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

In connection with the implementation of the Dodd-Frank Act, the FDIC announced a series of roundtable discussions with external parties. The first discussion was held on August 31, 2010, and the agenda for the meeting was focused on the new resolution authority provided in the Dodd-Frank Act for the largest financial firms.  The FDIC will announce subsequent roundtable discussions here.  

Government officials, industry executives, academics, and investors were scheduled to discuss the framework of the resolution process, the treatment of creditors and the creation of living wills.  Participation at the roundtable discussions is by invitation only.  However, the FDIC will webcast each roundtable, and interested parties may view the discussion by clicking here. According to the FDIC website, an archived version of the webcast will be made available approximately two to three days following the live webcast.

The roundtables are part of the FDIC’s overall effort to bring transparency into the process. Previously, the FDIC announced that it was seeking input from the widest audience possible by encouraging the public to submit views via email on how the FDIC should implement the new law.  According to the FDIC, these comments will become part of the record and will be posted on the FDIC website. Interested parties are directed to send comments to

The U.S. Commodity Futures Trading Commission has issued regulations concerning off-exchange retail foreign currency transactions. The rules implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Food, Conservation, and Energy Act of 2008, which, together, provide the CFTC with broad authority to register and regulate entities wishing to serve as counterparties to, or to intermediate, retail foreign exchange, or forex, transactions.

 The final forex rules put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital and other business conduct and operational standards. Specifically, the regulations require the registration of counterparties offering retail foreign currency contracts as either futures commission merchants, or FCMs, or retail foreign exchange dealers, or RFEDs, as a new category of registrant. Persons who solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex also will be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators (as appropriate) or as associated persons of such entities. “Otherwise regulated” entities, such as United States financial institutions and SEC-registered brokers or dealers, remain able to serve as counterparties in such transactions under the oversight of their primary regulators.

 The final rules include financial requirements designed to ensure the financial integrity of firms engaging in retail forex transactions and robust customer protections. For example, FCMs and RFEDs are required to maintain net capital of $20 million plus 5 percent of the amount, if any, by which liabilities to retail forex customers exceed $10 million. Leverage in retail forex customer accounts will be subject to a security deposit requirement to be set by the National Futures Association within limits provided by the CFTC. All retail forex counterparties and intermediaries will be required to distribute forex-specific risk disclosure statements to customers and comply with comprehensive recordkeeping and reporting requirements.

 The final rules become effective October 18, 2010.

 Check frequently for updates on the Dodd-Frank Act.

As the CFTC gears up to implement the Dodd-Frank Act through the more than 60 rulemakings required of it over the next eleven months, it has taken the unusual step of publishing a notice soliciting “across the board” public input before publishing any proposed rules. The Commission has set up electronic mailboxes for 29 of the 30 categories of rulemakings it has identified as necessary for implementation of the Act. The e-mail addresses for each rulemaking category are available by clicking on a category and then on the hyperlinked address included in the description of that category.

As many observers have questioned the adequacy of the Commission’s resources to promulgate so many rules in so little time, this informal public comment process may present a valuable opportunity to provide input that frames some of the rules before they are ever released for comment—after which the tight timeline required of the Commission might make it disinclined to do any significant reshaping.

The Securities and Exchange Commission today issued a report cautioning credit rating agencies about deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings.

The report says that because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the SEC declined to pursue a fraud enforcement action against Moody’s Investors Service, Inc. The report notes that the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act provided expressly that federal district courts have jurisdiction over SEC enforcement actions alleging violations of the antifraud provisions of the securities laws when conduct includes significant steps, or a foreseeable substantial effect, within the United States. The report also notes that the Dodd-Frank Act amended the securities laws to require nationally recognized statistical rating organizations (NRSROs) to “establish, maintain, enforce, and document an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings.”

Check frequently for updates on the Dodd-Frank Act.

In a comment letter recently sent to the SEC, one firm describes how in a span of just 10 days it had already “filed several whistle-blower complaints with the SEC, pursuant to the new statute, involving major Wall Street firms, which filings appear to implicate hundreds of millions of dollars, if not more, of investor related fraud issues, including on behalf of former senior employee(s) of entities.”  

The fact that these whistleblower claims are starting to roll in under the new whistleblower provisions of Dodd-Frank is not unexpected. As described in Steve’s posting, the new rules provide, among other things, that if a whistleblower provides original information in certain judicial or administrative actions, the whistleblower may be entitled to as much as 10% to 30% of the monetary sanctions imposed.  In fact, anyone who provides a tip that leads to a successful SEC action resulting in total monetary sanctions in excess of $1 million will be entitled to collect between 10% and 30% of the amount recovered.  Penalties, disgorgement and interest paid count toward the $1 million threshold.

