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

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires certain investment advisers to “private funds” to maintain certain records and file reports with the SEC for the purpose of providing the SEC and the Financial Stability Oversight Council with an opportunity to identify potential systemic risk in the system and to address those risks before they result in a major market disruption  A private fund is defined as an entity that would fall within the definition of an “investment company” under the Investment Company Act but for reliance on one of two exemptions from that definition.  An “investment company” is broadly defined to include those entities which hold themselves out as being  primarily engaged in investing in securities. The first exemption from the definition of an “investment company” referred to in Dodd-Frank is available when an issuer has less than 100 beneficial owners of its securities.  The second exemption applies when all of the issuers owners are “qualified purchasers,” meaning certain entities that have significant invested amounts.  Many  private equity funds and hedge funds may fall within the definition of a private fund and be subject to these provisions of the Dodd-Frank Act.

Advisers to Private Funds Registered With the SEC

Section 404 of the Dodd-Frank Act, which amends Section 204 of the Investment Advisers Act of 1940, sets forth the general rules for advisers to private funds that are registered with the SEC.  It provides the SEC may require any investment adviser to a private fund registered with the SEC:

  • to maintain such records of, and file with the SEC such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council; and
  • to provide or make available to the Council those reports or records or the information contained therein.

Under the Dodd-Frank Act the records of private funds that are advised by investment advisers subject to Section 404 are deemed to be the records of the investment adviser.  Presumably, this will have the effect of subjecting new types of information on private funds to existing record keeping requirements applicable to investment advisers.  

In addition, Section 404 of the Dodd-Frank Act requires investment advisers to maintain certain records and information relating to clients, subject to inspection by the SEC.  These records and information include, for each private fund advised by the investment adviser, a description of:

  • the amount of assets under management and the use of leverage, including off-balance-sheet leverage;
  • counterparty credit risk exposure;
  • trading and investment positions;
  • valuation policies and practices of the fund;
  • types of assets held;
  • side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements  than other investors;
  • trading practices; and
  • such other information as the SEC, in consultation with the Financial Stability Oversight Council, determines is necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk, which may include the establishment of different reporting requirements for different classes of fund advisers, based on the type or size of private fund being advised.

A number of issues relating to these new record-keeping requirements have not yet been resolved, and will be the subject of forthcoming rules to be developed by the SEC.  For example, the SEC will promulgate rules relating to how long records must be retained by investment advisers, how often investment advisers will be subject to regular record inspections, and the conditions pursuant to which the SEC may conduct non-scheduled record inspections “as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.”  Forthcoming rules will also specify the form and content of new reports that investment advisers will be required to file relating to their work with private funds.

Confidentiality of Information Relating to Private Funds

The Dodd-Frank Act requires the SEC to share information it collects on private funds with the Financial Stability Oversight Council, and allows for information sharing with other departments and agencies.  One concern relating to the additional record keeping, reporting, and inspection provisions applicable to advisers to private funds is that compliance with these new rules and the sharing of information among regulators will lead to the disclosure of highly confidential and proprietary information that has traditionally been closely guarded by private funds.  The Dodd-Frank Act attempts to address this concern by providing that the Financial Stability Oversight Council and any other department or agency that receives information relating to private funds must maintain the same level of confidentiality with respect to that information as was maintained by the SEC.

The SEC has the authority to maintain a high level of confidentiality with respect to sensitive information, and is exempt from the public disclosure requirements contained in the Freedom of Information Act (Title 5, Section 552 of the United States Code).  The Dodd-Frank Act identifies a subclass of “proprietary information” collected by the SEC for special treatment.  Proprietary information included in reports to the SEC is subject to the same limitations on disclosure as are provided in Section 210(b) of the Investment Advisers Act, which  amongst other things, prohibits the disclosure of such information to anyone not a member, officer, or employee of the SEC without the approval of the SEC. Proprietary information is defined to include sensitive, nonpublic information regarding:

  • the investment or trading strategies of the investment adviser;
  • analytical or research methodologies;
  • trading data;
  • computer hardware or software containing intellectual property; and
  • any additional information that the SEC determines to be proprietary.

