Corporate & Financial Weekly Digest : Corporate Finance Lawyers & Attorneys for Legal Developments in Business & Financial Services

Co-authored by Palash Pandya

On July 23, the Securities and Exchange Commission's Division of Corporation Finance issued a new Compliance and Disclosure Interpretation (CDI) in connection with the change to the definition of "accredited investor" under Rules 215 and 501 of the Securities Act of 1933 mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). As reported in the July 23 edition of the Corporate and Financial Weekly Digest, Section 413 of the Act excludes the value of a person’s primary residence from the calculation of net worth when determining an "accredited investor" under Rules 215 and 501(a)(5). CDI 179.01 (as well as CDI 255.47 which is identical), while confirming that the exclusion was effective upon enactment of the Act, also states that the SEC will issue amendments to its rules to conform them to the adjusted net worth standard in the Act. CDI 179.01 also states that while the value of the person's primary residence must be excluded when determining net worth for purposes of Rules 215 and 501(a)(5), pending implementation of the changes to the SEC rules, the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded when determining net worth for purposes of such Rules. However, indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted when determining net worth for purposes of Rules 215 and 501(a)(5).

In addition, the SEC's Division of Corporation Finance withdrew CDI 255.13, which provided that an investor may include the estimated fair market value of his principal residence as an asset for purposes of Rule 501(a)(5). The withdrawal was necessary to be consistent with Section 413(a) of the Act.

CDI 179.01 can be found here.

Katten's July 23 edition of the Corporate and Weekly Financial Digest can be found here.
 

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Co-authored by Jonathan Weiner

On July 27, Securities and Exchange Commission Chairman Mary Schapiro announced that the SEC is soliciting public comments in connection with regulatory initiatives required to be undertaken by the SEC pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). The SEC is generally required by law to establish a public comment period at the time it proposes rules or rule amendments. However, because of the volume of new regulations required by the Act and the time constraints imposed, the public will have the opportunity to express its views (and will have access to others’ views) on various topics requiring regulatory rulemaking and study under the Act even before the SEC proposes rules or amendments. To facilitate this process, the SEC has established a web-based platform for members of the public to submit and review comments on each of the various topics that will be subject to SEC rulemaking and study.

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Co-authored by Natalya S. Zelensky

The Securities and Exchange Commission has requested public comment regarding the effectiveness of the existing standard of care for brokers, dealers, investment advisers and their associated persons when providing personalized investment advice and recommendations about securities to retail customers. As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Act), the SEC is conducting a study on this subject and must submit a report on the study to the Senate and the House within six months after enactment of the Act. The SEC is seeking public input on a variety of issues regarding the obligations of brokers, dealers and investment advisers, particularly regarding the effectiveness of and whether there are gaps, shortcomings or overlaps in existing legal or regulatory standards of care for brokers, dealers and investment advisers when providing personalized investment advice and recommendations about securities to retail customers. At the completion of the study, the SEC will have the authority to write rules that would create a uniform standard of conduct for professionals who provide personalized investment advice to retail customers. The SEC will accept comments on or before 30 days from publication in the Federal Register.

Click here to read Securities and Exchange Commission Release No. 34-62577.

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The Commodity Futures Trading Commission has announced that it will amend its Regulation 190.04(d)(2) regarding the operation of a commodity broker in bankruptcy. Currently, a bankruptcy trustee is prohibited, immediately upon the commencement of the commodity broker’s bankruptcy case, from processing any new trades on behalf of customers of the commodity broker, with limited exceptions. Under the amended Regulation, bankruptcy trustees will be permitted, under appropriate circumstances as determined by the CFTC, to operate the business of the commodity broker in the ordinary course, including entering into new commodity contracts on behalf of customers.

The amendment will become effective 30 days from the date it is published in the Federal Register.

The CFTC press release can be found here.

The final rule can be found here.
 

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Co-authored by Joshua Penner

The National Futures Association (NFA) has set an effective date of January 3, 2011 for changes to its Compliance Rule 2-30 and the associated Interpretive Notice, which set out "know-your-customer" and customer risk disclosure requirements for NFA member firms.

The amended rules expand Compliance Rule 2-30 to cover all customers who are not eligible contract participants (rather than covering only natural persons, as is currently the case); require futures commission merchants (FCMs) to periodically request updated account information from their active customers; require the NFA member that currently solicits and communicates with a customer (whether the clearing FCM, a separate introducing FCM, an introducing broker or commodity trading advisor) to determine, based on any updated account information received by the clearing FCM, whether additional risk disclosure to the customer is necessary; and prohibit NFA members and their associated persons from making individualized recommendations to customers who have been (or should have been) advised that futures trading is too risky for them.

The NFA notice can be found here.

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Co-authored by Jonathan Rotenberg 

Plaintiff brought claims for federal securities fraud against defendants, alleging that defendants made false and misleading statements in a business plan which contained projections which were presented to prospective investors in a natural gas development. Plaintiff alleged that defendants used the projections to entice investors but never intended to take steps to effectuate the projections. The lower court granted defendants’ judgment as a matter of law after a trial, finding that plaintiff failed to show reliance on any material misrepresentation made by defendants.

The U.S. Court of Appeals for the Fifth Circuit affirmed. It held that defendants’ business plan contained only forward-looking projections of future performance which generally do not provide a basis for securities fraud. The Fifth Circuit also found that there was no basis to plaintiff’s claim that the defendants knew the projections contained in the business plan were false when made. Instead, the evidence showed that defendants completed the first phase of the business plan and had been diligently working to complete the next stage.

Arkoma Basin Project Limited Partnership v. West Fork Energy Co., LLC, 2010 WL 2711086 (5th Cir. June 29, 2010)

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Co-authored by Jonathan Rotenberg 

Plaintiff brought claims for securities fraud under Kentucky’s Blue Sky Laws in the U.S. District Court for the Western District of Kentucky, alleging that defendant convinced plaintiff to invest in International Tractor Co. (ITC), a purported supplier of heavy construction equipment. Plaintiff’s complaint alleged that the investments were in fact part of a Ponzi scheme perpetrated by defendant, and that plaintiff lost substantially all of his $1.6 million investment.

Defendant moved to dismiss plaintiff’s securities fraud claims on a variety of grounds, including that the agreement by which plaintiff invested in ITC was not a contract for the sale of securities, as is required to state a claim under the Blue Sky Laws. Defendant argued that the "common scheme or enterprise" prong of the test for whether a contract is one for securities was not met because the complaint failed to allege any sharing or pooling of funds of individual investors, and instead alleged that plaintiff’s investment was earmarked for specific purchases and was not combined with the investments of others.

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Federal agencies issued final rules on July 28 requiring residential mortgage loan originators who are employees of national and state banks, savings associations, Farm Credit System institutions, credit unions, and certain of their subsidiaries (agency-regulated institutions) to meet the registration requirements of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (S.A.F.E. Act). The final rules are being issued by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of Thrift Supervision, Farm Credit Administration, and National Credit Union Administration (the agencies).

The S.A.F.E. Act requires, subject to a de minimus exception, residential mortgage loan originators who are employees of agency-regulated institutions to be registered with the Nationwide Mortgage Licensing System and Registry (registry). The registry is a database created by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators to support the licensing of mortgage loan originators by the states. As part of this registration process, residential mortgage loan originators must furnish to the registry information and fingerprints for background checks. The S.A.F.E. Act generally prohibits employees of agency-regulated institutions from originating residential mortgage loans unless they register with the registry.

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Co-authored by Andrew Bridgman and Daniel Lange.

On July 16, the U.S. Department of Labor (DOL) issued interim final regulations that will require certain Employee Retirement Income Security Act (ERISA) retirement plan service providers to disclose information about services performed and fees received from such plans. While the current regulations do not apply to welfare plans, the DOL has indicated that it intends to publish separate regulations requiring welfare plan disclosures at a later date.

Compliance with the regulations’ disclosure requirements will be required for contractual agreements between service providers and retirement plans in order to qualify for an exemption from the prohibited transaction rules under ERISA and the Internal Revenue Code of 1986, as amended. In other words, noncompliance with the regulation would mean that the statutory exemption is not available for an agreement if a service provider is a party in interest with respect to the plan, thus making the service provider liable for taxes and penalties related to prohibited transactions. Certain plan fiduciaries may also incur liability if a prohibited transaction occurs, but the regulations contain a special provision to help diligent plan fiduciaries avoid liability.

