2014 Securities and Regulatory Update Essential Road Map of the Year Ahead
27 February 2014 ReedSmith The business of relationships.SM
What Keeps You Up At Night? One Likely Answer
Post-Financial Crisis: The Increased Legislative, Regulatory and Enforcement Initiatives Aimed at Stabilizing Capital Markets and Protecting Investors What Chief Legal Officers Say
• 88 percent of Corporate Counsel from around the world say Compliance & Ethics Issues are among their most pressing concerns in 2014
• 83 percent of these Corporate Counsel say Regulatory or Governmental changes are their top concern
Bloomberg BNA/ACC
What Directors Say
• 75 percent believe that increased regulatory and enforcement initiatives have added costs to companies that exceed benefits
• 56 percent believe that they have put excessive burdens on Directors (PwCs Annual Corporate Directors Survey)
Directors/CEO’s Were Asked
How concerned are you about each of the following potential economic and policy threats to your company’s growth prospects?
Questions for Companies
Does Your Organization: • Keep abreast of regulatory and compliance requirements? • Have the right personnel in place to handle these matters? • Track regulatory proposals under consideration impacting your organization? • Provide input to regulators on relevant proposals? First Panel: Keynote Address By Roger Altman • Roger Altman: • U.S. Deputy Treasury Secretary Under President Clinton • Executive Chairman of Evercore Partners
• Perry A. Napolitano: Chair of the Financial Industry Group of Reed Smith
Second Panel: Capital Markets Trends & Forecast Capital Market Trends in 2014 The JOBS Act—Where Are We Now?
• Yvan-Claude J. Pierre – Moderator, Chair, U.S. Capital Markets Group
• Grant Miller – Managing Director, Head of Equity Capital Markets at Cowen and Company
• Doug Baird - Managing Director, Chairman of Equity Capital Markets at Citibank Capital Markets
• Demetrios Frangiskatos – Partner at BDO LLP
• Adele Hogan – Managing Partner at Hogan Law Associates
Third Panel: SEC Enforcement Presentation Aggressive New Enforcement Policies Asset Management Industry in the Crosshairs New Analytical Modeling Tools
• Terence M. Healy, Moderator, Partner, Reed Smith • Matthew Solomon, Chief Litigation Counsel, U.S. Securities and Exchange Commission • Joshua E. Levine, Managing Director and Associate General Counsel Head – ICG Regulatory Enforcement at Citigroup, Inc. • Anthony J. Galioto, Global Head of Enforcement & Investigations at The Bank of New York Mellon
Fourth Panel: Role of Compliance Presentation Evolving Responsibilities of Compliance Officers Dodd -Frank Requirements and Their Effects Volcker Rule Implementation
• Amy J. Greer, Moderator, Co-Chair of Reed Smith’s Securities Litigation & Enforcement Group
• Sherry Williams, Sr. Vice President & Chief Ethics & Compliance Officer at Halliburton Company
• Penny J. Morgante, First Vice President at First Niagara Financial Group, Inc.
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Capital Markets Trends and Forecast Capital Markets
Grant Miller Cowen Group Doug Baird Demetrios Frangiskatos Managing Director, Head of Citibank Capital Markets BDO LLP Equity Capital Markets Managing Director, Chairman Partner of Equity Capital Markets
Adele Hogan Yvan-Claude J. Pierre Hogan Law Associates PLLC Reed Smith LLP Managing Partner Partner
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IPO Market Review and Outlook Strong Equity Market While VIX Remains at Record Low S&P 500 Performance 2013 - Current 2,000
1,900 +29.6% 1,800
1,700
1,600
1,500
1,400 01/01/13 03/01/13 05/01/13 07/01/13 09/01/13 11/01/13 01/01/14 S&P 500 VIX Performance 2008 - Current 90 80 70 60 50 40 30 20 10 01/01/08 07/01/08 01/01/09 07/01/09 01/01/10 07/01/10 01/01/11 07/01/11 01/01/12 07/01/12 01/01/13 07/01/13 01/01/14 VIX Source: Factset.
1 Driving Record IPO Issuance Total Proceeds Raised
($BN) $104 1996 - 2013 $99
$66 $62
$49 $47 $48 $44 $42 $40 $39 $41 $35 $33
$26 $25 $24
$15
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Dealogic.
3 It’s More Than Just Price: It’s Multiple Expansion 2014 FV / EBITDA Historic Internet Multiples 2013 - Current Jan 1, 2013 Current % Change
19.3x 23.3x 20.7%
14.4x 23.7 74.3
23.5x 42.0 78.7
25.7x 44.0 71.2
10.4x 19.1 83.6
26.8x 73.1 172.7
13.6x 70.6 419.1
Source: FactSet..
4 Growth Sectors Continue to Drive IPO Issuance
IPO Issuance Volume by Sector IPO Backlog Volume by Sector 2013 - Current
Healthcare 29% Finance 20%
Technology 18% Technology 20%
Consumer / Retail 11% Consumer / Retail 15%
Energy / Power 11%
Healthcare 13%
Real Estate 10%
Real Estate 13%
Finance 9%
Industrial 9% Industrial 8%
Energy / Power 7% Media / Leisure 3%
Telecom 1% Media / Leisure 3%
Source: Dealogic.
5 IPO Industry Themes Consumer Unit growth models in retail + restaurants Single category product companies Energy Development of the Permian, Marcellus & Utica shale deposits MLP formation to meet transmission needs Spin-outs as industry de-consolidates Financials Re-birth of finance company model Renewed pursuit of the subprime borrower Non-bank models – payments, mortgages, deposits, and loans Asset managers rotating to equity products
6 IPO Industry Themes
Healthcare Biotech – earlier stage companies, orphan drug and platform companies Services – Obamacare opportunities Industrial Levered businesses in cyclical upswing Spin-outs Technology Software – cloud, SaaS, big data, security “Focused” category eCommerce Online marketplace models China
7 ReedSmith The business of relationships.SM
SEC Enforcement Aggressive new enforcement policies Asset Management industry in the crosshairs New analytical modeling tools
SEC Enforcement
Joshua E. Levine Citigroup, Inc. Matthew Solomon Managing Director & Chief Litigation Counsel Associate General Counsel U.S. Securities and Exchange Head – ICG Regulatory Commission Enforcement
Anthony J. Galioto The Bank of New York Mellon Terence M. Healy Global Head of Enforcement & Reed Smith LLP Investigations Partner
DOJ “Takeover” of the SEC Robert Khuzami Lorin Reisner Director, Division of Deputy Director, ENF Division of ENF
George Canellos Andrew Ceresney Co-Director, Co-Director, Division Division of ENF of ENF
Matthew Martens Matt Solomon Chief Litigation Chief Litigation Counsel Counsel
Paul Levenson David Glockner Regional Director, Regional Director, Boston RO Chicago RO Mary Jo White Chair An Aggressive Tone
“bold an unrelenting” enforcement
“felt and feared”
“tough cop on the beat” Mary Jo White Chair “boots on the ground”
“force multiplier”
“to be everywhere” “settlements [must] have teeth”
“meaningful monetary penalties” Requiring Admissions: No Clear Standard
. “Cases where a large number of investors have been harmed or the conduct was otherwise egregious.”
. “Cases where the conduct posed a significant risk to the market or investors.”
. “Cases where admissions would aid investors deciding whether to deal with a particular party in the future.”
. “Cases where reciting unambiguous facts would send an important message to the market about a particular case.”
. Cases “where the defendant engaged in unlawful obstruction of the commission’s processes.” SEC’s Recent Trial Record
. SEC v. Mark Cuban (N.D. Tex.) (Oct. 2013) – Defense verdict
. SEC v. S. Kovzan (D. Kan.)(Dec. 2013) – Defense verdict
. SEC v. Peter Jensen (C.D. Cal.) (Dec. 2013) – Dismissed
. SEC v. Larry Schvacho (N.D. Ga.) (Jan. 2014) – Dismissed
. SEC v. Yang (N.D. Ill.) (Jan. 2014) – Defense verdict as to IT
. SEC v. Steffes (N.D. Ill.) (Jan. 2014) – Defense verdict ReedSmith The business of relationships.SM
Role of Compliance Evolving responsibilities of compliance officers Dodd-Frank requirements and their effects Volcker Rule implementation
Role of Compliance
Sherry D. Williams Penny J. Morgante Halliburton Company First Niagara Financial Group, Inc. Sr. Vice President & Chief Ethics & First Vice President Compliance Officer
Amy J. Greer Reed Smith LLP Partner REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Speaker Biographies
Roger C. Altman
Evercore Partners Founder and Executive Chairman
Former U.S. Deputy Treasury Secretary
Roger Altman is Founder and Executive Chairman of Evercore, which, in most years, is the most active independent investment bank in the United States. Mr. Altman began his investment banking career at Lehman Brothers and became a general partner of that firm in 1974. Beginning in 1977, he served as Assistant Secretary of the U.S. Treasury for four years. He then returned to Lehman Brothers, later becoming co- d of ov nv t nt b nk ng b of t f ’ M n g nt Committee and its Board. He remained in those positions until the firm was sold.
In 1987, Mr. Altman joined The Blackstone Group as Vice Chairman, head of the f ’ dv o bu n nd member of its Investment Committee. Mr. Altman also had primary responsibility for Black ton ’ nt n t on business.
Beginning in January 1993, Mr. Altman returned to Washington to serve as Deputy Secretary of the U.S. Treasury for two years. In 1996, he formed Evercore. Today, the firm has 74 partners, 1,000 employees and has handled over $1.3 trillion of merger, acquisition, recapitalization and restructuring transactions. In its other role, Evercore also manages over $13 billion of third party assets.
Mr. Altman is a Trustee of New York-Presbyterian Hospital, serving on its Finance Committee, and is Vice Chairman of the Board of the American Museum of Natural History. He also serves as Chairman of New Visions for Public Schools and is a Director of Conservation International. He is a member of The Council on Foreign Relations. Mr. Altman received an A.B. from Georgetown University and an M.B.A. from the University of Chicago.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Douglas J. Baird
Citigroup Global Markets Managing Director Chairman, Equity Capital Markets [email protected]
M . B d C n of C t ’ Equ t C p t M k t bu n w pon b fo t o g n t on t uctu ng and execution of equity and equity- nk d f n nc ng t n ct on fo t B nk’ co po t c nt . H 25+ ’ experience in initial public offerings, follow-on financings, convertible debt and preferred offerings, registered block trades, dutch auction repurchases and other transactions involving the public equity markets. He is also involved in t F ’ qu t p v t p c nt bu n nc ud ng PIPE g t d d ct off ng nd R g D p c nt .
Steven Cooper
Reed Smith LLP Partner [email protected]
Steven is a partner in the Commercial Litigation Group. Steven is an experienced trial lawyer with numerous successful verdicts for Reed Smith clients. He has handled virtually all types of complex commercial litigation, class actions and financial services litigation, for both plaintiffs and defendants, involving securities fraud, consumer fraud, breach of contract, Foreign Sovereign Immunities Act, fraudulent transfer, intellectual property, breach of fiduciary duty and theft of trade secrets. He has also been involved in a number of preliminary injunction hearings and arbitrations. He has served clients in the financial services, telecommunications, pharmaceuticals, internet and technology, media, professional services, retail, real estate and hospitality industries. Recently, Steven has been engaged by Fortune 200 companies to combat the counterfeiting of their products. Steven has argued numerous times before the U. S. Court of Appeals, U. S. District Court, the New York State Court of Appeals, the New York State Appellate Divisions and the New York State Supreme Court. He has been recognized in a survey of his peers as a New York "Super Lawyer" in the area of business litigation, and Martindale-Hubbell gave him its highest ranking signifying that his "legal abilities are of the very highest standard."
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Demetrios Frangiskatos, CPA
BDO LLP Assurance Partner [email protected]
Demetrios has over thirteen years of experience providing accounting, auditing and business advisory services. Since joining BDO, Demetrios has served middle-market clients throughout the country and internationally with extensive experience in serving Securities and Exchange Commission reporting companies, which includes experience with companies undergoing initial public offerings and secondary offerings.
His professional background includes engagements from high emerging growth to Fortune 1,000 companies, both publicly and privately held businesses, across a multitude of industries, with an emphasis on technology (software, SAAS and e-commerce), media and service clients. Demetrios has been involved in numerous merger and acquisition transactions for both domestic and international entities. This work involves the evaluation and structuring of transactions as well as the performance of due diligence procedures. He has experience servicing his clients on financial statement and internal controls over financial reporting audits, agreed upon procedures, technical research, business process analysis and providing recommendations for operational improvement for growth stage companies. Demetrios develops and teaches various BDO Continued Professional Education classes.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Amy J Greer
Reed Smith LLP Partner [email protected]
Amy is a partner and co-leader of the Securities Litigation and Enforcement practice, a component of the Global Regulatory and Enforcement group. Amy specializes in a broad range of securities litigation and enforcement matters and advises, among others:
Financial institutions Broker-dealers Hedge funds Mutual funds Other investment companies and advisers Securities issuers and reporting companies, and European and U.S. commodities traders Amy regularly represents clients in all manner of securities regulatory investigations and enforcement proceedings; where necessary, coordinating efforts with ongoing criminal investigations, multiple enforcement/regulatory efforts or civil litigation matters. At any given time, Amy has multiple active confidential investigation matters pending in several different offices of:
Securities and Exchange Commission (SEC) Department of Justice (DOJ) Financial Industry Regulatory Authority (FINRA) Self-Regulatory Organizations (SROs) State Attorneys General and Securities Commissions In addition to conducting and managing internal investigations and providing compliance counseling, she advises on:
Allegations of insider trading Financial fraud claims Issuer disclosure and reporting violations Fraud allegations relating to securities offerings Municipal securities-related violations Sarbanes-Oxley issues Anti-money laundering issues Violations of the Foreign Corrupt Practices Act (FCPA)
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Terence Healy
Reed Smith LLP Partner [email protected]
Terence is a seasoned trial lawyer whose practice focuses on matters related to SEC enforcement, internal investigations, regulatory compliance, and complex litigation. For nearly two decades, Terence has represented clients – both in private practice and with the Securities and Exchange Commission (SEC) and Department of Justice (DOJ) – in complex disputes before trial and appellate courts throughout the country. He has been lead trial counsel in numerous complex matters tried to verdict, including a recent SEC enforcement action against the CEO and CAO of a large public company. He has also led non-public investigations into securities fraud and related issues.
As Senior Assistant Chief Litigation Counsel for the SEC, Terence represented the Commission in cases related to accounting fraud, revenue recognition, options backdating, insider trading, FCPA, structured products, and other issues. He worked closely with the Staff of the Enforcement Division in determining the scope of investigations and in making charging recommendations. He also supervised a team of experienced first-chair SEC trial lawyers. Prior to joining the SEC, Terence spent nine years as a Trial Attorney for the Department of Justice where he defended the United States in several high-profile cases. At DOJ, Terence was lead counsel for the government in several multidistrict matters consolidated under 28 USC § 1407. In this role, he successfully defended government in multiple cases tried to bench or jury and protected the public treasury from significant monetary claims.
After completing a clerkship following law school, Terence began his career as a litigation associate for a national law firm.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
N. Adele Hogan
Hogan Law Associates PLLC Partner [email protected]
Adele Hogan's practice focuses on:
General corporate matters Securities & finance M&A and joint ventures Corporate work in restructurings and bankruptcies Private equity, hedge funds and derivatives Internal investigations, FCPA and dispute resolutions Regulatory, compliance and risk In the securities area, Ms. Hogan has worked for underwriters and issuers in a wide array of industries on offerings of diverse types of securities, including investment grade debt, IPOs of common stock, trust preferred securities, medium- term note programs, 144A offerings, debt tenders, and consent solicitations. She regularly advises on SEC reporting, disclosure and corporate governance issues. Throughout her career, Ms. Hogan has worked on more than 125 offerings totaling over $200 billion.
In the M&A area, she has experience with public company tender offers, going-private transactions, spin-offs, joint ventures and private equity deals.
Her corporate work in the restructuring and bankruptcy area involves diverse industries, including airlines, automotive, chemicals, energy and utilities, financial institutions, gaming, hotels and leisure, real estate, and retail. In regulatory, compliance, risk and internal investigations, her work has included FCPA and whistleblower matters, SEC and FINRA regulatory matters, and corporate governance work. p ct c d co po t w t o of N w Yo k C t ’ g t f nc ud ng C v t w n & Moo LLP fo over 10 years, and Cadwalader, Wickersham & Taft LLP, Shearman & Sterling LLP and Willkie, Farr & Gallagher, and has been an equity partner at Linklaters LLP and White & Case LLP.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Joshua E. Levine
Citigroup, Inc. Managing Director & Associate General Counsel Head – ICG Regulatory Enforcement
Josh is a Managing Director and the Head of the Regulatory Enforcement Group, which handles regulatory inquiries and related investigations, sweeps and enforcement proceedings, and works on a broad range of matters initiated by the SEC, CFTC, Department of Justice, SROs and other federal and state securities regulators. Prior to Citi, Josh was an enforcement attorney in the SEC's New York Regional Office, with responsibility for planning and directing investigations and litigations involving all aspects of the securities markets. Prior to the SEC, Josh was a litigation associate at Davis Polk & Wardwell. Josh received a J.D. from NYU School of Law in 1999, an M.A. in Political Science from Columbia University in 1995, and a B.A. in Government and History from Connecticut College in 1994.
Grant Miller
Cowen and Company Managing Director Head of Equity Capital Markets [email protected]
Grant Miller is head of the equity capital markets group, which is responsible for the origination and execution of all equity transactions, including bought, public marketed, and confidentially marketed transactions. Mr. Miller has been working in capital markets for more than 17 years and has book-run hundreds of transactions across many industry sectors. Prior to joining Cowen, Mr. Miller was a managing director in B nc of A c ’ qu t c p t group. Previously, Mr. Miller worked at Lehman Brothers, where he held a variety of capital markets positions, including responsibility for all PIPE and registered direct transactions. Prior to banking, Mr. Miller was a manager at Andersen Consulting.
Mr. Miller has a B.A. in economics, magna cum laude, from the University of Pennsylvania, and an M.B.A, Phi Beta Kappa, from Columbia Business School.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Penny Morgante
First Niagara Financial Group, Inc. First Vice President (Ethics, Capital Markets, PCS/Trust, Investments and Insurance, Privacy) [email protected]
Penny joined First Niagara in September 2004, working as in Area Manager in the Retail Bank. In her current capacity as Compliance Officer, she manages compliance oversight for the wealth business units including First Niagara Investment Services, Private Client Services/Trust, First Niagara Risk Management and Capital Markets. Penny also serves as the Ethics Officer for First Niagara and oversees the Privacy Program.
Penny is a graduate of the State University College at Buffalo with a Bachelor of Science in Mathematics (1986). She has her New York State Life, Accident, and Health insurance licenses, FINRA Series 7, 6 and 63 securities licenses and Series 24 Supervisory Principal license. She has participated in many volunteer organizations, including serving as a board member of Meals on Wheels for WNY (2004-2010) and ECMC Lifeline Foundation (2006-present).
Perry A. Napolitano
Reed Smith LLP Partner [email protected]
Perry is the Chair of Reed Smith's Financial Industry Group. In this role, he is responsible for leading administrative, personnel, business development, and client management activities for the firm's largest industry group, focused on banks, other lenders, investment advisers and funds, life, health and disability, insurers, and other institutions across the globe.
Perry's commercial litigation practice focuses on individual, derivative and class actions in the banking, consumer finance, investment management, and insurance industries, as well as class actions of all sorts. He also provides risk management counseling concerning such issues. He has broad experience in general commercial and other complex litigation. Perry has defended dozens of putative class actions in Alabama, Florida, Indiana, Michigan, New York, North Carolina, Ohio, Pennsylvania, Tennessee, and West Virginia.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Yvan-Claude J. Pierre
Reed Smith LLP Partner [email protected]
Yvan-C ud C of R d t ’ U. . C p t M k t G oup nd p tn n t Co po t & cu t G oup n the New York office. He is a leading capital markets and M&A practitioner. Yvan-Claude has worked on a full range of public offerings on NYSE and Nasdaq, in the U.S., as well as from Europe, China, India, Australia, Japan, Brazil and Israel. He represents publicly traded and privately held companies, investment banks, financial institutions and private equity sponsors and venture capital firms, with a particular focus emerging and public growth companies. On their behalf, he provides representation in securities, general corporate, corporate finance and acquisitions, and corporate governance matters, including advising boards of directors and related committees (and special committees for major transactions).
His corporate finance practice includes extensive experience with both public and private offerings, including IPOs, follow-on offerings, At-The-Market offerings, spin-offs, PIPEs, SPACs, 144A equity and debt, private placements and other securities transactions and compliance matters. He is a recognized as a leading counselor in the area of public offerings. He has been involved in more than 250 capital markets offerings and 100 public and private M&A transactions. Yvan-Claude is a frequent public speaker on matters relating to public offerings, mergers and acquisitions, PIPE and SPAC transactions, venture capital transactions and other topics relevant to private and public companies. He has been quot d n n n w ou c nd ndu t jou n d ng ut o t on IPO nc ud ng R ut Inv to ’ Business Daily, BBC News, BusinessDesk, The Deal, Financial Times, Directorship, Legal 500, Law360, Social Cloudcast, Zimbio, Technology Spectator and Business Spectator.
Before entering law school, Yvan-Claude worked in the financial investments groups at TIAA-CREF and Morgan Stanley, and as an accountant on the financial audit staff of Ernst & Young LLP. While attending law school, he worked in the private client group at Merrill Lynch & Co.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Matthew Solomon
U.S. Securities and Exchange Commission Chief Litigation Counsel [email protected]
Matthew C. Solomon is the Chief Litigation Counsel at the Securities and Exchange Commission. Mr. Solomon n g t g t on ng out of t EC’ Ho Off c nd t n t t g t on ffo t nd t d v op nt of t EC’ n t on t g t on p og t oug t v n g on off c .
Mr. Solomon joined the SEC in June 2012 as Deputy Chief Litigation Counsel, and assumed his current role in October 2013. Before joining the SEC, Mr. Solomon held several positions at the U.S. Department of Justice. Most recently, he served as the Fraud Unit Chief (2010-12) and as an Assistant U.S. Attorney (2008-10) in the Fraud and Public Co upt on ct on of t Un t d t t Atto n ’ Off c fo t D t ct of Co u b . In both positions, Mr. Solomon investigated and prosecuted white collar crime, including bribery, mail and wire fraud, securities fraud, tax fraud and violations of the Foreign Corrupt Practices Act. Before becoming an AUSA, Mr. Solomon served as Counsel to the U.S. Senate Committee on the Judiciary (2007-08) nd t tto n n t Ju t c D p t nt’ Pub c Int g t Section (2002-07). He also served as a law clerk for the Honorable James Robertson, of the United States District Court for the District of Columbia, and the Honorable Dennis Jacobs, of the United States Court of Appeals for the Second Circuit.
Mr. Solomon is a magna cum laude graduate of Wesleyan University and a magna cum laude graduate of Georgetown University Law Center, where he served as an editor of the Georgetown Law Journal.
REED SMITH LLP | BLOOMBERG BNA | 2014 SECURITIES AND REGULATORY OUTLOOK: ESSENTIAL ROAD MAP FOR THE YEAR AHEAD | 27 FEBRUARY 2014
Supplemental Articles
Reed Smith LLP, Corporate & Securities Alert, The JOBS Act – Where Are We Now – 2014?
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Corporate & Securities
If you have questions or would like additional The JOBS Act – Where Are We Now – 2014? information on the material covered in this Alert, please On April 5, 2012, President Barack Obama signed the Jumpstart Our Business contact one of the authors: Startups Act (the “JOBS Act”) into law.1 The stated purpose of the JOBS Act Yvan-Claude J. Pierre Chair, U.S. Capital Markets was to increase job creation and stimulate economic growth.2 Often referred to Group – Partner, New York as the “IPO on-ramp,” the JOBS Act was enacted in part to improve access to +1 212 549 0378 [email protected] public capital markets by alleviating, or in some instances eliminating, some of Marianne C. Sarrazin the restrictions placed on a new category of companies called “emerging growth Counsel, San Francisco companies”3 (“EGCs”) during the initial public offering (“IPO”) process. +1 415 659 5936 [email protected] Market Overview 2013/2014 Since the passage of the JOBS Act, the U.S. IPO Barbara H. Bispham Associate, New York market has strengthened significantly. In fact, 2013 was a record year for the +1 212 521 5403 U.S. IPO market—the best since 2000—with a total of 222 companies going [email protected] public, generating approximately $55 billion in proceeds.4 By comparison, in Leah D. Braukman Associate, New York 2012, roughly 128 companies completed an initial public offering, generating +1 212 521 5469 approximately $43 billion in proceeds.5 In the last quarter of 2013 alone, [email protected] 70 companies priced IPOs – more than any other quarter that year.6 In 2013, the …or the Reed Smith lawyer average U.S. IPO return rate was a staggering 41% compared to an average with whom you regularly work. return rate of 21% in 2012.7 For the first time since 2004, the North American region (the United States and Canada) surpassed other regions, including the Asia Pacific region, with roughly a 29% gain in proceeds raised and an average return of approximately 26%.8
The JOBS Act may not be the only driving force behind the recent surge in U.S. IPO activity though. BDO USA, LLP (“BDO”), one of the nation’s leading accounting firms, conducted an annual survey of capital markets executives, which concluded that other factors may have contributed to the rise in IPO debuts. Such factors include (i) lower interest rates (increasing investor demand for high-yielding assets), (ii) increased confidence in the U.S. economy, and (iii) successful offerings by other companies. No matter the reason, it remains
reedsmith.com Client Alert 14-054 February 2014 undisputed that IPO performance in 2013 was impressive, beating benchmark indices, with an average return rate of 41%.
According to quarterly data published by another leading accounting firm, so- called “EGCs” accounted for approximately 81% of all IPOs that priced in 2013. Below are some reforms made available to EGCs navigating the IPO process under the JOBS Act. An EGC usually consults its counsel and the underwriters to determine of which options it should avail itself based on the unique characteristics of the company.
• Confidential submission of draft registration statement.
• The option to make limited disclosures or rely on exemptions from certain disclosure requirements for up to five years following an EGC’s IPO, including limited executive compensation disclosure requirements.
• Exemption from the requirements under section 404(b) of the Sarbanes- Oxley Act of 2002 (the “Sarbanes-Oxley Act”) to have an auditor attest to the effectiveness of the EGC’s internal control over financial reporting.
• Presentation of two years of audited financial statements, as opposed to the three-year requirement applicable to non-EGCs.
• Allowing both oral and written communications with qualified institutional buyers (“QIBs”) and institutional accredited investors before or after the filing of a registration statement to gauge interest in the offering.
• Allowing broker-dealers to publish or distribute a research report regarding the securities of an EGC.
• Taking advantage of an extended transition period for complying with any new or revised standards issued by the Financial Accounting Standards Board to its Accounting Standards Codification.
• Refraining from conducting “say-on-pay” votes at initial annual meetings.
Confidential Submission of Registration Statements Section 6(e) of the Securities Act of 1933, as amended (the “Securities Act”), provides that an EGC may confidentially submit a draft registration statement to the U.S. Securities and Exchange Commission (the “SEC”) for review by the SEC’s staff prior to public filing. However, the registration statement must be publicly filed at least 21 days before the issuer starts the road show process.
While evidence shows that a vast majority of EGCs that completed an IPO in 2013 took advantage of the opportunity to confidentially submit a draft registration statement, others chose to file their registration statements publicly, either to drum up early investor interest or to avoid potential delays prior to launching the road show. reedsmith.com Client Alert 14-054 February 2014 One benefit to confidentially submitting a draft registration statement prior to publicly filing a registration statement is that it allows an EGC to begin the review process with the SEC without prematurely revealing sensitive information about the company, such as growth plans, business strategies, or financial data. In addition, it allows the company to postpone or terminate its IPO efforts outside of the public eye. This way, potentials investors are less likely to know if the company failed in its IPO attempt.
Practice Tips
• If an EGC chooses to confidentially submit a draft registration statement, it does not need to be signed and does not need to include the consent of the auditors or other experts, as the submission does not constitute a filing. However, the SEC does expect a draft registration statement to be “substantially complete” at the time of confidential submission (i.e., an EGC must include a signed audit report of an independent registered public accounting firm covering the fiscal years presented in the draft registration statement).9
• Because a confidential submission is not a filing, EGCs do not need to pay SEC filing fees when they confidentially submit draft registration statements. Rather, SEC filing fees are paid with the first public filing. However, confidential submissions do trigger Financial Industry Regulatory Authority (“FINRA”) filing requirements and the payment of FINRA’s applicable filing fee (unless no FINRA member broker-dealer is yet involved in the offering) if an underwriter is named in the registration statement.
• An EGC that has filed its registration statement confidentially may issue a press release informing the public of such filing in accordance with Rule 135 under the Securities Act. Some companies that have issued such press releases include Twitter, GoPro, and SunEdison, to name a few.
Exemption from Certain Executive Compensation Disclosure Section 102 of the JOBS Act allows EGCs to forego certain disclosure requirements regarding executive compensation that are outlined in Item 402 of Regulation S-K. For example, an EGC can omit (i) the “Compensation Discussion and Analysis” section of a registration statement (which discusses the compensation awarded to, earned by, or paid to certain executive officers) and (ii) the “Grants of Plan-Based Awards” table, the “Option Exercises and Stock Vested” table, the “Pension Benefits” table, and the “Nonqualified Deferred Compensation” table. In essence, an EGC complies with the requirements outlined in Item 402 of Regulation S-K if it complies with the requirements for “smaller reporting companies,” even if it does not otherwise qualify as one. A majority of the EGCs that completed initial public offerings in 2012 and 2013 opted for this reduced approach to executive compensation disclosure.
Practice Tips
• Once a company goes public, potential investors and future shareholders closely monitor its executive compensation practices. Therefore, it is necessary for EGC issuers to consider carefully whether it makes sense to add less disclosure initially when it comes to executive compensation.
reedsmith.com Client Alert 14-054 February 2014 • EGCs are required to provide compensation disclosure for three named executive officers (the CEO and the two other highest-paid executives), whereas non-EGCs must disclose the compensation levels for five named executive officers (the CEO, the CFO, and the three other highest-paid executives).
Exemption from Section 404(b) of the Sarbanes-Oxley Act Under the Sarbanes-Oxley Act, the management of public companies must assess the effectiveness of the company’s internal control over financial reporting.10 It also requires that the company’s auditor report on management’s assessment of its internal controls.11 But Title I of the JOBS Act exempts EGCs from auditor attestation of its internal control over financial reporting.
Non-accelerated filers (companies with a public float below $75 million) are also exempt from the Sarbanes-Oxley requirement of providing auditor attestation of its internal control over financial reporting under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).
Practice Tips
• Despite being able to rely on an exemption to section 404(b) of the Sarbanes-Oxley Act, EGCs must still comply with section 404(a) of the Sarbanes-Oxley Act, which requires management to assess the effectiveness of the company’s internal control over financial reporting on its second annual report on Form 10-K.
Exemption from Full Financial Disclosure In our experience, many EGCs opt to take advantage of reduced financial statement disclosure requirements in their registration statements. The table below compares the requirements for EGCs and non-EGCs:
EGCs Non-EGCs Two Years of Audited Financial Three Years of Audited Financial Statements Statements As little as Two Years of Unaudited Five Years of Unaudited Selected Selected Financial Data Financial Data
Three years of audited financial statements are required to be included in an EGC’s annual report on Form 10-K. Even so, an EGC is not required to include audited financial statements for any period prior to the earliest audited period presented in connection with its IPO.12
It should be noted that some EGCs choose not to take advantage of the optional reduced financial statement disclosure requirements, believing that the benefits do not outweigh the possible perception by potential investors that the company is not ready for the burdens of being a public reporting company.
reedsmith.com Client Alert 14-054 February 2014 Practice Tips
• If an EGC presents two years of audited financial statements, it must present at least two years Basic Guidelines for of unaudited selected financial data. If an EGC chooses to present more than two years of “Test-the-Waters” audited financial statements, then its unaudited selected financial data must match the same Communications number of years. The lead underwriter usually has detailed Leeway to “Test the Waters” Section 5 of the Securities Act prohibits certain procedures for “test-the- waters” communications. communication regarding the sale of securities without an effective registration Common practices for statement. However, EGCs and their underwriters (or other authorized persons) these communications include: may engage in oral or written communications with QIBs and institutional accredited investors in order to assess a potential investor’s interest in the • Communications may only be with QIBs and/or offering. How many EGCs “test the waters” with early communications is institutional accredited unclear, as this practice is still developing with investment banks and these investors. communications are not typically filed with the SEC. • No written materials or handouts should be Practice Tips used. • Presentation materials • Antifraud provisions of the federal securities laws apply to the content of “testing-the-waters” should not be emailed communications. or viewable except in person. • The SEC frequently asks EGCs for copies of any materials used to “test the waters” in comment letters. Therefore, EGCs must ensure that “testing-the-waters” communications conform to • The presentation and statutory prospectus disclosure requirements. answers to anticipated questions should be scripted. Ability to Publish Research Reports Broker-dealers for EGCs may issue • Content must be factual, research reports regarding these companies. This is significant in that a “research balanced and not misleading. report” is now excluded from the definition of an “offer” to sell a security, which is prohibited without an effective registration statement. A “research report” includes • Historical financial information is permitted, any “written, electronic, or oral communication that includes information, opinions but projections are not. or recommendations with respect to securities of an issuer or an analysis of a • General valuation security or an issuer, whether or not it provides information reasonably sufficient concepts may be upon which to base an investment decision.”13 discussed, but binding indications of interest may not be solicited. Despite this exception to the prohibition on offers to sell securities, underwriters for EGCs do not appear to be actively publishing research reports before or during • No media members may attend investor an IPO. Rather, it seems as though underwriters continue to follow the traditional meetings, and no notion that research should not be published until 25 days after the expiration of broadcasts or recordings the initial prospectus delivery period.14 may be made.
• Presentation materials Practice Tips and scripts should be reviewed in advance • Similar to “testing-the-waters” communications, the SEC often requests copies of any research by counsel, and reports published or distributed by broker-dealers for EGCs. Therefore, it is important to be supplementally provided to the SEC. mindful of the content of these reports.
reedsmith.com Client Alert 14-054 February 2014 Flexibility in Complying with Accounting Standards While EGCs are not required to “comply with any new or revised financial accounting standards until” private companies are required to comply with any new GAAP standards, it appears as though only a few EGCs are taking advantage of the lengthier transition period for new or revised financial accounting standards.15
Practice Tips
• Once an EGC decides to take advantage of this exemption, it can decide not to at any time (i.e., comply with accounting standards applicable to non-EGCs). However, if an EGC initially decides to “opt out” of this exemption, the decision is final.
• If an EGC decides to avail itself of this exemption, it must state in both the risk factor section and the critical accounting policies section of the registration statement that financial statements may not be comparable to those of companies that comply with public company requirements.
No “Say-on-Pay” Vote Requirement EGCs are not required to comply with the “say-on-pay” provisions of the Dodd-Frank Act, and do not have to conduct “say- on-pay” votes for a minimum of three years. As of May 2013, only 24% of EGCs had conducted say-on-pay votes at initial annual meetings.16
Practice Tips
• Once a company is no longer considered an EGC, a “say-on-pay” vote is required at the first annual meeting after losing EGC status. If a company loses its EGC status within the first two years after its IPO, a “say-on-pay” vote is required the third year following its IPO.
Industries According to industry research, the energy, financial, technology, and health care sectors were among the most active sectors in 2013 in terms of IPO proceeds raised. The health care sector had its biggest year in 2013, with 54 life sciences companies completing an IPO—only nine of which ended the year trading below their issue price.17 The technology sector fell just below the health care sector in terms of the number of companies that completed an IPO, with a total of 45 companies going public.18 To date, life sciences companies continue to dominate the IPO market.
Going Forward: What to Expect in 2014 With a building backlog of IPOs, 50 new IPO public filings in 2014 already made (a 194% increase from last year during the same period), and economic indicators continuing to improve, the capital markets community expects continued growth and strong performance of IPOs in 2014. During the first two months of 2014, more than 35 IPOs have priced, representing a 75% increase from last year, and the average IPO return has been approximately 24% from its offer price.
We expect it to be another strong year for IPOs. Some industry experts are predicting that total IPO proceeds will be at least $66 billion and that there will be reedsmith.com Client Alert 14-054 February 2014 a 9% increase in the number of U.S. IPOs in 2014. Although the health care sector has been particularly active so far this year, we expect a terrific year from the technology sector in 2014 as well, with some companies like GoPro, King Digital, and Coupons.com coming to market.
Reed Smith LLP will continue to monitor the impact of the JOBS Act on U.S. public capital markets in 2014 and review proposed amendments to or additional legislation affecting the JOBS Act.
______Endnotes 1 Jumpstart Our Business Startups Act, H.R. 3606, 112th Cong. (Apr. 5, 2012) (the “JOBS Act”). 2 Id. 3 The Securities Act of 1933, as amended (the “Securities Act”), defines an EGC as an issuer with “total annual gross revenues” of less than $1 billion during its most recently completed fiscal year. Once a company is an emerging growth company, it will remain one until the last day of the fiscal year in which it has total annual gross revenues of $1 billion or more or the last day of the fiscal year following the fifth anniversary of its IPO. 4 Renaissance Capital, US IPO Market, 2013 Annual Review, January 2, 2014 (the “Renaissance Capital 2013 Annual Review”). 5 Id. 6 Renaissance Capital, Global IPO Market, 2013 Annual Review, December 18, 2013. 7 Renaissance Capital 2013 Annual Review; Renaissance Capital, US IPO Market, 2012 Annual Review, January 2, 2013. 8 Id. 9 U.S. Securities and Exchange Commission, Jumpstart Our Business Startups Act Frequently Asked Questions – Confidential Submission Process for Emerging Growth Companies (April 10, 2014), http://www.sec.gov/divisions/corpfin/guidance/cfjumpstartfaq.htm. 10 American Institute for CPAs, Section 404(b) of Sarbanes-Oxley Act of 2002, http://www.aicpa.org/ advocacy/issues/pages/section404bofsox.aspx. 11 Id. 12 U.S. Securities and Exchange Commission, Jumpstart Our Business Startups Act Frequently Asked Questions – Generally Applicable Questions on Title I of the JOBS Act (September 28, 2012, May 3, 2012, and April 16, 2012), http://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq- title-i-general.htm. 13 15 U.S.C. §77(b)(3). 14 The Wall Street Journal, IPO Quiet Time: Banks Can’t Let Go (August 20, 2012), http://online.wsj. com/news/articles/SB10000872396390444233104577591773919525202. 15 The JOBS Act. 16 Bloomberg Law, Study Finds Start-Up Firms Using Relaxed JOBS Act Disclosure Rules, Securities This Alert is presented for Regulation & Law Report, The Bureau of National Affairs, Inc. (May 13, 2013). informational purposes only 17 Renaissance Capital 2013 Annual Review. and is not intended to 18 constitute legal advice. Id.
© Reed Smith LLP 2014. All rights reserved. For additional information, visit http://www.reedsmith.com/legal/
reedsmith.com Client Alert 14-054 February 2014
NEW YORK LONDON HONG KONG CHICAGO WASHINGTON, D.C. BEIJING PARIS LOS ANGELES SAN FRANCISCO PHILADELPHIA SHANGHAI PITTSBURGH
HOUSTON SINGAPORE MUNICH ABU DHABI PRINCETON N. VIRGINIA WILMINGTON SILICON VALLEY DUBAI CENTURY CITY RICHMOND GREECE KAZAKHSTAN This document is being provided for the exclusive use of CARL SUSSMAN at BUREAU OF NATIONAL AFFAIRS INC
2013 Year Mergers E nd
R eview This document is being provided for the exclusive use of CARL SUSSMAN at BUREAU OF NATIONAL AFFAIRS INC
www.bloombergbriefs.com Bloomberg Brief | Mergers 2013 Year End Review 2
INTRODUCTION
A Year That Didn’t Live Up to Expectations
For the third year running, all the founda- equity sphere, six new deals worth more natural gas gathering and processing tions seemed to be in place at the outset than $5 billion were announced, up from businesses, a goal of Jana Partners LLC, of 2013 for a surge in merger activity: three in each of the previous two years which disclosed a stake in October. rising stock prices, an abundance of cash (page 14). The biggest, for HJ Heinz & Consolidation in the telecommunica- on corporate balance sheets and financ- Co. and Dell Inc., were far above that tions industry in Europe and the U.S. in ing costs at historic lows. When the tallies threshold, at $27.4 billion and $16.4 bil- 2013 gave a lift to dealmaking. It shows were made, last year didn’t quite live up to lion, respectively. every sign of continuing this year judg- its billing, with total deal volumes up only In addition to rich stocks, cash and cheap ing by activity this month. John Malone- slightly year on year. Scratch the biggest debt, a third force was at work to stir up controlled Liberty Media Inc. and Charter deal of the year off the list — the long- deals: activist investors. They made their Communications Inc., in which Liberty expected $130 billion buyout by Verizon presence felt in 2013, sometimes promoting has a big stake, kicked off 2014 with hefty Communications Inc. of Vodafone transactions and other times opposing take- new offers for Sirius XM Holdings Inc. Group Plc’s 45 percent stake in Verizon over offers they considered too stingy. The (the remaining 47 percent for $10.6 billion) Wireless — and the yearly total would be $6.7 billion buyout of BMC Software Inc. by and Time Warner Cable Inc. ($61.3 billion) down a hair from 2012 (page 4). Bain Capital LLC and Golden Gate Capi- (page 16). Still, there were signs of building mo- tal in September grew out of a campaign by Signs, perhaps, that 2014 will deliver mentum, including more deals over $500 activist Paul Singer’s Elliott Management on the promise of a return of large-scale million, even if mega-deals were still few Corp. in 2012. Likewise, QEP Resources dealmaking. and far between (page 6). In the private Inc. agreed in December to separate its — John E. Morris
Contents
TIMELINE MARKET DRIVERS PRIVATE EQUITY Highlights of the year in M&A. Page 3 The background to this year’s deals: rising New investments, exits by sale, financing and stock markets, cheap debt, a robust IPO mar- IPO exits. Page 14 The YEAR AT A GLANCE ket and cash-rich balance sheets. Deal volumes and breakdowns by sector and Page 8 JOHN MALONE’s BUSY Year region. Page 4 The cable industry veteran was behind a string REGIONS of the biggest deals in Europe and the U.S. A GLOBAL TOP 50 Activity levels, sector breakdowns, top deals chart of Malone’s deals and attempted deals The largest transactions. Page 5 and advisers. last year. Page 16 — North America. Page 10 BEHIND THE HEADLINES — Europe, Middle East & Africa. Page 11 DEALmAKER PROFILES Analysis of deal size, valuations, investors’ — Asia Pacific. Page 12 Seven bankers who played key roles in major reactions and terminated deals. Page 6 — Latin America & Caribbean. Page 13 mergers in 2013. Page 17
Bloomberg Brief Mergers To subscribe via the Bloomberg ter- minal type BRIEF
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Notable 2013 M&A Events
Jan. 14: Bloomberg Feb. 5: Dell said it March 19: John News reported that planned to go private Malone’s Liberty Media Dell Inc. held buyout in a leveraged buyout Corp. said it would buy talks with private- led by Michael Dell Feb. 6: Liberty Global more than 25 percent equity firms. and Silver Lake Inc. agreed to buy stake in Charter Management LLC. Virgin Media Inc. Communications Inc.
Jan. Feb. Mar. Jan. 31: The U.S. Justice March 25: Dell said it got competing Department filed an antitrust suit to Feb. 14: Berkshire Hathaway Inc. and buyout proposals from Blackstone block Anheuser-Busch InBev NV’s 3G Capital agreed to buy HJ Heinz Co. for about Group LP and Carl Icahn. takeover of Grupo Modelo SAB. The $23 billion. The same day, AMR Corp and US buyer made concessions and the Airways Inc. announced their merger. deal was completed in June. June 24: Vodafone May 20: Yahoo! Group Plc won a April 12: Joh. A. Benckiser May 10: Icahn and Southeastern Asset Inc. said it would bidding contest for SE said it would buy coffee Management Inc. proposed an alternative buy Tumblr Kabel Deutschland roaster D.E. Master Blenders deal for Dell shareholders that would let Inc. for about Holding AG, paying 1753 NV for about $10 billion. them keep their equity stakes. $1.1 billion. $10.1 billion.
Apr. May Jun.
April 15: Thermo Fisher May 6: BMC Software May 29: Shuanghui June 27: Bloomberg News Scientific Inc. agreed to buy Inc. agreed to be International Holdings Ltd. reported John Malone was Life Technologies Corp. for taken private by Bain agreed to acquire Smithfield exploring ways Charter $13.6 billion. Capital LLC and Foods Inc. in the biggest Communications Inc. Golden Gate Capital Chinese takeover deal of a U.S. could acquire Time Warner in a $6.9 billion deal. company. Cable Inc.
Aug. 13: Carl Icahn said he built July 15: Loblaw Sept. 3: Microsoft up a stake in Apple Inc. and Cos. said it would Corp. said it would buy discussed his support for a larger buy Shoppers July 29: Perrigo Co. Nokia Oyj’s handset stock buyback with its Chief Drug Mart Corp. for agreed to buy Elan business for $7.2 billion. Executive Officer Tim Cook. about $12 billion. Corp. for $8.6 billion.
July Aug. SEP.
July 31: Bill Ackman’s Pershing Aug. 9: America Movil Aug. 25: Amgen Inc. Square Capital Management SAB said it planned to agreed to buy Onyx LP amassed a 9.8 percent buy the rest of Royal Pharmaceuticals Inc. in stake in Air Products & KPN NV for $10 billion. a $10.4 billion deal. Chemicals Inc., Ackman said.
Sept. 23: BlackBerry Ltd. received a tentative buyout Oct. 9: Men’s Nov. 1: Bloomberg News reported Dec. 9: Sysco Corp. offer from a group led by Wearhouse Inc. Oct. 30: Dell’s AT&T Inc. executives were agreed to acquire US Fairfax Financial Holdings rejected a takeover buyout by Michael preparing for a potential takeover Foods from its private- Ltd that was terminated two offer from Jos. A. Bank Dell and Silver Lake of Vodafone Group Plc in 2014. equity owners. months later. Clothiers Inc. was completed.
OCt. NOV. Dec.
Sept. 30: Blackstone Group LP’s Oct. 16: America Movil withdrew its Steve Schwarzman said in an offer for Royal KPN and determined Nov. 12: American Airlines and US Airways interview that his 1994 decision it couldn’t expand its stake to more reached an agreement with the U.S. Justice to sell what’s now BlackRock Inc. than 50 percent. Department over the government’s bid to was a “heroic mistake.” block their merger.
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The YEar AT A GLANCE BY WILL ROBINSON
The Sale of Vodafone’s Stake in Verizon Wireless Pushed 2013’s Total Ahead of 2012 The Pace of Dealmaking Global mergers and acquisitions value climbed just four percent $4,000 last year as a single transaction pushed total M&A value ahead Verizon Wireless of the 2012 pace: Vodafone Group Plc’s $130 billion sale of its $3,500 deal contributed stake in Verizon Wireless to Verizon Communications Inc. $130B $3,000 Verizon’s mega-deal with Vodafone was the largest M&A transac- $2,500 tion in a decade, accounting for more than 5 percent of last year’s $2,000 aggregate transaction value. If it hadn’t been announced last year, total M&A would have matched the $2.2 trillion worth of deals Billions $1,500 from 2010, the first full year of economic recovery after the global $1,000 recession in 2009. $500 Although dealmaking hasn’t approached its 2006-2007 peak, it $0 has remained steady, averaging about $2.3 trillion a year since 2007 2008 2009 2010 2011 2012 2013 the end of the economic downturn, keeping it ahead of the M&A Source: Bloomberg DMON activity levels of the early 2000s.
Deal Volume by Sector The energy sector accounted for a smaller portion of global trans- 100% Utilities actions than it has in the past three years. None of last year’s 10 Technology largest M&A moves were energy deals. 80% Industrial Communications deals made up a much larger share of last Financial/RE year’s activity. Aside from Verizon’s giant purchase, Liberty 60% Energy Global Plc bought Virgin Media Inc. for $21.6 billion and adver- Diversified tising companies Omnicom Group Inc. and Publicis Groupe SA agreed to combine. 40% Consumer Noncycl Consumer Cycl Financial acquirers, rather than strategic buyers, made two of 20% Communications the year’s 10 biggest deals. Berkshire Hathaway Inc. and 3G Basic Materials Capital bought HJ Heinz Co. for $27.4 billion, while Michael Dell 0% and Silver Lake Management LLC completed a $16.4 billion 2007 2008 2009 2010 2011 2012 2013 take-private of Dell Inc. Source: Bloomberg
Deal Volume by Region For a third year North America was the dominant region for deals, 100% accounting for more than 40 percent of global activity. Nearly ev- Middle East & ery transaction of $10 billion or more included a North American 80% Africa participant. LatAm & Caribbean Among the largest exceptions were a pair of European telecom 60% Europe trades: Spain’s Telefonica SA agreed to buy the E-Plus German wireless unit of the Netherlands’ Royal KPN NV in a $11.3 bil- lion deal and Vodafone bought German cable operator Kabel 40% Asia Pacific Deutschland Holding AG for $11.2 billion.
20% North America
0% 2007 2008 2009 2010 2011 2012 2013 Source: Bloomberg
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Global top 50 Click on for deal advisers
ANNOUNCED TARGET COUNTRY TARGET INDUSTRY ACQUirer COUNTRY Value ($M)
9/2/13 Verizon Wireless (45% Vodafone stake) US Telecommunications Verizon Communications Inc US 130,100 2/14/13 HJ Heinz Co US Food Berkshire Hathaway, 3G Capital Multi 27,403 7/12/13 Caisse des Depots, Republic of France units FR Finance Bpifrance FR 23,406 2/5/13 Virgin Media Inc US Telecommunications Liberty Global PLC GB 21,627 7/28/13 Omnicom Group Inc US Advertising Publicis Groupe SA FR 19,420 2/12/13 NBCUniversal LLC US Media Comcast Corp US 16,700 2/5/13 Dell Inc US Computers MSD Capital LP, Silver Lake Mgmt US 16,436 4/15/13 Life Technologies Corp US Healthcare-Products Thermo Fisher Scientific Inc US 15,901 10/2/13 Portugal Telecom SGPS SA PT Telecommunications Oi SA BR 14,297 7/15/13 Shoppers Drug Mart Corp CA Retail Loblaw Cos Ltd CA 13,007 4/16/13 National Bank of Greece SA GR Banks Hellenic Financial Stability Fund GR 12,853 7/23/13 E-Plus Mobilfunk GmbH & Co KG DE Telecommunications Telefonica Deutschland Holding AG DE 11,296 6/24/13 Kabel Deutschland Holding AG DE Media Vodafone Group PLC GB 11,186 4/23/13 Piraeus Bank SA GR Banks Hellenic Financial Stability Fund GR 10,967 1/18/13 Orascom Construction Industries EG Engineering OCI NL 10,488 5/29/13 NV Energy Inc US Electric Berkshire Hathaway Inc US 10,366 10/23/13 Cole Real Estate Investment Inc US REITS American Realty Capital Properties Inc US 9,846 6/14/13 Taikang Asset Management Co Ltd CH Finance PetroChina Co Ltd CN 9,787 4/12/13 DE Master Blenders 1753 NV NL Beverages Joh A Benckiser SE AT 9,615 4/27/13 Former Fortis structured credit assets BE Finance Credit Suisse, Lone Star Funds Multi 8,723 5/27/13 Bausch & Lomb Inc US Healthcare-Products Valeant Pharmaceuticals Int'l Inc US 8,700 6/30/13 Onyx Pharmaceuticals Inc US Pharmaceuticals Amgen Inc US 8,531 12/9/13 US Foods Inc US Food Sysco Corp US 8,374 11/22/13 Galeao airport concession BR Infrastructure Odebrecht SA, Changi Airport Group etc BR 8,308 5/20/13 Warner Chilcott PLC IE Pharmaceuticals Actavis plc US 7,809 6/11/13 Eurobank Ergasias SA GR Banks Hellenic Financial Stability Fund GR 7,753 7/30/13 Health Management Associates Inc US Healthcare-Services Community Health Systems Inc US 7,527 6/3/13 Dubai Aluminium Co Ltd AE Metal Fabricate Emirates Aluminium Co Ltd AE 7,500 5/31/13 SM Land Inc PH Real Estate SM Prime Holdings Inc PH 7,330 9/3/13 Nokia's Devices & Services business FI Technology Microsoft Corp US 7,165 5/29/13 Smithfield Foods Inc US Food Shuanghui International Holdings Ltd HK 6,955 11/5/13 Maroc Telecom MA Telecommunications Emirates Telecommunications Corp AE 6,810 9/24/13 Tokyo Electron Ltd JP Semiconductors Applied Materials Inc US 6,794 5/6/13 BMC Software Inc US Software GIC Special Investments et al Multi 6,736 9/9/13 Molex Inc US Electrical Equip Koch Industries Inc US 6,528 12/9/13 BRE Properties Inc US REITS Essex Property Trust Inc US 6,334 7/29/13 Elan Corp PLC IE Pharmaceuticals Perrigo Co Plc US 6,199 9/9/13 Neiman Marcus Group LLC/The US Retail Canada Pension Plan Inv Bd, Ares Mgmt Multi 6,000 11/20/13 Eagle Ford assets US Energy Devon Energy Corp US 6,000 5/9/13 Alpha Bank AE GR Banks Hellenic Financial Stability Fund GR 5,994 7/26/13 Activision Blizzard Inc US Software Activision Blizzard Inc US 5,830 6/12/13 Canada Safeway Ltd CA Food Empire Co Ltd CA 5,694 10/10/13 PVR Partners LP US Pipelines Regency Energy Partners LP US 5,629 12/16/13 LSI Corp US Semiconductors Avago Technologies Ltd SG 5,596 7/2/13 Bank of Ayudhya PCL TH Banks Mitsubishi UFJ Financial Group Inc JP 5,505 7/2/13 Kashagan caspian oil project (8.4%) KZ Energy KazMunayGas National Co JSC KZ 5,400 4/12/13 Port Kembla, Port Botany AU Infrastructure Hesta AG, Industry Funds Mgmt Pty Ltd et al AU 5,325 12/16/13 International Lease Finance Corp US Finance AerCap Holdings NV NL 5,088 2/1/13 SNS REAAL NV NL Banks Kingdom of the Netherlands NL 5,058 9/30/13 Brookfield Office Properties Inc US Real Estate Brookfield Property Partners LP US 5,037 Source: Bloomberg
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Behind the Headlines BY John E. Morris, WILL ROBINSON and Alicia LOONEY
Analysis of Deal Size Distributions, Valuation Multiples and Market Reactions
A Rise in Mega Deals Wasn’t Sustained The number of deals worth more than $5 billion spiked during $1,500 Deal volume (left): 50 >$5B the second-quarter of last year to the highest in more than two $500M-$5B years. Life Technologies Corp.’s $15.9 billion sale to Thermo $1,250 40 $50M-$500M Fisher Scientific Inc., Kabel Deutschland AG’s takeover and $1,000 $0-$50M Berkshire Hathaway Inc.’s $10.4 billion purchase of NV Energy 30 Inc. were among the large M&A deals announced between April Deals > $5B (right) $750 and June. 20 Billions $500 The number of very large deals tapered off in the second half of the year. $250 10
$0 0
Source: Bloomberg
Large-But-Not-Mega Deals Increased Transactions between $500 million and $5 billion rose steadily as Change in number of deals: 800% 2013 progressed. December alone featured 80 deals in that size $0-$50M range, versus just 60 in January. $50M-$500M 600% $500M-$5B >$5B 400%
200%
0%
Rebased to Q1 2002 -200%
Source: Bloomberg
Valuations Rebounded After a Dip in 2012 The prices paid by buyers as measured by five key valuation 2011 multiples rebounded last year from a dip in 2012. Three of the five Net Income 2012 2013 metrics — average multiples of net income, free cashflow and book value — were higher than they were in 2011 as well. Aver- Free cashflow age Ebitda and revenue multiples rose but didn’t match the level of two years earlier. Ebitda
Book value
Revenue
0x 2x 4x 6x 8x 10x 12x 14x 16x 18x 20x 22x Source: Bloomberg
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Behind the Headlines: Analysis
Investors Continue to Reward Acquirers 6 Acquirers benefitted, on average, when they announced deals,
continuing a trend of the past two years. Sysco Corp. climbed 4 10 percent after it announced an $8.4 billion deal to buy US 2 Foods from private-equity firms KKR & Co. and Clayton, Dubil- 0 ier & Rice LLC in September. After disclosing plans to purchase -2 Virgin Media Inc., Liberty Global Plc rose more than 30 percent -4 during the remainder of last year. -6 On average, North American companies that announced acquisi- -8 North America ex Mexico tions saw their shares gain 2.8 percent in 2013 versus 2.7 percent % change on announcement -10 Europe the year before, according to data compiled by Bloomberg. In -12 Europe last year the average gain after an announcement was 2.5 percent, up from 1.5 percent in 2012. The figures are based on acquirers with market capitalizations over $500 million. Source: Bloomberg MA
The Deals That Weren’t: Largest Deals Terminated Last Year
Announced Terminated Target Country Industry Acquirer Value ($M) 4/15/13 6/18/13 Sprint US Telecommunications DISH Network 37,723 8/9/13 10/16/13 Royal KPN NL Telecommunications America Movil 22,695 3/25/13 4/19/13 Dell US Computers Blackstone Group et al 21,228 4/2/12 5/14/12 Avon US Cosmetics/Personal Care Joh A Benckiser 12,854 11/15/12 1/21/13 Fraser and Neave SG Beverages OUE, Orange Circle Investments 12,685 3/25/13 9/9/13 Dell US Computers Icahn Enterprises 10,380 3/20/13 4/11/13 Cole REIT US REITS American Realty Capital Properties 9,822 1/8/13 6/26/13 Clearwire US Telecommunications DISH Network 9,507 2/25/13 6/18/13 Elan IE Pharmaceuticals Royalty Pharma 7,777 8/6/12 3/1/13 Best Buy US Retail Richard Schulze 7,594 5/10/13 7/22/13 China Resources Gas HK Gas China Resources Power 7,065 Source: Bloomberg MA Deals announced in 2012 or 2013 and terminated in 2013
who’s buying who? > go companies driving m&a in 2014: ma <
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Market DRIVERs Compiled by John E. Morris, Will Robinson, AnthonY Fasanella and Alicia Looney
Heady Stock Markets, Cheap Debt, Mountain of Cash Didn’t Produce Expected Surge in M&A Stocks Rose U.S. and European stocks gained last year. The Standard & 50% Change since Jan. 2008: Poor’s 500 index climbed 30 percent last year. Germany’s DAX 40% Index, an equity benchmark for Europe’s largest economy, rose S&P500 FTSE100 30% about 25 percent. DAX HK Hang Seng 20% 10% 0% -10% -20% -30% -40% -50% 2008 2009 2010 2011 2012 2013 Source: Bloomberg
Interest Rates Remained Low Buyers also benefitted from cheap borrowing costs and plentiful 25% credit. High Grade 20% HJ Heinz Co. obtained $14.1 billion in financing from JPMorgan High Yield Chase & Co. and Wells Fargo & Co. in February to support its 15% buyout — the biggest financing to fund an acquisition since 2007. Then Verizon Communications Inc. sold $49 billion of debt 10% Sept. 11 in the biggest corporate bond deal ever to help it fund the buyout of Vodafone Group Plc’s Verizon Wireless stake. 5%
0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Bank of America Merrill Lynch
The IPO Market Offered an Alternative to M&A Initial public offerings picked up in 2013 as M&A activity remained Middle-East & Africa Latin America somewhat constant. The number of deals increased almost five $1,000 Asia Pacific Europe percent from 2012 and aggregate value was the highest in three North America years. That provided exit routes for private-equity, venture-backed $800 and other privately held companies that in other circumstances might have been sold. $600 Blackstone Group LP took Hilton Worldwide Holdings Inc. public in December, six years after acquiring it for $26 billion at $400 the end of the buyout boom.
