Thursday, April 28, 2016

Delaware justice league disclaims idea of 'super-directors'

By Anne Sherry, J.D.

As sanctions for their misconduct during the litigation, the Delaware Court of Chancery dismissed the claims of OptimisCorp and its CEO against three directors and the CFO. The Delaware Supreme Court affirmed, but its opinion clarified where it diverged from the trial court's 200-page opinion. The high court discouraged the use of "Pearl Harbor-like" plans by board factions to disenfranchise other directors and chided the chancery court for labeling large stockholders as "super directors" (OptimisCorp v. Waite, April 25, 2016, Strine, L.).

Super directors to the rescue? One of the claims by the CEO plaintiff was that the director defendants had intentionally failed to notify him that an amendment to a stockholders agreement to which he was a party would be on the agenda at a special meeting. The chancery court characterized this as a theory in which directors with large holdings and accompanying voting rights enjoy special rights as "super-directors." The high court took issue with this description, which obscured the core question of whether all directors are entitled to fair notice of the agenda for a special meeting. The court wrote that it is "uncomfortable embracing the idea that cliques of the board may confer and sandbag a fellow director" whether that director has a controlling interest or only a few shares.

Furthermore, the "super-director" moniker trivializes the rights that large stockholders procure in exchange for their investment in a corporation. The rights of control that come along with stockholder agreements "are important to the willingness of people to commit capital to corporations and therefore to the ability of society to create wealth through the corporate form."

Fair notice. The supreme court also disagreed with the court of chancery's framework for analyzing whether by leaving the plaintiff in the dark, the defendant directors behaved inequitably. The trial court seemed to assume that if all directors are entitled to fair notice of a special meeting agenda, a director with board appointment rights will simply elect new directors. This may happen, but the actions of those newly appointed directors will be subject to other shareholders' "potent remedies" for breach of fiduciary duty. The supreme court cautioned that new directors who take office during corporate turmoil are likely to know that their actions will draw close scrutiny and likely litigation.

Finally, the high court would not endorse a possible reading of the chancery court opinion permitting deception on the part of a board faction, so long as the faction subjectively believes it is doing right by the corporation. In contrast to such "Pearl Harbor-like" plans, Delaware law values the collaboration that results when all directors are given material information and the entire board deliberates on corporate action.

The case is No. 523, 2015.

Wednesday, April 27, 2016

Adviser official to pay $650K for soft-dollar manipulation, misuse

By Amy Leisinger, J.D.

A federal district court granted summary judgment in favor of the SEC in an action against an adviser executive who engaged in a long-term fraudulent scheme to collect bogus “research expenses” and higher fees from funds. According to the court, the defendant was aware of, and assisted in, the misuse of soft-dollars for his compensation and actively engaged in trading activities to artificially inflate the value of the funds’ assets. The court permanently enjoined the defendant from further violations and ordered payment of nearly $650,000 in disgorgement and penalties (SEC v. Markusen, April 25, 2016, Davis, M.).

Fraudulent activities. According to the court, Archer Advisors LLC, its principal, and another company insider perpetrated a scheme to misappropriate fund assets and artificially pump up the value of the hedge funds that Archer managed. The funds were only authorized to pay Archer in two manners: a monthly management fee and an annual performance fee. On Archer’s behalf, the individuals opened soft-dollar brokerage accounts in the funds’ names that could pay money generated from trade commissions to third parties who provided “research related services.” The insider was listed in offering materials as Archer’s chief operating officer and engaged in marketing, the court stated, but he issued monthly invoices for his work, classifying his efforts as “research provided for Archer,” and received the bulk of his pay from “soft dollars” from the brokerage firm.

When the soft-dollar balance fell too low to pay the fake invoices, the court stated, the individuals churned the stocks in the funds’ brokerage accounts to generate more, increasing the trade commissions paid by the funds. When they knew the funds would need to close due to poor performance, they continued to trade in the accounts to eliminate the deficit in the soft-dollar balance that Archer would have had to pay when it closed the soft-dollar accounts. The excessive trading was inconsistent with the funds’ stated investment strategy, the court noted.

In addition, the court found that the defendants traded significantly in a thinly traded stock, “marking the close” more than 20 times over the course of three years to artificially inflate the price of the stock. The particular stock was the funds’ largest holding, and the defendants’ knew that Archer’s performance and (and the related fees) were based on the funds’ value at the end of a given month. They continued to do this even as fund performance fell and the share price dropped, according to the court.

Antifraud violations. The SEC charged Archer and the individual defendants with 16 counts of violating the antifraud provisions of the federal securities laws and certain reporting provisions. The COO filed an answer in late 2014, but neither Archer nor the principal responded, and a default judgment was entered. In its opinion, the court concluded that permanent injunctions against Archer and its principal were appropriate given the repeated exploitation of investors. The court also ordered joint and several disgorgement of ill-gotten gains of just over $630,000, plus prejudgment interest, and a $100,000 civil penalty. The court, however, withheld entry of the default judgment pending resolution of the claims against the COO.

In the case at bar, the court found that the COO made material omissions in furtherance of the scheme and that his intent to defraud can be inferred from his active participation. In addition, the court stated, by attempting to manipulate the price of the stock, he violated the scheme liability provisions of the Exchange Act and the Securities Act. The COO also aided and abetted Archer’s and the principal’s violations of the Advisers Act, the court found, and, given the breadth of the fraudulent scheme, a permanent injunction against him is warranted. Entering summary judgment in favor of the SEC, the court also ordered the COO to pay disgorgement of nearly $550,000 ($449,784 in soft-dollar payments and $99,500 in research fees from Archer), plus prejudgment interest, and a $100,000 civil penalty.

The case is No. 14-3395 (MJD/TNL).

Tuesday, April 26, 2016

Group urges caution before imposing new regulations on Treasury futures markets

By Kevin Kulling, J.D.

Responding to a Request for Information (RFI) from the Department of the Treasury seeking public comment about the evolution of the Treasury market structure, the Futures Industry Association (FIA) cautioned against imposing additional regulations and changes, noting that there is already a comprehensive regulatory scheme under the Commodity Exchange Act and the rules of the CFTC.

The FIA submitted the letter in connection with the RFI which sought comments on structural changes in the U.S. Treasury market and their implications for market functioning; trading and risk management practices across the U.S. Treasury market; consideration with respect to more comprehensive official sector access to Treasury market data; and benefits and risks of increased public disclosure of Treasury market activity.

Response to market volatility. Treasury’s RFI was an outgrowth of the Joint Staff Report; The U.S. Treasury Market on October 15, 2014, which analyzed a specific 12-minute window of unusually high volatility that occurred in the Treasury securities market and related Treasury and interest rate futures markets on October 15, 2014. The staff report did not identify a cause of the specific volatility.

FIA said that it was “critically important for the regulators to keep in mind that the U.S. futures exchanges, futures industry professionals and market participants are subject to comprehensive regulation under the Commodity Exchange Act and rules of the CFTC, including in the areas of trading risk controls, enhanced market surveillance and market data collection, as addressed in the RFI.”

The group said it was important for regulators to “avoid imposing additional unnecessary regulation” in these areas on the futures markets. FIA noted that the CFTC is addressing some of the same regulatory matters contemplated in the RFI through its pending Regulation AT rulemaking. FIA said it firmly believes that any future regulatory action addressing automated trading in the futures markets is the primary responsibility of the CFTC and the futures exchanges, as self-regulatory organizations, working together with the futures industry.