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On July 26, HM Treasury launched a consultation (A new approach to financial regulation: judgment, focus and stability) on the reform of the UK financial services regulatory regime announced by the Chancellor of the Exchequer in June, as reported in the June 18, 2010 edition of Corporate and Financial Weekly Digest.

The Government considers that reforms must focus on three key areas: (i) macro-prudential regulation; (ii) improved prudential regulation of individual firms; and (iii) improved consumer protection and markets regulation.

The consultation document contains detailed reform proposals and the Government also proposes to establish three new regulatory bodies:

i. the Financial Policy Committee (FPC) designed to give the Bank of England increased power over macro prudential regulation and likely to be established on an interim basis before the end of 2010;

ii. the Prudential Regulation Authority (PRA), under the control of the Bank of England/FPC, to be responsible for supervising banks, other deposit-takers, broker-dealers, investment banks, insurers and certain other financial institutions. The PRA will be headed by a Deputy Governor of the Bank of England, initially the current Financial Services Authority Chief Executive, Hector Sants; and

iii. the Consumer Protection and Markets Authority (CPMA) which will regulate conduct of business.

The introduction of macro-prudential regulation is designed to correct a perceived prior lack of regulatory focus on systemic risk and the financial system as a whole.

The FPC is at the heart of the new system. Six of its eleven members will be from the Bank of England, and the Treasury will have a non-voting representative and a watching brief on behalf of the UK Government. The CPMA Chief Executive will also sit on the FPC. Along with the close cooperation between the FPC and the PRA, this is intended to ensure that potential systemic risks arising from activities monitored by the CPMA or the PRA will be taken into account in FPC decisions.

The consultation will close on October 18.

Read more.

Katten's June 18 edition of the Corporate and Weekly Financial Digest can be found here.
 

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On July 28, the UK Financial Services Authority (FSA) banned Stephen Coles, Luke Ryan and Michael Yamoah, the three directors of Simply Trading Group Limited (STG) (a small private client advisory stockbroker) from holding any financial services senior management positions.

Coles, Ryan and Yamoah shared responsibility for the management of STG, which specialized in telephone sales of securities traded on the London Stock Exchange and higher risk securities traded on the AIM and PLUS markets, through two “appointed representatives.”

The FSA investigation found that Coles, Ryan and Yamoah:

i. relied too heavily on an external compliance consultant for advice on how to run the compliance aspects of STG’s business;

ii. failed to make sure that STG met regulatory requirements, including capital resources and systems and controls requirements; and

iii. failed to monitor adequately their two appointed representatives, creating a serious risk that customers would received unsuitable investment advice. This included a failure to ensure that call monitoring equipment was in place at one of the appointed representatives.

As a result of the ban imposed on its three directors, STG no longer met FSA authorization requirements and its FSA permission to conduct investment business was cancelled.

Read more.

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On July 29, the UK Financial Services Authority (FSA) announced plans to update its Remuneration Code to take account of new remuneration rules required under the EU Capital Requirements Directive (CRD3).

The FSA’s current Code requires that firms apply ‘remuneration policies, practices and procedures that are consistent with and promote effective risk management.’ Although it is broadly consistent with CRD3 provisions, the FSA is required to make some changes to ensure full alignment.

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On July 19, the Committee of European Securities Regulators (CESR) published a consultation paper (CESR/10-610) on the standardization and exchange trading of over-the-counter (OTC) derivatives, seeking views on a number of issues, including:

• Exchange trading. CESR supports providing incentives to promote the use of organized trading venues for derivatives and is consulting on whether it would be desirable to make such usage mandatory.
• Standardization. CESR considers that greater standardization of OTC derivatives contracts could deliver efficiency benefits, although firms should be able to retain the flexibility to customize aspects of an OTC derivatives contract such as standard valuation, payment structures and payment dates. The consultation seeks views on how standardization can be increased. CESR is also considering recommending that the European Commission take regulatory action to make the use of electronic confirmation systems mandatory for European trading of OTC derivatives.

The consultation period ends on August 16. CESR intends to send technical advice to the Commission, based on responses to the consultation, in September 2010.

Read more.

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On July 29, the Committee of European Securities Regulators (CESR) published advice to the European Commission after conducting a reviewing of and consultation on the EU Markets in Financial Instruments Directive (MiFID) If adopted, the reforms proposed by CESR would significantly change the EU regulatory landscape.

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Two little-noted provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), enacted on July 21, have the potential to make less attractive a "safe harbor" exemption for private placements of securities currently available under the Securities Act of 1933, as amended (the '33 Act).

Rule 506 of Regulation D, promulgated under the '33 Act, has provided, subject to other provisions of Regulation D, a "safe harbor" for the sale of securities to an unlimited number of "accredited investors" as well as to no more than 35 sophisticated investors who are not "accredited investors." The Dodd-Frank Act provides for the narrowing of the definition of "accredited investor" and adds "bad boy" provisions to Rule 506 of Regulation D.

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Co-authored by Joshua Penner

The National Futures Association (NFA) has amended Sections 11(b) and (c) of the NFA Financial Requirements. These rules currently provide that a Forex Dealer Member (FDM) may include assets as current for purposes of determining adjusted net capital and as cover for currency positions, only if the assets are held at the following regulated entities not affiliated with the FDM: (1) a financial institution regulated by a U.S. banking regulator; (2) a broker-dealer registered with the Securities and Exchange Commission; (3) a futures commission merchant or a retail forex dealer registered with the Commodity Futures Trading Commission; (4) a state-regulated insurance company; or (5) a regulated foreign equivalent of such entities.

The amended rules remove regulated foreign entities from the list of regulated entities. However, the NFA will continue to have authority to approve the use of certain regulated foreign equivalents that are appropriately regulated and capitalized.

The amendments will become effective October 1.

The NFA notice concerning the amendments can be found here.

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Co-authored by Joshua Penner

The Commodity Futures Trading Commission will begin publishing a new report, entitled Traders in Financial Futures (TFF). The TFF report expands upon the disaggregation of data in the CFTC’s weekly Commitments of Traders (COT) Reports implemented by the CFTC last year.

The TFF report uses the same data that appears in the COT reports, but separates large traders in the financial futures markets into the following four categories: Dealer/Intermediary; Asset Manager/Institutional; Leveraged Funds; and Other Reportables. Like the COT reports, the TFF report provides a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. The report will be published in futures-only and futures-and-options-combined formats and will be published concurrently with the legacy COT. The TFF report is not a disaggregation of the COT data for the financial markets. The traders classified into one of the four categories in the TFF report may be drawn from either the “commercial” or “noncommercial” categories of traders in the legacy COT reports. The CFTC anticipates releasing four years of historical data for the new report.

The CFTC press release announcing the TFF reports can be found here.

Explanatory notes from the CFTC on the TFF reports can be found here.

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Co-authored by Joshua Penner

The Commodity Futures Trading Commission has determined that certain contracts traded on IntercontinentalExchange Inc. perform significant price discovery functions and, therefore, must be traded in compliance with the statutory provisions, including core principles, applicable to "significant price discovery contracts" (SPDCs).

A list of the relevant final orders declaring certain contracts to be SPDCs can be found here.

The CFTC press release can be found here.

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Co-authored by Joshua Penner

The Commodity Futures Trading Commission has released a list of 30 separate rulemakings that it must undertake to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act and is soliciting public input prior to publishing proposed rules for comment. The CFTC is generally required to promulgate these rules in 360 days from the date of enactment (July 21), although certain of the rules must be promulgated within 90, 180 or 270 days.

The CFTC has established a separate e-mail address for each of the rulemakings to which comments may be submitted. The email address for a particular subject can be accessed by clicking on the link below, and then clicking on the subject in question. The user will be directed to a page containing an email address to which comments should be addressed.

The list of rule-writing subjects and access to the email addresses to which comments should be directed can be found here.

The CFTC press release can be found here.

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See "Dodd-Frank Reform Bill May Put a Damper On Private Placements" in SEC/Corporate. For purposes of the "accredited investor" test under Regulation D, effective immediately, the value of an individual's primary residence is no longer included as a component of net worth. All issuers, including hedge and private equity funds, currently engaged in private placements in the U.S. relying on Rule 506 of Regulation D must update their subscription documents immediately and take this new standard into account for pending and future subscriptions that were not consummated prior to July 21.

