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

The CFTC approved, by a 4 to 1 vote today, issuance of a proposed rule that establishes limits on positions in physical commodity futures contracts as well as swaps that are economically equivalent to those contracts.

Contracts/Commodities. The position limits will apply to contracts in 28 commodities, consisting of contracts in 19 agricultural commodities, 5 metals, and the following 4 energy commodities:

– NYMEX Light Sweet Crude Oil;
– NYMEX New York Harbor No. 2 Heating Oil;
– NYMEX New York Harbor Gasoline Blendstock; and
– NYMEX Henry Hub Natural Gas.

The proposed rule is similar in structure to the position limits rule proposed by the CFTC in January 2010 regarding only energy commodities, which was later withdrawn to accommodate the current rulemaking under the expanded authority provided by the Dodd-Frank Act.

Implementation. Under the Commission’s proposed rule, position limits on physical commodity derivatives will be established in two phases. In the initial transitional phase, limits will be imposed on spot-month positions only, and the limits will be based on deliverable supply determined by and levels currently set by Designated Contract Markets. In the second phase, the spot-month position limits will be based on the Commission’s determination of deliverable supply and limits on positions outside of the spot month will also be imposed.

The Limits. The proposed rule calls for:

– Spot-month position limit levels set at 25% of deliverable supply for a given commodity, with a conditional spot-month limit of five times that amount for entities with positions exclusively in cash-settled contracts.
– Non-spot-month position limits (aggregate single-month and all-months-combined limits that would apply across classes, as well as single-month and all-months-combined position limits separately for futures and swaps) set for each referenced contract at 10 percent of open interest in that contract up to the first 25,000 contracts, and 2.5 percent thereafter.

Bona Fide Hedging Exemption. The proposed rule exempts bona fide hedging positions from counting towards the limits. Notably, the Commission scrapped the controversial “crowding out” provisions from its January 2010 proposed rule, under which an entity seeking to hold hedging positions in excess of an applicable position limit could not generally also hold speculative positions.

Who Will Be Affected? The Commission estimates that, on an annual basis:

– Agricultural contracts–70 traders will be affected by the proposed spot month position limits, 80 by the all-months-combined and single-month position limits.
– Base metals contracts–6 traders will be affected by the proposed spot month position limits, 25 by the all-months-combined and single-month position limits.
– Precious metals contracts–8 traders will be affected by the proposed spot month position limits, 20 by the all-months-combined and single-month position limits.
– Energy contracts–40 traders will be affected by the proposed spot month position limits, 10 by the all-months-combined and single-month position limits.

The SEC charged a Kansas-based company that manages government websites and four current or former company executives with failing to disclose to investors more than $1.18 million in perks paid to the former CEO over a six-year period.

The SEC alleges that NIC Inc.’s public filings failed to disclose that the company footed the bill for wide-ranging perks enjoyed by former CEO Jeffrey Fraser, his girlfriend, and his family — including vacations, computers, and day-to-day personal living expenses.  NIC failed to disclose that it paid thousands of dollars per month for Fraser to live in a Wyoming ski lodge and commute by private aircraft to his office at NIC’s Kansas headquarters.  Meanwhile, NIC and its executives falsely represented to investors that Fraser worked virtually for free from 2002 to 2005, and then continued to materially understate the perks that Fraser received in 2006 and 2007.  NIC’s related party disclosures for 2002 through 2005 also were misleading.

NIC, Fraser, current CEO Harry Herington and former CFO Eric Bur agreed to pay a combined $2.8 million to settle the SEC’s charges against them without admitting or denying the allegations.  The SEC’s litigation continues against NIC’s current CFO Stephen Kovzan.

