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

Co-authored by Blase J. Kornacki

Section 404 of the Sarbanes-Oxley Act (SOX 404) mandates that public companies assess their internal controls over financial reporting (ICFRs). SOX 404(a) requires company management to assess ICFRs, and SOX 404(b) calls for registered public accounting firms to attest to and report on the assessments, made by management.

Implementation of SOX 404 began with U.S. accelerated filers who were first required to provide management assessment and auditor attestation in annual reports for periods ending on or after November 15, 2004. Since 2004, all filers, other than non-accelerated filers (who now have been permanently exempted from the requirements of SOX 404(b) by the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act), have phased into the SOX 404 regulatory scheme and are currently required to provide SOX 404(a) and (b) certifications in their annual reports.

In the six years since the initial implementation date of SOX 404, Audit Analytics has compiled annual reports and published data on the required auditor attestations and management assessments. The SOX 404 Dashboard - Year Six Update, published in October, reports that in year six of SOX 404, only 2.4% of filings contained adverse auditor attestation disclosures. This represents a more than 50% drop since year five, in which the adverse disclosure rate came in at 5%, and an even more significant drop since year one, in which the adverse disclosure rate was 16.9%. The study shows a steady decline in adverse auditor attestations throughout the six years of SOX 404’s existence and suggests that auditor involvement in the evaluation process may have led to the improvement of companies’ ICFRs. However, the study also shows that adverse disclosure rate for management-only assessments continues to be high—27.8% in 2010. Nonetheless, the year six figure reflects a drop from 32.3% in year five, 32.0% in year four, and 32.8% in year three. The study suggests that the high percentage of adverse management assessments indicates that non-accelerated filers fail to maintain ICFRs that are as reliable as ICFRs maintained by accelerated filers.

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On November 12, the Securities and Exchange Commission approved proposed rule changes submitted by the Chicago Board Options Exchange, Incorporated (CBOE) that amend its qualification, registration and continuing education requirements for individual Trading Permit Holders (TPHs) and individual associated persons. In general, the amendments (1) expand CBOE’s registration and qualification requirements to include additional types of individual TPHs and individual associated persons, (2) require all individual TPHs and associated persons engaged in a securities business on CBOE or on CBOE Stock Exchange not already registered with the Financial Industry Regulatory Authority to register as such, by January 11, 2011, and (3) will require all individual TPHs and associated persons to pass a qualification examination. CBOE is developing within the next six months an alternative to the Series 7 examination that will be tailored to individual TPHs and associated persons that are engaged in proprietary trading. All individual TPHs and individual associated persons will be required to pass this new examination no later than August 12, 2011.

To read the SEC release, click here.
To read a summary of the Notice of Proposed Rule Changes, click here.

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Co-authored by Kenneth M. Rosenzweig and Christian B. Hennion

The Commodity Futures Trading Commission has requested comments on six rule proposals to implement additional provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

• Registration of Foreign Boards of Trade: Section 738 of the Dodd-Frank Act provides the CFTC with authority to implement a registration system for a foreign board of trade (FBOT) that provides direct access to its trading system to market participants located in the United States. The CFTC’s proposed rules would create a registration process for FBOTs to replace the existing system of staff-issued no-action relief (from which the proposed rules are substantially derived), and would make it unlawful for any FBOT to permit direct access to U.S. participants without first registering with the CFTC. An FBOT that seeks to provide direct access to participants in the United States must submit a registration application to the CFTC that includes information regarding the FBOT’s membership criteria, trading system, contracts to be made available to U.S. participants, settlement and clearing systems, home regulatory regime, and rules and rule enforcement. FBOTs currently operating pursuant to no-action relief would be required to apply for registration pursuant to a “limited” registration application process. The factors to be considered by the CFTC in determining whether to grant an FBOT application are substantially similar to those currently applicable to the no-action review process, including evaluation of whether the FBOT’s home regulatory authority oversees the FBOT in a manner that is comparable to CFTC oversight of designated contract markets (DCMs).

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Co-authored by Kenneth M. Rosenzweig and Christian B. Hennion

National Futures Association (NFA) has launched a new online system to assist futures commission merchants (FCMs) and introducing brokers (IBs) in developing anti-money laundering (AML) programs. The system is designed to help users identify the minimum required components of an AML program and to provide additional guidance and information on the various components of the program, including example provisions. FCMs and IBs are not required to use the system in designing their AML program, and use of the system does not provide users with a “safe harbor” from applicable AML requirements under NFA rules or federal law. NFA further cautions that the system is only intended to provide an outline for an AML program, which may need to be further tailored to the specific risks of a firm’s business.