$200
$0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Bloomberg
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Market DRIVERs
Corporations Continued to Stockpile Cash Continuing a trend that has held steady since the financial crisis, +18% $4,500 corporations accumulated more cash on their balance sheets +6% $4,000 +13% that could, in theory, be used for acquisitions. American compa- $3,500 nies reported $4.2 trillion of cash and cash equivalents on their $3,000 books at the end of the third quarter, according to data compiled $2,500 by Bloomberg. That was up 18 percent from a year earlier, and $2,000 40 percent higher than the total reported in September 2010. Billions $1,500 $1,000 $500 $0
Cash and cash equivalents at U.S. companies at quarter ended. Source: Bloomberg
The Portion of All-Cash Deals Remained High The portion of deals paid for entirely in cash fell to 60.3 percent 80% last year from a high of 66.3 percent in 2012. Still, that figure was 70% high by historical standards. All-cash acquisitions peaked in the 60% third and fourth quarters of 2012, when they accounted for more than 70 percent of all deals. 50% 40% 30% 20% 10% Proportion of all-cash deals 0%
Source: Bloomberg MA
ma su
top m&a buyers in europe: go ma <
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North America
Telecoms, Media and Tech Sectors Yielded the Biggest Deals
← Value Deal count → $2,000 15,000 15%
$1,500 5% Cellular telecom 10,000 Real estate 4% $1,000 Computers
Billions 4% Oil E&P 5,000 3% Food $500 69% Other
$0 0
Source: Bloomberg Source: Bloomberg MA
Top 10 Deals deal Value Target Acquirer Seller Payment Type Deal Status ($ mln) Verizon Wireless (Vodafone stake) Verizon Communications Inc Vodafone Group PLC 130,100 Cash, Stock & Debt Pending HJ Heinz Co Berkshire Hathaway Inc, 3G Capital Inc - 27,403 Cash Complete Omnicom Group Inc Publicis Groupe SA - 19,420 Stock Pending NBCUniversal LLC Comcast Corp General Electric Co 16,700 Cash and Stock Complete Dell Inc Michael Dell, Silver Lake Management LLC - 16,436 Cash Complete Life Technologies Corp Thermo Fisher Scientific Inc - 15,901 Cash Pending Shoppers Drug Mart Corp Loblaw Cos Ltd - 13,007 Cash or Stock Pending NV Energy Inc Berkshire Hathaway Inc - 10,366 Cash Complete Cole Real Estate Investment Inc American Realty Capital Properties Inc - 9,846 Cash or Stock Pending Bausch & Lomb Inc Valeant Pharmaceuticals International Inc Warburg Pincus LLC et al 8,700 Cash Complete Source: Bloomberg
Top Financial Advisers Top Legal Advisers
Total Ave Total Ave Share Deal Share Deal Adviser Rank Deals Deal Adviser Rank Deals Deal (%) Count (%) Count ($ MLN) ($ Mln) ($ MLN) ($ Mln) BofA Merrill Lynch 1 33.5 352,455 3,119 113 Wachtell Lipton Rosen & 1 28.0 294,402 4,600 64 Goldman Sachs & Co 2 32.3 339,737 2,084 163 Davis Polk & Wardwell 2 24.2 254,081 3,970 64 JP Morgan 3 31.6 331,956 2,573 129 Simpson Thacher & Bartlett 3 24.0 252,760 2,319 109 Morgan Stanley 4 27.3 286,629 2,239 128 Weil Gotshal & Manges LLP 4 22.5 236,973 2,418 98 Barclays 5 25.1 264,245 2,565 103 Jones Day 5 18.0 189,401 799 237 UBS 6 18.8 197,803 3,470 57 Slaughter and May 6 17.6 185,338 26,477 7 Guggenheim Capital LLC 7 12.6 132,825 66,413 2 Osler Hoskin & Harcourt LLP 7 17.0 178,944 1,924 93 PJT Capital LLC 8 12.4 130,100 130,100 1 Debevoise & Plimpton LLP 8 16.8 176,423 5,041 35 Citi 9 12.3 128,828 1,516 85 Latham & Watkins LLP 9 16.4 172,731 919 188 Deutsche Bank AG 10 11.2 118,130 2,188 54 Hogan Lovells 10 16.1 168,743 3,245 52 Source: Bloomberg Source: Bloomberg
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Eup ro e, Middle East And Africa
Bailouts, Government Divestitures Topped Even Biggest Telecoms Deals
$1,800 12,000 ← Value Deal count → 8% $1,500 10,000 5% 5% $1,200 8,000 Commercial banks
4% Telecoms $900 6,000 3% Real estate operations
Billions $600 4,000 Telephone - integrated Finance - commercial $300 2,000 74% Other
$0 0
Source: Bloomberg Source: Bloomberg MA
Top 10 Deals deal Value Payment Target Acquirer Seller Deal Status ($ mln) Type Caisse des Depots, Investment operations Bpifrance (new entity) 23,406 Cash Complete Republic of France Virgin Media Inc Liberty Global PLC - 21,627 Cash and Stock Complete Portugal Telecom SGPS SA Oi SA - 14,297 Stock Pending National Bank of Greece SA Hellenic Financial Stability Fund - 12,853 Cash Complete E-Plus Mobilfunk GmbH & Co KG Telefonica Deutschland Holding AG Koninklijke KPN NV 11,296 Cash and Stock Pending Kabel Deutschland Holding AG Vodafone Group PLC - 11,186 Cash Complete Piraeus Bank SA Hellenic Financial Stability Fund - 10,967 Cash Complete Orascom Construction Industries OCI - 10,488 Cash or Stock Pending DE Master Blenders 1753 NV Joh A Benckiser SE - 9,615 Cash Pending RPI portfolio asset Credit Suisse Group, Lone Star Funds Royal Park Investments SA 8,723 Cash Pending Source: Bloomberg
Top Financial Advisers Top Legal Advisers
Total Ave Total Ave Share Deal Share Deal Adviser Rank Deals Deal Adviser Rank Deals Deal (%) Count (%) Count ($ MLN) ($ Mln) ($ MLN) ($ Mln) Goldman Sachs & Co 1 26.4 179,334 1,793 100 Linklaters LLP 1 14.8 99,323 588 169 Morgan Stanley 2 22.7 154,596 1,982 78 Allen & Overy LLP 2 13.1 87,877 486 181 JP Morgan 3 18.1 122,809 1,949 63 Freshfields Bruckhaus Deringer 3 12.1 81,241 454 179 BNP Paribas Group 4 14.6 99,196 1,210 82 Shearman & Sterling LLP 4 6.6 44,429 1,111 40 Barclays 5 13.9 94,423 1,475 64 White & Case LLP 5 6.0 40,381 439 92 Deutsche Bank AG 6 12.6 85,780 1,384 62 Bredin Prat 6 5.8 38,810 1,848 21 Citi 7 12.6 85,686 1,260 68 De Brauw Blackstone Westbroek 7 5.5 37,216 1,201 31 BofA Merrill Lynch 8 11.9 80,819 1,443 56 Clifford Chance LLP 8 5.4 36,309 288 126 Lazard Ltd 9 11.7 79,453 946 84 Skadden Arps 9 5.2 35,076 1,032 34 Credit Suisse 10 10.3 70,371 1,257 56 Hengeler Mueller 10 5.2 35,053 1,252 28 Source: Bloomberg Source: Bloomberg
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Asia Pacific
Consolidation in Property, Energy and Financial Sectors Pushed Up Volume Modestly
$600 12,000 ← Value Deal count → 11% $500 10,000 4% 3% $400 8,000 Real estate operations 3%
Commercial banks $300 6,000 3% Buildings
Billions $200 4,000 Investment cos. Real estate mgmt $100 2,000 76% Other $0 0
Source: Bloomberg Source: Bloomberg MA
Top 10 Deals
deal Value ($ Payment Target Acquirer Seller Deal Status mln) Type Taikang Asset Management Co Ltd PetroChina Co Ltd - 9,787 Cash Pending SM Land Inc SM Prime Holdings Inc - 7,330 Stock Pending Tokyo Electron Ltd Applied Materials Inc - 6,794 Stock Pending Bank of Ayudhya PCL Mitsubishi UFJ Financial Group Inc - 5,505 Cash Complete Kashagan caspian oil project KazMunayGas National Co JSC ConocoPhillips 5,400 Cash Complete Port Kembla, Port Botany Australia Hesta AG, Industry Funds Mgmt Pty et al - 5,325 Cash Complete Kashagan caspian oil project China National Petroleum Corp KazMunayGas National Co 5,000 Cash Pending GD Midea Holding Co Ltd Midea Group Co Ltd - 4,924 Stock Complete Beijing Xinwei Telecom Technology Co Beijing Zhongchuang Telecom Test Co - 4,393 Stock Pending Siam Makro PCL CP ALL PCL SHV Holdings NV 4,083 Cash Complete Source: Bloomberg
Top Financial Advisers Top Legal Advisers
Total Ave Total Ave Share Deal Share Deal Adviser Rank Deals Deal Adviser Rank Deals Deal (%) Count (%) Count ($ MLN) ($ Mln) ($ MLN) ($ Mln) Morgan Stanley 1 8.3 41,767 597 70 Nishimura & Asahi 1 5.8 29,193 343 85 UBS 2 7.6 38,298 766 50 Baker & McKenzie 2 5.1 25,515 287 89 Goldman Sachs & Co 3 7.3 36,524 529 69 Herbert Smith Freehills 3 5.0 25,091 358 70 JP Morgan 4 6.1 30,712 749 41 King & Wood Mallesons 4 4.5 22,708 307 74 Macquarie Group Ltd 5 4.9 24,734 538 46 Mori Hamada & Matsumoto 5 4.3 21,897 153 143 BofA Merrill Lynch 6 4.5 22,802 671 34 Linklaters LLP 6 3.7 18,782 606 31 Barclays 7 4.3 21,715 987 22 Allen & Overy LLP 7 3.7 18,514 343 54 HSBC Bank PLC 8 4.2 21,178 784 27 Freshfields Bruckhaus Deringer 8 3.1 15,827 396 40 Nomura Holdings Inc 9 3.5 17,611 210 84 Allens 9 3.1 15,551 311 50 CITIC Securities Co Ltd 10 3.4 17,243 663 26 Kim & Chang 10 2.8 14,377 158 91 Source: Bloomberg Source: Bloomberg
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LAtin America & Caribbean
Deal Volumes Slid for Third Straight Year
$250 1,250 ← Value Deal count → 9%
$200 1,000 7% Airport development $150 750 7%
Oil E&P Investment cos. $100 500 7% Billions Buildings 67% 4% Schools $50 250 Other
$0 0
Source: Bloomberg Source: Bloomberg MA
Top 10 Deals
deal Value Payment Target Acquirer Seller Deal Status ($ mln) Type Galeao airport concession Odebrecht SA, Changi Airport Group etc Republic of Brazil 8,308 Cash Pending LNG Portfolio Royal Dutch Shell PLC Repsol SA 4,100 Cash Complete Zenda & Seara Brasil assets JBS SA Marfrig Alimentos SA 2,726 Undisclosed Complete Anhanguera Educacional Participacoes SA Kroton Educacional SA - 2,703 Stock Pending Petrobras Energia Peru SA China National Petroleum Corp Petroleo Brasileiro SA 2,600 Undisclosed Pending MMX Porto Sudeste Ltda Mubadala Development Co PJSC et al MMX Mineracao e Metalicos SA 2,246 Cash Pending HSBC Panama Unit Bancolombia SA HSBC Holdings PLC 2,234 Cash Complete Vale SA Cemig Geracao e Transmissao SA - 1,896 Undisclosed Pending Spaipa S/A Industria Brasileira de Bebidas Coca-Cola Femsa SAB de CV - 1,855 Cash Complete Diagnosticos da America SA Cromossomo Participacoes II SA - 1,855 Cash Pending Source: Bloomberg Top Financial Advisers Top Legal Advisers
Total Ave Total Ave Share Deal Share Deal Adviser Rank Deals Deal Adviser Rank Deals Deal (%) Count (%) Count ($ MLN) ($ Mln) ($ MLN) ($ Mln) Credit Suisse 1 25.7 26,158 747 35 Souza Cescon Barrieu 1 17.2 17,520 531 33 Banco BTG Pactual SA 2 18.4 18,745 329 57 Mattos Filho Veiga 2 9.8 10,020 244 41 Goldman Sachs & Co 3 16.4 16,692 879 19 Barbosa Mussnich 3 8.8 8,982 249 36 Bradesco BBI SA 4 15.4 15,657 626 25 Linklaters LLP 4 8.0 8,127 903 9 Banco Itau BBA SA 5 14.4 14,624 348 42 Davis Polk & Wardwell 5 7.1 7,223 722 10 Citi 6 8.8 8,971 528 17 Pinheiro Neto Advogados 6 6.5 6,670 202 33 Morgan Stanley 7 8.2 8,306 519 16 Lefosse Advogados 7 6.2 6,311 316 20 Banco Santander SA 8 7.3 7,450 497 15 Sullivan & Cromwell 8 5.6 5,718 953 6 Deutsche Bank AG 9 6.8 6,921 769 9 Skadden Arps 9 4.9 5,036 1,007 5 BofA Merrill Lynch 10 6.7 6,847 527 13 Stocche Forbes Padis 10 4.8 4,868 152 32 Source: Bloomberg Source: Bloomberg
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Pr ivate EQUITY Compiled by John E. Morris
Private Equity Firms Were Slow to Invest and Resorted to Refinancings, IPOs to Cash Out
Investments Continued at a Steady Pace $700 28 Private equity investment levels rose 18 percent last year from 2012, to $238 billion, their highest level since 2007, according to $600 24 data compiled by Bloomberg. Still, deal volume was behind 2005 ← Value - all deals and just 36 percent of its 2007 peak. $500 20 No. of deals >$5B → One encouraging sign: Six deals worth more than $5 billion were $400 16 announced last year, double the figures in 2011 and 2012. The list was led by the $27.4 billion purchase by Berkshire Hatha-
$300 12 Deals way Inc. and 3G Capital Inc. of ketchup maker HJ Heinz Co.; Billions $200 8 the $16.4 billion take-private of computer maker Dell Inc. by its founder Michael Dell and Silver Lake Management LLC; and $100 4 the $9.6 billion buyout of coffee blender D.E. Master Blenders $0 0 1753 NV by the German investment firm Joh A Benckiser S.E.
Source: Bloomberg
Exits Via Sales Were Down $300 900 The value of private-equity-backed companies sold slid 26.5 percent last year after a 19 percent drop the year before. Instead, ← Value $250 750 sponsors turned to refinancings (see next chart) or to initial public Exits → offerings (see next page) to realize profits. $200 600
$150 450
Deals Deals
Billions $100 300
$50 150
$0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Bloomberg
Junk Debt Funded Dividends As Well As LBOs Junk bond issuance in the U.S. hit a new high as yields fell to an $180 47% of total all-time low (see chart on page 6). $160 Use of proceeds: While credit was readily available, nearly half of the leveraged $140 Dividend payout finance obtained last year financed dividend payouts, not new $120 acquisitions, according to data compiled by Bloomberg. Nearly LBO $100 $79 billion of new debt was used for dividends, or 47 percent of the total, the same percentage as in 2012. In 2009, the bottom of $80 the market, only 13 percent went to payouts.
Billions $60 $40 $20 $0 2009 2010 2011 2012 2013 Source: Bloomberg
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Private equity
Selling Shares Rather Than Companies: Largest IPOs of Private-Equity-Backed Companies in 2013
Priced Issuer Name Country Backers Offer Size (M)
10/15/13 Plains GP US Occidental Petroleum Corp, Energy & Minerals Group 2,912
12/11/13 Hilton Worldwide US Blackstone 2,706
10/9/13 Antero Resources US Antero Resources, Yorktown Partners, Warburg Pincus, Trilantic Capital Partners et al 1,802
11/8/13 Merlin Entertainments UK Kirkbi A/S, Blackstone, CVC Capital Partners 1,700
1/31/13 LEG Immobilien Germany Perry Capital, Whitehall Funds 1,527
6/12/13 Coty US JAB Holdings, Berkshire Partners, Rhone Capital 1,140
6/19/13 bpost Belgium CVC Capital Partners 1,120
8/13/13 Envision Healthcare US Clayton Dubilier & Rice 1,111
6/26/13 HD Supply US Carlyle, Bain Capital, Clayton Dubilier, THD Holdings et al 1,101
5/8/13 Quintiles Transnational US TPG Capital, Bain Capital, 3i Group, Aisling Capital, Temasek 1,089
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JOHN MALONE’S BUSY YEAR
The Cable Industry Veteran Aims to Reshape the Sector on Two Continents
One man has had a leading role in more took a substantial stake in a sixth — deals Back home in the U.S., he bought mergers, attempted and complete, over the that, if completed, would be worth about control of satellite radio operator Sirius past year than any other: John Malone. $128 billion. XM Holdings Inc. in January 2013 Through his controlling stakes in two cable In Germany, after acquiring Kabel and this month offered to buy the rest. operators, Liberty Media Inc. and Lib- Baden-Wuerttemberg GmbH in 2011, Meanwhile, he is using cable operator erty Global Plc, he has pressed the case Liberty Global took a run last year at Kabel Charter Communications Inc., in which for consolidation in the telecommunica- Deutschland AG before Vodafone Group he first invested last May, as a vehicle to tions sector on both sides of the Atlantic. Plc outbid it with a $13.6 billion offer. launch an unsolicited $61.3 billion bid for Since January 2013, his companies have Frustrated in Germany, Malone turned the much larger Time Warner Cable Inc. spawned full takeover attempts for five his sights back to the Netherlands, build- this month. telecommunications companies in the U.S., ing up a position in Ziggo NV and now — John E. Morris and Will Robinson Britain, Germany and the Netherlands, and negotiating for a full takeover.
JOHN MALONE
Liberty Media Corp Liberty Global Plc Discovery Malone owns: Communications Inc. 94.6% (class B) 85.3% (class B) 93.1% (class B)
Gained control in Bought initial 12.6% Jan. 2013. Offered Purchased 27% stake in March, then this month to buy stake from Apollo raised in stages. Discovery discussed remaining 47% Global consortium Closed $21.6B Talks for full takeover bid for Scripps in for about $10.6B. in May for $2.6B. takeover in June. revived in December. November
Sirius XM Charter Virgin Media Inc. Ziggo NV Scripps Network Holdings Inc. Communications Interactive Inc. Liberty Media: Inc. Liberty Global: 28.5% 53.0% 25.8% 100.0%
Disclosed unsolicited $61.3B Lost out to Vodafone in bid- Competition clearance for 2011 deal offer on Jan. 13, 2014 ding war. Final price: $13.6B. reversed by German court in August.
Time Warner Kabel Deutsch- Kabel Baden- Cable Inc. land Holding AG Wuerttemberg GmbH Key: Acquisition Target
Source: Bloomberg News, Bloomberg MA
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DEALMAKER PROFILES By Will Robinson
The Advisers Behind Some of the Past Year’s Biggest Deals Blair Effron Centerview Partners LLC Partner and Co-founder Effron counseled global food products manufacturer HJ Heinz Co. on its $27.4 billion buyout by Warren Buffett’s Berkshire Hathaway Inc. and Jorge Paulo Lemann’s 3G Capital. The deal was announced in February and complet- ed in June. Effron also advised General Electric Co. on its $16.7 billion sale of its NBC Universal stake to Comcast Corp., which closed in March.
George Lee Goldman Sachs Group Inc. Chairman of the global technology, media and telecom group and chief information officer for the investment bank- ing division Lee, who was the head of the TMT group last year, was named that unit’s chairman in January, as well as CIO for the investment bank. He worked with Dell Inc. on its leveraged buyout and helped Microsoft Corp. reach a deal in September to buy Nokia Oyj’s mobile-devices unit for $5.4 billion.
Jimmy Lee JPMorgan Chase & Co. Vice Chairman Lee worked with General Electric Co. as it sold the remainder of its NBC Universal stake to Comcast Corp. for $16.7 billion, and he advised the Dell board on its $16.4 billion buyout by Michael Dell and Silver Lake Manage- ment LLC. He also worked on Twitter Inc.’s initial public offering, which was announced in September and priced in November.
Ken Moelis Moelis & Co. Co-founder and CEO The boutique banker worked with the HJ Heinz board committee on the ketchup maker’s $27.4 billion sale. He also advised Omnicom Group Inc. on its merger with Publicis Groupe SA. His firm is exploring an initial public of- fering, people with knowledge told Bloomberg News this month.
Paul Taubman PJT Capital LLC Principal Taubman, a former Morgan Stanley banker who left the company in 2013, won a role as an independent adviser on the year’s largest M&A transaction, helping Verizon Communications Inc. on its its $130 billion purchase of Voda- fone Group Plc’s stake in their wireless joint venture. Taubman began PJT Capital LLC last year as part of his role as an individual adviser on Verizon’s deal with Vodafone.
Chris Ventresca JPMorgan Chase & Co. Global co-head of M&A Ventresca advised Verizon Communications on deal with Vodafone and worked with Virgin Media Inc. on its $22 billion sale to Liberty Global Plc. JPMorgan named him co-head of global M&A in May along with Hernan Cris- terna. Ventresca previously ran North American M&A.
Antonio Weiss Lazard Ltd. Global head of investment banking Weiss helped Berkshire Hathaway and 3G Capital secure their purchase of HJ Heinz. He also worked with D.E. Master Blenders 1753 NV on its $9.6 billion sale to Joh. A Benckiser SE, the investment arm of the billionaire Reimann family.
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Chair: SEC Looking to Bring Actions To Stress Support for Compliance Functions, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
Chair: SEC Looking to Bring Actions To Stress Support for Compliance Functions, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ October 28, 2013
SEC Enforcement
Chair: SEC Looking to Bring Actions To Stress Support for Compliance Functions By Yin Wilczek
Oct. 22 — The Securities and Exchange Commission is looking for more cases to bring to emphasize its support for compliance programs, Chairman Mary Jo White said Oct. 22.
Addressing a gathering of compliance officials, White cited the recent novel action in which the commission proceeded against a former portfolio manager who allegedly misled his firm's chief compliance officer and falsified documents to hide his failure to report personal securities trades (45 SRLR 1599, 9/2/13).
It was the agency's first case under Rule 38a-1(c) of the 1940 Investment Company Act, which makes it unlawful for investment fund employees to mislead or otherwise manipulate a firm's CCO.
“This was a very important case because it held the portfolio manager directly accountable, not only for his substantive violations, but also for obstructing the compliance officer's work,” White told a meeting of the National Society of Compliance Professionals in Washington. “We want your firms to know, at every level, how important your work is to investors and to us.”
Adviser Shortfalls
White also observed that the Compliance Program Initiative—an effort by the Enforcement Division, the Office of Compliance Inspections and Examinations, and other SEC staff to identify repeated compliance shortfalls by registered investment advisers—so far has yielded six settled cases. She added that more actions “are in the pipeline.”
In an update: the day after White's speech, the SEC announced sanctions against three advisers under the compliance initiative [see related report in this issue].
On yet another enforcement front, OCIE has several specialized working groups in areas such as securities valuation, marketing and sales practices, and fixed income and municipal securities, that are working with enforcement staff to bring cases, White said. For example, she observed, the group specializing in fixed income and municipal securities helped the Enforcement Division bring several major cases against local municipal entities over alleged financial misstatements.
White assured the audience that even though the SEC has sued compliance officers in the past, those who perform their responsibilities diligently and in good faith need not fear a commission action. She also said that not every deficiency warrants an enforcement response. “Indeed, in the vast majority of cases, we address instances of noncompliance through engagement with the registrant, deficiency letters, and other approaches short of an enforcement action.”
‘Broken Windows’ Analogy
White, answering a question from the audience, clarified that she did not intend in a recent speech—in which she used the analogy of the “broken windows” approach of the New York State Police Department (45 SRLR 1883, 10/14/13)—to indicate that the SEC will bring enforcement actions against every minor violator.
“Broken windows” is “just an analogy,” White said. “It's not a game of gotcha at all.” Rather, the point is that the commission must pay attention to “programmatic violations.” As an example, she cited the commission's recent administrative proceedings against 23 firms under Regulation M Rule 105 for violating short-sale proscriptions in advance of stock offerings (45 SRLR 1783, 9/30/13).
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 Chair: SEC Looking to Bring Actions To Stress Support for Compliance Functions, Securities Regulation & Law Report (BNA)
The SEC has to act in those situations to “send a really strong deterrent message,” White said. “On the other hand, I think our judgment and our charging discretion are very important to exercise with appropriate restraint.”
The balance between enforcement and collaboration with the industry is “critical,” she continued. “The industry and the SEC work best in partnership.”
In other remarks, White told the audience that other divisions at the SEC are working to support the role of compliance officers. For example, she observed that OCIE now is more transparent with respect to its examination priorities, and is issuing alerts to raise registrants' awareness of high-risk areas.
Moreover, OCIE has improved its ability to analyze large data sets, White said. OCIE's Risk Analysis Examination—an initiative utilizing analytics to identify a wide range of potential violations—and other new SEC tools “should allow us to detect and inform you about activities, trends, and issues of which you may be unaware.”
In the Aftermath of Urban
Speaking to reporters after her speech, White said the SEC will not be seeking a “test case” to clarify the present ambiguity over who is a “supervisor” in the wake of In re Urban. “I don't look for test cases,” she said. “The cases we bring are driven by the law and the evidence.”
In the administrative proceeding, the SEC alleged that Theodore Urban, the then-general counsel of Ferris Baker Watts Inc., failed to reasonably supervise a broker engaged in a market manipulation scheme. Urban was absolved at the administrative law judge level, with Chief ALJ Brenda Murray concluding that he “performed his responsibilities in a cautious, objective, thorough, and reasonable manner” (42 SRLR 1719, 9/20/10).
However, industry and legal groups—including the Association of Corporate Counsel—cautioned at the time that the standard used by Murray to conclude that Urban was a supervisor for purposes of 1934 Securities Exchange Act Section 15 set a problematic precedent that would make it more difficult for inhouse counsel and compliance personnel to do their jobs (042 SRLR 2280, 12/6/10).
On review, the commission dismissed the claims against Urban because the two members participating in the decision could not agree on an outcome (44 SRLR 208, 1/30/12).
Since then, SEC Commissioner Daniel Gallagher repeatedly has called for more clarity, arguing that the current uncertainty over the commission's position could chill compliance functions (45 SRLR 653, 4/15/13).
The SEC's Division of Trading and Markets Sept. 30 issued guidance to clarify supervisory liability for compliance personnel ( 45 SRLR 1889, 10/14/13).
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The text of White's speech is available at http://www.sec.gov/News/Speech/Detail/Speech/1370539960588#.UmaxuRAWkoo.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2
SEC's Whistle-Blower Report for FY 2013 Shows Bounty Program's Gradual Expansion, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
SEC's Whistle-Blower Report for FY 2013 Shows Bounty Program's Gradual Expansion, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ November 25, 2013
Whistle-Blowers
SEC's Whistle-Blower Report for FY 2013 Shows Bounty Program's Gradual Expansion Nov. 15 — The Securities and Exchange Commission's whistle-blower bounty program is slowly expanding, according to the latest annual report from its Office of the Whistleblower Nov. 15.
The report said that in fiscal year 2013, the office received 3,238 tips and complaints, compared to the 3,001 that were received in FY 2012 (44 SRLR 2109, 11/19/12).
The report also said that in FY 2013, the complaints came from all 50 states in the U.S. and from 55 foreign jurisdictions. The SEC in FY 2012 received tips and complaints from all 50 states and from 49 jurisdictions outside the U.S.
However, the types of tips and complaints received in FY 2012 and 2013 have remained consistent. As in the prior fiscal year, the most common complaint categories in FY 2013 were corporate disclosures and financials, offering fraud, and manipulation, the report said.
Dodd-Frank Mandate
The bounty program was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The financial reform legislation directed the SEC to pay whistle-blowers between 10 percent to 30 percent of monetary sanctions collected if their tip led to successful SEC enforcement actions resulting in more than $1 million in fines.
Since the inception of the program in August 2011, the commission has received 6,573 whistle-blower tips and complaints, and granted awards to six whistle-blowers, four of them in FY 2013, the report said.
Among other highlights, the program issued its biggest award to date in FY 2013—$14 million in October to a whistle-blower whose information led to an enforcement action in which “substantial investor funds” were recovered (45 SRLR 1823, 10/7/13 ).
Sean McKessy, chief of the Whistleblower Office, said in the report that while the program's payout of more than $14 million in FY 2013 is significant, “the bigger story is the untold numbers of current and future investors who were shielded from harm thanks to the information and cooperation provided by whistleblowers.”
McKessy also said that the office continues to coordinate closely with the SEC Enforcement Division to identify cases in which employers may have retaliated against their employees for reporting potential securities law violations, or used confidentiality, severance or other agreements to discourage employees from voicing concerns about possible wrongdoing.
The SEC is authorized under Dodd-Frank to bring actions to enforce the statute's anti-retaliation provisions.
In the meantime, the report said the SEC's Investor Protection Fund—which funds the bounty program—had more than $439 million at the end of FY 2013.
For More Information
The report is available at http://www.sec.gov/about/offices/owb/annual-report-2013.pdf.
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SEC Announces $14M Award To Whistle-Blower; Is Largest to Date, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
SEC Announces $14M Award To Whistle-Blower; Is Largest to Date, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ October 07, 2013
Whistle-Blowers
SEC Announces $14M Award To Whistle-Blower; Is Largest to Date
BNA Snapshot
Award: Whistle-blower whose tip led to a successful SEC enforcement action awarded $14 million.
What's Next? The size of the award—the agency's largest to date—could motivate more whistle-blowers to come forward.
By Phyllis Diamond
Oct. 1 — A whistle-blower whose information led to an enforcement action in which “substantial investor funds” were recovered has received a $14 million award, the Securities and Exchange Commission announced Oct. 1.
In a release, the agency said the award is the largest made to date by its whistle-blower bounty program.
The SEC noted that whistle-blower payments are made from a separate fund established by the Dodd-Frank Wall Street Reform and Consumer Protection Act; they are not paid out of the commission's annual appropriations and do not reduce payments to harmed investors.
“Our whistleblower program already has had a big impact on our investigations by providing us with high quality, meaningful tips," SEC Chairman Mary Jo White said. “We hope an award like this encourages more individuals with information to come forward.”
Original Information
At least one Washington lawyer thinks that it will. “This is an eye-popping award that will get everyone's attention,” Stephen Crimmins, K&L Gates LLP, told Bloomberg BNA.
“The huge size of the award, as well as the secrecy about what kind of information led to it, will surely encourage a surge in whistleblower activity.”
According to the SEC, the whistle-blower in this case did not wish to be identified. It said only that the individual “provided original information and assistance that allowed the SEC to investigate an enforcement matter more quickly than otherwise would have been possible.”
The commission said it brought its case within six months of receiving the tip.
Crimmins was not the only lawyer who predicted that the $14 million award will encourage more whistle-blowers to come forward. “I think the award will definitely help promote the whistleblower program and encourage more whistleblowers to report suspected violations,” Michael MacPhail, Faegre Baker Daniels, Denver, told Bloomberg BNA.
Better News for Investors
Washington attorney William McLucas, a former SEC enforcement director who currently is a member of WilmerHale LLP, concurred, saying “an award of this magnitude is sufficiently large that indeed, it will get the attention of others and likely inspire more people to come forward as purported whistleblowers.”
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However, he told Bloomberg BNA, “[w]hether culling trough the tips and adequately evaluating them will actually yield the cases justifying the commitment of resources (much less real improvements and deterrence in the markets), remains to be seen.”
He noted that there have always been “principled whistleblowers”—those who seek to expose misconduct without expecting to be paid. However, McLucas said that “with the bounty payments, we now do not know whether either the benefits compared to the related costs will make the system better.”
McLucas' Washington colleague Laura Wertheimer offered a similar perspective. “I don't think people are motivated by money, but an amount of this magnitude, it's not insignificant.”
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins in Washington at [email protected].
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Regulators Mulling Coordination Of Volcker Rule Exams, SEC Official Says, Securities Law Daily (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
Regulators Mulling Coordination Of Volcker Rule Exams, SEC Official Says, Securities Law Daily (BNA)
Securities Law Daily™ February 24, 2014
Financial Institutions
Regulators Mulling Coordination Of Volcker Rule Exams, SEC Official Says By Yin Wilczek
Feb. 21 — While the multiple regulators tasked with enforcing the Volcker rule have started to confer about how they will coordinate their examination focus, a “lot more discussion” is necessary on the matter, a senior Securities and Exchange Commission official said Feb. 21.
John Ramsay, acting director of the SEC's Division of Trading and Markets, said his expectation is that the SEC will be taking a “lead” role with respect to broker-dealers regulated under the rule. The staff will be consulting with the firms about how they are implementing the rule's requirements, and will share that information with the other agencies to ensure that there is as much coordination as possible on how exams are conducted, he said.
Ramsay spoke with other TM officials at the Practising Law Institute's SEC Speaks event in Washington. They said they spoke their own views, which did not necessarily reflect those of the commission or other staff members.
Coordinated Rulemaking
In December, the SEC, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Commodity Futures Trading Commission adopted regulations to implement the Volcker rule. The rule—Dodd-Frank Wall Street Reform and Consumer Protection Act Section 619—bars banks from engaging in proprietary trading and limits their investments in hedge and private equity funds.
The regulations take effect April 1. Covered banking organizations have to fully conform with the requirements by July 21, 2015.
Earlier this month, SEC Chairman Mary Jo White told lawmakers that the five regulators have formed a working group to discuss implementation of the controversial restrictions on trading and fund ownership by banks. White, in testimony at a House Financial Services Committee hearing on the rule, said the interagency group plans to meet regularly and will coordinate the regulators' interpretations and implementation of the final rule.
At the PLI panel, TM Deputy Director James Burns said the working group likely will be rolling out guidance—in the form of “frequently asked questions”—as it proceeds forward on a coordinated implementation process. There are a number of interpretive questions for which FAQs are necessary, he said.
Uniform Fiduciary Standard
In other announcements, TM Chief Counsel David Blass referenced White's remarks earlier in the day that the SEC will intensify its consideration of whether there should be a uniform fiduciary standard for broker-dealers and investment advisers. Blass said that the staff continues to “formulate potential next steps” on the issue.
TM Associate Director Brian Bussey also said that the staff is “working really hard to finish a final recommendation” on the SEC's proposal to regulate cross-border swaps. Given that the percentage of U.S. to U.S. trades constitute only 10 percent of the market, the cross-border proposal is a “key part” of the SEC's implementation of Dodd-Frank Title VII, he said.
Meanwhile, the staff is “well along” in developing a recommendation to the commission on a final Regulation Systems Compliance and Integrity (SCI), TM Associate Director David Shillman said. The SEC proposed the regulation in March 2013, which would require exchanges and other market participants to craft and maintain comprehensive programs to ensure that
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Consolidated Audit Trail
Shillman also noted that the “first deliverable” for the consolidated audit trail is due Sept. 30, by which time the self-regulatory organizations must submit to the commission their plan for the central data repository. Once implemented, CAT will collect and identify orders, cancellations, and executions for all exchange-listed equities and options across all U.S. markets. Once implemented, it will allow regulators to more closely monitor market trading.
The SROs are in the midst of a “request for proposal” process to select a processor to build and administer CAT, Shillman continued. Once the SRO's plan is approved, it will take another three years before the plan is implemented, he said. Accordingly, the CAT system still is “a long way” off.
In other remarks, panel commentator David Ruder, a former SEC chairman who now is a Northwestern University law professor, asked whether TM is planning a “holistic” review of equity market structure, a move supported by all the current commissioners.
Ramsay responded that a “holistic” review means different things to different people. He also noted that a comprehensive review will have to be funded and planned in advance. “Our thoughts are that there are many significant issues that do warrant focused attention,” he said. The staff is trying to address some of the issues—such as high frequency trading, market fragmentation and small business capital formation—“topically and thematically” by soliciting views through the SEC's market structure website, he said.
Ramsay also told the audience that he will be leaving the commission soon and moving back to New York. He did not say what his next venture will be. The SEC Feb. 20 announced that it has named Washington lawyer Stephen Luparello, WilmerHale LLP, division director.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
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SEC, Frequently Asked Questions, Frequently Asked Questions About Liability Of Compliance And Legal Personnel At Broker-Dealers Under Sections 15(b)(4) And 15(b)(6) Of The Exchange Act
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
SEC, Frequently Asked Questions, Frequently Asked Questions About Liability Of Compliance And Legal Personnel At Broker-
Frequently Asked Questions About Liability Of Compliance And Legal Personnel At Broker- Dealers Under Sections 15(b)(4) And 15(b)(6) Of The Exchange Act
Division of Trading and Markets:
September 30, 2013
In responding to these Frequently Asked Questions ("FAQs"), the Division of Trading and Markets is providing guidance relating to liability that ma y arise under Sections 15(b)(4) and 15(b)(6) of the Securities Exchange Act of 1934 in connection with the role and duties of Chief Compliance Officers and other compliance and legal personnel at broker-dealers. Responses to these FAQs were prepared by and represent the views of the Division of Trading and Markets. They are not rules, regulations or statements of the Commission. The Commission has neither approved nor disapproved these interpretive answers.
The staff may update these questions and answers periodically. In each update, the questions added after publication of the last version will be marked with "MODIFIED" or "NEW."
For Further Information Contact: Any of the following at (202) 551-5550: David W. Blass, Chief Counsel; Joseph Furey, Assistant Chief Counsel; Joanne Rutkowski, Branch Chief; or Stephen J. Benham, Attorney-Adviser, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-7010.
Background Broker-dealers may choose to structure their supervisory and compliance systems in different ways. No matter which particular structure is employed, compliance and legal personnel play a critical role in efforts by broker-dealers to comply with legal and regulatory requirements through the implementation of effective systems.
Liability for failure to supervise is a facts and circumstances determination. The purpose of these FAQs is to provide staff guidance to consider in assessing whether particular facts and circumstances result in potential supervisory liability for broker-dealers' compliance and legal personnel. 1 The Exchange Act does not presume that a broker- dealer's compliance or legal personnel are supervisors solely by virtue of their compliance or legal functions. 2 Rather, the question is whether compliance or legal personnel have supervisory authority over business units or other personnel outside the compliance and legal departments as could be the case, for example, if a chief executive or operating officer also is the firm's chief compliance officer. Supervisory authority also can be implicitly delegated to, or assumed by, compliance or legal personnel.
Section 15(b)(6) of the Exchange Act authorizes the Commission to institute proceedings against a natural person associated with a broker-dealer if someone under that person's supervision violates the provisions of the federal securities laws, the Commodity Exchange Act, the rules or regulations under those statutes, or the rules of the Municipal Securities Rulemaking Board, and the supervisor failed reasonably to supervise that person with a view to preventing the particular violation. Most enforcement actions against individuals for failure to supervise have involved business line personnel. The Commission has brought failure to supervise actions against broker-dealer legal or compliance personnel only in limited circumstances in which these individuals have been delegated, or have assumed, supervisory responsibility for particular activities or situations, and therefore have "the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue." 3
The Commission has stated that ultimately the responsibility for a broker-dealer's compliance resides with its chief executive officer and senior management. 4 When Commission staff seeks to bring legal actions for failure to supervise, our focus is on the roles and responsibilities of the respective parties. As a general matter, the staff does not single out compliance or legal personnel. Rather we encourage compliance officers and other compliance and legal personnel to take strong and vigorous action regarding indications of misconduct.
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Responses to Frequently Asked Questions Question 1. Is a chief compliance officer or any other compliance or legal personnel a supervisor of broker-dealer business personnel solely by virtue of the compliance or legal position?
Answer: No. Compliance and legal personnel are not "supervisors" of business line personnel for purposes of Exchange Act Sections 15(b)(4) and 15(b)(6) solely because they occupy compliance or legal positions. 5 Determining if a particular person is a supervisor depends on whether, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue. 6
Question 2. What does it mean to have the requisite degree of responsibility, ability or authority to affect the conduct of another employee?
Answer: A person's actual responsibilities and authority, rather than, for example, his or her "line" or "non-line" status, determine whether he or she is a "supervisor" for purposes of Exchange Act Sections 15(b)(4) and 15(b)(6) . 7 Among the questions to consider in this regard:
• Has the person clearly been given, or otherwise assumed, supervisory authority or responsibility for particular business activities or situations? • Do the firm's policies and procedures, or other documents, identify the person as responsible for supervising, or for overseeing, one or more business persons or activities? • Did the person have the power to affect another's conduct? Did the person, for example, have the ability to hire, reward or punish that person? 8 • Did the person otherwise have authority and responsibility such that he or she could have prevented the violation from continuing, even if he or she did not have the power to fire, demote or reduce the pay of the person in question? • Did the person know that he or she was responsible for the actions of another, and that he or she could have taken effective action to fulfill that responsibility? • Should the person nonetheless reasonably have known in light of all the facts and circumstances that he or she had the authority or responsibility within the administrative structure to exercise control to prevent the underlying violation?
Question 3. Can compliance and legal personnel provide advice and counsel to business line personnel without being considered supervisors of the business line personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by providing advice and counsel to business line personnel. Compliance and legal personnel do not become "supervisors" solely because they have provided advice or counsel concerning compliance or legal issues to business line personnel, or assisted in the remediation of an issue. If their responsibilities or authorities extend beyond compliance and legal functions such that they have the requisite degree of responsibility, ability or authority to affect the conduct of business line personnel, additional inquiry may be necessary to determine if they could be considered supervisors of the business line personnel.
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Question 4. Can a broker-dealer establish and implement a robust compliance program without its compliance and legal personnel being considered to be supervisors for purposes of the Exchange Act?
Answer: Yes. Broker-dealers have a duty to build effective compliance programs that are reasonably designed to ensure compliance with applicable laws and regulations. 9 Among the things that firms should consider including in their programs are robust compliance monitoring systems, processes to escalate identified instances of noncompliance to business line personnel for remediation, and procedures that clearly designate responsibility to business line personnel for supervision of functions and persons.
Broker-dealers should consider clearly defining compliance and advisory duties and distinguishing those duties from business line duties in order for persons who perform only compliance and legal functions to avoid becoming supervisors of business line employees. Management at broker-dealers can greatly benefit from the participation and input of compliance and legal personnel.
Question 5. Can compliance or legal personnel participate in a management or other committee without being considered supervisors of business activities or business personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by participating in management and other committees. Compliance and legal personnel do not become "supervisors" solely because they participate in, provide advice to, or consult with a management or other committee. As explained above, the determination whether a particular person is a supervisor depends on whether, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue. 10
Question 6. Can compliance or legal personnel provide advice to, or consult with, senior management without being considered supervisors of business activities or business personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by providing advice and counsel to senior management. Compliance and legal personnel do not become "supervisors" solely because they provide advice to, or consult with, senior management. In fact, compliance and legal personnel play a key role in providing advice and counsel to senior management, including keeping management informed about the state of compliance at the broker- dealer, major regulatory developments, and external events that may have an impact on the broker-dealer. In this regard, compliance and legal personnel should inform direct supervisors of business line employees about conduct that raises red flags and continue to follow up in situations where misconduct may have occurred to help ensure that a proper response to an issue is implemented by business line supervisors. Compliance and legal personnel may need to escalate situations to persons of higher authority if they determine that concerns have not been addressed.
Question 7. What is the status of the initial decision in the Theodore W. Urban matter? 11
Answer:
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Under the Commission's rules of practice, if a majority of the Commissioners do not agree on the merits (as was the case in Urban ), the initial decision "shall be of no effect." 12
Question 8. What responsibilities does a person working in a compliance or legal capacity have if he or she is a supervisor for purposes of the Exchange Act?
Answer: Once a person has supervisory obligations, he or she must reasonably supervise with a view to preventing violations of the federal securities laws, the Commodity Exchange Act, the rules or regulations under those statutes, or the rules of the Municipal Securities Rulemaking Board. That person must reasonably discharge those obligations or know that others are taking appropriate action. It is not reasonable for a person with supervisory obligations to be a mere bystander to events that occurred, or to ignore wrongdoing or "red flags" or other suggestions of irregularity. 13
Exchange Act Section 15(b)(4)(E) provides an affirmative defense to potential liability for failure to supervise if a firm has established procedures and a system for applying those procedures that would reasonably be expected to prevent and detect, insofar as practicable, a violation, and the supervisor has reasonably discharged his or her duties pursuant to the procedures and system, without reasonable cause to believe that the procedures and system were not being complied with. fn 1 Regardless of their status as supervisors, compliance and legal personnel who otherwise violate the federal securities laws or aid and abet or cause a violation may independently be held liable for the violation. fn 2 Compliance and legal personnel may, of course, have supervisory responsibility for personnel within their departments. These FAQs focus on circumstances where compliance and legal personnel are dealing with employees who work outside the compliance and legal departments and report to business line management, e.g., sales and marketing. fn 3 John H. Gutfreund, Exchange Act Release No. 31554 (Dec. 3, 1992). fn 4 Sheldon v. SEC, 45 F.3d 1515, 1517 (11th Cir. 1995) ("The president of a corporate broker-dealer is responsible for compliance with all of the requirements imposed on his firm unless and until he reasonably delegates particular functions to another person in that firm, and neither knows nor has reason to know that such person's performance is deficient."), quoting Universal Heritage Investments Corp., 47 S.E.C. 839, 845 (1982) (finding securities firm's president had properly delegated duties). fn 5 Gutfreund, supra note 3. fn 6 Id. fn 7 Id. at n. 24. fn 8 We note that the Supreme Court recently considered the question of supervisory status for purposes of Title VII of the Civil Rights Act of 1964. See Vanc e v. Ball State Univ., 133 S. Ct. 2434 (2013) (holding that an employee is a "supervisor" of another employee for purposes of vicarious liability under Title VII of the Civil Rights Act of 1964 only if he or she is empowered by the employer to take tangible employment actions against the other employee. Tangible employment actions include hiring, firing, failing to promote, reassigning with significantly different responsibilities, and making a decision causing a significant change in benefits). Vance does not address supervisory responsibility for purposes of the Exchange Act, and does not reflect all of the factors that are relevant
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to establishing such responsibility under the Exchange Act. fn 9 See, e.g., Section 15(g) of the Exchange Act and relevant rules of self-regulatory organizations. fn 10 Firms should evaluate what role legal or compliance personnel perform on management or other committees. In this regard, broker-dealers could consider whether legal or compliance personnel should serve ex offic io, as non- voting members, serving in an active but advisory role to the committee. fn 11 Theodore W. Urban, SEC Administrative Proceeding File No. 3-13655 , Initial Decision Release No. 402 (September 8, 2010), dismissed by Exchange Act Release No. 66359 (January 26, 2012). fn 12Commission Rule of Practice 411(f), 17 C.F.R. § 201.411(f) . fn 13 Gutfreund, supra note 3 ("Even where the knowledge of supervisors is limited to 'red flags' or 'suggestions' of irregularity, they cannot discharge their supervisory obligations simply by relying on the unverified representations of employees.").
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SEC Congressional Testimony, Testimony On SEC Budget
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
SEC Congressional Testimony, Testimony On SEC Budget
Testimony On SEC Budget by Chair Mary Jo White U.S. Securities and Exchange Commission Before the Subcommittee on Financial Services and General Government,
Committee on Appropriations,
United States House of Representatives
May 7, 2013
Chairman Crenshaw, Ranking Member Serrano, and Members of the Subcommittee:
Thank you for the opportunity to testify today in support of the President's fiscal year (FY) 2014 budget request for the U.S. Securities and Exchange Commission (SEC).1 I welcome the chance to discuss how the SEC would make effective use of the $1.674 billion requested for the coming fiscal year and to explain why the agency needs the funding it is seeking to do the job it is required to do on behalf of investors and our capital markets.2 As described in more detail below, the agency's funding request is critical to support the additional staff, technology, and training needed to fulfill our mission. Even though our funding mechanism is deficit-neutral, I recognize it is critical that we use appropriated funds in the most efficient and effective way possible as stewards of these resources.
As you know, the SEC has a broad, three-part mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Although I have been at the agency less than a month, two things were immediately apparent: first, the tremendous scope and importance of that mission, and second, the exceptional level of commitment, talent, and expertise the agency's staff demonstrates each and every day on behalf of America's investors and markets. The U.S. markets are the envy of the world precisely because of the SEC's work effectively regulating the markets, requiring comprehensive disclosure, and vigorously enforcing the securities laws. I am honored to have the opportunity to lead the SEC in executing its mission.
Today, the SEC's jurisdiction and responsibilities have evolved to cover significant new aspects of the securities markets. As part of its core responsibilities, the SEC is charged with implementing and enforcing the federal securities laws, overseeing thousands of key market participants (over 25,000 entities currently),3 and reviewing disclosures and financial statements of approximately 9,100 reporting companies. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and the Jumpstart Our Business Startups Act (JOBS Act), the agency's importance and scope of responsibilities increased, with the Dodd-Frank Act giving the Commission significant additional responsibilities for over-the-counter derivatives, hedge fund and other private fund advisers, municipal advisors, and security-based swap clearing agencies, and the JOBS Act providing new private offering exemptions, including a new regime for crowdfunding offerings.
In recent years, the agency has made significant strides forward to strengthen its oversight over markets that are so critical to the savings of American families and to the growth potential of American businesses. With the help of the resources provided by Congress in recent years, the SEC has bolstered its examination and enforcement functions, improved its capacity to assess risks, and enhanced its technology. It also has made a number of necessary and important internal improvements designed to maximize efficiencies and reform its operations. Much more, however, remains to be accomplished.
The SEC's current level of resources still presents significant challenges as we seek to keep pace with the growing size and complexity of the securities markets and fulfill our broad mandates and responsibilities. The FY 2014 budget request - all of which would be fully offset by matching collections of fees on securities transactions and thus will not increase the Federal budget deficit - seeks to address these challenges directly, to better position the agency to
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 SEC Congressional Testimony, Testimony On SEC Budget provide the kind of market oversight that the public expects and deserves.
Before delving into the details of our funding needs for 2014, I would like to briefly highlight a few key areas that I believe should be our top priorities and that have been important drivers for our budget request.
Key Priorities First, the SEC must complete, swiftly and thoughtfully, the rulemaking mandates contained in the Dodd-Frank Act and JOBS Act. Of the more than 90 Dodd-Frank Act provisions that require SEC rulemaking, the SEC has proposed or adopted rules for over 80 percent of them, and also has finalized 17 of the more than 20 studies and reports that it was directed to complete. But there is still much Dodd-Frank Act work that remains. Similarly, the JOBS Act requires significant Commission rulemaking which has not yet been completed. To fulfill these legislative mandates expeditiously must be an immediate imperative for the Commission. In connection with those rules, I will continue the Commission's efforts to ensure that the SEC performs robust economic analysis, as rigorous economic analysis is important and should inform and help guide our decisions.
While the Commission, with its existing staff, is already far along in many of its statutorily mandated rulemakings, we need additional staff and investments in technology to successfully implement these mandates. For example, the FY 2014 budget request would enable the SEC to bring in more economists to perform economic and risk analyses to assist in all of our rulemaking decisions, as well as support new technology for a municipal advisor registration system. We also need additional resources to improve our ability to help our markets and participants transition to new rules and requirements. Market certainty is critical to its functioning, especially during periods of regulatory change. The FY 2014 request would allow us to hire additional staff with technical skills and experience to process and review on a timely basis requests for interpretations, registrations, and other required approvals. Additional resources also will be needed to help conduct risk-based supervision of newly registered entities such as security-based swaps dealers and major swap participants, which will be subject to registration and regulation by the agency.
Second, I am committed to further strengthening the core enforcement and examination functions of the SEC. Strong enforcement of the securities laws is necessary for investor confidence and is essential to the integrity of our financial markets. Successful enforcement actions result in sanctions that deter and punish wrongdoing and protect investors, both now and in the future. Similarly, our National Examination Program (NEP) is critical to improving compliance, preventing and detecting fraud, and monitoring market risks. As described in more detail below, the current level of resources is not sufficient to permit the SEC to examine regulated entities and enforce compliance with the securities laws in a way that investors deserve and expect.
Third, the SEC needs to be in a position to provide adequate oversight over today's highly complex and dispersed marketplace so that it can be wisely and optimally regulated, which means without undue cost and without undermining its vitality. There must be a sense of urgency brought to understanding more fully the impact on investors and the quality of our markets of high-frequency trading, complex trading algorithms, dark pools, and intricate new order types so that appropriate regulatory responses can be made. I know that many in Congress are also interested in this important area. The FY 2014 budget request would assist the SEC in making investments in much needed technology and expertise, not only helping us keep better pace with the markets we monitor and regulate, but also permitting us to see around corners and anticipate issues that may arise.
FY 2014 Request The SEC is requesting $1.674 billion for FY 2014. If enacted, this request would permit us to add approximately 676 new staff positions, both to improve core operations and implement the agency's new responsibilities. While we understand that this request comes during a time of serious fiscal challenges, we have tried to be as targeted as we could in making these requests in the areas where the immediate deployment of resources is most critical.
The budget request would provide additional funding for the following key areas:
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• expanding oversight of investment advisers and improving their regulation and compliance - a point at which investors are most at risk of being defrauded and harmed; • bolstering enforcement - a primary function of the agency is to enforce the law and deter other would-be wrongdoers; • economic and risk analysis to support rulemaking and oversight - critical to good and valid rulemaking; • building oversight of derivatives and clearing agencies - significant new agency responsibilities to help safeguard against future financial crises; • enhancing reviews of corporate disclosures - including supporting implementation of the JOBS Act; • leveraging technology - to improve our ability to detect wrongdoing, streamline our operations, and tighten the security of our data; and • enhancing training and development of SEC staff - to increase our staff expertise.
I would now like to describe each of these in more detail.
Expanding Oversight of Investment Advisers and Improving Their Regulation and Compliance During FY 2012, although the SEC continued to use and improve risk-based analysis to select examination candidates in its examination program, it was able to examine only about eight percent of registered investment advisers. Over 40 percent of advisers have never been examined. The number of registered advisers has increased by more than 40 percent over the last decade, while the assets under management by these advisers have increased more than two-fold, more than $50 trillion. In addition to this exponential growth in size, the industry is increasingly complex. This complexity includes: the use of new and sophisticated products, including derivatives and certain structured products; technologies that facilitate high-frequency and algorithmic trading; and complex "families" of financial services companies with integrated operations that include both broker-dealer and investment adviser affiliates. Although the agency has successfully focused its limited examination resources on those areas posing the greatest risk to investor assets, the SEC's examination coverage continues to be insufficient in comparison with the rates achieved by other financial regulators and in the opinion of many third-party observers.
Therefore, under the FY 2014 request, one of the SEC's top priorities is to hire 250 additional examiners to increase the proportion of advisers examined each year, the rate of first-time examinations, and the examination coverage of investment advisers and newly registered private fund advisers. This would be an important step in a multi-year effort to increase coverage by our examination program to meet our regulatory responsibilities to investors who increasingly turn to investment advisers for assistance navigating the securities markets and investing for retirement and family needs.
The NEP also would be able to add 60 positions to improve oversight and examination functions related to broker- dealers, clearing agencies, transfer agents, self-regulatory organizations (SROs), and municipal advisors. In addition, 15 positions would be used to support other critical program initiatives such as enhancing global risk assessment and surveillance efforts and improving technology capabilities. These positions are vital as the agency continues to strive to adapt to the rapid change and increasing complexity of the markets it regulates and its increased examination responsibilities with regard to clearing agencies, securities-based swap market participants, and municipal advisors.
Bolstering Enforcement The ability to identify and bring timely, high-quality enforcement actions when violations of the federal securities laws occur is integral to the SEC's core mission. The SEC must enhance its enforcement function not only to send strong messages to wrongdoers that misconduct will be swiftly and aggressively addressed, but also to adapt for the highly automated, high-speed, and high-volume markets of today and tomorrow. Under this budget request, we would be able to further refine our analysis of tips and leverage incoming data to identify trends of possible misconduct across product, sector, or geographic areas. We also would engage additional industry experts and proactive data analytics to better target industry practices that may harm investors. For example, we have developed certain algorithms to mine publicly available hedge fund performance data to identify aberrational performance returns that could be indicative of conduct warranting further investigation. With additional front line investigative attorney, trial attorney, and
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 3 SEC Congressional Testimony, Testimony On SEC Budget forensic accountant resources, we would further bolster our core work of pursuing potential securities laws violations identified from these and other sources. The Division of Enforcement would focus its hiring of 131 staff on increased expertise in the securities industry and new product areas, trial attorneys, and forensic accountants, as well as staff for the Office of Market Intelligence, the Office of the Whistleblower, and the SEC's collections and distributions functions.
Economic and Risk Analysis to Support Rulemaking and Oversight For FY 2014, the SEC requests funding to add 45 positions in the Division of Risk, Strategy and Financial Innovation (RSFI), a roughly 45 percent increase in the size of this essential function. These positions would be used primarily for additional financial economists to perform economic analyses and research in support of the Commission's activities. Specifically, RSFI would seek economists with expertise in analyzing high frequency trading data and market structure and practices, executive compensation and related areas of corporate governance, and credit-default swaps in support of Dodd-Frank Act required rulemakings. RSFI also plans to hire operations research analysts with backgrounds in mathematics, statistics or econometrics to expand the development and delivery of risk metrics and analytics to inform risk assessment in examinations and investigations, rulemaking, and economic analysis.
Building Oversight of Derivatives and Clearing Agencies The Commission's regulatory responsibilities have been significantly expanded with the addition of new categories of registered entities (including security-based swap execution facilities, security-based swap data repositories, security- based swap dealers, and major security-based swap participants); the required regulatory reporting and public dissemination of security-based swap data; and the mandatory clearing of security-based swaps. To avoid bottlenecks and unintended market disruptions as the new requirements become operational over the next two years, the agency will need additional staff going forward with technical skills and experience to process and review on a timely basis the requests for rule interpretations, registration, or required approvals. New staff also will be needed to supervise registered security-based swap dealers and participants, and to use newly-available data to identify excessive risks or other threats to security-based swap markets and investors.
In addition, the agency intends to focus on further enhancing its oversight of clearing agencies, including clearing agencies expected to register with the Commission in the near future. Currently, six clearing agencies have been designated systemically important by the Financial Stability Oversight Council (FSOC) and, of the six, the SEC is the supervisory agency for four. This has been accompanied by a materially higher level of work, including, for example, an annual exam requirement for the clearing agencies for which we are the supervisory agency and enhanced coordination with other agencies for proposed changes and supervision activities. We also anticipate additional work associated with Commission rules relating to clearing of security-based swaps, as the requirements are new and the relevant clearing agencies are new agency registrants.
Currently, the average transaction volume cleared and settled by the seven active registered clearing agencies is approximately $6.6 trillion a day. Notwithstanding this tremendous volume, the SEC currently has on staff 14 examiners devoted to examining registered clearing agencies, with only a limited on-site presence existing in four of the seven. Additionally, the SEC has about a dozen other staff focused on the monitoring and evaluation of risk management systems used by the existing clearing agencies, and will need to expand these efforts to address the expected increase in the number of clearing agencies and rule filings raising risk management issues. Without these additional resources, the mismatch between the amount of regulated clearing activity and staffing will be exacerbated both by the additional clearing agencies that are expected to register with the SEC as a result of security-based swap activities and the expanded oversight required due to clearing agencies' designations as systemically important by the FSOC. Accordingly, the FY 2014 budget request seeks to add 25 positions in the Division of Trading and Markets and in the NEP to support these functions.
Enhancing Reviews of Corporate Disclosures, Including Supporting Implementation of the JOBS Act For FY 2014, the SEC requests 25 new positions for the Division of Corporation Finance. These positions would permit us to hire additional attorneys and accountants to continue to enhance the Division's reviews of large companies, review draft registration statements submitted by emerging growth companies under the JOBS Act,
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 4 SEC Congressional Testimony, Testimony On SEC Budget prepare and finalize the remaining rules and projects to implement the Dodd-Frank Act and the JOBS Act, and respond to requests for interpretive guidance, including with respect to new rules. Further, the additional positions would allow the Division to enhance its review of SEC rules and regulations impacting small business capital formation and better evaluate trends in increasingly complex offerings.
Leveraging Technology Beyond the need to increase the number of experts dedicated to overseeing the securities industry, it also is critically important to continue leveraging technology to streamline operations and increase the effectiveness of the agency's programs. While the SEC has made significant progress over the past few years in modernizing our technology systems, the agency must continue to make significant investments if it is to properly oversee the markets and entities it regulates. The FY 2014 budget request would add $56 million for technology to support a number of key Information Technology (IT) initiatives, including enhancements to the system for receiving tips, complaints, and referrals (TCR), improvements to IT security, and infrastructure upgrades to achieve efficiencies in business operations and reduce long-term costs.
The SEC plans to enhance its TCR system by building an interface to the agency's exam and case management systems, adding intake and routing functionality for referrals from the self-regulatory organizations (SROs), and expanding internal reporting to SEC management on the tracking, investigation, and disposition of TCRs. Additionally, the agency plans to develop a component of the TCR system that will automatically triage incoming tips so they can quickly be flagged for additional follow-up.
The agency also seeks to make a significant investment in its information security program to deploy a new set of security tools and develop and train staff to monitor, respond to, and remediate threats. Additionally, the SEC is requesting resources to implement infrastructure upgrades that will achieve efficiencies in business operations and reduce long-term costs. For example, the agency plans a number of initiatives to automate business processes and share data across the agency, to improve collaboration and content management across the agency, and continue strategic replacement of existing hardware and software to hold down maintenance costs.
While the need for resources is significant, we also realize and appreciate the imperative to identify ways to reduce costs wherever possible, so we can dedicate more funds to fulfilling our mission. The SEC has made important strides forward in this regard, identifying and realizing substantial savings and operational efficiencies in recent years. For example, in the technology areas, agency initiatives have resulted in more robust IT infrastructure support contracts, savings in software maintenance and support contracts, upgrades to data storage systems, and reductions in remote connectivity and network costs. Together these steps yielded cost savings of approximately $12 million in FY 2012, and continued savings are expected in FY 2013 and beyond.
The SEC's savings initiatives are expected to continue into FY 2014, as the agency is working to identify and implement new technologies and business process improvements that will offer increased performance with reduced operational costs.
SEC Reserve Fund In FY 2014, the SEC plans to use $50 million from the SEC Reserve Fund, established by statute, to fund large, multi- year, mission-critical technology projects. As required by statute, we will continue to notify this Subcommittee within ten days of each obligation from the Reserve Fund. Among other projects, the agency would continue its multi-year effort to overhaul the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system to create a new, modernized system that will meet Commission requirements for real-time system updates, reduce filer burden by providing simplified search and filing options based on filer experience (i.e., professional or novice), improve data capture by moving to structured formats for various SEC forms, and reduce the long term costs of operating and maintaining the system.
In addition, we plan to use the SEC Reserve Fund for the construction and enhancement of the Enterprise Data
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 5 SEC Congressional Testimony, Testimony On SEC Budget
Warehouse (EDW). The EDW is a critical step in combining currently disparate sources of data from EDGAR filings, exam reports, investigations, external vendors, and many other sources. An organized central data repository will allow enhanced analytical capabilities, predictive modeling, and strengthened governance of data controls and quality standards.
We also plan to use the SEC Reserve Fund toward the development of the capability to intake, store and analyze data from the upcoming Consolidated Audit Trail (CAT) that the Commission has mandated the SROs create to increase the data available to regulators. A CAT repository would enable the SEC to intake CAT data and store it in the EDW, as well as to develop analytical tools and a single software platform that will allow the SEC to identify patterns, trends, and anomalies in the CAT data. The tools and platform will allow seamless searches of data sets to examine activity to reveal suspicious behavior in securities-related activities and quickly trace the origin.
Enhancing Training and Development of SEC Staff The SEC's hardworking staff is the most important component of the agency's successes. The FY 2014 request includes a significant increase in the SEC's total training budget to deepen expertise and skills, in order to keep pace with the rapidly evolving nature of the markets and areas of new responsibility. The planned investment principally supports training and development for employees directly involved in examinations, investigations, fraud detection, litigation, and other core mission responsibilities of the SEC. The training will consist of specialized in-depth training concerning new trends in the securities industry and changing market conditions, the impact of the current market structure on compliance and trading activities, and analytics and forensics using market data. The resources requested in the FY 2014 budget would bring the SEC's level of training investment more on par with other Federal financial regulatory agencies.
Conclusion I very much appreciate your consideration of the President's FY 2014 budget request. Your support for the SEC's expansive and vital mission will allow us to better protect investors and facilitate capital formation, more effectively oversee the markets and entities we regulate, and build upon the significant improvements we have made to date.
Thank you for inviting me to be here today. I would be happy to answer your questions. fn 1 A copy of the SEC's FY2014 Budget Congressional Justification can be found on our website at http://www.sec.gov/about/reports/secfy14congbudgjust.pdf. fn 2The views expressed in this testimony are those of the Chair of the Securities and Exchange Commission and do not necessarily represent the views of the President or the full Commission. In accordance with past practice, the budget justification of the agency was submitted by the Chair and was not voted on by the full Commission. fn 3 These participants include about 10,600 investment advisers, 9,700 mutual funds and exchange traded funds, 4,600 broker-dealers, and approximately 460 transfer agents. We also oversee 17 national securities exchanges, seven active registered clearing agencies, and 10 nationally recognized statistical rating organizations (NRSROs), as well as the Public Company Accounting Oversight Board (PCAOB), Financial Industry Regulatory Authority (FINRA), Municipal Securities Rulemaking Board (MSRB), the Securities Investor Protection Corporation (SIPC), and the Financial Accounting Standards Board (FASB).
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 6
In Seeking Admissions, SEC Will Not Factor in Defendants' Collateral Impacts, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
In Seeking Admissions, SEC Will Not Factor in Defendants' Collateral Impacts, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ October 14, 2013
SEC Enforcement
In Seeking Admissions, SEC Will Not Factor in Defendants' Collateral Impacts By Yin Wilczek
Oct. 10 — In determining whether to seek admissions in the settlement of an enforcement action, the Securities and Exchange Commission will not take into account any collateral consequences that might befall the defendant in question, co-Enforcement Director Andrew Ceresney said Oct. 9.
Ceresney said the recent change in the agency's “neither admit/nor deny” policy is not about collateral consequences. Instead, the SEC is “looking at the facts in particular cases and whether” admissions are justified based upon the need for accountability, he said.
The SEC will have to try those cases in which it wants—but the defendant refuses to make—an admission, Ceresney added. “Ultimately the facts will be aired in court, and then some fact finder will decide.”
Meanwhile, former SEC Enforcement directors warned Ceresney that how the commission exercises its discretion in deciding when to pursue admissions could become a major issue going forward.
Former Directors
Ceresney spoke on a panel at the Securities Enforcement Forum in Washington on which four former Enforcement directors also participated. The other panelists were:
• Robert Khuzami, a Washington-based Kirkland & Ellis LLP partner who was director from February 2009 to January 2013;
• Linda Chatman Thomsen, a Washington-based Davis Polk & Wardwell LLP partner who was director from 2005 to early 2009 and the only woman to have served in that capacity;
• William McLucas, a Washington-based Wilmer Cutler Pickering Hale & Dorr LLP partner who was the division's longest serving director, from 1989 to 1998; and
• retired federal district court judge Stanley Sporkin, who led the division from 1974 to 1981.
The panel was moderated by Bradley Bondi, a partner at Cadwalader, Wickersham & Taft LLP, Washington. Ceresney said he spoke his own views, and not on behalf of the commission or other staff members.
In June, SEC Chairman Mary Jo White announced that in certain limited situations, the commission would forgo its traditional policy of allowing defendants to settle their cases without admitting to the allegations (45 SRLR 1150, 6/24/13). SEC officials, including Ceresney, said that the few instances in which the agency will strive for admissions include where the misconduct harmed large numbers of investors or placed them at risk of potentially serious harm, or where the commission wants to send a message (45 SRLR 1757, 9/23/13).
