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

The District Court for the Northeastern District of Illinois recently granted a Rule 12(b)(6) motion to dismiss an action styled Noble v. AAR Corp.  The plaintiff alleged that the company failed to provide adequate disclosures as to what exactly the Board considered in relation to the say-on-pay proposal.

The court granted the defendants’ motion to dismiss because the Dodd-Frank Act provides that the only relevant disclosures are those set forth in Item 402 of Regulation S-K.  The court noted that plaintiff’s attempts to create additional disclosure obligations for say-on-pay votes were without merit.

Information on another case, the Symantec say-on-pay dismissal can be found here.

Our thanks to The Conference Board blog for pointing this case out.  The blog also has a handy scorecard for the results of similar litigation to date:

  • Faruqi (the law firm brining these actions) plaintiffs succeeded in obtaining a preliminary injunction and substantial legal fees settlement in one case;
  • Scored several quick legal fees settlements without having to litigate their preliminary injunction claims;
  • Lost motions to obtain preliminary injunctions in several cases where companies refused to settle;
  • In the only two decisions on the merits, plaintiffs have seen their lawsuits dismissed for failing to state causes of action in Symantec and AAR Corp.

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

 

On March 28, 2013, the Commodity Futures Trading Commission issued a final rule that largely affirmed its earlier proposal to exempt certain FERC and Texas PUC regulated transactions from CFTC jurisdiction and provided helpful clarifications to market participants. In its proposed order, the CFTC proposed to define and then exempt, subject to conditions, from CFTC regulation four types of transactions, Financial Transmission Rights, Energy Transactions, Forward Capacity Transactions and Reserve or Regulation Transactions. (Cite our August 22 blog CFTC Proposes Exemption to Regulation of Transactions in ISO-RTO Markets as “Swaps” under CEA) .

In response to comments:

  • While the CFTC refused to exempt additional transactions that are “logical outgrowths” of the four transactions, they clarified that the exemption is not limited “to those products that are currently traded in a Requesting Party’s markets” (slip Op. at 220) and include any products now or in the future, pursuant to a FERC or PUCT-approved tariff and that fall within these definitions.
  • The CFTC clarified that energy transactions include virtual and convergence bids.
  • The Commission refused to impose position limits on the transactions exempted.
  • The CFTC said that the requisite performance of an energy transaction may occur in the Real-Time Market through “a cash payment or receipt at the price established in the Day-Ahead Market or Real Time Market (as permitted by the tariff)” (slip Op. at 33) but that any energy transaction settling based upon the Day-Ahead price must be inextricably linked to physical delivery of electric energy.
  • While the CFTC refused to extend the exemption to any person that satisfies the market participant eligibility criteria established by the RTOs, the CFTC expanded the scope of appropriate persons for purposes of the exemption to include “a person who actively participates in the generation, transmission or distribution of electric energy, i.e., ‘a person in the business of (1) generating, transmitting or distributing electric energy or (2) providing electric energy services that are necessary to support the reliable operation of the transmission system.’” (slip Op. at 77.) Such a person need not own physical transmission or generation assets, as long as that person satisfies these criteria. The CFTC said, however, that the exemption does not apply to persons or entities engaged in purely financial transactions and who are not eligible contract participants or meet the criteria in Sections 4(c)(3)(A) through (J) of the Commodity Exchange Act.

Since the advent of a mandatory but advisory say-on-pay vote required by the Dodd-Frank Act, issuers have used additional soliciting materials in connection with the say-on-pay vote.  Often the filings are made in connection with a negative recommendation by ISS or another proxy advisory firm.  For some high profile examples of the use of these materials, see the examples here and here.

Relying on the EDGAR full-text search engine, there were 45 examples of additional soliciting materials using EDGAR code DEFA14A that mentioned ISS between January 1, 2012 and April 5, 2012.  For the same period this year, there were 49 such filings.

It is important to note:

  • The search picks up issues, such as governance issues, in addition to say-on-pay.
  • Not all of the filings relate to negative ISS recommendations.  For instance some are investor presentations that happen to mention ISS.
  • The search picks up filings related to mergers where ISS has made either a positive or negative recommendation.