The NFA notice to members announcing the launch of the new system, as well as instructions for accessing the system, is available here.

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Co-authored by Robert Grundstein

In an open meeting scheduled for November 19, the Securities and Exchange Commission will consider proposing rules that would increase the statutory threshold for registration by investment advisers with the SEC, require advisers to hedge funds and other private funds to register with the SEC, and address reporting by certain investment advisers that are exempt from registration. Other proposed rules to be considered would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States, and clarify the meaning of certain terms included in a new exemption for foreign private advisers.

To read the SEC News Digest click here.

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Nine months after the U.S. District Court for the Southern District of Texas approved a fee application in the In re Enron class action litigation, plaintiff Michael Brown, an unnamed member of the class, brought a new action in the same court, asserting claims of fraud and breach of fiduciary duty against Thomas Bilek and his law firm, seeking disgorgement of the $16 million in attorneys’ fees awarded Mr. Bilek for his work in the litigation. In the Enron litigation, pursuant to the Private Securities Litigation and Reform Act (PSLRA), the court had appointed the Regents of the University of California as lead plaintiff. The Regents selected Milberg Weiss Bershad Hynes & Lerach LLP as lead counsel for the class, and the district court approved that selection. Milberg Weiss, whose California office was handling the matter, chose Mr. Bilek and his law firm to serve as local counsel in the Southern District of Texas.

Mr. Brown filed his complaint on behalf of the putative class of shareholders of Enron Corporation who participated in and received monies as a result of the settlement of the class action. Mr. Brown’s complaint alleged that in connection with the fee application in the Enron litigation, Mr. Bilek had provided false and exaggerated information regarding his work on behalf of the class. Mr. Brown asserted that these fraudulent misrepresentations resulted in Mr. Bilek being awarded attorneys’ fees in the inflated amount of more than $16 million, which ultimately reduced the recovery to the class members. Mr. Brown sought disgorgement of the attorneys’ fees Mr. Bilek received.

The district court dismissed Mr. Brown’s complaint and the Fifth Circuit affirmed, ruling that Mr. Brown’s claims were “inextricably woven” into the Enron litigation and could only have been brought by lead plaintiff in that litigation. The court held that “an unnamed class member may not circumvent a PSLRA lead plaintiff’s authority by filing an independent tort lawsuit on behalf of members of the class complaining of acts and omissions that occurred in the context of the PSLRA-governed litigation.” The court went on to note that, assuming the allegations were worth pursuing and the facts on which the claims were based were not known at the time the fees were approved, the claims should have been made by the lead plaintiff in a Rule 60(b) motion to set aside the judgment. (Brown v. Bilek, No. 09-20654 (5th Cir. Nov. 12, 2010))

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Kitchin Associates LLC is a Pennsylvania limited liability company that is no longer in business. Richard Kitchin and his son were the members of Kitchin LLC and each held a 50% ownership interest in the entity. In a bankruptcy court proceeding, the Joan I. Glisson Trust asserted a claim against Mr. Kitchin in the amount of $257,047.63, arising from an unsatisfied mortgage loan to Kitchin LLC, the proceeds of which were used to purchase a property in Pennsylvania. Mr. Kitchin was not a party to the loan transaction, but did execute the loan documents in his capacity as a member of Kitchin LLC. The Trust asserted that Mr. Kitchin should be personally liable for Kitchin LLC’s loan, asserting that the corporate veil should be pierced because he directly participated in the company’s torts and because he was subject to personal liability under an alter ego theory.

The Bankruptcy Court for the Eastern District of Pennsylvania found that the Trust’s attempt to pierce the corporate veil based on Mr. Kitchin’s alleged participation in the torts of the company failed as a matter of law because the Trust’s claims against Kitchin LLC sounded in contract, not tort. However, applying the equitable remedy of alter ego liability, the court held that the corporate veil should be pierced because the Trust had demonstrated that Mr. Kitchin controlled the company and that injustice would result if the corporate fiction was maintained, the two elements necessary to pierce the corporate veil under Pennsylvania law.

