Friday, February 15, 2019

United stockholder loses challenge to ex-CEO’s severance

By Anne Sherry, J.D.

A stockholder’s demand on the full board of United Airlines that it claw back severance paid to ousted CEO Jeffery Smisek did not concede the disinterestedness or independence of the special committee that rejected that demand. However, the Delaware Court of Chancery dismissed the pension fund’s derivative complaint on the basis that it failed to plead with sufficient particularity that the special committee was conflicted (City of Tamarac Firefighters’ Pension Trust Fund v. Corvi, February 12, 2019, McCormick, K.).

David Samson, then Port Authority chairman, proposed to Smisek that United reinstitute an unprofitable route between Newark, New Jersey, and Columbia, South Carolina, where Samson owned a vacation home. Smisek agreed to reopen the route in exchange for Samson’s approval of projects at United’s regional hub. A federal investigation into an unrelated matter uncovered this arrangement in 2014, and Smisek and United entered into a separation agreement negotiated and approved by a special committee of outside directors.

The pension fund plaintiff made two litigation demands asking United’s board to claw back the severance package or rescind the separation agreement. Rather than consider the demands itself, the board delegated them to a special committee, which recommended that the demands be rejected. The executive committee followed that recommendation.

When a stockholder makes a presuit litigation demand, it tacitly concedes that the board is disinterested and independent for purposes of considering the demand. The decision of that concededly disinterested and independent board is thus entitled to the business judgment presumption. The defendants argued that this tacit concession automatically extends to board committees, but the court disagreed. By making demand on the full board, the stockholder concedes only that a majority of the board is capable of considering the demand. The court described a hypothetical in which a nine-member board delegates consideration of a demand challenging the CEO’s pay to a special committee consisting only of the CEO. There, it is easy to understand why the board’s decision to delegate that decision to the CEO could be grossly negligent or in bad faith—but it would still need to analyze whether the CEO is conflicted.

Here, the plaintiff failed to make that showing of conflicts on the part of the special committee that refused the demand. The fund did not allege any financial or personal benefit to the director defendants in approving the separation agreement or rejecting the litigation demands. Instead, it focused on the committee members’ prior involvement in the decision to approve the separation agreements. But a person is not conflicted in deciding whether to exercise a contractual right by reason of the fact that the person negotiated for the right. The plaintiff did not allege that the committee members were involved in United’s clawback policies or the decisions to approve the separation agreement. The court concluded that “for the prior-involvement theory of conflicts to have legs, at a minimum, Plaintiff must allege some prior involvement.”

The case is No. 2017-0341-KSJM.

Thursday, February 14, 2019

IOSCO finds gaps in implementation of key market principles in emerging member jurisdictions

By John Filar Atwood

IOSCO issued a report that found that implementation of its five secondary and other market principles is high across most member jurisdictions, but lags in new and emerging markets. The five principles seek to promote fair, efficient and transparent markets, and the report provides recommendations to help certain countries strengthen their implementation of the principles.

The five principles, which are a sub-set of IOSCO’s objectives and principles of securities regulation, are intended to promote fair, efficient, and transparent markets. Two of the principles deal with authorization, oversight, and ongoing supervision requirements, and another covers transparency requirements. A fourth principle covers detection and deterring market misconduct and the fifth deals with managing risks such as monitoring large exposures, default procedures and short selling.

The report is based on review of 40 ISOCO member jurisdictions. The review was intended to provide a global overview of the status of implementation of the five principles by participating member jurisdictions, based on their self-assessments.

Securities exchanges. Principle 33 states that the establishment of trading systems, including securities exchanges, should be subject to regulatory authorization and oversight. The review found that this principle has been largely implemented, with all jurisdictions reported having the requirement for the authorization of exchanges. In addition, IOSCO found that implementation has been high in relation to arrangements for supervision of exchanges, disclosure of order routing procedures and execution rules, and equitable access to market rules and operating procedures.

The gaps in implementation of Principle 33 mainly related to some jurisdictions lacking adequate trading control mechanisms and offering no access to books and records of outsourced service providers. Some countries also lacked sufficient prudential arrangements, had no automated pre-trade controls, no criteria for authorization of exchange, and lacked mechanisms for review of trade matching algorithms.

Principle 34 states that there should be ongoing regulatory supervision of exchanges and trading systems to ensure that the integrity of trading is maintained through fair and equitable rules that strike a balance between the demands of different market participants. All participating member jurisdictions reported having requirements for supervision of exchanges, monitoring of day-to-day trading on exchanges, and regulator’s access to all pre-trade and post-trade information. The primary gap on this principle related to the inability of four jurisdictions to withdraw the authorization of the authorized exchanges.

Transparency. Principle 35 provides that regulation should promote transparency of trading. The report states that all participating jurisdictions have requirements for pre-trade and post-trade transparency relating to trading on authorized exchanges. Exemption from real time transparency is permitted in most jurisdictions, and the regulator has access to information relating to such exemptions.

Principle 36 states that regulation should be designed to detect and deter manipulation and other unfair trading practices. IOSCO found that all member jurisdictions have the regulatory framework for prohibition of market manipulation. The gaps in implementation of this principle related to adequacy of enforcement sanctions in one jurisdiction and cross-market surveillance in one jurisdiction.

Principle 37 provides that regulation should aim to ensure the proper management of large exposures, default risk and market disruption. The report states that this principle has largely been implemented, but gaps were found in the monitoring of large exposures in three jurisdictions, default procedures in two jurisdictions, reporting of short selling in four jurisdictions, and reporting of large trader positions in commodity derivatives markets in one jurisdiction.

Recommended improvements. The report provides specific recommendations for improvement in a number of jurisdictions. For example, in Mexico, IOSCO recommended that the securities regulator consider making the default procedures transparent and available to public. It also suggested that the regulator consider developing and implementing a reporting regime for short selling activities and evaluating the need for providing appropriate exceptions in short selling regime for certain types of transactions such as hedging, market making, and arbitrage activities.

In South Africa, which now has multiple exchanges, IOSCO recommended that the regulator consider developing capacity for conducting cross-market surveillance for monitoring trading activities across the exchanges. Since covered short selling is permitted in South Africa, IOSCO also suggested that the regulator consider implementing a reporting regime for short selling activities and evaluate the need for providing appropriate exceptions for certain types of transactions such as market making.

Wednesday, February 13, 2019

Corporate political disclosure remains hot topic in new Congress

By Mark S. Nelson, J.D.

The Supreme Court’s Citizens United opinion has resulted a in persistent effort to require corporate disclosures of political spending although, so far, those efforts have not produced enacted legislation or SEC rules. Representative Salud Carbajal (D-Cal) is the author of the latest attempt to bring transparency to how companies spend company funds on political activities with his reintroduction of the Corporate Political Disclosure Act of 2019 (H.R. 1053).

Uniformity in reporting. “For years, Congressional Republicans have blocked the SEC from shining a light on the political contributions that shareholder funds are supporting. That must change,” said Rep. Carbajal. “The voices of Central Coast residents and small businesses shouldn’t be drowned out by billions of dollars in secret political advertising backed by corporations that place making a profit above the public interest.”

The text of the reintroduced bill was unavailable as of publication, but the prior version of the bill introduced in the 115th Congress (H.R. 5670) would require the SEC to adopt rules to mandate disclosure of a company’s political activities during the previous year in its annual report and on its Internet website, which must be accessible to shareholders and the public. According to Rep. Carbajal, the goal of the bill is to establish a “uniform reporting requirement.” The representative also cited a study indicating that more than half of the S&P 500 companies have already made some political spending disclosures in response to shareholders’ concerns.

Other legislation. Currently, the SEC is barred from mandating public company disclosures about political spending under provisions that have been part of appropriations bills, including recent efforts to reopen the federal government. However, Sen. Elizabeth Warren’s (D-Mass) Accountable Capitalism Act from the 115th Congress would have required super majority approval of political donations by boards and shareholders. The signature government ethics bill introduced by the Democratic majority in the House in the 116th Congress (Rep. Carbajal is one of 227 co-sponsors, all Democrats) would lift the ban on SEC rules for public company political donations although, as drafted, the removal of the ban would apply only for FY 2019. Lawmakers are now working on a larger appropriations package to keep the federal government open for the remainder of FY 2019 after temporary funding expires in Mid-February and it remains to be seen if a similar provision banning SEC rules on political spending disclosures will be retained.