Among the alleged undisclosed perks for Fraser outlined in the SEC’s complaints filed in federal court in the District of Kansas:

  • More than $4,000 per month to live in a ski lodge in Wyoming.
  • Costs to commute by private aircraft from his home in Wyoming to his office at NIC’s Kansas headquarters.
  • Monthly cash payments for purported rent for a Kansas house owned by an entity Fraser set up and controlled.
  • Vacations for Fraser, his girlfriend and his family.
  • Fraser’s flight training, hunting, skiing, spa and health club expenses.
  • Computers and electronics for Fraser and his family.
  • A leased Lexus SUV.
  • Other day-to-day living expenses for Fraser, such as groceries, liquor, tobacco, nutritional supplements, and clothing.

The SEC’s complaints allege that Fraser, who did not have a personal credit card, routinely charged living expenses on NIC credit cards and submitted expense vouchers falsely claiming personal items were business-related in order to have NIC pay for these personal expenses. Fraser also sought reimbursement for certain expenses he had not incurred.

The SEC alleges that Kovzan, who was then the company’s Chief Accounting Officer, authorized NIC’s payment of Fraser’s personal expenses, circumventing NIC’s internal controls and policies that required the CEO to document the business purpose for his expenses.  Kovzan allegedly knew, or was reckless in not knowing, that Fraser’s expenses were falsely characterized as business expenses in NIC’s books and records.  Kovzan prepared, reviewed or signed NIC’s proxy statements, annual reports and registration statements that materially underreported Fraser’s compensation, and Kovzan allegedly made false representations to NIC’s independent auditors.

The SEC alleges that Bur, who was then NIC’s Chief Financial Officer, permitted NIC to pay the expenses that Fraser submitted on his expense vouchers even though he was informed that Fraser was not submitting the required documentation. A finance department employee raised concerns to Bur that some of Fraser’s expenses were not business-related.  Bur was aware of the SEC’s rules requiring the disclosure of executive perks, yet he reviewed, signed or certified NIC’s public filings that failed to disclose Fraser’s perks.

The SEC alleges that Herington, who was then NIC’s Chief Operating Officer, was informed of problems with Fraser’s expense reporting and failed to adequately address them.  Herington received information showing that NIC was paying for some of Fraser’s personal expenses, yet he reviewed or signed NIC’s public filings that failed to disclose Fraser’s perks.

According to the SEC’s complaints, NIC failed to correct Fraser’s expense reporting problems even after the finance department employee warned in 2006 of the risk of possible income tax fraud charges, a whistleblower complained to NIC and the company learned of the SEC’s investigation of this matter in mid-2007.  The majority of Fraser’s perks were not repaid or disclosed, and NIC continued to make misleading public filings.  NIC failed to disclose to investors in public filings that an internal review concluded Fraser had intentionally misclassified his expenses.

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

Representative Michelle Bachman has introduced the following legislation to repeal the Dodd-Frank Act:

112th CONGRESS 

1st Session

H. R. 87

To repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act.

IN THE HOUSE OF REPRESENTATIVES

January 5, 2011 

Mrs. Bachmann (for herself, Mr. McClintock, Mr. Posey, Mr. Akin, and Mr. Issa) introduced the following bill; which was referred to the Committee on Financial Services, and in addition to the Committees on Agriculture, Energy and Commerce, the Judiciary, the Budget, Oversight and Government Reform, Ways and Means, and Small Business, for a period to be subsequently determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned:

A BILL

To repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act.

            Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. REPEAL.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111-203) is repealed and the provisions of law amended by such Act are revived or restored as if such Act had not been enacted.

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

Section 961 of the Dodd-Frank Act requires that the SEC provide the Senate Committee on Banking, Housing, and Urban Affairs, and the House Committee on Financial Services, a report on the “supervisory controls” over the conduct by the SEC of examinations of registered entities, enforcement investigations, and reviews of corporate financial securities filings.  The report is required to be provided not later than 90 days after the end of each fiscal year. The SEC has delivered the first such report for the fiscal year ending September 30, 2010.