First, the court found that Mr. Kitchin exercised sufficient control over Kitchin LLC to impose alter ego liability because he directed the company to engage in the transactions that depleted the company’s assets. In particular, as confirmed by his son, Mr. Kitchin directed that the company transfer money from Kitchin LLC to pay the debts of another company he controlled. In addition, the court held that the second element necessary for alter ego liability was also present because Mr. Kitchin, “along with his son, disregarded the corporate form and acted as though the assets of Kitchin LLC were theirs to manage and distribute without regard to its creditors.” As a result, it held that the corporate veil could be pierced to hold Mr. Kitchin liable for the debts of the company. (In re Richard R. Kitchin, Jr. and Donna Kitchin, No. 09-17891-MDC (Bankr. E.D. Pa. Nov. 9, 2010))

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On November 17, the Federal Reserve Board issued guidelines for evaluating proposals by large bank holding companies (BHCs) to undertake capital actions in 2011, such as increasing dividend payments or repurchasing or redeeming stock. According to the Board, “The criteria provide a common, conservative approach to ensure that BHCs hold adequate capital to maintain ready access to funding, continue operations, and continue to serve as credit intermediaries, even under adverse conditions.” Bank holding companies should consult with Federal Reserve staff before taking any actions that could result in a diminished capital base, including actions such as increasing dividends, implementing common stock repurchase programs, or redeeming or repurchasing capital instruments more broadly (planned capital actions).

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On November 17, the Federal Reserve Board requested comment on a proposed rule to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that give banking firms a defined period of time to conform their activities and investments to the Volcker Rule. The Volcker Rule generally prohibits banking entities from engaging in proprietary trading in securities, derivatives or certain other financial instruments, and from investing in, sponsoring or having certain relationships with a hedge fund or private equity fund. The statute generally provides banking entities two years to bring their activities and investments into compliance with the Volcker Rule, and allows the Board to extend this conformance period for specified periods under certain conditions. The proposed rule does not address other aspects of the Volcker Rule that are subject to separate rulemaking requirements by other agencies.

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On November 10, the UK Financial Services Authority (FSA) circulated its proposals for increased disclosure requirements for bankers’ remuneration. Under these proposals, British banks will have to provide a more detailed breakdown of the pay of senior managers and employees who have a material impact on each bank’s risk profile in any single year. Banks will be obliged to supply the total amount paid in cash and share bonuses, deferred remuneration (awarded and outstanding) and severance payments made to employees. The proposals will enter into force at the start of 2011, and their requirements will begin to apply with respect to pay awarded for work during 2010.

There is a short consultation period of a month for these proposals, which are designed to implement European provisions enacted earlier this year as part of the revised Capital Requirements Directive.

As several other member states (including Germany and France) have not yet produced their equivalent rules, the FSA has been criticized in some quarters for compromising London’s status as a European financial center by providing for its rules to be effective from January 2011.

Read more.

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On November 11, the UK Financial Services Authority (FSA) published its Policy Statement 10/17 (feedback on its “taping of mobile phones” consultation and final rules). This follows the FSA’s consultation paper CP10/7 of March 2010, which proposed the removal of the mobile phone exemption from the FSA taping rules. The CP10/7 consultation period ended in June of this year.

The FSA confirmed that the exemption will be removed. As a result, from November 14, 2011, the following will be required of FSA regulated firms:

• all relevant communications made with, sent from or received on mobile phones and other handheld electronic communication devices that are issued by firms for business purposes must be recorded and stored for six months; and
• reasonable steps must be taken to ensure that such communications do not take place on personal devices that cannot be recorded for privacy reasons.

To read the policy statement, click here.

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On November 17, the UK government announced another step towards the creation of the new “post-Financial Services Authority” (FSA) UK regulatory regime (as described in the June 18 and July 30 editions of Corporate and Financial Weekly Digest). The projected Consumer Protection and Markets Authority (CPMA) will take responsibility for criminal prosecution of insider dealing as well as the listing role currently handled by the FSA in its capacity as UK Listing Authority.

The UK Treasury emphasized that the government was “absolutely committed to prosecuting financial crime,” adding that “after much consideration we have decided that for the moment the FSA’s powers of prosecution will lie with the new CPMA rather than the new Economic Crime Agency (ECA). The government recognizes the importance to the City of London of a strong markets division being established within the CPMA and giving it these powers will make it a stronger and more credible regulator.”

The Treasury added that the government “remains committed to the creation of a strong and powerful new ECA to tackle serious economic crime coherently and effectively.” The ECA will combine the Serious Fraud Office with parts of the Office of Fair Trading and several smaller agencies.

Read more.

