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

The SEC and CFTC have proposed joint rules regarding reporting by registered investment advisers to private funds and certain commodity pool operators, or CTOs, and commodity trading advisers, or CTAs, pursuant to Title IV of the Dodd-Frank Act.  Among other things,  the SEC defines the terms “hedge fund” and “private equity fund” in the proposed rules. 

Reporting would be accomplished by filing new Form PF with the SEC which looks more difficult than a tax return.  Form PF is comprised of 63 pages of forms, instructions and glossaries.  The report would not be made public pursuant to the confidentiality provisions of the Dodd-Frank Act.  The report will be filed electronically on a yet to be designed system and would require payment of a fee which has not yet been determined.  Larger funds may have to begin reporting by January 15, 2012.

Persons Required to Report

The SEC is proposing a new Rule 204(b)-1 under the Advisers Act to require that SEC-registered investment advisers file Form PF if they advise one or more private funds.  For registered CPOs and CTAs that are also registered as investment advisers with the SEC and advise a private fund, this report also would serve as substitute compliance for a portion of the CFTC’s proposed systemic risk reporting requirements under proposed Commodity Exchange Act rule 4.27(d).

Timing of Filings

Smaller private fund advisers will be required to report basic information about the operations of its private funds on Form PF once each year.  However, “Large Private Fund Advisers”  will be required to submit this basic information each quarter along with additional systemic risk related information required by Form PF concerning certain of their private funds.  Large Private Fund Advisers are:

  • Advisers managing hedge funds that collectively have at least $1 billion in assets as of the close of business on any day during the reporting period for the required report;
  • Advisers managing private equity funds that collectively have at least $1 billion in assets as of the close of business on the last day of the quarterly reporting period for the required report; and
  • Advisers managing a liquidity fund and having combined liquidity fund and registered money market fund assets of at least $1 billion as of the close of business on any day during the reporting period for the required report.

Hedge funds and liquidity funds would be required to measure the $1 billion threshold daily.  Private equity funds would be required to measure the threshold quarterly.

Hedge Funds, Private Equity Funds and Liquidity Funds

Proposed Form PF would define “hedge fund” as any private fund that:

  • has a performance fee or allocation calculated by taking into account unrealized gains;
  • may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or
  • may sell securities or other assets short.

A “liquidity fund” would be defined as any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.

Finally, a “private equity fund” would be defined as any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not provide investors with redemption rights in the ordinary course.

More on Form PF

Each investment adviser required to file Form PF would have to complete Section 1 of the Form.  Form PF would require private fund advisers who had at least $1 billion in hedge fund assets under management as of the close of business on any day during the reporting period to complete Section 2.  Section 3 of Form PF would have to be completed by private fund advisers advising a liquidity fund and managing at least $1 billion in combined liquidity fund and registered money market fund assets as of the close of business on any day in the reporting period.  Finally, Section 4 of Form PF would have to be completed by private fund advisers managing at least $1 billion in private equity fund assets as of the close of business on the last day of the reporting period.

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

We reviewed five Form 8-Ks we located that were filed on January 26 and 27, 2011 disclosing say-on-pay vote results for non-TARP recipients.  In each case the shareholders voted with the board recommendation on the frequency vote (three annual and two triennial).  The highest percentage vote against the say-on-pay resolution was 21%.  Two of the issuers were smaller reporting companies, which but for the accident of timing of their annual meeting date, would have been exempt under the SEC final rules issued this week.

Harleysville Savings

3% voted against the say-on-pay resolution.  The board recommended a three year frequency vote and the results were:  annual 14%, biannual 3 %, triennial 79%, abstain 4%.  Other factors:  no institutional ownership; 12% held by insiders and 5% by an ESOP; market cap – $44.9 million; 21% broker non-votes.

Laclede Group

9% voted against the say-on-pay resolution.   The board recommended a three year frequency vote and the results were:  annual 45%, biannual 3%, triennial 48%, abstain 4%.  Other factors:  9% institutional ownership, 8% held by insiders; market cap $700 million; 19% broker non-votes.

