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

The SEC has proposed rules intended to mitigate conflicts of interest for security-based swap clearing agencies, security-based swap execution facilities, and national securities exchanges that post security-based swaps or make them available for trading.  Section 765 of the Dodd-Frank Act lays out requirements designed to mitigate conflicts of interests at clearing agencies that clear security-based swaps, at security-based swap execution facilities, or SEFs, and at national securities exchanges that post or make available for trading security-based swaps. To accomplish this, the section provides that the SEC may adopt rules that include numerical limits on control of, or voting rights with respect to, such clearing agencies, execution facilities and exchanges.

 The over-the-counter derivatives market has a relatively high concentration of market activity among a limited number of dealers that earn significant revenues from the currently opaque over-the-counter market.  SEC staff have identified three primary areas where it believes a conflict of interest could adversely affect the central clearing of security-based swaps:

  • First, participants could seek to limit access to the security-based swap clearing agency by other participants in order to maintain a competitive advantage.
  • Second, participants could seek to limit the scope of products eligible for clearing at the security-based swap clearing agency, particularly if there is an economic incentive to keep the product traded in the over-the-counter market.
  • Third, participants could seek to lower the risk management controls of a security-based swap clearing agency in order to reduce their collateral requirements.

 The proposed rules, known as Proposed Regulation MC, require security-based swap clearing agencies, security-based SEFs and security-based swap exchanges to adopt ownership and voting limitations as well as certain governance requirements. Key elements of the proposal include requiring, with respect to security-based swap clearing agencies, one of the following two alternatives:

 First Alternative

  •  Restrict an individual clearing agency participant from beneficially owning or voting more than 20 percent of any voting interest in the security-based swap clearing agency.
  • Restrict clearing agency participants from beneficially owning or voting more than 40 percent of any voting interest in the security-based swap clearing agency in the aggregate with any other clearing agency participants.
  • The board of directors and any committee that has authority to act on behalf of the board be composed of 35 percent of independent directors.
  • The nominating committee be composed of a majority of independent directors.

Second Alternative

  •  Restrict an individual clearing agency participant from beneficially owning or voting more than 5 percent of any voting interest in the security-based swap clearing agency.
  • The board of directors and any committee that has authority to act on behalf of the board be composed of a majority of independent directors.
  • The nominating committee be composed solely of independent directors.

 Other key elements of the proposal include:

  •  Security-based SEFs and security-based swap exchanges restrict participants or members, as applicable, from owning or holding more than 20 percent of any voting interest of such entity.
  • The board of directors of a security-based SEF or security-based swap exchange, any executive committee of the board of a security-based SEF or security-based swap exchange, and any board committee exercising powers of the board of a security-based SEF or security-based swap exchange be composed of a majority of independent directors.
  • The nominating committee of a security-based SEF or security-based swap exchange consists solely of independent directors.
  • The board of directors of a security-based SEF or security-based swap exchange establish a regulatory oversight committee consisting solely of independent directors to oversee the security-based SEF’s or security-based swap exchange’s regulatory program, and any recommendation of a regulatory oversight committee that is not adopted by the board of a security-based SEF or security-based swaps exchange be reported promptly to the Commission.
  • The disciplinary panels of a security-based swap clearing agency, security-based SEF or security-based swap exchange be compositionally balanced and include one person who would qualify as an independent director.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

Section 766 of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act  requires the SEC to adopt an interim final rule for the reporting of security-based swaps entered into before July 21, 2010, the terms of which had not expired as of that date (“pre-enactment security-based swap transactions”), within 90 days of the enactment of the Dodd-Frank Act.  Pursuant to this requirement, the SEC adopted an interim final temporary rule (Release No. 34-63094) that requires specified counterparties to pre-enactment security-based swap transactions to report certain information relating to pre-enactment security-based swaps to a registered security-based swap data repository or to the SEC by the compliance date established in the security-based swap reporting rules required under Sections 3C(e) and 13A(a) of the Securities Exchange Act of 1934 (“Exchange Act”), or within 60 days after a registered security-based swap data repository commences operations to receive and maintain data concerning such security-based swaps, whichever occurs first and report information relating to pre-enactment security-based swaps to the SEC upon request.