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Two of the European Parliament’s groupings, the Socialists and the European People’s Party (EPP), have expressed their approval of the report of Dr. Kay Swinburne MEP, which recommended tougher rules on high-frequency trading and dark pools.

The report suggested that a lack of transparency in the financial system was an “aggravating factor” in the financial crisis. It also blamed the Markets in Financial Instruments Directive (MiFID) for problems in the financial market that have arisen since its adoption in 2007.

Although the economic and monetary affairs committee will not directly impact regulatory changes or legislation, this support for harsher rules is indicative of the European Parliament’s views at a time when the European Commission is preparing for a much-anticipated formal review of the MiFID in 2011.

To read Dr. Swinburne’s report, click here.

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On November 11, the European Parliament announced that it had adopted the Alternative Investment Fund Managers Directive (AIFMD) by a vote of 513 to 92 with three abstentions.

The deadline for member state implementation will be a date in 2013, two years after the final approved version of the Directive is published in the EU Official Journal.

The detailed implementation of many areas of the Directive will depend on “level 2” rules and guidelines which will be prepared over the coming months by the European Securities and Markets Authority.

To read the provisional version of the AIFMD, click here.

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On November 17, the European Council announced that it had approved the regulation establishing the European Securities and Markets Authority (ESMA). The Council also adopted without debate the so-called “Omnibus I Directive” concerning the powers of other new European supervisory authorities for the banking and insurance industries.

The ESMA will be established with effect from January 1, 2011. As indicated above (in “European Parliament Adopts AIFM Directive”), one of its first priorities will be the preparation of regulations setting out detailed provisions of the regime under that Directive.

Read more.

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Co-authored by Natalya S. Zelensky

The Securities and Exchange Commission has approved the NASDAQ Stock Market LLC’s proposed rule change creating a new data distribution model (or Managed Data Solution) to further the distribution of NASDAQ TotalView, NASDAQ OpenView and/or NASDAQ Level 2 Information (collectively, NASDAQ Depth Information). The new Managed Data Solution is intended to offer a new delivery method to firms seeking simplified market data administration and may be offered by distributors to clients and/or client organizations that are using NASDAQ Depth Information internally. According to the SEC release, the new pricing and administrative option is in response to industry demand, as well as due to changes in the technology used to distribute market data.

Click here to read SEC Release 34-63276.

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Co-authored by Natalya S. Zelensky

The Financial Industry Regulatory Authority is proposing a rule change regarding the handling of stop orders. FINRA is proposing to delete FINRA Rule 6140(h), which would then permit members to determine whether the trigger of a stop order should be based on transactions or quotations in the subject security at the stop price. FINRA also is proposing to delete FINRA Rule 6140(i), which defines the terms “stop stock price” and “stop stock transaction,” and, in an effort to reduce confusion for members, to relocate the definition of “initial public offering” from FINRA Rule 6220 to FINRA Rule 6130.

Click here to read SEC Release 34-63256.

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Co-authored by Natalya S. Zelensky

The Securities and Exchange Commission has approved the Financial Industry Regulatory Authority’s proposal to delay the effective date of the changes to FINRA trade reporting and Order Audit Trail System rules approved by the SEC on October 4. The new effective date for the rules will be February 28, 2011, which also is the new compliance date for the amendments to SEC Regulation SHO approved on February 26.

Click here to read SEC Release 34-63277.

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Co-authored by Kenneth M. Rosenzweig and Joshua A. Penner

The Futures Industry Association’s Principal Traders Group has released a report setting out a number of recommended risk controls for trading firms that have direct access to exchange matching engines.

The report expands on a previous set of recommendations published in April 2010 and includes recommendations for risk controls applicable to trading operations and electronic trading systems. The recommendations cover such issues as access and oversight, pre-trade risk management, trading interruptions, post-execution and back office functions, physical security, electronic security and business continuity.

The FIA report can be found here.

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Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the Securities and Exchange Commission to study the extent to which designating one or more self-regulatory organizations (SROs) to augment its efforts in overseeing investment advisers would improve the frequency of examinations of investment advisers. In a November 2 comment letter to the SEC regarding its study, Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority, advocated establishing one or more investment adviser SROs. Chairman Ketchum wrote that the main problem with the oversight of investment advisers is the lack of examination resources. He pointed out that the SEC, despite its best efforts, is unlikely to successfully oversee investment advisers because of funding limits. He further added that cooperating with one or more SROs in the oversight process would help increase the frequency of examinations and resources devoted to enforcement, and suggested that FINRA would be ready and willing to assist the SEC. If FINRA were to seek authorization as an investment adviser SRO, it would create a separate affiliate, with its own Board of Governors, to ensure that the SRO establishes programs appropriate to the adviser industry.