New Jersey Resources

 5% voted against the say-on-pay resolution.  The board recommended an annual frequency and the results were:  81% annual; 1% biannual; 16% triennial, 2% abstain.  Other factors:  12% institutional ownership;  1% held by insiders; market cap $1.5 billion; 19% broker non-votes.

Tech/Ops Sevcon

Less than 1% voted against the say-on-pay resolution.  The board recommended an annual frequency and the results were:  annual 67%, biannual less than 1%, triennial 2%; abstain 30%.  Other factors:  30% institutional ownership; 3% held by insiders; market cap $12 million; 16% broker non-votes.

Mueller Water Products

21% voted against the say-on-pay resolution. The board recommended an annual frequency and the results were:  annual 85%; biannual less than 1%; triennial 11%; abstain 3%.  Other factors:  7% institutional ownership; 2% held by insiders; Market cap $732 million; 24% broker non-votes.

Market cap information is as disclosed on the cover of Form 10-K for the second fiscal quarter.  Institutional ownership is based on greater than 5% holders disclosed in proxy statements (and takes a bit of a guess to identify them) so this factor may be understated.

See our results from January 25 8-Ks here.

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

Section 919B of the Dodd-Frank Act directs the SEC to complete a study, including recommendations, of ways to improve the access of investors to registration information about registered and previously registered investment advisers, associated persons of investment advisers, brokers and dealers and their associated persons, and to identify additional information that should be made publicly available.  The Dodd-Frank Act requires the SEC to complete the study within six months after the date of enactment of the Dodd-Frank Act (i.e., by January 21, 2011), and to implement any recommendations within eighteen months after completion of the study.  The required study conducted by the SEC staff has been released to the public.

The SEC and its staff have long maintained that investors should examine relevant registration information before choosing a broker-dealer or investment adviser.  Information pertaining to a broker-dealer or investment adviser’s federal or state registration, such as information about its associated persons, including licensing and other qualification data, disciplinary and employment history, contact information, and customer complaints, can help investors make better-educated decisions in selecting a broker-dealer or investment adviser, as well as better protect themselves against fraud.

Currently, a significant amount of registration data is publicly available, primarily through BrokerCheck (an online application maintained through FINRA with information about broker-dealers) and Investment Adviser Public Disclosure, or IAPD (for investment advisers and their associated persons).  Additionally, both the SEC and state securities regulators require investment advisers to deliver to advisory clients brochures and brochure supplements regarding employees, including investment adviser representatives, who provide advisory services.

While the current process enables investors to obtain registration information about a broker-dealer or investment adviser, the study states improvements could be made within the statutorily-mandated eighteen-month period that would further promote investors’ interests.  In that context, the staff made a number of recommendations.  First, the staff, pursuant to Section 919B, considered the advantages and disadvantages of further centralizing the two systems.  The primary advantage would be to provide investors access to relevant data through one request, regardless of whether they seek data about a broker-dealer or an investment adviser.  The staff believes that a unified public disclosure database would be optimal to achieve this goal. However, the practical difficulties involved – including Section 919B’s eighteen-month timeframe for implementation – militate toward a near-term recommendation that would involve less structural change.  As a result, the study recommends unifying search returns for BrokerCheck and IAPD while continuing to maintain the separate databases.  This would allow investors to find registration information on both broker-dealers and investment advisers, regardless of whether investors are using BrokerCheck or IAPD.

Second, the study includes two additional recommendations pertaining to increasing the usefulness of the systems to investors. The staff recommends that BrokerCheck and IAPD search functions be expanded to permit searches for broker-dealers, investment advisers, registered representatives, and investment adviser representatives, based on ZIP code or other indicator of location.  This feature would offer a valuable tool for investors who are beginning a search for a broker-dealer, investment adviser, or registered person, but who have limited online access to registration data organized by location.  The staff further recommends that BrokerCheck and IAPD be enhanced by adding educational content, such as links and definitional material, perhaps, embedded in alternate text tags (e.g., “bubbles,” “pop-ups,” or other kinds of “hover” text) that would appear automatically whenever a user’s electronic cursor hovers over certain text or items on the BrokerCheck and IAPD web pages. These functions would provide definitions or other explanatory content to help a user better understand the significance of a particular technical term or reference.