 Definitions

 New Section 3(a)(68) of the Exchange Act, which was added by Section 761 of the Dodd-Frank Act, defines a security-based swap to include a swap, as defined in Section 1a of the Commodity Exchange Act, that is based on a narrow-based security index, or a single security or loan, or any interest therein or on the value thereof, or the occurrence or non-occurrence of an event relating to an issuer of a security or the issuers of securities in a narrow-based index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer.   Section 761 of the Dodd-Frank Act also adds new definitions in Section 3(a) of the Exchange Act for entities involved in the security-based swaps markets, including, among others, security-based swap dealer, major security-based swap participant, security-based swap data repository, and security-based swap execution facility.

 Reporting Obligations in General

 The SEC adopted Rule 13Aa-2T under the Exchange Act to specify the reporting requirements applicable to pre-enactment security-based swaps.  Rule 13Aa-2T requires specified counterparties to a pre-enactment security-based swap transaction to: (1) report certain information relating to pre-enactment security-based swaps to a registered security-based swap data repository or to the SEC by the compliance date established in the security-based swap reporting rules required by Section 3C(e) and 13A(a)(1) of the Exchange Act, or within 60 days after a registered security-based swap data repository commences operations to receive and maintain data concerning such security-based swaps, whichever occurs first; and (2) report information relating to pre-enactment security-based swaps to the SEC upon request during an interim period.

 Party Responsible for Reporting

Section 13A(a)(3) to the Exchange Act specifies the party obligated to report a security-based swap – either a security-based swap dealer, a major security-based swap participant, or a counterparty to the swap.  These provisions apply for purposes of reporting pursuant to the interim final temporary rule.  Specifically, Section 13A(a)(3) of the Exchange Act provides that with respect to a security-based swap in which only one counterparty is a security-based swap dealer or major security-based swap participant, the security-based swap dealer or major security-based swap participant shall report the security-based swap; with respect to a security-based swap in which one counterparty is a security-based swap dealer and the other counterparty is a major security-based swap participant, the security-based swap dealer shall report the security-based swap; and with respect to any other security-based swap, the counterparties to the security-based swap shall select a counterparty to report the security-based swap.

 Record Retention Requirements

 Pre-enactment security-based swaps that must be reported pursuant to Section 13A(a)(2) of the Exchange Act and new interim final temporary Rule 13Aa-2T thereunder have already occurred prior to enactment of the Dodd-Frank Act.  Thus, to support the reporting requirements in Rule 13Aa-2T(b), a Note to paragraphs (b)(1) and (2) of Rule 13Aa-2T requires each counterparty to a pre-enactment security-based swap transaction that may be required to report such transaction to retain information and documents relating to the terms of the transaction.  Specifically, the Note requires a counterparty to a pre-enactment security-based swap transaction that may be required to report such transaction to retain in its existing format all information and documents, if available, to the extent and in such form as they currently exist, relating to the terms of the security-based swap transaction, including but not limited to: any information necessary to identify and value the transaction; the date and time of execution of the transaction; all information from which the price of the transaction was derived; whether the transaction was accepted for clearing by any clearing agency or derivatives clearing organization, and, if so, the identity of such clearing agency or derivatives clearing organization; any modification(s) to the terms of the transaction; and the final confirmation of the transaction.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

The SEC has proposed new requirements in order to implement Section 945 and a portion of Section 932 of the Dodd-Frank Act (Release No. 33-9150).   First, the SEC has proposed a new rule under the Securities Act of 1933 to require any issuer registering the offer and sale of an asset-backed security (ABS), to perform a review of the assets underlying the ABS.  The SEC also proposed new 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. If the issuer has engaged a third party for purposes of reviewing the assets, the SEC proposes to require that the issuer disclose the third-party’s findings and conclusions.  The SEC also proposed to require that an issuer or underwriter of an ABS offering file a new form to include certain disclosure relating to third-party due diligence providers, to implement Section 15E(s)(4)(A) of the Securities Exchange Act of 1934, a new provision added by Section 932 of the Dodd-Frank Act.

