Monday, February 27, 2017

SEC issues statement on relief from pre-Dodd-Frank collateral bars

By Rodney F. Tonkovic, J.D.

The SEC has issued a statement on a recent D.C. Circuit decision halting the imposition of collateral bars for conduct occurring before the enactment of the Dodd-Frank Act. The court in SEC v. Bartko held that the imposition of collateral bars for conduct before the Act's effective fate was impermissibly retroactive. Having determined not to seek review of Bartko, the Commission has also provided a form for those affected by the decision to request an order vacating the bar or bars.

Bartko. Between 2004 and 2005, Gregory Bartko was behind a scheme to defraud investors through the sale of securities. After Bartko was convicted in 2010 of conspiracy, mail fraud, and selling unregistered securities, the Commission instituted a follow-on administrative proceeding in which Bartko was permanently barred from association with every class of securities market participants. At the time of his violations, however, Bartko was only associated with a broker-dealer.

In Bartko, decided on January 17, 2017, the D.C. Circuit vacated the collateral bars against Bartko from association with investment advisers, municipal securities dealers, transfer agents, municipal advisors, and nationally recognized statistical rating organizations. The 2010 Dodd-Frank Act gave the Commission the power to impose collateral bars, but applying those provisions to pre-Dodd-Frank conduct was impermissibly retroactive, the court said.

Relief from collateral bars. The Commission has decided not to seek further review of the Bartko decision. Those that are the subject of a Commission order imposing a collateral bar from associating in any capacity in the securities industry as a consequence of conduct before the July 22, 2010 enactment of Dodd-Frank may complete a form requesting that the Commission issue an order vacating the bar or bars. The Commission's statement notes that if relief is granted from the affected collateral bars, any other bars or suspension from association that were imposed will remain in force. The Commission may also bring a separate follow-on proceeding to determine whether to impose any remedial sanctions under existing law if you attempt to associate in a new capacity in the securities industry in the future.

Friday, February 24, 2017

Minerals review comments start to flow, disagreement on costs

By Mark S. Nelson, J.D.

Early comments on the SEC’s review of its conflict minerals rule guidance are divided on the contours of and need for the disclosure regime mandated by the Dodd-Frank Act. Still, commenters appeared united on tackling the issue of compliance costs.

Gregory Kleffner, executive vice president and CFO of Stein Mart, Inc., an apparel retailer with stores across the county, said the conflict minerals rule is a diversion from the SEC’s core mission, the consideration that should be the primary driver of the agency’s review. But Kleffner also said compliance costs, especially for non-reporting vendors, may not be reflected in data on the burdens imposed by the rule on businesses. In Stein Mart’s case, Kleffner said the company currently pays about $50,000 annually for a consultant and attorneys in order to deal with the conflict minerals rule. While he said that number was lower than the company’s initial compliance cost, he urged the Commission not to ignore the fact that the overall trend of lower costs for all companies subject to the rule can mask the still quite large burden on businesses.

Also on the matter of cost, Lawrence Heim, managing director at Elm Sustainability Partners LLC, characterized the Commission’s cost estimates in the final rule as “grossly overestimated” in light of recent trends. Heim noted that some analyses of the conflict minerals rule could only be grasped via “retrospective analysis” and the Commission should instead mull the newer data as part of its review. But Heim also urged the Commission to consider adding a de minimis threshold, an item left out of the final rule, but which would reduce compliance costs and match regulatory developments in the European Union.

A comment by the CEO of Source Intelligence, Jess Kraus, suggested that technology evolutions since the adoption of the conflict minerals rule have led to improved tracing of minerals and less costly compliance. He also said his firm was unaware of its customers ending contracts with suppliers who use minerals from “legitimate mines” in areas of Africa impacted by the conflict minerals rule.

Lauren Compere, managing director, Boston Common Asset Management, and a group of additional investor signatories, expressed support for the conflict minerals rule. The letter urged the SEC to enforce the disclosure requirements contained in the conflict minerals rule. Moreover, the signatories noted that despite lingering hurdles to peace in the Democratic Republic of the Congo, the emergence of environmental, social, and governance investing and regulatory developments in Europe, and the possibility of future developments in China, had set the stage for supply chain due diligence to emerge as a “global norm” largely because of U.S. leadership.

Thursday, February 23, 2017

Some proxy access proposals meet with success, while others fail

By Jacquelyn Lumb

John Chevedden was successful in gaining inclusion in multiple companies’ proxy materials of his proposal asking the boards to take the necessary steps to allow up to 50 shareholders to aggregate their shares for the purpose of proxy access. Chevedden and others were unsuccessful, however, at Eastman Chemical Company and a number of other companies where the staff concluded that the company’s policies, practices, and procedures compared favorably to the guidelines in the proposal. The most common proxy access model has been the aggregation of shares by up to 20 shareholders to meet a 3 percent threshold of shares held continuously for three years, but as Chevedden noted on behalf of Kenneth Steiner in his proposal to Citigroup, even if the 20 largest public pension funds were to aggregate their holdings, they would not meet the threshold.

Citi’s current proxy access provision. Citigroup pointed out that Chevedden agreed to the current provisions in the bylaw it adopted in 2015, which included a 20 shareholder aggregation limit. The board adopted the proxy access bylaw after shareholders approved a proposal included in its 2015 proxy materials. Citigroup sought to omit the current proposal on the basis that it has substantially implemented the proposal, noting that it has implemented all of the key features—the 3 percent and three year holding thresholds, but with a 20 shareholder aggregation limit. It referred to the proposal as a minor refinement to its bylaw, which it said would be inconsistent with the purpose of Rule 14a-8(i)(10).

Citigroup noted that five of its largest shareholders each own over 3 percent of its common shares and the 20 largest shareholders own approximately 35 percent of its outstanding common shares. The firm also pointed out that there are more than 200 combinations of its shareholders that could aggregate their shares to own more than 3 percent. The 20 shareholder limit is a standard and reasonable provision that is included in the vast majority of companies’ proxy access by-laws, according to Citigroup.

The firm also argued that, in addition to Rule 14a-8(i)(10), the proposal could be omitted under Rule 14a-8(i)(3) because it was materially false and misleading in suggesting that the current bylaw is illusory.

Staff response. The staff said it was unable to concur with Citigroup that the proposal could be omitted under Rule 14a-8(i)(3) because it had not demonstrated objectively that the proposal was false and misleading. The staff was also unable to conclude that Citigroup had met its burden of establishing that the proposal could be excluded under Rule 14a-8(i)(10).