The staff also recommends that, subsequent to the eighteen-month implementation period, SEC staff and FINRA continue to analyze, including through investor testing, the feasibility and advisability of expanding BrokerCheck to include information currently available in the Central Registration Depository, or CRD (a centralized data base that consolidates information about broker-dealers and similar persons), as well as the method and format of publishing that information; and that SEC staff continue to evaluate expanding IAPD content and the method and format of publishing that content, including through investor testing.  Potential modifications could include adding summary data for advisory firms on IAPD, hyperlinks between CRD numbers and SEC file numbers containing information related to a particular CRD number, and additional links to content available elsewhere on BrokerCheck or IAPD.

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

Based on filed 8-Ks, two companies have reported the results of the shareholder advisory vote on frequency of the say-on-pay vote as of January 25, 2011.  In both, the board recommended a triennial vote.  However, the shareholders in one voted for an annual say-on-pay vote, and the other went with a three year vote.

The shareholders in Monsanto voted for the one year frequency (62.2% annual, 35.9% biennial, 1.4% triennial and 0.5% abstain).  Given Monsanto status as a large cap and ISS’s one year recommendation, perhaps the surprise here is the number of shareholders electing a biennial vote.  ISS was quick to pound its chest, issuing this statement which says “Monsanto investors overwhelmingly defied management’s triennial recommendation and voted for an annual advisory vote on executive compensation.”

But not so fast.  Little known Roebling Financial Corp, Inc. filed an 8-K as well, where the shareholders approved a triennial vote (27% annual, 4% biennial, 64% triennial, 5% abstain).  Roebling’s proxy statement discloses insider ownership at 22.8% with no institutional owners.

While the end of the story remains to be written, the results make clear what we have been telling clients for months will probably happen:  If ISS has significant influence over your shareholder base, expect a one year frequency vote.  For the vast majority of other smaller issues (by number, not market cap), you stand a much better chance of obtaining a triennial vote if that is what the Board is willing to recommend.

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

The SEC has issued its final say-on-pay rules (Release No. 33-9178; 34-63768).  The good news is the final rules are mostly tweaks, and issuers’ advance planning to date will be fruitful.  In addition, smaller reporting companies will be exempt from say-on-pay and frequency votes for any meeting held prior to January 21, 2013 (but not approval of so called “golden parachute compensation” in connection with an acquisition).  On the downside, the SEC did not grant any significant advantages to submitting “golden parachute compensation” to a shareholder advisory vote at an annual meeting to take advantage of an exception from including the advisory vote on golden parachute compensation in connection with a merger.

Some of the more important changes are highlighted below.

Form of Say-on-Pay Resolution Approving Compensation

The final rule does not require issuers to use any specific language or form of resolution to be voted on by shareholders.  As the SEC noted in the proposing release, however, the shareholder advisory vote must relate to all executive compensation disclosure disclosed pursuant to Item 402 of Regulation S-K.  Section 14A(a)(1) of the Exchange Act requires that the shareholder advisory vote must be “to approve the compensation of executives, as disclosed pursuant to [Item 402 of Regulation S-K] or any successor thereto.”  The SEC has added an instruction to Rule 14a-21(a) to indicate that this language from Section 14A(a)(1) should be included in an issuer’s resolution for the say-on-pay vote.  The SEC has also provided the following non-exclusive example of a resolution that would satisfy the applicable requirements:

“RESOLVED, that the compensation paid to the company’s named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion is hereby APPROVED.”

We do not see any reason not to use the example provided by the SEC.  Perhaps somewhat inconsistently, the SEC declined to give any example of a resolution for the frequency vote.