In separate prior comment letters to the SEC, the Managed Funds Association, the Investment Adviser Association and the Investment Company Institute have each argued against establishing an investment adviser SRO.

To read FINRA’s letter click here.
To read the MFA’s letter click here.
To read the IAA’s letter click here.
To read the ICI’s letter click here.

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Co-authored by Gregory C. Johnson

The U.S. Court of Appeals for the Seventh Circuit vacated a $5.6 million breach of contract damages award for lost profits because the plaintiff did not establish the prospective earnings of its Internet-based marketing venture with sufficient certainty.

Publications International Ltd. operates an auto guide and a related website that provide price quotes to consumers considering potential automobile purchases. The company originally derived revenue from selling sales leads generated by its website to wholesalers, who in turn sold those leads to individual automobile dealerships. Publications International then decided to sell its sales leads directly to dealerships, and it retained Smart Marketing Corp. to develop and market the direct-sales program. But technical glitches and disappointing sales hampered the project, and after five months Publications International terminated the Smart Marketing agreement. Smart Marketing sued Publications International for breach of contract and obtained a jury award of $5.6 million for lost profits.

Publications International appealed the damages award, arguing that the amount was speculative because the direct-sales program was an unestablished venture and because Smart Marketing had lost money during its brief time in operation. Smart Marketing contended that the relevant market was sufficiently developed, as Publications International had previously sold the same leads through wholesalers, and that its losses were attributable to start-up costs. The Seventh Circuit ruled that prior sales of Internet-generated leads through wholesalers did not demonstrate that the direct-sales program was feasible and that Smart Marketing had failed to establish how successful the venture would have been. The case was remanded for retrial on damages. (Smart Marketing Group Inc. v. Publications Intern. Ltd., 2010 WL 4237443 (7th Cir. Oct. 28, 2010))

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Co-authored by Gregory C. Johnson

The U.S. Court of Appeals for the Eleventh Circuit affirmed the dismissal of a real estate developer’s tortious interference claim against a zoning officer who “re-reviewed” and rejected the developer’s project applications.

Developer Forum Architects LLC, and its partner Isaac Walton Investors, LLC, submitted six project applications to a zoning officer of Yankeetown, Fla. That zoning officer sent a letter to town officials indicating that the applications were in order but did not submit formal certificates of approval. After the first zoning officer resigned, a second Yankeetown zoning officer reviewed the applications and rejected five of them. Forum Architects sued the second officer for tortious interference, alleging that the officer was biased against commercial development and was not authorized to “re-review” the previously approved plans. The district court granted the zoning officer’s summary judgment motion, and Forum Architects appealed.

Forum Architects argued that its allegations raised triable issues of fact regarding the zoning officer’s alleged bias and intentional interference with the firm’s construction contracts. The Eleventh Circuit disagreed, holding that the zoning officer was entitled to review any unapproved development applications and that the absence of formal certificates of approval warranted dismissal of the developer’s claim. (Forum Architects LLC v. Jetton, 2010 WL 4358386 (11th Cir. Nov. 4, 2010))

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On November 9, the Federal Deposit Insurance Corporation approved a final rule to implement Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 343 provides temporary unlimited coverage for noninterest-bearing transaction accounts. This separate coverage will become effective on December 31, 2010, and will end on December 31, 2012. All funds held in such accounts are fully insured, without limit, and this coverage is separate from, and in addition to, the coverage provided to depositors for other accounts at an insured depository institution.

Noninterest-bearing accounts, as defined in Dodd-Frank, include only traditional, noninterest-bearing demand deposit (or checking) accounts that allow for an unlimited number of transfers and withdrawals at any time, whether held by a business, individual or other type of depositor. The final rule expressly states that Negotiable Order of Withdrawal (NOW) and Interest On Lawyers Trust Accounts (IOLTAs) are not covered under the Dodd-Frank definition of noninterest-bearing transaction accounts and do not qualify for temporary unlimited coverage. Insured institutions must post a notice in the main office, in every branch and on the bank’s website, and must further mail notice to all holders of NOW and IOLTA accounts no later than December 31.

Read more.

