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

The Municipal Securities Rulemaking Board, or MSRB, is requesting comment on draft amendments to MSRB Rule G-20 (on gifts and gratuities), which would apply the rule to municipal advisors, as well as associated draft amendments to Rule G-8 (on books and records) and Rule G-9 (on preservation of records).

Rule G-20 was adopted by the MSRB to prevent brokers, dealers, and municipal securities dealers from attempting to induce other organizations active in the municipal securities market to engage in business with such dealers by means of personal gifts or gratuities given to employees of the organizations, including but not limited to acts of commercial bribery, and to help to ensure that dealers’ municipal securities activities are undertaken in arm’s length, merit-based transactions in which conflicts of interest are minimized.  The MSRB has interpreted Rule G-20 to preclude the payment by dealers of “excessive or lavish” entertainment or travel expenses of issuer personnel,

The Dodd-Frank Wall Street Reform and Consumer Protection Act authorized the MSRB to establish a comprehensive body of regulation for all municipal advisors.  Pursuant to the authority granted to it by the Dodd-Frank Act, the MSRB is requesting comment on draft amendments to Rule G-20.  Just as the existing rule helps to ensure that dealers’ municipal securities activities are undertaken in arm’s length, merit-based transactions in which conflicts of interest are minimized, the MSRB seeks to reduce the potential for conflicts of interest in municipal advisory activities. The MSRB believes the draft amendments to Rule G-20 would help to ensure that engagements of municipal advisors, as well as engagements of dealers, municipal advisors, and investment advisers for which municipal advisors serve as solicitors, are awarded on the basis of merit and not as a result of gifts made to employees controlling the award of such business.

The draft amendments to Rule G-20 would make the rule applicable to municipal advisors and would:

  • prohibit municipal advisors from giving or permitting to be given, directly or indirectly, any thing or service of value, including gratuities, in excess of $100 per year to a person other than an employee or partner of the municipal advisor, if such payments or services are in relation to the municipal advisory activities of the municipal advisor;
  • provide certain exemptions from the above prohibition, including: (i) occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the municipal advisor; (ii) legitimate business functions sponsored by the municipal advisor that are recognized by the Internal Revenue Service as deductible business expenses; or (iii) gifts of reminder advertising, provided that such gifts must not be so frequent or so extensive as to raise a suggestion of unethical conduct; and
  • permit contracts of employment or compensation for services rendered by a person other than an employee of the municipal advisor; provided that there is a written agreement between the municipal advisor and the person who is to perform such services, prior to the time of employment or before the services are rendered.

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

The Municipal Securities Rule Making Board, or MSRB, is requesting comments on a draft rule and two interpretive notices applicable to municipal advisors.

The interpretive notices are based upon the statutory definition of municipal advisor set forth in the Dodd-Frank Act without regard to any interpretation of that term proposed by the SEC in its proposed permanent registration rule for municipal advisors (SEC Release No. 34-63576 (December 20, 2010).  If the SEC’s permanent registration rule is adopted in its current form, the MSRB may request comment on revisions to the draft interpretive notice. 

Fiduciary Duty of Municipal Advisors

The Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 15B(c)(1) of the Securities Exchange Act of 1934 to provide that municipal advisors have a fiduciary duty to their municipal entity clients.  Section 15B(b)(2)(L)(i) of the Exchange Act directs the MSRB to establish rules with respect to municipal advisors that “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients.”

The MSRB requests comment on draft Rule G-36 and a related draft interpretive notice.

Draft Rule G-36 (on fiduciary duty of municipal advisors) provides:

In the conduct of its municipal activities on behalf of municipal entities, a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care.

The interpretive notice provides that the Rule G-36 duty of loyalty requires the municipal advisor to deal honestly and in good faith with the municipal entity and to act in the municipal entity’s best interests without regard to financial or other interests of the municipal advisor.  It requires a municipal advisor to make clear, written disclosure of all material conflicts of interest, such as those that might impair its ability to satisfy the duty of loyalty, and to receive the written, informed consent of officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor.  Such disclosure must be made before the municipal advisor may provide municipal advisory services to the municipal entity or, in the case of conflicts arising after the municipal advisory relationship has commenced, before the municipal advisor may continue to provide such services.

The notice provides that the Rule G-36 duty of care requires that a municipal advisor act competently and provide advice to the municipal entity after inquiry into reasonably feasible alternatives to the financings or products proposed (unless the engagement is of a limited nature).