New 8-K Reporting Requirement; 10-K and 10-Q Disclosure Eliminated

The SEC proposed amendments to Form 10-Q and Form 10-K to require additional disclosure regarding the issuer’s decision to adopt a policy on the frequency of say-on-pay votes following a shareholder advisory vote on frequency.  After considering the comments, the SEC is not adopting amendments to Form 10-Q and Form 10-K.  Instead, the SEC is adopting a new Form 8-K Item to require disclosure of the issuer’s decision on the frequency of say-on-pay votes.

Under the final rule, Item 5.07 of Form 8-K requires an issuer to disclose its decision regarding how frequently it will conduct shareholder advisory votes on executive compensation following each shareholder vote on the frequency of say-on-pay votes.  To comply, an issuer will file an amendment to its prior Form 8-K filings under Item 5.07 that disclose the preliminary and final results of the shareholder vote on frequency.  This amended Form 8-K will be due no later than 150 calendar days after the date of the end of the annual or other meeting in which the vote required by Rule 14a-21(b) took place, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals under Rule 14a-8 for the subsequent annual meeting, as disclosed in the issuer’s proxy materials for the meeting at which the frequency vote occurred.  In the amended Item 5.07 Form 8-K, the issuer must disclose its determination regarding the frequency of say-on-pay votes.

The SEC also adopted a technical amendment to Item 5.07(b) of Form 8-K to facilitate reporting of shareholder votes on frequency.  Item 5.07 of Form 8-K generally requires an issuer to “state the number of votes cast for, against, or withheld, as well as the number of abstentions and broker non-votes as to each such matter….”  The final rules clarify that, with respect to the vote on the frequency of say-on-pay votes, the issuer will be required to disclose the number of votes cast for each of 1 year, 2, years, and 3 years, as well as the number of abstentions.

Consideration of Say-on-Pay Vote—Only the Most Recent

The SEC proposed to amend Item 402(b)(1) to add to the mandatory CD&A topics whether, and if so, how an issuer has considered the results of previous shareholder votes on executive compensation required by Section 14A or Rule 14a-20 in determining compensation policies and decisions and, if so, how that consideration has affected its compensation policies and decisions.  In the final rule the SEC limited the mandatory topic to “the most recent say-on-pay vote.”  The SEC also stated that consistent with the principles-based nature of CD&A, issuers should address their consideration of the results of earlier say-on-pay votes to the extent such consideration is material to the compensation policies and decisions discussed.

Enhanced Frequency Disclosure

Proxy statements will now have to disclose pursuant to Item 24 of Schedule 14A the current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur.

Voting of Uninstructed Proxy Cards

In response to comment, the SEC noted that issuers may vote uninstructed proxy cards in accordance with management’s recommendation for the frequency vote only if the issuer follows the existing requirements of Rule 14a-4 to (1) include a recommendation for the frequency of say-on-pay votes in the proxy statement, (2) permit abstention on the proxy card, and (3) include language regarding how uninstructed shares will be voted in bold on the proxy card.  Make sure this is on your checklist.

No Flexibility in Golden Parachute Disclosures for Annual Meetings

Consistent with Section 14A(b)(2) of the Exchange Act and the SEC proposal, issuers will not be required to include in a merger proxy a separate shareholder vote on the golden parachute compensation if required disclosure of that compensation had been included in the executive compensation disclosure that was subject to a prior vote of shareholders under Section 14A(a)(1) of the Exchange Act and Rule 14a-21(a).   Note that Section 14A(b)(2) requires only that the golden parachute arrangements have been subject to a prior shareholder vote under Section 14A(a)(1); such arrangements need not have been approved by shareholders.

For issuers to take advantage of this exception, however, the executive compensation disclosure subject to the prior shareholder vote must have included Item 402(t) disclosure of the same golden parachute arrangements. The exception will be available only to the extent the same golden parachute arrangements previously subject to an annual meeting shareholder vote remain in effect, and the terms of those arrangements have not been modified subsequent to the Section 14A(a)(1) shareholder vote.