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On November 9, the Federal Deposit Insurance Corporation approved two proposed rules that would amend the deposit insurance assessment regulations. The first would implement a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act that changes the assessment base from one based on domestic deposits (as it has been since 1935) to one based on assets. The second proposal would re-propose changes for the deposit insurance assessment system for large institutions ($10 billion and higher) given Dodd-Frank’s changes to the assessment base. This proposal replaces a proposed rule approved by the FDIC Board in April.

In accordance with a provision in Dodd-Frank, the FDIC is proposing to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity. Since the new base would be much larger than the current base, the FDIC is also proposing to lower assessment rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry.

The second assessment-related item replaces a proposed rule revising the deposit insurance assessment system for large institutions that was approved by the FDIC on April 13. The proposal approved on November 9 would eliminate risk categories and debt ratings from the assessment calculation for large banks and would instead use scorecards. The scorecards would include financial measures that are predictive of long-term performance.

The proposed rule incorporates a change in the timing of assessments in that it appears to measure when risk is assumed as opposed to when problems develop. Speaking of this forward view of assessment, FDIC Chairman Sheila Bair stated, “Over the long term, institutions that pose higher risk would pay higher assessments when they assume these risks rather than when conditions deteriorate. During the crisis, it became clear that our large bank pricing metrics were lagging indicators of financial deterioration, to a greater extent than the metrics we use for smaller institutions.”

Both proposals will have a 45-day comment period upon publication in the Federal Register. The FDIC is also proposing that both changes in the assessment system be effective as of April 1, 2011.

Click here to read the first notice of proposed rulemaking.
Click here to read the second notice of proposed rulemaking.

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Co-authored by Hannah C. Amoah

The Employee Benefits Security Administration (EBSA) of the U.S. Department of Labor has proposed a rule to define more broadly the term “fiduciary.” The proposed rule would amend 29 CFR 2510.3-21(c), which was issued in 1975 following the enactment of the Employee Retirement Income Security Act (ERISA), and defines when a person who renders investment advice becomes a fiduciary under ERISA. The amendment is based on findings that indicate that the 1975 rule’s approach to fiduciary status may inappropriately limit its ability to protect plans, participants and beneficiaries in the current marketplace.

The proposed amendment takes account of changes in the expectations of plan officials and participants who receive investment advice, and details added circumstances where providing investment advice is subject to ERISA’s fiduciary duties. It also takes account of industry changes, including, among other things, the variety of complex fee practices currently in use and the conflicts of interest that may arise from these practices. If enacted, the amendment could result in an increased number of service providers being classified as fiduciaries of the plans to which they provide services. Classification as a fiduciary could result in higher costs of doing business due to increased exposure to liability.

“We believe that this proposal more closely reflects the statutory language of ERISA and the realities of the current investment marketplace, and therefore will ensure those who provide investment advice are held accountable as fiduciaries under the law,” said Phyllis Borzi, Assistant Secretary of Labor for EBSA.

Click here for the DOL release.

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Co-authored by Palash Pandya

On November 3, the Securities and Exchange Commission issued proposed rules for implementing the whistleblower provisions added to Section 21F of the Securities Exchange Act of 1934 by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the proposed rules, the SEC will pay an award or awards to one or more whistleblowers who voluntarily provide the SEC with original information that leads to the successful enforcement by the SEC of a federal court or administrative action in which the SEC obtains monetary sanctions totaling more than $1 million.

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Co-authored by James B. Anderson

The Securities and Exchange Commission has released a letter sent in late October by its Division of Corporation Finance to the chief financial officers of certain public companies to remind them of disclosure obligations in their upcoming Form 10-Qs and subsequent filings in light of continued concerns about potential risks and costs associated with mortgage- and foreclosure-related activities or exposures. The letter instructs companies to review their various mortgage-related representations and warranties made in sale agreements with purchasers of the mortgages or mortgage-backed securities and consider the implications on their accounting and disclosures. In addition, companies undertaking reviews of their loan documentation and foreclosure practices and which have suspended foreclosures pending completion of such reviews should consider their treatment of loss contingencies and disclosures.