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

The CFTC Division of Market Oversight (DMO) has issued a no-action letter that will allow most swaps end users to report all trade options on an annual aggregate basis. Trade options are commodity options (which include some forward contracts with embedded optionality) that satisfy certain conditions regarding the counterparties’ (1) commercial activities with respect to the underlying commodity and (2) intent to make or take physical delivery. Prior to the no-action letter, trade options were reportable on an annual aggregate basis on CFTC Form TO only if neither of the counterparties had been required to report a non-trade option swap as a swap reporting counterparty within the previous 12 months. Trade options that did not satisfy that condition were required to be reported on a transaction-by-transaction basis. The no-action letter effectively allows all trade options by a non-swap dealer/non-major swap participant (non-SD/MSP) counterparty to be reportable on the annual Form TO as long as the counterparty notifies the DMO within 30 days if it enters into trade options having an aggregate notional value in excess of $1 billion during any calendar year.

The no-action letter also relieves non-SD/MSP counterparties from all recordkeeping requirements with respect to trade options other than the CFTC’s rule 45.2 recordkeeping requirements as long as the counterparty satisfies the same $1 billion notice requirement, provides its legal entity identifier (LEI) to any SD/MSP trade option counterparties, and complies with the other non-recordkeeping requirements (e.g., position limits, fraud prohibitions) with respect to its trade options.

The Federal Reserve Board has approved a final rule that establishes the requirements for determining when a company is “predominantly engaged in financial activities.” The requirements will be used by the Financial Stability Oversight Council, or FSOC, when it considers the potential designation of a nonbank financial company for consolidated supervision by the Federal Reserve.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a nonbank financial company can be designated by the FSOC for supervision by the Federal Reserve only if it is “predominantly engaged in financial activities.” A company is considered to be predominantly engaged in financial activities if 85 percent or more of the company’s revenues or assets are related to activities that are defined as financial in nature under the Bank Holding Company Act. Additionally, the FSOC may issue recommendations for primary financial regulatory agencies to apply new or heightened standards to a financial activity or practice conducted by companies that are predominantly engaged in financial activities.

The final rule largely adopts the approach in the proposed rule, with a few exceptions. For example, the final rule states that engaging in physically settled derivatives transactions generally will not be considered a financial activity, a change from the proposal.

The final rule also defines the terms “significant nonbank financial company” and “significant bank holding company.” Among the factors the FSOC must consider when determining whether to designate a nonbank financial company for consolidated supervision by the Federal Reserve is the extent and nature of the company’s transactions and relationships with other significant nonbank financial companies and significant bank holding companies. If designated, those nonbank financial companies will be required to submit reports to the Federal Reserve, the FSOC, and the Federal Deposit Insurance Corporation on the company’s credit exposure to other significant nonbank financial companies and significant bank holding companies as well as the credit exposure of such significant entities to the company. Consistent with the proposal, a firm will be considered significant if it has $50 billion or more in total consolidated assets or has been designated by the FSOC as systemically important.

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 announced four enforcement actions to end what the Bureau believes to be improper kickbacks paid by mortgage insurers to mortgage lenders in exchange for business. The CFPB filed complaints and proposed consent orders against four national mortgage insurance companies in order to stop these practices, which have been prevalent for more than 10 years. The proposed orders require the four mortgage insurers to pay more than $15 million in penalties to the CFPB.

The CFPB alleges that four mortgage insurance companies violated federal consumer financial law by engaging in widespread kickback arrangements with lenders across the country. The CFPB believes the mortgage insurers named in today’s enforcement actions provided kickbacks to mortgage lenders by purchasing captive reinsurance that was essentially worthless but was designed to make a profit for the lenders.

The four companies named in the actions are Genworth Mortgage Insurance Corporation, United Guaranty Corporation, Radian Guaranty Inc., and Mortgage Guaranty Insurance Corporation. According to the CFPB, in exchange for kickbacks, these mortgage insurers received lucrative business referrals from lenders.

The proposed consent orders have been signed by the CFPB and the named companies. The proposed consent orders have been filed with the United States District Court for the Southern District of Florida court and will have the full force of law only when signed by the presiding judge.  The complaint is not a finding or ruling that the defendants have actually violated the law.

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

David W. Blass, Chief Counsel, Division of Trading and Markets, SEC, recently gave a speech before the American Bar Association Trading and Markets Subcommittee on April 5, 2013. The topic of the speech was whether and when investment advisers to private funds are required to register with the SEC as broker-dealers. 

As a result of Title IV of the Dodd-Frank Act, most advisers to private funds (hedge funds and private equity funds) are required to register with the SEC, whereas these funds had previously taken advantage of a registration exemption known as the “private adviser exemption,” which was eliminated by the Dodd-Frank Act and replaced with several narrower exemptions.  So more private fund advisers are now subject to SEC regulation, and the SEC will be stepping up its private fund adviser examinations due to the new regulatory requirements and the SEC’s own observations about the conduct of private fund advisers.  The purpose of the speech by Mr. Blass was to provide private fund advisers with the tools necessary to examine their own conduct (which will be under new scrutiny from the SEC due to the investment adviser regulation) vis-à-vis broker-dealer activity (which they may have previously overlooked) so that the private fund advisers can be prepared for broker-dealer registration or can alter their practices so as to avoid registration.

