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

On December 26, 2013, the SEC granted its second waiver from disqualification from reliance on Regulation D because of prohibited conduct under new Rule 506(d).   The waiver was granted to a Broker-Dealer alleged to have paid about $430,000 in soft dollars to one of its Clients for improper purposes that were outside of the Exchange Act Section 28(e) safe harbor for the use of commission credits for certain research and brokerage expenses.  Allegedly, the soft dollar payments were used to pay personal obligations of the Client’s president to his ex-wife, to pay sham-rent in the president’s home, and to pay for the president’s personal time share property.  Despite nearly overwhelming red flags in the payment review process, the Broker-Dealer approved the payments. 

A December 26, 2013 Exchange Act Release indicates that the Broker-Dealer and the SEC agreed to settle the matter, with the Broker-Dealer paying about $800,000 in penalties and agreeing to a number of undertakings.  Nevertheless, the Exchange Act Release constitutes an administrative order relating to conduct prohibited by Rule 506(d).

On the same day that the Exchange Act Release was made public, the Broker-Dealer requested by letter, and the SEC granted, a waiver from the disqualification from future reliance on Regulation D.  Since all of this happened on December 26, 2013, the waiver was likely a part of the settlement discussions between the Broker-Dealer and the SEC.

The reasons for the granting of the waiver include:

  • The conduct alleged to have occurred did not relate to a Regulation D offering and allegedly occurred more than three years ago;
  • Pursuant to the settlement agreement, the Broker-Dealer would engage a consultant to review the relevant soft dollar policies and procedures, under SEC supervision, and the Broker-Dealer would agree to adopt all changes recommended by the consultant;
  • Barring the broker-dealer from participation in Regulation D offerings would have an adverse effect on third parties that rely on the Broker-Dealer; and
  • For a period of five years, the Broker-Dealer would provide disclosure of the settlement order to purchasers in Regulation D offerings that the Broker-Dealer would have been disqualified from participating in.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC Office of Municipal Securities has issued interpretive guidance to address questions from market participants regarding the implementation of new final SEC rules requiring municipal advisors to register with the SEC.

The staff guidance, in the form of answers to frequently asked questions, or FAQs, covers topics including:

  • the advice standard, including the general information exclusion and the treatment of business promotional materials used by underwriters
  • the request for proposals-request for qualifications exemption
  • the exemption for independent municipal advisors
  • the exclusion for registered investment advisers
  • the underwriter exclusion, including engagements as underwriters
  • issuance of municipal securities and post-issuance advice
  • remarketing agent services
  • opinions by citizens in public discourse
  • the effective date of the final rules and the compliance period for using the final registration forms

Advice Standard–General

As to the advice standard, the SEC noted the focus of the advice standard in the final rules is whether or not, under all the relevant facts and circumstances, the information presented to a municipal entity or obligated person is sufficiently limited so that it does not involve a recommendation that constitutes advice. In other words, the determination of whether a person provides advice under the advice standard for municipal advisor registration purposes generally involves whether the person makes a recommendation. In the adopting release, the SEC stated “for purposes of the municipal advisor definition, the Commission believes that the determination of whether a recommendation has been made is an objective rather than a subjective inquiry. An important factor in this inquiry is whether, considering its content, context and manner of presentation, the information communicated to the municipal entity or obligated person reasonably would be viewed as a suggestion that the municipal entity or obligated person take action or refrain from taking action regarding municipal financial products or the issuance of municipal securities.”

Examples of the General Information Exclusion from Advice

The staff believes that a person could rely on the general information exclusion from advice under the final rules when providing a municipal entity or obligated person with information that does not involve a recommendation, such as factual information that does not contain subjective assumptions, opinions, or views. Examples of this type of general information include:

  • information regarding a person’s professional qualifications and prior experience (e.g., lists, descriptions, terms, or other information regarding prior experience on completed transactions involving municipal financial products or issuances of municipal securities);
  • general market and financial information (e.g., market statistics regarding issuance activity for municipal securities or current market interest rates or index rates for different types of bonds or categories of credits);
  • information regarding a financial institution’s currently-available investments (e.g., the terms, maturities, and interest rates at which the financial institution offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity or obligated person;
  • factual information describing various types of debt financing structures (e.g., fixed rate debt, variable rate debt, general obligation debt, debt secured by various types of revenues, or insured debt), including a comparison of the general characteristics, risks, advantages, and disadvantages of these debt financing structures; and
  • factual and educational information regarding various government financing programs and incentives (e.g., programs that promote energy conservation and the use of renewable energy).