Exempt Advisers to Private Funds

Investment advisers with assets under management of less than $150,000,000 that solely act as advisers to private funds are exempt from registration as investment advisers under the Dodd-Frank Act.  These exempt advisers to private funds are not subject to the record keeping requirements described above.  Exempt advisers will still be subject to some level of record keeping requirements and to some form of reporting, but the specifics of these obligations are left to the discretion of the SEC. The Dodd-Frank Act requires the SEC, when promulgating rules applicable to exempt advisers,  to take into account the size, governance, and investment strategy of such funds to determine whether they pose systemic risk, and to match the administrative burden of the new rules with the level of systemic risk posed by such funds.

HP’s Chief Executive Officer, Mark Hurd, resigned after an investigation disclosed that Hurd had a “close personal relationship” with an H-P contractor hired by the Office of the CEO and that “Mark never disclosed that.”  According to HP’s General Counsel, “there were instances of compensation and reimbursement for services that were never performed,  and there were “inaccurate expense reports submitted by Mark or on his behalf” that were intended to conceal the relationship.  See the Wall Street Journal account of the conference call where this was announced.

Now the San Francisco Chronicle is reporting  that Mr. Hurd will be receiving $50 million in severance payments.  Seems a little unbelievable for a guy that filed false expense reports.   Maybe it is because the HP board did not have the back bone to fire Mr. Hurd for cause or his relevant agreements did not permit it.

Its unclear to me where the $50 million number came from, but HP’s 8-K  states in “connection with Mr. Hurd’s resignation from HP, HP and Mr. Hurd entered into a Separation Agreement and Release (the “Separation Agreement”) that provides Mr. Hurd, in exchange for signing a general release of claims in favor of HP, with (i) a severance payment of $12,224,693 under the HP Severance Plan for Executive Officers; (ii) an extension until September 7, 2010 of the expiration date of his outstanding options to purchase up to 775,000 shares of HP common stock that were vested as of the date of his resignation; (iii) pro-rata vesting and settlement, at the same time and on the same terms as other HP employees, of 330,177 performance-based restricted stock units granted to Mr. Hurd in January 17, 2008 based on actual HP performance during the three-year performance period ending on October 31, 2010; and (iv) settlement on December 11, 2010 of 15,853 time-based restricted stock units granted to Mr. Hurd on December 11, 2009 at a price equal to the lesser of (a) the closing price of HP’s common stock on August 6, 2010 or (b) the per share closing trading price of HP common stock on December 11, 2010.  The value of both the pro-rata performance-based restricted stock units and the time-based restricted stock units to which Mr. Hurd is entitled is capped such that Mr. Hurd will not receive greater value in respect of those awards on their dates of settlement than what he would be entitled to assuming the closing price of HP’s common stock on their respective settlement dates is the same as the closing price on August 6, 2010.”

So it’s not a surprise that Congress decided to reform executive compensation through Dodd-Frank.

I have been thinking about the new Dodd-Frank requirement for public companies to report the ratio of the median annual total compensation of all the company’s employees (other than the CEO) to the CEO’s annual total compensation.  This is a provision that requires SEC regulatory guidance before it becomes effective, but may be in place for the 2011 proxy season.

Think of the problems you face in determining the “annual total compensation” under SEC regulations for your named executive officers.  Multiply that by the number of employees you have.  Will the SEC provide ways to simplify these calculations when the rules are issued?

And think about the number of employees that you have.  Think about your normal headcount; then ask your payroll department how many W-2s you issue each year.  Each W-2 represents an employee.  If you have a lot of turnover, chances are your median compensation number will be lower than you might think, since it may include a number of employees who did not work a full year and so did not earn a full year’s wage for their position.  Will the SEC allow for that compensation to be annualized?  Will that simplify or complicate the calculation?

What if you have employees in foreign countries?  Add them to this mix and the calculations will be even messier and the significance of the ratio even less clear.

Will investors understand the limitations of the ratio?  Will the ratio have any meaning at all?  Time will tell.