Electronic trading. FIA noted that the growth of electronic trading and the growing participation of principal trading firms are certainly part of the narrative explaining the evolution of the Treasury markets to their current state, but they may not be the only relevant factors. FIA encouraged Treasury to assess “other potential factors that may be shaping the Treasury markets,” such as whether regulatory capital constraints on banks or other market participants may be inhibiting their level of participation in the Treasury markets, potentially harming market liquidity.

FIA also said it encouraged Treasury, working closely with the CFTC, to consider whether there were any areas where regulatory requirements posed obstacles to the fair and efficient operation of the Treasury markets, or impeded market innovation that could enhance the interconnections among the segments.

FIA said it fully endorsed the step identified in the RFI for regulators to continue their efforts to strengthen monitoring and surveillance of the U.S. Treasury markets through interagency coordination related to trading across the various segments comprising those markets.

Treasury futures. FIA also said in its submission that Treasury futures are only segments of the broader U.S. futures markets, all of which are subject to extensive regulation. Singling out Treasury futures for special, additional regulatory requirements in the areas of risk control, market data collection, and market surveillance could be highly disruptive to the procedures and infrastructure that the exchanges and industry have already put in place to comply with their comprehensive regulatory obligations under the Commodity Exchange Act framework, the FIA comment said.

FIA said it has long supported the use of properly placed controls to mitigate disruptive trading events. FIA reiterated that it believed the CFTC and exchanges were best positioned to address trading risk controls for all segments of the U.S. futures markets, including the Treasury futures markets.

Monday, April 25, 2016

SEC continues Newman-enabled fight against health care exec

By Matthew Garza, J.D.

The former chairman of medical equipment maker Home Diagnostics, Inc. continues to command attention from the SEC’s General Counsel through his efforts to have his 2012 insider trading guilty plea vacated. George Holley, the co-founder and chairman of Home Diagnostics, Inc., was sued by the SEC after tipping family and friends about his company’s upcoming merger with Nipro Corporation. Holley settled with the SEC in the New Jersey District Court on December 8, 2014, two days before the Second Circuit decided U.S. v. Newman. Holley failed to convince the district court that his plea should be vacated because Newman changed the law in his favor, and the SEC has now filed a brief in the appeal of that decision (SEC v. Holley, April 20, 2016).

Guilty plea. Holley pleaded guilty to criminal charges on August 8, 2012. In the criminal case, Holley pleaded guilty to two counts of insider trading by facilitating the profitable trading of his cousin and a close friend. The subsequent consent judgment with the SEC imposed a $386,000 penalty and a bar from serving as an officer or director of a public company. He moved to vacate the judgment on the argument that he received no personal benefit in return for his tip.

The district court found that although Holley may not have disclosed the anticipated merger in order to receive a tangible benefit in return, he acknowledged that the information was disclosed for the purpose of benefiting his friend and his cousin. This was precisely the type of circumstance that the Second Circuit anticipated when it held that a personal benefit was established by evidence of “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter],” said the court.

Brief. The SEC’s brief on appeal asserts that Newman did not change the law of the Second Circuit as it applies to Holley’s situation, and Holley’s FRCP 60(b) motion is in fact improperly attempting to affect that change. Even if Newman somehow changed the law of the Second Circuit on Exchange Act Section 10(b), the SEC wrote, it did not change the law of the Third Circuit, and furthermore, the conduct was illegal under separate provisions of the law—namely Exchange Act Section 14(e) and Rule 14e-3 on fraud related to tender offers. Those provisions make it unlawful to communicate material, nonpublic information about a tender offer even in the absence of a personal benefit.

The SEC also argued that Holley’s conduct was illegal even under the more stringent Newman standard because unlike the Newman defendants, Holley “orchestrated” the trading, in part by opening a brokerage account in another person’s name, seeding the account with $120,000, and arranging for trades.

Even if liability turned solely on Newman, the SEC continued, the conduct remains illegal because unlike Holley, the insiders in Newman tipped only casual acquaintances, not close friends or family members, and did not intend to benefit the people they tipped. “Ignoring that factual context, Holley reads Newman to hold that a ‘pecuniary or similarly valuable benefit’ is required in all tipping cases under Section 10(b),” and that view cannot be reconciled under either Newman or Dirks, asserted the brief. His activity is illegal under long standing precedent and remains so even after Newman, the SEC argued.

Finally, the SEC said that the district court acted within its discretion because Holley failed to demonstrate equitable factors justifying FRCP Rule 60(b) relief. “Equity does not entitle Holley to relitigate a defense he voluntarily abandoned in exchange for settlement, nor does equity favor permitting Holley to return to the boardrooms of public companies,” wrote the SEC.

The case is No. 15-3457.

Friday, April 22, 2016

Advisory committee debuts access fee pilot details; Order extends LU/LD pilot

By Mark S. Nelson, J.D.

The SEC’s Equity Market Structure Advisory Committee previewed its recommendations on a variety of topics ahead of its public meeting on April 26. An EMSAC subcommittee’s draft recommendation on studying the maker-taker model urged a pilot program, but possibly without some features that could impact the study of rebates, inverted venues, and trade-at provisions. The SEC has announced the agenda for the EMSAC meeting.

The various EMSAC subcommittee memos arrive as the Commission works on several market structure initiatives and as Congress eyes U.S. equity markets. Next week’s EMSAC meeting also will deal with market volatility issues addressed in a new Commission order extending the National Market System Plan to Address Extraordinary Market Volatility (LU/LD plan) to April 21, 2017 while also approving a modification of the definition of “opening price” (Release No. 34-77679, April 21, 2016).

Maker-taker pilot. The EMSAC’s Regulation NMS Subcommittee memorandum noted the controversy that infuses discussions of the maker-taker model and reform of the access fees that are now capped by Regulation NMS Rule 610. But the subcommittee also acknowledged several problems with constructing a valid method to study the impact of access fee caps under current rules. For example, the EMSAC said a pilot that is focused on a single market has limited value in showing the potential impact of access fee reforms on the wider market. The subcommittee pointed to a recent Nasdaq pilot that produced inconclusive results.

Instead, the NMS Subcommittee proposed a pilot that would be comprised of four buckets: a control bucket plus three others with graduated access fee caps, including one bucket designed to produce de minimis economic incentives. But the subcommittee noted disagreement over whether to bar rebates and whether to apply the access fee cap to inverted venues.

But the NMS Subcommittee recommended against including a trade-at provision in the pilot, as some industry participants had urged. The subcommittee memorandum explained that the presence of a trade-at provision could shift the focus of the pilot to other market issues and it would make the pilot too complex. The Securities Industry and Financial Markets Association, while broadly supporting the EMSAC’s overall efforts, also said in a statement that an access fee pilot should not include a trade-at provision.

The maker-taker model was one of the five areas SEC Chair Mary Jo White identified for further review in her 2014 speech outlining her principles for market structure reform. In recent Congressional testimony, Stephen Luparello, Director of the SEC’s Division of Trading and Markets, noted that staff in his division had prepared a briefing paper on the history of the maker-taker model that also may help to inform the EMSAC’s pilot recommendation.

Limit up/limit down order. The Division of Trading and Markets invoked its delegated authority to extend the LU/LD plan pilot until April 21, 2017. But the order also granted the participant exchanges’ request to modify the definition of “opening price,” the first reference price of the day, to mean the prior day’s closing price (or the last price reported by the securities information processor if no closing price exists) rather than the midpoint of the relevant quotations. The participants conducted back-testing that showed how the new definition could avoid many trading pauses.

