SEC No-Action Letters Provide Added Insight on Regulations

Sometimes the Securities and Exchange Commission provides better guidance on complying with its regulations by saying what it's not concerned with.

SEC “no-action letters” sent to answer public company queries about whether the agency would view a particular product, service, or action as a violation of its rules can be crucial to interpreting rulemaking and steering clear of enforcement actions. Recent letters, for example, have created a new breed of venture capital firm, given investment banks the ability to market securities offerings online, and provided regulatory compliance relief for broker-dealers.

“There are other guidance materials, but no-action letters tend to have a lot of gravitational pull and are very important, especially for seeing how new rules are going to be applied,” says Chris Hitt, product manager at LexisNexis, which tracks the letters.  “They are not legally binding, but the conversations you see play a role much like that of case law.”

While no-action letters related to shareholder issues dominate the number of those issued by the Commission, other issues they address can have market-changing effects. An example of how just a few paragraphs can prove revolutionary can be seen in the rise to prominence of proxy advisory firms. In 2003, the SEC issued no-action letters clarifying company proxy requirements that, as pointed out in a recent speech by Commissioner Michael Piwowar, “had the unintended effect of institutionalizing the use of proxy advisory firms to vote shares,” and gave rise to their ubiquity.

Though there was nothing of that magnitude, there were some notable issuances in 2013 and into this year. “The interesting ones to me are related to crowdfunding and other provisions under the JOBS Act,” Hitt says. “It is all brand new, so any no-action letters related to it are going to constitute a trend.”

VC Funds Go Online

The JOBS Act—passed by Congress with the intent of easing disclosure requirements for emerging growth companies and fostering investment capital—is still being fully implemented through SEC rulemaking. Required rulemaking providing a regulatory framework for crowdfunding is still in the proposed rule stage, but two industry-shaping no-action letters have essentially already launched equity crowdfunding efforts

Issued to FundersClub last March, one clarified that the Commission would not recommend enforcement action against its private-equity platform, essentially allowing it to be the first sanctioned, online venture capital firm. A similar no-action letter to one of its rivals, AngelList, gave it a similar imprimatur.

The no-action letters are “a very big development in the emerging world of accredited crowdfunding” and allow certain angel investment platforms to get around a transaction-based compensation restriction contained in the JOBS Act,” says William Carleton of the law firm McNaul Ebel Nawrot & Helgren and also an active member of the Angel Capital Association.

Essentially, FundersClub and AngelList received the go-ahead to run venture capital funds without registering or being regulated as broker-dealers. The SEC will allow them to run these funds as online ventures and crowdfund the investment capital, he explains.

The SEC also recently adopted rules to implement a JOBS Act provision that removes the longstanding prohibition against general advertising for securities offerings. The rulemaking allows private funds to engage in general solicitation without losing registration exclusions under the Investment Company Act.

An SEC no-action letter, issued to the Managed Funds Association on behalf of its members in the alternative investment space, updates the rulemaking by providing new guidance on the definition of “knowledgeable employees.” SEC rules exclude private funds—including hedge funds, private equity funds, and other types of pooled investment vehicles—from registration requirements. The exemption, excludes funds whose outstanding securities are owned by less than 100 investors and there is no public offering of the securities. Citing, among other reasons, that “an employee can have a policy-making function regardless of title,” the no-action letter establishes new standards for classifying employees and keeping them from counting against the 100-investor limit.

Internet Roadshows

Investment banks that underwrite municipal securities have a greater understanding of how to tap into new technology when reaching out to investors thanks to a no-action letter issued January to NetRoadshow in response to a letter drafted on its behalf by the law firm Alston & Bird.

“There are other guidance materials, but no-action letters tend to have a lot of gravitational pull and are very important, especially for seeing how new rules are going to be applied.”

—Chris Hitt,

Product Manager,

LexisNexis

Historically, the SEC has had a difficult time exerting control over the municipal securities marketplace, explains Bradley Patterson, a partner with the law firm Ballard Spahr. It took the bankruptcy of Orange County, California, in 1994 to serve as a catalyst for change. “The SEC adopted a rule that requires ongoing disclosure, something the corporate world has been familiar with for decades,” he says.

