Wednesday, June 29, 2016

Timbervest proceeding remanded to SEC to hear additional evidence

By Amanda Maine, J.D.

The D.C. Circuit has remanded proceedings against Timbervest LLC to the SEC for the purpose of hearing additional evidence relating to the SEC’s original disgorgement order; in particular, an agreement of settlement Timbervest made with the aggrieved party. The SEC had not opposed remand, but objected to Timbervest’s request that the SEC’s order be vacated (Timbervest, LLC v. SEC, June 24, 2016, per curiam).

Commission’s order. The SEC brought proceedings against Timbervest and several executives alleging that they defrauded AT&T, one of their pension fund clients, by selling one of AT&T’s assets at a below-market rate to another Timbervest client without disclosing the conflict of interest their role in the transaction created. An SEC administrative law judge concluded, and the Commission agreed, that the Timbervest respondents were unjustly enriched, and ordered disgorgement.

Timbervest motion. Timbervest moved to vacate the SEC’s order on several grounds, including that Timbervest had since reached a settlement with AT&T to pay in complete satisfaction all claims relating to the disposition fee paid by AT&T, which was the amount used to determine disgorgement in the SEC’s final order. Under the recently decided case SEC v. Graham (11th Cir.), disgorgement and forfeiture are “effectively synonymous” and thus barred by the five-year statute of limitations in 28 U.S.C. 2462 because it goes beyond remedying the damage caused to the harmed parties by the respondents’ action.

Remand, not vacate. The SEC did not oppose the request to remand the proceedings for the purpose of taking additional evidence on the settlement. However, the SEC argued that Timbervest’s claim that the original order has been materially altered by the settlement means that the district court may not consider it because those material facts were not before the Commission, and under the SEC’s statutory review scheme, the Commission, not the courts, must first be given an opportunity to adduce the new evidence.

Circuit court’s order. In a one-page order, a panel of the D.C. Circuit ordered that the record be remanded to the Commission for the “limited purpose of allowing the Commission to consider additional evidence” that Timbervest cited in its motion to determine its effect, if any, on the Commission’s original order. The panel also ordered that Timbervest’s appeal be held in abeyance pending further court action.

Other issues remain. Timbervest’s brief to the D.C. Circuit had cited several other issues it felt the court should consider, including the unconstitutionality of the SEC’s administrative forum, equal protection rights afforded to respondents under the SEC’s in-house regime, and evidentiary failures resulting into unwarranted sanctions. The SEC’s administrative regime has come under fire over the last year, with litigants bringing suit in various federal courts. Most challenges to the regime have so far been unsuccessful.

The case is No. 15-1416.

Tuesday, June 28, 2016

Tax condition lets oil company out of unfavorable merger

By Anne Sherry, J.D.

The inability to procure a legal opinion allowed Energy Transfer Equity, L.P. (ETE) to back out of an unfavorable merger with The Williams Companies, Inc. The energy market tanked after the parties agreed to the merger, rendering it a bad deal for ETE, which would have had to borrow $6 billion against its devalued assets to pay the fixed cash price. The Delaware Chancery Court took a skeptical view as a result, but observed that "motive to avoid a deal does not demonstrate lack of a contractual right to do so" (The Williams Companies, Inc. v. Energy Transfer Equity, L.P., June 24, 2016, Glasscock, S.).

Merger mechanics. Both Williams' stock and ETE's common units trade on the NYSE. The deal was structured so that Williams shareholders would retain publicly traded stock post-closing and receive a substantial cash payment. ETE created a new limited partnership, taxable as a corporation, into which Williams would merge. The new entity would then transfer 19 percent of its own stock, in addition to the former Williams assets, to ETE in exchange for partnership units and $6 billion in cash. The cash would be distributed to the former Williams stockholders.

ETE pursued the deal "assiduously," and the parties negotiated heavily to come to an agreement that they executed on September 28, 2015. The merger's potential tax ramifications were a particular concern. Although the deal does not give ETE a financing or solvency out, a condition precedent to consummation of the merger is that ETE's tax attorneys, Latham & Watkins, issue an opinion that a specific transaction "should" be treated as a tax-free exchange under the Internal Revenue Code. Latham has been unable to issue that opinion, and that is unlikely to change before June 28, the outside date for consummating the merger.

Contract trumps motive. Williams maintained that ETE was estopped from leveraging the condition precedent because it breached the merger agreement by failing to use "commercially reasonable efforts" to secure the legal opinion. This is an equitable argument, and the court observed that Delaware law, which governed the agreement, is "strongly contractarian." Using equity to consummate the merger would force ETE to accept the potential tax risk without the comfort of a tax opinion from Latham.

Latham's good faith. The court examined the various interests that colored its interpretation of the facts. The sophisticated parties negotiated a condition precedent that required a subjective opinion and assigned that determination to ETE's tax lawyer rather than a neutral third party, the court noted. It was not appropriate to substitute the court's judgment on the tax issue for that of Latham; the court's role was to determine whether the refusal to issue the opinion is in good faith. On the other hand, the court had to look at Latham's decision—which favored its client—"with a somewhat jaundiced eye." Latham was originally prepared to issue the opinion, but reconsidered after the market stacked the deal against ETE. However, Latham is a large, international firm whose interests are larger than those of this particular representation. Clients generally want their deals to go through; Latham's deal-breaking conclusion was counter to the firm's reputational interest going forward.

The court found that Latham made its determination in good faith and that a condition precedent to the consummation of the merger has not been met. Under the relevant Internal Revenue Code provision, a contribution of property for an interest in a partnership is not a taxable event. But the merger included another exchange, of $6 billion in cash for shares of the new LP. The drop in value of ETE units meant that the cash transaction represented a payment of $6 billion for between $2 and $3 billion worth of stock. The tax authorities could consider the overpayment to be part of a hidden sale of assets, which would trigger tax liability. At the time the agreement was executed, the cash transaction involved assets of equivalent value, and Latham was able to give an opinion that the transaction should be considered a tax-free event. But the drop in the shares' value, relative to the fixed cash payment, changed that. ETE hired Morgan Lewis attorneys and a professor to examine the transaction; both also concluded that it was likely to trigger tax liability.

ETE did not breach. The merger agreement required ETE to use "commercially reasonable efforts" to obtain the legal opinion, but it did not define the phrase. This was an objective standard, the court determined. But Williams could point to no commercially reasonable efforts that ETE could have taken to cause Latham to issue the legal opinion in good faith. Whatever ETE's motivations, there was no material breach on the facts before the court.

The case is No. 12168-VCG.

Monday, June 27, 2016

House Agriculture leaders warn proposed CFTC energy order would cause inconsistency

By Lene Powell, J.D.