As a reminder, the general rule is that any person engaged in the business of effecting transactions in securities for the account of others must register as a broker-dealer.  The determination of whether a person is “engaged in the business . . .” is based on a case-by-case analysis of the facts, but one factor in particular – the receipt by the person of transaction-based compensation (a “salesman’s stake”) – has been said to be a “hallmark” of broker-dealer status.

Mr. Blass provides a road-map for private fund advisers to begin a self-analysis to determine whether they might be approaching broker-dealer status.  He advises that private fund advisers should examine their practices with the following points in mind:

  • With regard to soliciting and retaining investors, a dedicated sales force of employees carrying out a marketing function “may strongly indicate that they are in the business of effecting transactions in the private fund.”
  • If employees who solicit investors have no other duties, or if they spend the great majority of their time carrying out the investor solicitation function, then the adviser might be a broker-dealer.
  • Compensating employees who solicit investors in any way (bonuses, etc.) that is linked to successful investments may indicate broker-dealer status.
  • If a private equity fund executing a leveraged buyout strategy collects fees other than advisory fees that are linked to an acquisition or disposition – for example, if the manager directs a portfolio company to pay fees to the adviser or its affiliates, even if the payment is nominally for investment banking activity such as negotiating the transaction, soliciting purchasers, etc. – then the transaction-based compensation threshold may be triggered.  “The combination of success fees which cause the adviser to take on a salesman’s stake and the activities involved in effecting securities transactions appear, at least on their face, to cause such an adviser to fall within the meaning of the term ‘broker.’”

Mr. Blass also addressed three strands of push-back the SEC has received from private fund advisers seeking to avoid broker-dealer registration:

  • The advisers are not engaging in broker-dealer activity when the transaction-based payments offset or reduce the amount of the advisory fee.  Mr. Blass agrees, conceptually, that in this instance the transaction-based compensation is merely another way of paying the advisory fee.
  • Where the general partner of the fund is also the adviser to the fund or an affiliate of the adviser to the fund, then the general partner should be viewed as the same person as the fund such that the adviser is not engaging in securities transactions “for the account of others.”  This rationale is not plausible to Mr. Blass, who notes that if the general partner and the fund are the same person, then there is no need to pay the fee to any person other than the fund.
  • The SEC should not spend it’s time taking on registration of private fund advisers as broker-dealers without an underlying policy objective.  Mr. Blass sees the situation as dependent on the activities of the private fund advisers, though, rather than the SEC.  If private fund advisers are not prepared to register as broker-dealers, then they should avoid engaging in broker-dealer activity.

Mr. Blass concluded by noting that, in his view, it would not be difficult for private fund advisers to alter their practices in order to ensure that they do not fall within the broker-dealer definition.

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

The SEC recently granted two accredited crowdfunding sites exemptions from the broker-dealer rules because the type of carried interest (or close equivalent) used to compensate the site is not transaction based compensation.  But some of the accredited crowdfunding sites broadly attract potential investors to their sites by what could constitute advertising on the face of the site or elsewhere. The concern is whether that sort of advertising constitutes a general solicitation and whether the procedures are adequate to determine investors are in fact accredited to qualify for the Regulation D exemption.

Sure, before gaining entrance you have to fill out a questionnaire and certify that you are accredited.  But we all think we know how this works.  You answer a few canned questions about your income and net worth, and perhaps whether you have invested in start-ups before or something like that.  We then suspect a computer instantaneously determines whether or not you are accredited.

But does this combination of advertising and perfunctory qualification work?  We believe the SEC has not passed directly on that question.  But as Travis Crabtree of Looper Reed points out, in one of the no-action letters the company tips its hat, saying they are relying on a no-action letter issued to Lamp Technologies Inc. We decided to peel back the onion and take a closer look, and for the time being ignoring the fact that only the person to whom the no-action letter is issued can rely on it.

Lamp Technologies offers powerful analogies that the accredited crowdfunding sites are not engaged in general solicitation.  Lamp Technologies is really two no-action letters, which you can read here and here. Like some of the accredited crowdfunding sites, the Lamp letters state that a general solicitation does not occur if potential investors complete a questionnaire to allow Lamp to form a “reasonable basis” that the subscriber is an accredited investor, the qualified investors are given a password to access the information, and a waiting period occurs before any investment is made.