Eastman’s successful argument for omission. Eastman, which received the identical proposal, wrote that it had substantially implemented the proposal when it adopted an amendment on February 18, 2016 to provide for proxy access. Eastman’s bylaw provisions follow the standard guidelines of 3 percent held for three years with an aggregation of up to 20 shareholders. Eastman said the proponent did not explain how or cite any facts to support an argument that increasing the number of shareholders permitted to aggregate their shares would be a meaningful change for the ability of its shareholders to make use of proxy access.

Eastman advised that its 20 largest institutional shareholders own approximately 48.9 percent of its outstanding common shares. The company also pointed out that the proponent had submitted, or was named as the representative for shareholders who submitted, substantially identical proposals to at least 10 other companies without performing an individualized analysis to determine the relevance to each company’s shareholder base. Eastman added that it would also be possible to assemble a group of 20 shareholders that own at least 3 percent of its common shares that does not include any of its largest 90 institutional shareholders. For that reason, as the proposal applies to Eastman, the company said its aggregation limit compares favorably to the guidelines in Chevedden’s proposal.

A number of companies were also successful in omitting the proposal based on arguments similar to that of Eastman.

Wednesday, February 22, 2017

Supremes won't hear petition on ‘same price’ test to rebut reliance presumption

By Rodney F. Tonkovic, J.D.

The Supreme Court has denied certiorari for a petition asking that it clarify the proper way to rebut the presumption of reliance. The petition maintained that the proper way to rebut the presumption of reliance is to prove that an investor, knowing of the fraud, would have paid the same price in the same transaction. This "same price" test has been used by the Fifth and Seventh Circuits, but the Second Circuit declined to endorse in its opinion in this case (GAMCO Investors, Inc. v. Vivendi Universal, S.A., December 27, 2016).

Petitioner GAMCO is a value investor, meaning that it makes its own estimation of the value of a company's securities and tries to buy when the market price is lower than GAMCO's internal valuation. GAMCO claimed that Vivendi, a French multimedia company, had engaged in fraud with respect to GAMCO's transaction in Vivendi's American Depositary Shares.

The district court concluded that it was more likely than not that GAMCO did not rely on the market price of Vivendi securities because the facts demonstrated GAMCO's purchasing decisions relied in large part on an independent valuation of the worth of Vivendi securities.

The sole issue before the Second Circuit was whether Vivendi successfully rebutted the fraud on the market presumption invoked by GAMCO to satisfy the reliance element of its Section 10(b) claim. The presumption was rebutted, the court said, because the record established that GAMCO, as a value investor, would have purchased the securities even had it known of the alleged fraud since it would still have believed the deal it made was a good one.

Circumstances for rebuttal. The petition asked the Court to clarify under what circumstances the presumption of reliance might be rebutted for a value investor who trades in an efficient market, without inside information, and assumes that the price paid was "an honest figure." GAMCO argued that the test should be whether the investor would have paid the same price in the same transactions if he knew about the fraud. This objective "same price" test is the rule in the Fifth and Seventh Circuits, the petition noted, but was not applied by the Second Circuit. The petition urged the court to endorse the "same price" rule.

The petition is No. 16-818.

Tuesday, February 21, 2017

Promissory notes with repayment option were not securities

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

Promissory notes issued to a single investor in connection with a real estate development scheme did not constitute securities under the California Corporate Securities Law. The California Court of Appeal found that the notes were issued in an individually negotiated, one-on-one transaction, while providing a repayment option that was not contingent on the success of the enterprise. As the promissory notes did not meet either the risk-capital or the Howey test for a security, the trial court properly set aside two criminal charges that the defendant used false statements in the sale of a security (People v. Black, February 16, 2017, Premo, E.).

Terms of the promissory notes. The defendant persuaded an acquaintance to invest in a real estate development opportunity in Idaho in return for a promissory note, the terms of which were amended and extended several times. The note promised that if the property were sold, the defendant’s company would repay the principal together with interest based on a percentage of the profits received from the sale. If the borrower developed the property, the lender would select and receive two parcels. If the deal failed and neither event took place within a specified period, the principal would come due, together with interest at the rate of 10 percent.

After the lender had not been repaid after several years, the district attorney filed a criminal information, ultimately charging the defendant with five counts of using false statements in the sale of a security. The first three counts pertained to the issuance of the original promissory note and subsequent amendments, and counts four and five concerned two additional extensions to the repayment period. The trial court, however, dismissed counts four and five, concluding that the promissory notes were not securities under either the risk-capital or Howey tests adopted by the California courts.

Howey test. On appeal, the court noted that the risk-capital test for a security requires a finding of an indiscriminate offering to the public at large, a factor that did not find support in the record. Turning next to the Howey test, the court observed that the state did not offer any cases in which an individualized contract with repayment provisions similar to the ones at issue had been construed as a security within the meaning of the California Corporate Securities Law. Instead, the court found that a repayment option not contingent on the success of the enterprise, together with a provision binding the defendant’s separate property for purposes of enforcing payment on the notes, inserted an element of redress that did not fall within the concept of a security.

Contrary to the state’s suggestion, this did not involve a finding that all one-on-one contracts are excluded as a matter of law from the definition of a security, the court stated. Rather, the individualized nature of the transaction is one factor that must be considered in determining whether that transaction comes within the scope of the securities laws. Accordingly, the order to set aside counts four and five was affirmed.

The case is No. H043360.

Friday, February 17, 2017

SEC advisory committee ponders why companies are staying private

By Anne Sherry, J.D.

“Because they can,” quipped panelists at an SEC advisory committee session examining why companies are staying private longer. A higher accredited investor limit and unprecedented amounts of private capital were cited as key reasons that companies are able to delay their IPOs. But some members of the Advisory Committee on Small and Emerging Companies reported that they had not experienced the “gusher of small capital” the panelists described.

JOBS Act flexibility. Glen Giovannetti (Ernst & Young) attributed companies’ staying private to technological and regulatory factors. The digital transformation means companies’ business models require less capital, he said. Decimalization, tick size, reduced availability of analyst coverage, and related effects on trading profitability reduce intermediaries’ incentive to take small companies public. Giovannetti also cited the JOBS Act, which allows companies to delay registering with the SEC until they amass 2000 accredited investors. Google and Facebook went public once they reached the previous 500-investor limit, he noted.

James A. Hutchinson (Goodwin Procter LLP) also credited the JOBS Act and the FAST Act’s safe harbor for secondary sales with allowing companies more flexibility. Additionally, he emphasized the high costs of being a public company. Beyond the costs directly attributable to the IPO, recurring costs include salary increases, board expansion, advisory fees, and new investments of technology. Regulatory compliance is also “real money,” he said. It costs millions to go public and millions to stay public, so that decision needs to make economic sense.

