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

The Securities and Exchange Commission announced on September 2, 2010, that it has adopted a temporary rule requiring municipal advisors to register with the SEC by October 1, a deadline established by the newly-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act.

Municipal advisors provide advice to state and local governments and other borrowers involved in the issuance of municipal securities. The advice typically relates to municipal derivatives, guaranteed investment contracts, investment strategies or the issuance of municipal securities. Municipal advisors also solicit business from a state or local government for a third party.

Municipal advisors can now access and complete the new registration form (Form MA-T) on the SEC’s website. Municipal advisors are encouraged to begin the registration process as soon as possible because of the impending registration deadline and the requirement that applicants first obtain an ID and password.

The SEC implemented the registration provision on an interim basis in order for municipal advisors to meet the new law’s October 1 registration deadline. The SEC expects to propose a permanent rule later this year.

Information filed by municipal advisors will be made publicly available on the SEC’s website by the registration deadline.

Subject to certain exemptions, the definition of municipal advisor under the Dodd-Frank Act includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and certain swap advisors that provide municipal advisory services.

Form MA-T requires municipal advisors to provide identifying and contact information, and select from a list of municipal advisory activities in which they engage. Municipal advisors also are required to provide disciplinary history information similar to what the SEC obtains from registered broker-dealers and investment advisers. Municipal advisors will be required to amend the form whenever any identifying and contact information or disciplinary information has become inaccurate in any way, and whenever a municipal advisor wishes to withdraw from temporary registration.

This regulation is the first adopted by the SEC to implement the requirements of the Dodd-Frank Act.

The Commission and its staff have already taken several other actions stemming from the new law, including seeking public comment regarding the ongoing study of the obligations of brokers, dealers, and investment advisers; issuing guidance interpreting how the “value of the primary residence” should be determined for purposes of calculating an investor’s net worth; seeking public comment about various definitions in connection with over-the-counter derivatives; holding a staff roundtable, jointly with the CFTC staff, regarding the governance of clearing facilities and conflicts; and posting job announcements for many new positions required by the legislation, including 25 positions related to the new Office of Credit Ratings.

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

Upon receipt of a notice of a shareholder nominee under the proxy access rules, public companies have a series of decisions to make with tight time lines imposed by the new proxy access rules.  Decisions will have to be made beginning on receipt of the notice and will continue through the filing of the proxy statement, the solicitation period before the meeting and at the shareholders’ meeting itself.

Public companies will generally become aware through the filing of a Schedule 14N on EDGAR by a nominating shareholder or shareholder group.  Schedule 14N includes a variety of information, including information about the nominating shareholder, the nominee and a statement of up to 500 words supporting the nominee.

Upon Receipt of a Proxy Access Nominee 

The first step to take is to verify the eligibility of the nomination.  Public companies should take the following steps:

  • Determine whether the nomination was submitted during the required window period.  Generally 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.
  • Verify that the shareholder or shareholder group owns the requisite securities and has held them for the requisite period of time.  Under Rule 14a-11(b)(1), the shareholder or group must own at least 3% of the voting power of the company’s securities that are entitled to be voted on the election of directors at the annual meeting of shareholders.  The shares used to satisfy the minimum ownership requirement must have been held continuously for at least three years as of the date of the shareholder notice on Schedule 14N.  Proof of ownership can include record ownership (which an issuer can verify with the transfer agent) or referencing Schedule 13D, Schedule 13G or Forms 3, 4 or 5.  In addition, the nominating shareholder or group can attach a statement to Schedule 14N from brokers or banks stating that the nominating shareholder continuously held the securities used to satisfy the ownership requirement for three or more years.
  • Verify that the remainder of Schedule 14N has been prepared in accordance with the rules.  For instance, Rule 14a-11(b)(4) requires a statement by the nominating shareholder or each member of the shareholder group that such persons intend to continue to hold the securities used to satisfy the minimum ownership requirement through the date of the shareholders’ meeting.  Likewise, under Rule 14a-11(b)(5) the nominating shareholder or group must include a statement of intent with respect to continued ownership after the election of directors.

It is possible that a company may receive nominations from more than one shareholder or shareholder group.  In that instance, Rule 14a-11(e) specifies that the number of available nominations are filled based on those proposed by the nominating shareholder or group with the highest qualifying voting power percentage disclosed as of the date of the filing of the Schedule 14N.  The rule permits the nomination of the greater of one director or 25% of the registrant’s board of directors.  If multiple nominations are received, issuers will want to verify all nominations as discussed above and determine the order of priority.

As we have noted, the proxy access rules grant nominating shareholders and groups exemptions to the proxy solicitation rules.  During this period and through the shareholders’ meeting, we recommend that public companies monitor the solicitation activities of nominating shareholders and groups for violations of the proxy rules.

Excluding a Nominee

            Under Rule 14a-11(g), a public company may exclude a shareholder nominee for the following reasons:

  • Rule 14a-11 is not applicable to the company.  For instance, the company could be a debt only issuer or state or foreign law or the company’s governing documents could prohibit a shareholder from nominating a candidate.
  • The nominating shareholder or group or nominee failed to satisfy the eligibility requirements in Rule 14a-11(b) (i.e., the 3% ownership test or three year holding requirement was not met).
  • Including the nominee or nominees would result in the company exceeding the maximum number of nominees it is required to include in its proxy statement and form of proxy.

