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

The SEC has issued proposed rules regarding performance fees that can be charged by investment advisers.  As a result of changes to the Investment Advisers Act effected by the Dodd-Frank Act, many private equity sponsors and hedge fund advisers will be required to register with the SEC.  These fund advisors should breathe a sigh of relief that the proposed rules will grandfather their existing advisory arrangements that would not otherwise be permitted.

History

Section 205(a)(1) of the Investment Advisers Act generally prohibits an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of a client.  Congress prohibited these compensation arrangements (also known as performance compensation or performance fees) in 1940 to protect advisory clients from arrangements it believed might encourage advisers to take undue risks with client funds to increase advisory fees.  In 1970, Congress provided an exception from the prohibition for advisory contracts relating to the investment of assets in excess of $1,000,000, if an appropriate “fulcrum fee” is used.  Congress subsequently authorized the SEC to exempt any advisory contract from the performance fee prohibition if the contract is with persons that the SEC determines do not need the protections of that prohibition.

The SEC adopted Rule 205-3 in 1985 to exempt an investment adviser from the prohibition against charging a client performance fees in certain circumstances.  The Rule, when adopted, allowed an adviser to charge performance fees if the client had at least $500,000 under management with the adviser immediately after entering into the advisory contract (“assets-under-management test”) or if the adviser reasonably believed the client had a net worth of more than $1 million at the time the contract was entered into (“net worth test”). The SEC stated that these standards would limit the availability of the exemption to clients who are financially experienced and able to bear the risks of performance fee arrangements.

In 1998, the SEC amended Rule 205-3 to change the dollar amounts of the assets-under-management test and net worth test to adjust for the effects of inflation since 1985.  The SEC revised the former from $500,000 to $750,000, and the latter from $1 million to $1.5 million.

Indexing for Inflation; Conforming Changes to Accredited Investor Stadard

The Dodd-Frank Act, among other things, amended Section 205(e) of the Advisers Act to state that, by July 21, 2011 and every five years thereafter, the SEC shall adjust for inflation the dollar amount tests included in rules issued under Section 205(e).  Pursuant to Section 418 of the Dodd-Frank Act, the SEC has provided notice that it intends to issue an order revising the dollar amount tests of Rule 205-3 to account for the effects of inflation.  The SEC also proposed for public comment amendments to Rule 205-3 to provide that the SEC will subsequently issue orders making future inflation adjustments every five years.  In addition, the SEC proposed  to amend Rule 205-3 to exclude the value of a person’s primary residence from the determination of whether a person meets the net worth standard required to qualify as a “qualified client.”  The latter conforms the net worth calculation to the proposed rules defining the term “accredited investor” for the purposes of Regulation D.

Grandfather Provisions

The proposed amendments would replace the current transition rules Section of Rule 205-3 with two new subsections to allow an investment adviser and its clients to maintain existing performance fee arrangements that were permissible when the advisory contract was entered into, even if performance fees would not be permissible under the contract if it were entered into at a later date. These transition provisions, proposed rules 205-3(c)(1) and (2), are both designed so that restrictions on the charging of performance fees apply to new contractual arrangements and do not apply retroactively to existing contractual arrangements.  This approach would minimize the disruption of existing contracts that meet applicable standards at the time the parties entered into the contract.

First, proposed Rule 205-3(c)(1) would provide that, if a registered investment adviser entered into a contract and satisfied the conditions of the Rule that were in effect when the contract was entered into, the adviser will be considered to satisfy the conditions of the Rule.  Second, proposed Rule 205-3(c)(2) would provide that, if an investment adviser was previously exempt pursuant to Section 203 from registration with the SEC and subsequently registers with the SEC, Section 205(a)(1) of the Act would not apply to the contractual arrangements into which the adviser entered when it was exempt from registration with the SEC.

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[Update:  The case against TradingScreen was ultimately dismissed.  Interested readers should refer to subsequent case history.]

