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

The first five inspections of broker-dealer audit and new attestation engagements subject to PCAOB standards show deficiencies in the auditors’ application of these standards according to the PCAOB.

The requirement to follow PCAOB standards became effective for broker-dealer annual reports with fiscal years that ended on or after June 1, 2014, pursuant to an amendment to SEC Exchange Act Rule 17a-5.

The PCAOB audit standards differ in certain respects from audit standards that previously applied. In addition, the new attestation standards distinguish between the requirements for carrying broker-dealers with custody of customer assets and those who are non-carrying and do not have such custody.

In a brief summary inspection report covering five broker-dealer audit and attestation engagements conducted by five auditors in 2014, the PCAOB described deficiencies, relative to the new requirements, observed in the five audits and four of the five related attestation engagements.

Auditors of broker dealers are under scrutiny.  In a recent enforcement sweep, the SEC and PCAOB collectively charged 15 audit firms for violating independence requirements in connection with audits of broker-dealers.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.

SEC Commissioner Kara Stein recently described what many saw as a possible model for harsher bad actor waivers after settling a matter with the SEC.  According to Ms. Stein “The waiver was for a limited time, and only if certain conditions were met, creating essentially a probationary period for the firm with a right to reapply after a second showing of good cause.  And the conditions are important.  For example, the recent case included a review by an independent compliance consultant, and a document signed by the principal executive or principal legal officer when the consultant’s recommendations have been implemented.”  Ms. Stein added “This approach represents a breakthrough in the Commission’s method of handling waivers, and I hope to see more of this and other thoughtful approaches in the future.”  She also remarked “Each waiver request should receive an individualized, detailed, and careful analysis based on all of the relevant facts and the particular waiver policy.”

Many wondered if her remarks actually foreshadowed a change in policy by the SEC in granting waivers.  The question may now be answered.  The SEC charged Oppenheimer & Co. with violating federal securities laws while improperly selling penny stocks in unregistered offerings on behalf of customers. Oppenheimer agreed to admit wrongdoing and pay $10 million to settle the SEC’s charges.

The SEC granted Oppenheimer a waiver as a bad actor under Rule 506(d).  The SEC’s order says “Oppenheimer will comply with the conditions stated in its December 10, 2014 waiver request letter, including that it will retain a law firm to review its policies and procedures relating to Rule 506 offerings, and that it will adopt improvements or changes, both as private placement agent in its investment banking business and as issuer and as compensated solicitor in its wealth management business. Oppenheimer’s waiver is also conditioned upon its completing firm wide training for all registered persons on compliance with Rule 506 of Regulation D.”

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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 recently provided no-action relief for five-day tender offers. The new no-action letter eases requirements in the following areas:

  • The tender offer must be open for five business days rather than a seven to ten calendar day period under existing no-action relief.
  • The relief allows for exchange offers that meet defined parameters.
  • The no-action letter eliminates the distinction between investment grade and non-investment grade securities.

Among other things, the relief is not available where an issuer seeks to solicit exit consents to modify the terms of an indenture to strip covenants.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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 Division of Corporation Finance recently informed public companies that it will express no views on the application of Rule 14a-8(i)(9) during the current proxy season.  The Corp Fin decision leaves public companies who have received proxy access proposals in a lurch on what to do if they wish to make their own proxy access proposal.  Those companies wonder how ISS and Glass Lewis may react to  their decisions.

The Business Roundtable has sent a letter to ISS and Glass Lewis giving its views on how the proxy advisory firms should react to issuers decisions on proxy access proposals.

According to the Business Roundtable, it believes that it would be inappropriate for ISS and Glass Lewis to apply their voting policies in a way that substitutes their own judgment as to the appropriate course of action in place of the Board’s judgment.  In addition, the Business Roundtable noted:

“Accordingly, we believe that it would be inappropriate for ISS and Glass Lewis to make proxy voting recommendations based on a company’s reliance on Rule 14a-8(i)(9) when the Commission has not taken formal regulatory action to change the rule. Just as Chair White has determined to study the issue and the Division has determined to express no views on the matter at this time, we urge ISS and Glass Lewis to proceed in a deliberate fashion and exercise restraint as it considers how it will assess the response of companies that exclude shareholder proposals from their company proxy materials based on solid SEC precedent governing “conflicting” company proposals.”

