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Social Media Policy Update

In the frenetic early days of social media foward-thinking companies thoughtfully sat down and crafted sensible policies to help guide employees who had suddenly turned into web publishers.The companies recognized the risks involved, whether the employee was acting recklessly, or merely writing down unacceptable material without realizing the implications. It was still a small area of risk.

Things change. Facebook has launched as a public company worth billions (although apparently not worth $100 billion). Social media is challenging traditional media in several different way.

You would think that employers should be even more aggressive about curtailing employees and making it clear what is acceptable and note. The National Labor Relations Board apparently thinks otherwise. The NLRB has released its third report on social media cases brought to the NLRB [pdf].

Good luck trying to figure out what the NLRB considers acceptable in a social media policy and what it considers unacceptable.

Confidentiality:

  • Illegal: A policy that prohibits the “release [of] confidential guest, team member or company information”.
  • Legal: A policy that cautions employees to be suspicious when asked to disclose confidential information.

Copyright:

  • Illegal: “Get permission before reusing others’ content or images”.
  • Legal: “Respect all copyright and other intellectual property laws.”

Offensive or abusive language:

  • Illegal: “Offensive, demeaning, abusive or inappropriate remarks are as out of place online as they are offline”
  • Legal: “Employees should avoid harming the image and integrity of the company and any harassment, bullying, discrimination, or retaliation that would not be permissible in the workplace is not permissible between co-workers online, even if it is done after hours, from home and on home computers”.

Accuracy:

  • Illegal: Requiring employees to be “completely accurate and not misleading”.
  • Legal: “Make sure you are always honest and accurate when posting information or news, and if you make a mistake, correct it quickly.”

Non-Public information

  • Illegal: “Do not reveal non-public information on any public site.”

So not everything a policy may work, so how about a savings clause like this?:

This policy is for the mutual protection of the company and our employees, and we respect an individual’s rights to self-expression and concerted activity. This policy will not be interpreted or applied in a way that would interfere with the rights of employees to self organize, form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, or to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection or to refrain from engaging in such activities.

The NLRB says no. A savings clause “does not cure the ambiguities in a policy’s otherwise unlawful provisions.

On the bright side, the NLRB did include the complete text of a social media policy that the NLRB considers lawful.

Sources:

What is a Security? Is Real Estate a Security?


Previously, I went through the analysis that a fund manager is considered an investment adviser. But left open the question of “what is a security?” That’s a key question for fund managers with alternative investments, like real estate.

The Investment Advisers Act gives a very broad definition of a security:

any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guaranty of, or warrant or right to subscribe to or purchase any of the foregoing. [202(a)(18)]

What’s missing from that definition is hard assets (collectibles, like baseball cards), futures contracts relating to commodities (but not future contracts relating to securities), and real estate (but not shares in real estate companies).

Pure bricks and mortar are not securities. So private equity funds that invest directly in hard real estate assets are not giving advice regarding securities.  As you start adding additional levels of ownership and holding companies, things get a bit grayer as you have more and more organizational boxes between the fund and the real estate.

One of the early seminal Supreme Court cases on the definition of a security involved a real estate deal. In 1946, SEC v W.J. Howey Co. (328 U.S. 293) involved an offering of units of a citrus grove development, coupled with a contract for cultivating, marketing, and remitting the net proceeds to the investor. They held that it was an offering of an “investment contract” within the meaning of that term as used in the provision of § 2(1) of the Securities Act of 1933 defining “security” as including any “investment contract,” and was therefore subject to the registration requirements of the Act.

For purposes of the Securities Act, an investment contract (undefined by the Act) means a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.

There are three components:

  1. expectation of profits
  2. a common enterprise
  3. depends “solely” for its success on the efforts of others.

So passive investments, where investors do not have any decision-making power are securities. Investments made by the principals who are actively involved in the management of the enterprise are not securities. Of course, that leaves a whole lot of business arrangement in between.