Egan v. TradingScreen Inc. (S.D.N.Y. May 4, 2011) is the first case dealing with the Dodd-Frank Act’s whistleblower provisions that we are aware of.  Plaintiff Patrick Egan was employed by TradingScreen.  It seems to fall into the category of “bad facts make bad law.”  Plaintiff uncovers allegations of serious misconduct, reports it, is fired by the person responsible for the misconduct, and then has his retaliatory discharge claim opposed.  What court is not going to go out of its way to find protection for the Plaintiff?

More specifically, Plaintiff learned that TradingScreen’s CEO, Philippe Buhannic, was diverting corporate assets.  Plaintiff reported the conduct to TradingScreen’s President, who informed the independent directors.  The independent directors hired Latham & Watkins to conduct an investigation, which confirmed Plaintiff’s allegations.  Buhannic somehow gained control of the board of directors, which prevented Buhannic from being fired.  Two of the independent directors assured plaintiff he would not be fired.  Nevertheless, Buhannic fired plaintiff.

Plaintiff asserted he was entitled to relief under the retaliatory discharge provisions incorporated into the whistleblower provisions of the Dodd-Frank Act.  The court noted anti-retaliation provisions of the Dodd-Frank Act explicitly prohibit retaliation against whistleblowers that provide information and testimony to the SEC. In addition, they also protect whistleblowers that make disclosures falling into one of four categories: “disclosures that are required or protected under the Sarbanes-Oxley Act . . . the Securities Exchange Act of 1934 . . . section 1513(e) of title 18, United States Code, and any other law, rule, or regulation subject to the jurisdiction of the Commission.”  These latter provision do not require that disclosure be made directly to the SEC.

While the court disregarded many of the Plaintiff’s arguments for whistleblower protection, the court looked closely at Plaintiff’s arguments his that disclosures were protected by 18 U.S.C. § 1513(e), which prohibits “interference with the lawful employment or livelihood of any person” who provides truthful information “to a law enforcement officer” relating to the commission of federal offenses.  According to the court, a claim of whistleblowing under section 1513(e) relies on the question of whether Plaintiff or anyone acting jointly with him did in fact report to the SEC.

Plaintiff argued that he acted jointly with the attorneys from Latham to reveal Buhannic’s malfeasance.  Plaintiff’s claim posed the following question: Is a prospective whistleblower covered by the Dodd-Frank Act if he gave information to attorneys who he alleges on information and belief reported it to the SEC?  Defendants countered that the Latham attorneys merely interviewed Plaintiff and that the complaint does not state that he was a source of substantial information, that he hired the Latham attorneys, or directed their actions. The court noted that this argument would effectively rewrite the phrase “acting jointly” in the Dodd-Frank Act to require leadership, hiring, or direction of any investigation or effort to report information to the SEC.  According to the Court, the plain text of the statute merely requires that the person seeking to invoke a private right of action to have acted with others in such reporting, not that he or she led the effort to do so.

The court also discussed that defendants’ claim that the Latham attorneys merely interviewed Plaintiff is belied by the allegations in the complaint.

The question remained as to whether Latham reported the matters to the SEC.  The court found that given the surrounding circumstances it could be plausibly alleged that the misconduct was reported.  The court granted Plaintiff leave to amend his complaint to make appropriate allegations.

Given the foregoing, it is likely practices in internal investigations will be modified so that witnesses are clearly advised that those conducting the investigation are not acting jointly with a person that potentially may provide whistleblower type information to prevent claims of retaliatory discharge.

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The Treasury announced its intention to create a Federal Advisory Committee on Insurance.  This is one in a series of steps that Treasury is taking to establish the new Federal Insurance Office, or FIO, created under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Committee will provide advice to the FIO and the Treasury Department, including to the FIO Director in the Director’s role as a member of the Financial Stability Oversight Council, or FSOC.  Through the Committee, the FIO and the Treasury believe they will benefit from the deep knowledge and regulatory experience of state insurance regulators, as well as the perspective of industry experts, academics, and other stakeholders and affected constituencies. 