Follow-On Problems
Collateral consequences, including follow-on private securities litigation and other enforcement actions by foreign and domestic authorities, are a main reason that defendants balk at admitting to SEC violations. Bondi, in asking Ceresney about the SEC's consideration of collateral consequences, observed that defense contractors face additional problems, such as
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 In Seeking Admissions, SEC Will Not Factor in Defendants' Collateral Impacts, Securities Regulation & Law Report (BNA) being barred from future federal contracts.
Khuzami said that when he was Enforcement director, he considered whether the SEC should try to obtain admissions but added that he “didn't believe in a notion” where admissions would be required in a “subcategory” of actions. It is “a question of costs and benefits,” he added.
While the benefits of getting an admission are public, the costs are “largely hidden,” Khuzami continued. The collateral consequences that defendants face are unpredictable, and the SEC—in trying cases in which it wants admissions—will not have the resources to undertake other activities.
In addition, there is a “cost to the notion of justice” given that the SEC will have to pick and choose which cases in which it wants admissions, Khuzami warned. Accordingly, it is incumbent upon the division co-directors and White to closely monitor how such decisions are reached, and their attendant costs and benefits, he said.
Other panel members also suggested that the SEC could achieve accountability without demanding admissions. It will be a challenge for the SEC to exercise its discretion, and its decisions will be debated going forward, they said. People will be asking: “did you do it in the right or wrong case?” Sporkin said.
Penalty Inflation?
During the panel, Ceresney also was asked whether there is penalty inflation at the SEC and other regulators. For example, Bondi observed that the SEC reached a then-record $550 million settlement with Goldman Sachs & Co. (GS) in 2010 over alleged misrepresentations in the marketing of a collateralized debt obligation (42 SRLR 1404, 7/26/10). More recently, JPMorgan Chase & Co. (JPM) agreed to pay $920 million to U.S. and U.K. authorities over losses by a derivatives trader, he said (45 SRLR 1720, 9/23/13).
Ceresney responded that the SEC considers very carefully the penalties it imposes on defendants. Corporate penalties can “speak volumes” in appropriate cases, he said. Not only do large penalties prove a deterrent, they cause the regulated community to focus on compliance issues and to improve their internal controls. “You get that sort of impact by having” large penalties in the right cases, he said.
Prosecutors in SEC
From the floor, Jacob Frenkel, a partner at Shulman, Rogers, Gandal, Pordy & Ecker PA in Potomac, Md., asked if the hiring of former federal prosecutors in SEC leadership positions might be resulting in the Enforcement Division becoming something it was not meant to be.
Khuzami, a former prosecutor, responded that he and the other officials, including Ceresney and White, were former defense attorneys as well. Accordingly, they share the perspectives of the defense bar, he said. The issue also begs the question of what is the “proper role” of the division, Khuzami continued. Given the increasing market complexity and the financial crisis, “I suspect that the division would be more aggressive” even if the SEC had not hired a single prosecutor.
McLucas also said he would not “worry” about the presence of federal prosecutors in the SEC. Given the pressures on the agency, “the rhetoric will be the same” no matter who is in charge. What is important is to ensure that the SEC has staff with market expertise and different perspectives to deal with the “extraordinary market challenges” the commission faces, he said.
On the other hand, Thomsen, also a former prosecutor, suggested that enforcement might be easier than rulemaking given the politicizing of the agency. “As the SEC becomes more politicized,” that puts more pressure on enforcement, which has to be balanced by the rest of the staff, she said.
Specialized Units
In other discussion, Ceresney told the audience that the SEC has no plans to eliminate the division's specialized units, short of “tweaks” to “resize” the units' geographical reach. He also said that the division's “Structured and New Products Unit” has been renamed the “Complex Financial Instruments Unit” and retooled to focus less on structured products and more on other complex instruments (45 SRLR 1633, 9/16/13).
Khuzami said the creation of the units was one of his proudest achievements at the agency because “they live on irrespective of any director's tenure.”
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2 In Seeking Admissions, SEC Will Not Factor in Defendants' Collateral Impacts, Securities Regulation & Law Report (BNA)
“I had a window of opportunity to accomplish this” because the SEC—reeling from the Bernard Madoff controversy and the financial crisis—engaged in a period of “reflection and introspection,” he said.
McLucas added that the units and their specialized talents are more necessary than ever given the speed and expansion of U.S. markets.
Sporkin, for his part, noted that the SEC's focus on gatekeepers began with the “access theory” advanced during his tenure as Enforcement director, in which the agency decided to pursue professionals that facilitate access to U.S. markets.
More recently, the SEC launched “Operation Broken Gate” in which it is targeting deficient auditors (45 SRLR 1861, 10/7/13). White, also addressing the Securities Enforcement Forum, said the SEC will target gatekeepers to help it broaden its enforcement reach [see related report in this issue].
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 3
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Chair: SEC Lawyers Ready for Litigation To Arise From Change in Settlement Policy, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
Chair: SEC Lawyers Ready for Litigation To Arise From Change in Settlement Policy, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ November 18, 2013
SEC Enforcement
Chair: SEC Lawyers Ready for Litigation To Arise From Change in Settlement Policy By Yin Wilczek
Nov. 15 — Securities and Exchange Commission Chairman Mary Jo White Nov. 14 said the agency's attorneys are prepared for more trials likely to result from its new policy of requiring admissions from certain settling defendants.
“At the SEC, I am glad and proud to say that our attorneys who try our cases are incredibly skilled and effective,” White told a legal gathering. “Over the past three years, our team has achieved an 80 percent success rate—a rate that may explain why most lawyers counsel their clients against going to trial against the SEC and why we achieve strong settlements in most of our cases.”
The SEC litigation team's record is more impressive considering how difficult and complex securities cases can be, White added. “Unlike our colleagues at the [Department of Justice], we most often proceed without the benefit of cooperators, wiretaps, surveillance evidence, and many of the other tools at the disposal of prosecutors,” she said. “In our cases, we often must rely heavily on circumstantial evidence, hostile witnesses, or on the cross-examination of the defendant in order to prove our case.”
White spoke at the Judge Thomas A. Flannery Lecture in Washington. “Trials allow for more thoughtful and nuanced interpretations of the law,” Protocol Change White said. In June, White announced that in certain limited situations, the commission would forgo its traditional policy of allowing defendants to settle their cases without admitting to the allegations (45 SRLR 1150, 6/24/13). SEC officials said that the agency will strive for admissions in situations where the misconduct harmed large numbers of investors or placed them at risk of potentially serious harm, or where the commission wants to send a message (45 SRLR 1757, 9/23/13).
Defense attorneys predict that one consequence of the new protocol will be more litigation as defendants balk at making admissions, especially given the possible collateral consequences, such as follow-on private civil lawsuits and other regulatory action (45 SRLR 1150, 6/24/13). The attorneys, pointing to the agency's mixed record in recent actions, also have questioned the SEC's ability to win major complex cases, the most likely candidates for the agency to seek acknowledgements of wrongdoing.
Reason for Change
On the change to the settlement policy, White noted that when she was U.S. Attorney for the Southern District of New York, she entered into the first-ever deferred prosecution agreement with a company. She said she structured the agreement to require an admission of wrongdoing because it was “necessary to give the resolution sufficient teeth and ensure greater public accountability.” Since then, nearly all DPAs have such admissions, she observed.
White said that against that backdrop, she decided to review the SEC's settlement policy when she assumed its helm. “After consulting with the Enforcement Division directors and my fellow Commissioners, I decided to alter” the policy, she said.
In other comments, White told the audience that “the administration of justice” will be “one clear winner” from the commission's policy change.
“Trials allow for more thoughtful and nuanced interpretations of the law,” White said, citing for example the U.S. Supreme
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 Chair: SEC Lawyers Ready for Litigation To Arise From Change in Settlement Policy, Securities Regulation & Law Report (BNA)
Court's decision in United States v. O'Hagan, 521 U.S. 642 (1997). In O'Hagan, the high court upheld an individual's insider trading conviction and extended securities fraud liability by establishing the misappropriation theory of insider trading.
Under the misappropriation theory, a wrongdoer who owes no fiduciary duty to the company for which the material nonpublic information pertains may nevertheless be liable for insider trading if he or she “misappropriates” the confidential information in violation of a fiduciary duty.
That theory now forms the basis for many of the insider trading cases brought by the SEC, White said. “And it is a theory supported by the law established on a fully developed trial record.”
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The text of White's speech is available at http://www.sec.gov/News/Speech/Detail/Speech/1370540374908#.UoY-X-IWkoo.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2
ConvergEx Subsidiaries to Pay $150.8M In SEC/DOJ Settlements Over Mark- Ups, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
ConvergEx Subsidiaries to Pay $150.8M In SEC/DOJ Settlements Over Mark-Ups, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ December 23, 2013
Crime
ConvergEx Subsidiaries to Pay $150.8M In SEC/DOJ Settlements Over Mark-Ups Securities and Exchange Commission and Justice Department officials announced Dec. 18 that global trading firm ConvergEx Group LLC, three brokerage subsidiaries, and two former ConvergEx employees agreed that day to pay fines and disgorgement totalling more than $150 million to resolve administrative and/or criminal charges that they caused numerous institutional clients to pay substantially higher amounts than disclosed to execute trading orders.
Specifically, DOJ said in a release, ConvergEx Global Markets Ltd., a brokerage subsidiary of ConvergEx Group, pleaded guilty in the U.S. District Court for the District of New Jersey to wire fraud and conspiracy charges. ConvergEx group entered into a deferred prosecution agreement.
Together, the entities agreed to pay a criminal penalty of approximately $18 million and to forfeit approximately $12.8 million—a total penalty of $30.8 million. They also agreed to pay restitution of approximately $12.8 million to defrauded customers.
In addition, DOJ said, Jonathan Daspin, the head trader at the brokerage subsidiary, and Thomas Lekargeren, a sales trader at a different ConvergEx subsidiary, pleaded guilty to conspiracy charges over their alleged roles in the controversy.
In remarks prepared for a press briefing, Acting Assistant Attorney General Mythili Raman said that as described in court documents, “ConvergEx—a broker for some of the most sophisticated institutional investors in the world—engaged in a concerted and coordinated effort to fleece its clients by charging them millions of dollars in unwarranted fees.”
“Although the theft of money from ConvergEx's clients was large in scale,” Raman said, “the fraud scheme was committed in the most basic of ways: ConvergEx and its traders, plain and simple, lied to their clients to hide that they were stealing their money.”
SEC
Meanwhile, the SEC resolved administrative cease and desist proceedings against three ConvergEx Group subsidiaries, Das pin, and Lekargeren ( In re G-Trade Services LLC, SEC, Admin. Proc. File No. 3-15654, 12/18/13; In re Daspin, SEC, Admin. Proc. File No. 3-15652, 12/18/13; In re Lekargeren, SEC, Admin. Proc. File No. 3-15653, 12/18/13).
The subsidiaries—G-Trade Services LLC, ConvergEx Global Markets, and ConvergEx Execution Solutions LLC—acknowledged committing securities law violations and agreed to pay more than $107 million—disgorgement and prejudgment interest totaling $87,424,429 and a $20 million penalty. In settling the penalty amount, the SEC said, it considered the entities' prompt remedial action and cooperation in the investigation.
In a release, the commission said Daspin and Lekargeren, who are cooperating in the investigation, admitted that they took steps to conceal the practice of taking trading profits from customers. Daspin agreed to pay a total of $1,111,550 in disgorgement and prejudgment interest, and Lekargeren agreed to pay a total of $117,042 in disgorgement and prejudgment interest.
The SEC said it considered their cooperation in determining the terms of settlement. It added that it seeks to return the money collected in the settlements to injured customers through a Fair Fund distribution.
“Customers have a right to expect honesty from their brokers and accurate information in response to their inquiries,” said Andrew Ceresney, co-director of the SEC's Enforcement Division. “These ConvergEx brokers misled their customers and
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 ConvergEx Subsidiaries to Pay $150.8M In SEC/DOJ Settlements Over Mark-Ups, Securities Regulation & Law Report (BNA)
failed to provide complete information about the costs they were charging.”
For More Information
To see the SEC administrative orders, go to http://www.sec.gov/litigation/admin/2013/34-71128.pdf (G-Trade); http://www.sec. gov/litigation/admin/2013/34-71127.pdf (Lekargeren); http://www.sec.gov/litigation/admin/2013/34-71126.pdf (Daspin).
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2
Calls Rise for Action Against Executives As JPMorgan Agrees to Pay $920 Million, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
Calls Rise for Action Against Executives As JPMorgan Agrees to Pay $920 Million, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ September 23, 2013
Enforcement
Calls Rise for Action Against Executives As JPMorgan Agrees to Pay $920 Million
BNA Snapshot
Fallout Seen from $920 Million JPM Settlement
Key Development: JPMorgan in $920 million trading settlement with SEC, OCC, Fed, and the U.K.'s FCA.
Potential Impact: Accord signals heightened stress on internal controls for all banks, and extra regulatory and political heat for large financial firms, as senators urge more action against executives.
By Chris Bruce
Sept. 19 — JPMorgan Chase & Co. (JPM) will pay $920 million to U.S. and U.K. regulators who said weak internal controls left the bank vulnerable to $6 billion in losses in 2012 by a derivatives trader nicknamed the London Whale, even as a reported criminal probe by U.S. prosecutors continues and senators called for more action against bank executives ( In re JPMorgan Chase & Co., SEC, Admin. Proc. File No. 3-15507, 9/19/13).
“JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses,” said George S. Canellos, co-director of the Securities and Exchange Commission's division of enforcement. “While grappling with how to fix its internal control breakdowns, JPMorgan's senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company's problems and determine whether accurate and reliable information was being disclosed to investors and regulators.”
The settlement resolves claims by several regulators, with payments to each. The holding company will pay $200 million each to the SEC and the Federal Reserve Board, while JPMorgan Chase Bank N.A. will pay $300 million to the Office of the Comptroller of the Currency and $220 million to the U.K's Financial Conduct Authority.
According to the SEC, JPMorgan admitted the facts underlying the SEC's charges, and publicly acknowledged it violated federal securities laws.
A Major Step
In a statement, JPMorgan Chief Executive Officer Jamie Dimon called the collective accord “a major step in the firm's ongoing efforts to put these issues behind it.”
“We have accepted responsibility and acknowledged our mistakes from the start, and we have learned from them and worked to fix them. We will continue to strive towards being considered the best bank—across all measures—not only by our shareholders and customers, but also by our regulators,” Dimon said.
The settlement came days after former JPMorgan traders Javier Martin-Artajo and Julien Grout were indicted in New York on securities fraud charges [see related report in this issue]. Prosecutors said they helped conceal trading losses. The two also face enforcement action by the SEC.
Bruno Iksil, nicknamed the London Whale because of his massive trades, has not been charged and is cooperating with prosecutors.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 Calls Rise for Action Against Executives As JPMorgan Agrees to Pay $920 Million, Securities Regulation & Law Report (BNA)
Curry Warns Banks
In separate action Sept. 19, the Consumer Financial Protection Bureau and the OCC announced other penalties against JPMorgan on consumer protection matters, including a $60 million fine by the OCC and a $20 million penalty leveled by the CFPB.
In each of the two major actions Sept. 19, it was the OCC that posted the largest fines—$300 million in the trading settlement, and $60 million in the consumer protection accord.
Comptroller of the Currency Thomas J. Curry, who has been warning banks about operational risk, repeated that warning in a statement on the $920 million trading settlement, signaling that banks of all sizes will need tight and effective internal controls. Anything less, he said, “is unacceptable and will not be tolerated.”
“Banks are in the business of managing risk, and bank management must implement the appropriate governance, controls, risk management and audit functions to ensure the bank operates in a safe and sound manner. Bank management must also ensure open and effective communication with supervisors, so that we can effectively do our jobs,” Curry said.
JPMorgan may face more action by regulators and authorities. The Commodity Futures Trading Commission is probing allegations that JPMorgan manipulated a bond index.
CFTC Spokesman Steven Adamske Sept. 19 generally declined to comment on possible action by the CFTC. “Our investigation continues,” Adamske told Bloomberg BNA.
Senators Want More
The Sept. 19 settlements, though focused on the institution itself, could have fallout for JPMorgan executives. In a Sept. 19 statement, Sen. Carl Levin (D-Mich.), chairman of the Senate Permanent Subcommittee on Investigations, said a nine-month investigation into the London Whale trades by his panel showed that senior bank executives “made a series of inaccurate statements that misinformed investors and the public as the London Whale disaster unfolded.”
“Other civil and criminal proceedings apart from this settlement are continuing, so there is still time to determine any accountability on that matter,” Levin said.
Similar calls grew as the day went on from senators who said regulators should focus on JPMorgan executives. Sen. Charles Grassley (R-Iowa) released a statement saying the SEC failed to put enough focus on disclosures to the public and shareholders, while Sen. John McCain (R-Ariz.) pressed SEC Chairman Mary Jo White for answers on the possibility of criminal referrals and a focus on individual misconduct.
“While the $920 million settlement constitutes a significant rebuke to the institution, I believe that the government must hold accountable those individuals who compromised the integrity of our nation's financial markets. The government's incomplete enforcement actions to date fail to achieve that goal,” McCain said in a letter to White.
Dennis Kelleher, president of Better Markets, a nonprofit organization that promotes public interest in the financial markets, said harsher action is needed.
“The behavior and culture on Wall Street must change and that will only happen when CEOs and other senior executives are personally charged and held responsible. Buildings and banks don't break laws. People do,” Kelleher said in a Sept. 19 press release.
Risk May Migrate
Other large financial firms may also feel the effects. The settlements give JPMorgan some breathing room but highlight the risk for other big institutions, said Jaret Seiberg, a financial institutions analyst with WRG Financial Services, a unit of Guggenheim Partners.
“Now that JPMorgan is putting these scandals behind it, the question is which of the other mega banks will fall within the spotlight of Congress and the regulators? We won't speculate which bank is next, but the list of mega banks only contains a few other institutions,” Seiberg said in Sept. 19 market commentary.
Jennifer A. Thompson, managing director for research at Portales Partners LLC in New York, predicted higher litigation and
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2 Calls Rise for Action Against Executives As JPMorgan Agrees to Pay $920 Million, Securities Regulation & Law Report (BNA)
compliance costs for Bank of America (BAC), Citigroup (C), and other banks with capital markets and trading businesses. Regulators want to reduce the benefits of being a big bank, in part through higher litigation costs, she said.
“We expect regulators to ratchet up the cost of noncompliance with the rules for exactly that reason. This is an issue that's not going away any time soon and we are looking at a cyclical rise in litigation expenses for the largest banks,” Thompson told Bloomberg BNA Sept. 19.
Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc., a Washington consulting firm, said JPMorgan was hit especially hard in part because the case came late in a cycle of banking problems.
“By the time this case broke in 2012, so many other big banks had settled for so little despite so much damage to the global financial system that the pressure to put a big-bank's head on a stake was inexorable. JPM is thus the case in which regulators are trying to show they aren't as toothless as many allege, biting JPM extra hard to make the point,” Petrou said in a statement.
To contact the reporter on this story: Chris Bruce in Washington at [email protected]
To contact the editor responsible for this story: Joe Tinkelman at [email protected]
For More Information
The cease and desist order with the Federal Reserve is at http://op.bna.com/bar.nsf/r?Open=cbre-9bphwf.
The letter by Sen. McCain is at http://op.bna.com/bar.nsf/r?Open=cbre-9bpswr.
The SEC's order against JPMorgan is at http://www.sec.gov/litigation/admin/2013/34-70458.pdf.
The SEC's complaint against Martin-Artajo and Grout is at http://www.sec.gov/litigation/complaints/2013/comp-pr2013-154.pdf .
The FCA's release is at http://www.fca.org.uk/news/consumers/jpmorgan-chase-bank-na-fined.
The OCC's consent order against JPMorgan is at http://www.occ.gov/static/enforcement-actions/ea2013-140.pdf.
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Falcone, Firm Agree to Pay $18M, Admit To Certain Misconduct to Settle SEC Suits, Securities Regulation & Law Report (BNA)
Printed By: CSUSSMAN on Tuesday, February 25, 2014 - 4:00 PM
Falcone, Firm Agree to Pay $18M, Admit To Certain Misconduct to Settle SEC Suits, Securities Regulation & Law Report (BNA)
Securities Regulation & Law Report™ August 26, 2013
Hedge Funds
Falcone, Firm Agree to Pay $18M, Admit To Certain Misconduct to Settle SEC Suits By Maria Lokshin
Hedge fund giant Philip Falcone and his firm Harbinger Capital Partners have agreed to pay roughly $18 million and admit to certain misconduct to settle Securities and Exchange Commission actions over misuse of client money and other allegedly illicit practices in connection with several Harbinger Capital funds, the agency announced Aug. 19 ( SEC v. Harbinger Capital Partners LLC, S.D.N.Y., 12-05028, 8/19/13; SEC v. Falcone, S.D.N.Y., 12-05027, 8/19/13).
The moves comes just months after the agency announced a new policy that it would require admissions in certain enforcement actions where accountability is particularly warranted. The commission recently rejected an earlier proposed $18 million settlement with Falcone and Harbinger Capital—an agreement that did not include admissions by the defendants (45 SRLR 1380, 7/29/13).
SEC spokesman John Nester declined to comment on the rationale behind the commission's latest decision to accept the settlement.
In a statement e-mailed to BNA, Falcone said, “I believe putting these issues behind me now is the best course of action for me and our investors.”
“It will allow me to continue to focus on my permanent capital vehicles and maximizing the value of LightSquared for all stakeholders,” he said. “I remain committed to managing Harbinger Capital's portfolio of investments for the benefit of our investors.”
Client Funds Misused
In 2012, the SEC filed several fraud suits against Falcone and his firm. Among other allegations, the SEC said that Falcone misused client funds, authorizing a $113.2 million loan to himself from one of the Harbinger Capital funds to repay a personal tax debt (44 SRLR 1284, 7/2/12). Falcone, the SEC said, repaid the money after the commission launched its investigation.
The SEC further alleged that Falcone and Harbinger Capital entered into “quid pro quo arrangements” with certain investors in one of the hedge funds regarding liquidity and withdrawal restrictions. In addition, the agency said the defendants engaged in market manipulation.
Admissions, Bar
In a release, the SEC said that, among other matters, Falcone and his firm admitted to: improperly borrowing $113.2 million from a Harbinger Capital hedge fund, granting certain investors preferential redemption and liquidity terms without disclosing them to the board of HCP Fund I and the fund's other investors; and improperly interfering with the “normal interplay of supply and demand” of certain bonds.
In addition to paying $18 million, Falcone also agreed to be barred for five years from associating with a broker-dealer, investment adviser, or similar entities. However, he may “assist” with liquidating his hedge funds under the supervision of an independent monitor, the SEC said. The earlier agreement rejected by the commission contemplated a two-year bar for Falcone.
The rejection of the earlier settlement—disclosed in July in a regulatory filing by Harbinger Capital's parent company
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 Falcone, Firm Agree to Pay $18M, Admit To Certain Misconduct to Settle SEC Suits, Securities Regulation & Law Report (BNA)
Harbinger Group Inc. (HRG) —came on the heels of an announcement by SEC Chairman Mary Jo White that the agency was changing its “neither admit nor deny” policy (45 SRLR 1335, 7/22/13). While White, a former prosecutor, said the SEC would continue the policy of not requiring denials or admissions in civil settlements, she said that in some circumstances in which public interest demands accountability, the agency will seek denials or admissions.
The settlement is subject to approval by the U.S. District Court for the Southern District of New York.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2
Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
Printed By: CSUSSMAN on Friday, February 28, 2014 - 4:51 PM
Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
Securities Regulation & Law Report™ 46 SRLR Issue No. 4 - January 27, 2014
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Highlights and Contents Highlights for this Issue HIGHLIGHTS OUTLOOK 2014: SEC Hopes to Complete DF, JOBS Act Rulemaking In 2014, the Securities and Exchange will focus on completing its Dodd-Frank and JOBS Act rulemaking, while the Commodity Futures Trading Commission—under interim leadership and with several vacancies—faces reauthorization this year. More », More » Meanwhile, the SEC Enforcement Division will seek admissions in more cases and work to be more efficient. More » On Capitol Hill, lawmakers are looking to make Dodd-Frank and JOBS Act adjustments, and to ease certain Volcker rule restrictions. More » O n the private litigation front, securities lawyers are awaiting a Supreme Court decision that could have a major impact on class securities fraud actions. More »
Obama Signs Spending Bill Funding SEC, CFTC for FY 2014 President Obama signs an omnibus spending bill for fiscal 2014 that will fund the Securities and Exchange Commission and the Commodity Futures Trading Commission through Sept. 30, though at levels far less than they requested. More »
ALJ Says China-Based Auditors Violated SOX by Not Producing Work Papers A Securities and Exchange Commission administrative law judge concludes that the China-based affiliates of five U.S. auditing firms willfully violated the Sarbanes-Oxley Act by failing to produce work papers of clients under SEC investigation. More »
Carper Asks CFTC to Clarify Stance on Regulating Digital Currency Sen. Tom Carper calls on the Commodity Futures Trading Commission to clarify if or how it would regulate the virtual currency business. More »
Del. Court Seeks Review of Ruling on Closed-Door Arbitration The Delaware Chancery Court asks the U.S. Supreme Court to review a federal appeals court's decision invalidating a state law that allowed issuers to resolve disputes through closed-door arbitrations presided over by a sitting judge. More »
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 1 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
BNA INSIGHTS: Mitigating and Managing Retaliation Risks William McLucas, Laura Wertheimer, and Arian June, WilmerHale LLP, write about whether employees working outside the U.S. who report potential securities law violations are protected from retaliation. More »
INTERVIEW: New Task Force Seeking Whistle-Blowers, Woodcock Says While one top priority for the Securities and Exchange Commission's Financial Reporting and Audit Task Force is to develop computer methodology to ferret out accounting irregularities, it also is reaching out to finance professionals to blow the whistle on financial misconduct, task force chief David Woodcock tells Bloomberg BNA. More »
ALSO IN THE NEWS INVESTMENT ADVISERS: A SIFMA official says the Labor Department should wait to propose a definition of “fiduciary” until the SEC issues its own proposal on the topic. More »
WHISTLE-BLOWERS: SEC, CFTC, and IRS officials say they intend to crack down on employers that retaliate against whistle-blowers and to ensure that companies are allowing potential misconduct to be reported inside the corporation. More »
ENFORCEMENT: Former MF Global Inc. Chief Executive Officer Jon Corzine and former MFG Assistant Treasurer Edith O'Brien lose their bid in federal district court for dismissal of a CFTC lawsuit over the 2011 collapse of MF Global Holdings Ltd. The dismissal motions are “without merit,” the court says. More »
DERIVATIVES: The CFTC establishes an interdivisional staff group to review swaps data recordkeeping and reporting requirements and to make recommendations for improvement. More »
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 2 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
WHISTLE-BLOWERS: A federal appeals court affirms dismissal of a SOX whistle-blower claim against a pharmaceutical company. It says the claims were barred by information in the entity's Form 8-K . More »
Table of Contents OUTLOOK 2014 FUTURES REGULATION
Reauthorization looms as year begins; interim leadership clouds CFTC future 150
SEC REGULATION
In 2014, SEC will focus on advancing Dodd-Frank, JOBS Act rule mandates 141
SECURITIES LEGISLATION
Lawmakers look ahead to Dodd-Frank, Volcker rule, JOBS act fixes in 2014 153
SECURITIES LITIGATION
Lawyers awaiting Halliburton decision; could have big impact on class litigation 156
SEC enforcers to pursue admissions, more efficient investigations in 2014 146
FEDERAL NEWS ANTIFRAUD
Court dismisses would-be class suit against Harman International Industries 164
Ex-portfolio manager to pay $100K 166
ATTORNEYS
Dixie Johnson, Bill Johnson move to King Spalding 165
BROKER-DEALERS
9th Cir. affirms SEC order against broker-dealer 166
Electronic communications will yield more enforcement actions, attorneys say 160
SEC OKs FINRA rule change on ATS reporting 165
CAPITAL FORMATION
SEC issues more C&DIs on general solicitation rule 165
CONGRESS
Obama signs spending bill funding SEC, CFTC for FY 2014 160
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 3 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
ENFORCEMENT
Man who failed to produce documents in SEC probe arrested on contempt charges 164
Markey calls for SEC, FTC inquiry into Herbalife's compensation system 163
FINANCIAL INSTITUTIONS
Treasury Department, FHFA seek early end to suits on Fannie Mae, Freddie Mac profits 162
INSIDER TRADING
JPM V.P., broker agree to insider trading bans 166
INVESTMENT ADVISERS
Refrain from fiduciary rulemaking until SEC acts on unified standard, SIFMA says 162
WHISTLE-BLOWERS
Info in SEC filing foils SOX claims, 9th Cir. affirms 164
Regulators want ‘culture of compliance' handling whistle-blowers in-house, panel says 161
BNA INSIGHTS WHISTLE-BLOWERS
Don't tread on whistleblowers: Mitigating and managing retaliation risks — part II 167
INTERVIEW ENFORCEMENT
Woodcock: New task force seeking whistle-blowers to scope out financial fraud 176
INTERNATIONAL NEWS SHORT SALES
EU high court dismisses U.K. efforts to block new EU short-selling ban 179
STATE NEWS ARBITRATION
Del. court seeks review of ruling closed-door arbitration law unconstitutional 180
N.Y. court vacates $11M award against Citi 180
BROKER-DEALERS
SIFMA seeks exemption from Maine social media bill 181
JURISDICTION AND PROCEDURE
Court tosses Nevada suit against FINRA in wake of stock scheme 181
DBSI files cert petition in Minn. jurisdictional dispute 181
FUTURES REGULATION
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 4 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
DERIVATIVES
CFTC forms interdivisional group to study, make recommendations on swaps reporting 184
CFTC makes new MAT determinations, putting swap contracts on SEFs, DCOs 185
CFTC staff makes first MAT certifications; swaps will begin trading on platforms 2/15 184
ENFORCEMENT
Corzine loses bid for dismissal of CFTC's MF Global lawsuit 183
FUTURES REGULATION
Carper asks CFTC to clarify stance on regulating digital currency 183
CFTC reopens comments on auto trading release 185
ACCOUNTING AUDITING
SEC judge finds China-based auditors violated SOX by not producing work papers 186
ENFORCEMENT
KPMG to pay $8.2M over independence violations 187
TABLE OF CASES Bancorp Int'l Grp. v. Fin. Indus. Regulatory Auth. (D. Nev.) 181
BDO China Dahua CPA Co., In re (SEC) 186
Citigroup Global Markets Inc. v. Fiorilla (N.Y. Sup.Ct.) 180
Deangelis v. Corzine (S.D.N.Y.) 183
Deutsche Bank Securities Inc. v. MoneyGram Payment Systems Inc. (U.S.) 181
Gutman, In re (FINRA) 166
Harman Int'l Indus., Inc. Sec. Litig., In re (D.D.C.) 164
KPMG LLP, In re (SEC) 187
McManus v. McManus Fin. Consultants, Inc. (9th Cir.) 164
Perry Capital v. Lew (D.D.C.) 162
SEC v. Coronati (S.D.N.Y.) 164
Strine v. Del. Coal. for Open Gov't Inc. (U.S.) 180
Williamson, In re (SEC) 166
World Trade Fin. Corp. v. SEC (9th Cir.) 166
Outlook 2014 In 2014, SEC Will Focus on Advancing Dodd-Frank, JOBS Act Rule Mandates
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 5 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
OUTLOOK 2014: SEC REGULATION
Securities and Exchange Commission Chairman Mary Jo White will focus this year on completing the SEC's rulemaking inventory under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Jumpstart Our Business Startups Act. Problematic rulemakings include Dodd-Frank's executive compensation requirements, proposed amendments to 1933 Securities Act Regulation D under the JOBS Act, and money market mutual fund reform. Meanwhile, attorneys urge the SEC to start on its plan to review its disclosure regime.
By Yin Wilczek
Jan. 24 — The Securities and Exchange Commission this year will have a laser focus on completing mandated rulemakings under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Jumpstart Our Business Startups Act.
Along the way, the commission could encounter some difficulties in proposing executive compensation rules required by Dodd-Frank on clawbacks, pay for performance and hedging, attorneys contacted by Bloomberg BNA in late December and early January suggested.
On other 2014 initiatives, the attorneys said there is a good chance that the SEC will overhaul the “accredited investor” definition. The SEC also will adopt a pay ratio rule this year, and some portion of its controversial proposed amendments to 1933 Securities Act Regulation D.
Meanwhile, money market mutual fund reform—depending on how the SEC proceeds—could well be the most controversial of the commission's rulemaking initiatives in 2014.
New Members “I expect Chair White will get the mandatory rules done as quickly as 2013 was a period of upheaval for the commission, with the advent of a new chairman—Mary Jo White—and two new possible.” commissioners: Kara Stein and Michael Piwowar (45 SRLR 1527, 8/19/13). Meredith Cross Wilmer Cutler Pickering Hale & Dorr Meanwhile, the SEC is far behind on its Dodd-Frank mandates. According to Davis Polk & Wardwell LLP's Dodd-Frank LLP Progress Report, as of Jan. 2, the SEC has finalized only 42 of the 95 rules it must write under the financial reform statute. The commission has missed 41 deadlines.
The SEC also lags behind the Commodity Futures Trading Commission in its swaps rulemaking. While the CFTC has adopted 36 of the 43 rules it must write under Dodd-Frank Title VII, the SEC has finalized only 10 of its 29 swaps rules, Davis Polk said.
White, in conferences with reporters and in other public statements, repeatedly has stressed her commitment to completing the commission's mandated rules. Based on her track record, White will move the SEC's agenda forward, even on controversial issues, attorneys said.
“I expect Chair White will get the mandatory rules done as quickly as possible,” said Meredith Cross, a former director of the SEC Division of Corporation Finance who led much of the division's Dodd-Frank and JOBS Act rulemaking efforts before leaving in December 2012 (44 SRLR 2222, 12/10/12). “She is very good at getting things done.”
Cross now is a Washington-based partner at Wilmer Cutler Pickering Hale & Dorr LLP.
Moreover, White has not shied away from pushing for a speedy vote even when fellow commissioners ask for more time, as happened with the registration rules for municipal advisors. During the open meeting on the matter, Piwowar—who had been commissioner for a little over a month at that time—complained that White had not acceded to his repeated requests to delay the vote so he could more thoroughly review the adopting release (45 SRLR 1717, 9/23/13).
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 6 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
White “is not afraid of moving forward on a 3-2 vote basis,” observed Keir Gumbs, a Washington-based partner at Covington & Burling LLP.
Roadmap
The SEC has laid out a rough roadmap regarding its 2014 rulemaking initiatives in its 2013 financial report, as well as in its rule list in the unified agenda maintained by the Office of Information and Regulatory Affairs (45 SRLR 2228, 12/9/13).
Among other initiatives in the first half of the year, the commission likely will propose executive compensation rules required by Dodd-Frank on clawbacks, pay for performance and hedging. In addition, there will be activity around the “accredited investor” definition, which the SEC must review this year under Dodd-Frank.
On a longer-term basis, the SEC will finalize its pay ratio proposal, as well as its swap proposals.
Under the JOBS Act, the SEC likely will finalize its crowdfunding rules by summer. The SEC also is likely to adopt Regulation A Plus this year, and advance its proposed Reg D changes.
Outside the mandatory rulemakings, the SEC will consider adoption of money market mutual fund reform. The prospect for a proposal on a uniform fiduciary standard for broker-dealers and investment advisers remains less clear.
Executive Compensation
Under Dodd-Frank, the SEC must develop rules on clawing back “erroneously awarded” pay. The commission further must require companies to disclose how their executive pay packages relate to corporate performance, and disclose whether they allow employees and directors to hedge their stock holdings.
In recent comments, Corp Fin Director Keith Higgins said he anticipated that the SEC will issue proposals on the requirements “not too long into” the new year (45 SRLR 2225, 12/9/13).
Attorneys disagree on whether the rulemaking will go smoothly. While some say the rules are “relatively straightforward,” others say there could be problems.
Of the three rulemaking matters, the clawback provision is the “most difficult,” said Stanley Keller, a partner at Edwards Wildman Palmer LLP, Boston.
Cross described the clawback requirement as a “sleeper provision.” Although it hasn't yet garnered a lot of publicity, “it has teeth because … giving back money is obviously a big issue for anybody,” she said. “Reaching consensus on the commission for this one will likely depend on how the staff's recommendation approaches the areas in the statute where there is discretion.”
Cross also suggested that pay for performance “could be more difficult than people anticipate.” There will be questions around what should be included in compensation that is “actually paid,” she said. In addition, “performance” will probably need to be defined.
The statute also appears “pretty prescriptive” in directing that the disclosure take into account total shareholder returns, Cross said. “Whether the commission goes out with a proposal that is more principles-based and less prescriptive, or hews closely to the statutory language is going to be an interesting question.”
However, Gumbs argued that many issuers, in anticipation of the Dodd-Frank requirements, already have implemented their own policies on hedging, pay for performance and clawbacks. Such internal policies are not that different from the Dodd-Frank provisions, he said.
“That tells me that people are ready to make those changes,” Gumbs added. “One could argue that the rules already are implemented by common practice with respect to some of these issues.”
Pay Ratios?
It is less clear when the SEC will move to adopt a fourth Dodd-Frank executive compensation requirement—that
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 7 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 for ratios comparing issuers' chief executive and employee pay. The SEC's proposal—issued in September (45 SRLR 1718, 9/23/13)—has divided the issuer and investor communities (45 SRLR 2290, 12/16/13). The comment period for the proposal ended in early December.
Attorneys expect the SEC to adopt a pay ratio rule this year, “perhaps with some tweaking,” Keller suggested.
While the proposal is controversial, the corporate community is “One could argue that the [executive not calling for its wholesale revision, Gumbs observed. compensation] rules already are Ultimately, while some may question the utility of the implemented by common practice with disclosures, the impact of the pay ratio rule “is not going to be anywhere near as broad as the impact” anticipated from the respect to some of these issues.” conflict minerals and resource extraction rules, he said. “It's not even close, in my opinion.” Keir Gumbs Shortly after their adoption, the conflict minerals and resource Covington & Burling LLP extraction disclosure regulations were challenged by industry groups. The resource extraction rule was struck by the U.S. District Court for the District of Columbia in July 2013, and the SEC currently is working on a new proposal (45 SRLR 1635, 9/16/13). The conflict minerals rule is in ongoing litigation (46 SRLR 68, 1/13/14).
Accredited Investor
Also under Dodd-Frank, the SEC this year must determine whether the accredited investor definition for natural persons should be revised in light of market and regulatory changes. Under the current test, an individual qualifies as an accredited investor if he or she has at least $200,000 in annual income in each of the two most recent years ($300,000 for married couples), or $1 million in net worth without taking into account the primary residence.
Attorneys told Bloomberg BNA they expect to see some changes to the definition. One reason is that Dodd- Frank has provided the impetus for the SEC to review the definition, they said. Another is that the dollar values of the current definition—originating from the 1980s—is extremely outdated.
“My guess” is that the economic measures—the annual income and net worth tests—will be increased and indexed, and a “new qualification based upon assets invested will be added,” Keller said.
Cross said the success of any revision will likely depend on whether the commission can keep the percentage of the population that qualifies as “accredited” similar to what it was under the old tests. Cutting down on the population of accredited investors will be a major concern for small businesses, she said. “If you cut off access to capital for small business, there will be significant pushback.”
In November, White told House lawmakers that the SEC, among other considerations, is mulling whether professional qualifications may serve as alternative criteria for accredited investors (45 SRLR 2169, 11/25/13).
Cross suggested that there probably will be movement on the accredited investor definition early in the year, given that the SEC will want commenters to weigh in on the issue. She added that the commission may well issue a general request for comments or other information on the standard.
Derivatives
In other Dodd-Frank rulemakings, SEC this year will act on pending proposals for security-based swaps. Among other measures, the proposals address cross-border issues, the registration and regulation of security-based swap data repositories and execution facilities; the end-user exception to mandatory clearing; and trade reporting.
At this point, it is not clear how an industry lawsuit challenging the CFTC's cross-border guidance for swaps will impact the SEC's cross-border initiative, consisting of proposed rules and interpretive guidance (46 SRLR 133, 1/20/14). In a lawsuit filed in December, four trade associations alleged that the CFTC acted improperly by proceeding through interpretative guidance rather than rulemaking to regulate cross-border swap transactions.
“From everything that we've previously heard,” the cross-border
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“We'd love the certainty, we'd love for” measure is an SEC priority because, the CFTC having adopted the SEC to finalize its swap rules. it—challenged or not—it could create some real disparities within the market to not know what to do with respect to Karrie McMillan security-based swaps,” Karrie McMillan, general counsel at the Investment Company Institute, told Bloomberg BNA. Investment Company Institute General Counsel Although the different pace of rulemaking at the two agencies is causing some uncertainty, market participants would rather that the SEC get its rules right, McMillan said. “I think what has helped us is that the security-based swaps market is much smaller than what the CFTC oversees,” she continued. “It's not that large of a market that has been left kind of in limbo.”
However, that being said, “we'd love the certainty, we'd love for” the SEC to get its rules done, McMillan said.
Looking ahead, there are inconsistencies between the SEC's proposed regulations and what the CFTC has adopted, including on cross-border issues, McMillan said . Although ICI's members prefer the SEC's cross- border approach in some respects, it would be much easier for them to work under one set of principles, she added. Given that the CFTC adopted its measures first, ICI members would rather that the SEC “conform to what the CFTC already has done.”
Resource Extraction
In yet another Dodd-Frank rulemaking, it is not clear whether the SEC will repropose resource extraction disclosure requirements in 2014.
White “seems to be in no hurry” to take up the rulemaking, “particularly with the [U.S. Court of Appeals for the District of Columbia Circuit] still to decide the appeal on the conflict minerals rule,” commented John Olson, a Washington-based partner at Gibson Dunn & Crutcher LLP.
The commission omitted resource extraction from its latest regulatory flexibility agenda, but supporters of the rulemaking—including Sen. Ben Cardin (D-Md.), one of the key authors of the Dodd-Frank provision mandating the requirements—say they believe the SEC will act on a reproposal this year (45 SRLR 2228, 12/9/13).
Cross, who was Corp Fin director when the original resource extraction regulation was adopted, told Bloomberg BNA that she expected that the SEC—pursuant to its Dodd-Frank mandate—will repropose the rule, although the timing is “really hard to predict.”
The American Petroleum Institute—one of the groups that sued over the rule—in November proposed an altern ative transparency regime. Should the SEC incorporate some of API's ideas, that could lessen industry opposition to a reproposed rule.
In the meantime, the Corp Fin staff continues to be lobbied heavily on the rulemaking, not just by industry players and nongovernmental organizations, but also by foreign regimes—including the European Commission—interested in establishing their own transparency frameworks.
Fiduciary Standard
Even less clear is whether the SEC will advance this year on a uniform fiduciary standard for broker-dealers and investment advisers. “I don't see fiduciary duty moving soon,” Olson said.
Similarly, Gumbs said he doubts the SEC will issue a proposal this year. “They have too much on their plate, and I don't see them looking to fight new fights this year.”
On the other hand, David Tittsworth, executive director of the Investment Adviser Association, pointed out that the SEC's long-term agenda for 2014 includes the fiduciary duty rulemaking. “I think it is likely that the SEC will issue a proposed rulemaking later in the year,” he said.
Meanwhile, attorneys suggested that as the SEC completes its inventory of required rulemaking, Corp Fin may be able to turn its attention to updating beneficial ownership reporting rules under 1934 Securities Exchange Act Section 13(d).
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“It's an area that certainly needs modernization,” Cross said. She added that when she was Corp Fin director, staff from the division's Office of Mergers and Acquisitions had been considering the possibility of acting on Dodd-Frank authority to shorten the 10-day initial filing requirement and otherwise modernizing the reporting requirements (43 SRLR 362, 2/21/11).
There also is a pending rulemaking petition from Wachtell Lipton Rosen & Katz LLP dating back to March 2011 urging the commission to amend the beneficial ownership rules (43 SRLR 532, 3/14/11). Then-SEC Chairman Mary Schapiro had planned a broad review of the rules in 2012 (43 SRLR 2527, 12/19/11), but the initiative was derailed by the commission's rulemaking obligations.
“I wouldn't be surprised to see the SEC issue some sort of concept release” on the beneficial reporting rules, Cross continued. “It is a very, very controversial topic,” she added, noting that while the corporate community wants the reporting period to be shorter, “I understand that idea is strongly opposed by hedge funds and some others in the institutional investor community.”
JOBS Act
Moving on to the JOBS Act, attorneys predicted that the SEC will adopt crowdfunding rules by summer, and Reg A Plus later in the year.
The SEC's proposed Regulation Crowdfunding would allow startups and small issuers to raise capital through the offer and sale of crowdfunded securities (45 SRLR 1967, 10/28/13). The comment period for the proposed rules ends Feb. 3.
One potential stumbling block is that market participants are voicing concerns that the proposed requirements make crowdfunding too expensive for small businesses ((45 SRLR 2025, 11/4/13).
The House Small Business Investigations Subcommittee held a hearing on the SEC proposal Jan. 16. At the hearing, witnesses called on the commission to ease the costs and burdens of the proposed requirements. For example, Jason Best, a principal of Crowdfund Capital Advisors, testified that the requirement that issuers provide CPA audited financials to investors if they seek to raise more than $500,000 would place “an unreasonable burden” on small businesses.
Subcommittee chairman David Schweikert (R-Ariz.) also criticized the proposed requirements. “After a year and a half, and over a year late, the SEC brought us a complex and overly-burdensome 585-page set of proposed rules that threaten crowdfunding's usability for small businesses,” Schweikert said in his opening statement.
Reg A Plus
Pursuant to another JOBS Act mandate, the SEC in December proposed a two-tier expansion of Reg A that would allow offerings per year of up to $5 million and $50 million respectively (45 SRLR 2329, 12/23/13). Under the proposal, state securities regulations would be preempted for Tier 2 offerings with a cap of $50 million.
State securities regulators have started lobbying efforts to try to persuade the SEC to change its mind on the preemption of blue sky laws for Tier 2 offerings.
However, Keller predicted that the SEC ultimately will adopt Reg A Plus largely as proposed. “The SEC is committed to making these capital raising alternatives workable,” he said.
A July 2012 Government Accountability Office report found that the cost of the state review process was deterring small businesses from using Reg A to raise capital (44 SRLR 1334, 7/9/12).
However, other attorneys have posited that state preemption is not a given in light of remarks by White and the Democratic commissioners at the open meeting for Reg A Plus saying they are closely monitoring efforts by the state securities regulators to streamline their review process (46 SRLR 62, 1/13/14).
Reg D Proposal
The most controversial rulemaking under the capital formation statute this year involves additional amendments
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 10 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 to Reg D that the SEC proposed at the same time it adopted its new general solicitation regime in July 2013 (45 SRLR 1285, 7/15/13). The proposed changes—which the commission said would help it monitor the use of general solicitation—would require Form D filers to make additional disclosures and would impose a one-year ban for defective filings.
White previously said that she plans to advance the rulemaking (45 SRLR 1722, 9/23/13).
Attorneys told Bloomberg BNA that it will be difficult for the SEC to finalize the changes as proposed in light of the strong opposition raised by small businesses, the very community that the JOBS Act aims to help.
“I doubt advance filing will be required and I do not expect to see retroactive disqualification for filing foot faults,” Keller said. Those provisions have been heavily criticized by commenters (45 SRLR 1776, 9/30/13).
However, private fund advisers expect the SEC to finalize proposed changes pertaining to their industry. “We expect the SEC to act on its proposed rules under Reg D and 1933 Securities Act Rule 156 in connection with the JOBS Act to impose new requirements on private fund advisers,” Tittsworth said.
Among other measures, the SEC's proposal would extend Rule 156—which bars investment companies from using misleading sales materials—to private funds.
S-K Review “It is not clear what the SEC could sensibly do” in the area of proxy Meanwhile, attorneys urged the SEC to start on its broad review of the commission's disclosure regime, which White advisers. promised in the wake of a report on Regulation S-K that was issued in December (46 SRLR 8, 1/6/14). The Reg S-K report Stanley Keller was issued pursuant to the JOBS Act, which directed the Edwards Wildman Palmer LLP commission to review whether its disclosure regimen could be streamlined for emerging growth companies.
White has directed Corp Fin staff to gather input from the corporate and investor communities and to develop specific recommendations on how the SEC can update its disclosure rules. White previously said the initiative is a personal key priority (45 SRLR 1923, 10/21/13).
The disclosure system “clearly needs updating,” said Cross, who added that she repeatedly has warned that the multitude of SEC disclosure documents and the manner in which they are presented on EDGAR may lead the public to go elsewhere for information. “There is a real opportunity here for the SEC to make its disclosure requirements, and the output from those requirements, much more relevant,” she said.
Money Fund Reform
In other priorities not dictated by statute, the SEC has indicated that it will advance its money market reform proposal (45 SRLR 1077, 6/10/13).
The proposal suggests two alternative measures: the first would require institutional prime money market funds, which were hard hit during the financial crisis, to operate with a floating net asset value. The second would require non-government money market funds to impose a 2 percent liquidity fee on all redemptions if the level of weekly liquid assets fell below 15 percent of total assets.
Industry participants and other close observers told Bloomberg BNA it is difficult to predict where the commission will proceed on the proposal. Since the proposal was issued in June 2013, the SEC has replaced two of its members—Troy Paredes and Elisse Walter—with Stein and Piwowar.
“To be honest, I haven't a clue” as to how the commission will vote, said Robert Plaze, a former deputy director of the SEC's Division of Investment Management who led the money fund rule-writing efforts. Plaze now is a partner at Stroock & Stroock & Lavan LLP, Washington.
Given that there are three ways the SEC could proceed—adopt either of the alternatives or combine the two—it is “much harder to get a sense of where” the commission will come out, said ICI's McMillan. She added, however, that in light of the strong opposition to floating the funds' NAVs, “it would be a surprise” if the SEC
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Local and state governments and lawmakers have written to the SEC warning that floating NAVs would decrease investment in money funds, and thus increase the borrowing costs for municipalities.
Fees and Gates
McMillan said it would be the least disruptive for the SEC to adopt the second alternative. Fees and gates “would not disrupt the way that money market funds are operated on a daily basis” but would only kick in during times of extreme stress, she said. “So for most investors, the experience would stay the same.”
McMillan added that it might take longer than anticipated for the commission to advance the proposal. The SEC must review the large volume of comments received on the proposal, as well as the responses to the Financial Stability Oversight Council on its money fund recommendations, she observed. The debates goes back to the President's Working Group on Financial Markets report that was issued in October 2010 (42 SRLR 2002, 10/25/10), she said.
“So there's a lot for the commission to sort through,” McMillan said. “I think it's going to take a while. I think it is going to be a lot warmer than it is now before we see” some action on the matter.
Gumbs, for his part, suggested that White might have trouble finding consensus within the commission on money funds. “I think it's too controversial,” he said. “I would not be surprised to see them repropose it in light of the strength of the comments received.”
“It's a market-changing proposal, not dissimilar to what is happening right now with the Volcker rule,” that could radically change retail and institutional markets and the money fund industry, Gumbs continued. “There are major consequences, and I just can't imagine that they would take any of that very lightly.”
Proxy Advisers?
On another controversial issue, observers questioned whether the SEC will act on proxy advisory firms this year. Changes, if any, are likely to be minor, they said. “It is not clear what the SEC could sensibly do in this area,” Keller said.
In December, the SEC hosted a roundtable to discuss concerns raised by the corporate community, including potential conflicts of interest, surrounding the use of proxy advisory services (45 SRLR 2231, 12/9/13).
Others suggested that the SEC most likely will issue interpretive guidance to address some of the issues raised, including whether investment advisers are abdicating their fiduciary duties by relying too heavily on proxy firms.
Lawsuits?
Attorneys told Bloomberg BNA that it is difficult to predict whether the SEC will be sued over any rulemaking in 2014. One factor increasing the chances of litigation is whether well-funded groups are significantly impacted by the new regulations, they said.
One possibility for a lawsuit in the SEC's 2014 rulemaking agenda is money market reform, depending on how the SEC proceeds, they said.
Meanwhile, commenters—seizing on the D.C. Circuit's July 2011 decision vacating the SEC's proxy access regulation—Business Roundtable v. SEC—frequently are raising cost-benefit analysis in their comments on the commission's rule proposals.
Business Roundtable struck down—on the basis of inadequate economic analysis—an SEC rule that would have allowed qualifying shareholders, for the first time, to have their director nominees included in corporate proxy solicitation materials .
The SEC currently is litigating a challenge to its conflict minerals rule before the D.C. Circuit.
The D.C. Circuit also is hearing a lawsuit filed by the American Bankers Association challenging parts of the
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Volcker rule (46 SRLR 6, 1/6/14). Although the commission was not named in the action, it is one of five federal agencies that was involved in the rulemaking ((45 SRLR 2278, 12/16/13). House lawmakers also recently questioned the SEC's cost-benefit analysis for Volcker ((46 SRLR 108, 1/20/14).
Regulation and Courts
“In terms of regulatory activity, it will be just as important to look to the courts as to the commission,” said former SEC Commissioner Joseph Grundfest, now a Stanford law professor.
Grundfest told Bloomberg BNA that many questions remain as to the approach that the courts will take in reviewing the agency's rulemaking record in the dozens of Dodd-Frank rules that have been adopted and that are waiting to be adopted.
The fact that there are three new judges on the D.C. Circuit also adds uncertainty, “even though many observers think they know how these judges are likely to rule,” Grundfest added. “Let's remember that judges can surprise.”
The Senate Jan. 13 confirmed Judge Robert Wilkins to the appellate court, which now has a full bench. Judges Patricia Millett and Cornelia Pillard were appointed to the D.C. Circuit in December. All three were nominated by President Obama, as was Judge Sri Srinivasan, who was appointed to the court in May 2013.
However, Gumbs argued that D.C. Circuit precedent “creates a pretty high standard” for SEC rulemaking. “Even with the new judges on a panel, I'm not sure that will change the result,” he said.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
SEC Enforcers to Pursue Admissions, More Efficient Investigations in 2014
OUTLOOK 2014: SEC ENFORCEMENT
Securities and Exchange Commission Enforcement Director Andrew Ceresney says that in 2014, the agency will seek admissions in more cases, even in those not involving intentional or reckless behavior. He also says the division will strive to be as streamlined and efficient as possible in investigating and bringing actions. Meanwhile, some attorneys and legal experts question whether the SEC's heightened enforcement focus could be counterproductive.
By Yin Wilczek
Jan. 24 — In 2014, defendants in Securities and Exchange Commission cases should expect to face tougher settlement negotiations, as the agency ramps up on its revised policy to seek admissions where it considers appropriate.
SEC Enforcement Director Andrew Ceresney told Bloomberg BNA in a recent interview that he expects to see more admissions coming down the pipe, including in cases not involving intentional or reckless behavior.
“I think there's been a little bit of misconception that maybe we're just focused on cases with intentional or reckless misconduct,” he said. “I think we're going to seek admissions also in certain types of control issue cases—where scienter is not required—which present a risk to the market, or in which there is some sort of additional message that can be made unambiguously through admissions.”
In addition, the Division of Enforcement will try to be as effective and efficient in its investigations as possible, Ceresney said in the Jan. 7 interview.
The SEC official observed that in 2013, he and then co-director George Canellos had been sending out the message to staff members to cut to the heart of investigations, complete them, and bring actions as quickly as they can. “And I think [our] folks are very focused on this,” he said.
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Other new developments for the division include a broker-dealer task force, and investigations in connection with the SEC's general solicitation regime, Ceresney said.
Meanwhile, attorneys and securities enforcement experts contacted by Bloomberg BNA in late December and early January said they are waiting this year in anticipation—and with some apprehension—for further developments on enforcement initiatives announced by the SEC in FY 2013, including its revised policy on settlements.
Last Fiscal Year
The division comes off a record-breaking fiscal year 2013, in which it won $3.4 billion in monetary sanctions (45 SRLR 2336, 12/23/13).
However, defense attorneys have pointed out that the number of new SEC actions filed in FY 2013 was lower than in previous years. For example, Gibson Dunn & Crutcher LLP—in its 2013 Year-End Securities Enforcement Update—said that FY 2013 “turned out to be the slowest year for new cases since 2006.”
For her part, SEC Chairman Mary Jo White—a former federal prosecutor—has stressed through a series of speeches in 2013 that the commission is pursuing a tough enforcement program (45 SRLR 1883, 10/14/13).
As the latest example of its tougher stance, the SEC Jan. 23 announced that a Staten Island man under agency investigation was held in contempt and arrested for failing to comply with subpoenas requiring him to produce documents and testify [see related report in this issue].
Canellos Departure
Meanwhile, Canellos announced his resignation early this year, leaving Ceresney the sole head of the division ( 46 SRLR 9, 1/6/14).
Ceresney told Bloomberg BNA that there will not be “radical changes” resulting from Canellos's departure. “George and I were on the same page with respect to the direction of the division, so I don't think his departure will really effect much change.”
Looking ahead, the SEC official said the changes initiated by There will not be “radical changes” his predecessor Robert Khuzami—including specialized resulting from Canellos's departure. enforcement units—situate the enforcement program well for the future. The units not only provide the division with expertise SEC Enforcement Director Andrew in important areas, but focuses it on areas critical to its mission, he said. Ceresney In the past six months, the SEC has supplemented the division with task forces in areas that need additional focus, such as the Financial Reporting and Audit Task Force, Ceresney continued. There may be “some results” coming out of the financial reporting task force this year, “but the real dividends will be paid over the longer term.”
Moreover, the Microcap Fraud Task Force “is going to be really successful,” Ceresney said. “We've opened a record number of microcap cases in the last few months, focused mainly on gatekeepers and repeat players, but also we've made use more frequently of the trading suspension authority that we have” under Section 12(k) of the 1934 Securities Exchange Act.
Task Force on Broker-Dealers
Meanwhile, the division intends to formally announce a new broker-dealer task force later this year, Ceresney said (46 SRLR 7, 1/6/14). The broker-dealer task force will probably be fully functional “in the next couple of months,” he said.
The task force—co-chaired by New York Regional Director Andrew Calamari and Associate Director Antonia Chion—will serve as a think tank on broker-dealer issues, and create initiatives in that arena to be rolled out to the home and regional offices, Ceresney said. The Asset Management Unit “has done a great job of liaising with the investment adviser exam staff,” he added. “We're hoping that this task force can do the same on the broker-
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Of the three task forces, the Microcap Fraud Task Force is the largest in terms of manpower with 20 full-time attorneys. Second is the financial reporting task force, with 12 full-time attorneys and accountants. The broker- dealer task force—once fully assigned—will not have full-time members. Instead, attorneys assigned to the task force will have other responsibilities as well.
JOBS Act “We have a number of investigations that are in process relating to JOBS In other remarks, Ceresney said the division has a core group of attorneys focused on issues arising from the Jumpstart Our Act issues, including inadequate Business Startups Act. These attorneys are working closely accreditation efforts” and with other SEC divisions, the Financial Industry Regulatory misrepresentations “in terms of past Authority and state regulators, he said. “We have a number of investigations that are in process relating to JOBS Act issues, performance and the like.” including inadequate accreditation efforts” and misrepresentations “in terms of past performance and the like.” SEC Enforcement Director Andrew Ceresney Pursuant to the JOBS Act, issuers since Sept. 23 may widely solicit investors to their private placements under 1933 Securiti es Act Rule 144A and Regulation D Rule 506, provided the offerings are sold only to certain sophisticated investors (45 SRLR 1285, 7/15/13).
Ceresney also told Bloomberg BNA that the division is preparing for the impending adoption of new crowdfunding rules. He noted that it is still too early to tell whether the JOBS Act's new capital raising measures will lead to violations. “We'll have to see how they develop,” he said.
At the same time, the division will continue to target traditional areas, such as asset managers, insider trading, market structure issues—including alternative trading systems and compliance with the SEC's market access rule, 1934 Act Rule 15c3-5—and financial reporting, Ceresney said. “We've also focused on non-intent and failure to supervise cases, and we'll continue that.”
Moreover, the division will try to use statutes and rules that have not been used much in the past, the SEC official said. As an example, Ceresney said the division will be bringing more cases on “causing” violations. The Dodd-Frank Wall Street Reform and Consumer Protection Act extended the SEC's penalty authority with respect to those who cause a violation of the federal securities laws. “We're going to use all the tools available to us,” he said.
Rule 105 Actions
In other ongoing initiatives, Ceresney said the division likely will bring another series of actions under Regulation M Rule 105 pertaining to short-sale proscriptions in advance of stock offerings. In addition to the Rule 105 cases, there are “cases in some other areas coming down the pike that I can't go into yet,” he said.
Such actions are part of White's “broken windows” approach—unveiled in October (45 SRLR 1883, 10/14/13)—i n which the SEC will target repeat offenders typically for strict liability matters through streamlined investigations and settlements.
Ceresney added that the kinds of areas the SEC is focusing on under “broken windows” will become clear as the division brings more actions. Similarly, the kinds of cases in which the SEC will demand admissions from settling defendants will become clearer over time, he said.
In June 2013, White announced that in certain limited situations, the commission will forgo its traditional policy of allowing defendants to settle their cases without admitting to the allegations (45 SRLR 1150, 6/24/13). As of Jan. 7, there have been three cases in which the SEC has obtained admissions from defendants under its revised policy:
• SEC v. Harbinger Capital Partners LLC (45 SRLR 1565, 8/26/13);
• In re JPMorgan Chase & Co. (JPM) (45 SRLR 1720, 9/23/13); and
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• In re G-Trade Services LLC (45 SRLR 2335, 12/23/13).
Trial Performance
As to commentators' observations that the revised settlement policy will lead to more trials, Ceresney said he is confident of the division's ability to handle the cases. “We've had around an 80 percent win rate over the past few years, which is particularly impressive given the difficulty and complexity of the cases we try, which often rely on hostile witnesses and largely circumstantial evidence,” he said.
Conceding that the division has lost some recent cases, he added, “I don't think any of us regret bringing those cases. If you're not losing cases, you're not being aggressive enough.”
In the meantime, the use of data analytics will continue to be very important for the enforcement program, Ceresney said. In areas such as insider trading and financial fraud, “the amount of data available these days to use in investigations has grown exponentially,” he said. “And we have gotten much better in using that data to both detect possible misconduct and then conduct investigations.”
Among other technologies, the SEC uses its Advanced Bluesheet Analysis Program to identify trading trends or patterns. The commission also uses technology from Palantir that helps the staff identify connections between data.
The SEC Division of Economic and Risk Analysis further is developing a risk analytics tool known as the “Accounting Quality Model” to be used by various divisions, including Enforcement, to identify outliers in financial statements.
Funding for FY 2014
Shortly after the interview, President Obama signed an omnibus spending bill that funds the SEC at $1.35 billion for FY 2014 [see related report in this issue]. That amount is $29 million above the commission's FY 2013 enacted level but $324 million below the agency's request (45 SRLR 650, 4/15/13). The bill also reduced by half a $50 million reserve fund that the SEC tapped for technology projects.
In a recent statement, SEC spokesman John Nester said the funding level “falls short” of what the agency needs to fulfill its responsibilities. Among other problems, Nester said the shortfall “will limit our ability to bolster our enforcement and examinations programs,” and to “invest in critical technology for market oversight and law enforcement.”
SEC officials did not provide details on the specific impact of the funding on the commission's enforcement program and technology investments.
Key Areas for FY 2014 A renewed emphasis by the SEC on accounting fraud “may well turn out to Meanwhile, attorneys and enforcement experts told Bloomberg BNA that the SEC's financial reporting task force—and a be significant as this is an area ripe for potential increase in financial and accounting fraud enforcement.” investigations—and the agency's revised settlement policy are two key areas to watch in 2014. Berkeley Research Group Director H. At one time, accounting fraud actions constituted 25 percent to David Kotz 30 percent of SEC enforcement cases, reaching a peak of 219 cases in fiscal year 2007 (45 SRLR 181, 1/28/13). Since that time, however, the number of SEC financial fraud cases has steadily decreased, reaching new lows of 79 actions in FY 2012, and 68 actions in FY 2013.
