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

Bruce Karpati, Chief, of the SEC Enforcement Division’s Asset Management Unit, recently gave his views on certain matters related to private equity.

Mr. Karpati stated “Private equity went through a significant growth spurt in the run-up to the financial crisis and is a rapidly maturing industry. In terms of assets under management, it’s roughly equivalent to, and perhaps larger than, the hedge fund industry. Also, many private equity managers have only recently become registered investment advisers. As a result of these developments, it’s not unreasonable to think that the number of cases involving private equity will increase” (emphasis added).

Mr. Karpati also noted “Much of the improper conduct in private equity arises out of conflicts of interest, which can lead to misappropriation, deal cherry picking and other forms of misconduct. I’d like to discuss those conflicts and talk about the types of issues they present.”  Mr. Karpati cited the following frequent conflicts of interest:

  • The conflict between the profitability of the management company and the best interests of investors. This conflict exists at all firms, but may be particularly acute at firms that have publicly listed their management company shares and may therefore feel additional pressure from their public shareholders to generate short-term results.
  • The shifting of expenses from the management company to the funds including utilizing the funds’ buying power to get better deals from vendors — such as law and accounting firms — for the management company at the expense of the fund.
  • Charging additional fees especially to the portfolio companies where the allowable fees may be poorly defined by the partnership agreement.
  • Conflicts arising from managing different clients, investors and products under the same umbrella. Some specifics mentioned include:
    • Broken deal expenses rolled into future transactions that may be ultimately paid by other clients. The SEC has observed certain preferred clients incur no broken deal expenses at all, which are all absorbed by a core co-mingled fund.
    • Improper shifting of organizational expenses, where co-mingled vehicles foot the bill for preferred clients.
    • Complementary products supporting each other such as a primary vehicle making fund commitments to create deal flow for a more profitable co-investment vehicle.
  • Conflicts with a manager’s other business which may be run in parallel with the adviser and may incentivize managers to usurp investment opportunities or enter into related party transactions at the expense of investors.

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

Various NYSE require listed companies to provide notice to the NYSE upon certain events.  The methods specified to give notice vary from rule to rule and sometimes no notice method is specified.  The SEC has approved an amendment to the NYSE rules to specify a uniform method for giving notice to the Exchange in many, but not all, circumstances.  The new rule provides that, when a provision of the Listed Company Manual requires a company to give notice to the Exchange pursuant to Section 204.00 of the Listed Company manual, the company shall provide such notice through a web-based communication system – either a web portal or email address – specified by the Exchange in a prominent position on its website.  Should the Exchange ever change the web-based communication system it uses to receive notifications pursuant to Section 204.00, the proposed text of Section 204.00 would require the Exchange to promptly update and display the applicable information on its website.

In addition, the NYSE also  amended Section 204.00 of the Listed Company manual to address several other scenarios that impact the notifications that companies must provide to the Exchange. First, amended Section 204.00 permits that, in emergency situations – for instance, lack of computer or internet access, technical problems at the Exchange or company, or incompatibility between Exchange and company systems – companies may provide notifications required pursuant to the Section by telephone and confirmed by facsimile, as specified by the Exchange on its website. Second, amended Section 204.00 would require that, in cases where a material event or a statement dealing with a rumor which calls for immediate release is made shortly before the opening or during market hours, companies must notify the Exchange using the telephone alert procedures set forth in Section 202.06(B) of the Manual.

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 issued rules to prevent mortgage lenders from steering borrowers into risky and high-cost loans. According to the CFPB, the rules ban certain incentives that loan originators had to sell unsafe loans to consumers in the run-up to the financial crisis.

