Friday, May 26, 2017

Acting SG urges justices to hear SLUSA case, provide uniformity

By Mark S. Nelson, J.D.

The Acting U.S. Solicitor General has asked the Supreme Court to take a case raising the question of whether a state court may hear a case that is a covered class action but raises only claims brought under the Securities Act. The justices invited the government to present its views on the Securities Litigation Uniform Standards Act of 1998, which sought to clarify jurisdictional issues left open following enactment of the Private Securities Litigation Reform Act of 1995. According to the government, a decision by the justices could bring uniformity to a muddled aspect of securities litigation (Cyan, Inc. v. Beaver County Employees Retirement Fund, May 23, 2017).

What does “except” mean? The underlying case involved a law suit filed in state court over disclosures made in registration statements and prospectuses and involved only claims under the Securities Act without any state law claims. The defendant below (petitioner in the Supreme Court), Cyan, Inc., lost its bid for judgment on the pleadings in the California Superior Court based on that court’s reading of a California appellate court opinion that previously held that concurrent jurisdiction in cases like this one still exists post-SLUSA. The California Court of Appeal denied Cyan’s petition for writ of mandate, and the state’s supreme court denied Cyan’s petition for review.

Securities Act Sections 16 and 22 work in tandem, albeit in a complex manner, to close a post-PSLRA loophole that many feared could lead to abusive litigation, although the specific question presented in Cyan’s petition to the Supreme Court remains unsettled:
Whether state courts lack subject matter jurisdiction over "covered class actions" . . . that allege only claims under the Securities Act of 1933.
The government characterized Cyan’s argument as going too far by asserting that Section 22’s “except” clause refers to Section 16’s definition of “covered class action.” Likewise, the government found fault in the respondent’s explanation, which was lacking in detail, but nevertheless offered an interpretation that would impose a bar only on state-law actions.

According to the government, the respondent’s view is better because Cyan’s view is out of synch with the words Congress used in the law. The government suggested that Congress may have drafted the “except” clause to deal with hybrid class actions or to ensure that general jurisdictional provisions in the Securities Act could not be used to undermine SLUSA.

Obstacles to cert grant? Despite the government’s urging the court to take the case, there may be formidable hurdles to a certiorari grant. The government, for example, relies heavily on Supreme Court Rule 10(c), which explains that the court may grant certiorari when a state or federal court decides an important federal law question that the justices ought to resolve but, for a multitude of reasons, have not done so.

The government concedes there is no split of authority among federal appeals courts (although one case is pending in the Ninth Circuit), nor is there a split among the states’ highest courts. But the government does note a split among federal district courts, especially between district courts in New York and California.

But there also is “some uncertainty” about whether the California court in Cyan’s case disposed of the company’s petition on federal or on adequate and independent state grounds. Still, the government emphasized that the practical realities of SLUSA litigation reduce the chances that lower courts will produce reviewable decisions and Cyan’s case offers the justices an opportunity to clarify Securities Act jurisdiction.

The case is No. 15-1439.

Thursday, May 25, 2017

American Pipe tolls statute of limitations for class actions too

By Anne Sherry, J.D.

Assessing the viability of a securities fraud class action, the Court of Appeals for the Ninth Circuit held that the statute of limitations was tolled during the pendency of two prior class actions. The court read American Pipe in conjunction with subsequent Supreme Court cases to toll not just individual actions, but also class actions. Allowing class action plaintiffs who were unnamed class members in previously uncertified classes to avail themselves of tolling would advance the policy objectives that led the Court to permit tolling in the first place (Resh v. China Agritech, Inc., May 24, 2017, Fletcher, W.).

China Agritech actions. Several named plaintiffs brought a class action against China Agritech and its officers and directors. The plaintiffs were unnamed plaintiffs in two earlier class actions against most of the same defendants based on the same underlying events; class certification was denied in both of those earlier actions. The district court in Pasadena dismissed the new class action as time-barred, observing that the Supreme Court has not yet determined whether American Pipe allows tolling for an entirely new class action based on a substantially identical class. To hold the case timely “would allow tolling to extend indefinitely as class action plaintiffs repeatedly attempt to demonstrate suitability for class certification on the basis of different expert testimony and/or other evidence,” reasoned the district judge (who also presided over the two earlier class actions).

American Pipe analysis. It was undisputed on appeal that the earlier class actions were timely and that American Pipe and Crown, Cork & Seal tolled the statute of limitations for the individual claims of would-be class members. The appeals court had to decide whether the plaintiffs’ would-be class action based on the same claims was timely. In American Pipe, the Court characterized its tolling rule as serving the judicial economy interests underlying both statutes of limitations and class actions. In Crown, Cork & Seal, which extended American Pipe to the filing of new actions, the Court reasoned that inefficiencies would ensue if tolling were only permitted for class members seeking to intervene in an existing lawsuit.

The Ninth Circuit did, in Catholic Social Services, address the analytic structure in which American Pipe applies to future class actions. Although the court there held that a prior class action tolled the statute of limitations for a subsequent class action, it also wrote that if class certification had been denied in an earlier case, it would not allow plaintiffs to bring a class action to relitigate the correctness of that denial. But this is because of preclusion, not tolling, the Ninth Circuit now clarifies, with support from three recent Supreme Court decisions examining the interplay between statutes of limitations and other legal principles.

Based on a reading of this precedent, the appeals court concluded that “permitting future class action named plaintiffs, who were unnamed class members in previously uncertified classes, to avail themselves of American Pipe tolling would advance the policy objectives that led the Supreme Court to permit tolling in the first place.” Defendants will not be unfairly surprised because the prior class action already alerted them to the claims brought against them and the number and general identities of the plaintiffs who may participate. The rule also promotes judicial economy by reducing incentives for filing protective class actions. Finally, the current legal system is adequate to respond to concerns about abusive filing of repetitive class actions.

The case is No. 15-55432.

Wednesday, May 24, 2017

In light of Bandimere, SEC stays proceedings subject to Tenth Circuit review

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

In light of the Tenth Circuit’s decision to deny the SEC’s petition for rehearing en banc of Bandimere v. SEC, the SEC has stayed certain administrative proceedings assigned to an administrative law judge in which respondents may seek review in the Tenth Circuit of a final Commission order. The stay takes effect immediately and will remain in effect until the time has expired for the government to file a petition for writ of certiorari in Bandimere, the resolution of any cert petition and any decision issued by the Supreme Court in that case, or further order of the Commission.

The order implementing the stay affects final orders of the Commission that are subject to Tenth Circuit review under Securities Act Section 9(a), Exchange Act Section 25(a), Investment Company Act Section 43(a), and Advisers Act Section 213(a).

On May 4, the Tenth Circuit denied the SEC’s petition for a rehearing en banc of the divided panel decision in Bandimere, which held that the Commission’s administrative law judges (ALJs) are unconstitutionally appointed inferior officers. The panel had decided on a 2-1 vote that the SEC’s appointment of its ALJs violated the Appointments Clause of the Constitution, thus setting aside an ALJ’s ruling that David F. Bandimere was liable for violations of the federal securities laws. The panel reasoned that since ALJs exercise significant discretion in carrying out important functions, including the power to find respondents liable, to impose sanctions, and to enter default judgments, they meet the criteria established under the Supreme Court’s Freytag decision to be considered “inferior officers.”