A renewed emphasis by the SEC on accounting fraud “may well turn out to be significant as this is an area ripe for enforcement,” said H. David Kotz, the SEC's former Inspector General who now is a director at Berkeley Research Group.
Other commenters told Bloomberg BNA that the SEC has opened a number of investigations through efforts by the task force. However, the commission's emphasis on accounting and financial fraud might ironically, at least
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 16 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 in the short term, lead to fewer enforcement actions, they said. Not only do such cases take time to develop, they are harder to discover when the economy is on the upswing.
‘Attuned to Economic Cycle.’
“Accounting fraud is very much attuned to the economic cycle, so that the old Warren Buffett quote about seeing who is swimming naked when the tide goes out really applies in this area,” said Peter Henning, a law professor at Wayne State University in Detroit and a frequent commentator on white collar issues.
Henning noted that companies can keep questionable accounting practices from coming to the surface when they have enough sales/revenue to perpetuate their financial reporting decisions. However, in times of slowdown, accounting fraud surfaces because “the shuffle cannot continue,” he said, citing for example the subprime mortgage mess exposed by the fall in housing prices.
“So this is an area where the SEC needs to be paying extra attention, but I don't think we will see much from the ‘tougher’ enforcement environment in the next year, unless the economy goes south.”
Yet another problem is the sheer difficulty of bringing such cases, attorneys said. “Bringing strong accounting cases against senior corporate executives is hard because they often are unaware of technical accounting rules and rely on their finance departments and outside auditors,” said David Kornblau, a New York-based partner at Covington & Burling LLP.
Thomas Gorman, a Washington-based partner at Dorsey & Whitney LLP and author of the SEC Actions blog, suggested that the critical issue is whether the Enforcement Division has the patience to develop such cases.
Although technology and risk analytics can help, financial and accounting fraud cases in the end take “painstaking analysis and time to develop,” Gorman said. “The question is whether, in the day of the 24/7 news cycle, the division wants to invest the resources” in this area.
Past Experience
However, Jason Flemmons, a former deputy chief accountant in the Enforcement Division who now is a senior managing director at FTI Consulting Inc., suggested that while the task force still is a work in progress, it has great potential. He said the SEC's past dedication of resources to accounting and financial fraud yielded “a lot of successes.”
Flemmons told Bloomberg BNA that when he was at the SEC, there was significant accountant resources devoted to proactive and risk-based initiatives similar to what the task force will be undertaking. Among other proactive measures, the cross-border efforts led to a big jump in enforcement actions against China-based issuers and auditors, he said.
Flemmons, among other roles in the division, co-chaired its Cross-Border Working Group.
In those days, it was at times very challenging to get enforcement attorneys on board because of the raw investigative legwork and time necessary to develop a financial fraud case, Flemmons said. What is different today is that the SEC has made that investment ahead of time and “dedicated attorney bandwidth” to the task force. “The creation of the task force is certainly a very positive development” that hopefully will lead to more high quality cases in future, he said.
Flemmons added that one potential concern may be the increased pressure on the Enforcement Division to show results from its renewed focus on financial and accounting fraud. Will that added pressure “result in Enforcement taking actions on much smaller violations that historically were not deemed to be actionable?” he asked.
That concern also applies to remedies, Flemmons said. “You just hope that putting more emphasis and pressure on the staff to send the message that this is a high priority does not result in remedies that go far beyond the underlying conduct.”
Revised Settlement Policy
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As to settlements, the defense bar is waiting for further indication as to how the SEC will apply its revised policy. Observers told Bloomberg BNA that they already have seen delays in some settlement negotiations where SEC attorneys are pushing for admissions.
Ultimately, if the SEC applies the new policy across the board in enforcement actions, “that could be a game changer and have reverberations throughout the securities industry,” Kotz said.
In the meantime, attorneys said the three cases in which the SEC has obtained admissions have not provided a clear roadmap for when the commission will press for an admission (46 SRLR 68, 1/13/14).
At this point, the new policy is still evolving and untested, said Joseph Grundfest, a former SEC Commissioner who now is a Stanford law professor. Looking ahead, the major challenge for the new policy is when the commission demands an admission that has significant collateral consequences for the defendant, and that defendant threatens to litigate rather than settle, he said. “It remains to be seen whether the commission or the potential defendant will step back, or whether litigation will ensue.”
This question is especially relevant in the accounting and financial fraud arena, a key enforcement priority for the division. “Obtaining admissions in these cases will be especially difficult, because they will be viewed as opening the door to potentially huge exposure to shareholder actions,” Kornblau said.
Enforcement Toughness
In other comments, defense attorneys and other legal experts told Bloomberg BNA that the jury still is out as to whether the SEC can deliver on the tough enforcement agenda that White promised. Some also suggested that the question is not whether the SEC can deliver, but whether the tough stance is effective.
In its traditional role, the SEC effectively acted as regulator by halting infractions and using ancillary relief to prevent a recurrence of the problem and to safeguard markets, Gorman said. However, seeking to punish defendants through big fines and admissions pushes the commission into the territory of prosecutor, he suggested. “At this point the agency appears to be trying to tread both paths, which may prove difficult at best.”
Gorman also said the SEC must improve its trial record. Critical to the commission's heightened enforcement focus is its ability to take cases to trial and win, he said. “To date the SEC has very mixed results in major trials.”
Andrew Vollmer, a University of Virginia law professor, described the SEC's “zero tolerance” for any securities law violation—including strict liability transgressions—as “questionable enforcement policy and probably counterproductive” for a whole host of reasons.
“The commission will not properly communicate the goals of compliance and deterrence by seeking to enforce in equal measure a rule forbidding deceit of a counterparty and a rule obliging a financial report to use a specific XBRL tag,” said Vollmer, who previously was a Washington-based partner at Wilmer Cutler Pickering Hale & Dorr LLP, and before that former deputy general counsel of the SEC. “Securities enforcement requires more carefully calibrated priorities.”
Resource Allocation
Given the SEC's lack of resources, it would be far more effective for the enforcement program to achieve the greatest impact by moving in areas causing the greatest harm to the largest number of people, Vollmer continued. “A program pursuing the smallest infraction or showing zero tolerance for a strict liability foot fault is a program with no priorities and no thoughtful allocation of resources.”
Vollmer further suggested that “overzealous enforcement” could lead to “two extremely damaging consequences”: departure from settled law and unfair treatment of those under investigation. “As Enforcement staff press to bring cases, they shunt the legitimate interests of the private parties to the sidelines, and they develop novel and expanded theories of legal liability to capture conduct not prohibited by established precedent,” he warned.
Mike Koehler, an assistant professor at Southern Illinois University School of Law, questioned whether the SEC's heightened emphasis on tough enforcement extends to the Foreign Corrupt Practices Act.
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“To say that the SEC ‘enforces’ the FCPA is subject to debate given that in most recent years, approximately 50 percent of corporate FCPA actions are the result of voluntary disclosures,” said Koehler, who also is founder and editor of the FCPA Professor blog. “Whether the SEC ‘processes’ these voluntary disclosures in any given year is the more appropriate question.”
Koehler also noted that enforcement success is best measured by whether an enforcement agency meets its burden of proof. “The SEC has an overall losing record” when put to its burden of proof in FCPA enforcement actions involving individuals, he said.
In addition, the academic suggested that there is a “troubling” development in which the SEC increasingly has bypassed judicial scrutiny in resolving corporate FCPA actions. “For instance, in 2013, 50 percent of corporate FCPA enforcement actions were not subject to one ounce of judicial scrutiny either because the SEC used a non-prosecution agreement (Ralph Lauren (45 SRLR 769, 4/29/13)) or resolved the matter administratively (Koninklijke Philips Electronics NV; Total SA (45 SRLR 1036, 6/3/13); and Stryker Corp. (45 SRLR 1983, 10/28/13)),” he said.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Reauthorization Looms as Year Begins; Interim Leadership Clouds CFTC Future
OUTLOOK 2014: FUTURES REGULATION
Operating under an acting chairman, the CFTC enters 2014 on a note of uncertainty as it faces final Dodd-Frank rulemaking, resolution of cross-border issues and a pending concept release on automated trading. Meanwhile, the House and Senate Agriculture committees are focused on passing a farm bill, meaning derivatives priorities such as nomination hearings for three open CFTC seats and Commodity Exchange Act reauthorization will have to wait.
By Richard Hill
Jan. 24 — The Commodity Futures Trading Commission is beginning 2014 on a note of uncertainty as—under interim leadership and with several vacancies waiting to be filled—it faces reauthorization, completion of rulemaking under the Dodd-Frank Wall Street Reform and Consumer Protection Act and controversy over its cross-border policy.
Meanwhile, on Capitol Hill, the CFTC's two main oversight committees—the House and Senate Agriculture committees—are still working to craft a farm bill, which remains their top priority. As a result, they are unlikely to tackle reauthorizing the Commodity Exchange Act or holding nomination hearings for three CFTC candidates in the next few months, according to observers.
Specifically, Chairman Gary Gensler, who led the agency while it adopted more than 60 rulemakings and guidances under Dodd-Frank over the last three years, resigned in January after his term expired. President Obama has nominated Treasury official Timothy Massad to replace Gensler, but in the meantime, Democratic Commissioner Mark Wetjen is leading the agency as acting chairman (45 SRLR 2345, 12/23/13).
Wetjen, however, is leading a depleted group: Two CFTC seats—one Democratic and one Republican—are vacant, and a third commissioner, Democrat Bart Chilton, announced his intention to resign in November (45 SRLR 2088, 11/11/13). Chilton had said he would be leaving before the end of 2013, but at presstime was still with the agency.
The current composition of the commission—Republican Scott O'Malia is the third member—led many observers to speculate that the CFTC will be in somewhat of a holding pattern, at least until Massad or someone else is confirmed as chairman.
Futures Industry Association President Walter Lukken, who spent 19 months as acting CFTC chairman between 2007 and 2009 while awaiting Senate confirmation as permanent chair, told Bloomberg BNA that acting chairmen “are really stewards. They're not making major policy decisions.”
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No Significant Changes
Wetjen, he said, “knows that there's another chairman likely to be confirmed in the next several months, so he's not going to take significant policy changes.”
Susan Ervin, a partner in Davis Polk & Wardwell's Financial Institutions Group in Washington and a former CFTC attorney, said, “commission-level decisions on anything of real policy significance will almost certainly be postponed until the new chairman takes office.”
While it is possible for a three-member to engage in rulemaking, according to Ervin, “it's unlikely to be done on matters of great importance as the vote would lack some of the weight of a full commission.”
A CFTC spokesman declined to comment for this article.
Breathing Room
At the same time, observers noted that the CFTC has largely completed its Dodd-Frank rulemaking. While a handful of significant rules, addressing margin for uncleared swaps, position limits and futures block trades, still await adoption, the regulated community is beginning to operate under the Dodd-Frank regime. New requirements under the statute include mandatory trading on swap execution facilities, registration of swap dealers, compulsory reporting of swaps data and business conduct rules. While O'Malia hopes to revisit several Dodd-Frank rules in 2014 that he says were adopted in haste or without adequate justification or data, observers doubt that will happen.
One Hill staffer who works in the derivatives area and spoke on background to Bloomberg BNA said, “I think it's going to be quite a while before the CFTC will be able to revisit swap rules. There may be some hot spots where people are having trouble complying and these may receive special attention, but I would be surprised if they actually undertook any new rulemaking to revise” recently adopted regulations.
For his part, Lukken said that after three years of major rulemakings, the slowdown at the commission “definitely gives us some breathing room.” The FIA president said industry now has a chance “to take stock of what's happened in the last [several] years and prioritize what, if any, fixes are needed in the regulatory apparatus.”
Adjustments on the Table
However Robert Pickel, chief executive officer of the International Swaps and Derivatives Association, said his hope “is that if we have real evidence of adverse market effects, and if we can go to the commission and present that in a factual sort of way, that they will be responsive to making adjustments—adjusting rules to reflect reality. That was true before and I'm hopeful it will be going forward.”
Ervin, meanwhile, said the CFTC and the regulated community might not have the luxury of taking a breather at this juncture. “A number of the rules are unclear, have gaps, or are otherwise difficult to apply,” she said. “If staff can give guidance during this interim period, these problems can be addressed, at least temporarily.”
Observers have speculated, however, that under Gensler's leadership, staff was not allowed to issue relief without the chairman's approval. According to one attorney who follows CFTC matters closely, of the one hundred-plus no-action letters that have been issued to address Dodd-Frank rulemaking, “my understanding is, every single one of those went through Gary Gensler. The staff was not authorized to issue those until they went through the chairman's office.”
However, it remains unclear how the interim nature of Wetjen's acting chairmanship will affect the staff's ability to provide the industry with guidance and relief. “Will staff, now that Gary Gensler is gone, feel they can do that?” the attorney asked. “I don't know. It depends on what kinds of signals Mark Wetjen gives.”
The attorney added that Wetjen “seemed to be inclined to give relief in many situations. But when someone becomes chairman, it's very hard to know how they will manage the process.”
How long Wetjen remains acting chairman is unclear as the Senate Agriculture Committee has yet to schedule a nomination hearing for Massad. While the committee failed to respond to several calls and e-mails regarding its timeline for a hearing for Massad and two other CFTC nominees—J. Christopher Giancarlo and Sharon
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Bowen—observers said it could take several months.
“I think it's a priority, but it's affected by the timing of the farm bill,” said Dawn Stump, an FIA senior vice president and its head of government affairs.
At the same time, she said, “I don't think they'll delay [nomination hearings] if the farm bill becomes a much longer-term project. But at this time, distracting committee members from anything other than the farm bill is unlikely.”
Reauthorization
Congress' other priority, according to observers, is to pass a reauthorization bill. “I think reauthorization is where Congress is going to focus” in 2014, Stump said.
According to observers, at this point, House lawmakers are taking the lead on the reauthorization process. In October, leaders of the Agriculture General Farm Commodities and Risk Management Subcommittee, which held a series of hearings on the topic in 2013, told Bloomberg BNA that staff was in the process of crafting reauthorization legislation, but that it would be taking a back seat to passing a farm bill (45 SRLR 1909, 10/14/13; 45 SRLR 2000, 10/28/13). At that time, subcommittee Chairman Michael Conaway (R-Texas) said he envisioned a bill that contained some lawmakers' legislative priorities for the derivatives industry as opposed to one that simply reauthorized the CEA and the CFTC for another five years, as occurred in 2008.
A spokesman for Conaway declined to comment for this article. However, committee observers said work on the reauthorization bill has shifted away from the subcommittee and more towards the committee as a whole.
Stump said the timing of a reauthorization bill “largely depends on the farm bill.” While the House has finished its preparations and is ready to get to work on reauthorization language, “the Senate is not as far along in the process. They will need to have a few more hearings” she said. Stump, meanwhile, said a farm bill could be completed within weeks.
One derivatives lawyer said she could see “some significant changes coming up” in reauthorization, such as revisions to Dodd-Frank and in the area of customer protection. She said, however, “I don't think it's going to be a sea-change kind of event” because there does not seem to be a consensus on major legislative changes.
Diminished Significance?
At the same time, several observers downplayed the significance of completing a reauthorization bill in a timely manner. They said that reauthorization used to create great debates on topics that otherwise did not have a platform to be aired. However, with the sweeping Dodd-Frank law and an otherwise increased spotlight on derivatives issues among lawmakers, reauthorization is not as consequential as it may have been in the past.
“I think reauthorization has become less important,” Lukken told Bloomberg BNA. “Reauthorization traditionally has presented a convenient opportunity that comes around every five years or so for people to consider what fixes are needed in the CFTC's oversight of the futures industry. But now that the CEA is constantly being looked at, I think there is less of a demand for a full-scale reauthorization process as there has been in the past.”
Lukken said he could “easily see” reauthorization being completed in 2014. However, he acknowledged, lawmakers could extend the process into the following year. He added that “I think people want to go through the exercise—have hearings [and] talk about what needs to be fixed; potentially even do a markup in committee—but that may be as far as it gets.”
According to Ervin, “it used to be that reauthorization was the lightning rod that surfaced all or most of the major issues. Now, the CFTC is such a major player that issues receive more continuous attention.”
As one observer stated, “Nothing really happens” if reauthorization is not completed. “The CFTC does not discontinue operations.”
A House Agriculture Committee spokesman did not respond to a request for comment for this article.
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Meanwhile, Stump predicted that the House, under Republican leadership, will continue to pass bills that revisit Dodd-Frank, though she added that “typically those efforts go no farther than the House floor, as Senate Democrats have resisted reopening any aspect of Dodd-Frank. ”
“I think there's going to be a lot of discussions about all of the regulations,” Stump said, “but it's really hard to see how any changes to Dodd-Frank could get through both houses of Congress this year.”
Period of ‘Certainty.’
For his part, Lukken said that might be a good thing. “Dodd-Frank is just coming into play right now; people are just beginning to understand it and live with it. So I'm not sure we're going to have a clear idea on all the problems that are going to emerge until later on in the year.”
He continued, “We've gone through a five-year period of uncertainty and change. I think people want to live in a period of certainty for a time and then start working on the fixes.”
Back at the CFTC, while the agency is under interim leadership, several issues remain from 2013 that eventually will need to be tackled. Among those are block rules for futures trades, setting parameters for swaps block trades, adopting rules on position limits and margin for uncleared swaps, and completing substituted compliance designation to clarify the cross-border reach of Dodd-Frank swaps rules
Regarding swaps block rules, which the CFTC adopted in May 2013, Pickel said the question is getting the levels right (45 SRLR 957, 5/20/13). “If that takes a little more time and more data needs to be gathered, I think people generally feel that's time and effort well spent,” he said.
In the meantime, the commission has offered no indication of when the pending Dodd-Frank rules will be considered for adoption.
According to Ervin, however, the cross-border issues “are going to be square and center this year.” The commission made its first batch of substituted compliance determinations for six jurisdictions at the end of 2013, but Ervin described their activity so far as “very limited” (46 SRLR 35, 1/6/14). Eventually, they will have to make further substituted compliance determinations, as well as expand the types of rules that the determinations will cover.
Meanwhile, regulatory observers also are keeping track of a lawsuit filed by ISDA, the Securities Industry and Financial Markets Association and the Institute of International Bankers in December (45 SRLR 2260, 12/9/13). The groups alleged in the U.S. District Court for the District of Columbia that the CFTC acted illegally when it issued interpretive guidance and subsequent advisories regarding the cross-border reach of Dodd-Frank swaps rules because it disregarded federal rulemaking requirements. It is asking the court to vacate the July 2013 guidance and November advisory. Arguments to dismiss the case will be reveived by the court in March and April (46 SRLR 133, 1/20/14).
Another important issue that remains on the agency's radar from 2013 is the topic of automated trading. The CFTC issued a concept release in September soliciting views on system safeguards for algorithmic trading, and recently reopened its comment period (45 SRLR 1701, 9/16/13).
Lukken, however, said he thinks the issue might be far down the list of topics concerning commissioners at present. “There's some uncertainty as to what will happen next. My guess is that the discussion will stay at the staff level for a while, and it will be up to the next chairman to decide if there's a definite need for some sort of rulemaking here.”
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Lawmakers Look Ahead to Dodd-Frank, Volcker Rule, JOBS Act Fixes in 2014
OUTLOOK 2014: SECURITIES LEGISLATION
As the regulatory rollout continues for Dodd-Frank and the JOBS Act, lawmakers are pushing for legislative
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adjustments and oversight. The House has been more active than the Senate in both areas, but the Senate intends to undertake oversight of regulators' activities in the coming months. Meanwhile, Senate Banking Committee Chairman Tim Johnson of South Dakota is stepping down after his term ends later this year.
By Rob Tricchinelli
Jan. 24 — In the second session of the 113th Congress, lawmakers have proposed minor legislative adjustments to two major laws in the securities realm and prodded the Securities and Exchange Commission to make revisions as it works to implement the statutes.
The House has passed several bills, both this year and last, to modify the Dodd- Frank Wall Street Reform and Consumer Protection Act and Jumpstart Our Business Startups Act, and more House action on those fronts is coming. And already in 2014, the House has held a hearing on the Volcker rule and pressed federal regulators to change the rule's restrictions on certain asset classes.
Bills clearing the House have not seen much action in the Senate, however, because, for now, the Senate Banking Committee is focused on housing finance reform. Activity on Dodd-Frank and the JOBS Act will attract the upper chamber's attention later this year, although action there is likely to take the form of oversight rather than a series of small-scope bills as seen in the House.
Sen. Tim Johnson (D-S.D.), chairman of the Senate Banking Committee, is not seeking reelection in the 2014 midterms, and there are several Democratic senators who might end up holding the gavel in 2015—provided the Democratic caucus holds its small Senate majority once the ballots are counted.
Volcker Rule
In the House, the Financial Services Committee kicked off 2014 with a Jan. 15 hearing on the “impact and potential unintended consequences” of the Volcker rule. The panel's quick action signals that House lawmakers are likely to continue their efforts to refashion Dodd-Frank in 2014.
The Volcker rule, a Dodd-Frank provision, generally bars banks from engaging in short-term proprietary trades and limits their ability to invest in private equity funds and hedge funds. In December, five federal financial agencies, including the Securities and Exchange Commission and the Commodity Futures Trading Commission, adopted rules to implement the statute (45 SRLR 2280, 12/16/13).
Rep. Jeb Hensarling (R-Texas), who chairs the committee, and Rep. Scott Garrett (R-N.J.), who leads its Capital Markets subcommittee, have been active in leading the charge for legislative oversight of the Volcker rule, most recently asking SEC Chairman Mary Jo White about the economic analysis on which the rule was grounded (46 SRLR 108, 1/20/14).
Shortly after the Volcker rule regulations were adopted, lawmakers expressed concern that, under the rule, banks could not keep their interests in collateralized debt obligations backed primarily by trust-preferred securities—so-called TruPS CDOs. The American Bankers Association also filed a related legal challenge.
After the lawsuit was filed, Hensarling and Rep. Shelley Moore Capito (R-W.Va.) introduced a bill to ease the restrictions on TruPS CDOs, while House Democrats wrote regulators urging them to do the same (46 SRLR 59, 1/13/14).
On the Senate side, a pair of bills also addressed the matter. One, introduced by Sens. Joe Manchin (D-W.Va.) and Roger Wicker (R-Miss.), would lift the restriction for banks with total assets worth less than $50 billion.
A Republican-backed bill, sponsored by Sen. Mark Kirk (Ill.), would apply to all banks and “any collateralized debt obligations backed by trust-preferred securities or debt securities of collateralized loan obligations,” a broader application than the Manchin bill.
Faced with mounting pressure, regulators Jan. 14 approved an interim final rule that walked back the restriction on TruPS CDOs but did not affect collateralized loan obligations (46 SRLR 108, 1/20/14).
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Given the regulatory fix, related legislation is unlikely to “We expect to host one of our periodic advance. However, regulators may take additional action if oversight hearings with regulators in financial industry groups have their way. the coming weeks.” At the Jan. 15 hearing, several trade group representatives asked lawmakers to ease Volcker rule restrictions on CLOs (46 Senate Banking Committee aide SRLR 113, 1/20/14).
They warned that without further changes, banks would have to write down nearly $70 billion in CLO holdings.
Meanwhile, the American Bankers Association has withdrawn the part of its lawsuit asking for emergency relief.
Dodd-Frank Bills
In addition to seeking Volcker rule modifications, House lawmakers have pressed legislation, both in the Financial Services Committee and in the full body, to revise other Dodd-Frank provisions and look to continue doing so in 2014.
In December, the full House approved a bill (H.R. 1105) sponsored by Rep. Robert Hurt (R-Va.) that would exempt most private equity fund advisers from registering with the SEC, as Dodd-Frank requires (45 SRLR 2223, 12/9/13). The bill passed 254-159, with 36 Democrats in favor and only one Republican opposed.
Through a spokeswoman, Hurt told Bloomberg BNA that, if passed, the bill “will reduce unnecessary regulations implemented by Dodd-Frank,” and accordingly “promote greater access to capital for small businesses.”
Both the White House and the SEC oppose the measure.
The House also cleared the Retail Investor Protection Act (H.R. 2374), which would prohibit the Department of Labor from defining a “fiduciary” in its rules until the Securities and Exchange Commission adopts a rule of its own to impose a uniform standard of conduct on investment advisers and broker-dealers (45 SRLR 2025, 11/4/13).
The bill, sponsored by Rep. Ann Wagner (R-Mo.), passed 254-166 in October, mostly along party lines, although 30 Democrats voted in favor. It was referred to the Senate Banking Committee. The White House and the SEC oppose this measure as well.
A bill (H.R. 1135) is pending to roll back the Dodd-Frank requirement that public companies disclose the median income of all employees besides the chief executive officer, as well as the CEO's salary and the ratio of those two numbers.
After a contentious markup, the bill cleared the Financial Services Committee in June by a 31-26 vote (45 SRLR 1156, 6/24/13). It was sponsored by Rep. Bill Huizenga (R-Mich.).
“By forcing publicly traded companies to report median total compensation, the federal government is requiring companies to provide data that is potentially misleading to investors due to the differing geographic locations of the business,” a Huizenga aide told Bloomberg BNA. “The pay ratio requirement is a perfect example of an unnecessary and complex regulatory requirement that is not worth the cost and should be repealed.”
Dodd-Frank in the Senate
The House bills may receive little traction in the Senate, at least until more time passes to allow Senate staff to assess Dodd-Frank's impact. The Banking Committee in particular will likely be focusing on oversight rather than piecemeal legislative tweaks.
“Many of the significant final rules have recently been completed, but others are still pending,” a Johnson Banking Committee aide told Bloomberg BNA. “Chairman Johnson believes the implemented rules should be well tested before considering a corrections bill, which, of course, would need broad bipartisan support.”
Senate aides say the Banking Committee's near-term focus is on housing finance reform but could turn to Dodd-
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Frank once that hurdle is cleared. Oversight of Wall Street reform has always been a priority for Chairman Johnson, and it will continue to be a focus of the Committee's work this year,” a Johnson Banking Committee aide told Bloomberg BNA. “We expect to host one of our periodic oversight hearings with regulators in the coming weeks.”
Dodd-Frank fixes are a priority on the Republican side of the committee, including oversight to make sure the SEC and CFTC are using “robust cost-benefit analysis” to minimize the effect of Dodd-Frank rules on the economy, a Republican banking committee aide told Bloomberg BNA.
Republicans would have preferred to see the SEC and CFTC merged into a single agency when Dodd-Frank was first adopted, but “we're not going to see that” now, the aide said. Instead, ensuring coordination between the SEC and CFTC on the Dodd-Frank rollout is a Republican priority. The aide noted that the SEC is “well behind” the CFTC in rulemaking under Dodd Frank Title VII, which regulates the swaps market.
Other priorities of Banking Committee Republicans include S. An aide said Dodd-Frank fixes are a 888, introduced by Sens. Mike Johanns (R-Neb.) and Jon priority on the Republican side of the Tester (R-Mont.), which would exempt commercial end-users committee, including oversight to make from Dodd-Frank's swap margin and capital requirements (45 SRLR 887, 5/13/13). sure the SEC and CFTC are using “robust cost-benefit analysis.” The House version of the bill (H.R. 634), sponsored by Rep. Michael Grimm (R-N.Y.), passed 411-12 in June (45 SRLR 1138, 6/17/13).
GOP lawmakers also are focusing on S. 474, sponsored by Sen. Kay Hagan (D-N.C.), which would repeal most of Dodd-Frank's so-called push-out clause by broadening the types of swaps activities banks could participate in while retaining access to federal depository assistance.
Rep. Randy Hultgren (R-Ill.) sponsored the House version, which passed 229-122 in October (45 SRLR 2057, 11/4/13).
JOBS Act 2.0
Revising Dodd-Frank, however, is not the only item on House lawmakers' agenda. The chamber also has taken action on sundry legislation revisiting the JOBS Act, with several bills moving through committee and the full chamber. The Senate is still considering how to proceed on these adjustments at the committee level.
Specifically, on Nov. 14, the House Financial Services Committee recommended three bills aimed at aiding the growth of small businesses—part of a package of legislation dubbed JOBS Act 2.0. Two of the bills moved through the committee with unanimous bipartisan support, including H.R. 2274, The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, sponsored by Huizenga. The bill would allow brokers dealing in mergers and acquisitions of private companies to register with the SEC through electronic public notice-filing. In most cases, the registration would take place immediately.
Huizenga's bill passed the full House 422-0 on Jan. 14, and Manchin introduced a version in the Senate that same day (46 SRLR 112, 1/20/14).
“Congressman Huizenga is very encouraged by the overwhelming bipartisan support” the bill received, a Huizenga aide told BNA. “Having Senator Manchin introduce companion legislation in the Senate the same day the measure passed the House 422-0 is another positive development.”
The other JOBS Act bill that cleared the committee is H.R. 3448, which would allow “emerging growth companies” to increase their stock “tick size” to increments of five or 10 cents, for stock prices at or above one dollar. The legislation would implement the tick-size changes over a five-year pilot program; its sponsors have said the move would facilitate capital raising for small businesses.
A Republican aide told Bloomberg BNA that the bill, introduced by Reps. John Carney (D-Del.) and Sean Duffy (R-Wis.), will likely head to the full House early this year.
A third measure also made it out of the committee in November, over the objection of all but one Democrat. The
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 25 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 bill (H.R. 1800), sponsored by Grimm, would expand the capability of so-called business development companies to make loans to small and midsize businesses.
The bill would allow BDCs to invest in investment advisers or advisers to investment companies; lower BDCs' permitted asset-to-debt percentage to 150 percent from 200 percent; and allow BDCs to issue multiple classes of senior securities (45 SRLR 2117, 11/18/13).
During markup, Democrats expressed concerns about a lack of shareholder input in potential investments that BDCs could make under the bill. The bill has not been scheduled for consideration by the full House.
“I am working with my colleagues on the other side of the aisle on this important issue and I'm confident that H.R. 1800 will pass the House in 2014 with strong bipartisan support,” Grimm told Bloomberg BNA through a spokesman.
Another JOBS Act revision (H.R. 801) passed the House on Jan. 14 (46 SRLR 112, 1/20/14).
The Holding Company Registration Threshold Equalization Act, sponsored by Rep. Steve Womack (R-Ark.), would give savings and loan holding companies relief from shareholder reporting requirements that currently apply only to banks and bank holding companies.
The bill would adjust JOBS Act provisions regarding reporting and “deregistration” requirements for banks and bank holding companies. It passed 417-4. A companion bill in the Senate, introduced in May by Sen. Pat Toomey (R-Pa.), has seen no action. A Womack aide, however, told Bloomberg BNA that the Senate could eventually pass the measure by unanimous consent.
Meanwhile, bipartisan bills to reform the Securities Investor Protection Act by “modernizing” the way it distributes funds to victims of fraudulent broker-dealers and related entities (S. 1725, H.R. 3482) are pending in both chambers.
Committee hearings have been held on the House version, sponsored by Garrett, but the Senate version has seen no action.
Regarding the JOBS Act more generally, a Johnson Banking Committee aide told Bloomberg BNA that “the Senate would have to consider carefully any of the legislation proposed in the House, so it is too early to determine if any legislation will move forward.”
Despite the uncertain prognosis, a Republican Banking Committee aide told Bloomberg BNA that “monitoring JOBS Act 2.0 in the House” is a 2014 priority for committee Republicans.
Chairman Turnover
Any legislative activity in the Senate this session will be the last with Johnson at the head of the Banking Committee. The South Dakota Democrat announced in March 2013 that he is not running for reelection this year (45 SRLR 580, 4/1/13), leaving the chairmanship for 2015 and beyond an open question.
Johnson has been chairman since 2011, when Sen. Chris Dodd (D-Conn.) retired.
Seniority matters when it comes to committee leadership; traditionally, the most senior member of a committee serves as chairman or ranking member. On the Banking Committee, the next most senior Democrat is Sen. Jack Reed (D-R.I.).
Reed, however, is the second-ranking Democrat on the Senate Armed Services Committee, where Chairman Carl Levin (D-Mich.) also is retiring. Reed, a West Point graduate, has not stated which panel he would prefer to chair, if either.
In terms of seniority, Democratic Sens. Chuck Schumer (N.Y.), Robert Menendez (N.J.) and Sherrod Brown (Ohio) are next in line following Reed.
As vice chairman of the Democratic Caucus, however, Schumer could prefer to focus on his leadership role within the party. He is also chairman of the Democratic Policy and Communications Committee.
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Menendez, meanwhile, is chairman of the Senate Foreign Relations Committee and would have to step down from that role to head the Banking Committee. For his part, Brown has been very active in the banking realm and would likely accept the chairmanship if offered.
The Democrats' Senate majority is not assured beyond 2014, however, with a handful of Democratic retirements and vulnerable incumbents running for reelection. Sen. Mike Crapo (R-Idaho) is ranking member on the banking committee and could become chairman if control of the Senate turns over.
Republican conference rules mandate that no Republican member can be chairman of a committee for more than six years. Sen. Richard Shelby (R-Ala.) served as Banking Committee chairman for four years when the Republicans last controlled the Senate, and he would have the option to lead it for two more.
Shelby, though, is ranking member on the Senate Appropriations Committee and would be in line for that chairmanship.
Sen. Thad Cochran (R-Miss.) served for four years as appropriations chairman and could reclaim that mantle, but he is ranking member on the Senate Agriculture Committee and in line for that chair.
In the Republican edition of “musical chairs,” a Republican Senate aide told Bloomberg BNA that “most likely, Crapo would be chairman unless Shelby decided to come back and chair for two more years.”
To contact the reporter on this story: Rob Tricchinelli in Washington at rtricchinelli@bnacom
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Lawyers Awaiting Halliburton Decision; Could Have Big Impact on Class Litigation
OUTLOOK 2014: SECURITIES LITIGATION
Securities lawyers are awaiting the U.S. Supreme Court's decision in a certification controversy that could have a major impact on the future of class securities-fraud litigation. The justices also are expected to rule on a SLUSA jurisdictional issue arising from R. Alan Stanford's Ponzi scheme and a dispute over the Sarbanes-Oxley Act's whistle-blower anti-retaliation protections. Meanwhile, the high court's 2010 Morrison decision will continue to reverberate in 2014.
By Phyllis Diamond
Jan. 16 — Heading into 2014, the big story in private securities litigation is the U.S. Supreme Court's highly anticipated ruling in Halliburton Co. v. Erica P. John Fund Inc. and what it could mean for the future of class securities fraud litigation.
The controversy, which centers on the viability of the 25-year old fraud-on-the-market doctrine, could sound the death knell for the ability of allegedly defrauded investors to sue on a class basis.
In the words of New York lawyer John Dellaportas, Morgan Lewis & Bockius LLP, a successful fraud-on-the- market challenge “would be like a nuclear bomb dropping in the securities world.” A significant decline in securities fraud class lawsuits also would have a serious impact on attorneys for plaintiffs and defendants alike.
Presumption of Reliance
In the lawsuit, Halliburton Co., (HAL) which allegedly misled investors about its financial condition, is asking the justices to overturn Basic Inc. v. Levinson, a 1988 decision that established the fraud-on-the market presumption of reliance for investors who bought or sold securities in an efficient market.
Regardless of their view on the merits, lawyers contacted by Bloomberg BNA during January agreed that Halliburton could be momentous for both issuers and investors. The stakes for investors are enormous, Washington attorney Daniel Sommers, Cohen Milstein Sellers & Toll PLLC, said, He predicted that Halliburton “will be the most closely watched and potentially the most significant case impacting private securities litigation in the past quarter century.” The case is scheduled to be argued March 5.
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In other action, the justices are slated to rule on two pending cases, a jurisdictional question involving victims of a Ponzi scheme and a whistle-blower retaliation dispute. The year could also see appellate review of district court decisions interpreting the high court's Morrison decision.
Halliburton
In Halliburton, plaintiff Archdiocese of Milwaukee Supporting Fund Inc., now Erica P. John Fund Inc., alleged that between June 1999 and December 2001, the energy services company made material misrepresentations regarding litigation expenses and other matters. On its first Supreme Court trip in 2011, Halliburton failed to persuade the justices that plaintiffs must demonstrate loss causation to obtain class certification (43 SRLR 1206, 6/13/11).
Undeterred, Halliburton renewed its opposition to class certification; this time, it argued that the class should not be certified because the alleged fraud did not affect the market price of its securities. However, the district court concluded that price-impact evidence had no bearing on whether common issues predominated under Fed.R.Ci v.P. 23(b)(3) and the Fifth Circuit affirmed (45 SRLR 821, 5/6/13).
In a move that came as no surprise to many securities lawyers, in November, the supreme court granted Halliburton's certiorari petition (45 SRLR 2107, 11/18/13).
Over the past few years, the high court has tackled a number of cases involving class certification issues. A little less than a year ago, it concluded in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds that to obtain class certification, investors relying on the fraud-on-the-market doctrine were not required to prove that the alleged misrepresentations were material to their investment decision (45 SRLR 370, 3/4/13).
Amgen (AMGN) did not dispute that the market for its securities “Halliburton will be the most closely was efficient; as such, the economic validity of the efficient- watched and potentially the most market theory was not at issue. However, in the wake of the significant case impacting private ruling, a number of lawyers posited that the real significance of Amgen lay not in its holding but in the questions it raised securities litigation in the past quarter regarding the continued viability of the fraud-on-the-market century.” doctrine (45 SRLR 1791, 9/30/13). In particular, they pointed to four justices' remarks in Amgen as an indication that the high court might be contemplating the topic. Generally, a petition for Daniel S. Sommers certiorari will be granted if four justices are in favor. Cohen Milstein Sellers & Toll PLLC Dark Ages
Cohen Milstein's Sommers, co-chair of his firm's Securities Fraud and Investor Rights Practice Group, predicted that inasmuch as four justices in Amgen “openly questioned” Basic, there is little doubt the court will issue a sharply divided opinion in Halliburton.
Should the high court overturn or significantly modify its endorsement of the fraud-on-the market presumption, he told Bloomberg BNA, investors will have to demonstrate actual reliance on the alleged misrepresentations. “As a result, the reliance element of a securities fraud claim could become an overwhelming individualized issue preventing certification of an investor class.”
“Because investor losses—even those of large institutional investors—are typically too small to justify the cost of bringing an individual securities fraud case,” Sommers related, “many investors could be left without any meaningful remedy under the antifraud provisions of the federal securities laws.”
“If the fraud on the market presumption is jettisoned in its entirety, investors will be left to explore vastly inferior methods for demonstrating reliance, including framing cases as ‘omissions’ cases rather than cases of affirmative misrepresentations,” Sommers continued. “Such an outcome would bring investors back to the pre- Basic ‘dark ages’ of private securities litigation.”
Modest Outcome
Not all lawyers agreed with Sommers' bleak prognosis. According to Denver lawyer Michael MacPhail, Faegre Baker Daniels LLP, “the most modest and perhaps most likely outcome” is that the court will conclude that
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 28 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 defendants may rebut the presumption at the class certification stage by showing that the stock price did not move significantly in the wake of corrective disclosures.
However, MacPhail suggested, the court also could issue a broader ruling—i.e., that plaintiffs must show at the class certification stage that the market was efficient as to the specific disclosures in issue. “Market efficiency as to specific disclosures would be a very difficult showing for plaintiffs to make,” MacPhail commented.
Of course, he added, the high court could “simply do away with the fraud-on-the-market presumption, but this is the least likely outcome.”
Plaintiffs lawyer Darren Robbins, Robbins Geller Rudman & Dowd LLP, San Diego, also predicted that the justices are unlikely to invalidate the theory. He said the “notion that the court will disregard decades of jurisprudence” that has served as a mechanism to consolidate litigation into a single proceeding and lessened the burden on both courts and litigants “is, I think, somewhat fanciful.”
However, Robbins added, there are “powerful forces that have a coordinated strategy” to eliminate any potential for litigation exposure, regardless of the merits. He called Halliburton “simply a vehicle by very powerful corporate interests who regularly sit around and try to concoct legal strategies to eviscerate the protections of our financial markets. It seems somewhat shortsighted.”
San Francisco lawyer Mark Fickes, a former Securities and Exchange Commission enforcement lawyer, currently of counsel at Cannata, Ching & O'Toole LLP, had a more succinct analysis. “If the theory stands, I think we're going to continue to see securities class litigation.” On the other hand, “it's going to be tough for a lot of plaintiffs” if the theory is invalidated.
Asked to predict how the justices will rule, he said the court “has not always been favorable to class actions. So I think it's at least within the realm of possibility that they strike down the fraud-on-the-market theory.”
Meanwhile, two other securities cases—a Securities Litigation Uniform Standards Act dispute arising from R. Allen Stanford's $8 billion Ponzi scheme, and a dispute over the scope of Sarbanes-Oxley Act whistle-blower anti-retaliation protections—are awaiting high court resolution.
SLUSA
In the SLUSA case, lawyers, insurance brokers, and other third parties that allegedly aided Stanford's scam are appealing a decision by the U.S. Court of Appeals for the Fifth Circuit that allowed Stanford investors to bring state court class actions to recover their losses (Chadbourne & Parke LLP v. Troice; Willis of Colo. Inc. v. Troice; Proskauer Rose LLP v. Troice). SLUSA provides generally for federal preemption—removal, followed by dismissal—of state law class actions alleging “misrepresentations in connection with the purchase or sale of a covered security.” On a question of first impression, the Fifth Circuit concluded that the alleged fraud was only tangentially related to the purchase or sale of covered securities for SLUSA preemption purposes.
According to Jonathan Youngwood, Simpson Thacher & Bartlett LLP, New York, both Troice and Halliburton could lead to an increase in state-law class lawsuits, depending on how the high court rules.
If the justices invalidate the fraud-on-the-market theory in Halliburton, Youngwood reasoned, “securities fraud plaintiffs may be eager to find potential avenues for recovery other than bringing class actions in federal court under [1934 Securities Exchange Act] Section 10(b) and Rule 10b-5.” Similarly, he suggested, if the high court narrowly construes SLUSA's “in connection with” requirement” in Troice, “plaintiffs may increasingly attempt to rely on state law to bring class actions they might otherwise have brought” under those provisions.
Troice was argued Oct. 7, the first day of the high court's 2013-2014 term (45 SRLR 1885, 10/14/13).
SOX §806
In the whistle-blower case, Lawson v. FMR LLC, the plaintiffs were employees of private companies that provided contractual advising or management services to the Fidelity family of funds. One plaintiff claimed he was fired in retaliation for raising concerns about inaccuracies in a draft revised registration statement for certain Fidelity funds. The other plaintiff claimed she was constructively discharged for questioning her employer's mutual-fund accounting practices.
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The district court turned back a dismissal motion, but the U.S. Court of Appeals for the First Circuit reversed (44 SRLR 311, 2/13/12).In a divided opinion, it concluded that only employees of public companies are covered by SOX Section 806. The case was argued Nov. 12 (45 SRLR 2108, 11/18/13).
“If the court decides that private company employees have SOX whistle-blower protection, you're going to see an uptake in employment litigation,” Fickes predicted. Also, private companies will have to be mindful of their employment policies for whistle-blowers. “I could see a lot of people bringing claims against former employees if they're in that whistle-blower posture,” Fickes said.
Troice
While attorneys Bloomberg BNA spoke with agreed that Halliburton could have a dramatic impact on securities class actions, they said Troice, which also concerns class litigation, could be consequential as well.
MacPhail pointed out that the Ninth and Fifth Circuits have interpreted SLUSA narrowly to preempt only fraud claims that are more than “tangentially related” to covered security transactions. In contrast, the Second, Sixth, and Eleventh Circuits have applied SLUSA more broadly.
In MacPhail's view, the justices' questioning during oral argument suggests that the court “is likely to adopt the narrower interpretation, allowing some state class actions involving covered securities to proceed.”
However, he said, if the high court adopts the broader tests of the Second, Sixth and Eleventh circuits, most state-law securities class actions would be precluded. “In any event, the Court's decision should result in greater consistency among SLUSA preclusion decisions going forward,” MacPhail predicted.
San Francisco lawyer Thad Davis, Gibson Dunn & Crutcher LLP, was similarly inconclusive, saying the court “could adopt either a very narrow or a very broad interpretation of the ‘in connection with’ requirement.” Alternatively, he suggested, the court “could simply decide the case on the unique facts at issue.”
Meanwhile, Davis posited, ”[a] less noted potential result of the Troice decision is that however the Court chooses to get there, its holding will impact not only the types of cases that fall under SLUSA, but also the elements of a 10b-5 claim.”
In the 10b-5 context, he noted, issuers and other defendants generally favor a narrow construction of the requirement. In the SLUSA context, however, defendants—“who may be facing state law claims precisely because they are not ‘traditional’ 10b-5 defendants”—“typically argue for a broad construction.”
However, Davis noted, the “in connection with language” is the same in both SLUSA and Rule 10b-5. As such, he predicted, any decision in Troice will also be applied to interpreting the elements in future Rule 10b-5 cases.
Impact of Morrison
Meanwhile, the impact of the Supreme Court's decision in Morrison v. National Australia Bank Ltd., 561 U.S. __, (2010), will continue to be felt in 2014 and beyond.
In Morrison, the justices took a relatively narrow view of the federal securities laws' extraterritorial reach, concluding that Section 10(b) applies only to securities listed on a U.S. exchange or to securities transactions that take place in the U.S.
Given the increasingly global nature of securities transactions, it is all but certain that the decision will give rise to interpretive questions for years to come. One such issue, according to Georgetown University law professor Donald Langevoort, is how the courts will interpret the Dodd-Frank Wall Street Reform and Consumer Protection Act's “save” for SEC enforcement actions—“largely because cases currently in litigation tend to be based on facts that arose before Dodd-Frank was enacted.”
However, Langevoort said, “[t]hat is in the process of changing, and there are many practitioners convinced that Congress did not do enough to restore the Commission's pre-Morrison authority.”
Dodd-Frank Section 929P(b)41 amended the jurisdictional provisions of the securities laws to provide that the federal district courts have jurisdiction over SEC or U.S. actions alleging a securities fraud violation involving
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U.S. conduct “that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors.”
The statute also provides for jurisdiction over overseas conduct “that has a foreseeable substantial effect within the United States.” Although the new law can be read as restoring the pre-Morrison conduct-and-effects test, its impact is uncertain, inasmuch as Morrison addressed not jurisdiction but the scope of Section 10(b). In May, a senior SEC official told a legal gathering that the dismissal of SEC allegations over an alleged international boiler-room scheme raised a good question as to the adequacy of the congressional fix to restore the agency's extraterritorial enforcement authority (45 SRLR 874, 5/13/13)).
Similarly, Deloitte's Shanghai affiliate told the U.S. District Court for the District of Columbia in March that the commission was attempting to “‘leapfrog’” over Morrison by subpoenaing its U.S. counsel to obtain the work papers of a China-based issuer (45 SRLR 511, 3/18/13). Although a ruling in the agency's favor could have set precedent for SEC subpoena actions involving foreign auditors and issuers, the parties later resolved their differences.
In August, the Second Circuit concluded, in United States v. The court's decision in Troice “should Vilar that Morrison applies to criminal as well as civil cases (45 result in greater consistency among SRLR 1631, 9/16/13). In addition, the federal district courts SLUSA preclusion decisions going decided a number of Morrison issues in 2013, any of which could provide a vehicle for appellate review. forward.” For example, in March, the U.S. District Court for the Southern Michael MacPhail District of New York concluded in connection with a motion for class certification that the fact that a securities transaction is Faegre Baker Daniels LLP cleared in the U.S. does not in and of itself mean that the transaction meets Morrison parameters (45 SRLR 537, 3/25/13 ). At around the same time, the Southern District cited Morrison in dismissing a Russian woman's claims that she was defrauded by a New York-based financial services organization, in violation of Commodity Exchange Act Sections 4o and 22 (Loginovskaya v. Batratchenko, (45 SRLR 689, 4/15/13).
In October, the same court dismissed anti-retaliation claims by a Taiwan man who complained of a Foreign Corrupt Practices Act kickback scam at Siemens AG's China subsidiary (45 SRLR 1974, 10/28/13). Citing Morrison, it found no indication that Congress intended the Dodd-Frank Act's anti-retaliation provision to apply extraterritorially.
Adverse Impact
While the parameters of Morrison continue to unfold, Sommers said the decision already is having “a significant adverse impact on U.S. investors.”
First, Sommers related, U.S. investors have been disadvantaged in cases where issuers have dual listed securities with ordinary shares traded overseas and American Depositary Receipts traded in the U.S.
“In those cases,” he said, “U.S. investors have found themselves with a federal securities law remedy for purchases in the U.S. but without such a remedy for purchases of ordinary shares, even though the underlying conduct is identical and even if substantial conduct took place in the U.S.”
Sommers noted that in some cases, investors are attempting to use state law, non-class remedies in the U.S. “It is still too early to tell whether these efforts will be successful for investors,” he said. In any event, such remedies “will not be useful to investors with losses too small to justify individual litigation.”
In addition, Sommers posited, Morrison “has forced U.S. investors to closely monitor their non-U.S. investments and to wade into the highly complex world of pursuing non-U.S. litigation.”
“I expect this trend to continue over the next few years and that Loss causation is “a serious weapon in we will see substantial, sophisticated U.S. investors become the securities defendant's arsenal,” increasingly active in pursuing their rights in non-U.S. forums Thad Davis, Gibson Dunn & Crutcher despite the generally less friendly substantive and procedural laws in many non-U.S. jurisdictions.”
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LLP, said. Circuit Split
It remains to be seen what, if any, Morrison issues will work their way up through the appeals courts and/or result in high court resolution. However, Gibson Dunn's Davis identified a recent appeals court decision that, in his view, could be a candidate for Supreme Court review.
In Indiana State District Council of Laborers and Hod Carriers Pension and Welfare Fund v. Omnicare, 719 F.3d 498 (6th Cir. 2013), the U.S. Court of Appeals for the Sixth Circuit revived an investor suit alleging that Omnicare Inc. (OCR) and its officials violated 1933 Securities Act Section 11 by stating in securities registration documents that the concern's billing practices complied with state and federal requirements, when it actually was involved in hidden kickback arrangements with manufacturers and other misconduct (45 SRLR 1032, 6/3/13).
The pro-plaintiff ruling in the long-running action set up a split with the Second and Ninth Circuits on whether a plaintiff is required to plead that the defendant knew its disclosures were false to state a Section 11 claim. On Oct. 4, defendant Omnicare filed a certiorari petition.
“As plaintiffs are frequently relying on Section 11 claims, this case is of significant interest and the circuit split may also lend support to a petition grant,” Davis said.
Loss Causation
In terms of emerging issues, he commented there were several loss-causation cases during 2013 “that will serve as useful tools for defendants.” Specifically, he pointed to:
• Meyer v. Greene, in which the Eleventh Circuit affirmed the dismissal of a would-be class securities fraud action against a Florida-based real-estate development company (45 SRLR 372, 3/4/13).
• IBEW Local 90 Pension Fund v. Deutsche Bank AG, in which the U.S. District Court for the Southern District of New York denied a motion for class certification over the plaintiffs' failure to meet Rule 23(b) typicality requirements.
• Lighthouse Financial Group v. Royal Bank of Scotland, in which the Southern District refused to allow the plaintiffs to amend their complaint in part because of their failure adequately to allege loss causation; and
• Central States, Southeast and Southwest Areas Pension Fund v. Federal Home Loan Mortgage Corp., in which the Second Circuit affirmed that the plaintiff failed to demonstrate losses that were directly attributable to the alleged misstatements, rather than the bursting of the housing bubble that occurred during the same period.
“These cases cover a broad range of deficiencies that may arise in a plaintiff's case and which can be resolved as early as the class certification or motion to dismiss stage,” Davis noted. “Cumulatively, these cases give renewed importance to the loss causation prong, making it a serious weapon in the securities defendant's arsenal.”
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
Federal News Antifraud: Court Dismisses Would-Be Class Suit Against Harman International Industries
BNA Snapshot
In re Harman Int'l Indus., Inc. Sec. Litig. , 2014 BL 13797, D.D.C., No. 07-1757(RC), 1/17/14
Key Holding: The court dismisses a would-be class action against Harman International Industries Inc.
Key Takeaway: The shareholder plaintiffs failed to allege an actionable material misrepresentation or omission, and also failed to allege scienter.
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Jan. 21 — The U.S. District Court for the District of Columbia Jan. 17 dismissed a would be class action alleging that audio products manufacturer Harman International Industries Inc.(HAR) and its executives inflated the company's stock price by making misleading representations and failing to disclose material adverse facts about the company's financial condition ( In re Harman Int'l Indus., Inc. Sec. Litig. , 2014 BL 13797, D.D.C., No. 07-1757(RC), 1/17/14).
Judge Rudolph Contreras held that the plaintiffs—Harman shareholders—failed to point to a “single actionable material misrepresentation or omission” or to raise a strong inference of scienter.
Alleged Misrepresentations, Omissions
The court recounted that the plaintiffs alleged three categories of misrepresentations or omissions. First, the plaintiffs said that Harman made misleading statements regarding an anticipated acquisition by Kohlberg Kravis Roberts & Co. and an affiliate of Goldman Sachs & Co., valued at approximately $8 billion.
After Harman announced the proposed acquisition, the plaintiffs said, Harman engaged in “excessive capital spending,” without disclosing such spending to the shareholders. This caused the company to breach a covenant in the merger agreement that prohibited it from exceeding certain capital expenditures before the merger. As a result, the plaintiffs said, the proposed acquisition was terminated.
Second, the plaintiffs said that Harman and its officers failed to disclose various problems associated with its infotainment system for personal vehicles. Specifically, the defendants allegedly failed to disclose that Harman's relationship with its main client—DaimlerChrysler—was strained due to the problems and that the contract with Chrysler forced Harman to sell the products at a net loss.
Finally, the defendants allegedly made material omissions about the sales of its aftermarket personal navigation devices in Europe. Specifically, the plaintiffs alleged that Harman knew, but failed to disclose, that it had a large inventory of obsolete navigation devices and had no basis for its sales projections. Based on these allegations, the plaintiffs asserted violations of 1934 Securities Exchange Act Sections 10(b), 20(a) and Rule 10b-5. The defendants moved to dismiss.
Dismissed
The court first addressed whether the issuer's state of mind is relevant to the application of the safe harbor for forward-looking statements in the Private Securities Litigation Reform Act. “The D.C. Circuit has not yet weighed in on this thorny issue,” the court explained. Analyzing other courts' interpretations, the text, and legislative history of the safe harbor, the court held that the issuer's state of mind is “irrelevant.”
With this backdrop, the court held that the plaintiffs failed to allege any actionable forward-looking statement, as all of them are “protected” by the safe-harbor. The court agreed with the defendants that the alleged misstatements were “inactionable puffery.” Similarly, the court also held that the plaintiffs failed to allege any actionable material omission.
In addition, the court held that the plaintiffs also failed to sufficiently allege scienter. Finding that the plaintiff failed to plead a primary securities fraud violation, the court also dismissed the Section 20(a) claim.
For More Information
To see the opinion, go to http://www.bloomberglaw.com/public/document/IN_RE_HARMAN_INTERNATIONAL_I NDUSTRIES_INC_SECURITIES_LITIGATION_N.
Broker-Dealers: Electronic Communications Will Yield More Enforcement Actions, Attorneys Say By Yin Wilczek
Jan. 23 — E-mail retention and other electronic communications issues will be a
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major area of by broker-dealer enforcement by the Securities and Exchange Commission and the Financial Industry Regulatory Authority in 2014 and beyond, attorneys said at a Jan. 22 webcast.
Electronic communications include e-mail, instant messaging and other ways in which broker-dealers communicate among themselves, their customers and the public. FINRA rules provide that firms must supervise and retain electronic communications, among other requirements.
Everyone is using e-mail, and e-mails now are key to SEC and FINRA investigations and actions, said Brian Rubin, a Washington-based partner at Sutherland Asbill & Brennan LLP. Given the trends and the possible issues that could arise, “I think we're going to see a lot more electronic communications cases this year and the future,” he said. “There are so many ways that firms can have problems with these technologies.”
John Hewitt, director of the business & commercial litigation department at Gibbons PC, New York, agreed, adding that the electronic communications issue “is going to explode over the next four to five years.”
The attorneys spoke with others on a broker-dealer regulation panel sponsored by the American Law Institute's Continuing Legal Education group. The event was recorded Jan. 8.
Top Enforcement Issue
According to Sutherland Asbill statistics, electronic communications was the top FINRA enforcement issue in 2013.
In a recent action, Barclays Capital Inc. agreed Dec. 26 to be fined $3.75 million by FINRA for allegedly failing to keep electronic messages and improperly storing its electronic records in a non-rewritable format (46 SRLR 26, 1/6/14). According to FINRA, Barclays did not keep e-mail attachments and failed to retain more than 3 million instant messages, in violation of FINRA and SEC rules.
Rubin observed that this year, he already has worked on several cases involving “e-mail implications and e-mail issues.” E-mail-related problems may be brought as standalone cases, or may be discovered once the SEC or FINRA see the communications as part of their investigations into other allegations, he said.
K. Susan Grafton, a Washington-based partner at K&L Gates LLP, suggested that a related development is the use by broker-dealer employees of personal iphone and other communication devices. “I've seen clients increasingly getting requests” from employees to be allowed to use their personal devices, she said. “I think this is an issue that we have to focus on.”
Amended Rule 8210
In other discussions, Rubin warned that enforcement actions and litigation could arise this year from FINRA's amended Rule 8210. Although no actions have been filed so far, “FINRA is going to be taking a new direction with regards to the types of books and records it requests from individuals and firms so we anticipate seeing something there,” he said.
The amendment—which went into effect February 2013—clarified the scope of FINRA's right to inspect and copy the books and records of its members and associated persons (45 SRLR 196, 2/4/13). The amended rule states that FINRA adjudicators and staff have the right to inspect and copy data in the “possession, custody or control” of members and others over whom the self-regulatory organization has jurisdiction.
Rubin noted that because FINRA is not a governmental authority, firms cannot invoke the Fifth Amendment to stop it from inspecting their books and records. In addition, firms cannot formally object to a Rule 8210 request except to refuse to produce the requested materials and face potential disciplinary action, he said. “You're kind of stuck between a rock and a hard place.”
Lack of Clarity
The amended Rule 8210 does not help the situation but instead “will exacerbate it,” Rubin said. Among other issues, the attorney said there is no clear understanding of what constitute “possession, custody or control.” The
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supplementary language in the amended rule to explain the concepts also has “made it more complicated,” he said.
Meanwhile, guidance issued by FINRA in May 2013 in the form of “frequently asked questions” explained, “not very helpfully,” that whether a document is in the “control” of someone depends on the facts and circumstances, Rubin said. In any case, even if a firm had the legal right or authority to obtain a document on demand, that does not mean it has the authority to turn it over to FINRA, he said.
The bottom line is that “FINRA will push” the rule as far as it can, he said. “I expect at some point, we'll see litigation over this.”
The amended rule's primary focus appears to be firms' outside business activities and private securities transactions, Rubin continued. Accordingly, broker-dealers—to avoid being targeted under Rule 8210—should increase their supervision and other efforts to ensure they know what their representatives are doing outside the firm, he said.
“It also probably makes sense for firms to sit down and think about what their books and records and accounts are, and what they think belongs to affiliates, what they have control over, what they don't, so if FINRA comes to them at some point down the road and wants the information, they will have at least thought about it before they have 14 days to respond,” Rubin said. In addition, “they probably want to train the reps and others in the firm to think about the implications of these issues and what they mean or may mean with regards” to the firm's business model.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
Congress: Obama Signs Spending Bill Funding SEC, CFTC for FY 2014 By Richard Hill
Jan. 17 — President Obama signed an omnibus spending bill for fiscal year 2014 Jan. 17 that will fund the Securities and Exchange Commission and the Commodity Futures Trading Commission through Sept. 30, though at levels far less than they had requested.
The president signed the measure one day after the Senate, led by its Democratic majority, passed the bill easily, 72-26. That chamber acted the day after the House passed the bill, 359-67 (46 SRLR 107, 1/20/14).
The bill will fund the SEC at $1.35 billion and the CFTC at $215 million. The agencies had requested $1.674 billion and $315 million, respectively.
House Appropriations Committee Chairman Hal Rogers (R-Ky.) said Jan. 14 that on the whole, the bill “will continue the downward trend in federal spending to put our nation on a sustainable fiscal path.”
The SEC's funding will be $29 million above its FY 2013 enacted level but $324 million below the agency's request (45 SRLR 650, 4/15/13). The CFTC funding will restore money lost to “sequester” in 2013 plus approximately an extra $9 million, but is $100 million below the agency's request (45 SRLR 685, 4/15/13). The agency currently is receiving approximately $195 million.
An SEC spokesman expressed disappointment Jan. 15 in the proposed funding level for that agency, while the acting chairman of the CFTC on Jan. 14 called the modest increase from current funding levels “a step in the right direction.”
Democrats: ‘Not Perfect.’
Senate Appropriations Committee Chairman Barbara Mikulski (D-Md.) acknowledged Jan. 14 that the agreement “will not be viewed as perfect by everyone. It required difficult choices, and nobody got everything they wanted.” She said Democratic appropriators agreed to the spending measure “because we are determined
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to fulfill Congress' most basic Constitutional responsibility: funding the operations of the federal government.”
Meanwhile, CFTC Commissioner Scott O'Malia on Jan. 14 called the increase for the CFTC “modest” and said that the agency, which now oversees the nearly $400 trillion domestic swaps market in addition to traditional futures markets, will “need to pick its funding priorities carefully.”
To contact the reporter on this story: Richard Hill in Washington at [email protected].
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Enforcement: Markey Calls for SEC, FTC Inquiry Into Herbalife's Compensation System By Rob Tricchinelli
Jan. 23 — Sen. Ed Markey (D-Mass.) asked federal regulators Jan. 23 to “look into” whether Herbalife, a nutritional supplements company, is akin to a pyramid scheme in the way it compensates its sellers.
“There is nothing nutritional about possible pyramid schemes that promise financial benefit but result in economic ruin for vulnerable families,” Markey said in a statement. “Herbalife may be a purveyor of health and wellness products, but some of its distributors are suffering serious economic ill-health as a result of their involvement in the company.”
Herbalife (HLF) sells its products through individual distributors and encourages them to recruit new ones. It labels itself a “multilevel marketing company,” in which sellers are paid both for the supplement sales they make and the sales of their recruit network.
SEC Letter
Markey wrote to the Securities and Exchange Commission, Federal Trade Commission and Herbalife itself.
“This compensation system appears to strongly favor distributors who focus on selling to other distributors rather than the general public, a common feature of pyramid schemes,” a statement accompanying Markey's letters said.
“We received the letter from Senator Markey this morning and look forward to an opportunity to introduce the company to him and address his concerns at his earliest convenience,” Barb Henderson, an Herbalife spokeswoman, said in a statement e-mailed to Bloomberg BNA.
In his letter to the SEC, Markey asked how many “compensation system levels” multilevel marketing companies and pyramid schemes typically have, and whether the complexity of such a system is a warning sign of a pyramid scheme.
Markey's statement said one of his constituents lost approximately $130,000 investing in Herbalife.
Big Short Bet
Herbalife stock dipped in reaction to Markey's letters, opening the day at 73.18 dollars per share and closing at 65.92, a 10 percent drop.
Herbalife has attracted public attention before for its marketing strategy. Hedge fund manager William Ackman, founder and chief executive officer of Pershing Square Capital Management LP, also equated Herbalife to a pyramid scheme and revealed in late 2012 that his fund had taken a $1 billion short position against the company.
Herbalife stock rose nearly 150 percent in 2013, costing Ackman's fund several hundred million dollars. Ackman has restructured his short position to make it less risky but still spoke out against the company.