More recently, questions about companies’ political spending and institutional investors have arisen. These concerns, for example, have been taking up by Rep. Jamie Raskin (D-Md), who recently introduced the Shareholders United Act of 2019 (H.R. 936), and by Delaware Chief Justice Leo Strine, who recently expressed his views in a paper.

Within in the SEC, Commissioner Robert Jackson has been the most outspoken in favor of additional disclosures, especially before joining the Commission. Disclosure of companies’ political spending habits has been a controversial topic at both the SEC and in past Senate confirmation hearings for SEC nominees because of the Commission’s lack of action (partly due to Congressional appropriations measures limiting the agency’s ability to issue rules) despite millions of public comments received on several rulemaking petitions. Jackson, for example, signed a petition in 2011 urging the Commission to issue political disclosure rules.

Tuesday, February 12, 2019

Upcoming cryptocurrency guidance should cast Howey net narrowly, Commissioner Peirce urges

By Lene Powell, J.D.

Peirce reaffirmed remarks of Division of Corporation Finance Director Bill Hinman likening security tokens to the orange groves in Howey, saying that when they are not sold as investment contracts, tokens are not securities at all.

In regulating token-based securities offerings, the Howey test “seems generally to make sense,” but the SEC must be careful not to apply it too broadly, said Commissioner Hester Peirce. Remarks last June by Division of Corporation Finance Bill Hinman provide a useful framework for analyzing token offerings, said Peirce, and this will be supplemented by supplemental staff guidance and possibly Congressional action. She reminded market participants that there is a standing offer for people to approach the SEC for no-action relief in connection with a particular token or project, and to provide feedback generally.

Enabling, not stifling innovation. Although her remarks at the University of Missouri School of Law focused on cryptocurrency and token offerings, Peirce stressed the need for the SEC to continually look for ways to facilitate capital formation in general.

“As a regulator, when I think about protecting the public, I think not only of protecting investors, but also of ensuring that the capital markets are able to serve the rest of the economy without undue barriers,” said Peirce.

Cautioning against putting a “thumb on the scale” in favor of entrenched market participants, Peirce welcomed Martha Miller to the SEC, who was recently appointed the agency’s first Advocate for Small Business Capital Formation. She listed questions the SEC should consider:
  • Can we look for ways for unaccredited investors to pool their resources to invest in private companies?
  • Can we change rules that mandate the use of outdated technology in, for example, our recordkeeping rules so that financial institutions can incorporate new technology and thus lower the costs of the services they provide?
  • Can we allow more experimentation in the way that funds and investment advisers communicate with investors?
  • Can we reexamine our assumptions about the types and methods of disclosure we require in light of the enormous changes in communication technology that have occurred since the federal securities laws were written in the 1930s?
  • Can we permit more issuer communication with investors, which perhaps could open the door to a back-and-forth style of disclosure facilitated by online chats and message boards? 
Regulation of token offerings. Turning specifically to offerings involving securities tokens, Peirce said that blockchain-based networks offer a new way of coordinating human action that does not fit neatly within the existing securities framework. Peirce reaffirmed remarks by Bill Hinman in a June 2018 speech, “Digital Asset Transactions: When Howey Met Gary (Plastic).” Just like the oranges and groves in the Howey case were not securities standing on their own, but the overall package sold to investors was, a token all by itself is not a security, said Hinman. Decentralization diminishes the likelihood that a token offering is a security. Once “a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosure becomes less meaningful,” and offers and sales of tokens are no longer subject to the securities laws.

Although the Commission has spoken indirectly through a number of enforcement actions, “enforcement actions are not my preferred method for setting expectations for people trying to figure out how to raise money,” said Peirce. The enforcement actions found that the token offerings at issue were securities offerings, but token offerings do not always map perfectly onto traditional securities offerings. Again, the decentralized nature of blockchain networks plays a role, as functions traditionally completed by people designated as “issuers” or “promoters” under securities laws may be performed by a number of unaffiliated people, or by no one at all.

Mapping the framework. In calibrating its regulations, the SEC must take care not to cast the Howey net so wide that it swallows the “efforts of others” prong entirely, said Peirce. A forthcoming paper by Georgetown Law professor Chris Brummer argues that ICOs have certain features that make the regulatory framework applicable to IPOs inappropriate. Congress may step in and resolve the matter by requiring that at least some digital assets be treated as a separate asset class, as a bill recently introduced in the House by Congressmen Warren Davidson (R-Ohio) and Darren Soto (D-Fla) does, provided the token truly operates in a decentralized network.

Warning that her “antennae will go up when apparently legitimate projects cannot proceed because our securities laws make them unworkable,” Peirce said the SEC ought not to assume that absent the application of the securities laws to the world of tokens, there would never be any order, since the market imposes its own discipline regarding disclosures. Peirce is also concerned that the SEC’s approach to exchange-traded products based on bitcoin or other cryptocurrencies “borders on merit-based regulation,” and the agency should avoid substituting its own judgment for that of potential investors.

“We rightfully fault investors for jumping blindly at anything labeled crypto, but at times we seem to be equally impulsive in running away from anything labeled crypto,” said Peirce. “We owe it to investors to be careful, but we also owe it to them not to define their investment universe with our preferences.”

Monday, February 11, 2019

Murphy & McGonigle attorneys expect more aggressive offshore enforcement in wake of Scoville decision

By James K. Goldfarb, Daniel T. Brown, Stephen J. Crimmins, Larry E. Bergmann, Murphy & McGonigle

The Tenth Circuit’s decision in SEC v. Scoville was a major victory for the SEC, confirming the extraterritorial enforcement power that the Commission believes was provided by the Dodd-Frank Act, according to Murphy & McGonigle attorneys James Goldfarb, Daniel Brown, Stephen Crimmins and Larry Bergmann. They expect the SEC to waste little time in using that power but warn that court challenges may not be far off. In their view, until the Supreme Court or Congress weighs in, Scoville presages more aggressive overseas enforcement activity, even in cases where the misconduct is not connected to domestic securities transactions.

To read the entire article, click here.

Friday, February 08, 2019

FASB proposes relief for firms transitioning to the credit losses standard

By Amy Leisinger, J.D.

The Financial Accounting Standards Board has proposed an Accounting Standards Update (ASU) to ease the entities’ transition to the credit losses standard by providing them with the option to measure certain types of assets at fair value. Under the proposed ASU, preparers could irrevocably elect the fair value option for eligible financial assets measured at amortized cost basis upon adoption of the standard. In a press release, FASB notes that the proposed change would increase comparability of financial statements across institutions that otherwise would report similar instruments using different methodologies and potentially decrease costs.

Credit losses standard. Adopted by FASB in June 2016, the standard’s current expected credit losses methodology will replace the incurred loss methodology that financial institutions currently use to recognize credit losses. Under the new methodology, recognition of a credit loss no longer will be delayed until that loss is probable; rather, institutions will be required to use a broader range of data to estimate likely credit losses over the life of an asset or pool of similar assets. Relevant data would include historical performance and both current and predicted future economic conditions.

Proposed fair value option. Since the issuance of the update, FASB has received several letters requesting that it consider amending the transition guidance for the update. Stakeholders noted that some financial statement preparers are planning to elect the fair value option on newly originated or purchased assets, even though those entities have historically measured similar financial assets on an amortized cost basis. Without targeted transition relief, the entities would need to maintain dual measurement methodologies that could result in non-comparable financial statement information.

As such, the proposed amendments would provide an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. An entity that elects the fair value option would subsequently apply the guidance in Subtopics 820-10, Fair Value Measurement—Overall, and 825-10. This change would increase comparability of financial statement information and decrease costs for some preparers while providing financial statement users with more useful information.

Comment period. FASB requests comment on the proposed update, particularly with regard to whether additional disclosures would be needed for the proposed amendments. The Board also asks whether stakeholders agree with its decision not to provide entities with an option to discontinue fair value measurements for financial assets measured at fair value through net income and instead apply the measurement guidance in Subtopic 326-20.

Comments on the proposal are due by March 8, 2019.

Thursday, February 07, 2019

New CorpFin Regulation S-K C&DIs offer guidance on board diversity disclosures

By Mark S. Nelson, J.D.

Companies may need to do more to meet their disclosure obligations regarding the self-identified diversity characteristics of director nominees who have agreed that the company can disclose these characteristics about them, according to a pair of new C&DIs issued by the SEC’s Division of Corporation Finance. The C&DIs note that self-described diversity characteristics can include “race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background.” CorpFin’s new mirror image C&DIs (Questions 116.11 and 133.13) are its first issued since the federal government reopened and provide guidance to companies regarding how to apply Items 401 and 407 of Regulation S-K.