The emotional side. Yanev Suissa (SineWave Ventures) added that there are subjective, even emotional reasons, that companies don’t go public. Entrepreneurs believe in their company and want to grow it long-term, he said; they don’t want to hear that their passion isn’t working because an investor doesn’t understand it. He observed, however, that many tech companies, including Uber and AirBnB, are probably feeling the pressure to go public this year. Speaking as a venture capitalist, Suissa said that VCs who have a bad experience “wear their scars forever.” If they leap back in and get burned again, it kills the opportunity set.

Where is all this capital? There was a lively discussion around the so-called gusher of small capital. Many committee members seemed to doubt that there was such a phenomenon. The panelists maintained that there are unprecedented levels of capital at the moment, but conceded that the funds may not be making their way to all companies. Giovannetti focused specifically on biotech as an industry that isn’t seeing the influx of capital. Very few investors are going to write a check and wait around for five years to see if the drug comes out, he said. The financing model doesn’t fit the business model. Suissa had a more pragmatic explanation. “There are a lot of companies that shouldn’t be companies out there,” he said. “A lot of companies that shouldn’t get funding.” But he also recognized that the problem is one of information and matchmaking. Companies like Kickstarter and Angel List provide opportunities for capital-raising beyond the VC set.

Board diversity proposal. The committee also discussed its draft recommendation that the SEC require board diversity disclosure. Currently, Item 407(c)(2)(vi) of Regulation S-K requires companies to disclose whether, and if so how, a nominating committee considers diversity. The committee found that this rule failed to generate useful information and proposed a new requirement that companies further disclose the extent to which their boards are diverse. The draft recommended that:
The Commission amend Item 407(c)(2) of Regulation S -K to require issuers to describe, in addition to their policy with respect to diversity, if any, the extent to which their boards are diverse. While, generally, the definition of diversity should be up to each issuer, issuers should include disclosure regarding race, gender, and ethnicity of each member/nominee as self - identified by the individual. While disclosure should be the default, issuers should have the option to opt -out. 
The committee discussed whether to retain or strike the last sentence. Several members argued that the sentence would allow companies to withhold information the committee had already determined was relevant to investors. The issuer’s ability to define diversity however it chooses provides enough flexibility without making disclosure optional, one posited. Another committee member reported that she had spoken with women-owned businesses who opt out of diversity disclosure in other contexts because they feel it will hurt their business.

Sara Hanks, who co-chairs the committee, remarked that the recommendation does not have to be perfect or anticipate all issues. The rule-writers will craft an appropriate regulation. The committee voted to strike the last sentence from the draft recommendation.

Thursday, February 16, 2017

Dissolution and sanctions appropriate for feuding co-owners

By Amy Leisinger, J.D.

The Delaware Supreme Court affirmed chancery court decisions appointing a custodian to sell a highly profitable, yet managerially dysfunctional company and requiring one of the company’s CEOs to pay over $7.1 million in sanctions to his business partner in connection with litigation misconduct. Over the dissent of one justice, the court found that the lower court did not abuse its discretion in determining that dissolution was the most effective solution to address the deadlock and ongoing threats to the company and rejected additional arguments made for the first time on appeal. In a separate opinion, the court concluded that the chancery court did not abuse its discretion by sanctioning the officer and ordering him to pay his business partner’s fees “based on a clear record of egregious misconduct and repeated falsehoods during the litigation” (Shawe v. Elting (custodian, sanctions), February 13, 2017, Seitz, C.).

Company turmoil. TransPerfect Global, Inc. (TPG), one of the world’s leading providers of translation, website localization, and litigation support services, is owned and operated by Elizabeth Elting and Philip Shawe; Elting owns 50 of the company’s shares, Shawe owns 49, and Shawe’s mother owns the remaining one. Several years ago, disputes between Shawe and Elting became a regular occurrence. Elting suggested that Shawe buy her out, but the agreement was never signed, and the parties began to engage in “mutual hostaging,” blocking each other’s activities and regularly undermining each other’s decisions. The extremely tumultuous relationship, including personal harassment, continued over time, and several attempts to compromise failed.

Chancery Court decisions. Elting moved for dissolution of TransPerfect and the appointment of a custodian to sell the company and to resolve the deadlocks between Shawe and Elting. The chancery court granted the motion, noting that, the business of even a profitable corporation may suffer “irreparable injury” when directors’ approaches are so diametrically opposed that they are unable to govern. The company has already suffered from dysfunction and is threatened with much more grievous harm if the issues are not addressed, the court stated.

The chancery court also ordered Shawe to pay over $7.1 million in sanctions after finding that he made false statements, recklessly failed to safeguard evidence, and intentionally sought to destroy other evidence he had been ordered to make available. While agreeing to sustain certain of Shawe’s objections to the total payment requested, the court found that Shawe’s “deplorable behavior” warranted redress in the form of attorney fees expend in addressing his misconduct.

Forced sale appropriate. On appeal, Shawe and his mother challenged the decision to appoint a custodian to sell the company, arguing (for the first time on appeal) that the court exceeded its statutory authority, that “less drastic” measures could have been taken to address the issues, and that the custodian’s sale of the company could result in an unconstitutional taking of their TPG shares. The court noted that, under Delaware law, a court may appoint a custodian for dissolution of a solvent corporation when the stockholders are so divided that they have failed to elect directors and the business of is suffering or threatened with irreparable injury. The court agreed with the chancery court that a profitable business could be suffering from “irreparable injury” when directors cannot effectively govern. The deadlock was undisputed, the court found, and the chancery court made extensive factual findings of threatened and actual harm to the company. With the failure of intermediate measures, the court properly exercised its discretion to sell the company and distribute the proceeds, according to the court.

In addition, the court stated that it generally would not consider arguments made for the first time on appeal but did address the issues in response to the dissenting opinion’s discussion of the arguments. The dissent argues that interpretive principles lead to the statutory language being read to permit liquidation only in certain circumstances, the majority noted, but, if a statute is unambiguous, the plain meaning controls. Under a plain reading, the custodian has the powers of a receiver and his duties are to continue the business unless the court otherwise orders, according to the court.

