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

The SEC has recently announced settlement of enforcement actions targeting violations of beneficial reporting requirements under Section 13(d) of the Act.

In one of the most recent actions (available here), the SEC’s Enforcement Staff brought proceedings against certain shareholder activists and their affiliate for failing to properly disclose beneficial ownership information during a series of campaigns to influence or exert control over certain microcap companies.

According to the SEC’s release, the activist group “collectively owned more than five percent and sometimes even more than 10 percent of the companies’ outstanding common stock, yet the required ownership filings to disclose that information to the investing public were either incomplete, untimely, or altogether absent.” Without admitting or denying the findings, the parties consented to the SEC’s order and agreed to penalties ranging from $30,000 and $180,000.

Section 13(d) requires any person or group who directly or indirectly acquires beneficial ownership of more than five percent of an issuer’s equity securities to make a filing with the Commission disclosing information relating to such beneficial ownership within 10 days of the acquisition including:

  • the identity of the acquirer;
  • a description of the purpose(s) of the acquisition (including any plans (i) to affect the issuer’s Board of Directors; (ii) to cause an extraordinary corporate transaction, such as a merger, reorganization, or liquidation; (iii) to sell or transfer a material amount of assets of the issuer or any of its subsidiaries; or (iv) to otherwise materially change the issuer’s business or corporate structure); and
  • the interests of all persons making the filing, including those acting together as a group.

As such, filings made pursuant to Section 13(d) provide material information about the holdings of significant shareholders and their ownership intent which allows shareholders to consider how these parties could exert control, influence, or otherwise impact investments in a given security.

The SEC’s announcement of the settlements is a clear sign that the Staff is taking a close look at Section 13(d) reporting in the context of proxy battles where omission of information about the parties involved could have a significant result. And it should be of no surprise that the staff of the Division of Corporation Finance’s Office of Mergers and Acquisitions was involved in an advisory role in helping to pursue the violations. As the primary reviewer of proxy contests, Corp Fin’s OM&A group are experts in interpreting the proxy rules and beneficial reporting requirements of Schedule 13D/G filings.

These recent cases underscore the SEC’s focus on ensuring a level playing field in proxy battles and should serve as a warning to all participants in proxy fights that they need to actively comply with all beneficial ownership reporting requirements.

On February 10th, the SEC took action to formally approve of changes proposed by the NASDAQ Stock Market, NYSE MKT LLC, and New York Stock Exchange LLC’s, to shorten the standard settlement cycle for most broker-dealer transaction from three business days (T+3) to two business days (T+2).

According to each of the releases (available here, here and here), the exchanges plan to publicly announce the effective date of the adopted rule at a later date and file a separate proposed rule change, triggering an industry-led transition to a T+2 standard settlement. The Depository Trust and Clearing Corporation, in collaboration with the Investment Company Institute, SIFMA, and other market participants, have formed an Industry Steering Group (“ISC”) and an industry working group to facilitate the transition to a T+2 settlement cycle.  The ISC has identified September 5, 2017, as the target date for the transition to a T+2 settlement cycle to occur.

The proposed change appears to have been met with widespread approval, receiving only two comment letters (expressing support for the proposed change) after being published in the Federal Register in late December.

The SEC’s adopting release does not, however, address the shortening of the T+4 settlement standard currently in place for certain firm commitment offerings under the exemption in Rule 15c6-1(c), as previously discussed in our prior posting (available here).  It appears that, for now, despite contemplating such a change and soliciting for comment in the proposing release, the SEC and SROs are content to retain T+4 settlement for firm commitment offerings.

