Friday, January 19, 2018

Boeing is unsuccessful in attempts to omit ‘lap dog’ references from shareholder proposals

By Jacquelyn Lumb

Boeing Company was unable to convince the Division of Corporation Finance that it could omit portions of three separate shareholder proposals from its proxy materials—one seeking a requirement that the chairman be an independent member of the board, one to require shareholder approval to increase the number of board members, and one giving holders of 10 percent of the outstanding shares the power to call a special shareholder meeting. In each case, Boeing sought to omit portions of the supporting statements on the basis that they impugned character, integrity, or personal reputation without a factual foundation in violation of Rule 14a-9.

Lap dog reference. In the proposals to give shareholders the power to call special meetings and to require an independent chairman, the supporting statements referred to the 20-year tenure of lead director Kenneth Duberstein and suggested that his lengthy tenure may make him “a lap dog.” Both proposals also noted that a director with only one-year’s tenure has received a negative vote that is five times higher than the other directors. In the proposal relating to board expansion, the supporting statement notes that CEO directors can tend to be lap dogs for a fellow CEO, and Boeing recently added two CEOs to its board.

In the proponents’ view, a lengthy tenure can detract from a director’s independence regardless of his or her qualifications. They also noted that Duberstein’s experience as a long-time lobbyist may not be an asset and raised concerns that the directors who are CEOs may show deference to each other which may not be in the best interest of shareholders. In addition, the board has grown to what they see as the “unwieldy” size of 14 directors, which the proponents believe can lead to CEO domination. The size of the board increased last year from 12 to 14 without a shareholder vote, according to the proponents.

Impugning character. Boeing asked the staff to concur with its view that it could omit the lap dog references in the supporting statements because they impugned the character, integrity or personal reputation of a director without a factual foundation. The accusations are baseless, Boeing argued, and it defended Duberstein for having a distinguished record as a Boeing director, the chairman of a preeminent strategic consulting firm, and a former White House chief of staff. The proponents provided no basis for their unfounded attacks, according to Boeing. Boeing also advised that each of the sitting CEOs on its board is a respected and preeminent leader in corporate America.

Staff response. In response to each of the no-action letter requests, the staff advised that it was unable to concur with Boeing’s wish to exclude the lap dog portions of the supporting statements in reliance on Rule 14a-8(i)(3) because it was unable to conclude that the references impugned character, integrity or personal reputation in violation of Rule 14a-9.

Thursday, January 18, 2018

Pennsylvania adopts new securities rules

By Jay Fishman, J.D.

The Department of Banking and Securities has amended its securities rules in their entirety, primarily to non-substantively re-write the rules in more plain English for better clarity, to replace outdated references to "Commission" and "NASD" with "Department" and "FINRA," respectively, and to repeal a number of outdated rules. The Department has additionally adopted a handful of new rules and some significant rule changes. The changes took effect on January 13, 2018 and are highlighted below.

Federal covered securities. The Department added a provision to its federal covered securities rule to cover 18(b)(3) offerings in light of the SEC’s adoption of Regulation A + rules. The added provision allows the Department to create an order for issuers intending to make an 18(b)(3) offering in Pennsylvania, such as a Tier 2 offering under federal Regulation A, to submit to the Department: (1) SEC-filed documents pertaining to the offering; (2) a Department-specified notice; and (3) a prescribed fee.

Private fund adviser exemption. Private fund advisers are exempt from investment adviser registration requirements if neither the advisers nor their advisory affiliates are subject to "bad boy" disqualification provisions under federal Regulation A Rule 262, and the advisers electronically file with the Department through the IARD the reports and amendments required for exempt reporting advisers under SEC Rule 204-4. The exemption takes effect when the reports and amendments are filed and accepted by the IARD on the Department's behalf.

Federal covered investment advisers, i.e., private fund advisers registered with the SEC, are ineligible for the exemption and, therefore, must comply with Pennsylvania notice filing requirements. Investment advisers that become ineligible for the private fund adviser exemption must, within 90 days following their ineligibility, register or notice file as investment advisers (as applicable) in Pennsylvania. Investment adviser representatives employed by or associated with exemption-eligible investment advisers are, themselves, exempt from investment adviser representative registration if they do not otherwise act as investment adviser representatives.

Additional requirements for private fund advisers to certain 3(c)(1) funds. Private fund advisers advising at least one fund under Section 3(c)(1) of the Investment Company Act of 1940 that is not a venture capital fund must, in addition to meeting the above-mentioned basic requirements, (1) advise only those 3(c)(1) funds, other than venture capital funds, whose outstanding securities (other than short term paper) are beneficially owned entirely by persons who would each meet the "qualified client" definition in SEC Rule 205-3 at the time the securities are purchased from the issuer, and (2) disclose in writing, at the time of purchase, to each beneficial owner of a 3(c)(1) fund that is not a venture capital fund: (a) the services, if any, the advisers will provide to them; (b) the duties, if any, the advisers owe them; and (c) all other material information affecting the beneficial owners' rights or responsibilities.

Private fund advisers must annually obtain audited financial statements for each 3(c)(1) fund that is not a venture capital fund and deliver a copy of those audited financial statements to each beneficial owner of the fund.

Grandfathering exemption for investment advisers. Notwithstanding the above requirements, private fund advisers to one or more 3(c)(1) funds that are not venture capital funds but that have one or more non "qualified client"- defined beneficial owners can still qualify for the exemption if: (1) the subject fund(s) existed before this rule’s effective date; (2) the funds cease to accept beneficial owners that are not qualified clients as of this rule’s effective date; (3) the adviser makes the above "service, duty and material information" disclosures to all beneficial owners of the fund; and (4) the adviser delivers the above audited financial statements as of this rule’s effective date.

Terms defined. The following terms are defined for purposes of the private fund adviser exemption: "private fund adviser," "qualified client," "qualifying private fund," "3(c)(1) fund," "3(c)(7) fund," and "venture capital fund."

Solicitor exemption. A solicitor is exempt from Pennsylvania investment adviser and investment adviser registration requirements if the solicitor is in compliance with Pennsylvania’s "cash payment for client solicitation" rule, provides impersonal investment advisory services, and is not subject to any Pennsylvania Securities Act "bad boy" disqualification provisions.

Existing securityholder exemption. Pennsylvania’s existing securityholder exemption is retitled the "existing equity securityholder" exemption.

Net worth requirement for IAs registered as BDs. Investment advisers registered as broker-dealers that have a Pennsylvania principal place of business must maintain the minimum net capital required for broker-dealers under Exchange Act Rule 15c3-1.

Broker-dealer recordkeeping. Broker-dealers registered in Pennsylvania, but not with the SEC, who fail to create and maintain the records required by Exchange Act Rule 17a-3 must immediately notify the Department of this failure and file a report with the Department, within 24 hours of filing the notice, setting forth the steps that have or will be taken to comply with this rule provision.

Abandoned applications; Industry person applications. The Department may consider "abandoned" a broker-dealer, agent, investment adviser, or investment adviser representative application on file with Department for a minimum of six consecutive months if the applicant failed to: (1) respond within 60 days following the Department’s sending the applicant a first class mailed notice to the applicant’s last known address; (2) respond to any request for additional information; or (3) complete the showing required for action on the application.

Securities registration applications. The Department may consider "abandoned" a securities registration application on file with the Department for a minimum of 12 consecutive months if the applicant failed to: (1) respond within 60 calendar days following the Department’s sending the applicant a first class mailed notice of abandonment to the applicant’s last known address; (2) respond to any request for additional information; or (3) complete the showing required for action on the application.

Senior specific certifications/professional designation: Prohibition. The Department, under specified circumstances, will deem a dishonest practice a broker-dealer’s, agent’s, investment adviser’s, or investment adviser representative’s using a certification or professional designation to declare its expertise in offering, selling, or providing advice about securities to senior citizens.

Dual registration of agents—REPEALED. A rule permitting agents to register with more than broker-dealer was repealed.