The SEC’s whistle-blowing program used to be limited to insider trading cases and offered only small discretionary rewards ranging from 0% to 10% of the money recovered. Dodd-Frank extends the program beyond insider-trading cases to all securities law violations and offers bigger, mandatory payoffs and therefore greater incentive to come forward with information.  We can expect to see more whistleblower complaints than ever before.

As many know, the SEC adopted the proxy access rules on August 25, 2010.  The new rules will be effective 60 days from publication in the Federal Register, excepting smaller reporting companies, for which the rules are deferred for three years.  Federal Register publication is expected fairly quickly barring some bureaucratic snafu.

 We recommend that public companies gain an understanding of the proxy access rules as soon as possible, even if your annual meeting is months away.  The reason—the rules permit activist shareholders to begin taking public steps toward submitting nominations, or in some cases actually submitting nominations, once the 60 day waiting period has passed.  By SEC standards, the rules are taking effect with a lightning speed not seen since the days following Sarbanes-Oxley.

 In addition, proxy statements filed after the 60 days have passed will be required to include new disclosures.  There are new Form 8-K triggering items as well.

 What public steps can an activist take after the 60 days have passed?  The activists will begin filing new Schedule 14N.  It’s likely some activists will use the 60 day period to select targets (if they have not already) and begin laying the groundwork for filing a Schedule 14N.

 A Schedule 14N filed by an activist will contain the following information that will be important for public company targets to immediately understand and digest.  That information includes:

  • A shareholder’s intent to use written soliciting materials to form a shareholder group to submit a nominee for inclusion in a company’s proxy statement under rule 14a-2(b)(7).  Under the rules shareholders can form a group to meet the 3% ownership threshold necessary to submit a nominee.  Basically, the filing of the Schedule 14N is a written advertisement of interest to form a shareholders group, a tactic that would not have been allowed before the proxy access rules.
  • A shareholder’s intent to orally solicit other shareholders to form a nominating committee.  Again, another written advertisement.

 Public companies should monitor EDGAR for Schedule 14N filings with respect to their company.  If one should come to their attention, a core team should be formed, including legal counsel, to consider an appropriate action plan.

 New Rule 14a-11(b)(10) requires a shareholder or shareholder group that wishes to include a nominee in a company’s proxy statement to file a Schedule 14N during a specified “window period.”  The window period is not more than 150 calendar days and not less than 120 calendar days before the anniversary of the date the company mailed its proxy statement for the prior year’s annual meeting.  At this point, the public company will engage in a complex dance with the nominating shareholder and the SEC to determine whether the nominee must be included or may be excluded from the company’s proxy statement.

 There are other disclosure and Form 8-K filing requirements that will become effective 60 days after publication in the Federal Register.  Under amended Rule 14a-5, every proxy statement filed after the new rules become effective will have to disclose the deadline for submitting nominees for inclusion in the company’s proxy materials for the next annual meeting of shareholders.

 A Form 8-K will be required if the company did not hold an annual meeting in the prior year, or if the date of the meeting has changed by more than 30 calendar days from the prior year.  The Form 8-K must advise shareholders of the date by when a Schedule 14N must be filed to be considered timely to include a nominee in the company’s proxy statement.

Check frequently for updates on the new proxy access rules.

In a recent posting we highlighted issues surrounding the imposition of a fiduciary standard on broker-dealers.  Gauging from the overwhelming majority of comments received to date, the SEC will continue, as expected, to receive strong pushback not only from the largest brokerage houses, but also from solo and smaller firm industry participants.  Their mantra has been and continues to be “no more regulation,” arguing that additional layers of oversight would further burden brokers administratively and would not, in fact, solve the problems the legislation was intended to remedy.   We’ll continue to watch with interest as this continues to unfold and develop.

Section 407 of the Dodd-Frank Act provides an exemption from registration as an investment adviser if the investment adviser provides advice solely to one or more venture capital funds.  The Dodd-Frank Act goes on to require the SEC to define the term “venture capital fund.” 

The SEC previously attempted to regulate hedge funds, but not private equity groups or venture capital funds, when it adopted Rule 203(b)(3)-2 under the Investment Advisers Act.  Rule 203(b)(3)-2 was ultimately invalidated in the case of Goldstein v. SEC (D.C. Cir. June 23, 2006). However, the Rule’s history demonstrates the difficulty the SEC will have in distinguishing venture capital funds from private equity and hedge funds.

Rule 203(b)(3)-2 was adopted in SEC Release No. IA-2333.  In that release, the SEC noted that one of the distinguishing characteristics of a venture capital fund was that venture capital funds are generally organized to invest in the start-up or early stages of a company.  That does not seem to be a precise enough line on which to exclude venture capital funds from regulatory jurisdiction.  In that same release, the SEC also said distinguishing a venture capital fund from a hedge fund based on investment strategy or portfolio composition was not appropriate because the SEC was concerned that it could serve to chill advisers’ use of certain investment strategies solely in order to avoid registration under the Investment Advisers Act, which might negatively affect the markets.