One of the features of the Revised Uniform Limited Liability Company Act (RULLCA) that has been adopted in Minnesota and many other states is that it allows for an LLC to expel a member by judicial order under certain circumstances. One of the triggers for expulsion requires a finding by the court that it is “not reasonably practicable to carry on” the LLC’s activities with the person remaining as a member.   So far, there is little judicial guidance on how to analyze and apply the “not reasonably practicable” standard, and the RULLCA commentary does not provide guidance, either. But in 2015 a New Jersey state court decision seemed to indicate that proving that standard was a relatively low bar that required the court to engage in predictive analysis and merely come up with potential drawbacks or impracticalities that might result from the member’s continuing membership.  In late 2016, the New Jersey Supreme Court reversed that decision, and in doing so established that the “not reasonably practicable” standard is a high bar, providing a set of seven factors that should be considered when evaluating whether the standard has been met. Due to the scant case law, there is a high likelihood that a court considering this question in jurisdictions outside of New Jersey will at least consider the New Jersey opinion (just as the New Jersey Supreme Court itself considered some Colorado case law in deriving its seven-factor test) in analyzing an expulsion claim.

IE Test, LLC v. Carroll, 226 N.J. 166 (2016), involved three individuals, Kenneth Carroll, Patrick Cupo, and Byron James. Carroll and Cupo had previously owned and operated Instrumentation Engineering, LLC, which had employed James.  Carroll was the majority owner, and the company ultimately failed, filing for bankruptcy with alleged outstanding liabilities owed to Carroll and his other businesses of approximately $2.5 million.  Carroll, Cupo, and James subsequently formed IE Test, LLC and purchased some of the key assets of the now-defunct Instrumentation Engineering.  The three men had nearly equal percentage interests (Cupo had 34% to the others’ 33%), and Cupo and James played active roles in the business and drew salaries of $170,000 each, with $10,000 bonuses paid from time to time.  Carroll was a passive owner and was not paid any salary or bonus.  There was no written operating agreement for IE Test.  Carroll claimed that the three had an agreement that, over time, IE Test would compensate Carroll for his unrecovered $2.5 million from the prior business.  Carroll proposed an operating agreement that included a compensation mechanism intended to allow him to recoup that prior loss over time.  The IE Test business was successful, but Cupo and James came to view Carroll and his request for compensation as a drag on the business.  Via email, they posited that the business was not profitable enough to support three owners drawing out money.  Cupo and James caused IE Test to initiate a lawsuit seeking, among other things, the expulsion of Carroll based on the claim that it was not reasonably practicable to continue the business with Carroll as a member.

The trial court agreed with IE Test, first determining that the “not reasonably practicable” standard required predictive reasoning and analysis, and then surmising that Carroll’s continued involvement in the business might, in the future, lead to the inability to secure Carroll’s approval of essential documents, or that Carroll’s continued involvement might lead to more controversy and litigation that would be a drain on the business. This was a troubling result, especially in light of the fact that it was undisputed that Carroll did not have a day-to-day role with the company and had never interfered in company business in any direct way. It appeared that a disagreement among the members as to the financial terms of the operating agreement was enough to trigger expulsion.

The New Jersey Supreme Court reversed the trial court, holding that the “not reasonably practicable” standard was a high bar that required a finding that it is “unfeasible, despite reasonable efforts” to continue the business of the company under its current circumstances.

“Significantly, the Legislature did not authorize a court to premise expulsion under subsection 3(c) on a finding that it would be more challenging or complicated for other members to run the business with the LLC member than without him. Nor does the statute permit the LLC members to expel a member to avoid sharing the LLC’s profits with that member.”

The court then laid out a seven factor test to be considered by New Jersey courts in confronting this question in the future, with no single factor or group of factors being dispositive one way or another:

  1. The nature of the member’s conduct in relation to the company’s business;
  2. Whether the entity can be managed so as to promote the purposes for which it was formed with the member remaining;
  3. Whether the dispute precludes the members from working with one another to pursue the company’s goals;
  4. Whether there is deadlock among the members;
  5. Whether, despite deadlock, members can make decisions on the management of the company pursuant to the operating agreement;
  6. Whether there is still a business to operate, in light of the company’s financial position; and
  7. Whether continuing the company with the member is financially feasible.