Click here to read the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

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Co-authored by Joseph Iskowitz

On July 21, the Securities and Exchange Commission voted unanimously to adopt changes to Form ADV, Part 2. Commonly referred to as the “brochure,” Form ADV, Part 2 is the principal disclosure document that SEC registered investment advisers must provide to their clients and prospective clients. Currently, Form ADV, Part 2 consists primarily of a “check-the-box” format, in which investment advisers respond to a series of multiple-choice and fill-in-the-blank questions that are designed to inform investors of advisers’ qualifications, investment strategies, and business practices. Unfortunately, the current format frequently does not correspond well to an adviser’s business.

Under the amended rules, SEC-registered investment advisers are required to prepare a narrative, plain English, brochure, presented in a consistent, uniform manner that will make it easier for clients to compare different advisers’ disclosures. The new brochure will contain enhanced disclosures on those topics the SEC believes are most relevant to clients, including, a description of: the adviser’s business, fees and compensation, performance-based fees and side-by-side management (with an explanation of any conflicts of interest that arise from the simultaneous management of accounts that are charged a performance fee and accounts that are not and how the adviser addresses those conflicts), methods of analysis and investment strategies and the attendant risks of loss, disciplinary information material to a client’s evaluation of the adviser's business and the integrity of its management, the adviser's code of ethics and the nature of its participation or interest in client transactions and personal trading and factors it considers in selecting broker-dealers.

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Co-authored by Jessica Garrett

A Connecticut federal district court recently denied a motion for summary judgment by an individual, Gary Richetelli, seeking dismissal of claims brought in an enforcement action by the Securities and Exchange Commission. The SEC alleged that Richetelli carried out a fraudulent stock purchase scheme in violation of Section 10(b) of the Securities Exchange Act of 1934 by providing several New Haven Savings Bank depositors with the financing to obtain shares of newly-issued stock through the bank’s initial public offering (IPO) in exchange for repayment of the loans in full shortly after the IPO, as well as payment of the majority of the profits from the sale of those shares. The terms of the IPO prohibited such arrangements and each of the depositors executed stock order forms in which they declared under oath that they were “purchasing solely for [their] own account, and there is no agreement or understanding regarding the sale or transfer of the shares or the right to subscribe for the shares.”

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Co-authored by Jessica Garrett

The Securities and Exchange Commission recently brought an enforcement action against six former officers and directors of Fischer Imaging Corporation (Fischer), a designer, manufacturer and seller of medical imaging systems used for the diagnosis and screening of diseases. The SEC alleged that the officers and directors engaged in a fraudulent scheme to inflate reports of Fischer's profits by improperly recording income from sales transactions that were not complete. Contrary to Generally Accepted Accounting Principles, Fischer recognized income when equipment was shipped to Fischer-controlled warehouses, where the equipment was stored and insured by Fischer for significant periods of time before purchasers were ready to accept delivery (“ship in place sales”).

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On July 22, the Securities and Exchange Commission released a staff report recommending that life settlements be clearly defined as "securities" for purposes of the federal securities laws in order to better protect investors.

The report was prepared by the Commission's Life Settlements Task Force, which had been created in August 2009 to examine emerging issues in the life settlements market and to advise the Commission on the need to improve market practices and regulatory oversight. The Task Force is comprised of members from multiple divisions of the Commission, including Corporation Finance, Enforcement, Investment Management, and Trading and Markets.

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Co-authored by Michael Durnwald

On June 25, President Obama signed legislation that provides short-term funding relief to sponsors of underfunded defined benefit pension plans. The new law, known as the Preservations of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (the Relief Act), permits temporary modification of existing pension funding rules by allowing plan sponsors of single-employer plans to elect one of two methods for delaying payments to pension plans. By delaying those payments, sponsors should have more cash available in the short term to help fund ongoing operations—a result which is likely to be seen as a benefit to many plan sponsors given recent economic turmoil. However, because the delay methods do not decrease the net amount that must eventually be contributed to a pension plan, use of the Relief Act provisions will likely result in contributions for later years being larger than they otherwise would have been. Sponsors should keep in mind the probable effect of increased contributions in later years when deciding how to satisfy their plan funding obligations.

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On July 16, HM Revenue and Customs (HMRC) published a revised version of its anti-money laundering guidance for money services businesses which it supervises. The revised guidance addresses issues arising under the Counter-Terrorism Act 2008. HMRC also stated that guidance for e-money issuers will be incorporated into a further revised version of the guidance which will be issued shortly.

Read more.

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On July 19, the UK Financial Services Authority (FSA) announced that it had fined Jeremy Burley £144,200 (approx. US$219,700) and his father, Jeffery Burley, £35,000 (approx. US$53,300) for market abuse in relation to the shares of Tower Resources plc (Tower), an oil and gas exploration company, in June 2009.

Jeremy Burley, a British citizen resident in Uganda, was at the relevant time the Managing Director of BMS Minerals, a Ugandan company which provided vehicles and equipment to oil and gas exploration companies in Uganda, including Tower Resources. Jeffery Burley opened a share trading account in the UK, which he used to trade shares on behalf of his son.

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On July 20, the UK Financial Services Authority (FSA) announced that it had secured £3,717,000 (approx. US$5,660,000) in compensation for investors in an unauthorized collective investment scheme operated by Upton & Co. Accountants Limited (Upton), owned and controlled by Darren Upton, a member of the Association of Chartered Certified Accountants.

The Wakefield-based firm, which was not authorized by the FSA to do so, operated a collective investment scheme known as the “Currency Plan” promising investors high rates of return allegedly derived from foreign exchange investments. However, limited foreign exchange trading occurred and very little was ever returned in cash.

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On July 19, the Committee of European Securities Regulators (CESR) published consultation paper CESR/10-809 setting out proposals for transaction reporting for over-the-counter (OTC) derivatives and the extension of the scope of transaction reporting obligations.

CESR’s OTC derivatives transaction reporting proposal is based on the assumption that all persons not exempted from European Market Infrastructure Legislation (EMIL) (including Markets in Financial Instruments Directive (MiFID) authorized firms) would have to report their OTC derivatives transactions to trade repositories (TRs) after these will have been established and registered under EMIL.

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On July 20, the Committee of European Securities Regulators published the following four consultation papers on the key investor information document (KII) under the Undertakings for Collective Investments in Transferable Securities (UCITS) Directive (2009/65/EC) (knows as “UCITS IV”).

• A consultation on level 3 guidance on the selection and presentation of performance scenarios in the KII for structured UCITS (that is, certain types of capital-protected and guaranteed UCITS). Read more.
• A consultation on guidelines for the transition from the simplified prospectus to the KII. Read more.
• A consultation on a guide to clear language and the layout for the KII. Read more.
• A consultation on a template for the KII. Read more.

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Yesterday, the Senate approved the Dodd-Frank Wall Street Reform and Consumer Protection Act with no changes to the governance provisions of the Conference Committee version of the bill. President Obama is expected to sign it in the near future. The bill includes significant changes to corporate governance and executive compensation and disclosure applicable to publicly traded issuers. Provisions address say on pay, proxy access, compensation clawbacks, compensation committee independence and further restrictions on broker discretionary voting.

Click here to read the Katten Client Advisory providing a more detailed discussion of these Dodd-Frank provisions.
Click here to read the bill.

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On July 9, Securities and Exchange Commission Chairman Mary Schapiro spoke at the National Conference of the Society of Corporate Secretaries and Governance Professionals in Chicago about upcoming SEC governance and disclosure rulemaking.

In particular, following enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC will be focusing on drafting implementing rules and initiating studies as directed by the Act. The staff will also be reevaluating all of the corporate issuer filing forms and disclosure requirements to confirm the current relevancy and comprehensiveness of the information. The SEC expects to act quickly as to recommendations for revision of the risk disclosure requirements and to consider more comprehensive changes such as changing filing formats so that basic information can be more easily updated by companies and used by investors.

Chairman Schapiro noted that the “SEC’s job is not to define for the market what constitutes ‘good’ or ‘bad’ governance, in a one-size-fits-all approach. Rather, the SEC’s job is to ensure that its rules support effective communication and accountability” among shareholders, directors and executives.

Read more.