The leaders of the House Agriculture Committee wrote to CFTC Chairman Timothy Massad to express concern about a proposed CFTC order that would recognize a private right of action for market manipulation involving certain transactions in the electricity markets. The transactions were largely but not completely exempted from the Commodity Exchange Act (CEA) by a previous CFTC order, creating uncertainty whether private actions involving the excluded transactions were permitted. According to the legislators, allowing private lawsuits in this area would upset the existing division of authority between CFTC and the Federal Energy Regulatory Commission (FERC) and lead to legal inconsistency.

“We recognize the harm to consumers of fraud and market manipulation in electricity markets, and value the CFTC’s rigorous work to police these shared markets,” wrote the lawmakers. “However, to uphold the Congressional intent expressed in Section 720(a) of the Dodd-Frank Act, and to ensure that FERC and the CFTC are able to continue their effective and cooperative monitoring of the energy markets, we urge you to consider the possibility that the proposals will result in widespread, inconsistent judicial interpretations of the CEA.”

The letter was signed by Chairman Michael Conaway (R-Texas) and Ranking Member Collin Peterson (D-Minn), as well as Austin Scott (R-Ga) and David Scott (D-Ga), chairman and ranking member of the Subcommittee on Commodity Exchanges, Energy, and Credit.

Transactions excluded. In 2012, a group of Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs) petitioned the CFTC to exempt specified electricity transactions from the CEA and CFTC regulations. The following year, the CFTC issued a final order that exempted the purchase or sale of defined “financial transmission rights,” “energy transactions,” “forward capacity transactions,” and “reserve or regulation transactions” offered or sold in a market administered by one of the petitioning RTOs or ISOs under a tariff or protocol approved or permitted to take effect by FERC or the Public Utility Commission of Texas (PUCT). The exemption was subject to conditions, and the transactions remained subject to the CFTC anti-fraud and anti-manipulation authority and scienter-based prohibitions.

In a subsequent private action that alleged market manipulation in the Texas electricity markets, a federal district court in Texas interpreted the 2013 order as prohibiting private actions involving the excluded transactions. The Fifth Circuit affirmed the decision of the district court (Aspire Commodities v. GDF Suez Energy North America).

Private right of action. In May 2016, the CFTC proposed to revise the 2013 order to explicitly provide that the order does not exempt covered entities from the private right of action in CEA Section 22 with respect to the excluded transactions. Chairman Timothy Massad explained that although regulatory certainty is important, private actions play an important role in protecting market participants and the public interest. Commissioner J. Christopher Giancarlo dissented from the proposal, noting that the covered entities are extensively regulated and monitored by the Federal Energy Regulatory Commission, lessening the policing role of private suits involving these markets. The comment period for the proposal closed June 15, 2016.

Aspire Commodities, the trading firm that brought the market manipulation action, supported the proposal. According to Aspire, private actions are needed to prevent market manipulation because the RTOs and ISOs do not adequately police the markets and the CFTC does not have the resources or knowledge to do so either. But FERC and PUCT joined energy trade associations in opposing the proposal, saying it could upset the Congressionally-mandated balance of overlapping jurisdiction between the CFTC and FERC.

House Agriculture opposition. Led by Chairman Conaway, the leadership of the House Agriculture Committee pointed out that Congress specifically intended to avoid uncertainty in the electricity markets by requiring the CFTC and FERC to enter into a Memorandum of Understanding (MOU) delineating oversight between the two agencies. A private right of action would open market rules to judicial interpretation, likely resulting in inconsistent determinations across the country. This would undermine the ability of the carefully negotiated MOU to provide a consistent, efficient, and effective framework for energy producers and market participants, the lawmakers warned.

Friday, June 24, 2016

IDC warns against fund proposals pushing managerial tasks onto boards

By Amy Leisinger, J.D.

The Independent Directors Council filed a supplement to its comment letters on the SEC’s proposals regarding liquidity risk management and funds’ derivatives use. According to the IDC, both proposals raise issues regarding the fund boards’ oversight role and the responsibilities of independent directors, and the SEC should hold a roundtable to provide a forum for a full discussion of fund governance and appropriate parameters for directors’ oversight responsibilities. The Commission must be cautious against imposing management functions on directors that contradict their stated duties, the group stated.

Liquidity risk management proposal. The SEC proposed a new rule and amendments to promote effective liquidity risk management and to reduce the possibility that funds will be unable to meet redemption obligations and mitigating dilution of the interests of fund shareholders. The Commission proposed new Rule 22e-4, which would require each registered open-end fund, including open-end exchange-traded funds but not including money market funds, to establish a liquidity risk management program. The SEC also proposed to permit a fund, under certain circumstances, to use swing pricing and to change disclosure requirements to give investors, market participants, and Commission staff improved information on fund liquidity and redemption practices.

Derivatives use proposal. The SEC proposed rules to enhance regulation of the use of derivatives by registered investment companies. Specifically, the proposal would require each fund to comply with limitations on the amount of its leverage derivatives and other transactions and to manage risks associated with derivatives transactions by segregating assets in an amount sufficient to enable the fund to meet its obligations under stressed conditions. A fund that engages in more than a limited amount of derivatives transactions would also be required to establish a formalized derivatives risk management program under the rule. The proposed reforms would also address funds’ use of financial commitment transactions by requiring funds to segregate certain assets to cover their obligations.

IDC on directors’ role. According to the IDC’s comments, directors are most effective when they can provide an independent perspective regarding management decisions without direct day-to-day involvement in the process. Board members need to focus on the oversight of forest, not the individual trees, the group continued, and participation in daily management matters is not where they can add value.

The SEC needs to consider which obligations can be appropriately imposed on independent directors and which activities go too far into management function, the IDC explained. In the past, the Commission has imposed specific responsibilities on independent directors when a matter involves a conflict of interest, the group noted, but the two proposals do not present conflicts that warrant independent scrutiny. In fact, according to the IDC, the interests of a fund’s adviser and the fund are typically aligned in matters of liquidity management and limitations on derivatives use. In addition, under the proposals, directors would have to develop deep understanding of technical matters, which could divert their focus from the matters most important to shareholders, the IDC stated.

According to the group, imposing specific managerial obligations could also set directors up for failure in making on-the-ground managerial decisions and increase the potential for liability. Moreover, managerial responsibilities on board members could lead to overemphasis on directors with subject-matter expertise, thereby limiting the pool of qualified candidates. The SEC should consider how the existing Rule 38a-1 oversight framework for boards addresses the proposals’ concerns and whether the proposed changes would create uncertainty in relation to current compliance programs, the IDC said.

The Commission must clearly draw the line between board oversight and day-to-day management, the IDC concluded.

Thursday, June 23, 2016

Post-Tilton, ALJ regime challengers gear up for new round of arguments

By Rodney F. Tonkovic, J.D.