      In addition, a company would be permitted to exclude a statement in support of a nominee or nominees included with the Schedule 14N if the statement in support exceeds 500 words for each nominee. In such cases, a company would be required to include the nominee or nominees, provided the eligibility requirements were satisfied, but would be permitted to exclude the statement in support.  Under the final rule a company may not exclude a nominee or a statement in support on the basis that, in the company’s view, the Schedule 14N (including the statement in support) contains materially false or misleading statements.  Nominating shareholders and groups will have liability for any materially false or misleading information or for making a false or misleading certification in the notice filed on Schedule 14N, and companies will not be responsible for that information.

      If a company determines it may exclude a nomination or a statement of support, the registrant must notify the nominating shareholder of group no later than 14 calendar days after the close of the window period.  The notice must include a basis for the determination.  The nominating shareholder or group then has 14 calendar days after receipt of the company’s notice to respond to the company notice and correct certain eligibility or procedural deficiencies identified in the notice.  If, after receipt of the response, the company intends to continue to exclude the nominee or statement of support, the company must generally notify the SEC 80 calendar days before it files its definitive proxy statement.  The notice to the SEC must include:

  • Identification of the nominating shareholder or each member of the nominating shareholder group, as applicable.
  • The name of the nominee or nominees.
  • An explanation of the company’s basis for determining that the company may exclude the nominee or nominees or a statement of support.
  • A supporting opinion of counsel when the company’s basis for excluding a nominee or nominees relies on a matter of state or foreign law.

      At the time the company files its notice, the company also may seek a no-action letter from the SEC staff with regard to its determination to exclude from its proxy materials a nominee or nominees or a statement of support.  If a company seeks a no-action letter from the staff with respect to its decision to exclude any Rule 14a-11 nominee or nominees, it should seek a no-action letter with regard to all nominees that it wishes to exclude at the outset and should assert all available bases for exclusion at that time. For example, if a company receives more nominees than it is required to include, its reasons for exclusion would note that basis. In addition, if the company believes it has other bases to exclude the nominee, it should note those other bases in its notice and include the other bases in its request for a no-action letter.  The company must provide the nominating shareholder or group with notice of whether it will include the shareholder nominee, promptly upon receipt of the staff response to the no-action letter request.

Disclosure in the Proxy Statement

If a shareholder or shareholder group’s nominee is included in the proxy statement there are detailed disclosure requirements.  Item 7(e) of Schedule 14A requires the company to disclose in its proxy statement the information included in Item 5 of Schedule 14N.  That information includes:

  • A statement that the nominee consents to be named in the proxy statement.
  • Biographical information about the nominee, information about related party transactions and information regarding independence “as applicable.”
  • Information about the nominating shareholder or shareholder group, including certain information as to legal proceedings.
  • Information about relationships between the nominating shareholder or group, the nominee and the company and its affiliates.
  • The nominating shareholder or group’s statement in support of the nominee.

Companies will also be required to include additional disclosures, in addition to including information about the nominating shareholder or group and the nominee which is provided on Schedule 14N.  Here, the SEC chose not to amend existing disclosure requirements with its final rules, but pointed out that companies are obligated to make the disclosures in existing Rule 14a-12(c).  The adopting release also states a company has “the option to include a statement in support of the management nominees” but there is no further elaboration or new rules that illuminate on the company’s boundaries in this regard.

New Rules for the Proxy Card

Rule 14a-4(b)(2) now provides the form of proxy must include any person nominated in accordance with Rule 14a-11.  In a change from the existing rules, if there is a proxy access nominee, the proxy card cannot grant authority to vote for any nominees as a group or to withhold authority for any nominees as a group.

Between Filing the Proxy and the Shareholders’ Meeting

The SEC noted both the nominating shareholder or group and the company may wish to solicit in favor of their nominees for director by various means, including orally, by U.S. mail, electronic mail, and Web site postings. The SEC noted that the company ultimately would file a proxy statement and therefore could rely on the existing proxy rules to solicit outside the proxy statement.

In new Rule 14a2-(b)(8), the SEC provided an exemption from the disclosure, filing and other requirements of the proxy rules for solicitations by or on behalf of a nominating shareholder group.  The requirements to rely on the rule provide that:

  • The soliciting party does not seek the power to act as proxy and does not furnish or request a form of proxy revocation, abstention, consent or authorization.
  • Each written communication must include certain information, including the identity of the nominating shareholder or group and his or her direct or indirect interests, by security holdings or otherwise and a legend urging readers to read the proxy statement and other matters.
  • Each written communication must be filed by Schedule 14N.

The Shareholders’ Meeting

Under the rules, a nominating shareholder or group have no obligation to attend the annual or special meeting at which its nominee or nominees is being presented to shareholders for a vote.  The SEC decided not to include such a requirement because it believes that shareholders will have sufficient incentive to take steps to assure that their nominees are voted on at the meeting, whether through attending the meeting or sending a qualified representative, or through other arrangements with the company. 

The SEC noted that state law will control what happens if a candidate is not nominated at the meeting because the person supporting the candidate does not attend the meeting or make other arrangements.  In a footnote, the SEC elaborated that while state statutes are largely silent on the subject of presentation of nominations, motions or other business at meetings of shareholders, the chairman of the meeting typically has broad discretionary authority over its conduct.  The SEC believes it is prevailing practice for the chairman to invite nominations of directors from the meeting floor.

Check https://dodd-frank.com/ frequently for updates on the new proxy access rules.

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 FinReformComments@fdic.gov.

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 dodd-frank.com 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 dodd-frank.com 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 dodd-frank.com frequently for updates on the new proxy access rules.

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.