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

The Dodd-Frank Act exempted small debit card issuers from the interchange fee standard set forth in the regulations which were adopted, but not from the statute’s prohibition on network exclusivity. For the purpose of the rule, a small debit card issuer is an issuer that, together with its affiliates, has assets of less than $10 billion.  During the rulemaking process, numerous parties raised concerns that the exemption from the interchange fee standard would not be effective because networks would not establish separate interchange fee schedules for exempt issuers. These parties were concerned that merchants would route their transactions over the lowest-cost available network, placing downward pressure on interchange fees and thereby undermining further the effectiveness of the small issuer exemption from the interchange fee standard. Moreover, numerous parties raised concerns that the network exclusivity prohibition would impose costs on small debit card issuers.

The Board of Governors of the Federal Reserve System has recently released a study of the effect on interchange fees since adoption of the related rule.  Among other things, the Fed released the following data points:

  • In 2009, the average interchange fee for all issuers was 43 cents.  For the first three quarters of 2011, before the interchange fee standard took effect, exempt issuers received an average of 44 cents per debit card transaction. The average interchange fee per transaction received by exempt issuers has returned to the 2009 level of 43 cents since the implementation of the interchange fee standard.
  • In 2012, exempt issuers received $7.4 billion in total debit card interchange revenue, compared with approximately $5.3 billion in debit card interchange revenue in 2009.

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

The Commodity Futures Trading Commission’s (CFTC’s) final interpretative guidance and policy statement on disruptive trading clarifies various aspects of, but does not deviate significantly from, its proposed interpretive order in 2011.  Like the proposed order, the final statement addresses three areas:  (i) violating bids or offers, (ii) orderly execution of transactions during the closing period, and (iii) spoofing.  In response to comments filed, the CFTC clarified its proposal, both generally and in certain specific areas discussed below, but did not deviate significantly from the proposed rule.

On a general level, the CFTC refused to prohibit the three disruptive trading practices only on platforms or venues that have “order book” functionality.  Rather,  the prohibition on such practices will apply to any trading, practices or conduct on a registered entity, such as a designated contract market or swap execution facility.  The Commission said, however, that it would not apply these prohibitions to either block trades (privately negotiated transactions executed apart and away from the trading facilities) or exchanges for related positions (exchanges of futures contracts for related cash or over-the-counter derivative positions, such as options or swaps).

More specifically, the CFTC reiterated that the prohibition on violating bids or offers prohibits a person, on a registered entity, from buying a contract at a price that is higher than the lowest available price offered for such contract or selling a contract at a price that is lower than the highest available price bid for such contract.  The Commission said such conduct would be a per se offense – the CFTC would not have to show intent. 

The Commission, however, clarified that the prohibition would not apply in several situations.  First, the CFTC clarified that it does not intend to exercise its discretion to bring an enforcement action against an individual who, by accident, makes a one-off trade in violation of the prohibition.  Second, the Commission does not interpret the prohibition as applying to non-cleared swap transactions, even if they are transacted on or through a registered entity, or to bids or offers on swaps that would be cleared at different clearing houses, since in such circumstances parties may take credit and other non-price factors into consideration.  Third, the CFTC did not create a “best execution standard” across multiple registered entities — a person’s obligation to not violate bids or offers applies only to the specific registered entity being utilized at a particular time.  Fourth, the CFTC will not apply the prohibition where an individual is “buying the board,” i.e., executing a sequence of trades to buy all available offers or sell to all available bids on an order book, in accordance with the rules of the facility. 

Regarding the intentional or reckless disregard for the orderly execution of transactions during the closing period, the CFTC clarified that physical products priced using indices or benchmarks have a closing period, i.e., during the window of time when the price reporting agencies calculate price indexes.  Further, the CFTC clarified that conduct outside the closing period could violate this section if a market participant accumulates a large position in a product or contract in the period immediately preceding the closing period with the intent (or reckless disregard) to disrupt the orderly execution of transactions during the product’s, or a similar product’s, defined closing period. 