The SEC’s order directs ALJs in applicable cases to issue a notice indicating that the proceeding has been stayed. The order does not prohibit the Commission, however, from assigning any proceeding pending before an ALJ to itself or to any member of the Commission. The order also stays all administrative proceedings pending before the Commission on review from an initial decision by an ALJ in which a respondent has the option to seek review in the Tenth Circuit of a final Commission order.

On May 24, the D.C. Circuit will hear oral argument in Raymond J. Lucia Companies, Inc. v. SEC, another case in which the respondents have challenged the constitutionality of the SEC’s administrative enforcement regime. The D.C. Circuit previously held for the SEC, finding that the SEC’s ALJs more closely resembled those of the FDIC, which the court held in its 2000 Landry decision are not inferior officers, than the special trial judges in Freytag. That decision has been vacated, however, pending the rehearing en banc.

Tuesday, May 23, 2017

Town supervisor convicted in muni bonds fraud case

By Amanda Maine, J.D.

The former town supervisor of Ramapo, New York, has been found guilty by a jury of 20 counts of conspiracy, securities fraud, and wire fraud, the U.S. Attorney’s Office for the Southern District of New York announced. The charges related to a cover-up of Ramapo’s deteriorating financial condition in the issuance of municipal bonds, including the costs of building a minor league baseball stadium. It is the first conviction for securities fraud in connection with a municipal bond offering (U.S. v. St. Lawrence, May 19, 2017).

General Fund misrepresentations. According to the indictment, former Town Supervisor Christopher St. Lawrence made up false assets in Ramapo’s General Fund, which is the town’s primary operating fund. The amount of these false assets was included in bond issues made pursuant to placement memoranda describing Ramapo’s finances. One of the bond issues related to the construction of a $58 million minor league baseball stadium. The town of Ramapo ended up financing half the cost of the stadium, even after a town-wide referendum overwhelmingly rejected a resolution to guarantee long-term bonds to finance the stadium.

The town also issued several million dollars in public improvement refunding bonds and bond anticipation notes. All of these issuances were made pursuant to statements containing false information about the town’s assets. The false assets included several fake receivables which served to inflate the balance of the General Fund, partly to conceal the extent to which Ramapo financed the stadium and the impact of the financing, and partly to conceal the illiquidity of the Ramapo Local Development Corporation (RLDC), which was authorized to issue bonds to the public. St. Lawrence also allegedly inflated a receivable from FEMA to reimburse the town for expenses related to Hurricane Irene and Hurricane Sandy, even though Ramapo had not submitted the claims to FEMA at the time.

Ramapo also allegedly transferred revenues from an ambulance fund to the General Fund, and the town’s financial statements failed to include accounts payable to a civil engineer. According to the indictment, St. Lawrence made false and misleading statements to the town and its auditors and conspired with other town officials to cover up the misrepresentations.

Guilty verdict. The 11 counts of wire fraud and eight counts of securities fraud for which St. Lawrence was found guilty each carry a maximum sentence of 20 years in prison. The guilty verdict of conspiracy carries a maximum sentence of five years in prison. St. Lawrence was acquitted of one count of securities fraud and one count of wire fraud.

Other litigation. In March, the former director of RLDC pleaded guilty to securities fraud and conspiracy charges. The town’s audit firm and senior engagement partner settled charges with the SEC relating to improper professional conduct in issuing the audit reports while ignoring red flags and relying on false representations by Ramapo officials about the inflation of the General Fund.

Monday, May 22, 2017

CII tells Speaker Ryan of CHOICE Act worries

By Mark S. Nelson, J.D.

The Council of Institutional Investors and 53 public pension funds, investors, and advisers sent a letter to Speaker Paul Ryan (R-Wis) urging him to hear the CII’s concerns about shareholder and executive pay provisions tucked into the GOP-led Financial CHOICE Act of 2017. CII said these provisions could erode safeguards that protect investors and help to hold public companies responsible for their actions. The letter’s signatories include the California Public Employees’ Retirement System, the California State Teachers’ Retirement System, the New York City Comptroller, and the New York State Comptroller.

CHOICE Act shareholder concerns. The CII objects to the CHOICE Act’s (H.R. 10) multiple shareholder provisions, some of which did not make the cut in the first version of the bill introduced in the last Congress. Section 844 of the revised CHOICE Act would significantly alter the shareholder proposal requirements by changing the eligibility threshold to eliminate the dollar amount option (currently $2,000 or 1 percent for one year) and by increasing the holding period from one to three years. CII noted that by retaining only the 1 percent ownership threshold, a shareholder would need to hold billions of dollars of stock to be eligible to submit a proposal at some high market capitalization companies.

The CHOICE Act also would increase the tiered resubmission thresholds for shareholder proposals, currently set at 3, 6, and 10 percent, to 6, 15, and 30 percent. Shareholder proposals also could not be submitted by proxies on behalf of a shareholder. Moreover, the revised bill would bar the Commission from requiring a single ballot. The Commission issued its proposal for a universal proxy last year (See CII’s comment letter supporting the proposal and earlier petition for rulemaking/guidance).

Proxy advisers. In addition to eased executive compensation requirements and SEC rulemaking curbs, the CII objected to inclusion of a proxy adviser registration requirement. Sections 481-483 of the CHOICE Act include the bulk of a bill introduced last Congress by Rep. Sean Duffy (R-Wis) (H.R. 5311) that, as drafted, would grant regulators new authorities over proxy advisers’ management of conflicts of interest and draft recommendations. The SEC also would be required to issue rules barring unfair or coercive practices by proxy advisers. CII worries that the provision could deprive shareholders of independent research and may even force some advisory firms to close.

Democrats’ opposition. The House Financial Services Committee reported out the CHOICE Act on a party-line vote after a three-day mark-up session. Democrats opposed to the bill held their own Minority Day hearing before the mark-up in protest of the one-day hearing held by the full House FSC. Democrats have since renewed their call for further consideration of the bill by all the House committees with jurisdiction over parts of it before the full House votes on the bill (the bill was referred to eight committees other than the FSC). Dodd-Frank Act corrections legislation will face much tougher opposition in the Senate, where Democrats have a stronger minority position.

Friday, May 19, 2017

Comments received on proposed swap dealer and major swap participant capital rules reflect diverse views

By Brad Rosen, J.D.

The comment period for a controversial CFTC rule proposal addressing capital requirements for swap dealers (SDs) and major swap participants (MSP’s) came to a close on May 15, 2017. The commission received over 30 comments reflecting diverse perspectives and representing a cross section of financial firms and institutions, industry associations, end users, public interest groups, law firms, and members of the general public.

The subject rules were again proposed in December, 2016 after the CFTC’s proposal in 2011 stalled as a result of unresolved margin standards for uncleared swaps globally. The rules are proposed as part of the Dodd-Frank market reform legislation enacted in 2010.

