Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC settled actions with ten companies for alleged Form 8-K violations.  The investigation centered on failure to file Form 8-K when shares of common stock are sold in transactions that are not registered with the SEC under the federal securities laws and constitute at least five percent of the total stock held by their shareholders.

The SEC alleged the following Form 8-K violations occurred:

  • Under Item 1.01 of Form 8-K, a registrant must disclose within four business days its entry into a material definitive agreement.
  • Under Item 3.02 of Form 8-K, a smaller reporting company must disclose within four business days the unregistered sales of equity securities unless they constitute less than five percent of the number of last reported shares outstanding of the class of equity securities sold.
  • In Form 10-Q or 10-K (quarterly or annual reports), issuers must disclose the number of outstanding shares of their common stock as of the latest practicable date, and the information must be true, correct, and complete.  Three of the companies allegedly failed to use accurate numbers when later reporting the dilution of their common stock in quarterly or annual reports.

The majority of the charged issuers appeared to be sitting ducks, with the increases reportedly being between 95% and 35,000%, with others at 7%, 15%, 25% and 50%.

Seven percent may be a “broken window” but it seems hard to take that position with some of the others.  It is also interesting no one was charged for disclosure controls and procedure violations and no individuals were charged.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The Office of Inspector General, or OIG, of the Board of Governors of the Federal Reserve System has issued its first listing of major management challenges facing the CFPB. These challenges represent what OIG believes to be the areas that, if not addressed, are most likely to hamper the CFPB’s accomplishment of its strategic objectives.

The major management challenges are:

  • Improving the operational efficiency of supervision
  • Building and sustaining a high-performing workforce
  • Implementing new management operations
  • Providing for space needs
  • Ensuring an effective information security program

As to improving operational efficiency of supervision, OIG’s work indicated that improving operational effectiveness will be a focus of management’s attention in the coming year as the CFPB works to:

  • Clear a considerable number of draft examination reports that have yet to be issued
  • Improve its reporting timeliness
  • Ensure the timely recording of data in its tracking system
  • Formalize the process for scheduling and tracking examiner hours

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The SEC announced charges against an investment advisory firm and three of its top officials for violating the “custody rule” that requires firms to follow certain procedures when they control or have access to client money or securities.

Advisory firms with custody of private fund assets can comply with the custody rule by distributing audited financial statements to fund investors within 120 days of the end of the fiscal year.  This provides investors with regular independent verification of their assets as a safeguard against misuse or theft.  The SEC’s Enforcement Division alleges that the investment advisory firm was late in providing investors with audited financial statements of its private funds and that the three officials were responsible for the violation.

The SEC alleges the investment advisory firm was at least 40 days late in distributing audited financial statements to investors in 10 private funds for fiscal year 2010.  The next year, audited financial statements for those same funds were delivered anywhere from six months to eight months late.  According to the SEC, the same materials for fiscal year 2012 were distributed to investors approximately three months late.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

Six federal agencies approved a final rule requiring sponsors of securitization transactions to retain risk in those transactions.  The final rule implements the risk retention requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The final rule is being issued jointly by the Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission.

According to the regulators, the final rule largely retains the risk retention framework contained in the proposal issued by the agencies in August 2013 and generally requires sponsors of asset-backed securities, or ABS, to retain not less than five percent of the credit risk of the assets collateralizing the ABS issuance.  The rule also sets forth prohibitions on transferring or hedging the credit risk that the sponsor is required to retain.

As required by the Dodd-Frank Act, the final rule defines a “qualified residential mortgage,” or QRM, and exempts securitizations of QRMs from the risk retention requirement.  The final rule aligns the QRM definition with that of a qualified mortgage as defined by the Consumer Financial Protection Bureau.  The final rule also requires the agencies to review the definition of QRM no later than four years after the effective date of the rule with respect to the securitization of residential mortgages and every five years thereafter, and allows each agency to request a review of the definition at any time.  The final rule also does not require any retention for securitizations of commercial loans, commercial mortgages, or automobile loans if they meet specific standards for high quality underwriting.

