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

The FDIC has issued a final rule that treats a mutual insurance holding company as an insurance company for purposes of Section 203(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule clarifies that the liquidation and rehabilitation of a covered financial company that is a mutual insurance holding company will be conducted in the same manner as an insurance company. The final rule harmonizes the treatment of mutual insurance holding companies under Section 203(e) of the Dodd-Frank Act with the treatment of such companies under state insurance company insolvency laws.

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

We, like others, are anxiously awaiting the JOBS Act rule making which will permit general solicitation in Rule 506 offerings.   We believe however, there may be some bumps in the road, and have set forth some thoughts below as to what those might be.

Seemingly forgotten while hoards of people get ready to start posting adds selling securities on the internet is Section 926 of the Dodd-Frank Act.  Section 926 of the Dodd-Frank Act directs the SEC to issue rules which would prevent the use of Regulation D Rule 506 offerings by certain “bad actors.”  The Dodd-Frank Act directs the SEC to adopt rules similar to the current disqualifiers in Regulation A.  The SEC rules must also prohibit Rule 506 offerings by persons subject to final orders which bar them from association with entities regulated by certain authorities, such as state securities commissions, or that have been convicted of any felony or misdemeanor in connection with the purchase or sale of any security.  We have discussed some of the problems with Section 926 here.

The SEC has previously proposed rules under Section 926 of the Dodd-Frank Act and according to their rulemaking schedule the SEC intends to adopt them by the end of June.  It seems likely the SEC will put these rules on the front burner so they can claim they have helped to combat fraud in connection with general solicitations.  For an example of how problematic the Section 926 rules  could be, read the ABA comment letter.

Section 201 of the JOBS Act requires issuers to take “reasonable steps to verify that purchasers of securities are accredited investors.”  However, an issuer would violate securities law by an inadvertent  sale to one non-accredited investor even if the issuer took such reasonable steps under a literal reading of the JOBS Act.  Hopefully, this will be fixed in the rulemaking.  Otherwise, a general solicitation could be a fairly risky proposition.

Rule 506 offerings  and Regulation S offerings are often conducted in tandem.  One of the requirements of Regulation S is that there be no “directed selling efforts” in the US, which includes advertisements.  In addition, in Regulation S offerings, no attempt is made to verify that purchasers are accredited investors, and in our experience asking for such a representation would be problematic because of the US-based focus of the definition.  Hopefully, this can be fixed in the rulemaking process.

And if the SEC wants to make a general solicitation difficult, they can.  For instance, they could require all solicitation material be attached to Form D filed with the SEC.  Let’s hope they don’t go there.

Check jobs-act-info.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 launched a public inquiry into how consumers and financial services companies are affected by arbitration and arbitration clauses.

For purposes of conducting the study, the Bureau is asking the public about:

  • The prevalence of arbitration clauses in consumer financial products and services;
  • What claims consumers bring in arbitration against financial services companies;
  • If claims are brought by financial services companies against consumers in arbitration;
  • How consumers and companies are affected by actual arbitrations; and
  • How consumers and companies are affected by arbitration clauses outside of actual arbitrations.

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

 

I was a guest speaker for a Corporations class at Hamline School of Law in St. Paul, Minnesota.   I addressed takeover defense in Minnesota and my presentation covered:

  • the Minnesota control share acquisition statute
  • the Minnesota business combinations statute
  • the Minnesota fair price statute
  • registration of corporate takeovers in Minnesota
  • the applicability of the Revlon doctrine in Minnesota, and
  • other relevant parts of the Minnesota Business Corporation Act

You can find the presentation here.

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

Last year, Invesco Mortgage Capital’s shareholders indicated a preference for an annual say-on-pay vote.  Nonetheless, the board adopted a triennial frequency policy.  Subsequently Invesco filed an 8-K, after this year’s proxy statement was mailed, indicating that Invesco would implement an annual frequency vote in the future.