Recognizing the important role of state insurance regulators, half of the Committee’s membership has been reserved for state and tribal insurance regulators.  The remaining members of the Committee will represent a diverse range of perspectives from, for example, the property and casualty insurance industry, the life insurance industry, the reinsurance industry, the agent and broker community, public advocates, and academia.

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We have been asked by general counsels of many public companies, and readers of our blog, if anyone was using the optional advisory approval of golden parachute arrangements permitted by the Dodd-Frank Act in connection with an annual meeting.  If done right, approval of golden parachute arrangements at an annual meeting obviates the need to seek an advisory vote of those matters in connection with a merger or make disclosures in similar transactions, except to the extent changes occur.  Ignoring one smaller reporting issuer that filed its proxy statement before the rules were finalized (Tech/Ops Sevcon, Inc.), we found five issuers that sought such approval. All had respectable market caps between $1.4 billion and $4.1 billion, except one which was under $100 million.  Two had institutional ownership of more than 60%.

It is a popular misconception that if you include the golden parachute disclosures to obtain advance advisory approval of golden parachute arrangements that you need two ballot items – one to approve executive compensation and one to approve the golden parachute arrangements.  That is not the case.  If the disclosures with respect to golden parachute arrangements are made, they are covered by the general advisory vote on executive compensation.

Most public companies have chosen not to make the optional disclosures for the following reasons:

  • Perhaps it will be interpreted as signaling an impending change-of-control transaction.
  • Required data for preparing the disclosures are different from other tables, thereby making the disclosures more difficult to prepare.
  • ISS and other advisors may object to the golden parachute arrangements, thereby impairing a favorable vote on executive compensation.
  • Changes to golden parachute arrangements between the shareholder vote in which golden parachute arrangements are approved and a change in control transaction are subject to a separate advisory vote at the time of a change-in-control.

We note that all of the issuers who have sought approval of golden parachute arrangements to date have treated the matter as sort of a “magic bullet.”  Sneak in the table for golden parachute arrangements at the end of your compensation tables, do not say more, and you are good to go upon a change-of-control.   Should shareholders be told that their vote on executive compensation has an effect on subsequent advisory approval in connection with a change-of-control?  It looks like fertile ground for SEC comment.  That being said, disclosures would be difficult to make as issuers would have to fashion it to say no change-in-control transactions are contemplated, if true.

Our thoughts on some of the specific disclosures that have been made are set forth below.

Protective Life Corp.  (Market cap $2.1 billion; institutional ownership 86%)  This issuer has one of the most  complex benefit plans of all of the issuers we looked at, so it may be the best starting point for others contemplating this disclosure.  This issuer did not make disclosures required by S-K Rule 402(j) for termination of employment upon a change in control matters and included only the golden parachute table required by S-K Rule 402(t).   The adopting release states (page 74) “The issuer must still include in an annual meeting proxy statement disclosure in accordance with Item 402(j) about payments that may be made to named executive officers upon termination of employment.”  Perhaps there is no substantive difference here, but others need to be aware of this when following this precedent.

Transdigm Group Incorporated.  (Market cap $4.1 billion; institutional ownership 91%)  This issuer did make the separate disclosure required by both S-K Rules 402(j) and 402(t), but the amounts are identical.  The proposing release (page 42 et. seq.) goes out of its way to explain how the calculations under 402(j) and 402(t) could be different.  While there may be no substantive difference here, others need to be aware of this when relying on this precedent.

Sucampo Pharmaceuticals, Inc. (Market cap $64.2 million; institutional ownership 37%).  This issuer made disclosures under both S-K Rule 402(j) and 402(t) with differing amounts.  Hat tip to Thomas J. Knapp, General Counsel, whom we have worked with in the past and have great respect.

