Friday, December 02, 2016

NASAA defends extraterritorial application of Kansas Blue Sky law

By John M. Jascob, J.D., LL.M.

NASAA has urged a state appellate court to reverse a lower court ruling that Kansas lacked territorial jurisdiction over offers of securities made in California by a Kansas-based issuer. In an amicus brief filed with the Kansas Court of Appeals, NASAA argued that Kansas does have territorial jurisdiction over the case under either of the two tests used by courts to determine whether an offer has “originated from” a state (State v. Lundberg, November 28, 2016).

The defendants in the case were members or sponsors of four Kansas limited liability companies that owned real property and had “substantial operations” in Kansas. The LLCs prepared and issued promissory notes that were signed by the defendants and were offered and sold to individuals both inside and outside of Kansas. The offers outside of Kansas were facilitated by California-based selling agents, and all investors wired their investments to bank accounts in Minnesota. The trial court concluded that Kansas lacked territorial jurisdiction to prosecute the defendants for violations involving the out-of-state offers because the offers did not “originate from within” Kansas within the meaning of the Kansas Uniform Securities Act.

Statutory misconstruction. NASAA began by arguing that the trial court had misconstrued basic securities law terms and principles, including what it means to be an “issuer” or an “offeror.” Although the trial court thought that “an issuer has to be a person and not an entity,” NASAA pointed out that for partnerships and closely-held corporations, the entity and any natural person controlling the entity will be considered issuers of the entity’s securities. Thus, both the Kansas LLCs sponsored by the defendants and the defendants themselves were “issuers” under Kansas law.

In addition, NASAA argued, the trial court erroneously concluded that the California selling agents were the only “offerors” because they were the only ones actually soliciting investors. Rather, both federal and state courts have accepted the view that an offeror can either be an issuer or a broker-dealer or agent selling a security on behalf of the issuer. By construing the California selling agents as the sole offerors, the trial court committed legal error in its jurisdictional analysis, NASAA contended.

Question of origination. Although a majority of states have, like Kansas, adopted the “originates from” standard of the 1956 and 2002 Uniform Securities Acts for extraterritorial offers, NASAA observed that there is no consensus as to how courts should evaluate the issue. Nevertheless, both the Newsome test and the Lintz test adopted by the courts ask whether out-of-state offers are traceable back to in-state activities.

Under Newsome, an out-of-state offer or sale originates from the state if “any portion of the selling process” occurred in the state. Under Lintz, territorial jurisdiction exists if there is a sufficient “territorial nexus” between the state and an out-of-state offer or sale. In NASAA’s view, the facts of the case support territorial jurisdiction under either the Newsome test or the Lintz test. The trial court, however, applied neither test, nor did it evaluate whether the activities of the California selling agents related back to the defendants’ sponsorship of the Kansas LLCs’ securities. Accordingly, the trial court erred when it concluded that Kansas lacked territorial jurisdiction, NASAA concluded.

The case is No. 15114897-A and No. 15114898-A.

Thursday, December 01, 2016

Petition asks if contracts can be false statements under the SOX anti-shredding provision

By Rodney F. Tonkovic, J.D.

A petition for certiorari has been filed asking the Supreme Court to consider whether contracts can constitute false statements for the purposes of federal criminal law. The government charged a former governor of Connecticut with violating the Sarbanes-Oxley anti-shredding provision by executing contracts that omitted that he was being paid to work on political campaigns. The petition argues that the Second Circuit's holding that contracts that misrepresented the true relationships among the parties were false is a sweeping construction of the provision that is at odds with decisions in other circuits (Rowland v. U.S., November 14, 2016).

John G. Rowland had a long career in politics, including a 10-year term as governor of Connecticut. He had to resign the governorship, however, in the wake of a corruption investigation in which he pleaded guilty to conspiracy to commit honest services and tax fraud. Rowland's felony conviction precludes him for running for public office, but he is still able to assist with the political campaigns of others.

False contracts. According to the government's charges, Rowland twice contracted to do consulting work for private entities. These contracts, one of which was never executed, were allegedly "false" because they omitted the fact that Rowland was really assisting in two separate political campaigns.

At trial, Rowland maintained that the contracts contained no false statements, and requested a jury instruction that defined falsification of a document to be the knowing inclusion of any material fact that the defendant knows to be false. The district court, however, adopted the government's proposed instruction that the knowing omission of any material fact renders a document false.

In 2015, Rowland was convicted, among other counts, of falsifying documents under the SOX anti-shredding provision. This provision, 18 U.S.C. Section 1519, prohibits the falsification of "any record, document, or tangible object with the intent to impede, obstruct, or influence" a federal investigation. The Second Circuit affirmed, ruling that the contracts were false because they misrepresented the true relationships among the parties. Here, the contracts said that Rowland would be providing consulting services and intentionally did not reflect that he would be assisting with political campaigns.

Reach of anti-shredding provision. According to the petition, the Second Circuit's decision expands the reach of Section 1519, as well as many other statutes that criminalize various types of false statements. The decision conflicts with decisions in the Tenth and Eleventh circuits holding that contractual commitments are not statements that can be "true" or "false," as well as a Sixth Circuit rule that material omissions from otherwise-true statements are not lies.

The petition argues further that the Second Circuit's construction of the provision conflicts with Supreme Court precedent, as well as the plain statutory text. Rowland points to precedent stating that written promises are legal commitments rather than statements that can be true or false and that omitting a material fact is different than telling a lie. The petition also notes that Yates v. U.S. cautions the government and courts to construe Section 1519 narrowly. Additionally, the plain text of Section 1519 is limited to "falsifying documents," which, the petition says means to forge or counterfeit, and not to enter into an authentic contract that fails to capture the totality of the parties' relationship.

In closing, the petition asserts that the question presented implicates over 100 federal statutes that criminalize false statements in a variety of contexts. The issue of whether contractual commitments are statements and whether material omissions are tantamount to lies can arise in construing dozens of criminal prohibitions, and ensuring consistent interpretation of these statutes warrants the Court's time and attention, the petition states.

The petition is No. 16-639.

Wednesday, November 30, 2016

EC unveils orderly resolution proposal for central counterparties

By Mark S. Nelson, J.D.

The European Commission proposed rules that would allow for the recovery or resolution of central counterparties. CCPs already face regulation under the European Market Infrastructure Regulation, but those rules do not include provisions for dealing with financially stressed, systemically important CCPs across Europe. The proposal, an outgrowth of the earlier G20 commitment to clear standardized OTC derivatives, now goes to the European Parliament and the EC Council for further approvals.

Under the proposal, CCPs would draft recovery plans and resolution authorities would create resolution plans for a scenario in which a CCP became so financially stressed as to call into question its viability. CCP supervisors would be granted powers to intervene early in the CCP’s affairs via resolution colleges that would include all relevant EU authorities.

According to an FAQ, the resolution authorities may be invoked if a CCP realistically could not be recovered in an appropriate time frame, all other intervention measures have been exhausted, and traditional bankruptcy proceedings could result in prolonged market uncertainties and financial instability. The European Securities and Markets Authority would coordinate the various supervisory authorities and could act as a binding mediator.

Resolution tools would include the ability to sell a business. Another option would involve the use of a bridge CCP structure to enable the sale of a CCP’s essential functions to another firm while liquidating the CCP’s non-essential functions via traditional bankruptcy. Additional options include position and loss allocation tools, and tools for the write-down and conversion of capital/debt instruments or other unsecured liabilities.