A motion requesting permission to file a joint petition for rehearing has been filed in Tilton v. SEC. Undeterred by a recent ruling in the SEC's favor, plaintiff-appellant Patriarch Partners, together with the plaintiff-appellee in Duka v. SEC, Barbara Duka, seek an en banc rehearing of the Second Circuit's opinion affirming the dismissal of Patriarch's constitutional challenge to an SEC administrative proceeding for lack of subject-matter jurisdiction (Tilton v. SEC, June 21, 2016).

On June 1, a Second Circuit panel rejected Tilton's arguments regarding the ability of respondents in SEC administrative proceedings to force constitutional arguments to be heard in federal district court. The divided panel sided with the lower court's finding that it did not have subject matter jurisdiction. Examining the issue under factors outlined in Thunder Basin, Free Enterprise, and Elgin, the two-judge majority concluded that Congress intended the SEC's administrative scheme to preclude district court jurisdiction and that the scheme encompasses an Appointments Clause challenge to a presiding ALJ.

Duka. Barbara Duka the ex-Standard & Poor's Rating Services executive whose handling of ratings for commercial mortgage backed securities allegedly ran afoul of the SEC's rules, is the respondent in a separate, unrelated administrative proceeding. The district court in Duka previously ruled that, based on Duka's complaint, the SEC's administrative law judges may have been appointed in violation of Article II of the U.S. Constitution. The Tilton majority, however, reached the opposite conclusion. After Tilton was decided, the Second Circuit vacated the district court's order that halted the SEC's proceeding against Duka and remanded for proceedings consistent with the Tilton opinion.

Petition for rehearing. The motion notes that Patriarch and Duka are similarly situated and have identical interests in petitioning the court for a rehearing of Tilton. According to the motion, the procedural history demonstrates that the court has consistently viewed Patriarch and Duka's cases as being controlled by the same issues. The decision in Tilton places Patriarch and Duka in similar positions and each has the same arguments to make as to why the court should grant en banc review. Finally, the motion argues that a joint petition would serve the interests of judicial economy. Duka plans to file a parallel motion requesting the same relief.

Raymond Lucia. Another matter taking aim at the Commission's in-house enforcement proceedings is Raymond J. Lucia's appeal currently before the Court of Appeals for the D.C. Circuit. The Commission imposed an industry bar on Lucia, a 40-year veteran of the advisory business, and civil penalties against both him and his firm. Among other arguments, Lucia has contended that the Commission's rules of practice give the agency a “home court advantage” by eliminating the procedure and evidence rules of the federal courts.

The Commission’s Office of the General Counsel has written to inform the D.C. Circuit of the Duka order as well as the Eleventh Circuit's recent decision in Hill v. SEC. In both cases, the Commission notes, the circuit courts vacated district court decisions preliminarily enjoining Commission administrative proceedings, holding that the district courts lacked jurisdiction over the plaintiffs' Appointments Clause challenges; the letter also mentions the holding in Tilton. Lucia, the Commission observed, relied on Duka and Hill in support of the argument that SEC ALJs are "officers" subject to the Appointments Clause.

In response, Lucia's attorneys agree that the jurisdictional question addressed in Duka and Hill is already law in the D.C. Circuit. Neither the Second nor Eleventh Circuit opinions, however, addressed the constitutional merits, and the petitioners did not "rely" on those cases, the letter said. There is, therefore, no threshold jurisdictional obstacle and the vacatur of the district court decisions on purely jurisdictional grounds does not rehabilitate the Commission's defense of its ALJs' appointments, which, the letter notes, has been rejected by every Article III judge to consider it.

The case is No. 15-2103.

Wednesday, June 22, 2016

SEC investor panel offers Reg. S-K views, looks at non-GAAP issues

By Mark S. Nelson, J.D.

The SEC’s Investor Advisory Committee published a final version of its preliminary views on the agency’s disclosure effectiveness initiative in which the panel spotlighted several proposals, including non-GAAP financial measures. The letter, coming just weeks after issuance of a draft version, also turned up some areas of disagreement among IAC members. The panel offered its views as part of the SEC’s Regulation S-K concept release and as part of its consultative duties under a related provision in the Fixing America’s Surface Transportation (FAST) Act.

Non-GAAP disclosures. The IAC noted growing worries over non-GAAP financial disclosures as evidenced by the SEC’s latest Compliance & Disclosure Interpretations. Overall, the IAC said non-GAAP measures should not convey inaccurate information, but the requirements for them also could be updated to provide for review by a company’s outside auditor.

Item 10(e) of Regulation S-K governs non-GAAP financial measures included in SEC filings and requires the most directly comparable GAAP financial measure to be presented with “equal or greater prominence” to the non-GAAP measure. Regulation G covers registrants’ public disclosures of material information that includes a non-GAAP financial measure. The Commission’s non-GAAP financial measures release provides guidance on how to present this information.

Should non-GAAP rules apply more widely? The SEC’s new non-GAAP C&DIs provide examples of what the SEC staff could view as misleading non-GAAP disclosures. SEC Chief Accountant James Schnurr previously called attention to the sometimes “troubling” use of these measures and the prominence they are given not just by companies but also by analysts and others who report on companies’ fortunes.

The question for disclosure reform is whether the rules for non-GAAP disclosures sweep broadly enough. The IAC said the “equal or greater prominence” requirement could be extended to areas outside the context of SEC filings. But some IAC members questioned the benefits of doing this when the prominence requirement already applies in other settings, such as earnings release disclosures on Form 8-K.

Tuesday, June 21, 2016

EU authorities agree on framework for new conflict minerals regulation

By John Filar Atwood

The European Commission (EC), Council and Parliament have agreed on a framework for a new EU regulation that will focus on stopping profits from trading minerals used to fund armed conflicts. The negotiations pave the way for technical work and final adoption of the regulation over the next several months.

The EC said in a news release that it will take a number of additional steps to stop the financing of armed groups through trade in conflict minerals. These steps include the development of reporting tools to further boost supply chain due diligence by large and small EU companies that use the metals and minerals as components in consumer goods.

EU Trade Commissioner Cecelia Malmstrom noted in a blog posting that the trade in conflict minerals has led to human rights abuses. She believes that the EU, as the world’s biggest trading bloc, has a responsibility to contribute to fair, transparent, and value-based trade.

Due diligence. According to Malmstrom, the framework sets out mandatory due diligence obligations for the critical “upstream” part of the mineral supply chain, which includes those who import raw materials to smelting and refinery plants in the EU. The needs of small companies will be addressed, she said, to avoid subjecting them to overly burdensome procedures by exempting recycled minerals, and imports of very small volumes.

Reporting tools. For “downstream” companies that use the refined forms of the metals and minerals in components and goods, the EC will develop reporting tools, standards to further boost due diligence in the supply chain, and a transparency database, Malmstrom added. Downstream operators who import refined, metal-stage products into the EU will be covered by the mandatory obligations.

She noted that the framework is accompanied by foreign policy and cooperation efforts to promote change in the regions affected, and to support small and medium-sized businesses to make the new regulation workable. The political understanding will help trade work for peace in areas around the world impacted by armed conflict, and not to finance the campaigns of warlords and human rights abusers, she concluded.