To contact the reporter on this story: Rob Tricchinelli in Washington at [email protected]
To contact the editor responsible for this story:
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 36 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
For More Information
To see Markey's letter to the SEC, visit http://www.markey.senate.gov/imo/media/doc/2014-1-22_White_Herbalif e.pdf
To see Markey's letter to Herbalife, visit http://www.markey.senate.gov/imo/media/doc/2014-1-22_Johnson_Her balife.pdf
Enforcement: Man Who Failed to Produce Documents In SEC Probe Arrested on Contempt Charges
BNA Snapshot
SEC v. Coronati, S.D.N.Y., Civil Action No. 13-misc-0372-P1, 1/23/14
Court Order: Defendant arrested, found in contempt for failure to comply with SEC subpoena, must pay agency $4,812.
Takeaway: Move reflects commission's tougher approach to enforcement matters.
Jan. 23 — Reflecting its new, tougher enforcement stance, the Securities and Exchange Commission announced Jan. 23 that a Staten Island man under agency investigation has been held in contempt and arrested for failing to comply with subpoenas requiring him to produce documents and testify ( SEC v. Coronati, S.D.N.Y., Civil Action No. 13-misc-0372-P1, 1/23/14).
In a release, it said Judge William H. Pauley released defendant Anthony Coronati on a $50,000 bond and restricted his travel to the Southern and Eastern Districts of New York.
Subpoena Enforcement Action
The SEC recounted that in early November, it filed a subpoena enforcement action against Coronati, saying entities he controlled solicited investments relating to the securities of Facebook Inc. (FB) and other “sought- after private companies” that investors hoped would engage in initial public offerings. The commission said it is investigating whether Coronati used investor funds to pay personal expenses.
“Despite two SEC investigative subpoenas in 2013, Coronati has neither produced documents nor appeared for testimony,” the agency recapped. It noted that in November, the court ordered Coronati to comply with the subpoenas. On Jan. 17, the commission said, the court found Coronati in civil contempt for ignoring its earlier order. “The contempt order requires Coronati, who repeatedly attempted to evade service, to pay $4,812 to the SEC to reimburse the agency for its costs of serving him with court papers in this proceeding,” the SEC said.
It added that further hearing will be held Feb. 6.
For More Information
To see the contempt order, go to http://www.bloomberglaw.com/public/document/Securities_and_Exchange_Co mmission_v_Coronati_Docket_No_113mc0037/2.
Financial Institutions: Treasury Department, FHFA Seek Early End To Suits on Fannie Mae, Freddie Mac Profits
BNA Snapshot
Perry Capital v. Lew, D.D.C., No. 13-cv-01025, 1/17/14
Key Development: Treasury and FHFA ask judge to dismiss three suits claiming illegal diversion of Fannie, Freddie profits.
Potential Impact: Investors say U.S. government action in 2012 wiped out their investments.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 37 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
By Chris Bruce
Jan. 21 — The Treasury Department late Jan. 17 asked a federal judge to end a hedge fund's lawsuit that says the U.S. government illegally diverted $61 billion in Fannie Mae and Freddie Mac profits ( Perry Capital v. Lew, D.D.C., No. 13- cv-01025, 1/17/14).
The suit by Perry Capital LLC, filed in the U.S. District Court for the District of Columbia in July (45 SRLR 1291, 7/15/13), says amendments to stock agreements in 2012 wiped out its investment in the two government-sponsored enterprises and made Treasury the sole beneficiary.
According to Treasury, it amended the stock agreements to allow Fannie Mae and Freddie Mac to pay dividends on funds already provided by Treasury without seeking more assistance.
Treasury asked the court to dismiss the suit, or to rule for it on summary judgment. Treasury also asked the court to dismiss two similar suits—one by the Fairholme Funds (FAIRX), and another by Arrowpoint Indemnity Co., an insurance unit of Arrowpoint Capital Corp.
In a brief that accompanied the Jan. 17 motion, Treasury said the case concerns “extraordinary, and ongoing” efforts to keep Fannie Mae and Freddie Mac solvent.
“Treasury acted reasonably to protect the national economy” by amending the stock agreement, the brief said.
FHFA Seeks Dismissal
The Federal Housing Finance Agency, the conservator for Fannie Mae and Freddie Mac, also filed a motion for dismissal and/or summary judgment Jan. 17. In an accompanying brief, FHFA said the plaintiffs' suit seeks “financial value that they are not owed under the terms of their stock certificates or statutes, and to ignore the rights of the Enterprises' senior preferred stockholder, the U.S. Treasury.”
“By doing so, Plaintiffs seek not only to undermine the purposes of conservatorship, but also the very statutory mission of the Enterprises in which they chose to invest,” FHFA said.
Treasury and FHFA also asked the court to dismiss two similar suits—one by the Fairholme Funds (FAIRX), and another by Arrowpoint Indemnity Co., an insurance unit of Arrowpoint Capital Corp.
The Treasury Department is represented by Joel L. McElvain of the Department of Justice.
The FHFA is represented by Howard N. Cayne of Arnold & Porter in Washington.
Perry Capital is represented by Theodore B. Olson of Gibson Dunn in Washington.
Fairholme Funds Inc. is represented by Charles J. Cooper of Cooper & Kirk in Washington.
Arrowood Indemnity is represented by Michael H. Barr of Dentons LLP in New York.
To contact the reporter on this story: Chris Bruce in Washington at [email protected]
To contact the editor responsible for this story: Richard Cowden at [email protected]
For More Information
The Treasury's Jan. 17 brief is at http://www.bloomberglaw.com/public/document/PERRY_CAPITAL_LLC_v_LE W_et_al_Docket_No_113cv01025_DDC_Jul_07_201/1. The FHFA's Jan. 17 brief is at http://www.bloomberglaw. com/public/document/PERRY_CAPITAL_LLC_v_LEW_et_al_Docket_No_113cv01025_DDC_Jul_07_201/2.The July 2013 complaint by Perry Capital is at http://www.bloomberglaw.com/public/document/PERRY_CAPITAL_LL C_v_LEW_et_al_Docket_No_113cv01025_DDC_Jul_07_201. The Fairholme complaint is at http://www.bloomber glaw.com/public/document/FAIRHOLME_FUNDS_INC_et_al_v_FEDERAL_HOUSING_FINANCE_AGENCY_et_
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al_, and the Arrowood suit is at http://www.bloomberglaw.com/public/document/ARROWOOD_INDEMNITY_CO MPANY_et_al_v_FEDERAL_NATIONAL_MORTGAGE_ASSO.
Investment Advisers: Refrain From Fiduciary Rulemaking Until SEC Acts on Unified Standard, SIFMA Says
BNA Snapshot
SEC, Labor Department Contemplating Fiduciary Rule
Key Development: SIFMA says DOL shouldn't issue an expected proposed rule revising its definition of fiduciary standard of care until SEC decides whether it will issue its own fiduciary rule.
Ahead: Labor Department intends to issue its proposal in August, perhaps earlier.
By Stephen Joyce
Jan. 17 — The Labor Department should “stand down” and not issue an expected proposed rule regarding its definition of fiduciary standard of care until the Securities and Exchange Commission issues its own proposal on the topic, Securities Industry and Financial Markets Association General Counsel Ira Hammerman told Bloomberg BNA.
Currently, the term fiduciary is defined in the Employee Retirement Income Security Act (ERISA), a statute enforced by the Labor Department. Although laws enforced by the SEC don't define the term fiduciary, federal courts have recognized a fiduciary obligation for investment advisers registered with the SEC.
The Labor Department in 2010 proposed to revise the ERISA definition of fiduciary, withdrew the proposal in 2011, and currently intends to repropose a rule on the topic by August. Meantime, the SEC continues to contemplate whether it will act on an SEC staff report that recommended the commission propose its own rule creating a unified fiduciary standard for investment advisers and broker-dealers providing personalized investment advice to retail clients.
Hammerman, who is also a SIFMA executive vice president, told Bloomberg BNA Jan. 17 the Labor Department should wait until the SEC acts before it makes any proposal of its own regarding a fiduciary definition, arguing that the Dodd-Frank Wall Street Reform and Consumer Protection Act expressly authorizes the SEC to propose a rule creating a definition for the term fiduciary.
Proposal Years in Making
On Sept. 10, 2010, the Labor Department issued a proposed rule that would have updated and expanded its definition of fiduciary under ERISA, and on Jan. 21, 2011, the SEC staff issued a report recommending SEC commissioners propose a rule establishing a unified fiduciary standard for investment advisers and broker- dealers when they provide personalized investment advice to retail clients.
Amid criticism that its proposal didn't adequately consider economic consequences, the Labor Department withdrew its proposal Sept. 19, 2011.
Since that time, the department has worked to create a comprehensive proposed rule replete with a regulatory impact analysis and cost-benefit analysis, Labor Department Deputy Assistant Secretary for Program Operations Timothy Hauser told Bloomberg BNA Jan. 16.
The revision is necessary because individuals save for retirement in materially different ways compared with 1974, when ERISA was first enacted, and because of persistent conflicts of interest regarding investment counselors, Hauser said.
“It's a very big undertaking, and we're unquestionably taking our time. We're working very hard to get the thing right,” he said. “[W]hen we have everything the way we think is ideal, that's when we're going to release it. August is our regulatory agenda date, but we're just going to get it out when it's ready,” Hauser said.
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‘Hold On.’
Hammerman, who said the Labor Department's 2010 proposal tried to expand the department's jurisidictional reach in ways that may restrict investor choice, said Dodd-Frank clearly recognized the SEC as the agency to study the issue of establishing a fiduciary standard of care and ultimately propose a rule regarding the topic if the SEC concluded one is needed.
The Labor Department should give the SEC time to study the topic and act if it so chooses before the department proceeds with its own proposed rulemaking, which if proposed should consider comments on the proposal from the public. If the Labor Department concludes after the SEC acts it still needs to issue its own proposal, “then certainly as the agency that administers ERISA they should have that prerogative to put out that rule proposal,” Hammerman said.
Section 913 of Dodd-Frank required the SEC to conduct a study regarding the effectiveness of the current regulatory regime surrounding fiduciaries, including different standards of care for entities providing personalized investment advice and recommendations about securities to retail customers.
DOL Response
Hauser said his agency should have the ability to propose rules it has determined are required to fulfill its mandate.
“The argument is being made that we shouldn't even put out our [proposal] for public comment—that people should not even see what we've been working on for all this period—until the SEC is done with its work. And I don't know what the logic is for that,” Hauser said.
“What we're talking about is putting something out for public comment. We are going to put an entire package out and address the specific objections everybody had to the first package,” Hauser said.
“It's going to include a full and transparent regulatory analysis. People will be able to see our economic analysis. They'll be able to judge for themselves whether the current state of play, the conflicted advice in this marketplace, is causing the kinds of losses we think it's causing to ordinary savers and investors in the retirement market,” he said.
To contact the reporter on this story: Stephen Joyce in New York at [email protected]
To contact the editor responsible for this story: Brett Ferguson at [email protected]
Whistle-Blowers: Info in SEC Filing Foils SOX Claims, 9th Cir. Affirms
BNA Snapshot
McManus v. McManus Fin. Consultants, Inc. , 2014 BL 14557, 9th Cir., No. 12-15857, 1/17/14
Key Holding: The U.S. Court of Appeals for the Ninth Circuit affirms dismissal of a Sarbanes-Oxley Act whistle- blower claim against Aeolus Pharmaceuticals, Inc.
Key Takeaway: The plaintiff's claims are barred by because the information in question was diclosed in Aeolus's Form 8-K filed with the Securities and Exchange Commission.
Jan. 21 — The U.S. Court of Appeals for the Ninth Circuit Jan. 17 affirmed dismiss al of a Sarbanes-Oxley Act whistle-blower claim against Aeolus Pharmaceuticals Inc.(AOLS) ( McManus v. McManus Fin. Consultants, Inc. , 2014 BL 14557, 9th Cir., No. 12-15857, 1/17/14).
In an unpublished ruling, the court said that the plaintiff's claims were barred by the information in Aeolus's Form 8-K filed with the Securities and Exchange Commission. The company's website says that it is a biotechnology concern with government funding to develop novel technology that protects healthy tissue from the damages of radiation, and also engages in additional anticancer activities.
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SOX bars public companies from discriminating against an employee in the terms and conditions of employment for providing information as to conduct that the employee “’reasonably believes’” constitutes a violation of mail fraud, wire fraud, bank fraud, securities fraud, any SEC rule, or any provision of federal law involving fraud against shareholders“ (18 U.S.C. § 1514A (a) (1)).
Financing Agreement
The court said that the lower court held that Aeolus's SEC Form 8-K, which disclosed Aeolus's amended financing agreement, “directly contradicted” McManus’ allegations that Aeolus omitted material facts from its shareholders about the nature of that agreement.
The court said that to survive dismissal, McManus must allege, among other specifics, that he had a “‘subjective belief’” that the conduct at issue violated a listed law and that his belief also was “‘objectively reasonable.’”
In his complaint, the court said, McManus alleged that Aeolus committed securities fraud by knowingly omitting from other shareholders the lack of a new agreement and/or consideration.
‘Dilemma.'
The court said that “McManus’ dilemma is that Aeolus disclosed both of these alleged facts” to its shareholders in its Dec. 24, 2009 Form 8-K. Aeolus's disclosure, specifically of the facts alleged by McManus to be material, “precludes any objectively reasonably belief in securities fraud,” the court said.
Rejecting other arguments advanced by McManus, the court said that he failed to state a claim under SOX. The court said that even if it felt that McManus's complaint was susceptible of amendment, “which we do not, he did not request leave to amend below or on appeal.”
For More Information
To see the opinion, go to http://www.bloomberglaw.com/public/document/McManus_v_McManus_Fin_Consultan ts_Inc_1215857_DC_No_311cv00134LRH.
Whistle-blowers: Lawyers Say Regulators Want Culture Of Compliance Regarding Whistle-Blowers By Rob Tricchinelli
Jan. 22 — Cracking down on employer retaliation against whistle-blowers and ensuring that companies are adequately allowing internal reporting of potential lawbreaking are on federal regulators' agenda for the upcoming year, according to a Jan. 22 webcast hosted by the American Bar Association.
“One of the pressing issues for is this year is we have the authority to enforce the anti-retaliation provisions,” Sean McKessy, director of the Securities and Exchange Commission's Office of the Whistleblower, said, “which basically indicate that employers shall not take any action in retaliation for reporting potential securities law violations to us.”
Christopher Ehrman, director of the whistle-blower office at the Commodity Futures Trading Commission, and Stephen Whitlock, who holds the same position at the Internal Revenue Service, also were on the panel.
Dodd-Frank
The SEC and CFTC's whistle-blower offices were created by the Dodd Frank Wall Street Reform and Consumer Protection Act. The IRS's office was created by a 2006 statute. All three agencies may give awards to whistle- blowers whose tips lead to monetary sanctions or penalties. The awards are a percentage of the money paid to the regulator, typically 10-30 percent.
“We're a nascent program, we're up and running, and we do have a track record of making payouts,” McKessy said, adding that payouts will likely increase as the program becomes more established. The SEC received more than 3,200 whistleblower tips in the 2013 fiscal year.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 41 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
Internal Reporting
The panel said they want companies to have a “culture of compliance” to properly handle whistle-blowers' tips about a company internally, before involving federal regulators.
“Sometimes we've had whistle-blowers come in and they'd tried to report internally, and the reason they came to is because they felt like they got blown off, that their concerns were not dealt with seriously by the internal compliance people where they worked,” Ehrman said.
Most people who come to the SEC with a complaint about a current or former employer, McKessy said, do so after “experiencing some level of frustration around the fact that reporting internally didn't give them any satisfaction.”
To combat this, “there are enumerated economic incentives written into the rules to encourage whistle-blowers to report internally before coming to us,” Ehrman said.
For example, he noted, if a whistle-blower's tip leads to an internal investigation, the fruit of that investigation is attributed to the whistle-blower, which could lead to a larger award.
To contact the reporter on this story: Rob Tricchinelli in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Federal Briefs SEC Issues More C&DIs on General Solicitation Rule Jan. 23 — The Securities and Exchange Commission Division of Corporation Finance Jan. 23 issued new guidance to clarify how issuers may proceed after switching their Regulation D Rule 506(b) private placements to offerings under the new Rule 506(c).
Rule 506(c) allows issuers to generally solicit investors to their private placements, as long as they are sold only to accredited investors.
In Compliance and Disclosure Interpretation questions No. 260.33 and 260.34, the staff answered that issuers may switch their Rule 506(b) offerings to 506(c) offerings even if they already sold the securities to nonaccredited investors. After the switch, however, the issuers must verify that the investors who buy the 506(c) offerings are accredited, the staff said.
For More Information
The new C&DIs are available at http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules- interps.htm#260-33.
SEC OKs FINRA Rule Change on ATS Reporting Jan. 23 — The Securities and Exchange Commission Jan. 17 approved an amended rule change by the Financial Industry Regulatory Authority to require alternative trading systems to report weekly volume information and number of trades, and to use a single unique market participant identifier—MPID—when reporting information.
FINRA submitted its original proposal in September (45 SRLR 1830, 10/7/13). The self-regulatory organization submitted an amended proposal Jan. 15 in response to comments received on the original proposal, and to add clarifying supplementary material to explain when trades are deemed to have occurred “within an ATS.”
The SEC approved the amended proposal, but also is seeking comments on it. Comments should refer to File No. SR-FINRA-2013-042, and be submitted within 21 days of the rule change's publication in the
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 42 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
Federal Register.
The rule change is effective upon the commission's approval. “Thus, rules that permit FINRA members to use multiple MPIDs would immediately convert from operating on a pilot to a permanent basis,” the SEC said.
For More Information
The SEC release is available at http://www.sec.gov/rules/sro/finra/2014/34-71341.pdf.
Dixie Johnson, Bill Johnson Move to King Spalding King & Spalding LLP Jan. 24 announced a “significant enhancement” of its Securities and Exchange Commission enforcement and white collar criminal practices, saying Dixie L. Johnson and Bill Johnson have joined the firm in its Washington and New York offices respectively.
The two previously were members of Fried Frank Harris Shriver & Jacobson LLP, where they co-headed the SEC enforcement and white collar criminal defense groups, King & Spalding said in a release.
In the release, the firm said Dixie Johnson “is among the most prominent SEC enforcement defense practitioners in the country. She has dedicated her entire 27-year legal career to assisting financial services firms, public companies, professional service firms and individual executives in SEC investigations and related litigation matters.”
“Bill Johnson is also a nationally recognized SEC enforcement and white-collar defense lawyer, representing clients in both civil and criminal securities fraud investigations,” the release continued. He spent a total of 17 years with the SEC's Enforcement Division and the U.S. Attorney's Office for the Southern District of New York, “including four years as Chief and Deputy Chief of the Southern District's prestigious Securities and Commodities Fraud Task Force.”
9th Cir. Affirms SEC Order Against B-D Jan. 22 — The U.S. Court of Appeals for the Ninth Circuit Jan. 16 affirmed a Securities and Exchange Commission order upholding fines and sanctions imposed by the Financial Industry Regulatory Authority against a broker-dealer and its executives for failing to meet their duty of inquiry in promoting shares of a company ( World Trade Fin. Corp. v. SEC , 2014 BL 13048, 9th Cir., No. 12-70681, 1/16/14). Judge Ronald M. Gould found that World Trade Financial Corp. violated the 1933 Securities Act‘s prohibition against the sale or offer of a security without filing a registration statement, and failed to meet their duty of inquiry necessary to claim a brokers’ exemption under ‘33 Act Section 4(4). WTFC failed to inquire into the origins of the stocks at issue despite numerous red flags, which required “a more diligent inquiry,” the appeals court said.
For More Information
To see the opinion, go to http://www.bloomberglaw.com/public/document/World_Trade_Fin_Corp_v_SEC _No_1270681_2014_BL_13048_9th_Cir_Jan_1.
JPM V.P., Broker Agree to Insider Trading Bans Jan. 16 — A J.P. Morgan (JPM) vice president and a broker-dealer registered representative agreed Jan. 15 to be barred from the securities industry to settle Financial Industry Regulatory Authority allegations that they participated in an insider trading scheme ( In re Gutman, FINRA, No. 2012033227402, 1/15/14).
FINRA said the J.P. Morgan executive, David Michael Gutman, shared
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material, non-public information with registered rep Christopher Tyndall bet ween 2006 and 2007 about at least 15 pending mergers and acquisitions that Gutman learned by working in the firm's conflicts office. The two were described by FINRA as “longtime close friends.”
Tyndall, who worked at Meyers Associates LP, allegedly used the information to trade ahead of six corporate announcements. FINRA said he made some of the trades using the accounts of family members. He also allegedly recommended making such trades to clients and friends.
Some of the companies involved in the mergers and acquisitions were American Power Conversion Corp., Genesis HealthCare Corp., First Data Corp., SLM Corp., (SLM) and Alliance Data Systems Corp. (ADS)
In settling their cases, neither Gutman nor Tyndall admitted or denied the allegations.
Meanwhile, FINRA noted that it barred another broker and friend of Tyndall's, Joseph Critelli, of Westrock Advisors Inc., in January 2013 for failing to appear to give testimony in the case.
For More Information
The settlement in the Gutman/Tyndall case can be seen at http://www.finra.org/web/groups/industry/@ip/ @enf/@ad/documents/industry/p431923.pdf and http://disciplinaryactions.finra.org/viewdocument.aspx? DocNB=34961.
The settlement in the Critelli case can be seen at http://disciplinaryactions.finra.org/viewdocument.aspx? DocNB=32899.
Ex-Portfolio Manager to Pay $100K Former Oppenheimer & Co. (OPY) portfolio manager Brian Williamson Jan. 22 settled Securities and Exchange Commission charges he misled investors about the performance and valuation of a fund consisting of other private equity funds ( In re Williamson, SEC, Admin. Proc. File No. 3-15430, 1/22/14).
In a release, the SEC said Williamson agreed without admitting or denying wrongdoing to pay $100,000 and to be barred from the industry for at least two years. He also agreed to cease and desist from future violations.
The SEC alleged that Williamson marketed Oppenheimer Global Resource Private Equity Fund I LP by representing an internal rate of return that excluded fees and expenses that the fund paid to the underlying fund managers or to Oppenheimer (45 SRLR 1575, 8/26/13). He also allegedly falsely suggested that the fund's increased rate of return was due to increased performance or third party valuations—not his own revised valuations.
“Investors rely on truthful and complete disclosures about valuation methodologies and fund fees and expenses, especially when committing to a long-term private equity investment,” Julie M. Riewe, co-chief of the SEC Enforcement Division's Asset Management Unit, said in the release. “Williamson misled prospective investors by marking up the fund's interim valuations and concealing his role in enhancing its reported performance.”
Last year, Oppenheimer agreed to pay a total of $2.8 million to the SEC and state regulators to settle related allegations (45 SRLR 489, 3/18/13).
For More Information
To see the SEC's order, go to http://www.sec.gov/litigation/admin/2014/33-9515.pdf.
BNA Insights Don't Tread on Whistleblowers: Mitigating and Managing Retaliation Risks — Part II
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 44 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
WHISTLEBLOWERS
By William McLucas, Laura Wertheimer, and Arian June
William McLucas, chair of WilmerHale's Securities Department, is a partner resident in the firm's Washington, DC, office. Laura Wertheimer is a partner resident in WilmerHale's Washington, DC office and a member of its Securities Department. Arian June is a counsel resident in WilmerHale's Washington, DC, office and a member of the Securities Department. Mr. McLucas may be reached at (202) 663-6622 or william.mclucas@wilmerhale. com. Ms. Wertheimer may be reached at (202) 663-6450 or [email protected]. Ms. June may be reached at (202) 663-6213 or [email protected].
In the first installment of this Article published Jan. 13, we discussed, in Parts I and II, the broad anti-retaliation provisions in SOX and in Dodd-Frank designed to protect employees from adverse employment actions taken in response to the employee's report of possible securities law violations within the organization and to the SEC. As we explained, an employer may not discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of an action by the employee that is protected by statute. Under SOX and Dodd-Frank, a qualified reporting employee may prosecute a retaliation claim regardless of whether the underlying allegations of a securities law violation are found to have merit. Because the remedies available under Dodd-Frank are more generous than the SOX remedies and the statute of limitations is considerably longer, we explained in Part III that a number of claimants have filed complaints in federal court under Dodd-Frank alleging unlawful retaliation sparked by internal reports protected by SOX. We further discuss the conflicting interpretations of Dodd-Frank's whistleblower-protection provisions in the federal courts.
In this second installment, we discuss in Part IV whether employees working outside the U.S. who report potential violations of the securities laws, either internally and externally, are protected from retaliatory conduct under either SOX or Dodd-Frank. Indeed, more than 10 percent of the whistleblower tips received by the SEC during FY 2012 came from employees working outside the U.S. and as unknown number of additional employees working outside the U.S. reported concerns about potential violations of law only to their employers. Last, in Part V, we outline a number of steps for organizations to consider to improve existing anti-retaliation policies and practices to reduce the risk of retaliation complaints.
IV. Retaliation Protections for Foreign Whistleblowers?
A. Extraterritorial Reach of SOX Whistleblower Protection Provisions
As we discussed in Part I, SOX Section 806 provides protection from retaliation for employees of entities subject to the registration or reporting requirements of the Exchange Act. 92 The text of Section 806 is silent on its extraterritorial application. The legislative history of Section 806 reflects that Congress was primarily concerned about the lack of adequate, uniform state law protections for whistleblowers even though many publicly traded companies did business across the U.S. 93 Where Congress intended SOX provisions to apply extraterritorially, it made its intent clear. For example, in Section 1107 of SOX Congress amended 18 U.S.C. §1513, which makes it a crime to retaliate against a witness, victim or informant, to include an express provision of extraterritoriality. 94
92 Foreign private issuers, as defined by Rule 36-4(c) of the Exchange Act, which are subject to SEC reporting and registration obligations, are subject to Section 806. Where a foreign issuer is exempt from SEC filing requirements under Rule 12g3-2(b) of the Exchange Act, it is excluded from coverage. E.g., Gallagher v. Granada Entm't USA, 2004- SOX-74 (ALJ Apr. 1, 2005) (finding Section 806 protections did not apply where employer became subject to Exchange Act after a merger on Feb. 2, 2004 but adverse action occurred on Jan. 22, 2004); Deutschmann v. Fortis Invs., 2006- SOX-80 (ALJ June 14, 2006) (finding Section 806 protections did not apply where corporation was registered only on
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European stock exchanges with securities exempt from SEC registration under Rule 12g3-2(b)). Conversely, where a foreign entity does business in the U.S., it is subject to Section 806 because SOX applies to companies “with a class of securities registered under §12 of the Securities Exchange Act” or “required to file reports” under the Exchange Act.
93 Seesupra notes 6-9, ; Statement of Senator Leahy, 148 Cong. Rec. S7420 (daily ed. July 26, 2002) (Section 806 was created to remedy the situation where “corporate employees who report fraud are subject to the patchwork and vagaries of current state laws, even though most publicly traded companies do business nationwide. Thus, a whistleblowing employee in one state (e.g., Texas …) may be far more vulnerable to retaliation than a fellow employee in another state who takes the same actions.”).
94 18 U.S.C. § 1513(d).
The U.S. Court of Appeals for the First Circuit, which is the only Court of Appeals to date to address the question, held that there is no extraterritorial reach of Section 806. 95 That court found no mention of extraterritoriality in the language of Section 806 and its lengthy review of the legislative history of Section 806 found no indication that Congress considered, much less intended, Section 806 to apply outside the U.S. 96 It recognized the presumption announced by the Supreme Court that where Congress “includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion.” 97 The Court found that Congress provided for extraterritorial reach in the SOX criminal whistleblower provision, Section 1107, but did not do so in the civil whistleblower provision, Section 806, which reflected that Congress knew how to expressly provide for extraterritorial application where it so intended. 98 For those reasons, the First Circuit concluded that Section 806 had no extraterritorial application. 99 The Administrative Review Boards (“ARB”) and Administrative Law Judges (“ALJ”) have reached the same conclusion and dismissed complaints where the complainants were foreign residents working for foreign subsidiaries of U.S. companies outside the U.S. and the retaliation complaint was grounded in adverse actions taking place outside the U.S. 100 In a handful of situations, a significant “nexus” between the alleged wrongful conduct, the complainant, and the U.S. caused the tribunal to conclude that Section 806 protections attached to an employee working outside the U.S. 101
95 Carnero v. Boston Scientific Corp., 433 F.3d 1 (1st Cir.), cert. denied, 548 U.S. 906 (June 26, 2006) (finding no extraterritorial application of Section 806 where complainant was a foreign citizen working abroad who was employed and paid by a foreign subsidiary of a U.S. corporation, whose duties were performed outside the U.S, and whose complaint was made outside the U.S.).
96 Id., at 11-15.
97 Id. at 9-11, quoting Russello v. United States, 464 U.S. 16, 23 (1983) (citation omitted; internal quotations omitted).
98 Id. at 10.
99 See alsoLiu v. Siemens AG, No. 13-0317, 2013 BL 289928, 2013 WL 5692504 (S.D.N.Y. Oct. 21, 2013) (dismissing plaintiff's SOX Section 806 retaliation claim, reasoning that disclosures made outside the U.S. are not entitled to SOX Section 806 protection because Section 806 has no extraterritorial application).
100 See, e.g., Ahluwalia v. ABB, Inc., ARB No. 08-008, 2009 WL 6496920 (ARB June 30, 2009); Pik v. Goldman Sachs Grp., Inc., ARB No. 08-062, 2009 WL 6496922 (ARB June 30, 2009); Salian v. Reedhycalog UK, ARB No. 07-080, ALJ No. 2007-SOX-20 (ARB Dec. 31, 2008); Ede v. Swatch Grp. Ltd., ARB No. 05-053, 2007 WL 1935560 ( ARB June 27, 2007); Pik v. Credit Suisse AG, ALJ No. 2011-SOX-00006, 2011 WL 841044 (ALJ Mar. 3, 2011); Tali sse v. UBS AG, ALJ No. 2008-SOX-00074, 2009 WL 6496752 (ALJ Jan. 8, 2009); Beck v. Citigroup, Inc., ALJ No. 2006-SOX-00003, 2006 WL 3246814 (ALJ Aug. 1, 2006); Concone v. Capital One Fin. Corp., 2005-SOX-6 (ALJ Dec. 3, 2005); Concone v. Capital One Fin. Corp., ALJ No. 2005-SOX-00006, 2004 WL 5030305 (ALJ Dec. 3, 2004).
101 Where the facts alleged did not require the extraterritorial application of Section 806 because of the “nexus” between the conduct at issue, the employee, and the U.S., or the “effects” of the transaction on commerce within the U.S. and because some of the wrongful conduct occurred in the U.S., one court and numerous ALJs have concluded that the protections of Section 806 attached to a foreign employee. SeeO'Mahony v. Accenture Ltd., 537 F. Supp. 2d 506 ( S.D.N.Y. 2008) (finding Section 806 protections applied where employee, who worked in France for a U.S. subsidiary, alleged fraud occurred in the U.S., and the alleged retaliatory conduct occurred in the U.S.); Walters v. Deutsche Bank, 2008-SOX-70 (ALJ Mar. 23, 2009) (finding Section 806 protections applied to an employee who worked in Switzerland but protected activity and decision to retaliate occurred in the U.S.); Penesso v. LLC Int'l, Inc., 2005-SOX-16 (ALJ Mar. 4, 2005) (denying summary decision to employer where complainant was a U.S. citizen employed in Italy by the Italian subsidiary of a U.S. corporation, came to respondent's U.S. headquarters to report about financial improprieties he believed were taking place in Italy, and at least one of the retaliatory actions was taken in the U.S.).
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In June 2010, the U.S. Supreme Court issued its decision in Morrison v. National Australia Bank. 102 There, the Court considered whether Section 10(b) of the Exchange Act allowed Australian investors to recover for securities fraud that inflated the value of shares traded on Australian exchanges where a portion of the fraud involving a U.S. subsidiary took place in the U.S. The Court dismissed plaintiffs' claims, holding that the antifraud provisions of Section 10(b) of the Exchange Act did not provide a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges, even if the losses could have arisen from fraudulent conduct in the U.S. In its opinion, the Court set forth the framework for determining the extraterritorial application of federal statutes. First, the Court reaffirmed the “longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.” 103 In the Court's view, this principle “rests on the perception that Congress ordinarily legislates with respect to domestic, not foreign matters.” 104 A ccording to the Court, courts must “apply the presumption in all cases,” thereby “preserving a stable background against which Congress can legislate with predictable effects.” 105 The presumption that a statute's reach ends at the U.S. border can be overcome only where “the affirmative intention of the Congress [is] clearly expressed to give a statute extraterritorial effect.” 106 The Court succinctly instructed: “When a statute gives no clear indication of an extraterritorial application, it has none.” 107 After examining the language of Section 10(b) and its legislative history, the Court concluded there was no clear congressional intent to apply the statute extraterritorially. 108 The Court declined to infer a congressional intent to create extraterritorial application from a different section of the Act that has some limited applicability to transactions in other countries. 109
102 130 S. Ct. 2869 (2010).
103 Id. at 2877.
104 Id.
105 Id. at 2881.
106 Id. at 2877 (Internal quotations and citation omitted)
107 Id.
108 Id. at 2881-2882.
109 Id. at 2882.
The Solicitor General in Morrison argued that no extraterritorial application of Section 10(b) was warranted because the fraud at issue involved significant conduct in the U.S that was material to the fraud's success. The Court rejected that argument, explaining that it would effectively nullify the presumption against extraterritoriality because it “is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States.’’ 110 To determine whether the domestic activity in Morrison was sufficient to cause the Section 10(b) cause of action to fall outside the presumption against extraterritoriality, the Court looked at the text and structure of the Exchange Act to find the “focus” of congressional concern. Finding that the “focus” was not on the “the place where the deception originated” but rather on “the purchase or sale of a security listed on an American stock exchange and the purchase or sale of any security in the United States,” the Court concluded that the petitioners could not escape the presumption because the shares were not listed on an American exchange and the petitioners had not purchased the shares in the U.S. 111
110 Id. at 2884.
111 Id. at 2888.
Shortly after the June 2010 Morrison decision, Congress apparently intended to partly overrule Morrison by inserting Section 929P(b), captioned “Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws,” into Dodd-Frank in an effort to provide federal courts with jurisdiction to hear cases brought by the SEC or DOJ under Section 10(b) that involve extraterritorial elements. 112 It also added Section 929Y, titled “Study on Extraterritorial Private Rights of Action,” to Dodd-Frank which directs the SEC to “solicit public comment and thereafter conduct a study to determine the extent to which private rights of action” should be extended to transnational securities frauds. 113 To be sure, there is disagreement whether Section 929P(b) overturns Morrison and enlarges the scope of the government's enforcement powers with respect to Section 10(b) cases with extraterritorial elements or whether its use of jurisdictional language fails to expand the substantive reach of Section 10(b). 114 There should, however, be no disagreement that Congress understood,
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 47 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 from Morrison and other Supreme Court cases, that it needed to make “a clear statement that a statute applies overseas.” 115 It sought to provide such a statement in Section 929P(b) and asked the SEC, in Section 929Y, to evaluate the merits of extraterritorial private rights of action.
112 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), Pub. L. 111-203, §929P(b) (20 10).
113 Dodd-Frank Act, Pub. L. 111-203, §929Y(a) (2010).
114 Compare Statement of Representative Paul Kanjorski, 156 Cong. Rec. H5237 (daily ed. June 30, 2010) (purpose of Section 929P(b) “is to make clear” that in actions or proceedings brought by SEC or Department of Justice, federal securities laws “may have extraterritorial application … irrespective of whether the securities are
traded on a domestic exchange or the transactions occur in the United States”); SEC Request for Comments – Study on Extraterritorial Private Rights of Action Request for Comments at 4-5, available at www.sec.gov/rules/other/2010/34-6 3174.pdf; SEC's Memorandum of Law in Opposition to Defendant Tourre's Motion for Judgment on the Pleadings, S.E.C. v. Goldman Sachs & Co. (Tourre), No. 10-3229, (S.D.N.Y. Oct. 13, 2010), 2010 WL 4520690, a *7 n.1 with Richard W. Painter, The Dodd-Frank Extraterritorial Jurisdiction Provision: Was It Effective, Needed or Sufficient?, 1 Harv. Bus. L. Rev. 195, 208 (2011) (“Section 929P was ‘stillborn’ in that it conferred jurisdiction that could not be used for anything substantive … until a further statute were enacted.”); Genevieve Beyea, Morrison v. National Australia Bank and the Future of Extraterritorial Application of the U.S. Securities Laws, 72 Ohio St. L. J. 537, 570-71 (2011) (“the language of the Act as drafted … may not have any effect on the application of Section 10(b), depending on the willingness of the courts to overlook the plain language of the statute”); George Conway, , Wachtell, Lipton, Rosen & Katz Client Memorandum, Extraterritoriality of the Federal Securities Laws After Dodd-Frank: Partly Because of a Drafting Error, the Status Quo Should Remain Unchanged (July 21, 2010), available at http://www.wlrk.com/webdocs/wlrknew/WLRK Memos/WLRK/WLRK.17763.10.pdf.
A federal district court in Illinois recently reviewed the ambiguity of Section 929P(b) and questioned whether that provision could be interpreted to nullify Morrison’s bright line rule on the extraterritorial reach of the Exchange Act.
SEC v. A Chicago Conv. Ctr. LLC, No. 13 C 982, 2013 WL 4012638, at *1 (N.D. Ill. Aug. 6, 2013). The Second Circuit, in United States v. Vilar, 729 F.3d 62 (2d Cir. 2013) held that Section 10(b) of the Exchange Act does not apply to extraterritorial conduct, whether liability is sought civilly or criminally, but found that the record at trial “confirms that [defendants] did perpetrate fraud in connection with domestic securities transactions” and affirmed the convictions. Id. at 67. Because defendants' misconduct and conviction occurred prior to the passage of Dodd-Frank, the Second Circuit did not address the applicability of Section 929P(b).
115 EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 258 (1991).
Contemporaneous with its adoption of these sections of Dodd-Frank, Congress adopted Section 929A which amended Section 806 to clarify that it reaches employees of a company's subsidiaries and affiliates. Had Congress intended Section 806 to have extraterritorial application, it could have made that intent clear in this amendment. It did not. As the Supreme Court instructed in Russello v. United States, when Congress “includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion.” 116 Because Congress expressly provided for limited extraterritorial jurisdiction in Section 929P(b) of Dodd-Frank, it is reasonable to presume that it intentionally excluded employees outside the U.S. from the protections of Section 806.
116 464 U.S. 16, 23 (1983). See also Morrison, 130 S. Ct. at 2883 (“[W]hen a statute provides for some extraterritorial application, the presumption against extraterritoriality operates to limit that provision to its terms.”).
Applying Morrison, the ARB, in a 3-2 en banc decision issued in December 2011, held that the anti-retaliation protections in Section 806 have no extraterritorial application and dismissed a retaliation complaint filed by a Colombian employee working in Columbia for a Columbian company that was an indirect subsidiary of a Dutch company whose shares traded on the New York Stock Exchange. 117 The complainant alleged that he had sent e-mails to corporate executives in Houston reporting on tax avoidance schemes outside the U.S. and claimed that executives in the U.S. determined to fire him as a result of those emails in violation of Section 806. He maintained that his claim did not require an extraterritorial application of Section 806 because the accounting practices that led to the alleged tax fraud occurred in the U.S. and that the allegedly fraudulent scheme he disclosed and the retaliatory termination of his employment were perpetrated by American executives within the U.S. The ARB rejected that argument. 118 The ARB then examined whether Section 806 included extraterritorial application. Reviewing the text of the statute and the legislative history, the ARB found no
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 48 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 indication that Congress intended Section 806 to apply outside the U.S. It recognized that Congress, in passing Dodd-Frank, vested federal courts with extraterritorial jurisdiction over government enforcement proceedings in Section 929P and provided extraterritorial effect to the criminal sanctions for retaliation against a whistleblower who provides information to a law enforcement officer in Section 1107(d) and found that the silence of Section 806 “as to its extraterritorial application requires that we not extend it in that way.” 119 An appeal of the ARB decision is pending before the U.S. Court of Appeals for the Fifth Circuit.
117 Final Decision and Order of the Department of Labor's Administrative Review Board, Villanueva v. Core Labs. NV, ARB Case No. 09-108, ALJ Case No. 2009-SOX-006, 2011 WL 6981989, at *1 (Dep't of Labor, Dec. 22, 2011) (en banc).
118 The ARB identified four factors in cases involving potential extraterritorial application of Section 806 to consider whether the quality and quantity of contacts with the U.S. were sufficient to void the presumption of extraterritoriality: i) the location of the protected activity; ii) the location of the job and the company the complainant is fired from; iii) the location of the retaliatory act, and iv) the nationality of the laws allegedly violated that the complainant has been punished for reporting. Because Mr. Villaneuva worked in Columbia and submitted his internal report in Columbia regarding violations of foreign laws and did not identify any violations of U.S. law, the ARB concluded that the quality and quantity of domestic contacts were not sufficient to overcome the presumption. In Dos Santos v. Delta Airlines, Inc., 2012-AIR-20 (ALJ Jan. 11, 2013), the ALJ applied these four factors to the facts alleged by the complainant, a U.S. citizen working for Delta Airlines in Paris, France, who complained of unlawful retaliation under the Ford Aviation Investment and Reform Act for the 21st Century after he reported that his supervisor falsified safety clearance documents. Because the ALJ concluded that the complaint fell within the activity protected by statute, the ALJ found that the alleged facts did not require extraterritorial application of the statute.
119 Final Decision and Order of the Department of Labor's Administrative Review Board, Villanueva v. Core Labs. NV, ARB Case No. 09-108, ALJ Case No. 2009-SOX-006, 2011 WL 6981989, at *9 (ALJ Dec. 22, 2011). In an amicus brief filed by the U.S. Department of Labor in the ARB proceeding, the Department of Labor argued that “SOX Section 806 do es not have extraterritorial reach over alleged acts of employer retaliation occurring in a foreign nation.” Brief for the Assistant Secretary of Labor for Occupational Safety and Health as Amicus Curiae, Villanueva v. Core Labs NV, ARB Case No. 09-108, ALJ Case No. 2009-SOX-006 (Dep't of Labor Aug. 23, 2011), available athttp://www.dol.gov/sol/medi a/briefs/main.htm.
B. Extraterritorial Reach of Dodd-Frank's Whistleblower Protection Provisions
In the three years since Morrison, lower courts have applied the Morrison framework to dismiss civil actions against foreign companies under the securities laws and to a number of other federal statutes providing civil remedies to private plaintiffs outside the securities laws. 120 Last term, the Supreme Court, in Kiobel v. Royal Dutch Petroleum Co., applied the Morrison framework to analyze the extraterritorial reach of the Alien Tort Statute (“ATS”) which creates federal jurisdiction for civil actions brought by aliens for torts committed in violation of the law of nations or a U.S. treaty. 121 The Court affirmed the dismissal of an ATS complaint alleging violations of international law in Nigeria, holding that the presumption against applying federal statutes extraterritorially applied to the ATS. The Court explained that nothing in the text or history of the ATS overcomes the presumption against construing statutes to reach “conduct in the territory of another sovereign.” Because “all the relevant conduct” in Kiobel “took place outside the United States,” the Court held that dismissal of the case was required. The Court added that “even where the claims touch and concern the territory of the United States, they must do so with sufficient force to displace the presumption against extraterritorial application.” 122 It cautioned that a defendant's “mere corporate presence” in the U.S. would not suffice because “[c]orporations are often present in many countries.” 123
120 Applying Morrison in securities law cases, courts have found that the presence of one or more connections to the U.S. has not been sufficient to overcome the strong presumption against extraterritoriality. E.g., Quail Cruise Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, No. 09-23248-CIV (S.D. Fla. Aug. 6, 2010) (closing of a transaction in the U.S. that otherwise has no connection to this country does not overcome the Morrison presumption); In re Alstom SA Sec. Litig., No. 03 Civ. 6595 (VM) (S.D.N.Y. Sept. 13, 2010) (dismissing claims even though a “buy order” was placed in the U.S. by U.S. citizens); Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., No. 08 Civ. 1958 (JGK), at 20-22 (S.D.N.Y. Oct. 4, 2010) (“the mere act of electronically transmitting a purchase order from within the United States” to a foreign exchange is “insufficient to subject the purchase to the coverage of Section 10(b)”); Absolut e Activist Value Master Fund Ltd. v. Florian Homm , No. 09 CV 08862, at 10 (S.D.N.Y. Dec. 22, 2010) (“mere fact that a stock is listed on a domestic exchange does not give rise to a claim under domestic securities laws when the shares are purchased elsewhere”); Elliott Assocs. v. Porsche Automobil Holding SE, No. 10 Civ. 0532 (HB) (S.D.N.Y. Dec. 30, 2010) (choice of U.S. law and forum in a stock purchase contract insufficient to overcome the presumption); In re Royal Bank of Scotland (RBS) Grp. PLC Sec. Litig., No. 09 Civ. 300 (S.D.N.Y. Jan. 11, 2011) (allegation that plaintiffs are U.S. residents who were in the U.S. when they purchased foreign insufficient to overcome Morrison
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presumption); In re Vivendi Universal, S.A. Sec. Litig., No. 02-CV-05571, at 17, 19 (S.D.N.Y. Feb. 22, 2011) (even though American investors purchased foreign shares “listed” on the NYSE and “registered” with the SEC, the court found that such listing and registration alone “cannot carry the freight that plaintiffs ask it to bear” because it is “contrary to the spirit” of Morrison and threw out most of a securities class action jury verdict).
Courts have also used the Morrison framework to analyze whether the Racketeer Influenced Corrupt Organizations Act (RICO) should be applied extraterritorially. Guided by the Court's announcement that “[w]hen a statute gives no clear indication of an extraterritorial application, it has none,” lower courts have recognized that RICO is silent as to any extraterritorial application and contains no evidence of Congressional intent to apply it extraterritorially. These courts have sought to determine the location of the enterprise, as demonstrated by the quality and quantity of contacts, to determine whether it falls within the ambit of the civil RICO statute. E.g., Norex Petroleum Ltd. v. Access Indus., Inc., 631 F.3d 29, 30–31 (2d Cir. 2010) (per curiam) (affirmed dismissal of civil RICO claim on the grounds that civil RICO does not reach the alleged conduct of an enterprise “to take over a substantial portion of the Russian oil industry,” notwithstanding statute's express reference to “foreign commerce” and explicit extraterritorial effect of certain predicate acts in the RICO statute); European Cmty. v. RJR Nabisco, Inc., 2011 BL 65192, at *8, 2011 U.S. Dist. LEXIS 23538, at *23 (E.D.N.Y. Mar. 7, 2011) (dismissing plaintiffs' RICO complaint because “when read as a whole, [the complaint] strongly suggests [that] the money laundering cycle [engaged by the alleged enterprise] was directed by South American and European criminal organizations, … [and] not [by] Defendants in the United States”); Cedeño et al. v. Intech Grp., Inc., 733 F. Supp. 2d 471, 472 (S.D.N.Y. 2010) (dismissing RICO claims by a foreign plaintiff against a RICO enterprise comprised of the “[t]he foreign exchange regime of the government of Venezuela” where predicate acts of money laundering involved transfers into and out of the district by U.S. banks). Indeed, the district court for the District of Columbia nullified its prior decision granting prospective injunctive relief against British American Tobacco Company (“BAT”) where it found that the sole basis for BAT's RICO liability was its foreign conduct and where the intervening Supreme Court decision in Morrison invalidated that basis for liability. United States v. Phillip Morris USA, No. 99-2496 (GK), 2011 WL 1252662 (D.D.C . Mar. 28, 2011).
One court has applied Morrison to narrow the reach of the Robinson-Patman Act. See Newmarket Corp. v. Innospec, Inc., 2011 BL 133578, at *4, 2011 U.S. Dist LEXIS 54901, at *12 (E.D. Va. May 20, 2011) (dismissing a claim concerning payments made to Iraqi and Indonesian officials because “the language of [that Act] contains no intention that it is to apply extraterritorially”).
121 Kiobel v. Royal Dutch Petroleum Co., 133 S. Ct. 1659 (2013).
122 133 S. Ct. at 1666, 1669.
123 Id. at 1669.
As with the statutes at issue in Morrison and in Kiobel, Section 922(a) of Dodd-Frank is silent on its extraterritorial reach. The Court has been unequivocal that “[w]hen a statute gives no clear indication of an extraterritorial application, it has none.” It has instructed that where a statute is silent on extraterritoriality, “silence means no extraterritorial application.” 124 Other provisions of Dodd Frank, like Sections 929P(b) and 929Y, make express references to extraterritoriality. While an argument could be made that Congress, by providing for extraterritorial jurisdiction in Section 929P(b), evidenced its intent to protect foreign whistleblowers from retaliation because such whistleblowers could provide information to the SEC that could be used in enforcement actions, such an argument runs afoul of Morrison’s clear instruction: “[W]hen a statute provides for some extraterritorial application, the presumption against extraterritoriality operates to limit that provision to its terms.” 125 As of this writing, two district courts have addressed whether Dodd-Frank's protection against retaliation applies extraterritorially and both have concluded that it does not. 126 While it is too soon to draw conclusions on whether federal courts will permit Dodd-Frank retaliation claims brought by non-U.S. residents working outside the U.S. to go forward, these decisions cast significant doubt on the viability of such claims.
124 Morrison, 130 S. Ct. at 2881.
125 Id. at 2883.
126 Liu, 2013 BL 289928, 2013 WL 5692504; Asadi v. G.E. Energy (USA), LLC, No. 12-345, 2012 BL 160743, at *5, 2012 WL 2522599, at *7 (S.D. Tex. June 28, 2012), aff'd on other grounds, 720 F.3d 620 (5th Cir. 2013).
Recognizing the hurdles imposed by Morrison and Kiobel, foreign whistleblowers are likely to attempt to plead around the presumption against extraterritoriality by alleging that a sufficient amount of conduct in the U.S. to justify application of U.S. law. The quality and extent of conduct in the U.S. required to nullify the presumption, however, is an open question. In Morrison, the Court determined that the defendant's registration of American Depository Receipts for trade on the New York Stock Exchange, which subjected defendant to application of the U.S. securities laws, was not sufficient to overcome the presumption against extraterritorial application of U.S.
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 50 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 securities laws to foreign conduct. 127 The Court cautioned that the presumption “would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case.” 128 While the Court found that the particular “domestic activity” of defendants was not enough to displace the presumption, it did not define what conduct would suffice. In Kiobel, the “domestic activity” amounted to the “mere” corporate presence of a defendant, which the Court determined was not a sufficient nexus with the U.S. to trigger application of U.S. law. 129 Kiobel suggests that something more that the domicile of the defendant corporation is required to overcome the presumption: the claims themselves must “touch and concern the territory of the United States . . . with sufficient force to displace the presumption against extraterritoriality.” Exactly how much “domestic activity” will be sufficient to overcome the presumption against the extraterritorial application of Section 922 remains to be seen.
127 Morrison, 130 S. Ct. at 2875, 2883, 2888.
128 Morrison, 130 S. Ct. at 2884.
129 Shortly after issuing its Kiobel decision, the Supreme Court granted certiorari in DaimlerChrysler AG v. Bauman, t o review a decision from the Ninth Circuit holding that Daimler AG, the German parent company with no operations or employees in the U.S., could be sued under a California state equivalent of the ATS in federal court by Argentine nationals for human rights abuses allegedly committed by Daimler's Argentine subsidiary in Argentina, because of the contacts that a different Daimler subsidiary, Mercedes Benz USA, had in the state. Bauman v. DaimlerChrysler Corp., 644 F.3d 909 (9th Cir. 2011), cert. granted, 133 S. Ct. 1995 (2013). While Bauman involves whether a subsidiary's presence in a state is enough to confer jurisdiction over the parent for the actions of a different subsidiary, the Court's opinion may provide guidance on what is needed, beyond “mere corporate presence” in the U.S. to overcome the presumption against extraterritoriality.
V. Considerations for Mitigating Retaliation Risks
Virtually every organization subject to SOX adopted a zero-tolerance policy for retaliatory behavior. Those policies stand in stark contrast to the findings of a 2011 survey by the Ethics Resource Center of 4,683 employees in the for-profit sector 130 which found that retaliation rates were “up across the board” and “[i]n workplaces where employees at all levels demonstrate a commitment to integrity and ethical business conduct, the rate of retaliation is nearly four times as high as in 2009.” 131 That data suggests that existing policies either are not enforced or are not sufficient to prevent retaliatory behavior.
130 Workplace Ethics in Transition, supra note 83 at 13.
131 See Retaliation: When Whistleblowers Become Victims, supra note 83.
SOX and Dodd-Frank encourage whistleblowing as a tool in detecting and preventing misconduct and both protect whistleblowers from retaliation. Recent ARB and federal court decisions interpreting Section 806 of SOX and the SEC implementing rules for Section 922(a) of Dodd-Frank make clear that whistleblower protections will attach in many instances where the underlying report or complaint lacks merit, provided that the individual acted in good faith when making the report. 132 The likely increase in whistleblower retaliation claims, with a concomitant rise in the costs of defending such claims, counsel that organizations covered by SOX and Dodd- Frank take a hard look at critical elements of their compliance framework and make appropriate enhancements. 133
132 Pursuant to Section 922(a), a “whistleblower” must only show that he had a “reasonable belief” that the information provided related to a possible securities law violation that either had occurred, was occurring, or was about to occur.
133 See William McLucas, Laura Wertheimer & Arian June, Get Ahead of the Bus or Be Hit by the Bus: Practical Strategies for Meeting the Challenges and Mitigating the Risks of the Dodd-Frank Whistleblower Program, 44 Bloomberg BNA Sec. Reg. & L. Report 11, 526 (Mar. 12, 2012).
Possible areas for such a review include:
• “Tone at the Top”: Employees at all levels of an organization take their lead from the most senior management of that organization. The 2011 Ethics Resource Center survey found that “retaliation declines precipitously when top management and supervisors make ethics a priority and model ethical conduct.” 134 Does the management team emphasize and reemphasize the core values and guiding principles of the organization and the organization's expectation that each employee is personally responsible for acting in accord with those values and principles? Are members of the senior management team personally committed to and act in accordance with the values they promote? Is there a gap between the written and
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 51 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 spoken values and principles and the personal conduct of senior management?
• Code of Conduct and Whistleblower and Anti-Retaliation Policies (if separate): An organization's Code of Conduct and associated policies set forth the written standards by which it conducts its business and the expectations for its employees. Does the Code stress the duty of every employee to speak up when he or she sees or hears something that might involve a violation of the Code, company policies or of the law? Does it provide detailed guidance on the numerous internal mechanisms available for reporting those concerns, including hotlines where employees can report concerns anonymously? Do the Code and complementary compliance policies clearly explain that discrimination or retaliation against employees who report possible misconduct is unlawful and will not be tolerated and that retaliatory conduct will subject that employee to discipline, including termination? Do they include a clear explanation of “retaliation” and “discrimination” to make clear that they include not only termination and demotion but salary adjustments, harassment, hostile work environment and threatened termination? Do they explain that reports of employment-related retaliation are taken seriously and will be appropriately investigated by persons with authority?
• Established Process to Review Every Internal Report of Compliance Concerns or Possible Misconduct: W here an organization has established fair processes to review internal reports of compliance concerns and of alleged misconduct which are applied uniformly, employees recognize that speaking up will not be futile. Has a written protocol been developed that sets forth the process to be followed after receipt of either type of internal report? Is that written protocol contained in the Code of Conduct or whistleblower policy distributed to employees? Is the organization in a position to demonstrate to employees that the established processes are used in practice?
• Established Process to Review and Resolve Retaliation Complaints: Ten years of experience with retaliation claims filed under Section 806 teaches that employees often file retaliation claims when they perceive there is no resource within the organization to resolve their concerns regarding retaliatory or discriminatory conduct. For an employee to plead and prove a retaliation claim under SOX, he or she must only show that the protected activity was a “contributing factor” in the adverse personnel decision, not the only or primary factor. The U.S. Court of Appeals for the Third Circuit recently explained that Congress intended this “contributing factor” test to be protective of plaintiff-employees. This fairly low threshold puts a premium on an organization's internal processes to investigate all reports of retaliation or workplace discrimination and remediate legitimate concerns. Of course, retaliation concerns may surface in a variety of other ways, such as conversations with Human Resources, or observations by a co-worker, or comments made to Internal Audit. Wherever such concerns are voiced, the established process should be used to review whether the conduct amounts to retaliation or discrimination, to take appropriate remedial measures, and to take any appropriate disciplinary action against the retaliating employee. The established process must be sufficiently robust and independent from supervisors of any aggrieved employee. Where an organization has clear processes that require prompt review of internal reports of alleged retaliatory conduct and redress of any improper conduct, employees perceive that a “zero tolerance” policy has teeth.
• Mandatory Employee Training: The standards announced in the Code and the internal mechanisms available to report deviations from those standards should be explained to employees through mandatory, periodic training. Because individuals typically act on the basis of perceptions, mandatory training should also target employee perceptions. Have employees been surveyed individually or in focus groups regarding their understanding of the obligation to speak up to report compliance concerns, the organization's commitment to take reported compliance concerns seriously and willingness to address problems and the extent that they believe they will experience retaliation if they report concerns? Does current training explain the benefits to the organization from employee reports of compliance concerns? Does it address the processes adopted by the organization to review reported compliance concerns so that employees can appreciate that the processes are fair and thorough? Does it make clear that retaliation or discrimination against an employee who reports conduct that he or she “reasonably believes” violated or might violate certain federal laws is unlawful? Does it explain the potential consequences when retaliatory conduct is found?
• Mandatory Training for Managers: As we have explained, survey data shows that an overwhelming number of employees who speak up to report compliance concerns within an organization speak to an immediate supervisor or to more senior managers with perceived authority to remedy the concern. 135 This same data makes clear that many of these reporting employees become external whistleblowers when a manager or supervisor reacts defensively, dismisses the report or, worse, takes action that the employee
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 52 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4 considers to be retaliatory. No written protocol for handling internal reports of possible misconduct will be useful unless supervisors and managers are trained on how to recognize protected activity and how to respond appropriately. Specific mandatory whistleblower training should be required for managers, in addition to any compliance training provided to all employees. This training could include: 1) real-life examples of the broad scope of conduct protected under SOX Section 806 and Section 922 of Dodd-Frank; 2) a script for supervisors with appropriate words to use when responding to an employee's report of a compliance concern or possible misconduct and scenario based role-playing so supervisors are comfortable with the scripted response; 3) a reminder of the organization's established processes to escalate such reports to the function in the organization charged with prompt review and investigation of internal reports; 4) the critical need to consistently and contemporaneously document performance issues for every underperforming employee; 5) real-life examples of the breadth of the protection against retaliatory or discriminatory conduct, including subtle inequities in how a reporting employee/whistleblower is treated; and 6) the consequences to the organization and the individual of behaviors found to be retaliatory or discriminatory. Training should test the manager's understanding of what should and should not be said to a reporting employee and the imperative to escalate all internal reports so they can be reviewed and addressed.
• Regular Communications Across the Organization: Experience has shown that it is not sufficient to inform employees about their obligation to report compliance concerns or possible misconduct and about the organization's commitment to review all such reports and address inappropriate conduct and its zero tolerance for retaliation against reporting employees. These messages must be reinforced on a continual basis through many different vehicles, such as formal communications from senior management, weekly department meetings, town hall meetings, annual letters from the Chief Executive Officer, and in one on one performance reviews. What communications are sent on a regular basis to all employees about the organization's established processes to review reported compliance concerns and address misconduct? Do the communications explain that mandatory training has been provided to management to reassure employees that managers understand the protections in place for those who report? Have managers incorporated those message points into their briefings to employees and in informal discussions?
• Reinforce the Compliance Culture: Survey data suggests that employees must continually be reminded about the organization's commitment to compliance, their obligation to speak up and report conduct that may violate the Code, policies or law, the different internal mechanisms available for such reporting, and the organization's intolerance of retaliation against any reporting employee. In addition to driving home those messages through regular communications with employees, a reminder could appear on the log-in page of the organization's intranet with a link to the Code, whistleblower and anti-retaliation policies, if separate, the number of the anonymous hotline, and a brief summary of other internal reporting mechanisms. The same reminders could be summarized on one page and that page could be inserted at the front of employee manuals and distributed as a stand-alone page to all employees. Articles in employee newsletters, blogs and intranets could highlight the benefit to the organization from internal employee reports.
• Notify Managers and Supervisors of an Internal Report From an Employee They Supervise: Depending on the organization, it may be advisable in certain circumstances to notify the reporting employee's direct supervisor and perhaps more senior management that an internal report has been submitted raising compliance concerns or possible misconduct and the identity of the reporting employee, where that employee has not asked the organization to keep his identity confidential. That same notice could remind recipients that the internal report will be investigated pursuant to the organization's written policy and that the organization has zero tolerance for any retaliation against the reporting employee. The notice could direct that no internal discussions or communications, including e-mail, should occur regarding the facts underlying the report or with the reporting employee about the report, or about the reporting employee. Perhaps most importantly, the notice should underscore that no employment action involving the reporting employee may be taken unless and until it is reviewed and approved by either Human Resources or the General Counsel. In other organizations, it may be appropriate to shield the reporting employee's direct supervisors and managers up the chain from any investigation of the internal report of compliance concerns or potential misconduct. The approach taken should be documented to show the organization's efforts to prevent retaliatory conduct.
• Close the Communications Gap: We have written previously about studies showing that employees who report internally are more likely to air their concerns outside the organization when they perceive that the
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organization does not take their reported concerns seriously or that they have been ostracized by co- workers or supervisors for speaking up to report their concerns. 136 Speaking at a recent conference, SEC Associate Enforcement Director Stephen Cohen reported that “almost uniformly, the whistleblowers in my investigations have reported internally [and] in most instances repeatedly and to multiple people. They were either not listened to, or were retaliated against” before they complained to the SEC. 137 Even in those organizations which adopt “best practices” for review of internal complaints, a failure to keep the reporting employee updated on the progress of the ongoing review is likely to raise questions about the organization's commitment to get to the bottom of the concern and to deal with it appropriately.
134 See Retaliation: When Whistleblowers Become Victims, supra note 83, at 14.
135 William McLucas, Laura Wertheimer & Arian June, Preparing for the Deluge: How to Respond When Employees Speak Up and Report Possible Compliance Violations, 44 Bloomberg BNA Sec. Reg. & L. Report 19, 922 (May 7, 2012); McLucas et al., supra note 133.
136 Id.
137 Richard Hill, SEC Official Says Whistleblowers Almost Always Report Internally First, 45 Bloomberg BNA Sec. Reg. & L. Rep. 872 (May 13, 2013).
How an organization responds to a reporting employee may, in many instances, control whether the situation can be managed and resolved internally or whether the employee reports to a third party. We again recommend that organizations consider designating an individual to serve as liaison to the reporting employee. The designated liaison serves a critical role: where reporting employees perceive that their concerns are being taken seriously and will be (and have been) reviewed fairly and thoroughly, they are more likely to have confidence in the organization's internal investigation and conclusions and less likely to report their concerns externally. At the liaison's first contact with a reporting employee, that individual should be assured that the organization will not tolerate retaliation, that any form of retaliatory conduct, including perceptions of subtle retaliation, such as exclusion from conferences, or networking events, should be reported immediately using a reporting mechanism with which the employee is comfortable, and that the organization will address any reported concerns immediately. As part of the liaison's regular status updates to the reporting employee, the liaison could remind the employee that the organization does not tolerate retaliation and could encourage the employee to bring forward concerns about unfair treatment and perceived retaliation. The designated liaison should be an individual with a track record of fairness and trustworthiness. Before appointing a designated liaison, organizations should consider employee perceptions. For example, in some organizations, employees may question the trustworthiness of Human Resources and it may be prudent to go outside management and select an Internal Audit employee or employee in the compliance function. Of course, retaliation concerns may surface in a variety of other ways, such as conversations with Human Resources, or observations by a co-worker, or comments made to Internal Audit. Communications between the reporting employee should be documented.
