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

On March 6, 2012, SEC Chairman Mary Schapiro gave testimony before the Subcommittee on Financial Services and General Government Committee on Appropriations United States House of Representatives.   According to this Bloomberg article, Chairman Schapiro also stated the final conflicts mineral rule will not be ready until the middle of the year. 

In her written testimony, Chairman Schapiro also stated “As the Commission implements the rules required under the Dodd-Frank Act, there will be a need for additional staff to respond to the demand from companies, investors, and their advisors for interpretive advice about the new rules. In FY 2013, for example, we expect a heightened number of interpretive inquiries from public companies on new rules relating to listing standards for executive compensation, disqualification of felons and other bad actors from certain exempt offerings, and specialized disclosure rules with respect to conflict minerals and payments to foreign or U.S. governments by resource extraction issuers.”

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The CFTC has adopted final rules regarding business conduct standards for swap dealers.  The rules are expected to have far reaching impacts on the way corporate counterparties enter into typical derivative transactions.

Know Your Counterparty.  Swap dealers must implement policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each counterparty whose identity is known to the swap dealer prior to the execution of the transaction that are necessary for conducting business with such counterparty. For purposes of this section, the essential facts concerning a counterparty are:

  • Facts required to comply with applicable laws, regulations and rules;
  • Facts required to implement the swap dealer’s credit and operational risk management policies in connection with transactions entered into with such counterparty; and
  • Information regarding the authority of any person acting for such counterparty.

Disclosure of Material Information.  Prior to entering into a swap, a swap must disclose to any counterparty to the swap material information concerning the swap in a manner reasonably designed to allow the counterparty to assess:

  • The material risks of the particular swap, which may include market, credit, liquidity, foreign currency, legal, operational, and any other applicable risks;
  • The material characteristics of the particular swap, which must include the material economic terms of the swap, the terms relating to the operation of the swap, and the rights and obligations of the parties during the term of the swap; and
  • The material incentives and conflicts of interest that the swap dealer may have in connection with a particular swap.

Fair Dealing in Communications.  In any communication between a swap dealer and any counterparty, the swap dealer must communicate in a fair and balanced manner based on principles of fair dealing and good faith.

Antifraud Rules.  The Commodity Exchange Act, or CEA,  grants the CFTC discretionary authority to promulgate rules applicable to swap dealers related to fraud, manipulation and abusive practices. The statutory provision prohibits fraudulent, deceptive and manipulative practices by swap dealers.  Rule § 23.410(a) follows the statutory text.  The rules as adopted includes an affirmative defense for violations of the business conduct rules if the swap dealer can establish it did not act intentionally or recklessly in connection with the violation and complied in good faith with policies and procedures designed to meet the business conduct rules.

Private Right of Action.  Commenters on the proposed rule noted that the proposed rules may indirectly subject swap dealers to private rights of action because of the statutory language in Section 4s(h) of the CEA.  Section 22 of the CEA provides a private right of action for any violation of the CEA, and Section 4s(h)(l) states that ‘‘[e]ach registered swap dealer and major swap participant shall conform with such business conduct standards * * * as may be prescribed by the Commission by rule or regulation.”  The CFTC noted in the adopting release that the CFTC cannot exempt swap dealers from private rights of action under Section 22 of the CEA.

Reliance on Representations.  A swap dealer can rely on the written representations of a counterparty to satisfy its due diligence requirements under the business conduct standards, unless it has information that would cause a reasonable person to question the accuracy of the representation. If agreed to by the counterparties, the representations may be included in counterparty relationship documentation and may satisfy the relevant requirements for subsequent swaps offered to or entered into with a counterparty.  However, the  counterparty must undertakes to timely update any material changes to the representations.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has issued a Small Entity Compliance Guide on the new “accredited investor” standard.   Section 413(a) of the Dodd-Frank Act requires that the value of a person’s primary residence be excluded when determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million.  The guide gives examples of the required net worth calculations and provides other useful information about the application of the net worth standard.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB, has begun accepting consumer complaints about bank accounts, including checking accounts, savings accounts, CDs, and related services.

The CFPB expects banks to respond to complaints within 15 days and seeks to close all complaints within 60 days. Consumers are given a tracking number after submitting a complaint. They are then able to log in to the CFPB website at any time and check the status of their case. Each complaint will be processed individually and consumers will have the option to dispute a bank’s resolution.

The CFPB anticipates receiving complaints in five categories:

  • Account opening, closing, and management;
  • Deposits and withdrawals;
  • Using a debit or ATM card;
  • Making or receiving payments and sending money to others; and
  • Problems related to low account funds.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Walt Disney Company has filed additional soliciting material here and here in response to negative ISS recommendations.  ISS has recommended against voting for the members of Disney’s Governance and Nominating Committee as a result of appointing its Chief Executive Officer as Chairman of the Board as part of a reasoned CEO succession strategy.  ISS has also recommended against Disney’s position on say-on-pay.