Wednesday, January 17, 2018

Valeant defendants remain in price-gouging hot seat

By Anne Sherry, J.D.

A private lawsuit filed by funds that invested in Valeant Pharmaceuticals overcame 20 motions to dismiss filed by Valeant and individual defendants. The District of New Jersey, in an unpublished opinion, held that the Exchange Act Section 18(a) claims adequately pleaded reliance on Valeant’s alleged false statements. The court also declined to limit the Section 10(b) and 18 claims to securities purchases made within certain date ranges (T. Rowe Price Growth Stock Fund, Inc. v. Valeant Pharmaceuticals International, Inc., January 12, 2018, Shipp, M.).

The complaints are direct actions under Sections 10(b), 18(a), and 20(a) of the Exchange Act, not to be confused with the class action pending before the same court and arising out of the same facts and circumstances. The plaintiffs allege that Valeant concealed practices that carried enormous risk, which in turn caused securities to trade at artificially inflated prices. Specifically, Valeant allegedly hid the use of a secret pharmacy network, “extraordinary price gouging,” fictitious and improper accounting, and other deceptive practices. As the misconduct came to light between September 2015 and August 2016, Valeant’s stock price fell from $262 to $25 per share.

Section 18 claims. Section 18 creates a private remedy for damages when a purchaser or seller relied on a false or misleading statement contained in any SEC-filed document. Scienter is not an element of a Section 18 claim. The defendants sought dismissal of these claims on the basis that the plaintiffs did not tie every purchase to a relied-upon statement; instead, they listed year-long periods and estimated the number of purchases made. The court, however, agreed with the plaintiffs that they were not required to link particular misrepresentations with particular trades. The complaint identified the alleged misstatements in SEC-filed documents and pleaded “eyeball” reliance on those statements in purchasing Valeant securities.

The court also denied the defendants’ request to limit certain Section 18 claims to purchases occurring after the date of the earliest SEC filing at issue in those claims. The court was able to read the complaint reasonably as alleging that the plaintiffs purchased the securities after the filing of the 2014 10-K.

Section 10(b) and Rule 10b-5 claims. The defendants also moved to time-limit the 10(b) and 10b-5 claims. They argued that the “truth was revealed” by October 30, 2015, so the plaintiffs cannot rely on the fraud-on-the-market theory for purchases after this date. The plaintiffs countered that this argument had already been rejected in the class action and that based on the allegations, the defendants could not establish this defense as a matter of law. The complaints alleged that the truth was only partially revealed on the October date and identified subsequent corrective disclosures. The court agreed that the complaints did not conclusively establish that the full truth was revealed to the market in October.

Individuals’ motions to dismiss. Finally, Valeant’s former controller and an executive vice president sought in vain to be taken out of the case entirely. The controller argued that the complaints did not allege that she made any false statements or acted with scienter. Although the plaintiffs identified two statements during an investor call, the controller defendant argued that these were accurate recitations of Valeant’s historical disclosure analysis concerning the mail-order pharmacy Philidor. But the court reasoned that literally true statements can, in context, mislead, and whether the controller “made” the statements within the meaning of Janus was a fact-intensive inquiry to be made at a later stage of litigation.

The court also found that the complaints created a strong inference of scienter with respect to all of the alleged statements by the controller, including allegations that she approved improper accounting relating to Philidor, publicly defended that accounting in response to a report questioning whether Valeant was inflating revenue, and was ultimately placed on administrative leave in connection with Valeant’s accounting restatement.

The executive vice president, who led Valeant’s dermatology department, argued that being an executive was not enough to establish scienter. The complaints went further, though, piecing that fact together with other allegations, such as her direct responsibility for several drugs sold in large quantities through Philidor, her involvement in improper copay practices, and her sudden departure from the company. These allegations together created a strong inference of scienter.

The case is No. 16-5034.

Tuesday, January 16, 2018

Defendant still has burden of persuasion when rebutting Basic presumption of reliance

By Mark S. Nelson, J.D.

The Second Circuit reiterated that a securities fraud defendant bears the burden of persuasion with respect to rebuttal of a plaintiff’s invocation of the Supreme Court’s Basic fraud-on-the-market presumption of reliance. The case arose out of Goldman Sachs Group, Inc.’s alleged failure to disclose conflicts it had regarding collateralized debt obligations involving funds investing in subprime mortgages. The panel followed the holding of a different Second Circuit panel that had previously explained that a securities fraud defendant can rebut the reliance presumption by showing by a preponderance of the evidence that there was no price impact. As a result, the district court’s opinion in the Goldman Sachs case was vacated and remanded for further proceedings, including an evidentiary hearing or other oral argument, both of which the panel encouraged the lower court to pursue (Arkansas Teachers Retirement System v. Goldman Sachs Group, Inc., January 12, 2018, Wesley, R.).

Who has which burden? Plaintiffs, public pensions and others, had alleged that Goldman Sachs misled investors about the role that one of its hedge fund clients played in selecting assets for Abacus 2007 AC-1, a CDO transaction. Goldman Sachs allegedly let the client, which had a short position in the fund, choose particularly risky subprime mortgage assets in the hope that the fund would perform poorly. The plaintiffs also alleged similar conflicts on Goldman Sachs’s part in three other CDO transactions involving subprime mortgages.

The district court had certified the class of Goldman Sachs investors who bought the firm’s common shares between February 2006 and June 2010. On appeal, there was no dispute that most of the requirements for class certification had been satisfied, nor was there any dispute over plaintiffs’ invocation of the Basic presumption and that the plaintiffs’ claims were brought after the alleged misrepresentation yet before the truth about the CDOs was revealed. The parties did dispute the allocation of burdens regarding the rebuttal of price impact.

According to Goldman Sachs, the district court imposed too high a burden on the firm. The Supreme Court in Halliburton II reaffirmed the Basic v. Levinson presumption of reliance, commonly known as the fraud-on-the-market theory, which posits that a company’s share price, when its shares are traded in an efficient market, will take into account all public information. But the justices also held that a securities fraud defendant can rebut this presumption by showing the lack of a price impact. The Second Circuit noted that the absence of a price impact in the Goldman Sachs case could undermine the plaintiffs’ assertion of predominance under Federal Rule of Civil Procedure 23(b)(3).

Goldman Sachs had argued that Federal Rule of Evidence (FRE) 301 puts the burden of persuasion on the plaintiffs. FRE 301 provides that unless a federal law or the FREs state otherwise, a defendant in a civil case has the burden of production, but the burden of persuasion remains with the party that had it originally. Goldman Sachs also relied on language from Basic that the firm said suggests that “[a]ny showing” (emphasis in original) breaking the connection between share price and an alleged misrepresentation would rebut the Basic presumption. According to Goldman Sachs, because the plaintiffs must prove predominance and reliance, they also must also bear the burden of persuasion.

But the Second Circuit said Goldman Sachs’s price impact rebuttal must instead comport with circuit precedent placing the burden of persuasion on securities defendants. In Waggoner, decided last November, a different three-judge panel concluded that the same Basic text cited by Goldman Sachs regarding “any showing” is more consistent with a burden of persuasion than it is with a burden of production. Said the Waggoner panel: “… the Court requires defendants to do more than merely produce evidence that might result in a favorable outcome; they must demonstrate that the misrepresentations did not affect the stock’s price by a preponderance of the evidence” (emphasis in original).

Moreover, the panel in the Goldman Sachs case observed that the Waggoner panel also had countered the FRE 301 theory. According to the Waggoner panel, the Basic presumption has roots in federal securities laws and, thus, satisfies FRE 301’s “federal statute” exception. Still, the case would have to be vacated and remanded because it was unclear to the Second Circuit panel which burden the trial judge had imposed on Goldman Sachs. The district court spoke of “conclusive” proof while also mentioning the Waggoner standard via footnote.

