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The Implications of Marijuana Reclassification Part 2: The Healthcare Sector 

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By Mehdi Sinaki

The Implications of Marijuana's Potential Reclassification for the Healthcare 

As word spreads about the U.S. Department of Health and Human Services' recent recommendation to reclassify marijuana from a Schedule I to a Schedule III controlled substance, healthcare providers, insurers, and pharmaceutical companies are justifiably keen to understand the full scope of this proposed change. This article provides an overview of just how reclassification would reverberate throughout the healthcare industry. 

Expanded Research Capabilities 

Currently, marijuana’s Schedule I status severely curtails medical research by imposing rigorous regulatory hurdles, including stringent DEA approval requirements and a limited supply of research-grade cannabis. A reclassification to Schedule III would relax these constraints, permitting an acceleration in clinical trials and research. This could yield new cannabis-based medical treatments and significantly expand our understanding of marijuana's therapeutic effects. Moreover, partnerships between academic research institutions and the private sector could flourish, advancing more rapid and diverse studies. 

Prescribing Regulations 

Moving marijuana to Schedule III would affect prescribing practices. Unlike Schedule I substances, Schedule III drugs can be prescribed by a healthcare provider, but with certain restrictions. Providers would need to familiarize themselves with these new rules and possibly undergo specific training to prescribe cannabis-based products legally, even opening up new specialized health insurance products. 

Insurance Coverage 

The Schedule I status of marijuana has long been a sticking point in the insurance industry, making it virtually impossible for patients to get coverage for medical cannabis treatments. A change in federal classification would likely lead to a re-evaluation of insurance policies concerning marijuana. While immediate universal coverage is improbable, incremental changes could result in more comprehensive insurance options for patients seeking cannabis-based therapies. 

Drug Scheduling and Pharmacy Distribution 

Currently, marijuana products are generally distributed through specialized dispensaries. A shift to Schedule III would open the possibility for mainstream pharmacies to dispense cannabis-based medications, under strict regulations. Pharmacies and healthcare facilities would need to adhere to new guidelines for the storage, prescription, and sale of these products, a change that would require legal oversight and compliance procedures. Furthermore, pharmaceutical companies may compete for patents and FDA approval of specific cannabis-based drugs, changing the competitive landscape. 

Risk Management and Liability 

Healthcare providers prescribing or administering cannabis-based treatments would find themselves navigating a new landscape of potential risks and liabilities. Medical malpractice insurance policies may need to be updated to include cannabis-related treatments, and informed consent procedures would need to be revised to incorporate the specific risks and benefits associated with such therapies. 

Regulatory Compliance 

Should the proposed reclassification materialize, healthcare institutions would need to update their compliance programs to incorporate new federal and state regulations concerning the use and prescription of cannabis-based products. Failure to adhere to these evolving guidelines could result in legal penalties, including fines and potential revocation of medical licenses. Telemedicine protocols for prescribing cannabis could also come into play, requiring an update to existing telehealth regulations. 

Ethical Considerations 

Beyond the legal implications, healthcare providers would face ethical questions, particularly regarding the prescription of cannabis for certain patient demographics like minors or pregnant women. This would necessitate revising ethical guidelines and potentially require consultations with ethics committees to navigate complex scenarios. The potential for increased recreational use also raises public health concerns, especially among adolescents. 

The possible reclassification of marijuana could serve as a transformative catalyst in the healthcare sector, presenting new opportunities, challenges, and legal complexities. Given the seismic shifts that would result should cannabis be classified as a Schedule III substance, which could happen as early as 2024, it is imperative for stakeholders in the healthcare industry to seek informed legal counsel to prepare for the challenges and opportunities that lie ahead and navigate the intricacies of this evolving landscape effectively. 

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations. 

Yet Another Court Win for Crypto, but SEC’s Gensler Fights Back 

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By Sam Licker and Liza Kirillova

Following a federal court’s ruling that Ripple Labs did not violate federal law by selling its XRP token on public exchanges, the U.S. Security and Exchange Commission took another hit with respect to its aversion to cryptocurrency. In late August, a three-judge panel of the D.C. Court of Appeals ruled that the SEC was wrong to deny Grayscale Investment’s (Grayscale) proposal to convert its Bitcoin Trust (OTC:GBTC) into a spot Bitcoin ETF, which would follow Bitcoin’s underlying market value and provide investors with exposure to the digital currency without actually needing to buy it.  

By way of background, an ETF—or exchange-traded fund—is a “bundle” of securities that investors can buy or sell on a stock exchange. The securities underlying the ETF can be stocks, bonds, commodities, or other assets. While ETFs fluctuate just like the rest of the market, they are poised to allow investors to diversify their portfolios and allow everyday investors access to certain stocks that they may otherwise be priced out of or unable to purchase. Notably, the SEC has denied all spot EFT applications in the past, claiming that applicants have not successfully proven that they can protect investors from market manipulation.   

 The legal battle involving Grayscale commenced when the investment company sued the SEC for allegedly arbitrarily blocking Grayscale’s proposal for conversion. Ultimately, the appellate court determined that the SEC had, in fact, acted too hastily in denying Grayscale’s proposal and ordered that the Commission “reevaluate” its decision. In the opinion filed by Judge Neomi Rao, the three-judge panel held that the “Commission’s unexplained discounting of the obvious financial and mathematical relationship between the spot and futures markets falls short of the standard for reasoned [sic] decisionmaking.” In other words, the SEC failed to adequately explain why it previously approved the listing of Bitcoin futures ETFs, but not Grayscale’s proposed Bitcoin ETF. For its part, Grayscale’s legal counsel commented that if there was a reason “offered in attempting to differentiate” the two arrangements “[they] are confident that it would have surfaced by now.” The ruling lead to an immediate surge in Bitcoin prices and gave many domestic investors hope that we may yet see a spot Bitcoin ETF in the U.S.  