Fair Dealing

The MSRB amended Rule G-17, effective December 22, 2010, to make the rule applicable to municipal advisors.  Amended Rule G-17 provides:

In the conduct of its municipal securities or municipal advisory activities, each broker, dealer, municipal securities dealer, and municipal advisor shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.

The draft interpretive notice notes Rule G-17 precludes a municipal advisor from engaging in any deceptive, dishonest, or unfair practice with any person, including a municipal entity or an obligated person.  The rule contains an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the SEC under the Exchange Act.  Thus, a municipal advisor must not misrepresent the facts, risks, or other material information about municipal advisory activities undertaken with a municipal entity or obligated person.  However, Rule G-17 does not merely prohibit deceptive conduct on the part of the municipal advisor. It also establishes a general duty of a municipal advisor to deal fairly with all persons (including but not limited to municipal entities and obligated persons), even in the absence of fraud.

According to the draft interpretive notice, a municipal advisor’s duties to its obligated person client under Rule G-17 will vary depending upon whether the municipal advisor has recommended a municipal securities transaction or municipal financial product to its client, or whether it has been asked to review such a transaction or product recommended by another person.  If a municipal advisor has recommended such a transaction or product to its client, the advisor must have concluded, in its professional judgment, that the transaction or product is appropriate for the client, given its financial circumstances, objectives, and market conditions, and must advise the client of material risks and characteristics of the structure or product.  The municipal advisor must also advise the client of any incentives for the municipal advisor to recommend the transaction or product and any other associated conflicts of interest.

If a municipal advisor has been engaged by its obligated person client to review a municipal securities transaction or municipal financial product recommended by another party (e.g., an underwriter), Rule G-17 requires the municipal advisor to evaluate and advise the client of the material risks and characteristics of the transaction or product and its appropriateness for the client, based on the client’s financial circumstances, objectives, and market conditions.  The municipal advisor is not required to have considered then reasonably feasible alternatives unless otherwise requested to do so by the client.  Furthermore, the municipal advisor need not advise its client as to the appropriateness of the transaction or product if it has expressly disclaimed that obligation in its engagement letter or other writing with the client.

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 begun operating a new website.  It is not the typical website run by government regulators—it invites consumers to submit comments by YouTube and Twitter.

The site discloses the CFPB now has 100 employees.  It has moved out of Treasury Department offices and into temporary headquarters which it anticipates it will occupy for the next several months.  The conference rooms in the temporary headquarters are named Dodd-Frank (after the name of the legislation that created the CFPB); Full Disclosure (one of the CFPB’s goals for the costs, risks, and other important terms of consumer financial products and services); Accountability (another of the CFPB’s goals); and Boomer Sooner (the name of the University of Oklahoma’s fight song – a nod to Professor Elizabeth Warren’s Oklahoma roots). 

The CFPB expects to hire several hundred employees over the course of 2011 and 2012. Additionally, the CFPB expects to receive staff transferred from six of the federal agencies that will be transferring consumer financial protection functions to the consumer bureau. 

Under the Dodd-Frank Act, the CFPB is funded by transfers from the Board of Governors of the Federal Reserve System. The CFPB can request funds from the Federal Reserve that are reasonably necessary to carry out its consumer financial protection functions, but the CFPB’s funding from the Federal Reserve is capped at a pre-set percentage of the total operating expenses of the Federal Reserve, subject to an annual adjustment. To date, the CFPB has requested two funding transfers from the Federal Reserve for a total of just under $33 million. 

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

Item 5.07 to Form 8-K was revised in connection with the adoption of the final say-on-pay rules.  Issuers must now amend their Form 8-Ks that disclose voting results to “disclose the company’s decision in light of such vote as to how frequently the company will include a shareholder vote on the compensation of executives in its proxy materials until the next required vote on the frequency of shareholder votes on the compensation of executives.”  The amendment must be made “no later than one hundred fifty calendar days after the end of the annual or other meeting of shareholders at which shareholders voted on the frequency of shareholder votes on the compensation of executives as required by section 14A(a)(2) of the Securities Exchange Act of 1934 (15 U.S.C. 78n-1), but in no event later than sixty calendar days prior to the deadline for submission of shareholder proposals under §240.14a-8.”

Although issuers are not required to disclose their decision on how often the advisory vote on compensation will be held for a period of time, some issuers are including the disclosure in the initial reports filed with respect to the results of the vote.  Obviously that cuts off the need to file an amendment, but only works where a quick decision can be made.