Required Issuer Review of Assets

The SEC proposed new Rule 193 under the Securities Act to require issuers of ABS to perform a review of the assets underlying registered ABS offerings.  This rule would implement Securities Act Section 7(d)(1), as added by Section 945 of the Dodd-Frank Act.  Rule 193 would not specify the level or type of review an issuer is required to perform.  The SEC expects that the issuer’s level and type of review of the assets may vary depending on the circumstances.  For example, the level or type of review may vary among different asset classes.  While proposed Rule 193 would not require a particular level or type of review, the SEC noted that, if adopted, required responsive disclosure would describe the level and type of review.  The SEC believes the disclosure requirements of the rule will give investors an ability to evaluate the level and adequacy of the issuer’s review of the assets.  If an issuer engages a third party for purposes of reviewing the pool assets, then an issuer may rely on the third-party’s review to satisfy its obligations under proposed 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.

Proposed Disclosure Requirements

Item 1111 of Regulation AB outlines several aspects of an ABS pool that the prospectus disclosure for ABS should cover. The SEC proposed amendments to Item 1111 to require disclosure regarding the nature of the issuer’s review of the assets under proposed Rule 193 and the findings and conclusions of the review. In addition, the SEC re-proposed amendments from its 2010 ABS Proposing Release to require disclosure regarding the composition of the pool as it relates to assets that do not meet disclosed underwriting standards, as the SEC believes this information would promote a better understanding of the impact of the review on the composition of the pool assets.  The SEC expects that 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 or what kind of sampling technique was employed (i.e., random or adverse). This proposed requirement would implement Securities Act Section 7(d)(2), as added by the Dodd-Frank Act.

New Form ABS-15G

Section 932 of the Dodd-Frank Act amends Exchange Act Section 15E by adding, among other things, a new Section 15E(s)(4)(A) which sets forth the requirement that the issuer or underwriter of any ABS make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter.  Unlike Securities Act Section 7(d), which is expressly limited to registered ABS offerings, the SEC believes that the requirements of Exchange Act Section 15E(s)(4)(A) were intended to apply to issuers and underwriters of both registered and unregistered offerings of ABS.  In this regard, the SEC noted that Section 941 of the Act amends Section 3(a) of the Exchange Act to add a definition of “asset-backed security” and that this definition includes asset-backed securities typically offered and sold in unregistered transactions. Further, unlike Section 945 of the Act, Section 932 does not refer to Section 7 of the Securities Act or registration statements filed under the Securities Act.

For registered ABS offerings, this disclosure, with respect to reports obtained by issuers, would be required to be provided in the prospectus as described above. In order to implement the disclosure requirement for unregistered offerings the SEC proposed new Rule 15Ga-2 under the Exchange Act.  Proposed Rule 15Ga-2 would require an issuer of Exchange Act-ABS to file a new Form ABS-15G to disclose the findings and conclusions of any third party engaged for purposes of performing a review obtained by an issuer with respect to unregistered transactions. Rule 15Ga-2 also would require an underwriter of Exchange Act-ABS to file Form ABS-15G with the same information for reports obtained by an underwriter in registered and unregistered transactions.  Proposed Form ABS-15G would be filed with the SEC on EDGAR.