While the current proposal reflects a flexible approach by allowing for three alternative methods to determine capital requirements which depend on an SD’s regulatory status, some commentators found the proposed rules overly burdensome while others thought them not stringent enough. The three approaches to determining capital requirements under the proposed rule can be summarized as follows:
  1. In the event that an SD is a bank affiliate, capital requirements and methods permitted by bank regulators are acceptable; 
  2. If an SD is a broker-dealer or futures commission merchant, that party may look to either the CFTC or SEC for its net liquid assets requirements; and
  3. SDs that are primarily engaged in non-financial activities, as well as MSPs, may elect minimum capital requirements based upon the tangible net worth of the entity. 
Under the proposal, SDs are also permitted to use internal models for the purpose of computing their regulatory capital, subject to the prior approval of either the CFTC or the National Futures Association (NFA).

The Futures Industry Association (FIA), in its comments, noted that the proposal might adversely impact futures brokerage firms, whether or not they are SDs, by “requiring an FCM to include its proprietary swaps and security-based swaps positions in its calculation of eight percent of risk margin [that] would create an unnecessary and unacceptable financial burden” and that “[t]he proposed rule would most dramatically affect less well-capitalized FCMs that are not also registered as broker-dealers.” The FIA also contended that the proposed rules may have the effect of causing smaller commercial end users such as farmers and ranchers to pay higher fees to engage in swaps to manage their risks.

In contrast, the Americans for Financial Reform (AFR), a public interest group, asserted that the proposed rules were too lenient and expressed concerns that the proposal heavily relies on the use of internal models at covered swap entities and “that the reliance on internal models can permit regulated entities to manipulate risk controls to increase their own profits at the cost of increasing risks to the public.” The AFR also indicated its skepticism with the commission’s approach that permitted loss absorbency based on tangible net worth, as opposed to a more stringent requirement that the capital requirements be met with assets that are actually liquid.

The Edison Electric Institute, an association of electric companies, and National Rural Electric Cooperative Association, a national service organization representing over 900 not-for-profit rural electric utilities, also weighed in jointly on the proposed rules. They warned against continuing to utilize a one-size-fits-all approach to evaluating and assigning risk ratings to uncleared swap positions being measured against such minimum regulatory capital requirements. The parties also urged the commission to allow SDs and MSPs to apply lower risk factors for swaps with commercial end user counterparties.

The CFTC will now consider the proposed rule in light of the comments received.

Thursday, May 18, 2017

Staff grants no-action relief for Yahoo’s pricing formula in Dutch auction tender offer

By Jacquelyn Lumb

The SEC’s Division of Corporation Finance has granted no-action relief requested by Yahoo! Inc. that will permit it to rely on a particular formula to determine the purchase price of its common shares and the number of shares accepted in a planned issuer tender offer. Yahoo plans to offer up to $3 billion for its shares in the self-tender offer which will occur in advance of its sale to Verizon Communications Inc.

Verizon agreement. Yahoo and Verizon entered into a share purchase agreement last year in which Verizon agreed to purchase Yahoo’s operating business for an aggregate purchase price of $4,475,800 in cash, subject to certain adjustments. Prior to the completion of the sale, Yahoo will transfer the assets and liabilities of its operating business to a wholly-owned subsidiary and sell Verizon all of the outstanding shares of the subsidiary. Prior to the sale of the subsidiary, Yahoo will cause the subsidiary to sell to a foreign subsidiary of Verizon all of the equity interests in a newly formed foreign subsidiary of Yahoo that will hold certain foreign subsidiaries relating to the operating business.

Yahoo becomes investment company. Upon the completion of the sale transaction, Yahoo’s remaining assets will consist of assets and liabilities that were excluded in the transfer, which include cash and marketable debt securities, shares in Alibaba Group Holding Limited, shares in Yahoo Japan Corporation, certain other minority equity investments, and Excaliber IP, LLC, which is a subsidiary that owns a portfolio of non-core patent assets. Yahoo will continue to be a Delaware corporation publicly traded on the NASDAQ Global Select Market but will be renamed Altaba Inc. Since its assets will consist primarily of its equity investments, short-term debt investments, and cash, it will be required to register as an investment company.

Self-tender offer. After the completion of the sale, Yahoo intends to return substantially all of its cash to its shareholders but will retain sufficient cash to satisfy its obligations to creditors and for working capital. The transaction is subject to shareholder approval at a special meeting scheduled for June 8, 2017, followed by a closing of the sale in mid-June 2017. The sale transaction is not conditioned upon the commencement or the consummation of the offer.

Yahoo will offer to acquire a portion of its outstanding shares in order to provide liquidity to a potentially significant number of its shareholders that will be forced to sell their shares at or prior to the sale transaction. Some of the shareholders will be subject to restrictions on holding Yahoo shares once it becomes a registered investment company and other shareholders, including index funds, will be required to sell the shares once they are removed from the Standard & Poor’s 500 Composite Index and other indices.

Pricing formula. The offer will be structured as a modified Dutch auction tender offer in which shareholders who tender shares will select a multiple that will be fixed throughout the duration of the offer. Yahoo will determine a final multiple that will clear the aggregate consideration of $3 billion or, if less, the top of the multiple range. Yahoo will apply the final multiple to the per share daily volume-weighted average pricing for an American Depositary Share of Alibaba. According to Yahoo, the pricing formula is intended to reflect the current correlation between the trading prices of its common shares and Alibaba’s ADSs.

Yahoo explained that its investment in Alibaba is its most important asset and its common shares are highly sensitive to movements in the price of the ADSs, so in determining the pricing formula, it wanted to ensure that the price paid for the common shares tendered in the offer reflect current market values. Yahoo added that the use of the value of the ADSs as part of the formula is particularly important because it lacks access to nonpublic information about Alibaba’s management or operations.

No-action relief. The no-action relief is strictly limited to the application of the regulatory provisions of the offer, according to the staff. Yahoo should discontinue the offer pending further consultation with the staff if any of the facts or representations in its request for no-action relief change.

Wednesday, May 17, 2017

Class certified in action over how funds were marketed

By Rodney F. Tonkovic, J.D.

A class has been certified in a fraud action brought against an investment adviser that allegedly advertised back-tested, hypothetical results as actual performance. The court found that the proposed class satisfied the typicality and adequacy requirements of Rule 23(a) and was entitled to a presumption of reliance, thus satisfying the predominance requirement (In re Virtus Investment Partners, Inc. Securities Litigation, May 15, 2017, Pauley, W.).

Virtus Investment Partners began marketing a family of funds called "AlphaSector" in 2009. In its marketing materials, the adviser represented that the funds' outsized performance was the result of live trading with real client assets since 2001. AlphaSector, however, did not exist before 2008. In a January 2013 conference call, Virtus's CEO touted the firm's strong performance and noted that this performance was a key driver of its "high level sales and net flows." These remarks, the complaint said, failed to mention that at least part of this performance was attributable to misleading statements about AlphaSector.

Earlier proceedings. The court had previously granted in part and denied in part the defendants' motion to dismiss two class action complaints brought by purchasers of Virtus securities and mutual funds, respectively. Both actions concerned representations by a Virtus subadviser, F-Squared and AlphaSector's track record. Also, the SEC obtained a $35 million settlement and admission of wrongdoing from F-Squared and, later, a $16.5 million settlement from Virtus. "If an investment adviser chooses to advertise, it is responsible for the content and accuracy of its ads," Enforcement Director Andrew Ceresney said at the time.