Perhaps some key differences from Lamp and the practices of accredited crowdfunding sites are:

  • The SEC took no position that the information obtained by Lamp is sufficient to form a reasonable basis for believing that the investor is accredited.
  • Lamp’s business was fundamentally different than an accredited crowdfunding site’s business.  Lamp’s business was to make hedge fund data readily available and easily accessible to professionals so it could be monitored by those in the hedge fund industry, and not to sell securities.
  • It is unknown what sort of advertising Lamp employed to attract users to its web site.
  • Lamp also represented it would review the questionnaires and that access to the site would be limited to a select group of advisers that have been pre-qualified.

The Lamp letters closely follow no-action relief granted to IPONET (publicly available July 26, 1996).  (As an aside, we couldn’t find this posted on-line so no link is provided.)  IPONET offered pre-qualifed investors access to password protected private placement memorandums.  IPONET allowed prospective participants to complete the questionnaire on-line. The business of IPONET more closely matches the business of the accredited crowdfunding sites, all of which is good.  But here again, the SEC stated it took no position on whether the information obtained by the site sponsor was sufficient to form a reasonable basis for believing an investor to be “accredited or sophisticated.”  IPONET also represented that it will “verify the information in the questionnaire to determine that the member is an accredited investor.”

The SEC then took up the issues raised by Lamp and IPONET in Release No. 33-7856.  The release states “Moreover, some non-broker-dealer web site operators are not even requiring prospective investors to complete questionnaires providing information needed to form a reasonable belief regarding their accreditation or sophistication. Instead, these web sites permit interested persons to certify themselves as accredited or sophisticated merely by checking a box.”  Here the SEC is referring to checking a single box that says “I am accredited.”  But remember, the SEC has never said how many boxes is enough or whether computer automated verification is sufficient, to our knowledge.

The release continues “These web sites, particularly those allowing for self-accreditation, raise significant concerns as to whether the offerings that they facilitate involve general solicitations.  In these instances, one method of ensuring that a general solicitation is not involved is to establish the existence of a “pre-existing, substantive relationship.” . . . Generally, staff interpretations of whether a “pre-existing, substantive relationship” exists have been limited to procedures established by broker-dealers in connection with their customers. This is because traditional broker-dealer relationships require that a broker-dealer deal fairly with, and make suitable recommendations to, customers, and, thus, implies that a substantive relationship exists between the broker-dealer and its customers. We have long stated, however, that the presence or absence of a general solicitation is always dependent on the facts and circumstances of each particular case.  Thus, there may be facts and circumstances in which a third party, other than a registered broker-dealer, could establish a “pre-existing, substantive relationship” sufficient to avoid a “general solicitation.””

Footnote 88 to the release elaborates “We understand that securities lawyers may have interpreted staff responses to Lamp Technologies, Inc. as extending the “pre-existing, substantive relationship” doctrine to solicitations conducted by third parties other than a registered broker-dealer. . .We disagree. In the Lamp Technologies no-action letters, the staff of the Divisions of Investment Management and Corporation Finance recognized a separate means to satisfy the “no general solicitation” requirement solely in the context of offerings by private hedge funds that are excluded from regulation as investment companies pursuant to Sections 3(c)(1) and 3(c)(7) of the Investment Company Act.”

So perhaps the accredited crowdfunding sites fall within the release because they ask prospective participants to check enough boxes in the accreditation process, the waiting period obviates the need for a pre-existing relationship, and after all the accredited crowdfunding sites appear to be organizing funds consisting of a single issuer’s securities pursuant to Sections 3(c)(1) and 3(c)(7) of the Investment Company Act.

But also consider the statement that “the presence or absence of a general solicitation is always dependent on the facts and circumstances of each particular case.”  In addition, our guess is the single issuer funds being organized by the accredited crowdfunding sites are significantly different than the “private hedge funds” referred to in Lamp.

Footnote 88 also states “We encourage web site operators offering these services to work with the Commission staff to resolve any securities law issues raised by their activities.”  If only it were so easy.

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

Many may remember the Netflix matter.  That stemmed from an inquiry the SEC’s Division of Enforcement launched about a post that Netflix CEO Reed Hastings made on his personal Facebook page.  The post stated that Netflix’s monthly online viewing had exceeded one billion hours for the first time.