The SEC recognizes that public disclosure of information relating to an unregistered offering could raise concerns regarding an issuer’s or underwriter’s reliance on the private offering exemptions and safe harbors under the Securities Act.  The SEC intends for Form ABS-15G to be used for both registered and unregistered ABS transactions (although, if the information has already been provided in a prospectus for a registered transaction, it need not be provided again in Form ABS-15G).  The SEC is of the view that issuers and underwriters can disclose information required by Rule 15Ga-2 without jeopardizing reliance on those exemptions and safe harbors, provided that the only information made publicly available is that which is required by the proposed rule, and the issuer does not otherwise use Form ABS-15G to offer or sell securities or in a manner that conditions the market for offers or sales of its securities.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

 The SEC has stayed the application of proxy access rules set forth in Rule 14a-11.  The question remains whether issuers should make any Rule 14a-11 disclosures in their proxy statements at this time.  We reviewed 14 proxy statements filed between October 6, 2010 and October 12, 2010.  That review indicated eleven issuers did not make any Rule 14a-11 disclosures while three did.  The results could also be somewhat skewed as perhaps issuers chose not to make disclosures as Rule 14a-11 was not effective until November 15, 2010 in any event.

Of the three issuers choosing to make disclosures, we found two made useful disclosures about the application of the SEC stay.  Those examples are set forth below.

Globecomm Systems Inc. (filed October 8, 2010)

On August 25, 2010, the SEC adopted amendments to the federal proxy rules that will implement a new system of “proxy access,” under which a shareholder or group of shareholders meeting eligibility requirements can require the Company to include a limited number of director nominees proposed by the shareholder in management’s proxy materials. The proxy access procedure is in addition to the director nomination procedure described in the preceding paragraphs and nomination provisions set forth in the Company’s Bylaws. The proxy access rules are principally set forth in SEC Rule 14a-11, which was originally set to become effective on November 15, 2010. On September 29, 2010, the Business Roundtable and the Chamber of Commerce of the United States of America (the “Petitioners”) filed a petition with the US Court of Appeals for the District of Columbia Circuit (the “Court”) seeking a review of the proxy access and related rules. On the same date, the Petitioners filed with the SEC a motion to stay the effect of Rule 14a-11 and associated amendments pending the Court’s review. On October 4, 2010, the SEC issued an order granting a stay of the proxy access and related rules, pending judicial review. Although the SEC and the Petititoners will seek expedited review of the Petitioners’ challenge, the timing for the Court’s review is unclear. Accordingly, it is uncertain whether the proxy access rules will be available to eligible shareholders of the Company in connection with the Company’s 2011 annual meeting of shareholders.

If it is effective and available to eligible shareholders of the Company in connection with the Company’s 2011 annual meeting of shareholders, Rule 14a-11 will require a company to include in its proxy materials director nominees proposed by any owner of at least 3% of the total voting power of the company’s securities entitled to be voted in the election of directors who has held the securities continuously for at least three years. A nominating shareholder will be required to continue to own the required amount of securities at least through the date of the meeting at which directors are elected. Shareholders may aggregate holdings to establish sufficient ownership. The nominating shareholder or group must hold both voting and investment power, either directly or through any person acting on their behalf, in order to satisfy the 3% ownership and three continuous year holding thresholds. Nominating shareholders or groups will be required to file a new form, Schedule 14N, to provide information relating to eligibility and nominees. The notice on Schedule 14N to the company and the filing with the SEC must be made on the same day, no earlier than 150 calendar days (i.e., May 11, 2011), and no later than 120 calendar days (i.e., June 10, 2011) prior to the anniversary of the prior year’s proxy material mail date. If multiple shareholders or groups submit nominations and the number of nominees surpasses the maximum number required to be included by Rule 14a-11, the nominating shareholder or group of nominating shareholders with the highest percentage of the company’s voting power will have its nominee or nominees included in the company’s proxy materials.

A qualifying shareholder or group may nominate the greater of one nominee and a number of nominees equal to no more than 25% (rounded down) of the Board of Directors’ total membership. Any person may be nominated under the proxy access rule if that person’s candidacy or, if elected, board membership would not violate controlling state, federal or foreign law, or the applicable standards of a national securities exchange or national securities association (i.e., NASDAQ, in the case of the Company), other than rules relating to director independence that rely on a subjective determination by the Board of Directors. The nominee must, however, satisfy objective independence standards of the applicable national securities exchange or national securities association.