The proposal to create recovery and resolution authorities beyond the EMIR includes aspects of the guidance previously issued by the International Organization of Securities Commissions and the Financial Stability Board. The proposal also has similar features to the Bank Recovery and Resolution Directive and could aid financial stability, avoid costs to taxpayers, and prevent the destruction of value. A total of 17 European CCPs clear a significant portion of the €500 trillion in derivatives contracts outstanding globally.

Tuesday, November 29, 2016

Board not liable for inability to extricate company from ‘symbiotic’ relationship

By Anne Sherry, J.D.

A general release foreclosed an investor’s suit over Clear Channel Outdoor Holdings’ continued entanglement with its former parent, iHeart Communications. GAMCO Asset Management invested in CCOH despite the intercompany agreements that locked it into a “symbiotic” relationship with iHeart. GAMCO’s suit resurrected many of the same derivative claims that were settled in 2013, the Delaware Court of Chancery found (GAMCO Asset Management Inc. v. iHeartMedia Inc., November 23, 2016, Slights, J.).

The intercompany agreements, entered into in anticipation of CCOH’s 2005 IPO, positioned iHeart so that it could exercise significant control over nearly every aspect of CCOH’s operations. iHeart contracted to provide management, IT, legal, and executive services to CCOH, and mutual financing commitments required CCOH to sweep its excess cash to iHeart every day.

Derivative suits then and now. In 2012, CCOH stockholders sued derivatively on the basis that iHeart was abusing its position as controlling stockholder. An independent special litigation committee of CCOH concluded that CCOH could not breach or modify the agreements without risking irreparable consequences; the committee negotiated a forward-looking settlement that instituted corporate governance reforms to address conflicts and manage the ongoing relationship between the companies.

Citing Yogi Berra, the court suggested that GAMCO’s suit a few years later was “like déjà vu all over again.” Like the 2012 plaintiffs, GAMCO argued that the CCOH board’s compliance with the contracts did not excuse its failure to extricate CCOH from the intercompany agreements in the face of iHeart’s deteriorating financial condition. GAMCO also alleged that the CCOH board breached its fiduciary duties and committed corporate waste when it approved a debt offering and asset sales to fund special dividends so that iHeart could address its liquidity needs.

Every new claim barred. The court concluded that the claims relating to the intercompany agreements were barred either by the 2013 settlement agreement and release or by res judicata. The court also dismissed the claims relating to the asset sales and debt offerings because these were arm’s-length transactions that secured pro rata benefits to all CCOH shareholders. GAMCO failed to allege facts that came close to overcoming the business judgment presumption with respect to those transactions.

While GAMCO was correct that many of the facts on which it based its claims occurred after the 2013 settlement, the claims were based on the same or similar operative facts as the 2012 lawsuit. iHeart’s financial condition continued to deteriorate following the settlement, but the parties anticipated that and negotiated forward-looking liquidity triggers to address it. GAMCO failed to allege that these triggers had been activated or that the board failed to comply with its monitoring and reporting obligations under the settlement.

Again, GAMCO was correct that Delaware does not permit corporate fiduciaries to contract around their duties. But the intercompany agreements placed CCOH in a difficult position; then-Chancellor Strine said at the 2013 fairness hearing that he could conceive of no legal theory that would permit CCOH to back out. “Given the corner into which the Intercompany Agreements have painted the CCOH Board, there is no reasonably conceivable basis upon which GAMCO can establish that the Board has breached its fiduciary duty by adhering to the carefully-negotiated governance and monitoring provisions agreed to in the 2013 Settlement,” the chancery court concluded.

The case is No. 12312-VCS.

Monday, November 28, 2016

Corp Fin staff updates guidance on tender offers and schedules

By Jacquelyn Lumb

The SEC’s Division of Corporation Finance recently updated its guidance related to tender offers and schedules. In the first Q&A, the staff said that a financial adviser which is engaged to assist an issuer with its Schedule 14D-9 would be considered a person that is directly employed, retained, or to be compensated to make solicitations or recommendations in connection with a transaction, and must be disclosed under Item 1009(a) of Regulation M-A and Item 5 of Schedule 14D-9. The disclosure must include all material terms of the adviser’s employment, retainer, or other arrangement of compensation.

Compensation disclosure. The use of generic disclosure in this regard, such as “customary compensation will be paid to the adviser,” will ordinarily be insufficient, according to the staff. While it depends on the facts and circumstances, the term “customary compensation” generally lacks the specificity that securities holders need to evaluate the merits of the solicitation or recommendation and the objectivity of the financial adviser’s analysis or conclusions.

Quantifying the amount of the compensation may not be required in all instances, but the summary of material terms of the compensation arrangements should include the types of fees payable to the financial advisers. If the adviser will receive multiple types of fees and there is no quantification of these fees, the narrative should be sufficiently detailed to allow securities holders to identify the fees that will provide the primary financial incentive.

The disclosure also should include any contingencies, milestones, or triggers relating to the payment of the adviser’s compensation, such as payment upon consummation of the transaction, which includes a bidder in an unsolicited tender or exchange offer. Issuers should disclose any other information about the compensation arrangement that would be material to a securities holder’s assessment of the adviser’s analysis or conclusions, including any material incentives or conflicts.

No-action letter. In response to a series of questions about a no-action letter on abbreviated tender or exchange offers for non-convertible debt (Abbreviated Tender or Exchange Offers for Non-Convertible Debt Securities, January 23, 2015), the staff advised that a foreign private issuer may satisfy the requirement to furnish a press release announcing the abbreviated offer by filing a Form 6-K, rather than a Form 8-K as noted in the letter, prior to noon on the first business day of the offer.

In connection with that same letter, the staff wrote that abbreviated offers must be made for any and all subject debt securities. In response to whether that means that abbreviated offers cannot have minimum tender conditions, the staff advised that abbreviated offers can have minimum tender conditions.

Also in connection with the same letter, the staff said the amount of cash consideration offered concurrently to persons other than qualified institutional buyers and non-U.S. persons can be calculated with reference to a fixed spread to a benchmark, provided that the calculation is the same as the one used in determining the amount of qualified debt securities.

In response to the final question involving the no-action letter, the staff advised that offerors may announce an abbreviated offer at any time, but should not commence the offer prior to 5:01 p.m. on the tenth business day after the first public announcement of a purchase, sale, or transfer of a material business or an amount of assets as described in the letter. If the abbreviated offer is commenced after 5:01 p.m. on a particular business day, the first day of the five business day period described in the letter would be the next business day.

Friday, November 25, 2016

CFTC FY 2016 sees 68 enforcement cases, $1.29B in sanctions

By Amy Leisinger, J.D.

The CFTC has released its enforcement results for FY 2016, highlighting 68 enforcement actions addressing a wide range of misconduct and just shy of $1.3 billion in monetary sanctions. The agency and its Enforcement Division also pursued litigation in over 100 cases involving, among other things, manipulation, spoofing, and unlawful use of customer funds, and issued its largest whistleblower award to date—$10 million.

Notable actions. The CFTC spotlighted two actions charging employees with trading on material, nonpublic information in breach of their duties for their personal benefit and a $100 million action against JP Morgan for failure to disclose certain conflicts of interest to wealth management clients. In addition, the agency brought nine actions against registered swaps dealers and futures commission merchants for failure to report accurately trading and market information and to maintain proper records. The CFTC also called attention to an action against a natural gas firm and a trader for attempted manipulation of natural gas monthly index settlement prices (which resulted in a $3.6 million penalty) and multiple proceedings involving fraud on retail customers.