Truth-on-the-market. The Second Circuit, however, noted one error in the district court’s class certification. The district court appeared to view certain evidence presented by Goldman Sachs as being a truth-on-the-market defense. That theory posits that investors could not have relied on misstatements because those misstatements were already known to the market. The panel instead concluded that truth-on-the-market was not offered by Goldman Sachs as defense, but rather offered as evidence that prior revelations about conflicts resulted in no decline in the firm’s share price.

The case is No. 16-250.

Mandelbaum Salsburg launches new securities practice

By Lene Powell, J.D.

Mandelbaum Salsburg has added a new Securities Law Practice Group. Partner and Group Chair Vincent McGill and Counsel Mark Orenstein will advise on securities transactions and securities-related matters, including public offerings and private placements of equity and debt offerings.

The practice launch comes ahead of an expansion of the firm’s New York office, which will be announced in the coming weeks. The firm has 70 attorneys in New York, New Jersey, and Florida.

Vincent McGill has wide-ranging experience in corporate and securities law, with a focus on corporate finance. He has represented underwriters, placement agents and finders in public offerings and private placements, leveraged buyouts, reverse mergers and SPACs, and the design of tax sensitive partnerships and LLCs including REITs.

Mark Orenstein began his career at the SEC Division of Corporation Finance and has over 40 years of experience in structuring, negotiating and documenting sophisticated corporate transactions, including public offerings and private placements for foreign and domestic issuers, mergers and acquisitions, and compliance.

McGill and Orenstein joined from Eaton VanWinkle in New York, where McGill was managing partner.

Monday, January 15, 2018

The Warmth of Their Own Suns Can Shine Because of Dr. King

[In commemoration of Martin Luther King, Jr. Day, we republish a post by the late Jim Hamilton from January 17, 2011, honoring Dr. King and his legacy.]

By Jim Hamilton, J.D., LL.M.

"I was taking a part of the South to transplant in alien soil. To see if I could respond to the warmth of other suns."

- Richard Wright

"This is the faith that I go back to the South with, knowing that somehow this situation can and will be changed."

- Dr. Martin Luther King, Jr., ``I Have a Dream’’ speech

In her prize-winning book, "The Warmth of Other Suns,’’ NY Times reporter Isabel Wilkerson details the Great Migration of six million Southern blacks from the segregated South to the cities of the North through the stories of an orange picker from Central Florida who moved to NYC and a poor woman from the Mississippi Delta who found a new life in Chicago. The greatness of Dr. Martin Luther King, Jr. is that he engineered a Civil Rights revolution that allowed Southern blacks to stay under the warmth of their own suns. It is not given to many people in all of history to change a region’s Way of Life, but Dr. King did and, by doing so, allowed the New South to be born. Now people can find work in the VW plant in Tennessee and the Mercedes plant in Alabama and the new office buildings of Atlanta. Every time I see a gleaming new Siemens electronics facility or BMW engine plant as I drive the highways of the South, I silently thank Dr. King for making it all possible, because no international company would ever have come to a segregated South, and that is the God’s truth.

Friday, January 12, 2018

SEC holds inaugural meeting of its Fixed Income Market Structure Advisory Committee

By Jacquelyn Lumb

SEC Chairman Jay Clayton welcomed members to the inaugural meeting of the Fixed Income Market Structure Advisory Committee (FIMSAC) and welcomed new commissioners Robert Jackson and Hester Peirce who were sworn in this morning. Clayton said it is difficult to overstate the importance of the fixed income markets, the growth of which has outpaced the equity markets. He also mentioned that the SEC’s Equity Market Structure Advisory Committee’s charter expired this week. The committee will not be renewed, according to Clayton, but will instead be replaced by a series of roundtable discussions on targeted equity market structure issues.

The formation of the committee and its members was announced on November 9, 2017. Its focus is on the corporate bond and municipal securities markets. Clayton emphasized the importance of ensuring that the SEC’s regulatory approach meets the needs of retail investors, in addition to companies and state and local governments. Michael Heaney, the non-executive director of Investment Management Americas, was appointed chairman of FIMSAC. He said the group intends to make actionable recommendations to the Commission. The FIMSAC agenda included presentations of research on bond market liquidity, followed by panelists’ discussions of the data.

Commissioner Michael Piwowar issued the same challenge to FIMSAC that he offered to EMSAC, which was to take control of the agenda and use the members’ collective expertise to advise the SEC on the areas that warrant the most attention. He noted that not so long ago, the lack of bond market liquidity was the subject of an intense debate amidst concerns about the financial markets. While many have moved on from the subject, Piwowar said that fears of potential liquidity shock remain, so it is important to consider appropriate regulatory measures.

Commissioner Kara Stein talked about the changes to the market with new investors entering and banks reducing their holdings. She also noted the increase in the size of the market, from $5.9 trillion in 2010 to $8.1 trillion in corporate bonds outstanding in 2016. Stein said that FIMSAC’s diversity of viewpoints will assist the SEC is assessing these changes and their impact on the market.

Heaney will reach out to members to serve on three subcommittees, all of which will report back at the next meeting in April.

Thursday, January 11, 2018

Senators stand behind CFTC Chairman in efforts to uphold equivalency agreement with the EC

By Brad Rosen, J.D.

CFTC Chairman J. Christopher Giancarlo has received the full support from U.S. Senate Committee on Agriculture, Nutrition, and Forestry Chairman Pat Roberts (R-Kan) and Ranking Member Debbie Stabenow (D-Mich) for his stated commitment to honor mutually recognized equivalency agreements regarding cross-border clearinghouses as set forth in a letter sent by the senators.

Less than two years ago, and prior to the United Kingdom’s 2016 referendum to leave the European Union (commonly referred to as “Brexit”), the CFTC and the European Commission (EC) reached a unanimous and bipartisan agreement on cross-border clearinghouse oversight. This equivalence agreement, the product of over three years of intense discussions between the CFTC and the EU authorities, resulted in strong oversight while still providing firms with the flexibility that is needed in the global derivatives marketplace.

Post-Brexit, the EC proposed a major overhaul of its financial services regulatory framework that threatened the 2016 CFTC-EC equivalence agreement, while at the same time empowered European regulators with broad and duplicative supervisory authority over U.S. clearinghouses.

In their letter, Roberts and Stabenow wrote, “Failure to abide by the terms of the 2016 CFTC-EC agreement would call into question the credibility of the process that has been undertaken cooperatively by the CFTC and the EC in recent years, particularly given the agreement was finalized less than two years ago.” They continued, “We support your efforts to ensure a universal solution that recognizes the respective supervisory authorities of the CFTC and the EC, and encapsulates the principles set forth in the CFTC-EC agreement. Disjointed regulatory activities will serve no market, and will only cause undue stress.”

The senators further noted, “In a recent speech, you stated that any unilateral change by European authorities would be a violation of trust and cooperation between the U.S. and Europe. We agree with that assessment. If the EC moves away from the 2016 CFTC-EC agreement, the CFTC should review the appropriateness of the exemptions and relief it has granted to foreign entities, including clearinghouses established in the European Union. The CFTC has existing authority to initiate such review, and we would support your efforts if you deem them appropriate and necessary.”

Chairman Giancarlo, in a statement responding to the senators’ letter, expressed his appreciation for their strong support and further noted, “Their letter expresses the critical importance of keeping in place the 2016 equivalence agreement ..." and that, “[r]egulatory and supervisory deference needs to remain the key principle governing how the CFTC and EU authorities work together on the supervision of US and EU CCPs.”

Wednesday, January 10, 2018

China, intellectual property drive hearing on CFIUS

By Mark S. Nelson, J.D.

The House Financial Services Subcommittee on Monetary Policy and Trade held its second hearing in a month regarding the need to update the law governing operations of the Committee on Foreign Investment in the United States (CFIUS). Much of this latest hearing focused on how CFIUS could do more to focus attention on U.S. investments by private and state-owned Chinese firms. Many of the perceived threats from China and elsewhere also involve the acquisition of U.S. intellectual property. The subcommittee last considered making changes to the law governing CFIUS in December.