Shares of stock in a corporation do not have enough involvement to get them out of the characterization of securities. Most real estate is owned in partnership or partnership-like entities to take advantage of some favorable tax treatment.  There is an expectation of profits and it’s going to be a common enterprise. That leaves the “success on the efforts of others” as the key test for investment entities.

Traditionally, limited partnership interests are generally securities because limited partners rely on the general partners to manage the partnership. Since Delaware and other states have given limited partners to have more power in the management of the partnership and still retain their liability shield, the analysis has gotten harder.

For a general partnership, those interests are generally not securities because they fail to satisfy the “solely from the efforts of others” part of the test. Usually all general partners have decision making power with respect to the affairs of the partnership.

Limited liability company interests are tougher to make a general statement. If the LLC is member-managed, then each member is involved in management of the enterprise  and therefore their interests would generally not be securities. On the other hand, if the LLC is manager-managed, then members are may be just passive investors, and their LLC interests are more likely to be securities.

When it comes to real estate joint ventures, the managing interest is not going to be a security. The non-managing interest is more likely to be a security.

Notes, debt, and debt-to-own interests are likely to be considered securities. You can see notes listed right in the definition of securities. Given the continuing distress in the real estate debt markets, many fund managers are looking at buying distressed debt instead of pure bricks and mortar. That’s going to push them into the role of giving “advice about securities” and force them to look at registration as an investment adviser.

Deal structure may influence the analysis. It’s common in some jurisdictions to structure the transaction as a sale of interests in the owner of the real estate instead of a sale of the asset itself. That transaction structure could be viewed as a sale of securities, instead of a sale of real estate.

Image of Glass office building in downtown Los Angeles is by Ricardo Diaz

The Knowledgeable Employee Exemption for Private Funds

UPDATE: See More Guidance on Knowledgeable Employee Exemption for Private Funds

When operating under the Section 3(c)(7) exemption from the Investment Company Act, the issue then becomes how a private investment fund can provide an equity ownership to key employees.

Its unlikely that your key employees will have the $5 million in investments needed to qualify as an investor. (Each investor in a 3(c)(7) private investment fund must be Qualified Purchaser.)

The SEC established Rule 3C-5 to allow “knowledgeable employees” to invest in their company’s private fund without having to be a qualified purchaser. The rule also exempts these knowledgeable employees from the 100 investor limit under the Section 3(c)(1) exemption from the Investment Company Act.

You will still need to determine if the employee’s acquisition of the interest is exempt from the registration requirements of the Securities Act. Most likely that will mean that the knowledgeable employee will need to be an accredited investor. Meeting that $200,000 per year / $300,000 per year if married income (and a reasonable expectation of that income continuing) threshold may be the biggest impediment to offering equity interests further down the company ladder.

The first category of “knowledgeable employees” is the management of the covered company, which covers these positions:

  • director [see Section 2(a)(12)]
  • trustee
  • general partner
  • advisory board member [see Section 2(a)(1)]
  • “executive officer”

Executive Officer is defined in Rule 3C-5 as:

  • president
  • vice president in charge of a principal business unit, division or function
  • any other officer who performs a policy-making function
  • any other person who performs a similar policy-making function

The second group of knowledgeable employees are those who participate in the investment activities. Those employees need to meet these requirements:

  • Participate in the investment activities in connection with his or her regular functions or duties,
  • has been performing such functions and duties for at least 12 months, and
  • is not performing solely clerical, secretarial or administrative functions.

The 12 month limit is not limited to 12 months at the employee’s current company. The SEC concluded that it is not necessary to require that an employee work for the particular fund or management affiliate for the entire 12-month period as long as the employee has the requisite experience to appreciate the risks of investing in the fund and performed substantially similar functions or duties for another company during that 12 month period.