Monday, June 20, 2016

Convicted tipper challenges ‘personal benefit’ findings

By Amy Leisinger, J.D.

An individual has petitioned the Supreme Court to vacate and remand a Second Circuit decision upholding his insider trading conviction. According to the petitioner, the Court must resolve whether the personal benefit element of insider trading requires the government to show that the insider tipped material, nonpublic information in order to obtain tangible, pecuniary gain as opposed to minimal or intangible benefits. The petitioner notes that this issue is under consideration in another matter before the court (Salman v. U.S.) and requests that the court hold his petition pending its determination in that case (Riley v. U.S., June 13, 2016).

Questioned activities. From at least 2007 through 2009, the petitioner would meet with an analyst from Artis Capital Management, LP, to whom he conveyed information concerning a planned acquisition of the petitioner’s firm. Artis then acquired larger positions in the firm, and the share price rose dramatically following the public announcement of the acquisition. When the acquiring company had trouble securing financing, the petitioner spoke to the analyst, and Artis sold the securities short, avoiding significant losses.

Previous determinations. The petitioner was convicted of securities fraud and conspiracy to commit securities fraud, and the Southern District of New York denied a motion for a judgment of acquittal or a new trial, finding that U.S. v. Newman acknowledged that a tipper has received a personal benefit when there is “‘a relationship between the insider and the recipient that suggests a quid pro quo from the latter” and that the petitioner obtained business and career assistance from the analyst, as well as stock tips. The court refused to grant judgment notwithstanding the verdict, noting that there was sufficient evidence to support the jury’s conclusions. According to the court, “[a]lthough the [c]ourt’s instructions to the jury would have been different following Newman, the evidence adduced at trial left no reasonable doubt.”

The Second Circuit affirmed the conviction, ruling that the trial evidence was sufficient to support the jury’s determinations, that a jury would have found the defendant guilty regardless of the instructions given, and that the law did not require proof of the motive for receiving the personal benefit to support the conviction.

Personal benefit. The petitioner argues that his interaction with the analyst did not involve a quid pro quo or any effort to exploit the material, nonpublic information for his personal gain. In Newman, he stated, the court narrowed the definition of “personal benefit” to exclude the mere fact of a friendship without additional proof of a close relationship that generates an exchange that is objective and consequential and represents at least a potential gain of a pecuniary or valuable nature. The purported personal benefit in this case involves business and career advice and a couple of stock tips, the petitioner contends, “gestures that, as the district court aptly noted at sentencing, amounted to ‘essentially nothing’ or ‘peanuts.’” These intangible and de minimis benefits do not satisfy the personal benefit required to support an insider trading conviction, he said.

In the district court, the petitioner continues, a jury instruction improperly stated that the jury only needed to find some anticipated personal benefit of some kind and that it did not need to be financial or tangible. The jury was also incorrectly informed that motive was not an element of insider trading, he argues. As the dissent in the Court’s Dirks v. SEC notes, the law imposes a motivational requirement on the fiduciary duty doctrine, and the jury was correct to focus on motive, the petitioner states. The reason for the disclosure does matter, and, without anticipation of personal benefit or a personal gain, there is no breach of duty, he explained.

The petitioner asks the Court to hold his petition until resolving the substantially similar “personal benefit” question in the pending Salman case as to whether Dirks requires proof of an exchange representing at least a potential pecuniary or valuable gain. A favorable determination in Salman will affect the view of the sufficiency of evidence, jury instructions, and the motive question addressed in the petition, the petitioner concludes.

The case is No. 15-1511.

Friday, June 17, 2016

SEC proposes rules to modernize mining industry disclosure requirements

By Jacquelyn Lumb

The SEC has issued a proposal to update the disclosure requirements for mining companies. The proposal is part of the SEC’s disclosure effectiveness initiative, and addresses the significant changes that have taken place in the mining industry since the SEC last updated Industry Guide 7. If adopted, the rules would rescind Industry Guide 7, which has not been updated for more than 30 years, and would include the new disclosure in a subpart of Regulation S-K. The comment period will be open for 60 days (Release No. 33-10098).

Global standards. Mining has become an increasingly globalized industry. The SEC noted that a number of foreign countries have adopted mining disclosure requirements that are based on the Committee for Mineral Reserves International Reporting Standards, which differ significantly from Industry Guide 7. The proposal would align the SEC’s disclosure requirements with global standards to enable investors to make more informed decisions.

Outdated guidance. Industry Guide 7 reflects the Division of Corporation Finance’s views on how mining company registrants can comply with the disclosure requirements in Item 102 of Regulation S-K. The centerpiece of the industry guide is the disclosure guidance for mineral reserves. The staff has provided supplemental guidance over the years, but registrants have urged the SEC to align its disclosure requirements with the international standards to allow them to disclose both mineral resources and reserves.

Members of Congress have also asked the SEC to update and harmonize Industry Guide 7 with global reporting standards to provide investors with a more complete understanding of the economic potential of a mining company’s properties and to put U.S. mining companies on a more level playing field with foreign companies that are subject to the international mining codes.

New disclosure proposal. The proposal would provide one standard for disclosing the mining operations that are material to a company’s business or financial condition. Registrants would be required to disclose mineral resources and material exploration results in addition to their mineral reserves. The rules would permit the disclosure of mineral reserves based on either a preliminary or a final feasibility study.

The proposal also would update the definitions of mineral reserves and mineral resources. It would require summary disclosure in a tabular format of the mining operations as a whole, along with more detailed disclosure about material individual properties.

A mining company’s registration statement must disclose information about mineral resources, reserves, and material exploration results, which must be supported and documented by a qualified person. The registrant also must obtain a summary report from the qualified person for each material property which includes the qualified person’s conclusions about exploration results, mineral resources or mineral reserves. The summary report, which would require the qualified person’s written consent to use, would be filed as an exhibit to the annual report or registration statement. A qualified person would be a mineral industry professional with at least five years of relevant experience.

Economic analysis. The proposal includes a 43-page economic analysis which concludes that the proposed revisions would increase the amount and quality of information about a registrant’s mining operations and provide a single source in Regulation S-K for the disclosure obligations. The analysis also concludes that the proposal would promote compliance by eliminating the complexity resulting from the disclosure obligations in Regulation S-K and the staff guidance in Industry Guide 7.

Thursday, June 16, 2016

House Ag chair asks CFTC to release staff economist report on position limits

By Lene Powell, J.D.

In a letter, House Agriculture Committee Chairman Michael Conaway (R-Tex) asked CFTC Chairman Timothy Massad to release a draft report by the CFTC Office of the Chief Economist (OCE) on position limits. According to Conaway, staff economists completed a draft literature review examining the impact of excessive speculation on prices and volatility in the commodity futures markets, but the report was not finalized or circulated to the Commission.

