.

The change of policy, notes the Staff, is due to the trend of a vast majority of foreign private issuers listing their securities exclusively on a U.S. securities exchange, as opposed to both a foreign and U.S. security exchange. As a result, the former rationale that these companies should not be subjected to public disclosure of their registration statement before completion of review, as required by the U.S., while their foreign market did not require such disclosure, no longer makes sense as the general policy.

These new registration limitations on foreign private issuers follow the Staff’s approval last month of new restrictions on listing standards for companies that have effected reverse mergers. The Staff seems very focused on heightening disclosure standards for foreign private issuers and making their entry into the U.S. capital markets more rigorous and “safe” for investors. Non-U.S. issuers (even those that have already started the registration process) now have additional concerns and considerations prior to entering the U.S. capital markets, including their eligibility for the non-public review process, and the implications of filing if not so eligible, and should plan accordingly.

The SEC’s statement on Non-Public Submissions from Foreign Issuers can be found at http://www.sec.gov/divisions/corpfin/internatl/nonpublicsubmissions.htm.

Craig Tzvi Gherman is a member of the Corporate and Securities practice groups at Schwell Wimpfheimer & Associates.  His clients range from individuals and start-ups to Fortune 500 public companies.  His practice focuses on public and private company stock and asset based acquisitions and sales, mergers, tender offers, joint ventures and corporate governance/Sarbanes-Oxley compliance.  He can be reached at cgherman@swalegal.com or 646 328 0788.

The information contained in this publication is not intended as legal advice or as an opinion on specific facts. For more information about these issues, please contact Craig Tzvi Gherman. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

A reverse merger is a transaction in which a private company (either U.S. or foreign) is acquired by an existing public “shell company.” Via the merger, the private operating company is able to “go public” by merging into the public shell, giving the operating company stockholders equity in the shell company, and thereby providing theoretical access to funding in the U.S. capital markets (unlike public companies which have a deeper potential funding pool from their access to public investors, private companies generally have much more limited access from private forms of equity). Additional attractions of the reverse merger are that it is quicker and cheaper than a standard initial public offering, with lower legal and accounting fees and no registration required under the Securities Act of 1933. The shell company is a public reporting company with minimal or no operations, while the private company is an actual operating company. The private company shareholders typically exchange their private company shares for a majority of the shell company shares – enough to gain a controlling interest in the voting power and outstanding public shell company shares. In addition, generally, the board of directors and management of the public company are supplanted by that of the private operating company. Finally, the assets and business operations of the post-merger surviving public company are primarily, if not solely, those of the former private operating company.

Investors can find reverse merger companies listed on different exchanges and can buy and sell their shares, just like those of other operating companies. However, the SEC has been concerned about the inability of investors, auditors and regulators to obtain reliable information from reverse merger companies, particularly those based overseas. As a result of such concern, the SEC has taken a number of steps to better regulate reverse merger companies and to provide investors with less risk and more information when making an investment decision in a reverse merger company.

The New Reverse Merger Rules, in particular, work to increase the time investors have to analyze the reverse merger company, as well as the amount of company information and trading history available to an investor, prior to investing. The New Reverse Merger Rules raise the standards the reverse merger company need to satisfy before being eligible for listing on a U.S. exchange. Under the New Reverse Merger Rules, a post-reverse merger company will be prohibited from applying to list on the NYSE, NYSE Amex or NASDAQ until:

• The company has completed a one-year “seasoning period” by trading in the U.S. over-the-counter market or on another regulated U.S. or foreign exchange following the reverse merger, and filed all required reports with the SEC, including audited financial statements; and

• The company maintains the requisite minimum share price for a sustained period, and for at least 30 of the 60 trading days, immediately prior to its listing application and the exchange’s decision to list.

However, if the post-reverse merger company is listing in connection with a substantial firm commitment underwritten public offering, or if the reverse merger was effected at a date where at least four annual reports with audited financial information have been filed with the SEC prior to its listing, then, in general, the reverse merger company would be exempt from these special requirements.