Fulton Financial Corporation (Market cap $2.3 billion; institutional ownership 49%).  A fairly complex disclosure that includes 402(j) and 402(t) amounts in a single table without differing amounts.  One draw back to this approach is uncertainty on whether you are invoking shareholder approval of golden parachute arrangements.  We assume that is the case here.

FNB Bancorp.  (Market cap $1.4 billion; institutional ownership 56%).  The least complex disclosure, apparently there are only cash payments on a change of control.  Others seeking to rely on this precedent should review the definition of “plan” in S-K Rule 402(a)(6) of Regulation S-K which differentiates S-K Rule 402(t) calculations from other disclosures and picks up certain non-discriminatory plans in S-K Rule 402(t) calculations.

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

Noting that its proposed rules now provide a “substantially complete mosaic” of the regulatory framework for swaps under the Dodd-Frank Act, the CFTC has reopened and extended the comment period for thirty-two of its proposed rules. The reopening and extension is designed to allow the public to comment on the regulations based on a more complete understanding of how they will interact. The Commission is also requesting comment on the order in which it should consider its final rulemakings. For the thirty-two rulemakings listed in the Federal Register notice, the comment period will be reopened and/or extended until June 3, 2011. The Commission has requested comments on the identified rulemakings individually, in combination, or globally—including, specifically, with respect to their costs and benefits.

The Chairman of the FDIC has established the FDIC Systemic Resolution Advisory Committee, or the SR Advisory Committee. The SR Advisory Committee will provide advice and recommendations on a broad range of issues regarding the resolution of systemically important financial companies pursuant to Title II of the Dodd-Frank Act.  The SR Advisory Committee is also intended to facilitate discussion on how the FDIC’s systemic resolution authority, and its implementation, may impact regulated entities and other stakeholders potentially affected by the process. The SR Advisory Committee will serve solely in an advisory capacity and will have no final decision-making authority, nor will it have access to or discuss any non-public, confidential or institution-specific information. 

Separately, thecorporatecounsel.net notes that regulatory agencies missed all 26 required rulemakings in April.

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Kirby Corp has filed this S-4 in connection with an acquisition of K-Sea Transportation Partners L.P.  The joint proxy statement/prospectus includes a Dodd-Frank advisory say-on-pay golden parachute vote.  The disclosures are pretty straightforward but others may want to add more of a sales pitch as to why shareholders should vote for the golden parachute compensation.  Another disclosure worth adding may be that failure to approve the golden parachute compensation will not affect whether or not the merger is approved.

The agenda item for the vote is as follows:

In accordance with Section 14A of the Exchange Act, K-Sea is providing unitholders with the opportunity to cast an advisory vote on the compensation that may be payable to the K-Sea Management GP named executive officers in connection with the merger as reported on the Golden Parachute Compensation table on page 73. The K-Sea Board of Directors unanimously recommends that you vote “FOR” the proposal to approve the executive compensation payable in connection with the merger.

The “required vote” disclosure is as follows:

The advisory vote of K-Sea unitholders on the compensation to be received by K-Sea Management GP executive officers in connection with the merger will be approved if the holders of a majority of the outstanding K-Sea common units and outstanding K-Sea preferred units (voting on an as-converted to common units basis), voting together as a single class, vote “For” such proposal. This proposal is advisory in nature and will not be binding on K-Sea or the K-Sea Board of Directors.

The text of the required golden parachute disclosure under Rule S-K402(t) is fairly straight forward with the required table.  We were expecting something more complex.  Disclosures other than the table include the following (italics added):

The merger agreement provides that all K-Sea phantom units will vest upon the consummation of the merger. Each executive officer that holds K-Sea phantom units has the right to elect to receive either cash or a combination of cash and Kirby common stock in the merger as if such K-Sea phantom units were K-Sea common units.