China’s efforts to acquire U.S. technology. The headline threat addressed at the hearing was the evolving effort by China to acquire sensitive U.S. technologies, although other threats exist, such as Russian companies seeking access to offshore oil drilling technologies that can be used in cold water, as noted by Rep. Al Green (D-Tex).

But the subtext of the hearing was how to tweak the Foreign Investment Risk Review Modernization Act of 2017 (H.R. 4311), sponsored by Rep. Robert Pittenger (R-NC), which offers the largest re-write in over a decade of Section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (Public Law No. 110–49). The bill posits that foreign investment in the U.S. is generally beneficial and that the U.S should welcome such investments if they are “consistent with national security.”

But the bill would urge the president to do more to persuade U.S. allies and partners to adopt CFIUS-like procedures. The bill also urges the president to enhance multilateral export controls around the world with respect to “certain countries of special concern.” The bill would define “country of special concern” to mean a country that poses a significant national security threat to U.S. interests. CFIUS, however, would not have to keep a list of such countries.

Dr. Derek M. Scissors, resident scholar at the American Enterprise Institute, testified that he had concerns about language in the bill regarding “country of special concern” because the emphasis should specifically be on China. Scissors views Chinese private firms and Chinese state-owned enterprises as different economically, but not so different legally. He also noted that while Chinese investment in the U.S. was down 50 percent in 2017 over 2016 levels, the global trend for Chinese investment is one of growth, especially in Europe.

By contrast, Dr. Scott Kennedy, director of the Project on Chinese Business & Political Economy at the Center for Strategic & International Studies, said a focus on countries of special concern is appropriate, but legislation should not expand CFIUS’s mandate to include outward U.S. investments. Kennedy described China’s technology policy as having evolved under China’s President Xi Jinping from “techno-nationalism” into a policy that seeks to serve both economic and national security interests. He also said that, overall, China’s technology policy is inefficient, but nevertheless effective.

Still, CFIUS does have some blind spots under current law. Rod Hunter, partner at Baker & McKenzie LLP and former special assistant to the President and senior director on the National Security Council, observed that existing definitions in the law applicable to CFIUS do not account for real assets that have no commercial activity and, thus, no business, for CFIUS to examine. He cited the example of a foreign investor who acquires land near a sensitive U.S. government site.

Meanwhile, Theodore W. Kassinger, partner and O’Melveny & Myers LLP and former deputy secretary at the Department of Commerce, urged lawmakers and regulators to observe three principles as they mull re-writing CFIUS’s founding statute: (1) continue to welcome foreign investment in the U.S.; (2) ensure that any statutory or regulatory changes for CFIUS focus on predictability, transparency, and efficient procedures; and (3) follow the process employed during the last round of statutory and regulatory amendments, which he said had produced good results after a year-long process.

Intellectual property. The Pittenger bill also would address a range of issues centered on intellectual property transfers. “Covered transaction” would be defined in a more detailed manner and include transfers of intellectual property by a U.S. critical technology company of intellectual property and associated support to a foreign person through joint ventures or other arrangements. The bill would allow CFIUS to define “intellectual property.” The bill also would include new language regarding “critical infrastructure,” “critical materials,” “critical technologies,” and “malicious cyber-enabled activities.”

Admiral Dennis C. Blair, co-chair of The Commission on the Theft of American Intellectual Property and former Director of National Intelligence, told the subcommittee that not only should Congress enact a modernization of the CFIUS law, lawmakers also should add a provision that makes clear that foreign companies that steal U.S. intellectual property cannot invest in the U.S.

In reply to several sets of questions posed by Rep. Denny Heck (D-Wash), Blair explained China’s recent evolution as a military power. Representative Heck had asked Blair to describe advances by China’s armed forces in the last decade and whether those advances were materially advanced by the theft of intellectual property. Blair said China’s armed forces had evolved from a defensive, light infantry force in the 1990s into an advanced force with the ability to project power within Asia. Blain said China had acquired its technology by both “fair” and “foul” methods. Representative Heck then asked about the role of outbound investment by U.S. firms doing business in China. Blair said the primary threat now is that China seeks to penetrate U.S. sources, such as the defense industry. Blair explained that much of the outbound technology is “second rate” and China would prefer to acquire better technology directly.

Some lawmakers asked about the possibility of giving CFIUS authority with respect to technology controls. Baker & McKenzie’s Hunter noted in both his testimony and prepared remarks that CFIUS is ill-suited to handle technology transfer issues. He said that uncertainty could arise over CFIUS determinations, partly due to CFIUS lacking sufficient resources, such that companies’ resource and development activities could migrate from the U.S. to other countries. Hunter urged lawmakers to adhere to the separate export control regime for dealing with technology transfer issues.

Tuesday, January 09, 2018

Post-recess, Court strikes respondent brief and denies certiorari in two cases

By Rodney F. Tonkovic, J.D.

The Supreme Court has returned from its holiday recess with a lengthy order list that affects a trio of securities-related petitions. In a pending case, the Court granted the petitioners motion to strike the respondents’ supplemental brief. Also, certiorari was denied in two cases.

Motion to strike. In Cyan, Inc. v. Beaver County Employees Retirement Fund (15-1439), the Court granted the petitioner's motion to strike a supplemental brief filed by the respondents. The supplemental brief responded to several arguments made in the petitioners' reply brief. The short brief took issue with the petitioners' assertions that there has been a "dramatic" increase in class action filings in California under the Securities Act and that no such class actions had been filed in any state court until the passage of the PSLRA. The brief also stated that the petitioners' suggestion that they did not seek to remove this case from state to federal court due to fear of beings sanctions "cannot be accurate."

In response, the petitioners maintain that the respondents’ brief is "entirely inappropriate" and should be stricken as "manifestly improper." In a letter accompanying the brief, counsel for the petitioners notes that the Court has clear rules under what circumstances a party may file a supplemental brief and that the brief meets none of these. "The allowance for supplemental briefs is not a backdoor for parties to file surreplies," the letter says.

In the event the Court chose to consider the filing, the petitioners filed their own supplemental brief rebutting the respondent's arguments. Stating that each of the respondents’ assertions is misleading or false, the brief says that the increase in class actions filed in California is "not open to debate." The petitioner also stands by its statement that no class action stating only Securities Act claims was filed in state court prior to the PSLRA. Equally meritless, the petitioner says, is the assertion that there was no reason to fear sanctions for seeking removal, since defendants have, in fact, been sanctioned.

The petition in Cyan asks whether state courts lack subject matter jurisdiction over covered class actions that allege only Securities Act claims. Oral argument was heard on November 28, 2017.

Certiorari denied. The court also denied certiorari in two cases:
  • Knight v. SEC (17-734): This petition asked the Court to consider whether the SEC can choose, piecemeal, alleged actions in a continuous course of action so as to avoid prosecution being time-barred pursuant to 28 U.S.C. Code § 2462. In this case the petitioner claimed that the Commission's allegations were time-barred, but the Second Circuit disagreed, stating that the claims did not accrue until the earliest alleged violation in September 1999, and the Commission timely filed its action in September 2004. The petitioner argued that the appellate court failed to consider that the actions at issue were part of an alleged course of conduct that began years before the five-year statutory period and that the Commission commenced its action long after the limitations period had passed. This, the petition, stated, is a frequent tactic employed by the SEC to escape statutes of limitations, with dire consequences for Knight and "countless others."
  • Veleron Holding, B.V. v. Morgan Stanley (17-363): This petition asked whether a plaintiff prosecuting a misappropriation theory insider trading claim establishes scienter by proving that: (1) the defendant knowingly possessed material, nonpublic information; (2) the defendant owed a duty to keep such information confidential; and (3) the defendant breached its duty by trading on the basis of that information. And, whether the plaintiff must also prove that the defendant was aware of its duty at the time it traded. By requiring proof of an "awareness of a duty" in order to establish scienter, the petition argues, the Second Circuit impermissibly burdens a plaintiff with having to establish lack of good faith and limits the scope of liability by excluding recklessness and, in fact, compelling plaintiffs to prove a culpable state of mind that exceeds recklessness.
Remaining pending cases. There are currently four petitions still pending before the Court:
  • The Court has not yet taken action on the oldest securities-related cases before it: Lucia v. SEC and Bandimere v. SEC. Both petitions ask the Court to address whether SEC administrative law judges are inferior officers under the Appointments Clause. The cases were distributed for the January 5, 2018, conference.
  • Petroleo Brasileiro S.A. - Petrobras v. Universities Superannuation Scheme Limited has been rescheduled after a motion to defer consideration of the petition for writ of certiorari was jointly filed. The petition concerns the level of proof needed to invoke the Basic presumption of reliance.
  • The newest securities-related petition, ZPR Investment Management, Inc. v. SEC, was brought by an investment adviser charged with false advertising and asks whether a later disclosure can correct a previous false statement.
Read the docket. This case, and others pending before the Court, can be referenced in the latest version of the Supreme Court Docket, a regular feature of our daily reporting service, Securities Regulation Daily. Cases are listed separately, along with a brief summary of the questions raised and the status of the appeal.