Perhaps not surprisingly, the SEC concluded no significant deficiencies in internal supervisory controls were identified as of September 30, 2010.  Based on the results of the evaluation, the report also concluded the internal supervisory controls of the SEC with respect to examinations of the Office of Compliance and Inspections, or OCIE, enforcement investigations, and Corporation Finance filing reviews are effective, and the procedures of the SEC applicable to the OCIE, enforcement, and Corporation Finance staff who perform examinations of registered entities, enforcement investigations, and reviews of corporate financial securities filings, respectively, are effective.

We’ll see if the Comptroller General agrees when it reviews the adequacy of the SEC’s internal supervisory control structure and procedures once every three years, as required by the Dodd-Frank Act.  After all, the SEC left itself plenty of wiggle room.  For instance, the report states “there may be instances where judgments made in good faith are, in hindsight, deemed inappropriate.”  A reference to the Madoff investigations perhaps?

The report describes some of the procedures used.   For instance, the OCIE assessment team identified the key parties responsible for execution of the controls and created a “process flow narrative” that is, a step-by-step description of how the controls apply to the examination and investigative processes.  There will probably not be a lot of sympathy from corporate America that has been grappling with the costs of Sarbanes-Oxley Section 404 compliance for the last several years.

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

This release is one of several that the SEC is issuing to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act related to asset-backed securities, or ABS. Section 942(a) of the Dodd-Frank Act eliminated the automatic suspension of the duty to file under Section 15(d) of the Exchange Act for ABS issuers and granted the SEC the authority to issue rules providing for the suspension or termination of such duty.

The SEC is proposing in new Exchange Act Rule 15d-22(b) to permit suspension of the reporting obligations for a given class of ABS pursuant to Exchange Act Section 15(d) for any fiscal year, other than the fiscal year within which the registration statement became effective, if, at the beginning of the fiscal year, there are no longer ABS of the class that were sold in a registered transaction held by non-affiliates of the depositor.  As revised by the Dodd-Frank Act, Exchange Act Section 15(d) no longer provides for the automatic suspension of the duty to file periodic and other reports for issuers of a class of ABS.  Without action by the SEC, ABS issuers that have filed a registration statement that has become effective pursuant to the Securities Act or that have conducted a takedown off of a shelf registration statement as described above, would be obligated to continue to file such reports for the life of the security.

In light of the statutory changes to Exchange Act Section 15(d), the SEC is proposing to update Exchange Act Rule 15d-22 to indicate when annual and other reports need to be filed and when starting and suspension dates are determined with respect to a takedown.   The SEC is also  proposing to amend Exchange Act Rule 12h-3(b)(1) to add the language “, other than any class of asset-backed securities,” to conform the rule to the language of amended Exchange Act Section 15(d) and to add a clarifying note.

A suspension from reporting under Exchange Act Section 15(d) is applicable under the statute only for a year and needs to be reconsidered each subsequent year.  Consequently, once an issuer has registered an offering under the Securities Act it needs to consider at the beginning of each fiscal year whether it has a reporting obligation under Exchange Act Section 15(d).  This is the case even if an issuer has previously been eligible to suspend reporting under Exchange Act Section 15(d).  As a result, the revision to Exchange Act Section 15(d) results in a “springing” Section 15(d) reporting obligation for ABS issuers on the first day of their next fiscal year since, by its terms, Section 15(d) as amended, does not provide for the suspension of reporting for ABS, unless the SEC exercises its authority to provide for a suspension or termination of such reporting.  The SEC noted that unlike corporate issuers that can generate new revenue and actively manage their assets and business, ABS issuers by definition are a discrete pool of self-liquidating assets.  One commentator has noted, among other things, that historically the transaction documents have not contained provisions necessary to support an ongoing reporting obligation, or provide for the funds to cover the costs of taking steps to recommence reporting.  While the transaction documents may not provide for recommencing reporting, the SEC noted that most transaction documents require ABS issuers to provide periodic distribution reports to the trustee or security holders in order to provide information for investors for the life of the securitization.  Taking into account all of these factors, the staff of the Division of Corporation Finance has issued a no-action letter applicable to all ABS issuers whose reporting obligations had been suspended prior to the date of enactment of the Dodd-Frank Act that states that, provided the issuer continues complying with requirements under the transaction agreements to make ongoing information regarding the ABS and the related pool assets available to security holders in the manner and to the extent required under those transaction agreements, the Division would not recommend enforcement action if the issuer continues to determine its reporting requirements based on the standards set forth in Section 15(d) of the Exchange Act immediately prior to enactment of the Dodd-Frank Act.  The letter also requires as an additional condition to the no-action position that the issuer retain the information for at least five years after the ABS are no longer outstanding and provide copies of such information to the SEC or its staff upon request.