In addition, the staff believes that information that is particularized to the municipal entity or obligated person in limited respects could be consistent with the general information exclusion from advice, provided that the information is factual in nature and does not contain or express subjective assumptions, opinions, or views, or constitute a recommendation. For example, the staff believes that a person could provide general market information regarding a municipal entity’s particular outstanding bonds, such as current market prices and yields, without this information constituting a recommendation.

Potential Implied Recommendations

The staff further believes, however, that information that is particularized in more than the limited respects described above in the immediately preceding paragraph to a municipal entity or obligated person potentially could imply a recommendation that could constitute advice under the final rules, depending on all of the relevant facts and circumstances. The more individually tailored the information is to a specific municipal entity or obligated person or group of municipal entities or obligated persons that share similar characteristics, the more likely the information will be considered to be a recommendation. For example, if a person provided information regarding debt financing structuring options that was tailored to address the specific needs, objectives, or circumstances of a municipal entity or obligated person, such as information tailored to address particular fiscal needs or to incorporate particular revenue projections, the staff believes that presenting these particularized options likely would suggest a preferred financing approach that likely would imply a recommendation.

Effect of Disclosures and Disclaimers on Advice Analysis.

The staff believes that disclosures and disclaimers regarding a person’s intentions in providing information to a municipal entity or obligated person are factors that bear upon whether or not the person’s communications would be a recommendation that constitutes advice under the final rules. The staff believes that the following disclosures and disclaimers, clearly and conspicuously stated, in written materials that accompany communications to a municipal entity or obligated person, would be factors that weigh against treatment of information as a recommendation that constitutes advice:

  • this person is not recommending an action to the municipal entity or obligated person;
  • this person is not acting as an advisor to the municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Exchange Act to the municipal entity or obligated person with respect to the information and material contained in this communication;
  • this person is acting for its own interests; and
  • the municipal entity or obligated person should discuss any information and material contained in this communication with any and all internal or external advisors and experts that the municipal entity or obligated person deems appropriate before acting on this information or material.

Effect of Overall Course of Conduct on Advice Analysis

The staff further believes that, while the presentation of information with the disclosures and disclaimers described above are factors that suggest that a person may not be making a recommendation that would constitute advice under the final rules, such disclosures and disclaimers are not controlling and must be considered in the context of a person’s overall course of conduct, taking into account all of the relevant facts and circumstances. Thus, any actions or communications that are inconsistent with these disclosures and disclaimers or inconsistent with the arm’s length nature of a non-advisory business relationship between a person and a municipal entity or obligated person could suggest that the person is making a recommendation and acting as a municipal advisor, which, absent an available exemption, would require registration with the SEC as a municipal advisor.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

We have explained that the District Court upheld the SEC’s conflict minerals rules.  Recently, oral argument on the appeal was heard by the U.S. Court of Appeals for the District of Columbia Circuit.  Some press reports have speculated because of tough questioning by the appellate panel that the appeals court may invalidate the law.  It’s a lot to read into the tea leaves though.  See TheCorporateCounsel.net, eenews, Compliance Week, Main Justice (now defunct) and The Hill.

One of the principal objections to the rule is the cost of compliance.  The best explanation of why the law was enacted I have seen can be found here, which includes a discussion about an announcement by a major manufacturer of conflict minerals free products.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC staff has issued a report on the examinations conducted by the staff  under Section 15E(p)(3) of the Securities Exchange Act of 1934.  The Exchange Act requires the SEC Office of Credit Ratings, or OCR, to conduct an examination of each nationally recognized statistical rating organization, or NRSRO at least annually.  The Exchange Act also requires the SEC to make publicly available an annual report summarizing:

  • the essential findings of all Section 15E examinations, as deemed appropriate by the SEC;
  • the NRSROs’ responses to any material regulatory deficiencies identified by the SEC; and
  • whether the NRSROs have appropriately addressed the recommendations of the SEC contained in previous annual reports on examinations.

The most recent annual report acknowledges that NRSROs have implemented compliance improvements and have taken steps toward improving compliance since Section 15E exams began in 2010. For future examinations, the staff will continue to refine its risk assessment to ensure a balance between verifying compliance with key laws and regulations and identifying and examining emerging risk areas.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The controversy continues around the proposed SEC rules that would require a Form D be filed prior to commencing a general solicitation.  Recently, seven senators sent this letter to SEC Chair Mary Jo White supporting the proposed amendments, stating they were needed by state securities regulators to protect investors (hat tip Jim Hamilton).

Brok Romanek at TheCorporateCounsel.Net also indicated the tide may be turning, noting that SEC Commissioner Aguilar and Senator Levin have weighed in supporting the proposals.

For other information on the JOBS Act, see JOBS Act and Other Securities Law Essentials for Growing Companies.

Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

On January 2, approximately three years after the applicable deadline under the Dodd-Frank Act, the Federal Energy Regulatory Commission and Commodity Futures Trading Commission entered into two Memoranda of Understanding regarding high level procedures for: (1) resolving jurisdictional issues between the two agencies and (2) sharing information of mutual interest.

I. Jurisdictional MOU

The Jurisdictional MOU establishes high-level procedures for FERC and the CFTC to: (1) apply their respective authorities effectively and efficiently, (2) resolve conflicts concerning overlapping jurisdiction and (3) avoid conflicting or duplicative regulation. Accordingly, the two agencies agreed that:

1. They will notify and consult with staff of the other agency when considering an authorization or exemption with respect to a market participant that may fall within the jurisdiction of the other agency.
2. The notified agency will promptly advise the notifying agency whether it believes it has any interest in the matter.
3. On matters of mutual interest, the agencies will cooperate to develop an approach that meets both agencies’ regulatory concerns.

FERC and CFTC discord has escalated in recent years as FERC sought broad authority to issue civil penalties to individual futures market traders (the Brian Hunter case). In March of 2013, the U.S. Court of Appeals rejected FERC’s arguments that it had authority to levy a $30 million fine and clearly stated that the Commodity Exchange Act vested exclusive jurisdiction to the CFTC over futures markets.

II. The Information Sharing MOU

The Information Sharing MOU establishes procedures for the two agencies to share information and coordinate information requests in connection with market surveillance and investigations of manipulation, fraud and market power abuse. To enhance coordination and avoid duplicative information requests, the MOU provides that FERC will direct requests for information from designated contract markets (e.g., NYMEX), swap execution facilities (e.g., ICE Swap Trade), derivatives-clearing organizations or any other board of trade, exchange, derivatives market or swap data repository (i.e., entities generally under CFTC jurisdiction) to the CFTC. Likewise, the CFTC has agreed to direct requests for information from Regional Transmission Organizations, Independent System Operators, independent market monitors, the North American Electric Reliability Corporation, or interstate pipelines or storage facilities (i.e., entities generally under FERC jurisdiction) to FERC. Both agencies agreed to take all steps necessary to promptly obtain and furnish responsive information to such requests, subject to confidentiality requirements. If implemented as envisioned, the Information Sharing MOU should improve the efficiency of investigations for agencies and market participants alike and improve the agencies’ information gathering abilities with respect to market participants’ activities in related markets outside each agency’s traditional purview.

Check dodd-frank.com frequently for updated information on the the Dodd-Frank Act, the JOBS Act and other important derivatives and securities law matters.

The CFPB has issued a report pursuant to Section 1017(e)(4) of the Dodd-Frank Act to the Committees on Appropriations of the United States Senate and House of Representatives.  The report covers the time period from August 1, 2012 through September 30, 2013, the end of the CFPB’s fiscal year.  The report includes a broad overview of the CFPB’s activities during the relevant time period, and sets forth consumer resources, together with supervision, enforcement and fair lending activities and budget and hiring practices.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

 

The SEC has adopted amendments (here and here) to eliminate references in certain of its rules and forms to credit ratings by nationally recognized statistical rating organizations, or NRSROs.

The changes were required by the Dodd-Frank Wall Street Reform and Consumer Protection Act and remove credit rating references from:

  • Rule 5b-3 under the Investment Company Act — a rule that permits funds to look through repurchase agreements to the underlying collateral securities for certain counterparty limitation and diversification purposes provided the collateral meets certain credit quality standards
  • Forms N-1A, N-2, and N-3 — forms that contain requirements for funds to report information about their activities to shareholders, including information about the credit quality of their portfolios
  • Rule 15c3-1 (and certain appendices) under the Securities Exchange Act of 1934 — a rule that requires broker-dealers to maintain more than a dollar of highly liquid assets for each dollar of liabilities, which helps ensure that if the broker-dealer fails, it will have sufficient liquid assets to cover its liabilities
  • Rule 15c3-3 under the Securities Exchange Act of 1934 — a rule that prohibits broker-dealers from using customer securities and cash to finance the firm’s own business.  By segregating customer securities and cash from the firm’s proprietary business activities, the rule increases the likelihood that customer assets will be readily available to be returned to customers if the broker-dealer fails.
  • Rule 10b-10 under the Securities Exchange Act of 1934 — the SEC’s confirmation rule that generally requires broker-dealers effecting transactions for customers in securities other than U.S. savings bonds or municipal securities to provide those customers with written notification of the terms of the transaction at or before the completion of the transaction.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

As we’ve described previously, new Rule 506(d) imposes a number of bad actor disqualifications on certain persons that are associated with the issuer, including officers, directors, and 20% beneficial owners.  On January 3, 2014, the SEC released a new set of C&DIs relating to 20% beneficial owners.  Here is what we learned from this latest round of FAQs:

Issuers will need to perform due diligence on any person that is going to become a 20% beneficial owner in an offering, because it will impact the remainder of the offering.  For example, assume that there is an active Rule 506 offering pursuant to which the issuer is holding periodic closings.  An existing 15% shareholder subscribes to purchase shares in the offering that, upon the initial closing, will make her a 20% beneficial owner.  Although Rules 506(d) and 506(e) don’t apply to the shareholder for purposes of the transaction that makes her a 20% beneficial owner, they DO apply to each subsequent sale in the offering (i.e., each subsequent sale can be tainted by the bad acts of the now-20% owner).  This scenario is not likely to be a common one, but it’s something that issuers should keep in mind nonetheless.

The term “beneficial owner” in Rule 506(d) will be interpreted the same way that the term is defined for purposes of Exchange Act Rule 13d-3.  In other words, beneficial ownership consists of the direct or indirect possession, including shared possession, of voting power and/or investment power.  The provisions of Rule 13d-3 relating to when a person will and will not be deemed to be the owner of a security for purposes of determining beneficial ownership therefore also apply in the context of Rule 506 (e.g., a person with a right to acquire securities exercisable within 60 days is deemed to be the beneficial owner of those securities).  Likewise, both direct and indirect beneficial ownership are relevant for purposes of Rule 506, just as they are for purposes of Rule 13d-3, so it is necessary to look through entities – perhaps multiple layers of entities – in order to determine who the ultimate beneficial owners are.

Beneficial ownership of group members and groups will be analyzed under the same principles that apply under Exchange Act Rules 13d-3 and 13d-5(b).  If shareholders enter into a voting agreement, they have thereby formed a group, and the group will be deemed to beneficially own all of the shares beneficially owned by each group member.  If that aggregation exceeds 20%, then the group itself, as a distinct entity, is subject to Rule 506(d) and Rule 506(e).  On the other hand, the individual group members will only be deemed to beneficially own those shares over which they have voting power.  If a shareholder has ceded voting power over shares, those shares will not be attributed to her; if a shareholder has accepted voting power with respect to the shares of the other group members, those shares will be attributed to her, and could lead to her becoming subject to Rules 506(d) and 506(e).

C&DI 260.32 is a brain teaser that may have little practical application. Rule 506(d)(2)(iii) provides that a prohibited act or condition applicable to a covered person for purposes of Rule 506(d) will not affect the issuer “If, before the relevant sale, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing (whether contained in the relevant judgment, order or decree or separately to the Commission or its staff) that disqualification under paragraph (d)(1) of this section should not arise as a consequence of such order, judgment or decree.”  However, even if an issuer has received one of these orders, if any conduct that initially gave rise to the order occurred prior to September 23, 2013, then the disclosure obligation in Rule 506(e) still applies (which requires disclosure of prior conduct that would have violated Rule 506(d) if the rule had been in effect at the time of the conduct).  The post-September 23, 2013 order does not change the fact that conduct occurred prior to September 23, 2013 that would have constituted a violation of Rule 506(d) at that time if Rule 506(d) had then applied.  The Commission further provides, though, that if there were a pre-September 23, 2013 order relating to conduct that could require disclosure under Rule 506(e), a post-September 23, 2013 regulatory authority could determine that the pre-September 23, 2013 order would not have constituted a violation of Rule 506(d), thereby eliminating the Rule 506(e) disclosure requirement with respect to the pre-September 23, 2013 order.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The first half of 2014 will bring changes to the end user reporting requirements for trade options and swaps—namely, (1) the commencement of the annual Form TO reporting requirement for unreported trade options and (2) a reduced time period for reporting swaps to a swap data repository if an end user (non-swap dealer/major swap participant) is the reporting counterparty.

Trade options are commodity options in which:  (1) the offeror and offeree are both producers, processors or commercial users of, or merchants handling, the subject commodity and are entering into the transaction solely for purposes related to their business (alternatively, this prong can be satisfied with respect to the offeror if the offeror qualifies as an “eligible contract participant”); and (2) the parties intend to physically settle the transaction if the option is exercised.  Under the new reporting requirement, trade options that were entered into after April 10, 2013, and were not reported to a swap data repository must be reported to the CFTC on Form TO by March 1, 2014.  Filers of Form TO report the aggregate amount of unreported trade options exercised during the previous calendar year by swap category (energy, metals, agriculture and other) and amount ($0, $0 to $10 million, $10 million to $100 million and over $100 million).

Beginning April 10, 2014, end user reporting counterparties’ deadlines for reporting swaps to a swap data repository will be reduced from within 48 business hours of execution/confirmation to within 36 business hours of execution/confirmation.