Sanctions appropriate. With regard to sanctions, Shawe argued that the chancery court erred in finding that he acted in bad faith during the course of the proceedings, the court stated, but it found clear evidence that he intentionally deleted computer files to thwart the discovery process and was, at best, reckless in failing to safeguard evidence on his phone. In addition, the court found that the evidence showed that Shawe provided false interrogatory answers and deposition testimony and lied during the merits trial to cover up his deletions and his extraction of information from Elting’s computer. He contends that, because Elting was not prejudiced by his misconduct, the court was without power to sanction him. However, the court stated, there is no requirement that efforts to thwart proceedings be successful, and courts have found bad faith where parties have unnecessarily prolonged litigation and falsified records and testimony. “Shawe’s behavior was ‘unusually deplorable,’ and thus the Court of Chancery acted well within its discretion by sanctioning him,” the court concluded.

The cases are No. 423, 2016 and No. 487, 2016.

Wednesday, February 15, 2017

Focus on governance, enforcement to rebuild faith in institutions, says CFTC’s Bowen

By Lene Powell, J.D.

Rapid technological change and structural economic problems, including massive manufacturing job losses, are causing many Americans to feel they’re not getting a fair deal, said CFTC Commissioner Sharon Bowen in recent remarks at Northwestern University. Warning of a widespread loss of faith in societal institutions, Bowen discussed the impact of major disruptive trends on the markets and the broader economy. She urged regulators to be mindful of the human dimension of change and suggested actions the CFTC can take as a market regulator to restore confidence, including working to democratize markets for end users, bring more large cases to court, and strengthen governance at regulated entities.

Demographic changes. The demographics of the professions, the economy, and the country have changed from 50 years ago, or even 15 years ago, said Bowen, and that’s for the better. As a child in southern Virginia, she saw a cross burned on her neighbor’s front lawn. Several decades later, she became the first African-American commissioner of the CFTC.

But to fully realize the benefits of diversity, including improved decision-making outcomes, it’s important to increase diversity of all kinds, said Bowen. For the futures and swaps world in particular, it’s important to increase the involvement of farmers in the heartland. She noted that futures markets were originally created to give farmers a better way of receiving fair and efficient prices for their goods. Farmers were the heart of the economy for much of American history, but they are increasingly not being given enough consideration when it comes to economic development and market regulation, she said.

Economic upheaval. Although the economy has made great strides since the Great Recession of 2008–2009, including increased employment and a stronger financial system, the country still has economic problems, said Bowen. Real median household income was lower in 2015 than in 2000 or 2007, and manufacturing jobs have declined by nearly 30 percent in just the last 16 years.

In both the U.S. and abroad, market regulators including the CFTC need to consider the effect of rules on end users and ordinary investors and consumers, said Bowen. Regulators need to consider, in more than just a cursory or passing way, whether rules democratize markets and make them more fair and accessible to consumers and investors. Along those lines, Bowen continues to support proposed CFTC rules to set position limits to reduce excessive speculation, and hopes that the CFTC will complete the rulemaking “in the near future or a few years off.”

Technological disruption. From futures trading being carried out mostly by human traders up through the end of the twentieth century, the vast majority of trading is now done electronically, making up over 99 percent of CME Group trading volume, said Bowen. In addition, most trading now occurs via automatic algorithms.

Bowen observed that these changes have brought benefits including faster and more consistent order execution, but also the potential for disruption. In addition to the societal cost of lost middle-class jobs—a technological displacement mirrored throughout the economy—increased automation also brings increased cyber risk, including potential attacks by non-state actors or hostile foreign governments. The CFTC adopted final rules last year requiring futures and swaps market participants to have adequate cybersecurity safeguards. Given cybersecurity breaches, however, Bowen wonders if it’s already time to strengthen these safeguards. She is optimistic that CFTC rules on automated trading, for which the comment period was recently extended to May 1, can be finished this year.

What the CFTC can do. Along with these disruptive trends causing radical change in markets, the economy, and American society, Bowen sees a troubling fourth trend that makes responding to the others difficult. Americans have increasingly lost faith in institutions across the board, with less than half saying they had a “great deal” or “quite a bit of” confidence in 17 broad institutional categories, including government, the financial industry, large corporations, the media, public schools, or even religious leaders and organizations.

“Simply put, we have a crisis in our institutions, and that is a crisis for our markets, for our government, and for our society,” said Bowen.

This broad lack of faith will take a long time to fix, and there are no easy answers, she said. One aspect to tackle, however, is that when investors and consumers feel that there are two sets of standards, one for the well-connected and one for everyone else, that is a recipe for further destruction of faith in government. For the CFTC’s part, Bowen said the agency should be more aggressive in enforcing rules fairly, including being willing to take individuals and institutions to court rather than just settling. This is difficult due to limited agency resources, but it’s important to try to take more big cases to court, she said.

In addition to more aggressive enforcement, it’s important to focus on governance, said Bowen. She hopes that the CFTC will promulgate a rule soon, as it is obligated to do under Dodd-Frank, to improve governance at regulated entities. Along with that, she hopes that institutions consider ways they can improve their own internal governance, as this will help to rebuild faith.

“I am a believer that just about all of a company’s culture and record goes to the state of its governance,” said Bowen.

Tuesday, February 14, 2017

SEC extends expiration date for interim final swaps rules

By Jacquelyn Lumb

The SEC has extended for one year the expiration dates in its interim final rules that provide exemptions for securities-based swaps that prior to July 16, 2011, were security-based swap agreements and are now defined as “securities” under the Dodd-Frank Act provisions. The extension was necessary to avoid disruption in the security-based swaps market while the SEC continues to consider whether other regulatory action is appropriate. The new expiration date is February 11, 2018 (Release No. 33-10305).

Exemptions. The interim final rules provide exemptions under the Securities Act, the Exchange Act, and the Trust Indenture Act for offers and sales of security-based swap agreements that became security-based swaps under Title VII of the Dodd-Frank Act as long as certain conditions are met. The interim final rules were intended to allow security-based swap agreements that became security-based swaps on the Title VII effective date to continue to trade as they did prior to its enactment.

When the SEC adopted the interim final rules, commenters expressed concern about the availability of exemptions from the Securities Act registration requirements, including the exemption for security-based swap transactions entered into solely between eligible contract participants due to the operation of certain trading platforms and the publication or distribution of other information about the swaps. Commenters suggested that the publication or distribution of certain communications on an unrestricted basis could be viewed as offers of the swaps, which would trigger compliance with the registration provisions absent an exemption.

Communications. Commenters also noted that the communications could be considered offers to persons who were not eligible contract participants even if they were not permitted to purchase the swaps. If registration of the transactions was required, it could negatively impact the security-based swap market, according to commenters.