The Dodd-Frank Act and the Sarbanes-Oxley Act both have provisions for clawbacks.  Public companies need to be familiar with all of these provisions.

Dodd-Frank

Section 954 of the Act requires national securities exchanges to adopt rules as directed by the SEC, which rules will require issuers to develop and implement a policy providing:

  • for disclosure of an issuer’s policy on incentive compensation that is based on financial information required to be reported under securities laws; and
  • that, if an accounting restatement is prepared, the issuer will recover any excess incentive-based compensation from any current or former executive officer who received such incentive-based compensation in the three preceding years.

The Dodd-Frank Act does not provide any required timeline for implementation of these rules.  The exchanges and the SEC will have to make a number of important interpretive calls, including:

  • What incentive compensation is covered?
  • Is incentive compensation that is based on financial metrics but not required to be reported subject to a clawback?
  • How is “excess incentive based compensation” calculated?
  • How is the “preceding three years” calculated—where does the period begin and end?

Sarbanes-Oxley

Section 304 of the Sarbanes-Oxley provides that if an “issuer” is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for:

  • any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and
  • any profits realized from the sale of securities of the issuer during that 12-month period.

The definition of “issuer” in Sarbanes-Oxley requires the issuer to have a class of securities registered under Section 12 of the Exchange Act.  It is therefore applicable to a broader class of companies than Dodd-Frank, which only applies to issuers with securities listed on a national securities exchange, such as the NYSE, Amex or NASDAQ.  As a result, issuers traded in the “pink sheets” and other over-the counter markets are not subject to Dodd-Frank, but most likely are covered by Sarbanes-Oxley.

In SEC v. Jenkins, a federal district court held Section 304 could be used to return incentive compensation even when the CEO had no personal involvement in the fraud.  The SEC has used Section 304 in other actions to enforce the return of equity based compensation without proving fraud by the CEO and CFO.  See SEC v. Walden O’Dell.

What Does All This Mean?

Compensation committees for exchange listed companies should begin to inform themselves about the design of clawback policies and available choices so they are in a position to make a decision once applicable rules are promulgated.  One important consideration will be how many other employees should be covered by the policy in addition to the “executive officers” referred to in Dodd-Frank.  Some companies may considered delayed payment of a portion of equity compensation until the three year period covered by Dodd-Frank has run.  There is probably no clawback policy that will be eagerly accepted by management, so fairness to management, to the extent permitted by Dodd-Frank, will be an important consideration.  For instance, a Dodd-Frank policy should give credit for any amounts clawed back by the Sarbanes-Oxley provision.

The Dodd-Frank Act contains a number of provisions designed to improve the independence and operations of Compensation Committees.  But in doing so, has Congress made it more difficult – if not impossible – for a company’s regular outside law firm to assist its Comp Committee?

The Act provides that a Comp Committee may only select a compensation consultant, legal counsel, or other advisor after taking into consideration certain factors to be identified by the SEC, which affect the independence of such consultant, counsel or other advisor.

Those factors include:

  • the provision of other services to the company by the law firm;
  • the amount of fees received by the law firm from the company, as a percentage of its total revenues;
  • the law firm’s policies and procedures designed to prevent conflicts of interest;
  • any business or personal relationship between the lawyer advising the Comp Committee and any member of the Committee; and
  • any stock of the company owned by the lawyer.

Of course, these same factors apply to compensation consultants and other advisors, but these factors are probably less likely to apply to them than to a company’s regular outside law firm.

 The Act also makes clear that the Comp Committee is “directly responsible for the appointment, compensation, and oversight of the work of independent legal counsel and other advisers.”  While we believe this language was designed to ensure that the Comp Committee operates independently of Board of Directors control, it also informs the members of the Comp Committee that they will be required to take their responsibilities seriously.

In a separate section covering just compensation consultants, companies are required to disclose the following in their proxy statements for meetings occurring one year after the date of enactment of the Act (i.e., meetings taking place in August 2011 and thereafter):

  • whether the work of the consultant raised any conflict of interest and, if so,
  • how it was being addressed.

We wonder whether some court could apply a broad reading of this section and apply it to legal counsel as well.