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

The U.S. Department of the Treasury announced the selection of Holly Petraeus to establish the Office of Servicemember Affairs being built by the Consumer Financial Protection Bureau, or CFPB, implementation team currently housed at Treasury.  Petraeus, a military spouse for more than 35 years, is also the wife of Army Gen. David Petraeus, current Commander of the International Security Assistance Force in Afghanistan and former Commander of the U.S. Central Command. 

 The Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law by President Obama last summer explicitly requires the creation of such an office within the CFPB. Servicemembers and their families have been targets of unscrupulous lenders in the past.

 The Office of Servicemember Affairs will seek to work in partnership with the Department of Defense to help ensure that: military families receive the financial education they need to make the best financial decisions for them; complaints and questions from military families are monitored and responded to; and federal and state agencies coordinate their activities to improve consumer protection measures for military families.

 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, implementation team currently housed within the US Department of the Treasury and the Conference of State Bank Supervisors, CSBS, signed a memorandum of understanding, or MOU, to establish a foundation of state and federal coordination and cooperation for supervision of providers of consumer financial products and services.  The CFPB was established by the Dodd-Frank Act. 

In particular, state regulators and the CFPB will seek to promote consistent examination procedures and effective enforcement of state and federal consumer laws and to minimize regulatory burden and efficiently deploy supervisory resources.  In addition, the MOU provides that state regulators and the CFPB will consult each other regarding the standards, procedures, and practices used by state regulators and the CFPB to conduct compliance examinations of providers of consumer financial products and services, including non-depository mortgage lenders, mortgage servicers, private student lenders, and payday lenders.

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

On December 2, 2010 the SEC issued a notice indicating its intent to charge revised fees IARD filing fees for investment advisers registering or registered with the SEC.  The revised fees were based on the recommendation of FINRA, which manages the IARD system.  Based on projections of expected revenues and expenses and taking into account an expected reduction in the number of investment advisers registered or reporting to the SEC as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC believes these revised fee levels would be reasonable, as the SEC projects that they will provide adequate funding to cover IARD system expenditures.

 The SEC has issued an order approving the revised fees.  For annual updating amendments to Form ADV filed on or after January 1, 2011, the filing fee due from SEC-registered investment advisers is $40 for advisers with assets under management under $25 million; $150 for investment advisers with assets under management from $25 million to $100 million; and $225 for investment advisers with assets under management of $100 million or higher.  For initial applications to register as an investment adviser with the SEC filed on or after January 1, 2011, the filing fee due from SEC-registered advisers is $40 for advisers with assets under management under $25 million; $150 for advisers with assets under management from $25 million to $100 million; and $225 for advisers with assets under management of $100 million or higher.

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

In September 2010, the SEC published its Dodd-Frank rulemaking timetable.  The rulemaking timetable has been revised.  We compared the September timetable to the current timetable to identify some objectives which had been missed. 