The rules:

  • Prohibit steering incentives: The rules prohibit compensation that varies with the loan terms. A broker or loan officer cannot get paid more if the consumer takes a loan with a higher interest rate, a prepayment penalty, or higher fees. Moreover, the mortgage originator cannot get paid more if, for example, the consumer agrees to buy title insurance from the lender’s affiliate.
  • Prohibit “dual compensation”: Under the CFPB’s rules, the loan originator cannot get paid by both the consumer and another person such as the creditor.
  • Set Qualification and Screening Standards: Under state law and the federal Secure and Fair Enforcement for Mortgage Licensing (SAFE) Act, loan originators currently have to meet different sets of qualification standards, depending on whether they work for a bank, thrift, mortgage brokerage, or nonprofit organization. These rules implement Dodd-Frank Act requirements that require a more level playing field so consumers can be confident that originators are ethical and knowledgeable. The final rules generally include:
    • Character and Fitness Requirements: Loan originators must meet character, fitness, and financial responsibility reviews;
    • Criminal Background Checks: Loan originators must be screened for felony convictions; and
    • Training Requirements: Loan originators are required to undertake training to ensure they have the knowledge about the rules governing the types of loans they originate.

The final rule also implements Dodd-Frank provisions that, for mortgage and home equity loans, generally prohibit mandatory arbitration of disputes related to mortgage loans and the practice of increasing loan amounts to cover credit insurance premiums.

In August, the CFPB issued a proposed rule requiring mortgage loan originators to make available a loan option with no upfront discount points or origination fees, if they were making available one with upfront discount points or origination fees. Based on the comments received, the CFPB has decided not to finalize this part of the proposal.

The rules will take effect in January 2014, except that the prohibition on mandatory arbitration and on the financing of credit insurance will take effect in June 2013.

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 approved Nasdaq’s compensation committee independence rules.  By July 1, 2013, most listed issuers must comply with the following:

  • Have a compensation committee charter which provides:
    • The compensation committee will review and assess the adequacy of the formal written charter on an annual basis;
    • The scope of the compensation committee’s responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
    • The compensation committee’s responsibility for determining, or recommending to the board for determination, the compensation of the chief executive officer and all other executive officers of the Company;
    • That the chief executive officer may not be present during voting or deliberations on his or her compensation;
    • The compensation committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, legal counsel or other adviser;
    • The compensation committee shall be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, legal counsel and other adviser retained by the compensation committee;
    • The Company must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to a compensation consultant, legal counsel or any other adviser retained by the compensation committee;
    • The compensation committee may select, or receive advice from, a compensation consultant, legal counsel or other adviser to the compensation committee, other than in-house legal counsel, only after taking into consideration the following factors:
      • The provision of other services to the Company by the person that employs the compensation consultant, legal counsel or other adviser;
      • The amount of fees received from the Company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser;
      • The policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest;
      • Any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee;
      • Any stock of the Company owned by the compensation consultant, legal counsel or other adviser;
      • Any business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the Company;
      • Commentary to the rule provides the compensation committee is required to conduct the independence assessment outlined above with respect to any compensation consultant, legal counsel or other adviser that provides advice to the compensation committee, other than in-house legal counsel. However, nothing requires a compensation consultant, legal counsel or other compensation adviser to be independent, only that the compensation committee consider the enumerated independence factors before selecting, or receiving advice from, a compensation adviser; and
      • Commentary to the rule also provides the compensation committee is not required to conduct an independence assessment for a compensation adviser that acts in a role limited to the following activities for which no disclosure is required under Item 407(e)(3)(iii) of Regulation S-K: (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the Company, and that is available generally to all salaried employees; and/or (b) providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

Most listed companies will have until the earlier of their first annual meeting after January 14, 2014, or October 14, 2014, to comply with the new director independence standards with respect to their compensation committees:

  • Each Company must have, and certify that it has and will continue to have, a compensation committee of at least two members, each of whom must:
    • Be an independent director as otherwise defined under Nasdaq rules; and
    • Not accept directly or indirectly any consulting, advisory or other compensatory fee from the Company or any subsidiary thereof. Compensatory fees shall not include: (i) fees received as a member of the compensation committee, the board of directors or any other board committee; or (ii) the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the Company (provided that such compensation is not contingent in any way on continued service).
    • In determining whether a director is eligible to serve on the compensation committee, a Company’s board also must consider whether the director is affiliated with the Company, a subsidiary of the Company or an affiliate of a subsidiary of the Company to determine whether such affiliation would impair the director’s judgment as a member of the compensation committee.
  • A Company must certify to Nasdaq, no later than 30 days after the final implementation deadline applicable to it, that it has complied with the compensation committee charter and independence provisions.