Class certified. The court certified a class consisting of purchasers of Virtus common stock between January 25, 2013 and May 11, 2015. The Arkansas Teacher Retirement System was appointed class representative and Labaton Sucharow LLP and Bernstein Litowitz Berger & Grossmann LLP is class counsel.

The court first found that the proposed class satisfied the typicality and adequacy requirements. Virtus argued that the lead plaintiff was subject to unique defenses because it was an "in-and-out" trader and sold all of its shares prior to the end of the class period. The court disagreed, noting that the lead plaintiff held a large number of shares through the first corrective disclosure, which subjected it to the same wrongful acts as the rest of the class. Virtus argued further that the lead plaintiff purchased Virtus shares after the truth was revealed, but the court said that these purchases were still before the truth was fully revealed to the market.

Turning to the Rule 23(b) requirements, the court found that the class was able to show reliance under both the Basic and Affiliated Ute presumptions. The class qualified for the Basic presumption because the alleged misstatements were contained in publicly-filed prospectuses and statements; the relevant transactions took place before the truth was revealed; and Virtus's common stock traded on an efficient market. The defendants offered a "truth-on-the-market" defense, which was inappropriate on a motion for class certification and were also unable to offer alternative explanations for the drops in share price.

The lead plaintiff was also entitled to a presumption of reliance under Affiliated Ute for the CEO's statements in the 2013 conference call. Here, the CEO omitted the AlphaSector's misleading performance history, stating a half-truth at best. Other statements were characterized as false and misleading statements, not omissions, and were not subject to the Affiliate Ute presumption.

The case is No. 15cv1249.

Tuesday, May 16, 2017

RetailMeNot tender offer: an in-progress case study in post-Trulia practice

By Mark S. Nelson, J.D.

Ashley Boening recently became one of three RetailMeNot, Inc. shareholders to sue the company within a span of a few days over allegedly lax disclosures regarding an upcoming tender offer for their RetailMeNot shares that would result in RetailMeNot joining Harland Clarke Holdings Corp.’s roster of operating companies with new efficiencies planned for Harland Clarke’s “consumer savings” business. Within days of Boening’s complaint, RetailMeNot announced that it had filed an amended Schedule 14D-9 which the company said addressed the plaintiffs’ concerns, and which spurred the plaintiff in at least one of the other cases against RetailMeNot to inform the court it would withdraw its motion to preliminarily enjoin the tender offer, which is set to expire May 22.

New disclosures. Specifically, RetailMeNot’s fourth amended Schedule 14D-9 added disclosures in three categories: past contracts; the solicitation recommendation; and financial projections. With respect to contracts, the company said its executives had no material discussions with the buyer about post-merger employment and that its board would be replaced by the buyer. The confidentiality agreements, which RetailMeNot said contain “customary ‘fall away’ provisions” that would end the standstill agreement, also do not contain a “don’t ask don’t waive” provision. The company’s disclosures will provide still more data about cash, cash equivalents, debt valuation, and the basis for its dilution projections. RetailMeNot also said it would furnish revised tabular information about unlevered free cash flow and non-GAAP operating income.

RetailMeNot said it opted to make supplemental disclosures to avoid potentially costly litigation although it still “disagrees with” allegations made by Boening and another lawsuit referred to as the Scarantino complaint, “denies” the claims asserted in both of these complaints, and further asserts that its SEC filings do not contain material omissions. RetailMeNot described the new disclosures as non-material and not legally required. Moreover, RetailMeNot said it, along with Boening and Scarantino, agreed to a memorandum of understanding under which Boening and Scarantino will seek to voluntarily dismiss their complaints.

RetailMeNot said it considered a third complaint filed by Edward McNally “no longer viable” because of the company’s supplemental disclosures. McNally too has indicated that he will voluntarily dismiss his case against RetailMeNot. Lawyers for McNally said in the court filing that the supplemental disclosures were a “substantial benefit” to shareholders that answered key questions about the RetailMeNot tender offer raised by McNally’s complaint.

Post-Trulia practice. The law suits regarding RetailMeNot are one example of cases where shareholders seeking additional disclosures regarding M&A deals can end up in federal court, at least in part, because of Delaware’s toughened standard for disclosure-only settlements. While it remains to be seen how federal courts more generally will receive Delaware’s Trulia decision, a divided Seventh Circuit favorably applied the Delaware case last year (a district judge who sat by designation on the Seventh Circuit panel has yet to file the text of her dissenting opinion). Trulia’s influence can be felt even in jurisdictions that have not yet had occasion to explicitly mull its reasoning.

Overall, the result has been for some disclosure-only cases to migrate from state to federal court, and for companies to try to moot litigation by voluntarily making supplemental disclosures. Delaware Chancellor Andre Bouchard, Trulia’s author, noted the preferability of the preliminary injunction and mootness approaches (both retain an adversarial component) over the disclosure-only settlement. Bouchard further observed in Trulia that “[t]he preferred scenario of a mootness dismissal appears to be catching on.”

Monday, May 15, 2017

Experts express skepticism over proposals for deregulation

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

A panel of experts at NASAA’s Public Policy Conference expressed deep skepticism over many of the current proposals in Congress for regulatory reform, suggesting that some of the proposals will not only weaken investor protection but may actually result in an increase in regulation. Moderated by New York Investor Protection Bureau Chief Katherine Milgram, members of the panel discussed what adjustments we might see to the legislation and regulation enacted in response to the financial crisis while offering their views on where regulation may be heading in the new administration.

Alabama Securities Commissioner and NASAA President-elect Joseph Borg opened the discussion by saying that we will likely see some deregulation, but he hopes that the process will not go too far in undoing the reforms put in place over the past 10 years. In addition to the reforms implemented under Dodd-Frank, Borg noted that the securities industry has also invested a good deal on money in risk management in the decade since the financial crisis. Borg said that there are many live regulatory issues, and many unknowns. Some of the key areas in which we may see a push for deregulation are the Department of Labor’s fiduciary rule, liquidity management, and the SEC’s enforcement sweep regarding the Customer Protection Rule.

University of Michigan Law Professor Michael Barr agreed with Borg’s assessment that we are in a period of uncertainty. Barr, who was a key architect in drafting the Dodd-Frank Act, said that there appears to be “collective amnesia” in Washington with regard to rolling back some of the Act’s provisions, even while we are still trying to recover from the effects of the financial crisis. For example, Barr said that it would be “insane” to pull back provisions mandating the supervision of systemically important insurance companies and investment banks.

With regard to the Republicans’ proposed replacement for Dodd-Frank, the Financial CHOICE Act, Barr said that we need to look at the bill holistically. Barr believes that the bill is “dead” in the Senate, with no prospects for passing in its entirety. Pieces of the legislation, however, may survive in the House of Representatives.