According to Disney it “fundamentally disagrees with certain of ISS’s recommendations, which are based on both flawed premises and methodology. The Company’s Board of Directors adheres to a rigorous performance test for compensation, and the Company’s tremendous performance under Bob Iger is evident. Disney had record financial performance in Fiscal Year 2011 and its total shareholder return is more than four times greater than that of the S&P 500 during Mr. Iger’s more than six years of leadership. After careful and considered deliberation, the Board took action to secure Mr. Iger’s leadership through his expected retirement in 2016 to provide for an effective, seamless succession and management transition and continuity of the Company’s proven strategy. In addition, the board will appoint an independent lead director with duties and responsibilities that, ironically, exceed in scope those recommended by ISS.”

Last year, ISS apparently had two issues with Disney’s proxy statement.  ISS objected to tax gross-ups in executive employment agreements.  ISS also recommended voting for a shareholder proposal regarding performance tests for restricted stock unit awards.

Disney ultimately eliminated the tax gross-ups from the executive employment contracts prior to the meeting.  Perhaps after engaging with a few key shareholders, it determined that absent such action its rational set forth in response to ISS’s recommendation was not going to carry the day.  The key here however was there was something Disney could do, given the cooperation of its executives.  By taking that action, it avoided the embarrassment of a failed vote and having to spend board resources to deal with the issue in the upcoming year.  Perhaps Disney also reasoned that by removing that institutional irritant it was more likely institutions would not be persuaded by what appeared to be ISS’s weak recommendation with respect to the shareholder proposal on restricted stock units.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

 

 

Under the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”), the Federal Credit Reporting Act was amended to require that certain federal agencies, including the  FTC and FDIC, jointly issue rules and guidelines related to identity theft, which have colloquially been termed the “red flag rules.”  The FACT Act also required the agencies to issue joint rules and guidelines relating to issuers of credit and debt cards.  Final card issuer rules and red flags rules were issued by the agencies in 2007 – you can find more information on those rules here, at the FTC’s red flags website.

The Dodd-Frank Act amended the FACT  Act to add the SEC and the CFTC to the list of agencies that are required to issue joint red flags rules and card issuer rules, proposed forms of which were announced today by the SEC.  The notice of proposed rules explains that the practical effect of the Dodd-Frank Act’s amendment of the FACT Act is to shift the rulemaking authority for the red flags rules and card issuer rules from other agencies to the SEC and CFTC.

Although the proposed rules are coming from the SEC and CFTC, they are “substantially similar” to the rules adopted by the other agencies in 2007.  The notice of proposed rules assures businesses that “the proposed rules and guidelines, if adopted, would not contain new requirements not already in the [existing red flags and card issuer rules], nor would they expand the scope of those rules to include new entities that were not already previously [sic] covered.”

Check back frequently here at dodd-frank.com for continuing coverage of the implementation of the Dodd-Frank Act and analysis of its impacts.

SEC Commissioner Daniel M. Gallagher gave his views on the liability of an investment adviser’s legal and compliance personnel at remarks for PLI’s “The SEC Speaks in 2012” seminar.  The remarks address “failure to supervise” liability for compliance and legal personnel.  The Exchange Act vests the SEC with the authority to impose sanctions on a person associated with a broker-dealer if that person “has failed reasonably to supervise, with a view to preventing violations of the provisions of [the securities] statutes, rules, and regulations, another person who commits such a violation, if such other person is subject to his supervision.” The nearly identical language in the Investment Advisers Act grants the SEC the same authority with respect to associated persons of investment advisers.  A key question, therefore, is at what point can legal and compliance personnel be reasonably deemed “supervisors” as they carry out their responsibility to prevent and, if necessary, address violations of laws or regulations by firm employees and to provide advice and guidance to management?

Perhaps the clearest guidance on this question was set forth in the Gutfreund Section 21(A) report issued by the SEC in 1992 in connection with an administrative proceeding involving the general counsel of a broker-dealer. In that report, the SEC noted that legal and compliance personnel “do not become ‘supervisors’ for purposes of [the Exchange Act] . . . solely because they occupy those positions.” The SEC explained, however, that an in-house lawyer can be deemed a supervisor when other members of senior management “involve him as part of management’s collective response to the problem.” The SEC further noted that, “determining if a particular person is a ‘supervisor’ depends on whether, under the facts and circumstances of a particular case, that person has a requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.”