The impact of the ruling by the Court of Appeals goes far beyond Grayscale and Bitcoin. Indeed, the decision has rippled throughout the entire crypto industry, leading stocks for crypto exchanges, such as Coinbase, and crypto mining companies, like Marathon Digital, to soar. The outcome on appeal has also provided some reassurance to other asset managers seeking to win approval for their products (read: BlackRock’s proposal to create its own spot Bitcoin ETF, which it filed in June).  

 Of note, excitement in the wake of the determination in the Grayscale case may be premature. The ruling does not serve to approve the ETF; instead, it only orders the SEC to reevaluate its denial. As a matter of procedure, the SEC has 45 days from the August 29 ruling to appeal, after which the case will be sent to the entire D.C. appeals court or, potentially,  to the Supreme Court. In the meantime, the SEC has postponed its decisions on six pending applications for spot Bitcoin EFTs.  

The SEC and Chairman Gary Gensler still have an arsenal of options to delay or deny Grayscale’s proposal. If the SEC appeals, the process could take months or years to work its way back through the legal system, and even if the Commission acquiesces to the ruling, it may demand Grayscale to file an entirely new application, which could take up to another year to process. The SEC may also cite concerns over market manipulation that could result from a spot ETF, as the SEC’s position appears to remain that the crypto market as a whole is not a normal functioning market. That being said, a spot ETF could help bring stability to the marketplace, providing consumers with the peace of mind that comes with regulatory oversight, accessibility, investor protection, and institutional adoption for crypto.  

As the story unfolds, we will be keeping an eye on this ruling, the SEC’s response, and future crypto news.  

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations. 

The Implications of Marijuana Reclassification Part 1: The Corporate Sector

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By Mehdi Sinaki

The U.S. Department of Health and Human Services’ recent call to the Drug Enforcement Agency for the reclassification of marijuana to a Schedule III substance under the Controlled Substances Act has roused considerable attention across industries. For those in the burgeoning cannabis space, it represents a potential paradigm shift, though the potential move is not without its drawbacks. This analysis aims to dissect the prospective changes that reclassification could engender for marijuana-related businesses.

Corporate Governance and Compliance

The reclassification of marijuana to a Schedule III drug would necessitate an extensive review of existing compliance protocols for cannabis-related businesses. Regulatory frameworks would be expected to evolve, affecting licensing, distribution, and marketing strategies. Companies would be well-advised to anticipate such changes and adapt their compliance mechanisms accordingly. Moreover, the acknowledgment of marijuana's medicinal benefits could open up avenues for more FDA-approved medical applications and pharmaceutical collaborations.

The Stock Market and Investment

Investors have already reacted positively to the news of the possible reclassification of marijuana, as evidenced by a spike in cannabis-related stocks. Reclassification could also pave the way for these cannabis companies to be listed on major stock exchanges, providing an infusion of investment capital that could catalyze further growth. Additionally, reclassification could open up the U.S. market for foreign cannabis companies, leading to a more globalized marketplace.

Taxation Ramifications

Currently, marijuana is classified as a Schedule I substance, rendering it subject to severe federal restrictions and penalties. Critically for corporate interests, Section 280E of the Internal Revenue Code prohibits businesses dealing with Schedule I substances from claiming standard tax deductions or credits. As a result, cannabis enterprises have been shouldering taxes on their total revenue without the ability to offset taxable income through standard business deductions. A transition to Schedule III would not only relieve this tax burden but also enable interstate commerce, adding a new dimension of business expansion opportunities.

Remaining Challenges and Criticisms

It is crucial to note, however, that mere reclassification of marijuana to a Schedule III substance would fall short of resolving some broader legal challenges, most notably the conflicts between state and federal law. While a Schedule III status would signify federal acquiescence to some extent, it would not end the disconnect between federal illegality and state legalization efforts. Nor would it necessarily mitigate ongoing social justice issues related to marijuana criminalization.

The prospective reclassification currently under the microscope is undoubtedly a watershed moment in federal drug policy and offers several benefits for marijuana-related enterprises. That being said, it is not an end-all solution and cannabis-related companies should remain agile, attentive to forthcoming regulatory changes, and prepared to navigate a landscape that remains fraught with legal intricacies and social implications. With the possibility of reclassification as early as 2024, ahead of the Presidential elections, companies should be prepared for rapid policy shifts and should adjust their corporate strategies accordingly.

No doubt about it, as we move closer to a potential reclassification, perhaps as early as 2024, proactive legal strategy will be paramount for corporate success in this complex and evolving sector.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.

Understanding Regulation D of the Securities Act: A Summary Guide for Company Management

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By Elliot Weiss

In the realm of corporate finance, Regulation D of the Securities Act of 1933, as amended, plays a pivotal role in enabling companies to raise capital through private placements of securities. This regulation provides issuers of securities with safe harbor exemptions from registration requirements under the Securities Act that would otherwise apply to public offerings. As otherwise stated, Regulation D lets companies doing specific types of private placements raise capital without needing to register the securities with the U.S. Securities and Exchange Commission. That being said, for company management, a comprehensive understanding of Regulation D is essential to navigate the complexities of fundraising while staying compliant with securities laws. Here, some of the most significant rules and implications of Regulation D are summarized.