Monday, January 08, 2018

SEC amends Advisers Act rules to reflect FAST Act provisions

By Amy Leisinger, J.D.

The SEC has amended the definition of a venture capital fund and the private fund adviser exemption in its Investment Advisers Act rule in order to reflect changes made by the FAST Act. The FAST Act amended the exemption from investment adviser registration for any advisers to venture capital funds by deeming small business investment companies (SBICs) to be venture capital funds. The FAST Act also amended the exemption from registration for any advisers to private funds with less than $150 million in assets under management by excluding the assets of SBICs when calculating private fund assets toward the registration threshold of $150 million (Amendments to Investment Advisers Act Rules to Reflect Changes Made by the FAST Act, Release No. IA-4839, January 5, 2018).

In its May 2017 rule proposal, the SEC noted that the FAST Act does not require it to amend the rules but explained that the amendments would eliminate any confusion that may arise without the revisions. The Commission did not receive any comments specifically addressing the proposed amendments.

As amended, the definition of "venture capital fund" in Advisers Act Rule 203(l)-1 will now include SBICs, and the definition of "assets under management" for purposes of the private fund adviser exemption found in Investment Advisers Act Rule 203(m)-1 will be amended to exclude the assets of SBICs. Advisers to SBICs can now rely on three exemptions from registration—(1) the SBIC adviser exemption and advise only SBICs; (2) the venture capital fund adviser exemption and advise both SBICs and venture capital funds; or (3) the private fund adviser exemption and advise both SBICs and non-SBIC private funds, provided that the non-SBIC private funds account for less than $150 million in assets under management in the U.S.

Advisers that rely on the SBIC exemption are not subject to the Advisers Act’s reporting or recordkeeping provisions or to examination by SEC staff. Advisers that rely on the venture capital fund and private fund adviser exemptions, while exempt from registration, are considered exempt reporting advisers and must maintain records and submit reports that the SEC deems necessary. Exempt advisers are required to file a subset of the information required by Form ADV but are not subject to many of the other requirements to which registered investment advisers are subject.

The amendments will become effective 60 days following publication in the Federal Register.

The release is No. IA-4839.

Friday, January 05, 2018

2017 tallies 189 IPOs, a 61 percent increase over 2016

By John Filar Atwood

Despite a slow December, the IPO market turned in a solid performance in 2017. The 189 deals represented a 61 percent improvement on the 117 new issues completed in 2016. It was also slightly better than 2015’s 185 IPOs, and 2017’s aggregate offering proceeds of $44 billion far exceeded 2015’s $33 billion. No companies went public in the final week of the year, leaving December with 11 completed deals, a significant drop from November’s 28 offerings.

New registrants. Although no IPOs were completed, the week’s activity did include seven new registrations. Three pharmaceutical preparations companies—Menlo Therapeutics, ARMO BioSciences and resTORbio—registered last week. Menlo Therapeutics is developing a treatment for the itch associated with numerous dermatological conditions, while ARMO BioSciences is creating products to treat cancer. Boston-based resTORbio is working on therapeutics to treat aging-related maladies. PagSeguro Digital, a provider of online financial technology solutions to small businesses in Brazil, also filed its IPO plans. The only IPO in U.S. markets by a Brazil-headquartered company in the past three years was Netshoes’ April 2017 deal. Gates Industrial, which is incorporated in the U.K. and operates out of Denver, files a $100 million registration. The company is a global maker of highly engineered power transmission and fluid power systems. Affiliates of Blackstone Group will retain voting control of Gates following the IPO. The week’s other new registrants were Solid Biosciences and DFB Healthcare Acquisitions. Solid Biosciences is working to accelerate the development of treatments for Duchenne muscular dystrophy. DFB is a blank checks company that hopes to raise $287 million for the acquisition of a healthcare-related business. Overall, 18 companies filed new registrations in December, one more than in November. 2017 closed with 225 new filings compared to just 142 in 2016.

Withdrawals. No companies chose to withdraw last week. Only one Form RW was filed in December compared to four in November and nine in December 2016. The 2017 total for withdrawals was 31, less than half the 2016 tally of 65 Forms RW.

The information reported here was gathered using IPO Vital Signs, a Wolters Kluwer Regulatory U.S. database that includes all SEC registered IPOs, including REITs and those non-U.S. IPO filers seeking to list in the U.S. markets. IPO Vital Signs does not track closed-end funds, best efforts or non-underwritten deals, or IPO offerings for amounts less than $5 million.

Thursday, January 04, 2018

Getting into the Bitcoin weeds at CFTC Talks

By Brad Rosen, J.D.

Episode 24 of the CFTC Talks podcast featured Peter Van Valkenburgh, the research director at Coin Center, a leading Washington D.C. based non-profit research and advocacy center focused on the public policy issues surrounding cryptocurrency and decentralized computing technologies like Bitcoin and Ethereum. Coin Center seeks to educate policymakers and the media about cryptocurrency technology, engage in policy research to develop smart regulatory approaches to questions raised by the technology, and advocate for solutions to keep cryptocurrency networks open, decentralized, and permissionless. The podcast interview was moderated by CFTC Chief Market Intelligence Officer Andrew Busch.

During the course of the interview, Van Valkenburgh explored some of the technical Bitcoin weeds, but did so in clear, concise and readily understandable manner. The discussion focused on some of the key innovative features underlying Bitcoin including the consensus mechanism, and bitcoin mining, as well as some of the key issues Coin Center will be pursuing in the year ahead.

Consensus mechanism. Van Valkenburgh noted that the consensus mechanism is one of the main components that makes blockchain technology work. He observed, “in short, is we have all these networked computers. We have data that they are all compiling together, that shared data structure, that Blockchain. The consensus mechanism is how to get all those network computers to agree.”

He also observed what was really innovative about the introduction of Bitcoin in 2008 and 2009 is that its creator (whoever that might be), found a way to have useful consensus over data that did not require all of the participants or even any of the participants to be previously identified and given prior authorization with respect to access or having the ability to modify the data in the ledger. Van Valkenburgh observed, “The consensus mechanism is how to get all those network computers to agree, even if some of them are on the other side of the world, even if some of them go offline periodically”. He concluded, “[a] consensus mechanism is just a series of protocol rules and if data is processed by the software that doesn't fit those rules, it is rejected by the participants.”

Bitcoin mining. Bitcoin miners play an important role in verifying transactions on the blockchain and securing the ledger. In turn, a miner is compensated for the effort expended. Van Valkenburgh stated, “[n]ow, mining is not the best name for it because miner's kind of just do something that has no social benefit. They make giant holes in the earth in order to enrich themselves with gold. In the case of Bitcoin, you are doing something of social benefit. You are securing that ledger of transactions. You're participating in an open consensus mechanism to agree on important data on the order of payments and you are rewarded for that participation if it is verified and honest.”

