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

The proposed SEC whistleblower rules excluded certain company personnel from making whistleblower claims.  For instance, a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity could not be a whistleblower if the information was communicated to that person with the reasonable expectation that he or she would take appropriate steps to cause the entity to respond to the violation.  In addition, a person could not be a whistleblower if the information that was obtained from or through an entity’s legal, compliance, audit, or similar functions or processes for identifying, reporting, and addressing potential non-compliance with applicable law. Each rule was subject to an exception that made the exclusion inapplicable if the entity did not disclose the information to the SEC in a reasonable time, or proceeded in bad faith.

 

The rationale for these proposed exclusions was not implementing the Dodd-Frank Act in a way that created incentives for responsible persons who are informed of wrongdoing, or others who obtain information through an entity’s legal, audit, compliance, and similar functions, to circumvent or undermine the proper operation of the entity’s internal processes for responding to violations of law.   The SEC was concerned about creating incentives for company personnel to seek a personal financial benefit by “front running” internal investigations and similar processes that are important components of effective company compliance programs.

 

Like most areas of the proposed rules, the SEC received extensive comments on this portion of the proposal.  While the policy driving the exclusions remains in place, the rules have been revised to be more specific.  The following are now excluded from being whistleblowers if the information was obtained because the potential whistleblower was:

  • An officer, director, trustee, or partner of an entity and another person informed the potential whistleblower of allegations of misconduct, or the person learned the information in connection with the entity’s processes for identifying, reporting, and addressing possible violations of law;
  • An employee whose principal duties involve compliance or internal audit responsibilities, or the potential whistleblower was employed by or otherwise associated with a firm retained to perform compliance or internal audit functions for an entity;
  • Employed by or otherwise associated with a firm retained to conduct an inquiry or investigation into possible violations of law; or
  • An employee of, or other person associated with, a public accounting firm, if the potential whistleblower obtained the information through the performance of most engagements required of an independent public accountant under the federal securities laws and that information related to a violation by the engagement client or the client’s directors, officers or other employees.

 

Like every rule, there are exceptions.  The foregoing exclusions do not apply if:

  • The potential whistleblower has 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;
  • The potential whistleblower has a reasonable basis to believe that the relevant entity is engaging in conduct that will impede an investigation of the misconduct; or
  • At least 120 days have elapsed since the potential whistleblower provided the information to the relevant entity’s audit committee, chief legal officer, chief compliance officer (or their equivalents), or his or her supervisor, or since the potential whistleblower received the information, if the potential whistleblower received it under circumstances indicating that the entity’s audit committee, chief legal officer, chief compliance officer, or his or supervisor was already aware of the information.

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, is requesting comment on a proposed rule that would require municipal advisors to adopt a basic supervisory structure to ensure compliance with applicable MSRB and Securities and Exchange Commission (SEC) rules.

MSRB Rule G-44 would require municipal advisors to establish and maintain a system to supervise the municipal advisory activities of associated persons. The rule would set the minimum requirements for this system, including the establishment and maintenance of written procedures. Ultimate responsibility for appropriate supervision rests with the municipal advisor.

The rule would also require municipal advisors to adopt, maintain and enforce written procedures to ensure municipal advisory activities are conducted in accordance with applicable MSRB and SEC rules. The rule would set the minimum requirements for these procedures, including those relating to the manner in which municipal advisory activities will be monitored and supervised for compliance.

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

The SEC has adopted final whistleblower rules under Section 922 of the Dodd-Frank Act.  A controversial issue with respect to the proposed rules  was the impact of the whistleblower program on companies’ internal compliance processes.   The final rules do not to include a requirement that whistleblowers report violations internally, but the SEC has made additional changes to the rules that it believes further incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems when appropriate.

  • With respect to the criteria for determining the amount of an award, the final rules expressly provide: first, that a whistleblower’s voluntary participation in an entity’s internal compliance and reporting systems is a factor that can increase the amount of an award; and, second, that a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.
  • The final rules contain a provision under which a whistleblower can receive an award for reporting original information to an entity’s internal compliance and reporting systems, if the entity reports information to the SEC that leads to a successful SEC action. Under this provision, all the information provided by the entity to the SEC will be attributed to the whistleblower, which means that the whistleblower will get credit — and potentially a greater award — for any additional information generated by the entity in its investigation.
  • The final rule extends the time for a whistleblower to report to the SEC after first reporting internally and still be treated as if he or she had reported to the SEC at the earlier reporting date. The SEC proposed a “lookback period” of 90 days after the whistleblower’s internal report, but in response to comments, the SEC extended this period to 120 days in the final rules.