Sanctions and cooperation. The agency also noted that, during FY 2016, it collected over $484 million in civil monetary penalties, $748 million in civil monetary penalties, and $543 million in restitution and disgorgement. The Enforcement Division continued to cooperate with foreign regulators in combating international compliance failures and instances of misconduct and with domestic criminal authorities in order to pursue appropriate criminal sanctions for willful violations, the CFTC stated.

“The Division’s work over the past year demonstrates that those who would cheat or defraud investors in our markets, or undermine the integrity of the markets themselves, will face the determined efforts of the CFTC,” said Enforcement Director Aitan Goelman.

Wednesday, November 23, 2016

Trump Administration likely to modify, not eliminate, futures and derivatives reforms

By Brad Rosen, J.D.

The election of Donald Trump as the next President of the United States, combined with the Republican Party maintaining control of both houses of Congress, will likely lead to significant changes in the regulatory landscape for futures and derivatives industry participants. Nonetheless, many of the initiatives or proposals brought about as part of the Dodd-Frank reforms following the financial crisis of 2008 will likely survive, albeit in some modified form. This is according to Dawn Stump, a longtime government and public affairs specialist, who shared her views in a recent FIA webinar on the Trump transition and its impact on the financial services industry.

The first order of business, according to Stump, will be the selection, nomination, and confirmation of the key players to run the major financial regulatory bodies such as Treasury, the CFTC, and the SEC. Given the Republican domination over Congress, they will most likely have little difficulty bringing their chosen people on board.

SEC Commissioner Mary Jo White, a Democratic appointment, has already announced her intention to step down. On the CFTC side, the term for Chairman Timothy Massad, also a Democratic appointment, runs through April 2017, although it is quite possible he may step aside earlier in deference to the new Trump administration. Many believe that Commissioner John Giancarlo, a Republican, will assume the CFTC Chairmanship. It’s also worth noting that two Democratic nominees are currently awaiting congressional approval for open CFTC commissioner spots. Stump indicated that it is not clear how that will all shake out, although she expects at that there will be at least two commissioners with Democratic affiliations at the end of the day.

Regulatory impact. As for the impact on the regulatory landscape itself, Stump does not expect there will be a wholesale repeal of the Dodd-Frank legislation notwithstanding proclamations to the contrary by candidate Donald Trump prior to the election. In particular, Stump observed that Title VII of Dodd-Frank, also known as the Wall Street Transparency and Accountability Act, “will not be repealed.”

However, Stump pointed to a number of areas where she sees the possibility for less regulatory oversight and rigor. These include a less intrusive version of Regulation AT where the CFTC will not be able to obtain source code from traders absent a subpoena, fewer limitations on the use of derivatives by SEC regulated mutual funds, a rejection of the proposed DOL fiduciary rule, revisiting customer arbitration provision under the Consumer Financial Protection Board auspices, and reconsidering rules for tightening up position limits.

Trump promises. While President-elect Trump has promised to eliminate two regulations for every new regulation enacted, Stump indicated she is not sure how that will work in the context of futures and derivative regulations. Still, the changes in Washington and the White House promise to make for interesting and challenging times for both regulators and the regulated alike in the years to come.

Tuesday, November 22, 2016

FSOC working group on hedge funds recommends further analysis and monitoring

By Jacquelyn Lumb

The Financial Stability Oversight Council was recently briefed by its hedge fund working group about the potential financial stability risks from the use of leverage by large hedge funds. The working group reported that, due to the increase of information available through the SEC’s Form PF and the establishment of swap data repositories, its understanding of this segment of the financial markets is greatly improved. This additional transparency helped the working group identify channels for the potential transmission of risks, relevant factors for assessing those channels, data gaps that make it difficult to identify evolving risks, and metrics for measuring the risks associated with hedge fund leverage.

The working group has been reviewing asset management products and activities since May 2014 when it held a public conference, followed by a request for public input about whether certain asset management activities could pose risks to U.S. financial stability. An initial analysis was issued in April of this year in which the working group reported ample evidence that leverage, in combination with other factors, can contribute to risks to financial stability.

As the hedge fund industry continues to grow, the working group found that the use of leverage appears to be concentrated among a small number of hedge funds. Fund strategies that employ the highest amounts of leverage have grown as a percentage of overall hedge fund assets so their market footprint far exceeds their assets under management.

Risk factors. The working group identified factors that could increase or mitigate risks, and areas where regulators do not have the necessary data to assess the extent of the risks. One factor is the potential market disruption from forced selling. The use of significant leverage means that even small changes in asset prices could lead to margin calls or funding pressures.

A second factor is the potential for hedge funds to transmit risk to their counterparties, although the working group found this risk to be somewhat mitigated by increased central clearing of derivatives and other regulatory reforms.

Data gaps. During the next phase of its work, the group plans to focus on data gaps and limitations, and on the continued monitoring of potential financial stability risks. The working group said that data sharing among regulators is essential but difficult at this time due to a lack of standardized reporting across agencies. Form PF also could be refined to improve the timeliness and usefulness of the reported data.

The working group also urged regulators to periodically review and analyze funds’ use of leverage and share their findings with FSOC and other regulators. Hedge funds are important participants in the financial markets, the working group noted, but no single regulator has the authority or the information to identify the risks that their use of leverage could pose. The working group identified four categories of leverage measures that should be incorporated into the analysis of potential risks, which include gross measures, adjusted gross measures, net exposure measures, and risk-based metrics, such as value-at-risk.

Brown’s statement. Following the FSOC meeting, Senator Sherrod Brown (D-Ohio) released a statement in which he advised President-elect Trump of the importance of FSOC’s work. He said the next Treasury secretary should understand that any actions that undermine FSOCs mission could threaten the ability to address risky Wall Street practices and could leave taxpayers and the economy vulnerable to another crisis. If President-elect Trump is serious about stopping Wall Street and hedge funds from ‘getting away with murder’ as he said during his campaign, he will make sure that FSOC can keep doing its job, Brown advised.

Monday, November 21, 2016

Gira addresses FINRA market initiatives at recent town hall forum

By Joanne Cursinella, J.D.

At the recent MarketsMedia/Traders Magazine Equity Market Structure Town Hall Forum, Thomas Gira, FINRA’s executive vice president of Market Regulation, dedicated his remarks to how FINRA is concentrating on the evolution of the market by its focus on transparency and by making use of innovative technology in its surveillance programs.

Transparency. FINRA has a long history of bringing transparency to the equity and bond market, Gira said. He noted that the Trade Reporting and Compliance Engine (TRACE), launched in 2002, provides wide access to trade data for corporate bond transactions, including the price and size. Gira said that TRACE has been steadily expanded it to make trading in bonds less opaque. Investors now also have access to information about transactions in asset-backed securities, mortgage-backed securities, and Small Business Administration-backed securities in addition to corporate bonds.

On the equity side, Gira noted FINRA has also taken steps to increase market transparency of alternative trading systems, including dark pools. In June 2014, FINRA began publishing on its website volume and trade-count information for equity securities executed on an ATS. In April 2016, FINRA began posting the remaining, non-ATS OTC equity volume by member firm and security. And even more recently, FINRA began publishing monthly ATS block-size trading statistics in all National Market System stocks, Gira said.