 Kirby agreed that K-Sea would amend the employment agreements with Timothy J. Casey, Richard P. Falcinelli and Thomas M. Sullivan to extend their terms by one year following the merger, and to provide severance benefits in the event their employment is terminated without cause or for good reason under such agreements. Under their existing employment agreements, the severance that each of Messrs. Casey, Falcinelli and Sullivan would receive if they were terminated following a change in control is 3.5 times his base salary at the time of termination or resignation. Severance may be paid in a lump sum or in installments at the discretion of K-Sea. In addition, K-Sea would make COBRA payments on such officer’s behalf for a period of one year.

 Kirby has agreed that if Terrence P. Gill or Gregg Haslinsky are terminated without cause or they terminate their employment for good reason within one year following the merger, they will be entitled to eighteen months’ base salary and target bonus as severance, payable in a lump sum. For this purpose, good reason means (a) a material diminution in scope of responsibilities as in effect immediately prior to the merger, (b) material diminution in compensation opportunities, or (c) relocation of the officer’s principal work location by 75 miles or more.

 None of Kirby’s executive officers will receive any type of golden parachute compensation that is based on or otherwise relates to the merger.

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It is no secret that the SEC is expected to review disclosures regarding loss contingencies this year.  To see what may be ahead, we looked at some recent SEC comment letters regarding loss contingencies.  If the SEC notes a significant potential loss, they may ask pointed questions about it.  And if you talk about it during your earnings call, but do not mention it in your periodic report, they may still ask about it.

Casella Waste Systems, Inc.

Comment:

With respect to each of the legal proceedings that you are currently involved in, please revise your disclosure to ensure you identify (i) any and all damages sought, and (ii) the possible loss or range of loss when there is at least a reasonable possibility that a loss or an additional loss in excess of amounts accrued may have been incurred.  If you have determined that it is not possible to estimate the range of loss, please provide an explanation as to why this is not possible.  Refer to FASB ASC 450-20-50-3 and 450-20-50-4.

Response:

In future annual and interim filings, as applicable, we will include, where relevant, in our Commitment and Contingencies footnote, a statement of damages sought and indicate a range of loss where there is at least a reasonable possibility that a loss may occur.  In the 3Q 10-Q we included the following disclosure in response to the Staff’s comment: [omitted]

Anadarko Petroleum Corporation

The SEC asked an interesting question regarding Andarko’s interest in the well that was the subject of the BP Deepwater Horizon event.

Comment:

Please tell us whether you have entered into any settlement discussions regarding amounts that have been incurred on your behalf by the operator of the Macondo well and, if so, please describe the status of these negotiations.

Response:

To date, there have been no substantive discussions between the parties with respect to settlement around the Deepwater Horizon events. Any settlement discussions that occur would likely be subject to confidentiality agreements between the parties and would be evaluated under the provisions of FASB ASC 450-20 to ensure appropriate disclosure and, if necessary, liability accrual.

Capital One Financial Corporation

Comment:

We note your disclosures on pages 112-115 regarding the various litigation claims that you are subject to, and your disclosure in many instances that, given the various uncertainties, you cannot provide a “meaningful” range of reasonably possible losses. We note that “meaningful” is not the defined threshold for disclosure outlined in ASC 450-20 and that this analysis may be subject to significant interpretation. Please provide further clarity in your statements in many of your litigation matters that a “meaningful” range cannot be provided.  Please clarify how you define this term for purposes of your disclosure threshold.  In this regard, the staff notes that simply because a range of losses may be large, does not necessarily mean that the range is not required or “meaningful” to investors. Please see Examples 1 and 3 in ASC Topic 450-20-55.

Response:

We regularly review the most current available data to determine if we can estimate the reasonably possible loss or range of loss for disclosed litigation matters.  In using the phrase “we cannot provide a meaningful range of reasonably possible loss,” we did not intend to articulate a disclosure threshold different from the one required by ASC 450.  In future filings, we will use the word “estimate” and we will either provide an estimate of the reasonably possible loss or range of loss or state that such an estimate cannot be made.