Conaway said the report could help clarify what can and cannot be accomplished in position limits rules currently under consideration. He asked that the report be finalized and made public before continuing with the rulemaking, and requested a response from Chairman Massad by June 24, 2016.

Position limits rules. The CFTC is currently considering rules proposed in 2013 that would establish limits on speculative positions in 28 physical commodity futures contracts and economically equivalent swaps. The goal of the proposed rules is to prevent excessive speculation and market manipulation, while ensuring there is enough market liquidity for bona fide hedging and protection of the price discovery process. Portions of the proposed rules have been revised since the initial proposal. The proposal and revisions have received extensive comment and debate.

Inspector General report. In early 2016, the CFTC Office of the Inspector General issued a report following up a 2014 report on OCE issues. According to the inspector general, several staff economists said the chief economist declined to allow research on certain topics relevant to the CFTC mission, including position limits. Their impression was that OCE was censoring research topics that might conflict with the official positions of the CFTC.

In response, the chief economist agreed that he had initially rejected a research proposal on position limits on the basis that it was politically controversial. However, he said that research topic selection is a matter of discretion and he did not believe the CFTC had the data or in-house expertise to do this project. He added that OCE does allow research into politically controversial topics, giving examples of research on high-frequency trading and self-trading.

The inspector general recommended that CFTC give OCE economists protected research time and not prohibit research on topics relevant to the CFTC mission.

Conaway request. Noting that the Agriculture Committee is the principal authorizing committee for matters relating to agriculture and commodity exchanges, Conaway said the committee received a draft literature review summarizing and analyzing economic studies cited in comment letters on the position limits rulemaking. The review was sent to Massad’s office on June 30, 2015, but did not appear to have been submitted for final review within OCE afterward.

Conaway said he had reviewed the document and found it a comprehensive overview of the current state of economic research on excessive speculation and an objective analysis of the potential usefulness of position limits. The report authors raised important questions about whether position limits are an effective tool for limiting the effects of excessive speculation. The authors also reported that speculative activity has market stabilizing effects and suppressing it could have undesirable risks like disruptions to liquidity and price discovery, Conaway said.

“Given the sweeping nature of this rulemaking and the intense debate it has provoked since its inception, this even-handed report prepared by the Commission’s own economists should serve as an invaluable resource for the Commission and the public,” wrote Conaway. “Therefore, the Committee requests that you finalize this report before continuing with the next steps in the rulemaking process.”

Wednesday, June 15, 2016

States fail to overturn Reg A+ preemption provisions

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

The chief securities regulators from Massachusetts and Montana have failed in their challenge to the SEC’s preemption of state authority to register offerings conducted under Tier 2 of Regulation A. The D.C. Circuit Court of Appeals upheld the rule, holding that the Commission’s decision to preempt state registration of Tier 2 securities sold to “qualified purchasers” was entitled to deference under the Chevron test. The appellate panel also rejected arguments that amended Regulation A should be vacated as arbitrary and capricious because the SEC failed to explain adequately how the rule protects investors (Lindeen v. SEC, June 14, 2016, Henderson, K.).

Preemption challenge. In May 2015, Massachusetts Secretary of the Commonwealth William Galvin and Montana State Auditor Monica Lindeen filed separate petitions with the court, requesting judicial review of the legality of the Commission’s expansion of the exemptions available under Regulation A. Adopted by the SEC under the mandate of the JOBS Act on March 25, 2015, so-called Regulation A+ raised the dollar limit for smaller offerings that are exempt from Securities Act registration. The amendments also created two tiers of offerings under Regulation A, while preempting Tier 2 offerings of up to $50 million from state registration and qualification requirements.

The states 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 overstepped the Commission’s authority under the JOBS Act and stripped investors of valuable state law protections. The SEC, in turn, argued that its interpretation was consistent with its JOBS Act mandate and thus satisfied the statutory construction standards enunciated by the Supreme Court in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc. (1984).

Chevron step one. After tracing the history of Regulation A from its original adoption in 1936, the appellate panel turned to the states’ contention that the SEC’s definition of “qualified purchaser” contravenes the plain meaning of the Securities Act. In the states’ view, the term “qualified purchaser” cannot mean “any person” to whom Tier 2 securities are offered or sold, but instead must limit the universe of purchasers who possess the financial resources or sophistication to invest without state law safeguards.

The appellate panel found, however, that under Securities Act Section 18, Congress explicitly authorized the Commission to define the term “qualified purchaser” and to adopt different definitions for different types of securities. Exercising this grant, the SEC concluded that all purchasers of Tier-2 securities are qualified so long as non-accredited purchasers limit their purchase to 10 per cent of their annual income or net worth. Nothing in the text of the Securities Act unambiguously foreclosed the SEC from adopting this definition, the court reasoned.

Although the petitioners argued that commonly understood definition of “qualified” meant that the SEC must in some way reduce the universe of Tier 2 purchasers from “any purchaser,” the petitioners identified no statutory provision that barred the SEC from concluding that all Tier 2 purchasers are “qualified” in view of the other investor protections built into Tier 2. Congress explicitly granted the SEC discretion to determine how best to protect public and investors, and the Commission, in exercising that discretion, concluded that Tier 2 investors are sufficiently protected by the rule’s purchase cap and reporting requirements. The SEC did not nullify the term “qualified,” but rather concluded that all Tier 2 purchasers are qualified. Accordingly, Regulation A+ does not conflict with the Congress’s unambiguous intent.

Chevron step two. Next, the appellate panel moved on to the petitioners’ argument that the definition failed Chevron step two because the SEC’s failure to impose restrictions based on investor wealth, income or sophistication was unreasonable and manifestly contrary to the statute. For all the reasons set forth in the discussion under Chevron step one, the court held that the SEC acted reasonably and within its broad definitional authority. The court rejected the contention that Chevron deference was inappropriate in the preemption context, while finding that the SEC provided a reasoned explanation for why the final rules for Regulation A would provide for a meaningful addition to the existing capital formation options of smaller companies while maintaining important investor protections.

APA review. Finally, the court disagreed with the petitioners’ claim that Regulation A+ was arbitrary and capricious in violation of the Administrative Procedure Act because the SEC offered only a single paragraph to explain why the new rule might lessen the adverse effects of blue sky preemption. The court concluded that the Commission complied with its statutory obligation by providing a reasoned analysis of how its qualified-purchaser definition strikes the appropriate balance between mitigating cost and time demands on issuers and providing investor protections. Given the JOBS Act mandate to revitalize Regulation A, the SEC concluded that the potential decrease in investor protection was balanced by the reduced costs for Tier 2 issuers and purchasers.