The seven factors outlined in the decision are probably less important than the finding that the “not reasonably practicable” standard is a high bar that requires more than a showing of inconvenience or deadlock over the terms of the operating agreement.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client

The SEC’s Office of Compliance Inspections and Examinations, or OCIE, has published a list of the five compliance topics most frequently identified in deficiency letters that are sent to SEC-registered investment advisers. Within each of these topics, OCIE includes a few examples of typical deficiencies to highlight the risks and issues that examiners commonly identify. The five compliance topics addressed in this Risk Alert are deficiencies or weaknesses involving:

  • Rule 206(4)-7, which is referred to as the Compliance Rule. under the Investment Advisers Act of 1940, or the Advisers Act;
  • Required regulatory filings;
  • Rule 206(4)-2 under the Advisers Act, which is referred to as the Custody Rule;
  • Rule 204A-1 under the Advisers Act, which is referred to as the Code of Ethics Rule; and
  • Rule 204-2 under the Advisers Act, which is referred to as the Books and Records Rule.

President Donald Trump’s Executive Order requiring two regulations be repealed for every new one adopted and related OMB guidance have been challenged in a law suit commenced in the U.S. District Court for the District of Columbia. The law suit was commenced by Public Citizen, the Natural Resources Defense Council and the Communications Workers of America. The defendants are the President, the Acting Director of the OMB and the current or acting secretaries and directors of more than a dozen executive departments and agencies.

The plaintiffs are asking the court to issue a declaration that the order cannot be lawfully implemented and bar the agencies from implementing the order. The complaint alleges that the agencies cannot lawfully comply with the president’s order because doing so would violate the statutes under which the agencies operate and the Administrative Procedure Act.

According to the complaint, to repeal two regulations for the purpose of adopting one new one, based solely on a directive to impose zero net costs and without any consideration of benefits, is arbitrary, capricious, an abuse of discretion, and not in accordance with law, for at least three reasons:

  • No governing statute authorizes any agency to withhold a regulation intended to address identified harms to public safety, health, or other statutory objectives on the basis of an arbitrary upper limit on total costs (for fiscal year 2017, a limit of $0) that regulations may impose on regulated entities or the economy.
  • The Executive Order forces agencies to repeal regulations that they have already determined, through notice-and-comment rulemaking, advance the purposes of the underlying statutes, and forces the agencies to do so for the sole purpose of eliminating costs that the underlying statutes do not direct be eliminated.
  • No governing statute authorizes an agency to base its actions on a decision making criterion of zero net cost across multiple regulations.

 

Following on the heels of its announcement to reconsider implementation of the conflict minerals rule, SEC Acting Chairman Michael S. Piwowar has announced his intention to conduct a review of the Dodd-Frank pay ratio rule. The Commission adopted the pay ratio disclosure rule in August 2015 to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

According to Chairman Piwowar:

“Based on comments received during the rulemaking process, the Commission delayed compliance for companies until their first fiscal year beginning on or after January 1, 2017. Issuers are now actively engaged in the implementation and testing of systems and controls designed to collect and process the information necessary for compliance. However, it is my understanding that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline.

In order to better understand the nature of these difficulties, I am seeking public input on any unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed. I welcome and encourage the submission of detailed comments, and request that any comments be submitted within the next 45 days.

I have also directed the staff to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.

I understand that issuers need to be informed of any further Commission or staff action as soon as possible in order to plan and adjust their implementation processes accordingly. I encourage commenters and the staff to expedite their review in light of these unique circumstances.”

OMB’s Office of Information and Regulatory Affairs has provided interim guidance on the requirements in Section 2, “Regulatory Cap for Fiscal Year 2017,” of the Executive Order of January 30, 2017, titled “Reducing Regulation and Controlling Regulatory Costs” (“EO”).

Importantly, the guidance confirms that the EO is not applicable to independent agencies such as the SEC. According to the guidance, the requirements of Section 2 apply only to those agencies required to submit significant regulatory actions to OIRA for review under EO 12866. Nevertheless, the administration encourages independent regulatory agencies to identify existing regulations that, if repealed or revised, would achieve cost savings that would fully offset the costs of new significant regulatory actions.

In general, the guidance notes that executive departments and agencies (“agencies”) may comply with the EO by issuing two “deregulatory” actions for each new significant regulatory action that imposes costs. The savings of the two deregulatory actions are to fully offset the costs of the new significant regulatory action.