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 approved the NYSE’s compensation committee independence rules.  By July 1, 2013, most listed issuers must comply with the following:

  • Have a compensation committee charter which provides:
    • The compensation committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser.
    •  The compensation committee shall be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, independent legal counsel or other adviser retained by the compensation committee.
    • The listed company must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to a compensation consultant, independent legal counsel or any other adviser retained by the compensation committee.
    •  The compensation committee may select a compensation consultant, legal counsel or other adviser to the compensation committee only after taking into consideration, all factors relevant to that person’s independence from management, including the following:
      • The provision of other services to the listed company by the person that employs the compensation consultant, legal counsel or other adviser;
      • The amount of fees received from the listed company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser;
      • The policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest;
      • Any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee;
      • Any stock of the listed company owned by the compensation consultant, legal counsel or other adviser; and
      • Any business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the listed company.
      • The foregoing independence assessment compensation committee is not required for: (i) in-house legal counsel; and (ii) any compensation consultant, legal counsel or other adviser whose role is limited to the following activities for which no disclosure would be required under Item 407(e)(3)(iii) of Regulation S-K: consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the listed company, and that is available generally to all salaried employees; or providing information that either is not customized for a particular company or that is customized based on parameters that are not developed by the compensation consultant, and about which the compensation consultant does not provide advice.
      • The foregoing does not require a compensation consultant, legal counsel or other compensation adviser to be independent, only that the compensation committee consider the enumerated independence factors before selecting or receiving advice from a compensation adviser.

Most listed companies have until the earlier of their first annual meeting after January 15, 2014, or October 14, 2014, to comply the following new director independence standards with respect to their compensation committees:

  • In affirmatively determining the independence of any director who will serve on the compensation committee of the listed company’s board of directors, the board of directors must consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to:
    • The source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
    • Whether such director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.
  •  When considering the sources of a director’s compensation in determining his independence for purposes of compensation committee service, the board should consider whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the listed company’s executive compensation. Similarly, when considering any affiliate relationship a director has with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company, in determining his independence for purposes of compensation committee service, the board should consider whether the affiliate relationship places the director under the direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair his ability to make independent judgments about the listed company’s executive compensation.

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

We recently gave a presentation at a CLE titled Securities Law Essentials for Growing Companies.  The presentation included an overview of what constitutes a public offering, what is a security, classical private placements, mistakes made by issuers and lawyers, liability associated with private offerings, Regulation D safe harbors, use of finders and unregistered broker dealers, and changes required by the JOBS Act and the Dodd-Frank Act.  You can find the written materials here and the PowerPoint here.

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

Nasdaq has amended its proposal regarding independence of compensation committees required by the Dodd-Frank Act.  Nasdaq proposes to clarify that a compensation committee is not required to conduct the independence assessment required by proposed Listing Rule 5605(d)(3)(D) with respect to a compensation adviser that acts in a role limited to:

  • consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the Company, and that is available generally to all salaried employees; and/or
  • providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

This exception copies language from Item 407(e)(3)(iii) of Regulation S-K, which provides a limited exception to the Commission’s requirement for a registrant to disclose any role of compensation consultants in determining or recommending the amount and form of a registrant’s executive and director compensation.

The NYSE has proposed a similar amendment to its proposal, together with amendments addressing transition when smaller reporting companies are no longer eligible for that status.  The NYSE also proposes an amendment to clarify that compensation committees are not precluded from selecting or receiving advice from compensation advisers that are not independent.

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

The Consumer Financial Protection Bureau, or CFPB, has adopted a new rule that requires lenders to ensure prospective buyers have the ability to repay their mortgage.

Ability to Repay

Under the Ability-to-Repay rule announced today, all new mortgages must comply with basic requirements that protect consumers from taking on loans they don’t have the financial means to pay back. Among the features of the new rule:

  • Financial information has to be supplied and verified: Lenders must look at a consumer’s financial information.
  •  A borrower has to have sufficient assets or income to pay back the loan: Lenders must evaluate and conclude that the borrower can repay the loan.
  • Teaser rates can no longer mask the true cost of a mortgage: Lenders can’t base their evaluation of a consumer’s ability to repay on teaser rates.