Under Item 401 of Regulation S-K, a company must provide a description of director nominees’ backgrounds. The C&DIs explain that this description should cover a variety of items, including “specific experience, qualifications, attributes, or skills.” Under the new C&DIs, the Item 401 disclosure should, at minimum, identify self-identified diversity characteristics and state how they were considered by the nominating committee or by the board.

Item 407(c)(2)(vi) of Regulation S-K requires a description of a company’s process for nominating and evaluating director candidates. As part of that disclosure, a company must explain whether and how it considers diversity in identifying directors. A company must further describe how its diversity policy is implemented and how it judges the policy’s effectiveness.

The new C&DIs state that, for purposes of Item 407(c)(2)(vi) of Regulation S-K, a company should explain how it considered self-identified diversity characteristics under its diversity policy. That discussion also should note how the company considered other factors within the scope of its diversity policy, including “diverse work experiences, military service, or socio-economic or demographic characteristics.”

Wednesday, February 06, 2019

Sen. Sanders plans to introduce stock buyback bill

By Mark S. Nelson, J.D.

A stock buyback bill expected to be introduced by Sen. Sanders could track legislation he introduced in the last Congress that would have mandated gains for workers before companies can engage in stock buybacks.

Senator Bernie Sanders (I-Vt) said via a tweet that he plans to introduce legislation that would curb corporate stock buybacks unless companies provide more extensive benefits to their workers, including an increased minimum wage and paid sick leave. Although the new bill text was unavailable at publication, the outline of the legislation appears to track mirror-image bills introduced in the 115th Congress by Sen. Sanders and Rep. Ro Khanna (D-Cal). For comparison, Sen. Warren’s Accountable Capitalism Act, also introduced in the last Congress, would not have curbed buybacks per se, but it would have imposed a holding period on corporate executives at companies that do conduct buybacks.

Walmart as the common theme. Senator Sanders has consistently targeted Walmart Inc. as an example of a company that engages in stock buybacks, which he claims mostly benefit executives and large investors to the detriment of ordinary workers. Senator Sanders offered a preview of the forthcoming bill in a video posted on his Twitter account that also featured Senate Minority Leader Chuck Schumer (D-NY), who appeared to back the legislation. The video largely retraces the text of the senators’ joint Op-Ed piece that appeared this past weekend in The New York Times. According to Sen. Sanders, the bill text is still being finalized.

For its part, Walmart recently announced that it will provide its associates extra cash bonuses based on store performance and it will also permit associates to earn as much as 48 hours of “Protected PTO” or paid time off that can be used for unplanned absences. Walmart said the use of “Protected PTO” would not count against associates’ attendance records. Walmart said the changes were made in response to associate feedback and that they became effective for U.S. stores on February 2.

"We’re constantly testing, learning and seeking feedback to improve our stores for associates and customers," said Drew Holler, Walmart U.S.'s vice president of associate experience. "This change, along with previous wage investments, parental leave, adoption and other benefits, is another important step on our journey to be the employer of choice."

For Sen. Sanders, that might be a step in the right direction, although the senator has said that he still sees room for additional progress. In a statement following Walmart’s announcement, Sen. Sanders had this to say: “Walmart’s decision to provide 48 hours of paid sick leave to some of its employees is a small step forward, but not nearly good enough. Walmart, which is owned by the wealthiest family in America, is not a poor company. If Walmart can afford $20 billion for stock buybacks to enrich wealthy shareholders, it can afford to raise the pay of all its workers to a living wage. Walmart can and must pay all of its workers at least $15 an hour with good benefits.”

On the Sanders-Schumer video, Sen. Schumer said stock buybacks are not the only issue. The minority leader said separate tax legislation would have to address companies’ use of dividends to achieve results similar to stock buybacks.

Mechanics of the prior stock buyback bill. The Stop Welfare for Any Large Monopoly Amassing Revenue from Taxpayers Act of 2018 (informally referred to by Sen. Sanders and Rep. Khanna as the "Stop WALMART Act") would have denied a large company the ability to repurchase its stock on a national securities exchange during a fiscal year in which the company violated terms of the legislation. Press releases issued then by Sen. Sanders and Rep. Khanna explained their focus on Walmart. According to Sen. Sanders and Rep. Khanna, Walmart is highly profitable, pays its median worker less than $15 per hour, and plans to conduct a $20 billion stock buyback.

Violations of the bill would include the following: (1) paying wages below $15 per hour; (2) denying employees the right to one hour of paid sick time per 30 hours worked up to 56 hours (7 days) of paid sick time; and (3) having a compensation ratio that exceeds 150. Enforcement of the provision would seek to hold both the large company and its executives accountable. For one, the SEC could impose a civil penalty on the company in the amount the company paid to repurchase its stock. Second, an executive officer could not hold that position for one year following a first-time violation; if the violation is not a first-time violation, the executive officer would be barred from their position at the company for life. The SEC would have to adopt rules that tell stock exchanges and companies how to comply with the requirements of the bill.

With respect to key terms, "employee" would be defined broadly to include full- and part-time employees, some independent contractors and, subject to limits, joint employees. "Large employer" would mean a company that, during the prior fiscal year, employed on average at least 500 employees and was subject to the SEC’s Regulation S-K, one of the main sources of the requirements for making filings with the SEC. "Executive officer" would mean any person (but not a director) who is authorized or participates in the large employer’s "major policy-making functions" regardless of that person’s title or compensation. Moreover, "executive officer" includes a company’s chairman, president, vice presidents, and chief financial officer, unless these persons are excluded by a board resolution or bylaws from, and they do not participate in, major policy-making functions.

The compensation ratio mentioned in the bill would be similar to the SEC’s pay ratio disclosure requirement adopted under Dodd-Frank Act Section 953(b) and which is explained in related staff guidance (e.g., "total compensation" is found in disclosures made under Item 402(c)(2)(x) of Regulation S-K). For comparison purposes only, a blog post by Margaret Engel, et al. of Compensation Advisory Partners to the Harvard Law School Forum on Corporate Governance and Financial Regulation noted early 2018 proxy trends regarding pay ratio disclosures (the median was 87, the 25th percentile was 36, and the 75th percentile was 172), while a later post to the same publication by Deb Lifshey of Pearl Meyer & Partners, LLC, found a median of 69, an average of 144, and 25th and 75th percentiles of 32 and 141, respectively.

"Paid sick time" also would cover many circumstances, including medical and mental health conditions, caring for relatives or children, and treatment for or recovery from domestic violence, sexual assault or stalking (including obtaining services from a "victim services organization," which is defined to include nonprofit, nongovernmental organizations and victim advocates, such as rape crisis centers).

The Warren bill compared. Senator Warren’s Accountable Capitalism Act (S. 3348) would have approached some of the same employee issues via a federal corporate chartering framework. Under current securities laws, corporate stock buybacks are conducted under Exchange Act Rule 10b-18, which affords companies a safe harbor from liability for manipulation if the repurchases meet four conditions regarding the use of a single broker-dealer on a single day and regarding the timing, price, and volume of purchases. Section 7 of the Accountable Capitalism Act would bar a director or officer from selling their company stock for three years after a corporate buyback.

The prohibition would not apply to securities held on the day before the date of enactment of the Accountable Capitalism Act. The SEC also could sanction noncompliance by imposing a civil penalty of at least the fair market value of the securities sold, but not more than three times the fair market value of the securities the officer or director sold, measured in both instances from the date the securities were sold.

Elsewhere, the Accountable Capitalism Act would give employees more say in how their companies are run. Under Section 6, the SEC (in consultation with the National Labor Relations Board) would issue rules aimed at making the election of directors at U.S. corporations "fair and democratic." Specifically, the employees of a U.S. corporation would be allowed to elect two-fifths (40 percent) of the corporation’s directors. Both the SEC and the NLRB would monitor for compliance. The bill would require the Secretary of Labor to impose a civil money penalty of $50,000 to $100,000 per day that a U.S. corporation fails to comply with the board representation requirement. The Office of United States Corporations, to be created by the bill, may revoke a corporation’s federal charter for noncompliance.

Tuesday, February 05, 2019

Institutional investors group joins in opposition to Johnson & Johnson mandatory arbitration shareholder proposal

By Amanda Maine, J.D.

The Council of Institutional Investors (CII) has written to the SEC in opposition to a shareholder proposal that would request the board of Johnson & Johnson (J&J) to adopt a bylaw requiring arbitration of shareholder claims. CII joins NASAA in supporting the company’s position that the proposal should be excluded from the proxy materials for J&J’s upcoming annual meeting of shareholders.