For instance, one issuer stated  “In accordance with the voting results for this item, the Company’s Board of Directors determined that an advisory vote to approve the compensation of the named executive officers of the Company will be conducted every two years, until the next stockholder advisory vote on the frequency of the advisory vote to approve the compensation of the named executive officers of the Company.”

Another issuer stated “In accordance with the results of this vote, the Board of Directors determined to implement an annual advisory vote on executive compensation, commencing with the company’s 2012 annual meeting of shareholders.”

We like the relative precision of Irish company, Accenture PLC’s disclosure:  “In light of the voting results with respect to the frequency of shareholder votes on executive compensation, Accenture’s Board of Directors has decided that Accenture will hold an annual advisory vote on the compensation of named executive officers until the next required vote on the frequency of shareholder votes on the compensation of executives. Accenture is required to hold votes on frequency every six years.”

While not required to do so, other issuers are stating they will consider the results in the future.  An example is “The Compensation Committee of the Board of Directors expects to review and consider the results of these two non-binding advisory votes in conducting the affairs of the Compensation Committee over the coming year.”

Another more precise example from Zoll Medical is “The Board will evaluate the results of such non-binding advisory vote regarding the frequency of future non-binding, advisory votes on executive compensation at a future meeting and make a determination as to whether the Company will submit future non-binding advisory votes on executive compensation for consideration by shareholders every one, two or three years. The Company will amend this Current Report on Form 8-K to provide information regarding such determination.”

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

CFTC Commissioners Scott O’Malia (R) and Bart Chilton (D) have joined the fray over President Obama’s recently released budget for fiscal year 2012 by releasing statements in recent days regarding the budget’s allocation for CFTC spending. The President’s budget requests $308 million for the CFTC (a 45 percent increase over fiscal year 2011) and proposes to hire 316 additional staff (a 47 percent increase), plus an additional 218 contractors. To pay for some of this increase, the budget requests Congress to provide authority for the CFTC to impose user fees on market participants.

Commissioner O’Malia “strongly oppose[s]” the budget’s unauthorized user fee or “transaction tax” as a disingenuous effort to hide what will amount to an increased in the federal deficit. The Commissioner provided the following additional criticisms regarding the budget:

– It fails to outline a strategy for utilizing technology as a means to leverage staff resources and to keep pace with sophisticated trading practices in the market.
– It neglects reliance on self regulatory organizations such as exchanges and clearinghouses, or the Natural Futures Association.
– It provides for 85 additional full time employees to investigate fraud, but none for the purpose of fraud prevention through customer education and outreach.

By contrast, Commissioner Chilton stated that the budget presents an “admirable equilibrium” between fiscal restraint and the needed resources for market oversight and enforcement, noting that the agency’s regulatory purview has expanded from roughly $5 trillion in annualized trading to hundreds of trillions. While he expressed a preference for annual appropriations from Congress as opposed to imposition of a user fee on market participants, Commissioner Chilton stated that “if the choice is between user fees or inadequate resources to fund oversight and enforcement, then we need to pull the trigger on user fees.”

We have previously written about Section 951 of the Dodd-Frank Act, which adds new Section 14A to the Securities Exchange Act to require companies to conduct shareholder advisory votes to approve the compensation of executives, as disclosed pursuant to Item 403 of Regulation S-K, or any successor thereto.  We have also been tracking the implementation of the “say-on-pay” requirements pursuant to new Rule 14A-21 and the early results of the shareholder votes on say-on-pay.

            The SEC recently issued several new Compliance and Disclosure Interpretations (CD&Is) that address matters relating to the implementation of the say-on-pay and say-on-golden-parachute rules for issuers. Some of these new CD&Is are written for registrants that may qualify for optional smaller reporting company treatment pursuant to Rule 405 under the Securities Act, which entitles the registrant to scaled back disclosure for several items, including Item 402 of Regulation S-K regarding executive compensation (see Item 10 of Regulation S-K).

            Registrants must comply with Rule 14A-21 for the first annual or other meeting of shareholders on or after January 21, 2011.  However, the compliance date for smaller reporting companies is extended to January 21, 2013.  Status as a smaller reporting company is measured as of the last business day of the second fiscal quarter of 2010.