Although NASAA's amicus brief had faulted the SEC for relying on “little to no evidence” regarding the costs of state law compliance and state law preemption, the Commission did not have the data necessary to quantify those costs precisely because Regulation A was rarely used. The court declined to require the Commission “to measure the immeasurable,” and found that the SEC’s discussion of unquantifiable benefits fulfilled its statutory obligation to consider and evaluate potential costs and benefits. Accordingly, the petitions for review were denied.

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

Tuesday, June 14, 2016

Entity’s structure barred appointment of non-director to special litigation committee, court says

By Kevin Kulling, J.D.

The Delaware Chancery Court has granted summary judgment to a former board member who challenged the appointment of a retired federal judge to serve as the sole member of special litigation committees for two Delaware limited liability companies. The court said that the appointment was improper because the former judge was not a director or manager as required by the corporate-style governance structure chosen by the entities (Obeid v. Hogan, June 10, 2016, Laster, J.).

The parties. Gemini Equity Partners LLC adopted a governance structure paralleling that of a corporation, while the operating agreement for Gemini Real Estate Advisors, LLC adopted a manager-managed governance structure.

William Obeid brought suit contending that Michael Hogan, a retired federal judge who worked as a mediator, could not serve as the sole member of two parallel special litigation committees.

The Gemini entities jointly managed over $1 billion in real estate assets, including hotels and commercial properties. Obeid managed the day-to-day operations of the hospitality division until he was ousted. The internal affairs of the corporate entity, Gemini Equity Partners, were governed by its limited liability company agreement. The agreement established a governance structure paralleling that of a corporation in which power over the entity is vested in a board of directors. Obeid formerly was one of three board members.

Litigation summary. After the two other board members voted to remove Obeid as president and operating manager of Gemini Real Estate Advisors, Obeid filed an action against the two directors. The action claimed that the two had started competing companies using assets that belonged to the Gemini companies. The complaint asserted claims directly based on his rights as a member of the entities and derivatively on behalf of the entities themselves.

Obeid filed a second action claiming that the directors were improperly selling properties belonging to the Gemini entities to a competitor in return for side benefits. Obeid contended that demand was futile for purposes of the derivative claims because the directors suffered from conflicts of interest and divided loyalties that precluded them from exercising their independent business judgment on the matter.

Law firm hired, former judge appointed. After the actions were filed, the Gemini entities hired a law firm to serve as outside counsel, and Obeid contended the hiring was made without his input. During a joint special meeting, the law firm proposed that a retired federal judge be hired to function as a special litigation committee for each entity to investigate, analyze and make recommendations whether to pursue the derivative claims. While the other two directors voted in favor, Obeid voted against.

After Obeid learned that the other directors had hired former Judge Hogan, he brought a challenge in the Delaware Chancery Court.

Summary judgment for plaintiff. The court agreed that the judge could not serve as a one-man special litigation committee for the entity that adopted a governance structure paralleling that of a Delaware corporation. Because the judge was not a director, under Zapata v. Maldonodo, he therefore could not serve in the special committee capacity.

The court said that the LLC agreement substantially re-created the governance structure of a Delaware corporation using language drawn from the corporate domain. Provisions in the agreement established a board-centric governance model tracking that of a corporation and required that each committee consist of one or more of the directors of the company.

“By embracing the governance structure of a corporation and including provisions paralleling Sections 141(a) and (c), the drafters of the [agreement] evidenced their intent to have corporate principles govern the Corporate Board. Those principles include Zapata, under which only a duly empowered committee of directors can serve as a special litigation committee,” the court said.

Not only was Judge Hogan not able to function as a one-man special litigation committee on behalf of Gemini Equity Partners, he similarly was not able to serve as the sole member of a special litigation committee for Gemini Real Estate Advisors because he was not a manager.

The case is No. 11900-VCL.

Monday, June 13, 2016

House passes PROMESA bill to aid resolution of Puerto Rico debt crisis

By Mark S. Nelson, J.D.

The House passed what members of both parties said is an imperfect solution to Puerto Rico’s debt crisis. Sponsored by Rep. Sean Duffy (R-Wis), the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) (H.R. 5278; Rep. No. 114–602) creates an oversight board to work with the Commonwealth’s government to help restore economic stability and to allow for debt restructuring. The full House passed PROMESA by a vote of 297-127 following an afternoon session to mull eight amendments under a resolution adopted by the House Rules Committee.

A statement by the White House press secretary urged the Senate to quickly pass PROMESA. The statement noted that the president would like to sign the bill into law ahead of the July 1 payment deadline. A separate Administration message voiced strong support for the legislation, while noting worries about provisions regarding the minimum wage, public sector pensions, and the degree to which Puerto Ricans can voice their concerns to the oversight board.

Oversight board, debt restructuring. Representative Duffy called the bill an “excellent resolution” and a “great compromise” while asking members not let “the perfect be the enemy of the good.” According to Rep. Duffy, the bill’s two-pronged approach (oversight board and debt restructuring) to Puerto Rico’s debt crisis will help restore the island’s economic health and enable future economic growth. He also emphasized that the bill is not a taxpayer bailout because no taxpayer funds are involved. Representative Duffy summarized key provisions in the bill when he introduced it last month.

Of the several amendments for which debate was permitted, one offered by Rep. Duffy and Pedro Pierluisi (Resident Commissioner) won approval by voice vote. The revision will remove a statutory cap on participation by firms in Puerto Rico in the Small Business Administration’s HUBZone program, in which firms in historically underutilized business zones can gain access to opportunities regarding federal procurement. The amendment also imposes risk-based verification requirements.

Speaker Paul Ryan (R-Wis) warned that the crisis in Puerto Rico will become worse and could become “a man-made humanitarian disaster” if Congress does nothing. He also said the bill is not a bailout, but that taxpayer funds could be implicated if legislation does not move forward to help the Commonwealth fix its debt woes. The speaker also told critics of the bill it will not encourage bad behavior by states because the bill applies only to territories.

Friday, June 10, 2016

Revenue recognition, internal controls hot topics at financial reporting conference

By Amanda Maine, J.D.

SEC Deputy Chief Accountant Wesley Bricker discussed developments in financial reporting in remarks before the 35th Annual SEC and Financial Reporting Institute Conference. Bricker addressed FASB’s recently adopted revenue recognition standard as well as the importance of management’s role relating to internal controls over financial reporting.

OCA revenue recognition consultations. Bricker said that his staff continues to monitor the accounting profession’s activities regarding revenue recognition. He expressed concern that some questions have not yet been fully resolved by the AICPA industry groups or presented to FASB’s Revenue Transition Resource Group (TRG). He noted that two TRG meetings have been tentatively scheduled before the end of the year and encouraged relevant parties to give their views on the standard.

Bricker cited OCA’s own consultations with registrants regarding their policies for accounting for revenue recognition under the new standard. In particular, he noted that OCA consultations have addressed the application of the definition of a “contract,” the contract combination guidance which explicitly limits which contracts may be combined to those with the same customer or related parties of the same customer, and the application of OCA guidance for royalties based on when a report with the amount of revenues earned is received, not when the royalty sale or use occurred.