The foregoing is a summary of the new proxy access rules, and any shareholder nominee(s) submitted pursuant to those rules will be required to meet all of the eligibility rules applicable to the nominee(s) and the nominating shareholder or nominating shareholder group.

Green Earth Technologies, Inc. (filed October 6, 2010)

On August 25, 2010, the SEC adopted new Exchange Act Rule 14a-11, which will permit stockholders or groups holding 3% of the voting power of U.S. public companies who have held their shares for at least three years to include director nominees in company proxy materials.  In addition, the SEC also amended Rule 14a-8 to provide that companies may not exclude from their proxy materials stockholder proposals that seek to establish less restrictive proxy access procedures, and adopted a number of related rule amendments intended to facilitate proxy access.  The new rules will be effective 60 days after their publication in the Federal Register, and rule 14a-11 will apply for a company’s 2011 annual meeting if the first anniversary of the mailing of the 2010 proxy materials occurs within 120 days of effectiveness.  However, the compliance date of Rule 14a-11 for smaller reporting companies has been delayed for a period of three years from the effective date.  On October 4, 2010, the SEC delayed the effective date of Rule 14a-11 and the amendments to Rule 14a-8 indefinitely, pending review of Rule 14a-11 by the United States Court of Appeals of the District of Colombia.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

The FDIC announced the appointment of Mark Pearce as director of the newly-established Division of Depositor and Consumer Protection, or DCP. The FDIC Board of Directors approved the creation of the DCP last August to help carry out its responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The establishment of the DCP is dedicated to depositor and consumer protection is intended by the FDIC to provide increased visibility to the FDIC’s compliance examination and enforcement program. That program is meant to ensure that banks comply with a myriad of consumer protection and fair lending statutes and regulations. While Congress established the Consumer Financial Protection Bureau to promulgate consumer protection rules, the FDIC maintains the responsibility to enforce those rules for banks with $10 billion or less in assets and to perform its traditional depositor protection function. The new Division will also house FDIC staff and resources devoted to answering questions and promoting public understanding of deposit insurance and use of FDIC-insured bank accounts.

 Mr. Pearce has been the Chief Deputy Commissioner of Banks for North Carolina since 2009 where he manages the supervision of non-depository financial institutions operating in the state, including mortgage, consumer finance, check-cashing, and money service businesses. He also developed and managed the North Carolina Foreclosure Prevention Project. Prior to joining state government, Mr. Pearce spent more than ten years with the Center for Responsible Lending in Durham, North Carolina, one of the nation’s leading sources of expertise in consumer protection in financial services, holding an number of progressively responsible positions, including President and Chief Operating Officer.

The SEC has proposed a rule pursuant to Section 409 of the Dodd-Frank Act to define “family offices” that would be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940 (“Advisers Act”) and thus would not be subject to regulation under the Advisers Act.   “Family offices” are entities established by wealthy families to manage their wealth, plan for their families’ financial future, and provide other services to family members. Single family offices generally serve families with at least $100 million or more of investable assets.  Industry observers have estimated that there are 2,500 to 3,000 single family offices managing more than $1.2 trillion in assets.

 Many family offices have been structured to take advantage of the exemption from registration under section 203(b)(3) of the Advisers Act for any adviser that during the course of the preceding 12 months had fewer than 15 clients and neither held itself out to the public as an investment adviser nor advised any registered investment company or business development company.  Other family offices have sought and obtained orders from the SEC under the Advisers Act declaring those offices not to be investment advisers within the intent of section 202(a)(11) of the Advisers Act.

 SEC exemptive orders have included conditions designed to distinguish between a “family office,” as described above, and a “family-run office” that, although owned and controlled by a single family, provides advice to a broader group of clients and much more resembles the business model common among many smaller investment adviser firms that are registered with the SEC or state regulatory authorities.  Accordingly, SEC exemptive orders have limited relief to those family offices that provide advisory services only to members of a single family and their lineal descendants, with very limited exceptions.