All in all, Compensation Committees will have to think twice about using the company’s regular lawyers for assistance, and law firms will have to think twice about seeking such work.

Bloomberg is reporting the SEC is in a rift over clawback policies.  “The U.S. Securities and Exchange Commission is divided over when to seize pay from executives who unwittingly benefit from accounting fraud, a rift that has triggered internal disagreements over cases, according to people with direct knowledge of the matter.”  If true, it overshadows a rough rulemaking path from the SEC on the new clawback provisions under Dodd-Frank.

The Interaction Between Dodd-Frank and Minnesota Regulation of Investment Advisers

Before enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the following rules applied under the Investment Advisers Act of 1940:

  • The Investment Advisers Act precluded investment advisers with less than $25 million in assets under management from registering with the SEC and left the regulation of those investment advisers in the hands of the states. 
  • Investment advisers with more than $25 million under management but less than $30 million under management were eligible to register with the SEC as an alternative to registering with each state in which the advisers did business unless exempt under rules of the applicable state.
  • Investment advisers with more than $30 million under management were required to register with the SEC. 

Investment advisers often found SEC registration desirable as compliance was more easily achieved than registration and regulation by multiple states with differing regulatory and compliance regimes.

The Dodd-Frank Act attempts to shift regulation of investment advisers to the state level by making certain investment advisers who previously would have selected federal registration ineligible for registration with the SEC.  Under Section 410 of the Dodd-Frank Act, investment advisers who meet the following definition are precluded from registering with the SEC, unless the investment adviser would be required to register with 15 or more states:

  • The investment adviser is required to be registered as an investment adviser with the securities commissioner (or any agency or office performing like functions) of the state in which it maintains its principal office and place of business and, if registered, would be subject to examination as an investment adviser by any such commissioner, agency, or office; and
  • The investment adviser has assets under management between $25 million and $100 million.

On its face, Section 410 of the Dodd-Frank Act appears to compel many investment advisers that previously used the federal registration system to register with each state in which they do business.  However, under the Minnesota Securities Act and the associated rules, there are several exemptions available to investment advisers so that registration with the State of Minnesota would not be required in many circumstances.  For example, investment advisers whose only clients in the State of Minnesota are accredited investors (as defined in Rule 501 of Regulation D) or “institutional investors” (as defined in Minn. Stat. 80A.41, subd. 12) are not required to register with the State of Minnesota.  Investment advisers exempt from registration in the State of Minnesota with assets under management of between $25,000,000 and $100,000,000 would therefore still be required to register with the SEC because they would be neither “required to be registered” with the State of Minnesota nor “subject to examination” by the State.

Note that the Dodd-Frank Act also eliminates an exemption from federal registration for investment advisers with fewer than 15 clients, which is an exemption that has historically been relied upon by private equity groups and hedge funds.  However, the Dodd-Frank Act provides a separate exemption from registration with the SEC for most private equity groups and hedge funds so long as those funds have assets under management of less than $150 million.  It is likely those investment advisers are also exempt from registration with the State of Minnesota because the same exemptions discussed above are available.

Registration With the State of Minnesota

The following sections describe the process by which an investment adviser registers with the State of Minnesota.

An investment adviser makes an initial application for registration in Minnesota by paying a $100 filing fee and submitting a Uniform Application for Investment Adviser Registration on Form ADV.  Form ADV must be filed electronically through the Investment Advisory Registration Depository, or IARD, which is a uniform electronic filing system maintained by the SEC to facilitate both federal and state registration of investment advisers.  In addition, an investment adviser without a principal place of business in Minnesota must submit a consent to service of process in Minnesota and an appropriate resolution appointing the Commissioner of Commerce as its agent for such purposes, preferably on Form U-2 or U-2A.  There are also several other requirements for registration in Minnesota that are described in more detail below, including the provision of proof relating to the experience of supervisory personnel, the submission of financial statements meeting certain standards, minimum financial requirements, and, in some cases, the posting of a surety bond. 