Regulation D: A Brief Overview

Section 5 of the Securities Act requires all offers and sales of securities to be registered with the SEC unless there is an available registration exemption. Failure to comply with these requirements grants the purchaser a right to sue to rescind the purchase or seek damages against the issuer.

The two most common exemptions provided for in the Securities Act are Section 4(a)(2) and Regulation D. Regulation D is a set of rules and safe harbor exemptions that allow companies to raise capital through sales of securities without the need for a full-scale registration process with the SEC. Of note, any type of security can be offered to investors through a private placement under Regulation D including promissory notes, SAFE notes or equity interests (e.g.  common stock, preferred stock or membership interest in a limited liability company, etc.).

Rules 504 and 506 of Regulation D set forth different qualification requirements and restrictions with respect to an offer and sale by an issuer. As a safe harbor mechanism, Regulation D is non-exclusive, which means where it does not provide an exemption, Section 4(a)(2) still may. Pursuant to both Regulation D and Section 4(a)(2), securities sold under pursuant to these exemptions are considered restricted securities and cannot be resold without registration with the SEC or qualification under another exemption.

Types of Offerings under Regulation D

Regulation D provides three main types of exemptions for private placements:

(i) Rule 504. The exemption under Rule 504 allows companies to offer and sell up to $10 million of securities to any type of investor within a 12-month period. Rule 504 is often used by smaller companies and may be subject to state securities laws, which can vary significantly.

(ii) Rule 506. According to the SEC, the exemption under Rule 506 is by far the most widely used under Regulation D, accounting for an estimated 90 to 95% of all Regulation D offerings and the overwhelming majority of capital raised in transactions thereunder. Rule 506 offers two distinct options:

  • Rule 506(b): This rule allows an issuer to raise an unlimited amount of capital from up to 35 non-accredited investors and an unlimited number of accredited investors. Pursuant to Rule 506(b), issuers must provide specific disclosure documents to non-accredited investors and must have a pre-existing relationship with them. General solicitation is prohibited under Rule 506(b) offerings.
  • Rule 506(c): Rule 506(c) permits companies to broadly solicit and advertise their offerings to the public, but all investors must be accredited. This option does not have a specific limit on the amount of capital that can be raised. Rule 506(c) is especially helpful for rolling and other private investment funds since it allows management to engage in general solicitation. The SEC has confirmed that privately offered pooled investment vehicles relying on the qualified purchaser (Section 3(c)(7)) or 100-holder (Section 3(c)(1)) exclusions under the Investment Company Act of 1940 may engage in general solicitation under Rule 506(c).

Integration

Taking advantage of any registration exemptions through a Regulation D offering requires that all sales of securities of the same class or for the same purpose within the six months preceding and following a reported Reg offering must be integrated. Essentially, these types of offerings will all be considered a single offering, and as such, any limits on the sale price or number of purchasers is cumulative; however, any offers and sales will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the Securities Act or that an exemption from registration is available for the particular offering (including four specific safe harbors for non-integration). The concept of integration seeks to prevent issuers from improperly evading registration with the SEC by artificially dividing a single offering into multiple offerings.

Accredited Investors

Accredited investors play a central role in many Regulation D offerings. These investors are deemed to have the financial sophistication and capacity to assess the risks associated with private placements. Examples of accredited investors include individuals with high income, institutions with substantial assets, holders of certain professional certifications, and certain knowledgeable employees of the subject company. In recent years, the SEC has modernized the definition of "accredited investor” by including new groups given accredited investor status.

Company management must take steps to confirm that an investor qualifies as an accredited investor in each offering. These steps differ depending on the type of Regulation D offering being conducted. Under Rule 506(b), all accredited investors participating in a 506(b) private placement offering may self-verify that they qualify as an accredited investor, generally, by completing an accredited investor questionnaire issued by company management.

Issuers wishing to solicit or advertise under 506(c) must also take reasonable steps to verify the accredited investor status of purchasers. Rule 506(c) sets out a principles-based method for accredited investor verification, requiring an objective determination by the issuer as to whether the steps taken in verification were “reasonable” in context of the particular facts and circumstances of each purchaser and transaction. Note that the verification standard is heightened under Rule 506(c). The non-exhaustive list for accredited investor verification from Rule 506(c) includes:

  • Reviewing IRS documentation (e.g., tax returns) that state income levels and obtaining a written representation that the investor has a reasonable expectation of reaching the same income level necessary to qualify as an accredited investor during the current year;
  • Reviewing bank statements, brokerage statements, and other similar reports to determine net worth; and
  • Obtaining written confirmation of the investor’s accredited investor status from one of the following persons: a registered broker-dealer, an investment adviser registered with the SEC, a licensed attorney, or a CPA.

Disclosure Requirements

Even though Regulation D offerings are exempt from full SEC registration, issuers are still required to provide accurate disclosure of material information to non-accredited investors (there are no specific disclosure requirements for offerings sold only to accredited investors). If an offering is sold to any non-accredited investors, Rule 502(b) requires disclosure similar to that which would be required for a public offering. For example, if an offering is sold to any non-accredited investors under Rule 506(b), Rule 502(b) disclosure requirements are required to match Regulation A’s disclosure mandates (e.g., the disclosure of unaudited financial statements, as long as the offering amount is no more than $20 million, and in the case of Rule 506(b) offerings over $20 million, disclosures in Article 8 of Regulation S-X instead of the disclosures required in a registration statement).