The SEC did not require whistleblowers to first report internally for several reasons.  First, the SEC believes that there are a significant number of whistleblowers who would respond to the financial incentive offered by the whistleblower program by reporting only to the SEC, but who would not come forward either to the SEC or to the entity if the financial incentive were coupled with a mandatory internal reporting requirement.

Second, the SEC believes its approach should encourage companies to continue to strengthen their internal compliance programs in an effort to promote internal reporting. Potential whistleblowers are more likely to respond to the rules financial incentive by reporting internally when they believe that the company or entity has a good internal compliance program – i.e., a compliance program that will take their information seriously and not retaliate.  The SEC anticipates that companies will recognize this, take steps to promote a corporate environment where employees understand that internal reporting can have a constructive result, and that the net effect of this will be enhanced corporate compliance with the federal securities laws.

Third, while internal compliance programs are valuable, the SEC believes they are not substitutes for strong law enforcement. In some cases, law enforcement interests will be better served if we know of potential fraud before the entities or individuals involved learn of our investigation. This is particularly true when there is a risk that an entity or individual may try to hinder or impede our investigation by, for example, destroying documents or tampering with witnesses.

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

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 have the potential to impose significant burdens on public and private companies as well as hedge funds, private equity groups and venture capital funds.

Under the proposed rule, an offering would be unable to rely on the Rule 506 exemption if the issuer or any other person covered by the rule had a “disqualifying event.”

Covered Persons and the Obvious Challenges

The proposed rule would cover the issuer, including its predecessors and affiliated issuers, as well as:

  • Directors, officers, general partners and managing members of the issuer.
  • 10 percent beneficial owners and promoters of the issuer.
  • Persons compensated for soliciting investors, as well as the general partners, directors, officers and managing members of any compensated solicitor.

Public companies often rely on Rule 506 for issuing securities in M&A transactions or raising capital in PIPE transactions.  So public companies would have to us “reasonable care” to  investigate whether any 10% beneficial owners are subject to any disqualifying events described below.  Although they SEC might narrow the definition of the term “officer” in the final rules, a public company would have investigate the background of every vice president.

Smaller companies raising capital would have the above challenges and more.  They will have to investigate the background of every potential purchaser who might end up owning 10% of their stock, for fear that those purchasers could disqualify the issuer from using Rule 506 in the future.  They will have to select board members with care.

Private equity sponsors, hedge funds and venture capital funds will have to consider their fund raising procedures as well.  If a placement agent is used that receives a commission, you will have to investigate the general partners, directors, officers and managing members of the placement agent.  The rules apparently will apply across managed funds because of the “affiliated issuer” language which includes those under common control.

Disqualifying Events

It looks like you will have to be a white collar criminal defense attorney to know if any covered person has been subject to a “disqualifying event.”  Under the proposed rule, a “disqualifying event” would include:

  • Criminal convictions in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The criminal conviction would have to have occurred within 10 years of the proposed sale of securities (or five years, in the case of the issuer and its predecessors and affiliated issuers).
  • Court injunctions and restraining orders in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The injunction or restraining order would have to have occurred within five years of the proposed sale of securities.
  • Final orders from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from:
    • Associating with a regulated entity.
    • Engaging in the business of securities, insurance or banking.
    • Engaging in savings association or credit union activities. \

or orders that are based on fraudulent, manipulative or deceptive conduct and are issued within 10 years before the proposed sale of securities.

  • Certain SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons, which would be disqualifying for as long as the order is in effect;
  • Suspension or expulsion from membership in a “self-regulatory organization” or from association with an SRO member, which would be disqualifying for the period of suspension or expulsion;
  • SEC stop orders and orders suspending the Regulation A exemption issued within five years before the proposed sale of securities; and
  • U.S. Postal Service false representation orders issued within five years before the proposed sale of securities.

Reasonable Care Exception

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.

Application to Pre-Existing Disqualifying Events

Under the proposal, pre-existing convictions, suspensions, injunctions and orders would be disqualifying.