Generally speaking, an application becomes effective on the 45th day after the filing of a completed application.  Unless the investment adviser is a partnership, sole proprietorship, or Minnesota corporation, the adviser will need to qualify to do business in Minnesota as a foreign corporation.  Application information is available from the office of the Minnesota Secretary of State (www.sos.state.mn.us/).

Proof of Experience of Supervisory or Control Individuals

An investment adviser seeking registration in Minnesota must submit proof that each person in a supervisory or control capacity has passed either the Uniform Investment Adviser State Law Examination (S65) or the Uniform Combined State Law Examination (S66) within the two year period immediately preceding the date of application.  In addition, at least one person in a full-time supervisory position with the investment adviser must have been actively engaged in the securities business in a similar supervisory capacity for a minimum of three of the preceding five years.  Since Form U-4 does not provide sufficient detail of such background for purposes of this requirement, the adviser should submit a detailed descriptive narrative of the employment history of the supervisory person or persons.

The exam requirement may be waived in certain circumstances.  For example, if within the last two years the investment adviser has been registered in any other state that requires licensing, registration, or qualification of investment advisers, then the investment adviser is exempt from the examination requirement for purposes of its application for registration in Minnesota.  In addition, the examination requirement is waived for persons who have been awarded certain professional designations relating to the financial services industry (e.g., Certified Financial Planner awarded by the Certified Financial Planners Board of Standards), provided such designation is current and in good standing.

Financial Records

If an investment adviser has custody of client funds or securities, or requires the payment of advisory fees six months or more in advance and in amounts in excess of $500 per client, then the investment adviser must submit an audited balance sheet as of the investment adviser’s most recent fiscal year along with the application for registration in Minnesota.  If the investment adviser’s most recent fiscal year ended within 135 days of the date of application, then an audited balance sheet as of the adviser’s second most recent fiscal year is acceptable.

Investment advisers that do not have custody of client funds or securities, but do have discretionary authority over client funds or securities must submit a balance sheet along with the application for registration, although the balance sheet need not be audited.

Advisers whose principal place of business is outside of Minnesota need only submit the reports that are required by the adviser’s home state (provided the adviser is registered in its home state) along with the Minnesota application.  If a balance sheet, audited or otherwise, is not required in the adviser’s home state, it will not be required for registration in Minnesota.

Bonding Requirements

If an investment adviser seeking registration in Minnesota has or will have discretionary authority over or custody of client funds or securities, the adviser must post a surety bond or an irrevocable letter of credit in the amount of $25,000.  There is an exemption from this bonding requirement for an investment adviser that continuously maintains net capital of at least $100,000.

For an investment adviser with its principal place of business in another state, the adviser need not post a surety bond or letter of credit, provided that it is registered in its home state and is in compliance with its home state’s bonding requirements.

Minimum Financial Requirements

Investment advisers registered in Minnesota are subject to one of several different net worth standards, depending on the nature of the adviser’s business.  Investment advisers that have or will have custody of client funds or securities must maintain a net worth of at least $35,000.  However, this net worth requirement does not apply if the investment adviser only has custody of client funds or securities by reason of direct fee deduction or advising pooled investment vehicles, provided the adviser complies with rules relating to the safeguarding of client assets and the manner and method of deductions from client funds.

Investment advisers that have discretionary authority, but not custody, over client funds or securities must maintain a net worth of at least $10,000.  Investment advisers that have neither custody nor discretionary authority over client funds or securities, but that accept prepayment of more than $500 per client and six months or more in advance must maintain a positive net worth.

Note that “net worth” in this context has a specific definition that excludes the value of “all assets of intangible nature,” including intellectual property, as well as personal items that are not readily marketable, such as homes, home furnishings, and automobiles.  The value of loans or advances to insiders such as stockholder, officers, or partners is also excluded from the definition of net worth.

Annual Renewals

In order to maintain its Minnesota licensure, an investment adviser must submit an application for annual renewal registration electronically with IARD, along with a $100 renewal fee and, if the adviser is subject to the surety bond requirement, a copy of the surety bond.

 

The Dodd-Frank Act and the Sarbanes-Oxley Act both have provisions for whistleblowers.  Public companies need to be familiar with all of these provisions.