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Co-authored by Blase J. Kornacki

On July 14, the Securities and Exchange Commission unanimously approved the long-awaited concept release on mechanics of proxy distribution and collection. The release marks the Commission’s first public review of the proxy voting system in nearly 30 years. Highlighting that the proxy process is the principal means of communication between companies and investors, SEC Chairman Mary Schapiro stressed that the “transmission of this communication must be—and must be perceived to be—timely, accurate, unbiased, and fair.” The SEC hopes that the release will help guide the agency’s revisions of proxy mechanics and ensure that all market participants are afforded adequate proxy access.

The release solicits public comment on a number of key issues in three main areas: (1) accuracy, transparency and efficiency of the proxy voting process, (2) communication and shareholder participation, and (3) the relationship between voting power and economic interest. Within this framework, the release comprehensively analyzes a number of specific topics including:

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Co-authored by Natalya S. Zelensky and Louis Froelich

The Securities and Exchange Commission has approved Financial Industry Regulatory Authority amendments to its BrokerCheck system to expand the information released through BrokerCheck and establish a formal process to dispute the accuracy of or update information disclosed through BrokerCheck. A significant change is that FINRA has expanded the disclosure period for a FINRA member’s formerly associated persons from two years to ten years. Additionally, the conditions that must be met before “Historic Complaints” are displayed in BrokerCheck will be eliminated, and consequently, all Historic Complaints that were archived after the implementation of the Central Registration Depository on August 16, 1999, will become publicly available through BrokerCheck.

FINRA also will make publicly available on a permanent basis information regarding formerly associated persons, regardless of the time elapsed since such persons were associated with a FINRA member, if, among other things, they pleaded guilty or were convicted of a crime, were the subject of an investment-related civil injunction or court finding or were named in legal proceedings that resulted in an arbitration award or civil judgment against such person. Anticipating increased demand to ensure the accuracy of information displayed through BrokerCheck, FINRA also has formalized the process for brokers to dispute the accuracy of such information and will allow brokers to submit a written dispute notice and supporting documents to FINRA using an online form.

Click here to read Securities and Exchange Commission Release No. 34-62476.

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Co-authored by Natalya S. Zelensky and Louis Froelich

The Securities and Exchange Commission has approved a Financial Industry Regulatory Authority rule proposal to increase the number of arbitrators on lists generated by the “Neutral List Selection System,” a computer system that generates random lists of arbitrators from FINRA’s roster of arbitrators for arbitration cases. FINRA stated that increasing the number of arbitrators on such lists will increase the odds that parties will be appointed arbitrators they have chosen and ranked.

Click here to read Securities and Exchange Commission Release No. 34-62480.

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Co-authored by Christian B. Hennion

The Commodity Futures Trading Commission has proposed to issue new regulations under which the CFTC would collect account ownership and control information on a weekly basis from reporting entities from designated contract markets (DCMs), exempt commercial markets (ECMs) that list significant price discovery contracts, and foreign boards of trade that provide direct access to U.S. market participants. The CFTC Notice follows an Advanced Notice of Proposed Rulemaking on the same topic that was published for comment in July 2009, and incorporates certain changes made in response to comments received on the Advance Notice. Under the proposed rules, various account ownership and control information, including identifying and contact information with respect to both beneficial owners and account controllers, whether the account is traded pursuant to an automated system, the executing and clearing brokers, and an indication of whether the account is a firm omnibus account, will be collected by the CFTC via an account Ownership and Control Report.

The comment period for the Notice of Proposed Rulemaking will end 60 days after the publication of the Notice in the Federal Register. A copy of the Notice is available here.

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Co-authored by Christian B. Hennion

The Commodity Futures Trading Commission has published proposed rules that would establish standards for the recovery and resumption of operations by certain designated contract markets (DCMs) and derivatives clearing organizations (DCOs). The proposed standards would apply to DCMs that are determined by the CFTC to be “critical financial markets,” as well as to the DCOs for those markets, and would require any such DCM or DCO to establish and maintain business continuity and disaster recovery plans and resources (including appropriate geographic dispersal of personnel and infrastructure) sufficient to satisfy an objective of resuming trading and clearing operations on a same-day basis.

The comment period for the Notice of Proposed Rulemaking will end 30 days after the publication of the Notice in the Federal Register. A copy of the Notice is available here.

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Co-authored by Gregory C. Johnson

An energy firm may be liable for adopting the business plan of a prospective partner even though the appropriated plan was not unique enough to support a claim under New York’s “submission of an idea” doctrine.

The principals of Sokol Holdings, Inc. sought the rights to develop oil fields in western Kazakhstan and devised a plan to obtain a controlling interest in Emir Oil, LLP, a Kazakh firm licensed to conduct such exploration. Sokol presented this plan, which contained a confidentiality provision, to BMB Munai, Inc., which would provide initial financing under the plan. When BMB later withheld the initial financing and acquired Emir Oil on its own, Sokol sued for breach of contract under New York’s “submission of an idea” doctrine, as well as for unfair competition and unjust enrichment.

BMB sought dismissal, arguing that Sokol’s business plan was not novel enough to support a claim for breach of the confidentiality clause, and that the other claims were predicated on this purported breach. The U.S. District Court for the Southern District of New York agreed that Sokol’s plan lacked the uniqueness required for the breach of contract claim. But the court also ruled that BMB’s appropriation of Sokol’s work supported its claims for unfair competition and unjust enrichment and denied dismissal of those claims. (Sokol Holdings, Inc. v. BMB Munai, Inc., 2010 WL 2605842 (S.D.N.Y. June 29, 2010))

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Co-authored by Gregory C. Johnson

A former senior employee and member of a limited liability company can pursue his securities fraud claim against the firm and its managing member because his passive investment in the company supported a claim under Section 10(b) of the Securities Exchange Act of 1934.

Christopher Shirley was a member and senior trader of investment company JED Capital, LLC, and developed several of JED’s trading systems while receiving a share of the profits he generated. JED’s managing member convinced Mr. Shirley to invest $250,000 in the company by promising him that the funds would be used to expand JED’s trading operations. The manager actually funneled funds to his other ventures, according to Mr. Shirley, and Mr. Shirley sued JED and its manager for violating Section 10(b).

The defendants contended that Mr. Shirley was not a passive investor, and thus failed to state a Section 10(b) claim, because he received a portion of JED’s profits as compensation and because he was involved in JED’s daily operations. The U.S. District Court for the Northern District of Illinois rejected this argument, holding that Mr. Shirley’s inability to control how JED deployed its capital showed that he was sufficiently dependent on the entrepreneurial actions of the manager to support his federal claim. (Shirley v. JED Capital, LLC, 2010 WL 2721855 (N.D.Ill. July 8, 2010))

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On July 12, the four bank regulatory agencies, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Office of Thrift Supervision (OTS), and the Federal Deposit Insurance Corporation (FDIC) entered into a Memorandum of Understanding (MOU) that enhances the FDIC’s existing backup authority over insured depository institutions that the FDIC does not directly supervise. These institutions include national banks, federal savings associations and savings banks, and state-chartered banks that are members of the Federal Reserve System.

According to a press release issued by the FDIC, “[t]he revised agreement will improve the FDIC’s ability to access information necessary to understand, evaluate, and mitigate its exposure to insured depository institutions, especially the largest and most complex firms. FDIC Chairman Sheila Bair said: “The FDIC needs to have a more active on-site presence and greater direct access to information and bank personnel in order to fully evaluate the risks to the deposit insurance fund on an ongoing basis and to be prepared for all contingencies.”

Specifically, the revised MOU gives the FDIC backup supervision authority under an expanded list of circumstances, including when the insurance pricing system suggests an insured depository institution might be at higher risk, when institutions are defined as “large” under international regulatory guidelines, or when large, interconnected bank holding companies are defined as “systemic” by the financial reform legislation passed by Congress. At large, complex insured depositary institutions, the FDIC will establish an expanded continuous, full-time staff presence on-site.

In a public statement supporting the MOU, Comptroller of the Currency John Dugan, who serves on the FDIC’s Board of Governors, noted “a critical need that, in carrying out this important FDIC function, nothing be done to undermine the primary supervisory responsibility and accountability of the primary federal regulator.” According to Chairman Bair, ”[t]he FDIC supports the role of the primary federal regulator and has no interest in infringing upon their authorities. However, the FDIC has needs that are separate and distinct from the primary federal regulator that must be met in order to satisfy our statutory responsibilities.” Neither the Federal Reserve nor the OTS issued a formal press release with respect to the MOU.

