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

In testimony before the U.S. House of Representatives Committee on Financial Services, SEC Chair Mary Jo White stated that the Netflix Section 21(a) report stands for the proposition that use of social media is acceptable “so long as investors have been alerted about which social media outlets will be used to disseminate such information.  The report clarified that issuer communications through social media channels require careful Regulation FD analysis comparable to communications through more traditional channels, and that the principles outlined in the Commission’s earlier guidance on Regulation FD apply with equal force to corporate disclosures made through social media channels.”

The SEC recently declined to comment on the minimum number of Twitter followers needed for a company to safely tweet its earnings. According to the Wall Street Journal, Lona Nallengara, acting director of the SEC’s corporation-finance division, stated “We do not comment on specific situations.”

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

At its open meeting on May 16, 2013, the Commodity Futures Trading Commission will vote on the final interpretative rule for disruptive trading practices under Section 747 of the Dodd-Frank Act. That order should be of interest to CFTC compliance managers. But FERC (Federal Energy Regulatory Commission) compliance managers should also take note because FERC would surely find trading practices—disruptive under the Dodd-Frank Act—also disruptive (and manipulative) under the anti-manipulation provisions of the Natural Gas Act and the Federal Power Act.

Section 747 of the Dodd-Frank Act makes it unlawful under the Commodity Exchange Act (Section 4c(a)(5)) to engage in any trading, practice or conduct on or subject to the rules of a registered entity that (i) violates bids or offers, (ii) demonstrates intentional disregard for the orderly execution of transactions during the closing period or (iii) would be considered “spoofing” (bidding or offering with the intent to cancel the bid or offer before execution.)

On March 18, 2011, the CFTC took comments on its proposed interpretation of Section 747. In that proposal, the CFTC said a market participant would violate the “bids or offers provision” by buying a contract at a price that is higher than the lowest available offer price and/or selling a contract at a price that is lower than the highest available bid price.  On the “orderly execution” provision, the CFTC said it would look for reckless conduct during the closing period (the period in the contract or trade when the daily settlement price is determined under the rules of that trading facility) and apply current commodities and securities precedent in reviewing the appropriateness of that conduct.  On the spoofing provision, the CFTC said that spoofing also includes, but is not limited to, “(i) submitting or cancelling bids or offers to overload the quotation system of a registered entity, (ii) submitting or cancelling bids or offers to delay another person’s execution or (iii) submitting or cancelling multiple bids to create an appearance of false market depth.”

At its upcoming May 16 meeting, the CFTC will vote on the final interpretive rule. The CFTC’s decision should be of interest to CFTC compliance managers but also FERC compliance managers. While FERC does not specifically prohibit disruptive practices, its regulations do make it unlawful for any entity to “use or employ any device, scheme or artifice to defraud” or to “engage in any act, practice or course of business that operates as a fraud or deceit upon any entity” in FERC wholesale gas and electric markets. 18 C.F.R § 1c.2.  To the extent that a disruptive practice results in wholesale electric and natural gas prices that do not reflect the forces of supply and demand, FERC would find the disruptive practice manipulative.  Energy Transfer Partners. 120 FERC ¶ 61,086 at P 71 (2007).(“Market manipulation is harmful and inconsistent with free markets.  One of FERC’s most important responsibilities is to exercise regulatory oversight to assure that wholesale energy markets are free, open and fair, where supply and demand may freely meet at prices uninfluenced by manipulation.”) (emphasis added)

In a future Dodd-Frank blog post, we will be summarizing the final interpretative rule regarding disruptive practices.

It was another week of speculation as to when the SEC might finalize or propose any JOBS Act rule.  Broc Romanek of the TheCorporateCounsel.net pointed to one article which said the current JOBS Act proposal on eliminating general solicitation may be implemented as an interim final rule and compared that to statements attributed to SEC Chair Mary Jo White which spoke of the need for investor protection.  Broc concluded “So I don’t know what to believe…”  As we noted last week, Chief Counsel and Associate Director for the SEC’s Division of Trading and Markets was quoted as stating “I don’t think anybody who gives you a prediction on timing really knows what they’re talking about.”