The task is further complicated because of the similarities between venture capital funds and private equity funds.  The SEC noted that venture capital funds have the same features that distinguish private equity funds generally from hedge funds, such as capital contributions over the life of the fund and the long-term nature of the investment.   Finally, the SEC noted that a venture capital fund typically seeks to liquidate its investment once the value of the company increases above the value of the investment.

The SEC distinguished private equity and venture capital funds from hedge funds in Release No. IA-2333 by basing the determination on whether the fund permits investors to redeem their interests in the fund within two years of purchasing them.  Since both private equity and venture capital funds share that characteristic, it does not provide a useful tool to isolate venture capital funds.

The SEC has a difficult task in defining the term “venture capital fund.”  It appears the only avenue is to base the determination on investment strategy or portfolio composition, but the SEC has previously rejected that mechanic.

With respect to the borrowing of securities from customers, Section 929X of the Dodd-Frank Act imposes the following two additional requirements on broker-dealers:  (i) every registered broker or dealer must provide notice to its customers that they may elect not to allow their fully paid securities to be used in connection with short sales and (ii) if a broker or dealer uses a customer’s securities in connection with short sales, the broker or dealer must provide notice to its customer that the broker or dealer may receive compensation in connection with lending the customer’s securities.

SIFMA has outlined the following best practices for compliance with the notice requirements of Section 929X, which are based on discussions with various SIFMA members, as well as discussions with the staff in the SEC Division of Trading and Markets. Pursuant to Rule 15c3-3 under the Securities Exchange Act of 1934, broker-dealers are generally prohibited from borrowing a customer’s fully-paid securities unless the broker-dealer enters into a separate written agreement with the customer that contains the provisions set forth under Rule 15c3-3(b)(3).  Accordingly, broker-dealers should review their disclosures to existing customers with brokerage accounts with whom the broker-dealer has entered into a fully-paid lending agreement pursuant to Rule 15c3-3(b)(3) for compliance with the notice requirements of the Dodd-Frank Act, and make any necessary adjustments to such disclosures before engaging in any new borrows with such customers.  Specifically, broker-dealers should consider whether their disclosures provide notice to such customers that fully-paid securities they lend to the broker-dealer may be used in connection with short sales, and that the broker-dealer may receive compensation in connection with the use of the customer’s fully-paid securities.

Broker-dealers should also consider that the second requirement above does not specifically state that the disclosure only applies to fully-paid securities.  Therefore, Broker-dealers should consider whether such disclosure should also be sent to margin customers whose securities may be rehypothecated.  For existing margin customers, firms could include such notice in the course of standard information provided to existing margin customers in the next available cycle as part of information provided in a customer statement or otherwise.  This notice should be incorporated into the customer agreements for future margin customers.  The SEC may by rule, prescribe the form, content, time and manner of delivery of any such notice, but this provision of the Dodd-Frank Act otherwise appears to be self-operative.

As we noted, the SEC and CFTC held a joint roundtable on August 20, 2010 addressing governance and conflicts of interest on clearing and listing of swap transactions.  Gary Gensler, Chairman of the CFTC issued a statement which stated “Today’s public roundtable will help us as we move forward to write rules on the important matters of governance of clearinghouses and trading facilities and how to best protect their decision making from conflicts of interest. I thank the CFTC and SEC staffs who worked cooperatively and constructively to plan and execute today’s roundtable. We will continue to collaborate closely with the SEC and other Federal regulators as we draft rules to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act. We look forward to hosting several more roundtables along with the SEC on other important matters related to the Act.”

 Beyond that statement, there appears to have been little agreement in this highly contentious rule making effort resulting from the Dodd-Frank Act.  The Wall Street Journal (subscription required) noted that it was standing room only at the meeting.

 Parts of the debate appeared to center on ownership of any clearing and trading facilities required by the Dodd-Frank Act.  According to press reports,  Swaps and Derivatives Market Association Vice Chairman Jason Kastner told regulators at a public meeting  “If we put stuff into a clearinghouse and the clearinghouse has the same five guys in the room and the biggest three of them start to wobble, it’s going to be back to Congress with a one-pager asking for $750 billion.”

Others suggested diversified ownership of clearing and trading facilities would not serve the goals of the Dodd-Frank Act.  A representative of a large financial institution stated “They have to be able to trade very large amount of highly complex illiquid OTC derivatives, and if they can’t do that, by introducing them as a member into the clearinghouse you actually increase risk in the clearinghouse.”