As proposed and adopted, if the disclosure pursuant to Item 402(t) has been updated to change only the value of the items in the “Golden Parachute Compensation Table” to reflect price movements in the issuer’s securities, no new shareholder advisory vote under Section 14A(b)(1) will be required.  However, the SEC stated any change that would result in an IRC Section 280G tax gross-up becoming payable as a change in terms triggering such a separate vote, even if such tax gross-up becomes payable only because of an increase in the issuer’s share price.

The SEC also stated that changes in compensation because of a new named executive officer, additional grants of equity compensation in the ordinary course, and increases in salary, are significant changes to the golden parachute compensation disclosure and should be subject to a shareholder vote.  Because a shareholder vote would already have been obtained on portions of the arrangements, however, only the new arrangements and revised terms of the arrangements previously subject to a shareholder vote will be subject to the merger proxy separate shareholder vote.  We believe however that submitting such isolated changes have the likelihood of the advisory vote being limited to immaterial maters and causing shareholder confusion.

Backtracking on Rule 14a-8 Exclusions

The SEC’s proposed amendment to Rule 14a-8 would have added a note to Rule 14a-8(i)(10) to clarify the status of shareholder proposals that seek an advisory shareholder vote on executive compensation or that relate to the frequency of shareholder votes approving executive compensation.  Rule 14a-8 provides eligible shareholders with an opportunity to include a proposal in an issuer’s proxy materials for a vote at an annual or special meeting of shareholders. An issuer generally is required to include the proposal unless the shareholder has not complied with the rule’s procedural requirements or the proposal falls within one of the rule’s 13 substantive bases for exclusion. One of the substantive bases for exclusion, Rule 14a-8(i)(10), provides that an issuer may exclude a shareholder proposal that has already been substantially implemented.

The SEC proposed adding a note to Rule 14a-8(i)(10) to permit the exclusion of a shareholder proposal that would provide a say-on-pay vote or seeks future say-on-pay votes or that relates to the frequency of say-on-pay votes, provided the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with the plurality of votes cast in the most recent vote in accordance with Rule 14a-21(b).  The final rule only permits exclusion of a shareholder proposal if a policy is adopted consistent with a majority of votes cast.

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

The SEC has proposed rules pursuant to Section 413(a) of the Dodd-Frank Act which requires the definition of “accredited investor” in the SEC’s Securities Act rules to exclude the value of a person’s primary residence for purposes of determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million.  The amended definition of the term “accredited investor” appears to contain few surprises and is as follows:

“Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.”

The SEC considered proposing amendments that would have defined the term “primary residence” for purposes of the amended rules. While the SEC is soliciting comment on whether a definition should be added to the rule, the proposal does not contain a definition, consistent with the SEC’s past policies in this area, and in an attempt to avoid unnecessary complexity.

The SEC believes issuers and investors should be able to use the commonly understood meaning of “primary residence”—the home where a person lives most of the time.  The SEC also believes if additional analysis is needed under complex or unusual circumstances, helpful guidance may be found in rules that apply in other contexts, such as income tax rules and rules that apply when acquiring a mortgage loan for a primary residence, which often bears a lower interest rate than other mortgage loans.

The SEC is not proposing any special rules for transition to the new accredited investor net worth standards, since these new standards were effective upon enactment of the Dodd-Frank Act. Under the current rules, a company or fund is not permitted to treat an investor as accredited if the investor subsequently loses that status, even if the investor has previously invested in the company or fund at a time when it satisfied the accredited investor standard.  Investors must satisfy the applicable accredited investor income or net worth standard in effect at the time of every exempt sale of securities to the investor that is made in reliance upon the investor’s status as such.  The proposed amendments would not change this situation.

