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

Congress’s enactment of the insurance provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act signals the federal government’s most significant incursion into the regulation of insurance, an activity historically left to the states.

Title V, the insurance provisions of Dodd-Frank, are divided into two subtitles: Subtitle A, establishing the Federal Insurance Office, and Subtitle B, setting forth state-based insurance reforms, with Title 1 addressing non-admitted insurance and Part 2 addressing reinsurance.

Although the Federal Insurance Office is granted very limited direct regulatory authority (essentially dealing with international trade matters), Congress directs the new office to monitor a number of marketplace activities, study aspects of state regulation and report back to Congress in 18 months.

The reforms enacted to address surplus lines insurance fixes long-lingering regulatory overlap among the states. The legislation essentially allocates the surplus lines tax to an insured’s home state (subject to a to-be-developed interstate compact). Similarly, the legislation directs surplus lines regulatory and licensing jurisdiction to that home state as well.

The reforms addressing regulation of reinsurance also fixes potential regulatory overlap among the states. The legislation vests regulatory authority over credit for reinsurance to the ceding insurer’s state of domicile, essentially codifying the longstanding comity among the states in this regard. Correspondingly, the legislation designates a reinsurer’s state of domicile as its solvency regulator.

The surplus lines and reinsurance regulatory reforms bring jurisdictional clarity to potential duplicative regulation among the states. The monitoring and studying activities of the Federal Insurance Office, however, portend substantial future growth of the federal government into the regulation of insurance.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was signed into law by President Obama on July 21, 2010.

Referred to by many as the most sweeping financial reform legislation since the 1930s, the Dodd-Frank Act is likely to have a significant impact across the spectrum of securities and financial services litigation, including SEC enforcement actions, private securities litigation, consumer lending litigation and insurance litigation.  Among other things, the Dodd-Frank Act:

  • Lessens the burden on the SEC in connection with claims for aiding and abetting violations of the securities laws, by allowing liability to be imposed on any person who “recklessly” provides substantial assistance, in addition to those who “knowingly” do so.
  • Creates new incentives for whistleblowers that provide “original information” in SEC enforcement proceedings that result in monetary sanctions exceeding $1,000,000.
  • Allows the SEC and defendants in SEC federal court litigation to issue nationwide subpoenas requiring in-person attendance at trials and hearings.
  • Provides the SEC with rulemaking power to limit or prohibit brokers, dealers and investment advisers from requiring arbitration of customer disputes.
  • Establishes new mortgage reform regulations to prohibit unfair lending practices, including the prohibition of financial incentives for subprime loans and prepayment penalties.
  • Imposes penalties on lenders and mortgage brokers for noncompliance with new standards, enabling consumers to recover as much as three years of interest payments, in addition to damages and attorneys’ fees.
  • Creates a new Federal Insurance Office within the Department of the Treasury that will monitor all aspects of the insurance industry, gather information and data on and from the insurance industry and insurers (including by subpoena where necessary and appropriate under the Act), and consult with state regulators regarding insurance matters of national importance.
  • Allows for federal preemption of state insurance measures under certain circumstances.

We expect that these and other provisions of the Dodd-Frank Act will generate a substantial amount of litigation during the months and years to come, with a variety of procedural and substantive issues to be addressed. We will continue to monitor any new developments in this regard and update this blog accordingly.

The Dodd-Frank Wall Street Reform and Consumer Protection Act contains several provisions that will have a significant impact on investment advisors and removes some key exemptions from the requirement to register as an investment advisor.

Dodd-Frank also contains a “private fund” definition, which is a keystone for a number of other provisions contained in the Act, including several new exemptions.  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 relaiance 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.

All of the changes summarized below take effect on July 21, 2011.  However, advisers that will be required to register when these changes become effective need not wait until next year to begin the registration process, but instead are authorized to register with the SECduring this one year transition period.

Registration as an Investment Adviser

Elimination of the private adviser exemption. The private adviser exemption allowed an investment adviser to avoid registration if it had fewer than 15 clients in the preceding 12 months, did not hold itself out to the public as an investment adviser, and did not serve as an investment adviser to any registered investment company or any business development company.  For the purpose of determining the number of clients under the private adviser exemption, the Investment Advisers Act of 1940 allowed the shareholders, partners, or beneficial owners of an entity to be disregarded as separate clients apart from the entity itself, such that a fund with many investors would be regarded as a single client for purposes of the private adviser exemption. The Act eliminates the private adviser exemption and the consolidated method of counting clients altogether, exposing many previously exempt investment advisers to registration and regulation.  The Act does offer several new, narrow exemptions in place of the private adviser exemption.