On “spoofing,” at the CFTC’s open meeting regarding the final statement, CFTC Enforcement Director, David Meister clarified that “strobing” would be considered a “spoof.”  “Strobing” is high frequency trading strategy in which the same order is sent and cancelled many times to create the appearance of liquidity.  Mr. Miester said such trades would be considered “spoofing” because the orders were placed with the intent to cancel prior to execution.  Mr. Miester added that “strobing” would be considered “spoofing”– even if orders were executed — because the orders were placed with the intent to cancel.  In other words, that the orders were executed would not be a defense to a “strobing spoofing” violation.  Finally, Mr. Meister said that a “strobing spoofing” violation does not require any intent to create the appearance of liquidity – simply placing the orders with the intent to cancel would result in a “strobing spoofing” violation.

The SEC and Institutional Shareholder Services, Inc. (ISS) have settled public administrative and cease-and-desist proceedings initiated against ISS by the SEC alleging that ISS violated Section 204A of the Advisers Act by failing to establish, maintain, and enforce written policies and procedures designed to prevent the use of material nonpublic information by ISS in violation of the Advisers Act.   ISS has agreed to pay a $300,000 fine and to engage a consultant (with the oversight of the SEC) and to implement the recommendations of the consultant.

The basis for the proceedings against ISS (you can read the full order here) is the sale by ISS employees of confidential shareholder voting information to proxy solicitors in exchange for meals and entertainment.  Dealbook has some good commentary on why this information would be so valuable to proxy solictors and what this means for ISS’ reputation.  Although several employees and even managers at ISS were involved, much of the misconduct can be traced back to a single ISS employee and a single proxy solicitor.

ISS had a computer system that allowed its employees to access the instructions of all of its institutional clients regarding voting.  The proxy solicitor would e-mail the ISS employee with the names of ISS clients, the name of an issuer, and a particular ballot proposition, and ask “how many & how voted.”  From a remote location late at night or early in the morning, the ISS employee would access the information and forward it to his personal e-mail account for sharing with the proxy solicitor.  This practice went on from 2007 to 2012 and involved more than 100 ISS clients on hundreds of occasions, including “a number of significant proxy contests.”

It is clear from the e-mail correspondence between the ISS employee and the proxy solicitor that the vote information was provided in exchange for meals and gifts – the ISS employee even tells the proxy solicitor that certain information will “cost” him “another game.”  The proxy solicitor provided approximately $11,500 in sporting and concert tickets to the ISS employee, as well as approximately $20,000 in meals.

The SEC does not characterize this as a case of one bad apple, though, as it found evidence of systemic problems at ISS, such as:

  • The ISS Code of Ethics failed to establish policies designed to prevent ISS account managers from sharing confidential client information in exchange for gifts.
  • ISS did not exert sufficient control and monitoring over the access to client voting information.
  • The computer system used by ISS had built in audit capabilities that could have easily identified an employee who was accessing voting records more frequently than appropriate and from locations and at times that raise suspicion, but ISS failed to utilize the audit capabilities.
  • ISS managers were aware that proxy solicitors sought to establish relationships with ISS employees, even though there was no legitimate business reason for such relationships.
  • ISS managers were aware that proxy solicitors were providing entertainment and meals to ISS employees, and sometimes even partook in the entertainment and meals themselves.
  • In the words of the SEC, “ISS lacked policies or procedures concerning the relationship between its account managers and proxy solicitors even though the potential misuse of material nonpublic information s hould have been clear to ISS’ managers and compliance personnel.
  • Although the parent company of ISS had a written policy prohibiting ISS employees from receiving gifts of more than nominal value, ISS account managers were unclear on how the policy should be applied and interpreted.

It is unclear how far the fallout from this debacle will spread, or how much of a deletrious effect it will have on the already faltering reputation of ISS.  Check back frequently at dodd-frank.com for news and analysis of this and other securities law topics.

In Murray v. UBS Securities LLC et al (12-CV-5914 S.D.N.Y.) the court found that an employee who reports violations of securities laws to his supervisor, but not the SEC, is entitled to the anti-retaliation protections for whistleblowers under the Dodd-Frank Act.  Here, the plaintiff employee alleges he was pressured to write favorable research reports to support his employer’s ongoing CMBS trading and commercial loan originations.  The plaintiff believes he was pressured to write research reports that were false and misleading.  After complaining to his superiors and a number of interactions, plaintiff was fired.  Since this was a motion to dismiss, the court was required to accept the plaintiff’s well-pleaded allegations as true in making its decision.