David Lipton, a law professor at The Catholic University of America, derided the Trump Administration’s "one-in, two-out" proposal for regulatory reform, calling the scheme a "fantasy." Lipton observed that if Congress wants to enact more capital formation devices, such as it did with crowdfunding, then the result will actually be more regulation, not less. Lipton said that crowdfunding and other capital formation devices have resulted in a “breathtaking” complexity and depth of rulemaking. Lipton said that he is fairly sanguine, however, that the world will not change drastically in terms of basic securities regulation.

Friday, May 12, 2017

Experts examine dynamics of downward trend in U.S. IPOs

By John Filar Atwood

When looking for reasons for the drop in initial public offerings (IPOs) in the U.S. over the past 15 years, do not blame over-regulation. This was the view presented by a number of experts at the SEC-NYU dialogue on securities market regulation, the focus of which was how to revive the U.S. IPO market.

Chris Coper, global chief financial officer of Sequoia Capital, said that CEOs tell him regulation, including the oft-blamed Sarbanes-Oxley Act (SOX), is not a hurdle to going public. Most of them say that it would be great if it were easier and cheaper to go public, he continued, but they also acknowledge that SOX has made them a better company.

Steven Bochner, a partner at Wilson Sonsini Goodrich & Rosati, said that it has been his experience that companies want to take the value-maximizing path whether that is an IPO or not. “Regulation is part of the issue, but not the major issue,” he said. Bochner’s view was supported by research presented by Ohio State University finance professor Rene Stolz, which indicated, among other things, that regulatory costs are not a big part of the story behind the collapse of listings in the U.S.

Piwowar comments. The remarks addressed the question posed by SEC Commissioner Michael Piwowar in his opening statement about whether SOX and other regulatory changes may have contributed to the downward trend in IPOs. He also pointed to decimalization, Regulation NMS changes to the economics of market-making for small company stocks, and modifications to the Section 12(g) shareholder threshold introduced by the JOBS Act as possible contributors to the lower IPO numbers.

Piwowar noted that since 2000, the average annual number of IPOs is 135, less than one-third of the average annual number of IPOs (457) in the 1990s. The decline is primarily driven by the disappearance of small IPOs, he said, noting that in the 1980s and 1990s, IPOs with proceeds of less than $30 million constituted approximately 60 percent and 30 percent, respectively, of all IPOs. That trend reversed in the 2000s, and new issues with proceeds less than $30 million accounted for only 10 percent of all IPOs between 2000 and 2015, he added. In contrast, large IPOs increased from 13 percent of all new issues in the 1990s to 45 percent since then.

Lack of institutional support. Stolz’s research supported Piwowar’s statement about the drop in the number of small companies in the public markets. “Institutional investors will not invest in companies with under $30 million in market cap, so the market is tilted toward large companies,” Stolz said.

Bochner agreed, noting that it is not even a consideration in Silicon Valley for a company with under $30 million in market cap to go public. Institutional investors expect a higher caliber of company, he said.

Private funding. Panelists pointed to the ready availability of private capital as a factor in the drop in IPOs. Robin Graham, a managing director at Oppenheimer, noted that shift toward companies staying private longer. “There is unprecedented access to capital now, and the markets are healthy so companies are getting the money they need,” he said. “It just happens to be in the private space,” he added. Graham thinks it is positive to have more mature companies completing IPOs and questioned whether we need to revive the IPO market.

In Graham’s view, the primary impediment to going public is time allocation. Company founders and managers are reluctant to allocate 30 percent of their time to managing the aspects of being a public company, he said, particularly when there is plenty of money available in private markets.

Unicorns. Panelists also discussed the large number of unicorns—private companies with more than $1 billion in market cap—and whether they will start to go public soon. Bochner believes the market will see an increase in unicorn IPOs this year. Venture investors need liquidity, he noted, so those unicorns backed by venture capital will have to find an exit.

While the new 2,000-shareholder threshold for public reporting introduced by the JOBS Act has been cited as a contributor to the number of highly-valued private companies, Cooper said it is not really an issue for Sequoia. “We just think about whether a company is ready to go public instead of focusing on the number of shareholders,” he said.

Forcing a company to go public based on number of shareholders is a bad idea, according to Bochner. He favors legislative changes that would exclude accredited investors from the 2,000-shareholder limit. He said he would support a new version of the JOBS Act that included this change.

Thursday, May 11, 2017

SEC advisory committee talks small offerings, tick sizes

By Anne Sherry, J.D.

The SEC Advisory Committee on Small and Emerging Companies met again to discuss, among other things, the underwriting of small offerings. Representatives from WR Hambrecht + Co. and Stephens Inc. expressed optimism about Reg A+ offerings despite a dearth of success stories. At the morning session, officials from the Division of Trading and Markets and DERA updated the committee with preliminary musings on the tick size pilot program.

Clayton’s debut. In his first public remarks as SEC Chairman, Jay Clayton said that one of his priorities for the Commission is facilitating capital-raising opportunities for all companies. Bolstering small- and medium-sized businesses helps not only those companies, but expands opportunities for investors, bolsters the economy, facilitates innovation, and furthers job creation. Chairman Clayton closed his remarks by recognizing the efforts of the agency and the committee in light of Public Service Recognition Week.

Underwriting case studies. Robert L. Malin (WR Hambrecht + Co.) presented a retrospective of some of the key Reg A+ offerings to date, including case studies of several companies that hired Hambrecht to underwrite their efforts. Malin visualized the A+ distribution strategy as a pyramid with the crowd at the base, the independent broker-dealer network above that, and finally institutional investors at the top. He stressed, however, that while Reg A provides flexibility to include crowdfunding, there is no obligation for companies to include a crowdfunding component in their offerings.

Malin’s presentation of case studies began with Elio Motors, whose offering is considered the single success in the Reg A+ market. This was a self-sponsored and -marketed offering with no underwriter or broker/dealer support; Hambrecht’s role was in getting Elio’s shares quoted on the OTCQX market. One remarkable aspect of Elio is that the company was able to generate a massive community of interested investors—6300 investors in all. The fact that 60 percent of the investors already held reservations for a vehicle speaks to their success in converting fans and enthusiasts into investors.

BeautyKind had less success in getting customers to invest. Even though this cosmetics company had a strong marketing pitch, set a $5 million minimum, and engaged the broker-dealer network, ultimately it was unable to convert its fans into investors. Other unsuccessful Reg A offerings included Aperion Biologics, Allegiancy, and NewsBeatSocial. Malin emphasized that Hambrecht does substantial due diligence and uses a data-driven selection process to identify companies that should be financed in the public markets. Most of the firm’s fees in these offerings are success fees, so it really wants the companies to succeed, and it does not take the business unless it believes the issuer will meet its target. Despite the failures, Malin remains optimistic that their Reg A holds promise. Once Hambrecht racks up a few successes, thus proving this is a legitimate way to enter the market, other underwriters will join the space.

Absence of FINRA guidance. Malin observed that one issue with the smaller, unlisted offerings is a lack of specific FINRA guidance for compliance officers. Broker-dealers are concerned about scrutiny, not liquidity—individual brokers “are hungry for product” and would like to present these types of opportunities to their clients. In many cases, these offerings address a lot of risk concerns: for example, the issuers are seeking DTC eligibility and listing on an organized market. In a Reg A+ Tier 2 offering, the company is required to have a registered transfer agent. Malin suggested that FINRA could, for example, issue guidance that amounted to a checklist of sorts giving compliance officers comfort in the event these factors are present.