• Review Proposed Performance Evaluations and Employment Actions for Reporting Employees and Known Whistleblowers: Neither Section 806 of SOX nor Section 922(a) of Dodd-Frank prohibit an employer from taking adverse employment action against a reporting employee for reasons unrelated to the protected activities. A temporal relationship between protected activity and any adverse employment action, however, could be perceived by the employee as retaliatory and give rise to a retaliation claim. If a direct manager concludes that adverse employment action involving a reporting employee, such as negative performance reviews, downward compensation adjustments, proposed disciplinary actions and the like, is warranted, it is critical for an organization to require experienced staff in its Human Resources and General Counsel function to review the recommended adverse action and make an independent determination of whether it is clearly supported by contemporaneous documentation of performance issues, consistent with treatment of other similarly situated employees, and fair. Even where those criteria are met, a considered evaluation should be made whether the contemplated adverse action could be considered retaliatory and of the risks to the organization from a potential retaliation lawsuit and public airing of alleged compliance failings. Experienced staff in Human Resources and the General Counsel function should also be consulted with respect to any decisions involving compensation, performance reviews, and promotions to minimize the risk that reporting employees will perceive that they have being treated less favorably because they reported the potential violations. Organizations should document the grounds for every adverse employment action taken against a reporting employee.
Conclusion
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Retaliation claims, whether filed as Section 806 claims with the Department of Labor or as Section 922 claims in federal court, can pose significant risks for employers. Expansive reading of the statutory protections against retaliation by the ARB and by federal courts makes it easier for many retaliation claims to survive dispositive motions. And once discovery begins, weaknesses in an employer's compliance framework may begin to emerge, potentially creating another avenue of interest for other regulators.
Historically, SOX retaliation claimants fared poorly in administrative process. In May 2010, then-newly appointed Assistant Secretary of Labor David Michaels recognized that Occupational Safety and Health Administration (“OSHA”) investigators found merit in only 3 percent of all whistleblower retaliation claims filed with OSHA for Fiscal Year 2009, which he attributed to “a series of institutional, administrative and legislative barriers that stand between many whistleblowers and justice” and OSHA's “failure to protect legitimate whistleblowers.” 138 He served notice that such barriers must come down and OSHA must step up its efforts to protect whistleblowers from retaliation because protections from retaliation embody a “decades-old belief held by Congress, stakeholders, employers and society, that whistleblowers play an essential role in protecting workers and the public.” 139 After a top-to-bottom review of its Whistleblower Program, OSHA announced a series of initiatives 140 which it has implemented. 141 There is no question that this overhaul will result in an increased number of OSHA investigations. While it remains to be seen whether revamping of the Whistleblower Program will ultimately lead to an increase in the number of successful retaliation claims, employers should expect a sea change in the way in which OSHA staff investigate Section 806 retaliation claims, including witness interviews and substantial document requests and should understand that, pursuant to the Whistleblower Investigations Manual, documents that they provide to OSHA investigators will likely be provided to the complainants.
138 David Michaels, Assistant Sec'y of Labor For Occupational Safety and Health, “Whistleblowers and OSHA: Strengthening Professional Integrity,” Address Before the Professionals for the Public Interest (May 11, 2010), available atht tp://www.osha.gov/pls/oshaweb/owadisp.show_document?p_table=SPEECHES&p_id=2206.
139 Id.
140 Press Release, U.S. Dep't of Labor, U.S. Dep't of Labor's OSHA Announces Measures to Improve Whistleblower Protection Program (Aug. 1, 2011), available athttp://www.osha.gov/pls/oshaweb/owadisp.show_document?p_ta ble=NEWS_RELEASES&p_id=20394; Memorandum from David Michaels, Assistant Sec'y of Labor for OSHA (Aug. 1, 2011), available at http://www.whistleblowers.gov/cover_memo.html.
141 To date, OSHA has implemented several enhancements to the Whistleblower Program. See, e.g., Press Release, U.S. Dep't of Labor, U.S. Dep't of Labor's OSHA Whistleblower Protection Program Moved to Office of the Assistant Sec'y (Mar. 1, 2012), available athttp://www.osha.gov/pls/oshaweb/owadisp.show_document?p_table=NEWS_RELEAS ES&p_id=21909 (realigning the Whistleblower Program under the Office of the Assistant Sec'y to provide “a significantly elevated priority status for whistleblower enforcement” and establishing a separate line item for the Whistleblower Program to “better track and hold accountable its activities and accomplishments”); U.S. Dep't of Labor, FY 2013 Budget in Brief, 54 available athttp://www.dol.gov/dol/budget/2013/PDF/FY2013BIB.pdf (increasing the number of personnel in the Whistleblower Program, including additional investigators “to reduce the backlog of whistleblower claims, expedite the handling of current complaints received by the agency, and prepare for a high volume of complex cases with recently passed laws involving health care reform, food and safety, and finance reform” and significantly “enhanc[ing] the training of whistleblower investigators and supervisors”); Press Release, U.S. Dep't of Labor, U.S. Dep't of Labor's OSHA Issues Updated Whistleblower Investigations Manual (Sept. 21, 2011), available athttp://www.osha.gov/pls/oshaweb/owadis p.show_document?p_table=NEWS_RELEASES&p_id=20712 (updating the Whistleblower Investigations Manual to explain procedural changes that make it easier for employees to file and prosecute whistleblower complaints); Memorandum from David Michaels, supra note 140 (expanding OSHA's database and adding self-audit requirements “to ensure that complaints are properly handled and on a timely basis” and “to better track the progress of investigations” and appeals); Procedures for the Handling of Retaliation Complaints Under Section 806 of the Sarbanes-Oxley Act of 2002, as amended, 29 C.F.R. §1980 (2011) (adopting revised regulations implementing several of the whistleblower protection provisions, including revised regulations for SOX retaliation claims).
What can be done to mitigate the potentially increased risks and costs of defending against retaliation claims filed with OSHA or in court? Most organizations have adopted anti-retaliation policies that are provided to employees as well as hotlines, whether through a third party vendor, web channel, or intranet link, where employees can report retaliation concerns. In our experience, these policies and hotlines can create a sense of complacency that can be dangerous. We recommend a number of complimentary strategies for organizations to consider adapting into existing programs, controls and crisis response plans to reduce the risk that retaliatory conduct will occur and to detect and remediate retaliatory conduct if it does occur.
Interview
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Woodcock: New Task Force Seeking Whistle-Blowers to Scope Out Financial Fraud
Enforcement
By Phyllis Diamond
Jan. 22 — While a top priority for the Securities and Exchange Commission's Financial Reporting and Audit Task Force is to develop computer methodology to ferret out accounting irregularities, it also is reaching out to finance professionals to blow the whistle on financial misconduct, task force chief David Woodcock said Jan. 16.
Saying whistle-blowers “are immensely valuable,” he told Bloomberg BNA that the task force now has a page on the SEC website aimed specifically at people looking for ways to report financial statement fraud.
Latest Tools
In an interview, Woodcock recounted that the methodology the task force is developing will include the agency's new accounting quality model—“an econometric regression model that estimates discretionary accruals and identifies companies that are outliers relative to their industry peers.”
However, it also will include leveraging the work of other SEC divisions and offices, better understanding the work being done in academia, working more closely with the Public Company Accounting Oversight Board and other regulators, and reaching out to whistle-blowers—especially accountants and finance professionals. The task force also will use “industry-specific knowledge” within the SEC and otherwise to “dig deeper into specific industries.”
According to Woodcock, the goal is not to create a perfect model. Rather, “[i]t's to use the latest tools we can get internally or externally and mine the best thinking to build our own methodology that gives us the best chance of identifying financial reporting fraud as early as possible.”
A second key priority, Woodcock continued, is to gain a deeper understanding of where accounting fraud is occurring—what areas, industries, and companies.
“The first goal is very closely related to the second goal,” he amplified. “Building the methodology is about finding the right tools and methods to use in our overall effort to combat financial reporting violations. Developing a deeper understanding is focused on the substantive accounting issues and industries that deserve the most attention at the time.”
“The first goal will help us develop the second goal,” Woodcock added.
New Initiatives
In July 2013, the commission announced three initiatives, one of which was the task force, intended to build on the Enforcement Division's ongoing effort to concentrate resources on high-risk areas. The other two initiatives were a task force targeting misconduct involving microcap securities, and the Center for Risk and Quantitative Analytics, which uses quantitative data and analysis to profile high-risk transactions and conduct.
Woodcock said the purpose behind creating his task force was to ensure that the agency is doing all it can to deter, investigate and prosecute violations involving false or misleading financial statements and disclosures and audit failures. “That's broader than what you might think of as pure accounting fraud.”
Most of the dozen task force members are both attorneys and “We haven't automated enforcement.” certified public accountants. Woodcock related. “Not everyone,
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but most.
The task force also has an accountant from the Division of Corporation Finance and one from the Office of the Chief Accountant on rotation. “We've got extensive audit, public, and forensic accounting experience, and collectively have 125 years with the division investigating financial fraud,” Woodcock said. “Like we're one person with 125 years of experience.”
Real Time Focus
Woodcock emphasized that the task force is not focused on the psychology of why people commit accounting fraud; rather, it is seeking to determine where accounting and reporting misconduct is happening. “We're trying to get a better handle on that and be a lot more focused in real time on what the areas are.”
Woodcock added that in his view, the SEC, with its experience, access to data, and investigative history, “is probably in the best position of any organization to be the thought leader on accounting and financial reporting fraud.”
He said the SEC has substantial internal data, including EDGAR filings, historical enforcement databases, including the cases and individuals investigated, and a database of tips, complaints, and referrals. The task force also may make use of private-party tools and is working with other regulators to obtain information.
“It used to be the case that you didn't want a lot of data because you couldn't physically get through it,” Woodcock observed. “Now, the more data the better, because you have the tools, the computing power to sift through it and learn from it. It's a great time to be doing this in some ways.”
AQM
Meanwhile, Woodcock related, the AQM is designed to provide a set of market analytics that can be used to assess the degree to which a public company's financial statements appear anomalous relative to its peers. The information will be used along with information from other databases, internal and external, as well as with the analytics the task force is developing with the Center for Risk and Quantitative Analytics.
“Then all of these tools are going to be subject to the judgment and experience of the staff attorneys and accountants working on the task force. We haven't automated enforcement,” Woodcock emphasized. “You can't. It's going to take human judgment and the application of that judgment to every single case.”
He explained that a report that a particular company is an outlier “just begins the inquiry.” The staff then looks at the financial statements and the “whole host of things you might look at as an analyst or accountant or attorney,” and in some cases determines that there is an easy explanation.”
Asked about what makes enforcers want to take a closer look, Woodcock said the best models are peer-to-peer comparisons within industry groups. “Let's imagine you're in an industry that's driven by revenue growth. If a company's growth is 500 percent and everyone else in the industry is at 4 percent, that company is an outlier.”
That may mean that the company ”is really outperforming its peers, and there's nothing wrong with that,” Woodcock related. “But it may mean something else.”
“Enron is probably a great example,” he elaborated. “The revenue growth that Enron experienced in a short period of time was phenomenal. Phenomenal and anomalous. Obviously, looking back, that meant they were doing something wrong.”
“That's not always the case,” Woodcock acknowledged. Nonetheless, he said “comparison to industry peers is probably the easiest way to identify companies that might be doing something sneaky.”
Woodcock declined to specify what industries the task force might be focusing on. However, he said industries that have suffered from a high number of lawsuits or accounting issues, for example, could be candidates for scrutiny.
Whistle-Blowers
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In addition, Woodcock stated, there also are cases that don't present the kind of anomalies that would be detected by models or even fundamental analysis. That's where whistle-blowers come in.
For example, he said, if a firm manipulates its revenues or expenses “by just enough to allow it to beat its competitors or to turn a small loss to a small gain, that might have been material and it might have been fraudulent, but it may not have been enough to make it an outlier relative to its peers. So just looking at a model might not get you to where you're even asking questions about that company's performance.”
“In those cases, whistle-blowers play an important role.”
How does Woodcock hope to encourage whistle-blowers, “[C]omparison to industry peers is beyond the commission's existing bounty program? “We're probably the easiest way to identify working with the Office of the Whistleblower to find ways to do companies that might be doing this, either through speeches or other types of outreach.” In addition, the task force is trying to spread the word to something sneaky.” accountants and auditors “that they, in fact, can be whistle- blowers in some instances.”
What might those instances be? “As a general matter,” Woodcock explained, “auditors are precluded from reporting information they obtain during an audit or engagement required by the securities laws, or when they're acting in a compliance or internal audit function, or are helping a client investigate possible violations of law.”
However, he noted, auditors and accountants can be whistle-blowers if:
• the auditor believes disclosure is necessary to prevent “substantial injury” to the company or investors;
• the auditor believes the client is engaging in conduct that will impede an investigation of the misconduct; or
• 120 days has passed since the auditor reported the information to his or her supervisor or to the entity's audit committee, chief legal officer, or chief compliance officer.
“Moreover, accounting firm personnel are allowed to report that their own firms violated professional standards or securities laws.” Woodcock said.
Woodcock declined to comment on ongoing investigations, other than to say that there currently are investigations into matters uncovered by the task force. He also pointed out that financial reporting cases take a long time to investigate. “So you might not see some of our cases filed for a while.”
However, the task force will have only limited involvement once a case is filed, Woodcock said. “Our principal job is to find the cases and make referrals to enforcement teams who will then handle the investigation and litigation. In some cases,” he added, “we will ‘incubate’ a matter before referring it out to an investigative team, but this just means taking some preliminary investigative steps such as requesting documents, reviewing document productions, and conducting interviews. Our role is not to work all the investigations.”
Best Weapons
Clearly, however, no company welcomes an inquiry from SEC enforcers, and Woodcock had some advice for issuers hoping to avoid one.
“The best weapons against financial reporting fraud are a robust compliance program, an appropriately skeptical auditor, and a diligent audit committee. A diligent audit committee and auditor oversight are really essential,” Woodcock said, “particularly in the areas of judgment that may make financial statements and disclosures vulnerable to fraud.”
“Having good internal controls and compliance is probably the most important thing you can do to prevent an SEC inquiry into your financial reporting.”
As to what constitutes good internal controls, “I can't sit here and say that for good internal controls, you need to do X, Y and Z,” Woodcock stated. “It's a very company by company question” that depends on the nature of the
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business—how it sells its products, whether there are incentives surrounding sales commissions that might make them more or less likely to distort revenues, among other matters.
The answer also depends on the nature of a company's work force—“are there employees doing business in places where foreign bribery is a risk or are you selling products in a manner that makes it easier for sales staff to create fictitious revenues? It's really very contingent on the type of business that your company is operating and your internal controls need to be tailored to that,” Woodcock said.
However, he emphasized, at a higher level, “it comes down from the top in every way.” Do the company's top officials take good compliance seriously? Are they ethical? Do they demand ethical behavior in their employees? What kind of resources are devoted to the internal audit and compliance functions? Does the compliance officer, if there is one, have real access to the board or senior management?
“Those are the sorts of things that I think demonstrate good controls and good compliance. It's something we look at in every case. It helps us from the very beginning assess what kind of company or what kind of people we're dealing with in the investigation.”
Finally, Woodcock told Bloomberg BNA that in addition to other commission offices and divisions, the task force also has relationships outside the SEC. For example, he said, the task force is working very closely with the PCAOB on auditor-related issues, and communicates with foreign regulators as well.
“We're pretty much interested in talking with anyone or any regulator interested in improving the state of financial reporting and auditor conduct,” Woodcock concluded.
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
Biography.
David Woodcock is chair of the SEC Enforcement Division's Financial Reporting and Audit Task Force and director of the agency's Fort Worth Regional Office. Previously a partner at Vinson & Elkins LLP, Woodcock also practiced public accounting for several years at Price Waterhouse LLP and Ernst & Young LLP. He graduated from Louisiana State University and the University of Texas School of Law. After law school, Woodcock clerked for Judge Howell Cobb on the U.S. District Court for the Eastern District of Texas.
International News Short Sales: EU High Court Dismisses U.K. Efforts To Block New EU Short-Selling Ban By Joe Kirwin
Jan. 22 — The U.K. failed to curtail the powers of the European Securities and Market Authority (ESMA) to impose a short-selling ban in times of market turbulence, after the European Court of Justice said that ESMA has the right to impose decisions on national regulators involving cross-border issues.
The European Union high court judgment (C-270/12) said Jan. 22 that ESMA may take emergency steps such as imposing a temporary ban on short-selling, if the measure addresses a threat to financial markets or the stability of the EU's financial system and there are cross- border implications. The rejection of the challenge by the U.K. was a major vote of confidence for the ESMA, which was formed in 2011 as part of the EU response to the 2008 banking and financial market crisis.
“All ESMA measures are subject to the condition that no competent national authority has taken measures to address the threat or one or more of those authorities have taken measures that have proven not to address the threat adequately,” the ECJ said in its decision. “The ESMA is required to take into account the extent to which such measures address the threat to the financial markets or significantly improve the ability of the competent national authorities to monitor the threat.”
The U.K. contended unsuccessfully that ESMA was exercising powers beyond its 2011 legal mandate. The ECJ rejected the U.K. legal challenge “in its entirety.” The ruling also rejected the opinion of the ECJ's top legal
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adviser, which sided with the U.K. in an opinion issued in September 2013. The ECJ high court concurs with the EU Advocate General in approximately 80 percent of all cases.
The U.K. Treasury issued a statement saying it was disappointed with the ruling and it would “consider the judgment in detail and respond, in full, at a later date.
U.K. Debates EU Membership
“We are disappointed that the ECJ has chosen not to uphold the U.K.’s challenge on this case and, in doing so, has rejected the opinion of its own advocate general,” the U.K. Treasury statement said. “We have consistently said we want tough financial regulation that works but any powers conferred on EU agencies must be consistent with the EU treaties and ensure legal certainty.”
The ECJ ruling comes while the U.K. is in the midst of an intense political debate about its EU membership. With Prime Minister's David Cameron's Conservative Party facing pressure to withdraw from the EU, the decision is expected to be highlighted by rising political parties, such as the U.K. Independence Party, as another example of EU institutions encroaching on U.K. national sovereignty.
Raoul Ruparel, an official with the Brussels-based think tank Open Europe, said the ruling was especially worrying for the U.K. because it meant ESMA could take decisions for the euro zone that would have a negative impact for non-euro zone countries such as the U.K.
“Not only does it potentially set a worrying precedent that powers can be transferred to EU institutions by circumventing national vetoes,” Ruparel said. “It also highlights how single market rules in the EU treaties can be interpreted extremely widely—both of which could be exploited by the euro zone to the detriment of non-euro zone members such as the U.K.”
To contact the reporter on this story: Joe Kirwin in Brussels at [email protected]
To contact the editor responsible for this story: Heather Rothman at [email protected]
For More Information
A copy of the ECJ ruling can be found by logging onto the ECJ web site at http://curia.europa.eu and click on the search form and submit the case number (C-270/12).
State News Arbitration: Del. Court Seeks Review of Ruling Closed-Door Arbitration Law Unconstitutional
BNA Snapshot
Cert Petition: Delaware Chancery Court asks the U.S. Supreme Court to review a federal appeals court decision that a state law permitting companies to resolve disputes through closed-door arbitrations presided over by a sitting judge is inconsistent with the First Amendment.
Takeaway: The dispute could have significant implications for Delaware as a leading domicile for U.S. and global business entities,
By Phyllis Diamond
Jan. 22 — In a case that could affect Delaware's status as the jurisdiction of choice for many major corporations, the Delaware Chancery Court Jan. 21 petitioned the U.S. Supreme Court to review a federal appeals court's decision invalidating as unconstitutional astate law permitting companies to resolve disputes through closed-door arbitrations presided over by a sitting judge ( Strine v. Del. Coal. for Open Gov't Inc., U.S., No. __, 1/21/14).
In the ruling below, a divided U.S. Court of Appeals for the Third Circuit cited the “tradition of accessibility to proceedings like Delaware's government-sponsored arbitration” (45 SRLR 2002, 10/28/13)
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“[B]ecause access plays an important role in such proceedings, we find that there is a First Amendment right of access to Delaware's government-sponsored arbitrations,” the majority held, affirming the district court's decision (44 SRLR 1729, 9/17/12).
1st Amendment Challenge
In 2011, the Delaware Coalition for Open Government Inc., a nonprofit organization, sued the Chancery Court, its judges, and the state of Delaware, contending that 10 Del. C. §349, which allowed businesses to contract to resolve their disputes through confidential arbitrations, violated the First Amendment right of access to judicial proceedings.
After the law was enacted, the chancery court adopted rules closing the arbitrations and the records of the proceedings to the public. In its complaint, the coalition called the arbitrations “secret” judicial proceedings, pointing to similarities between the arbitrations and ordinary judicial proceedings—including the use of a sitting judge as the arbitrator.
The district court agreed, concluding that the “Delaware proceeding, although bearing the label arbitration, is essentially a civil trial.” In particular, it cited the fact that sitting Chancery Court judges preside over the proceedings.
The Third Circuit affirmed, over the dissent of one judge who said the system “was created to provide arbitration in Delaware to companies that consented to arbitration—and that would go elsewhere if Delaware did not offer arbitration before experienced arbitrators in a confidential setting.”
Conflicting Standard
In their certiorari petition, the state defendants said the First Amendment standard applied by the Third Circuit majority “conflicts with the approach utilized by other courts of appeal and state supreme courts and cannot be reconciled with this Court's decisions.” They urged that high court review “is plainly warranted.”
In a statement, Andrew J. Pincus, Mayer Brown LLP, Washington, counsel to the defendants, said the challenged statute “provides an efficient, cost-effective, and prompt means of resolving business disputes, and an additional reason for global firms to domicile in the United States.”
“Because of the importance of this issue, and the job-creating potential for Delaware and the nation of finding innovative solutions to temper the growing costs and delays of resolving business disputes, a definitive answer is being sought from the Supreme Court concerning the constitutionality of the Delaware statute,” Pincus wrote.
Counsel to the plaintiff did not respond immediately to a request for comment.
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
Jurisdiction and Procedure: Court Tosses Nevada Suit Against FINRA in Wake of Stock Scheme
BNA Snapshot
Bancorp Int'l Grp. v. Fin. Indus. Regulatory Auth. , 2014 BL 6710, D. Nev., No. 3:13-cv-00170-RCJ-WGC, 1/10/14
Key Holding: The court dismisses a Nevada action against the Financial Industry Regulatory Authority and others in the wake of the alleged release on the market of over 245 million shares of counterfeit Bancorp International Group Inc. stock certificates.
Key Takeaway: The court says that FINRA is correct that even if it were not covered by absolute immunity there is no private cause of action to compel or prevent actions by FINRA related to its regulatory authority. All claims here stem from FINRA's performance of its self-regulatory duties, the court finds.
Jan. 16 — The U.S. District Court for the District of Nevada Jan. 10 dismissed a
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Nevada action against the Financial Industry Regulatory Authority and others over their actions in the wake of the alleged release of over 245 million shares of counterfeit Bancorp International Group Inc. stock certificates ( Bancorp Int'l Grp. v. Fin. Indus. Regulatory Auth. , 2014 BL 6710, D. Nev., No. 3:13-cv-00170-RCJ- WGC, 1/10/14).
Even if FINRA were not covered by absolute immunity, Judge Robert Jones said, there is no private cause of action to compel or prevent actions by FINRA related to its regulatory authority. All claims here stem from FINRA's performance of its self-regulatory duties, the court said.
‘Unexplained' Increase
The court said that between May and August 2005, “some person or persons” allegedly issued 245 million shares of counterfeit Bancorp stock certificates. The introduction of these false shares, the court said, coincided with an unexplained increase in trading volume of over 2 billion shares—424 times the total of apparent shares and 1,892 times the total of legitimate shares.
As a result, defendant Depository Trust and Clearing Corp. (DTCC) suspended clearing services for Bancorp on Aug. 11, 2005. The Securities and Exchange Commission announced a temporary halt of trading on Bancorp's stock on Aug. 31, 2005 to last until Sept. 15, 2005.
In a separate case, U.S. District Court for the District of Oklahoma ordered that Bancorp issue 245 million shares to replace the counterfeit shares and that various parties would compensate Bancorp with cash damages, as part of a settlement agreement.
Bancorp was required to amend its articles of incorporation with the Nevada Secretary of State in order to comply, which it did.
Alleged Clerical Errors
However, the court said, FINRA allegedly failed to announce to DTCC and its members the change to the Committee on Uniform Securities Identification Procedures, or CUSIP numbers of Bancorp's stock, resulting in a failure of brokers nationwide to change the CUSIP numbers. Bancorp's stock began trading publicly again on Nov. 7, 2006, the court said, but the SEC halted trading after thirty minutes due to “clerical errors” in the CUSIP numbers. After four days, the SEC delisted Bancorp's stock from the OTC Bulletin Board market, the court said. The court also said that the plaintiffs claim that FINRA “failed and continues to fail” to untangle the CUSIP dispute.
Bancorp and one of its shareholders sued FINRA, DTCC, Depository Trust Co., National Securities Clearing Corp., and Fixed Income Clearing Corp. asserting several cause of action.
Absolute Immunity
The court dismissed the claims, first ruling that FINRA is absolutely immune from money damages for acts or omissions related to its regulatory function. Second, the court said, FINRA “is correct that, even if not covered by absolute immunity there is no private cause of action to compel or prevent actions by FINRA related to its regulatory authority.” All claims here arise out of FINRA's performance of its self-regulatory duties, the court said.
Finally, the court said that all of the defendants seek dismissal on Nevada limitations grounds. The court granted the dismissal on this basis as well. The facts giving rise to the running of these statutes of limitations appear on the face of the complaint, “obviating any need for Defendants to separately prove the statutes have run,” the court said.
On a final point, the court said that the Oklahoma federal district court “presumably retains jurisdiction to enforce its previous order.” The court said that this is the route for the plaintiffs to seek a remedy for any ongoing harm stemming arising out of failure to comply with that order.
For More Information
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 62 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
To see the opinion, go to http://www.bloomberglaw.com/public/document/Bancorp_Intl_Grp_Inc_v_Fin_Indus_R egulatory_Auth_No_313cv00170RCJ.
State News Briefs N.Y. Court Vacates $11M Award Against Citi Jan. 17 — The New York Supreme Court Jan. 2 vacated an $11 million Financial Industry Regulatory Authority arbitration award against Citigroup Global Markets Inc. and a Citi employee ( Citigroup Global Markets Inc. v. Fiorilla, N.Y. Sup.Ct., Index No. 653017/2013, 1/2/14).
In 2010, the investor complained of various tort law and regulatory violations related to his holdings of Royal Bank of Scotland stock. In July 2013, the arbitrators awarded the investor $11 million.
In this case, Judge Charles Ramos explained that Citi moved to vacate the award, claiming two of the arbitrators failed to disclose certain material information. Citi also contended that the arbitrators entered their award in a dispute the parties already had settled.
“In light of the fact that this matter was in fact settled,” the court wrote, “there is no need to delve into the troubling allegations of misconduct by the arbitrators. This award must be vacated.”
In so deciding, the court rejected the investor's argument that public policy favors deferring to arbitration awards. “There can be no legitimate public interest in respecting arbitrations of disputes that have already been settled,” the court wrote.
It said the investor's refusal to abide by the settlement “has resulted in a frivolous waste of counsel's time and efforts, as well as a waste of the scare resources available to New York's United Court System.”
For More Information
To see the award, go to http://finraawardsonline.finra.org/viewdocument.aspx?DocNB=61478 (award). To see the court's order, go to https://iapps.courts.state.ny.us/fbem/DocumentDisplayServlet?documentI d=ORfyhUShCiWTNUl93TnwGg==&system=prod.
DBSI Files Cert Petition Over Minn. Jurisdiction Jan. 22 — Deutsche Bank Securities Inc. Jan. 13 asked the U.S. Supreme Court to review a Minnesota appeals court's conclusion that it is subject to the personal jurisdiction of the Minnesota courts in a dispute over the sale of certain asset-backed securities ( Deutsche Bank Securities Inc. v. MoneyGram Payment Systems Inc., U.S., No. 13-851, 1/13/14).
In its certiorari petition, DBSI said the court's decision is inconsistent with due process, “and in practice impermissibly exposes every foreign person who enters into a sale with a Minnesota resident to suit in that state.”
DBSI recounted that it was sued in Minnesota state court by MoneyGram Inc., “an ultra-sophisticated institutional investor” formerly based in Minnesota. MoneyGram contended that the bank made material misrepresentations in selling it certain ABS, the value of which declined in the financial crisis.
Thereafter, DBSI recapped, the trial court dismissed the suit for lack of personal jurisdiction, concluding that MoneyGram failed to allege “‘any contacts between DBSI and Minnesota.’” However, DBSI continued, a Minnesota appeals court reversed and the state supreme court declined to review the controversy.
“Nowhere does the Complaint allege any contact between DBSI and Minnesota,” the bank wrote in seeking high court review. “At most,” it wrote, “the Complaint conclusorily alleges that DBSI sold securities to MoneyGram while the latter was a Minnesota resident.” However, “the specifics of how and where those sales were initiated, negotiated and executed are wholly absent.”
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DBSI was represented by Pamela Rogers Chepiga, Andrew Rhys Davies, and Laura R. Hall, Allen & Overy LLP, New York.
SIFMA Seeks Maine Exemption on Social Media Jan. 17 — The Securities Industry and Financial Markets Association Jan. 13 asked Maine legislators to consider a “narrow exemption” to a bill, LD 1194, that would bar employers from requiring employees to provide access to their social media accounts.
In a comment letter, SIFMA said that if enacted, the measure—“while well- intentioned”—would conflict with broker-dealers' obligations with respect to business-related communications.
SIFMA explained that the Financial Industry Regulatory Authority requires securities firms to supervise, record, and maintain employees' business communications—including those on social media sites. It said that while, the industry has no interest in accessing employees' personal accounts, “many people use the same account for both personal and business activity.”
A personal account that also is used for business purposes must be treated as a business account, SIFMA noted. As such, it asked lawmakers “to consider a narrow exemption to LD 1194 so that securities firms can continue to comply with state requirements and FINRA regulations.”
In June 2013, FINRA sent targeted examination letters asking broker-dealer members about their social media use (45 SRLR 1167, 6/24/13). Among other specifics, it asked for information about the firms' written supervisory procedures regarding social media communications, and the measures taken to monitor compliance.
For More Information
To see SIFMA' letter, go to http://www.sifma.org/issues/item.aspx?id=8589947018
Futures Regulation CFTC Enforcement: Corzine Loses Bid for Dismissal Of CFTC's MF Global Lawsuit By Christie Smythe and Patricia Hurtado
Jan. 21 — Former MF Global Inc. chief executive officer Jon Corzine Jan. 17 lost his bid for dismissal of the U.S. Commodity Futures Trade Commission's lawsuit over the 2011 collapse of MF Global Holdings Ltd. ( Dean gelis v. Corzine,S.D.N.Y., 1:11-cv-07866, 1/17/14).
The requests of Corzine and former MF Global Assistant Treasurer Edith O'Brien to throw out the case are “without merit,” U.S. District Judge Victor Marrero ruled.
The agency alleged in its complaint that the executives violated the Commodity Exchange Act by illegally transferring funds from customer accounts (45 SRLR 1232, 7/1/13).
The court said it was too soon in the case to rule on whether the CFTC can prove its claims. “At this state of the proceedings, the court must accept the pleadings as true, and draw any reasonable inferences and resolve any ambiguities in favor of the opponent of a motion to dismiss,” the court wrote.
MF Global, once touted by its senior officers and directors as having strong internal controls and liquidity levels, collapsed and filed for Chapter 11 bankruptcy protection in October 2011 after making bad bets on European sovereign debt and getting margin calls.
In November the company's brokerage unit was fined $100 million and forced to admit to allegations in a lawsuit by the CFTC over customer losses sustained in its failure.
To contact the reporters on this story: Patricia Hurtado at [email protected]; Christie Smythe at csmyt [email protected]
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 64 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 4
To contact the editor responsible for this story: Michael Hytha at [email protected]
© 2014 Bloomberg L.P. All rights reserved. Used with permission.
Derivatives: CFTC Forms Interdivisional Group to Study, Make Recommendations on Swaps Reporting By Richard Hill
Jan. 21 — The Commodity Futures Trading Commission said Jan. 21 that it has created an interdivisional staff group to review swaps data recordkeeping and reporting requirements and to make recommendations on how the rules and processes can be improved.
The working group, headed by Vince McGonagle, director of the Division of Market Oversight, will seek comment on several questions about the swaps reporting rules and “consistency” in reporting among market participants. The questions will be released to the public by March 15, and the group has been asked to make recommendations to the commission in June.
The commission asked the group to identify and make recommendations to: resolve reporting challenges, if any exist; review industry compliance; consider standardizing data fields in reporting; recommend additional reporting guidance or requirements; and explore whether the CFTC needs regulatory and technology improvements and more data analysis expertise.
Real-time data reporting of swaps transactions began in December 2012. Regulators, however, including Commissioner Scott O'Malia and former Chairman Gary Gensler, have noted flaws in the process.
Collection and Analysis
In October, Gensler said that while the agency is now receiving detailed information on swaps trades, more work needs to be done to maximize the collection and analysis process (45 SRLR 2089, 11/11/13). Specifically, he said the CFTC has insufficient staff to comb through the data, and that there is no standard format for swap dealers to submit the information. O'Malia, meanwhile, has said the CFTC needs to improve the quality of the data it receives and its ability to utilize it (45 SRLR 2262, 12/9/13).
CFTC Acting Chairman Mark Wetjen said Jan. 21 that for the CFTC to enforce new swaps rules under Dodd- Frank, “the agency must have accurate data and a clear picture of activity in the marketplace. We've seen an incredible shift to a transparent, regulated swaps marketplace, and this is an appropriate review to ensure the data we are receiving is of the best possible quality so the commission can effectively oversee the marketplace.”
O'Malia said that through the efforts of the group, staff “will develop a better understanding of specific changes that can be made to enhance regulatory compliance and data harmonization and reduce misreporting of data that has undermined the Commission's ability to use its regulatory data.” He urged the group to “carefully evaluate internal solutions that will enhance the commission's data utilization.”
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The announcement can be seen at http://www.cftc.gov/PressRoom/PressReleases/pr6837-14.
Derivatives: CFTC Staff Makes First MAT Certifications; Swaps Will Begin Trading on Platforms 2/15 Jan. 16 — Staff of the Commodity Futures Trading Commission made the agency's first made-available-to-trade determination Jan. 16, certifying certain interest rate swaps contracts that were submitted by Javelin SEF LLC.
A contract subject to a MAT determination must be executed on either a swap
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execution facility or a designated contract market pursuant to the Commodity Exc hange Act‘s trade execution requirement. Executing a contract on a SEF is disfavored by some swap dealers who could lose pricing advantages they have when the swap is negotiated privately.
The swaps certified in this determination will become subject to the trade execution requirement on Feb. 15. The commission made more MAT certifications on Jan. 23, which will become effective Feb. 21 [see related rep ort in this issue].
Javelin revised its MAT submission in November in the wake of feedback its request received from commenters (45 SRLR 2261, 12/9/13; (45 SRLR 2261, 12/9/13).
Specifically, several groups said Javelin's original submission, made in October, was too broad because it lumped several contracts together, precluding a judgment on each of them individually.
SEFs seeking a MAT determination must consider whether a contract can meet six factors, mostly gauging a contract's liquidity.
Roundtable
Meanwhile, CFTC staff clarified in its announcement that the inclusion of a swap subject to the trade execution requirement in a multi-legged transaction—i.e., a “package transaction”—would not “per se” relieve market participants of the obligation to trade such swap through a DCM or SEF.
The CFTC also announced that staff of the Division of Market Oversight, at the direction of Acting Chairman Mark Wetjen, will hold a roundtable on execution issues related to package transactions. “Based on public input, ” it said, “the division will consider whether and under what conditions to grant limited relief for package transactions to ensure proper implementation of the execution mandate,” it said.
The agency did not announce a date for the roundtable session.
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The CFTC statement and the affected swaps can be seen at http://www.cftc.gov/PressRoom/PressReleases/pr 6831-14.
Derivatives: CFTC Makes New MAT Determinations, Putting Swap Contracts on SEFs, DCOs By Richard Hill
Jan. 23 — The Commodity Futures Trading Commission's Division of Market Oversight Jan. 23 certified several interest rate swap contracts that had been submitted for “made-available-to-trade" (MAT) determinations by trueEX LLC.
The certifications will require the contracts to be traded on open platforms—specifically, a swap execution facility, such as trueEX, or a designated contract market—available to any market participant.
They also will be subject to the Commodity Exchange Act‘s trade execution requirement, meaning they must be executed in accordance with CFTC regulations, which include reporting and other obligations.
By being traded on a SEF or DCM, the contracts no longer are eligible for bilateral or private negotiations or to trade in the dark, possibly taking away the advantage swap dealers had when end-users and other buy-side participants could not see what others were bidding for a contract.
MAT certifications were mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act as
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a way to help ensure transparency and competition in swaps trading.
SEF Test
One derivatives lawyer told Bloomberg BNA that MAT certifications will be a test for SEFs, which became operational in October 2013. “I don't think there really is all that much volume on SEFs right now, so when you have categories of transactions that suddenly have to go on SEFs, there's going to be a big adjustment, for swaps participants as well as for SEFs,” she said.
The CFTC announced its first MAT certifications on Jan. 16 [see related report in this issue]. Those contracts also will become subject to the trade execution requirement on Feb. 15.
Some of the trueEX swaps subject to MAT determinations were certified Jan. 16. The remaining swaps will be subject to such requirements Feb. 21.
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The announcement, and the contracts in question, can be seen at http://www.cftc.gov/PressRoom/PressReleas es/pr6838-14.
Futures Regulation: Carper Asks CFTC to Clarify Stance on Regulating Digital Currency By Carter Dougherty
Jan. 17 — Sen. Tom Carper (D-Del.) Jan. 17 called on the Commodity Futures Trading Commission to clarify if or how it would regulate the emerging virtual currency business.
“Given that we read about a new venture in the digital currency space nearly every day, it is important that our government agencies respond appropriately and in a timely manner with thoughtful policy and oversight,” Carper said in an e-mail.
“Those willing to take risks and play by the rules should have the opportunity to thrive without the fog of uncertainty.”
Carper, who heads the Homeland Security and Governmental Affairs Committee, initially became interested in Bitcoin, the most prominent virtual currency, after reports that it was used in illicit transactions even as it showed promise as a legitimate payment system.
In November, the committee held the first congressional hearing about the new technology .
Carper's staff is now writing a report about virtual currencies, which will be released by the spring, his spokeswoman, Jennie Westbrook, said in an e-mail.
Carper was responding to a letter from former CFTC chairman Gary Gensler who answered a four-month-old request from Carper and Sen. Tom Coburn (R-Okla.), ranking member of the homeland security panel, on how the CFTC would handle virtual currencies.
Gensler wrote back Dec. 27, a few days before he left the commission. “While the commission does not have policies and procedures that are specific to virtual currencies, the agency's regulatory authority extends to futures and swaps contracts in any commodity,” Gensler wrote.
Broad Powers
He said the law “broadly defines the term commodity,” but did not lay out any plan to regulate virtual currencies or approve products based on them. Gensler also took note of the agency's “broad enforcement powers” on commodities.
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Bitcoin was introduced in 2008 by a programmer or group of programmers under the name Satoshi Nakamoto, and is the most prominent virtual currency to date. It has no central issuing authority, and uses a public ledger to verify transactions. The currency can be used to pay for a range of products and services, including t-shirts, food or an appointment with a Manhattan psychiatrist.
To contact the reporter on this story: Carter Dougherty in Washington at [email protected]
To contact the editor responsible for this story: Maura Reynolds at [email protected]
© 2014 Bloomberg L.P. All rights reserved. Used with permission.
For More Information
Gensler's Dec. 27 letter to Carper can be seen at http://op.bna.com/srlr.nsf/r?Open=rhil-9ffq8f.
Futures Briefs CFTC Reopens Comments on Auto Trading Release Jan. 21 — The Commodity Futures Trading Commission announced Jan. 17 that it has reopened the comment period for its concept release on risk controls and system safeguards for automated trading.
The 60-day comment period for the September release originally ended Dec. 11 (45 SRLR 2346, 12/23/13). It now will run through Feb. 14.
The agency gave no reason for its action.
Among other matters, the concept release discusses pre-trade risk controls, post-trade reporting, system safeguards—including design, testing and supervision of automated trading systems—and other potential market protections. It also includes 124 questions on measures and safeguards discussed in the release.
Many see the concept release as the first step toward rules that would require computerized platforms to install risk controls and safeguards.
Accounting Auditing: SEC Judge Finds China-Based Auditors Violated SOX by Not Producing Work Papers
BNA Snapshot
In re BDO China Dahua CPA Co., SEC, Admin. Proc. File Nos. 3-14872, 3-15116, 1/22/14
Key Holding: China affiliates of five U.S. auditing firms violated SOX by failing to produce work papers in response to SEC demands.
Potential Impact: None in the short term, given that the firms are appealing the decision.
By Yin Wilczek
Jan. 23 — In a decision that could significantly impact China-based issuers and auditors, a Securities and Exchange Commission administrative law judge Jan. 22 found that the China-based affiliates of the five major U.S. auditing firms willfully violated the 2002 Sarbanes-Oxley Act by failing to produce work papers of clients under SEC investigation ( In re BDO China Dahua CPA Co., SEC, Admin. Proc. File Nos. 3-14872 & 3-15116, 1/22/14).
ALJ Cameron Elliot concluded that BDO China Dahua Co. Ltd., Deloitte Touche Tohmatsu Certified Public Accountants Ltd. (DTTC), Ernst & Young Hua Ming LLP, KPMG Huazhen (Special General Partnership), and PricewaterhouseCoopers Zhong Tian CPAs Ltd. should be sanctioned under SEC Rule of Practice 102(e).
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Pursuant to the rule, the SEC may bar persons from appearing or practicing before it if they have been found to have willfully violated or willfully aided the violation of the federal securities laws.
The ALJ censured and barred all of the respondents, except BDO China Dahua, from practicing before the commission for six months. Elliot censured BDO China Dahua.
Appeal to Commission
In a joint statement, DTTC, E&Y Hua Ming, KPMG Huazhen and PwC Zhong Tian said they will seek SEC review “without delay.”
“It is regrettable that the SEC's administrative law judge has recommended sanctions against the big four firms in China for failing to produce work papers to the SEC in circumstances where such production would have violated Chinese law and regulations,” they said. “However, the firms note that the decision is neither final nor legally effective unless and until reviewed and approved by the full US SEC Commission.”
The firms also said they believe “it is in the best interests of all parties” if the information sharing could occur at the national level between Chinese and U.S. regulators.
The SEC, for its part, said the ruling bolstered its enforcement program.
The decision “upholds the Commission's authority to obtain essential records from audit firms registered in the U.S. even when they are located overseas,” Matthew Solomon, the SEC Enforcement Division's chief litigation counsel, said in a statement. “These records are critical to our ability to investigate potential securities law violations and protect investors.”
Dodd-Frank Amendment
The Dodd-Frank Wall Street Reform and Consumer Protection Act amended SOX Section 106 to allow the SEC and the Public Company Accounting Oversight Board to seek audit work papers relevant to their investigations from foreign accounting firms registered with the PCAOB.
The SEC filed its action against the firms in December 2012 (44 SRLR 2260, 12/10/12). In response, the firms mounted spirited defenses asserting that they were prevented by Chinese law from producing the work papers.
During the proceedings, former SEC Commissioner Paul Atkins testified as an expert witness that imposing sanctions on the respondents would “cripple” the ability of Chinese issuers to list on U.S. markets.
Bad Faith Not Necessary
In his decision, Elliot sided with the Enforcement Division that “willful refusal” for purposes of a SOX Section 106 request does not require proof of bad faith or bad intent. “‘[W]illful refusal to comply’ means ‘choosing not to act after receiving notice that action was requested,’ without regard to good faith,” the ALJ said.
Elliot also found that while the respondents' flouting of the SEC's authority might not be “as egregious as, say, accounting fraud,” it still was “egregious enough that it weighs against leniency.”
The ALJ weighed the respondents' conduct in considering the sanctions, and said he had “little sympathy” for them on that score. While the auditing firms were “caught between a rock and a hard place,” he added that it was “because they wanted to be there.”
When the firms registered with the PCAOB, they knew they would be called upon to produce documents under SOX Section 106, Elliot said. “Each Respondent made the affirmative decision, no later than the time it filed its Sarbanes-Oxley 106 designation of agent, to conduct its auditing business ‘at risk.’”
The ALJ redacted large portions of the decision pertaining to the SEC's interactions with Chinese authorities over the work audit requests. “[S]ome passages of this initial Decision discuss the Commission, the [China Securities Regulatory Commission], and their interaction more candidly than is customary in diplomatic circles,” he wrote.
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Supports SEC Position
Jason Flemmons, a former deputy chief accountant in the Enforcement Division who now is a senior managing director at FTI Consulting Inc., told Bloomberg BNA that the decision “clearly supports the SEC's position that in order to participate in U.S. markets, you have to play by U.S. rules.”
Flemmons, who formerly co-chaired the division's Cross-Border Working Group, noted that in addition to Chinese issuers, the decision—if upheld—could impact scores of multinational U.S. companies that have major subsidiaries in China. U.S.-based auditing firms rely on their China affiliates to perform the audits of such subsidiaries, he said.
In the short term however, the status quo will be maintained—even for the respondents' clients—while commission review is underway, Flemmons added.
The six-month bar will not kick in until the commission issues its opinion, and assuming that the ALJ is upheld, he said. “This stage of appeal usually takes months, which means the firms will likely be able to complete calendar year-end audits for existing clients while the appeal process runs its course.”
Too Far?
Other observers disagreed on whether the ALJ went too far, or not enough, in his ruling.
“The decision imposes a draconian sanction, which is vulnerable on appeal,” suggested Bradley Bondi, a Washington-based partner at Cadwalader, Wickersham & Taft LLP, and former counsel to Commissioner Atkins.
However, H. David Kotz, the SEC's former Inspector General who now is a director at Berkeley Research Group, described the decision as “not unexpected,” adding that it did not go as far as the SEC Enforcement Division's request for a permanent bar.
“What was somewhat surprising was the language and tone of the decision, which was particularly harsh,” Kotz said. “The appeal process will be very significant in terms of finally resolving this matter.”
Meanwhile, U.S. public company auditors—while not a party to the action—are concerned about the case's impact on U.S. companies with operations in China, Cindy Fornelli, executive director of the Center for Audit Quality, told Bloomberg BNA.
CAQ is a nonprofit group that advocates for high-quality auditing standards.
Fornelli added that the industry will continue to focus on the quality of the audit work performed by the China firms to maintain global standards for audit quality. “We remain encouraged by progress made between the PCAOB and Chinese regulators and believe discussions such as these are the appropriate venue to address this issue,” she said.
District Court Proceedings
The ALJ's decision also could have ramifications for an ongoing SEC case based on similar facts against DTTC in federal district court.
Before it filed the administrative action, the SEC sued DTTC in an action before the U.S. District Court for the District of Columbia in September 2011 to enforce a subpoena in connection with the agency's investigation of DTTC's client Longtop Financial Technologies Ltd. (43 SRLR 1927, 9/19/11).
Elliot's ruling comes days before the parties are due to submit Jan. 27 a joint status report to inform the court of whether the SEC's subpoena was satisfied by documents produced by the CSRC (45 SRLR 1895, 10/14/13).
DTTC argued unsuccessfully that the court should stay its proceedings until resolution of the administrative action, which would provide a “profession-wide solution” to the quandary faced by DTTC and other PRC auditors, its attorneys said (45 SRLR 461, 3/11/13).
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DTTC's attorneys—Miles Ruthberg, Latham & Watkins LLP, New York; and Michael Warden, Sidley Austin LLP, Washington—did not respond to a request for comment.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Enforcement: KPMG to Pay $8.2M Over Independence Violations
BNA Snapshot
Settlement: KPMG to pay $8.2 million to settle SEC charges it ran afoul of auditor independence requirements.
Section 21(a) Report: SEC issues report of investigation on loans of audit firm staff to audit clients.
By Phyllis Diamond
Jan. 24 — As part of its renewed focus on accounting issues, the Securities and Exchange Commission Jan. 24 entered into a settlement with KPMG LLP, in which the audit firm will pay a total of $8.2 million in disgorgement plus prejudgment interest and civil penalties to resolve allegations it ran afoul of rules requiring auditors to be independent of the public companies they audit ( In re KPMG LLP, SEC, Admin. Proc. File No. 3-15687, 1/24/14).
Separately, the commission issued a Section 21(a) report of investigation into whether KPMG's independence was impaired by its practice of loaning staff to assist audit clients.
The SEC did not bring an enforcement action against KPMG over this practice. However, it noted that “by their very nature, so-called ‘loaned staff arrangements’ between auditors and audit clients appear inconsistent with Rule 2-01 of Regulation S-X, which prohibits auditors from acting as employees of their audit clients.”
1934 Securities Exchange Act Section 21(a) authorizes the commission to investigate federal securities law violations and to publish information about them. Section 21(a) reports have been used to convey SEC policy on a given topic. In a 2001 report on its investigation of Seaboard Corp., the agency offered guidance on the kind of cooperation needed to win lenient treatment in an investigation.
More recently, in a Section 21(a) report prompted by a Netflix Inc. (NFLX) executive's post on his personal Facebook page, the SEC said that companies may use social media to announce material information—provided investors are told which social media will be used to disseminate the information(45 SRLR 609, 4/8/13).
Prohibited Services
In the case of KPMG, the SEC said in a release that the firm violated auditor independence rules “by providing prohibited non-audit services such as bookkeeping and expert services to affiliates of companies whose books they were auditing. Some KPMG personnel also owned stock in companies or affiliates of companies that were KPMG audit clients, further violating auditor independence rules.”
Without admitting or denying misconduct, KPMG also agreed to comply with certain remedial undertakings.
For More Information
To see the SEC's order, go to http://www.sec.gov/litigation/admin/2014/34-71389.pdf. To see the Section 21(a) report, go to http://www.sec.gov/litigation/investreport/34-71390.pdf.
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: [email protected]
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Reg Watch Commodity Futures Trading Commission Risk Controls and System Safeguards for Automated Trading Notice of the Commodity Futures Trading Commission announces the reopening of the comment period for a Sept. 12, 2013, notice (78 FR 56542) regarding a concept release pertaining to risk controls and system safeguards for automated trading environments in order to examine existing industry practices, determine their efficacy and implementation to date and evaluate the need for additional measures. Comments now are due Feb. 14, 2014. Contact: Sebastian Schott; CFTC; (202-418-5641)
79 FR 4104
FR Publish Date: 01/24/2014
SEC Release No.:
FR Number: 2014-01372
Aggregation of Positions/Certain Agricultural Commodities Notice of the Commodity Futures Trading Commission announces a correction to a Jan. 14, 2014, notice (79 FR 2394) that extended the comment period for a Nov. 15, 2013, proposed rule change (78 FR 68945) to amend regulations under 17 CFR 150.1, 150.3 and 150.4. The correction revises the subject heading to read “Aggregation of Positions.” Contact: Stephen Sherrod; CFTC, Division of Market Oversight; (202-418-5452)
79 FR 3547
FR Publish Date: 01/22/2014
SEC Release No.:
FR Number: C1-2014-00496
Securities and Exchange Commission NASDAQ OMX Group Charter and By-Laws Notice of the Securities and Exchange Commission approves five Dec. 12, 2013, proposed rule changes by the Boston Stock Exchange Clearing Corp., NASDAQ OMX BX, NASDAQ Stock Market, NASDAQ OMX PHLX and the Stock Clearing Corp. of Philadelphia to amend the charter and by-laws of their parent corporation, the NASDAQ OMX Group. The rule revises the charter to address the removal and replacement of supermajority voting requirements; the removal of directors; the adoption, alteration, amendment and repeal of by-laws; and the adoption, alteration, amendment and repeal of certain charter provisions. The rule also eliminates the Certificate of Designation, Preferences and Rights of Series A Convertible Preferred Stock. In addition, the rule makes nonsubstantive revisions to the by-laws to address special and annual meetings of stockholders, board vacancies, the use of e-mail for certain notices and waivers, the composition of the Management Compensation Committee, and changes to by- laws. The rule is effective Jan. 17, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4209
FR Publish Date: 01/24/2014
SEC Release No.: 34-71353
FR Number: 2014-01406
FINRA/Alternative Trading Systems Notice of the Securities and Exchange Commission announces the filing of Amendment No. 1 and an order granting accelerated approval of a Oct. 22, 2013, proposed rule change by FINRA to amend Rules
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6160, 6170, 6480 and 6720 and adopt Rule 4552 regarding alternative trading systems (ATS). The rule requires each ATS to report to FINRA weekly volume information and number of trades regarding securities transactions within the ATS. The rule also requires each ATS to acquire and use a single, unique market participant identifier when reporting information to FINRA. The rule is effective Jan. 17, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4213
FR Publish Date: 01/24/2014
SEC Release No.: 34-71341
FR Number: 2014-01395
CBOE/Quote Risk Monitor Mechanism Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by the Chicago Board Options Exchange to amend Rule 8.18 regarding the quote risk monitor (QRM) mechanism. The rule adds three new functions to QRM to control the risk of multiple, nearly simultaneous executions across related option series. The rule also clarifies that trading permit holder organizations with which a hybrid market-maker is associated may establish parameters by which the exchange will activate the QRM. The rule is effective Jan. 15, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4188
FR Publish Date: 01/24/2014
SEC Release No.: 34-71347
FR Number: 2014-01401
FINRA/Nasdaq Trade Reporting Facility Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by FINRA to adopt Rule 7640A regarding data products offered by Nasdaq. The rule describes FINRA's practices relating to the distribution of market data for over-the-counter transactions in national market system stocks generated through the operation of the FINRA/Nasdaq trade reporting facility (TRF) by the NASDAQ OMX Group and its affiliate, the NASDAQ Stock Market. The rule also identifies Nasdaq rules relating to products that distribute FINRA/Nasdaq TRF data to third parties, and specifically Nasdaq Rules 7039, 7047 and 7037 regarding Nasdaq Last Sale data feeds, Nasdaq Basic, and the Nasdaq FilterView service. The rule is effective Jan. 9, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4218
FR Publish Date: 01/24/2014
SEC Release No.: 34-71350
FR Number: 2014-01403
NYSE/New Market Model Pilot Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by the New York Stock Exchange to extend the operation of the New Market Model Pilot until the earlier of commission approval to make the program permanent or July 31, 2014. The rule is effective Jan. 6, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4221
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FR Publish Date: 01/24/2014
SEC Release No.: 34-71345
FR Number: 2014-01399
NYSEMKT/New Market Model Pilot Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by NYSE MKT to extend the operation of the New Market Model Pilot until the earlier of commission approval to make the program permanent or July 31, 2014. The rule is effective Jan. 6, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4197
FR Publish Date: 01/24/2014
SEC Release No.: 34-71342
FR Number: 2014-01396
NASDAQ/NASDAQ Last Sale Fee Pilot Program Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by the NASDAQ Stock Market to make permanent the pilot program used by NASDAQ to distribute the NASDAQ Last Sale (NLS) market data products to distributors for a capped fee. The rule is effective Jan. 9, 2014. Comments are due Feb. 14, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 4200
FR Publish Date: 01/24/2014
SEC Release No.: 34-71351
FR Number: 2014-01404
Unregistered Public Offering Disclosure Proposed rule of the Securities and Exchange Commission amends regulations under 17 CFR 230, 232, 239, 240 and 260 to establish a new exemption from registration under the Securities Act for small offerings, pursuant to Section 401 of the JOBS Act. The rule creates two tiers of exempt securities for offerings up to $5 million and for offerings up to $50 million, within a 12-month period. The rule also clarifies issuer eligibility, disclosure and reporting requirements for each tier. Comments are due March 24, 2014. Contact: Zachary Fallon; SEC; (202-551-3460)
79 FR 3925
FR Publish Date: 01/23/2014
SEC Release No.: 33-9497, 34-71120, 39-2493
FR Number: 2013-30508
MSRB/Trade Disclosures, Suitability and SMMPs Notice of the Securities and Exchange Commission announces an order instituting proceedings under Section (b)(2)(B) of the Securities Exchange Act to determine whether to disapprove an Oct. 22, 2013, proposed rule change (78 FR 62867) by the Municipal Securities Rulemaking Board to amend Rule G-19 and adopt Rules D-15, G-47 and G-48 to remove an interpretive guidance related to time of trade
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disclosures, suitability and sophisticated municipal market professionals (SMMPs). The rule adds a new time of trade disclosure rule, a revised suitability rule, and two new SMMP rules. The rule also harmonizes the board's suitability rule with FINRA's suitability rule. Comments are due Feb. 13, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 3909
FR Publish Date: 01/23/2014
SEC Release No.: 34-71326
FR Number: 2014-01248
NYSE ARCA/Order Types and Modifiers Notice of the Securities and Exchange Commission announces the filing of Amendment No. 1 and an order granting accelerated approval of a Oct. 22, 2013, proposed rule change (78 FR 62745) by the NYSE Arca to amend Rules 7.31, 7.32, 7.37 and 7.38 regarding order types and modifiers. The rule comprehensively updates order functionality to assure that various order types accurately describe the functionality associated with those order types and to clarify how different order types may interact. The rule is effective Jan. 16, 2014. Comments are due Feb. 13, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 3907
FR Publish Date: 01/23/2014
SEC Release No.: 34-71331
FR Number: 2014-01252
NYSE/Midpoint Passive Liquidity Order Notice of the Securities and Exchange Commission announces the approval of a Dec. 4, 2014, proposed rule change (78 FR 72968) by the New York Stock Exchange to amend Rules 13, 70.25, 107C and 1000 to adopt the Midpoint Passive Liquidity Order. The rule establishes a new order type defined as an undisplayed limit order that would automatically execute at the mid-point of the protected best bid and the protective best offer, collectively the protected best bid and offer (PBBO). The rule provides for interaction with the capital commitment schedule interest, permits d-Quotes to be designated with a midpoint modifier in order to set the discretionary price to the midpoint of the PBBO, and incorporates the new order into the retail liquidity program. The rule is effective Jan. 16, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 3895
FR Publish Date: 01/23/2014
SEC Release No.: 34-71330
FR Number: 2014-01251
NYSE MKT/Midpoint Passive Liquidity Order Notice of the Securities and Exchange Commission approves a Dec. 4, 2013, proposed rule change (78 FR 72965) by the NYSE MKT to amend Rules 13, 70.25, 107C and 1000 to adopt the Midpoint Passive Liquidity Order. The rule establishes a new order type defined as an undisplayed limit order that would automatically execute at the mid-point of the protected best bid and the protective best offer, collectively the protected best bid and offer (PBBO). The rule provides for interaction with the capital commitment schedule interest, permits d-Quotes to be designated with a midpoint modifier in order to set the discretionary price to the midpoint of the PBBO, and incorporates the new order into the retail liquidity program. The rule is effective Jan. 16, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
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79 FR 3904
FR Publish Date: 01/23/2014
SEC Release No.: 34-71329
FR Number: 2014-01250
Activities by Distribution Participants Notice of the Securities and Exchange Commission announces the submittal of a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Rule 101 of Regulation M (17 CFR 242.101) that prohibits distribution participants from purchasing activities at specified times during a distribution of securities. Comments are due Feb. 20, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3427
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00987
Activities by Issuers and Selling Security Holders Notice of the Securities and Exchange Commission announces the submittal of a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Rule 102 of Regulation M (17 CFR 242.102) that prohibits distribution participants, issuers and selling security holders from purchasing activities at specified times during a distribution of securities. Comments are due Feb. 20, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3426
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00988
NASDAQ Passive Market-Making Notice of the Securities and Exchange Commission announces the submittal of a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Rule 103 of Regulation M (17 CFR 242.103) that permits passive market-making in NASDAQ securities during a distribution. Comments are due Feb. 20 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3427
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00989
Stabilizing By a Distribution Participant Notice of the Securities and Exchange Commission announces the submittal of a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Rule 104 of Regulation M (17 CFR 242.104) that permits stabilizing by a distribution participant during a distribution
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as long as the distribution participant discloses information to the market and investors. Comments are due Feb. 20, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3426
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00990
Registration of Securities by Foreign Issuers Notice announces the intention of the Securities and Exchange Commission to submit a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Form F-4 (17 CFR 239.34) that is used by foreign issuers to register securities in business combinations, reorganizations and exchange offers pursuant to the Securities Act of 1933. Comments are due Mar. 24, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3425
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00991
Foreign Private Issuer Notice announces the intention of the Securities and Exchange Commission to submit a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Form 6-K (17 CFR 249.306) that is used for disclosure by foreign private issuers to report material information. The form addresses occurrences of specified or other important corporate events that are disclosed in the foreign private issuer's home country. Comments are due March 24, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3425
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00992
Tender Offers Notice announces the intention of the Securities and Exchange Commission to submit a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Schedule 14D-9 (17 CFR 240.14d-101) that is used by security holders in deciding how to respond to tender offers pursuant to Regulation 14D (17 CFR 240.14d-1 through 240.14d-11) and Regulation 14E (1 7 CFR 240.14e-1 through 240.14e-8). Comments are due March 24, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3424
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00994
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Securities Registration in Business Combination Transactions Notice announces the intention of the Securities and Exchange Commission to submit a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Form S-4 (17 CFR 239.25) that is used for registration of securities issued in business combination transactions. Comments are due March 24, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3424
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00993
Tender Offers Notice announces the intention of the Securities and Exchange Commission to submit a continuing information collection request to the OMB, as required by the Paperwork Reduction Act, regarding Schedule TO (17 CFR 240.14d-100) that is used by a reporting company that makes a tender offer for its own securities and persons other than the reporting company making a tender offer for equity securities registered under Section 12 of the Exchange Act. Comments are due March 24, 2014. Contact: Thomas Bayer; SEC; (202-551-8800)
79 FR 3424
FR Publish Date: 01/21/2014
SEC Release No.:
FR Number: 2014-00995
CBOE/Fees Schedule Notice of the Securities and Exchange Commission announces the filing and immediate effectiveness of a proposed rule change by the Chicago Board Options Exchange to amend the fees schedule. The rule makes several changes to the fee schedule relating to clearing trading permit holders (TPHs), customer fees, options transactions, market makers, the liquidity provider sliding scale, the proprietary products sliding scale, the VIX (Volatility Index) options sliding scale, PULSe workstations and routing fees. The rule also revises footnotes 10, 11, 25 and 26. the rule is effective Dec. 31, 2013. Comments are due Feb. 11, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 3443
FR Publish Date: 01/21/2014
SEC Release No.: 34-71295
FR Number: 2014-00984
NYSE Arca/Order Types Notice of the Securities and Exchange Commission announces the filing of a proposed rule change by NYSE Arca to amend Rule 6.62 concerning the applicability and functionality of certain order types. The rule clarifies definitions of various types of orders, including market, inside limit, stop and stop limit, stock contingency, tracking, one-cancels-the-other, single stock future/option, now, opening only, and liquidity adding. The rule Comments are due Feb. 11, 2014. Contact: Elizabeth Murphy; SEC; (202-551-5400)
79 FR 3429
FR Publish Date: 01/21/2014
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SEC Release No.: 34-71293
FR Number: 2014-00982
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Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
Printed By: CSUSSMAN on Friday, February 28, 2014 - 4:51 PM
Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
Securities Regulation & Law Report™ 46 SRLR Issue No. 7 - February 17, 2014
Expand All | Collapse All Highlights and Contents Highlights for this Issue HIGHLIGHTS House Passes Bipartisan Bill Upping Tick Sizes for Small-Cap Companies A bill to create a pilot program allowing small-cap companies to increase the tick sizes at which their stocks trade clears the House with bipartisan support. More »
Nonprofit Group Challenges $13B DOJ, JPMorgan Deal A public-interest nonprofit organization sues the Justice Department in the U.S. District Court for the District of Columbia over its recent $13 billion settlement with JPMorgan Chase & Co. over mortgage- related issues. The group alleges constitutional and other violations. More »
SPECIAL REPORT: Three-Member CFTC Pressing Forward Commodity Futures Trading Commissioner Scott O'Malia says his agency is pushing ahead with a number of key initiatives, despite the absence of two members and the imminent departure of a third. In an interview, he says the commission is “open for business and we're doing our jobs.” More »
Partially Divided 3d Cir. Affirms Order Against Plastics Exec A partially divided U.S. Court of Appeals for the Third Circuit concludes that a plastics industry executive and a trust he controlled properly were denied judgment on charges they failed to disclose their ownership interest in a company later acquired by Best Buy Inc. More »
SEC Appeals Case Involving Water-Treatment Execs to 9th Cir. The Securities and Exchange Commission asks the U.S. Court of Appeals for the Ninth Circuit to revive its case against two former water-treatment company executives who allegedly engaged in accounting improprieties. More »
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Gov't, NASAA to Justices: Don't Overturn Basic Presumption In an amicus curiae brief, the Solicitor General tells the U.S. Supreme Court that there is “no good reason” to overturn the fraud- on-the-market presumption of reliance laid out in Basic Inc. v. Levinson 25 years ago. More » The North American Securities Administrators Association and AARP also file an amicus brief urging the justices not to abandon Basic. More »
Commissioner Calls on SEC to Review Role of SROs, FINRA Securities and Exchange Commissioner Kara Stein says the agency should review the self-regulatory organization model—in particular the role of the Financial Industry Regulatory Authority. More »
BNA INSIGHTS: In the Crosshairs: The Asset Management Industry Terence Healy and Amy Greer, Reed Smith LLP, write about the steady rise in enforcement actions against asset managers and investment companies. More »
ALSO IN THE NEWS ATTORNEYS: George Canellos, who recently stepped down as co-chief of the SEC Enforcement Division, rejoins Milbank, Tweed, Hadley & McCloy LLP, where he will head the firm's Litigation Department. Mo re »
FUTURES REGULATION: Eight Democratic senators ask the CFTC to begin sharing futures and swaps market trading data with the Federal Energy Regulatory Commission by the end of February. They say FERC investigators need access to the commission's Large Trader Report. More »
ENFORCEMENT: A federal district court jury delivers a mixed verdict in an SEC enforcement action against Life Partners Holdings Inc. and its senior officials over alleged accounting and other improprieties. More »
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INVESTMENT ADVISERS: The SEC staff issues updated guidance regarding the definition of “knowledgeable employees” under 1940 Investment Company Act Rule 3c-5. More »
BROKER-DEALERS: FINRA sends targeted sweep letters to almost 20 broker-dealers asking about their approaches to managing cybersecurity risks. Mor e »
Table of Contents FEDERAL NEWS ANTIFRAUD
PE firm, others to pay $9.5M in pension fund case 301
ATTORNEYS
Canellos to head Milbank litigation department 300
BROKER-DEALERS
FINRA sends sweep letters asking firms about approach to cybersecurity threats 295
In view of market changes, commissioner calls on SEC to review role of SROs, FINRA 293
CLASS ACTIONS
Don't overrule Basic, NASAA, AARP tell Supreme Court in amicus brief 297
SG to justices: No reason to overturn Basic fraud-on-the market presumption 296
DISCLOSURE
Ex-chair: In disclosure regime overhaul, SEC should relax prescriptive requirements 294
ENFORCEMENT
BAP affirms dismissal of fraudster's adversary complaint 300
Group challenges $13B DOJ, JPMorgan deal alleging constitutional, statutory grounds 292
Jury finds mostly in SEC's favor in case of fund manager's role in Petters fraud 298
Partially divided 3d Cir. affirms order against plastics exec who lied in filings 296
SEC sees mixed verdict in suit against life settlements concern 298
USAO for Southern District of N.Y. recovered $4B in sanctions since 2013 299
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FINANCIAL INSTITUTIONS
Yellen promises new rules governing banks' commodities activity 295
INSIDER TRADING
Tenn. man settles SEC insider trading suit 300
Two Hong Kong firms agree to pay $11M to settle SEC insider trading charges 299
JURISDICTION AND PROCEDURE
Fraudulent transfer dispute sent to DNJ 301
SECURITIES AND EXCHANGE COMMISSION
Ass't GC named to Corp Fin slot 300
DC lawyer to head SEC global affairs office 300
NASAA's Fleming to be SEC's investor advocate 300
STOCK MARKETS
House passes bipartisan legislation upping tick sizes for small-cap companies 291
BNA INSIGHTS ENFORCEMENT
In the crosshairs: The asset management industry 302
SPECIAL REPORT FUTURES TRADING
Three-nember CFTC continues its work, pivots toward implementation role in 2014 307
STATE NEWS ATTORNEYS
Plaintiffs' counsel awarded $2.4M in settlement of Del. merger dispute 310
CORPORATE GOVERNANCE
Directors win summary judgment in Delaware suit over Answers Corp. merger 310
FUTURES REGULATION ANTIFRAUD
Court rebuffs dismissal challenge by Corzine, others in suit over MFG debacle 312
DERIVATIVES
CFTC issues interim final rule, relief to ease move to mandatory swaps trading 313
FIA suggests modifications to CFTC aggregation of positions proposal 314
ENFORCEMENT
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Distribution plan gets OK over bank's objection 316
FUTURES REGULATION
Senators ask CFTC to implement data sharing with FERC by end of month 313
FUTURES TRADING
CFTC grants relief allowing E.U. platforms to host swaps subject to execution mandate 312
FIA tells CFTC position limits proposal exceeds authority; others want stronger rule 314
ACCOUNTING AUDITING
China affiliates of ‘Big Four’ petition SEC to review ALJ ruling on audit work papers 317
ENFORCEMENT
Consulting exec named Enforcement Division chief accountant 318
SEC appeals to Ninth Circuit case involving water-treatment company execs 317
NO ACTION LETTERS INVESTMENT ADVISERS
SEC issues no-action letter regarding definition of ‘knowledgeable employee' 319
TABLE OF CASES Answers Corp. S'holders Litig., In re (Del. Ch.) 310
BDO China Dahua CPA Co., In re (SEC) 317
Behrens v. United States (B.A.P. 8th Cir.) 300
Better Markets Inc. v. Dep't of Justice (D.D.C.) 292
CFTC v. RFF GP LLC (E.D. Tex.) 316
Halliburton Co. v. Erica P. John Fund (U.S.) 296
Halliburton Co. v. Erica P. John Fund Inc. (U.S.) 297
Klatte v. Buckman Buckman & Reid Inc. (D. Minn.) 301
McMoRan Exploration Co. Stockholder Litig., In re (Del. Ch.) 310
MF Global Holdings Ltd. Investment Litigation (DeAngelis v. Corzine, In re (S.D.N.Y.) 312
SEC v. He (N.D. Ga.) 300
SEC v. Jensen (9th Cir.) 317
SEC v. Life Partners Holdings Inc. (W.D. Tex.) 298
SEC v. Onyx Capital Advisors, LLC (E.D. Mich.) 301
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SEC v. Quan (D. Minn.) 298
SEC v. Teo (3d Cir.) 296
SEC v. Well Advantage Ltd. (S.D.N.Y.) 299
SEC v. White (E.D. Tex.) 316
Federal News Broker-Dealers: In View of Market Changes, Commissioner Calls on SEC to Review Role of SROs, FINRA By Yin Wilczek
Feb. 7 — As U.S. markets are becoming increasingly splintered, it is time for the Securities and Exchange Commission to review the self-regulatory organization model, and in particular the role of the Financial Industry Regulatory Authority, Commissioner Kara Stein said Feb. 6.
