by T. GormanPosted on Posted in SECActions

The SEC clarified its view on the use of social media in the context of making disclosures and complying with Regulation FD in an Exchange Act Section 21(a) Report of Investigation. The Report grows out of the investigation by the Enforcement Division into certain disclosures made by the Chairman of Netfilx, Inc. on his Facebook page regarding the success of the firm’s streaming business. Exchange Act Release No. 69279 (April 2, 2013), Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, Netflix, Inc., and Reed Hastings.

Background

Netflix has focused on expanding its streaming business for subscribers over the past two years. In early January 2012 the company announced in a press release that it had streamed two billion hours of content in the fourth quarter of 2011. That metric was also featured in other subsequent disclosures. While the streaming metric did not specifically drive revenue since Netflix is a subscriber based service, its President, Reed Hastings, explained in a late January 2012 conference call that it is “a measure of an engagement and scale in terms of the adoption of our service and use of our service . . . It [two billion hours streaming in a quarter] is a great milestone for us to have hit . . . [and it] shows widespread adoption and usage of the service.”

In early June Netflix made a brief reference on its blog to people enjoying nearly “a billion hours per month . . . “ of content. In a July 3, 2012 post on his personal blog Mr. Hastings made a specific statement about the adoption of the streaming service stating in part: “Netflix monthly viewing exceeded 1 billion hours for the first time ever in June.” Later the same day the company issued a press release announcing the date of its second quarter earnings release. It did not mention the Facebook posting by Mr. Hastings.

The stock price began to rise at the open on July 3 and continued after the 11:00 a.m. Facebook post. About noon on the same day the Facebook post was disseminated to several reporters. Following an early market close the story was picked up by the media. The Facebook post sparked the Enforcement investigation.

Discussion

In the Release the Commission clarified its guidance regarding the use of social media in the wake of the Netflix investigation. The agency decided not to bring an enforcement action.

Regulation FD requires that an issuer discloses material nonpublic information to securities market professionals or shareholders where it is reasonably foreseeable that they will trade on the basis of the information in a manner reasonably designed to achieve effective broad and non-exclusionary distribution to the public. When the disclosure is intentional, distribution to the public must be simultaneous. While no particular method of distribution is required, if an issuer deviates from its customary approach, it may impact any determination as to whether the method selected is reasonable under the circumstances.

In August 2008 the Commission issued Guidance on the use of electronic media and disclosure focused largely on corporate websites. In that Guidance the Commission encouraged the use of the electronic media, according to the Report, while noting that the investing public must be alerted to the channels of distribution the company will use. It also provided a non-exclusive list of factors to be considered in evaluating if the corporate website constituted a recognized channel of distribution. It did not specifically address the use of social media.

In considering the use of social media as was done by Netflix, there are two critical issues. The first centers first on the application of Reg FD. In this regard it is important that the company evaluate statements made through the social media in the context of Reg FD. Specifically, when an issuer “makes a disclosure to an enumerated person [in FD], including to a broader group of recipients through a social media channel, the issuer must consider whether that disclosure implicates Regulation FD . . . if the issuer were to elect not to file a Form 8-K, the issuer would need to consider whether the information was being disseminated in a manner ‘reasonably designed to provide broad, non-exclusionary distribution . . . ’” of the information.

Second, the August 2008 Guidance, while not directed specifically at the social media, should be considered. The critical point here is to “alert the market about which forms of communication a company intends to use for the dissemination of material, non-public information, including the social media channels that may be used and the types of information that may be disclosed through these channels . . . “ While every case must be evaluated based on its specific facts “without advance notice to investors that the site may be used for this purpose, [it] is unlikely to qualify as . . . “ an appropriate method for Reg FD. Applying this two prong approach should result in adherence to Reg FD and the August 2008 Guidance “with minimal burden,” according to the Release.

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by T. GormanPosted on Posted in SECActions

The SEC lost a claimed Ponzi scheme case following a bench trial in a decision handed down late last week. The complaint alleged that a privately held exploration company defrauded promissory note investors by misrepresenting or not disclosing the use that would be made of the offering proceeds in violation of Exchange Act Section 10(b) and each subsection of Securities Act Section 17(a). SEC v. St. Anselm Exploration Co., Civil Case No. 11-cv- 00668 (D. Col. Decision issued March 29, 2013).