The court found it was not necessary to report unlawful conduct to the SEC to be entitled to the anti-retaliation protections of the Dodd-Frank Act for whistleblowers.  The court noted that when the SEC adopted the whistleblower rules, the SEC stated  that “[t]he second prong of the Rule 21F-2(b)(1) standard provides that, for purposes of the anti-retaliation protections, an individual must provide the information in a manner described in Section 21F(h)(1)(A). This change to the rule reflects the fact that the statutory anti-retaliation protections apply to three different categories of whistleblowers, and the third category includes individuals who report to persons or governmental authorities other than the Commission” (emphasis in the original).  The court also found that the SEC’s interpretation of the Dodd-Frank Act was entitled to deference under applicable judicial standards.

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

Broadly speaking, SEC Regulation BTR prohibits directors and executive officers of public companies from trading in the issuer’s securities which were acquired in connection with service to the issuer if a sufficient number of participants in the issuers’ benefit plans are also prohibited from trading in the issuer’s securities because of a plan blackout. It is sometimes hard to fathom what the rule is getting at.  It is meant to prevent a repeat of Enron, where officers and directors engaged in wide spread selling during a period of rapid price decline, but employees were prevented from selling Enron securities in their 401(k) plans because of a blackout imposed by the plan administrator.  The officers and directors made out good, the employees did not.

The SEC recently granted Pfizer no-action relief from Regulation BTR in connection with a planned exchange offer for Zoetis common stock of which Pfizer owns a significant interest.  In the planned exchange offer, Pfizer shareholders will be offered the opportunity to exchange their Pfizer shares for shares of Zoetis common stock.  The exchange offer is open to all holders of common stock, including executive officers and directors of Pfizer and Pfizer employees, including shares held though Pfizer’s 401(k) plan.  After inquiry of its plan administrators, Pfizer believes employees who elect to tender Pfizer shares in 401(k) plans will have their ability to engage in transactions regarding Pfizer stock suspended so that an accurate accounting can be made of the shares.  Hence the concern regarding Regulation BTR, although Pfizer does not know if the suspensions will include enough plan participants to trigger a blackout period.

Pfizer argued that a black-out period should not apply under Rule 101(c)(9) of Regulation BTR, which exempts ”any acquisition or disposition of equity securities in connection with a merger, acquisition, divestiture or similar transaction occurring by operation of law.”  It noted that it was between a rock and a hard place under the “all holders rule” (Rule 13e4(f)(8)(i)) as that rule requires the exchange offer to be open to all executive officers and directors, but Regulation BTR says they cannot participate.  Pfizer noted the exchange offer will be conducted in compliance with the SEC’s rules, which offers protection for participants.

In essence, Pfizer argued that the exchange offer would not result in inequitable treatment for those employees subject to a suspension, and hence Regulation BTR should not apply. In other words, this is not Enron. It’s why Regulation BTR includes an exception for mergers etc., which should apply here, even if Rule 101(c)(9) does not specifically refer to exchange offers.

The SEC granted the no-action request, subject to some conditions.  The most important condition is “Pfizer directors and executive officers would continue to be permitted to tender into the Exchange Offer during a blackout period, but would not otherwise be permitted to directly or indirectly purchase, sell or otherwise acquire or transfer Pfizer common stock during such blackout period if the shares involved were or would be acquired in connection with service or employment as a director or executive officer.”

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

On May 18, 2013, SEC Commissioner Luis A. Aguilar spoke at the annual gala of the Georgia Hispanic Chamber of Commerce, using the opportunity to highlight the contributions of immigrants (and Hispanic immigrants in particular) to the economy, tout the crowdfunding and so called “Regulation A – plus” provisions of the JOBS Act, and weigh in on the politics of immigration reform.

In his remarks, Mr. Aguilar made the pitch that the crowdfunding and Regulation A – plus provisions of the JOBS Act will benefit small businesses, such as the many small businesses that are owned by immigrants.  Mr. Aguilar didn’t provide any new information about these provisions of the JOBS Act or give any updates as to the rule-making timetable, but he did predict that state securities commissions and the SEC would work together to develop a uniform offering circular that would comply with state and federal requirements for Regulation A – plus offerings.