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

 

The Board of Directors of the Municipal Securities Rulemaking Board, or MSRB, held a special meeting on May 19-20, 2011 where it advanced major rule proposals governing fiduciary duty, conflicts of interest and fair dealing requirements for firms and individuals that provide financial advisory and underwriting services for municipal entities.

At its meeting, the Board amended earlier draft rule proposals based on public comments received and its intent to protect municipal entities and maintain an efficient market. Once approved by the Securities and Exchange Commission, MSRB rules have the force of federal law and apply to municipal advisors and dealers that provide municipal advisory and underwriting services to municipal entities, including state and local governments, public pension funds and obligated persons.

The MSRB Board of Directors agreed to seek SEC approval on the rule proposals covering the fiduciary duty responsibilities of municipal advisors toward municipal entity clients, including interpretive guidance on the duty of loyalty and care; the giving of gifts by municipal advisors in relation to their municipal advisory activities; and the application of the MSRB’s existing “fair dealing” rule to both municipal advisors and underwriters with respect to their work on behalf of municipal entities and obligated persons, as well as the solicitation of municipal entities on behalf of others. The MSRB expects to file all the rule proposals with the SEC during the month of June.

Since October 2010, the MSRB has been working to establish a regulatory framework for municipal advisors based on a set of principles-based rules consistent with provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The MSRB has also been reviewing dealer regulations to ensure that it is fulfilling its mission to protect municipal entities, in addition to investors and the public interest.

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

 The SEC has proposed new rules and amendments intended to increase transparency and improve the integrity of credit ratings.  The proposed rules would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings and Nationally Recognized Statistical Rating Organizations, or NRSROs.

 

Under the SEC’s proposal, NRSROs would be required to:

  • Report on internal controls.
  • Protect against conflicts of interest.
  • Establish professional standards for credit analysts.
  • Publicly provide – along with the publication of the credit rating – disclosure about the credit rating and the methodology used to determine it.
  • Enhance their public disclosures about the performance of their credit ratings.

The SEC’s proposal also requires disclosure concerning third-party due diligence reports for asset-backed securities.

 

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 the Know Before You Owe project, an effort to combine two federally required mortgage disclosures into a single, simpler form that makes the costs and risks of the loan clear and allows consumers to comparison shop for the best offer. 

The CFPB has begun testing two alternate prototype forms that are designed to be given to consumers who have just applied for a mortgage loan.  This testing – which will take place over the next several months and involve one-on-one interviews with consumers, lenders, and brokers – will precede and inform the CFPB’s formal rulemaking process.  The CFPB also has posted the prototypes on its website with an interactive tool to gather public input about the designs.

Current federal law requires that mortgage loan applicants receive two documents – the federal Truth in Lending Act (TILA) mortgage disclosure and the Real Estate Settlement Procedures Act (RESPA) Good Faith Estimate – within three days of application.  The current forms are two pages and three pages long, respectively.  While they are intended to convey basic facts about home loans to help consumers comparison shop, the CFPB believes these forms have overlapping information and complicated terms that can be difficult to understand.  Congress and federal regulators have considered merging the two documents in the past, and the Dodd-Frank Act directed the CFPB to propose new integrated disclosures. 

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

The Dodd-Frank Act requires an advisory vote on “golden parachute compensation” in connection with a shareholder vote on a merger transaction.  In addition, the SEC requires disclosure of golden parachute compensation in connection with tender offers.  In each case, the disclosures consist of a table including the information set forth in Rule 401(t) of Regulation S-K.  A few more examples of golden parachute disclosures and required advisory votes have appeared in acquisition related filings with the SEC.

Proxy Statements

One common theme is to emphasize that the golden parachute compensation will be paid regardless of the outcome of the advisory vote.

Lawson Software has a clear tabular presentation of golden parachute amounts and understandable footnotes.  It includes the following explanation of the effect of the vote:

“Stockholders should note that this proposal is merely an advisory vote which will not be binding on the Company, the Board, Parent or the surviving corporation. Further, the underlying plans and arrangements are contractual in nature and not, by their terms, subject to stockholder approval. Accordingly, regardless of the outcome of the advisory vote, if the merger is consummated, our named executive officers will be eligible to receive the various change in control payments in accordance with the terms and conditions applicable to those payments.”