The SEC has extended the expiration dates of the interim final rules twice before while it continues to evaluate the impact of security-based swaps defined as securities and continues to consider the comments it has received in determining whether further action is needed.

Following the most recent expiration of the interim final rules, the SEC proposed a rule to provide that certain communications involving security-based swaps that may be purchased only by eligible contract participants would not be deemed to constitute offers of the swaps that are subject to the communications or any guarantees of the swaps (Release No. 33-9643, September 8, 2014). The proposal would cover the dissemination of price quotes that relate to security-based swaps that may be purchased only by eligible contract participants and are traded on or processed through certain trading platforms.

The proposal would enable price quotes relating to security-based swaps to be disseminated on an unrestricted basis without concern that it could jeopardize the availability of exemptions from the registration requirements. The comments on the proposal are still being evaluated and final action has not been taken.

Accordingly, the SEC concluded that the interim final rules are needed to allow market participants that meet their conditions to continue to enter into transactions without concern that their activities may not comply with the applicable provisions of the Securities Act, the Exchange Act, and the Trust Indenture Act. If the SEC adopts rules relating to communications, it may alter the expiration dates of the interim final rules as part of the rulemaking.

The SEC determined that notice and solicitation of comment before extending the effective date were impracticable, unnecessary, or contrary to the public interest and found good cause to act immediately to extend the expiration dates.

Monday, February 13, 2017

House reintroduces bill to increase ETF research availability

By Amy Leisinger, J.D.

Rep. French Hill (R-Ariz) and Co-sponsor: Bill Foster (D-Ill) have reintroduced legislation designed to increase the availability of research and information on exchange traded funds to aid investors in informed decision-making. The Fair Access to Investment Research Act of 2017, H.R. 910, would provide a safe harbor for brokers and dealers to publish research reports on ETFs in a manner similar to the protections available for other asset classes without those reports being considered an offering of ETF shares. Hill introduced the same bill in the previous Congress, and it passed by a vote of 411-6.

Senators Dean Heller (R-Nev) and Gary Peters (D-Mich) also reintroduced a companion bill in the Senate, and similar provisions also appear in in Subtitle E of the Financial CHOICE Act, the plan set forth by Republicans last year to replace the Dodd-Frank Act.

“This legislation would create transparency in financial markets that will ultimately benefit consumers,” Rep. Foster said.

Provision highlights. Under existing law, issuers are prohibited from offering securities for sale without filing a registration statement with the SEC. Under Securities Act Section 5, investment research reports technically can be considered an “offer,” and the SEC has created safe harbors for research reports covering many asset classes, but not for ETFs. With ETFs becoming one of the fastest-growing investment products, legislators determined that parity between products is necessary.

The bill directs the SEC to revise its rules to provide that a covered investment fund research report published or distributed by a broker or dealer will not be deemed an offer for sale of a security. To be eligible for the safe harbor, the research report must relate to an ETF that is either an open-end company or a trust whose assets consist primarily of interests in commodities, currencies, or derivative instruments referencing commodities or currencies. In implementing the safe harbor, the SEC must not condition its application on whether the distribution of a report constitutes its initiation or re-initiation of research coverage and is also prevented from exceeding the registration, reporting, and float limitations already provided in its rules. The Commission must also provide that a self-regulatory organization may not prohibit the ability of a member to publish or distribute a report solely because the member is participating in a registered offering or other distribution of the covered investment fund’s securities or prohibit such participation because the member has published or distributed a report.

Friday, February 10, 2017

Korean futures trades were outside U.S. jurisdiction per Morrison

By Mark S. Nelson, J.D.

Korean futures contracts matched on a platform in the U.S. but made and settled on a Korean exchange were not subject to class action manipulation claims brought in the U.S. under the Commodity Exchange Act. The court applied the Supreme Court’s Morrison opinion and Second Circuit precedent in dismissing the plaintiffs’ first amended complaint with prejudice. The court also declined to entertain related control person liability claims, never reached other CEA merits claims, and dismissed a state law unjust enrichment claim (Choi v. Tower Research Capital LLC, February 8, 2017, Wood, K.).

Overnight trading on platform. According to the plaintiffs, Tower Research Capital LLC, along with the firm’s CEO, Mark Gorton, allegedly engaged in manipulative behaviors exemplified by the making of hundreds of trades the firm never intended to be matched to orders placed by other traders. Specifically, the trades involved the Korean KOSPI 200 futures contract, which tracks Korean stocks in a manner similar to well-known U.S. stock indices. Plaintiffs sought to trade the Korean-listed contract during “night market” hours when the Korean securities exchange (KRX) is closed and listed contracts trade instead on the CME Group’s Chicago Mercantile Exchange Globex Platform. CME is registered with the CFTC as a designated contract market, but CME Globex is not.

Applying Morrison. The court recited the Supreme Court’s Morrison presumption against extraterritorial application of U.S. laws absent Congressional intent to do so and then applied the now familiar two-pronged test: U.S. law applies if an allegedly illegal transaction (i) took place on a U.S.-registered exchange, or (ii) the transaction was made in the U.S.

Morrison’s first prong was not satisfied because CME Globex is a platform and not a registered exchange. The court likewise rejected the plaintiffs’ broader definitions of “exchange,” including a “website definition” from the CFTC’s online site, in favor of a more rigorous statutory definition.

Moreover, the plaintiffs fared no better regarding their argument that CME Globex falls under the CEA because it must abide by CME’s rules. This claim was grounded in the CEA’s anti-manipulation language. But the court said the complaint fell short of pleading a violation where a matching engine located in the U.S. resulted in trades made on, and subject to, the rules of a foreign exchange. Nor did the plaintiffs’ recitation of a series of CFTC no-action letters, including one on domestic KOSPI 200 transactions, support extraterritorial application of the CEA in this case.

The plaintiffs also failed to satisfy Morrison’s second prong. Judge Wood, who decided this latest case involving the CEA and Morrison, previously had ruled that Morrison’s second prong applied to the CEA (See, Starshinova (“Although no case law directly addresses whether the Morrison reasoning applies to the CEA, the Court finds that such application is warranted.”)). Second Circuit precedent, which binds judges in the U.S. District Court for the Southern District of New York, holds that a transaction is made in the U.S. if the transaction resulted in irrevocable liability or transfer of title within the U.S.

The plaintiffs had argued that the U.S.-based match resulted in a binding contract. But the court noted that KRX’s rules can be read to deny irrevocable liability to CME Globex matches because settlement of trades made on KRX would not occur until a day later when KRX re-opens for trading.

The case is No. 14-cv-9912.