Surveillance. FINRA is taking steps in its market surveillance program to prevent problems before they occur, Gira said. For example, FINRA has enhanced its ability to gather data across exchanges and alternative trading systems to see one virtual market instead of a disjointed patchwork of individual markets. Having this ability to review trading across markets, rather than at a single market at a time, is essential to any market surveillance program to hinder “bad actors” who try to “hide their fingerprints to avoid detection,” he added.

FINRA continues to refine existing patterns and develop new surveillance patterns to address new threat scenarios, Gira noted, and recently has launched a cross-market surveillance pattern to detect ramping at the open and close; a new surveillance pattern that looks for layering in the equity market to create favorable options prices; and is developing additional cross-market surveillance patterns to more closely monitor trading in ETPs. Gira believes that more needs to be done in this area so FINRA plans to introduce prototypes of a number of these surveillance patterns in the coming months.

FINRA’s board also recently approved rule proposals to expressly identify layering and spoofing as disruptive trading activity and to establish an expedited process for issuing cease-and-desist orders to prevent firms from engaging in the activity or providing access to a customer that engages in the activity, Gira reported.

Technology. FINRA continues to look for new ways to find and stop manipulative behavior and uncover manipulative schemes, Gira said. Specifically, FINRA is exploring data science tools, such as machine learning, that can be used in its surveillance development and ongoing parameter adjustment processes.

Machine learning can help the process of surveillance development, Gira said, “by having the surveillance analysts identify specific instances of behavior of interest and allow algorithms to ‘train’ themselves to identify additional instances in new data sets. This self-learning process would improve the efficiency of the process to determine appropriate parameters for the surveillance program.” FINRA is looking at a pilot to run a “self-adjusting” machine-learning version of an existing pattern to assess the benefits of such an approach to FINRA’s current automated surveillance program, Gira reported.

Friday, November 18, 2016

Issuers claim proxy advisers use one-size-fits-all approach, GAO tells Senate subcommittee

By John Filar Atwood

In a study of the state of the proxy advisory industry, the Government Accountability Office (GAO) heard from some corporate issuers that advisory firms continue to apply policies in a one-size-fits-all manner, which can lead to recommendations that are not in the best interest of shareholders. The GAO provided this and other results of the study in a report to the Subcommittee on Economic Policy of the Senate Committee on Banking, Housing, and Urban Affairs.

The GAO indicated in the report that corporate issuers said that they often do not understand the rationale for some advisory firm vote recommendations and would like to discuss them before they are finalized. Proxy advisory firms told the GAO that to maintain objectivity and satisfy research reporting timelines for clients, they limit the breadth of such discussions.

The subcommittee asked the GAO to review the current state of the proxy advisory industry given that institutional investment has grown over the last 30 years, and institutional investors increasingly rely on proxy advisory firms. Members of Congress, industry associations, and academics have raised issues about proxy advisory firms’ influence on voting and corporate governance, the level of transparency in their methods, and the level of regulatory oversight.

Advisory firm influence. The GAO found that institutional investors hire proxy advisory firms to obtain research and vote recommendations on issues, such as executive compensation and proposed mergers that are addressed at shareholder meetings. Market participants and other stakeholders with whom the GAO spoke agreed that with the increased demand for their services, proxy advisory firms’ influence on shareholder voting and corporate governance practices has increased, but disagreed on the extent of the influence.

Some study participants told the GAO that the influence of advisory firms can vary based on institutional investor size. Generally there is less influence on large institutional investors that often perform research in-house and have their own voting policies.

Proxy advisory firms, specifically Institutional Shareholder Services and Glass Lewis & Co., develop and update their general voting policies through a process that involves analysis of regulatory requirements, industry practices, and discussions with market participants. Corporate issuers and institutional investors told the GAO that unlike in the past, the firms have made more of an effort to engage market participants in the development and updating of voting policies.

According to the proxy advisory firms, they apply the general voting policies to publicly available company information to develop vote recommendations, the report states. The recommendations also are based on institutional investor voting instructions and criteria that firm analysts determine are applicable to the issue being voted on. According to the report, advisory firms have taken steps to communicate with corporate issuers and allow review of data used to make vote recommendations before they are finalized.

SEC oversight. The GAO said that the SEC’s oversight of proxy advisory firms and the services they provide has included gathering information, issuing guidance, and examining proxy advisory firms and use of the firms by investment companies. In 2010, the Commission summarized concerns regarding conflicts of interest, accuracy, and transparency of proxy advisory firms, and requested comments on potential regulatory solutions.

Late in 2013, SEC held a roundtable to discuss issues facing the proxy advisory industry, and issued guidance in June 2014 on disclosure of conflicts of interest. The GAO said that the Commission claims to still be addressing concerns surrounding proxy advisory firms through its examinations of investment advisers and investment companies that retain their services. The Commission made the examinations a priority in 2015 and an area of focus in its ongoing initiative for registered investment companies that had not been examined by SEC, according to the report.

ISS dominance. The GAO found that although the proxy advisory industry consists of five firms, ISS and Glass Lewis are the largest and most often used by institutional investors. To compete, proxy advisory firms must offer comprehensive coverage of corporate proxies and use sophisticated systems to provide research and proxy vote execution services, the GAO noted. The GAO concluded, as it did in 2007, that ISS’s long history of working with institutional investors, and its reputation for providing comprehensive proxy voting research and recommendations, makes it the most dominant proxy advisory firm.

The GAO stated that ISS’s dominance makes it difficult for competitors to attract clients and compete in the market. In addition, institutional investors may be reluctant to subscribe to a potentially inexperienced or less-established proxy advisory firm that may not provide thorough coverage of all of their institutional holdings. According to market participants and other stakeholders with whom the GAO spoke, these conditions continue to exist, and the initial investment required to develop and implement the necessary technology is a significant expense for firms.

Thursday, November 17, 2016

House Republicans ask White not to pass any ‘midnight rulemaking’

By Jacquelyn Lumb

In opening remarks at the House Financial Services Committee hearing to consider the SEC’s 2018 budget request, Chair Jeb Hensarling (R-Tex) strongly urged Chair Mary Jo White to resist the temptation to finalize any regulations, including Dodd-Frank Act Title VII regulations, in deference to the right of the incoming administration to set its own priorities. He said whenever there is a transfer of power from one administration to another, federal agencies are often tempted to rush pending rulemaking to implement policies of the outgoing administration. This type of “midnight rulemaking” is neither conducive to sound policy nor consistent with principles of democratic accountability, he warned.

Agenda already established. In subsequent questioning on the same topic, White assured committee members that the Commission does not intend to rush through any rules. The SEC’s agenda for this year was announced in February 2016, she said, and she does not anticipate any last minute additions. One committee member mentioned reports that regulators wanted to finalize executive compensation rules before the administration change. White said there is no benefit from being rushed. She said she was sensitive to committee concerns, but the executive compensation initiative has been proceeding apace all year and she could not provide a commitment that it would not come before the Commission prior to inauguration.

When asked what she would like to finish before her announced departure at the end of the Obama administration, White said the agenda includes the adoption of a consolidated audit trail, the Title VII capital and margin rules, the derivatives proposal in the asset management space, and the delivery of electronic mutual fund reports under Rule 30e-3.