Compliance and Investor Protection

While Regulation D provides valuable exemptions, companies must remain vigilant about compliance with stipulated rules. Missteps can lead to serious legal consequences and damage to a company's reputation. Investors are still afforded a certain level of protection, and any fraudulent or misleading practices can result in legal action.

Navigating State Securities Laws

Companies engaging in Regulation D offerings must also consider state securities laws, often referred to as "Blue Sky Laws." These laws vary by state and may impose additional filing requirements and regulations that could impact the offering.

Seeking Legal Counsel

Given the complexity of Regulation D and its potential legal ramifications, it is highly advisable for companies looking to avail themselves of Regulations D’s safe harbors to seek the expertise of legal professionals with experience in private financings and securities law. An attorney can help guide company management through the compliance process, draft necessary documents, and ensure that the company's interests are protected.

Without questions, Regulation D presents a valuable framework for companies seeking to raise capital through private placements. By understanding Regulation D and similar exemptions, investor qualifications, disclosure requirements, and compliance obligations, company management can navigate the intricacies of fundraising while adhering to securities laws.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.

When It Comes to AI, No Human Authorship Means No Copyright Protection

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For a work to be protected under the U.S. Copyright Act of 1976 (the Act), it must be an original work of authorship fixed in a tangible medium of expression. With that background, United States District Judge Beryl A. Howell recently ruled that art created solely by Artificial Intelligence (AI)—in that case, a program called “Creativity Machine”—is not subject to copyright protection. This is believed to be the first of its kind ruling.

In Thaler v. Perlmutter, the plaintiff and owner of the Creativity Machine applied for a copyright registration, seeking to protect a piece of art titled “A Recent Entrance to Paradise.” The plaintiff’s application stated that the artwork was “created autonomously by machine” and that his copyright claim was premised on his ownership of the Creativity Machine.

The Copyright Office denied Thaler’s application because the piece at issue “lack[ed] the human authorship necessary to support a copyright claim.” The Copyright Office further noted that copyright law only extends to works created by human beings. Judge Howell agreed.

It is the lack of human authorship that was central to Judge Howell’s decision. In ruling on summary judgment, she reiterated that courts have “uniformly declined to recognize copyright in works created absent any human involvement.” This decision tracks the March 2023 guidance issued by the U.S. Copyright Office concerning works containing material generated by AI, as well as the famous “monkey selfie” case where, a photograph taken by a monkey was denied copyright protection because of its lack of human authorship.

Questions Remain Concerning Copyright Protection of AI-Generated Works

Judge Howell’s decision, which is likely to be appealed by Thaler, concerns works created solely by machines. That determination does not definitively apply to all AI-generated creations. Specifically, Judge Howell stated, “Undoubtedly, we are approaching new frontiers in copyright as artists put AI in their toolbox to be used in the generation of new visual and other artistic works.” That being said, Judge Howell acknowledged that generative AI will “prompt challenging questions” regarding (1) the level of human input necessary to qualify for copyright protection and (2) the way in which originality of AI-generated works born of systems trained on existing copyrighted works will be assessed.

Takeaways

While the Thaler case was an easy one for Judge Howell to decide, these types of cases will certainly become much more challenging when registration is sought for AI-generated material that was created with significant human involvement. Of course, how much human involvement is necessary to move the needle from registrable to non-registerable remains to be seen.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations. 

An Apparent Blow to the SEC’s Regulatory Authority Over Crypto Exchanges 

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By Samuel Licker

A federal district judge in New York has handed down a long-awaited ruling to determine whether sales by Ripple Labs Inc. of its cryptocurrency, XRP, was considered a security. 

In SEC v. Ripple Labs Inc., Judge Analisa Torres, presiding in U.S. District Court for the Southern District of New York, decided that the  token is a security when sold to institutional investors but not the general public. In so ruling, Judge Torres accepted the SEC’s argument to use the so-called Howey Test to decide whether XRP should be classified as a security and, therefore, fall within the SEC’s regulatory ambit. By way of background, the Howey Test requires four elements to be satisfied for a transaction to trigger SEC regulation: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profits, (4) to be derived solely from the efforts of others. 

Judge Torres’s ruling—that sales of XRP to sophisticated investors satisfied the Howey Test, yet sales to the general public through crypto exchanges failed the test because there was no evidence presented that these investors knew that Ripple was the seller and they were not investing in Ripple’s future efforts, but rather buying for any number of reasons, such as general cryptocurrency market dynamics—is certainly a blow to the SEC’s regulatory authority.  

The SEC has indicated it will appeal the ruling as it relates to programmatic buyers. In the meantime, pursuant to the ruling, it appears that XRP, and other tokens like it, are not securities under the Howey Test, though sales of cryptocurrencies could still be considered sales of securities if there are subjective expectations between buyers and sellers. For instance, in the case before Judge Torres, institutional buyers entered into lock-up agreements or agreed to resale restrictions, which led to her conclusion that the expectation was not that the tokens in these circumstances would be used as a currency.  