Thursday, February 09, 2017

ESMA chair seeks no-action letter powers, overhaul of third country supervision

By John Filar Atwood

Steven Maijoor, the chair of the European Securities and Markets Authority (ESMA), believes that ESMA needs to have an instrument similar to no-action letters to improve the speed with which it can respond to pressing issues. In remarks before the European Parliament, Maijoor focused on improvements that are needed to assist ESMA, and recommended that the regulatory framework for third countries be overhauled.

Maijoor noted in his speech that no-action letters are available to most other financial markets regulators. He said that while changing EU technical standards is quicker than amending a directive or a regulation, it is still not fast enough to handle some situations. In the case of quickly evaporating liquidity, for example, it is important to have an instrument to allow the rapid termination of a clearing or trading requirement, he said.

Higher fines. Maijoor told the Parliament that ESMA also would be more effective if it could impose higher fines on supervised entities. In the last four years ESMA has issued one censure and three fines on supervised entities, he noted. The fines ESMA can impose must be higher to ensure that ESMA’s enforcement is seen as a credible support to its supervision, in his opinion.

On the issue of the regulation of third countries, Maijoor acknowledged that the existing framework tries to achieve consistent supervision of global financial markets and to improve the EU’s position as a stable region where it is attractive to conduct financial activities. However, in his view the EU third-country framework needs to be overhauled.

Patchwork supervision. He pointed out that there is no real third-country framework, but simply a patchwork of arrangements that vary across the numerous pieces of legislation. No country’s arrangement is identical to another’s, he said, and the arrangements are a mixture of equivalence, endorsement, recognition, third-country passporting, or nothing at all. Some differentiation is inevitable to respond to the different nature of various financial market activities, he noted, but he believes markets would benefit from greater consistency.

The third-country system also is time and resource intensive, in Maijoor’s opinion. It requires assessments of the regulatory regimes of third countries, negotiations if a third country is not equivalent, and the assessment of applications for third country entities that need to be recognized. At a minimum, ESMA should be allowed to charge fees to third country entities requiring recognition to cover some of the resources involved, he recommended.

Other fundamental problems with the EU third-country framework can be seen through the equivalence system as applied under EMIR, according to Maijoor. When the regulatory and supervisory outcomes are determined to be equivalent, a third country central counterparty (CCP) can be recognized and provide its services to EU clients. However, under this regime there is a heavy reliance on the home regulator, which can be a problem, he said.

In his view, the equivalence system works best when all main jurisdictions apply the approach that an internationally active CCP would mainly be supervised by its home regulator. This would help avoid duplications and inconsistencies in supervision and regulation, he noted.

The problem is that the EU has mostly opted for individual registration of CCPs that want to do cross-border business, Maijoor stated. As a result, third country CCPs have benefited from the EU’s system, while internationally active EU CCPs must be authorized and are subject to the supervision of third country regulators.

Home country reliance. Another concern with strong reliance on the home country regulator, in his opinion, is the lack of assurance that a third country regulator has the right incentive to appropriately assess and address the risks associated with the activities of its supervised entities outside its jurisdiction. In addition, ESMA has very limited opportunities to see the specific risks that third country CCPs might be creating in the EU, he noted, since it has limited powers regarding information collection and risk assessment, and no regular supervision and enforcement tools.

Maijoor recommended that the EU overhaul the framework for third countries in financial markets legislation. The goals should remain consistent regulation of global financial markets and strengthening the EU as a stable global financial region, he said, while ensuring that risks posed by the activities of third country entities in the EU can be adequately assessed and addressed.

Wednesday, February 08, 2017

New York courts should evaluate ‘best interests of the corporation’ in settlements

By Amanda Maine, J.D.

The Appellate Division of the New York Supreme Court reversed a lower court ruling in approving a “disclosure-only” settlement with Verizon shareholders in its merger with Vodafone. In doing so, the court found that the settlement met the five factors that are evaluated when determining whether a settlement should be approved. Over the objection of one judge on the panel, the court also added two additional factors: whether the settlement is in the best interest of the class as a whole, and whether it is in the best interests of the corporation (Gordon v. Verizon Communications Inc., February 2, 2017, Kahn, M.)

Lawsuit. The plaintiff, a Verizon shareholder, alleged that Verizon had breached its fiduciary duty by failing to disclose material information in the preliminary proxy statement (PPS) outlining the merger transaction. A 2013 agreement in principle was reached to settle the action, which required Verizon to disseminate additional disclosures and, in the event of sale to another company, to obtain a fairness opinion from an independent financial advisor.

The lower court declined to approve the settlement, and cited four supplemental disclosures that could “materially enhance” the disclosures in the PPS. The lower court also found that the corporate governance aspect of the proposed settlement could curtail Verizon’s directors’ flexibility in managing minimal asset dispositions. As such, the motion court denied not only approval of the settlement, but also any award of attorney fees to the plaintiff’s counsel.

Settlement review. The appellate division outlined factors under In the Matter of Colt Industry, which under New York law, provide a framework under which a settlement should be approved. The first factor of likelihood to succeed on the merits weighed in favor of approving the settlement because the negotiation process revealed that the plaintiff would have obtained additional corporate disclosures in addition to corporate governance reform.

The second Colt factor, support from the parties for the proposed settlement, also weighed in favor of the settlement, the court said, noting that only three out of 2.25 million Verizon shareholders had objected. Judgment of counsel, the third factor, also swung towards approval, because the lawyers involved were competent and experienced in complex class actions involving fiduciary duties. The court also found that, consistent with Colt’s fourth factor, the negotiations were conducted in good faith and at arm’s length. As for the fifth Colt factor, the court noted that, under the “disclosure-only” settlement, the plaintiff had abandoned her claims for monetary relief.

Revisiting Colt. In addition to meeting the five-factor Colt test, the court proclaimed that, because of decades of mergers and acquisitions litigation and “overzealous litigating shareholders and their counsel,” further guidance is warranted. Under the court’s “enhanced standard,” the sixth factor, an evaluation of whether the proposed settlement is in the best interests of the class, which included four categories of supplemental disclosures made by Verizon to its shareholders (and especially the requirement of future fairness opinions), was met.

A seventh factor the court decided to add to the established Colt five-factor test requires the examination of whether the proposed settlement is in the best interest of the corporation. The court determined that, by agreeing to the settlement and avoiding additional legal fees and expenses of a trial, the settlement also survived scrutiny under this new seventh factor.

Delaware departure. The court’s decision departs from the Delaware Trulia standard by adding the additional considerations of whether a settlement is in the best interests of the settlement class as a whole and whether it is in the best interests of the corporation.