According to a memorandum prepared by three FDIC division directors and approved by FDIC General Counsel Michael Bradfield, “[t]his proposal addresses the recommendations made by the FDIC and Treasury Inspectors General.... In particular, the MOU explicitly provides that it does not limit the authority of the FDIC to make Special Examinations of [insured depository institutions] both covered and uncovered by this MOU....”

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On July 15, the U.S. Senate voted to pass the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173), which contains, among other things, provisions addressing risk retention, conflict of interest issues, and the treatment of Nationally Recognized Statistical Rating Organizations (NRSROs) under existing securities laws. The bill will now go to President Obama for his signature. The bill contains a 5% risk retention requirement for issuers of “asset-backed securities”, including collateralized debt obligations, but exempts “qualified residential mortgages.” For commercial mortgaged-backed securities, specified alternative forms of retention for commercial mortgages “may” be accepted as alternatives to retention, at the discretion of federal regulators. Additionally, portions of the bill will remove exemptions for NRSROs under Rule 436(g) of the Securities Act of 1933, which currently excludes NRSROs from being treated as “experts” when their ratings are used for a registered offering, and under Regulation FD. The legislation also amends the Securities Act of 1933 to prohibit any sponsor, underwriter, or placement agent of an asset-backed security, or any affiliate of any such entity, from engaging “in any transaction that would involve or result in any material conflict of interest…”

Please click here for the unofficial conference report of H.R. 4173.

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On June 22, interim final regulations were issued regarding the “Patient’s Bill of Rights” requirements of the Patient Protection and Affordable Care Act of 2010 (PPACA), Pub. L. No. 111-148. These regulations were released jointly by the Departments of Health and Human Services, Labor (DOL) and Treasury. The regulations provide examples, safe harbors and other provisions helpful to the implementation of PPACA.

These rules are generally applicable to all group health plans for plan years starting on or after September 23, 2010, including “grandfathered” plans. This includes the annual dollar limits, the lifetime dollar limits, prohibition on preexisting condition exclusions and prohibition on coverage rescissions. However, the “patient protection” provisions do NOT apply to grandfathered plans.

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On July 14, the UK Takeover Panel announced the decision of the Takeover Appeal Board to uphold the decision of the Hearing Committee of the Takeover Panel to ban Daniel Posen, Brian Myerson and Brian Padgett for three years from all dealings with any person registered with the Financial Services Authority.

The Appeal Board upheld the finding that in March 2009, 6.7 million shares of Principle Capital Investment Trust Plc (PCIT) were acquired by Messrs. Posen, Myerson and Padgett acting jointly as a “concert party.” In a deliberate attempt to circumvent the requirement under Rule 9 of the City Code on Takeovers and Mergers to make an offer to shareholders of PCIT generally, they purported to be acting separately rather than as a concert party. When the Takeover Panel investigated the transaction, in breach of their obligations to assist the Panel, Messrs. Posen, Myerson and Padgett attempted to conceal the circumstances relating to their acquisition of PCIT shares and to present a false picture.

This type of ban, known as “cold shouldering,” is the first imposed by the Takeover Panel since 1992. It is effectively a three-year ban on any UK financial services or mergers and acquisition activity for the three men concerned.

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Co-authored by Frank Zarb

The Securities and Exchange Commission has announced that it will hold an open meeting on July 14 to consider issuance of its long-anticipated concept release on proxy mechanics. The concept release is expected to cover a wide variety of topics relating to shareholder communication and proxy voting. The topics may include whether investors should continue to have the right to maintain the confidentiality of their investments (the “NOBO/OBO” mechanism), ways to increase retail shareholder voting (e.g., “client directed voting”), the structure of the overall system for distribution of proxy materials, including the fees paid by issuers, and whether the SEC should adopt additional regulations governing the activities of proxy advisors retained by institutional investors. We anticipate a 90-day comment period, and encourage all interested parties to weigh in on these important topics.

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On June 30, the Securities and Exchange Commission announced that the exchanges and the Financial Industry Regulatory Authority filed proposed rules to expand the newly adopted stock-by-stock circuit breaker program. Trading in a security included in the program is paused for a five-minute period if the security experiences a 10% change in price over the preceding five minutes. Currently, only stocks in the S&P 500 Index are subject to stock-by-stock circuit breakers. Under the new proposal, all stocks in the Russell 1000 Index and certain exchange-traded funds would be added to the program.

The proposed rules, which are expected to be in effect on a pilot basis until December 10, will be published in the Federal Register for a 10-day public comment period.

To read the SEC’s order implementing the stock-by-stock circuit breaker program, click here.

See also the June 11 edition of Corporate and Financial Weekly Digest discussing the SEC’s approval of rules requiring the exchanges and FINRA to implement stock-by-stock circuit breakers.

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The Securities and Exchange Commission has reopened the period for public comment on its proposal to eliminate the flash order exception set out in Rule 602 of Regulation NMS, solely as it relates to listed options. Flash orders generally are orders that are exposed to market participants for a very brief period (typically less than a second) and are immediately executable at prices that “lock” the best displayed quote on the opposite side of the market (without such order being routed away to another market for execution). In September 2009, the SEC previously proposed to amend Rule 602 of Regulation NMS to eliminate the exception which allows exchanges to permit the use of flash orders for trading both NMS stocks and listed options without including such orders in the exchange’s consolidated quotation data.

In reopening the comment period on the proposed rule change with respect to listed options, the SEC has specifically requested comment on a number of issues, including the relationship between flash orders and access fees charged by options exchanges (including the advisability of a cap on such access fees), the relative quality of execution received by flash and non-flash orders in listed options, how brokers assess whether flashed orders receive “best execution” and whether the elimination of the flash order exception would lead to more aggressive quoting by options exchanges (and corresponding narrowing of “national best bid and offer” spreads for listed options).

The comment period closes on August 9.

A copy of the SEC release is available here.

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On June 22, the Securities and Exchange Commission approved rule changes that the Financial Industry Regulatory Authority proposed in August 2009 that would extend certain of the rules that apply to National Market System securities to over-the-counter (OTC) equity securities. The new rules:

• prohibit FINRA members from displaying, ranking or accepting a bid or offer, order or indication of interest in an OTC equity security in an increment smaller than one cent where such bid or offer, order or indication of interest is one dollar or more per share;
• require that FINRA members implement policies and procedures to prevent displaying, locking or crossing quotations in an OTC equity security within the same inter-dealer quotation system;
• allow market-makers, alternative trading systems and electronic communications networks to charge undisplayed access fees and limit non-subscriber access and post-transaction fees in all OTC equity securities; and
• require a market-maker displaying price quotations in an inter-dealer quotation system to immediately display any customer limit order it receives that improves (1) the price of a bid or offer or (2) the size of its bid or offer by more than a de minimis amount, with certain exceptions.

The SEC Release No. 34-62359 is available here.

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Co-authored by Brian Schmidt

The U.S. District Court for the District of Delaware denied defendants’ motion to dismiss an Employee Retirement Income Security Act (ERISA) complaint, ruling among other things that plaintiffs properly alleged facts to reach the corporate parent defendants on a theory of piercing the corporate veil.

Plaintiffs, former employees of two subsidiary companies named as defendants, brought a series of claims alleging that their former employer failed to make payments due under the company’s group severance plan following a period of layoffs. In addition to the subsidiary defendants, plaintiffs also named two corporate parent entities. Plaintiffs made a variety of factual submissions supporting their veil-piercing argument including, for example, that the parent defendants retained a 77% shareholder interest on one of the subsidiaries, that substantial financing, over €500 million (approximately $635 million), was provided to the subsidiary defendants by one of the parent defendants, and that the parents reported the subsidiaries’ earnings on a consolidated basis in some of their own financial statements. Relying on these and other facts provided by the plaintiffs, the court noted that the standard for piercing the corporate veil was reduced in ERISA cases and denied defendants’ motion to dismiss. In so doing, the court found that plaintiffs successfully alleged that the corporate parent and subsidiary defendants were a “single entity” under the alter ego doctrine, and that if the parent defendants did, as alleged, misdirect funds, exercise crippling control and purposefully siphon profits from one subsidiary to prop up another, then plaintiffs successfully alleged a requisite fraud or injustice to pierce the corporate veil. (Blair v. Infineon Tech. A.G., Civ. No. 09-295 (SLR), 2010 WL 2608959 (D.Del. June 29, 2010))

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Co-authored by Brian Schmidt

The U.S. Court of Appeals for the Ninth Circuit upheld a district court’s dismissal of a securities fraud class action suit, ruling that defendants’ alleged incomplete disclosures were not material omissions and that the issuer’s earnings projections fell within the statutory safe harbor under the Private Securities Litigation Reform Act (PSLRA). In the process, the court clarified case law within that circuit on the application of the PSLRA safe harbor provisions.