Park Sterling’s S-4 is interesting.  It includes golden parachute compensation payable by the acquirer, Park Sterling, and compensation payable by the target, Community Capital.  Here the golden parachute compensation is relatively straight forward.  We like the Q&A’s which address the golden parachute vote:

Q:    Why am I being asked to cast an advisory (nonbinding) vote to approve “golden parachute” compensation that certain Community Capital officers will receive in connection with the merger?

A:    The SEC recently has adopted new rules that require us to seek an advisory (nonbinding) vote with respect to certain payments that will be made to our named executive officers by Community Capital and CapitalBank in connection with the merger.

Q:    What will happen if shareholders do not approve the “golden parachute” compensation at the special meeting?

A:    Approval of the “golden parachute” compensation payable under existing agreements that certain Community Capital officers will receive from Community Capital and CapitalBank in connection with the merger is not a condition to completion of the merger. The vote with respect to the “golden parachute” compensation is an advisory vote and will not be binding on Community Capital. Therefore, if the merger is approved by the shareholders and completed, the “golden parachute” compensation will still be paid to the Community Capital named executive officers.

The following disclosure is made regarding the required vote for the advisory vote to pass:

The approval of the proposal regarding “golden parachute” compensation payable under existing agreements that certain Community Capital officers will receive from Community Capital and CapitalBank in connection with the merger requires the number of votes cast at the special meeting, in person or by proxy and entitled to vote thereon, in favor of the proposal to exceed the number of votes cast against the proposal.

We have previously discussed Kirby Corp.’s disclosure here.

Tender Offers

Tender offers do not require a shareholder vote — stockholders merely tender their shares.  Dodd-Frank did not mandate that any golden parachute disclosures be made for tender offers, but the SEC decided disclosures should be made.  It was not a bad decision by the SEC, because a merger and a tender offer end in the same result — target is acquired.

In a tender offer, the target must file a Schedule 14D-9 with the SEC outlining the target’s position with respect to the tender offer.  That is where the golden parachute compensation disclosures are included.

We have located the following disclosures regarding golden parachute compensation in Schedule 14D-9s:

  • Vital Images:  Fairly complex golden parachute arrangements with extensive footnotes and detail on the agreements.
  • Volcom Inc:  Like many, the required footnotes explaining each item of compensation includes further sub-tables.
  • CNA Surety Corp.
  • TradeStation Group:  Rather than burying the disclosures in Item 8 at the end, this issuer included the disclosures in Item 3 where other matters regarding officers and directors are typically disclosed.
  • SunPower Corp.

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

 

 

The Federal Reserve Board has requested public comment on a proposed rule that would create new protections for consumers who send remittance transfers to recipients located in a foreign country.

The proposed rule would require that remittance transfer providers make certain disclosures to senders of remittance transfers, including information about fees and the exchange rate, as applicable, and the amount of currency to be received by the recipient. In addition, the proposed rule would provide error resolution and cancellation rights for senders of remittance transfers.

The proposal is being made under Regulation E (Electronic Fund Transfers) pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

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

The Board of Directors of the Federal Deposit Insurance Corporation, or FDIC, has approved a proposed rule to adopt requirements for FDIC-supervised institutions that may engage in certain foreign exchange transactions with retail customers which fall under the provisions of Section 742 of the Dodd-Frank Act.

The FDIC’s proposed rule closely tracks regulations adopted by the Commodity Futures Trading Commission in September 2010. It also is similar to a proposed rule published in the Federal Register by the Office of the Comptroller of the Currency on April 22, 2011.

The proposed rule applies only to transactions with retail customers, and only to futures, options, and similar transactions, such as rolling spot trades. It does not cover forward contracts or spot contracts. The proposed rule focuses on the safety and soundness of the underlying transactions through enhanced margin requirements and consumer protection through enhanced disclosure requirements among other elements. It establishes requirements dealing with disclosure, recordkeeping, capital and margin, reporting, business conduct, and documentation.

While some small businesses may be considered retail customers under the proposed rule, the rule also would not apply to foreign exchange forward contracts or spot contracts, which those businesses may use to manage their foreign exchange risks. The rule would not apply to transactions in the interbank forex market because participants in those markets are not retail customers.

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