The new CD&Is provide that:

  •  Even if a registrant has never before checked the box indicating it was a smaller reporting company on a periodic report, if the registrant qualifies as a smaller reporting company as of the last day of the second fiscal quarter of 2010, and it plans to file as a smaller reporting company going forward, it is still eligible for the delayed January 21, 2013 phase-in date for Rule 14A-21. (CD&I 169.01)

 

  • A registrant that has historically qualified as a smaller reporting company, but that fails to qualify as a smaller reporting company for 2011, will not be permitted to check the “Smaller Reporting Company” box on the cover of its Form 10-Q for the first fiscal quarter of 2011.  However, the registrant will be able to check the box as a smaller reporting company for its 10-K for fiscal year 2010, even though the 10-K will be filed after January 21, 2011.  (CD&I 169.02)

 

  • A registrant whose 2011 fiscal year will not begin until April 1, 2011, and that fails to qualify as a smaller reporting company for fiscal 2011 based on the measurement of its public float on the last day of its second fiscal quarter in 2010 (in this case, September 30, 2010) is still eligible for the delayed phase-in date of January 21, 2013.  This is because the registrant was still a smaller reporting company in its 2010 fiscal year when the January 21, 2011 phase-in date for larger companies occurred.  (CD&I 169.03)

 

  • The say-on-frequency vote that is required by Rule 14a-21(b) need not be in the form of a resolution, like the say-on-pay vote. (CD&I 169.04)

 

  • The say-on-pay vote can use plain English to explain the regulatory sources of the required vote, rather than recite the words “pursuant to Item 402 of Regulation S-K.” (CD&I 169.05)

 

  • The say-on-frequency vote can use the words “every year, every other year, or every three years, or abstain” instead of Regulation S-K’s “every 1, 2, or 3 years, or abstain.” (CD&I 169.06)

 

  • A registrant must include certain information relating to golden parachute arrangements in its proxy or consent solicitations relating to a merger, acquisition, consolidation, proposed sale, or other disposition of all or substantially all of the registrant’s assets, pursuant to new Item 402(t) of Regulation S-K.  Although instruction 1 to Item 402(t)(2) of Regulation S-K states that this information must be supplied for those executive officers who were included in the most recently filed Summary Compensation Table, this instruction will not permit the registrant to omit this information with respect to a newly hired executive whose information was not included within the most recently filed Summary Compensation Table. (CD&I 128B.01)

Check back at Dodd-Frank.com frequently as we continue to monitor and comment on the implementation of this landmark legislation.

Developments this week included  another no vote at Beazer Homes and a three-year frequency cycle being approved at Tyson Foods.  Smaller reporting issuers who published a proxy statement before the SEC granted an exemption are seeking to limit the damage.

Beazer Homes No Vote-Positive Results Don’t Count

 53.7% of the shares voted opposed Beazer Homes’ executive compensation.  According to Riskmetrics’ corporate governance blog, the reasons for the no vote included increased CEO compensation in the face of negative shareholder returns.

We do not know if the no vote was merited or not, but it is pretty easy to take the other side of the argument.    While total shareholder return may have been negative, significantly better financial results were reported during the three year period.  The net loss in 2008 was $951,912,000, 2009 net loss was $189,383,000 and 2010 net loss was $34,049,000.  The CEO did not receive a bonus in the prior year and had not received equity grants for several years.  It seems dangerous to us that advisory firms are recommending no votes in challenged industries based on negative shareholder returns where demonstrable improvements have been made at specific companies.  But once again the damage by the no vote may have been self inflicted because the CD&A did not seem to emphasize relevant facts.

Tyson Foods Means Nothing

  Tyson Foods did succeed in having a three year frequency vote approved but published reports to date seem to ignore the fact that 69.8% of its voting power was controlled by a single insider.  So this is not a surprise and is not predictive of other issuers.  Some also tout the positive results on the say-on-pay vote.  We question that, as 11% of the shares were voted against executive compensation, and with 69% controlled by an insider, this means roughly 36% of the non-insiders are unhappy with executive compensation.

Smaller Reporting Issuers Seek to Avoid Future Votes Despite What They Said In Their Proxy Statements

Temporarily exempt from say-on-pay rules are smaller reporting issuers.  For those that have filed proxy statements before final rules were published, language is being included in 8-Ks reporting voting results emphasizing the new exemption.  See CSP Inc:
“Accordingly, as provided in the Adopting Release, we are not required to comply with the say-on-pay and say-when-on-pay regulations until our first Annual Meeting on or after January 21, 2013. At that Annual Meeting, we currently anticipate that we would seek advisory shareholder votes regarding approval of executive compensation and the frequency of votes for approval of executive compensation, and we will subsequently disclose in Form 8-K our decision about how frequently we will conduct shareholder advisory votes on the compensation of executives.”