Whether an employee actively “participates in the investment activities” of a private fund will be a factual determination made on a case-by-case basis.  In a 1999 No Action letter sent to the ABA the SEC said the following would NOT be knowledge employees:

  • Marketing and investor relations professionals who explain potential and actual portfolio investments of a fund and the investment decision-making process and strategy being followed to clients and prospective investors and interface among the fund, the portfolio mangers and the fund’s clients.
  • Attorneys who
    • provide advice in the preparation of offering documents and the negotiation of related agreements,
    • who also are familiar with investment company management issues, and
    • respond to questions or give advice concerning ongoing fund investments, operations and compliance matters.
  • Brokers and traders of a broker-dealer related to the Fund who are Series 7 registered.
  • Financial, compliance, operational and accounting officers of a fund who have management responsibilities for compliance, accounting and auditing functions of funds.

The SEC also said that research analysts who investigate the potential investments for the fund may not be knowledgeable employees unless they research all potential portfolio investments and provide recommendations to the portfolio manager.

Sources:

Photo is of the Board of Directors and Officers of the Industrial Exhibition Association of Toronto 1930 used under Creative Commons License from the Toronto Public Library Special Collections

Qualified Purchasers under the Investment Company Act

In a private fund exempt under 3(c)(1) investors only generally need to be accredited investors (and “qualified clients” if the fund manager is SEC registered. If you have more than 100 investors in the fund you will need to fall under the 3(c)(7) exemption. That means all of your investors must be “qualified purchasers.” A qualified purchaser is a much greater requirement than an accredited investor and a qualified client.

To paraphrase the requirements under Section 2(a)(51) of the Investment Company Act, a “qualified purchaser” means:

  • a person not less than $5 million in investments
  • a company with not less than $5 million in investments owned by close family members
  • a trust, not formed for the investment, with not less than $5 million in investments
  • an investment manager with not less than $25 million under management
  • a company with not less than $25 million of investments

To that list you can also add:

  • A company (regardless of the amount of such company’s Investments) beneficially owned exclusively by Qualified Purchasers.
  • A “Qualified Institutional Buyer” under Rule 144A of the 33 Act (except that “dealers” under Rule 144 must meet the $25 million standard of the 1940 Act, rather than the $10 million standard of Rule 144A). Rule 144A generally defines a “Qualified Institutional Buyer” as institutions, including registered Investment Companies, that own and invest on a discretionary basis $100 million of securities that are affiliated with the institution, banks that own and invest on a discretionary basis $100 million in  securities and have an audited net worth of $25 million, and certain registered dealers.

“Investments” generally means the following:

  1. Securities, including stocks, bonds and notes, other than securities of an issuer that  is under common control with the qualified purchaser.
  2. Real estate held for investment purposes.
  3. Commodity futures contracts, options or commodity futures and options on physical commodities traded on a contract market or board of trade, held for investment purposes.
  4. Physical commodities (e.g., gold and silver), with respect to which futures contracts are traded on a contract market or board of trade, held for investment purposes.
  5. Financial contracts (e.g., swaps and similar individually negotiated financial transactions), other than securities, held for investment purposes.
  6. For an investment company or a commodity pool, any binding capital commitments.
  7. Cash and cash equivalents held for investment purposes. Neither cash used by an individual to meet everyday expenses nor working capital used by a business is considered cash held for investment purposes.

Sources:

Image of Coin Stacks is by Darren Hester under a creative commons license.

Private Fund Exemptions under the Investment Company Act

Private investment funds primarily use two exemptions to avoid being defined as an “investment company” under the Investment Company Act of 1940: Section 3(c)(1) or Section 3(c)(7).

Less than 100 Investors

Section 3(c)(1) of the Investment Company Act excludes from being an investment company any issuer whose outstanding securities are beneficially owned by not more than 100 persons and that is not making and does not presently propose to make a public offering of its securities. The benefit of Section 3(c)(1) is that there is no additional status requirement for the investor, such as net worth, total assets, or total investments owned beyond the “accredited investor” standard.

There are some catches in trying to count the number of investors. There are several types of investors that result in a look through their ownership.