The SEC nevertheless is seeking comment on whether some transition and other rules might be appropriate to facilitate subsequent investments by an investor who previously qualified as accredited but was disqualified by the change effected by the Dodd-Frank Act.  For example, an investor that qualified as an accredited investor in a previous sale under Regulation D before enactment of the Dodd-Frank Act may wish to invest in the same company or fund in order to retain its proportionate interest in the company or fund or to exercise rights that have arisen because of that interest.  Or a company may wish to make a rights offering to current investors who invested as accredited investors.  In this case, the company may not wish to be subject to the additional information requirements it may incur under Regulation D if it offers and sells securities to non-accredited investors, and the company may be precluded from making the offering if the number of non-accredited investors exceeds the limit of 35 non-accredited investors imposed in Rule 505 and Rule 506 offerings.  In some of these cases, the investor may have spent a substantial amount of time and money performing due diligence on the company or fund before his or her previous investments and may be familiar with the issuer as an existing investor.  Under these circumstances, some have argued that the investor should be able to invest again as an accredited investor even if the investor does not satisfy the standards applicable at the time of the subsequent investment.

In addition, Section 413(b) of the Dodd-Frank Act specifically authorizes the SEC to undertake a review of the definition of the term “accredited investor” as it applies to natural persons, and requires the SEC to undertake a review of the definition “in its entirety” every four years, beginning four years after enactment of the Dodd-Frank Act.  The SEC is also authorized to engage in rulemaking to make adjustments to the definition after each such review.  The SEC is not proposing to make revisions to the definitions of “accredited investor” that are not required by the Dodd-Frank Act at this time, but may consider doing so in future rulemaking.  Section 415 of the Dodd-Frank Act requires the Comptroller General of the United States to conduct a “Study and Report on Accredited Investors” examining “the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.”  The study is due three years after enactment of the Dodd-Frank Act.  The SEC expects that the results of this study will inform any future rulemaking in this area that takes place after the study is completed.

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

The staff of the SEC has delivered to Congress a long-awaited study pursuant to Section 913 of the Dodd-Frank Act.  That provision of the Dodd-Frank Act requires the SEC to conduct a study to evaluate:

  • The effectiveness of existing legal or regulatory standards of care (imposed by the SEC, a national securities association, and other federal or state authorities) for providing personalized investment advice and recommendations about securities to retail customers; and
  • Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute.

The 208 page study, delivered on January 21, 2011, noted that the regulatory schemes for investment advisers and broker-dealers are designed to protect investors through different approaches.

Investment Advisers.  Investment advisers are fiduciaries to their clients, and the regulation under the Investment Advisers Act of 1940 generally is principles-based.  An investment adviser is a fiduciary whose duty is to serve the best interests of its clients, including an obligation not to subordinate clients’ interests to its own.  Included in the fiduciary standard are the duties of loyalty and care.  An investment adviser that has a material conflict of interest must either eliminate that conflict or fully disclose to its clients all material facts relating to the conflict.

Broker-Dealers:  Broker-dealers that do business with the public generally must become members of FINRA.  Under the antifraud provisions of the federal securities laws and self regulatory organization, or SRO, rules, including SRO rules relating to just and equitable principles of trade and high standards of commercial honor, broker-dealers are required to deal fairly with their customers.  While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts have found broker-dealers to have a fiduciary duty under certain circumstances.  Moreover, broker-dealers are subject to statutory, SEC and SRO requirements that are designed to promote business conduct that protects customers from abusive practices, including practices that may be unethical but may not necessarily be fraudulent.  The federal securities laws and rules and SRO rules address broker-dealer conflicts in one of three ways: express prohibition; mitigation; or disclosure.

An important aspect of a broker-dealer’s duty of fair dealing is the suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the interests of its customer.  Broker-dealers also are required under certain circumstances, such as when making a recommendation, to disclose material conflicts of interest to their customers, in some cases at the time of the completion of the transaction.  The federal securities laws and FINRA rules restrict broker-dealers from participating in certain transactions that may present particularly acute potential conflicts of interest.  At the state level, broker-dealers and their agents must register with or be licensed by the states in which they conduct their business.

Recommendations.  Consistent with Congress’s grant of authority in Section 913, the staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2).  In particular, the staff recommends that the SEC exercise its rulemaking authority under Dodd-Frank Act Section 913(g), which permits the SEC to promulgate rules to provide that:

“[T]he standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the [SEC] may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.’