Frequency Votes

By our count, 54 issuers have reported the results of frequency votes.  No issuer with a market cap of over $10 billion has had a triennial vote approved (eight have tried).  For issuers with a market cap of over $1 billion to $10 billion, only one issuer, other than controlled Tyson Foods, has had a triennial frequency approved (five have tried).  Three issuers with a market cap between $200 million and $1 billion have had a triennial frequency approved, but two of these issuers were controlled (six have tried).  Eleven of twelve issuers with a market cap of less than $200 million that have sought a triennial frequency have had it approved but many of these issuers are controlled.
Three issuers have had a biennial frequency approved, but all were controlled (seven have tried).

No Votes

Here we tracked issuers with a market cap of over $1 billion and eliminated issuers with greater than 30% control (lower control thresholds would not have changed this significantly).  There were 17 issuers included in this data.  Ten issuers, or 59%, had no votes of five percent or less.  Twelve issuers, or 70%, had no votes of ten percent or less.

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

The Federal Deposit Insurance Corporation (FDIC) announced the hiring of key senior leadership staff for the Office of Complex Financial Institutions (CFI) and the Division of Depositor and Consumer Protection (DCP).  The FDIC Board of Directors approved the establishment of these new organizations in August 2010 to enhance the FDIC’s ability to carry out its new and enhanced responsibilities under the Dodd-Frank Act.  According to the FDIC, CFI will provide strategic direction to the FDIC’s new mission responsibilities under the Dodd-Frank Act to monitor and address risks in the largest, systemically important financial institutions, and DCP will provide greater focus and visibility to FDIC’s depositor and consumer protection programs.

Both organizations will begin formal operations on February 13, 2011.  In addition, the Division of Supervision and Consumer Protection will become the Division of Risk Management Supervision on that date.

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, approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing. The rule implements changes to the deposit insurance assessment system mandated by the Dodd-Frank Act and revises the assessment system applicable to large banks to eliminate reliance on debt issuer ratings and make it more forward looking. The Dodd-Frank Act required that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on assets. 

In November 2010, the Board approved a proposed rule to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity and reissued a proposed rule revising the deposit insurance assessment system for large institutions that was approved by the FDIC in April 2010. The Board approved a proposed rule on Assessment Dividends, Assessment Rates and the Designated Reserve Ratio in October 2010. The final rule encompasses all of these proposed rules. 

This final rule is intended to better reflect risks to the deposit insurance fund, while also providing the industry greater certainty regarding what rates will be over the long run.  By changing the assessment base from deposits to assets minus tangible equity, the Dodd-Frank Act allows the FDIC to charge deposit insurance assessments on secured liabilities, which the FDIC has always protected.  The rule is meant to keep the overall amount collected from the industry very close to unchanged, although the amounts that individual institutions pay will be different.

The FDIC believes the new large bank pricing system will result in higher assessment rates for banks with high-risk asset concentrations, less stable balance sheet liquidity, or potentially higher loss severity in the event of failure.  Over the long term, large institutions that pose higher risk will pay higher assessments when they assume these risks rather than when conditions deteriorate. 

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

The Federal Reserve Board has published for comment proposed amendments to Regulation Y that (1) establish the criteria for determining whether a company is “predominantly engaged in financial activities” and (2) define the terms “significant nonbank financial company” and “significant bank holding company” for purposes of Title I of the Dodd-Frank Act.  These terms are relevant to various provisions of Title I of the Dodd-Frank Act, including Section 113, which authorizes the Financial Stability Oversight Council, or FSOC, to designate a nonbank financial company for supervision by the Federal Reserve Board if the FSOC determines that the company could pose a threat to the financial stability of the United States. The FSOC recently requested comment on a proposed rule to implement Section 113 of the Dodd-Frank Act. 

More specifically, the Federal Reserve Board’s proposed rule establishes the requirements for determining if a company is “predominantly engaged in financial activities.” Under the Dodd-Frank Act, a company generally can be designated by the FSOC only if 85 percent or more of the company’s revenues or assets are related to activities that have been determined to be financial in nature under the Bank Holding Company Act. 

As mentioned, the Federal Reserve Board’s proposed rule defines the terms “significant nonbank financial company” and “significant bank holding company.”  Among the factors the FSOC must consider in determining whether to designate a nonbank financial company for supervision by the Federal Reserve Board is the extent and nature of the company’s transactions and relationships with other “significant” nonbank financial companies and “significant” bank holding companies.  Under the proposal, a firm would be considered “significant” if it has $50 billion or more in total consolidated assets or had been designated by the FSOC as systemically important.

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