The SEC has now backed down with some public fanfare, putting its own spin on the matter.  The SEC issued a press release captioned “SEC Says Social Media OK for Company Announcements if Investors Are Alerted.”   Obviously, the SEC recognizes it cannot stand in the way of progress, and maybe recognized it didn’t have a winnable case, perhaps because of the materiality issue, among other things (some believe in footnote 15 to the SEC’s report discussed below, the SEC concedes the materiality issue).  The SEC noted “The SEC did not initiate an enforcement action or allege wrongdoing by Hastings or Netflix. Recognizing that there has been market uncertainty about the application of Regulation FD to social media, the SEC issued the report of investigation pursuant to Section 21(a) of the Securities Exchange Act of 1934.”

While the guidance is not hard to understand, it will be difficult to apply.  And the SEC will be looking for someone to cross the line. 

According to the SEC, the report of investigation explains that although every case must be evaluated on its own facts, disclosure of material, nonpublic information on the personal social media site of an individual corporate officer — without advance notice to investors that the site may be used for this purpose — is unlikely to qualify as an acceptable method of disclosure under the securities laws. The SEC opines that personal social media sites of individuals employed by a public company would not ordinarily be assumed to be channels through which the company would disclose material corporate information.

So it’s OK for an officer to use social media for company announcements, as long as it has been authorized and disclosed in advance.  How many companies are going to authorize that?  And what is acceptable advance notice?  The SEC directs issuers to 2008 guidance on corporate web sites for further analysis.

This is the second Section 21(a) report on Regulation FD.  The first centered on Motorola, where the SEC noted “before engaging in the conduct in question, Motorola officials sought the advice of in-house legal counsel. Counsel approved the conduct in question based on a determination that the information in question was not material or nonpublic. Counsel’s determination was erroneous in both respects. Nevertheless, because it appears that counsel’s advice was sought and given in good faith, and in light of the surrounding facts and circumstances, we are issuing this Report rather than bringing an enforcement action against Motorola or its senior officials.”

For a fairly current analysis of prior Regulation FD enforcement actions, see Vanessa Schoenthaler’s write-up on IR Web Report.

An interesting question is “Just what is a Section 21(a) Report?”  As Broc Romanek of TheCorporateCounsel.net has noted, the SEC uses the report to “as a vehicle to signal how it views a particular problematic area or set of practices – so they are essentially policy statements. Perhaps more important, they put people on notice that going forward the SEC and it’s Enforcement Division will consider similar conduct to be fair game for more conventional enforcement action.”

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

The CFTC has issued a final rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement under the Commodity Exchange Act, or CEA, and CFTC regulations.

The CFTC rule permits affiliated counterparties to elect not to clear a swap subject to the clearing requirement if those counterparties are majority-owned affiliates whose financial statements are included in the same consolidated financial statements. In addition:

  • both affiliated counterparties must elect not to clear the swap,
  • the terms of the swap must be documented in a swap trading relationship document (or comply with the requirements of Commission regulation 23.504, if one of the affiliated counterparties is a swap dealer or a major swap participant),
  • the swap must be subject to a centralized risk management program that is reasonably designed to monitor and manage the risks associated with the swap (or if one of the affiliated counterparties is a swap dealer or a major swap participant, the requirements of Commission regulation 23.600 must be met), and
  • each swap entered into by the affiliated counterparties with unaffiliated counterparties must be cleared.

The requirement to clear swaps entered into with unaffiliated counterparties may be met by:

  • complying with the Commission’s clearing requirement;
  • complying with a foreign jurisdiction’s clearing mandate that the Commission has determined is comparable, and comprehensive but not necessarily identical, to the Commission’s clearing requirement;
  • complying with an exception or exemption from the clearing requirement under the CEA or the Commission’s regulations;
  • complying with an exception or exemption under a foreign jurisdiction’s clearing mandate, provided that the Commission has determined that the foreign jurisdiction’s clearing mandate is comparable, and comprehensive but not necessarily identical, to the Commission’s clearing requirement, and the foreign jurisdiction’s exception or exemption is comparable to an exception or exemption under the CEA or the Commission’s regulations; or
  • clearing such swaps through a registered derivatives clearing organization or a clearing organization that is subject to supervision by appropriate government authorities in the home country of the clearing organization and has been assessed to be in compliance with the Principles for Financial Market Infrastructures.

The final rule requires the reporting counterparty to report to a swap data repository, or SDR (or if no SDR is available, to the Commission) the following information for each swap for which the inter-affiliate exemption applies:

  • confirmation that both affiliated counterparties to the swap are electing not to clear the swap and that each of the electing eligible affiliate counterparties satisfies the requirements of the rule;
  • information regarding how both affiliated counterparties generally meet their financial obligations associated with entering into non-cleared swaps; and
  • certain information, if the affiliated counterparties are issuers of securities registered under section 12, or are required to file reports under section 15(d), of the Securities Exchange Act of 1934.

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