EMSAC’s Market Quality subcommittee also will examine the LU/LD plan and has issued some preliminary recommendations based on its conclusion that the LU/LD bands work, but the reopening process still has too many pitfalls. First, a stock that is “stuck” in the LU/LD should automatically re-adjust after a period of time without its trading being halted. On a related note, the time during which a stock remains in the limit state condition should be extended from 15 to 30 seconds to allow markets to re-assess the stock prior to band re-adjustment.

A second proposal would have exchanges’ clearly erroneous rules conform to the LU/LD bands. Yet another proposal would invoke the concept of mean reversion to clarify that the LU band should not be triggered for a stock that trades up after having reset or halted because it had traded down to its LD band. As an example, the subcommittee memo suggested a $100 stock that traded down to $90 would not trigger the LU band when it trades back to $100, one dollar above the new $99 LU band trigger.

The EMSAC’s Trading Venues Regulation Subcommittee also published its recommendations on increasing rule-based exchange liability levels. Members of the EMSAC’s Customer Issues Subcommittee also plan to provide a status report at next week’s meeting.

The release is No. 34-77679.

Thursday, April 21, 2016

Accounting-related class actions still on the rise, report finds

By John Filar Atwood

The number of securities class actions with accounting allegations rose for the third straight year in 2015, according to a report from litigation consulting firm Cornerstone Research. There were 71 accounting-related class actions last year, a slight increase over the 69 filed in 2014, the report stated.

The report said that the increase in total filings is not the result of non-traditional filings, such as the Chinese reverse merger class actions in 2010 and 2011. Rather, the recent increases are from more traditional accounting-related filings, with a majority being allegations of internal control weaknesses. In 2015, 62 percent of accounting case filings involved internal control weaknesses, according to the report.

Settlement dollars. The report found that accounting case settlement dollars reached $2.6 billion in 2015, from 50 settled cases. In 2014, 44 settled accounting-related cases generated $1.1 billion in settlement dollars. In terms of total securities class action settlement dollars for 2015, accounting cases represented 87 percent of the total value.

Market cap losses. Cornerstone found that the increase in accounting-related class action filings was accompanied by an increase of just over 20 percent in market capitalization losses in 2015. The total losses of $34.8 billion were the second highest total in the past seven years, second only to 2013’s $44.8 billion.

In 2015, cases were almost evenly split between NYSE and Nasdaq companies, the report noted. However, the market capitalization losses associated with the cases filed against NYSE firms were over 4.5 times greater than the amount associated with cases filed against Nasdaq firms.

Non-U.S. companies. Cornerstone said in a press release that in 2015, 37 percent of accounting cases were filed in the Ninth Circuit, more than any other circuit, and the number of accounting cases against companies with headquarters outside the U.S. increased 43 percent to its second highest level in the last 10 years. Cases against China-headquartered companies increased 75 percent between 2014 and 2015, the report noted.

Wednesday, April 20, 2016

Delaware registration of out-of-state companies does not confer general jurisdiction

By Amanda Maine, J.D.

The Delaware Supreme Court has ruled that the state’s requirement that foreign companies be registered to do business in the state and appoint an agent for in-state service of process does not by itself subject those companies to general personal jurisdiction. The decision, drawing from recent Supreme Court decisions on personal jurisdiction, overturns 28-year old state precedent (Genuine Parts Company v. Cepec, April 18, 2016, Strine, L).

Lawsuit. Georgia residents Ralph and Sandra Cepec sued Genuine Parts Company and six other companies associated with asbestos in Delaware superior court. Ralph worked at Genuine Parts’ Jacksonville, Florida warehouse for three years and, according to the complaint, developed asbestos-related ailments. Genuine Parts, which is known for operating NAPA auto parts stores, is a Georgia corporation that is registered to do business in the state of Delaware.

Genuine Parts moved to dismiss the lawsuit for lack of general and specific personal jurisdiction. The Cepecs argued that the company had consented to Delaware’s general jurisdiction by registering to do business in the state and appointing an in-state agent for service of process. The superior court agreed with the plaintiffs, and Genuine Parts submitted an interlocutory appeal to the Delaware Supreme Court.

Sternberg, Goodyear, and Daimler. Under Sternberg v. O’Neil (Del. 1988), a defendant foreign corporation consents to Delaware’s general jurisdiction by registering to do business in the state and appointing an in-state agent for service of process. Chief Justice Strine pointed out, however, that two U.S. Supreme Court cases, Goodyear Dunlop Tires Operations, S.A. v. Brown (2011) and Daimler AG v. Bauman (2014) set due process limits on states’ exercise of general jurisdiction over non-residents. The Goodyear court rejected the notion that North Carolina had jurisdiction over Goodyear’s foreign subsidiaries because some of the tires that the subsidiaries manufactured had reached North Carolina through the stream of commerce.

Following the reasoning of Goodyear, the Daimler court held that the proper inquiry for general jurisdiction is whether the corporation’s affiliations with the state “are so continuous and systematic as to render [it] essentially at home in the forum state.” Daimler also rejected the idea that a company that engages in a “substantial, continuous and systematic course of business” subjects a corporation to general jurisdiction, stating that such “all-purpose jurisdiction” would prevent out-of-state defendants from structuring their conduct with assurance of where that conduct could make them subject to lawsuits.

No general jurisdiction. Goodyear and Daimler arose in the context of a global economy, Chief Justice Strine wrote, advising that “we no longer live in a time where foreign corporations cannot operate in other states unless they somehow become a resident.” Delaware’s statutory provisions requiring registration and service of process agents, working in tandem with its long-arm statute, mean Delaware can exercise personal jurisdiction over registered business when causes of action arise out of their activities in Delaware, the court said. However, simply registering to do business in the state does not mean it is “at home” under Daimler. Genuine Parts is “at home” in Georgia, where it is incorporated and where it runs its principal place of business, not in Delaware. Fewer than 1 percent of its employees work in Delaware, fewer than 1 percent of its stores are in Delaware, and less than 1 percent of its revenue comes from Delaware.

In light of Daimler, the service of process provision can be construed as requiring a foreign corporation to allow service of process to be made upon it, but not as a consent to general jurisdiction, according to Chief Justice Strine. He stressed, however, that plaintiffs with a fair basis to subject out-of-state corporations to lawsuits in Delaware may do so. He also expressed concern that should every state confer general jurisdiction simply by way of registration/service of process requirements, legal certainty for businesses would be impaired. “It is one thing for every state to be able to exercise personal jurisdiction in situations when corporations face causes of action arising out of specific contacts in those states; it is another for every major corporation to be subject to the general jurisdiction of all fifty states,” he said.

In addition, Chief Justice Strine noted that at the federal level, the Delaware District Court has issued conflicting decisions on how Daimler should be applied in the state. However, he also advised that the majority of federal courts that have considered the issue have adopted the position espoused in this decision.

Accordingly, the Delaware Supreme Court reversed the decision of the lower court that denied Genuine Part’s motion to dismiss.

The case is No. 528, 2015.

Tuesday, April 19, 2016

Comment period closes on transfer agent modernization concept release

By Jacquelyn Lumb

The comment period has closed on the SEC’s concept release on the transfer agent regulations, which explores registration and reporting requirements, safeguarding of funds and securities, standards for restrictive legends, and cybersecurity. The staff also sought input on recordkeeping for beneficial owners, administration of issuer plans, and the role of transfer agents with respect to mutual funds and crowdfunding. The original comment period ended February 29, 2016, but after requests for additional time, it was extended through April 14, 2016.