More than 100 Investors

If your private fund will have more than 100 investors, either directly or because of a look-through, then the fund will need to fit under the Section 3(c)(7) exemption. As with Section 3(c)(1) you cannot anticipate making a public offering. Investors in 3(c)(1) fund need only be accredited investors, but investors in a 3(c)(7) fund must be “qualified purchasers.”

The higher standard of qualified purchaser limits potential investors to institutional investors, investment managers and high net worth individuals. (More on the “qualified purchaser” definition in my next post.)

Contacting lots of investors may be viewed as general solicitation so you need to pay attention to the prohibition on general solicitation or advertisement under .

You will also need to be careful in limiting future transfers of interest in the private investment funds. With more than 100 investors, you will no longer be in the safe harbor exemption from being a publicly traded partnership.

500 or more Investors

Once you have 500 or more investors and more than $10 million in assets you are subject to the reporting requirements of the Exchange Act. Effectively you are no longer a private fund.

I believe something analogous happened to Google. They had gotten so big and their shares ended up in the hands of more than 500 people. Since they would have to begin complying with the reporting requirements, they may as well let the shares trade publicly.

So if you are going to end up with more than 500 investors in a private fund, you are better off having several smaller funds to avoid the public reporting requirements under the Exchange Act.

Sources:

Image of the Twenty Dollar Bill is by Darren Hester under a Creative Commons License.

New Codes of Conduct for Real Estate Companies

It’s always useful to look at what your competition is doing. The same is true in drafting your code of conduct (or code of ethics or whatever name you chose). It is useful to look at you what your competitors’ codes of conduct look like.

Since Sarbanes-Oxley requires a public company to have a code of conduct, its fairly easy to dig around the investor relations portion of their website or SEC filings to get your hands on examples.

Since my company is a real estate company, I put together a database of Codes of Conduct for Real Estate Companies.

My original goal was to find codes for other real estate private equity companies. I struck out.

So I expanded to public REITs and real estate investment advisers. All of the companies in the database are public.

So far I have not found a private real estate company that has published its Code of Conduct. This is what I expected and not a criticism. In fairness, I haven’t publicly published my Code of Conduct.

With compliance, it’s better to think of competitors as peers instead of the competition. You might get some market gain with a competitor lost to a compliance or ethical failure. You’re more likely to get more government oversight and regulation, less of investor confidence and many more headaches.

Database of Codes of Conduct for Real Estate Companies

Image of Columbia Center is by simonsonjh from Wikimedia Commons

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Massachusetts Amends Its Strict Data Privacy Law (Yet, Again)

Massachusetts-State-House

Massachusetts has revised its data privacy regulations one more time. The revised regulations are less demanding that the original version released over a year ago. But this law is the strictest in the country and will be the de facto law of the land for many companies.

Office of Consumer Affairs and Business Regulation released a press release announcing that revised regulations have been filed with the Secretary of State and published on the OCABR website.

Fortunately, Gabriel M. Helmer of Foley Hoag’s Security & Privacy practice produced a redline showing the changes.

There are very few changes to the regulations that were released in August:

  • The Massachusetts Data Privacy regulations apply to anyone who “stores” personal information, in addition to those who receive, maintain, process, or otherwise have access to personal information.
  • Service Providers include anyone who “stores” personal information through their provision of services to anyone is subject to the regulations, in addition to those who receive, maintain, process, or otherwise are permitted access to personal information.
  • The U.S. Postal Service is no longer expressly excluded from the definition of “Service Providers.”
  • Service Provider agreements entered into before March 1, 2010 do not have to be amended to comply with these regulations until March 1, 2012.

The effective date is still March 1, 2010.

The regulations apply to personal information of Massachusetts residents. The reach of the regulations is not limited to businesses in Massachusetts.

References:

Compliance, Van Halen and Brown M&M’s

You may have heard the story about Van Halen’s banning of brown M&M’s from its dressing room. I chalked it up to the pampered life of rock stars. (Especially, when compared to the more mundane life of a chief compliance officer.)