Top Issues for 2018. According to Van Valkenburgh, Coin Center will be focusing its energies on largely on state money transmission licensing issues, as well as the ongoing role of the Securities and Exchange Commission in the year ahead.

With regard to money transmitters, Coin Center will be continuing to work with states to help them rationalize legal requirements for these business that are involved with exchanging dollars for Bitcoins and other cryptocurrencies. Presently, such activities might or might not be subject to regulation depending on particularities of a given state’s law.

On a related front, Coin Center has been working with the various states to exclude software developers from being deemed as regulated money transmitters on the premise that these entities are not holding money, and risk is not being created for customers. The organization has worked with Uniform Law Commission to draft a model state regulation of Virtual Currencies Businesses Act which has been finalized after almost two years of notice, comment, and debate. Coin Center will be working towards further implementation on this front in 2018.

Van Valkenburgh is also keenly aware of regulatory controversies surrounding ICOs, issues related to SEC registration, as well at the outright fraud that frequently occurs in this space. He concluded, “we will continue to do as much education and outreach to the SEC, to the commissioners, to the staff, to make sure they have the tools necessary to go after the scams and really the unregistered securities issuance activities without, in an overbearing way, crushing the fundamental innovations here.”

Wednesday, January 03, 2018

SEC sees credit rating agencies improving in compliance, competition

By Anne Sherry, J.D.

Two SEC staff reports on credit rating agencies find that the 10 registered NRSROs show improved compliance, increased resources devoted to information technology, and continued competition between the seven smaller firms and the three larger ones (Fitch, Moody’s, and S&P). The staff’s annual report discusses competition, transparency, and conflicts among NRSROs, while the annual exam report summarizes staff examinations of each rating agency.

Competition. The annual report reveals that the three large rating agencies together account for 96.4 percent of outstanding ratings, down from 96.5 percent as of the end of 2015. The change is due to the fact that smaller NRSROs have gained market share in the asset-backed securities rating category. Specifically, the smaller agencies have gained ground by rating asset-backed securities backed by newer or unique asset types, or “esoteric” asset-backed securities. Some of the smaller NRSROs have also gained market share in rating more traditional types of asset-backed securities; for example, DBRS, Inc., rated nearly two-thirds of the transactions backed by student loans that priced during the report period.

The report also cautions that measuring outstanding ratings may not provide the most comprehensive picture of the state of competition. The larger rating agencies have a longer history of issuing ratings, and that history includes those for debt obligations and obligors that were rated well before the newer agencies entered the field. Other limitations to the use of this measure stem from the facts that some NRSROs specialize in particular rating categories; the reported information does not include categories in which an NRSRO is not SEC-registered; and NRSROs’ determinations of the ratings categories and numbers are not consistent from one firm to the next. For a fuller picture of competition, the staff suggests considering the information about gained market share in the esoteric asset-backed securities categories.

Even so, the staff’s analysis based on the number of outstanding ratings suggests that the NRSRO industry is a “highly concentrated” market, equivalent to an industry with 2.67 firms having equal market share. Although barriers to entry continue to exist, the report cites progress with respect to minimum ratings requirements and investors’ openness to securities rated by a wider group of agencies. The SEC also attempted to address concerns about compliance burdens on smaller agencies in the adopted version of the NRSRO rule amendments under the Dodd-Frank Act, which allow rating agencies to tailor requirements to their business models, size, and methodologies.

Transparency. The SEC’s NRSRO Amendments also sought to improve transparency by requiring rating agencies to disclose standardized statistics, consolidated information about rating histories, clear definitions of symbols and scores used in the rating scale, and other information. The annual report also notes that several NRSROs published commentaries and research that shed further light on their viewpoints on particular securities, ratings, or asset classes.

Conflicts of interest. Potential conflicts inhere in both business models under which NRSROs operate. Under the “issuer-pay” model, the credit rating agency may be influenced to determine higher ratings in order to keep the client. In the “subscriber-pay” model, the rating agency may be aware that a key subscriber holds a position that could be advantaged by a particular rating. In another scenario, a subscriber may be prevented by internal guidelines from buying a particular security unless the rating is upgraded. During the report period, staff issued letters to NRSROs’ compliance officers to emphasize that policies and procedures should provide for a look-back review when a former analyst participated in rating his or her new employer in the preceding year.

OCR examinations. In examining the ten NRSROs, the Office of Credit Ratings staff focused on information technology; new and amended NRSRO rules; performance challenges; the use of XBRL; and quantitative models. The examiners observed that the rating agencies had refined their policies, procedures, and controls related to the new NRSRO rules and that personnel displayed a better understanding of the rules. In general, the staff saw improvements in the compliance monitoring and internal audit functions of the agencies. Rating agencies self-identified conduct not in compliance with legal requirements or weaknesses in policies and procedures. In some cases, they took corrective action before staff learned of the conduct or weakness. However, the bulk of the report describes the staff’s essential findings of areas in which the rating agencies fell short in eight review areas.

OCR statement. "NRSROs are continuing to display a greater awareness of their obligations as regulated entities," said Jessica S. Kane, acting director of the Office of Credit Ratings. "The staff will continue to engage with the firms and monitor potential risks to promote compliance, strengthen governance, and ensure that NRSROs provide robust disclosure for the benefit of investors."

Tuesday, January 02, 2018

Apple may not omit shareholder proposal seeking human rights committee

By Jacquelyn Lumb

Apple Inc. may not omit a shareholder proposal from its proxy materials which recommends that the company establish a human rights committee to review, assess, disclose, and make recommendations to enhance its policy and practice on human rights. Apple sought to omit the proposal on the grounds that it related to ordinary business operations, but the staff was not convinced that that the proposal was not sufficiently significant to Apple’s business operations to warrant its exclusion. The staff cited Apple’s own statement in its no-action letter that the board and management firmly believe that human rights are an integral component of its business operations.

Operations in China. The shareholder proponent, in a supporting statement, raised concerns about Apple’s operations in China and whether the company sufficiently promotes human rights by offering products that are designed to help Internet users evade censorship by the Chinese government. The proponent cited news reports about Apple removing apps from a China store that help Internet users evade censorship and Apple bowing to Chinese censors.

Current practices. Apple’s website includes a statement that the company has a responsibility to protect the rights of all people in its supply chain, and to do everything it can to protect the environment. Apple also noted that it requires its suppliers to agree to adhere to its code of conduct and supporting standards, which it said goes beyond mere compliance with the law. Human rights standards factor into every decision that management makes in Apple’s day-to-day operations, and it has a dedicated vice president for environment, policy, and social initiatives who advocates for government policies that protect individual privacy and civil rights.

Apple said the new board committee proposed by the proponent would be redundant given its existing practices and policies. In addition, the company’s compliance with governmental laws and regulations, including those related to human rights, is a key management function. Management has specific knowledge of Apple’s operations in China and is in the best position to assess the requirements of those regulations and its response, the company advised.

Apple concluded that the proponent’s interest in its human rights strategy is fully aligned with that of the company, so it did not believe that the proposal required a vote of shareholders at the 2018 annual meeting.

Verizon Communications, Hewlett-Packard, and Goldman Sachs.The proponent countered that his proposal was basically the same proposal that he had submitted to other companies, such as Verizon Communications in 2017 and Hewlett-Packard and Goldman Sachs in 2013. It is not ordinary business to follow the law wherever a company does business even where the law requires it to violate basic human rights, the proponent wrote.

Staff response. In denying Apple’s no-action request to omit the proposal, the staff advised that the board’s analysis did not explain how this particular proposal would not raise a significant policy issue for the company. Accordingly, the staff did not believe the proposal could be omitted in reliance on Rule 14a-8(i)(7).

Friday, December 29, 2017

FINRA proposal far from solving unpaid arb award problem, says NASAA

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

NASAA has criticized a FINRA proposal for not going far enough to solve the problem of unpaid arbitration awards. In a comment letter concerning FINRA Regulatory Notice 17-33, NASAA offered support for FINRA’s efforts to expand customers’ litigation options when a broker-dealer or associated person becomes inactive. In NASAA’s view, however, the proposed amendments fail to address the core of the unpaid arbitration award issue or boost investor confidence in FINRA’s arbitration process.