SEC Commissioner Luis A. Aguilar addressed the point that the QRM definition is linked to CFPB rulemaking, but the CFPB was not tasked by the Dodd-Frank Act to promulgate the rulemaking.  As a result of that linkage, the QRM definition will be subject to change over time at the sole discretion of just one agency—the CFPB—and it may not always be reflective of what the particular agencies involved in this rulemaking may deem appropriate.  However, Commissioner Aguilar noted “[f]or these reasons, today’s rules mandate a periodic review of the QRM definition—four years after the effective date of this final rule, and every five years thereafter. Additionally, any of the agencies who participated in this rulemaking can request a review of the QRM definition at any time. I view this oversight responsibility as an important check to make sure that the QRM definition will continue to be appropriate in the face of the inevitable changes of financial markets, and other unpredictable and unforeseen developments.”

The final rule will be effective one year after publication in the Federal Register for residential mortgage-backed securitizations and two years after publication for all other securitization types.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

A key component to evaluating whether to place an equity plan proposal in a proxy is whether or not ISS will support the plan.  Accoding to ISS, while it has historically recommended against approximately 30 percent of equity plan proposals each year under existing policy (ranging from 30 percent to 42 percent during the period from 2005 to 2013), the vast majority of plan proposals receive the requisite number of votes to pass. In the aftermath of the 2008-2009 financial “meltdown,” no more than nine equity plan proposals have failed to garner majority support each year (2010 through 2013), compared with 22 failed plans in 2005.

ISS is proposing to change the methodology used to evaluate equity plan proposals.  ISS proposes to use a an equity plan scorecard, or EPSC, that considers a range of positive and negative factors, rather than a series of “pass/fail” tests as applied in the existing policy, to evaluate equity incentive plan proposals. A company’s total EPSC score will generally determine whether a “For” or “Against” recommendation is warranted.

It remains to be seen whether the proposed EPSC will make the ISS black box blacker, making it more difficult to determine whether a proposal will be supported.  It’s possible the lack of bright line drawing may be a benefit to issuers. According to ISS, the proposed policy is not designed to increase or decrease the number of companies that would receive adverse vote recommendations.

Scorecard factors evaluated will fall under three main categories:  plan cost, plan features, and grant practices.

Plan Cost:  Plan cost will be measured by the total potential cost of the company’s equity plans relative to industry/market cap peers, measured by the company’s estimated shareholder value transfer or SVT, in relation to peers. SVT will be calculated for both:

  • new shares requested plus shares remaining for future grants, plus outstanding unvested/unexercised grants, and
  • only on new shares requested plus shares remaining for future grants.

Plan Features:  Plan features to be evaluated include:

  • Automatic single-triggered award vesting upon a CIC;
  • Discretionary vesting authority;
  • Liberal share recycling on various award types; and
  • Minimum vesting period for grants made under the plan.

Grant Practices:  Grant practices to be evaluated include:

The company’s three-year burn rate relative to its industry/market cap peers;

  • Vesting requirements in most recent CEO equity grants;
  • The estimated duration of the plan based on the sum of shares remaining available and the new shares requested, divided by the average annual shares granted in the prior three years;
  • The proportion of the CEO’s most recent equity grants/awards subject to performance conditions;
  • Whether the company maintains a claw-back policy; and
  • Whether the company has established post exercise/vesting share-holding requirements.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

ISS is requesting feedback on a change to its voting policy on independent chair shareholder proposals.  ISS’ current policy is to generally recommend for independent chair shareholder proposals unless the company satisfies all of the following criteria:

  • The company designates a lead director, who is elected by and from the independent board members with clearly delineated and comprehensive duties.
  • The board is at least two-thirds independent.
  • The key board committees are fully independent.
  • The company has disclosed governance guidelines.
  • The company has not exhibited sustained poor TSR performance (defined as one- and three-year TSR in the bottom half of the company’s four digit industry group, unless there has been a change in the CEO position within that time).
  • The company does not have any problematic governance issues.