Item 103 (Legal Proceedings) and Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of Regulation S-K, as well as accounting rules regarding contingencies set forth in Accounting Standards Codification Subtopic 450-20 (SFAS 5), require public companies to provide clear and transparent disclosure regarding their obligations relating to representations and warranties made in connection with securitization activities and whole loan sales, including a roll forward of related reserves. In addition, companies are encouraged to discuss implications of any foreclosure review, including potential delays in completing foreclosures, if applicable. These disclosures may include increased risks and uncertainties, including litigation risks, potential defects in securitizations, impairments and liquidity, and should address the company’s role as an originator, securitizer, servicer or investor, as applicable. The letter notes that some of these disclosure issues are not limited to financial institutions that sold or securitized mortgages or mortgage-backed securities, and instructs companies that engage in mortgage servicing, title insurance, mortgage insurance and other activities relating to residential mortgages to consider the impact of these and similar issues for their disclosures.

Click here for a copy of the SEC letter.

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On November 1, the staff of the Securities and Exchange Commission’s Division of Risk, Strategy and Financial Innovation released a report of its review of the Interactive Data Financial Statement submissions during June–August. The submissions reviewed included the first group of mandated detailed tagged public company filings and the initial filings of the second phase-in group of public companies. The staff expects these deficiencies to be addressed by filers in their November Form 10-Q filings and future filings.

The most common deficiencies identified in the review included incorrect tagging of data with negative values, unnecessary use of custom elements where existing U.S. Generally Accepted Accounting Principles taxonomy is appropriate, incorrect tagging of classes of stock, and improper designations by consolidated entities of parent company and subsidiary information, and incorrect tagging of parenthetical line item data.

Click here to read the staff report.

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Co-authored by Janet M. Angstadt

The Financial Industry Regulatory Authority released a notice requesting comment on its proposal that would require member firms at or prior to commencing a business relationship with a retail customer to provide a written statement to such customer describing the types of accounts and services it provides, potential conflicts associated with such services and any limitations on the duties the firm otherwise owes to retail customers.

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Co-authored by Janet M. Angstadt

On November 3, the Securities and Exchange Commission announced the adoption of Rule 15c3-5, which prohibits broker-dealers from providing customers with “unfiltered” or “naked” access to an exchange or alternative trading system (i.e., where broker-dealers allow customers to trade in those markets electronically using the broker-dealers’ market participant identifiers). The rule also requires broker-dealers to have better risk controls when they access the market on behalf of their customers or themselves. For example, broker-dealers must put in place risk management controls and supervisory procedures to help prevent erroneous orders, ensure compliance with regulatory requirements and enforce preset credit or capital thresholds.

The final rule includes certain limited exceptions to these requirements. For example, a broker-dealer providing market access is permitted to reasonably allocate control over specific regulatory risk management controls and supervisory procedures to a customer that is a broker-dealer, so long as such broker-dealer customer has better access to that ultimate customer and its trading information such that it can more effectively implement the specified controls and procedures.

According to the SEC, the new rule aims to bring greater standardization, accountability and transparency to market behaviors. “I have previously likened unfiltered access to giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied,” said SEC Chairman Mary Schapiro. “This rule requires that broker-dealers not only remain in the car, but also maintain control of it so we can all be assured the rules of the road will be observed before the car is ever put into drive.”

The new rule will be effective 60 days from the date of its publication in the Federal Register. Once effective, broker-dealers subject to the rule will have six months to comply with the requirements.

Click here to read the SEC press release regarding adoption of Rule 15c3-5, issued on November 3.
SEC Release No. 34-63241 is available here.

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Co-authored by Janet M. Angstadt

On November 3, the Securities and Exchange Commission proposed a new rule under the Securities Exchange Act of 1934 (Exchange Act) that is intended to prevent fraud, manipulation and deception in connection with the offer, purchase or sale of any security-based swap, the exercise of any right or performance of any obligations under a security based-swap, or the avoidance of such exercise or performance.

Section 761(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act defines a “security-based swap” as “any agreement, contract, or transaction that is a swap, as defined in Section 1(a) of the Commodity Exchange Act, that is based on a narrow-based security index, or a single security or loan, or any interest therein or on the value thereof, or the occurrence or non-occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that such event directly affects the financial statement, financial condition or financial obligations of the issuer.”

A key characteristic of most security-based swaps, as compared to other securities, is the obligation for and right to ongoing payments or deliveries between the parties throughout the life of the security-based swap. The exercise of such rights or performance of such obligations under a security-based swap presents opportunities and incentives for fraudulent conduct. Parties to a security-based swap may engage in misconduct to trigger, avoid or affect the value of such ongoing payments or deliveries. To address the increased exposure to fraudulent conduct related to security-based swaps, the SEC is proposing Exchange Act Rule 9j-1.