Proposal. Johnson & Johnson shareholder Hal Scott submitted a proposal to be voted on at J&J’s 2019 shareholder meeting requesting that J&J’s board of directors “take all practicable steps to adopt a mandatory arbitration bylaw.” J&J submitted a letter to the SEC’s Division of Corporation Finance requesting that it be allowed to exclude the proposal from its proxy materials. In the company’s view, if implemented, Scott’s proposal would cause the company to violate federal law.

CII letter. CII’s letter to CorpFin urges the Division to grant the no-action relief requested by J&J. According to CII, shareholder arbitration clauses in public company governing documents are against the principles of sound corporate governance because when disputes go to arbitration instead of the court system, they are not part of the public record and can lose their deterrent effect.

CII also cited the SEC’s longstanding view opposing shareholder arbitration clauses in U.S. IPO registration statements and noted that Chairman Jay Clayton stated at CII’s Spring 2018 meeting that this policy should not be changed without input from all interested constituents. In addition, CII also referenced Chairman Clayton’s letter to Rep. Carolyn Maloney (D-NY) in April 2018, in which he stated that he would expect prior to any decision on the matter, the SEC would “give the issue full consideration and in a measured and deliberative measure” and not through delegated authority.

In its letter, CII referenced remarks made by SEC Commissioner Robert Jackson, who has expressed skepticism about permitting companies to include mandatory shareholder arbitration clauses in IPO documents. Jackson has stated that private shareholder actions against companies aid the SEC in identifying and addressing corporate wrongdoing. Much of the law governing securities fraud has developed out of this kind of litigation and has supplemented the SEC’s limited enforcement resources, Jackson has advised.

NASAA also rejects mandatory arbitration. CII joins the North American Securities Administrators Association (NASAA) in calling for the SEC to permit the exclusion of Scott’s proposal from J&J’s proxy materials. Describing the proposal as “drastic and misguided,” NASAA advised that the proposal would be incompatible with the anti-waiver provisions of the Exchange Act because it would interfere with shareholder rights to right to bring a Section 10(b) class action lawsuit in federal court, as well as lawsuits under Sections 11 and 12 of the Securities Act.

Monday, February 04, 2019

Practitioners attempt to untangle web of insider trading law in ABA webinar

By Amanda Maine, J.D.

The American Bar Association recently hosted a webinar where panelists outlined recent federal court decisions on insider trading laws and their possible implications for the future. The webinar featured a discussion on the Second Circuit’s ruling in U.S. v. Newman and cases that followed that have spawned debate about the current state of insider trading law in the U.S.

Newman and Salman. Moderator Antonia Apps of Milbank Tweed discussed the Second Circuit’s 2013 Newman decision, which upended the prevailing theory of what a “personal benefit” is under Dirks. Dirks, Apps explained, was the origin of the personal benefit test. The language seized upon in Dirks by the Newman panel involved a “trading relative or friend.” In the Newman decision, the court tried to narrow the scope of a personal benefit for proving insider trading liability, stating that “to the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee … such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

Carl Loewenson, Jr. of Morrison & Foerster turned the discussion to U.S. v. Salman. The Ninth Circuit had upheld the defendant’s insider trading conviction in an opinion written by Southern District of New York District Judge Jed Rakoff (sitting by designation), who Loewenson quipped “has a way of appearing on an awful lot of insider trading cases.” The Supreme Court affirmed the conviction, but Loewenson noted that the Court’s ruling was quite narrow. Deferring to Dirks, the unanimous opinion felt that the language in Dirks mentioning a “trading relative” was sufficient to resolve the case at hand. While the government had tried to use the Salman case as a challenge to Newman, the court rejected this approach in favor of a much narrower ruling, Loewenson advised.

Martoma. U.S. v Martoma brought up the issue of when tipping a perfect stranger crosses the line to legal liability, Apps said. The issue can end up in ridiculous hypotheticals, but those are just part of the discussions that make up the dialogue on what is a “personal benefit.” The jury in Martoma had found the defendant guilty, but Martoma later appealed because the jury instructions were given prior to the Newman decision. Martoma’s argument was based on the Newman-inspired personal benefit test; however, the Second Circuit panel held that the Salman decision had effectively overruled the Newman personal benefit test. Judge Pooler penned a strong dissent, and following an en banc hearing, the Second Circuit ruled that its prior decision had gone too far and that the personal benefit test articulated in Newman was not overruled by Salman—although it still upheld Martoma’s criminal conviction. Martoma has recently filed with the Supreme Court a petition for certiorari.

Now and beyond. Ruti Smithline of Morrison & Foerster used U.S. v. Blaszczak to illustrate the convoluted nature of the current state of insider trading law. Smithline noted that the defendant had been charged with both Title 15 securities fraud and Title 18 securities fraud. The jury instructions for the Title 15 charges took 20 pages of transcripts and presented the jury with 10 specific issues to address, including the tipper’s breach of duty and expectation of a personal benefit. In contrast, Smithline said, the jury instructions for the Title 18 charges took only four pages and did not include elements of liability such as breach of duty and personal benefit. The result: verdicts of not guilty on all Title 15 counts and guilty on all four Title 18 fraud counts.

Responding to the question “Where do we go from here?” on insider trading law, Loewenson harkened back to the Dirks opinion, which he said may have predicted the current state of affairs when it stated that determining what a personal benefit is will not always be easy for the courts. He also namechecked Judge Rakoff again, quoting him as saying, “The crime of insider trading is a straightforward concept that some courts have somehow managed to complicate.” Loewenson slyly added that by “some courts,” Rakoff probably meant the Second Circuit. Between Newman, Martoma, and Martoma, it is difficult to determine what the law is. “The Second Circuit’s efforts to untangle these concepts of personal benefit and meaningfully close personal friendship is like trying to count the angels dancing on the head of a pin,” Loewenson remarked.

Friday, February 01, 2019

Corporate compliance landscape explored in comprehensive law firm webinar

By Brad Rosen, J.D.

A panel of Gibson Dunn attorneys explored various regulatory developments that took hold in 2018 which significantly impact corporate compliance efforts in a webinar titled Challenges in Compliance and Corporate Governance. The presentation marked the 18th year Gibson Dunn has provided the community with an overview of these developments. Some of the hot topics covered included impact of the Trump administration and the recent government shutdown, cybersecurity and data privacy, SEC related disclosures, gatekeeper liability, as well as a review of key developments at the SEC and CFTC.

The panelists included Joseph Warren, Michael Mencher, Kendall Day, Sacha Harber-Kelly, Stuart Delery, Adam Smith, and Lori Zyskowski.

The Trump administration and impact of the government shutdown. The panelists generally agreed that in the first two years of the Trump administration, regulatory agencies have devoted resources and attention to many of the same priorities as in previous years. Especially at the SEC, things have stayed on track despite initial indications of vast overhauls at the agency. Cybersecurity and data privacy continue to be areas of focus for corporations and enforcement authorities alike in the wake of numerous announcements in 2018 of large-scale private and public sector data breaches. Criminal enforcement remains robust. Aggregate fines (from DOJ and civil enforcers) were down slightly, but remain significant—$10.91 billion in 2018 versus $11.75 billion in 2017.

As for the recent government shutdown, Michael Mencher noted that it will take many weeks for things to get back to normal. He observed that this was the case with the 2013 shutdown which lasted only 16 days. Clients can expect long delays when dealing with government agencies, even on routine matters, he noted.

State enforcers remain active. State enforcement authorities were active in 2018, utilizing a broad complement of enforcement tools. New York’s Department of Financial Services (“DFS”) remains a major player, and regulators from a number of states have taken action, particularly with respect to data privacy and security. California, Illinois, Massachusetts, and New York are all filling gaps created by decreased federal government enforcement in certain areas.