Back in May, M&R reported on Bittrex, a global cryptocurrency exchange, having been charged by the SEC with, among other things, failing to register as a national securities exchange. In the wake of the ruling in the Ripple Labs case, the SEC’s argument in Bittrex is called into question. If tokens sold on an exchange fail the Howey Test and are not considered securities, then the exchange itself likely cannot be considered a securities exchange. While the Bittrex case is pending in the Washington Western District Court, litigators defending Bittrex are optimistic that the determination in Ripple will bolster Bittrex’s position that the crypto assets the company sold should not be considered unregistered securities.   

With both sides gearing up for a long fight, other jurisdictions or the Second Circuit Court of Appeals might flip the switch on the SEC’s ability to regulate cryptocurrencies sold on consumer exchanges, especially as other companies are on the hotseat, including Binance, TerraForm Labs, Gemini Trust Company, and Coinbase. The corporate and securities pros at M&R are keeping their heads on a swivel as more rulings and analysis emerge in the crypto markets. We will be sure to report back. 

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.   

New SEC Cybersecurity Disclosure Rules Are on the Horizon 

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Megan Penick and Jia Song


By Megan Penick and Jia Song

Last week, new cybersecurity rules were adopted by the Securities and Exchange Commission that directly impact public companies, including foreign private issuers (FPIs), requiring them to make certain disclosures about cybersecurity incidents, risk management, strategy and governance. Taken together, the SEC’s new rules markedly expand upon the federal agency’s current cybersecurity disclosure mandates.

Disclosure on Current Report

The final rule requires public companies to disclose material cybersecurity incidents within four business days on a Current Report on Form 8-K under a new Item 1.05 (Form 6-K for FPIs). Pursuant to Item 1.05, public companies must disclose any cybersecurity incidents they experience that are determined to be material and describe their (1) nature, scope and timing and (2) the expected impact or reasonably likely impact of the incidents upon the companies, their financial condition and results of operations.

A disclosure under Item 1.05 of Form 8-K will need to be filed within four business days after a company has determined an incident to be material in nature. As reporting on cybersecurity breaches can be difficult—because the severity or extent of a breach may not be clear until after significant internal investigation—the SEC has also adopted a rule that requires companies to amend their original Item 1.05 disclosures when and as additional information material to a given breach (or breaches, if there is more than one that is deemed related) is discovered. The SEC has indicated that in order to make cybersecurity incident disclosures clear and easy to find by investors, it was preferred that a Form 8-K disclosing the breach be amended for further disclosures, as opposed to companies simply reporting additional findings in their periodic reports on Forms 10-Q or 10-K.

Disclosure on Annual Report

In addition, the final rule compels public companies to disclose material information regarding their cybersecurity risk management, strategies and governance on their annual reports on Form 10-K (Form 20-F for FPIs)—this by adding a new Item 1C to Part I of the Form 10-K. Item 1C requires registrants to furnish the information required by Item 106 of Regulation S-K (Item 106). Item 106(b) requires registrants to describe their processes, if any, for assessing, identifying and managing material risks from cybersecurity threats, as well as the material effects or reasonably likely material effects of risks from cybersecurity threats and previous cybersecurity incidents. Board of directors’ oversight of risks from cybersecurity threats and managements’ role and expertise in assessing and managing material risks from cybersecurity threats are also mandated pursuant to Item 106(c).

Effective Timeline

The final rule will become effective 30 days after publication in the Federal Register. The Form 10-K and Form 20-F disclosures will be due beginning with annual reports for fiscal years ending on or after December 15, 2023, while the due date for the Form 8-K and Form 6-K disclosures will be the later of 90 days after the date of publication in the Federal Register or December 18, 2023. For their part, smaller reporting companies will have an additional 180 days before they must begin providing the Form 8-K disclosure. With respect to compliance with the structured data requirements, all registrants must tag disclosures required under the final rules in Inline XBRL beginning one year after initial compliance with the related disclosure requirement.

Practical Guidance

Historically, many companies have been slow to disclose hacking or other cybersecurity incidents, fearing that disclosure could expose them to further risks and hamper their ability to assess and secure their data and systems. As a result, many of these incidents have not been reported until long after they occurred. However, as more and more companies have been affected by cyber criminals and data breaches in recent years, a need for prompt and effective disclosure has been seen by many as increasingly necessary. This is particularly the case because many companies rely on third parties to handle data storage and data management, and customers and investors need to be able to assess their own risk and exposure as a result of such incidents. The SEC’s new disclosure mandate is designed to do just that.

To decide whether an event qualifies as a material incident requiring  SEC reporting is a practical issue. Companies should consult with their securities counsel to determine whether an incident is material in nature and, accordingly, whether it will need to be disclosed in a Current Report on Form 8-K. Further, companies, along with their legal counsel and financial advisors, need to value the size, nature and /or reputation or financial harms such incidents may cause, as well as other factors to determine materiality.

Of course, the public securities and cybersecurity pros at Michelman & Robinson, LLP are available to provide more detail and answer any questions you may have about the SEC’s new cybersecurity rules.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.

SCOTUS Ruling Means Shareholders Will Have to Pick Up the Slack in Direct Listings

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By Megan Penick, Samuel Licker, and Sara Sarvestani

In the case of Slack Technologies, LLC v. Pirani, the Supreme Court unanimously ruled in favor of Slack, avoiding the distinction between Direct Listings and Initial Public Offerings when citing long-standing precedent concerning the application of Section 11 of the Securities Act of 1933. As a result of his failure to directly link his purchased shares to the 118 million shares registered in Slack’s registration statement, plaintiff Fiyyaz Pirani was denied legal standing in his claim that Slack’s Registration Statement had misled investors who purchased Slack shares following the Company’s June 2019 direct listing to sell its shares to the public on the New York Stock Exchange (NYSE). 