A non-exhaustive list of things the SEC set out to do by year end but did not accomplish is as follows:

  • §413: Propose rules to revise the “accredited investor” standard
  • §926: Propose rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated
  • §952: Propose exchange listing standards regarding compensation committee independence and factors affecting compensation adviser independence; propose disclosure rules regarding compensation consultant conflicts
  • §942: Propose rules regarding the reporting obligations of ABS issuers that, prior to enactment of the Act, were not required to report under section §15(d) of the Securities Exchange Act
  • §929W: Propose revisions to rules regarding due diligence for the delivery of dividends, interest and other valuable property to missing securities holders
  • §961: Report and certification to Congress regarding internal supervisory controls
  • §916: Adopt streamlined procedural rules regarding filings by self-regulatory organizations

In addition, the following activities have been deferred due to budgetary uncertainty:

  • §342: Creation and staffing of Office of Women & Minority Conclusion (activities regarding diversity in hiring and small business contracting continuing to be performed by staff in existing EEO Office)
  • §911: Creation of new Investor Advisory Committee
  • §915 and 919D: Creation and staffing of Office of Investor Advocate (activities regarding investor perspectives in rulemaking continuing to be performed by staff in existing Office of Investor Education & Advocacy)
  • §924: Creation and staffing of Whistleblower Office (functions temporarily assigned to existing staff within the Division of Enforcement)
  • §932: Creation and staffing of Office of Credit Ratings (rulemaking functions remain with staff within the Division of Trading and Markets; examination functions continuing to be performed by existing Office of Compliance Inspections & Examination)
  • §979: Creation and staffing of Office of Municipal Securities (functions continue to be assigned to staff within the Division of Trading and Markets) 

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

Section 954 of the Dodd-Frank Act requires the SEC to direct national securities exchanges to prohibit the listing of public companies that, among other things, do not develop and implement a policy providing for the recovery of erroneously paid incentive-based compensation following a required accounting restatement.  While the SEC has not issued rules implementing Section 954 of the Dodd-Frank Act, public companies may wish to consider the impact on compensation programs under development and otherwise be prepared to consider variables when final rules are adopted.  A short checklist of items to consider is set forth below:

Current Proxy Season Disclosure.  Public companies that currently have clawback policies will want to continue to disclose those policies in their CD&As.  Our review of many recently filed proxy statements indicates that issuers which currently do not have clawback policies generally are not disclosing the Dodd-Frank requirement to adopt policies in the future in their proxy statements.

Inventory.  Create an inventory of current plans that have a clawback policy to determine which plans may have to be modified to comply with the eventual rules.  Also create an inventory of plans which are likely to include “incentive-based compensation” that may eventually need to be subject to a clawback policy.

Depth.  How deep into the organization should the clawback policy extend?  Section 954 refers to “current and former executive officers,” which are terms yet to be defined.  Issuers with current policies that extend deeper than required may want to consider the administrative complexities of implementing a new policy that is broader than required.  On the other side of the coin is the question of fairness and cutting off compensation recovery at a level artificially set by Congress and the SEC.

Triggers.  Section 954 of the Dodd-Frank Act requires recoupment upon a requirement to prepare an accounting restatement due to any material noncompliance of the issuer with any financial reporting requirement under the securities laws.  The statutory mandate appears to apply without fault, contrary to some existing clawback policies.  Many existing clawback policies also require recoupment for other events such as materially disruptive activities or ethical or criminal violations.  When amending or implementing clawback policies companies may want to consider appropriate triggers.

Recovery.  What actions can the issuer take to recoup the clawed-back compensation?  Some current plans permit offset against other benefit plans, future payments of incentive compensation, cancellation of existing option grants, withholding of future equity awards and the like.

Sarbanes-Oxley Double Counting.  Section 304 of Sarbanes-Oxley Act also requires forfeiture by the CEO and CFO of certain incentive compensation in similar, but different circumstances than the Dodd-Frank Act.  To the extent permissible under the Dodd-Frank rules, clawback policies which are developed should prevent any double counting of clawbacks under Dodd-Frank and Sarbanes-Oxley.  Some plans we have reviewed describe the clawback as being “in addition to” the Sarbanes-Oxley requirements which could be an incorrect choice of words.

Board Discretion.  Section 954 of the Dodd-Frank Act does not appear to permit any discretion on whether to enforce a clawback.  However, consistent with many plans adopted to date, the board or compensation committee should have discretion on whether to pursue a clawback to the extent a policy broader than required by the Dodd-Frank Act is adopted.

We have provided recent examples of clawback policies here and here.

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