The SEC recently approved a proposal regarding the regulation of derivative use by foreign banks under the Dodd-Frank Act.  The New York Times ran an editorial which lambasted SEC Chair White because the proposal “implies that foreign regulation will be adequate, but the rules elsewhere are weak or nonexistent.”  The editorial moves onto the JOBS Act and concludes “Ms. White’s immediate predecessors supported an early proposal of the rule [eliminating the ban on general solicitation] that, shockingly, did not include any specific investor protections. What is needed is a new proposal with the safeguards recommended by the S.E.C.’s own Investor Advisory Committee . . . This is a critical test for Ms. White, who has yet to show that she supports stronger regulations.”

Jim Hamilton’s blog notes “In a letter to SEC Chair Mary Jo White, consumer groups and former SEC Commissioner Steven M.H. Wallman urged the Commission to re-propose the regulation implementing the JOBS Act provision eliminating the ban on general solicitation so that the recommendations of the SEC Investor Advisory Committee can be incorporated into the final regulation.”

SEC Commissioner Luis A. Aguilar gave a speech addressing the need for robust SEC oversight of self-regulatory organizations, or SROs.  We predict he will feel the same about the oversight of crowdfunding platforms under Title III of the JOBS Act.

The SEC Government-Business Forum on Small Business Capital Formation issued its final report.  Some of the more interesting thoughts include:

  • Simplified crowdfunding disclosures and financial statement requirements
  • Simplified regulation of crowdfunding portals as compared to broker-dealers
  • Detailed recommendations on determination of accredited investor status in connection with the elimination of the ban on general solicitation

Thecrowdcafe ran an interesting piece on the funded status of various crowdfunding platforms.

CFO.com has an article on how companies can prepare for crowdfunding.  The central tenet is how to utilize crowdfunding with a planned follow-on venture capital investment.  One idea which is floated is to structure  crowdfunded securities that allow venture capitalists to buy out crowdfunded investors at a certain multiple of their investment at a later stage. For instance the crowdfunders would get three times their money back when the company does a Series A.  It’s an interesting thought, but historically venture capital funds often want the company to put their money to work for growth, rather than buying out existing investors at a premium.  That could potentially change if it becomes the price of admission.  Complications may also arise for venture funds relying on an exemption from Investment Adviser Act regulation and the definition of “venture capital fund” under Investment Adviser Act Rule 203(l)-1, depending on how the buy-out of the crowdfunders is structured.

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

The Public Company Accounting Oversight Board, or PCAOB, has reproposed a new auditing standard, Related Parties, and certain other amendments to its standards.  Overall, the reproposal is directed at detecting material misstatements and fraud.  But the proposed standards also include audit procedures related to executive compensation, given the possible incentive compensation can have on to manipulate financial results or engage in fraud.

Required audit procedures include reading employment and compensation contracts with executive officers and reading proxy statements.  For some reason, I thought auditors already did this.  The term “executive officers” is defined the same as Rule 3b-7 under the Exchange Act. The proposal does not change the existing standard to obtain an understanding of compensation arrangements with “senior management,” a broader term than “executive officers.”

Some procedures the auditors “should consider” include (see pages A3-1 to A3-2):

  • Inquiries of the compensation committee chair and any compensation consultant regarding the structure of executive officer compensation; and
  • Obtaining an understanding of policies and procedures regarding the expense reimbursements of executive officers.

Influence on Executive Compensation.  The reproposal and comments on the original proposal are explained on pages A4-75 to A4-87.  Some commenters objected to the initial proposal on the grounds that auditors might influence the design of compensation programs or require the auditor to substantively judge the executive compensation programs. The PCAOB thinks it solved these problems by emphasizing that the purpose of the procedures is to further the auditor’s risk assessment of material misstatement rather than to determine the appropriateness of executive compensation.

Inquiries of Compensation Committee Chair and Consultants.  The PCAOB received mixed comments on suggesting the auditors make inquiries of the compensation committee chair and compensation consultants.  Not surprisingly, some said this would be intrusive.  The PCAOB responded by stating it is not required, the auditors only need consider it.  Once this suggestion appears on an audit checklist, we wonder how many auditors will be able to resist, given the threat of a PCAOB inspection.

Litigation.  Another commenter pointed out that auditor documentation could complicate any litigation or claims related to executive compensation disclosures.  The PCAOB seems to give this the short shrift by stating litigation is not a concern when preparing audit workpapers.  We can now see these workpapers on a standard discovery list by the strike-suit types, and can only hope that they are prepared with the same sensitivity as say loss contingency and tax accrual workpapers.