Hensarling’s criticisms. Hensarling thanked White for appearing at hearings without requesting artificial time limits, for always submitting her testimony on a timely basis, and for always making division and office directors available at Capital Markets Subcommittee meetings. He then laid out a series of issues on which he was not satisfied, including what he saw as the lack of a capital formation agenda, the failure to act on recommendations by the Small Business Capital Formation Forum, and the simplification of the SEC’s disclosure regime. As for the 2018 budget request, he said claims that the agency is underfunded are not supported by the facts, given that its budget has increased by 325 percent since 2000. The SEC’s authorization request is for $2.227 billion, a $445 million increase over its 2017 request.

In her prepared testimony, White presented an extensive list of actions and accomplishments since she became chair in April 2013. She also pointed out that the SEC’s responsibilities have increased significantly to include new and expanded responsibilities for securities-based swaps, hedge fund and other private advisers, credit rating agencies, municipal advisers, clearing agencies, and crowdfunding portals. White reminded the committee that the budget is offset by matching collections of fees on securities transactions, so it has no impact on the deficit or the amount of funding available for other agencies.

Fixed income markets. Hensarling raised concerns that the next financial crisis could be triggered by illiquidity in the bond markets and urged White to focus significant resources in that area, an issue of concern that was raised by a number of other committee members as well. White was asked whether the Volcker and Basel rules were contributing factors to the decrease in liquidity in the fixed income markets. White said there was no evidence to support that belief, but SEC economists and the Financial Stability Oversight Council continue to study it.

FAST Act and EMSAC. Scott Garrett (R-NJ), chair of the Subcommittee on Capital Markets, who was defeated in his reelection bid, asked White about the status of a report the SEC is required to submit under the FAST Act and about the expiration of the Equity Market Structure Advisory Committee’s charter early next year. With respect to the FAST Act study on modernizing and simplifying Regulation S-K requirements, White said the staff report is under review by the Commission and she expects that it will be submitted by the deadline of November 28. As for EMSAC, in White’s opinion, its charter should be renewed. In response to Garrett’s question about Regulation NMS, White said it is front and center in the SEC’s equity markets review.

Fintech initiatives. A couple of the committee members asked about the next steps following the SEC’s first Fintech Forum. White said the staff continues to engage in significant outreach efforts which, along with the forum discussions, will help inform the SEC’s working group recommendations. Those recommendations are not imminent, she said, but may be ready in the coming months. She assured the members that the SEC does not have the mindset that regulation is needed. The SEC does not want to thwart innovation, but wants to protect investors, she advised.

Request to stay. In response to a question of whether White had made her decision to leave the Commission prior to the election, she said she had, which is the normal course of action when there is a change in administrations. Rep. Brad Sherman (D-Cal) agreed that it was the traditional thing to do, but added that the tradition began before Congress started obstructing so many presidential appointments, including two pending Commission seats. He noted that White is part of FSOC and asked her to consider staying on, since her spot on the Council should not be unrepresented.

Wednesday, November 16, 2016

Massad outlines areas of continued focus for derivatives regulation

By Lene Powell, J.D.

In remarks before CME Global Financial Leadership Conference, CFTC Chairman Timothy Massad said he does not expect a wholesale repeal of the Dodd-Frank Act in the next administration, though this is being cited as a priority of the Trump administration. Massad declined to give predictions on what rules might undergo changes under a new CFTC chairman, but he believes the areas of technological change, clearinghouse risk and market liquidity, and international coordination will continue to be areas of focus for the CFTC.

Progress on reforms. Massad emphasized broad agreement among commissioners in the agency’s Dodd-Frank rulemaking to date, saying fault lines have been about details, not goals. He noted that the CFTC has taken a number of actions to fine-tune the Dodd-Frank framework to address many end user concerns and focus regulation more strongly on areas of greatest risk, including uncleared swaps. The agency has also worked to harmonize rules domestically and internationally and to strengthen relationships with international regulators, which helped to resolve a longstanding dispute over clearinghouse regulation.

Massad said there are a “few things” he hopes the CFTC can complete in the time remaining before the turnover, but did not provide details.

Technology. Massad thinks the CFTC will continue to concentrate on technological changes in the markets the CFTC oversees. The agency focuses on cybersecurity in its examinations, and recently adopted rules requiring cybersecurity testing by clearinghouses, exchanges, and swap data repositories. The CFTC also recently hosted a cybersecurity exercise including participants from government agencies as well as CME, ICE, clearing firms, and trading firms.

The CFTC has modernized market surveillance tools and proposed rules to implement risk controls to reduce the risk of disruptions from automated trading, Massad said. Enforcement efforts have also been stepped up, and last week the CFTC settled its case against Navinder Sarao, whose spoofing activity is believed to have contributed to the Flash Crash of 2010. Other technological developments include the advent of blockchain. The CFTC is working on rules related to this, including looking at recordkeeping rules, which are outdated and will become more so if developments like smart contracts become a reality, said Massad.

Clearinghouse risk and market liquidity. Massad stressed the need for data-driven analysis and a focus on risk. He observed that any repeal that increases the risk of failure of a globally significant financial institution risks crashing the economy and requiring a bailout. Alternatively, repeal may involve reducing regulatory impact on smaller banks and commercial companies, which were not the cause of the financial crisis. Some have raised questions whether reforms have concentrated risk and created new systemic points of potential failure. Massad said the CFTC will release the results of stress tests of five clearinghouses on November 16.

Addressing concerns that capital requirements and limits on certain activities have constrained liquidity, Massad said that liquidity is shaped by many non-regulatory factors, including market structure, technological change, and general economic conditions. There are questions about how automated trading may be affecting liquidity, and many traditional commercial end users including agricultural end users are concerned about being able to hedge effectively. Other questions include what happens to liquidity during market stress and the effects of some capital reforms on the clearing member industry.

International coordination. Massad said he has made it a priority to work closely with other regulators on oversight and harmonization of regulations. Beyond Europe and the U.K., areas of coordination include China and India on possible recognition of clearinghouses, Japan and other regulators on automated trading, and Asian Pacific jurisdictions on a variety of issues.

In closing, Massad said he believes these areas of regulation will be important regardless of the political composition or leadership of the CFTC, and he hopes they can be addressed without partisan divisions.

Tuesday, November 15, 2016

Attorney knew that opinion letters were false

By Rodney F. Tonkovic, J.D.

A Second Circuit panel has affirmed by summary order a district court judgment finding an attorney liable for issuing false opinion letters. There was no dispute that the shares at issue were not registered and that the statements in the letters were false (SEC v. Frohling, November 8, 2016, per curiam).

The Commission brought the underlying enforcement action in connection with public offerings of unregistered shares of Greenstone Holdings, Inc. The district court found that attorney John Frohling, Greenstone's securities counsel in 2006-2008, wrote, approved, or concurred in 11 opinion letters stating that the shares could lawfully be transferred as unrestricted shares. The letters cited the Rule 144(k) exemption as it existed at the time and said that the shares were acquired by persons unaffiliated with Greenstone solely in exchange for other Greenstone securities they had received more than two years earlier.

Opinion letters were false. On appeal, Frohling maintained that he had no knowledge that the opinion letters that he issued, approved, or concurred in were false, or any knowledge that would alert him to that falsity. The court stated, however, that there was no dispute that the Greenstone shares at issue were not registered and that that the statements in the letters were false. Frohling wrote or approved opinion letters stating that the unregistered shares may be issued without restriction and without a legend identifying them as restricted. Without these opinion letters, the court said in agreement with the district court, Greenstone's transfer agent would not have issued any of the unregistered shares. The panel found no reason to disturb the district court's conclusion that Frohling violated the registration provisions of the Securities Act.