Beyond that, however, the Commission's hands are often tied. “It is very difficult for the SEC to regulate municipal entities, because it can't enforce any kind of registration requirements on the municipal market,” he says. “So, what they do is regulate the underwriters and indirectly regulate the governmental entities that way.” New municipal advisor rules that go into effect on July 1 will also bring broker-dealers who serve in that role under increased oversight.

The no-action letter addresses growing concerns about internet-based roadshows, a high-tech variation on what was once in-person outreach to potential investors by investment banks and issuers.  The use of these online forums raised questions about whether the presentation is considered part of the required statements that are mandatory for investors to receive. If it is deemed part of the official statement, it raises issues of compliance for underwriters. Internet road shows could also raise issues of compliance with the anti-fraud provisions of securities law.

“We've seen a greater use of internet roadshows, and it is just one more thing out there to help market the securities,” Patterson says. “The SEC wants to make sure they are taking certain kinds of precautions.”

The no-action letter says online presentations to retail investors would not trigger an enforcement action so long as they are conducted in accordance with certain practices and precautions. Among them: The roadshows should not contain information that conflicts with information in the official statement; investors should be consistently reminded to review that document; and prospective investors should only view the road show in its intended order so they don't receive information out of context.

Broker-Dealer Relief

NO-ACTION LETTER

The following table from Thomson Reuters

provides details on no-action letters during

the 2013-2014 season, as of 1/31/14.

Registrants Submitting the Most

No-Action Requests

Dominion Resources: 10

JPMorgan Chase: 10

Verizon: 9

General Electic: 8

Proponents Most Frequently

Cited in No-Action Letters

J. Chevedden & Collaborators: 69

Qube Inv. Mgmt.: 18

Nat'l Center for Public Policy: 10

Investor Voice: 9

Number of Letters by Proponent Type

Activist Funds: 50

Labor Organizations: 19

Religious Organizations: 16

Pension Funds: 9

Most Common Proposal Subjects

Executive Compensation: 35

Simple Majority Voting: 33

Environmental Matters: 29

Independent Board Chair: 22

Totals

No-Action Requests: 274

Number of Registrants: 139

Number of Proponents: 99

Source: Thomson Reuters.

In a recent client advisory, Anna Pinedo, a partner with the law firm Morrison Foerster, described a Jan. 31 no-action letter as “groundbreaking,” because of its conclusion that a financial intermediary that limits its business activities to advising privately held companies in M&A transactions does not have to register as a broker-dealer. This “departs from the SEC's longstanding position that treated M&A brokers in the same manner as more traditional broker-dealers,” she wrote. “It also opens the door for brokers who only represent private companies in M&A transactions to withdraw their broker-dealer registration with the SEC.”

The rationale, as stated in the letter, is that registration requirements were not necessarily in place to protect parties that were private and “sophisticated.”

The SEC issued another significant no-action letter for the financial community to the Securities Industry and Financial Markets Association on behalf of its members.

It said that staff of the Division of Trading and Markets will not recommend enforcement action if a broker-dealer relies on a registered investment adviser to perform some or all of its customer identification program obligations as long as it has an acceptable anti-money laundering program.

An Omen of Enforcement?

Is there insight to be gleaned from no-comment letters for how the SEC will be led under Chairman Mary Jo White? Hitt says it is too early to tell, but trends may emerge over time. “She's got a lot of attention for tough talk about stepping up enforcement and having a tougher reign on everything,” he says. “That could end up being reflected in no-action letters with a higher percentage of ‘unable to concur' determinations, which means fewer exemptions, and be consistent with a tougher, less-flexible approach.”

According to Henryk Hiller, director of research information for LexisNexis' Knowledge Mosaic, the SEC fails to go along with an issuers request for a no-action letter about 15 to 20 percent of the time, a low count that suggests most requests are met favorably.

Hitt suggests also watching to see if the number of no-action letters issued changes. “Since the SEC is not required to respond to no-action letters, under budgetary pressures, it may stop consistently replying or responding to no-action letter requests,” he says. “There could be more enforcement actions in inverse proportion to the number of no-action letters, because they are designed to prevent enforcement by instructing companies on how not to let a concern get that far.”