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.

Amicus briefs are pouring in in favor of Wal-Mart in its appeal to the Third Circuit.  Wal-Mart appealed the United States District of Delaware’s decision that denied Wal-Mart the right to exclude a shareholder proposal submitted by Trinity Wall Street.  The District Court held that the SEC was incorrect when it rendered a no-action letter permitting exclusion of a shareholder proposal submitted under Rule 18a-8 in Trinity Wall Street v Wal-Mart Stores, Inc.  Wal-Mart had argued to the SEC that the proposal was excludable under Rule 14a-8(i)(7) as a matter related to ordinary business operations.

National Association of Manufacturers.  I don’t want to diminish the excellent efforts that went into the other amicus briefs, but this one was my favorite because of its vivid discussion of the consequences of ruling in favor of Trinity Wall Street.  According to NAM:

  • The District Court’s analysis has troubling ramifications for public companies and manufacturers because it opens the door to the possibility that any lawful product that could draw some social objection is ripe for shareholder consideration.
  • It should be assumed that many products may be offensive to the views or values of one of countless constituencies in the domestic or even global marketplace. The shareholder proposal rules were not intended to allow a shareholder referendum on how a retailer selects its inventory. If the mix of products a retailer chooses to stock and sell is not subject to the ordinary business exception, that exception is rendered a nullity.
  • Of great concern to NAM, the shareholder proposal process is increasingly dominated by activists advancing social or policy concerns that are divorced from increasing shareholder value.
  • A ruling by this Court that Trinity’s proposal is not excludable could have serious implications for U.S. public companies, including manufacturers. Emboldened by such a ruling, and with the ordinary business exception bluepenciled out of the SEC’s regulations, in future years it is likely that shareholders will submit an endless supply of resolutions that were previously excludable on ordinary business grounds. This concern is not a theoretical one, as there are several well-known shareholder activists that select a single issue then routinely submit proposals on that topic to large numbers of public companies for inclusion in management’s proxy statement. For example, the Harvard Shareholder Rights Project has made declassification of boards of directors its central mission under the Rule 14a-8 process, boasting of “121 successful engagements” from 2012 to 2014.

Washington Legal Foundation.  One of the missions of WLF is to protect against “losses caused by ill-conceived proxy proposals and the distracting proxy battles they generate.”  I liked this brief because it ties in the other issue of the day — the Whole Foods controversy.  According to WLF:

  • WLF opposes the inclusion of frivolous and inappropriate Rule 14a-8 shareholder proposals in proxy statements at the company’s expense—and, therefore, at the expense of every other shareholder.
  • The issues presented in this appeal arrive “amid a growing frustration by some public companies that the SEC has abdicated its traditional role as referee separating frivolous shareholder proposals from legitimate ones.” Last week, the SEC announced that it was reversing a December 1, 2014 no-action letter that had agreed Whole Foods Market, Inc. could exclude a shareholder proposal that would have allowed any shareholder owning at least 3% of the company’s stock to nominate candidates for election to the board. On January 16, 2015, the SEC’s Division of Corporation Finance released a statement announcing that, going forward, it would “express no views” on the application of Rule 14a-8(i)(9), which allows a company to exclude a shareholder proposal that “directly conflicts” with a management proposal.

Throughout the SEC’s history, the ability of public companies to solicit informal guidance from the staff on the correct interpretation of federal securities laws and regulations has been cited as a real strength of the agency. Staff no-action letters in the Rule 14a-8 context are especially valuable because of the impending external deadline for action—the date of the annual shareholder meeting. But, if activist shareholders can now rely on district court judges to ignore longstanding SEC guidance, and if the SEC staff itself is going to back away from its traditional role in providing that guidance, then public companies will no longer be able to prepare their proxy materials with any reasonable degree of confidence, but will be left adrift in a sea of uncertainty.

Excellent briefs were also submitted by the American Petroleum Institute, Business Roundtable and U.S. Chamber of Commerce, the Society of Corporate Secretaries and Governance Professionals and the Retail Litigation Center.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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 United States Supreme Court has denied a petition for a writ of certiorari in NACS, fka National Association of Convenience Stores, et al., v. Board of Governors of the Federal Reserve System.  The denial effectively ends the retailers efforts  to overturn the Federal Reserve’s interchange fee rules which establish a cap of 21 cents plus an adjustment for fraud losses of 0.05 percent of the transaction value on all debit card transactions.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.