The proposed rule would subject security-based swaps, as securities, to the general antifraud and anti-manipulation provisions of the federal securities laws (e.g., Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933), but would also explicitly reach misconduct that is in connection with the “exercise of any right or performance of any obligation under” a security-based swap. Therefore, the proposed rule would explicitly reach misconduct in connection with the ongoing payments or deliveries characteristic of security-based swaps. Misconduct to trigger, avoid or affect the value of such ongoing payments or deliveries would be explicitly prohibited.

Click here to read the full text of the SEC release.

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On November 4, the Securities and Exchange Commission announced it will extend the date for compliance with the SEC’s new short sale rule to February 28, 2011. The extension was granted to give certain exchanges additional time to modify their market opening, reopening and closing procedures for individual securities covered by the rule, and in order to provide additional time to market participants for programming and testing of systems for implementation.

The new short sale rule will, in part, restrict the prices at which a stock can be sold short if the stock's price drops 10% or more in one day.

SEC Release No. 34-63247 is available here.
Click here for the text of the final short sale rule.

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Co-authored by Kenneth M. Rosenzweig

The Commodity Futures Trading Commission announced that it will hold a public meeting to propose rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding: (1) registration of foreign boards of trade; (2) registration of swap dealers and major swap participants; (3) implementation of the new whistleblower provisions of the Commodity Exchange Act; (4) conflict of interest policies and procedures for futures commission merchants (FCMs), introducing brokers, swap dealers and major swap participants; and (5) FCM, swap dealer and major swap participant compliance policies.

The meeting will take place at 1:00 p.m. Eastern on November 10.

The CFTC’s press release, which includes information on viewing a webcast of the meeting, can be found here.

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Co-authored by Brian Schmidt

The U.S. District Court for the Southern District of Florida dismissed a civil Racketeer Influenced and Corrupt Organizations Act complaint based on a series of investments made with a group of India-based companies.

Plaintiffs made 35 investments with two corporations related to the defendants between May 2007 and March 2009. According to the plaintiffs, the corporate defendants were created to hide money originally stolen from them through a series of sham transactions. Plaintiffs alleged that the companies pretended to purchase diamonds from Indian diamond merchants, reflected in fake invoices, as part of a complicated scheme to legitimize the stolen funds. Plaintiffs included invoices, details about specific wire transfers and a flow chart to support their allegations. The court held that the plaintiffs’ allegations that the diamond sales and related paperwork were “fake” and that the transferred funds were “embezzled” and “converted” were “conclusory” because “[t]hey are simply unsupported statements of plaintiffs’ belief as to the origin of the funds” rather than actual facts supporting their claims. Accordingly, the case was dismissed. (Rajput v. City Trading, LLC et al., 10-Civ.-21654, 2010 WL 4259955 (S.D.Fla. Oct. 25, 2010))

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Co-authored by Brian Schmidt

The U.S. District Court for the District of Massachusetts granted a motion to dismiss in a breach of contract and promissory estoppel case, ruling that plaintiff failed to plead the requisite justification for piercing the corporate veil of the defendants.

Plaintiff, TechTarget Inc., provided advertising services pursuant to a contract with one of the defendants, Spark Design, LLC. Spark Design fell behind on payments owing under the contract almost immediately. Thereafter, defendant WW Capital Partners, LLC, a wholly owned subsidiary of defendant Black Mountain Enterprises, LLC, acquired a controlling interest in Spark Design. After that acquisition, WW Capital made representations to TechTarget that past-due invoices would be paid. WW Capital issued checks to TechTarget, but one check was returned for insufficient funds and another had a stop payment order placed on it. After TechTarget filed suit on the contract, Spark Design filed for Chapter 11 Bankruptcy, staying the proceeding against it, and WW Capital and Black Mountain moved to dismiss. Although TechTarget alleged that the three corporate defendants shared common ownership, that WW Capital and Black Mountain may have exercised pervasive control over Spark, and that business assets were intermingled between the three companies, TechTarget failed to include any allegations of fraudulent or improper use of Spark Design’s corporate form in a manner related to the contract. Accordingly, the court could not find that Spark Design was the alter ego of WW Capital and Black Mountain, and the claims against those entities were dismissed. (TechTarget, Inc. v. Spark Design, LLC, Black Mountain Enterprises, LLC, WW Capital Partners, LLC, No. 10-Civ.-11266 (WGY), 2010 WL 4269602 (D. Mass. Oct. 27, 2010))

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