Different perspectives on JOBS Act. J. Bradford Eichler (Stephens Inc.) also seemed positive about the Reg A outlook. From his perspective as an investment manager, the JOBS Act is a “total home run,” he said. Testing-the-waters, confidential filing, and reduced financial disclosure are all helpful on the front end. But, he said, clients find the Act stifling. Private equity is playing a much bigger role and these firms tend to prefer a clean exit via an M&A rather than taking the company public.

Tick size pilot. The morning session concluded with an update from Trading and Markets and DERA on the tick size pilot program. David Shillman (Trading and Markets) provided an overview of the pilot, which is eight months into its two-year run. The pilot comprises small and mid-cap companies, half of which are in a control group. The other half are split into three buckets, with a goal of testing what moving from a penny to a nickel increment will do. The most controversial bucket introduces a trade-at requirement.

David Saltiel (Trading and Markets) said that preliminary findings are not all that surprising. Spreads have widened, of course, and, as a result, more volume to trade is required to move a quote. Also as a result of the wider spreads, trading costs are higher for test group stocks. Saltiel also observed that there is a shift in where trading is taking place. All stocks have shifted away from maker-taker exchanges in favor of inverted exchanges. Two of the buckets have shifted to dark venues or ATSs, while the bucket with the trade-at requirement has shifted away from dark venues.

Amy Edwards (DERA) gave a preview of studies that the Division is planning, most likely after the SROs submit their assessment of the pilot program. DERA’s studies will involve hypothesis testing, with a goal of filling in gaps in information. Is there a way to tell who’s profiting, and can DERA disentangle some of the effects and see what the economics would be in changing tick size for all? Stephen M. Graham (Fenwick & West), who co-chairs the committee, posited that because the pilot is being done in isolation, it doesn’t consider other factors that could adversely affect the ecosystem—akin to treating only one symptom in a patient with multiple issues. But Edwards said it was too early to know what the answers will end up being, especially if the experiment is open to the idea that the answers can be different for different stocks.

Wednesday, May 10, 2017

Deloitte urges SEC to clarify auditor’s role with respect to inline XBRL data

By Jacquelyn Lumb

Deloitte & Touche LLP, in a comment letter responding to the SEC’s proposal to require the use of the inline XBRL format for tagged data, complimented the agency for its leadership in adopting new technologies that assist investors with their analysis. Deloitte said the use of inline XBRL will improve the transparency of information for financial statement users, but offered a number of recommendations for the SEC’s consideration before it adopts a final rule.

Deloitte expects that some improvements may occur by combining HTML and XBRL filings, but the firm does not believe the proposal will significantly affect the quality of the underlying XBRL data or tagging, and will not ensure consistency and comparability. The firm explained that the quality of data is not a function of technology—it is dependent on strong internal processes and controls. Accordingly, concerns about the quality of the underlying data, including errors in tagging, will likely continue.

Guidance. Deloitte said the SEC may want to consider encouraging filers to use the guidance and validation rules issued by the XBRL U.S. Data Quality Committee to reduce errors in XBRL-formatted information. The SEC also may wish to consider whether interactive data should be incorporated into officer certifications or in Item 9a disclosures. Some companies voluntarily engage auditors to perform procedures related to XBRL, according to Deloitte. If additional assurance beyond these agreed-upon procedures is called for, Deloitte said the SEC should consider issuing interpretive guidance related to examinations or reviews, and additional standards regarding audit procedures would be required.

Assurance. Deloitte encouraged the SEC to work with the PCAOB and the auditing profession to ensure that assurance models evolve to meet the needs of financial statement users. The assurance may be in the form of stand-alone reporting or in an expansion of the scope of internal control over financial reporting to include the disclosure of the interactive data. The application of independent assurance procedures to the interactive data would build trust in the reliability of the information while improving consistency and comparability of tagged data, in Deloitte’s view.

Auditor’s role. Deloitte said it is essential that the auditor’s association with inline XBRL is clear to financial statement users. If the proposal is adopted, the data tags will be embedded in companies’ Form 10-K and 10-Q filings, Deloitte explained, and financial statement users may not understand that the data tags are not subject to the same audit procedures as financial statements and other information that accompanies the financial statements. The SEC should refine the proposal to avoid any unintended expectation gaps with respect to the auditor’s involvement, Deloitte advised.

Deloitte recommended that the SEC identify the parts of a filing that are considered the XBRL code so that financial statement users know which parts of the filing are subject to audit. The final rule should clearly state the auditor’s responsibility, or lack thereof, regarding XBRL, the firm advised. Deloitte also suggested that registrants be required to disclose that interactive data is unaudited, either in management’s disclosures about controls and procedures or in the footnotes or tagging headers.

Tuesday, May 09, 2017

Apple conflict minerals report among first bellwether documents after new guidance

By Mark S. Nelson, J.D.

Apple Inc. filed its latest conflict minerals report late last week, making the company one of the first bellwether firms to report after the SEC’s Division of Corporation Finance issued revised guidance in April following a request by then-Acting Chairman Michael Piwowar. Forms SD are due by May 31, but the new CorpFin guidance sates that the Division will not recommend enforcement to the Commission if a company does not include the due diligence portion otherwise required by Item 1.01(c) of Form SD.

Apple conflict minerals report. Apple, through its Form SD and conflict minerals report filed April 5, continues to assert that it employs modes of tracking its conflict minerals supply chains beyond what is legally required. The company boasted that for the second consecutive year all its identified smelters and refiners (250 total) participated in an independent third-party audit program. Apple said that its due diligence conformed to the Organization for Economic Co-operation and Development’s Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas.

According to Apple, it places significant emphasis on tracking incident reports. Apple observed that 15 of 1,300 such incident reports were possibly linked to armed groups, which are the focus of the SEC’s conflict minerals rule. The company said local officials followed-up on five incidents, while other incidents resulted in improved mine security. Several incidents were still under investigation, including two incidents regarding gold that are under review by the London Bullion Market Association. Apple later noted that it could not determine if its products contained specific minerals related to the 15 incident reports.

A review of the SEC’s EDGAR database revealed eight companies had filed conflict minerals reports between January 1 and May 8 of 2017. Companies in addition to Apple that filed conflict minerals reports include: Sphere 3D Corp.; Quantum Corporation; Amerityre Corporation; O2 Micro International Limited; Jason Industries, Inc.; Babcock & Wilcox Enterprises, Inc.; and KEMET Corporation. Several other bellwether companies, including Intel Corporation, have yet to make their latest filings.

CorpFin guidance. This year’s Forms SD will require companies to navigate two sets of guidance, one issued in April 2014 that provides detailed information about CorpFin’s expectations for conflict minerals filings, and more recent guidance issued in April 2017 announcing that the Division “will not recommend enforcement action to the Commission if companies, including those that are subject to paragraph (c) of Item 1.01 of Form SD, only file disclosure under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD.”