NASAA noted that the problem of unpaid arbitration awards is well documented. NASAA cited a 2000 report by the Government Accountability Office (GAO) that identified issues with customers failing to collect on arbitration awards, as well as a 2016 report on the same subject by the Public Investors Arbitration Bar Association (PIABA). In response, FINRA offered the proposed amendments as a way to address the challenges faced by investors who are unable to collect monetary damages awarded to them through FINRA Dispute Resolution’s mandatory arbitration process.

NASAA praised FINRA’s attempts to provide investors with additional options to alter their litigation strategy when an industry member goes inactive, such as allowing investors to withdraw claims, amend the pleadings, postpone hearings, and receive a refund of filing fees. NASAA wrote that the proposal does little, however, to provide relief to investors left holding the bag when awards go unpaid and broker-dealers are not held responsible for their misconduct.

NASAA also worries that permitting a customer to withdraw a claim when a broker-dealer or associated person becomes inactive may pose a reporting issue when FINRA Dispute Resolution publishes statistics on customer claim withdrawals. Unless customer claim withdrawals are categorized in a way that references the reason a customer withdrew his or her claim, FINRA’s statistics concerning customer claim withdrawals may be misleading, leading investors and regulators to believe that a customer withdrew a claim because it lacked merit.

Accordingly, NASAA urged FINRA to create a new reporting mechanism providing transparency on industry participants who became inactive due to unpaid arbitrations or judgments in favor of customers. NASAA believes that this statistic would provide investors with important additional information when making a decision about whether to work with a specific FINRA member or associated person.

Thursday, December 28, 2017

Accounting firms and industry groups comment on proposed Reg. S-K modernization

By Jacquelyn Lumb

The SEC’s comment period on proposals to modernize and simplify disclosures under Regulation S-K closes January 2, 2018, with letters recently submitted by accounting firms Deloitte & Touche, PricewaterhouseCoopers, BDO USA, the Council of Institutional Investors, and the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC). Among the areas of focus in the comment letters is a proposal to allow registrants to omit the earliest of the three years of MD&A in some situations (Release No. 33-10425, October 11, 2017).

Deloitte & Touche. Deloitte recommended that registrants be allowed to omit the discussion of the earliest of the three years in MD&A if that discussion was provided in any filing a registrant made on EDGAR rather than restricting it to disclosures that were made on Form 10-K. Deloitte also suggested that registrants be permitted to exclude a discussion of the earliest year even when there has been a change in the financial statements due to a retrospective adoption of a new accounting principle as long as the discussion of the third year was previously provided in a filing on EDGAR.

Deloitte also wrote that it supports cross-referencing and internal hyperlinks within a company’s filings and suggested that the SEC consider whether it is appropriate to permit cross-referencing in the financial statements of a foreign private issuer on Form 20-F where it is permitted by home country accounting standards, laws, or regulations.

PricewaterhouseCoopers. PricewaterhouseCoopers echoed Deloitte’s view regarding the earlier year discussion in MD&A, recommending that a registrant be permitted to omit from its current Form 10-K the discussion of the earliest of the three years if it was previously filed in any SEC filing, with disclosure of where that discussion appeared. PwC added that registrants should be allowed to omit the MD&A discussion of the earliest of three years in all filings other than initial registration statements, and urged the SEC to make conforming changes to Form 20-F for foreign private issuers.

BDO USA, LLP. BDO raised concerns that the requirement to include the earliest of the three years of financial statement based on an evaluation of its materiality would add unnecessary ambiguity to the decision. If the condition for omitting the discussion is challenging to apply, BDO said registrants would likely default to including the discussion. BDO also agreed with the other accounting firms that registrants should be permitted to omit the discussion of the earliest period if it was included in any previous filing under the Securities or Exchange Acts since it would already be part of the total mix of information available to investors.

BDO urged the SEC to consolidate its MD&A guidance in a single place since doing so may improve the disclosure. The guidance can currently be found in releases, sections of the financial reporting manual, and in compliance and disclosure interpretations. BDO agreed that the SEC should make conforming amendments to Form 20-F for foreign private issuers.

Council of Institutional Investors. The Council of Institutional Investors said the SEC should not allow registrants to exclude the discussion of the earliest year in their MD&A if there has been a material change to either of the two earlier years due to a restatement or a retrospective adoption of a new accounting principle. In those circumstances, CII said the context may be particularly useful in assessing a registrant’s financial condition. As an alternative, CII said the SEC could retain the earliest year requirement but allow registrants to hyperlink to the disclosure rather than repeat it.

CII said it does not support the proposed amendment to eliminate the risk factor examples that appear in Item 503(c). In CII’s view, the examples provide useful guidance and help focus the disclosure. CII also raised concerns about the proposal to permit registrants to omit confidential information from material contracts without submitting a confidential treatment request to the Commission, explaining that the amount of information that is redacted could increase significantly as a result.

Center for Capital Markets Competitiveness. CCMC noted that it has long been a supporter of the SEC’s disclosure effectiveness initiative and it is encouraged that the initiative appears to be back on track. In brief, CCMC said it supports the proposal relating to property disclosures but without any presumptive materiality thresholds; the streamlining of MD&A; the changes relating to the process for reviewing confidential treatment requests; and many of the technical amendments included in the proposing release. CCMC urged the SEC to consider more ambitious reforms to the delivery of periodic reports.

CCMC also urged the SEC to help resolve a split among the circuit courts of appeal resulting from the settlement in Leidos, Inc. v. Indiana Public Retirement System which has created uncertainty about the level of detail that is required in MD&A. The Second Circuit held that an omission of material information that must be disclosed in the MD&A of a quarterly or annual report can provide the basis for a claim of securities fraud even if the omission does not make an affirmative statement misleading. CCMC said the finding that Item 303 of Regulation S-K imposed a duty to disclose the omitted information departed from an earlier Ninth Circuit opinion which held that “pure omissions” are not actionable under Section 10(b) and Rule 10b-5.

In CCMC’s view, the amicus brief filed by the U.S. in Leidos further complicates the analysis for public companies by refuting the Ninth Circuit’s view, and suggested that the SEC provide a formal clarification of its position on the issues in dispute.

Wednesday, December 27, 2017

SEC proposes FOIA regs revamp

By Lene Powell, J.D.

The SEC is seeking comment on proposed amendments to Freedom of Information Act (FOIA) regulations. The amendments would reflect changes required by the FOIA Improvement Act of 2016 and update and clarify other procedural provisions. Comments will be due 30 days after publication in the Federal Register.

Required changes. The FOIA Improvement Act of 2016 amended FOIA to address various procedural issues, including records format, timelines, and appeals. The SEC proposes to make four changes to conform its regulations to the Act:
  • Revise Section 200.80(a) to provide that, for records that FOIA requires to be made available for public inspection, they will be made available in electronic format.
  • Revise Section 200.80(c) relating to grounds for request denial, including that disclosure would harm an interest protected by an applicable exemption.
  • Revise provisions relating to assistance from Office of FOIA Services’ FOIA Public Liaisons and dispute resolution.
  • Revise Section 200.80(g) relating to fee waivers.
Updates and clarifications. The proposed amendments would also make numerous other procedural changes, including updates and clarifications relating to submission methods, the 20-day statutory time limit for responses, and aggregation of related requests.

Tuesday, December 26, 2017

Caremark claim over Citigroup ‘corporate traumas’ dismissed

By Mark S. Nelson, J.D.

For the second time in a week Delaware courts have explained, in the words of former Chancellor Allen, the author of the Caremark decision, why the Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Citigroup, Inc. shareholders had alleged that the bank’s officers and its board failed to conduct oversight with respect to anti-money laundering violations, fraud at a subsidiary bank, foreign exchange (FX) benchmark manipulation, and unlawful credit card practices. Days before the decision in the Citigroup case, the Delaware Supreme Court had reiterated the difficulties inherent in Caremark claims by rejecting a Caremark claim brought against Duke Energy for the company’s role in an environmental catastrophe, albeit over a dissent by Chief Justice Strine (Oklahoma Firefighters Pension & Retirement System v. Corbat, December 18, 2017, Glasscock, S.).