In a world where trading occurs in hundreds of venues, “the exchange-based SRO model warrants significant reconsideration,” Stein told a gathering of market participants.
The SEC also must better understand and clarify the role of FINRA, which is taking on more and more critical cross-market surveillance functions, Stein said. “While this may be one way to deal with increasing market complexity, it arguably has also created new challenges including how to effectively oversee a very important, but private regulator,” she added. “We need to be thinking about the interactions between FINRA and its customers, other market participants, the Commission, and regulators and participants in related markets.”
Stein spoke at the Trader Forum Equity Trading Summit in New York.
Market Oversight
FINRA is the largest independent securities regulator in the U.S., overseeing some 4,000 broker-dealer firms with more than 600,000 brokers. It currently conducts cross-market surveillance for 90 percent of the U.S.-listed equities market.
A regulatory services agreement it signed Feb. 6 with BATS Global Markets Inc., once fully implemented, will allow FINRA to survey 99 percent of the market.
In response to Stein's remarks, FINRA spokesperson Michelle Ong Feb. 7 told Bloomberg BNA that the organization works closely with the SEC and commission staff on an ongoing basis. “[W]e look forward to discussing these important topics further with Commissioner Stein,” she said in a e-mail.
In other comments, Stein told the audience that the May 6, 2010, “flash crash” was an important wake-up call for regulators, investors and policy makers.
On that day, a large trading order by a mutual fund triggered a spate of aggressive selling by market participants already unnerved over the Greek debt crisis (42 SRLR 1889, 10/11/10). The result was wild price swings in interconnected venues overseen by multiple regulators.
Reliability
To ensure better system reliability, firms that can directly access markets and execution venues should have detailed procedures for testing their systems, Stein said. A comprehensive review of critical market infrastructure—particularly on the “points of failure”—also is essential, she said.
Moreover, the commission must gather as much market data as it can, and be willing to explore alternative approaches, Stein said. For example, the SEC should explore how the market-maker model impacts liquidity and execution quality, she said. In addition, the commission must understand the various order types.
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Stein urged market participants to help expedite the development of the consolidated audit trail, a central data repository being built by the SROs (45 SRLR 2295, 12/16/13). Once implemented, the CAT will collect and identify orders, cancellations, and executions for all exchange-listed equities and options across all U.S. markets.
The repository must be up and running as soon as possible, Stein said. “Until regulators, buy-side traders, brokers, consultants, and the academic community can pore over the data [that the CAT can provide], we simply don't know what we're missing.”
Tick Size Pilot
Stein also told the audience that the commission is mulling whether it should implement a tick size pilot for smaller issuers. She urged market participants to share their views. “A carefully-constructed tick size pilot program might help inform this debate,” she said. “But a poorly-constructed one could easily harm investors and the markets.”
The SEC's Investor Advisory Committee recently recommended that the commission not proceed with a pilot program, saying that increasing tick sizes may lead to higher transaction costs for small issuers (46 SRLR 209, 2/3/14).
However, there is a bill—H.R. 3448—sponsored by Rep. Sean Duffy (R-Wis.) to create a five-year pilot program allowing for five- and ten-cent tick sizes (45 SRLR 2117, 11/18/13).
There is also a pending recommendation from the SEC Advisory Committee on Small and Emerging Companies that the commission adopt rules to allow smaller issuers, on a voluntary basis, to choose their own tick sizes within a limited range (45 SRLR 244, 2/11/13).
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The text of Stein's speech is available at http://www.sec.gov/News/Speech/Detail/Speech/1370540761194#.Uv UaWLS8Aoo.
Broker-Dealers: FINRA Sends Sweep Letters Asking Firms About Approach to Cybersecurity Threats By Yin Wilczek
Feb. 7 — The Financial Industry Regulatory Authority has sent targeted sweep lett ers to almost 20 broker-dealers querying their approaches to managing cybersecurity risks, a spokesperson told Bloomberg BNA Feb. 7.
Among other questions, the survey asks the firms about their:
• approaches to information technology risk assessment;
• business continuity plans in case of a cyber-attack;
• organizational structures and reporting lines; and
• processes for sharing and obtaining information about cybersecurity threats.
FINRA spokesperson Michelle Ong said the letters were sent to a “diverse group of firms with different business models.”
Risk Concern
The survey was prompted by the fact that broker-dealers consistently have said, during discussions with FINRA,
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that cybersecurity is one of their top five risk concerns, Ong said. “We thought it was important to better understand what controls are in place, and identify best practices and areas of concern.”
Cybersecurity has become a top regulatory concern in the wake of high profile attacks on Target Corp. (46 SRLR 211, 2/3/14), Neiman Marcus and other companies.
FINRA posted the sweep notice on its website Feb. 6. It said in the notice that it wants to better understand the types of cyber threats firms face, and their “risk appetite, exposure and major areas of vulnerabilities.” FINRA said it will share the survey findings with its members where appropriate.
FINRA and other regulators, including the Securities and Exchange Commission, conduct targeted examinations—known as sweeps—to gather information and to facilitate investigations. Data gathered from sweep letters—which are sent to select regulated entities based on various factors—helps the regulators focus their exams and learn more about emerging issues.
SEC Exam Priority
Meanwhile, SEC Chairman Mary Jo White testified Feb. 6 before the Senate Banking Committee that the agency's National Examination Program has included cybersecurity as an examination priority for 2014.
In January, Jane Jarcho, NEP national associate director, said SEC examiners will be reviewing the resources expended by registrants on information security, their policies to ensure regular assessment of cybersecurity risks, and their policies to prevent, detect and respond to cyber attacks (46 SRLR 199, 2/3/14). The examiners also will look at registrants' plans for identity theft, lost information and business continuity, Jarcho said.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
FINRA's sweep notification is available at http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminati onLetters/P443219.
White's testimony is available at http://www.sec.gov/News/Testimony/Detail/Testimony/1370540757488#.UvVc WJUo61s.
Class Actions: SG to Justices: No Reason to Overturn Basic Fraud-on-the Market Presumption
BNA Snapshot
Amicus Brief: In brief supporting the plaintiff's position, Solicitor General cites “no good reason to overrule” the fraud- on-the-market presumption of reliance in class securities litigation.
Takeaway: The presumption “has proved workable, and its essential premises remain sound.”
Next Step: Case will be argued March 5.
By Phyllis Diamond
Feb. 7 — The Solicitor General told the U.S. Supreme Court Feb. 5 that Haliburton Co. and other defendants in a would-be class securities fraud suit “identify no good reason” to overturn the fraud-on-the-market presumption of reliance laid out in Basic Inc. v. Levinson 25 years ago ( Halliburton Co. v. Erica P. John Fund, U.S., No. 13-317, 2/5/14).
In an amicus curiae brief, the SG and other government lawyers argued that the presumption “has proved workable, and its essential premises remain sound.”
“Academic debate about the efficient-market hypothesis has not under-mined the presumption,” the government
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said.
The case has garnered substantial interest in light of what it could mean for the future of class securities fraud litigation. According to Washington lawyer Daniel Sommers, Cohen Millstein Sellers & Toll PLLC, Halliburton will “be the most closely watched and potentially the most significant case impacting private securities litigation in the past quarter century” (46 SRLR 156, 1/27/14).
Halliburton
In the controversy, plaintiff Archdiocese of Milwaukee Supporting Fund Inc., now Erica P. John Fund Inc., alleged that between June 1999 and December 2001, the energy services company made material misrepresentations regarding litigation expenses and other matters. On its first Supreme Court trip in 2011, Halliburton failed to persuade the justices that plaintiffs must demonstrate loss causation to obtain class certification (43 SRLR 1206, 6/13/11).
In this case, Halliburton renewed its opposition to class certification, saying the class should not be certified because its alleged fraud did not affect the market price of its securities. However, the district court concluded that price-impact evidence had no bearing on whether common issues predominated under Fed.R.Civ.P. 23(b)(3) and the Fifth Circuit affirmed (45 SRLR 821, 5/6/13).
In November, the supreme court granted Halliburton's certiorari petition (45 SRLR 2107, 11/18/13); the case is slated to be argued March 5.
Common-Sense Presumption
In its brief, the government told the justices that the presumption set out in Basic “rests on the common-sense premise that public, material information about a publicly-traded company affects the price of the company's stock. The presumption also reflects the view that investors, in deciding whether to buy publicly-traded securities, may reasonably assume that the market price has not been tainted by material misinformation.”
“Congress had precisely that understanding” when it enacted The presumption set out in Basic “rests the 1934 Securities Exchange Act, the government lawyers on the common-sense premise that said, “and it has consistently declined to disturb the fraud-on- public, material information about a the-market presumption.” publicly-traded company affects the Saying “academic debate about the efficient-market hypothesis price of the company's stock.” has not undermined” the validity of the doctrine, they urged the court to “reject petitioners' request to upset this settled and sensible presumption.” Government Amicus Brief The government was represented by Solicitor General Donald B. Verrilli Jr., Deputy Solicitor General Malcolm L. Stewart and Nicole A. Saharsky, Assistant to the Solicitor General, Justice Department; and by General Counsel Anne Small, Deputy General Counsel Michael A. Conley, Solicitor Jacob H. Stillman, and Senior Litigation Counsel Jeffrey A. Berger, Securities and Exchange Commission, Washington.
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The brief can be seen on the American Bar Association's website at http://www.americanbar.org/content/dam/ab a/publications/supreme_court_preview/briefs-v3/13-317_resp_amcu_usa.authcheckdam.pdf.
Class Actions: Don't Overrule Basic, NASAA, AARP Tell Supreme Court in Amicus Brief
BNA Snapshot
Amicus Brief: NASAA, AARP urge Supreme Court not to abandon its 25-year old ruling in Basic Inc. v. Levinson.
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Takeaway: They say doing so essentially would prevent securities fraud plaintiffs from bringing a class action.
Feb. 10 — The North American Securities Administrators Association and AARP Feb. 4 urged the U.S. Supreme Court not to abandon its 25-year old ruling in Basic Inc. v. Levinson establishing the fraud-on-the-market doctrine ( Halliburton Co. v. Erica P. John Fund Inc., U.S., No. 13-317, 2/5/14).
In an amicus curiae brief, the two consumer-oriented organizations told the justices that without presumption of reliance afforded by the doctrine, securities fraud plaintiffs essentially would be foreclosed from bringing a class lawsuit.
In the case pending before the court, Halliburton Co., which allegedly made misstatements about litigation expenses and other matters, opposed certification of a plaintiff class, arguing that its alleged fraud did not affect the market price of its securities. However, the district court concluded that price-impact evidence had no bearing on whether common issues predominated under Fed.R.Civ.P. 23(b)(3) and the U.S. Court of Appeals for the Fifth Circuit affirmed (45 SRLR 821, 5/6/13).
In November, the supreme court granted Halliburton's certiorari petition (45 SRLR 2107, 11/18/13) and is slated to hear oral argument March 5.
Federal Limitations
“Given federal limitations on state law-based securities fraud clams, Rule 10b-5 class actions that utilize Basic's presumption remain one of the few viable means by which victims of securities fraud can hope to gain significant recovery,” the amici wrote.
“Moreover,” they told the justices, “Congress, in its attempts to address perceived abuses in securities fraud litigation” by adopting the Private Securities Litigation Reform Act and the Securities Litigation Uniform Standards Act, “continued to recognize the importance of rule 10b-5 class actions and determined that the provisions of the PSLRA and the SLUSA struck the proper balance between perceived vexatious litigation and the important role played by securities fraud class actions, leaving Basic's presumption intact.”
“Overruling or significantly modifying Basic would disrupt the delicate balance these statutes created and would implement a hurdle that Congress chose not to enact,” AARP and NASAA said.
The two are among a number of amici curiae, most of whom have supported Halliburton's position. The government, however, has sided with the plaintiffs. In a Feb. 5 amicus brief, it said the defendants identified “no good reason” to overturn the fraud-on-the-market presumption [see related report in this issue].
AARP was represented by Jay E. Sushelsky, AARP Foundation Litigation; and Michael Schuster, AARP, Washington.
NASAA was represented by Joseph Brady, Rick Fleming, A. Valerie Mirko and Christopher Staley, NASAA, Washington.
For More Information
The brief can be seen on NASAA's website at http://www.nasaa.org/wp-content/uploads/2011/08/Halliburton-v- Erica-John-Fund-final-brief-2-5-14.pdf.
Disclosure: Ex-Chair: In Disclosure Regime Overhaul, SEC Should Relax Prescriptive Requirements By Yin Wilczek
Feb. 12 — To improve its disclosure framework, the Securities and Exchange Commission should “bite the bullet,” take a “holistic approach” and make disclosures “less specifically prescriptive,” former chairman Elisse Walter said Feb. 12.
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If it tries to tackle disclosure on a piecemeal basis, the commission will just end up “with different, but another set of pieces, that do exactly the same thing,” Walter told a legal gathering.
Of course, “all of this will not work unless there is a public/private partnership,” she added. “If people want less prescription and volume, I think the corporate community has to step up to the plate and really think about” how they can improve their disclosures if given more flexibility to do it.
Walter spoke at the Practising Law Institute's Corporate Governance conference in New York.
Former Chair
Walter—who left the SEC in August 2013—served as chairman from December 2012 until April 2013, when Mary Jo White took the reins. Walter now sits on the Sustainability Accounting Standards Board's board, and is a member of the Financial Industry Regulatory Authority's Investor Issues Committee (45 SRLR 2332, 12/23/13 ).
Meanwhile, White recently announced that the SEC is rethinking its disclosure regime, a move precipitated by the requirement under the Jumpstart Our Business Startups Act for the commission to review Regulation S-K (4 6 SRLR 8, 1/6/14).
Walter also told the audience that she “worries” about the recent trend of Congress trying to achieve social and humanitarian goals through the SEC's disclosure requirements. While the goals are laudable, trying to fit them within the framework of the federal disclosure requirements is “the road to hell,” she said. You end up with disclosures, and enforcement of those disclosures, “in the wrong place.”
Conflict Minerals
Walter cited, for example, the SEC's conflict minerals rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC staff and commissioners are not experts on the Congo, she said. “This is a job that really belongs to the State Department.”
On highly specialized issues in which the SEC lacks expertise, a better approach might be through guidance, Walter suggested, citing the SEC's 2010 climate change guidance (42 SRLR 170, 2/1/10). That release reminded companies about their disclosure obligations and issues they should consider with respect to materiality, “as opposed to a mandate,” she said.
In other discussions, Meredith Cross, a Washington-based partner at Wilmer Cutler Pickering Hale & Dorr LLP and a former director of the SEC Division of Corporation Finance, cited a recent trend of companies filing lawsuits to omit shareholder proposals from their proxy materials, rather than going through the SEC's informal no-action staff process.
The lawsuits have primarily targeted John Chevedden, a prolific submitter of shareholder proposals (46 SRLR 264, 2/10/14).
SEC as Referee
Walter warned that while the corporate and shareholder communities might not be “thrilled” by the SEC's referee role with respect to shareholder proposals, they “will be much less happy with the job that courts do.” The commission, “for better or for worse, has built up a great deal of expertise in trying to make the difficult judgments that have to be made in this area,” she said.
Walter also remarked on the development of proxy access through the shareholder proposal process. After private ordering was instituted, “I believe in general the corporate community now believes” it would have been smarter not to challenge the federal access rule in court, she said. Now issuers are fighting proxy access “one company at a time,” which is “not really the best way to go about it.”
In 2010, the SEC created a federal access regime under a new 1934 Securities Exchange Act Rule 14a-11, which would have allowed qualifying shareholders, for the first time, to have their director nominees included in corporate proxy solicitation materials (42 SRLR 1621, 8/30/10). At the same time, the SEC amended its
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shareholder proposal rule—1934 Act Rule 14a-8—to allow companies, under certain circumstances, to include shareholder proposals seeking to establish access procedures.
Subsequently, Rule 14a-11 was invalidated by the U.S. Court of Appeals for the District of Columbia Circuit in July 2011 (43 SRLR 1510, 7/25/11).
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Enforcement: Group Challenges $13B DOJ, JPMorgan Deal Alleging Constitutional, Statutory Grounds
BNA Snapshot
Better Mkts. Inc. v. DOJ, D.D.C., No. 14-cv-00190, 2/10/14
Key Issue: Group files lawsuit to challenge DOJ, JPMorgan's historic $13 billion settlement.
Potential Impact: Lawsuit likely to be dismissed for lack of standing.
By Yin Wilczek
Feb. 10 — Better Markets Inc., a public-interest nonprofit organization, Feb. 10 filed a novel lawsuit against the Department of Justice and Attorney General Eric Holder challenging DOJ's recent historic $13 billion settlement with JPMorgan Chase & Co. to resolve mortgage-related state and federal claims ( Better Mkts. Inc. v. DOJ, D.D.C., No. 14-cv-00190, 2/10/14).
In a complaint filed in the U.S. District Court for the District of Columbia, Better Markets alleged that DOJ and Holder violated the Constitution, the 1989 Financial Institutions Reform, Recovery and Enforcement Act and the Administrative Procedure Act by reaching a “secretive backroom deal” in which JPMorgan received “blanket civil immunity” without the benefit of court review or approval.
“The Justice Department cannot act as prosecutor, jury and judge and extract $13 billion in exchange for blanket civil immunity to the largest, richest, most politically-connected bank on Wall Street,” Better Markets President and Chief Executive Officer Dennis Kelleher said in a related release. “The executive branch does not have this unilateral power because it violates the constitutional requirement of checks and balances.”
Record Deal
The settlement—unveiled in November—is the largest ever reached by DOJ with a U.S. company (45 SRLR 2167, 11/25/13). The deal includes $9 billion in cash payments to settle mortgage-related claims by a cluster of federal and state authorities, and a $4 billion commitment broadly aimed at helping borrowers stay in their homes.
In response, DOJ spokesperson Ellen Canale told Bloomberg BNA, “The Department is confident that the settlement reached with JP Morgan Chase complies with the law.”
JPMorgan spokesman Brian Marchiony declined to comment.
Meanwhile, legal experts suggested that while the lawsuit raises interesting issues, Better Markets likely will have an uphill battle overcoming two significant hurdles: showing its standing to sue, and the general reluctance of courts to interfere with prosecutorial discretion.
In its complaint, Better Markets alleged that the settlement was a “mere contract” between DOJ and JPMorgan that was conducted entirely “in secret behind closed doors, in significant part by the Attorney General personally.”
Fair or Reasonable?
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Because of the secrecy, there is no way to determine if the settlement is fair, adequate or reasonable, the complaint said. “Indeed, one could argue that the $13 billion payment was for making sure no one ever learns the scope and detail of JP Morgan Chase's illegal conduct.”
“Congress has never authorized the DOJ to pursue the type of monetary sanctions at issue in the $13 Billion Agreement entirely outside the purview of a court,” the complaint continued. “For example, with respect to the civil monetary penalty under FIRREA, Congress has expressly provided that the Attorney General must seek such a remedy through an action in federal court.”
FIRREA states that whoever violates any of its provisions “shall be subject to a civil penalty in an amount assessed by the court in a civil action under this section.”
Better Markets asked the court to declare the agreement unlawful and to bar DOJ from enforcing it until it has been reviewed and approved by a court.
In a press conference to announce the lawsuit, Kelleher acknowledged that the lawsuit raises some novel questions based on unprecedented facts. He also agreed that DOJ will fight vigorously on the threshold matter of standing.
Although the law on standing “tilts towards commercial injury,” there nonetheless is a “thick body of law”—primarily in the environmental and health contexts—“that supports claims in these circumstances” by organizations such as Better Markets, Kelleher said. Better Markets will show it has “concrete and demonstrable injury across a variety of issues, not the least of which is, the organization exists for the sole and unique purpose of promoting transparency, accountability and oversight in the financial markets.”
More important, if Better Markets is found not to have standing, that will mean that no one can challenge “a backroom deal” between the Executive Branch and other parties, Kelleher added. “It reads the separation of powers, of checks and balances, out of the Constitution, and it grants the Executive Branch a breadth and scope of unilateral, unlimited, unreviewed power that I don't think anybody contemplates that” it has.
Chance of Success
Kelleher also rated the lawsuit's chance of success as high, noting that Better Markets has worked since November to determine the appropriate legal course of action. “We're quite confident in the claims we've asserted on both the threshold issues and the substantive legal issues and we expect to prevail,” he said.
However, Wayne State University law professor Peter Henning, a frequent commentator on white collar issues, told Bloomberg BNA that standing will be a significant problem, given that the courts generally require a direct injury. Henning also questioned the group's interpretation of FIRREA, noting that the statute does not say that a court is the only way in which penalties may be assessed.
Henning added that the separation of powers, while a principle of constitutional law, is “not something subject to judicial enforcement except in very rare situations.”
The lawsuit raises good points, “but these are more policy issues than legal issues involving enforceable rights,” he said. “Judges don't like getting involved in” these kinds of decisions.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The complaint is available at http://www.bloomberglaw.com/public/document/BETTER_MARKETS_INC_v_DEP ARTMENT_OF_JUSTICE_et_al_Docket_No_114cv0.
Better Markets' release is available at http://www.bettermarkets.com/blogs/suing-doj-require-transparency- accountability#.Uvld5IW8Aoo.
Enforcement: Partially Divided 3d Cir. Affirms Order Against Plastics Exec Who Lied in Filings
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BNA Snapshot
Ruling: Partially divided appeals court affirms district court order denying judgment for plastics exec who allegedly lied in SEC filings regarding his ownership of a company later acquired by Best Buy.
Takeaway: A dissenting judge objects to the disgorgement order to the extent it includes profits stemming from Best Buy's tender offer for the company.
Feb. 10 — A partially divided U.S. Court of Appeals for the Third Circuit Feb. 10 h eld that a plastics industry executive and a trust he controlled properly were denied judgment on charges they failed to disclose their ownership interest in a company later acquired by Best Buy Inc. and affirmed a $17 million disgorgement order against them ( SEC v. Teo, 3d Cir., No. 12-1168, 2/10/14).
Among other specifics, Judge Richard Nygaard said the district court did not abuse its discretion in concluding that the defendants were unjustly enriched by the profits they realized in selling the Musicland stock they acquired while violating the law.
However, in a partial dissent, Judge Kent Jordan said that because Best Buy's tender offer was independent of the defendants' securities law violations, profits solely attributable to the tender offer should not be subject to disgorgement.
Ownership Interest Concealed
In 2004, the Securities and Exchange Commission alleged that defendant Alfred Teo and his trust filed false and misleading Forms 13D and otherwise failed to disclose the extent of their ownership of Musicland stock.
According to the SEC, Teo lied about how many shares he controlled in order to avoid triggering Musicland's poison-pill shareholders rights plan, which would have significantly diluted his stock and caused him substantial losses. Allegedly, Teo deceptively purchased millions of Musicland shares well above the poison pill threshold, selling most of it in the Best Buy tender offer.
In May 2011, a jury found Teo and his trust liable for fraud and/or disclosure violations (43 SRLR 1171, 6/6/11). Thereafter, the appeals court recapped, the district court denied the defendants' motions for judgment as a matter of law and for a new trial. It also ordered the defendants to pay a total of $49.5 million in disgorgement plus prejudgment interest and civil penalties (44 SRLR 21, 1/2/12).
Affirming, the appeals court first concluded that there was sufficient evidence to support the jury's verdict holding the defendants liable; as such, the district court properly denied their motions for judgment as a matter of law and for a new trial.
Unjust Enrichment
Next, the appeals court said, the defendants argued that the profits subject to the disgorgement order “resulted solely” from the sale of Musicland shares under the Best Buy tender offer, which had nothing to do with their securities law violations. They claimed the district court erred because it ignored the tender offer as the proximate cause of their profits.
“They are not correct,” the appeals court rejoined. It said that “[w]hile there is strong legal support for the application of tort-based proximate cause analysis in the context of private enforcement litigation, we have no such authority upon which we can rely to impose any such requirement on SEC-initiated civil actions.”
Rather, it said the policies underlying disgorgement—deterrence and preventing unjust enrichment—“must always weigh heavily in the court's consideration of whether particular profits are legally attributable to the wrongdoing, constituting unjust enrichment.” In this case, the court said, it might have been possible for the defendants to show “that intervening causes made the profits in question greatly attenuated from the violations at issue, but they failed to do so.”
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In any event, it added, even if the defendants had shown that the Best buy tender offer was the direct cause of their profits, “it would not have changed our conclusion that the District Court was within its discretion to grant the SEC's motion for disgorgement.”
According to the court, the SEC based its bid for disgorgement on the defendants' “serial Section 13(d) violations over the course of years, and on the jury's conclusion that Teo's conduct was motivated by fraud, in violation of Section 10(b).”
It noted that the defendants' misconduct enabled them “to acquire a sizeable ownership interest” in a public company unbeknownst to the directors, fellow shareholders, the SEC, or the market. When sold to Best Buy, the stock netted the defendants huge profits.
“In light of all of this, the District Court rightly judged the enforcement objectives to weigh decisively in favor of disgorgement,” the Third Circuit said. “This decision was only made easier by the fact that the [defendants] provided virtually no evidence to support a contrary conclusion.”
For these and other reasons, the appeals court affirmed the district court's order.
For More Information
To see the decision, go to http://www.bloomberglaw.com/public/document/SEC_v_Alfred_Teo_Sr_et_al_Docket_ No_1201168_3d_Cir_Jan_25_2012_Co.
Enforcement: SEC Sees Mixed Verdict In Suit Against Life Settlements Concern By Phyllis Diamond
Feb. 6 — A jury in the U.S. District Court for the Western District of Texas Feb. 3 delivered a mixed verdict in the Securities and Exchange Commission's enforcement action against Life Partners Holdings Inc. and its senior officials over alleged accounting and other improprieties ( SEC v. Life Partners Holdings Inc., W .D. Tex., No. 1:12-CV-33-JRN, 2/3/14).
Among other specifics, the jury absolved the defendants of 1934 Securities Excha nge Act Section 10(b) securities fraud and insider trading violations. However, the defendants were found liable for fraud under 1933 Securities Act Section 17(a) and for various reporting violations.
Life Expectancy Estimates
In early 2012, charged Life Partners and executives David Martin, Brian Pardo, and R. Scott Peden over their alleged roles in a fraudulent disclosure and accounting scheme involving life settlements(44 SRLR 62, 1/9/12). According to the commission, the defendants misled shareholders by failing to disclose a significant risk to Life Partners' business—i.e., that the company was materially underestimating the life expectancy estimates it used to price transactions.
The commission also charged Pardo and Peden with insider trading in their firm's stock; the two allegedly sold Life Partners stock at inflated prices while in possession of material non-public information regarding the ongoing scam.
Late last year, the court denied the SEC's summary judgment motion (45 SRLR 2315, 12/16/13). Earlier this year, Martin settled the lawsuit, agreeing to pay approximately $35,000 and to be barred from future violations.
Win-Win Transaction
In a release posted to the firm's website, Pardo, Life Partners' chief executive officer, said, “We are extremely pleased that the jury has exonerated our company, our business practices, and the life settlement asset class itself.”
“As we demonstrated to the jury, life settlements as transacted through Life Partners provide a valuable service to senior Americans who want to sell their unwanted life insurance policies and are a tremendous alternative
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asset class for accredited investors seeking to avoid the volatility of the stock market.”
“We provide a win-win transaction for everyone involved and, when put to the test, the jury could see the SEC's allegations were not true,” the release said.
Through a spokesperson, the SEC declined to comment.
By Phyllis Diamond
For More Information
To see the verdict, go to http://www.bloomberglaw.com/public/document/Securities_and_Exchange_Commissio n_v_Life_Partners_Holdings_Inc_e.
To contact the reporter on this story: Phyllis Diamond at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
Enforcement: USAO for Southern District of N.Y. Recovered $4B in Sanctions Since 2013 Feb. 11 — Since January 2013, the U.S. Attorney's Office for the Southern District of New York has collected, or entered into agreements to recover, nearly $4 billion in forfeitures, penalties and fines, U.S. Attorney Preet Bharara announced Feb. 11.
In a release, Bharara said his office has obtained recoveries of more than $2.7 billion in forfeiture actions since January 2013. The office also has collected or entered into agreements to collect $1.06 billion in restitution, criminal fines and special assessments. Moreover, it has recovered $149.8 million from civil actions.
Major Cases
According to the release, the bulk of the monetary sanctions resulted from two cases:
• JPMorgan Chase & Co.'s agreement to pay $1.7 billion in civil forfeiture to resolve allegations that it ignored red flags for almost two decades in connection with Bernard Madoff's Ponzi scheme (46 SRLR 57, 1/13/14); and
• SAC Capital Advisors LP's agreement in November to pay $1.2 billion in penalties to resolve criminal and civil insider trading charges (45 SRLR 2065, 11/11/13).
The office also collected an additional $63 million from criminal and civil insider trading charges involving other parties, including forfeiture of $53.8 million by former Galleon Management LP principal Raj Rajaratnam.
“It is fair to say the taxpayers have gotten a great return on their investment—almost 8,000 percent—as this $4 billion represents nearly 80 times the Office's annual budget,” Bharara said. He added that a significant portion of the money will go towards compensating victims of misconduct who suffered financial loss.
For More Information
The release is available at http://www.justice.gov/usao/nys/pressreleases/February14/Collections2013PR.php.
Financial Institutions: Yellen Promises New Rules Governing Banks' Commodities Activity By Cheyenne Hopkins
Feb. 11 — Federal Reserve Chairman Janet Yellen pledged that the regulator will make changes in its oversight of banks' role in the commodities business, which has attracted regulatory and lawmaker scrutiny.
“The Federal Reserve's main focus in our supervision of these areas is to make sure that banks operate in the commodities activities in a safe and sound manner,” Yellen said at a House Financial Services hearing.
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Risks
The Federal Reserve announced Jan. 14 that it was seeking comments on the risks posed by bank ownership and trading of commodities, such as oil, gas and aluminum and the possible benefits of imposing additional capital standards on such activities. Comments are due by March 15.
The Fed's review of banks' commodities activities followed congressional inquiries, including from Sens. Sherrod Brown (D-Ohio) and Carl Levin of Michigan(D-Mich.) into possible conflicts of interest and manipulation in those markets.
JPMorgan Chase & Co. and Morgan Stanley have announced plans to sell portions of their commodities business.
Soliciting comment doesn't bind the Fed to issuing a rule at a later date. The central bank has issued such preliminary notices before, including for a credit-ratings rule in 2010 and capital rules in 2003. After gathering outside views, the Fed could propose a rule that would be open for further comments before the central bank issues a final version.
To contact the reporter on this story: Cheyenne Hopkins in Washington at [email protected] To contact the editor responsible for this story: Maura Reynolds at [email protected]
© 2014 Bloomberg L.P. All rights reserved. Used with permission.
Insider Trading: Two Hong Kong Firms Agree to Pay $11M to Settle SEC Insider Trading Charges Feb. 11 — The Securities and Exchange Commission Feb. 11 announced that two Hong Kong-based asset management firms have agreed to pay nearly $11 million to settle insider-trading allegations involving the trading of Nexen Inc. stock ahead of the company's acquisition by a China-based entity ( SEC v. Well Advantage Ltd., S.D.N.Y., No. 12-cv-05786-RJS, 2/11/14).
In a release, the SEC said China Shenghai Investment Management Ltd. agreed to disgorge ill-gotten gains totaling almost $4.3 million by the firm and eight clients on whose behalf Nexen stock was traded ahead of the announcement that the company would be acquired by CNOOC Ltd.
CITIC Securities International Investment Management (HK) Ltd. agreed to disgorge $3.3 million and to pay a $3.3 million penalty for buying Nexen shares in the U.S. for the accounts of two affiliates.
The two firms did not admit or deny the SEC's allegations.
Court Approval
Judge Richard Sullivan of the U.S. District Court for the Southern District of New York approved the China Shenghai settlement Feb. 11, and the CITIC settlement in late January.
The SEC filed an emergency action in 2012 to freeze the accounts of the firms and others after discovering that traders using brokerage accounts in Hong Kong and Singapore stood to gain more than $13 million in illegal profits from Nexen stock trades while in possession of nonpublic information about the pending acquisition.
China Shenghai and CITIC managed the last remaining frozen accounts in the case, the SEC said.
“The SEC's swift action in this case ensured that traders located on the other side of the globe were not only deprived of their illegal insider trading profits but eventually paid steep penalties,” Sanjay Wadhwa, senior associate director for enforcement in the SEC's New York Regional Office, said in the release. “Our efforts have recouped nearly $30 million and sent a strong deterrent message that insider trading in the U.S. even if carried out from overseas simply doesn't pay.”
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 17 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
For More Information
The SEC's release is available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540775561 #.UvqfNoW8Aoo.
SEC Enforcement: Jury Finds Mostly in SEC's Favor in Case Of Fund Manager's Role in Petters Fraud By Yin Wilczek
Feb. 12 — A jury returned a mixed verdict Feb. 11 in an enforcement action against a Connecticut hedge fund manager who the Securities and Exchange Commission alleged facilitated the Ponzi scheme perpetrated by Thomas Petters ( SEC v. Quan, D. Minn., No. 11-cv-00723, 2/11/14).
A jury in the U.S. District Court for the District of Minnesota found that Marlon Quan and his firms—Stewardship Investment Advisors LLC, Acorn Capital Group LLC and ACG II LLC—were liable under 1934 Securities Exchange Act Rule 10b-5 and 1933 Securities Act Sections 17(a)(2) and 17(a)(3) for, among other acts, funneling millions of dollars of investor funds into Petters' fraud.
However, the jury found that Quan and the firms did not violate 1933 Act Section 17(a)(1).
Unlike Section 17(a)(1), Sections 17(a)(2) and 17(a)(3) do not require scienter, or culpable intent.
Accountability
The commission—reeling from a number of recent high profile losses (46 SRLR 249, 2/10/14)—claimed victory, saying that the verdict means Quan will be held accountable for his role in the scheme.
“Facilitators of Ponzi schemes are just as culpable and harmful to investors as those who are conducting the schemes, and we thank the jury for sending that message in its verdict,” SEC Enforcement Director Andrew Ceresney said in a release.
However, the defendants' attorney—Christopher Casamassima, Wilmer Cutler Pickering Hale & Dorr LLP, Los Angeles—said in a Feb. 11 statement that the SEC's release “does not tell the whole story.”
“The SEC brought two claims against Mr. Quan for securities fraud based on identical conduct under two different securities laws that are also identical in their application to this case,” Casamassima said. “The jury unanimously found that the SEC prevailed on one of its securities fraud claims, and it unanimously found that Mr. Quan prevailed on the other securities fraud claim for the same conduct.”
“Because these findings cannot be reconciled, they reflect a split, non-unanimous jury,” he continued. “Since unanimity is required for liability, the effect of the two inconsistent findings is that the SEC has failed to sustain its claim of securities fraud against Mr. Quan.”
Casamassima, speaking to Bloomberg BNA on the matter, declined to comment as to what the defendants' next steps will be.
During the trial, the jury was instructed that the elements of a Rule 10b-5 and Section 17(a)(1) violation are “substantially the same,” including that they both require a finding that the defendant acted with scienter.
In Prison
Petters was convicted of operating a Ponzi scheme valued at $3.7 billion and sentenced in 2010 to 50 years in prison, the longest sentence ever imposed in Minnesota in a financial fraud case (42 SRLR 685, 4/12/10).
In a complaint filed in March 2011, the SEC alleged that Quan and his firms invested hedge fund assets with Petters, pocketing fees of more than $90 million (43 SRLR 731, 4/4/11). According to the complaint, Quan and his firms falsely assured investors that their funds would be safeguarded by “lock box accounts” to protect them against defaults.
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When Petters was unable to make payments on investments held by the funds that Quan managed, “Quan and his firms concealed Petters' defaults from investors by concocting sham round trip transactions with Petters,” the SEC asserted.
The jury reached its verdict after a two-week trial. The SEC Feb. 11 said that based on the verdict, it will seek entry of a court order of permanent injunction against Quan and the firms, as well as an order for disgorgement, prejudgment interest and financial penalties.
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The SEC's release is available at http://www.sec.gov/litigation/litreleases/2014/lr22925.htm.
Stock Markets: House Passes Bipartisan Legislation Upping Tick Sizes for Small-Cap Companies
BNA Snapshot
Bill: Bill to create pilot program allowing small-cap companies to increase the tick sizes their stocks trade at clears the House with bipartisan support.
Takeaway: The move marks a step forward in capital formation reform, but it is unclear whether further action will come in the Senate, or even from the SEC itself.
By Rob Tricchinelli
Feb. 11 — A bill to create a pilot program allowing small-cap companies to increase the tick sizes their stocks trade at passed the House Feb. 11 with bipartisan support.
The Small Cap Liquidity Reform Act (H.R. 3448), introduced by Reps. Sean Duffy (R-Wis.) and John Carney (D-Del.), was approved 412-4.
The bill's passage reflects broad legislative support for changing tick sizes, a tweak to the Jumpstart Our Business Startups Act, although an advisory committee to the Securities and Exchange Commission recently recommended not adopting a pilot program.
The move marks a step forward in capital formation reform, but it is unclear whether further action will come in the Senate, or even from the SEC itself. If enacted, the bill would give the SEC broad authority to adjust the pilot program, including expanding eligible participating companies and changing the program's length.
Bill Details
Under the bill, a company with less than $750 million in annual revenue could choose to have its stock quoted and traded on exchanges at a nickel or dime tick size. Stocks are quoted at a penny increment under the SEC's default decimalization policy.
A company trading at less than $1 would not be able to opt into “I think we've struck the right balance,” the pilot program, and a company whose stock fell below that Rep. Sean Duffy said. level for a 90-day period would go back to the penny increment. Initial public offerings less than $1 could not opt in, either. Companies opting in could back out and be traded at the penny default once again.
“I think we've struck the right balance, after talking to all those parties interested, in a bill that will give us good information, good data, [and] it's the right length of time,” Duffy told Bloomberg BNA.
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The bill will draw more attention to small-cap stocks, Carney told Bloomberg BNA. More attention means increased coverage from brokers and analysts, he said, which will help attract more investment. The bill passed the House Financial Services Committee 57-0 in November (45 SRLR 2117, 11/18/13).
Raising Capital
Duffy told Bloomberg BNA that he has heard from representatives of “emerging growth companies” that even with JOBS Act reforms, those businesses still had liquidity problems. Accordingly, he and Carney introduced the bill with an eye toward helping small cap companies raise capital. Supporters say small cap company offerings would be less volatile with a wider tick and therefore more attractive to investors.
“If these companies are unnecessarily and artificially restrained in their ability to raise growth capital by the SEC's current decimalization market rules, then this is a costly situation which results in far fewer jobs being created than would probably be possible with a modification to the current market rules,” Stephen Holmes, chief operating officer of venture capital firm InterWest Partners, told Bloomberg BNA. Holmes also sits on the SEC's Investor Advisory Committee.
The IAC recently recommended that the SEC as a whole not undertake such a pilot program (46 SRLR 209, 2/3/14). Endorsers of the IAC's report said there is no evidence that a tick size bill would benefit investors and that there are other ways to improve capital formation. Instead, they said, increasing tick size would cause wider spreads between bid and ask prices, leading to higher transaction costs.
“In general, decreasing tick sizes creates more competitive pricing for the buying and selling of securities,” the report said. Holmes dissented from the recommendation.
Costs
Increasing tick sizes will drive up trading costs, critics say, which would benefit broker-dealers at the cost of retail investors. “The bill requires an experiment in government price-fixing for all but the very largest public companies in the hopes that artificially inflating the cost of trading will somehow promote liquidity,” Barbara Roper told Bloomberg BNA. Roper is director of investor protection at the Consumer Federation of America and chairs the Investor as Purchaser Subcommittee, part of the IAC.
“Perhaps at some point members of Congress will realize that if you really do want to promote small company capital formation, taking steps that harm the interests of the providers of capital is not the best way to go about it,” she said. These increased costs could in turn chill investment.
“I'm not sure it will encourage retail investors,” Daniel G. Weaver, a finance professor at Rutgers Business School, told Bloomberg BNA. With larger tick sizes, brokers get larger rebates, the spreads of individual stocks widen and individuals get discouraged from trading, he said.
SEC
Despite the bill's passage and the IAC's recommendation to maintain its decimalization policy, the SEC could still take action on its own. Commissioner Michael S. Piwowar has publicly supported a pilot program, citing “little downside risk” (46 SRLR 209, 2/3/14).
Piwowar said that even if investors do not benefit substantially, a pilot could provide useful data for the commission.
“A carefully-constructed tick size pilot program might help inform this debate,” Commissioner Kara Stein said in a Feb. 6 speech. “But a poorly-constructed one could easily harm investors and the markets.”
Manipulation
In addition to its purported capital formation benefits, supporters of the tick-size increase say the reforms would discourage market manipulation by large institutional investors.
“Today's market structure with 1 penny tick sizes really makes it easy [for large institutional investors] to manipulate illiquid markets and disadvantage small investors by shorting and stepping in front,” David Weild, a
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former Nasdaq vice chairman, told Bloomberg BNA.
Weild said that high-frequency traders need only move a stock by a penny to cover a potential short position and make money, and that a tick size increase would deter short-term investors. “What higher tick sizes will do is stop the predators and allow long-term fundamental investors and the market makers that support them to transact without having a target on their back.”
Weild is an investment banker and some of his written recommendations were incorporated into the JOBS Act.
“It is just stupid to think that we should have the same market structure to trade Apple, a $450 billion market value company, that we do to trade the many stocks that are 1/4500th the size,” he said.
Pilot Program
“Some have said this isn't going to work, some said it will work,” Duffy told Bloomberg BNA. “That's why we do a pilot program.”
Roper, however, disputed the usefulness of the pilot program's terms as designed. “The bill requires that the experiment be conducted on terms that minimize the likelihood that it would produce any usable data,” she told Bloomberg BNA. “The fact that companies can opt out is a key factor, so you won't really have a controlled experiment.”
The bill passed with bipartisan support, and Duffy told Bloomberg BNA that he is “hopeful we'll keep moving it” on the Senate side. Its prognosis in the upper chamber is unclear, however, with the Banking Committee focused in the near-term on housing finance reform.
“I don't care who gets credit, how it happens,” Duffy told Bloomberg BNA. “I think moving forward with a pilot program to get good information is what we want.” If the SEC implements a pilot program with “broad parameters” similar to the bill, he said, “we'll be fine with that.”
To contact the reporter on this story: Rob Tricchinelli in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
Federal Briefs Canellos to Head Milbank Litigation Department Feb. 12 — Milbank, Tweed, Hadley & McCloy LLP announced Feb. 12 that George Canellos, who recently stepped down as co-chief of the Securities and Exchange Commission Enforcement Division (46 SRLR 9, 1/6/14), will return to the firm in the middle of March to become global head of the Litigation Department.
In a release, Milbank recapped that Canellos joined the SEC in 2009 as director of the agency's New York Regional Office. In 2012, he was named co-director of the Enforcement Division, along with current director Andrew Ceresney (45 SRLR 767, 4/29/13).
Canellos also spent many years as a prosecutor in the U.S. Attorney's Office for the Southern District of New York.
NASAA's Fleming to Be SEC's Investor Advocate Feb. 12 — Rick A. Fleming will become the Securities and Exchange Commission's first investor advocate, the commission announced Feb. 12.
Fleming will leave his post as deputy general counsel of the North American Securities Administrators Association in Washington and start Feb. 24 at the SEC.
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The Office of the Investor Advocate was created by Section 915 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to resolve investor problems with the SEC, other regulators, financial service providers and investment products.
The investor advocate is also empowered by the statute to suggest changes to rules and regulations to benefit investors, as well as provide analysis of the effects on investors of proposed rules and regulations.
Under the law, the investor advocate reports directly to the SEC chairman.
Fleming has been with NASAA since 2011, and in that capacity he has testified before Congress on the Jumpstart Our Business Startups Act (45 SRLR 2025, 11/4/13).
Before NASAA, he worked for Office of the Securities Commissioner in his native Kansas.
“I look forward to helping ensure that investors are always heard and treated fairly,” Fleming said in an SEC news release.
He is a graduate of Washburn University and Wake Forest University School of Law.
DC Lawyer to Head SEC Global Affairs Office Feb. 12 — The Securities and Exchange Commission announced Feb. 12 that Paul A. Leder, a member of Richards Kibbe & Orbe LLP, Washington, has been named director of the Office of International Affairs.
The office advises the agency on cross-border matters and coordinates its involvement with global regulators. Its former director, Ethiopis Tafara, stepped down from his role approximately a year ago (45 SRLR 388, 3/4/13).
In a release, the SEC said Leder previously spent more than a decade at the commission, which he joined in 1987 as a trial attorney in the Enforcement Division. After the OIA was formed in 1989, Leder was part of the initial leadership team, serving as assistant director and later deputy director. “From 1997 to 1999, he also served as senior adviser for international issues to Chairman Arthur Levitt.”
In the release, the SEC said Leder earned his bachelor's degree and law degree from the University of Michigan. He began his legal career at the Public Defender Service for the District of Columbia.
Ass't GC Named to Corp Fin Slot Feb. 12 — The Securities and Exchange Commission announced Feb. 12 that David Fredrickson, assistant general counsel in the Office of General Counsel, has been named associate director and chief counsel in the Division of Corporation Finance.
He will assume his new position in March, the agency said in a release.
It said that in his new role, Fredrickson will oversee the work of the division's Office of Chief Counsel and Office of Capital Markets Trends. He will be responsible for the division's no-action positions on the securities registration process; disclosures by corporate officers, directors and principal shareholders; executive compensation disclosure; corporate succession; and rules on proxy solicitation and shareholder proposals.
Before joining the OGC in 1997, Fredrickson spent three years as an enforcement attorney in the SEC's San Francisco Regional Office. Before that, he was in private legal practice. He graduated from the University of California at Berkeley and Georgetown University Law Center, the SEC said.
Dismissal of Fraudster's Complaint Affirmed
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 22 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
Feb. 12 — The U.S. Court of Appeals for the Eighth Circuit's Bankruptcy Appellate Panel Feb. 12 rebuffed convicted fraudster Bryan Behrens' bid to revive his adversary complaint against the U.S. ( Behrens v. United States, B.A.P. 8th Cir., No. 13-6052, 2/12/14).
Judge Charles L. Nail Jr. said a bankruptcy proceeding may not be used to mount a collateral attack on a criminal judgment. “That is all Behrens's adversary complaint did.” In his complaint, Behrens sought to void a restitution order entered in a 2011 criminal sentence on the ground that it benefited the same individuals as those affected by a 2008 civil receivership that resulted from a Securities and Exchange Commission enforcement action.
The bankruptcy court dismissed the complaint for failure to state a claim, and the appellate panel affirmed. It said that if Behrens has an argument “challenging the validity of the criminal judgment from which the restitution debt and attendant lien arose, Behrens will need to make that argument to the district court that entered the judgment.”
For More Information
To see the decision, go to http://www.bloomberglaw.com/public/document/Bryan_Behrens_v_USA_Dock et_No_1306052_8th_Cir_Sept_30_2013_Court_.
Tenn. Man Settles SEC Insider Trading Suit Feb. 10 — The U.S. District Court for the Northern District of Georgia Feb. 7 ordered a Tennessee resident to pay $175,974.46 in disgorgement plus prejudgment interest and a $169,819.10 penalty to settle allegations that he engaged in insider trading in the securities of a Shanghai-based company ( SEC v. He, N.D. Ga., No. 1:14-cv-00344-MHS, 2/7/14).
Defendant Hao He—also known as Jimmy He—also consented, without admitting or denying the Securities and Exchange Commission's allegations, to be enjoined from future violations.
According to the SEC's Feb. 6 complaint, between October and November 2012, He obtained material nonpublic information about Sina Corp.'s future negative earnings guidance. Based on the information, the SEC said, He purchased short-term put options, and realized $169,819.10 in illicit profits when Sina announced “unexpected negative guidance” a few days later.
An attorney for He could not be identified immediately.
For More Information
To see the final judgment against He, go to http://www.bloomberglaw.com/public/document/Securities_an d_Exchange_Commission_v_He_Docket_No_114cv00344_ND_G.
To see the SEC's complaint, go to http://www.bloomberglaw.com/public/document/Securities_and_Excha nge_Commission_v_He_Docket_No_114cv00344_ND_G/1.
Fraudulent Transfer Dispute Sent to DNJ Feb. 11 — Ruling in a fraudulent transfer dispute, the U.S. District Court for the District of Minnesota Feb. 3 granted the defendant brokerage firm's motion for a change of venue to the U.S. District Court for the District of New Jersey ( Klatte v. Buckman Buckman & Reid Inc., D. Minn., No. 13-3109 (RHK/SER), 2/3/14).
Judge Richard Kyle concluded that on balance, the defendant met its heavy burden of showing that a change of venue is warranted.
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The court recounted that the case arose from the alleged mismanagement of retirement funds the plaintiffs—all Minnesota residents—entrusted to Leonard Demers, a New York-based investment adviser who worked for Mercer Capital Ltd. The plaintiffs ultimately were awarded more than $1 million in Financial Industry Regulatory Authority arbitration proceedings against Mercer and Demers.
However, the court said, in attempting to enforce the awards, the plaintiffs learned that Demers had died and that Mercer's assets had been transferred to defendant Buckman Buckman & Reid Inc., a New Jersey-based brokerage. They sued Buckman in Minnesota state court, contending that the firm was “simply a continuation” of Mercer and that Mercer's assets were transferred solely to avoid satisfying the judgments in the FINRA proceedings. Buckman, in turn, removed the lawsuit to this court, where it sought to transfer the dispute to the District of New Jersey.
Granting Buckman's motion, the court said that in terms of the parties' convenience, “there are thumbs pressing” on both sides of the scale. However, it said, “the convenience-of-witnesses factor heavily favors transfer.”
Moreover, the court noted, Buckman has no offices or assets in Minnesota; as such, the plaintiffs “appear unable to enforce a judgment against it in this state.”
The “substantial nexus” between the plaintiffs' claims and New Jersey, combined with the plaintiffs' inability to enforce a judgment on those claims without additional litigation in New Jersey, outweigh any deference accorded the plaintiffs' choice of forum, the court concluded, granting Buckman's venue transfer motion.
The plaintiffs were represented by Donald R. McNeil Jr., Heley Duncan & Melander PLLP, Minneapolis; and Michael MacDonald, Law Office of Michael S. MacDonald, Sunfish Lake, Minn.
Buckman was represented by Margaret R. Ryan and Jacalyn N. Chinander, Meagher & Geer PLLP, Minneapolis; and Mark J. Astarita, Sallah Astarita & Cox LLC, Verona, N.J.
For More Information
To see the decision, go to http://www.bloomberglaw.com/public/document/Klatte_et_al_v_Buckman_Buck man__Reid_Inc_Docket_No_013cv03109_D_M.
PE Firm, Others to Pay $9.5M in Pension Fund Case Feb. 10 — The U.S. District Court for the Eastern District of Michigan has o rdered a Detroit-based private equity firm, its founder and an associate to pay more than $5.4 million in disgorgement and more than $4.1 million in civil penalties for stealing millions of dollars from three public pension funds, the Securities and Exchange Commission said in a release Feb. 7 ( SEC v. Onyx Capital Advisors, LLC, E.D. Mich., Case No. 10—11633, 1/31/14).
Judge Denise Page Hood also enjoined Onyx Capital Advisors LLC and its founder, Roy Dixon Jr. from future violations of the 1933 Securities Act, the 1934 Securities Exchange Act and the 1940 Investment Advisers Act.
According to the SEC's complaint, filed in April 2010, Onyx and Dixon raised approximately $23.8 million from three public pension funds and then siphoned the funds to pay for personal and other business expenses (42 SRLR 851, 5/3/10). The SEC also alleged that Onyx and Dixon misappropriated the funds under the guise of management fees and diverted funds into used car companies controlled by Dixon's friend, Michael A. Farr. In the release, the SEC said that the court previously entered a summary judgment against Onyx and Dixon and a consent judgment against Farr. The court found that Onyx and Dixon received more than $2 million in excess fees, misappropriated over $1 million through Farr and his companies, and that Farr received approximately $2.3 million from Onyx as investments in his used car companies.
In the Jan. 31 order, the court held Onyx and Dixon jointly and severally liable for more than $3.1 million
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in disgorgement, plus prejudgment interest, and more than $3.1 million in civil penalty. The court also ordered Farr to disgorge more than $2.3 million, plus prejudgment interest, and pay a $1 million penalty.
For More Information
To see the Jan. 31 order, go to http://www.bloomberglaw.com/public/document/United_States_Securities _and_Exchange_Commission_v_Onyx_Capital_A.
To see the SEC's release, go to http://www.sec.gov/litigation/litreleases/2014/lr22922.htm.
BNA Insights In the Crosshairs: The Asset Management Industry
ENFORCEMENT
By Terence Healy and Amy Greer
Terence Healy is a partner at Reed Smith LLP in Washington. He regularly represents financial institutions and individuals in matters against the Securities and Exchange Commission, Department of Justice, and other regulators. Before joining Reed Smith, Mr. Healy was Senior Assistant Chief Litigation Counsel for the SEC's Division of Enforcement.
Amy Greer is a Partner in Reed Smith's New York office and co-leads the Firm's Securities Litigation and Enforcement Practice. Prior to joining Reed Smith, Ms. Greer served as Chief Trial Counsel in the SEC's Philadelphia Regional Office, handling complex litigated and investigative matters and managing the Office's trial program. Her current practice focuses largely on regulatory investigations—SEC, FINRA, DOJ, and State - internal investigations, and litigated securities matters.
The asset management industry has never been far from the gaze of regulators. But when the Securities and Exchange Commission (“SEC”) opened a special Asset Management Unit in 2010, it was clear the industry would be the subject of increased federal scrutiny. Since that time, there has been a steady rise in enforcement actions against asset managers and investment companies as regulators try to grapple with this complex and growing area. Add in new registration requirements for some private fund advisers under the Dodd-Frank Wall Street Reform and Consumer Protection Act, plus removing limits on general solicitations under the Jumpstart Our Business Startups Act, and the reasons for greater regulatory focus on this sector become apparent.
The asset management industry now controls a large percentage of investor wealth for both retail and institutional investors, with increasingly complex products offered even at the retail level. The size of industry—with nearly 11,000 registered investment advisors—and the complexity of some of the products offered to investors have posed a challenge to regulators. To confront this challenge, the SEC and other agencies have undertaken a number of targeted enforcement initiatives as they try to get their arms around this burgeoning industry. This regulatory momentum will continue to build. 1
1 Indeed, in recent testimony before Congress, SEC Chairman Mary Jo White identified increasing the agency's examination program of investment advisors as one of her top priorities. Mary Jo White, Testimony before the Subcommittee on Financial Services and General Government, Committee on Appropriations, United States House of Representatives, May , 2013.
Asset Management Writ Large
In the decades preceding the financial crisis, the asset management industry grew dramatically. Both in the U.S. and abroad, total assets under management (“AUM”) skyrocketed, fueled by long periods of easy credit and
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 25 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7 increasing individual net worth. 2 Though the industry was battered in the crisis years, it bounced back with a storm, and by 2012 total AUM exceeded pre-crisis levels. 3 Today, the global fund industry controls a staggering $120 trillion in investor assets, 4 with asset managers in the U.S. alone responsible for more than $50 trillion in AUM. 5
2 See Michael Pinedo, Global Asset Management: Strategies, Risks, Processes and Technologies 9 (Palgrave Macmillan 2013).
3 See Sujata Rao, Global Fund Industry Rebound, Reuters News, November 13, 2012
4 See id.
5 Office of Financial Research, Asset Management and Financial Stability 4 (September 2013).
Broadly speaking, the modern asset management industry can be divided into two groups, institutional asset management and retail asset management. The institutional group, which includes hedge funds, private equity funds, and advisory firms, deals directly with other institutions. 6 The retail asset management group, which includes all mutual funds and pension funds, maintains individual investor accounts and operates under a generally higher regulatory structure. 7 Few firms manage assets for both retail and institutional clients. 8
6 See Michael Pinedo, Global Asset Management: Strategies, Risks, Processes and Technologies 8-9 (Palgrave Macmillan 2013).
