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

The CFTC’s new anti-manipulation and anti-fraud rules are based on the SEC’s Rule 10b-5.  One CFTC Commissioner believes the new rule will end the CFTC’s nearly unanimous 35-year losing streak in this area, while another believes the rule’s lack of clarity and vagueness will cause significant confusion in the marketplace.  It looks to generate a lot of work for lawyers, since the rule imports the notion of insider trading and the like.

Section 753 of the Dodd-Frank Act amended section 6(c) of the Commodity Exchange Act, or CEA, to prohibit manipulation and fraud in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.

Among other things, Dodd-Frank Act Section 753:

  • Expands the reach of the CFTC to prohibit manipulative and fraudulent behavior by eliminating the requirement to show an artificial price and lowering the scienter standard to recklessness for fraud-based manipulations.
  • Preserves the CFTC’s existing authority to prohibit the manipulation of prices even in the absence of fraud.
  • Adds a special provision for manipulation by false reporting, including an exception for good faith mistakes.
  • Makes it unlawful to provide materially false information to the CFTC.

According to the CFTC, its final rules, to be codified in 17 CFR Part 180, function to protect the public from manipulation and fraud in connection with any swap, or contract of sale of a commodity in interstate commerce, or contract for future delivery on or subject to the rules of any registered entity.

Rule 180.1, which is modeled on Securities and Exchange Commission Rule 10b-5, broadly prohibits manipulative and deceptive devices and contrivances, employed intentionally or recklessly, regardless of whether the conduct in question was intended to create or did create an artificial price.

The CFTC believes respective scienter requirements of final Rule 180.1 (intentional or reckless), final Rule 180.2 (specific intent), and CEA section 9(a)(2) (specific intent) function to ensure that good-faith mistakes or negligence will not constitute a violation of the final Rules.

According to the CFTC the final rule:

  • Reaches all manner of fraud and manipulation within the scope of the statute it implements, CEA section 6(c)(1).
  • Does not impose any new affirmative duties of inquiry, diligence, or disclosure. The failure to disclose information prior to entering into a transaction, either in an anonymous market setting or in bilateral negotiations, will not, by itself, constitute a violation. However, depending on all of the facts and circumstances, trading on the basis of material nonpublic information in breach of a pre-existing duty (established by another law or rule, agreement, understanding, or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception, may violate final Rule 180.1. Similarly, fraud-by-partial-omission or half-truths could violate final Rule 180.1 if the facts and circumstances of a particular case so warrant.
  • The “in connection with” requirement is to be read broadly, not technically or restrictively. Section 6(c)(1) and final Rule 180.1 reach all manipulative or deceptive conduct in connection with the purchase, sale, solicitation, execution, pendency, or termination of any swap, or contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.

CFTC Commissioner Bart Chilton stated “Currently, we have a nearly impossible manipulation standard, winning only one case in 35 years.  We have had to prove intent, artificial price, market control and that the manipulators actually caused the artificial price.  A very tall order.  With the adoption of this new rule, the CFTC will be able to prosecute a broader array of commodity law violations.  Here are a few of them:

  • First, it will give us the ability to go after fraudulent practices that manipulate prices—like disseminating misinformation about the global availability of crude oil to manipulate the market.
  • Pocketing profits from the misuse of privileged information will now be prosecuted.  We’ll be able to get at, for example, bad actors akin to insider traders.
  • Also, this new regulation moves us toward a reckless standard similar to that under securities laws as defined by the courts, and the law specifically gives us a reckless standard for false reporting.”

CFTC Commission Scott Omalia took a contrary view: “I have concerns that the Anti-Manipulation rule has not provided adequate clarity and that such vagueness as to the course of action that will be taken by the Commission in enforcing this rule will add confusion to the markets. The wholesale incorporation of standards and case law developed under Rule 10b-5 of the Securities Exchange Act of 1934 runs the risk of disregarding the unique qualities of the futures and derivatives markets in its attempts to apply concepts developed in the securities markets such as insider trading based on misappropriation. It is therefore essential for the Commission to be clear as to how judicial precedents under Rule 10b-5 guide our judgment and decision-making as we exercise authority under this rule . . . I believe the Commission could have been more responsive to requests for guidance through the provision of examples of violative conduct. This is especially so with regard to relatively new concepts of liability in our markets such as insider trading and “fraud-on-the-market.””

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

The FDIC has adopted final rules which provide that the FDIC, as receiver of a covered financial company, may recover from senior executives and directors who were substantially responsible for the failed condition of the company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud.

A “covered financial company” is a financial company, other than an insured depository institution, which the Treasury Secretary has determined satisfies the criteria for FDIC receivership under Section 203(b) of the Dodd-Frank Act.  Among other things, a determination by the Secretary under Section 203(b) requires a determination that the failure of the financial company would have serous adverse effects on the stability of the United States.  “Financial companies” means bank holding companies, nonbank financial companies supervised by the Federal Reserve System and companies the Federal Reserve has determined are predominately engaged in activities that are financial in nature.

“Compensation” is broadly defined to mean any direct or indirect financial remuneration received from the covered financial company, including, but not limited to, salary; bonuses; incentives; benefits; severance pay; deferred compensation; golden parachute benefits; benefits derived from an employment contract, or other compensation or benefit arrangement; perquisites; stock option plans; post-employment benefits; profits realized from a sale of securities in the covered financial company; or any cash or noncash

payments or benefits granted to or for the benefit of the senior executive or director.

The proposed rule provided a standard of conduct in which, among other things, a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the requisite degree of skill and care required by that position. The final rule clarifies the standard and provides that a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances.  The revision clarifies that the standard of care that will trigger a clawback is a negligence standard; a higher standard, such as gross negligence, is not required.

In the event that a covered financial company is liquidated under Title II of the Dodd-Frank Act, the FDIC as receiver will undertake an analysis of whether the individual has breached his or her duty of care, including an assessment of whether the individual exercised his or her business judgment. The burden of proof, however, is on the senior executive or director to establish that he or she exercised his or her business judgment. State “business judgment rules” and “insulating statutes” will not shift the burden of proof to the FDIC or increase the standard of care under which the FDIC as receiver may recoup compensation.

The proposed rule provided that, in certain limited circumstances, a senior executive or director would be presumed to be substantially responsible for the failed condition of the covered financial company. The use of rebuttable presumptions for those individuals under the limited circumstances in the final rule is aligned with the intent shown in the statutory language; thus, the presumptions remain unchanged in the final rule.

The following presumptions apply for purposes of assessing whether a senior executive or director is substantially responsible for the failed condition of a covered financial company:

  • The senior executive or director served as the chairman of the board of directors, chief executive officer, president, chief financial officer, or in any other similar role regardless of his or her title if in this role he or she had responsibility for the strategic, policymaking, or company-wide operational decisions of the covered financial company prior to the date that it was placed into receivership under the orderly liquidation authority of the Dodd-Frank Act;
  • The senior executive or director is adjudged liable by a court or tribunal of competent jurisdiction for having breached his or her duty of loyalty to the covered financial company;
  • The senior executive was removed from the management of the covered financial company under 12. U.S.C. 5386(4); or
  • The director was removed from the board of directors of the covered financial company under 12 U.S.C. 5386(5).

The FDIC anticipates that it will seek recoupment of compensation through the court system using a procedure similar to the procedure that it currently uses when it seeks recovery from individuals whose negligent actions have caused losses to failed financial institutions.  In those situations, the FDIC as receiver undertakes an investigation to determine if there are meritorious and cost effective claims and, if so, staff requests authority to sue from the Board or the appropriate delegated authority. Similarly the FDIC anticipates that it will investigate whether the statutory criteria for compensation recoupment are met, and, if so, staff will request authorization of a suit for recoupment. The final rule reflects this procedure by indicating that the FDIC as receiver may file an action to seek recoupment of compensation.

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

The Federal Reserve Board and the Federal Trade Commission have issued final rules to implement the credit score disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. If a credit score is used in setting material terms of credit or in taking adverse action, the statute requires creditors to disclose credit scores and related information to consumers in notices under the Fair Credit Reporting Act, or FCRA.

Regulation V

The final rules amend Regulation V (Fair Credit Reporting) to revise the content requirements for risk-based pricing notices, and to add related model forms that reflect the new credit score disclosure requirements. The Board is issuing these final rules jointly with the FTC.

Section 1100F of the Dodd-Frank Act amends section 615(h) of the FCRA to require that additional content be disclosed to consumers in risk-based pricing notices; specifically, if a credit score is used in making the credit decision, the creditor must disclose that score and certain information relating to the credit score. The effective date of these amendments is July 21, 2011.

Title X of the Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection, to which rulewriting authority for certain consumer protection laws will transfer. Section 1088(a)(9) of the Dodd-Frank Act amends section 615(h)(6) to provide that rulewriting authority for section 615(h) will transfer to the CFPB. Pursuant to section 1100H of the Dodd-Frank Act, however, this rulewriting authority does not transfer to the CFPB until July 21, 2011. Thus, rulewriting authority for the risk-based pricing provisions of the FCRA, including the amendments prescribed by section 1100F of the Dodd-Frank Act, will not be vested in the Bureau until the date that the section 1100F amendments become effective.

The Board and the FTC believe it is important to have implementing regulations and revised model forms in place as close as possible to July 21, 2011. This will help ensure that consumers receive consistent disclosures of credit scores and information relating to credit scores, and will help facilitate uniform compliance when section 1100F of the Dodd-Frank Act becomes effective.

Regulation B

The final rules also amend certain model notices in Regulation B (Equal Credit Opportunity), which combine the adverse action notice requirements for Regulation B and the FCRA, to reflect the new credit score disclosure requirements.

Section 1100F of the Dodd-Frank Act amends section 615(a) of the FCRA to require creditors to disclose on FCRA adverse action notices a credit score used in taking any adverse action and information relating to that score. The effective date of these amendments is July 21, 2011.

After considering the comments received on the Board’s proposal, the Board is issuing revised model adverse action notices substantially as proposed. As revised, the adverse action model notices in Regulation B are consistent with the requirements of section 1100F of the Dodd-Frank Act to help facilitate compliance with that provision when it becomes effective.

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

The CFTC has published a draft no-action letter regarding certain Dodd-Frank provisions.  Certain proposed exemptive relief  and the staff draft no-action letter, taken together, would provide greater clarity during the transition to the new regulatory framework for swaps in light of the general effective date in Title VII of the Dodd-Frank Act of July 16, 2011.

Specifically, the draft no-action letter provides that the Division of Market Oversight and the Division of Clearing and Intermediary Oversight would not recommend that the CFTC commence an enforcement action against any person for failure to comply with:

  • ·        Section 4s(l) of the Commodity Exchange Act, or CEA, which imposes upon swap dealers and major swap participants certain segregation requirements with respect to collateral for uncleared swaps;
  • ·        Section 5b(a) of the CEA, which requires a derivatives clearing organization to register with the CFTC in order to clear swaps; and
  • ·        Section 4s(k) of the CEA, which provides for the duties and designation of a chief compliance officer for swap dealers and major swap participants. The proposed staff no-action letter would not limit the CFTC’s applicable anti-fraud and anti-manipulation authority.

Under the terms of the draft no-action letter, relief would automatically expire no later than December 31, 2011.

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

 

The SEC has provided additional guidance to clarify which U.S. securities laws will apply to security-based swaps starting July 16 — the effective date of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The SEC approved an order granting temporary relief and interpretive guidance to make clear that a substantial number of the requirements of the Exchange Act applicable to securities will not apply to security-based swaps when the revised definition of “security” goes into effect on July 16. Nevertheless, federal securities laws prohibiting fraud and manipulation will continue to apply to security-based swaps after that date. To enhance legal certainty for market participants, the SEC also provided temporary relief from provisions of U.S. securities laws that allow the voiding of contracts made in violation of those laws.

In addition, the SEC approved an interim final rule providing exemptions from the Securities Act, Trust Indenture Act and other provisions of the federal securities laws to allow certain security-based swaps to continue to trade and be cleared as they have pre-Dodd-Frank.  That interim relief will extend until the Commission adopts rules further defining “security-based swap” and “eligible contract participant.”

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

 

The SEC has proposed rules that would impose certain business conduct standards upon security-based swap dealers and major security-based swap participants when those parties engage in security-based swap transactions.  The SEC’s proposed rules stem from Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which authorizes the Commission to implement a comprehensive framework for regulating the over-the-counter swaps markets.

The proposed rules (15Fh-1 through 15Fh-6 and 15Fk-1) seek to implement the business conduct requirements described in Section 764 of the Dodd-Frank Act. Among other things, the proposed rules would require security-based swap dealers and major security-based swap participants to:

  • Verify whether a counterparty is an eligible contract participant and whether it is a special entity.
  • Disclose to the counterparty material information about the security-based swap, including material risks, characteristics, incentives and conflicts of interest.
  • Provide the counterparty with information concerning the daily mark of the security-based swap.
  • Provide the counterparty with information regarding the ability to require clearing of the security-based swap.
  • Communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.
  • Establish a supervisory and compliance infrastructure.
  • Designate a chief compliance officer that is required to fulfill the described duties and provide an annual compliance report.

The proposed rules also would require security-based swap dealers to:

  • Determine that any recommendations they make regarding security-based swaps are suitable for their counterparties.
  • Establish, maintain and enforce policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each known counterparty that are necessary to conduct business with such counterparty.
  • Comply with rules designed to prevent “pay-to-play.”

The proposed rules also would define what it means to “act as an advisor” to a special entity, and would require that a security-based swap dealer who acts as an advisor to a special entity:

  • Act in the “best interests” of the special entity.
  • Make reasonable efforts to obtain information that it needs to determine that the recommendation is in the “best interests” of the special entity.

In addition, the proposed rules would require security-based swap dealers and major security-based swap participants acting as counterparties to special entities to reasonably believe that the counterparty has an independent representative who meets the following requirements:

  • Has sufficient knowledge to evaluate the transaction and risks.
  • Is not subject to a statutory disqualification.
  • Is independent of the security-based swap dealer or major security-based swap participant.
  • Undertakes a duty to act in the best interests of the special entity.
  • Makes appropriate disclosures of material information concerning the security-based swap.
  • Provides written representations to the special entity regarding fair pricing and appropriateness of the security-based swap.

Follow me on Twitter – @squinlivan

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

All public companies must now comply with the SEC’s mandate to use XBRL technology when filing financial statements. How hard has compliance been? How do you amend a filing when you discover an error?  Listen to the attached podcast that I did with Matthew Kelly of  Compliance Week to hear the answers to these questions more.  You can also review prior posts related to XBRL Compliance.

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

As many know, the SEC has issued rules which define which venture capital advisers will not have to register as investment advisers with the SEC.  In addition, the SEC has issued rules which exempt many hedge fund managers and private equity groups with assets under management of less than $150 million from registration as an investment adviser. It is important to note however, that under final rules issued by the SEC, these “exempt reporting advisers” to venture capital funds, hedge funds and private equity groups will still have to file Form ADV with the SEC which will be publicly available.

Reporting Requirements

Rule 204-4 requires exempt reporting advisers to file reports with the Commission electronically on Form ADV through the IARD using the same process used by registered investment advisers.  The IARD system is maintained by FINRA on behalf of the SEC.  Exempt advisers will have to report a subset of information that registered advisers must report.

An exempt reporting adviser must submit its initial Form ADV within 60 days of relying on the exemption from registration afforded venture capital advisers or advisers to private funds with less than $150 million in assets under management.  Each Form ADV is considered filed with the SEC upon acceptance by the IARD.  Under the transition provisions of the new rules, exempt reporting advisers must file their first reports on Form ADV through IARD between January 1 and March 30, 2012.

The SEC anticipates that filing fees, which the SEC will consider separately, will be the same as those for registered investment advisers, which currently range from $40 to $225 based on the amount of assets an adviser has under management.

Rule 204-1 requires an exempt reporting adviser, like a registered adviser, to amend its reports on Form ADV: (i) at least annually, within 90 days of the end of the adviser‘s fiscal year; and (ii) more frequently, if required by the instructions to Form ADV. General Instruction 4 to Form ADV requires an exempt reporting adviser, like a registered adviser, to update promptly Items 1 (Identification Information), 3 (Form of Organization), and 11 (Disciplinary Information) if they become inaccurate in any way, and to update Item 10 (Control Persons) if it becomes materially inaccurate.

Content of Information to be Disclosed

Exempt reporting advisers will be required to complete the following items of Part 1A of Form ADV:

  • 1 – Identifying Information
  • 2.B. – SEC Reporting by Exempt Reporting Advisers
  • 3 – Form of Organization
  • 6 – Other Business Activities
  • 7 – Financial Industry Affiliations and Private Fund Reporting
  • 10 – Control Persons, and
  • 11 – Disclosure Information

In addition, the SEC requires that exempt reporting advisers also complete corresponding sections of Schedules A, B, C, and D to Form ADV.

Follow me on Twitter – @squinlivan

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

The SEC has issued its final rules exempting advisers to venture capital funds from registration under the Investment Advisors Act.  Importantly, the rules exempt certain pre-existing venture capital funds from regulation.  Under the rule, the definition of ― venture capital fund includes any private fund that:

  • represented to investors and potential investors at the time the fund offered its securities that it pursues a venture capital strategy;
  • has sold securities to one or more investors prior to December 31, 2010; and
  • does not sell any securities to, including accepting any capital commitments from, any person after July 21, 2011.  

A grandfathered fund would thus include any fund that has accepted all capital commitments by July 21, 2011 (including capital commitments from existing and new investors) even if none of the capital commitments has been called by such date.  The calling of capital after July 21, 2011 would be consistent with the grandfathering provision, as long as the investor became obligated by July 21, 2011 to make a future capital contribution.  

It is not necessary for a qualifying fund to name itself as a venture capital fund in order for its adviser to rely on the venture capital exemption.  A fund may qualify of the exemption even if its name does not use the words venture capital as long as its name is not inconsistent with pursuing a venture capital strategy.  Whether or not a fund represents itself as pursuing a venture capital strategy, however, will depend on the particular facts and circumstances. Statements made by a fund to its investors and prospective investors, not just what the fund calls itself, are important to an investor‘s understanding of the fund and its investment strategy.  The appropriate framework for analyzing whether a qualifying fund has satisfied the holding out criterion depends on all of the statements (and omissions) made by the fund to its investors and prospective investors. While this includes the fund name, it is only part of the analysis.  The SEC does not expect existing funds identifying themselves as pursuing a “private equity” or “hedge fund” strategy would be able to rely on this element of the grandfathering provision.

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 issued a Notice and Request for Comment seeking public input on a key element of the agency’s nonbank supervision program: the statutory requirement to define who is a “larger participant” in certain consumer financial markets.

The Dodd-Frank Wall Street Reform and Consumer Protection Act charged the CFPB with ensuring that both banks and nonbanks comply with federal consumer financial laws.  Historically, banks, thrifts, and credit unions have been subject to examinations by federal regulators, but other types of companies providing consumer financial services generally have not.

The Dodd-Frank Act authorizes the CFPB to examine all sizes of nonbank mortgage companies, payday lenders, and private education lenders. Generally, before CFPB begins its nonbank supervision program in other markets, the Dodd-Frank Act requires that the agency first define by rule who is “a larger participant of a market for other consumer financial products or services.” The CFPB must issue an initial “larger participant” rule no later than July 21, 2012.

To prepare for this eventual rulemaking, the CFPB is seeking public input through a Notice and Request for Comment, which identifies six markets for potential inclusion in an initial rule: debt collection; consumer reporting; consumer credit and related activities; money transmitting, check cashing, and related activities; prepaid cards; and debt relief services. The larger participant rule will not impose substantive consumer protection requirements.  Instead, the rule will enable CFPB to begin a supervision program for larger participants in certain markets.

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