In addition, beginning immediately, agencies planning to issue one or more significant regulatory action on or before September 30, 2017, should for each such significant regulatory action:

  • A reasonable period of time before the agency issues that action, identify two existing regulatory actions the agency plans to eliminate or propose for elimination on or before September 30, 2017; and
  • Fully offset the total incremental cost of such new significant regulatory action as of September 30, 2017.

As we reported, the House and Senate have passed a joint resolution under the Congressional Review Act disapproving the SEC Resource Extraction Rule and that President Trump was expected to sign the legislation that eliminates the regulation.

What else is there percolating under the Congressional Review Act?

According to the White House, H.J. Res 38 would nullify the Stream Protection Rule, 81 Fed. Reg. 93066 (Dec. 20, 2016), a final rule recently promulgated by the Department of the Interior, Office of Surface Mining Reclamation and Enforcement. The bill disapproves a rule that would establish requirements for coal mining operations, and impose compliance burdens on America’s coal production. The disapproved rule also duplicates existing protections in the Clean Water Act and is unnecessary given the other Federal and State regulations already in place.

H.J. Res 38 has passed both the House and Senate and White House advisors will recommend to the President that he sign the legislation.

Also, according to the White House, H.J. Res. 36 would nullify the final rule Waste Prevention, Production Subject to Royalties, and Resource Conservation. 81 Fed. Reg. 83008 (Nov. 18, 2016), promulgated by the Department of the Interior, Bureau of Land Management. The bill disapproves a rule that would require oil and gas producers to reduce natural gas waste and emissions, regardless of whether or not it is economically viable to do so. The majority of affected oil and gas operators are small businesses, and productive wells could be unnecessarily shut in to meet the requirements of this rule.

In addition, H.J. Res. 40 would nullify the final rule Implementation of the NICS Improvement Amendments Act of 2007, 81 Fed. Reg. 91702 (Dec. 19, 2016), promulgated by the Social Security Administration (SSA). The bill disapproves a rule that would allow SSA to provide records on certain individuals who receive Disability Insurance benefits under title II of the Social Security Act or Supplemental Security Income payments under title XVI of the Social Security Act to the Attorney General for inclusion in the National Instant Criminal Background Check System. The rule could prevent some Americans with disabilities from purchasing or possessing firearms based on their decision to seek Social Security benefits.

H.J. Res. 37 would nullify the rule Federal Acquisition Regulation; Fair Pay and Safe Workspaces, 81 Fed. Reg. 58562 (August 25, 2016). The bill disapproves a rule that would require federal contractors to disclose findings of non-compliance with labor laws. The rule would burden Federal procurement with unnecessary processes that could result in delays, and decreased competition for Federal government contracts. Rolling back this rule will also help to reduce costs in Federal procurement.

H.J. Res 36, 37 and 40 have all passed the House, and if they reach the President’s desk after Senate approval, President Trump’s advisors will recommend to the President that he sign the legislation.

 

Under current law, stockbrokers are only required to recommend suitable investments to their clients. The Department of Labor has issued a so called “fiduciary rule” which requires brokers, advisors and insurance agents, when providing investment advice for retirement accounts, to act at a higher fiduciary standard.  The DOL rule has not yet taken effect.

President Trump has issued the Secretary of Labor a “Presidential Memorandum on Fiduciary Duty Rule.”  The Presidential Memorandum notes that one of the priorities of the Trump Administration is to empower Americans to make their own financial decisions, to facilitate their ability to save for retirement and build the individual wealth necessary to afford typical lifetime expenses, such as buying a home and paying for college, and to withstand unexpected financial emergencies.

The Presidential Memorandum directs the Secretary of Labor to examine the Fiduciary Duty Rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice. As part of this examination, the Secretary shall prepare an updated economic and legal analysis concerning the likely impact of the Fiduciary Duty Rule, which shall consider, among other things, the following:

  • Whether the anticipated applicability of the Fiduciary Duty Rule has harmed or is likely to harm investors due to a reduction of Americans’ access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice;
  • Whether the anticipated applicability of the Fiduciary Duty Rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and
  • Whether the Fiduciary Duty Rule is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services.