7 Id.
8 Id.
Within these groups, the industry encompasses a range of firms and classes of investment funds. Many banks have separate asset management divisions that offer customers wealth management services. 9 These services can be offered through collective investment funds or separate accounts. Similarly, many insurance companies also provide asset management services to their customers, such as retirement planning. Dedicated asset management companies, depending on their structure, can also offer collective investment funds or retirement accounts to customers. Most dedicated asset management companies are registered as investment advisors. 10
9 Banks generally are not required to register their wealth management services with the SEC, unless those services are being provided to a registered investment company. Office of Financial Research, Asset Management and Financial Stability 27 (September 2013).
10 Id.
The sheer size of the industry poses a regulatory challenge. By September 2010, the number of registered investment advisors (“RIAs”) had grown to nearly 12,000. 11 Even in the recession years following the financial crisis, when total AUM dipped across the industry, the number of RIAs continued to increase. The overall number of RIAs has decreased somewhat since 2010, as Dodd-Frank has allowed advisors with less than $100 million in AUM to bypass the SEC and register with state authorities, but the total still stands at nearly 11,000. In addition to RIAs, the SEC is charged with oversight of approximately 9,700 mutual and exchange-traded funds and 30,000 private funds. 12
11 At the close of the 2010 fiscal year (Sept. 30, 2010), there were 11,888 investment advisors registered with the SEC. See SEC Division of Investment Management, Study on Enhancing Investment Adviser Examinations 8 (Jan. 2011).
12 See Mary Jo White, Remarks at National Society of Compliance Professionals National Membership Meeting, Oct. 23, 2013.
Against these tens-of-thousands of funds and advisors, the SEC is armed with a staff of only about 460 professional examiners. 13 The ratio of examiners to regulated entities makes any regular, meaningful examination of all funds and advisors an impossibility, particularly given that, as AUM increase, the complexity and time required to complete an exam increase correspondingly. 14 As a result, in fiscal year 2012, the SEC was only able to examine about 8 percent of registered advisors. So what is a regulator to do?
13 In fact, while the number of RIAs and AUM grew steadily in the years leading to the financial crisis, the number of SEC examiners actually decreased by 13 percent. See SEC Division of Investment Management, Study on Enhancing Investment Adviser Examinations 11 (Jan. 2011). Even today, the SEC still has fewer examiners than it did in 2005.
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14 As an asset manager grows larger, the size and complexity of their operations generally increase also. Id. at 8-9. Larger asset managers will typically have more clients, more affiliated business activities, and more complex investment strategies. Id. All of these factors affect the complexity of the regulator's examination.
Search for the Holy Grail
The SEC has described early detection and prevention of fraud as the “holy grail of securities law enforcement.” 15 To try to grasp this elusive prize—and to get a handle on a $50 trillion domestic industry—the SEC and other regulators have employed a series analytical tools and enforcement initiatives targeted at asset managers. These efforts have included:
15 SEC Press Release, SEC Charges Multiple Hedge Fund Managers with Fraud in Inquiry Targeting Suspicious Investment Returns (Dec. 1, 2011).
Aberrational Performance Inquiry. In March 2011, the SEC unveiled an Aberrational Performance Inquiry designed to identify funds that consistently outperformed standard market indexes. Those funds whose performance stood out from the crowd would be targeted for closer examination. This initiative first appeared to bear fruit in December 2011 when the Commission charged two hedge fund managers, Michael Balboa and Gilles De Charsonville, with fraud for overvaluing the returns of a fund which, at its peak, claimed to have more than $840 million in AUM. 16 On the same day, the SEC charged four other fund managers for similarly overvaluing the performance of their funds and similar misdeeds. 17 The Commission stated each of these actions grew out of its Aberrational Performance Inquiry.
16 Id.
17 Id.
In October 2012, the SEC announced another enforcement action against a hedge fund advisory firm and its executives arising from the Aberrational Performance Inquiry. In that case, the Commission charged Yorkville Advisors LLC and its president, Mark Angelo, and chief financial officer, Edward Schinik, with fraud for misleading investors as to their funds' valuation procedures and investments. 18 Bruce Karpati, then-chief of the SEC's Asset Management Unit, said the agency's analytical tools put Yorkville “front and center on our radar screen,” leading ultimately to their uncovering the fraud.
18 SEC Litigation Release, SEC Charges Hedge Fund Adviser and Two Executives with Fraud (Oct. 17, 2012).
The Commission will continue to look for funds whose performance is “aberrant” and target those funds for closer scrutiny. This may lead to more frauds being discovered in an earlier stage. It may also mean that many successful funds, and funds with unique investment models, will increasingly find the regulators showing up at their doors for examinations.
Private Equity. Despite controlling more than a $1 trillion in assets, the private equity industry traditionally received little attention from regulators. Private equity firms generally do not trade securities and, unlike banks and hedge funds, private equity was never accused of being a root cause of the financial crisis. But the industry's time in the shadows may be coming to a close. The SEC has reported that, in total AUM, private equity now equals, and may exceed, the entire hedge fund industry. 19 This fact alone provides reason for increased scrutiny from regulators. Bruce Karpati also stated in January 2013 that “private equity has other unique characteristics that may make the industry more susceptible to fraud,” including the lack of transparency in how portfolio companies are controlled. 20
19 See Bruce Karpati, Remarks at the Private Equity International Conference, Jan. 23, 2013.
20 Id.
To address these issues, the SEC's Asset Management Unit undertook a Private Equity Initiative in which it analyzes portfolio data to identify fund managers who have assets under management but appear unable to raise follow-on vehicles. The SEC believes these so-called “zombie funds” may be more likely to lead to misuse of investor funds. 21 The SEC staff has identified other areas of concern in the private equity industry, including valuation of illiquid securities, disclosure and allocation of fees and expenses, and related-party transactions. 22 This shows the SEC is now looking at private equity beyond market-facing activity, such as insider trading, to examine more closely the business operations of firms.
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21 Id.
22 Id.
In March of last year, the SEC announced the filing of settled charges against two private equity firms and some employees. The Commission alleged that Ranieri Partners, a New York-based private equity firm, and one of its senior managing partners, Donald Phillips, aided and abetted violations of Section 15(a) of the 1934 Securities Exchange Act by allowing one of Phillips' friends, William Stephens, to act as an unregistered broker soliciting investors. 23 The SEC charged that Stephens, while acting as a “finder” for private funds which affiliates of Ranieri managed, actively solicited investors and in return received transaction-based compensation totaling approximately $2.4 million. 24
23 SEC Press Release, SEC Charges Private Equity Firm, Former Executive, and Consultant for Improperly Soliciting Investments (Mar. 11, 2013).
24 In the Matter of Ranieri Partners LLC and Donald W. Phillips, Admin. Proceeding File No. 3-15234 (Mar. 11, 2013).
On the same day as the charges against Ranieri, the SEC announced settled charges against Oppenheimer Asset Management and Oppenheimer Alternative Investment Management, both registered investment advisors, for violating the antifraud provisions of the 1933 Securities Act and the 1940 Investment Advisors Act by misleading investors as to the valuation methods used to value some of the underlying portfolio assets in a private equity fund they managed. 25 In filing the charges, Julie Riewe, then-deputy chief of the SEC's Asset Management Unit, warned that private equity managers may become “incentivized” to artificially inflate portfolio valuations. 26 This comment, which mirrors others from the Enforcement Division staff, shows valuation will continue to be a focus area for regulators.
25 SEC Press Release, SEC Charges New York-Based Private Equity Fund Advisers with Misleading Investors about Valuation and Performance (Mar. 11, 2013). In August 2013, the SEC instituted administrative proceedings against the portfolio manager of one of the underlying funds, Brian Williamson, for making misrepresentations to investors as to valuation methods. In the Matter of Brian Williamson, Admin. Proceeding File No. 3-15430 (Aug. 20, 2013).
26 Id.
Insider Trading. Insider trading has been called “the drug crime of the financial world” and continues to be a high priority for both the Justice Department and SEC. These cases, which are often well covered in the media, are popular with regulators. George Canellos, former co-director of the SEC's Division of Enforcement, said in March 2013 that “sophisticated hedge funds” pose risks for insider trading and that the SEC would be bringing more cases in that area. 27 Over the past two years, there has been an explosion of blockbuster case filings, settlements, and trials in the area of insider trading, many of which arose out of the asset management industry.
27 George Canellos, Remarks at the SIFMA Compliance and Legal Society Annual Seminar, Mar. 18, 2013.
In November 2012, the government unveiled the mother-of-all insider trading cases when it charged some affiliated entities of the Connecticut hedge fund SAC Capital Advisors (“SAC”), and one of its employees, with insider trading. 28 The government alleged the defendants made a record $276 million in illicit profits and losses avoided through a scheme to trade based non-public information involving the clinical trials of an Alzheimer's drug. The hyperbole from the regulators in announcing the charges—in which they referred to “yet another corrupt hedge fund manager” 29 —underscores the focus on insider trading in the asset management industry, particularly as to hedge funds.
28 On November 20, 2012, the SEC charged CR Intrinsic Investors, LLC, a Connecticut hedge fund advisory firm; Matthew Martoma, its former portfolio manager, and Dr. Sidney Gilman, a Michigan medical consultant, with insider trading. See SEC Press Release, SEC Charges Hedge Fund Firm CR Intrinsic and Two Others in $276 Million Insider Trading Scheme Involving Alzheimer's Drug (Nov. 20, 2012). On the same day, the Department of Justice unsealed a criminal indictment against Matthew Martoma charging him with securities fraud. He was arrested at his home in Florida that day. The SEC later amended its complaint to add claims against CR Intrinsic Investments, LLC, SAC Capital Advisors, LLC, SAC Capital Associates, LLC, SAC International Equities, LLC, and SAC Select Fund, LLC as relief defendants.
29 Id.
The government's pursuit of SAC continued throughout 2013. In July, the Justice Department unsealed an indictment charging the company with securities fraud and alleging a pattern of “pervasive” insider trading “on a scale without known precedent in the hedge fund industry.” 30 In November, SAC agreed to plead guilty and pay a landmark $1.8 billion in penalties. In other proceedings, Michael Steinberg, a former portfolio manager of
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 28 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7 an SAC affiliate, was convicted of insider trading in December. 31 And in February 2014, Michael Martoma, the portfolio manager at the center of the $276 million insider trading scheme disclosed in November 2012, was convicted of securities fraud.
30 Indictment, United States v. SAC Capital Advisors LP, No. 13-CR-00541 (SDNY Jul. 25, 2013).
31 DOJ Press Release, SAC Capital Portfolio Manager Michael Steinberg Found Guilty in Manhattan Federal Court of Insider Trading Charges (Dec. 18, 2013).
Beyond SAC, the SEC and DOJ continue to pursue insider trading investigations across the asset management industry. Insider trading will remain a core priority with regulators.
Compliance. The role of compliance in the financial services industry continues to evolve. Following the financial crisis, regulators concluded many firms lacked sufficient internal risk management and compliance operations. 32 Under Dodd Frank, Congress increased the responsibilities of compliance officials, requiring closer involvement in basic business operations. 33 Just as these responsibilities continue to expand and become more complex—with significant new statutes and regulations to integrate into compliance programs, both domestically and (for larger organizations) abroad—regulators have come to hold compliance officials more accountable for violations at their firms.
32 See Carlo V. di Florio, Remarks at the Compliance Outreach Program (Jan. 31, 2012).
33 See SIFMA, The Evolving Role of Compliance 1 (Mar. 2013).
Last year, the SEC brought a series of cases against compliance officers and their firms alleging failures in their compliance programs. In July, the Commission charged Comprehensive Capital Management Inc. and Ronald Rollins, its chief compliance officer, for failure to supervise an employee who used falsified authorization forms to transfer more than $16 million from advisory accounts into accounts he controlled. 34 The SEC alleged Rollins aided and abetted violations of the Custody Rule, books and records provisions, and some compliance provisions of the Investment Advisors Act. 35
34 In the Matter of Ronald Rollins, Admin. Proceeding File No. 3-15392 (Jul. 29, 2013).
35 Id.
In October, the SEC brought enforcement proceedings against three investment advisory firms, Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC, for ignoring problems with their compliance programs. 36 The actions arose out of the Commission's Compliance Program Initiative which targets firms that have been previously warned of compliance deficiencies but failed to address them. The SEC alleged these compliance deficiencies allowed the firms to commit various violations, such as misrepresenting AUM, conflicts of interest, and improper client billing. 37
36 SEC Press Release, SEC Sanctions Three Firms Under Compliance Program Initiative (Oct. 23, 2013).
37 Id.
These cases, where compliance officers were held liable for failing to prevent the underlying—even willful—violations at their firms, have sent a chilling message to the compliance profession. They also represent another area where regulators will demand more accountability from the asset management industry.
Custody. The safety of client assets is considered “the heart of the relationship between [investment] advisors and their customers.” 38 An adviser is considered to have custody if it holds client funds, directly or indirectly, or securities or has authority to obtain possession of them. 39 The Custody Rule under the Investment Advisors Act 40 provides for the safekeeping of client assets at qualified custodians. The SEC's National Examination Program has found “widespread and varied non-compliance with elements of the custody rule.” 41 Improving compliance with the Custody Rule remains an enforcement priority for the SEC.
38 SEC Press Release, SEC Charges Three Firms With Violating Custody Rule (Oct. 28, 2013).
39 Rule 206(4)-2(d)(2) to the Investment Advisers Act of 1940.
40 Rule 206(4)-2 to the Investment Advisers Act of 1940.
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41 SEC Office of Compliance Inspections and Examinations, National Examination Program Risk Alert, Significant Deficiencies Involving Adviser Custody and Safety of Client Assets (Mar. 4, 2013).
In 2010, the SEC strengthened the Custody Rule by requiring all advisers with custody of client assets to undergo annual “surprise exams” to certify those assets. Advisers must also have a reasonable basis to believe that a qualified custodian is sending investors account statements at least quarterly. 42
42 See SEC Press Release, SEC Charges Three Firms With Violating Custody Rule (Oct. 28, 2013).
In October, the SEC charged three investment advisory firms with violating the Custody Rule. The Commission alleged Further Lane Asset Management LLC, GW & Wade LLC, and Knelman Asset Management Group LLC failed to maintain client assets with qualified custodians or to engage independent accountants to conduct surprise exams. 43 The firms agreed to settle administrative proceedings.
43 Id.
Ensuring more consistent compliance with the Custody Rule will continue to be a priority of the SEC across its exam and enforcement programs.
Valuation. Valuation of assets has long been a focus of regulators. The SEC has warned that with hedge funds, based on their compensation structures, fund managers may have “incentives” to overstate their AUM. 44 The SEC has brought a number of cases (some of which are discussed above) against funds and fund managers challenging the accuracy of valuations and compliance with valuation procedures. The Commission's commitment in this area was underscored in 2012 when it took the step of charging eight former members of the Morgan Keegan board of directors with failing to oversee valuation procedures at the firm's underlying funds. 45 The SEC will continue to give close scrutiny to valuation issues across the asset management industry.
44 Bruce Karpati, Remarks before the Regulatory Compliance Association (Dec. 28, 2012).
45 SEC Press Release, SEC Charges Eight Mutual Fund Directors for Failure to Properly Oversee Asset Valuation (Dec. 10, 2012).
General Solicitations. One of the most significant recent changes to the securities laws came through the JOBS Act, which removed the decades-old prohibition on general solicitation of investors for private securities offerings. 46 The SEC rules implementing some of the major provisions of the JOBS Act went into effect in September 2013, and some private funds are now free to advertise and solicit investors directly. Under these provisions, sales are limited to accredited investors and an issuer must take reasonable steps to verify that all purchasers of the securities are accredited.
46 The SEC reports that private funds raised over $700 billion in 2012 under Rule 506 of Reg D. See Mary Jo White, Remarks at the Managed Funds Association Outlook 2013 Conference (Oct. 18, 2014).
Even as the ban on general solicitations was being lifted, the SEC was quick to emphasize that it would look closely at general solicitations to address any frauds as they occur. 47 Private fund managers should expect the SEC to be very proactive in monitoring this area.
47 See id.
As these various initiatives show, the asset management industry will be in the spotlight of regulators for years to come, and to a degree not seen in the recent past. The last three fiscal years have shown a near doubling in the number of cases the SEC brought against investment advisors and investment companies compared to 2009 and earlier. This trend is likely to continue as regulators try to tackle an industry with more than $50 trillion in assets under management in the U.S. alone.
Special Report Three-Member CFTC Continues Its Work, Pivots Toward Implementation Role in 2014
BNA Snapshot
Three, Not Five, Commissioners at CFTC
Key Development: Commission pushes ahead with initiatives as some hint at caretaker, transitional role until five
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commissioners are seated again.
Next Steps: Timing of Senate Agriculture Committee confirmation hearing for president's nominees to the commission uncertain.
COMMODITY FUTURES TRADING COMMISSION
By Stephen Joyce
Feb. 11 — The Commodity Futures Trading Commission is pushing ahead with a number of key initiatives and pressing for timely completion of agency obligations—despite the absence of two members, CFTC member Scott O'Malia said.
O'Malia, Acting Chairman Mark Wetjen and Commissioner Bart Chilton currently comprise the commission, which typically has five members. President Barack Obama has nominated successors to former commissioners Jill Sommers and former CFTC Chairman Gary Gensler as well as Chilton, who announced his intention to leave the agency in November. Even though the commission has less than five members and the Senate Agriculture Committee hasn't scheduled confirmation hearings for the nominees, O'Malia said in a Feb. 6 interview that the agency is “open for business and we're doing our jobs.”
Indeed, a source with knowledge of the situation told Bloomberg BNA that European and CFTC negotiators continue to work on a key agreement that, if finalized in a timely fashion, would permit qualifying European trading platforms to satisfy the requirements of a CFTC rule entering into force Feb. 15. Additionally, O'Malia listed several items CFTC commissioners are currently working to complete, such as continuing work to resolve differences between U.S. and non-U.S. regulators regarding derivatives trading rules and devising remedies associated with several temporary no-action relief letters.
The appointment of a single CFTC commissioner may influence Replacing 60 percent of the agency's agency deliberations, so replacing 60 percent of the agency's commissioners might materially commissioners might materially change agency priorities, change agency priorities, lawyers and lawyers and regulatory specialists said. Moreover, the envisioned change in leadership is anticipated as the agency's regulatory specialists said. overarching responsibilities mean it will pivot from an entity writing rules in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203) in 2013 to a rule implementer in 2014, practitioners said.
“You see an end of an era here,” former CFTC member Michael Dunn told Bloomberg BNA. “The majority of the Dodd-Frank regulations are out there and Gary's leaving. The next guy is going to have to wrestle with this. And it's going to be a tough job.”
Interregnum
Whether Wetjen will act as a caretaker chairman during the pendency of the nominations or try to effectuate longer-term CFTC policy is a subject of debate among CFTC observers.
Some private-sector lawyers with work experience at the agency told Bloomberg BNA that Wetjen may avoid making major policy decisions because the president has already demonstrated his preferred direction for the commission by nominating a new chairman. More generally, they said the changes within the commission will probably alter the milieu of both commission and staff.
Julian Hammar, of counsel at Morrison Foerster LLP and a former CFTC assistant general counsel, told Bloomberg BNA that while the work of the commission will continue—enforcement will continue to bring its cases, for example—he doesn't expect Wetjen to advance major policy initiatives.
Others disagreed, saying Wetjen has already demonstrated acute interest in certain CFTC policy areas, such as
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 31 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7 cross-border rules for derivatives trading. They pointed to meetings Wetjen attended in late January with European Commission officials in Brussels and the Financial Conduct Authority (FCA) in London as evidence of his desire to effectuate change in the area.
EC spokeswoman Chantal Hughes told Bloomberg BNA that Wetjen and other U.S. officials met with Jonathan Faull, director general for Internal Market and Services directorate, and others Jan. 23 to discuss several matters, including derivatives. Spokesmen for the CFTC and the FCA declined to comment on the meetings.
O'Malia: Moving Forward
O'Malia said the commission isn't waiting for the scheduling of any Senate confirmation hearing, much less the seating of new commissioners, before acting on a number of projects, chief among them work to implement rules approved in 2013 to implement Dodd-Frank. A key task is to address what he labeled as deficiencies associated with several no-action letters, previously announced, that provide temporary relief from Dodd-Frank requirements.
“There is no reason to wait to fix errors that we are aware of or must address,” O'Malia said. “I don't think anyone expects us to stop and wait for the new commissioners.”
“Listen, we've put together some big successes in the last week or two,” O'Malia said in the Feb. 6 interview, mentioning the issuance of guidance on the trading of certain interest rate swaps, the coordination of an interim final rule with other federal agencies regarding collateralized debt obligations (46 SRLR 108, 1/20/14), work with international regulators regarding cross-border Dodd-Frank compliance, and the scheduling of several committees and roundtables to explore in detail issues before the commission. .
“Without a doubt, we are operating with our eyes wide open,” O'Malia said. He labeled 2014 a “year of implementation” of already approved rules.
Additionally, CFTC is working on House-mandated reporting requirements, including the creation of a spending plan listing how the agency intends to spend its $215 million fiscal 2014 budget, and the design of a multiyear strategic information technology plan that has to be submitted to Congress, O'Malia said.
Through a spokesman, Wetjen declined to comment for this report.
Cross-Border SEF Action
A key contentious issue facing U.S. derivatives regulators and their European counterparts is the issue of when Dodd-Frank derivatives rules should apply to entities defined by Dodd-Frank and affiliated regulations as non U.S. persons and entities outside the U.S.
On Feb. 15 the CFTC's made-available-for-trading requirement goes into effect, which requires U.S. persons and certain non-U.S. persons subject to CFTC regulations engaging in specific swap trades—four types of interest rate swaps and two credit default swaps—to utilize a swap-execution facility or a designated contract market for the trade. The trades are also subject to clearing requirements (45 SRLR 957, 5/20/13; (46 SRLR 184, 1/27/14).
The CFTC and EC regulators are currently working to complete This will be a “year of implementation” an agreement that would allow entities to use European trading of already approved rules. platforms and still satisfy the obligations of the CFTC requirement, a source with knowledge of the negotiations told CFTC Member Scott O'Malia Bloomberg BNA. The agreement could be temporary, but it could also be a first step in establishing a permanent recognition regime by the U.S. of foreign trading platforms for the purposes of CFTC trading rules, the source said.
Chilton's Next Move
While Chilton said during a Nov. 5 public meeting that he had informed the president of his intention to leave the commission the same day, he remains an active CFTC commissioner.
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“Bart is still here and voting,” O'Malia said.
“I've been asked by many on the Hill to stick around as long as I can, and as long as my personal circumstances allow it, I'll do so,” he told Bloomberg BNA in a Jan. 30 e-mail. “That said, I still expect to leave in the near future.”
This isn't the first time the CFTC has operated with less than a full complement of commissioners. Between June 28, 2007, and Aug. 8, 2007, the commission counted just two individuals as commissioners: Dunn and former acting chairman Walter Lukken.
Chilton told Bloomberg TV Feb. 4 that upon leaving the CFTC, he hopes to work in a consumer advocacy role. “I'm looking forward to continuing to fight for consumers in any way I can. So we'll see what the future holds,” he said.
Commission Countenance
When the commission again has five members, sources said it is probable that the CFTC's countenance will change markedly. New commissioners bring their personal experiences and priorities with them to the commission, and those elements are sure to change the CFTC's direction, they said.
“When you replace 60 percent of the commission, it's going to be different,” said Dunn, now a senior policy adviser at Patton Boggs LLP. “When I first went onto the commission, I was a far-left winger. When I left the commission I was a centrist, even though I didn't change my positions,” he said. “The commissioners changed.”
While Wetjen has shown interest in cross-border regulatory matters, O'Malia continues to champion the importance of technology and market data improvements. A signal Chilton priority was establishing position limits for 28 physical commodity futures contracts plus swaps that are economically equivalent to those contracts.
No matter who is seated on the commission in 2014, agreement was voiced by virtually every practitioner interviewed for this report regarding the departure of Gensler, who injected a sense of importance and urgency into the commission's work finalizing rules to implement Title VII of Dodd-Frank, which regulates derivatives for the first time.
“He was the heart and soul behind Dodd-Frank, at least for derivatives regulation,” Hammar said.
Nominees
O'Malia is currently the lone Republican commissioner; Wetjen and Chilton are both Democrats. Wetjen was elected acting chairman Dec. 16 (45 SRLR 2345, 12/23/13).
Jill Sommers left the commission July 8, Gensler left Jan. 3, and Chilton has announced his departure. Obama nominated J. Christopher Giancarlo to succeed Sommers, Timothy Massad to succeed Gensler as chairman, and Sharon Bowen to succeed Chilton.
A spokesman for the Senate Agriculture Committee, which has jurisdiction over the CFTC, declined to comment on when a confirmation hearing or hearings might be held to consider the nominations of Giancarlo, Massad, and Bowen.
Giancarlo is an executive vice president at interdealer broker GFI Group Inc., where he is responsible for the company's strategic development and communications.
Massad is currently a Treasury Department assistant secretary, a job that required Senate confirmation. Previously, he worked in the Office of Financial Stability, which manages the Treasury Department's Troubled Assets Relief Program (TARP). Before joining the Treasury Department in 2009, Massad was a partner at Cravath Swaine & Moore LLP in New York.
Bowen is currently a partner and corporate lawyer at Latham & Watkins LLP. She also serves as the acting chairman at the Securities Investor Protection Corp., an organization created by federal statute that oversees
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 33 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
the liquidation of financially troubled or bankrupt broker-dealers.
To contact the reporter on this story: Stephen Joyce in New York at [email protected]
To contact the editor responsible for this story: Heather Rothman at [email protected]
State News Attorneys: Plaintiffs' Counsel Awarded $2.4M In Settlement of Del. Merger Dispute
BNA Snapshot
Award: Court awards plaintiffs' counsel $2.4 million in merger dispute.
Takeaway: Although there was no increase in the merger consideration, the court took into account additional disclosures and other benefits obtained by the plaintiffs.
Feb. 10 — The Delaware Chancery Court Feb. 5 awarded plaintiffs' class counsel $2.4 million in the settlement of a “complex” shareholder dispute over the acquisition of McMoRan Exploration Co. by defendant Freeport-McMoRan Copper & Gold Inc. ( In re McMoRan Exploration Co. Stockholder Litig., Del. Ch., No. 8132-VCN, 2/5/14).
In a letter ruling, Vice Chancellor John Noble noted that quantifying the benefits achieved by the plaintiffs is difficult, given that there was no increase in the merger consideration.
However, after considering other benefits—additional disclosures, a contractual commitment to obtain a listing of certain trust units on a national exchange, and limitation of an exemption from a supermajority-vote requirement—the court concluded that a $2.4 million award of fees and expenses is appropriate.
In a footnote, the court said the plaintiffs sought an award of $6 million. The defendants, on the other hand, suggested that $1.5 million “might be appropriate.”
Other Benefits
The court noted that the most important factor in awarding counsel fees is the benefit achieved by the plaintiffs for the shareholder class. In this case, it said, the parties disputed the value of the benefits received and in some instances, whether those benefits were fully attributable to the efforts of plaintiffs' counsel.
The court said the plaintiffs devoted approximately 5,700 hours of attorney time and incurred expenses of almost $320,000, including more than $200,000 in expert fees. It said the plaintiffs did not obtain an increase in the nominal consideration received by class members—$14.75 per share and 1.15 units of Gulf Coast Ultra Deep Royalty Trust, which held royalty interest related to production from some of MMR's then-existing properties
“The Plaintiffs decided not to pursue their price and process claims,” the court said. “Instead, they secured additional disclosures,” and a contractual commitment requiring the use of best efforts to list the trust units on a recognized national market.
The plaintiffs also claimed credit for certain revisions in the trust agreement and for restricting the scope of a proposed amendment of MMR's certificate so that Freeport only would be exempt from a supermajority vote requirement with respect to its merger with MMR. “Thus, if the merger did not occur, Freeport would return to being subject to the supermajority vote requirement.”
Listing
According to the court, the counsel fee debates centers on the listing provision. It said that while the contractual protection provided value for the shareholders, “[t]he difficulty is quantifying that value.”
Nonetheless, the court said, “[d]espite the absence of a reliable quantification of this benefit for the class
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members,” it warrants a fee in $400,000 to $600,000 range.
The additional disclosures, meanwhile, justify a fee in the range of $400,000 to $850,000, and the plaintiffs' efforts in preserving the supermajority feature supports a fee in the range of $250,000 to $400,000, the court decided. Finally, it said, revisions to the trust agreement merit a fee of between $400,000 and $750,000.
“After considering the foregoing,” the court concluded that an award of $2.4 million is appropriate.
Lawyers
The parties' attorneys include: Michael Hanrahan and Paul A. Fioravanti Jr., Prickett Jones & Elliott PA, Wilmington, Del.; Lewis H. Lazarus and Joseph R. Slights III, Morris James LLP, Wilmington, Del., Lisa A. Schmidt and Srinivas M. Raju, Richards Layton & Finger PA, Wilmington, Del.; Seth D. Rigrodsky and Brian D. Long, Rigrodsky & Long PA, Wilmington, Del., Collins J. Seitz Jr. and Bradley R. Aronstam, Seitz Ross Aronstam & Moritz LLP, Wilmington, Del.; and M. Duncan Grant and James G. McMillan III, Pepper Hamilton LLP, Wilmington, Del.
For More Information
To see the decision, go to http://www.bloomberglaw.com/public/document/CONF_ORD_CONS_WCA_8100_810 6_8107_8115_8117_8128__8151VCN_IN_RE_MC.
Corporate Governance: Directors Win Summary Judgment In Delaware Suit Over Answers Corp. Merger
BNA Snapshot
In re Answers Corp. S'holders Litig. , 2014 BL 27678, Del. Ch., C.A. No. 6170-VCN, 2/3/14
Key Holding: The Delaware Chancery Court grants the defendants' summary judgment in a consolidated shareholder lawsuit asserting breach of fiduciary duty claims against Answers Corp.'s board its merger with a private equity firm's portfolio company.
Key Takeaway: The board did not act in bad faith, nor did three allegedly conflicted directors control the board.
Feb. 10 — The Delaware Chancery Court Feb. 3 ruled in favor of Answers Corp. directors and rejected shareholder claims that they breached their fiduciary duties of loyalty in connection with a merger ( In re Answers Corp. S'holders Litig. , 2014 BL 27678, Del. Ch., C.A. No. 6170-VCN, 2/3/14).
Vice Chancellor John W. Noble, granting the directors' motion for summary judgment, held that the directors did not act in bad faith. The court also found that the merger was approved by an independent and disinterested majority of the board.
Before the merger, Answers was a Delaware corporation based in New York, operating Answers.com—a question and answer website. Answers's seven-person board included its founder and chairman, Robert Rosenschein, as well as Allen Beasley and Thomas Dyal—two partners of the company's largest shareholder, Redpoint Ventures. The court recapped that “it is uncontested” that besides Rosenschein, Beasley, and Dyal, the four remaining directors were disinterested directors.
In March 2010, AFCV Holdings LLC—a portfolio company of Summit Partners LP, a private equity firm—contacted Redpoint, expressing interest in a possible business combination with Answers. Around the same time, the court said, other entities also expressed interest in a possible business deal with Answers. After rounds of negotiations and conducting a market check for other potential buyers, the Answers board unanimously approved the transaction in February 2011. In April 2011, a majority of the company's shareholders approved the merger.
No Bad Faith
Several complaints challenging the transaction were filed and consolidated. In April 2012, the court refused to
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dismiss the plaintiffs' breach of fiduciary duty claims against the Answers board as well as their claim against AFCV for aiding and abetting the directors' breach of fiduciary duty (44 SRLR 836, 4/23/12). Subsequently, the defendants moved for summary judgment.
The court summarized that the plaintiffs' surviving claims are that Rosenschein, Beasley, and Dyal were “conflicted and controlled the negotiation process,” and that the Answers board acted in bad faith. Specifically, the plaintiffs argued that the Answers board purposefully engaged in a limited shopping process, willfully ignoring alternatives to the AFCV offer.
The court, however, disagreed, concluding that the Answers board did not act in bad faith. Nor did the three allegedly conflicted directors—Rosenschein, Beasley, and Dyal—control the board.
Contrary to the plaintiffs' assertion that the board engaged in a limited shopping process, the court explained, the Answers board “fielded a variety of unsolicited offers.”
Despite discussions with at least seven potential buyers, it continued, “no potential acquirer, other than AFCV, ultimately made an offer.” The board also rejected AFCV's request for exclusivity several times to preserve its right to negotiate with other buyers, the court said. There is “no evidence” that the Answers board “utterly failed” to comply with its fiduciary duties.
Further, the court held that the plaintiffs failed to prove that Rosenschein or Beasely or Dyal “dominated the board,” causing it to sell the company under allegedly unfavorable terms. The board's decision to sell the company is supported by various reasons “cognizable under the business judgment rule,” the court concluded. Finding no underlying breach of fiduciary duty, the court also granted AFCV's bid for summary judgment.
Attorneys
The plaintiffs were represented by Jessica Zeldin, Rosenthal, Monhait & Goddess PA, Wilmington, Del.; and Arthur N. Abbey and Karin E. Fisch, Abbey Spanier LLP, New York.
Answers and the director defendants were represented by Kevin R. Shannon, Berton W. Ashman, and Andrew E. Cunningham, Potter Anderson & Corroon LLP, Wilmington, Del.; and Jonathan M. Wagner, Adina C. Levine, and Susan Jacquemot, Kramer Levin Naftalis & Frankel LLP, New York.
AFCV was represented by William M. Lafferty and D. McKinley Measley, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Del.; and David J. Berger, Steven Guggenheim, Diane M. Walters, and Luke A. Liss, Wilson Sonsini Goodrich & Rosati PC, Palo Alto, Calif.
For More Information
To see the opinion, go to http://www.bloomberglaw.com/public/document/In_re_Answers_Corp_Sholders_Litig_ CA_No_6170VCN_2014_BL_27678_Del.
Futures Regulation Antifraud: Court Rebuffs Dismissal Challenge By Corzine, Others in Suit Over MFG Debacle
BNA Snapshot
Ruling: District court turns back dismissal motion by former MF Global CEO Jon Corzine, others in customer suit over FCM's collapse.
Takeaway: In a financial collapse of the magnitude “exhaustively” detailed by the plaintiffs, “it is reasonable to infer that someone, somewhere, at some time did something wrong.” However, the court dismisses claims against MFG's outside auditor, and certain common law claims against two former MFG officials.
Next Steps: The court gives the plaintiffs 21 days to file an amended complaint.
Feb. 11 — In one of many lawsuits stemming from the collapse of MF Global Holdings Ltd. and futures commission merchant MF Global Inc., the U.S. District Court for the Southern District of New York Feb. 11 allowed customers of the
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failed FCM to proceed with most of their claims against the entity's former chief executive officer Jon Corzine and other former MFG officers and directors ( In re MF Global Holdings Ltd. Investment Litigation (DeAngelis v. Corzine), S.D.N.Y., 11 Civ. 7866 (VM), 2/11/14).
However, Judge Victor Marrero dismissed the plaintiffs' allegations against MFG's outside auditor and some claims against two former MFG officials and gave them 21 days to file an amended complaint.
Minimal Threshold Met
In denying the bulk of the dismissal motion, the court commented that the plaintiffs' burden “is not onerous” at this stage of the litigation. To survive a dismissal challenge, assuming the truth of the allegations, the plaintiffs need only show that it is plausible the defendants are liable for the alleged misconduct.
“In a spectacular financial collapse of the magnitude that Plaintiffs exhaustively detail in their amended complaint,” the court said, “it is reasonable to infer that someone, somewhere, at some time did something wrong.”
Saying the complaint “meets that minimal threshold in many respects,” the court said the plaintiffs alleged “in ample detail what happened at MF Global during the summer and fall of 2011—not only that $1.6 billion of Plaintiffs' customer funds went missing from accounts at MF Global that were required to be segregated and secured, but that the money vanished because MF Global's entire senior management leadership, corporate accountability, and required oversight all went missing as well.”
Inconvenient Reality
The court said the director/officer defendants argued “that it is not even plausible that anyone of them could bear any responsibility for any part of the harm MF Global's disintegration caused.” However, the court rejoined, those defendants “cannot overcome the inconvenient reality” that, if true, the facts alleged “give rise to two reasonable inferences:
• that a massive collapse” like the one in this case “does not occur in a vacuum, nor in a corporate environment characterized by diligent management and vigilant oversight by officers and directors; and
• that senior MFG officials failed to carry out their legal obligations to the firm's customers.
However, the court dismissed aiding and abetting claims against former MFG general counsel Laurie Ferber and former MFG chief financial officer Christine Serwinski, and professional negligence and other claims against PwC. Among other specifics, the court said the plaintiffs did not allege that they had any direct contact with the audit firm—or even that they read the firm's audit.
For More Information
To see the decision, go to http://www.bloomberglaw.com/public/document/Deangelis_v_Corzine_et_al_Docket_ No_111cv07866_SDNY_Nov_03_2011_C/4.
Derivatives: CFTC Issues Interim Final Rule, Relief To Ease Move to Mandatory Swaps Trading Feb. 10 — The Commodity Futures Trading Commission issued an interim final rule Feb. 10 clarifying that a party to an anonymous trade executed on a swap execution facility or a designated contract market cannot access information in swap data repositories to obtain the identity of its counterparty.
The agency hailed the move as a way to incentivize anonymous trading on the platforms.
The same day, the agency and its staff took two other actions intended to support “an orderly transition” to mandatory swaps trading.
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First, the agency's Division of Market Oversight issued a no-action letter providing temporary relief—until May 15—from the trade execution requirement for certain swaps executed as part of a “package transaction” (CFTC No-Action Letter No. 14-12, 2/10/14) .
In a statement, Commissioner Scott O'Malia said the temporary relief “will provide staff with the time to perform the necessary analysis” on package transactions.
DMO also issued guidance Feb. 10 confirming that all market participants accessing a SEF, including customers of asset managers and introducing brokers, must consent to the jurisdiction of the platform.
SIFMA Plea
The guidance responded to a letter from the Securities Industry and Financial Markets Association's Asset Management Group asking CFTC staff to clarify that asset manager and introducing broker customers were not subject to the jurisdiction of a SEF (46 SRLR 233, 2/3/14).
It warned in a Jan. 24 letter to staff that requiring such parties to consent to a SEF's jurisdiction “would add little or no incremental benefit” for SEFs or the CFTC but would cause “unnecessary burdens” on asset managers.
The group said that if a client's consent to jurisdiction could not be obtained before a particular swap is required to be traded on a SEF or DCM, the manager would have to cease trading the contract in question on behalf of the client.
DMO, however, said in its guidance that “all market participants on a SEF that either directly or indirectly effect transactions” must consent to its jurisdiction as a prerequisite to access. Staff added that a SEF may comply with the jurisdiction requirement by including the rule in its rulebook; by doing so, it would not have to obtain written consent from a market participant.
Staff said the jurisdiction rule implements a SEF core principle requiring the platform to “establish and enforce compliance with any rule” that it establishes. It noted that in promulgating the jurisdiction rule, the CFTC said “market participants” are persons that directly or indirectly transact on a SEF, including parties “whose trades are intermediated.”
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The guidance can be seen at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/dmostaffguida nce021014.pdf. A letter to market participants, No. 14-12, can be seen at http://www.cftc.gov/ucm/groups/public/ @newsroom/documents/letter/14-12.pdf.
Derivatives: FIA Suggests Modifications To CFTC Aggregation of Positions Proposal Feb. 7 — The Futures Industry Association told the Commodity Futures Trading Commission Feb. 6 that it “generally supports” the agency's proposal on the aggregation of positions, but offered several changes that it said could improve the release.
The existing aggregation policy generally requires that, barring an exemption, a person must aggregate all positions for which it controls the trading decisions with all positions for which it has a 10 percent or greater ownership interest in an account or position. Two or more parties “acting pursuant to an expressed or implied agreement or understanding” also must aggregate.
The Nov. 5 proposal offers several new exemptions from aggregation rules, meaning more parties could disaggregate their positions and potentially steer clear of position limits (45 SRLR 2087, 11/11/13).
In a comment letter, FIA said the CFTC should clarify that the aggregation requirement would apply to two or
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more parties only when they agree they are trading contracts “pursuant to an express or implied agreement or understanding.”
FIA urged further that the proposal:
• clarify that an exemption would be available for entities that share trading and position information only for risk-management purposes, even if done on a real-time or on-demand basis. Without this exemption, it said, the proposal “may inadvertently limit beneficial and prudent risk-management activities”;
• permit the disaggregation of positions of majority-owned affiliates that demonstrate that their trading positions and decisions are subject to independent control, regardless of whether the parties are required to consolidate their financial statements. A consolidation requirement is based on accounting principles, FIA said, that are “wholly unrelated to the question of actual control of day-to-day trading decisions and positions”;
• permit registered broker-dealers to disaggregate any ownership or equity interest predicated on the ownership of securities acquired in the normal course of doing business as a dealer. The ownership will be temporary, FIA explained, and “will not implicate the independence of the owned entity's trading activity”;
• exempt banks and other financial institutions from aggregation requirements when they hold a transitory ownership or equity interest in an independently controlled entity that was acquired through foreclosure or a similar credit process. In many cases, FIA said, prior notice to the CFTC of intent to disaggregate “may not be possible”;
• offer a safe harbor for notice filings received up to 180 days after aggregation is required for entities that otherwise would qualify for an exemption. Such a safe harbor would “reduce regulatory uncertainty and potential liability” in situations where a party might unknowingly be subject to aggregation requirements, FIA said; and
• allow entities to aggregate the positions of an owned entity on a pro-rata basis, in proportion to their ownership or equity interest.
The comment period for the proposal closes Feb. 10.
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The letter can be seen at http://op.bna.com/srlr.nsf/r?Open=rhil-9g4s7k.
Futures Regulation: Senators Ask CFTC to Implement Data Sharing With FERC by End of Month Feb. 10 — Eight Democratic senators, led by the chairman of the Energy and Natural Resources Committee, Feb. 7 asked the Commodity Futures Trading Commission to begin sharing futures and swaps market trading data with the Federal Energy Regulatory Commission by the end of February.
In a letter to Acting CFTC Chairman Mark Wetjen, Sen. Ron Wyden (D-Or.) and the other signatories noted that the CFTC and FERC signed a memorandum of understanding in January that included provisions for information sharing. Congress directed the agencies to complete the MOU as part of the 2010 Dodd- Frank Wall Street Reform and Consumer Protection Act.
The information-sharing MOU was signed Jan. 2 and establishes procedures for the agencies to share information “of mutual interest” that is gleaned from market surveillance and other investigatory tools (46 SRLR 92, 1/13/14).
The senators told Wetjen that FERC investigators “have explained articulately and effectively that they need
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access to CFTC's Large Trader Report in order to oversee trading in fully integrated energy markets and prevent future manipulation.”
They asked the CFTC to “facilitate this data sharing as soon as possible,” adding that information sharing between CFTC and FERC “has been delayed for too long, putting our energy markets at risk of abuse unnecessarily.”
Technical Problems?
The senators told the CFTC that if technical issues are preventing the information-sharing—and if budget constraints prevent fixing those problems—the agency should tell Congress in its fiscal year 2014 spending plan, due to Capitol Hill Feb. 17.
“Considering the CFTC's technical ability to share data with other nations and other regulators, we believe that technical barriers preventing the sharing of information with FERC—a fellow arm of the federal government—could be addressed and solved in a matter of weeks under your direction and leadership,” they said.
In addition to Wyden, the letter was signed by Sens. Dianne Feinstein (D-Calif.), Barbara Boxer (D-Calif.), Elizabeth Warren (D-Mass.), Ed Markey (D-Mass.), Jeff Merkley (D-Ore.), Maria Cantwell (D-Wash.) and Carl Levin (D-Mich.).
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The letter can be seen at http://www.energy.senate.gov/public/index.cfm/files/serve?File_id=46b2025f- ff8e-477c-9d94-05ba664aec7b.
Futures Trading: CFTC Grants Relief Allowing E.U. Platforms To Host Swaps Subject to Execution Mandate Feb. 12 — The U.S. and the European Union Feb. 12 moved closer to closing a gap in derivatives regulation, as the staff of the Commodity Futures Trading Commission issued two no-action letters granting E.U.-regulated trading facilities temporary relief from having to register in the U.S. (CFTC No-Action Letters Nos. 14-15 and 14-16, 2/12/14).
The relief, announced at a news conference and in a joint statement by the CFTC and the European Commission, will expire when rules establishing procedures for foreign swaps trading platforms to come under CFTC oversight are adopted. However, qualifying E.U. trading platforms will have until March 24 to identify themselves to the CFTC and for their regulators to begin imposing the conditions of the relief.
Under CFTC rules adopted to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act, swaps that have been certified by CFTC staff as “made available to trade” must be traded on a CFTC-regulated swap execution facility or designated contract market. The relief will allow such contracts to trade on Europe's version of SEFs—multilateral trading facitlities—that meet certain reporting, clearing and other qualifying conditions, regardless of whether the platforms have been registered.
The relief, extended by the Division of Market Oversight, was necessary because while the U.S. is poised to begin mandatory trading of certain swaps beginning Feb. 15, the E.U. has yet to adopt a regulatory framework for its swaps trading platforms. The regulatory gap was anticipated, as was the relief, which was discussed in the “path forward” agreement between the CFTC and the E.U. that was hammered out in July (45 SRLR 1316, 7/15/13).
‘Practical Solution.’
In a conference call with reporters, Acting CFTC Chairman Mark Wetjen called the relief “a practical solution to
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[the E.U.'s] procedural challenges.”
The relief extends to MTFs that meet several requirements. Specifically, they must operate under certain execution protocols, such as order books, request for quote procedures and impartial access, that meet U.S. standards; require clearing for executed swaps; and have post-trade reporting standards and surveillance procedures. Wetjen said relief will be withdrawn without notice for any platform that falls short of those standards.
In a separate statement, Wetjen said the relief shows that the CFTC and the E.U. are “in a global race-to-the- top” in derivatives regulation. Michel Barnier, European Commissioner for the Single Market, said in a statement the relief is “an important further step in implementing a joined up, consistent global approach” to derivatives regulation.
Wetjen singled out the U.K. as being the European jurisdiction closest to adopting a regulatory framework for its swaps trading venues, saying it could happen in “a very short amount of time.”
Meanwhile, the acting chairman said he anticipated a rulemaking proposal “in a matter of weeks” that would establish procedures for foreign swaps trading platforms to seek CFTC regulatory treatment.
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Susan Jenkins at [email protected]
For More Information
The letters can be seen at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-15.pdf an d http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-16.pdf.
Futures Trading: FIA Tells CFTC Position Limits Proposal Exceeds Authority; Others Want Stronger Rule Feb. 11 — The Futures Industry Association Feb. 7 said the Commodity Futures Trading Commission's latest position limits proposal would “significantly restrict” market participants' ability to hedge risk and impose “substantial” compliance burdens and obligations.
In a comment letter, FIA said that “less costly and restrictive alternatives” exist, and that the agency should gather more data before going forward.
The letter was one of dozens received by the commission as its comment window for the proposal closed Feb. 10. While many trade groups contended that the CFTC overstepped its authority and failed to prove that limits are necessary, consumer groups and others said the proposal does not go far enough.
The CFTC proposed its position limits rule in November (45 SRLR 2087, 11/11/13), approximately a year after the U.S. District Court for the District of Columbia vacated an earlier position limits rule (44 SRLR 1882, 10/8/12) . In the lawsuit, the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association argued that the CFTC failed to show that position limits were necessary or to follow required procedures in its rulemaking.
In its letter, FIA urged the CFTC to defer action on its latest position limits proposal until it has collected enough data to show that limits are necessary. Barring that, it recommended 23 guidelines for the proposal, including:
• not imposing spot-month speculative position limits, and instead establishing position “accountability levels”;
• giving market participants the ability to make “commercially reasonable” decisions about whether to hedge components of portfolios of risk;
• permitting affiliated legal entities to rely on separate hedging exemptions, rather than requiring them to aggregate their positions; and
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• exempting swap execution facilities from any requirement to enforce position limits.
ISDA, SIFMA ‘Deeply Troubled.’
Meanwhile, in a joint Feb. 10 letter, SIFMA and ISDA said they “remain deeply concerned” with much of the proposal, and that they “continue to challenge” the CFTC's authority to impose limits at this time. Congress, they stated, “unambiguously directed” the CFTC in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act to meet “a series of standards and to make specific determinations of necessity and appropriateness” prior to proposing position limits.
They added that the agency again failed “to provide any meaningful consideration” of the costs and benefits of the proposal. ISDA and SIFMA made a similar claim in their 2011 challenge to the position limits rule, but the court made its decision on another basis.
If the CFTC does not withdraw the proposal, ISDA and SIFMA said, it should delete any requirement imposing position limits outside the spot month. Non-spot-month limits would be “arbitrary and capricious” and unlawful, they said. Instead, the commission should monitor non-spot-month levels and employ accountability levels, SIFMA and ISDA said.
For its part, SIFMA's Asset Management Group told the CFTC in a Feb. 10 letter that the agency has not met statutory requirements for creating speculative position limits—i.e., it has not shown that they are “necessary” or “appropriate.” At the same time, it said that if the agency proceeds with a position limits rule, it should withdraw or increase non-spot-month position limit levels; give SEFs and designated contract markets discretion in enforcing position limits rules; preserve the risk-management exemption from speculative limits; and exempt registered investment companies and retirement accounts from speculative limits, and counterparties to commodity index contracts if they are managing risk associated with positions related to such contracts.
Alternatives Sought
The Managed Funds Association, meanwhile, Feb. 9 urged the CFTC to continue studying data and consider “less onerous alternatives.” It said rulemaking in this area “should be empirically driven and not a response to popular sentiment or partial analyses.” In that vein, it said the CFTC “has not made an adequate finding” that limits are necessary.
MFA said the proposal “create[s] uncertainty” with respect to which contracts will be considered “reference contracts”—the 28 core physical commodity futures and options contracts and their economically equivalent swaps that will be subject to the limits. For instance, the group said it is concerned that the CFTC could determine retroactively that a customized over-the-counter swap is a referenced contract, “despite a good-faith determination” by a market participant that the swap is not a referenced contract.
MFA added that it does not support limits for any cash-settled contracts, and that the CFTC's approach to establishing non-spot-month and all-months-combined limits “is too simplistic” because it relies on a one-size- fits-all percentage of open interest applied to all reference contracts.
Meanwhile, in a Feb. 10 letter, the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness said the proposal would unnecessarily restrict hedging opportunities for commercial businesses and decrease liquidity and transparency in the referenced contracts. It added that the proposal fails to utilize current data—and that the commission cannot guarantee the accuracy of any data it might consider—to support the need for limits. The CFTC, it said, “continues to rely on soft, stale data.”
Strengthen Proposal
Other parties, however, urged the CFTC to strengthen its proposal. Sen. Carl Levin (D-Mich.), chairman of the Permanent Subcommittee on Investigations and a long-time proponent of position limits, told the CFTC Feb. 10 that the proposed rules “are critical to stopping price manipulation and excessive speculation, and promoting fairer pricing and efficient commodity markets.” According to Levin, the proposal contains “an extensive and convincing justification” for imposing limits.
At the same time, he said the proposed limits for spot-month cash-settled contracts are too high. The proposed
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holdings thresholds would “raise the affected position limits to levels where they would be effectively meaningless,” the senator said. In that vein, he continued, it would discourage use of physically delivered contracts. The CFTC, Levin said, “should strive to treat all speculators in an equal and dispassionate manner.”
The senator also urged the CFTC to ensure that traders seeking to use the bona fide hedging exemption be required to identify the specific risk they are seeking to hedge. The agency, Levin said, should design reporting requirements “to discourage traders from attempting to mask speculative trades under the guise of hedges.”
For its part, public interest group Better Markets Inc. said the proposal “falls short” and is “largely a failure” because it seeks position limits that are so high and narrow that they would not prevent excessive speculation “outside of the most egregious cases of manipulation.” The proposed limits, it said, seek to curb “extraordinary instances” of manipulation while failing to capture non-manipulative behavior that nevertheless skews markets.
Position limits, it stated, “were not intended to be limited to prevention of market manipulation.” Instead, they are meant to “reduc[e] the burden” that arises from speculation, which could amount to something just as significant as manipulation, Better Markets said.
Meanwhile, Public Citizen, another consumer-oriented group, echoed that the proposed limits are too high, “allowing traders wide latitude to unduly influence markets.” It added that the commission should revisit the limits annually instead of every two years, as proposed.
To contact the reporter on this story: Richard Hill in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
All position limit proposal comment letters can be accessed at http://comments.cftc.gov/PublicComments/Comm entList.aspx?id=1436. The FIA letter can be seen at http://www.futuresindustry.org/downloads/FIA_Position_Lim its_Comment_Letter_020714.pdf. The MFA letter can be seen at https://www.managedfunds.org/wp- content/uploads/2014/02/MFA-Position-Limits-final-2-9-14.pdf. The Better Markets letter can be seen at http://w ww.bettermarkets.com/sites/default/files/CFTC-%20CL-%20Position%20Limits-%202-10-14-%20Final.pdf.
Futures Briefs Distribution Plan Gets OK Over Bank's Objection Feb. 5 — A magistrate judge in the U.S. District Court for the Eastern District of Texas Feb. 4 recommended that the court approve a distribution plan related to a fraudulent forex investment scheme, notwithstanding a community bank's objection ( CFTC v. RFF GP LLC, E.D. Tex., No. 4:13- cv-382, 2/4/14; SEC v. White, E.D. Tex., No. 4:13-cv-383, 2/4/14
Ruling in companion enforcement actions against defendant Kevin White and various affiliated entities, the court explained that the “long and short of White's scheme was that he represented that his company had made astonishing returns in foreign exchange investments, when it had not, and that he utilized approximately $1.7 million of the investors' monies for his own personal expenses.”
According to the court, the distribution plan filed by court-appointed receiver Kelly Crawford received one objection. Specifically, Community Trust Bank filed a claim of $91,419.90—secured by certain of the defendants' assets—arising out of a promissory note. Crawford, it said, recommended that $700.16 on deposit at the bank be turned over, and that the remaining balance be allowed as an unsecured claim.
The bank objected to Crawford's plan to pay investors on a pro rata basis before paying anything to non- investor creditors. It contended that under the receiver's plans, no money would be left to pay it as a creditor.
However, Magistrate Judge Don Bush concluded that Crawford's plan of distribution is equitable. “It is not an easy call, and CTB makes a compelling argument on its behalf,” the court wrote. “However, courts regulatory grant defrauded investors a higher priority than defrauded creditors, and there is persuasive
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 43 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7
authority supporting this view.”
For More Information
To see the report and recommendation, go to http://www.bloomberglaw.com/public/document/US_Comm odity_Futures_Trading_Commission_v_RFF_GP_LLC_et_al_Docket.
Accounting Auditing: China Affiliates of ‘Big Four’ Petition SEC To Review ALJ Ruling on Audit Work Papers By Yin Wilczek
Feb. 12 — The China affiliates of the “Big Four” accounting firms Feb. 12 asked the Securities and Exchange Commission to review an initial decision finding that they violated the 2002 Sarbanes-Oxley Act by refusing to turn over the audit papers of certain clients ( In re BDO China Dahua CPA Co., SEC, Admin. Proc. File Nos. 3-14872 & 3-15116, 2/12/14).
In a petition, Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen (Special General Partnership), and PricewaterhouseCoopers Zhong Tian CPAs Ltd. argued that the initial decision contained numerous “erroneous conclusions of law and findings of fact.”
“The Initial Decision addresses an issue of first impression and of paramount importance to accounting firms around the world, the international capital markets, and, perhaps most importantly, relations between the SEC and its counterpart in China, the China Securities Regulatory Commission,” the petition said. “It also ignored critical exculpatory evidence, and proposed sanctions that are inconsistent with the law and which the SEC Division of Enforcement itself argued are manifestly not in the public interest.”
SOX Section 106
The initial decision—issued in January by Administrative Law Judge Cameron Elliot—concluded that the four firms and BDO China Dahua Co. Ltd. violated SOX Section 106 by failing to produce the work papers in connection with the SEC's investigations of their customers (46 SRLR 186, 1/27/14).
The ALJ found that “willful refusal” for purposes of the provision does not require proof of bad faith or bad intent. Instead, it means “‘choosing not to act after receiving notice that action was requested,’ without regard to good faith,” Elliot said.
The ALJ censured and barred all of the respondents, except BDO China Dahua, from practicing before the commission for six months. Elliot censured BDO China Dahua.
Following the decision, DTTC, E&Y Hua Ming, KPMG Huazhen and PwC Zhong Tian said they would seek commission review.
The accounting industry is closely watching the case, given the impact that it could have on China-based issuers that list in the U.S., and on U.S. companies with major operations in China.
The firms have maintained throughout the litigation that they are barred by Chinese law from producing the papers, and that a better resolution would be for the commission to obtain them through the Chinese authorities.
Exculpatory Evidence
In a separate filing, the four firms asked to be allowed to present evidence that they described as “critical to the proper resolution” of the case and that the ALJ declined to consider.
“In particular, this undisputed evidence shows that several sets of the workpapers at issue in this proceeding have been produced by the China Securities Regulatory Commission to the SEC, and that the CSRC is assisting the SEC in obtaining the remaining workpapers,” they said. “The ALJ nonetheless rejected the admission of the Supplemental Evidence on the grounds that it was a ‘better approach’ for the Supplemental
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Evidence to be adduced and analyzed upon review by the full Commission.”
The CSRC produced the work papers in connection with a lawsuit filed by the commission against DTTC in federal court, which has since been dismissed (46 SRLR 237, 2/3/14).
In related proceedings, ALJ Elliot Feb. 12 agreed to the firms' request to allow certain individuals to access the sealed version of his initial decision, which contains sensitive and proprietary information. The individuals include SEC staff, outside consultants retained by the parties and witnesses.
The firms, in asking for the access, argued that it was “critical to their ability to participate fully in their defense.”
To contact the reporter on this story: Yin Wilczek in Washington at [email protected]
To contact the editor responsible for this story: Phyllis Diamond at [email protected]
For More Information
The ALJ's order is available at http://www.sec.gov/alj/aljorders/2014/ap-1238.pdf.
Enforcement: SEC Appeals to Ninth Circuit Case Involving Water-Treatment Company Execs Feb. 11 — The Securities and Exchange Commission has appealed to the U.S. Court of Appeals for the Ninth Circuit a lower court judgment finding that the agency failed to show that two former water-treatment company executives engaged in accounting improprieties ( SEC v. Jensen, 9th Cir., No. 14-55221, 2/7/14).
In December, the U.S. District Court for the Central District of California rejected SEC allegations that Peter L. Jensen, Basin Water Inc. chief executive officer, and Thomas Tekulve Jr., the concern's former chief financial officer, improperly recognized revenue to disguise the company's true financial condition (45 SRLR 2353, 12/23/13).
Judge Manuel Real held that the “revenue recognition in this case was within the range of reasonable treatment and therefore consistent with” generally accepted accounting principles.
According to the briefing schedule set by the Ninth Circuit, the SEC's opening brief is due July 21. Jensen and Tekulve's response is due Aug. 20.
The SEC is represented by Karen Lynn Matteson and Roberto A. Tercero from the agency's Los Angeles office.
Jensen is represented by Jean Nelson, Overland Borenstein Scheper & Kim LLP, Los Angeles.
Tekulve is represented by Seth Alben Aronson and Carolyn Kubota, O'Melveny & Myers LLP, Los Angeles.
Accounting Briefs Exec Named Enforcement Division Chief Accountant Feb. 11 — The Securities and Exchange Commission announced Feb. 11 that Navigant Consulting Inc. executive Michael F. Maloney has been named Enforcement Division chief accountant.
In a release, the commission said Maloney currently is a managing director at Navigant, where he oversees the firm's forensic accounting practice. “He has led teams conducting complex forensic investigations in high-profile accounting, securities, and other fraud matters,” the SEC said.
In the release, it said Maloney began working at Navigant in 2002. He previously was a partner at Arthur Andersen LLP. Maloney also has served as an adjunct professor at Georgetown University's McDonough School of Business.
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Maloney earned his B.S. in Accountancy with high honors from the University of Illinois, the SEC recapped. He will join the commission later in February.
Howard Scheck, Maloney's predecessor in the Enforcement Division, stepped down to become a partner at KPMG LLP in the firm's Forensic Advisory Practice (45 SRLR 2096, 11/11/13).
No Action Letters Investment Advisers: SEC Issues No-Action Letter Regarding Definition of ‘Knowledgeable Employee' Feb. 7 — The Securities and Exchange Commission Division of Investment Management Feb. 6 issued updated guidance regarding the definition of “knowledgeable employees” under Rule 3c-5 of the 1940 Investment Company Act (Managed Funds Ass'n, SEC No-Action Letter, avail. 2/6/14).
In a release the same day, Managed Funds Association Executive Vice President Stuart Kaswell said the relief allows “more employees of fund managers to invest in their respective funds” while preserving “important investor protections.” According to MFA, it worked with the SEC staff in drafting the no-action letter, which it believes “represents a substantial improvement over the existing guidance” on the definition of knowledgeable employees.
‘Knowledgeable Employees'
In a letter signed by senior counsels Alpa Patel and Catherine Courtney Gordon, the SEC staff explained that “private funds” include private equity funds, hedge funds, and other pooled investment vehicles, which are excluded from the definition of an “investment company.” Investment Company Act Rule 3c-5 permits a knowledgeable employee of a private fund—“covered fund”—or a knowledgeable employee of an affiliated person managing the investments of a covered fund—“affiliated management person”—to invest in a covered fund, without being subject to certain conditions under Investment Company Act Section 3 that would otherwise apply.
The SEC staff clarified the definition of a knowledgeable employee by analyzing the various categories of the term under Rule 3c-5.
• Executive Officers: The staff explained that the first category of a knowledgeable employee includes an executive officer, a director, or a person serving in a similar capacity. The staff agreed with MFA that the principal status of a division, unit, or function depends on the facts and circumstances of a particular investment manager's business operations. Moreover, the staff explained that the division or the unit need not be part of the investment activities of a covered fund to be considered a principal, and that the size of the department is not “determinative as to whether a function should be considered principal.”
• Policy-Making Employees: The staff also agreed with MFA that an employee who does not have a senior management title may still be considered an executive officer under Rule 3c-5, if the employee “performs a policy-making function on behalf of the investment manager.” Further, employees can meet this standard individually or as a part of a group or a committee.
• Participating in Investment Activities: The second category of knowledgeable employee includes an employee whose regular duties include participating in the investment activities of a covered fund or investment companies managed by an affiliated management person of a covered fund. The staff clarified that an employee can be regarded as participating in the investment activities, even if his or her functions relate only to a particular portfolio and not the entire fund, or to a separate account.
• Related Advisers: The staff recounted that it recently stated that under certain circumstances, it would not recommend enforcement action if a “‘filing adviser' filed a single Form ADV on behalf of itself and ‘relying advisers' that are affiliated with the filing adviser as part of a single advisory business.” It agreed with MFA that a knowledgeable employee of a “filing adviser or any of its affiliated relying advisers” may be regarded as a knowledgeable employee “with respect to any Covered Fund managed by the filing adviser or its affiliated relying advisers,” as long as the entities are allowed to report on a single Form ADV.
Based on these representations, the staff confirmed that it will not recommend enforcement action against
© 2014 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service View at Bloomberg Law // PAGE 46 Securities Regulation & Law Report (BNA), 46 SRLR Issue No. 7 covered funds if they treat certain employees of covered separate accounts as knowledgeable employees. The staff further explained that other employees may also qualify as knowledgeable employees, depending on the facts and circumstances.
The letter recommended that investment managers maintain a written record of employees that have been “permitted to invest in a Covered Fund as knowledgeable employees” and should be able to explain why a particular employee qualifies as a knowledgeable employee.
For More Information
To see the no-action letter, go to https://www.managedfunds.org/wp-content/uploads/2014/02/Staff-Response- to-MFA-3c-5-Letter-Final-Outgoing-2-6-14-no-sigs.pdf.
To see the MFA's release, go to https://www.managedfunds.org/wp-content/uploads/2014/02/release-MFA- NoActionLetter_02-06-2014.pdf.
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