Narrowing of the intrastate exemption.  The Advisers Act previously provided an exemption from registration for investment advisers that served clients only in the state in which the investment adviser had its principal place of business and that refrained from furnishing advice or analysis relating to securities listed on a national exchange.  The Act significantly narrows this intrastate exemption by excluding investment advisers that advise a private fund.

Exemption for advisers to venture capital funds. Investment advisers that advise only one or more venture capital funds are not subject to the registration requirements of the Advisers Act.  The SEC is directed to promulgate rules within the next year that define the term “venture capital fund” and provide for the maintenance of records and filing of reports by advisers subject to this new exemption.

Exemption for advisers to mid-sized private funds. Under the Act, an investment adviser that serves as an adviser only to private funds and has assets under management in the U.S. of less than $150 million will be exempt from SEC registration as an investment adviser.  The Act does not directly provide this exemption, but instead directs the SEC to promulgate rules to define its scope and other provisions  However, such advisers will still be subject to the reporting requirements set forth below, and state regulation.

Exemption for family offices. Another important new exemption is the Act’s amendment of the definition of “investment adviser” in the Advisers Act to exclude “family offices.”  The Act also directs the SEC to develop, through rules, regulations, or orders, a definition of “family office” that is consistent with the SEC’s previous exemptive orders and other SEC guidance for family offices.

Increased Information Reporting and Regulation

The Advisers Act previously provided that no provision of the act should be construed to allow the SEC to require any investment adviser to “disclose the identity, investments, or affairs of any client of such investment adviser, except insofar as such disclosure may be necessary or appropriate in a particular proceeding or investigation.”  The Act now carves out an exception to this principle, allowing the SEC to require the disclosure of such information “for purposes of assessment of potential systemic risk.”  This new authority of the SEC to require disclosure of highly confidential information is manifested in record keeping and reporting requirements applicable to advisers to private funds.

Disclosure by advisers to private funds. The Act authorizes and directs the SEC to promulgate rules requiring investment advisers to private funds to collect, maintain, allow inspection of, and file periodic reports containing information relating to the private funds so that the Financial Stability Oversight Council can make evaluations relating to systemic risk.  These rules could require investment advisers to maintain and disclose to regulators records relating to highly confidential aspects of the operations of the private funds they advise, including:

  • 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;
  • types of assets held;
  • side arrangements, side letters, and other agreements that provide special treatment for certain investors in a fund;
  • trading practices; and
  • such other information as the SEC and the Council determine is necessary in the public interest in order to protect investors and assess systemic risk.

Disclosure by advisers to mid-sized private funds. Even though the Act provides a new exemption from registration for investment advisers to mid-sized private funds, these advisers will still be subject to rules requiring them to maintain records and file reports with the SEC.  The specific record keeping and reporting requirements will be developed by the SEC. 

Safeguarding client assets. In what is being called the “Madoff rule,” the Act now allows the SEC to require a registered investment adviser to take “steps to safeguard client assets over which such adviser has custody,” such as, for example, hiring an independent public accountant to verify the existence of the assets.

Emphasis on state regulation of advisers to private funds. The Act shifts the responsibility for regulation of investment advisers to the various states with respect to investment advisers to mid-sized private funds, perhaps allowing the SEC to focus on advisers with more assets under management.  The Act prohibits mid-sized investment advisers (defined as those that are required to register in the state of their principal place of business and that have between $25 million and $100 million in assets under management) from utilizing the federal registration regime.  There is an exception from this general prohibition of the use of federal registration for investment advisers that advise an investment company or a business development company, or that would otherwise be required to register in 15 or more states.

Dodd-Frank subjects the over-the-counter derivatives market in energy and other commodities to an expansive new regulatory regime to be placed under the jurisdiction of the Commodity Futures Trading Commission.

Energy traders now face new capital and margin requirements, reporting and recordkeeping obligations, and position limits with respect to energy contracts that they formerly traded virtually free from regulatory restrictions. The CFTC will be implementing the new regulatory requirements through an expansive program of 60 new rulemakings.

Leonard, Street and Deinard will be closely monitoring the CFTC rulemaking and implementation process and is available to update our clients and business relationships on important compliance requirements as they develop.

