Capital Markets & Public Companies Quarterly: California to Require Female Directors, Updated Rules and Guidance from the SEC and Enforcement Actions in the Digital Asset Markets


In the third quarter of 2018, California became the first state to mandate that public companies include at least one woman on their board of directors. In addition, the SEC staff withdrew prior guidance relating to investment advisors’ use of proxy advisory companies.

The SEC adopted Disclosure Update and Simplification amendments as part of its agenda to modernize and simplify the public company disclosure process, and enforcement actions and district court opinions continued to shape the contours of the regulation of blockchain and digital tokens.

In Depth

New California Law: Public Companies Must Have Female Directors

In an effort to promote gender diversity in the boardrooms of publicly traded companies, California passed into law Senate Bill 826 (SB 826) which mandates that certain public companies in the state of California have at least one female director on their board of directors by the end of 2019.

Specifically, SB 826 adds Section 301.3 to the California Corporations Code, requiring a minimum number of female directors at all corporations with shares listed on a major US stock exchange that, according to their public filings, have their principal executive offices in the state of California. In addition to the requirement of one female director by the close of 2019, SB 826 mandates that by the end of 2021 companies with companies with boards consisting of five directors have at least two female directors, and companies with boards of six or more directors have at least three female directors. The statute authorizes the imposition of penalties for failure to comply, ranging from $100,000 to $300,000.

As covered in our prior quarterly update, shareholders and shareholder groups have taken stronger positions in recent years with regard to gender representation on public company boards. BlackRock and the New York State Common Retirement Fund have announced voting policies that support greater representation of women on public boards. On October 1, 2018, a collaboration of institutional investors representing more than $5 trillion in assets filed with the US Securities and Exchange Commission (SEC) a petition requesting rulemaking and federal standards requiring public companies to disclose environmental, social, and governance (ESG) policies and information.

For additional commentary on Senate Bill 826, see our On the Subject, “California Becomes First State to Mandate Female Directors for Publicly Held Companies” and “In California, The State Becomes A Boardroom Partner” published by Forbes.

SEC Withdraws Guidance on Investment Adviser Use of Proxy Advisory Firms

On September 13, 2018, the SEC staff of the Division of Investment Management announced its withdrawal of prior guidance relating to the use of proxy advisory firms by investment advisers when voting shares held on behalf of their clients. Under Rule 206(4)-6 promulgated under the Investment Advisers Act of 1940, an investment adviser must adopt policies and procedures that are reasonably designed to ensure that client securities are voted in the best interest of the client. The withdrawn guidance (two no action letters issued in 2004) had stated that—as part of a policy for resolving material conflicts of interest—investment advisers could rely on recommendations provided by proxy advisory firms who acted as independent third parties.

Although there does not appear to be any immediate impact from the withdrawal of the guidance, it raises questions regarding the future of proxy advisory services, which have grown influential through the widespread adoption of their proxy voting guidelines. In the announcement, the SEC staff stated that they seek to address these questions and others at a Roundtable on the Proxy Process to be held at the SEC’s headquarters on November 15, 2018.

SEC Adopts Disclosure Update and Simplification Amendments

On August 17, 2018, the SEC adopted rule amendments that simplify and update certain disclosure requirements that had become redundant, duplicative, overlapping, outdated or superseded by other requirements, practices or the general environment for information exchange. Issued in connection with the SEC’s implementation of Section 72002 of the Fixing America’s Surface Transportation (FAST) Act, the amendments are intended to facilitate the disclosure of information to investors, simplify compliance without significantly altering the total mix of information provided to investors, improve investors’ ability to make investment decisions more efficiently and reduce issuer compliance costs. In addition, the SEC referred certain SEC disclosure requirements that overlap with US GAAP to the Financial Accounting Standards Board (FASB) for potential incorporation into US GAAP. For an overview of the amendments and commentary on the SEC’s Disclosure Update and Simplification amendments, see our On the Subject.