What is a Direct Listing, and how does it differ from an IPO?

Direct listings differ from traditional initial public offerings (IPOs) in that no new shares are issued and, instead, only existing, outstanding shares are sold to the public without the involvement of an underwriter. In other words, a direct listing allows a company’s current investors, promoters and employees who already hold shares in the company to directly sell such shares to the public. However, like an IPO, companies offering shares through the direct listing process must still file a Registration Statement on Form S-1 with the SEC and, as a result, anyone who purchases shares once they are being sold in the market will rely on the disclosures in that registration statement. 

Companies generally raise capital by going public. Traditionally, they do so through the IPO process, in which offerings are backed by underwriters or banks who put up their own capital and demand significant due diligence. IPO’s typically have “lockup agreements,” which prevent unregistered shares and shares owned by insiders from being sold immediately. These practices stabilize prices and boost investor confidence but are costly and time-consuming. To promote smaller private companies in going public, the SEC authorized direct listings in 2018.

What is Section 11 of the Securities Act?

Section 11 is a provision of the Securities Act that establishes civil liability for officers, directors, auditors and other experts signatory to registration statements, as well as underwriters, for material misstatements or omissions of material fact made in registration statements.  

While it’s not directly stated in Section 11 of the Securities Act, case law has historically required plaintiffs to prove they have purchased securities “traceable” to the Registration Statement in order to successfully bring a civil action under Section 11 against the issuer, underwriter, or anyone who contributed to the filing of a Registration Statement for any misrepresentations in such filing. In other words, a plaintiff must be able to “trace” their purchase of securities directly to shares registered in the allegedly misleading Registration Statement.

The Slack Case

Slack’s direct listing made available for purchase 118 million registered shares and 165 million unregistered shares, none of which were subject to lock-up provisions (as is common practice in IPOs) and thus all of which were potentially available for public purchase on the open market. Pirani, a young tech entrepreneur, purchased 30,000 Slack shares as soon as the company went public, and later bought an additional 220,000 registered and unregistered shares. While Slack filed a Registration Statement for the registered shares it intended to offer, investors like Pirani, who purchased his shares on the open market, were not able to distinguish registered shares from unregistered shares in order to trace specific shares to Slack’s Registration Statement. Pirani’s case claimed that all Slack shares available to the public should be covered by the registration statement and therefore he had standing to sue. As a result, the disclosure set forth in the Registration Statement was arguably material to any purchaser of Slack shares during that initial period because Slack had no periodic disclosure filings other than the Registration Statement for a two and half month period following its Direct Listing between June 20, 2019 until September 4, 2019.  

When Slack’s stock price dropped after the Direct Listing, in September 2019, Pirani filed a class-action lawsuit against the Slack under the Securities Act, alleging Slack had violated Section 11 of the Act by filing a fraudulent Registration Statement that contained material misrepresentations and/or omissions concerning service outages, credits for disrupted service and rival Microsoft Teams software. Slack unsuccessfully moved to dismiss on the grounds that Pirani could not fulfill Section 11’s tracing requirement. The district court held that Section 11 does not require tracing in the context of direct listings. On appeal, the Ninth Circuit affirmed, but on different reasoning, concluding that Section 11 does impose a tracing requirement applicable to direct listings, but because NYSE rules permit direct listings only if an effective Registration Statement is in place, unregistered shares qualify as “such securities” within the scope of Section 11. 

In a unanimous decision authored by Justice Gorsuch, the Supreme Court vacated the Ninth Circuit’s ruling. The Court determined that the language and structure of the Securities Act confirmed the long-standing view that Section 11 covers only securities that are registered under the Registration Statement under which the plaintiff has sued, leaving any differentiation between IPOs and Direct Listings to be clarified through Congress. As such, Pirani was denied standing since he had not shown that he had purchased shares registered under the Registration Statement and the Ninth Circuit’s ruling was vacated. Curiously, the SEC did not weigh in on the case.

Why does the SCOTUS ruling matter?

  • The Ninth Circuit’s decision threatened to substantially expand the scope of potential liability under Section 11 to unregistered shares if those shares had a “but for” connection to the challenged Registration Statement.
  • The SCOTUS ruling eliminated that risk by clarifying that Section 11 liability does not extend to unregistered shares or shares sold pursuant to any Registration Statement other than the specific filing being challenged.
  • The SCOTUS ruling reaffirms that Section 11 requires a plaintiff to plead and prove that the purchased securities are traceable to the challenged Registration Statement.

The Bottom Line

For now, the Supreme Court’s decision in Slack returns a sense of continuity to securities markets and the SEC regime. However, in the world of public offerings, the SCOTUS ruling may incentivize more companies to opt for direct listings over IPOs, given that direct listings minimize costs and delays. These companies would be well advised to heed Megan J. Penick’s, M&R partner and Public Securities Chair, advice in a recent interview with the National Law Journal about the SCOTUS decision. Put simply, Penick reminds companies that full disclosure is always the best legal advice.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.  

A Look at Qualified Small Business Company Stock: the Tax Benefits and Eligibility 

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By Elliot Weiss  

Tax law can be complex and daunting, to be sure. But that should not stop investors and shareholders from taking the time to understand the tax benefits available to those selling (or exchanging) Qualified Small Business Company Stock (QSBS).  