The panel agreed further with the district court's finding that a jury could not find that Frohling did not know that the letters' representations that the Greenstone shares were exempt were false. To illustrate, Frohling admitted at his deposition that he knew that at least some of the shares were being improperly sold for new consideration. Frohling also wrote two opinion letters to receive shares himself, opining that the exemption applied, despite knowing that he received the promissory note in exchange less than the required two years earlier. The panel concluded that the record amply showed that there was no genuine issue to be tried as to Frohling's knowledge that his representations as to the applicability of the Rule 144(k) exemption were false.

Relief. The panel went on to affirm the district court's order of injunctive relief, plus disgorgement, prejudgment interest and civil penalties totaling $204,161.86. The panel saw no abuse of discretion, given the fees received by Frohling for the fraudulent opinion letters and his lack of concern for his responsibilities under the federal securities laws.

The case is No. 13-3191-cv.

Monday, November 14, 2016

SEC updates Form S-8 C&DIs

By Mark S. Nelson, J.D.

The SEC’s Division of Corporation Finance issued several new Compensation and Disclosure Interpretations and revised some existing C&DIs. The latest guidance primarily deals with the transfer of filing fees and Form S-8.

For one, the Division revised existing Question 240.11 and added Question 126.42 in the Securities Act Rules and Forms C&DIs, respectively. The updated guidance (Rules C&DIs; Forms C&DIs) deals with the transfer of filing fees regarding unneeded securities. The staff said this is barred because Rule 457(p) limits when fees can be transferred to a new registration statement. The revised C&DIs largely track the prior text, but the staff has added some additional information about the use of a post-effective amendment to Form S-8.

Another set of Securities Act Rules and Forms C&DIs (Questions 240.15 and 126.43) deals with the use of Form S-8 in the context of equity compensation plans that are separated by a period of years. The guidance suggests two options: (i) use a new Form S-8 but, under the specific circumstances presented, there can be no offset of fees under Rule 457(p); or (ii) file a post-effective amendment to an earlier Form S-8 with specified disclosures on the cover page along with an explanation that the shares issued under an earlier plan may become authorized under a later plan. The staff noted that the second option applies only in the context of Form S-8.

Yet another pair of new C&DIs (Questions 240.16 and 126.44) explain that if an issuer uses fees paid regarding an earlier registration statement to offset fees due on a later one, the issuer should: (i) include the note to the table required by Rule 457(p); (ii) quantify the amount of unsold securities from the prior registration statement; and (iii) disclose that the prior registration statement was withdrawn or that any offering of the unsold securities was terminated or completed.

The Division also updated Securities Act Forms Question 126.06. The change alters the first sentence of the answer to clarify that the full title of each plan should appear on the face of the registration statement. The question, dealing with the registration of two plans on the same registrations statement, previously had been answered by stating that a company may file a registration statement with a table identifying both plans and other information about the amount of securities involved.

Friday, November 11, 2016

Ceresney optimistic that Supreme Court will uphold Dirks insider trading test

By John Filar Atwood

SEC Enforcement Director Andrew Ceresney believes that the Supreme Court appeared to be sympathetic to the government’s claims in the recently-argued Salman v. U.S. case, and he is hopeful that the court will uphold the insider trading personal benefit test established in Dirks v. Securities and Exchange Commission in 1983. A decision in the government’s favor would be consistent with the direction in which case law has gone since 2014’s U.S. v. Newman decision, he noted.

In an enforcement panel discussion at Practising Law Institute’s securities regulation conference, Dechert’s Jonathan Streeter agreed with Ceresney, saying that it looked like the government was winning the Salman oral argument. One friend giving the gift of information to another friend is going to be considered insider trading, he said.

Ceresney said that the SEC’s enforcement program, which brought 40 insider trading cases last year, has been much more focused on the issue of personal benefit since Newman. The test requires that the tippee know that the tipper was getting a personal benefit by providing the information, he said. In many cases that has been very hard to determine, he added.

Big data. Ceresney also discussed the rise in the number of instances where his staff requests large quantities of data from companies. That stems from Office of Compliance & Inspection’s current approach to examinations, which involves considerable data analysis, he said. The staff asks for the data, then looks for patterns such as insider trading, cherry picking, or mark-ups.

If the staff finds unusual patterns in the data, he noted, it will inform the company of its findings and ask the company to explain. Ceresney said that if the explanation convinces the staff that there is no reason for concern, it will not bring charges. The staff never brings a case without first discussing the data with the company, he said.

Cooperation benefits. On the issue of cooperation, Ceresney said that the staff has been trying to send a message that a company will get a benefit from self-reporting. This happened in the FCPA case involving Harris Corp., he noted, as well as in the Goodyear case where Goodyear was not penalized. In addition to reduced penalties, the staff will consider a non-prosecution agreement where a company self-reports, he added.

Milbank, Tweed, Hadley & McCloy partner George Canellos said that he is skeptical of the benefits of self-reporting. The staff will say that it considered a company’s cooperation, then impose a large penalty anyway. There is no way to measure whether the cooperation was considered, he noted, which has created a credibility gap with respect to the staff’s claims.

Whistleblowers. Ceresney provided an update on the whistleblower program, which passed $100 million in awards last year. To date, about half of the whistleblowers have been company insiders, and the other half are investors, people at competitors, people who do data analysis, or people with a personal relationship with the wrongdoer, he said.

Last year there was an increase in cases where companies interfered with the whistleblower, according to Ceresney. In these cases, the staff is looking for more proof than simply a company’s claim that no one was impeded. In particular, if there is an agreement in place that limits an employee’s options for coming forward, that in itself is considered interference, he said.

Other issues. Ceresney would not comment on whether there is an enforcement sweep underway in the area of non-GAAP reporting. It is an area the enforcement division has focused on, he noted, citing a recent non-GAAP case. The staff’s focus in this instance was whether the company had reconciled the non-GAAP numbers to GAAP and the prominence of the non-GAAP disclosure.

Asked whether the enforcement staff planned to take steps to cut down on overlapping actions with other agencies, Ceresney said the division already engages in coordination efforts with foreign authorities and the DOJ. The SEC handles disgorgement and the DOJ imposes penalties and they do not double count, he stated. The division also holds quarterly meeting with FINRA and the PCAOB to discuss who will handle cases, and sometimes hands matters over to state regulators, he added.

Thursday, November 10, 2016

IM Director Grim touts benefits of fund-regulation enhancements

By Amy Leisinger, J.D.

“October 13 was a great day for fund investors,” said Investment Management Director David Grim in recent remarks. The Commission adopted critical changes to modernize and enhance fund reporting and to strengthen liquidity risk management, and, now, the staff will have more information available to monitor the industry and identify risks, and investors will be better able to make informed decisions, he explained.

According to the director, current reporting requirements do not effectively address the complexity of information or enable the use of technology for analysis purposes. New Form N-PORT will require a fund to report portfolio-holdings information as of the close of the preceding month and the terms of derivatives investments and includes calculations that measure exposure to changing market conditions, he stated. In addition, Grim continued, amendments to Regulation S-X will require standardized, enhanced disclosure about derivatives in investment company financial statements to facilitate comparisons among funds. New annual reporting form, Form N-CEN, streamlines information reported to the Commission to reflect current needs, including disclosures as to whether underlying funds are offered as options under a variable annuity or variable life insurance contract and whether a unit investment trust is a separate account. The form will provide valuable information about separate accounts and the securities issued, he explained.