My guess as to what happened:  ISS recommended withheld votes against the directors pursuant to this policy: The board implements an advisory vote on executive compensation on a less frequent basis than the frequency that received the majority of votes cast at the most recent shareholder meeting at which shareholders voted on the say-on-pay frequency.

Invesco probably decided they did not like the heat and changed their policy.

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

The Office of Minority and Women Inclusion, or OMWI, of the U.S. Securities and Exchange Commission has submitted its first report pursuant to Section 342(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  The report covers Section 342-related activities at the SEC from the establishment of OMWI in July 2011 through the fiscal year ended September 30, 2011.

Under the Dodd-Frank Act, the annual report must include the following:

  • a statement of the total amounts paid to contractors during the reporting period;
  • the percentage of the amounts paid to contractors that were paid to minority-owned and women-owned businesses;
  • the successes achieved and challenges faced by the agency in operating minority and women outreach programs;
  • the challenges the agency may face in hiring qualified minority and women employees and contracting with qualified minority-owned and women-owned businesses; and,
  • any other information, findings, conclusions, and recommendations for legislative or agency action, as the OMWI Director determines appropriate.

The report notes that during fiscal year 2011, the SEC awarded $228 million to contractors. Of this $228 million, the SEC awarded $38.38 million (16.8%) to minority-owned businesses and $15.69 million (6.9%) to women-owned businesses.

The report also discloses that during fiscal year 2011, OMWI had limited staff as the office was newly created, and was unable to provide in-depth technical assistance to minority-owned and women-owned businesses. In fiscal year 2012,OMWI is in the process of hiring more staff and will have the resources to provide businesses seeking contracts with the SEC with a comprehensive overview of the contracting process from the proposal phase to the contract award phase, including an overview of the process of bidding on a requirement.

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 reminded lending institutions under its jurisdiction it is responsible for enforcing the Equal Credit Opportunity Act. In public statements, officials of the CFPB stated the Office of Fair Lending and Equal Opportunity at the CFPB helps ensure that all Americans have fair, equitable, and nondiscriminatory access to credit, and it will use every tool at its disposal to protect American consumers.

 The CFPB will look not only at mortgage lending, but also at other types of credit including student loans, loans for cars, and credit cards.

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

By a 4-1 vote today, the CFTC approved release of a rule defining the terms “swap dealer” (“SD”), “major swap participant” (“MSP”), and eligible contract participant (“ECP”) in a joint rulemaking with the SEC (which voted 5-0 in favor of approval) that also defined the terms for “security-based” SDs and MSPs. The definition of the term “swap dealer” is a foundational element of the regulation of swap markets under the Dodd-Frank Act and comes after several months of intense public commenting, political pressure, and last-minute rescheduling of pending release to accommodate further revision. The text of this so-called “entity definitions rule” has not been released, but the following summary draws on a fact sheet and Q&A released by the CFTC, along with written and oral statements delivered by the CFTC and staff during today’s open meeting.

Structure of the SD Definition Rule

Swap market participants looking for bright line safe harbors in avoiding categorization as a SD are likely to be disappointed unless they fall within the de minimis exemption, which provides fixed dollar amount thresholds that have increased substantially from the levels in the agencies’ original proposal. The definition of a SD is “activity-based,” dependent on “all relevant facts and circumstances.” Analysis of whether an entity is an SD, a determination that market participants must make themselves, begins with rule provisions that closely follow the statutory definition and exclusions under the Dodd-Frank Act. However, the Adopting Release accompanying the rulemaking provides further interpretive guidance as to what is and is not swap dealing activity. Once an entity has determined the scope of its swap dealing activities, if any, it can determine whether those activities fall below the bright-line de minimis thresholds, thus exempting the entity from the SD definition.