What Constitutes a QSBS? 

QSBS is stock in a small business that may qualify for a U.S. tax benefit—codified in Section 1202 of the Internal Revenue Code—allowing sellers to avoid paying capital gains taxes on sales (or exchanges) of QSBS. In fact, for sales of QSBS issued after 2010, sellers can exclude 100% of their  gains. This benefit was created to incentivize investment in qualifying small businesses. While the availability of the QSBS tax benefit is well known in the venture capital community, the topic is less understood outside the space. 

To be eligible for QSBS tax treatment, companies must meet the following requirements:  

Qualified Trade or Business 

The QSBS tax exemption requires the issuer of the capital stock to be engaged in a qualified trade or business other than an excluded business type set forth in Section 1202 of the Internal Revenue Code. These excluded business types include those that perform services in the fields of healthcare, law, engineering, architecture, financial and brokerage services or any other trade or business in which the principal asset is the reputation or skill of one or more of its employees. Likewise, businesses involved in banking, insurance, financing, leasing, investing, farming and hospitality are also generally not treated as qualified trades or businesses (and thus ineligible for QSBS tax treatment). That being said, companies in the business of manufacturing, technology, research and development and software may qualify as QSBS. 

Active Business 

In addition to the general qualified trade or business requirement, a company must meet the so-called 80% Test. Pursuant to Section 1202, for a company's stock to qualify as  QSBS, “at least 80 percent (by value) of the assets” of the corporation* must be used in the “active conduct of one or more qualified trades or businesses during substantially all of the taxpayer’s holding period for such stock.” Satisfying this 80% Test is oftentimes a challenge because it requires an assessment of the ongoing nature of the corporation’s business activities. Further, there is a lack of IRS guidance regarding the 80% Test, which places the burden of proof and persuasion on the taxpayer during an audit.  

*Note that C corporations can issue QSBS. Partnerships and LLCs can as well, but only if they file an election to be taxed as a corporation. For their part, S corporations will not qualify, unless converted into a C corporation and then, only after such a conversion.  

Gross Assets 

For a company’s stock to be deemed QSBS, the aggregate gross assets of the corporation (or any predecessor entity) must not exceed $50 million. To be clear, once a company’s gross assets are north of $50 million, it can never again issue QSBS. This is the case even if gross assets dip below the $50 million threshold at a later date; however, this is a going forward restriction, meaning prior QSBS issuances made before crossing the $50 million threshold will not be precluded from the tax benefit of gain exclusion under Section 1202 just because the $50 million threshold was crossed after the prior QSBS was issued.   

Original Issuance 

QSBS eligibility requires the stock to have been acquired directly from the corporation in exchange for money, property or services performed (other than services performed as an underwriter). The original issuance requirement is satisfied where the QSBS is acquired directly from the corporation upon formation, during a subsequent offering, upon the exercise of options or warrants, upon conversion of convertible debt, upon distribution from a partnership, or when received as a gift or at death. Stock obtained from the secondary market or upon transfer of an existing stockholder will not be deemed originally issued.   

Minimum Holding Period  

To take advantage of the tax benefits set forth in Section 1202, QSBS stock must be held for at least five years prior to sale, with the holding period beginning on the date of acquisition (or the date of exercise or conversion where the original issuance stems from the exercise or conversion of convertible securities).  

The Tax Benefit: Limitations on Excludable Amounts    

What does all this mean if the above requirements are met and a shareholder is in possession of QSBS at the time of a proposed stock sale? At minimum, a noncorporate shareholder can exclude 50% of the taxable gain from the sale of QSBS held for at least five years. This 50% exclusion increases to 75% for QSBS acquired from February 18, 2009 through September 27, 2010, and then again to 100% for QSBS obtained on or after September 28, 2010. It is important to note that the total taxable gain that may be excluded based on the foregoing is subject to cumulative and annual limitations. 

These limitations provide that for each annual year the total amount of gain exclusion is limited by the greater of (i) $10 million (reduced by the dollar amount of gain exclusions taken by the taxpayer on QSBS in prior years), or (ii) an annual limitation equal to 10x the aggregate adjusted basis of the QSBS that the taxpayer sold. Since the dollar cap on excludable gain involves the “greater of” the cumulative and the annual limitations, the annual limitation may allow the taxpayer to exclude more than a total of $10 million. 

Of course, legal and tax experts can weigh in on a seller’s specific tax situation and relevant QSBS qualifications. 

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.   

Our Number One Court Sides With Jack Daniel’s in Trademark Dispute Over a Number Two Dog Toy 

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Nicole Haff


By Nicole Haff

The U.S. Supreme Court issued a decision today holding that a dog toy laced with amusing, scatological-based references satirizing Jack Daniel’s iconic liquor bottle was not covered by the First Amendment’s free speech protections. 

A Bit of Background: Jack Daniel's Properties, Inc. v. VIP Products LLC 

VIP Products LLC (VIP) is the seller of a dog toy marketed as the "Bad Spaniels Silly Squeaker.” It resembles a bottle of Jack Daniel's Old No. 7 Black Label Tennessee Whiskey and sets forth alterations to the text Jack Daniel’s prints on its bottles. These modifications—mostly “bad doggie” references centered on potty humor—include a references to “Bad Spaniels” rather than “Jack Daniel’s,” “Old No. 2, on your Tennessee Carpet,” instead of “Old No. 7 Brand Tennessee Sour Mash Whiskey, and  a boast of "43% POO BY VOL.,” in lieu of a listing of alcohol by volume.  