SEC enforcement in 2018. The panel noted that the SEC’s DOE 2018 annual report referred to five key focus areas:
  1. protecting the Main Street investor;
  2. pursuing individual accountability;
  3. keeping pace with technological change; 
  4. imposing sanctions that most effectively further enforcement goals; and
  5. constantly assessing its allocation of resources.
Some important SEC enforcement cases in 2018 included the following:
  • In Somers v. Digital Realty Trust, the Supreme Court held 9-0 that the Dodd-Frank anti-retaliation provision applies only to whistleblowers who report their concerns to the SEC, not to those who only file internal reports.
  • In Lucia v. SEC, the Supreme Court held in a 7-2 decision that the SEC’s administrative law judges (“ALJ”) are “officers of the United States,” and thereby subject to the Appointments Clause of the Constitution. As a result, the SEC agreed to rehear more than 128 cases previously litigated before ALJs found to have been improperly appointed; the full SEC reaffirmed the ALJ appointments in compliance with the ruling.
  • In December, the Supreme Court heard oral argument in Lorenzo v. SEC, a case on appeal from the D.C. Circuit regarding the scope of scheme liability under Rule 10b-5. The petitioner claimed that he cannot be found liable under a theory of “scheme” liability for distributing a misstatement of which he was not the “maker” under the Janus standard.
A year of increased enforcement activity at the CFTC. In 2018, the Commodity Futures CFTC brought 83 enforcement-related actions, a substantial increase from 49 enforcement actions filed in 2017. The agency also imposed monetary judgments of $10 million or more in ten cases, more than in any other year; and aggressively pursued wrongdoing involving trading misconduct, such as manipulation, spoofing, and wash trading matters.

To advance its priorities, the CFTC created specialized task forces in four substantive areas: spoofing and manipulative trading; virtual currency; insider trading and protection of confidential information; and the Bank Secrecy Act. Additionally, cooperation advisories issued by the CFTC’s DOE in 2017 resulted in a number of reduced penalties during the year. In several spoofing enforcement actions, the CFTC specifically noted that the companies received credit for substantial cooperation and self-reporting.

Data privacy concerns remain front row and center. The panel noted that many data breaches started with mistakes. For instance, the New York Attorney General attributed a quarter of 2017 breaches to negligence, including inadvertent disclosure and lost devices. Meanwhile, an SEC investigation in October found that nine public companies lost almost $100 million from cyber frauds where employees wired money to individuals posing as executives or vendors. Additionally, ransomware incidents are ubiquitous with ransomware accounting for almost half of all malicious software in 2017. It was noted that approximately 93% of malware, including ransomware, is spread via e-mail. According to the panel, this underscores the importance of anti-phishing training.

Major SEC disclosure practices trends and developments. The panel identified a number of emerging SEC related disclosure practices. These include: 
  • Board Diversity. A growing number of companies are voluntarily enhancing their disclosures to highlight the diversity of their boards.
  • Cybersecurity. Companies have been increasing their focus on cybersecurity disclosure in connection with both cybersecurity incidents and descriptions of board oversight and expertise.
  • SEC disclosure update and simplification. In August, the SEC adopted several dozen amendments to existing disclosure requirements “to simplify compliance without significantly altering the total mix of information.”
  • Proposed legislation to expand climate-related disclosures. In September, the Senate introduced the Climate Risk Disclosure Act of 2018, which would require public companies to disclose substantial new information about their exposure to climate-related risk. These disclosures would be intended to provide qualitative and quantitative information about financial risks from climate change and climate change mitigation.
Gatekeepers remain in SEC sites. The SEC continues to pursue individuals and entities for gatekeeping related failures. Seventy percent of the SEC’s cases in FY 2018 were brought against individuals. Specifically, the SEC brought charges against six accountants for attempting to steal inspection information from the PCAOB, and against three accountants for unprofessional conduct that violated securities laws and auditing standards, such as pre-dating audit paperwork and signing blank audit papers. Moreover, the increased focus on cybersecurity issues, including the relatively new area of initial coin offerings (ICOs), has put attorneys and accountants advising on these transactions in the limelight.
Slides can be viewed here, and the webinar can be viewed in its entirety on replay by clicking here.

Thursday, January 31, 2019

Giancarlo emphasizes cross-border deference, delves into SEF reforms

By Lene Powell, J.D.

Stressing a need to correct CFTC overreach in cross-border regulation, Chairman J. Christopher Giancarlo announced that he will direct staff to prepare new proposals as soon as possible to adopt a new cross-border framework that is risk-based and offers deference to comparable non-U.S. regulations. In recent remarks to an ABA derivatives committee meeting, Giancarlo also addressed concerns about proposed amendments to rules for swap execution facilities (SEFs) and the trade execution requirement, saying the concerns were valid and would receive thoughtful attention by CFTC staff.

The chairman’s remarks were prepared for delivery on January 25, 2019 to the ABA Business Law Section, Derivatives & Futures Law Committee Winter Meeting.

Cross-border deference. Swaps trading reform has been an ongoing journey since CFTC implementation of the Dodd-Frank reform measures enacted in 2010. In Giancarlo’s view, most of the reforms appear to be working well, but some are creating a “mismatch” between the CFTC’s swaps trading regulatory framework and the distinct liquidity and trading dynamics of the global swaps markets. In 2017, the CFTC reached a landmark comparability determination with the European Commission, but Giancarlo believes that more needs to be done to reduce market fragmentation and improve liquidity.

Four months ago, Giancarlo released a White Paper that proposed updating the agency’s current cross-border application of its swaps regime with a rule-based framework based on regulatory deference to third-country regulatory jurisdictions that have adopted the G-20 swaps reforms. Conversations since the paper’s release have confirmed to the chairman that the CFTC’s current cross-border approach of applying its regulations to “each and every overseas swap transaction by a U.S. Person—whether or not such activity actually has a ‘direct and significant’ impact on the United States—is a flawed and over-expansive assertion of its Dodd-Frank Title VII jurisdiction.” According to Giancarlo, in addition to fragmenting markets and reducing liquidity, this overreach is untenable given the CFTC’s perennially restrained funding.

Therefore, Giancarlo will direct staff to prepare as soon as possible to put through the Administrative Procedure Act process various new cross-border rule proposals addressing various aspects of swaps reform, including the registration and regulation of swaps dealers, major swaps participants, non-U.S. swaps CCPs, and swaps trading venues. The new proposals would replace the cross-border guidance issued by the CFTC in 2013 and the cross-border rules proposed in 2016, as well as address certain positions taken in CFTC staff advisories and no action letters.

SEF reforms. Earlier this month, Giancarlo met with major participants in global swaps markets to discuss the agency’s proposed rule on Amendments to Regulations on Swap Execution Facilities and the Trade Execution Requirement and a Request for Comment regarding the practice of “Post-Trade Name Give-Up.” Many market participants supported certain aspects of the proposal, including making SEF execution methods more flexible, providing for broker proficiency exams, and bringing more cleared swaps products into scope. Many also agreed that the current framework, built upon various no action relief, staff guidance, and temporary regulatory forbearance, is unsustainable over the long term.

However, market participants criticized several elements of the proposal, including:
  • The process and timing of bringing new products into scope via the Made Available to Trade (MATT) process. Giancarlo would be interested to consider comment letters that suggest minimum conditions (such as listing on multiple SEFs) with adequate time for SEF connectivity and onboarding before any new mandatorily cleared swaps become mandatorily SEF traded.
  • Proposed restrictions on off-SEF, pre-trade communications. Giancarlo said the intent was not to disintermediate essential client relationships and communications between buy-side and sell-side market participants in current non-MATT products, and would consider comments addressing whether platform pre-trade communications need to be prohibited.
  • Overly simplified revisions to the standards for “impartial access.” Giancarlo is interested in comments on whether the revisions to “impartial access” would benefit from minimum standards for SEF membership criteria that are consistent with a SEF’s right to establish such criteria under Dodd-Frank.
  • How the proposal dovetails with reforming the current cross-border rule implementation. Here, Giancarlo noted that the proposal applies only to CFTC-regulated SEFs and said he does not expect the SEF proposal to have any impact on SEF-registration exemptions for EU trading venues consistent with the 2017 agreement reached with the European Commission on trading venue equivalence.
  • Various technical standards and provisions like error trade policy and financial resources
Despite the areas of difference, Giancarlo said he does not intend to “walk away” from the proposal, as reported in a recent Wall Street Journal article. He plans to seek extensions of the comment periods until March 15 to allow more time for comment, especially given the recent shutdown. The time to shore up the swaps regulatory foundation is now, while markets are robust, not later when they may be under stress, said Giancarlo, adding that better rules would reduce risk, foster innovation, increase the chance that the SEC will draw on the framework for their security-based swaps regime, and enhance U.S. markets as mechanisms for price discovery and risk mitigation.

To get there, however, Giancarlo may have to overcome objections from Commissioner Dan Berkovitz, who recently strongly criticized aspects of the proposal, particularly the “exclusionary access” provision and effective repeal of method-of-execution rules that require request-for-quote (RFQ) and order book trading systems. Berkowitz has proposed his own measures to improve competition and increase liquidity in the swap markets.