Presentation and disclosure. Bricker also addressed the presentation and disclosure policies under the new revenue recognition standard. He noted that the presentation of a company’s revenue recognition policies must be consistent with the principles of the new standard, which includes detailed information regarding the specific facts and circumstances within the arrangement; relevant accounting and reporting issues raised; conclusions reached and basis for those conclusions; analysis of the possible alternative answers considered and rejected; disclosure about the accounting; and audit committee views on management’s accounting and financial reporting conclusions.

Guidance on revenue recognition has changed, Bricker said, so companies should not assume their existing conclusions will remain unchanged under the amended guidance. He also stressed the need for companies to implement internal controls to evaluate the new standard. Companies should also inform investors about the new standard and its impact, Bricker said.

ICFR. Bricker said that he was pleased with the amount of attention internal controls over financial reporting (ICFR) assessments have been given at the conference. He highlighted a number of recent developments surrounding ICFR, stressing in particular the need for management to create the right “tone at the top” to foster effective internal controls.

Bricker also cited a recent SEC enforcement action that demonstrated the SEC’s efforts related to ICFR. Three important takeaways from the case were the responsibility of management to evaluate the severity of identified control deficiencies, the importance of maintaining adequate and competent accounting staff, and making sure management takes responsibility for its assessment of ICFR, according to Bricker.

Thursday, June 09, 2016

OTC Markets petitions to expand Reg A+ access to reporting companies

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

OTC Markets has filed a rulemaking petition asking the Commission to expand the scope of recently-amended Regulation A to allow offerings by SEC reporting companies. The petition argues that the SEC’s decision to exclude otherwise qualified companies that meet the high disclosure requirements of full SEC reporting is counterintuitive and inconsistent with the JOBS Act mandate to expand avenues of capital formation for all small companies.

Transparency and technology. The petition notes that online capital raising under Regulation A+ has the potential to change and modernize the capital markets by harnessing the connectivity and information distribution power of the Internet. In its March 2015 adopting release, the Commission embraced transparency and technology with respect to offerings conducted under Regulation A+ by requiring offering materials to be made publicly available. According to the petition, this represents a momentous philosophical change by the Commission, which now recognizes the danger of small company offerings being sold through private, phone-based sales, hidden from public and regulatory scrutiny.

According to OTC Markets, the next logical step in this evolution is to expand the scope of Regulation A+ to include SEC reporting issuers already providing in-depth periodic disclosures to the public. The petition observes that the JOBS Act itself does not limit the types of companies that may be afforded access to the streamlined qualification process under amended Regulation A. Although the SEC stated that it would prefer to wait until the Regulation A+ market developed before expanding the scope of authorized issuers, limiting the rule’s scope solely because it excluded reporting companies in its prior, seldom used form does not give effect to the congressional intent behind the JOBS Act, the petition argues.

“Lost opportunity.” In the view of OTC Markets, the SEC’s determination with respect to Exchange Act reporting companies is a lost opportunity to create more efficient paths for capital formation for all small issuers. Allowing smaller, fully SEC reporting companies to raise capital publicly via Regulation A+ offerings would engage a wider circle of investors and ultimately enhance liquidity in the secondary market, the petition states. Among other things, opening up Regulation A+ to smaller reporting issuers would allow smaller investors a greater opportunity to participate in what otherwise might be private offerings, limited to a small club of savvy professional investors.

In addition, other capital raising options for smaller reporting issuers lack the protections and advantages that investors receive in Regulation A+ offerings. For example, Regulation D securities are not freely tradable, which may result in a lower price per share and the potential for increased shareholder dilution. Moreover, private placements by publicly reporting companies through “PIPES” offerings have been associated in some instances with unsavory market participants and practices, including structures that harm public investors with aggressive share discounting and dilution.

Wednesday, June 08, 2016

Petition asks Supreme Court to clarify corporations' duty to disclose

By Rodney F. Tonkovic, J.D.

A petition for certiorari has been filed concerning securities fraud in a context the Supreme Court has yet to address: a privately held corporation trading in its own stock. In this case, a privately held company purchased its employees' shares without disclosing that it was pursuing a lucrative merger. With the exception of the Eleventh Circuit, the petitioner says, every circuit to address the issue has concluded that a corporation's insider status gives rise to a duty to disclose (Fried v. Stiefel Laboratories, Inc., May 31, 2016).

From 1987 through 1997, the petitioner was the CFO of Stiefel Labs, which was, at the time, a family-owned pharmaceutical company. In 2009, Stiefel repurchased its stock from its shareholders, including the petitioner, who held shares as part of a pension plan as well as non-pension shares. Stiefel, however, failed to disclose that it was actively engaged in merger negotiations, and, in fact had consistently maintained that it would never sell out or go public. The negotiations culminated in a merger in which the remaining shareholders were paid roughly four times the price Stiefel had paid shareholders like the petitioner.

Incorrect statement of law. The petitioner sued Stiefel on several grounds, including fraud under the Exchange Act. The fraud claim went to the jury, which returned a verdict in favor of Stiefel. On appeal to the Eleventh Circuit, the petitioner argued that an insider's failure to disclose all material facts when trading in the corporation’s stock is an omission under Rule 10b-5(b) and that the jury instructions should have said that Stiefel had a "duty to disclose all material information." The Eleventh Circuit panel disagreed, however, noting that this interpretation is contrary to the plain text of the rule, which prohibits "mak[ing] an untrue statement of material fact or omit[ting] to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading." The court also said that the requested jury instruction did not correctly state the law because it did not state the elements of a claim for insider trading under Rule 10b-5(a) or (c) because it did not require the jury to find that Stiefel traded “on the basis of” material information.

Duty to disclose. The petition asks whether the elements of a Section 10(b) and Rule 10b-5 private securities fraud claim based on the failure of a privately held corporation to disclose material information to shareholders before directly purchasing their stock are the same six elements the Supreme Court has held comprise a private securities fraud claim. The petition also asks whether, in order to prove that a defendant traded "on the basis of" undisclosed material information, it is necessary to prove that the defendant used the information, or only that the defendant was in knowing possession of the information.

According to the petitioner, this case presents the opportunity to clarify the contours of an Exchange Act fraud claim in this context for an alleged violation of the duty to disclose. The Eleventh Circuit's insistence that this relationship-based duty to disclose must proceed under Rule 10b-5 (a) or (c) and satisfy the elements of a classical insider trading claim conflicts with the approach taken by the Second, Ninth, and Tenth Circuits. These three circuits take a less formalistic approach, the petitioner says, and require only that the six elements of a fraud claim be applied. The Eleventh Circuit explicitly considered and rejected this more flexible approach to the rule.