A tag affixed to the Bad Spaniels item disclaims any affiliation with Jack Daniel’s. Nonetheless, Jack Daniel's Properties, Inc. (JD Properties) issued a cease and desist to VIP demanding that VIP stop selling the squeaky toy. In response, VIP filed a declaratory judgment action in federal court seeking a determination that the product did not infringe upon JD Properties’ trademark rights or dilute any of JD Properties’ trademarks or, in the alternative, that the Jack Daniel’s trade dress and bottle design were not entitled to trademark protection. In effect, VIP sought to cancel the registration for the trade dress in Jack Daniel’s No. 7 bottle. JD Properties counterclaimed, asserting infringement of trademarks and trade dress and dilution by tarnishment.  

Procedural Posture 

Before trial, VIP filed a motion for summary judgment on both claims, asserting that (1) the infringement claim filed by JD Properties failed under the Rogers test, a threshold test derived from the First Amendment to protect “expressive works,” and (2) there was no dilution because the Bad Spaniels toy was a parody of Jack Daniels and therefore it made “fair use” of its famous mark, under statutory exemptions available for dilution claims. The Court rejected both arguments, and after conducting a bench trial, the district court entered judgment against VIP.  The case was appealed.  

On appeal, the Court of Appeals for the Ninth Circuit held that the district court erred in finding trademark infringement without first requiring JD Properties to satisfy at least one of the two prongs of the Roger’s test (discussed below). The Ninth Circuit also ruled that the humorous message conveyed by the toy was protected non-commercial speech and thus not actionable. With that, it reversed the district court’s judgment holding in favor JD Properties’ dilution claim, vacated the judgment JD Properties received against VIP for its trademark infringement claims, and remanded the case back to the District Court for further proceedings. 

On remand, the district court found that Jack Daniel’s could not satisfy either prong of the Rogers test. Pursuant to this finding it granted summary judgment to VIP on infringement. The Ninth Circuit summarily affirmed and the case was then appealed to the Supreme Court. 

The Rogers Test and Its Prior Application  

While the test for trademark infringement varies slightly across circuits, trademark infringement boils down to whether the use of another’s trademark is likely to cause consumer confusion as to the source of goods or services. For more than three decades, the Rogers test, which spawns from the landmark case Rogers v. Grimaldi, has been the standard that courts throughout the country have used to determine when trademark protection should apply to artistic works. 

In Rogers, the Second Circuit held such instances were limited to when the public interest in avoiding consumer confusion outweighs the public interest in free expression. In the aftermath of Rogers, courts have used the test to make sure trademark law is not used to suppress otherwise protected speech, particularly for artistic and expressive works like movies, plays, books and songs. The Rogers test requires a party alleging trademark infringement to show that the defendant's use of the trademark either (1) is not artistically relevant to the work or (2) explicitly misleads consumers as to the source or content of the work. After this inquiry is met, likelihood of confusion is examined.  

The Jack Daniel’s Decision 

In a unanimous ruling, the U.S. Supreme Court held that when a mark is used as a source identifier, meaning as a trademark, the use does not receive special First Amendment protection and a threshold inquiry like the Rogers test should not apply, except perhaps in rare situations. Source identifiers, such as the Nike “swoosh” or the name of a brand, like Google, help consumers identify the source of goods and assist consumers in distinguishing that source from other sources. 

The Court also ruled that “this result does not change because the use of the mark has other expressive content – i.e., it conveys some message on top of source.” The justices, in unanimity, reasoned that many marks possess an expressive element and if a threshold test, like Rogers, was applied to all expressive marks, few cases would ever advance to the likelihood of confusion test. Thus, when a trademark is used as a trademark, the traditional likelihood of confusion test must be used to determine infringement claims. A plaintiff is not required to first satisfy the Rogers test before a likelihood of confusion is examined. Notably, the Court expressly declined to decide whether the Rogers test is “ever appropriate.” 

Further, the Court ruled that while goods, like the Bad Spaniels toy, may contain an expressive aspect, that “message” can be examined “in assessing confusion because consumers are not so likely to think that the maker of a mocked product is itself doing the mocking.” As such, mockery, humor and parody can still be considered but when a mark is being used as a source designator, that consideration is confined to the likelihood of confusion test, not a threshold First Amended inquiry, like Rogers. 

Regarding the dilution claims raised by JD Properties, the Court ruled that the use of a mark does not count as non-commercial, “just because it parodies, or otherwise comments on, another’s products.” The Lanham Act’s statutory exclusion from dilution liability for “[a]ny noncommerical use of a mark,” does not shield parody, criticism or commentary when an alleged diluter uses a mark as a designation of source for its own goods. 

Based on all of the foregoing, the Court vacated the judgment below and remanded the case for further proceedings consistent with its opinion. 

An Important Takeaway 

Businesses that produce parody products that use or imitate the trademarks of others should reconsider their business models in light of the Jack Daniel’s decision. While parody may be considered in conducting a likelihood of confusion test, the Rogers test is no longer available to the producers of parody goods when a mark is being used as a source identifier. In fact, it is unclear whether the Rogers test is “ever appropriate,” as the U.S. Supreme Court has declined to issue a holding on that issue. 

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.