Wednesday, January 30, 2019

SRI panelists mull blockchain uses, application of regulation to cryptocurrency

By Amy Leisinger, J.D.

According to panelists at Northwestern’s Securities Regulation Institute, blockchain and cryptocurrency and the potential regulatory issues raised in connection with technology remain a hot topic in the securities industry. The disintermediation of a blockchain system offers a great deal of promise, particularly in terms tracking assets over a distance and stabilizing transactions, but it also comes with a great deal of risk, they explained. Regulators need to exercise caution in determining whether a particular cryptocurrency is, or should be, subject to regulatory oversight, the panelists found.

Robert Rosenblum of Wilson Sonsini Goodrich & Rosati noted that the SEC is working with people now other than investment banks and big companies and that the individuals implementing blockchain technology and developing and marketing cryptocurrencies have a different level of understanding of what the SEC does. As the Commission works on how to provide proper oversight in this evolving field, it is important to think about unintended consequences, he noted. Davis Polk’s Linda Thompson agreed, opining that it is not always easy to quickly develop appropriate regulations but that enforcement actions can be easier, particularly in terms of potential fraud. In fact, even if a cryptocurrency does not fall under SEC or CFTC jurisdiction, state statutes and common law fraud can capture misconduct she explained.

Lee Schneider, general counsel for, contended that regulators may need to temper views on regulation with regard to progress and developments in technology and around the world. In fact, he opined, blockchain could potentially reduce existing regulation given its immutable nature. Removing intermediaries from transactions can also be useful, he said; “when you get down to two parties, they are each responsible,” he noted. The focus should be on the distinction between raising capital and earning revenue, and the features and functionality of a product are critical when applying the Howey test to determine whether a cryptocurrency is an investment contract and, thus, a security, Schneider said.

Rebecca Simmons of Sullivan & Cromwell noted that utility tokens, securities tokens, and consumer tokens are all very different and that, as such, coming to an affirmative conclusion on the status of a cryptocurrency is difficult at this point. In some circumstances, it is clear that a transaction involves a security, she stated, but this is not always the case. Simmons questioned whether a token really involves deriving profits predominately from the efforts of others; the issue may be more in how a token is marketed, she said. Pertinent factors that tend to lead to a conclusion that a token is a security often include the sale of a token in place of something that would be a security or trading in a market that looks like securities market, she explained.

Some investors lack the sophistication to protect themselves from the pitfalls of cryptocurrencies, and regulators do need to have some authority in this space, the panelists concluded.

Tuesday, January 29, 2019

Commissioner Berkovitz states his opposition to proposed swap trading rules

By Brad Rosen, J.D.

In remarks before the Commodity Markets Council State of the Industry 2019 conference, Commissioner Dan Berkovitz lays out a comprehensive argument that the CFTC’s proposed swaps trade execution requirement undermines competition

In a speech before the Commodity Markets Council State of the Industry 2019 conference, Commissioner Dan Berkovitz defended his lone dissenting vote on the CFTC’s controversial proposed Swap Execution Facilities and Trade Execution Requirement rule. The speech, titled "Competition, Concentration, and Cartels in the Swaps Market," focused on the role of free market principles as a cornerstone of the derivatives markets and how the CFTC’s proposed trade execution rule actually undermines these objectives. In November of last year the CFTC voted 4-1 to move forward with proposed rule over Berkovitz’ vehement dissent.

First principles. Berkovitz led off his remarks positing that free, fair, and competitive markets are the foundation of our economic system. He noted that one of the longstanding purposes of the CEA is to promote fair competition. The commissioner also observed that with the Dodd-Frank Act, Congress applied the principles of open markets and fair competition to swaps trading, and that Dodd Frank requires swap SEFs to provide all market participants with impartial access to the market and enable them to trade with many other market participants. He further noted that rules preserving competition, open markets, and level playing fields also are necessary because in any market the largest participants have a tendency to try to tilt the playing field in their favor.

The swap market is concentrated in the hands of a few large bank dealers. Berkovitz pointed to data from the swap data repositories showing that the largest five dealing institutions are party to about 70 percent of all reported swap transactions and 80 percent of the notional amount traded. Likewise, FCM data shows that five bank FCMs provide clearing for about 80 percent of cleared swaps. He noted that these high levels of concentration show that the largest dealers possess considerable market power. Moreover, these high levels of concentration also present potential systemic risks, since the failure of one of these firms in a highly interconnected market could have significant impacts on the other firms in the market.

The CFTC’s prosed trade execution requirement would thwart competition in several respects. According to Commissioner Berkovitz, the proposed rule as currently crafted would seriously undermine competitive market forces in a variety of ways. These include: 
  • SEFs would be able create exclusive markets for swap dealers. The proposal’s “exclusionary access” provision would perpetuate and strengthen the current two-tier market structure for cleared swaps. In one tier end-users and proprietary traders would buy from or sell swaps to dealers. In the other tier, dealers trade with each other exclusively and lay off the risks from their swaps at prices that only dealers can access. As a practical matter, under this structure only dealers would be able to economically and efficiently offer cleared swaps to end-users; 
  • The proposal would effectively repeal the method-of-execution rules that require request-for-quote, known as “RFQ,” and order book trading systems for liquid swaps that are made available to trade on a SEF. The Proposal provides no evidence to support its claim that allowing “flexible methods of execution” will benefit end users. The proposal fails to identify any trading method that can or will provide lower costs to end users than the RFQ method; and
  • In the absence of any constraints, the dealers undoubtedly will push trading with non-dealers to less transparent single-dealer platforms and platforms that only allow one-to-one trading where there is no direct, real-time price competition with other dealers. 
Berkovitz concluded that these changes would return the markets to the swaps world as it existed prior to the financial crisis and the Dodd-Frank Act. He observed that experience did not turn out well and notes there is ample evidence that the pro-competitive rules put in place by the CFTC after the financial crisis have led to lower prices for end-users compared to the unregulated swap markets that previously existed.

Proposed measures to improve competition. Berkovitz also set forth a number of measures which would improve competition and increase liquidity in the swap markets. Some of these include the following: 
  • Expand floor trader registration. Expanding the floor trader provision in the swap dealer definition is would permit non-dealer traders who trade large amounts of swaps on SEFs or designated contract markets for their own accounts to register as floor traders rather than swap dealers. Many proprietary traders acting as market makers in futures, equities, and FX markets and have expressed interest in doing so for liquid swaps; 
  • Revise bank capital requirements impacting FCMs. The Commission should work with the prudential regulators to ensure that bank capital requirements are adequate from a risk perspective, but also do not unduly restrict the availability of clearing services by bank FCMs;
  • Abolish name give-up. The CFTC should prohibit the practice of name give-up for most cleared swaps. Under this practice, on many platforms that provide anonymous trading, the identity of a counterparty is provided to the dealer after the completion of a trade. Name give-up is a major deterrent to non-dealers seeking to participate on dealer-only platforms as it provides the dealers with valuable information about a counterparty’s positions; and
  • Enable average pricing. The Commission should work with market participants and facilities to enable buy-side firms to obtain average pricing for buy-side swap trades. Although average pricing is available for futures, it currently is not available for swaps, which limits the direct participation of buy-side asset managers on SEFs. 
The proposed Swap Execution Facilities and Trade Execution Requirement rule is currently out for public comment. The comment period concludes on February 13, 2019.

Monday, January 28, 2019

Nevada first state to draft fiduciary duty rules

By Jay Fishman, J.D.

The Nevada Securities Division has proposed fiduciary duty regulations following the Nevada Legislature’s 2017 enacted law imposing a fiduciary duty on financial planners, and prohibiting broker-dealers and sales representatives from violating the imposed fiduciary duty. Interested persons have until March 1, 2019 to submit written comments about the proposals to Diana Foley at the Nevada Secretary of State’s Office, Securities Division, 2250 Las Vegas Boulevard North, Suite 400, North Las Vegas, NV 89030.

Fiduciary duty rule highlights. Highlights of the proposed rules include:
  • Imposing a fiduciary duty on broker-dealers, sales representatives, investment advisers and investment adviser representatives during the time they: (1) provide investment advice to clients, (2) manage client assets, (3) discretionarily trade client accounts, (4) act in a fiduciary capacity toward the client, and (5) disclose fees or gains—through the completion of any contract and through the term that services are engaged; and
  • Creating an “episodic fiduciary rule exemption” which initially imposes a fiduciary duty on broker-dealers and sales representatives related to their providing specific investment advice to a client, but ends once the client receives the advice, the transaction completes (if applicable), and the required fee and gain disclosures are made; this exemption can only apply, however, if the respective broker-dealers or sales representatives do not manage the client’s assets, or engage in other prescribed activities for the client. 
The proposed rules additionally set forth conduct that breaches the fiduciary duty, as well as conduct that is not per se a violation, along with those activities that exempt broker-dealers and sales representatives from the fiduciary duty. Lastly, a proposed rule authorizes the Nevada Administrator to, by order, adopt any fiduciary duty-related rule, exemption, form, or prohibition that the SEC has approved, provided the Nevada adoption does not materially diminish Nevada’s statutory fiduciary duties.