Determination of Executive Officers.  Some commenters recommended that the amendments clarify the role of the auditor  in determining who is an executive officer. The PCAOBs response is the amendments do not require the auditor to evaluate management’s identification of “executive officers” for SEC filing purposes and that the SEC definition is “objective.”  Objective perhaps, but fact intensive and specific, and who knows what happens if the auditors draw a different conclusion, including possible significant Section 16 issues.

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

A new study sponsored by the American Enterprise Institute on the impact of Dodd-Frank on community banks has been published.  The study notes:

  • If community banks are forced to merge, consolidate, or go out of business as a result of Dodd-Frank, one result will be an even greater concentration of assets on the books of the “too-big-to-fail” banks.
  • More than 1,200 US counties—with a combined population of 16 million Americans—would have severely limited banking access without community banks.
  • Community banks were not responsible for the causes of the financial crisis determined by the authors of Dodd-Frank.
  • Dodd-Frank will make it harder for community bank customers to obtain loans because it encourages financial product standardization, which undermines the relationship banking model and decreases the diversity of consumer banking options.

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

The SEC instituted a settled cease-and-desist proceeding against the City of Harrisburg, Pennsylvania for its violations of Section 10(b) of the Securities Exchange Act (“Exchange Act”) and Rule 10b-5.  In connection with the settlement, the SEC issued a Section 21(a) report captioned “Report of Investigation in the Matter of the City of Harrisburg, Pennsylvania Concerning the Potential Liability of Public Officials with Regard to Disclosure Obligations in the Secondary Market”.

The report states “Public officials should be mindful that their public statements, whether written or oral, may affect the total mix of information available to investors, and should understand that these public statements, if they are materially misleading or omit material information, can lead to potential liability under the antifraud provisions of the federal securities laws.”

The gist of the report is this:  When a municipal entity is faced with deteriorating health, investors of the municipality’s obligations may well look to written and oral information provided by public officials.  If the municipality is not providing complete and accurate information, the lack of disclosures may increase the risk that municipal officials’ public statements may be misleading or may omit material information. Hence, potential 10b-5 liability.

What can public officials do to reduce this risk?  Nothing much, other than be careful.  The SEC suggests, among other things:

  • adopting policies and procedures that are reasonably designed to result in accurate, timely, and complete public disclosures;
  • identifying those persons involved in the disclosure process;
  • evaluating other public disclosures that the municipal securities issuer has made, including financial information and other statements, prior to public dissemination; and
  • assuring that responsible individuals receive adequate training about their obligations under the federal securities laws.

What is a Section 21(a) report? See our blog here.

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

 

Mary Jo White, now chair of the SEC, submitted a written statement in her confirmation hearing that said “First, I would work with the staff and my fellow Commissioners to finish, in as timely and smart a way as possible, the rulemaking mandates contained in the Dodd-Frank Act and JOBS Act. The SEC needs to get the rules right, but it also needs to get them done. To complete these legislative mandates expeditiously must be an immediate imperative for the SEC.”  Here she is emphasizing in part she has multiple priorities on the front burner, and the remaining pieces of the Dodd-Frank Act are no piece of cake.

This week, according to MarketWatch, she told the SEC’s Advisory Committee on Small and Emerging Companies that “she wants to implement the JOBS Act – which seeks to ease access to capital for small businesses – by approving rules required by the law with a close eye on investor protection concerns. “If you don’t pay sufficient attention to them [investor protection concerns] the investing public won’t have sufficient confidence in an enterprise to invest in it and provide capital.””

Her later point in essence is haste makes waste.  She must deal with the polar extremes of the “let’s crowdfund now” lobby and the “worst piece of legislation” advocates on the other side.  If she wants to keep her job, she will have to deal with it all in the next few months.  As Broc Romanek of TheCorporateCounsel.net pointed out in “The Strange Case of SEC Chair White’s Confirmation,” she has only been appointed to a one year term.

In early April, Inc.com ran a piece that indicated predictions of timing were conjecture.  It describes a meeting that David Blass, the chief counsel of the SEC, has with a group of entrepreneurs.  Mr. Blass reportedly said “”It just is not possible for me to say a date in which it will or will not be up and running . . . I don’t think anybody who gives you a prediction on timing really knows what they’re talking about, unless they’ve been through the process and knows what goes into making an SEC rule final.”