The standard outlined above is referred to in the study as the “uniform fiduciary standard.”

SEC Commissioners Casey and Paredes. Commissioners Casey and Paredes issued a statement outlining certain reservations about the study. That statement said in part:

“In our view, the Study’s pervasive shortcoming is that it fails to adequately justify its recommendation that the [SEC] embark on fundamentally changing the regulatory regime for broker-dealers and investment advisers providing personalized investment advice to retail investors. The Study recommends the adoption of a new uniform fiduciary duty standard and harmonization of two disparate regulatory regimes. But it does so without adequate articulation or substantiation of the problems that would purportedly be addressed via that regulation. The Study also does not adequately recognize the risk that its recommendations could adversely impact investors . . .

Because of our concerns, we oppose the Study’s release to Congress as drafted.  We do not believe the Study fulfills the statutory mandate of Section 913 of the Dodd-Frank Act to evaluate the “effectiveness of existing legal or regulatory standards of care” applicable to broker-dealers and investment advisers.”

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

In transaction agreements that govern a securitization, issuers or originators of asset-backed securities, or ABS, typically make “representations and warranties” about the characteristics and the quality of loans included in a securitization.  If a loan does not comply with the representation or warranty, an ABS issuer or lender can be required to repurchase the loan from the pool or replace it with a substitute asset.

According to the SEC, many investors and other transaction parties have questioned whether the loans in the bundle meet the characteristics specified by the representations and warranties, and have been seeking to enforce repurchase provisions.  The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes new disclosure obligations about the representations, warranties and repurchase history so that investors may identify originators with clear underwriting deficiencies.

Section 943 of the Dodd-Frank Act requires the SEC to prescribe regulations on the use of representations and warranties in the market for SEC securities.  The SEC has approved final rules to implement Section 943.

Disclosure of Repurchase History on New Form ABS-15G

The final rules require ABS issuers to file with the SEC, in tabular format, the history of the requests they received and repurchases they made relating to their outstanding ABS.  The table will provide comparable disclosures so that investors may identify originators with clear underwriting deficiencies.  Specifically, issuers are required to disclose the last three years of repurchase history in an initial filing on EDGAR due by Feb. 14, 2012.

After the initial filing, the ABS issuer is required to file updated information on a quarterly basis, including:

  • Repurchase history for all outstanding ABS (regardless of whether the securities were offered in a transaction registered with the SEC) if the underlying transaction agreements include a covenant to repurchase or replace a pool asset.
  • History of all fulfilled and unfulfilled repurchase requests, including investor demands upon a trustee and pending requests.
  • The disclosure requirements will apply to issuers of unregistered ABS, including municipal ABS.  However, municipal ABS are provided an additional three-year phase-in period and will be permitted to provide their information on EMMA, the Municipal Securities Rulemaking Board’s centralized public database for information about municipal securities issuers and offerings.

Disclosure of Repurchase History in Prospectuses and Ongoing Reports

The final rules also provide investors with ready access to the most current information regarding an issuer’s repurchase history by requiring an issuer in a registered ABS offering to include — in the body of a prospectus — repurchase history for the last three years for ABS of the same asset class as the securities being registered.  This information must be included in registered offerings in a phase-in period commencing on Feb. 14, 2012.  In its ongoing reports, an issuer will be required to provide updated repurchase history for the particular, related asset pool beginning with distribution reports required to be filed on Form 10-D after Dec. 31, 2011.

Disclosure in Any Report Accompanying a Credit Rating by an NRSRO

As required by Section 943(1) of the Dodd-Frank Act, the final rules also require Nationally Recognized Statistical Rating Organizations, or (NRSROs, to provide a description of the representations, warranties and enforcement mechanisms available to investors in an ABS offering.  NRSROs will be required to disclose how the representations, warranties, and enforcement mechanisms differ from those of similar ABS.  NRSROs will be required to make the disclosures in any report accompanying a credit rating, including in presale reports that are distributed prior to the sale of the security.  NRSROs will be required to provide this information for any report issued on or after six months after the effective date of the rules.