Securities Transfer Association. The Securities Transfer Association, whose members maintain the records of more than 100 million registered shareholders on behalf of 15,000 issuers, wrote that a comprehensive review of the rules was needed to address all of the technological advances of the past 30 years and consolidation in the industry. Five large transfer agents lead the industry, according to STA. The association agrees with the Commission that its top priorities should be guidance or rulemaking to provide additional safeguards for monies or securities controlled by transfer agents, a requirement for written contracts, and a requirement that transfer agents engage in ongoing assessments of risks, including cybersecurity issues.

STA said that in drafting new rules, the SEC must consider the unique operations of bank versus non-bank transfer agents; transfer agents that provide services to smaller issuers, larger issuers, open-end mutual funds, and debt issuers; those that offer plan administration, paying agent or other services; and issuers that act as their own non-commercial transfer agent. Given the diversity of products and services offered by transfer agents, STA added that it is pleased that the SEC does not plan to take a one size fits all approach and urged the SEC to carefully weigh the costs and benefits of any proposed changes. STA also urged the SEC to narrowly tailor and address separately any concerns related to mutual fund transfer agents.

American Bankers Association. The American Bankers Association wrote that the SEC should exempt bank transfer agents from rules that conflict with or duplicate existing federal banking rules. In the ABA’s view, the model for broker-dealer registration is not appropriate for heavily regulated banking organizations, which are structured differently and are required to hold far more capital than broker-dealers.

In proposing new transfer agent rules, the ABA urged the SEC to identify specific risks to issuers and security holders because of inadequate or the lack of regulations; to narrowly tailor any revisions to those specific risks; and to ensure that the benefits of any new regulations outweigh the costs. ABA’s comments were directed to agents that provide services with respect to debt securities.

SIFMA. SIFMA cautioned the SEC to avoid duplicative regulations since many entities are already heavily regulated; urged that transfer agents be held to financial industry standards of fairness and transparency in their dealings with broker-dealers, clients, and shareholders; and recommended bringing the regulations on cybersecurity and business continuity planning in line with financial industry standards. SIFMA also offered additional suggestions for escheatment reporting and proxy processing activities.

While shareholder servicing, recordkeeping, and the transfer agent process have evolved to include broker-dealer participation through outsourced functions such as sub-accounting, SIFMA wrote that these activities do not pose regulatory issues or raise concerns about gaps that would require regulatory action. SIFMA urged the SEC to take into consideration the already heavy regulation that is imposed on broker-dealers, particularly with respect to the functions underlying sub-accounting.

Broadridge. Broadridge, which provides shareholder communications and proxy voting services, has a subsidiary that is a registered transfer agent. In Broadridge’s view, the existing regulatory systems for clearance and settlement, shareholder communications, and proxy voting function effectively, reliably, and efficiently, and require no changes. However, the organization agreed there are certain regulatory gaps that should be addressed and ways to reduce costs to investors, issuers and financial intermediaries.

Broadridge recommended that the SEC focus on transfer agent financial reporting, fee transparency, and technology management, while reducing costs by right-sizing the regulations. The SEC should maintain the current rules for beneficial ownership involving non-objecting and objecting beneficial owners and continue its current approach with separate and distinct roles and regulations for transfer agents and broker-dealers, according to Broadridge.

Depository Trust & Clearing Corporation. The Depository Trust & Clearing Corporation agreed that the regulation of transfer agents is critically outdated. While transfer agent failures are rare, they are bound to occur in the future, according to DTCC and their failures could potentially cause or add to a systemic crisis. DTCC said it agrees that transfer agents should be subject to reporting and substantive requirements to ensure their financial stability. This includes more robust registration and reporting requirements, new measures to safeguard against cyberattacks, and appropriate business continuity planning, DTCC wrote.

Council of Institutional Investors. The Council of Institutional Investors (CII) noted that it identified end-to-end vote confirmation as a key issue in 2010. Some market participants have undertaken voluntary efforts to implement this process, but full and precise vote conformation for all U.S. corporations remains unrealized. As part of the transfer agent modernization initiative, CII encouraged the SEC to explore how to make it a reality.

The transfer agent rules were adopted in 1977 and remain essentially unchanged, while the market in which transfer agents operate bears little resemblance to the 1977 market structure. The SEC’s release is characterized as both an advance notice of proposed rulemaking in specific areas and a concept release to address additional areas of interest.

Monday, April 18, 2016

States, SEC argue over definitions in Reg A preemption challenge

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

The states of Massachusetts and Montana faced off with the SEC in oral argument before the D.C. Circuit in their ongoing challenge to the preemption of state authority over Tier 2 offerings under Regulation A. The states have asked the court to vacate the rule, contending that the SEC’s failure to impose any meaningful standards on the “qualified purchasers” eligible to invest in Tier 2 offerings oversteps the authority delegated to the Commission under the JOBS Act and strip investors of valuable state law protections (SEC v. Lindeen, April 14, 2016).

Adopted by the SEC under the mandate of the JOBS Act on March 25, 2015, so-called Regulation A+ raises the dollar limit for smaller offerings that are exempt from Securities Act registration. The amendments also create two tiers of offerings under Regulation A while preempting Tier 2 offerings of up to $50 million from state regulation.

Arguments for the petitioners. Arguing on behalf of the petitioners, Robert E. Toone of the Massachusetts Attorney General’s Office stated that the SEC’s rule defies the clear direction of Congress that preemption under the qualified purchaser statutes may only occur when the Commission actually places meaningful qualifications on purchasers, i.e., qualifications that identify those investors who do not require the protection of state law. In effect, Toone argued, the SEC’s regulation reads the qualified purchaser requirement out of the statute by saying that any purchaser in a Tier 2 offering is a qualified purchaser.

The panel countered by asking why the SEC’s rule could not be regarded as having addressed the issue by simply making a determination that any investor in the specific context of a Tier 2 offering should be deemed qualified. According to the petitioners, however, Congress did not intend for the rule to contain a definition of “qualified purchaser” that doesn’t disqualify anyone. Toone cited language from the House committee report on Securities Act Section 18(b)(3), which the JOBS Act incorporates, stating that the Commission’s definition must be firmly rooted in the belief that qualified purchasers are sophisticated investors capable of protecting themselves.

Although Congress reserved to itself the power to categorically preempt securities under Section 18, the power granted to the SEC is much narrower, Toone argued. If the current rule is upheld, then the SEC will be able to preempt any category of securities it wants by issuing a similar rule in the future. Moreover, the rule’s 10 percent investment limitation does not impose qualifications on purchasers. Rather, the limitation serves only to limit the losses of those purchasers of Tier 2 offerings who do not meet the standards for “accredited investors” under Rule 501(a).

Toone acknowledged that the Commission does have discretion to adjust its definition of “qualified purchaser” to different categories of securities, based on the risk profile or complexity of a security. Toone stressed, however, that the D.C. Circuit had dealt with a very similar issue in Financial Planning Association v. SEC (2007), where the court vacated an SEC rule permitting brokers to receive fee-based compensation without also registering as investment advisers. In that case, the D.C. Circuit rejected the rule under step one of the Chevron analysis, quoting language from the Supreme Court that “Ambiguity is a creature not of definitional possibilities but of statutory context.” Here, according to the petitioners, the statutory context is clear: Congress reserves the power to preempt state law for categories of securities. The SEC’s authority is limited to “qualified purchasers” as that term has been used previously in the federal securities laws, a use which requires some degree of wealth, sophistication or risk-bearing ability on the part of the investor.