Cutera, Inc. is a retailer of lasers and other light-based aesthetic systems sold to medical professionals for use in cosmetic procedures. A purported class of shareholder plaintiffs sued based on alleged misrepresentations and omissions concerning an expansion of Cutera’s sales force in 2005 and 2006 to include junior sales executives and a lower-priced laser. The program did not proceed as hoped and was ultimately abandoned. During the program’s rollout, Cutera executives stated in a conference call in January of 2007 that they “wanted to have a more junior sales force focus on a certain segment of the market. We didn’t get the productivity we were looking for with that.” Despite this statement, Cutera projected a significant increase in revenue and its share price spiked. In later statements in April and May, Cutera downgraded its revenue projections, attributed in part to lower productivity levels from its recent sales expansion and “aberrantly high turnover.” The May press release, in particular, noted “the unsuccessful implementation of our junior sales program, unusually high sales employee turnover, and disappointing results from... national accounts.” Cutera’s share price closed after the May release more than 18% off the previous day’s price. The court ruled that despite the fluctuations in share price, there was no material difference between Cutera’s statements in January and its later statements in April and May. Plaintiffs failed to show that a reasonable investor would have received a materially different impression of Cutera’s state of affairs had the company used the April or May language in January.

The court also dismissed plaintiffs’ claims to the extent they relied on misleading revenue projections, finding that Cutera’s projections fell within the statutory safe harbor for forward-looking statements accompanied by meaningful cautionary disclosures. In so doing, the court clarified that under Ninth Circuit law, the various prongs or separate safe harbors set forth in the PSLRA are independent and should not be read in the conjunctive. The court’s decision is consistent with other circuits in holding that allegations showing a strong inference of actual knowledge cannot overcome safe harbor protection for such forward-looking statements. The court expressly rejected a footnote from one of its prior cases, seized on by plaintiffs and certain trial courts, which suggested that an actual knowledge showing could in fact defeat safe harbor protection for forward-looking statements accompanied by meaningful cautionary disclosures. (In re Cutera Sec. Litig., No. 08-17627, 2010 WL 2595281 (9th. Cir. June 30, 2010))

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The Federal Housing Finance Agency (FHFA), the agency that regulates Freddie Mac, Fannie Mae and the Federal Home Loan Banks, has determined that certain energy retrofit lending programs present significant safety and soundness concerns that must be addressed by its regulatees. Specifically, programs denominated as Property Assessed Clean Energy (PACE) seek to foster lending for retrofits of residential or commercial properties through a county or city’s tax assessment regime. Under most of these programs, such loans acquire a priority lien over existing mortgages. The FHFA has taken the position that such loans “present significant risk to lenders and secondary market entities, may alter valuations for mortgage-backed securities and are not essential for successful programs to spur energy conservation.”

FHFA has urged state and local governments to reconsider these programs and continues to call for a pause in such programs so concerns can be addressed. First liens for such loans represent a key alteration of traditional mortgage lending practice. While the first lien position offered in most PACE programs minimizes credit risk for investors funding the programs, it alters traditional lending priorities. Underwriting for PACE programs results in collateral-based lending rather than lending based upon ability-to-pay, the absence of Truth-in-Lending Act and other consumer protections, and uncertainty as to whether the home improvements actually produce meaningful reductions in energy consumption.

The Federal Deposit Insurance Corporation considered the FHFA announcement sufficiently important to warn insured institutions (banks and savings associations) that “these programs could affect their residential mortgage lending activities and the ability to sell loans to Fannie Mae and Freddie Mac.”

Click here to read the FHFA press release.
Click here to read the financial institution letter from the FDIC.
 

The Federal Housing Finance Agency (FHFA), the agency that regulates Freddie Mac, Fannie Mae and the Federal Home Loan Banks, has determined that certain energy retrofit lending programs present significant safety and soundness concerns that must be addressed by its regulatees. Specifically, programs denominated as Property Assessed Clean Energy (PACE) seek to foster lending for retrofits of residential or commercial properties through a county or city’s tax assessment regime. Under most of these programs, such loans acquire a priority lien over existing mortgages. The FHFA has taken the position that such loans “present significant risk to lenders and secondary market entities, may alter valuations for mortgage-backed securities and are not essential for successful programs to spur energy conservation.”

FHFA has urged state and local governments to reconsider these programs and continues to call for a pause in such programs so concerns can be addressed. First liens for such loans represent a key alteration of traditional mortgage lending practice. While the first lien position offered in most PACE programs minimizes credit risk for investors funding the programs, it alters traditional lending priorities. Underwriting for PACE programs results in collateral-based lending rather than lending based upon ability-to-pay, the absence of Truth-in-Lending Act and other consumer protections, and uncertainty as to whether the home improvements actually produce meaningful reductions in energy consumption.

The Federal Deposit Insurance Corporation considered the FHFA announcement sufficiently important to warn insured institutions (banks and savings associations) that “these programs could affect their residential mortgage lending activities and the ability to sell loans to Fannie Mae and Freddie Mac.”

Click here to read the FHFA press release.
Click here to read the financial institution letter from the FDIC.

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Co-authored by Aimee S. Lin

The Family Medical Leave Act (FMLA) allows qualified employees to take up to 12 weeks of unpaid, job-protected leave in order, among other things, to care for a child postpartum, to bond with a child after adoption, or to care for a child with a serious illness. In a recent Administrator’s Interpretation, the U.S. Department of Labor (DOL) expanded the category of people who may qualify for leave in this context.

The FMLA entitles an employee to leave in certain childcare situations where the employee is standing in loco parentis, or in the place of the parent. In such a case, a legal or biological relationship between the child and the caregiver is not required. A previously promulgated FMLA regulation defined being in loco parentis as both providing day-to-day care of the child and financially supporting the child.

However, the Interpretation requires only one or the other in order to qualify for leave under the FMLA. Converting what was formally a two-part test to a one-part test will lead to more people qualifying for leave in an in loco parentis backdrop.

Such an Interpretation by the DOL is not binding on courts, but it is entitled to deference. While it remains to be seen how the courts will deal with this Interpretation, which, on its face, seems inconsistent with the regulation, employers should be mindful of it for a few reasons.

For instance, an employer should consider more carefully whether an employee who requests leave, but who is not a part of a traditional parent-child circumstance, is entitled to the leave. Along these lines, the Interpretation permits an employer to “require the employee to provide reasonable documentation or statement of the family relationship.” Note that only a “simple statement” is required and employers should be cautious not to be too rigorous in their requirements lest they find themselves accused of putting a chilling effect on requests for leave, or worse, harassment.

Employers should also be mindful that the recent Interpretation may lead to a considerable increase in requests for FMLA leave.

The full text of the Interpretation, which provides a few helpful examples, is available here.

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On July 6, the UK Financial Services Authority (FSA) announced that it had fined Henry Cameron, CEO of Sibir, a former Alternative Investment Market (AIM)-quoted energy company, £350,000 (approximately $530,000) for making misleading announcements to the market regarding payments from Sibir to its major shareholder Chalva Tchigirinski. The penalty reflected a Stage 1 (30%) discount under the FSA’s settlement discount scheme.

Mr. Cameron was responsible for Sibir making two separate market announcements in December 2008 and February 2009, stating that Sibir had paid a total of $115.4 million to Mr. Tchigirinski. The correct amount was more than $300 million. This created a false market in Sibir’s shares by giving a misleading impression as to the nature and value of Sibir’s assets and the risks the company faced. When the true position became clear, Sibir’s shares were suspended from trading on AIM and its quotation was subsequently cancelled. Cameron was suspended from Sibir in February 2009 and dismissed in April 2009.