Clearly, the SEC is taking their concerns over reverse mergers seriously, particularly those companies with overseas operations. In the summer of 2010, the SEC launched an initiative to determine whether certain companies with foreign operations – including those that were the product of reverse mergers – were accurately reporting their financial results, and to assess the quality of the audits conducted of these companies. Since that time, the SEC and U.S. exchanges have suspended or halted trading in numerous companies based overseas citing a lack of current and accurate information about the firms and their finances, including companies that were formed by reverse mergers. In addition, this year, the SEC has revoked the securities registration of several reverse merger companies due to a failure to make required periodic filings which normally contain material information for investors, and there have been a number of enforcement actions involving reverse merger companies based on issues related to (i) the accuracy and completeness of information contained in public filings; (ii) failure to properly disclose auditor, legal counsel and director resignations; (iii) failure to disclose the lack of the required review of interim financial statements by an independent public accountant; (iv) questions regarding the size of operations and number of employees, material customer contracts, and the existence of two separate and materially different sets of corporate books and accounts; and (v) failure to file certain periodic reports with the SEC.

The New Reverse Merger Rules should help the SEC, as well as investors and companies considering reverse merger transactions (or those which have already effected reverse merger transactions), to avoid the disclosure and filing issues that have resulted in the enforcement actions and de-registrations mentioned above. In addition, those companies looking to access the U.S. public markets via a reverse merger transaction should pay particular attention to the New Reverse Merger Rules and plan accordingly.

Craig Tzvi Gherman is a member of the Corporate Practice Group at Schwell Wimpfheimer & Associates.  His clients range from individuals and start-ups to Fortune 500 public companies.  His practice focuses on public and private company stock and asset based acquisitions and sales, mergers, tender offers, joint ventures and corporate governance/Sarbanes-Oxley compliance.  He can be reached at cgherman@swalegal.com or 646 328 0788.

The information contained in this publication is not intended as legal advice or as an opinion on specific facts. For more information about these issues, please contact Craig Tzvi Gherman. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

On September 29, 2011, the Federal Trade Commission (FTC) issued an Order for Reebok International (RBK) to pay $25 million in refunds to consumers of its EasyTone and RunTone shoes (Reebok Toning Shoes),  and permanently enjoined Reebok  from making claims that such products are effective in strengthening muscles or that wearing such products will result in quantified percentage or amount of muscle toning or strengthening. Since the Internet has spawned a deluge of new marketing channels, Internet attorneys, marketers and advisors need to become sensitive to laws relating to deceptive advertising.

According to the FTC Complaint issued on September 28, 2011, the FTC concluded that Reebok deceptively claimed that the Reebok Toning Shoes had the special ability to strengthen legs and backsides. The FTC found that there was no scientific evidence to back up these claims. Therefore, these claims were both false and deceptive in violation of the FTC Act.

Based upon the FTC Complaint, it would be reasonable to conclude that Reebok out and out lied to consumers. What motive could such large and successful company have for doing such a thing? Well for starters, the market for toning shoes was estimated to be $1 billion in 2010.

Laws Violated

The specific sections of the FTC Act that the FTC claims Reebok violated are: Section 5(a) of the FTC Act, 15 U.S.C. § 45(a), which prohibits “unfair or deceptive acts or practices in or affecting commerce”  and Section 12 of the FTC Act, 15 U.S.C. § 52, which prohibits the dissemination of any false advertisement in or affecting commerce for the purpose of inducing, or which is likely to induce, the purchase of food, drugs, devices, services, or cosmetics.”  For the purposes of Section 12 of the FTC Act, the Reebok Toning Shoes are considered “device[s]”.

Specific False Representations

According to the FTC Complaint: Reebok represented, among other things, that walking in Reebok Toning Shoes “is proven to tone and strengthen the lower body — toning and strengthening the gluteus maximus muscle 28% more than walking in a typical walking shoe, and toning and strengthening both the hamstring and calf muscles 11% more than walking  in a typical walking shoe.”  Reebok further represented “that running in RunTone shoes increases muscle activation, toning, strength, and endurance as compared to running in typical running shoes.” 

Even before the FTC Order, a major industry group had questioned the claims contained in the Reebok Toning Shoe advertising campaign. On January 10, 2011, the National Advertising Division (NAD) had recommended in a decision that Reebok discontinue certain claims Reebok was making for the Reebok Toning Shoe line made in advertising due to failure of Reebok to provide substantiation for its fitness claims. The NAD decision noted that Reebok claimed that the Reebok Toning Shoes “feature something called ‘moving air technology,’ which involves pockets of shifting air. This allegedly creates a phenomenon called ‘micro-instability,’ something akin to what happens when one sits on a stability ball or stands on a wobble-board.” Reebok when responding to NAD’s inquiry, claimed that the Reebok Toning Shoes are the only fitness shoes that incorporate a “balance ball” design on the soles to create instability to each step which, in turn, requires muscles to work harder.