Consulting Services Group, LLC, or CSG, was a registered investment adviser whose business included providing consulting services to public pension funds. These consulting services included recommending third-party investment advisers to actively manage public pension accounts.

According to the SEC, during the relevant time period, CSG either failed to disclose or mischaracterized in its Forms ADV a 2009 $50,000 personal loan between its then Chief Executive Officer and a New York-based third-party investment adviser (the “New York Investment Adviser”) that CSG had recommended to certain of its public pension and other clients. CSG settled an enforcement action with the SEC where the SEC alleged CSG’s failure to disclose this conflict of interest to its pension fund clients was in violation of Sections 206(2) and 207 of the Advisers Act. In the settlement CSG did not admit or deny the facts alleged by the SEC.

The SEC alleged that sometime after the loan was discovered, CSG began disclosing the loan in its Form ADV. CSG allegedly stated the loan from the New York Investment Adviser to the CEO was for $50,000 at 3.10% interest as an advance of a redemption related to the CEO’s investment in the New York Investment Adviser’s long/short hedge fund. The disclosure stated repayment had not been made and was pending. The disclosure further noted this presented a potential conflict in that CSG may recommend the New York Investment Adviser over other money managers as a result of the loan.

The SEC alleged the foregoing statements were false and misleading. CSG failed to disclose that the note was over two years past due, and accruing interest at the default rate of 8% per year. Additionally, according to the SEC, the loan was not “an advance of a redemption” and it was not “related to” the CEO’s investment.

Separately, the SEC has commenced an administrative proceeding against the CEO for related matters.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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 Broker-Dealer section of the North American Securities Administrators Association (NASAA) has proposed a model uniform state rule (the “Model Rule”) that would exempt parties that act only as deal brokers in M&A transactions from regulation under applicable state broker-dealer laws.

Last January, the SEC released a no-action letter (the “SEC Letter”) in which it outlined circumstances in which it would not recommend enforcement against a party for failing to register as a broker-dealer pursuant to Section 15(a) of the Exchange Act when the party acted as an M&A broker (shopping an M&A transaction, providing relating services, and earning a fee in connection with the closing of a successful transaction) (our prior coverage here). The SEC Letter defined the concept of an “M&A Broker” and provided that it would not seek enforcement action against an M&A Broker that engaged solely in M&A Transactions for privately held companies, subject to several condition and limitations.

The Model Rule would provide exemption from state broker-dealer registration requirements, but not from other provisions, such as anti-fraud measures.

Under the Model Rule, a “Merger and Acquisition Broker” is defined as a broker or person associated with a broker engaged in the business of effecting transactions in securities solely in connection with the transfer in ownership of an “eligible privately held company,” if the broker or person reasonably believes that (i) following the transaction the acquirer will control and be active in the management of the business of the target (or its assets), and (ii) any person receiving securities in exchange for securities or assets of the target will receive or have access to certain financial information of the issuer prior to becoming legally bound to consummate the transaction. An “eligible privately held company” for purposes of the Model Rule is a company that (i) does not have securities registered under the Exchange Act and is not required to file periodic reports under the Exchange Act, and (ii) in its prior fiscal year had revenue of less than $250 million and EBITDA of less than $25 million.

A Merger and Acquisition Broker is only eligible for the exemption under the Model Rule if it avoids engaging in certain “Excluded Activities” and is not subject to certain final orders or disqualifications under the federal securities laws. The Excluded Activities consist of (i) having custody or control of the funds or securities that are the subject of the transaction, (ii) engaging in any public offering, and (iii) engaging in a transaction involving a shell company.

Although the Model Rule generally tracks the SEC Letter closely, there are conditions that were of note to the SEC but that are not present in the Model Rule, such as:

  • The requirement that an M&A broker not have the ability to bind a party to an M&A transaction
  • The requirement that the M&A broker not provide direct or indirect financing to any party for an M&A transaction
  • Certain disclosure requirements if the M&A broker will represent both buyers and sellers in a transaction
  • The requirement that the M&A broker cannot have assisted in the formation of a buying group in an M&A transaction.