Arguments of the SEC. Arguing on behalf of the SEC, Jeffrey A. Berger stressed the importance of Congress’s intent to use the JOBS Act to revitalize Regulation A, which had fallen into disuse partly because of the cost of complying with state registration and qualification laws. In implementing the mandate given to the SEC under the JOBS Act, the Commission exercised its express authority under Section 18 to define “qualified purchaser” to preempt those same state laws for Tier 2 offerings. This preemption removed a major impediment to the use of Regulation A while still providing a suite of investor protections by, among other things, requiring that the investors either be accredited or be subject to purchase limitations based on net worth or income.

Judge Sentelle inquired as to why, when Congress has delegated the authority to define the term “qualified purchaser,” we should not expect the definition produced by the SEC to include something about the characteristics of the purchaser, rather than simply to indicate the types of purchases to which the definition applies. Berger responded that the SEC’s definition does reflect the characteristics of the purchaser by either requiring that investors be accredited or by imposing investment limitations that incorporate by reference qualifications set forth in other SEC rules. Further, Berger noted that investment in Regulation A offerings had previously been available to anyone in any amount. And even though the Commission’s rule has removed the layer of state review from those offerings, the rule puts in place other protections, which form part of a plan to implement Congress’s desire to reinvigorate Regulation A. These protections include not only the purchase limitations but also a requirement that issuers provide audited financial statements with their offering circulars while subjecting those issuers to ongoing reporting requirements.

Berger emphasized that the states retain their antifraud authority over both Tier 1 and Tier 2 offerings. Moreover, Tier 1 offerings, which are not preempted by the SEC’s rule, are much likely to be localized offerings due to their smaller size. The state’s retention of registration over Tier 1 offerings thus offers the greatest marginal benefit in terms of investor protection. In contrast, a consistent federal regulatory standard is best able to do the job for Tier 2 offerings, which will likely be more national in scope. Berger disagreed with the petitioners’ argument that the Commission ignored investor protection when adopting the rule, stating that the SEC considered investor protection alongside the other aspects mandated by Congress, namely, efficiency, competition, and capital formation. The SEC considered all of these factors when developing a rule that fulfilled the goals of the JOBS Act in revitalizing Regulation A while still protecting investors.

The cases are Nos. 15-1149 and 15-1150.

Friday, April 15, 2016

SEC advisory committee urges cost disclosure in fund account statements

By Amy Leisinger, J.D.

The SEC’s Investor Advisory Committee approved a recommendation regarding enhancements to mutual fund cost disclosure. The proposed change is designed to increase investor understanding of the actual costs of participation in mutual funds in the short term and over the life of the investments. According to the committee, the most effective way to accomplish this goal would be through disclosure of specific costs on account statements, and the Commission should consider additional means by which to provide context for cost information to ensure that investors understand the true impact of the costs on their investments.

Recommendation. In the recommendation, the committee noted that costs have a significant effect on the long-term success of investments and total accumulation and that they can vary widely among funds. Clear disclosure of mutual fund costs has been, and should continue to be, a priority, according to the committee, but many mutual fund investors are not aware of how much they pay in fees or how fees may impact funds’ long-term performance. While the Commission has taken measures to improve mutual fund cost disclosures, more can be done, according to the committee, as existing disclosures are in documents that many investors do not read and the complex nature of the disclosures makes it difficult for investors who do read the documents to make use of the information.

As such, the committee recommended that the Commission explore ways to improve the effectiveness of mutual fund cost disclosures, including requiring standardized disclosure of the actual dollar amount of costs on customer account statements as a supplement to existing prospectus disclosures. Investors are very likely to review their account statements, and presenting actual costs juxtaposed with total fund returns (as opposed to a percentage of assets) would provide a more accurate view and increase the likelihood that investors will appreciate the significance of the costs, they said. Even investors who do not consider disclosures could benefit indirectly from increased market competition that could follow from improved transparency, according to the committee.

In connection with this change, the committee said, the Commission should also consider other changes to improve investors’ understanding of mutual fund costs, including ways to improve current disclosures and put cost information in context.

Committee comments. While generally applauding the initiative, some committee members questioned whether the lack of data on the feasibility of the new approach and whether the change would actually provide a benefit to investors. They noted the fact that the GAO recommended this approach years ago and that the Commission rejected it as cost prohibitive. The SEC must carefully weigh the costs and benefits of proposed changes, but the data necessary to calculate the actual dollar amount of costs for inclusion on account statements is already available, other members noted. The most important consideration should be whether it would really inform investors and affect the decision-making processes, they said.

While noting the need for concrete research about how disclosures are used and for investor testing, the committee found that investors need tools to make informed decisions and determined to make the recommendation to the Commission.

Thursday, April 14, 2016

Edison 401(k) beneficiaries waived duty-to-monitor argument

By Anne Sherry, J.D.

Despite an apparent victory in the Supreme Court, Edison International employees lost on their ERISA breach-of-duty claims on remand to the Ninth Circuit. The Supreme Court held that because trust law requires retirement plan administrators to continue to monitor plan investments, breach-of-duty claims are not necessarily time-barred just because the statute of limitations has run on the initial fund selection. On remand, however, the Ninth Circuit held that the employees forfeited the duty-to-monitor argument by not raising it before the appellate court (Tibble v. Edison International, April 13, 2016, O'Scannlain, D.).

Continuing duty to monitor investments. Several individual beneficiaries of Edison International’s 401(k) plan filed suit in 2007 over six retail-class mutual funds added to the plan in 1999 and 2002. The lawsuit questioned how the fiduciaries could have acted prudently in offering these funds when materially identical institutional-class funds were available. On appeal from the district court, the Ninth Circuit held that the claims as to the funds added in 1999 were untimely because the beneficiaries had not established a change in circumstances that might trigger an obligation to review and change investments within ERISA’s six-year statute of limitations.

The Supreme Court reversed and remanded. Trust law imposes a continuing duty to monitor trust investments, the Court wrote, and as long as the alleged breach of that duty occurred within six years of suit, the claim is timely. The Ninth Circuit went too far in taking the statute of limitations as an absolute bar based solely on the initial fund selection, without considering the contours of the alleged breach of duty. But the Court left it for the Ninth Circuit to decide whether the employees forfeited their claim of a new breach by not raising it below.

Forfeiture of argument. On remand, the appeals court concluded that the argument had been forfeited. The beneficiaries had not argued that Edison violated its duty of prudence by failing to monitor the funds added to the plan in 1999. Instead, they had argued that significant changes in those funds should have triggered a due-diligence review.

Furthermore, the district court did not forbid the beneficiaries from raising the duty-to-monitor argument. The court merely held that a time-barred claim could not be made timely by styling a past breach as a continuing violation. In fact, the district court had asked the beneficiaries' expert whether Edison should have removed the funds even if they had not undergone any changes. The court also permitted the beneficiaries to raise a duty-to-monitor argument with respect to another fund in the plan.

Setting aside the failure to raise the duty-to-monitor argument before the district court, the beneficiaries also failed to raise it before the Ninth Circuit. The claim was "doubly forfeit," the court concluded.

The case is No. 10-56406.

Wednesday, April 13, 2016

PCAOB proposes stricter requirements when lead auditors use the work of other auditors

By Jacquelyn Lumb

The PCAOB has unanimously approved a proposal that would strengthen a lead auditor’s supervisory requirements over other auditors that participate in the audit and a new standard governing the division of responsibilities with other auditing firms. The work performed by other auditors can be significant—approximately 40 percent of total assets and revenues of publicly listed companies are outside of the country of the signing auditor, according to the Board, and inspections have revealed a need to strengthen current practices.