Although the amendments are effective on November 5, the SEC has issued C&DI guidance informally establishing a longer period for adoption and incorporation into company filings. Specifically, the staff stated that it would not object if “a company did not incorporate changes in presentation of shareholders’ equity until it files its Form 10-Q for the quarter that begins after the effective date of the amendments.”

Continued Enforcement and Other Legal Developments for Digital Assets

During the last quarter, enforcement actions and judicial decisions evidenced a broadening scope of regulatory action in the cryptocurrency and digital asset space. As covered in our On the Subject, near the end of 2017 the SEC began to bring enforcement actions against issuers and promoters of ICOs, making a concerted effort to monitor the nascent market and discourage transactions the SEC believes are inconsistent with and in violation of US securities laws. Other regulators, such as the US Commodity Futures Trading Commission (CFTC), the US Department of the Treasury, Financial Crimes Enforcement Network (FinCEN) and the New York State Department of Financial Services (DFS), have also stepped in to regulate virtual currencies and digital assets.

On September 11, 2018, the SEC issued its first enforcement action regarding an investment company registration violation based on investments in digital assets. The SEC’s order states that Crypto Asset Fund, LLC, its manager, and its sole principal, Timothy Enneking, engaged in the business of investing, holding and trading certain digital assets that were investment securities. According to the order, the digital assets exceeded 40 percent of fund’s assets, causing the fund to operate as an unregistered investment company. The order also states that Crypto Asset Fund was touted as the “first regulated crypto asset fund in the United States” and its management claimed to have filed a registration statement with the SEC.

On the same day, the SEC also issued its first enforcement action charging unregistered broker-dealers for selling securities in the form of digital tokens. The SEC entered an order finding that TokenLot LLC, a self-described “ICO Superstore,” and its owners solicited and took orders for the sale of digital tokens in both ICOs and secondary market trading. According to the order, TokenLot handled hundreds of different digital tokens and the SEC found that these tokens included securities. TokenLot and its management performed such activities without registering as broker-dealers.

In addition, the Financial Industry Regulatory Authority (FINRA) issued its first disciplinary action involving cryptocurrencies. FINRA’s complaint alleges that Timothy Tilton Ayre, the president and the largest shareholder of Rocky Mountain Ayre, Inc., defrauded investors by making materially false statements and omissions regarding the nature of his company’s business. In addition, the complaint states that he conducted unlawful distributions of an unregistered security, a digital token named “HempCoin.”

Judicial decisions this quarter also supported a broader application of regulatory authority over cryptocurrencies and digital tokens. On August 23, 2018, following a three-day bench trial, US District Judge Jack B. Weinstein ordered a permanent injunction banning a defendant from dealing in virtual currency and ordering restitution and civil penalties. Important to the virtual currency community is the Court’s ruling that pursuant to the CFTC’s antifraud authority “virtual currency may be regulated by the CFTC as a commodity.” This confirmed a prior decision issued in the same matter, in which the court held that virtual currencies fall within both the common definition of a commodity and the definition of a commodity included in the Commodities Exchange Act.

On September 11, 2018, in United States v. Zaslavskiy, the court found that two purported virtual currencies, REcoin and DRC, and their related ICOs may meet the definition of “security” under the federal securities laws. In denying the defendants motion to dismiss the case, the US District Court for the Eastern District of New York held that purchases of REcoin and DRC could be “investment contracts” under the Howey test, and thus “securities,” and that a reasonable jury could make such a conclusion based on the facts alleged in the indictment.

As the legal framework continues to shift in this area, it is important for market participants to be aware of the various legal actions taken by regulators and courts, in order to make sure they are complying with current law.

For additional commentary on this topic, you may read our On the Subjects dated August 17, 2018, September 10, 2018 and September 18, 2018. For additional information on securities laws in token sales, see our Special Report “Digital Offerings and Sales under Regulation S.” For additional information about McDermott’s FinTech and Blockchain practice, please see the practice group page.