Under the SEC proposal  excluded family offices are not be permitted to have any investment advisory clients other than “family clients.”  Family clients would include family members, certain employees of the family office, charities established and funded exclusively by family members or former family members, trusts or estates existing for the sole benefit of family clients, and entities wholly owned and controlled exclusively by, and operated for the sole benefit of, family clients (with certain exceptions), and, under certain circumstances, former family members and former employees.

 The SEC proposes to define the term “family member” to include the individual and his or her spouse or spousal equivalent for whose benefit the family office was established and any of their subsequent spouses or spousal equivalents, their parents, their lineal descendants (including by adoption and stepchildren), and such lineal descendants’ spouses or spousal equivalents.

 The SEC proposal permits former family members, i.e., former spouses, spousal equivalents and stepchildren, to retain any investments held through the family office at the time they became a former family member.  However, the proposal limits former family members from making any new investments through the family office.

 The SEC proposes to treat as a “family client” any charitable foundation, charitable organization, or charitable trust established and funded exclusively by one or more family members and any trust or estate existing for the sole benefit of one or more family clients.  Similarly, the SEC proposal would also treat as a family client any company, including a pooled investment vehicle, that is wholly owned and controlled, directly or indirectly, by one or more family clients and operated for the sole benefit of family clients.

 The SEC also proposes to treat as family members certain key employees of the family office so that they may receive investment advice from and participate in investment opportunities provided by the family office. Such persons have been treated like family members in some of the SEC’s exemptive orders.  The SEC believes permitting participation by key employees allows such family offices to incentivize key employees to take a job with the family office and to create positive investment results at the family office under terms that could be available to them as employees of other types of money management firms.

 The proposal provides that to operate under the proposed exclusion from the Advisers Act the family office be wholly owned and controlled, either directly or indirectly, by family members.  This condition generally is consistent with SEC exemptive orders and assures that the family is in a position to protect its own interests and thus is less likely to need the protection of the federal securities laws.  The SEC believes this condition also helps distinguish family offices from family-run offices that may provide advice to other people, as well as other families, and operates as a more typical commercial investment adviser.

 Consistent with prior exemptive orders, the SEC proposes to prohibit a family office relying on the rule from holding itself out to the public as an investment adviser.   Holding itself out to the public as an investment adviser suggests that the family office is seeking to enter into typical advisory relationships with non-family clients, and thus is inconsistent with the basis on which the SEC has provided exemptive orders.

 The SEC is not proposing to rescind the orders it has issued to family offices because it does not believe that the policy behind the previously issued orders differs substantially from that of the current proposal. Further, single family offices do not compete with one another and thus there is no need to rescind exemptive orders to create a “level playing field.” Family offices currently operating under these orders could continue to rely on those orders or, if they meet the conditions of proposed rule 202(a)(11)(G)-1, they could rely on the rule once it becomes final.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

The Board of Directors of the Federal Deposit Insurance Corporation, or FDIC, voted on Friday, October 8, 2010, to approve a proposed rule clarifying how the agency would treat certain creditor claims under the new orderly liquidation authority established under the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The notice of proposed rulemaking, or NPR, was the subject of a briefing and board discussion during the FDIC open board meeting on September 27th, 2010.

 Title II of the Dodd-Frank Act provides a mechanism for the appointment of the FDIC as receiver for a financial company where the failure of the company and its liquidation under the Bankruptcy Code or other insolvency procedures would pose a significant risk to the financial stability of the United States.