The D.C. District Court has remanded the conflict minerals rule to the Commission regarding the portion of the rule previously held to violate the First Amendment. The latest SEC guidance explicitly warns that it is subject to further Commission action, addresses the Division’s view of enforcement only, and is not a legal conclusion regarding the conflict minerals rule.

The SEC’s conflict minerals rule, which has a lengthy and controversial history, also can result in liability for filed documents under Exchange Act Section 18. Moreover, the SEC’s rule contains special provisions for mergers and acquisitions. The Form SD recently filed by Intertape Polymer Group Inc. exemplifies usage of the delay provision applicable in the M&A setting.

Many firms may elect to make the disclosures they would have made even without the new CorpFin guidance because they were well along in the reporting process and to satisfy their environmental, social and governance constituencies. Companies also may be looking ahead to when similar European rules become effective in January 2021.

Monday, May 08, 2017

SEC releases quarterly stats on private funds

By Amanda Maine, J.D.

The SEC published a report detailing data and analyses of private fund statistics and trends from the third quarter of 2016. The 54-page report, which has been released quarterly since October 2015, aggregates data reported by private fund advisers on Form ADV and Form PF.

Forms PF and ADV. Form PF is required to be filed by SEC-registered investment advisers with at least $150 million in private fund assets. Large hedge fund advisers with at least $1.5 billion in hedge fund assets under management must file Form PF quarterly, while small private fund advisers and private equity advisers file Form PF on an annual basis. Registered investment advisers with less than $150 million in private fund assets report general private fund data on Form ADV.

Latest report. The most recent report reflects data from the fourth quarter of 2014 through the third quarter of 2016. According to the report, private equity funds were the most numerous type of fund, totaling over 9,700, with hedge funds coming in second with 8,947 funds. The number of advisers advising hedge funds was 1,676, and the number advising private equity funds was 1,015. At the end of 2016’s third quarter, the total number of funds, including private equity funds, hedge funds, real estate funds, securitized asset funds, and liquidity funds, totaled 27,020, with 2,816 advisers advising all funds examined in the report.

The aggregate private fund net asset value (NAV) was $3.4 billion for hedge funds and $1.9 billion for private equity funds. The U.S. was the number one domicile for all private funds at 50.8 percent, while the Cayman Islands was the second most popular domicile at 37.2 percent. The Cayman Islands was the top domicile for large hedge funds at 53.8 percent. Nearly 34 percent of large hedge funds were domiciled in the U.S. The U.S. was also the top domicile for private equity funds at 62.3 percent, with the Cayman Islands in second at 30 percent. All other domiciles represented less than 6 percent of the total funds’ domiciles, according to the report.

The report also contained information on beneficial ownership as a percentage of private funds’ aggregate NAV, including 18.7 percent in private funds, 13.2 percent in state or municipal pension plans, 12.8 percent in other pension plans, and 10.2 percent in non-profits.

Regarding hedge fund industry concentration, as a percentage of aggregate NAV, the top 10 hedge funds represented 7.9 percent, with the top 25 and 50 hedge funds representing 13.8 percent and 20.6 percent, respectively. The top 500 hedge funds represented 57.7 percent aggregate NAV of the hedge fund industry.

According to the report, 5.8 percent of gross assets in private equity funds advised by a large fund adviser were in the oil and gas extraction industry, followed by software publishers (4.7 percent), electric power (3.7 percent), telecommunications data processing services (2.6 percent), and pipeline transportation (2.2 percent).

Friday, May 05, 2017

SEC accounting chief concerned over calls to delay new credit losses standard

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

SEC Chief Accountant Wesley R. Bricker has expressed concern about recent calls to put on hold the Financial Accounting Standards Board’s new credit losses standard, pending an analysis of its long­term macroeconomic effects. Speaking before the Baruch College Financial Reporting Conference, Bricker emphasized the value of independence in the standard­-setting process, saying that accounting standards must be perceived as being above political concerns and special interests for investors to place full confidence in them. Accordingly, he urged those persons that do not like the direction or the outcome of the new standard to use appropriate forums provided by FASB to express their disagreements or doubts.

Credit losses. Bricker’s comments may have been aimed in part at the American Bankers Association, which last year called the adoption of the new standard "the biggest change in bank accounting over the past forty years." Adopted by the FASB on June 16, 2016, the standard’s current expected credit losses methodology (CECL) 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. The new standard takes effect in 2020 for public companies that file with the SEC.

Appropriate channels. Without naming the targets of his comments, Bricker worried that the methods used by critics to express disagreements or doubts about the CECL could serve to undermine FASB’s independence and its due process, and could distort the objectives of general purpose financial reporting standards. For example, Bricker reminded his audience of the pressures at work when the FASB required stock options to be expensed.

Bricker observed that the FASB developed the new credit losses standard in response to the needs of investors for more timely information about credit losses. By better anticipating credit losses, loan loss provisions under the new standard can provide investors with more timely information about the risks and economic conditions that affect providers of credit. Bricker also said that academic research has established that more transparent financial reporting leads to a lower cost of capita by reducing investor uncertainty about company prospects.

Bricker reminded his audience that the new credit losses standard applies to all industries, and banks are both providers of credit loss information when they report GAAP financial information as well as users of that information in their underwriting process. In Bricker’s view, if there are questions about implementing the accounting requirements of the new standard, then the FASB is the right body to address them. He urged banks to support the implementation process by identifying issues and submitting them to the FASB Transition Resource Group for Credit Losses, listening to those meetings, and then being willing to participate.

Thursday, May 04, 2017

Securities experts explore 2017 SEC enforcement trends at Garrett Institute

By Lene Powell, J.D.

Despite uncertainty resulting from the change in administration, experienced insiders can make educated guesses as to the direction of SEC enforcement in the new environment. A panel of experts at the 37th Annual Ray Garrett Jr. Corporate & Securities Law Institute offered advice for counsel in various enforcement areas including financial reporting violations, whistleblowers, surveillance tools, and communicating with the SEC during investigations.

The panel, "Perspectives on SEC Enforcement in 2017," was held at the Northwestern University Pritzker School of Law and was moderated by Peter K.M. Chan, a partner at Morgan Lewis and former head of the Municipal Securities and Public Pensions Unit in the SEC’s Chicago office. Other panelists included Susan Goetz Markel, a managing director at AlixPartners and former chief accountant for the Enforcement Division, and Tom Szromba, principal senior counsel at The Boeing Company.

To view the full paper, please click here.

Wednesday, May 03, 2017

Commenters weigh in on CFTC’s revised Regulation AT proposal

By Lene Powell, J.D.

The CFTC received a variety of comments on its revised proposal to regulate automated trading in the commodities and derivatives markets. Many aspects of the revised proposal were strongly opposed by the Futures Industry Association (FIA) and its Principal Traders Group (PTG), but were supported by public interest groups including Better Markets and Americans for Financial Reform.

Proposed rules. The CFTC issued a notice of proposed rulemaking in December 2015. Among other requirements, the proposed rules would create a new category of CFTC registration for “AT persons,” and would require various entities to use certain risk controls. The proposal would also establish testing, monitoring, supervision, and reporting and recordkeeping requirements. The initial proposal was followed by a supplemental notice of proposed rulemaking in November 2016 that made certain revisions to the proposal. The comment period for the supplemental proposal was initially scheduled to run until January 24, 2017, but was extended to May 1.