General Electric Company

Comment:

We see on page 2 of your earnings release that you increased reserves by $1.1 billion related to your former Japan consumer finance business that is included within discontinued operations. We additionally note that statements made by Keith Sherin during the October 15, 2010 Earnings Call, which discussed that you had adjusted your reserve estimate from the low end of the range of losses to your “best estimate and the ultimate exposure.”  Please describe for us the facts and circumstances, which occurred during the quarter ended September 30, 2010, which resulted in you increasing the loss reserves from the minimum amount of the range to a better estimate of $1.7 billion under FASB ASC 450-20-30-1. As part of your response, please include a discussion describing the timing and nature of the specific events and circumstances, which caused you to increase the reserve by $1.1 billion during the quarter ended September 30, 2010 and explain why these facts and circumstances were not considered in your reserve estimates for prior quarters in the fiscal year ended 2010.

Response:

[Introductory paragraphs omitted.]

Based on the results of this refined analysis, we recorded an adjustment to our reserves of $1,100 million in the third quarter of 2010 to bring the reserve to a better estimate of our probable loss. This adjustment reflects revisions in our assumptions and calculations of the number of estimated probable future incoming claims ($936 million), increases in claims severity assumptions ($119 million), reflecting recent trends in amounts paid per claim, and higher estimates of loss for claims in process of settlement ($45 million). As of September 30, 2010, our reserve for reimbursement of claims in excess of the statutory interest rate was $1,667 million.

Based on what we know today, we believe that our reserve for excess interest refund claims represents a better estimate of our probable loss, consistent with FASB ASC 450-20. We have included disclosure in our third quarter Form 10-Q of the events and circumstances in the third quarter 2010, along with a sensitivity analyses on expected future claims.

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In its joint proposed rule and guidance on product definitions with the SEC, the CFTC has provided guidance on the exclusion of forward contracts (with respect to nonfinancial commodities) from the definition of the term “swap,” which finds its statutory authority in the Dodd-Frank Act’s exclusion of “any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.”

Forward Contracts

1. The CFTC will interpret the forward contract exclusion from the term “swap” consistent with its historical interpretation of the forward contract exclusion from the regulation of futures contracts.
2. Intent to deliver is an essential element of a forward contract excluded from both the swap and futures contract definitions, and such intent in both instances should be evaluated based on the Commission’s established “facts and circumstances” test.
3. Book-out transactions in nonfinancial commodities that meet the requirements specified in the Brent Interpretation* (i.e., underlying contracts that (i) create a binding obligation to make or take delivery without providing any right to offset, cancel, or settle on a payment-of-differences basis and (ii) are between market participants that regularly make or take delivery of the referenced commodity in their ordinary course of business) and for which any book-out, offset, cancellation, or settlement on a payment-of-differences basis is effectuated through a subsequent, separately-negotiated agreement, should qualify for the forward exclusion from the swap definition.

Commodity Options Embedded in Forward Contracts

Given that commodity options are explicitly included in the Dodd-Frank Act’s definition of the term “swap” but forward contracts are explicitly excluded, the CFTC provided guidance regarding the treatment of embedded commodity options in forward contracts. Continuing to follow its 1985 Interpretation,** the Commission stated that a forward contract that contains an embedded commodity option would be an excluded forward contract (i.e., not a swap) if the embedded option:

1. May be used to adjust the forward contract price, but does not undermine the overall nature of the contract as a forward contract;
2. Does not target the delivery term, so that the predominant feature of the contract is actual delivery; and
3. Cannot be severed and marketed separately from the overall forward contract in which it is embedded.