According to Commissioner Gallagher, the question of what makes a legal or compliance officer a supervisor, however, remains disturbingly murky.  Unfortunately, robust engagement on the part of legal and compliance personnel raises the specter that such personnel could be deemed to be “supervisors” subject to liability for violations of law by the employees they are held to be supervising. This creates a dangerous dilemma, according to Commissioner Gallagher. A compliance officer or in-house attorney who stays ensconced in a dark corner of the firm drafting policies and sending out memoranda, but never interacting with the individuals governed by those policies or the recipients of those memos, risks diminished effectiveness or even irrelevance; but such a person would reduce his or her potential liability as a supervisor. On the other hand, the more engaged a firm’s legal counsel or compliance personnel become — the more they bring their expertise to bear in addressing important, real-world compliance issues and in providing real-time advice for concrete problems the firms and their employees face — the more likely they are to be deemed to be playing a supervisory role. Thus, the SEC’s position on supervisory liability for legal and compliance personnel may have had the perverse effect of increasing the risk of supervisory liability in direct proportion to the intensity of their engagement in legal and compliance activities.

Commissioner Gallagher said “Any understanding of the issue must begin with the fact that broker-dealer or investment adviser compliance and legal personnel are, by default, not supervisors but rather providers of support for the firm’s other employees.”  Almost every facet of broker-dealer and investment adviser “business” issues are also regulatory issues, and accordingly the SEC and the SROs should want legal and compliance in the discussion about most issues.  Commissioner Gallagher also stated “Deterring such engagement is contrary to the regulatory objectives of the Commission, and I am concerned that continuing uncertainty as to the contours of supervisory liability for legal and compliance personnel will have a chilling effect on the willingness of such personnel to provide the level of engagement that firms need – and that the Commission wants. In resolving this uncertainty, we should strive to avoid attacking or penalizing the willingness of compliance and legal personnel to be fully involved in firms’ responses to problematic actors or acts. To put it simply, if a firm employee in a traditionally non-supervisory role has expertise relevant to a compliance matter, that employee shouldn’t fear that sharing that expertise could result in Commission action for failure to supervise.”

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The CFTC approved four final rules (the “Internal Business Conduct Rules”) affecting duties of swap dealers (“SDs”) and major swap participants (“MSPs”) today, with Chairman Gensler and Commissioners Chilton and Wetjen voting in support of the rules over pointed dissents of Commissioners O’Malia and Sommers. The text of the rules has not been released yet, but the following summary draws from fact sheets released by the Commission with the rulemaking.

(1) Reporting, Recordkeeping, and Daily Trading Records Requirements for SDs and MSPs.

Under this final rule, SDs and MSPs must keep records including full and complete transaction and position information for all swap activities, including all documents on which trade information is originally recorded. Transaction records must be maintained in a manner that is identifiable and searchable by transaction and by counterparty. The final rule also requires that SDs and MSPs keep basic business records, including, among other things, minutes from meetings of the entity’s governing body, organizational charts, and audit documentation. Additionally, certain financial records, records of complaints against personnel, and marketing materials must be kept. Finally, swap dealers and major swap participants must maintain records of information required to be submitted to a swap data repository and reported on a real-time public basis.

The final rule prescribes daily trading record requirements. Pre-execution trade data must be kept, including records of all oral and written communications that lead to the execution of a swap. SDs and MSPs must preserve all information necessary to conduct a comprehensive and accurate trade reconstruction for each swap. Execution trade data must be kept, including all terms of each executed swap and date and time of execution. Post-execution data must be kept, including records of all confirmations, reconciliations, and margining of swaps. Finally, records must also be kept for all cash or forward transactions used to hedge, mitigate the risk of, or offset any swap held by the SD or MSP.

(2) Risk Management Duties for SDs and MSPs

Under the final rule implementing new section 4s(j) of the Commodity Exchange Act, SDs and MSPs must establish a risk management program consisting of written policies and procedures designed to monitor and manage the risks associated with their swap activities. Such program must take into account the following risks and any other relevant risk: market, credit, liquidity, foreign currency, legal, operational, and settlement risks. SDs and MSPs must establish polices for monitoring their traders throughout each trading day for compliance with trading limits established by the firm and require traders to follow established procedures for executing and confirming transactions. SDs and MSPs are required to provide diligent supervision of traders and to separate traders from their risk management units.

SDs and MSPs must establish procedures to monitor for and prevent violations of applicable position limits established by the CFTC or regulated exchanges and to:

1) provide annual training for personnel;
2) diligently monitor and supervise trading;
3) implement an early warning system;
4) test their position limit procedures;
5) document compliance with position limits on a quarterly basis; and
6) audit the procedures annually.

In addition, they must establish a business continuity and disaster recovery plan designed to enable them to resume operations on the business day following an emergency and adopt policies and procedures to prohibit antitrust-type violations.

(3) Conflicts of Interest for SDS, MSPs, Futures Commission Merchants (“FCMs”) and Introducing Brokers (“IBs”)

This rule places restrictions on influencing research analysts employed by SDs, MSPs, FCMs, and IBs, calling for separation of such analysts from a registrant’s trading functions, disclosing their financial interests, and prohibiting retaliation against them for reports adversely impacting the registrant’s business activities.

(4) Designation of Chief Compliance Officer (“CCO”) and Preparation of Annual Compliance Report by SDs and MSPs

Under the Dodd-Frank Act, SDs and MSPs must designate a CCO. The related final rule just approved identifies the following duties of a CCO:

• establish compliance policies;
• resolve conflicts of interest;
• take reasonable steps to ensure compliance of the registrant with the compliance policies, CEA requirements, and Commission regulations;
• identify noncompliance issues; and
• establish procedures for the remediation of such noncompliance issues.

The rule requires each CCO to prepare an annual report that would contain, among other things:

• a description of the registrant’s compliance with the CEA, Commission regulations, and the registrant’s own compliance policies;
• an assessment of the effectiveness of the registrant’s policies;
• a discussion of areas for improvement;
• a description of the resources set aside for compliance; and
• a description of any non-compliance issues identified and addressed.

Dissenting Commissioners

Commissioners O’Malia and Sommers provided statements severely criticizing the final rules. Commissioner O’Malia was particularly harsh regarding what he sees as a glaring failure by the Commission to provide an adequate cost-benefit analysis of the rules as required under the Commodity Exchange Act and by Executive Order, stating:

After reviewing the Internal Business Conduct Rules, I have reached a tipping point and can no longer tolerate the application of such weak standards to analyzing the costs and benefits of our rulemakings. Our inability to develop a quantitative analysis, or to develop a reasonable comparative analysis of legitimate options, hurts the credibility of this Commission and undermines the quality of our rules. I believe it is time for professional help, and I will be following up this statement with a letter to the Director of the OMB seeking an independent review of the Internal Business Conduct Rules to determine whether or not this rulemaking fully complies with the President’s Executive Orders. . . .

Commissioner Sommers lamented the duplicative nature of many requirements and concluded:

We consistently reject reasoned comments from industry professionals with little justification in our cost benefit analysis to support those rejections. . . . I do not believe that these rules have a chance of withstanding the test of time, and instead believe that this Commission will be consumed over the next few years using our valuable resources to rewrite rules that we knew or should have known would not work when we issued them.

The Consumer Financial Protection Bureau, or CFPB, has launched an inquiry into checking account overdraft programs to determine how these practices are impacting consumers. As part of that inquiry, the CFPB is seeking public input on a prototype “penalty fee box” – a disclosure on a consumer’s checking account statement that would highlight the amount overdrawn and total overdraft fees charged.

The inquiry is focused on four main areas:

  • Transaction re-ordering that increases consumer costs
  • Missing or confusing information
  • Misleading marketing materials
  • Disproportionate impact on low-income and young consumers

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB, has announced a proposed rule to include debt collectors and consumer reporting agencies under its nonbank supervision program. According to the CFPB, this would mark the first time these important and far-reaching consumer financial market participants are subject to federal supervision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the CFPB, authorizes the CFPB to supervise nonbanks in the specific markets of residential mortgage, payday lending, and private education lending. In addition, for other nonbank markets for consumer financial products or services, the CFPB has the authority to supervise “larger participants.” As directed by Dodd-Frank, the Bureau must define such “larger participants” by rule, and an initial such rule must be issued by July 21, 2012. Last summer, the CFPB sought public comment about possible markets to include in the initial rule and available data sources the Bureau could use to define larger participants in nonbank markets.

Under the proposed rule, debt collectors with more than $10 million in annual receipts from debt collection activities would be subject to supervision. Based on available data, the CFPB estimates that the proposed rule would cover approximately 175 debt collection firms — or 4 percent of debt collection firms — and that these firms account for 63 percent of annual receipts from the debt collection market.

Under the proposed rule, consumer reporting agencies with more than $7 million in annual receipts from consumer reporting activities would be subject to supervision. This would include approximately 7 percent of consumer reporting agencies based on available data. The proposed threshold would allow the CFPB to cover about 30 consumer reporting agencies. The CFPB estimates that these 30 companies account for about 94 percent of the annual receipts from consumer reporting.

This is the CFPB’s first in a series of rulemakings to define larger participants. The CFPB chose annual receipts as the criterion for both debt collection and consumer reporting because it approximates market participation in these two markets. As the CFPB adds new markets, it will choose the best criteria and the appropriate thresholds for each market.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.