The Dodd-Frank Act provides a monetary incentive for whistleblowers that provide the SEC with useful information.  The Act includes parallel non-retaliation provisions for whistleblowers.  As a result, human resource professionals need to be aware of the ramifications on their internal policies.

Public companies will also have to implement clawback policies for incentive pay in the event of an accounting restatement. Many of the these provisions of the Dodd-Frank Act overlap with similar provisions of the Sarbanes-Oxley Act, resulting in two compliance regimes.

Check back for more employment-related information as we become more familiar with the Act.

The Dodd-Frank Act will significantly impact the proxy process and the annual meeting with nonbinding say-on-pay votes, additional disclosures regarding executive compensation and permitting shareholders to include director nominees in a company proxy statement.

The Act will also significantly affect compensation by the introduction of mandatory clawbacks of incentive compensation in the event of accounting restatements and require compensation committees to implement new procedures when retaining compensation consultants, legal counsel and other advisors.

Other matters addressed by the Dodd-Frank Act include a further reduction in broker voting, disclosures regarding employee and director hedging, and new disclosures regarding chairman and CEO structures.

Check back soon for more information about corporate governance and public companies.

The Dodd-Frank Act looks like it will affect compensation and benefits law in three main areas:

  • Executive and incentive compensation, including new disclosure and corporate governance requirements.
  • Use of stable value funds, hedging arrangements and swaps in retirement plans.
  • Regulation of vendors servicing retirement and other plans.

A few initial thoughts related to compensation are noted below. We will be posting additional analysis as we become better acquainted with this law. And be sure to follow and monitor our twitter account—@leonardnews—for our latest updates.

What you should know now

Mandatory “Say-on-Pay” and “Golden Parachute” Vote. Section 951 of the Act requires the proxy statement for a meeting of shareholders to include, at least once every three years, a separate non-binding resolution to approve the compensation of executives. In addition, not less than every six years, a proxy statement must include a separate resolution to determine whether such vote must occur every one, two or three years.

Separately, at any meeting where shareholders are asked to approve an acquisition, merger, consolidation, proposed sale or other disposition of substantially all assets, the proxy statement must include a non-binding resolution on any agreements or understandings the issuer has with its named executive officers concerning any type of compensation that may become payable to the executive officers in connection with the transaction. The vote is not required if the agreements have been previously approved in another non-binding say-on-pay vote.

These provisions apply to shareholder meetings occurring more than six months after the date of enactment of the Act. It is important to note that these provisions, unlike many others, are not dependent upon any SEC rule making and are automatically effective.

In the past, say-on-pay votes may have been regarded by public companies as mere formalities or easily obtained forms of shareholder approval, since brokers have typically voted shares in favor of management, assuring passage of the proposal in most cases. That cannot occur in the future as broker voting on say-on-pay is eliminated by the Dodd-Frank Act.

Public companies outside of the financial institution industry need to monitor the rule-making process to determine if a preliminary proxy will need to be filed for the say-on-pay vote. Currently, Rule 14a-6 requires a preliminary proxy to be filed with the SEC for a say-on-pay vote, as the rule only carves out say-on-pay votes from the requirement to file a preliminary proxy for certain financial institutions pursuant to Section 111(e)(1) of the Emergency Economic Stabilization Act of 2008.

Independence of Compensation Committees. Section 952 of the Act contains extensive provisions regarding compensation committees, including:

  • Requiring national securities exchanges to prohibit the listing of issuers that have compensation committees which are not independent.
  • Requiring the SEC to identify factors that affect the independence of compensation consultants, legal advisors or other advisors to the compensation committee.
  • Requiring the SEC to adopt disclosure rules regarding whether the issuer retained a compensation consultant, whether the work of the compensation consultant raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.
  • Providing the compensation committee explicit authority to retain a compensation consultant, legal counsel and other advisors.

Executive Compensation Disclosures. Section 953 of the Act requires the SEC to adopt rules that require additional disclosures with respect to executive compensation in the following areas:

  • The relation of executive compensation actually paid and the financial performance of the issuer.
  • The median annual compensation of all employees of the issuer excluding the chief executive officer.
  • The annual total compensation of the chief executive officer.
  • The ratio of chief executive officer compensation to the median annual compensation of all employees of the issuer excluding the chief executive officer.

The text of Section 953 of the Act is ambiguous and the SEC could interpret it to require disclosures other than those set forth above.

Compensation Clawbacks. Section 954 of the Act requires national securities exchanges to adopt rules as directed by the SEC. Those 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.
  • 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.