The Presidential Memorandum further directs the Secretary that if the Secretary makes an affirmative determination as to any of the considerations identified above or if the Secretary concludes for any other reason after appropriate review that the Fiduciary Duty Rule is inconsistent with the priority identified above then the Secretary shall publish for notice and comment a proposed rule rescinding or revising the Rule, as appropriate and as consistent with law.

Remarks made by President Trump upon signing the Presidential Memorandum can be found here.

The DOL issued a short statement which said “The Department of Labor will now consider its legal options to delay the applicability date as we comply with the President’s memorandum.”

House Financial Services Committee Chairman Jeb Hensarling (R-TX) issued a press release which said “No unaccountable Washington bureaucrats should get in the way of hardworking Americans and their ability to make financial decisions that work best for their families. Republicans want to empower Americans to make their own financial decisions, but the Obama administration’s so-called fiduciary rule instead empowered unelected, unaccountable bureaucrats.  That means costs will go up and choices will go down – just like with Obamacare. Republicans believe if you like your retirement planner, you should be able to keep your retirement planner.  If you like your financial adviser, you should be able to keep your financial adviser.”

Congresswoman Maxine Waters (D-CA), Ranking Member of the House Committee on Financial Services shot back, saying “Trump’s first action, a memorandum to the Department of Labor, seeks to delay crucial rules that require that financial advice be in customer’s best interest. Why doesn’t the President explain to the people of Ohio, Pennsylvania, Michigan, and Wisconsin how delaying and repealing rules that protect seniors’ hard-earned savings from unscrupulous financial advisers is a good thing? In the past our nation’s workers and retirees have been swindled out of $17 billion in retirement savings each year because of conflicted financial advice from advisers seeking to fatten their own bottom line through excessive fees, high commissions, and kickback schemes. So, the Department of Labor stepped in and, after six years of careful consideration, finalized rules last year to require advisers to put the interests of their clients ahead of their own. Trump’s actions today delay those rules so that his cronies in the Administration and on Wall Street can ultimately repeal them. A repeal of these common sense rules will only benefit powerful lobbyists representing insurance companies, big business, brokers and banks, not the millions of working families across the country who would be left vulnerable to their predatory practices.”

President Trump has signed an executive order titled “Presidential Executive Order on Core Principles for Regulating the United States Financial System.“

The “Core Principles” are:

  • empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
  • prevent taxpayer-funded bailouts;
  • foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
  • enable American companies to be competitive with foreign firms in domestic and foreign markets;
  • advance American interests in international financial regulatory negotiations and meetings;
  • restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework.

Substantively, the executive order requires the Secretary of the Treasury to consult with the heads of the member agencies of the Financial Stability Oversight Council and to report to the President within 120 days of the date of the order (and periodically thereafter) on the extent to which existing laws, treaties, regulations, guidance, reporting and recordkeeping requirements, and other Government policies promote the Core Principles and what actions have been taken, and are currently being taken, to promote and support the Core Principles. That report, and all subsequent reports, must identify any laws, treaties, regulations, guidance, reporting and recordkeeping requirements, and other Government policies that inhibit Federal regulation of the United States financial system in a manner consistent with the Core Principles.

In a press release, House Financial Services Committee Chairman Jeb Hensarling noted: “I’m very pleased that President Trump signed this executive action, which closely mirrors provisions that are found in the Financial CHOICE Act to end Wall Street bailouts, end ‘too big to fail,’ and end top-down regulations that make it harder for our economy to grow and for hardworking Americans to achieve financial independence.  When Dodd-Frank was passed, Americans were promised a healthier economy, an end to bailouts and better consumer protections.  Instead, we have the weakest recovery in history, a guarantee of more Wall Street bailouts, and consumer costs have gone up while their choices have gone down.  Today the big banks are bigger and the small banks are fewer.  Everything from mortgages to credit cards to monthly checking fees costs more because of Dodd-Frank’s red tape, if consumers can even get access to them.”