Following the SD Statutory Definition

The final SD definition closely follows the text of the Dodd-Frank Act in defining the term “swap dealer” as any person who—

(i) holds itself out as a dealer in swaps;
(ii) makes a market in swaps;
(iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account; or
(iv) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in swaps, interpretive guidance.

Similarly, the rule excludes any person that enters into swaps for such person’s own account, either individually or in a fiduciary capacity, but not as a part of a regular business. Finally the rule follows the statute in providing de minimis thresholds and in allowing swap dealers to limit their designation as a swap dealer to only those parts of their business that engage in swap dealing activity.

Interpretive Guidance on Swap Dealing Activity

According to the CFTC, the Adopting Release accompanying the rule provides interpretive guidance on the “holding out” and “commonly known” criteria, market making, the not part of a “regular business” exception, and the overall interpretive approach to the definition. Among other things, the guidance appears to have added some potentially significant qualifiers to end users who may occasionally engage in activities that resemble swap dealing, providing that:

• the SD determination should focus on the activities of a person that are “usual and normal” in the person’s course of business and identifiable as a swap dealing business;
• making a market in swaps is appropriately described as “routinely” standing ready to enter into swaps at the request or demand of a counterparty;
• however, a person making a one-way market in swaps may be a market maker, and exchange-executed swaps are relevant in the determination; and
• examples of activities that are part of “a regular business,” and therefore indicative of swap dealing, are entering into swaps to satisfy the business or risk management needs of the counterparty, maintaining a separate profit and loss statement for swap activity, or allocating staff and resources to dealer-type activities.

Further, the CFTC responded to significant industry comments in allowing the SEC’s dealer-trader distinction to be applied in identifying swap dealers, at least in an informative manner. Finally, regarding one external indicator as to non-banking entities that the CFTC might view as falling within the SD definition, Chairman Gensler’s opening statement indicated that the list of primary dealers on the International Swaps and Derivatives Association’s website would be instructive.

Exclusion of Swaps that Hedge Physical Positions and of Swaps Between Affiliates

As a nod to end users, the CFTC has added, as an interim final rule inviting further comment, an exclusion from the SD definition for swaps hedging physical positions. Accordingly, the SD determination will exclude swaps that a person enters into for the purpose of offsetting or mitigating the person’s price risks if:

• the price risks arise from the potential change in the value of assets that the person owns, produces, manufactures, processes, or merchandises, liabilities that the person owns or anticipates incurring, or services that the person provides or purchases;
• the swap represents a substitute for transactions or positions in a physical marketing channel;
• the swap is economically appropriate to the reduction of the person’s risks in the conduct and management of a commercial enterprise; and
• the swap is entered into in accordance with sound commercial practices and is not structured to evade designation as a swap dealer.

Although the exclusion extends to portfolio hedging and anticipatory hedging, it received pointed criticism by Commissioner O’Malia (the lone dissenter) who saw the set of criteria as yet another definition of hedging (added to the four definitions already required or proposed by the CFTC under different parts of the Dodd-Frank Act) and found no good reason not to extend the exclusion to hedged financial positions (e.g. interest rate swaps).

In addition, swaps between majority-owned affiliates are also excluded from the determination of whether a person is a swap dealer.

De Minimis Exemption Thresholds Raised Substantially

The de minimis exemption thresholds under the final rule have been increased substantially from the levels in the proposed rule. During a 3 to 5-year phase in period, the threshold will be set at $8 billion in aggregate gross notional amount of swaps entered into over the prior 12 month period in connection with dealing activities. After the phase-in, the threshold will drop to $3 billion unless the CFTC makes further rulemaking changes. These levels are well above the $100 million threshold originally proposed, even more so for those entities that will gain relief from the new physical hedging exclusion. In addition, the CFTC appears to have dropped its additional de minimis requirements limiting the number of an entity’s swaps (20) and swap counterparties (15) over the prior 12 months.

With respect to “special entities” (defined to include certain governmental entities, employee benefit plans, and endowments), the threshold remains at the originally proposed level of $25 million, with no phase-in level.