Margaret Cole, Director of Enforcement and Financial Crime at the FSA, said, “As the most senior executive director at Sibir, Cameron should have known these announcements were misleading and the serious impact they were likely to have on the market. The consequences of his market abuse were so serious that it led to the suspension of trading in Sibir’s shares on AIM. Our fine reflects the gravity of his irresponsible actions and shows that we are serious about taking action against directors of publicly traded companies who commit market abuse. It is not acceptable for directors to take action which is in the interests of some shareholders while keeping others in the dark.”

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On July 7, the European Parliament approved, by a large majority, measures which will significantly restrict bonus payments by banks. They were passed in the context of amendments to the EU Capital Requirements Directive for banks and investment firms (proposal for a directive of the European Parliament and of the European Council amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-securitizations, and the supervisory review of remuneration policies).

The proportion of bonuses payable in cash may not exceed 30% of the total bonus amount (20% for large bonuses). Between 40% to 60% of all bonus must be deferred and can be clawed back if performance in subsequent years is not adequate. 50% of the total bonus would be paid as “contingent capital”—funds which can be called upon by the bank for use as capital if required. Bonuses must also be “capped to salary.” Each bank will have to establish limits on bonuses related to salaries, based on EU guidelines. There will be more stringent rules applicable to part-nationalized banks.

The detailed provisions implementing the above guidelines have not yet been published.

Separate draft remuneration rules for fund managers falling within the ambit of the draft Alternative Investment Funds Directive are being considered in the ongoing trialogue process between the European Commission, Council and the Parliament, under which the competing drafts produced by the European Council and the Parliament are being harmonized. An agreed text is expected to be passed to the Parliament for a plenary vote in September.

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Earlier this week, the House of Representatives approved the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Senate vote has been delayed until mid-July with signing by President Obama expected thereafter. The bill includes significant changes to corporate governance and executive compensation and disclosure applicable to publicly traded issuers. Provisions address say on pay, proxy access, compensation clawbacks, compensation committee independence and further restrictions on broker discretionary voting. Of note is that the majority voting requirement that would have required directors in uncontested elections to be approved by a majority of the votes cast was dropped from the Senate version of the bill.

An upcoming Katten Client Advisory will provide a more detailed discussion of the Dodd-Frank provisions.

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Co-authored by Louis Froelich

NYSE Arca, Inc. (the Exchange) has issued a rule proposal to revert back to how it handled order flow during a regulatory halt for a security listed on another primary listing market. Earlier this past June, NYSE Arca Equities Rule 7.11(f) was amended to require the Exchange, upon receiving a trading pause or regulatory halt message for a security from another primary listing market, to reject all orders for the stock until the stock has reopened, to accept and process all cancellations and to take certain other actions. As noted in its rule proposal, the Exchange believes there are times that trading should continue despite another market invoking a regulatory halt. It now proposes to revert back to how it handled order flow prior to the Rule 7.11(f) amendment, which means that it will reject and cancel orders or take other actions under Rule 7.11(f) for a trading pause on another primary listing market, but will not do so for a regulatory halt. Comments to the proposal should be submitted to the Securities and Exchange Commission on or before July 21.

Click here to read Securities and Exchange Commission Release No. 34-62368.

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Co-authored by Christian B. Hennion

National Futures Association (NFA) has submitted a petition for rulemaking to the Commodity Futures Trading Commission that would reinstate certain limitations on the marketing and trading activities of investment vehicles operated pursuant to CFTC Rule 4.5 (Rule 4.5 Entities), which the CFTC had removed from the rule in 2003. Rule 4.5 excludes from the definition of a “commodity pool operator” certain otherwise regulated persons and entities, including registered investment companies. NFA’s proposal would require that a Rule 4.5 Entity (1) not be marketed as a method for obtaining exposure to commodity futures or options, and (2) limit its commodity futures and options positions (other than positions held for bona fide hedging purposes) to no more than 5% of the liquidation value of the portfolio. In its petition, NFA cites its concerns regarding the recent establishment of several registered investment companies that are marketed to retail investors and engage in significant futures trading, but which are not subject to the registration and disclosure requirements set out in the CFTC’s Part 4 Rules due to the exclusion set out in Rule 4.5.

The NFA petition is available here.

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On July 1, the Securities and Exchange Commission adopted Rule 206(4)-5 under the Investment Advisers Act of 1940 to protect public pension plans and other government investors by deterring advisers from participating in “pay to play” practices. The new rule applies to investment advisers that are registered (or required to be registered) with the SEC or are exempt from registration under Section 203(b)(3) of the Advisers Act, including investment advisers to any “covered investment pool” in which a “government entity” (including public pension plans and other government investors) invests or is solicited to invest. Most, if not all, advisers that provide discretionary management with respect to public pension fund assets would fall under the scope of the new rule. “Covered investment pools” include entities that would be investment companies but for the exceptions provided by Sections 3(c)(1), 3(c)(7) or 3(c)(11) of the Investment Company Act of 1940, and any registered investment company that is an investment option under a government plan or program.

The new SEC rule has three key elements:

• It prohibits an investment adviser from providing investment advisory services for compensation to a government entity within two years after the investment adviser or any of its “covered associates” has made a contribution to an official of the government entity that is in a position to influence the selection of the investment adviser for its advisory services. This prohibition does not apply to certain de minimis contributions made by a covered associate who is a natural person (limited in the aggregate to $150 or $350 per election per candidate depending upon the circumstances).
• It prohibits an investment adviser or any of its covered associates from directly or indirectly paying any person to solicit a government entity for investment advisory services on its behalf, including soliciting investments to a covered investment pool advised by the investment adviser. This prohibition on paying third party marketers does not apply to “regulated persons,” such as registered investment advisers that have met certain preconditions and registered brokers who are subject to similar prohibitions on “pay to play” by the self-regulatory organization overseeing such broker.
• It prohibits an investment adviser or any of its covered associates from coordinating or soliciting any person or political action committee to make any (1) contribution to an official of a government entity to which the investment adviser is providing or seeking to provide investment advisory services, or (2) payment to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity.

The SEC also adopted amendments to the books and records maintenance obligations in Rule 204-2 under the Advisers Act to require registered investment advisers that provide investment advisory services to government entities to make and keep additional records related to political contributions made by such advisers and their covered associates.

Rule 206(4)-5 and the recordkeeping requirements in the amendment to Rule 204-2 become effective 60 days after their publication in the Federal Register, and compliance will generally be required within six months of the effective date. However, the SEC has allowed one year for compliance with the prohibition on paying third-party marketers who do not meet the new requirements and for all of the requirements (under both Rule 206(4)-5 and Rule 204-2) for advisers to registered investment companies that are covered investment pools.

To read the SEC’s press release on Rule 206(4)-5 click here.
To read the Adopting Release click here.
Click here for more information on the Proposing Release in the July 24, 2009, edition of Corporate and Financial Weekly Digest.

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Co-authored by Jonathan Rotenberg

The U.S. Court of Appeals for the Fifth Circuit affirmed a district court’s dismissal of a putative class action brought by a group of natural gas futures and options contract traders under the Commodities Exchange Act (CEA).

Plaintiffs alleged that defendants manipulated the natural gas futures and options prices in violation of the CEA by selling large quantities of natural gas for delivery at one delivery hub, the Houston Ship Channel, in order to depress the price of the natural gas at that hub to an artificial level. The defendants allegedly intended to profit from the difference in price at that hub and the Henry Hub, the hub where delivery was to be made for all natural gas contracts on the New York Mercantile Exchange (NYMEX). Plaintiffs further alleged that the defendants’ price manipulation caused the NYMEX price to decrease, resulting in a loss to plaintiffs, who traded futures and options on NYMEX.