TheCrowdCafe had an interesting article captioned “Crowdfunding’s Disruptive DNA: The Why, How and Who.  It makes the point that crowdfunding will enter the bottom of the market, targeting customers whom often can’t be profitably served by incumbents.  Platforms will then then move up the value-chain in search for greater profit/margin, directly challenging incumbents.”  It’s seems like a viable analysis, assuming SEC baggage doesn’t offset the advantages to entrepreneurs, investors accept capital bases with large shareholder groups, and investors make appropriate risk-adjusted returns over time when even VCs are challenged to do so.

The article also boldly predicts the extinctions of finders, being persons who solicit capital for companies and sometimes act unlawfully as unregistered broker-dealers.  Maybe, but not every entrepreneur will be successfully crowdfunded and maybe the failed efforts will be further prey for finders.  But we do like their restatement of what the SEC’s view’s probably are: “Finders who are not registered broker-dealers are only permitted to do one thing: charge a flat fee for introducing a company to investors. For example: For $10k I’ll introduce you my network of 100 individuals; but it must start and stop there, I cannot participate in the transaction in any capacity. Transactional fee’s—e.g. 8% of the raise + warrants upon success— are explicitly illegal for unregistered Finders.”

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

As most listed public companies know, as a result of the Dodd-Frank Act, the stock exchanges have adopted rules regarding the independence of compensation committees and their advisers.  NASDAQ and the NYSE require the first prong of these rules, which require revisions to compensation committee charters, to be completed by July 1, 2013.

You may find the following resources helpful in updating your compensation committee charters and complying with the rest of the rules:

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

On Monday, April 29, the Commodity Futures Trading Commission reiterated that wash trades (transactions without intent to take genuine, bona fide positions in the market, such as simultaneous purchases and sales designed to negate each other so that there are no changes in financial position) are “grave violations” when they penalized two traders $400,000 and prohibited them from trading for 140 days.  In the Matter of Kevin McLaren and Edward Gorman, CFTC Docket No. 13-22, April 29, 2013.

McLaren and Gorman entered into wash trades when they knowingly prearranged the execution of calendar spread trades opposite each other. Specifically, each entered into buy and sell orders for 25 March 2010/September 2010 corn futures calendar spread contracts at identical prices within two seconds of each other.  Two seconds later, they placed offsetting sell and buy orders within one second of each other for the identical number of March 2010/September 2010 corn futures calendar spread contracts at prices identical to those in the previous transaction.

The CFTC said that these transactions were wash trades because they involved (1) the purchase and sale (2) of the same delivery month of the same futures contract (3) at the same (or similar) price. Further, the transactions had the requisite scienter, i.e., the intent at the time the transactions were initiated to negate market risk (to a level where the transactions had no practical risk) or price competition.

There are two takeaways from this case.  First, the CFTC has long said that wash trades are “grave violations,” even in the absence of customer harm “because they [wash trades] undermine confidence in the market mechanism that underlies price discovery.”  In Re Piasio, [1999-2000 Transfer Binder] Comm. Fut. L. Rep ¶ 28,276 at 50,691 (CFTC Sep. 20, 2000).  Second, because McLaren and Gorman were experienced traders (both became registered as floor brokers in 1982 and have been registered as floor traders since 2007), they should have known the CFTC’s concerns with such trades, and the attributes of such trades, and proceeded accordingly.  They did not and now each will have to pay a fine of $200,000. Moreover, each are prohibited from “directly or indirectly engaging in trading on or subject to the rules of any registered entity” and all registered entities must “refuse them trading privileges” for a period of 140 days.

As previously noted, the Court of Appeals for the District of Columbia recently dismissed a challenge to the SEC’s resource extraction rules for lack of jurisdiction.  The case was left to proceed pursuant to a previously filed action in the District Court for the District of Colombia. 

A similar challenge was also pending before the Court of Appeals related to the SEC’s conflict minerals rules.  After the ruling in the resource extraction case, the judge sua sponte cancelled oral argument in the conflicts minerals case.  The plaintiffs in the conflicts minerals case then made an unopposed motion to transfer the conflicts minerals case to the District Court.

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