Mr. Aguilar presented his audience with a number of interesting data points that highlight the contributions of immigrants to the U.S. economy, such as:

  • In the last 20 years, there have been 356 public companies that were backed by venture capital, and immigrants founded or helped found 25% of those companies
  • First generation immigrants make up only 12% of the U.S. population but account for 16.7% of all new business owners.
  • Hispanic immigrants make up 28% of all small business owners, and the number of businesses owned by Hispanic immigrants is growing more than four times faster than the overall number of businesses.
  • Forty percent of Fortune 500 companies and seven out of the ten most valuable brands in the world were founded by immigrants or their children.
  • Small businesses owned by immigrants directly employed about 4.7 million people in the U.S.
  • At the top ten patent-producing universities, foreign-born inventors were credited with contributing to more than 75% of all patents issued.
  • Compared to the general population, immigrants are more likely to hold advanced degrees, and are almost twice as likely to hold a Ph.D.
  • Hispanic high school graduates are now more likely than white high school graduates to enroll in a two-year or four-year degree program.

Near the conclusion of his remarks, Mr. Aguilar seemed to express support for an immigration reform bill that provides a “path to citizenship” for immigrants who did not enter the United States lawfully: “I’m hopeful that we will finally see real immigration reform that will bring people out of the shadows and allow them to flourish and contribute to our society.  Freeing that powerful human capital can take our country to new levels of prosperity.  That’s particularly true of young Latinos and Latinas that came to this country as children and know no other country as their own.  We need immigration reform that will allow them to fulfill their dreams and, in so doing, take our country to greater heights.”

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

We previously noted that the challenge to the SEC’s conflict minerals rules was transferred from the Court of Appeals to the United States District Court for the District of Columbia.  A scheduling order has been entered in the case which provides that the parties’ cross-motions for summary judgment will be decided on the basis of briefs transferred from the Court of Appeals.  The Court also granted the parties’ request to expedite the cross motion for summary judgment.

We also noted that the Court of Appeals dismissed the challenge to the SEC’s resource extraction rules for lack of jurisdiction and that the case would proceed in the United States District Court for the District of Columbia.  The District Court has likewise entered a scheduling order which provides that the plaintiffs’ motion for summary judgment will be decided on the briefs submitted by the parties to the Court of Appeals.

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

The CFPB has ordered a Texas homebuilder, Paul Taylor, to surrender more than $100,000 he received in kickbacks for referring mortgage origination business to Benchmark Bank and to Willow Bend Mortgage Company. The Bureau is also prohibiting Taylor from engaging in future real estate settlement services, including mortgage origination.

According to the CFPB, Paul Taylor received illegal referral fees through partnerships with Benchmark Bank and Willow Bend Mortgage Company. Taylor and the bank created and jointly owned Stratford Mortgage Services, LC, which claimed to be a mortgage originator. Similarly, Taylor and Willow Bend created and jointly owned PTH Mortgage Company. According to the CFPB, both entities were shams designed to allow Taylor to receive the kickbacks. His homebuilding company, Paul Taylor Homes, then referred mortgage origination business to the sham entities. However, the work was actually performed by the Bank and Willow Bend. The kickbacks were passed through the sham entities back to Taylor through profit distributions and as a payment through a “service agreement.”

The settlement resolves violations of the Real Estate Settlement Procedures Act, or RESPA. RESPA prohibits giving and receiving kickbacks for services involving federally related mortgages.

The CFPB became aware of Taylor’s conduct related to Benchmark Bank and Stratford through a referral from the Federal Deposit Insurance Corporation, or FDIC. The FDIC separately fined Benchmark Bank for its role in the RESPA violations.

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

This week the SEC appointed Keith F. Higgins as Director of the Division of Corporation Finance.  We don’t know him personally but have seen him speak at conferences and observed his leadership of the ABA’s Federal Regulation of Securities Committee.  We think he is an energetic and practical securities lawyer that will give the JOBS Act the attention it needs.