ISS proposes to update the “Generally For” policy by adding new governance, board leadership, and performance factors to the analytical framework and to look at all of the factors in a holistic manner. Notably, the policy update would add new factors that are not considered under the current policy including the absence/presence of an executive chair, recent board and executive leadership transitions at the company, director/CEO tenure, and a longer (five-year) TSR performance period.

ISS probably chose this policy for attention because calls for independent board chairs were the most prevalent type of shareholder proposal offered for  consideration at U.S. companies’ annual meetings in 2014. As of June 30, 2014, 62 of these proposals have come to a shareholder vote, up from 55 resolutions over the same time period in 2013. According to ISS, the number of proposals calling for independent board chairs has more than doubled over the past five years. Under the current policy formulation, ISS says it recommended against 32 of these 62 proposals in 2014. In line with results from recent seasons, independent chair proposals received average support of 31.2 percent of votes cast at 2014 meetings. Only four of these proposals received the support of a majority of votes cast.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

FINRA has published a regulatory notice where it reminds firms that it is a violation of FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade) to include confidentiality provisions in settlement agreements or any other documents, including confidentiality stipulations made during a FINRA arbitration proceeding, that prohibit or restrict a customer or any other person from communicating with the Securities and Exchange Commission (SEC), FINRA, or any federal or state regulatory authority regarding a possible securities law violation.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The CFPB has issued a proposed policy where it would issue no-action letters in limited circumstances.  The proposed policy is designed for new financial products or services where there may be uncertainty about how they fit in the existing statutes and regulations.

Under the proposed policy, the no-action letter would not be an available tool unless the applicant shows the product holds the promise of substantial consumer benefit. As part of the application process, the CFPB will require an applicant to thoroughly demonstrate the characteristics of the proposed product, how it will work, and what consumer risks are involved. An applicant will need to explain exactly what regulatory uncertainty exists and how that uncertainty interferes with the development of the product. In addition, the applicant will need to demonstrate what consumer safeguards are in place and how consumer interests and safety will be monitored.

If the CFPB “specifically declines” to either grant or deny the request, either with or without explanation,  the CFPB may publish its response on the Bureau’s website, particularly if the staff believes that the information will be in the public interest.

The CFPB cautions no-action letters will not be routinely available. The Bureau anticipates that no-action letters will be provided only rarely and on the basis of exceptional circumstances and a thorough and persuasive demonstration of the appropriateness of such treatment.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

Last week the government handed down its first criminal indictment for allegedly engaging in “spoofing” and the Commodity Futures Trading Commission settled with Eric Moncada for spoofing. Spoofing is a form of trading in which traders place orders in the form of “bids” to buy or “offers” to sell a futures contract with no intent to execute the orders — with the intent to cancel the bid or offer before execution. We have previously written extensively on spoofing, including prior enforcement actions with respect to these two cases (Coscia and Moncada) and last week’s enforcement actions provide greater insight into the government’s view of spoofing, including its view that such activity is criminal.

Coscia Indictment

In the case of Michael Coscia, he was charged with six counts of commodities fraud and six counts of “spoofing” as a result of trading orders he placed through CME Group and European futures markets in 2011. The indictment marks the first federal prosecution under the anti-spoofing provision added to the Commodity Exchange Act by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

According to the indictment, Coscia spoofed to “create a false impression regarding the number of contracts available in the market, and to fraudulently induce other market participants to react to the deceptive market information he created. His strategy moved the markets in a direction favorable to him, enabling him to purchase contracts at prices lower than, or sell contracts at prices higher than, the prices available in the market before he entered and canceled his large-volume orders. Coscia then allegedly repeated this strategy in the opposite direction to immediately obtain a profit by buying futures contracts at a lower price than he paid for them, or by selling contracts at a higher price than he paid for them. Each such trade allegedly occurred in a matter of milliseconds.”