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The SEC has adopted new requirements in order to implement Section 945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  The new rules require any issuer registering the offer and sale of an asset-backed security, or ABS, to perform a review of the assets underlying the ABS.   The SEC has also adopted amendments to Item 1111 of Regulation AB that would require an ABS issuer to disclose the nature of its review of the assets and the findings and conclusions of the issuer’s review of the assets.

Under Rule 193, an issuer must perform a review of the assets underlying a registered ABS transaction that, at a minimum, must be designed and effected to provide reasonable assurance that the disclosure in the prospectus regarding the assets is accurate in all material respects.  Rule 193 does not specify the particular type of review an issuer is required to perform.   Thus, the term “reasonable assurance” in Rule 193 does not imply a single methodology, but encompasses the full range of reviews an issuer may perform to ensure that its review is designed and effected to provide reasonable assurance that the prospectus disclosure regarding the pool assets is accurate in all material respects.

If an issuer engages a third party for purposes of performing its Rule 193 review, then an issuer may rely on the third-party’s review to satisfy its obligations under Rule 193 provided the third party is named in the registration statement and consents to being named as an “expert” in accordance with Section 7 of the Securities Act and Rule 436 under the Securities Act.  On the other hand, if an issuer obtains assistance from a third party but attributes to itself the findings and conclusions of the review required by Rule 193, the third party would not be required to consent to being named as an expert.

New Item 1111(a)(7) of Regulation AB requires that an issuer of ABS disclose the nature of the review it conducts to satisfy proposed Rule 193.  This would include whether the issuer has hired a third-party firm for the purpose of reviewing the assets, or to assist it in reviewing the assets. This would include a description of the scope of the review, such as whether the issuer or a third party conducted a review of a sample of the assets and what kind of sampling technique was employed (i.e., random or adverse).  In addition, under new Item 1111(a)(7), the issuer will be required to disclose the findings and conclusions of the review performed by the issuer or by a third party engaged for purposes of reviewing the assets.  Item 1111(a)(8) of Regulation AB will require issuers to disclose how the assets in the pool deviate from the disclosed underwriting criteria and include data on the amount and characteristics of those assets that did not meet the disclosed standards.

Any registered offering of ABS commencing with an initial bona fide offer after December 31, 2011, must comply with the new rules.

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The United States Government Accountability Office, or GAO, has issued a report that responds to a mandate included in Section 919C of the Dodd-Frank Act that directed GAO to conduct a study on the oversight and regulation of financial planners.  There is no specific, direct regulation of “financial planners” per se at the federal or state level, but various laws and regulations apply to most of the services they provide. Financial planners are primarily regulated as investment advisers by the SEC and the states, and are subject to laws and regulations governing broker-dealers and insurance agents when acting in those capacities. In addition, Federal and state agencies have regulations on marketing and the use of titles and designations that can apply to financial planners.

The report notes that existing statutes and regulations appear to cover the great majority of financial planning services, and individual financial planners nearly always fall under one or more regulatory regimes, depending on their activities. While no single law governs the broad array of activities in which financial planners may engage, given available information, it does not appear that an additional layer of regulation specific to financial planners is warranted at this time.

The report also concludes consumers may be unclear about standards of care that apply to financial professionals, particularly when the same individual or firm offers multiple services that have differing standards of care.  As such, consumers may not always know whether and when a financial planner is required to serve their best interest.

In addition the GAO notes that financial planners can adopt a variety of titles and designations. The different designations can imply different types of qualifications, but consumers may not understand or distinguish among these designations, and thus may be unable to properly assess the qualifications and expertise of financial planners.  

GAO recommends that the SEC (i) assess investors’ understanding of financial planners’ titles and designations and (ii) collaborate with the states to identify methods to better understand issues associated with the financial planning activities of investment advisers.

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