Mr. Higgins was a member of an ABA drafting committee which submitted preliminary comments on the JOBS Act to the SEC.  We think many would agree with the direction taken, but they were the committee’s views, and not his.

The SEC’s Lona Nallengara and  Shelley E. Parratt spoke at a securities law conference on May 2, 2013.  According to reports they noted the SEC has established independent teams to work through each anticipated or proposed JOBS Act  rulemaking, but they did not provide any firm timetable for when any such rulemakings would be released.

When asked by the Wall Street Journal on the timing of JOBS Act rules, the agency declined to comment on timing, referring to testimony “this past week” from new SEC Chairman Mary Jo White, who said completing the JOBS Act rule-making is a “top” priority.

We’re not sure of what testimony “this past week” the SEC or the Wall Street Journal was referring to.  However, this week in  testimony to the U.S. House of Representatives Committee on Financial Services this week, Ms. White stated  “I believe that the SEC must complete, in as timely and smart a way as possible, the rulemaking mandates contained in both the Dodd-Frank Act and JOBS Act.”  However, some press reports infer that during her testimony she indicated her “No. 1 priority” is more investment adviser examinations.

As an aside, how long can it take for a government agency to adopt a rule?  We don’t know, but the IRS was authorized to implement IRC Section 336(e) in 1986, which permits an election to treat certain stock transfers as a deemed asset sale, akin to a 338(h)(10) election.  The IRS issued final 336(e) regulations last week.

The same Wall Street Journal article referenced above discusses how hedge funds are aggressively preparing marketing campaigns to be ready once the ban on general solicitication is lifted.  One hedge fund manager brags that he has already taken out ads in business magazines and discusses the redesign of his web site, which is certainly interesting.

The MoFo Jumpstarter blog notes some legislative developments:

  • The House has passed a bill imposing a deadline on the SEC to enact the “Regulation A+” provisions of the JOBS Act.
  • A bill has been introduced to amend the Securities Exchange Act of 1934, to make the shareholder threshold for registration of savings and loan holding companies the same as for bank holding companies.

This article notes “Equity crowdfunding as it emerged from the JOBS Act is the new ‘bridge to nowhere.’  It puts big deal procedures and liability on small deals. The expense of complying with crowdfunding, combined with the low issuer maximum that can be raised ($1 million over a trailing 12 month period) will be prohibitive for most issuers.. . . And it won’t create jobs except for plaintiff’s lawyers.”  Most of that has been said before, but we like some of the thoughts, and the ultimate utility remains to be seen.

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

Two partners from a self-described law firm that specializes in the representation of whistleblowers have sent a letter to the SEC Commissioners complaining about the use of severance agreements to prevent employees from participating in the SEC whistleblower program.  The letter complains about contractual clauses inserted in severance agreements with departing employees such as:

  • Employee agrees that he will not use or disclose any Company information at any time subsequent to the execution of the Agreement, except as required by law. Company information does not include information or knowledge which Employee is required to disclose by order of a governmental agency or court after timely notice of the order has been provided to the Company.
  • Employee represents that he has not filed any lawsuit, claim, charge, or complaint regarding the Company with any local, state, or federal agency, self-regulatory organization, or court.
  • Employee hereby irrevocably assigns to the federal government, or relevant state or local government, any right Employee may have to any proceeds, bounties or awards in connection with any claims filed by or on behalf of the government under any laws, including but not limited to, the False Claims Act and/or the Dodd-Frank Act (and/or any state or local counterparts of these federal statutes or any other federal, state or local qui tam or “bounty” statute) against the Company. Employee also represents and promises that Employee will deliver any such proceeds, bounties or awards to the United States government (or other appropriate governmental unit).
  • Employee will inform the Company within ten (10) days of receipt of a subpoena or inquiry requesting information relating to the Company and will cooperate with the Company in any investigation, regulatory matter, arbitration and/or any third-party lawsuit in which the Company is a subject or party.

The letter requests the SEC issue a regulation or an opinion clarifying the breadth of actions that the SEC views as likely to “impede” communication with the SEC under the whistleblower program.  The law firm believes this would stem the growth of what they believe is an apparent effort to discourage whistleblowers from providing information to the SEC.

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