Supporting Advertising Claims

In response to the NAD request for substantiation, Reebok offered as support a study that it commissioned in 2008.The NAD reviewed a study that Reebok commissioned in 2008 and concluded that the study did not support Reebok’s claims. The study commissioned by Reebok only examined five subjects some wearing the Reebok Toning Shoes, some wearing regular walking shoes and others wearing no shoes. Electrodes were attached to key muscle areas. The subjects chose their own pace for five minutes on a treadmill. The NAD concluded that:  “[T]his was a very small scale study both in number of participants and duration of the study,” and that a sample size of only five subjects is not “representative of the universe of consumers to whom this product making broad performance claims is targeted. It is well-established that tests offered to support product performance claims must reflect real world conditions. Here, the only testing that was conducted was on a treadmill for a five-minute period of time.” Reebok responded in a statement merely that it disagreed with the NAD’s conclusions.

Bottom Line

Manufacturers and advertisers should carefully take note of what the FTC requires in order to support claims similar to those made by Reebok. Such evidence must result from a well-controlled human clinical study which conforms to acceptable designs and protocols. Competent and reliable scientific evidence means tests, analyses, research, or studies that have been conducted and evaluated in an objective manner by qualified persons and are generally accepted in the profession to yield accurate and reliable results.

William Galkin has more than 20 years experience advising companies at all stages of development on entering into, structuring and managing a wide variety of relationships in the areas of information technology, Internet, e-commerce, content, and computer law, including licensing, development, alliance, distribution and outsourcing arrangements.  He can be reached at wgalkin@swalegal.com or at 410 484 2500.  Click here to read his Internet Lawyer Advisor Blog.

This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact William Galkin. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

If you have any questions about the posting and distribution requirements, or about the contents of the notice, please do not hesitate to contact Meira Ferziger, Esq, meira@swalegal.com, 646 328 0794.

Meira Ferziger is the head of the labor and employment practice at Schwell Wimpfheimer & Associates and has significant experience in drafting policies, agreements, employee handbooks and guidelines in compliance with U.S. federal and state law.  Meira functions as an integral part of the day to day operation of corporate clients by counseling them through their employment-related practices and decisions, and also advises clients as to employment issues that arise from corporate transactions, such as restructurings or acquisitions.

This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Meira Ferziger. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.

The representations must address the specific concerns raised by the unique nature of RECs.  As opposed to a contract for widgets, where a buyer is purchasing a known physical item, RECs are created by regulation and do not exist other than in relation to some governing set of rules.  At its most basic level, a REC represents the separation of certain environmental attributes from the actual power being generated by a renewable source that was not conveyed to the purchaser of the power. Those attributes may themselves be further disaggregated into components that are of value to particular buyers.  Accordingly, the representations help establish the scope and nature of the attributes owned and being transferred by the seller to the buyer.