Qualified Mortgages

Lenders will be presumed to have complied with the Ability-to-Repay rule if they issue “Qualified Mortgages.” These loans must meet certain requirements which prohibit or limit the risky features that harmed consumers in the recent mortgage crisis. If a lender complies with the clear criteria of a Qualified Mortgage, consumers will have greater assurance that they can pay back the loan. Among the features of a Qualified Mortgage:

  • No excess upfront points and fees: A Qualified Mortgage limits points and fees including those used to compensate loan originators, such as loan officers and brokers.
  • No toxic loan features: A Qualified Mortgage cannot have risky loan features, such as terms that exceed 30 years, interest-only payments, or negative-amortization payments where the principal amount increases.
  • Cap on how much income can go toward debt: Qualified Mortgages generally will be provided to people who have debt-to-income ratios less than or equal to 43 percent.

There are two kinds of Qualified Mortgages that have different protective features for a consumer and different legal consequences for the lender. The first, Qualified Mortgages with a rebuttable presumption, are higher-priced loans. These loans are generally given to consumers with insufficient or weak credit history. Legally, lenders that offer these loans are presumed to have determined that the borrower had an ability to repay the loan. Consumers can challenge that presumption, though, by proving that they did not, in fact, have sufficient income to pay the mortgage and their other living expenses.

The second, Qualified Mortgages that have a safe harbor status, are generally lower-priced loans. They are generally prime loans that are given to consumers who are considered to be less risky. They will also offer lenders the greatest legal certainty that they are complying with the new Ability-to-Repay rule. Consumers can legally challenge their lender if they believe the loan does not meet the definition of a Qualified Mortgage.

The Ability-to-Repay rule does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws.

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

Financial Industry Regulatory Authority, Inc., or FINRA, has filed  a proposed rule change with the SEC to amend FINRA Rule 2267 (Investor Education and Protection) to require that FINRA members include a prominent description of and link to FINRA BrokerCheck on:

  • their websites, social media pages and any comparable Internet presence, and
  • on websites, social media pages and any comparable Internet presence relating to a member’s investment banking or securities business maintained by or on behalf of any person associated with a member.

FINRA established BrokerCheck in 1988 (then known as the Public Disclosure Program) to provide the public with information on the professional background, business practices, and conduct of FINRA-member firms and their associated persons.

The proposed rule results in part from an SEC study in furtherance of Section 919B of the Dodd-Frank Act.

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 (CFTC) recently announced its second enforcement action against a commodity trader for engaging in the manipulative scheme called “spoofing.”  U.S. Commodity Futures Trading Commission v. Eric Moncada, 12 CV-8791, United States District Court for the Southern District of New York, December 4, 2012 (“Moncada”).  In “spoofing,” a trader manipulates prices — the resulting prices do not reflect supply and demand fundamentals — by manipulating the actual bidding process to create a false impression of market liquidity.  In Moncada, the trader “spoofed” by repeatedly:

(i)  placing and immediately cancelling numerous large-lot orders without the intent to have the large-lot orders filled, but instead with the intent to create the        misleading impression of increasing liquidity in the market;

(ii)  placing these large-lot orders at or near the best bid or offer price in a manner to avoid being filled by the market; and

(iii)  placing small-lot orders on the opposite side of the market from these large-lot orders with the intent of taking advantage of any price movements that might result from the misleading impression of increasing liquidity that the large-lot orders created.

In response, (1) the CFTC announced civil penalties (the higher of $140,000 or triple the monetary gains) and bans on future trading and registration and (2) the CFTC’s Director of Enforcement said:

The illegal scheme…entering and quickly cancelling large-lot futures orders without any intent to consummate a trade, undermines the integrity of the market. Traders may not employ deceptive schemes to simply drive price.  As our action today should make clear, we police the market for this type of activity and will bring charges against those who attempt to illegally game prices for their own advantage.  Release PR6441-12 December 4, 2012.

This is the second spoofing action that the CFTC has brought. In March 22, 2011, the CFTC fined Bunge Global Markets $550,000 for entering into trades they had no intention of executing for the purpose of determining the depth of and price in the market.  The Federal Energy Regulatory Commission has not yet acted on a spoofing case but would find “spoofing” a manipulative practice in trading wholesale natural gas and electric products.