Requested Comments

Comments on the proposed interpretation are due 60 days after it is published in the Federal Register. The Commission has requested comments on the following (and other) aspects of the proposed interpretation:

27. Should a minimum contract size for a transaction in a nonfinancial commodity (e.g., a tanker full of Brent Oil) be required for the transaction to qualify as a forward contract under the Brent Interpretation?
28. How often, and to what extent, do entities that do not regularly make or take delivery of the commodity in the ordinary course of their business engage in transactions that should qualify as forward contracts? Should such contracts qualify for the safe harbor provided by the Brent Interpretation?
30. Should contracts in nonfinancial commodities that may qualify as forward contracts be permitted to trade on registered trading platforms such as DCMs or swap execution facilities (“SEFs”)?
32. Should the forward contract exclusion from the swap definition apply to environmental commodities such as emissions allowances, carbon offsets/credits, or renewable energy certificates?
35. How would the proposed interpretive guidance set forth in this section affect full requirements contracts, capacity contracts, reserve sharing agreements, tolling agreements, energy management agreements, and ancillary services?

Notes

* Statutory Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39,188 (1990) (“Brent Interpretation”).
** Characteristics Distinguishing Cash and Forward Contracts and “Trade” Options, 50 Fed. Reg. 39,656 (1985) (“1985 Interpretation”).

As permitted by the Dodd-Frank Act,  the SEC and CFTC, in consultation with the Federal Reserve Board, have proposed to further define the term “swap.”  Commenters on an advance notice of proposed rulemaking pointed out a number of areas in which a broad reading of the swap and security-based swap definitions could cover certain consumer and commercial arrangements that historically have not been considered swaps or security-based swaps. Examples include variable rate debt, commercial contracts containing acceleration, escalation, or indexation clauses; agreements to acquire personal property or real property, or to obtain mortgages; employment, lease, and service agreements, including those that contain contingent payment arrangements; and consumer mortgage and utility rate caps.

According to the proposed rules, the Commissions do not believe that Congress intended to include these types of customary consumer and commercial agreements, contracts, or transactions in the swap or security-based swap definition, to limit the types of persons that can enter into or engage in them, or to otherwise to subject these agreements, contracts, or transactions to the regulatory scheme for swaps and security-based swaps.  The Commissions, therefore, proposed interpretive guidance to assist consumers and businesses in understanding whether certain agreements, contracts, or transactions that they enter into would be regulated as swaps or security-based swaps.

The types of commercial agreements, contracts, or transactions that involve customary business arrangements (whether or not involving a for-profit entity) and would not be considered swaps or security-based swaps under this proposed interpretive guidance include:

  • employment contracts and retirement benefit arrangements;
  • sales, servicing, or distribution arrangements; agreements, contracts, or transactions for the purpose of effecting a business combination transaction;
  • the purchase, sale, lease, or transfer of real property, intellectual property, equipment, or inventory;
  • warehouse lending arrangements in connection with building an inventory of assets in anticipation of a securitization of such assets (such as in a securitization of mortgages, student loans, or receivables);
  •  mortgage or mortgage purchase commitments, or sales of installment loan agreements or contracts or receivables; fixed or variable interest rate commercial loans entered into by non-banks; and
  • commercial agreements, contracts, and transactions (including, but not limited to, leases, service contracts, and employment agreements) containing escalation clauses linked to an underlying commodity such as an interest rate or consumer price index.

The types of agreements, contracts, and transactions discussed above are not intended to be exhaustive of the customary commercial arrangements that should not be considered to be swaps or security-based swaps.  There may be other, similar types of agreements, contracts, and transactions that also should not be considered to be swaps or security-based swaps.  In determining whether similar types of agreements, contracts, and transactions entered into by consumers or commercial entities are swaps or security-based swaps, the Commissions intend to consider the characteristics and factors that are common to the consumer and commercial transactions listed above:

  • they do not contain payment obligations, whether or not contingent, that are severable from the agreement, contract, or transaction;
  • they are not traded on an organized market or over-the-counter;
  • they are entered into:
    • by commercial or non-profit entities as principals (or by their agents) to serve an independent commercial, business, or non-profit purpose, and
    • other than for speculative, hedging, or investment purposes.

A similar list was provided by the Commissions for consumer transactions, and a similar analysis applies for transactions not on the specified list.

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