I just listened to the latest episode of  This American Life which revealed that the provision was not about pampering. It was about compliance.  Host Ira Glass talked with John Flansburgh (from the band They Might Be Giants) and he explained why the M&M clause was actually an ingenious business strategy. They recounted an except from David Lee Roth’s autobiography, Crazy from the Heat:

Van Halen was the first band to take huge productions into tertiary, third-level markets. We’d pull up with nine eighteen-wheeler trucks, full of gear, where the standard was three trucks, max. And there were many, many technical errors — whether it was the girders couldn’t support the weight, or the flooring would sink in, or the doors weren’t big enough to move the gear through.The contract rider read like a version of the Chinese Yellow Pages because there was so much equipment, and so many human beings to make it function. So just as a little test, in the technical aspect of the rider, it would say “Article 148: There will be fifteen amperage voltage sockets at twenty-foot spaces, evenly, providing nineteen amperes . . .” This kind of thing. And article number 126, in the middle of nowhere, was: “There will be no brown M&M’s in the backstage area, upon pain of forfeiture of the show, with full compensation.”

So, when I would walk backstage, if I saw a brown M&M in that bowl . . . well, line-check the entire production. Guaranteed you’re going to arrive at a technical error. They didn’t read the contract. Guaranteed you’d run into a problem. Sometimes it would threaten to just destroy the whole show. Something like, literally, life-threatening.

Van Halen used the candy as a warning flag for an indication that something may be wrong. I see some lessons to be learned.

Update:

Diamond Dave talking about Brown M&Ms.

Brown M&Ms from Van Halen on Vimeo.

(via NPR Music’s The Record: The Truth About Van Halen And Those Brown M&Ms by Jacob Ganz

References:

Workplace Computer Policy and the Attorney Client Privilege

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Back in April, I mentioned a New Jersey case that found e-mail, sent during work hours on a company computer, was not protected by the attorney-client privilege: Compliance Policies and Email (Stengart v. Loving Care [.pdf]) That case has now been overturned. It seems that a company’s policy on computer use may be more limited that I originally posted.

Factual Background:

The company provided Stengart with a laptop computer and a work email address. Prior to her resignation, plaintiff communicated with her attorneys, Budd Larner, P.C., by email about an anticipated suit against the company, and using the work-issued laptop but through her personal, web-based, password-protected Yahoo email account. After Stengart filed suit, the company extracted a forensic image of the hard drive from plaintiff’s computer. In reviewing plaintiff’s Internet browsing history, an attorney discovered numerous communications between Stengart and her attorney from the time period prior to her resignation from employment with Stengart.

I found it strange that the email from a web-based email account would be stored on the local computer. I am going to guess that it was attachments to the email that ended up stored on the computer in a temporary file and not the email itself.

Company Position:

According to the decision, the company’s policy may not have been clearly distributed and applied. There was some factual disputes about whether the company had ever adopted or distributed such a policy. There was a further dispute that even if the policy was put in place as to whether it applied to executives like Stengart.

Decision:

In the end the company’s position didn’t matter and the court assumed the policy was in place. Instead, the court took a harsh position:

A policy imposed by an employer, purporting to transform all private communications into company property — merely because the company owned the computer used to make private communications or used to access such private information during work hours — furthers no legitimate business interest. See Western Dairymen Coop., 684 P.2d 647, 649 (Utah 1984). When an employee, at work, engages in personal communications via a company computer, the company’s interest — absent circumstances the same or similar to those that occurred in State v. M.A., 402 N.J. Super. 353 (App. Div. 2008); Doe v. XYC Corp., 382 N.J. Super. 122, 126 (App. Div. 2005) — is not in the content of those communications; the company’s legitimate interest is in the fact that the employee is engaging in business other than the company’s business. Certainly, an employer may monitor whether an employee is distracted from the employer’s business and may take disciplinary action if an employee engages in personal matters during work hours; that right to discipline or terminate, however, does not extend to the confiscation of the employee’s personal communications.