 Among the issues addressed in the NPR is the availability of additional payments to creditors under the authority of the Dodd-Frank Act.  These provisions parallel the FDIC’s longstanding authority under the Federal Deposit Insurance Act and must be narrowly construed consistent with the Congressional intent.  Pursuant to the Dodd-Frank Act, the NPR proposes to absolutely bar any additional payments to holders of long-term senior debt, subordinated debt, or equity interests that would result in those creditors recovering more than other creditors entitled to the same priority of payments under the law.  Additional payments to holders of long-term senior debt, subordinated debt, or equity interests do not meet the statutory test that the payments must maximize the value of the assets or recoveries, minimize losses or be essential to implementation of the receivership or any bridge financial company.  The NPR also proposes to clarify that all creditors, must expect to absorb losses in any liquidation.  Under the NPR, no creditor can receive any additional payment unless the FDIC Board of Directors has determined, by recorded vote, that the payments meet the statutory standards.  In addition, such payments are subject to recoupment if ultimate recoveries are insufficient to repay any temporary government liquidity support provided as part of the orderly wind-down.  This recoupment must occur before imposition of a general industry assessment to cover any shortfalls. In no event may taxpayer money be used to cover losses associated with the failure of a large financial firm.

 The NPR also provides that secured creditors will only be protected to the extent of the fair value of their collateral.  To the extent that any portion of the claim is unsecured, it will absorb losses along with other unsecured creditors.  Secured obligations collateralized with US government securities will be valued at par.  The FDIC believes this provision should create additional incentives for market participants to use highly liquid and easy to value collateral such as US government obligations to collateralize short term debt.  The use of illiquid collateral to secure short term liabilities was a major contributor to the freezing of credit markets during the financial crisis.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act.

The Financial Stability Oversight Council (sometimes referred to as FSOC) convened its first “Official” meeting on October 1, 2010.  There’s no lack of political maneuvering behind the scenes.  Despite the congressional scuttlebutt, the Council appeared to have a focused, energized agenda.  It passed resolutions during its meeting concerning a variety of important steps to fulfill its mandate of identifying threats to the stability of our nation’s financial system.

Subject matter resolutions adopted by the Council are noted below.  Further information and pertinent documents about the below subjects may be located here.   The council passed the following resolutions:

1.      Organizational Bylaws for the Council –  The bylaws appear standard but there are some open positions to be filled and a budget needs to be established.

2.      Transparency Policy for the Council – A policy to engage stakeholders in an open process based on transparency and accountability.  Meetings will be open to the press and public via a live web stream except when confidential or sensitive information will be discussed or disclosed.  Meeting agenda and minutes (potentially redacted) will be made public.

3.      Supervision and regulation of Nonbank Financial Companies – Advanced Notice of Proposed Rulemaking – A series of Questions to identify public comment about the designation of nonbank financial companies for heightened supervision.  This is the first step in the Council’s process to bring certain nonbank financial companies under the supervision of the Federal Reserve Board.  The basic factors for designation will be the Council’s determination that material financial distress of such a firm, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the firm could pose a threat to the financed stability of the United States.

4.      Implementation of the Volcker Rule – A notice and request for information concerning matters involving the “Volcker Rule”, the prohibition, on banks engaging in proprietary trading and from maintaining certain relationships with hedge funds and private equity funds.  The Council is seeking comments on implementing these provisions.  Comments are due November 5, 2010.

5.      Integrated Implementation Roadmap – Coordinated timeline to implement Dodd-Frank by the Council and its member agencies.  The roadmap provides a concise summary of the dates targeted for accomplishing certain objectives.

We will write as the Council moves forward.

The cooperation of corporate whistleblowers may be a crucial element of a transparent and fully accountable market place.  However,  many employees with knowledge of violations remain silent for fear of retaliation from their employers.  The Sarbanes-Oxley Act attempted to increase the number of corporate insiders willing to come forward and blow the whistle by providing certain protections against retaliation for employees willing to cooperate in investigations. These protections, located at 18 U.S.C. 1514A, make it illegal for covered employers and their agents to “discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment” in retaliation for an employee’s cooperation in an investigation.   However, the law only applies to companies that either have registered securities under the Exchange Act or are subject to reporting requirements under Section 15(d) of the Exchange Act.