Overall risk control framework. FIA strongly believes that the proposed rules remain too prescriptive and should be more principles-based, and that more aspects should be delegated to exchanges (designated contract markets or DCMs) to set detailed rules. According to FIA, the rules do not take into account that many risk controls have already been implemented by traders and futures commission merchants (FCMs), including pre-trade maximum order size screens and self-trading controls, among other measures. FIA believes that a market participant should be allowed to rely on risk controls provided by the DCM, and that risk controls should be required for all electronic trading, not just automated trading.

Registration of AT persons. The FIA does not support required registration of “AT persons,” saying it is not the registration status of a person engaged in electronic trading that creates risk of market disruption, but rather the act of electronic trading itself. The FIA urged the CFTC to focus on the “what” rather than “who,” and suggested that the CFTC could conduct market oversight through unique identifiers in the messages transmitted to the DCM. Such identifiers are already widely implemented in the U.S. and could be incorporated into DCM audit trails, said the FIA.

In contrast, Better Markets believes the proposed registration requirement, based on trading volume is common sense and straightforward. A volumetric threshold test for AT Person registration is appropriate because it would identify market participants responsible for substantial amounts of automated trading in the derivatives markets. This would ultimately make the proposal more akin to a supervisory regulation over high frequency trading, as Better Markets has advocated in the past. Americans for Financial Reform (AFR) also supported the volumetric threshold, but warned that this could potentially be "gamed." Also, smaller entities that do not typically trade at high volume levels can create very significant disruptions to trading markets in a single incident, AFR said.

Source code. The original proposal would have required AT Persons to keep a repository of their algorithmic source code and make it available to the CFTC upon a books-and-records request. The FIA vehemently opposed this, contending that source code is the “lifeblood” of proprietary trading firms and is protected as intellectual property, and that firms could not trust that it could be kept safe by the CFTC. The revised proposal strengthens the process to obtain source code. Instead of a books-and-records request, the CFTC could access source code via an “Enhanced Special Call” approved by the Commission.

The FIA appreciated that the CFTC revised the initial proposal to provide stronger safeguards, but said the Enhanced Special Call process does not offer the protections of a subpoena, which is the approach FIA advocates. The subpoena process provides a clear legal route to challenge the production of source code or to seek legally enforceable protections, including protective orders, for sensitive property, said the FIA.

Better Markets and AFR were disappointed that the revised proposal backed off the books-and-records request in the original, saying the Enhanced Special Call was an unwarranted departure from standard practice. According to Better Markets, many types of predatory or manipulative behavior may not be identifiable using most conventionally reported market data, and the CFTC should require that the source code information be made available real time and also archived upon any material update. AFR noted that source code can be viewed as an investment or trading strategy, which have always been a subject for regulatory inspection and oversight. Accordingly, automated trading instructions should be part of the books and records of the organization, just as other order-related documents are, said AFR.

Other provisions. The commenters also voiced a number of other concerns. FIA is concerned that the definition of “Direct Electronic Access” is very broad and would capture virtually all customer orders placed through an FCM. The FIA is also troubled by a requirement for AT Persons to obtain certification from a third-party system developer that the relevant system or component meets regulatory requirements, and about requirements for software development, testing, deployment and monitoring.

Better Markets remains concerned that trades executed on Swap Execution Facilities (SEFs) are excluded from the proposed rules. The group urged the Commission to revisit the SEF exclusion at least periodically to reassess its appropriateness as the swaps markets continue to evolve.

Tuesday, May 02, 2017

Wyoming proposes investment adviser rules

By Jay Fishman, J.D.

Wyoming, the only state to have never regulated investment advisers, now proposes investment adviser rules. The rules will align with Wyoming’s new Securities Act, modeled after the Uniform Securities Act of 2002, that takes effect on July 1, 2017.

Initial registration. To initially register, investment adviser applicants would electronically file with the IARD a complete Form ADV, Uniform Application for Investment Adviser Registration. The application would be accompanied by: (1) proof of meeting written exam requirements; (2) financial statements including a copy of last fiscal year’s balance sheet (but an unaudited balance sheet is required instead if the last fiscal year’s balance sheet is older than 45 days from the application filing date); (3) a copy of a surety bond (if applicable); (4) a $250 fee; and (5) any other Wyoming Secretary of State-required information. The Secretary would accept a copy of Form ADV, Part II filed electronically with the IARD or a paper copy filed directly with the Secretary.

Annual renewal. To annually renew their registrations, investment advisers would electronically file with the IARD a $250 renewal fee and a copy of a surety bond (if applicable).

Amendments. Investment advisers would electronically file with the IARD any amendments to Form ADV. An amendment filed within 30 days of the event necessitating the amendment would be considered “promptly filed.” Investment advisers would also electronically file with the IARD an annual update to Form ADV, within 90 days of their fiscal year-end.

Completion of filing. An initial or renewal investment adviser application would not be considered “filed” until the Secretary has received the required documents and fees.

Withdrawal. Investment advisers could withdraw from registration by electronically filing with the IARD a Form ADV-W, Notice of Withdrawal from Registration as Investment Adviser.

Other IA topics. The proposed rules would additionally cover the following topics:
  • Investment adviser representative registration;
  • Federal covered investment adviser notice filing;
  • Exemption for private fund advisers;
  • Written exam requirement; 
  • Minimum financial requirement (net worth);
  • Financial reporting;
  • Recordkeeping;
  • Business continuity and succession planning;
  • Bonding;
  • Custody;
  • Disclosures (Brochure Rule);
  • Prohibited conduct; and
  • Investment advisory contract.

Monday, May 01, 2017

Commission to review disapproval of Bats bitcoin rule change

By Mark S. Nelson, J.D. 

The Commission granted Bats BZX Exchange, Inc.’s petition for review of the Division of Trading and Markets’s disapproval of a proposed Bats rule change to list and trade shares of the Winklevoss Bitcoin Trust. The Bats proposal was the first of two similar proposals to modify exchange rules to allow the listing and trading of bitcoin trust shares disapproved by the Division within the same month earlier this year. Persons who wish to submit statements about the Bats matter must do so before May 15, 2017 (In the Matter of Bats BZX Exchange, Inc., Release No. 34-80511, April 24, 2017). 

According to Bats’s petition for review, the Division applied too stringent a standard and failed to consider the many ways in which bitcoin markets can resist manipulation. Bats also argued that the novelty of its proposal made it a good candidate for Commission review. The Division’s primary basis for disapproving the Bats proposal was that bitcoin markets are unregulated and Bats could not obtain needed surveillance sharing agreements from significant markets. 

The Division also disapproved a similar proposal submitted by NYSE Arca, Inc. to list and trade shares of the SolidX Bitcoin Trust. While the underlying Winklevoss and SolidX registration statements have many similarities, they also have some differences. Separately, another trading venue has asked the Commission to clarify the treatment of digital assets like bitcoin through rulemaking or other guidance. 

The release is No. 34-80511.