The Dodd-Frank Act provides that if a “whistleblower” provides “original information” in certain judicial or administrative actions, the whistleblower may be entitled to as much as 10 percent to 30 percent of the monetary sanctions imposed.  The provisions of the Dodd-Frank Act, unlike the Sarbanes-Oxley Act, do not appear to be strictly limited to public companies.

The term whistleblower means any one or more individuals acting jointly who provide information to the SEC relating to a violation of securities laws.  The term “original information” as used in the Dodd-Frank Act means information that:

  • is derived from the independent knowledge or analysis of a whistleblower;
  • is not known to the Commission from any other source, unless the whistleblower is the original source of the information; and
  • is not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information.

 

The Dodd-Frank Act also provides protection for whistleblowers.  It states no employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because

of any lawful act done by the whistleblower:

  • in providing information to the SEC in accordance with the provisions of the Dodd-Frank Act;
  • in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such information; or
  • in making disclosures that are required or protected under the Sarbanes-Oxley Act, the Securities Exchange Act and any other law, rule, or regulation subject to the jurisdiction of the SEC.

 

The Dodd-Frank Act also provides an employee with remedies against the employer if the employer is found to have violated the whistleblower provisions of the Dodd-Frank Act.  Remedies available to the employee include reinstatement with the same seniority status that the individual would have had, two times the amount of back pay otherwise owed to the individual, with interest; and compensation for litigation costs, expert witness fees, and reasonable attorneys’ fees.

The Dodd-Frank Act provides a statute of limitations for whistleblower actions of six years after the date of violation and three years after the facts should have been reasonably known by the employee alleging a violation, with an outside limit of ten years.

The Dodd-Frank Act also includes a similar provision for whistleblower actions related to the violation of commodities laws that is supervised by the Commodity Futures Trading Commission.

Concern has been expressed by the issuer community about the ramifications of these whistleblower rewards.  Large monetary fines in recent Foreign Corrupt Practices Act cases may provide an incentive to report alleged FCPA violations.  Public companies have relatively few defenses to an FCPA action, especially if an employee pleads guilty.

Sarbanes-Oxley

Section 806 of Sarbanes-Oxley provides no company with a class of securities registered pursuant to the Securities Exchange Act of 1934 or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee:

  • to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of certain criminal statutes, any rule or regulation of the SEC, or any provision of Federal law relating to fraud against shareholders, when the information or assistance is provided to or the investigation is conducted by certain Federal regulatory agencies, certain congressional investigations or certain supervisory personnel; or
  • to file, cause to be filed, testify, participate in, or otherwise assist in a proceeding filed or about to be filed relating to the same criminal statutes, SEC rules, or any provision of Federal law relating to fraud against shareholders.

 

Damages and other remedies for breach of this section by employers can include  reinstatement with back pay and compensation for any special damages incurred.

Sarbanes-Oxley provides an action must be commenced by an employee within 90 days after the violation occurred by filing a complaint with the Secretary of Labor.

Section 301 of the Sarbanes-Oxley Act also requires each audit committee to establish procedures for:

  • the receipt, retention, and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and
  • the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters.

 

Finally Section 1107 of the Sarbanes-Oxley Act makes it a crime to knowingly, with the intent to retaliate, to take any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense.

What Does All This Mean?

Employers, particularly public companies, must tread carefully when dealing with potential whistleblowers because of the non-retaliation provisions.  In addition to Dodd-Frank and Sarbanes-Oxley, there may be state law protections as well.  Whistleblowers now have a monetary incentive to report matters to the SEC rather than company management.  Accordingly, management should reemphasize to all employees the importance of prompt reporting of violations to management in accordance with established procedures.  Public companies should pay increased attention to complaints submitted to audit committees or employee hotlines to address areas of potential concern.  Where appropriate, companies should also revisit FCPA compliance procedures to avoid whistleblower claims.

The Dodd-Frank Act contains provisions designed to help protect seniors (62 and over) from being victimized by persons who market securities, insurance products, or financial instruments to seniors and who claim to be specially certified to assist seniors in financial matters.