‘Red flags’ theory insufficient. The gist of the shareholders’ Caremark theory was that Citigroup’s officers and directors ignored red flags (the complaint said the board “sat like stones growing moss”) that should have alerted them to serious misconduct on the part of the bank. Vice Chancellor Glasscock set the stage. First, for purposes of demand futility analysis, the court turned to Rales for the proposition that the directors would not be liable unless they could not exercise independent and disinterested business judgment because of the risk they may face substantial personal liability. Second, with respect to the Caremark claim, the more recent exposition of Caremark in Stone v. Ritter requires allegations that the board failed to implement a system of controls, or that the board implemented such controls and then consciously disregarded them; scienter is required to show that the directors knew they acted contrary to their fiduciary duties.

As for the AML red flags, the court concluded that demand was not excused. The shareholders pointed to numerous regulatory orders, additional warnings, and a $140 million fine as evidence that Citigroup’s directors disregarded their duties. But the court said Caremark applies where a company’s board did “nothing” and not, as in the case of Citigroup, the board took imperfect actions but nevertheless acted on the information it had. The court also suggested that the documents cited in the complaint inaccurately described the Citigroup board’s actions; on this point, the court included a footnote reference to the recent Delaware Supreme Court decision regarding Duke Energy stating how to treat a plaintiff’s alleged exaggerations (“The plaintiffs unfairly describe the overall presentation, which we are not required to accept on a motion to dismiss,” said the majority in the Duke Energy case). Moreover, the court suggested that the shareholders would have alleged a Caremark claim if Citigroup’s board had in fact “sat like stones growing moss” (the court called this the plaintiffs’ “geologic metaphor”).

Demand also was not futile regarding two significant financial hits to Citigroup. Under one theory, the shareholders alleged that Citigroup’s board failed to oversee loans made by Banamex (a subsidiary) to a borrower that perpetrated a $400 million fraud on Citigroup by securing loans from Banamex based on fraudulent accounts receivable. The court said that Caremark claims based on the failure to monitor business risks related to a third party’s actions (as opposed to those of company employees) have not been clearly recognized. The other financial hit involved Banamex being fined $2.5 million by Mexican regulators for faulty controls. The court reviewed two sets of alleged red flags and determined that neither set was related to the shareholders’ Caremark allegations.

The third set of allegations against Citigroup posit that the bank’s board was aware of issues relating to the manipulation of FX benchmarks. Citigroup was ultimately fined $2.2 billion and pleaded guilty to conspiracy to violate federal antitrust laws. But the court examined the shareholders’ red flags and found them wanting because some were not red flags, some were red flags and the bank’s board took some good faith action on them, or the red flags never reached the board. As a result, the shareholders failed to state a Caremark claim and demand was not excused.

Lastly, the shareholders’ allegations about Citigroup’s credit card practices were insufficient to excuse demand. In one set of allegations, the shareholders recited how Citigroup enticed consumers to buy add-on services for which the bank was fined $35 million by the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency; the CFPB also ordered Citigroup to pay $700 million in restitution. But the court again found the alleged red flags wanting. One red flag involved alleged misconduct by two of Citigroup’s rivals. In another instance, Citigroup responded to warnings about control issues by requiring additional training. Yet another red flag related to Citigroup’s $1.95 million settlement with a state attorney general related to the marketing of consumer protections; the court concluded that the complaint failed to allege that at least half of the Citigroup board was aware of the settlement.

Holistic approach rebuffed. The court also took time to address two additional issues raised by the shareholders. First, the court rejected the shareholders’ request for a holistic examination of the cited red flags under Sanchez, a 2015 opinion by the Delaware Supreme Court discussing demand futility. According to the shareholders, the Citigroup defendants pursued a “divide and conquer” strategy with respect to the complaint, and they contended that the court should take a wider view of the shareholders’ red flags.

The court replied that not only was Sanchez inapt, but that it had performed the traditional Caremark analysis by asking if asserted red flags are in fact red flags and whether the company’s response to them was in bad faith. Said the court:
What emerges is a picture of directors of a very large, inorganically grown set of financial institutions, beset by control problems as it struggled to integrate. Those directors may be faulted for lack of energy, or for accepting incremental efforts of management advanced at a testudinal cadence, when decisive action was called for instead.
The court explained that such facts may indicate negligence but that the shareholders hold the remedy. As a result, the court reiterated its conclusion that the facts did not show bad faith by Citigroup’s board, even if the results from the board’s actions were less than perfect. Still, the court, again citing via footnote the Duke Energy case, noted that the shareholders were right that a series of events can help in the evaluation of a board’s scienter.

Second, the court rejected the shareholders’ attempt to compare Citigroup to other companies where shareholders brought Caremark claims. In those cases, the court said the boards and managers either engaged in “extreme” behavior or had “flout[ed]” the law (e.g. Massey, Pyott (Allergan), and Westmoreland (a Seventh Circuit case involving Baxter International).

The case is No. 12151-VCG.

Friday, December 22, 2017

Windy City blockchain lawyers gather in the Loop

By Brad Rosen, J.D.

"With respect to blockchain, we are seeing the rapid and mass adoption of a network of value, as well as a groundswell of demand that will not abate. This is a foundational technology that lawyers will need to become educated on sooner or later." So observed Nelson Rosario, a Chicago attorney who is the founder and main organizer for the Blockchain Lawyers of Chicago meetup and networking group. About 70 lawyers and other blockchain enthusiasts met up at a Chicago Loop watering hole recently to network, share experiences, and swap information on this nascent, but burgeoning, industry and area of the law.

The growth of the meetup group has mirrored the explosion in cryptocurrencies, ICO’s and blockchain itself in some respects. Rosario, a patent law specialist at Marshall Gerstein, a Chicago-based IP boutique, launched a LinkedIn group in April, 2017 that later evolved into the meetup group. The first meeting in October, 2017 attracted around 30 attendees according to Rosario. "I saw a market need developing. There were plenty of meetup opportunities for those involved in technical aspects of blockchain, but none for lawyers. It’s gratifying to see people connecting, lending support to each other, and sharing information," he noted.

Many of the meetup attendees were closely following the introduction of Bitcoin futures contracts at the CBOE Futures Exchange and the CME earlier in December, and the regulatory developments related to those product launches. Recent comments by SEC Chairman Jay Clayton on cryptocurrencies and ICOs were another a topic of intense interest and ongoing discussion as lawyers and laymen alike seek clues and clarification on how ICO’s are going to be addressed by the SEC in 2018.

The Blockchain Lawyers of Chicago meetup also captures the unique culture, energy and generosity that often accompanies blockchain related activities and innovation. One of the attendees, a cyptocurrency fund manager and trader, was intent on providing this writer with a comprehensive history of Bitcoin and its mythic inventor, Satoshi Nakamoto, who mysteriously disappeared from the scene around 2011. Nakamoto authored the legendary white paper, Bitcoin: A Peer-to-Peer Electronic Cash System in October, 2008. The fund manager noted, "this is the creation story for cryptocurrencies—its book of Genesis. I have read it many times."

Furthering blockchain history and lore, as well as promoting related education, appear to be at the core of this emerging community. Rosario is also playing a key role on this score as well. In January, 2018, he will be teaching a new course offering at Chicago-Kent College of Law titled Blockchain and the Law, along with Professor Daniel Katz, a leading authority on legal technology and innovation. According to Rosario, Kent is one of a handful of law schools that offers a course on legal issues associated with blockchain. "The course has been in high demand and filled up immediately. This is yet another sign of the growing interest in blockchain among members of the legal community," Rosario observed.

The Blockchain Lawyers of Chicago is scheduled to meet next on February 21, 2018.