Grim also discussed the reforms to promote effective liquidity risk management and to reduce the risk that funds will not be able meet redemption obligations and mitigate dilution of non-redeeming shareholders’ interests. Funds will be required to establish a written liquidity risk management programs, he stated, and classify the liquidity of their portfolio holdings and publicly report aggregate liquidity profiles on a quarterly basis. In addition, the changes codified a 15-percent limit on purchases of illiquid assets and established a “highly liquid investment minimum” to ensure stability, Grim said. The new swing pricing tool will also aid funds in effectively allocating the costs of managing purchases and redemptions, he noted.

With regard to insurance products, Grim noted that insurers continue to move away from offerings of variable insurance contracts with guaranteed benefits and that the staff continues to see buyouts and exchanges that may not be beneficial for contract owners. The staff will diligently review disclosures on these offers for to ensure comprehensive risk disclosures, he said.

The director encouraged a continued dialog regarding the proposed regulation of the use of derivatives by registered investment companies and the alternative portfolio limitations designed to limit the amount of leverage that a fund may obtain through derivatives, as well as the asset-segregation requirements. Grim also highlighted the ongoing disclosure effectiveness initiative and the staff’s consideration of means by which to improve the content and delivery of fund prospectuses. “Effective fund disclosures are a pillar of the Investment Company Act’s investor protection framework, and I believe nowhere is the need for effective disclosure more acute than with respect to the various risks associated with funds’ investment policies,” he concluded.

Wednesday, November 09, 2016

SEC Chief Accountant urges filers to be ready for new accounting standards

By John Filar Atwood

A number of major changes to the accounting disclosure regime are going into effect soon, and SEC Chief Accountant Wes Bricker said that the staff expects to start seeing disclosure about them this year. At Practising Law Institute’s securities regulation conference, he reminded companies that Staff Accounting Bulletin 74 requires current disclosure to preview the impact of the coming changes.

Bricker advised that under SAB74, companies are required to provide qualitative disclosure on the effect of a new standard. Even if there is no quantifiable amount to discuss, there is still a good amount of information investors should know about the new standard, he added.

Among other things, in upcoming filings companies should include the directional effects of the new standards, if they are known, and the state of implementation at the company. In addition, companies should provide an explanation of how it handling the implementation of the new standards. If a company is used to providing boilerplate disclosure, Bricker said, then it needs to refresh its controls so the appropriate content is provided.

Revenue recognition. Among the changes is a new revenue recognition standard that goes into effect in 2018 using 2017 numbers. Every company has top-line revenue that is affected by this standard, Bricker noted, and many new disclosures are required. He warned that the new standard may result in a change in timing of revenue and therefore in earnings.

PricewaterhouseCoopers managing partner Mike Gallagher said that current statistics on implementation of the revenue recognition standard are disappointing. He noted that 8 percent of public companies have not started implementation, 75 percent are in the assessment phase and 17 percent are implementing it. Companies have known about this change for a long time, he said, and the 8 percent that have not begun to make the needed changes are going to be in trouble.

Cravath Swaine & Moore partner John White indicated that anywhere there are financial metrics in a company’s disclosure, the numbers are likely to change under the new standard. Audit committees need to be aware of the changes, he said, and companies should consider whether it will change their sales practices.

Going concern. Other new accounting standards include a new leasing standard that is currently in the footnotes to the financial statements, but will be part of the balance sheet beginning in 2019. In addition, a new going concern standard shifts responsibility for making that determination. Previously the auditor issued an opinion on whether the company will be able to meet its obligations when they come due, but now management is required to make that determination.

Enhanced audit report. While not a new accounting standard, the panel discussed the enhanced audit report that the PCAOB is on the brink of approving. The proposal has been five years in the making, Bricker noted, but should be approved by the PCAOB before the end of the year. The changes would still be subject to SEC approval after that.

Gallagher pointed out that the enhanced audit report, which will require a discussion of critical accounting matters (CAMs), is already being used in Europe. They have already been through three reporting cycles with it, he noted.

He said that PwC supports the changes, including the disclosure surrounding CAMs. As it was developing the proposal, the PCAOB added a materiality standard to the CAM disclosure, which Gallagher applauded.

In his view, the adoption date of the enhanced audit report is important. If it gets approved at the end of this year, 2018 is not a practical adoption date for the changes, he believes. Companies need time to absorb the new requirements, and in his view 2019 is the soonest that it can be implemented responsibly. White noted that it will be a big change because what is now a one-quarter of a page report will become multiple pages.

Asked why Europe is so far ahead in adopting the enhanced report, Gallagher said that it is a passion project for PCAOB Chair James Doty who did not want to rush to put something in place. Doty wanted to observe how things are going in Europe to ensure that the right structure is used in the U.S., according to Gallagher.

He noted that for PwC, this applies to thousands of reports across the organization. PwC wants to be sure to deliver quality in every one of those reports, he added, so Gallagher understands why the PCAOB was being deliberate in its efforts to get the audit report right.

Tuesday, November 08, 2016

SIFMA recommends alternative minimum transfer amount for uncleared swaps margin requirements

By Lene Powell, J.D.

SIFMA Asset Management Group (AMG) submitted a comment letter requesting relief relating to uncleared swaps margin requirements established by the CFTC and prudential regulators. The group asked that separately managed accounts be provided a “minimum transfer amount” (MTA) of $50,000 or $100,000 at the account level. The group said this would help avoid costly and unnecessary transfers of small amounts of collateral. The letter was sent to the CFTC and the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Farm Credit Administration, and the Federal Housing Finance Agency.

Minimum transfer amount (MTA). Under uncleared swaps margin rules, a covered swap entity does not need to collect or post margin until the amount of required margin exceeds an MTA of $500,000. According to SIFMA, U.S. regulators are interpreting the MTA as applying at the entity level rather than the account level. This results in practical challenges because assets for each separately managed account managed by a particular asset manager are held, transferred and returned separately at the account level. Each account must calculate and post or collect collateral separately, per its applicable eligible master agreement. Thus, asset managers cannot collectively calculate MTA across the accounts, and cannot move collateral in aggregate across the accounts.

Effectively, applying MTA at the entity level requires asset managers to set MTA to zero at the account level, said SIFMA. The group estimated that this arrangement could increase daily collateral movements by up to 700 percent, resulting in the need to hire more staff and pay wire transfer costs. Moreover, an increase in small collateral movements could cause operational problems including more failed transactions and disputes over small discrepancies in valuation. This will all result in increased costs for derivatives users as well as higher error rates, SIFMA said.

Relief requested. SIFMA proposed that each eligible master netting agreement be given an independent MTA of $100,000 or, alternatively, $50,000 without an entity-level limit. The client would only be able to use this relief as an alternative to, not in addition to, the standard MTA of $500,000. The group also proposed operative language for the relief and a definition of “separately managed account.”

SIFMA acknowledged regulatory concerns about evasion, but does not believe that applying the MTA at the account level would cause evasion risks. Asset managers don’t know the positions of other asset managers trading for the same client, and do not act in coordination. In addition, once the calculation exceeds the MTA by even a small amount, the entire margin amount must be posted. To somehow reduce or evade margin requirements using an account-level MTA, asset managers would have to split netting sets into unworkably small sets of transactions and accept counterparty risk by having a counterparty not post margin. These would be unacceptable activities for registered intermediaries or advisers, SIFMA said.