Frequent use of other auditors. Chief Auditor Martin Baumann noted in opening remarks that the use of other auditors is common for large company audits performed by U.S. global network firms. He cited PCAOB data that other auditors are used in about 55 percent of the audits performed by the global networks and about 30 percent of the audits performed by non-global network firms. About 80 percent of Fortune 500 audits performed by U.S. global network firms include the use of other auditors.

Since other auditors may perform a significant share of an audit, it is critical that the lead auditor provide the necessary supervision. Inspections have identified deficiencies in the work of other auditors that the lead auditors did not identify or did not address. The proposal would amend the standards on supervision, audit planning, documentation, and engagement quality review, and would introduce a new standard on dividing the responsibility for an audit with another firm.

Amendments to standards. The amendment to the standard on supervision would outline the procedures the lead auditor should perform in supervising the other auditors’ work. The amendment to the audit planning standard would specify the tasks that must be undertaken by the lead auditor and would revise the requirements for determining a firm’s eligibility to serve as the lead auditor in an audit that involves other auditors.

The engagement quality reviewer would be required to evaluate the engagement partner’s determination of a firm’s eligibility to serve as lead auditor. The audit documentation standard would be revised to require that the lead auditor document the work papers of other auditors that were reviewed but not retained.

New standard. Under the newly proposed standard, the lead auditor would be required to disclose in the audit report the portions of the financial statements that were audited by other auditors. The lead auditor also would be required to obtain a representation from the other auditors that they are licensed to practice in their jurisdictions; determine whether they are or should be registered with the PCAOB if they play a substantial role in the audit, and disclose their names. This standard, if adopted, would supersede AS 1205, Part of the Audit Performed by Other Independent Auditors.

PCAOB Chair James Doty said that many engagement partners do a good job of overseeing the work of other audit firms, but inspections have also revealed engagements that were not well managed and where the work performed by the other auditor did not meet the objectives required by its role in the audit. The proposal would require the lead auditor to play a greater role in overseeing the other auditors, through communication, access to the work papers, and the evaluation of the auditor’s qualifications and work.

The comment period will be open through July 29, 2016.

Tuesday, April 12, 2016

Government will not seek Supreme Court review of conflict minerals decision

By Amanda Maine, J.D.

In a letter to House Speaker Paul Ryan, Attorney General Loretta Lynch has advised that the DOJ, in consultation with the SEC, will not file a petition for a writ of certiorari of the D.C. Circuit’s opinion striking down part of the SEC’s conflict minerals disclosure regime.

Conflict minerals rule. The SEC’s conflict minerals rules, promulgated pursuant to Section 1502 of the Dodd-Frank Act, require public companies to make certain disclosures about their use of “conflict minerals” from the Democratic Republic of the Congo (DRC) and neighboring countries. Several business groups challenged the rules as contrary to the free speech protections of the First Amendment. While the district court sided with the SEC, a panel of the D.C. Circuit struck down the requirement that issuers report to the SEC and state on their website that any of their products have “not been found to be DRC conflict free,” citing First Amendment concerns.

Following the circuit court’s decision on the constitutionality of country-of-origin labels, the panel held a rehearing on the SEC’s conflict minerals disclosure rule. The majority adhered to its prior decision, but added an alternative ground due to doctrinal uncertainty and circuit conflicts. The original decision applied an intermediate level of scrutiny to determine that the requirement was unconstitutional; however, upon rehearing, the two-judge majority concluded that even under a lower standard of scrutiny, the regulation could not pass constitutional muster because the disclosures required by the rule were not limited to “purely factual and uncontroversial information.”

No cert sought. The Attorney General’s letter explained that given that the majority had concluded that the challenged disclosure requirements would be unconstitutional even under the alternative, more lenient standard as articulated in the panel’s second opinion, this would be a “poor case” to seek the clarification of the Supreme Court on the proper standard of scrutiny. The letter noted that the majority opinion and the dissenting opinion of Judge Srinivasan disagreed whether requiring issuers to state publicly that their products have “not been found to be DRC conflict free” involved “purely factual and uncontroversial information.” Guidance on such a case-specific issue may be difficult for the Supreme Court to provide, she wrote.

The letter also noted that the panel’s decision may apply only to the SEC’s rule and not to the underlying language of Dodd-Frank. It is possible that the SEC could promulgate a new rule that would fulfill Dodd-Frank’s mandate and be consistent with the majority’s view of the First Amendment or that the district court could determine that the statute does not require the use of the phrase “not been found to be DRC conflict free,” according to the Attorney General.

The deadline for filing a writ of certiorari, which had been extended twice, was April 7, 2016.

Monday, April 11, 2016

Massachusetts Says Robo-Advisers Fail Fiduciary Duty Standard

By Jay Fishman, J.D.

The Massachusetts Securities Division has issued a policy statement proclaiming that because automated robo-advisers, unlike traditional human investment advisers, cannot provide fiduciary duties to clients, the Division will evaluate their Massachusetts registration applications on a case-by-case basis.

Definition. The Division defines a “robo-adviser” as either a fully automated adviser or an investment adviser that uses asset allocation algorithms combined with human services. The policy statement applies primarily to fully automated advisers, but with either type, a robo-adviser must be evaluated on a case-by-case basis to ensure that it meets its fiduciary obligation to clients when advising them for compensation.

Fiduciary duty. Inherent in the Division’s “case-by-case evaluation mandate” is the belief that robo-advisers cannot meet the fiduciary duty because:
  • They do not meet with or conduct significant (or any) due diligence on their clients;
  • They often provide totally depersonalized investment advice;
  • They fail to meet the high standard of care needed to make appropriate investment decisions for their clients; and
  • They specifically decline to act in their clients’ best interests by disclaiming this and other obligations in the electronic client agreement. 
The Division also based its decision on the following SEC/FINRA caution to investors: “An automated tool may rely on assumptions that could be incorrect or do not apply to your individual situation … An automated investment tool may not assess all of your particular circumstances, such as your age, financial situation and needs, investment experience, other holdings, tax situation, willingness to risk losing your investment money for potentially higher investment returns, time horizon for investing, need for cash, and investment goals. Consequently, some tools may suggest investments (including asset-allocation models) that may not be right for you.”

Friday, April 08, 2016

Spoofing Verdict Against High-Speed Trader Stands

By Matthew Garza, J.D.

The federal district court in Chicago rejected an attempt by a futures trader to overturn his conviction for commodities fraud and spoofing in an opinion that elucidated the criminal standard for a conviction under the Dodd-Frank-prohibited activity (U.S. v. Coscia, April 6, 2016, Leinenweber, H.).

Banned activity. The court said Michael Coscia, of Panther Energy Trading LLC, implemented a high-frequency trading program in August 2011 that placed large orders intended to move the market in a particular direction, and cancelled them before execution, allowing him to profit from small orders placed on the other side. The U.S. Attorney for the Northern District of Illinois charged Coscia with six counts of “spoofing” and six counts of commodities fraud in October 2014 and obtained a guilty verdict after one hour of jury deliberations in November 2015. The CFTC previously ordered Coscia to pay $2.8 million for his activity.

Spoofing was banned by the Dodd-Frank Act, which added Section 4c(a)(5)(C) of the Commodity Exchange Act to proscribe conduct that “is, is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).” Futures traders are closely watching developments in this area to determine precisely what conduct will be considered spoofing, and how successful the government is in bringing these cases.