Representations and Warranties – Scope

• Good and Marketable Title.  Seller should represent and warrant that it has good and marketable title to the REC. This means that the seller’s ownership of the REC is free of defects and the seller has the ability to transfer ownership to the buyer without third parties claiming the seller was not the rightful owner of the REC.  This is a basic representation for the sale of almost any asset.  A seller that either cannot make or is not willing to make this representation should be viewed with considerable concern.
• No Liens or Encumbrances. Seller should represent and warrant that there are no liens, claims or encumbrances of any kind on the REC.  If there were liens, claims or encumbrances, the Seller either would not have the right to sell the REC or the lien might travel with the REC, so the REC in the buyer’s hand would be subject to the same lien.  It is important to make sure that the representation is not limited to “liens, claims or encumbrances created by the Seller.”  Because RECs are assets capable of being sold more than one time, a buyer wants to know that no liens attached to the REC at any stage of its ownership. This distinction can create additional risk if the purchaser resells the REC and must represent to its buyer that there are no liens on the REC generally.
• Seller has not sold the product to any other person or entity.  If a buyer receives proper “good title” and “no lien” representations, this third representation is not, strictly speaking, necessary.  If an entity has already sold the REC to someone else, the seller either no longer has good and marketable title to the REC or there is a lien, claim or encumbrance on the REC.  However, some purchasers like to include this very tailored representation, especially when dealing with smaller counterparties where they think the risk of a double-sale may be higher.  It says in laymen’s terms what the first two representations say in legal terms and make the buyer’s expectations on this point beyond doubt.
• Product complies with the applicable renewable portfolio standard.  This representation goes to the heart of what a buyer is purchasing.  When a buyer negotiates the purchase of a REC, it negotiates a price and terms based on the REC it intends to purchase.  If it receives a different REC, that REC may either not be of value to the buyer or it may be of a different value than the REC for which it negotiated.  In any event, the buyer will not have the REC it intended to purchase.  To ensure that the REC that is delivered is the REC that the buyer intended to buy, a buyer should always ask for a representation that the REC complies with the applicable renewable portfolio standard.  Along the same lines, if there are other specific terms central to the buyer’s decision to buy a particular REC (e.g., generation at a particular facility), a buyer should also ask for representations attesting to those facts.
• Product has not been used to meet compliance requirements under the applicable renewable portfolio standard or any other regulatory or voluntary renewable program or standard.  Like the prior point, this representation gives the buyer comfort that it is getting the benefit of its bargain.  The buyer is being told that the REC has not been used to meet some other entity’s compliance requirements and is therefore available for the buyer to use it for its own compliance or resale needs.

Representations and Warranties – Timing

The timing of when representations and warranties are made is of equal importance as the scope of the representations and warranties being made.  The question presented is if a seller should make its representations and warranties as of the date it agrees to sell the REC (whether that is the trade date or the date it signs a written contract) or the date it delivers the REC.  This is especially important because REC purchases can be agreed to years in advance of the actual delivery dates.  Ultimately, the critical date is the date on which the seller delivers the REC.  A buyer’s initial position, however, should be that a seller gives its representations and warranties as of both the sale date and the delivery date.  The buyer would have the comfort of knowing that all the key assurances it is looking for are true as of the date it agrees to buy the REC and will be true as of the time the REC is delivered, and the request for sale date representations and warranties may provide an opportunity for some additional diligence.

A seller may have a specific and legitimate reason why it cannot make a particular representation as of the date it agrees to the sale.  For a long term contract, for example, a seller may say it does not have good and marketable title to a REC because the REC has not yet been created.  Alternatively, it may say that it has a blanket financing lien on its assets which will be released upon the actual sale of the asset.  In such situations, a seller can make the particular representation as of the delivery date but all other representations and warranties can still be made as of both dates.

A buyer should also consider other protections it may want in its agreements, particularly if it is signing a long term and/or multi-year arrangement,  or if its counterparty is a relatively young or not well-financed entity and taking into account it is transacting in a potentially changing regulatory landscape.  Although representations and warranties will almost never reduce a REC purchaser’s risk level to zero, a buyer can more effectively manage and reduce its risk by negotiating appropriate representations and warranties and other contractual protections.

Shanah Glick is the head of the Derivatives and Energy practice groups at Schwell Wimpfheimer & Associates.  She leads the attorneys in her practice groups in the negotiation of sophisticated agreements for a Fortune 100 energy company.  Shanah negotiates agreements with domestic and international counterparties, having experience with industry standard documentation relating to derivatives and energy trading, such as the ISDA, NAESB and EEI standard master agreements, and renewable energy credit purchase and sale agreements.  She can be reached at sglick@swalegal.com or at 646 328 0735.

Louis Barr chairs the Employee Benefits & Executive Compensation Practice at Schwell Wimpfheimer & Associates.  Louis advises public, private and tax-exempt entities with respect to the full range of issues in establishing and operating employee benefit programs (including qualified and non-qualified deferred compensation plans, welfare benefit arrangements, severance agreements and equity compensation incentive plans) and counsels fiduciaries with regard to the investment and management of plan assets.  He can be reached at lbarr@swalegal.com or 646 328 0783.

Alan Barth is a member of the Derivatives and Energy practice groups.  He negotiates sophisticated agreements for a Fortune 100 energy company, including agreements for the purchase and sale of energy commodities, including oil, natural gas, and electricity; renewable energy credit purchase and sale agreements, and guarantees and letters of credit securing the aforementioned transactions.  Alan can be reached at abarth@swalegal.com or 646 328 0784.

This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Shanah Glick. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.