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

The Consumer Financial Protection Bureau, or CFPB, today announced that it is seeking information from students, schools, industry, and other stakeholders on the private student loan market.  The CFPB is interested in a complete picture of private student lending, so it is seeking a broad swath of information, including:

  • Information available to shop for private student loans
  • The role of schools in the marketplace
  • Underwriting criteria
  • Repayment terms and behavior
  • Impact on choice of field of study and career choice
  • Servicing and loan modification
  • Financial education and default avoidance

The CFPB will use the collected input to assist with preparation of a report to Congress on private student lending. The Dodd-Frank Act requires the CFPB and the Department of Education to produce this report by July 21, 2012. The CFPB will also use the information it gathers to prioritize its own regulatory and education work.

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

Section 924(d) of the Dodd-Frank Act requires the SEC’s Office of the Whistleblower to report annually to Congress on its activities, whistleblower complaints, and the response of the SEC to such complaints.  In addition, Exchange Act § 21F(g)(5) requires the SEC to submit an annual report to Congress that addresses certain specific topics. The first such report has been prepared and issued by the SEC’s Office of the Whistleblower.

Because the SEC final rules became effective August 12, 2011, only 7 weeks of whistleblower tip data is available for fiscal year 2011.  According to the report, 334 whistleblower tips were received from August 12, 2011 through September 30, 2011. The most common complaint categories were:

  • market manipulation (16.2%),
  • corporate disclosures and financial statements (15.3%), and
  • offering fraud (15.6%).

The SEC received whistleblower submissions from individuals in 37 states, as well as from several foreign countries, including China (10) and the United Kingdom (9).  Domestically, the most complaints were received from California (34), New York (24), Florida (19) and Texas (18).  One whistleblower complaint originated in our home state of Minnesota.

The report notes that as a result of the relatively recent launch of the program and the small sample size, it is too early to identify any specific trends or conclusions from the data collected to date.

Given the time period covered by the report and the recent initiation of the whistleblower program, the report notes that no applications for awards had yet been processed. Accordingly, the SEC did not pay any whistleblower awards during fiscal year 2011.

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

The CFTC has confirmed that its Division of Enforcement is investigating MF Global, Inc. for possible violations of the Commodity Exchange Act, or CEA and/or CFTC regulations.  Scott D. O’Malia, a CFTC Commissioner, stated certain Dodd-Frank rules should be reexamined in light of the MF Global bankruptcy.

Mr. O’Malia believes the CFTC must reconsider the proposal that would limit investments of segregated customer funds.   According to Mr. O’Malia, it is premature to conclude that this proposal is the solution to the MF Global problem. At this time, the CFTC has not identified the cause of the segregation shortfall, and any action that the CFTC takes cannot be the solution until it has greater clarification on what caused the problem.

In the statement, Mr. O’Malia also noted another proposal that the CFTC should re-examine is the segregation of swaps customer funds. That proposal purports to offer greater protection to swaps customers, by permitting such customers to move their positions and collateral notwithstanding a shortfall. In order for the proposal to actually deliver such protection, the proposal relies on the CFTC actively intervening in insolvency proceedings to facilitate transfer of customer positions and collateral in the face of a shortfall, even if such action brings the CFTC into conflict with the trustee. The CFTC has not actively intervened in such a manner in MF Global, and so it is questionable whether the CFTC would so intervene in the future.

Finally, Mr. O’Malia noted MF Global was a clearing member at multiple clearing organizations and one of the main proponents of lower capital requirements for swaps clearing. In light of MF Global’s demise, Mr. O’Malia believes the CFTC should revisit the open access discussion, to ensure that clearing organizations are able to diversify their membership without introducing risk.

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

The SEC has recently adopted final Form PF, which requires reporting of certain information by advisers to hedge funds and private equity groups, as required by the Dodd-Frank Act.

The SEC believes Form PF, as adopted, addresses the concerns of many commenters so that the final Form will significantly reduce the burden of reporting and clarify how commenters are expected to respond. In particular:

  • The certification language was removed.  This would have required an authorized individual to affirm “under penalty of perjury” that the statements made in Form PF are “true and correct.” However, a number of commenters expressed concern that such a standard would be inappropriate for Form PF because the Form requires advisers to provide estimates and exercise significant judgment in preparing responses.
  • The ability of advisers to rely on their internal methodologies when reporting on Form PF was increased.  This change is intended, together with the removal of the certification, to clarify that Form PF does not require the time or expense involved in, for instance, an audit of the information included on Form PF

Form PF is comprised for four sections.

Section 1

Each adviser required to file Form PF must complete all or part of Section 1. This Section of the Form is divided into three parts: Section 1a requires information regarding the adviser’s identity and assets under management, Section 1b requires limited information regarding the size, leverage and performance of all private funds subject to the reporting requirements, and Section 1c requires additional basic information regarding hedge funds.

Section 2

A private fund adviser must complete Section 2 of Form PF if it had at least $1.5 billion in hedge fund assets under management as of the end of any month in the prior fiscal quarter. This Section of the Form requires additional information regarding the hedge funds these advisers manage, which the SEC believes it has tailored to focus on relevant areas of financial activity that have the potential to raise systemic concerns.  For example:

  • Section 2a requires certain aggregate information about the hedge funds the adviser manages. For example, one question requires the adviser to report the value of assets invested (on a short and long basis) in different types of securities and commodities (e.g., different types of equities, fixed income securities, derivatives, and structured products).
  • Another question requires the adviser to report the value of turnover in certain assets classes (including listed equities, corporate bonds, sovereign bonds and futures) in the hedge funds’ portfolios during the reporting period. This is intended to provide an indication of the adviser’s frequency of trading in those markets and the amount of liquidity hedge funds contribute to those markets.
  • Section 2b also requires for each qualifying hedge fund data regarding certain hedge fund risk metrics. For instance, Question 40 requires the adviser to report value at risk (“VaR”) for each month of the reporting period if, during the reporting period, the adviser regularly calculated a VaR metric for the qualifying hedge fund.

Certain data in Form PF, while filed with the CFTC and SEC on an annual or quarterly basis, must be reported on a monthly basis to provide sufficiently granular data to allow FSOC to better identify trends and to mitigate “window dressing.”  Nearly all of these requirements appear in Section 2 of the Form, which only large hedge fund advisers complete. The SEC believes that rapidly changing markets and portfolios merit collecting certain information more often than on a quarterly basis, and it was not persuaded that the large hedge fund and large liquidity fund advisers required to respond to these questions will be overwhelmed by this reporting. Also, as noted, the SEC made several changes that increase the ability of advisers to rely on their own internal methodologies in responding to the Form, which is expected to ease the burden of reporting monthly information by clarifying that advisers need not incur substantial additional burdens in verifying the data.

Section 3

A private fund adviser must complete Section 3 of Form PF if it manages one or more liquidity funds and had at least $1 billion in combined liquidity fund and registered money market fund assets under management as of the end of any month in the prior fiscal quarter.

Section 4

A private fund adviser must complete Section 4 of Form PF if it had at least $2 billion in private equity fund assets under management as of the end of its most recently completed fiscal year.

The SEC acknowledges that several potentially mitigating factors suggest that private equity funds may have less potential to pose systemic risk than some other types of private funds, and this has been taken into account in requiring substantially less information with respect to private equity funds than with respect to hedge funds or liquidity funds. According to the SEC the design of Form PF, however, is not intended to reflect a determination as to where systemic risk exists but rather to provide empirical data to FSOC with which it may make a determination about the extent to which the activities of private equity funds or their advisers pose such risk.  Based on SEC staff’s consultation with staff representing FSOC’s members, the SEC continues to believe that targeted information regarding private equity leverage practices may be important to FSOC’s monitoring of systemic risk.

The SEC, however, adopted Form PF with several significant changes that reduce the frequency of reporting with respect to private equity funds, and more closely align the required reporting with information available on portfolio company financial statements.

Section 4 requires that large private equity advisers report certain information for each private equity fund they manage, including certain information about guarantees of portfolio company obligations and the leverage of the portfolio companies that the fund controls.  Most of the reporting in Section 4 relates to portfolio companies because the SEC understands that leverage in private equity structures is generally incurred at the portfolio company level. This reporting is limited to controlled portfolio companies, rather than portfolio companies generally, to ensure that advisers are able to obtain the relevant information without incurring potentially substantial additional burdens.

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

The SEC has announced that the former chief executive officer and chairman of CSK Auto Corporation, Maynard Jenkins, has agreed to return $2.8 million in bonus compensation and stock profits that he received while the company was committing accounting fraud.  Mr. Jenkins was not personally charged by the SEC with any misconduct.  The litigation marked the agency’s first SOX clawback case against an individual who was not alleged to have otherwise violated the securities laws.

The SEC originally asked a court to order Mr. Jenkins to reimburse the company and its shareholders more than $4 million that he received in bonuses and stock sale profits while CSK was committing accounting fraud.

The SEC was initially successful in prevailing over Mr. Jenken’s motion to dismiss the case.  As noted on the Federal Securities Law Blog, on March 24, 2011, the parties advised the court that “Mr. Jenkins and the Staff of the Securities and Exchange Commission have reached a tentative settlement agreement to resolve this matter,” noting that “such tentative settlement agreement is subject to approval by the Securities and Exchange Commissioners.” According to the Washington Post article, “the proposed settlement was for less than half the amount the SEC originally sought,” citing a source familiar with the matter.

The Commissioners rejected the proposal. According to a second source “close to the matter,” the combination of two contrasting views resulted in the lack of support for the settlement. In the view of some Commissioners, the amount of the settlement was too low. However, a second view was that the case should not have been brought at all.

But in the end, Mr. Jenkins settled for substantially less than the SEC originally alleged.

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

According to the ISS blog, the first proxy access proposal was filed with MEMC Electronics.  The proxy access proposal was reportedly based on a model proposal developed by the United States Proxy Exchange.  The model proposal is a canned document designed to be used by small investors to submit shareholder proposals, which if successful, would allow other small investors to subsequently propose director nominees to be included in the company’s proxy statement.

MEMC’s last proxy statement stated shareholder proposals must be received by November 12, 2012.  If the proposal was filed November 11, 2012, as reported, then the proposal appears timely, but just barely.

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

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires or authorizes various federal financial regulators to issue hundreds of rules to implement reforms intended to strengthen the financial services industry. GAO is required to annually study financial services regulations. GAO has issued a report that examines:

  • the regulatory analyses, including cost-benefit analyses, financial regulators have performed to assess the impact of selected final rules issued pursuant to the Dodd-Frank Act;
  • how financial regulators consulted with each other in implementing the selected final rules to avoid duplication or conflicts; and
  • what is known about the impact of the final rules.

GAO examined the 32 final Dodd-Frank Act rules in effect as of July 21, 2011; the regulatory analyses conducted for 10 of the 32 rules that allowed for some level of agency discretion; statutes and executive orders requiring agencies to perform regulatory analysis; and studies on the impact of the Dodd-Frank Act. GAO also interviewed regulators, academics, and industry representatives.

The GAO report found that regulators had coordinated on some of the rules that were effective as of July 2011. It noted such coordination is a positive stepping stone for future coordination. However, GAO also found that most of the coordination, to date, had been informal and ad hoc. GAO also found that most of the federal financial regulators included in its review, including the CFPB, did not have formal policies to guide interagency coordination. According to GAO, while informal and ad hoc coordination can produce the desired results, such coordination can break down when disagreements arise or other work becomes pressing. Formal policies can institutionalize informal coordination practices and provide a framework for coordinating, helping to ensure that regulators are appropriately consulted and that their views, including conflicting viewpoints, are addressed in a consistent and transparent fashion. Given its membership and charge to help facilitate coordination among its member agencies, GAO believes FSOC is positioned to work with the federal financial regulatory agencies to establish compatible policies that would guide and facilitate interagency coordination among its members throughout the course of Dodd-Frank Act rulemakings.

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

On July 11, 2011, President Obama issued Executive Order 13579, “Regulation and Independent Regulatory Agencies.”  The FDIC, in response,  has noted it has a long-standing policy and practice of reviewing its proposed and existing regulations to evaluate their impact.

As part of its implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the FDIC is also engaged in an ongoing review of its rules affected by the Dodd-Frank Act. The FDIC has stated it is updating, streamlining, or rescinding some of its rules to comply with and conform to the Dodd-Frank Act. The FDIC stated it is also working to establish clear rules that will ensure a stable financial system and impose minimum regulatory burden. In all Dodd-Frank Act rulemakings, the FDIC maintains it has been coordinating its efforts closely with the other financial regulators to ensure consistency and avoid duplication of efforts.

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

The SEC announced that three former directors of DHB have agreed to more than $1.6 million in monetary sanctions to settle charges that they were involved in an accounting fraud.  The SEC stated “These directors failed to comply with their responsibilities by ignoring the repeated red flags of the massive accounting fraud that senior management orchestrated . . While we won’t second guess the good-faith efforts of most company directors, we will hold accountable those who completely abdicate the duties they owe to the companies and shareholders they represent.”  When the case was filed, the SEC noted “This massive accounting fraud permeated throughout an entire company and was facilitated by the egregious, wholesale failure of the company’s board to act in the face of mounting red flags. As the fraud swirled around them, the directors, Messrs. Krantz, Chasin, and Nadelman, ignored the obvious and submitted to the directives and decisions of DHB’s senior management while themselves profiting from sales of the company’s securities.”

In the initial complaint, the SEC noted Krantz, Nadelman, and Chasin lacked impartiality to serve as independent Board or Audit Committee members. They were the CEO’s, David Brooks, longtime friends and neighbors, with personal relationships with Brooks that spanned decades.  In addition to a close personal relationship, Krantz, Nadelman, and Chasin, the SEC alleged each had business relationships with Brooks that influenced their impartiality and independence.  Brooks demanded unquestioned loyalty from anyone associated with DHB and exercised absolute control over every aspect of the company, including the Board of Directors.

The SEC’s complaint alleges numerous red flags that the directors ignored.  For instance, on August 20,2003, Grant Thornton resigned and issued a material weakness letter to the Audit Committee concerning DHB’s internal control over financial reporting. The material weakness letter highlighted DHB’s failure to disclose a related entity that the Brooks family controlled, understaffing in the company’s accounting department, and the lack of a comprehensive or formal inventory management system. Grant Thornton resigned the day it issued the material weakness letter. Despite the auditors’ subsequent material weakness letter and resignation, the Audit Committee subsequently failed to examine or monitor transactions with the related entity or to independently investigate the nature of the business arrangement.

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

The United States Proxy Exchange has provided a “model” shareholder proposal for proxy access.  The USPE is a non-profit group that bills itself as “dedicated to facilitating shareowner rights and confronting Wall Street abuse.”  The model proposal is a canned document designed to be used by small investors to submit shareholder proposals, which if successful, would allow other small investors to subsequently propose director nominees to be included in the company’s proxy statement.

The model form would permit “[a]ny party of shareowners of whom one hundred or more satisfy SEC Rule 14a-8(b) eligibility requirements” to submit a director nominee for inclusion in the company’s proxy statement.  Rule 14a-8 generally permits shareholders who have held, continuously for one year, $2,000 of a company’s stock to submit proposals to be included in a company’s proxy statement.

The model form of course raises governance concerns about why it would be appropriate for shareholders with such a small stake to have rights to include director nominees in a proxy statement.  On top of that, there remain significant questions about how such group of shareholders could exercise their right to nominate without violating securities laws.  When the SEC adopted the now invalidated Rule 14a-11, it noted that when nominating shareholders band together, any related communications would be deemed solicitations under the proxy rules (See Release No.33-9136, page 205).  The SEC, in conjunction with Rule 14a-11, adopted exemptions from the proxy solicitation rules to permit shareholders to band together without violating the proxy rules.  Those rules however did not expand beyond the now invalidated Rule 14a-11 (see page 215 of the foregoing Release).  So how will the groups of 100 small shareholders be lawfully formed?

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