Review standard. Coscia faced a daunting hurdle to overturn the verdict. The court explained that in order to grant his motion for judgment of acquittal, it must find that the trial record contained “no evidence, regardless of how it is weighed, from which the jury could have concluded beyond a reasonable doubt that [the defendant] is guilty.” Coscia challenged the jury’s verdict on commodities fraud and spoofing, while also challenging the jury instructions as well as testimony given by government witnesses. He failed on each count.

Sarbanes-Oxley Act. Coscia asserted that the government needed to show that the actual orders he placed were fraudulent, but instead it relied on a “pure inducement” theory, which pinned the fraud on his actions to induce market participants to trade with him. The court said that the charges, brought under Sarbanes-Oxley Act Sec. 807 (18 USC §1348), required that the activity involved a scheme to defraud by intentionally misleading market participants about price and volume information through sham quote orders. The government’s allegations fit these requirements, said the court.

Coscia challenged the sufficiency of the evidence by asserting that the record did not show that his orders, which stayed on the market for 100 to 450 milliseconds, were deceptive. Some of his large orders traded, he pointed out. The court said this argument ignored substantial evidence showing that he never intended to fill large orders. Coscia’s programmer in fact testified that his program was designed to reduce the risk that orders could be filled. The deception was also material, said the court.

Vagueness. Coscia next attacked the spoofing statute as unconstitutionally vague, arguing that it encompasses much routine, innocuous conduct by commodities traders. The court said that his conduct could be differentiated from legitimate practices such as “fill-or-kill” or “partial-fill” orders because he intended to cancel the orders. The statute also provided sufficient notice to him that his activity was prohibited, said the court, noting that it was not reasonable to conclude that Congress intended to criminalize all orders that are eventually cancelled at any point, for any reason. The statute has a clear purpose—“to prevent abusive trading practices that artificially distort that market,” the court said, and that occurs when there is intent to defraud through the placement of illusory orders.

The court went on to reject Coscia’s argument that the jury instructions were insufficient. The Sarbanes-Oxley instructions properly required the jury to find separately that there was a scheme to defraud, that Coscia acted with an intent to defraud, and that the scheme was material. The spoofing instructions, which ignored his request that the jury be instructed that he not be found guilty if he intended to cancel orders only under certain conditions, were also sufficient. He was free to argue, said the court, that his program only cancelled orders under certain conditions. The court also rejected Coscia’s challenges to testimony given by a number of government witnesses.

The case is No. 14 CR 551.

Introducing Securities Topic Pages

Wolters Kluwer has created a new online resource, Topic Pages, now available on wklawbusiness.com! Topic Pages are developed by Wolters Kluwer editorial experts, who select relevant topics using data collected from our users, the industry, and search patterns from the open web. These pages are curated by our leading experts to ensure they contain the most important and timely content Wolters Kluwer has available on the topics that concern our customers the most.

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Alternatively, you can click on one of the links below. From these pages you can see all other Topic Pages listed under “Related Topics.”

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Wolters Kluwer would appreciate your comments on the pages themselves and your suggestions for other topics you would like to see covered in the future. Please send your feedback to Nicole.stone@wolterskluwer.com.

Thursday, April 07, 2016

Judge Rakoff Declines to Recommend Perjury Prosecution of Insider Trading Defendant

By Amanda Maine, J.D.

A securities fraud defendant who made seemingly inconsistent statements in his guilty plea allocution and during his civil trial will not face perjury charges on the formal referral of district court Judge Jed S. Rakoff. However, the judge advised that the SEC is still free to make its own referral to the U.S. Attorney’s Office to investigate possible perjury (SEC v. Payton, April 5, 2016, Rakoff, J.).

Criminal and civil charges. The U.S. attorney and the SEC brought securities fraud charges against the defendant and others, alleging that they traded on inside information ahead of IBM’s acquisition of SPSS, Inc. The defendant pleaded guilty to conspiracy to commit securities fraud and made a number of statements in his allocution to the court regarding his actions.

His guilty plea was later vacated by the court following the Second Circuit’s decision in United States v. Newman, which vacated two guilty verdicts for insider trading in an unrelated case and established a stricter personal benefit standard. The defendant argued that he never admitted that the tipper had received a personal benefit as now required by Newman, and the court agreed. The SEC, confident that it could prove liability even under the Newman standard, continued its civil litigation against the defendant and a jury found him liable for securities fraud on February 29, 2016.

Inconsistent statements. During the defendant’s civil trial, an issue arose of whether he gave testimony that materially conflicted with his now-vacated guilty plea. Judge Rakoff invited counsel from both parties to submit letters about whether he should formally refer the defendant to the U.S. Attorney’s Office for a possible perjury prosecution. While the judge was “deeply troubled” by the inconsistencies, he decided against making a formal referral.

The judge outlined several of the defendant’s arguments against recommending a perjury prosecution, none of which he found particularly convincing. The defendant’s argument that his memory was not as clear at trial as it was during his guilty plea hearing was unpersuasive given that only 15 months had passed between the two. The judge also doubted that the inconsistencies between his plea allocution and his trial testimony were the result of his former counsel “putting words in his mouth” by amending the allocution by colloquy since the defendant did not volunteer affirmative evidence indicating as such.

The defendant also argued that his allocution, when read as a whole, was “somewhat equivocal” on whether he found out about IBM’s pending acquisition of SPSS before or after trading on the information and whether the information was supposed to be confidential. The judge was unconvinced by this argument, stating that the “plain inference” was that the defendant knew the confidential nature of the information before he traded and there was nothing in the plea allocution that would establish otherwise.

No perjury referral. Despite his skepticism regarding Payton’s arguments that he did not commit perjury, the judge declined to formally refer him for a possible perjury prosecution. He noted that the jury had found the defendant liable for securities fraud, so even if he did commit perjury, it may have discredited his testimony. The defendant also faces substantial civil penalties so will, in a way, receive at least some adverse consequence from his seemingly untruthful testimony. The judge also advised that courts should be cautious about making perjury referrals only in exceptional cases so as not to have a “chilling effect” on testimony in suspicious circumstances.

While deciding against making a formal referral, the judge noted that the U.S. Attorney’s Office may conduct its own investigation about the defendant’s possible perjury. Similarly, the SEC itself may bring the issue to the attention of the U.S. attorney, the judge observed.

The case is No. 14-cv-4664.

Wednesday, April 06, 2016

NASAA Proposes Amendments to CorpFin Policies, Forms U-1 and U-2

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

NASAA has released for public comment proposed amendments to four of NASAA’s corporation finance statements of policy. The proposal comes in response to NASAA’s newly adopted Coordinated Review Program for Regulation A Offerings as well as to comments received from the Regulation A+ Working Group of the ABA’s Business Law Section. Separately, NASAA has proposed amending Uniform Forms U-1 and U-2 to facilitate the registration of securities offerings in multiple jurisdictions and to modernize the consent to service of process.

Corporation finance statements of policy. Specifically, NASAA’s Corporation Finance Section has proposed amendments to the following statements of policy:
  • Statement of Policy Regarding Preferred Stock
  • Statement of Policy Regarding Promoter’s Equity Investment
  • Statement of Policy Regarding Specificity In Use of Proceeds
  • Statement of Policy Regarding Unequal Voting Rights
Preferred Stock. This policy statement has been compressed into fewer sections to increase clarity. In addition, the policy has been revised to clarify that analysis may be based on either the last fiscal year or the last three fiscal years. The revised policy states that the failure to make certain disclosures regarding an offering of preferred stock constitutes grounds for denial of an application.