In announcing the indictment the U.S. Attorney said: “[t]raders and investors deserve a level playing field, and when the field is tilted by market manipulators, regardless of their speed or sophistication, we will prosecute criminal violations to help ensure fairness and restore market integrity,” adding “[t]his case reflects the reasons why, earlier this year, we [the government] established a Securities and Commodities Fraud Section, which is dedicated to protecting markets and preserving investors’ confidence.”

Moncada Settlement

The CFTC settled with Eric Moncada for $1.5 million and a ban on trading for a period of time. The CFTC described the manipulative scheme as follows: 1) manually placing and immediately canceling numerous orders for 200 or more lots of December 2009 Wheat Futures Contracts without the intent to have the large orders filled, but instead with the intent to create the misleading impression of increasing liquidity in the market; 2) placing these large-lot orders at or near the best bid or offer price in a manner to avoid being filled by the market; and 3) placing small lot orders on the opposite side of the market from these large-lot orders with the intent of taking advantage of any price movements that might result from the misleading impression of increasing liquidity that his large-lot orders created.

The CFTC settlement sets out some telltale signs of spoofing (see ¶¶ 23-25):

  • On the attempted manipulation dates, Moncada manually entered a total of 710 large-lot orders but Moncada manually canceled at least 98 percent of the total volume of these orders.
  • On the attempted manipulation dates, Moncada’s large-lot orders were manually canceled—on average within approximately 2.06 seconds of entry, and as quickly as 0.226 seconds.
  • On the attempted manipulation dates, Moncada placed significantly more large-lot orders in the December 2009 Wheat Futures Contract than all other market participants combined.
  • On the attempted manipulation dates, Moncada cancelled significantly higher percentage of the large-lot orders by volume in the December 2009 Wheat Futures Contract than all other market participants combined.

Finally, Moncada failed to use the “iceberg” capability on the trading platforms. An “iceberg” order is a large order for lots that only displays a small number of the lots to the market at any one time – hence the term “iceberg.” The trader predetermines the amount of the “iceberg” that the market sees. If the initial visible quantity of the lot in the “iceberg” is filled, then additional lots will automatically be shown to the market. This type of order entry allows traders to execute large-lot trades without signaling to the market their intention to fill a large quantity of lots. The CFTC said that “Moncada’s lack of use of ‘iceberg’ orders further illustrates that he had no intent to fill the vast majority of the large-lot orders he placed on the attempted manipulation dates.” See ¶¶ 23-25.

In announcing the Moncada settlement, the CFTC’s Director of Enforcement Aitan Goelman said: “The Commission remains committed to protecting the integrity of the markets by prosecuting manipulative conduct of all forms, including the type of conduct engaged in by Moncada – the wholesale entering and cancelling of orders without the intent to actually fill the orders.”

The International Swaps and Derivatives Association, Inc., or ISDA,  announced that 18 major global banks, referred to as G-18, have agreed to sign a new ISDA Resolution Stay Protocol.   The Protocol was developed in coordination with the Financial Stability Board to support cross-border resolution and reduce systemic risk. ISDA believes this represents a major step in strengthening systemic stability and reducing the risk that banks are considered ‘too big to fail’.

The Protocol will impose a stay on cross-default and early termination rights within standard ISDA derivatives contracts between G-18 firms in the event one of them is subject to resolution action in its jurisdiction. According to ISDA, the stay is intended to give regulators time to facilitate an orderly resolution of a troubled bank.

The terms of the Protocol have been agreed in principle, and it is scheduled for implementation in early November. The Protocol will take effect from January 1, 2015, and will govern both new and existing trades between adhering parties.

The first wave of adhering firms consists of the following banks and certain of their subsidiaries: Bank of America Merrill Lynch, Bank of Tokyo-Mitsubishi UFJ, Barclays, BNP Paribas, Citigroup, Crédit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan Chase, Mizuho Financial Group, Morgan Stanley, Nomura, Royal Bank of Scotland, Société Générale, Sumitomo Mitsui Financial Group and UBS.

The Fed and the FDIC sent out a joint release praising the Protocol.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.