Impact of the SD Definition Rule

The effective date of the entity definitions rule will likely be 60 days after the definition of “swap,” which Chairman Gensler indicated may be forthcoming in a matter of weeks and is currently the Commission’s top priority. According to the Chairman, the Adopting Release estimates that the entity definitions rule will capture 125 entities as SDs and 6 as MSPs. Such entities will be subject to significant compliance requirements including registration, margin, capital, business conduct standards, and increased reporting and recordkeeping requirements.

A recent no-action letter provides some clarification on the application of the new exemption from registration under the Investment Advisers Act of 1940 for “family offices.”

Background

Historically, Section 203(b)(3) of the Investment Advisers Act of 1940 allowed persons who would otherwise be required to register as investment advisers to avoid registration if they had fewer than fifteen clients.  This exemption not only allowed many hedge funds and other private funds to avoid regulation, but it also allowed so-called “family offices” to escape registration.  Broadly speaking, a family office is an entity established by a wealthy family to manage the family’s wealth and provide other related services, such as estate planning, tax services, and investment advisement.

The Dodd-Frank Act repealed Section 203(b)(3) of the Advisers Act in order to subject hedge funds and other private funds to regulation, but it also provided a new exemption for “family offices” in Section 202(a)(11)(G) of the Advisers Act and directed the SEC to adopt a rule defining the term “family office.”

The SEC responded by enacting new Rule 202(a)(11)(G)-1, which defines “family office”  as a company (including its directors, managers, partners, etc.) that: 1) has no clients other than family clients; 2) is wholly owned by family clients and exclusively controlled by family members or family entities; and 3) does not hold itself out to the public as an investment adviser.

The Adamson No-Action Letter

In a January 16, 2012 no-action letter request, Peter Adamson III proposed to provide investment advisory services to up to ten families in family office settings.  Adamson was about to retire from a forty-year career in the securities industry, giving up his post at $1 billion plus investment advisory firm that he had founded in 1997.  Each of the principals of the family offices had been a client of Adamson’s for at least ten years, Adamson would no longer be associated with any registered investment adviser or broker-dealer, and he would provide services only to the family clients of the family offices.  

Adamson sought assurance that he could provide advisory services to each of the ten family offices without running afoul of Rule 202(a)(11)(G)-1, which would be satisfied with respect to each of the ten offices, individually.  Adamson, through his attorney, pointed out that “nothing we have seen in the Rule, the commentary in the release adopting the Rule, or in the exemption orders issued prior to the Rule’s adoption suggest that an adviser in a family office must act exclusively for only one family office.”

The SEC denied Adamson’s request on the grounds that he had failed to demonstrate or explain how the proposed arrangement does not create a multi-family office.  The SEC pointed out that in Investment Advisers Act Release No. 3220 (June 22, 2011), the Commission had emphasized that the family office exemption does not extend to family offices serving multiple families: “In particular, footnote 114 states that if several unrelated families established separate family offices staffed with the same or substantially the same employees, such employees would be managing a de facto multifamily office, such that the family offices could not rely on the exclusion.”

The SEC press release relating to new Rule 202(a)(11)(G)-1 contains answers to some frequently asked questions about the definition of “family office,” and is a good place to start if you are tasked with determining whether a client meets the family office exemption.

Remember to check Dodd-Frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

In GAO’s audit of  the SEC’s fiscal years 2011 and 2010 financial statements, GAO identified four significant deficiencies in internal control as of September 30, 2011. These significant internal control deficiencies represent continuing deficiencies concerning controls over:

  • information systems,
  • financial reporting and accounting processes,
  • budgetary resources, and
  • registrant deposits and filing fees.

GAO believes these significant control deficiencies may adversely affect the accuracy and completeness of information used and reported by SEC’s management. The GAO made a total of 10 new recommendations to address these continuing significant internal control deficiencies.

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