Promoter’s Equity Investment. In response to concerns from the ABA Working Group that promoters have difficulty in meeting the current requirements of this policy, the formula for determining the required amount of the promoter’s equity investment (PEI) has been reduced by a change in the percentages and by a cap. In addition, state administrators are provided greater flexibility in approving offerings by permitting consideration of: (1) accumulated earned surplus; (2) goodwill and intellectual property; (3) proof that the promoters worked at a reduced salary or without a salary; and (4) in other non-cash contributions, in calculating whether the promoter has an acceptable PEI.

Specificity In Use of Proceeds. In response to comments from the ABA Working Group that policy should be more flexible, especially for mature companies, the limit for working capital or other unspecified uses has been increased to 20 percent for best efforts offerings. In addition, a new higher tier has been added that allows up to 35 percent if the offering is firmly underwritten. Changes have also been made to eliminate disclosure of the names and addresses of vendors and persons who receive commissions if the transactions are immaterial.

Unequal Voting Rights. The proposed amendments provide more flexibility for administrators to approve securities offerings with disproportionate voting rights per share where the issuer has a compelling rationale for issuing shares with lesser voting rights to public investors. The proposal sets forth specific disclosure requirements to assure that investors understand the applicable risks and have the material information they need to make an informed investment decision.

Forms U-1 and U-2. The proposed new uniform securities registration form, Multistate Form U-1, has been designed to assist issuers in registering offerings in multiple states, particularly with regard to approval through the coordinated review program. The new form will be made available as a fillable PDF, with the Consent to Service of Process built into the form. The form will also provide an electronic signature option with instructions and will eliminate the notarization requirement. The new uniform consent to service of process, Form U-2, includes updates to information pertaining to the listed service of process agencies to ensure accuracy.

Request for comments. Comments on each proposal are due by May 1, 2016. After the comment period has closed, NASAA will make the comments available for public viewing on its website.

Tuesday, April 05, 2016

Class Action Against WWE Gets Body Slam by Court

By R. Jason Howard, J.D.

A federal district court in Connecticut has granted a motion to dismiss a class action brought by shareholders alleging securities violations by executives at World Wrestling Entertainment, Inc. (WWE) for false statements or omissions made in connection with the company’s ability to multiply and transform its earnings profile (In re World Wrestling Entertainment, Inc. Securities Litigation, March 31, 2016, Thompson, A.).

Allegations. The plaintiffs argued that through a series of earnings conference calls and press releases during the class period from October 31, 2013, to May 16, 2014, the defendants misrepresented or omitted information concerning: (1) the size of WWE’s fan base; (2) the potentially cannibalistic effect of launching the WWE network; (3) a comparison between WWE and live sports; (4) the status of negotiations with NBCU; and (5) statements regarding the potential to double or triple the company’s 2012 OIBDA by 2015.

Findings. In each instance, the court sided with the defendants except as to the statements comparing the WWE to live sports, concerning which the court said that the plaintiffs had alleged “facts sufficient to suggest that there is a substantial likelihood that the disclosure of the discrepancy in advertising revenue would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” The court added that, given the context in which the statements comparing the WWE to live sports were made, there were sufficient facts to suggest that it was misleading to benchmark WWE advertising revenue against sports like NASCAR and that in order to render such a comparison not misleading, the discrepancy in advertising revenue needed to be disclosed.

Scienter. The court concluded that the plaintiffs had adequately pleaded material misrepresentations or omissions with respect to the statements comparing the WWE to NASCAR and other live sports without disclosing the discrepancy in advertising revenue, but not with respect to other categories of misrepresentations or omissions asserted. Therefore, the court only considered whether the plaintiffs had adequately pleaded scienter with respect to the statements that compared WWE to NASCAR and other live sports without disclosing advertising revenue, and determined that the plaintiffs had failed to do so.

Conclusion. The plaintiffs failed to allege facts sufficient to suggest that the defendants’ statements about the size of WWE’s fan base, statements about the cannibalistic effect of launching the WWE network, statements about the status of negotiations with NBC, and statements regarding the potential to double or triple OIBDA were materially false or misleading. Accordingly, the complaint was dismissed.

The case is No. 3:14-cv-1070 (AWT).

Monday, April 04, 2016

FinCEN Proposes to Include Crowdfunding Portals Within Definition of "Broker-Dealer"

By Rodney F. Tonkovic, J.D.

The Financial Crimes Enforcement Network (FinCEN) has issued a proposal that would require funding portals to comply with Bank Secrecy Act (BSA) requirements applicable to brokers or dealers. The rulemaking would amend those regulations to include crowdfunding portals within the definition of "broker-dealer" (Release No. 1506-AB29).

The release proposes amendments to the definitions of “broker or dealer in securities” and “broker-dealer” under the regulations implementing the BSA. Those definitions would be amended to explicitly include funding portals involved in the offering or selling of crowdfunding securities. As a consequence, funding portals would be required to implement policies and procedures reasonably designed to achieve compliance with the BSA requirements currently applicable to brokers or dealers in securities. Written comments on this Notice of Proposed Rulemaking must be submitted on or before June 3, 2016.

The BSA defines a "broker-dealer in securities" and "broker-dealer" as broker or dealer in securities registered, or required to be registered, with the SEC under the Exchange Act. The terms are defined in three places in the Act, but are substantively the same. In each instance, FinCEN proposes to add the phrase "a person registered, or required to be registered, as a funding portal with the Securities and Exchange Commission under section 4(a)(6) of the Securities Act of 1933 (15 U.S.C. 77d(a)(6))." Other technical amendments will create one standard definition of the terms "broker or dealer in securities" and "broker-dealer" to be used throughout the regulations.

Effect of JOBS Act. The JOBS Act amended the securities laws to create a new exemption for offerings of crowdfunded securities. Among other requirements, issuers of crowdfunded securities must use as an intermediary either a broker-dealer or "funding portal," as defined in Section 3(a)(80) of the Securities Act. Funding portals, while subject to the SEC's authority, are exempt from registration as a broker-dealer.

The problem. The BSA currently requires registered broker-dealers to maintain an anti-money laundering program and to file suspicious activity reports. Since funding portals are not registered broker-dealers, they are not subject to the BSA regulations that apply to broker-dealers. The proposed rulemaking, then, will ensure that funding portals are subject to BSA regulations.

The proposing release notes that what funding portals do is essentially similar to the activities of introducing brokers and would raise at least the same degree of money laundering and counter financing of terrorism risk. There is also the potential that funding portals will facilitate offerings of microcap or low-priced securities, which pose a money laundering risk because they are often used to generate illicit assets through market manipulation, insider trading, and fraud. FinCEN believes, the release says, that funding portals are in the best position to know their customers and could play a critical role in reporting money laundering and other illicit financing.

If implemented, this rulemaking would require funding portals to comply with the full range of BSA requirements applicable to broker-dealers, including: (1) maintaining an anti-money laundering program; (2) filing suspicious activity reports; (3) having a written Customer Identification Program; (4) providing Currency Transaction Reports; (5) recordkeeping and travel rules; (6) information sharing; (7) due diligence for private banking and certain foreign accounts; (8) the prohibition on correspondent accounts for foreign shell banks; and (9) the special measures to be taken to address certain money laundering risks.

The release is No. 1506-AB29.