 The Act requires the newly authorized Office of Financial Literacy to institute a system for providing grants of up to $500,000 per year for 3 years to states, state securities commissions, insurance regulators and consumer protection agencies to:

  • Hire staff to investigate and prosecute cases involving misleading or fraudulent marketing to seniors.
  • Fund technology, equipment and training for prosecutors and law enforcement to identify salespersons and advisers who target seniors with misleading designations.
  • Fund technology, equipment and training to improve prosecution of such persons.
  • Provide educational materials and training to seniors to increase awareness and understanding of misleading or fraudulent marketing.
  • Develop comprehensive plans to combat misleading or fraudulent marketing to seniors.

 To qualify, the state agency must meet the model rules of the North American Securities Administrators Association or the National Association of Insurance Commissioners, as applicable, on the use of senior-specific certifications and professional designations.

 “Misleading or fraudulent marketing” is defined as the use of a misleading designation by a person that sells to or advises seniors in connection with the sale of a financial product.

 State agencies should start preparing to file grant applications.

Although President Obama only recently signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has actively taken steps to implement the new law.

Remarks of Chairman Shapiro

On July 27, 2010, SEC Chairman Mary L. Shapiro addressed the U.S. Chamber of Commerce.  She noted that Congress has spoken and the issues are not open for re-debate. She noted the SEC is inviting public comment even before the various rules are proposed and before the official comment periods have begun. As part of this process, the SEC has created a series of e-mail inboxes—that can be accessed at www.sec.gov—so that anyone interested can easily weigh in on proposed rules before they are published. These mailboxes are organized by topic and have been deployed in tranches, starting with those rules that have the shortest timeframe for implementation.

Ms. Shapiro also sent an important signal to the broker-dealer community. In her speech, she noted, “As it stands now, investors who turn to a financial professional often do not realize there’s a difference between a broker and an adviser—and that the investor can be treated differently based on who they’re getting their investment advice from. In particular, an investment adviser is held to a ‘fiduciary standard,’ meaning they must put the interest of their clients before their own. Whereas a broker-dealer has to observe standards which include an obligation to make recommendations that are ‘suitable ‘for their clients.’”

She also stated that “I have advocated such a uniform fiduciary standard and I am pleased the legislation provides us with the rulemaking authority necessary to implement it.”

Accredited Investors

The Dodd-Frank Act precludes including the value of a primary residence in the $1 million net worth test for accredited investors. The SEC has published Compliance and Disclosure Interpretations with respect to that provision of the Dodd-Frank Act. One such interpretation is set forth below:

Question: Under Section 413(a) of the Dodd-Frank Act, the net worth standard for an accredited investor, as set forth in Securities Act Rules 215 and 501(a)(5), is adjusted to delete from the calculation of net worth the “value of the primary residence” of the investor. How should the value of the primary residence be determined for purposes of calculating an investor’s net worth?

Answer: Section 413(a) of the Dodd-Frank Act does not define the term “value,” nor does it address the treatment of mortgage and other indebtedness secured by the residence for purposes of the net worth calculation. As required by Section 413(a) of the Dodd-Frank Act, the Commission will issue amendments to its rules to conform them to the adjustment to the accredited investor net worth standard made by the Act. However, Section 413(a) provides that the adjustment is effective upon enactment of the Act. When determining net worth for purposes of Securities Act Rules 215 and 501(a)(5), the value of the person’s primary residence must be excluded. Pending implementation of the changes to the Commission’s rules required by the Act, the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted from the investor’s net worth. [July 23, 2010]

Comments on Obligations of Broker-Dealers and Investment Advisers

The SEC has published a request for public comment to inform its study of the obligations and standards of care of broker-dealers and investment advisers providing personalized investment advice about securities to retail investors.

As required by the Dodd-Frank Act, the SEC is requesting public input, comments, and data on issues related to the effectiveness of existing standards of care for brokers-dealers and investment advisers, and whether there are gaps, shortcomings, or overlaps in the current legal or regulatory standards.

The public comment period will remain open for 30 days, following publication of the comment request in the Federal Register.