Monday, November 07, 2016

Apple may not exclude proxy access proposal, SEC says

By John M. Jascob, J.D., LL.M.

Apple’s proxy materials may not exclude a shareholder proposal aimed at seeking meaningful proxy access for more shareholders, according to staff from the SEC’s Division of Corporation Finance. In declining Apple’s request for no-action relief, staff was unable to conclude that the company’s proxy access bylaw compares favorably with the guidelines of a proposal submitted by well-known shareholder activist James McRitchie. Accordingly, Apple may not omit the proposal from its proxy materials in reliance on the “substantially implemented” standard of Exchange Act Rule 14a-8(i)(10).

Proxy access proposal. McRitchie, who publishes the corporate governance portal CorpGov.Net, claims to have drafted the template used in a flurry of proxy access proposals submitted to companies since the beginning of the 2016 proxy season. Under the terms of McRitchie’s proposal to the Apple board: (1) the number of eligible shareholder nominees for the board would either be 25 percent of the then-serving directors or two, whichever is greater; (2) no limitation would be placed on the number of shareholders that can aggregate their shares to achieve the three percent ownership threshold required for creating a nominating group; and (3) no limitation could be imposed on the re-nomination of shareholder nominees based on a failure to receive a certain percentage of votes in a previous election.

Request for no-action relief. In arguing that the company had already substantially implemented the proposal, Apple claimed that its existing bylaws already provide a meaningful right of proxy access. In Apple’s view, McRitchie’s proposal would merely refine the bylaw at the margins, addressing issues that are secondary to the essential elements of proxy access. Allowing shareholders to continually revisit the details of the company's proxy access bylaw would run counter to the "substantial implementation" standard of Rule 14a-8(i)(10), which permits a proposal to be excluded if it differs from existing company policy in only minor respects.

McRitchie, however, responded that Apple’s counsel cited no prior no-action letters for the position that once a company has adopted proxy access it should be free to exclude any proposal on the same topic in the future, provided the initial proposal was substantially implemented. Rather, McRitchie countered, Apple’s arguments were very similar to those made earlier in the year by H&R Block and Microsoft, both of which were denied no-action relief in attempts to exclude proposals seeking revisions to existing proxy access bylaws.

Illusory access? In McRitchie’s view, Apple’s bylaws provide the illusion of proxy access, similar to how certain foods labeled as “natural” provide the illusion of being healthy. With regard to the proposed changes to the maximum number of shareholder nominees, McRitchie dismissed Apple’s contention that the proposal would not represent a meaningful change because it would result in an increase of just one additional potential director under the current bylaws. McRitchie noted that just one additional director would double the number of potential proxy access candidates nominated by shareholders, thus possibly preventing a sole shareholder-nominated director from being frozen out of discussions.

With regard to the size of the nominating group, McRitchie contended that there is a huge difference between Apple’s current limit of 20 shareholders, which the Council of Institutional Investors concludes cannot even be met by its own members at most companies, and the unlimited group size that he proposes. Finally, McRitchie argued that Apple provided no evidence that its current bylaw standard limiting the re-nomination of shareholder nominees would meet an essential purpose of his proposal, which was to facilitate the re-nomination of shareholder nominees without requiring them to meet specific voting thresholds.

Staff conclusion. Based on the information presented, the staff advised that Apple’s proxy access bylaw did not compare favorably with the guidelines in McRitchie's proposal and, accordingly, the proposal could not be omitted as having been substantially implemented.

Friday, November 04, 2016

Massachusetts proposes crowdfunding, Reg. A + notice filing requirements

By Jay Fishman, J.D.

The Massachusetts Securities Division has proposed preliminary notice filing requirements for issuers making federal Regulation Crowdfunding or Regulation A + offerings. The Division asks industry persons to submit comments about the preliminary proposals.

Crowdfunding. Issuer requirement. Issuers intending to make an offering under federal Regulation Crowdfunding (17 CFR §227) and Securities Act, Sections 4(a)(6) and 18(b)(4)(C) would initially file with the Massachusetts Securities Division Director: (1) copies of all SEC-filed documents; and (2) a Form U-2, Uniform Consent to Service of Process (with a Form U-2A, Uniform Corporate Resolution, if applicable).

The issuer would make the above filing when it makes its initial Form C filing for the SEC offering, provided the issuer’s principal place of business is in Massachusetts. However, if the issuer’s principal place of business is outside Massachusetts but Massachusetts residents have purchased at least 50 percent of the aggregate offering amount, the issuer would make the above filing when it becomes aware that the purchases have met this threshold, but in no event later than 15 days from the offering’s completion date.

The initial notice filing would take effect for 12 months from the filing date with the Director.

The issuer, to continue the same offering for an additional 12-month period, would renew the notice on or before the current notice filing’s expiration date, by sending the Director “renewal” marked copies of all SEC-filed documents and/or a cover letter (or other document) request renewal of the initial notice filing.

Funding portal requirement. A “funding portal” defined by Exchange Act, Section 3(a)(80) that is a FINRA member with a Massachusetts principal place of business would file the initial notice by sending the Division: (1) a copy of SEC-filed Form Funding Portal (FP); (2) a copy of FINRA-filed Form FP-NMA; and (3) Form U-2, Uniform Consent to Service of Process (with Form U-2A, Uniform Corporate Resolution, if applicable). Funding portals would promptly send the Division: (1) a copy of any SEC-filed Form Funding Portal (FP) amendments; and (2) a copy of any FINRA-filed Form FP-CMA amendments. Funding portals would withdraw from FINRA membership by sending the Division a copy of Form Funding Portal (FP). Funding portals would, in writing, notify the Division of the funding portal’s no longer having a Massachusetts principal place of business.

Regulation A +. Initial filing. Issuers intending to make a Regulation A, Tier 2 offering in Massachusetts would file with the Secretary of the Commonwealth of Massachusetts at least 21 calendar days before the initial sale in the state: (1) a complete Uniform Notice of Regulation A – Tier 2 Offering Form (or copies of all SEC-filed documents); (2) a Form U-2, Uniform Consent to Service of Process if not filing on the Uniform Notice of Regulation A – Tier 2 Offering Form; (3) a Form U-2A, Uniform Corporate Resolution (if applicable); and (4) a filing fee of 1/20 of one percent of the aggregate offering amount, with annual minimum and maximum fees of $300 and $1,500, respectively. The initial filing would take effect for 12 months from filing date with the Secretary.

Renewal. Issuers, to continue the same offering for an additional 12-month period, would send the Secretary on or before the current notice filing’s expiration date: (1) the Regulation A – Tier 2 Notice Filing Form marked “renewal” and/or a cover letter (or other document requesting renewal); and (2) a renewal fee of 1/20 of one percent of the aggregate offering amount, with annual minimum and maximum fees of $300 and $1,500, respectively.

Amendment. Issuers, to increase the amount of the securities offered, would file a Regulation A – Tier 2 Notice Filing Form marked “amendment” (or file another document describing the transaction). An issuer, to increase the amount of the notice filed securities, would use the above fee to calculate the additional increment of funds to cover the increase. The issuer would send this additional increment of funds to the Secretary.