Those were some broad statements, but the decision was ultimately limited to the attorney-client privilege.

There is no question — absent the impact of the company’s policy — that the attorney-client privilege applies to the emails and would protect them from the view of others. In weighing the attorney-client privilege, which attaches to the emails exchanged by plaintiff and her attorney, against the company’s claimed interest in ownership of or access to those communications based on its electronic communications policy, we conclude that the latter must give way. Even when we assume an employer may trespass to some degree into an employee’s privacy when buttressed by a legitimate business interest, we find little force in such a company policy when offered as the basis for an intrusion into communications otherwise shielded by the attorney-client privilege.

It seems that New Jersey courts are now taking the position that a company cannot read an employee’s personal e-mail, even when the employer has a policy stating that the employee has no reasonable expectation of privacy. The exception to this rule would be when the company needs to know the content of the e-mail to determine whether the employee broke the law or violated company policy.

References:

Ethical Integrity Leadership – Setting the Tone From The Top

ethicspoint-logo

EthicsPoint sponsored this webinar and these are my notes. Howard Sklar, Vice President & Global Anti-Corruption Leader, American Express Company was the presenter. Howard was quick to point out that it is not just the “tone” but having the right “tone.” Also, it not be just the tone “at” the top, but that it be the tone “from” the top.

Howard started off with trying to define “tone at the top.” Many people just default to the Justice Potter Stewart’s take on pornography: “We know it when we see it.” Howard likes the ACFE definition:

An organization’s leadership creates the tone at the top – an ethical (or unethical) atmosphere in the workplace. Management’s tone has a trickle-down effect on employees. If top managers uphold ethics and integrity so will employees. But if upper management appears unconcerned with ethics and focuses solely on the bottom line, employees will be more prone to commit fraud and feel that ethical conduct isn’t a priority. In short, employees will follow the examples of their bosses.

Howard offered up his working definition for the presentation:

Tone at the top is a visible willingness by senior management to let values drive decisions to prioritize those values above other factors – including financial results and to expect all others in the organization to do the same.

Howard pointed out that the first recommendation of the Treadway Commission was the importance of setting the tone at the top.

But who is the top? The Audit Committee, CEO, Board of Directors, vice presidents, . . .? They are clearly at the top of the organization. But in this context you need to be thinking about all leaders throughout the organization. Front-line employees are most influenced by their immediate manager.

Repetition is important. Leaders and employees throughout the organization need to hear the message and hear it consistently. It is important for leaders to talk about the values of the company and to live up to those values. You can not have a message of “win at any cost” and you can no longer operate as a company with the value of  “win at any cost.”

Howard says there is no such thing as “compliance training.” It is all business training. You sell the product in the right way. You need one message. It is also important to integrate personal stories into explaining the values of the company.

Compensation is an incredibly important part of the message. If your salary or bonus is not affected by compliance. [For an example of misaligned pay structure look at Countrywide in originating sub-prime mortgage loans: Did Compliance Programs Fail During the Financial Industry Meltdown?]

The example of an opposite message is a company ingraining earnings targets in employee. Employees should not be told that earning targets are the most important part of the company. Short term thinking is short term thinking, and values are long term.

Compliance can set the goals, but they are part of the business goals not a separate set of compliance goals.

An important measurement for compliance is whether an employee feels comfortable reporting misconduct.

Howard recommends that a compliance officer become a stop in the exit interview process. Departing interviews can offer some insights and discuss problems that they may have been unwilling to report when they were an employee.

Howard says you should make sure that compliance and the compliance officers are on the company’s organization chart.

Some of Howard’s other best practices:

  • Make compliance part of hiring. Check references.
  • Make compliance part of the non-monetary reward and recognition process. Recognize employees who do the right thing.
  • Trumpet your failures as well as your successes.

See: