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

We received favorable feedback on our article “Test Your Knowledge of the Whistleblower Rules,” so we thought a continuation would be appropriate.  Some specific factual questions and responses are set forth below.

 

1.         HighTech Corp. read the whistleblower rules carefully and noted that they do not specifically prohibit employees from waiving the protection of the anti-retaliation provisions of the Dodd-Frank Act.  HighTech therefore requires new employees to sign a waiver of those provisions.  Is it effective?

 

Not according to the SEC.  Since the whistleblower provisions amended the Securities Exchange Act, the anti-waiver provisions of Section 29(a) of the Exchange Act make such waivers ineffective.

 

2.         HighTech is conducting an internal investigation regarding potential violations of securities law although it has not yet been contacted by the SEC.  HighTech’s counsel interviews HighTech’s employee, Joe.  Joe figures something is up and immediately reports the same information to the SEC.  Is Joe a whistleblower?

 

Yes, Joe’s submission is considered “voluntary.”  See pages 33 to 34 of the adopting release.

 

3.         Mary and Julie are both employees of HighTech.  Mary communicates specific information about a securities law violation to Julie.  Mary and Julie had nothing to with the violation, and Julie did nothing to investigate or substantiate the information.  Julie reports the information to the SEC.  Is Julie a whistleblower?

 

Yes, assuming Julie is not Mary’s supervisor or does not have a compliance related function.  First hand knowledge is not required to have “independent knowledge” to be a whistleblower.  Page 47 of the adopting release states individuals can report information learned through their “observations, relationships or personal diligence.”

 

4.         Assume Mary later reports the information to the SEC.  Is Mary a whistleblower?

 

Yes.  Mary is the “original source” of the information.  Julie may still be eligible.  Julie may also have an advantage over Mary.  If Julie’s submission caused the SEC to open an investigation, and if a successful enforcement action resulted, then Julie’s submission “led to” a successful action.  If Mary made her submission after the SEC had already opened an enforcement action, then she will have to show that the information significantly contributed to the success of the action.  See adopting release pages 85 to 86.

 

5.         Assume the same facts as above, except Julie is Mary’s supervisor.  Is Julie a whistleblower?

 

The proposed rules excluded anyone in a “supervisory” capacity from being a whistleblower but this provision was significantly narrowed.  See adopting release page 64 and page 69.  Barring nothing else, Julie probably qualifies unless she is “an officer, director, trustee or partner” of HighTech (page 70 of the adopting release) or unless her “principal duties involve compliance or internal audit” (page 72 of the adopting release).

6.         Joe is a disgruntled employee and hacks into his supervisor’s company e-mail account and learns information that HighTech is violating securities laws.  Joe reports the information to the SEC.  Is Joe a whistleblower?

 

Joe will not be a whistleblower if a domestic court determines that Joe obtained the information in violation of federal or state criminal law.  Otherwise, Joe apparently qualifies.  See adopting release page 80.

 

7.         Joe makes a valid whistleblower complaint regarding HighTech.  Joe works closely with the SEC staff during the investigation and believes he has satisfied all necessary requirements.  Joe later reads in the paper that HighTech agreed to pay over $1,000,000 to the SEC to satisfy related allegations.  Joe celebrates and goes out and buys a big house in anticipation of a check, but does nothing else.  Will Joe receive a check?

 

No.  The SEC is required to publish a Notice of Covered Action on its website regarding the final judgment, and Joe must submit form WB-APP within 90 days thereafter to be eligible for an award.

 

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The Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation are seeking comment on proposed supervisory guidance regarding stress-testing practices at banking organizations with total consolidated assets of more than $10 billion.

The agencies are issuing the proposed guidance to emphasize the importance of stress testing in equipping banking organizations to assess the risks they face and address a range of potential adverse outcomes. The recent financial crisis underscored the need for banking organizations to conduct stress tests to help prepare for events and circumstances that can threaten their financial condition and viability.

Building on previously issued supervisory guidance that discusses the uses and merits of stress testing in specific areas of risk management, the proposed guidance provides an overview of how an organization should develop a structure for stress testing. The guidance outlines general principles for a satisfactory stress testing framework and describes how stress testing should be used at various levels within an organization. The guidance also discusses the importance of stress testing in capital and liquidity planning, and the importance of strong internal governance and controls in an effective stress-testing framework.

While the guidance does not explicitly address the stress testing requirements outlined in the Dodd-Frank Wall Street Reform and Consumer Protection Act, the agencies anticipate that rulemakings implementing these requirements would be consistent with the principles in the proposed guidance. The agencies also expect the guidance to be consistent with other supervisory initiatives, including those related to capital and liquidity planning. The agencies believe that it is important to establish the principles of stress testing as a background for these future rulemaking activities and supervisory initiatives.

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The SEC recently took a number of actions related to security based swaps.

Announcement of Guidance to be Issued on Effective Dates

The SEC said it is taking a series of actions in the coming weeks to clarify the requirements that will apply to security-based swap transactions as of July 16 – the effective date of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act – and to provide appropriate temporary relief.

Title VII is the portion of the Dodd-Frank Act that establishes a comprehensive framework for regulating over-the-counter derivatives. In particular, it authorizes the SEC to regulate “security-based swaps” while also authorizing the CFTC to regulate other swaps. The portion of Title VII referred to as Subsection B, which deals with the new regulatory regime for security-based swaps, will take effect on July 16 (360 days after the date of the Dodd-Frank Act’s enactment).

The SEC will:

  • Provide guidance regarding which provisions of Subtitle B of Title VII will become operable as of July 16, and, where appropriate, provide temporary relief from several of these provisions.
  • Provide guidance regarding – and where appropriate, temporary relief from – the various pre-Dodd-Frank provisions of the Exchange Act that would otherwise apply to security-based swaps on July 16. Under Dodd-Frank, security-based swaps would be included in the definition of “security” under the Exchange Act. While such swaps will be subject to provisions addressing fraud and manipulation, the SEC intends to provide temporary relief from certain other provisions of the Exchange Act so that the industry will have time to seek, and the SEC can consider, what if any further guidance or action is required.
  • Take other actions such as extending existing temporary rules under the Securities Act, the Exchange Act, and the Trust Indenture Act, and extending existing temporary relief from exchange registration under the Exchange Act. This will help to continue facilitating the clearing of certain credit default swaps by clearing agencies functioning as central counterparties.

Proposed Exemptions for Securities Based Swaps Issued by Clearing Agencies

The SEC has issued proposed rules that would provide certain clearing agencies with exemptions from the registration requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 for security-based swaps that they issue.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which established a comprehensive framework for regulating the over-the-counter swaps markets, envisioned that certain security-based swaps would be cleared through a clearing agency. The proposed exemptions would facilitate the clearing of such security-based swaps.

A clearing agency generally acts as a middleman between the parties to a transaction, and when providing central counterparty services, assumes the risk should there be a default. When structured and operated appropriately, such a clearing agency can provide benefits such as improving the management of counterparty risk and reducing outstanding exposures through multilateral netting of trades.

The proposed rules would exempt transactions by clearing agencies in these security-based swaps from all provisions of the Securities Act, other than the Section 17(a) anti-fraud provisions, as well as exempt these security-based swaps from Exchange Act registration requirements and from the provisions of the Trust Indenture Act, provided certain conditions are met.

On several previous occasions, the SEC has acted to facilitate clearing of certain credit default swaps by clearing agencies functioning as central counterparties. Among other things, the SEC previously adopted temporary rules that would exempt credit default swaps from these same registration and qualification requirements. The new proposed rules would create permanent exemptions that would cover these credit default swaps and the security-based swaps brought in through the Dodd-Frank Act and, as a result, supplant the temporary rules.

Because the current termination date for the temporary rules – July 16, 2011 – is expected to pass before the proposed exemptions are adopted, the SEC to extend the temporary rules in order to continue facilitating the clearing of certain credit default swaps by clearing agencies functioning as central counterparties.

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Carlo v. di Florio, the SEC’s Director of the Office of Compliance Inspections and Examinations, recently gave his views on private equity sponsors’ conflicts of interest as private equity sponsors ramp up to register as investment advisers as required by the Dodd-Frank Act.

Mr. di Florio outlined potential conflicts by various stages in the life cycle of a private equity fund:  the fund raising stage, the investment stage, the management stage and the exit stage.  Some of the specific conflicts Mr. di Florio believes may exist were:

Fund Raising Stage

  • Use of consultants and placement agents may be a conflict unless it is disclosed that the costs will be attributed to the fund.  In addition, to the extent consultants provide advice regarding the merits of investing, they need to disclose incentive compensation associated with the investment.
  • Undisclosed preferential terms to certain investors in side letters or intent to allow co-investment.
  • Disclosure of returns on previous investments.
  • Creating large funds to increase the amount of management fees.

Investment Stage

  • Insider trading on transactions involving public companies, or where a sponsor sits on the board of a private portfolio company and learns information about public companies.
  • Allocation of investment opportunities amongst funds or co-investment vehicles.
  • Investment by controlled funds in different levels of the capital structure of a portfolio company.
  • Charging transaction fees.

Management Stage

  • Many of the same conflicts as in the investment stage arise.
  • Calculations of investment values in reporting investment performance and in marketing materials.
  • Selective highlighting of successful investments.
  • Charging fees.
  • Conflicts which arise when appointing employees as members of boards of directors of portfolio companies.

Ext Stage

  • Delaying exits to accrue more management fees.
  • Sale of portfolio companies amongst funds or when joint holdings are not exited simultaneously
  • Valuation of portfolio assets and the impact on management fees.

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Consider these hypothetical facts:  Joe Ledger, an accountant at HighTech Co., an exchange traded company, finds some evidence of some mysterious transactions that occurred in the fourth quarter of 2010, indicating that revenue may have been improperly inflated.  In accordance with HighTech’s policy, Joe reports this information to Pete Flyspeck, HighTech’s Chief Compliance Officer, who is not an attorney.  Pete, again in accordance with HighTech’s policies, immediately reports the information to the Chair of the Audit Committee.  The Audit Committee promptly engages outside counsel to conduct an investigation.  In the meantime, Pete did some additional checking around, and finds additional credible evidence that revenue was inflated.  Two days after getting the initial information from Joe, Pete files a whistleblower claim with the SEC, knowing that HighTech was likely to miss its earnings expectations for 2011, like it did in 2010.  The SEC commences an investigation.  A couple weeks later, Joe also files a whistleblower claim with the SEC.  The Audit Committee subsequently completes its investigation, which is far more detailed and thorough than the information Pete and Joe provided, and turns over the results to the SEC.  The SEC and HighTech subsequently agree to settle the matter, with HighTech paying $1,500,000 in civil penalties for violations of securities laws.

Are Joe and Pete both whistleblowers, entitled to collect an award from the SEC?  Well the new rules are extraordinarily complex, and it may not be possible to answer that question with definitive certainty.  But some of the guideposts to consider are clear.

Joe

Joe’s case is pretty straightforward.  Assuming Joe is not an internal auditor and excluded from being a whistleblower in many circumstances, the fact that Pete made a whistleblower claim before him is not determinative.  Joe provided “original information” to the SEC under Rule 21F-4(b)(7).  Because he reported the information internally and filed a whistleblower claim within 120 days of reporting internally, Joe’s whistleblower claim relates back to the date of first internal reporting.

On the facts, the information Joe gathered appears a bit hazy, and Joe has to surmount the hurdle that the information he provided was “sufficiently specific, credible and timely to cause the staff to commence an examination.”  Under Rule 21F-4(c)(3) however, this test is likely deemed met.  Joe reported through HighTech’s compliance procedure, duly filed a whistleblower claim within 120 days and HighTech later provided the results of the investigation to the SEC.  The way the Rule reads, since the SEC had already commenced an investigation, the internal investigation must have “significantly contributed to the success of the action,” which we assume was met.

Pete

Pete has some different shoals to navigate.  First amongst them is Pete may not meet the requirement that the information was based on his “independent knowledge” and therefore he did not provide “original information” because of his role as Chief Compliance Officer.  Pete will strenuously argue that the guilty parties inflated revenue to in an attempt to meet earnings targets in 2010, and since HighTech is currently trailing expectations, the guilty parties are likely to do the same in 2011 unless the SEC stops them.  Pete will point to an exception from the rules barring compliance officers from being whistleblowers because he had a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the relevant entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors.  Whether this argument would succeed or not is an open question, but it may not be the most compelling reasoning.

Pete cannot claim to be the original source of the information Joe provided because of the look back rule.  Since the SEC already knows some information about the matter from Joe, Pete will have to show the information he independently provided “materially adds” to the information the SEC already possesses. 

Pete cannot tag-along on HighTech’s submission of its investigation to the SEC like Joe.  The reason is Pete did not report internally any original information he developed in connection with HighTech’s policies.  Nonetheless, that does not appear to be fatal in and of itself as the facts indicate the SEC commenced an investigation based on Pete’s report.

Who gets the money?

The above analysis addresses whether Joe and Pete are whistleblowers–not how much of a monetary reward they might receive.  The amount of the monetary award is in the discretion of the SEC, and will be at least 10% and no more than 30% of the monetary sanctions collected.  If the SEC decides to make an award to more than one whistleblower, it will determine an individual percentage for each whistleblower.  The rules set forth a list of factors the SEC will consider in determining the amount of the award.  Here Joe appears to have the upper hand since he reported to HighTech in accordance with its compliance procedures.

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ExxonMobil had a fairly innovative idea for its say on pay frequency proposal.  Its proxy statement provided “Consistent with the Board’s commitment to excellence in governance and responsiveness to shareholders, the Board will, however, follow the frequency that receives the plurality of votes cast by shareholders on this non-binding resolution. Furthermore, if the plurality of votes cast by shareholders is for triennial frequency, the Board will commit to hold the next frequency vote in three years, rather than the statutory requirement to hold this vote at least every six years.”

 

We wondered how the idea would fare and watched the progress of the proxy statement.  ExxonMobil soon encountered headwinds in the form of a negative recommendation from ISS on say-on-pay, opposition to its say-on-pay vote by activist investors such as ASFCME and RAM Trust, and negative comments from ISS’s blog to boot, with posts mysteriously appearing and disappearing.

 

ExxonMobil ultimately received majority support on its say-on-pay proposal.  However the other headwinds seem to have prevented it from garnering plurality support for its three year frequency proposal, as the annual option received 54.5% of the votes cast and the triennial option received 42.7% of the votes cast.

 

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

Section 1063(i) of the Consumer Financial Protection Act of 2010 (“Act”), which is otherwise known as Title X of the Dodd-Frank Act, requires the Bureau of Consumer Financial Protection to publish in the Federal Register a list of the rules and orders that will be enforced by the CFPB. The CFPB has published a notice that sets forth a list for public comment. A final list will be published not later than the date designated for the transfer of power to the CFPB, which is July 21, 2011.

The CFPB’s enforcement authority is defined by the Act and other applicable law. As a result, the list required by Section 1063(i) will not have a substantive effect on any rules or orders or the parties who may be subject to them; it will merely provide a convenient reference source.  Accordingly, the inclusion or exclusion of any rule or order would not alter the CFPB’s authority. In addition, Section 1063(i) does not require the CFPB to update, correct, or otherwise maintain the final list. 

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

The Municipal Securities Rulemaking Board, or  MSRB, has adopted a significant rule change to address concerns over conflicts of interest by financial intermediaries in municipal bond underwritings. The change prohibits municipal securities dealers from acting as a financial advisor to a municipal entity on a new bond issue and subsequently acting as an underwriter on the same issue.

MSRB Rule G-23 previously allowed a dealer serving as financial advisor for a new issue of municipal securities to resign from such role and serve as underwriter for the same issue if certain disclosure and consent requirements were met. Revised MSRB Rule G-23 prohibits such role-switching for new issues sold on both a negotiated and competitive bid basis.

The revised rule also prohibits a dealer that serves as a financial advisor for a particular issue from serving as the initial remarketing agent for the same issue. The rule will permit a dealer to serve as successor remarketing agent for the issue if the dealer’s financial advisory relationship with the issuer had been terminated for at least one year.

The amendments to the rule will change references in Rule G-23 from “a new issue or issues of municipal securities” to “the issuance of municipal securities” to conform the language of the rule to the language used in Section 15B of the Securities Exchange Act of 1934, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act; however, those changes will not change the meaning or operation of Rule G-23.  Further, the amendments will remove the requirement that financial advisory services be provided for compensation under Rule G-23(b), thereby conforming the rule to the provisions of Section 15B(e)(4) of the Exchange Act, which does not require that financial advisors receive compensation in order to be considered “municipal advisors.”

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

The SEC has proposed rules mandated by the Dodd-Frank Act that would require new disclosures by public companies concerning conflict minerals that originated in the Democratic Republic of the Congo or an adjoining country. Specifically, companies would be required to disclose annually whether they use “conflict minerals” that are “necessary to the functionality or production” of a product that they either manufacture or contract to be manufactured that originate from the Democratic Republic of the Congo or adjoining countries, referred to as “DRC countries.”  The conflict minerals are cassiterite, columbite-tantalite, gold, wolframite or their derivatives. These minerals are essential to many products – from jewelry to cell phones to jet engines.

The proposed SEC rules would require public companies to perform due diligence on their supply chain.  Hence, private companies that supply public companies may be contacted as part of this due diligence process.  While the Dodd-Frank Act required the SEC to issue final rules by April 15, 2011, the SEC has not yet done so.  The current version of the SEC’s publicly announced rule making schedule requires the SEC to adopt final rules between August and December 2011.

Further details are below.

The SEC Has Preliminarily Determined that Private Companies are Not Subject to the Disclosure Provisions

The SEC’s proposed rules would apply to any issuer that files reports with the SEC under the Exchange Act, provided that the issuer is a “person described” under Section 1502 of the Dodd-Frank Act, referred to as the “Conflict Minerals Provision.” The Conflict Minerals Provision defines a “person described” as one for whom conflict minerals are “necessary to the functionality or production of a product manufactured by such person.”   The SEC noted that the provision could be read to apply to any company, including companies that are not subject to SEC reporting requirements, or individuals, so long as conflict minerals are necessary to the functionality or production of a product manufactured by that entity or individual. The SEC believes such a broad reading of the provision, however, does not appear warranted given the provision’s background and its location in the section of the Exchange Act dealing with reporting issuers.  However, it has solicited further comments on this issue, which may be incorporated in the final rules.

The Analysis for Public Companies

Although private companies will likely not be subject to reporting requirements under the Dodd-Frank Act, it appears they probably will be contacted by public companies affected by the Dodd-Frank Act exercising supply chain due diligence.  To understand the impact on private companies, it is necessary to review the three step analysis that the SEC says is applicable to public companies.

The first step for public companies required by Section 1502 of the Dodd-Frank Act is for the issuer to determine whether it is subject to the Conflict Minerals Provision. An issuer is only subject to the Conflict Minerals Provision if it is a “person described,” which the Conflict Minerals Provision defines as one for whom “conflict minerals are necessary to the functionality or production of a product manufactured by such person.”  If an issuer does not meet this definition, the issuer would not be required to take any action, make any disclosures, or submit any reports.  If, however, an issuer meets this definition, that issuer would move to the second step.

The second step would require the issuer to determine after a reasonable country of origin inquiry whether its conflict minerals originated in the DRC countries.  If the issuer determines that its conflict minerals did not originate in the DRC countries, the issuer would disclose this determination and the reasonable country of origin inquiry it used in reaching this determination in the body of its annual report.  If, however, the issuer determines that its conflict minerals did originate in the DRC countries, or if it is unable to conclude that its conflict minerals did not originate in the DRC countries, the issuer would disclose this conclusion in its annual report and move to the third step.

Finally, the third step under the Conflict Minerals Provision would require an issuer with conflict minerals that originated in the DRC countries, or an issuer that is unable to conclude that its conflict minerals did not originate in the DRC countries, to furnish a “Conflict Minerals Report.”   In the Conflict Minerals Report, the issuer would be required to provide, among other information, a description of any of its products that contain conflict minerals that it is unable to determine did not “directly or indirectly finance or benefit armed groups” in the DRC countries.   The issuer would identify such products by describing them as not “DRC conflict free.”  If any of its products contain conflict minerals that do not “directly or indirectly finance or benefit” these armed groups, the issuer may describe such products as “DRC conflict free,” whether or not the minerals originated in the DRC countries.

Supply Chain Due Diligence

The proposed rules that would require issuers to disclose, based on their reasonable country of origin inquiry, whether their necessary conflict minerals originated in the DRC countries or that they are unable to determine, after such a reasonable country of origin inquiry, that their conflict minerals did not originate in the DRC countries. The proposed rules do not specify what constitutes a reasonable country of origin inquiry.  Instead, the proposed rules would require an issuer that determined its conflict minerals did not originate in the DRC countries to disclose its reasonable country of origin inquiry in making its determination.

Under the SEC’s proposal, the reliability of any inquiry would be based solely on whether the information used provides a reasonable basis for an issuer to be able to trace the origin of any particular conflict mineral it uses.  For example, the SEC stated it would not satisfy its proposed rules for an issuer to conclude that it is unreasonable for it to attempt to determine the origin of its conflict minerals solely because of the large amount of conflict minerals it uses in its products or the large number of its products that include conflict minerals.  Instead, that issuer would be required to make a reasonable country of origin inquiry as to the origin of all of its conflict minerals that are necessary to the functionality or production of its products that it manufactures or contracts to be manufactured to determine whether those conflict minerals originated in the DRC countries.

The SEC recognizes the possibility that issuers who have conducted a reasonable country of origin inquiry may nonetheless not be able to determine with absolute accuracy the origins of their conflict minerals. The SEC does not believe, however, that it is appropriate for its rules to permit issuers to satisfy their country of origin disclosure requirement by concluding that there is “no evidence” that their conflict minerals originated in the DRC countries and, thereby, not be required to provide any further information regarding their conflict minerals.  Therefore, under the SEC’s proposed rules such an issuer would still be required to file a Conflict Minerals Report and, therefore, would be required to exercise a greater level of investigation into the source and chain of custody of its conflict minerals.

The SEC’s proposed rules do not state what a reasonable country of origin inquiry would entail because it believes that necessarily would depend on the issuer’s particular facts and circumstances. The SEC noted that the reasonable country of origin inquiry requirement is not meant to suggest that issuers would have to determine with absolute certainty whether their conflict minerals originated in the DRC countries, as the SEC has often stated that a reasonableness standard is not the same as an absolute standard.

What Next?

Private companies that may supply public companies should begin to consider the impact of the Conflict Minerals Provision.  One first step may be to consider what public company customers might be impacted by the Conflict Minerals Provision and what components are supplied to the companies.  The next step might be to determine the feasibility of tracing those components back through the supply chain to determine if it will be possible to assist public company customers to determine if its products are DRC conflict free.  Some private companies may not wish to assist public companies in this process if it would require disclosure of trade secrets or confidential information.

Given that the SEC has not yet issued final rules, the timing for these disclosures is difficult to predict.  In the proposing release,  the SEC stated “Assuming we adopt rules in April 2011, as required by the statutory provision, a December 31 fiscal year-end issuer would first have to provide conflict minerals disclosure or a Conflict Minerals Report after the end of its December 31, 2012 fiscal year.”  Many of the comment letters submitted included helpful suggestions that the rules be phased-in over a period of time.

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

 

As we have noted, the SEC has proposed rules under Section 926 of the Dodd-Frank Act to disqualify offerings involving felons and other “bad actors” and associated persons  from relying on Rule 506 of Regulation D in private placements.  The proposed rules will force issuers to make difficult judgments as to whether or not their offering will qualify for an exemption under Rule 506.

The SEC has sought to minimize the impact of the rules.  The proposed rule would provide an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed.  But how much protection does that really provide?

For instance, a 10% beneficial owner who has committed a disqualifying event will preclude the issuer from relying on Rule 506.  So a careful issuer might send all 10% owners a questionnaire to complete.  But what if the owner will not return it?  Has the issuer exercised reasonable care and can it proceed?

Broker-dealers and others who receive compensation from an offering can also preclude reliance on Rule 506 if they have been subject to a disqualifying event.  Practice may develop where the placement agents make representations to the issuer that no disqualifying events have occurred.  Can an issuer rely on those representations?  Or must it check FINRA, SEC and other data bases as well?

And must issuers headed toward an IPO even be more careful?  What if the underwriters look under rock the issuer has not turned over during due diligence and find something?

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