Since its passage, Section 1514A has been interpreted by the executive branch in a manner contrary to what its drafters intended.  Since 2002 the authors of the SOX whistleblower protection provision, Senators Patrick Leahy and Chuck Grassley, have been protesting interpretations by the white house, the SEC, and the Department of Labor that construe the whistleblower protections as not applying to employees of a non-public subsidiary of a public company.  The latest such protest came in the form of an October 6 letter from Senators Leahy and Grassley to Secretary of Labor Hilda Solis, after reports that the Department of Labor had dismissed more than 1,000 of the 1,600 cases that had been filed by whistleblowers alleging retaliation.  Reportedly, many of these cases were dismissed on the grounds that the employee alleging retaliation worked for a private subsidiary of a public company, and thus was not covered by the whistleblower protections.  The letter asserts that the Senators “strongly disagree with this legal interpretation,” which “erroneously excludes thousands of employees Congress meant to protect when it passed Sarbanes-Oxley and contradicts the spirit and intent of the overall legislation.” 

Section 929A of the Dodd-Frank Act attempts to clarify the issue by amending 18 U.S.C. 1514A(a) to make clear that the whistleblower protections apply not only to public companies, but also to “any subsidiary or affiliate whose financial information is included in the consolidated financial statements” of those companies.  Presumably this amendment will prevent a large number of claims under Section 1514A from being dismissed.  But, as the current controversy demonstrates, in the end it will all depend on the interpretation and implementation of the amendment by the Department of Labor and the Obama administration.   

This is just one more example of the wide reach of the Dodd-Frank Act.  Check back at Dodd-Frank.com frequently as we continue to analyze and monitor the implementation of this landmark legislation.

As noted, the SEC has removed the rating agency exemption from Regulation FD as required by Section 939B of the Dodd-Frank Act.  Regulation FD provides that when an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer’s securities who may trade on the basis of the information), it must make public disclosure of that information.  The question remains what strategies a public company should employ when providing rating agencies information in the future.

Most commentators believe there will be little practical impact.  One reason is issuers have entered into, or will enter into, confidentiality agreements with rating agencies and as a result disclosure of information is then permitted under Regulation FD.  The CEO of Fitch Ratings has validated this strategy, stating “[i]n the event that issuers feel it necessary to have in place with Fitch a confidentiality agreement pursuant to that provision of Regulation FD (Rule 100(b)(2)(ii)), which permits selective disclosure to a person who expressly agrees to maintain the disclosed information in confidence, Fitch has received confirmation from [its outside counsel] that its standard form confidentiality agreement would suffice for this purpose.”

 Another reason many think the change to Regulation FD will have little practical impact is Regulation FD only operates with respect to disclosures to certain persons such as investment advisers, brokers or dealers or associated persons, institutional investment managers, certain investment companies (and those who would be an investment company but for Section 3(c)(1) or 3(c)(7) of the Investment Company Act) and to certain holders of the issuer’s securities.  Rating agencies are often outside this category of enumerated entities.  Major rating agencies have been registered as investment advisers in the past but are not believed to be currently registered as investment advisers.

 Rule 17g-4 under the Securities Exchange Act also provides some comfort.  It provides, among other things “[t]he written policies and procedures a nationally recognized statistical rating organization establishes, maintains, and enforces to prevent the misuse of material, nonpublic information pursuant to section 15E(g)(1) of the Act (15 U.S.C. 78o–7(g)(1)) must include policies and procedures reasonably designed to prevent . . .[t]he inappropriate dissemination within and outside the nationally recognized statistical rating organization of material nonpublic information obtained in connection with the performance of credit rating services [and] [a] person within the nationally recognized statistical rating organization from purchasing, selling, or otherwise benefiting from any transaction in securities or money market instruments when the person is aware of material nonpublic information obtained in connection with the performance of credit rating services that affects the securities or money market instruments”.  An example of the implementation of Rule 17g-4 can be found in Moody’s Code of Professional Conduct.

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