Having met the five Colt factors, in addition to its newly enshrined duo of best interests of class and corporation, the court reversed the lower court’s decision that disapproved the settlement.

Concurrence. Judge Moskowitz concurred in the decision reversing the lower court and approving the settlement. However, she felt the majority went too far in setting forth a new seven-part test to “enhance” the Colt factors. She noted that no party involved in the case had argued for this new standard or had suggested that the existing five-part test under Colt was inadequate for evaluating a class action settlement.

The case is No. 653084/13.

Tuesday, February 07, 2017

Lululemon board successfully defends appeal over founder’s trading

By Anne Sherry, J.D.

The Delaware Supreme Court affirmed the chancery court’s dismissal of a derivative action surrounding Lululemon’s founder’s alleged insider trades. The Southern District of New York had rejected a demand futility argument given the lack of allegations of the board’s knowledge and the fact that the trades were governed by a Rule 10b5-1 plan. This decision precluded the suit in Delaware state court (Laborers’ District Council Construction Industry Pension Fund v. Bensoussan, February 3, 2017, Vaughn, J.).

After oral argument and on the parties’ briefs, the high court affirmed the chancery court for the reasons assigned in its opinion. That decision found that issue preclusion applied because the district court necessarily decided the same demand futility issue that the Delaware court was asked to consider. The Delaware plaintiffs also failed to meet their burden of proving that they were not afforded an opportunity to litigate in the New York action. Claim preclusion also barred the suit because the New York action involved an adjudication on the merits, the Delaware plaintiffs stood in privity with the New York plaintiffs, and the claims were or could have been raised in the prior action.

In their briefs on appeal, the plaintiffs took issue with this ruling. The New York court dismissed the claims without prejudice, they argued, so there was no final adjudication on the merits. Although the Delaware plaintiffs moved to intervene in New York, the district judge denied intervention. Furthermore, collateral estoppel did not apply because the demand futility issues in the two suits were not identical: The New York plaintiffs alleged that the board members were under the founder’s control and so facilitated his trades, while the Delaware plaintiffs argued that the board failed to investigate the trades. The defendants countered that the New York action was an adjudication on the merits and that the plaintiffs’ claims were or could have been raised in that action.

Much of the oral argument focused on whether the district court decision was without prejudice to litigate demand futility or whether, as the chancery court had construed it, it was without prejudice to the plaintiffs’ right to make demand. Chief Justice Strine asked plaintiffs’ counsel whether anyone thought to ask the district judge whether she had intended her order to foreclose relitigation. A party can ask, he observed, and the judge can give a yay or nay. Counsel conceded that no one had sought that clarification.

The case is No. 358, 2016.

Monday, February 06, 2017

CFTC fines RBS $85 million for attempted manipulation of ISDAFIX benchmark

By Lene Powell, J.D.

The CFTC settled charges against The Royal Bank of Scotland plc (RBS), finding that certain of the bank’s traders attempted to manipulate U.S. Dollar ISDAFIX benchmark swap rates over the course of five years. The traders executed key transactions at the time of the daily fixing window in order to affect reference rates submitted for calculation of the benchmark, with the aim of benefiting the bank’s derivatives positions priced or valued off of the benchmark. In addition to paying an $85 million civil monetary penalty, RBS must strengthen its internal controls and procedures, including taking specific steps to detect and deter manipulative trading (In the Matter of The Royal Bank of Scotland plc, February 3, 2017).

The settlement resolves the CFTC’s fourth enforcement action involving the ISDAFIX benchmark, and brings the overall amount of penalties imposed by the CFTC in 19 benchmark cases to $5.2 billion.

“These actions, and the CFTC’s previous cases against those who sought to corrupt the LIBOR and foreign exchange benchmark rates, make clear that the Commission takes very seriously its role in ensuring the integrity of any and all benchmarks used in our markets,” said Aitan Goelman, Director of the CFTC’s Division of Enforcement.

ISDAFIX benchmark. USD ISDAFIX rates and spreads are among the leading benchmarks for interest rate swaps and related derivatives. During the relevant time, USD ISDAFIX rates and spreads were published daily for various maturities of U.S. dollar-denominated swaps, being used for various purposes including cash settlement of options on interest rate swaps, valuation of certain interest rate products, and the pricing of debt issuances.

At the time, USD ISDAFIX was set in a daily process in which a leading interest rate swaps broking firm disseminated rates and spreads captured in an 11 a.m. “fix” or “print” to a panel of banks including RBS. The banks then made submissions to indicate where they would each bid or offer interest rate swaps to a dealer of good credit.

Attempted manipulation. The order found that between 2007 and 2012, certain RBS traders in Stamford, Connecticut engaged in manipulative conduct to move USD ISDAFIX rates in whichever direction benefitted their positions. The traders bid, offered, and/or traded swap spread trades at and around the swaps broker’s 11 a.m. print, attempting to move reference rates and spreads by a quarter basis point or more.

As detailed in the order and a list of examples of misconduct, the traders identified RBS's target print, the amount that RBS was willing to spend to achieve that print (which they called "ammo"), and whether RBS wanted to use less than the full amount of ammo if possible. The traders then used a combination of timing techniques and ammo to try to get the desired result, discussing strategies both among themselves and with employees at the swaps broker. They generally tried to carry out the manipulative strategies at the lowest cost possible, but because affecting USD ISDAFIX could be so valuable, traders were sometimes willing to incur unnecessary transaction costs.

Traders joked about being caught by the CFTC. Conversations also indicated that the traders knew their manipulative conduct sometimes had an adverse impact on their counterparties. In one example, when a trader learned that an upcoming corporate bond pricing would take place right at 11 a.m., he wrote to a non-RBS employee, “Awesome—love it when corporates get boned by the 11:00 screen games.”

Sanctions. According to the order’s findings, which RBS did not admit or deny, the traders’ actions constituted attempted manipulation in violation of Sections 9(a)(2) and 6(c)(1),(3) of the Commodity Exchange Act, as well as Commission Regulation 180.2. RBS was liable as principal.

RBS was ordered to pay an $85 million civil monetary penalty, the smallest fine for the four ISDAFIX cases, which range from $115 million (Barclays) to $250 million (Citibank). The ISDAFIX penalties are smaller on average than those for attempted manipulation of LIBOR or foreign exchange benchmarks.

RBS represented that it had already taken certain measures to ensure the integrity of benchmark submissions, including increasing surveillance, implementing new recordkeeping measures, and stepping up employee training. RBS will also take further steps as specified in the order.