Friday, January 25, 2019

Staying ahead of the game, growing a legal practice efficiently and ethically in 2019

By Brad Rosen, J.D.

Chicago-based attorney marketing coach, Steve Fretzin, recently presented a workshop focusing on key business development principles, networking skills, and social media trends for the year ahead.

In the wake of the severe economic downturn in 2008, business coach Steve Fretzin’ s started receiving many phone calls from attorneys seeking to preserve or jumpstart their practices. Up until that time, Fretzin had worked primarily with entrepreneurs or sales personnel looking to grow their revenues. Out of the financial crisis, Fretzin saw an opportunity, and turned his full attention to helping attorneys dramatically grow their practices and rationalize their business development efforts. In the decade since, he hasn’t looked back.

Fretzin, along with Barry Zlotowicz, his company’s director of marketing, recently led an information-packed workshop in Northbrook, Illinois, titled, "You Inc." Five Simple Steps To Growing Your Law Practice Quickly & Ethically. In his opening remarks, Fretzin observed that lawyers are typically a “clean white board” when it comes marketing and business development knowledge. “As such, it is quite rewarding working with attorneys and seeing these skills blossom,” Fretzin remarked.

Fretzin’ s one-on-one training centers around discipline and accountability and often seeks to grow an attorney’s book of business by two or threefold within a couple of years’ time. Fretzin is also quick to share some of the business development principles and insights for attorneys he has developed over the years, some of which were explored in the workshop and are noted below.

Differentiating your practice—finding the blue ocean. One key business principle is to differentiate yourself from the competition. Fretzin raised a number of questions a lawyer should consider in this regard:
  • What do you do better than anyone else? 
  • What do your clients say about you? 
  • What is no one else saying in the marketplace? 
Fretzin alluded to an old sales adage on this theme: The sea is red bloody red with competition; you must go to where the blue ocean is.

Avoid spinning your wheels—identify the prospective clients and key contacts. According to Fretzin, it is important to carefully consider and identify the people within various industries and organizations with whom you would like to meet for the purpose of doing business or obtaining referrals. He puts these individuals within three categories and offers some insights: 
  • Direct prospects. This includes CEOs, GCs, CFOs, and business owners. While these are more challenging to meet, you may know some already. If the best contacts you have aren’t a fit for you, they may know others at the same level and may be happy to introduce you to them.
  • Strategic partners. These are the people who know the prospects you are looking to meet. Instead of focusing all your energy on meeting Mrs. Big, try getting quality introductions into new strategic partners through another trusted advisor, industry expert, or consultant who owns the relationship.
  • Centers of influence. These are similar to strategic partners, except they have a wider range of high-level connections. This may be a politician, a CEO, or a wealth manager. Just having one or two of these folks in your corner can make all the difference.
Smart and efficient networking —qualifying the people you meet through TLEND. Fretzin noted that in the world of networking three general archetypes exist. First there is the true giver, someone who is generous and helpful. Second, the true taker, someone that is self-centered and cares little to really help others; to be avoided. Finally, there is the apparent giver, a person who wants to be a helpful networker but might lack the capacity and skill to do so. To optimize networking efforts, it is paramount to qualify the people you meet. Toward this end, Fretzin has developed a helpful acronym, TLEND:
  • Trust — you must trust your prospective networking counterpart;
  • Like — you must like him;
  • Expertise — your networking counterpart must be knowledgeable in his given field;
  • Network — your networking counterpart must be an adept networker in his or her own right; and 
  • Decision Maker — it is help if your networking counterpart has the power to make decisions. 
Fretzin recognizes not every potential networking counterpart will possess all of these attributes. However, he views the first three qualities as mandatory.

A look at the current social media landscape for lawyers. Director of Marketing Barry Zlotowicz noted that most of the platforms have been around for some time now and one must look at the return on investment to determine whether incorporating a particular platform is worthwhile. In his estimation, Facebook, while potentially helpful for targeting clients in some areas of law, is generally not useful for attorney business development purposes.

Meanwhile, he views Twitter as a useful tool to expose your brand to world and in getting your message out. He noted, however, it’s how you use the platform that matters, “Being on Twitter, without posting, following, and liking is not going to get you anywhere from a business development perspective.”

Linked-In, on the other hand, has terrific potential for lawyers according to Fretzin. “This is your second website and Linked-In is of critical importance because it acts as your online resume.” In Fretzin’ s view Linked-In’s value derives from how much you use it, and added that having a complete and accurate profile will help lawyers develop new relationships and clients. Fretzin also observed that from his own perspective, Linked-In has played an important role in extending his reach and establishing relationships with lawyers throughout the United Sates.

Thursday, January 24, 2019

Institutional investor group praises reintroduced bill on Rule 10b5-1 trading plans

By Mark S. Nelson, J.D.

Previously, the Rule 10b5-1 plan bill was part of the larger package of legislation contained in JOBS Act 3.0, which overwhelmingly passed the House during the last Congress but never got a vote in the Senate.

House Financial Services Committee Chairwoman Maxine Waters (D-Calif) and Ranking Member Patrick McHenry (R-NC) recently reintroduced legislation that would bring new scrutiny to Rule 10b5-1 plans that are ostensibly used by corporate insiders to trade company stock without running afoul of the SEC’s antifraud authorities. The Council of Institutional Investors, in a letter to House FSC leaders signaled its “strong support” for the bill, which it said would address some of the concerns the CII had raised in a 2012 rulemaking petition it submitted to the SEC.

The “spirit” of Rule 10b5-1; Intel stock trades. The CII’s renewed interest and its rulemaking petition were, in part, prompted by a series of The Wall Street Journal articles that suggested corporate insiders were at least violating the “spirit” of Rule 10b5-1. Specifically, the CII petition cited executives’ practices of: (1) adopting plans while they are aware of material, non-public information; (2) regularly amending or canceling plans; and (3) adopting plans that permit trading soon after adoption.

A more recent motivation for bringing forward legislation on Rule 10b5-1 plans arose following news reports that Intel Corporation CEO Brian Krzanich had exercised company stock options and sold the resulting shares pursuant to a modified Rule 10b5-1 trading plan in a time frame when Intel allegedly became aware of the Meltdown and Spectre cybersecurity vulnerabilities affecting Intel processors.

Putting the spotlight on trading plans. Exchange Act Rule 10b5-1 specifies when securities trading is “on the basis of” material, nonpublic information regarding Exchange Act Section 10(b) and Rule 10b-5 which, in combination, constitute part of the SEC’s most significant anti-fraud authorities. An affirmative defense exists to liability in three instances, including when a company executive adopts a written trading plan. However, such written trading plans must be entered into in good faith and cannot be entered into for the purpose of evading the requirements of Rule 10b5-1.

The Promoting Transparent Standards for Corporate Insiders Act (H.R. 624) would require the SEC to examine Rule 10b5-1 for gaps in coverage in light of insiders’ current trading plan practices. Specifically, the SEC would have to consider whether to limit trading to issuer-adopted trading windows, to curb the use of multiple (the latest version drops the word “overlapping” as in “multiple, overlapping”) trading plans, to mandate a delay between adoption of a trading plan and the first executed trade under the plan, to restrict an insider’s ability to modify or cancel a trading plan, to require companies and insiders to make certain filings with the Commission, and to mandate that company boards adopt relevant policies and monitor for compliance.

The study also must consider factors such as whether revisions to Rule 10b5-1 would clarify existing limits on insider trading, alter companies’ desire to be public companies, impact capital formation, or affect the ability to recruit executives. The Commission would have to report to Congress within one year of enactment and, upon completing the study, conduct a notice and comment rulemaking to revise Rule 10b5-1.

The text of the latest version is nearly identical to both the stand-alone (H.R. 6320) and JOBS Act 3.0 (Title XXVII) versions introduced in the 115th Congress. The JOBS and Investor Confidence Act of 2018 (S. 488) (aka JOBS Act 3.0) passed the House by a vote of 406-4, while the stand-alone version of the Rule 10b5-1 plan bill in the last Congress was reported by the House FSC but was not brought before the full House (See the following White Paper for addition analysis of the JOBS Act 3.0 Rule 10b5-1 provision at pages 9-10).