The defendants include St. Anselm Exploration Co or SAE, a private company in the oil and gas exploration business based in Denver, Anna Well, its president, Mark Palmer, a vice president, Michael Zakroff, the secretary/treasurer and business manager and Steven Etkind, a vice president of corporate development. The SEC’s complaint alleged that between 2007 and 2010 the company sold notes to about 200 investors, raising $49 million. In connection with the sale of those notes the Commission claimed two primary misrepresentations were made. First, that investor funds would be used for company operations and specifically drilling and property acquisition. Second that payments to investors would be funded by company operations, primarily asset sales. The agency also claimed that investors were not told their funds would be used to pay existing debt and that the company had insufficient capital to pay ongoing expenses without raising new money from promissory notes.

SAE’s business plan, according to the Court’s findings, was to identify and acquire oil, gas and geothermal prospectus for development and sale. The company was not involved in the production of oil and gas properties. To fund its operations the company historically relied in part on the issuance of promissory notes which were personally guaranteed by the company principals. Those guarantees gave them “skin in the game” the Court found despite the fact that at the time of execution the individuals may not have been fully able to cover them financially.

From 2006 through 2010 the company had more than sufficient revenue to cover its obligations aside from any cash generated from the sale of the notes. During that period revenues were about $61 million while total debt was about $57 million.

Notes were only sold to accredited investors. The subscription agreement told investors the proceeds could be used for any proper business purpose. Mr. Etkind and Ms. Hattig confirmed this point. While the SEC presented testimony from three investors suggesting that their investments could only be used for oil and gas operations, the Court did not find the claim credible in view of the plain language of the subscription agreements and the concession of each witness that the company could use its funding for any legitimate business purpose.

In early 2010 the fortunes of the company plummeted. A large Ponzi scheme in Albuquerque which claimed to be an oil and gas business filed for bankruptcy, destabilizing investors. Economics in the industry deteriorated. As a result an IPO by the company failed. Accordingly, later in the year the company restructured its operations, altering its historical methods of operation. Nevertheless, after considering the terms of the restructuring 196 of 198 note holders accepted the terms and were issued new notes. Currently the company is operating as an ongoing concern.

At the close of the evidence the Court found against the Commission, granting a defense montion under Rule 52(c), Federal Rules of Civil Procedure. That Rule permits the Court to consider and evaluate the evidence after trial. First, the Court concluded that the defendants did not make misrepresentations to investors regarding the use of the investor funds. To the contrary, “the Subscription Agreement plainly stated that investor funds could be used for any purpose at the discretion of the company.”

Second, the Court rejected the SEC’s claim that Mr. Etkind committed fraud by assuring investors that the company was not a Ponzi scheme. A Ponzi scheme, the Court held “is an investment scheme in which returns to investors are not financed through the success of the underlying business venture, but are taken from . . . “ money raised from other investors. Here the SEC failed to establish that SAE conducted “little or no legitimate business operations” or that it “produced little or no profits or earnings.” To the contrary the evidence demonstrates that the company is an operating business. In reaching this conclusion the Court specifically rejected expert testimony to the contrary offered by the Commission because it was predicated on an incomplete and truncated analysis of the company.

Finally, the Court rejected the SEC’s claims that the materials furnished to investors contained material omissions because they did not specifically state that investor funds could be used to pay off existing debt – apparently the predicate of the Ponzi scheme claim. Here the subscription agreement “was not misleading simply because it did not specifically enumerate debt service as a possible use of investor funds. Even after this language was removed in 2007, the remaining disclosure is certainly broad enough to encompass these types of expenditures . . . [and] all three investors who testified [for the SEC] at trial admitted that debt servicing was a legitimate business purpose and thus within the scope of the agreements.” Accordingly, the Court ordered judgment entered in favor of the defendants.

Our thanks for a copy of the ruling and congratulations to David Zisser, Davis, Graham & Stubbs, LLP, Denver, CO. who represented Steven Etkind.