Defendants moved to dismiss plaintiff’s securities fraud claim before the district court. In granting the motion to dismiss, the district court reasoned that plaintiffs failed to allege that defendants specifically intended to manipulate the price of natural gas at Henry Hub, as required for a private right of action under the CEA. The plaintiffs argued that they had sufficiently alleged a CEA claim by alleging that the defendants intended to manipulate the price of the underlying commodity, natural gas, knowing that their manipulation would result in a decrease in the price at the Henry Hub and thereby affect the commodity contracts traded on NYMEX. In affirming the district court’s dismissal, the Fifth Circuit rejected plaintiffs’ contention that defendants’ purported knowledge that their actions would ultimately affect prices on the Henry Hub was sufficient to state a claim under the CEA. In so holding, the court noted that the “effect on the Henry Hub, and NYMEX futures contracts, was merely an unintended consequence of the defendants’ manipulative trading” and, as a result, the defendants lacked the requisite specific intent. (Hershey v. Energy Transfer Partners, L.P., No. 09-20651, 2010 WL 2510122 (5th Cir. June 23, 2010))

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Co-authored by Jonathan Rotenberg

The U.S. Court of Appeals for the Eleventh Circuit upheld the U.S. Department of Labor’s review of a summary dismissal of a whistleblower complaint filed by petitioner Michael Gale, the Chief Operations Officer and a director of World Securities Group (WSG), the affiliated broker-dealer of World Financial Group (WFG). Gale’s complaint alleges that he was discharged because he (1) provided information and opposed decisions made by company officers relating to waste and misuse of corporate monies that resulted in loss of shareholder equity and (2) raised concerns that the operation of WSG by WFG violated certain Securities and Exchange Commission rules and regulations.

The Administrative Law Judge (ALJ) granted WFG’s motion for summary dismissal on the ground that Mr. Gale’s complaint failed to plead that he reasonably believed WFG’s activities were illegal or fraudulent in nature, an essential element in a whistleblower action under the Sarbanes-Oxley Act (SOX). The ALJ found that none of Mr. Gale’s expressed concerns regarding WFG’s activities contained any factual basis for finding that WFG committed illegal or fraudulent acts prohibited by SOX. On appeal, the Department of Labor’s Administrative Review Board agreed with the ALJ’s finding that Mr. Gale had not presented sufficient evidence to create a genuine issue of fact that he engaged in activity protected by SOX.

On appeal to the Eleventh Circuit, Mr. Gale argued that to state a whistleblower claim it is not necessary for an employee to subjectively believe that his employer engaged in unlawful conduct, but rather asserted that it was sufficient for him to voice “sufficient concerns” about his employer’s practices. The Eleventh Circuit rejected Mr. Gale’s arguments and affirmed the dismissal of his claim, reasoning that to be protected by SOX, a whistleblower must reasonably believe that the information he is disclosing to a supervisory authority constitutes a violation of federal laws relating to fraud against shareholders. The court determined that while Mr. Gale had reservations about WFG’s practices, he did not know whether those practices were illegal, relying on the fact that Mr. Gale admitted during his deposition that he did not actually believe that WFG was engaging in illegal or fraudulent activities. (Gale v. U.S. Dep’t of Labor, No. 08-14232, 2010 WL 2543138 (11th Cir. 2010))

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Co-authored by Christina Grigorian

On June 24, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency issued the host state loan-to-deposit ratios they will use to determine compliance with Section 109 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Section 109). Section 109 generally prohibits a bank from establishing or acquiring a branch or branches outside of its home state primarily for the purpose of deposit production. Such ratios are published on an annual basis.

Section 109 specifically prescribes a two-step process to test compliance with the statutory requirements. The first step involves a loan-to-deposit ratio screen that compares a bank’s statewide loan-to-deposit ratio to the host state loan-to-deposit ratio for banks in a particular state. The second step is required if a bank’s statewide loan-to-deposit ratio is less than one-half of the published ratio for the state or if the data are not available at the bank to conduct the first step. (A statewide loan-to-deposit ratio relates to an individual bank and is the ratio of a bank’s loans to its deposits in a particular state where the bank has interstate branches.) The second step requires the appropriate banking agency to determine whether the bank is reasonably helping to meet the credit needs of the communities served by the bank’s interstate branches. If a bank fails both steps, it is in violation of Section 109.

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The UK Financial Services Authority (FSA) and the UK Financial Reporting Council (FRC) issued a discussion paper on June 24 which considers ways of enhancing auditors’ contribution to regulation.

The paper FSA DP 10/3 is entitled “Enhancing the auditor’s contribution to prudential regulation” and covers the following areas:

• questions aspects of the quality of audit work relevant to prudential regulation—in particular, whether the auditor has always been sufficiently skeptical and has paid sufficient attention to indicators of management bias when examining key areas of financial accounting and disclosure that depend critically on management judgement;
• outlines the FSA’s concerns about auditors’ work on client assets and how auditors fulfill their legal obligation to report to the FSA;
• explores a variety of ways in which changes are being made and further changes could be made by the FSA, FRC and auditors to increase the effectiveness with which auditors undertake their work; and 
• examines the regulatory environment in which auditors operate more widely and suggests measures to enhance how auditors contribute to prudential supervision.

Paul Sharma, the FSA’s Director of Prudential Policy, said, “Our experience has indicated that, at times, auditors have focused too much on gathering and accepting evidence to support firms’ assertions rather than exercising sufficient professional skepticism in their approach—this falls far short of what the FSA—and society at large—expects from auditors.”

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On June 28, the UK Financial Services Authority (FSA) announced that it had fined Steven Perkins, a former oil broker, £72,000 (approximately $109,000) for market abuse and had banned him from working in the UK financial services industry for a minimum of five years on the grounds that he was not a fit and proper person.

Mr. Perkins was an oil futures broker with PVM Oil Futures Ltd. His job involved trading Brent Crude Futures contracts on an execution-only basis in the ICE Futures Europe Exchange for PVM’s clients. PVM did no proprietary trading.

In the early hours of the morning of Tuesday, June 30, 2009, Mr. Perkins traded in the ICE August 2009 Brent contract without any client authorization, and in doing so accumulated a long outright position in Brent in excess of 7,000 lots (representing over 7 million barrels of oil).

As a direct result of Mr. Perkins’ trading, the price of Brent increased significantly. His trading manipulated the market in Brent by giving a false and misleading impression as to the supply, demand and price of Brent and caused the price of Brent to increase to an abnormal and artificial level.

The FSA findings state that Mr. Perkins initially lied repeatedly to PVM in order to try and cover up his unauthorized trading. They also stated that Mr. Perkins’ relevant trading seems to have been a consequence of extremely heavy drinking resulting from alcoholism, which he now acknowledges. He drank excessively over the weekend prior to and throughout Monday, June 29.

Alexander Justham, the FSA’s Director of Markets, said, “The FSA views market manipulation extremely seriously. Perkins’ trading caused disruption to the market and has been met with both a fine and prohibition. This reinforces the fact that a severe sanction will apply in cases of market manipulation, even where no profit is made.”

The FSA stated that Mr. Perkins’ behavior merited a penalty of £150,000 (approximately $228,000). Because such a fine would cause him serious financial hardship, this was reduced to £90,000 (approximately $136,000). Since Mr. Perkins agreed to settle the case, he qualified for a 20% discount on the fine under the FSA’s executive settlement procedures, bringing the fine down to £72,000. The ban imposed on Mr. Perkins was limited to a minimum term of five years since Perkins had joined an alcoholics rehabilitation program. Accordingly, the FSA considered that Mr. Perkins may be a fit and proper person for regulatory purposes at some future date.

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The newly-elected UK Government announced its first Budget on June 22. Key provisions include:

1. Capital Gains Tax is increased to a top rate of 28%, from a flat rate of 18%, with effect from midnight on June 22.
2. The introduction of a UK levy on banks (including the UK branches and subsidiaries of foreign banks). The levy will take effect on January 1, 2011, and will initially be charged at a rate of 0.04% on the total liabilities of the bank or branch (subject to certain exclusions). The rate will be increased to 0.07% on January 1, 2012. In order to encourage longer-term borrowings (perceived as less risky), liabilities with longer than a year to maturity will be taxed at half the standard rate. There will be the following exceptions to the levy: (i) Tier 1 capital (i.e. equity); (ii) insured retail deposits; (iii) repos secured on sovereign debt; and (iv) policyholder liabilities of retail insurance businesses within banking groups. Banks or branches with relevant liabilities below £20 billion (approximately $30 billion) will also be exempt from the levy.
3. In relation to asset management, the UK Government intends to: (i) implement the UCITS IV rules; (ii) establish tax transparent contractual funds along the lines of those currently offered by Ireland and Luxembourg; and (iii) consult on rules designed to reform the taxation of UK authorized investment trust companies and UK authorized funds investing in offshore funds (the budget gave no details of these reforms).

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