Looking ahead. The CII had previously expressed support for earlier versions of the Rule 10b5-1 legislation citing the Intel example as an additional reason for advancing the legislation. The North American Securities Administrators Association also said in a letter to Senate Banking Committee leaders that it “strongly support[ed]” the Rule 10b5-1 plan provision in JOBS Act 3.0. The U.S. Chamber of Commerce previously supported JOBS Act 3.0 in a statement following its passage by the House, although with emphasis on the bill’s capital formation provisions and without specifically mentioning the Rule 10b5-1 plan provision.

Going forward, practitioners might look for the Rule 10b5-1 plan bill to move forward on its own and, potentially, as part of a revived JOBS Act 3.0. The bill enjoyed high-ranking bipartisan support in the 115th Congress from then-House FSC Chairman Jeb Hensarling (R-Texas) and then-Ranking Member Waters. That level of support for the bill continues in the 116th Congress from now Chairwoman Waters, who hailed the bill as the first of more expected bipartisan bills, and Ranking Member McHenry, who described SEC fraud enforcement as “apolitical.”

Wednesday, January 23, 2019

Online platforms, fixed-income mark-ups top FINRA’s exam priorities

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

FINRA has highlighted online distribution platforms, fixed-income mark-up disclosures, and compliance with FinCEN’s Customer Due Diligence (CDD) as areas of focus for its risk monitoring and examination programs in the coming year. In its 2019 Risk Monitoring and Examination Priorities Letter, FINRA describes topics that member broker-dealers should consider as they seek to improve their compliance and risk management programs.

“This year’s Priorities Letter takes a new approach by highlighting those topics that will be materially new areas of focus for our risk monitoring and examination programs in the coming year,” said FINRA CEO Robert Cook in a news release. “[W]e agree with the suggestion from many of our member firms that a sharper focus on emerging issues will help them better determine whether those issues are relevant to their businesses and how they should be addressed.”

FINRA has also broadened the scope of the letter over those in previous years to include more explicitly its priorities for risk monitoring. Unlike previous letters, FINRA has not repeated topics that have been the mainstays of FINRA’s attention over the years.

Online distribution platforms. The letter notes that broker-dealers are increasingly involved in the distribution of securities through online platforms in reliance on Rule 506(c) of Regulation D and Regulation A. Some of these platforms are operated by unregistered entities that may use FINRA member firms as selling agents or brokers of record, or to perform custodial, escrow, and back-office functions.

FINRA is concerned that some member firms are asserting that they are not selling or recommending securities when involved with online distribution platforms despite evidence to the contrary, including handling customer accounts and funds, or receiving transaction-based compensation. FINRA will evaluate how firms conduct their suitability analyses, supervise communications with the public, and meet AML requirements. FINRA will also evaluate how firms are addressing the risk of offering documents or communications with the public that omit material information or may contain false or misleading statements, among other things.

Fixed income mark-up disclosure. FINRA will review firms’ compliance with their mark-up or mark-down disclosure obligations on fixed income transactions with customers under the amendments to FINRA Rule 2232 (Customer Confirmations) and MSRB Rule G-15, which became effective on May 14, 2018. FINRA will also look for any changes in firms’ behavior that might have been undertaken to avoid their mark-up and mark-down disclosure obligations.

Operational risks. FINRA stated that it will assess broker-dealers' compliance with FinCEN’s Customer Due Diligence rule, which became effective on May 11, 2018. The CDD rule requires that firms identify beneficial owners of legal entity customers, understand the nature and purpose of customer accounts, conduct ongoing monitoring of customer accounts to identify and report suspicious transactions and, on a risk basis, update customer information. FINRA will focus on the data integrity of those suspicious activity monitoring systems, as well as the decisions associated with changes to those systems.

FINRA will also review firms’ activities related to digital assets and assess firms’ compliance with applicable securities laws and their efforts to mitigate the risks associated with these activities. FINRA will coordinate with the SEC to consider how firms determine whether a digital asset is a security and whether firms have implemented adequate controls to ensure compliance with rules related to the marketing, sale, execution, control, clearance, recordkeeping and valuation of digital assets, as well as AML/Bank Secrecy Act rules and regulations.

Tuesday, January 22, 2019

IOSCO issues good practices report to support audit quality

By Joanne Cursinella, J.D.

The International Organization of Securities Commissions (IOSCO) has published the IOSCO Report on Good Practices for Audit Committees in Supporting Audit Quality. According to the a media release, the report aims to assist audit committees in promoting and supporting audit quality. The report provides IOSCO’s views on good practices for audit committees of listed companies in supporting external audit quality.

Good practices detailed. The report provides “good practices” that audit committees may consider when: recommending the appointment of an auditor; assessing potential and continuing auditors; setting audit fees; facilitating the audit process; assessing auditor independence; communicating with the auditor; and assessing audit quality. It also covers the features that an audit committee should have to be more effective in its role, including matters such as the qualifications and experience of audit committee members.

The role of audit committees and audit quality. The report provides details about the role of audit committees and audit quality. It briefly summarizes the role of other key parties in the financial reporting cycle and considers an entity’s governance structure, as well as noting that not all measures described in this paper may be able to be applied under the legal framework and governance structures in some jurisdictions. Audit quality is important because auditors play a critical role in ensuring that investors can be confident and informed when making investment decisions.

High-quality audits support the quality of financial reports and enable investors to rely on them, the report notes. The report goes on to discuss the factors that influence audit quality and the auditor’s responsibilities. It advises that audit committees should promote and support the quality of the audit through their various responsibilities and discusses the roles of directors and audit committees in relation to an audit and overseeing management on financial reporting as relevant to audit quality.

Good practices outlined. Good practices regarding the features an audit committee should have to more effectively promote and support audit quality are detailed. According to the report, these include the qualifications and experience of audit committee members, their level of knowledge in the field of financial reporting and audit, and whether they have questioning minds and appropriately challenge management and auditors, as well as adequate capacity and resources. Guidance on the following good practice topics are included in the report.
  • Recommending the appointment of an auditor. Audit committees should develop a recommendation on the selection of auditors independently of management with selection criteria set up front and tenderers assessed against those criteria. The focus should be on audit quality and not fee reduction.
  • Assessing potential and continuing auditors. In assessing the auditors audit committees should consider matters such as the auditor’s knowledge of the listed company´s business and industry, the extent of involvement of senior team members in the audit, use of other auditors, use of technical and specialist expertise, the capability accessible by the auditor in different geographical locations, coverage of internal systems and controls, and how the engagement partner and team are accountable within their firm for audit quality.
  • What matters should be considered in setting audit fees. Audit committees should consider the extent to which audit fees are consistent with the audit plan and a quality audit.
  • Facilitating the audit process. The role of audit committees is to promote quality and timely reporting by seeking explanations and advice on the appropriateness of accounting treatments and estimates, proper books and records, and systems and controls, which can facilitate a quality audit and avoid issues being missed or not adequately addressed due to deadline pressures. 
In other matters, the report also refers to the possibility of voluntary public reporting by audit committees on their support for audit quality. For example, the report says, “consideration might be given to providing a discussion of the involvement of, and process undertaken by, the audit committee to support audit quality in recommending the appointment of auditors, assessing the auditor’s ongoing performance, reviewing audit fees, or other areas.”

Monday, January 21, 2019

Abraham, Martin and John

[In commemoration of Martin Luther King, Jr. Day, we republish a post by the late Jim Hamilton from January 16, 2012, honoring Dr. King and his legacy.]

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

"I thought I saw him walkin' up over the hill,
With Abraham, Martin and John"

- Dion

Abraham Lincoln made the pledge a reality and one hundred years later Dr. Martin Luther King, Jr. redeemed it. That took far too long. How foolish the doctrine of Interposition seems today, how misguided was Massive Resistance and, as to the Southern Manifesto, I will leave that to history and, as John F. Kennedy said, move on to New Frontiers.

We hear a lot of talk today about job creation. Dr. King was one of the greatest job creators in US history. We must never forget that a great legacy of Dr. King is the new Toyota plant in Mississippi, the new VW plant in Tennessee, the new Siemens plant in North Carolina, and the new Hyundai plant in Alabama, because no international company would have ever built gleaming new facilities in a segregated South. So, in addition to everything else, thank you Dr. King for all the jobs you helped create in the New South.