The NASAA is requesting comment on the Model Rule, including comments on a set of specific questions included with the rule, until February 16, 2015.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.

Responding to investor pressure, and pressure by shareholder proponents, the SEC Division of Corporation Finance issued this statement:

“In light of Chair White’s direction to the staff to review Rule 14a-8(i)(9) and report to the Commission on its review, the Division of Corporation Finance will express no views on the application of Rule 14a-8(i)(9) during the current proxy season.”

The statement references public companies that have requested the SEC to permit exclusion of proxy access proposals by stating the shareholder proposal directly conflicts with the issuers own proposal that will be included in the proxy statement.  The practice began when Whole Foods was recently successful in obtaining SEC relief.  See our most recent coverage here.

The SEC sent this reconsideration letter regarding Whole Foods.  All in all, a victory for shareholder propenent James McRitchie.

Chair Mary Jo White released this statement:

The Commission’s proxy rules enable shareholders to submit proposals for inclusion in a company’s proxy materials for a vote at a shareholder meeting, subject to certain procedural and substantive exclusions.  One of the exclusions, Exchange Act Rule 14a-8(i)(9), allows a company to exclude a shareholder proposal that “directly conflicts” with a management proposal.  Due to questions that have arisen about the proper scope and application of Rule 14a-8(i)(9), I have directed the staff to review the rule and report to the Commission on its review.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.

 

In Stratte-McClure v. Morgan Stanley et al, the Second Circuit held that MD&A rules set forth in Item 303 of Regulation S-K can give rise to a Rule 10b-5 claim. In so doing, the Second Circuit split with the Ninth Circuit which drew the opposite conclusion.

Key to the understanding of the Second Circuit decision is recognition that the materiality standards in Item 303 are different from the materiality standards in Rule 10b-5.  Item 303 requires a two part assessment set forth in the rule once a trend becomes known.  On the other hand, materiality for Rule 10b-5 is based on the Supreme Court’s decision in Basic Inc. v. Levinson.

The Second Circuit held that a violation of Item 303’s disclosure requirements can only sustain a claim under Section 10(b) and Rule 10b‐5 if the allegedly omitted information satisfies Basic’s test for materiality. That is, a plaintiff must first allege that the defendant failed to comply with Item 303 in a 10-Q or other filing. Such a showing establishes that the defendant had a duty to disclose. A plaintiff must then allege that the omitted information was material under Basic’s probability/magnitude test, because 10b‐5 only makes unlawful an omission of “material information” that is “necessary to make . . . statements made,” . . . “not misleading.”

The Second Circuit explained the reasons why it differed from the Ninth Circuit:

  • The Ninth Circuit misinterpreted a precedent case.  The case did not foreclose a Rule 10b-5 claim based on Item 303 but only held because the materiality standards for Rule 10b‐5 and Item 303 differ significantly,” a violation of Item 303 “does not automatically give rise to a material omission under Rule 10b‐5.
  • The Ninth Circuit also misconstrued another precedent opinion regarding the relationship between Rule 10b-5 and Section 12(a)(2) of the Securities Act.  The Second Circuit noted that Rule 10b-5 and Section 12(a)(2) are textually identical.

The facts of the case involved long and short positions in differing types of credit default swaps.  The defendants argued that they satisfied their obligations under Item 303 by disclosing the deterioration of the real estate, credit, and subprime mortgage markets, and its potential to negatively affect Morgan Stanley. The Second Circuit stated Morgan Stanley’s disclosures about market trends were generic, spread out over several different filings, and often unconnected to the company’s financial position. The Court found such “generic cautionary language” does not satisfy Item 303. The SEC has emphasized that Item 303 “requires not only a ‘discussion’ but also an ‘analysis’ of known material trends,” and that disclosure is “necessary to an understanding of a company’s performance, and the extent to which reported financial information is indicative of future results.”

The Second Circuit also noted the SEC has never gone so far as to require a company to announce its internal business strategies or to identify the particulars of its trading positions. This is in line with the Court’s reluctance to interpret the securities laws in a manner that requires companies to give competitors notice of proprietary strategies and information.

Ultimately the Second Circuit decided the District Court properly dismissed the claims as the plaintiffs did not adequately allege scienter.

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 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and 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.