The case can also clarify the standard defining what conduct constitutes insider trading. Here, the Eleventh Circuit's embrace of a "use" requirement to define trading "on the basis of" material non-public information conflicts with the Second Circuit's less-exacting "knowing possession" threshold, an approach that has been endorsed by the SEC. According to the petition, the Eleventh Circuit ignored the SEC's interpretation of Section 10(b), and Rule 10b5-1, and relied on its own precedent that predated the enactment of Rule 10b5-1 in 2000. The conflict over the interpretation of "on the basis of" has persisted for nearly twenty years, the petition says.

The petition is No. 15-1458.

Tuesday, June 07, 2016

Best Buy price impact rebuttal ruling won’t get second look by panel, full court

By Mark S. Nelson, J.D.

The Eighth Circuit panel that recently held that a district court erred in handling Best Buy’s attempt to rebut evidence of price impact per Halliburton II in a securities fraud class action suit opted not to rehear its decision. The full court likewise declined to rehear the matter. That leaves in place the first circuit court decision seemingly to drop from its lexicon the price maintenance theory, although the theory may persist in other circuits (IBEW Local 98 Pension Fund v. Best Buy Co., Inc., June 1, 2016, per curiam).

After the Supreme Court in Halliburton II upheld its prior Basic reliance presumption and granted securities fraud defendants the opportunity to rebut this presumption before class certification, the district court in the Best Buy case certified a class that included all buyers of the company’s stock between September 14 and December 14, 2010. The case focused on two statements made by Best Buy executives during a conference call in which they tried to persuade analysts and investors that the company’s forecast announced earlier the same day via press release had roots in the company’s present performance (the district court found the press release itself was protected by the PSLRA’s safe harbor).

At oral argument before the Eighth Circuit panel (argument No. 4, October 22, 2015), Best Buy asserted that the two alleged misrepresentations had no price impact. A lawyer for the company also claimed the district judge’s decision to certify the class was not only contrary to Halliburton II, but also missed the mark regarding Federal Rule of Civil Procedure 23 for class certification and a federal evidentiary rule on presumptions in civil cases. By contrast, the plaintiffs’ lawyer noted that the Eighth Circuit was the first federal appeals court to mull a factual scenario in which an allegedly false statement maintained an already inflated stock price such that price impact was not observable until the end of the class period.

In its petition for panel and en banc rehearing, plaintiffs’ counsel sought uniformity with other circuits and emphasized that Halliburton II referred to the ordinary meaning of “impact,” which includes “any” impact, and not just the question of whether there was a font-end price impact. The petition also posited that the district court’s ruling cut against another Eighth Circuit decision that recognized price impact can occur even if a stock’s price does not move in the expected direction. Moreover, the plaintiffs noted that the Seventh and Eleventh Circuits still recognize the price maintenance theory, which would be discarded under the panel decision’s theory that a defendant need only show there was no price increase.

The two-judge Eighth Circuit panel majority opinion in Best Buy concluded that the district court abused its discretion by failing to do a rigorous enough analysis under FRCP 23. The majority pointed to the plaintiffs’ and defendants’ experts’ event studies, which it said both showed a broken link between the Best Buy conference call statements and the price paid by the plaintiffs for their stock. A dissenting judge emphasized the validity of the price maintenance theory, even though the Supreme Court (or any appellate court) has not explained how a defendant could rebut this theory of price impact.

The case is No. 14-3178.

Monday, June 06, 2016

CFTC to accept additional comments after Regulation AT roundtable

By Lene Powell, J.D.

The CFTC will reopen the comment period for proposed Regulation Automated Trading (AT) for two weeks following a public roundtable on June 10. During the reopened comment period, comments will be accepted relating to the announced roundtable agenda and any topics that arise during the roundtable.

Automated trading proposal. In November 2015, the CFTC proposed a set of rules to require risk controls and other safeguards to enhance the U.S. regulatory regime for automated trading. Proposed Regulation AT would require certain market participants using algorithmic trading systems to register with the CFTC, implement risk controls, submit reports of their trades, and maintain books and records about their risk controls and trading procedures. The proposal would also require futures commission merchants (FCMs) and exchanges to implement risk controls, and would require exchanges to provide information concerning trade matching platforms and market maker and incentive programs. The initial comment period closed in March 2016.

Derivatives industry groups including the Futures Industry Association and the International Swaps and Derivatives Association have expressed concerns with many aspects of the proposal. The groups particularly oppose the registration provisions, as well as a measure that would require covered persons to maintain the source code for their algorithmic software in a repository and provide it to the CFTC upon request.

Some industry participants have suggested that bids should be required to be kept open for a certain period of time before cancellation, to prevent what some perceive as “fleeting liquidity” where bids may be pulled before execution. However, CFTC Chairman Timothy Massad has said the CFTC is not looking at a prescriptive requirement in this area.

Roundtable. The CFTC has scheduled a public roundtable for June 10 to discuss specific topics relating to the proposal. The agenda includes:
  • Potential amendments to the proposed definition of “Direct Electronic Access” (DEA), consistent with and in furtherance of Regulation AT’s proposed registration regime;
  • Potential quantitative measures to establish the population of “AT Persons” covered by the rules;
  • A potential alternative to Regulation AT’s requirements for AT Persons in proposed Regulations 1.80, 1.81, and 1.83(a), which could require FCMs to impose specific requirements on their customers and perform due diligence regarding customers’ compliance;
  • AT Persons’ compliance with Regulation AT’s proposed requirements for Algorithmic Trading and Algorithmic Trading Systems when using third-party algorithms or systems;
  • Source code access and retention.
Reopened comment period. The comment period will reopen on June 10 and will close on June 24. The additional comment period is intended for public comments solely on the specific items in the agenda for the staff roundtable and that arise during the roundtable.

Friday, June 03, 2016

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California proposes broker-dealer registration exemption for finders

By Jay Fishman, J.D.

The California Department of Business Oversight has proposed a broker-dealer registration exemption for finders, namely those individuals who introduce investors to securities issuers. To qualify for the exemption, an individual would meet the “finder” definition and other requirements in the California Securities Law of 1968, and not be subject to either California or federal Regulation D, Rule 506(d) “bad boy” disqualification provisions.

Form filing (initial/renewal). Eligible individuals would file with the Department a Statement of Information for Finder Pursuant to Section 25206.1 of the California Corporations Code, accompanied by a $300 fee and any additional information the Commissioner requests. Finders would submit amendments to the Statement within 10 business days of the changes occurring. Finders would renew the exemption by annually filing the Statement accompanied by a $275 fee and any additional information the Commissioner requests.

Withdrawal. Finders would file the Statement within 15 calendar days of withdrawing from engaging in business under the exemption.

Recordkeeping. Finders would maintain and preserve the written agreement and other records for a statutory-prescribed time-period at a Statement-designated location. The records could be subject to Commissioner inspections at any time.

Prohibitions against fraud. California Securities Law prohibitions against fraud and misleading acts would apply to finders.