The case is CFTC Docket No. 17-08.

Friday, February 03, 2017

Vermont continues federal regulation crowdfunding trend

By Jay Fishman, J.D.

The Vermont Department of Financial Regulation is now the fourth state to promulgate a federal regulation crowdfunding rule following the SEC’s adoption of crowdfunding rules on May 16, 2016. Washington was the first jurisdiction to adopt a notice filing requirement for federal crowdfunding offerings on July 16, 2016. Thereafter, Massachusetts proposed a rule in November 2016 (which remains proposed), and Alabama’s rule takes effect on February 27, 2017. The state rules apply to offerings made under federal Regulation Crowdfunding 17 C.F.R. §227 and Securities Act, Sections 4(a)(6) and 18(b)(4)(C).

Vermont. As proposed, the Vermont rule would require issuers with either a Vermont principal place of business or who sell at least 50 percent of the aggregate offering amount to Vermont residents, to claim the federal regulation crowdfunding exemption by sending the Vermont Securities Commissioner: (1) a complete Uniform Notice of Federal Crowdfunding Offering Form or copies of all SEC-filed documents; and (2) a Form U-2, Uniform Consent to Service of Process (if the consent is not filed on the Uniform Notice of Federal Crowdfunding Offering Form). The notice would take effect for 12 months from the date it is filed with the Vermont Securities Commissioner.

An issuer, to renew the same offering for an additional 12 months, would file a complete Uniform Notice of Federal Crowdfunding Offering Form marked “renewal” and/or a cover letter or other document requesting renewal on or before the date the current notice expires.

Thursday, February 02, 2017

SEC seeks comment on conflict minerals rule guidance

By Jacquelyn Lumb

Acting SEC Chair Michael Piwowar has directed the staff to consider whether guidance on the conflict mineral rule is still appropriate and whether additional guidance is needed. The SEC partially stayed compliance with the rule in May 2014 after the D.C. Circuit Court ruled that certain of its provisions violated the First Amendment. Following the ruling, the SEC issued an order staying the compliance date for the provisions found unconstitutional and the Division of Corporation Finance issued guidance on complying with the remaining provisions. The case was remanded to the district court for further consideration.

Rule 13p-1 and Form SD were adopted pursuant to Exchange Act Section 13(p), which was added by Section 1502 of the Dodd-Frank Act. The court concluded that Section 13(p) and Rule 13p-1 violated the First Amendment to the extent that they required regulated entities to report to the SEC and to disclose on their websites that any of their products were not found to be Democratic Republic of Congo conflict free. The court had no objection to any of the other required disclosures.

Piwowar noted that the temporary transition period for the rule has expired and the reporting period beginning January 1, 2017 is the first reporting period for which no issuer falls within the terms of the transition period. Since the litigation is ongoing, Piwowar asked interested parties to submit comments within the next 45 days on whether the 2014 guidance is still appropriate.

Rule’s impact. In a separate statement, Piwowar reported on a trip he took to Africa last year where he heard first-hand about the effects of the rule. He said the disclosure requirements have led to a de facto boycott of minerals from certain areas beyond the Congo region, and legitimate mining operations are being forced to close due to the onerous costs of compliance. Piwowar added that it is unclear whether the rule has reduced the armed gangs or eased the suffering of innocent people in the Congo and surrounding areas. He also warned that withdrawal from the region could undermine U.S. national security interests by creating a vacuum filled by those with “less benign interests.”

A comment page has been created so that interested parties can express their views on the reconsideration of the conflict minerals rule and the 2014 guidance.

Wednesday, February 01, 2017

Sen. Baldwin, Rep. Cummings re-introduce regulator conflict of interest bills

By Mark S. Nelson, J.D.

Senator Tammy Baldwin (D-Wis) and Rep. Elijah Cummings (D-Md) re-introduced the Financial Services Conflict of Interest Act which they had pushed in the last Congress as a means of curbing the so-called revolving door between high-level federal government jobs and Wall Street. The bill would restrict certain types of bonuses and would impose tougher requirements on lobbying and conflicts of interest. The lawmakers announced the bills in a joint press release.

Specifically, the bill would ban government employees from taking bonuses from their former private sector employers for joining the government. The bill would place new limits on lobbying, including by extending the ban on lobbying the federal government from one to two years. Another provision would require senior financial regulators to recuse themselves when official actions directly or substantially benefit an employer (or client) they worked for within the two years before starting their government service.

Although the full text of the latest bills was not yet available, earlier versions of the bills (S. 1779; H.R. 3065) would have amended the Ethics in Government Act to define “covered financial services agency” to include the Fed, FDIC, CFPB, SEC, CFTC, and Treasury. “Covered financial services regulator” would include the officers and employees of a covered financial services agency who hold supervisory positions at the GS-15 level of the General Schedule plus other similar positions.

The Senate version of the bill introduced during the 114th Congress garnered four Democratic co-sponsors, including Sen. Elizabeth Warren (D-Mass), plus Independent co-sponsor and former presidential candidate, Bernard Sanders (I-Vt). The bill never advanced past the Senate Homeland Security and Governmental Affairs Committee. The prior House version of the bill stalled in three committees, but drew 17 Democratic co-sponsors.

Senator Baldwin and Rep. Cummings cited an Obama Treasury nominee and two Trump Administration nominees as examples of why they say their bill is needed. Among current Trump nominees, the lawmakers noted possible conflicts of interest for those who would fill top posts at the National Economic Council and the State Department.

Tuesday, January 31, 2017

Pfizer’s advertising is ordinary business, not political activity

By Amanda Maine, J.D.

The SEC’s Division of Corporation Finance will allow Pfizer to exclude from its proxy materials a proposal from conservative think tank National Center for Public Policy Research (NCPPR) that would direct the company’s board of directors to report to shareholders Pfizer’s assessment of the so-called political activity resulting from its advertising with certain national news organizations and the resulting exposure to risk. The Division concluded that the proposal could be excluded under the ordinary business exemption.

Proposal. According to NCPPR, Pfizer’s advertisements with “politicized media organizations,” including CNBC, The New York Times, CNN, Politico, The Washington Post, NBC, and ABC, can expose the company to financial and reputational risk. NCPPR cited WikiLeaks as evidence that there is collusion between high-level political personnel and national news outlet employees. The company’s financial support through the purchase of advertisements constitutes indirect political spending, NCPPR argued, which the SEC has determined is a significant policy issue. NCPPR said that boycotts of corporations that advertise on certain news networks have been organized and expose those corporations to risks.

Pfizer request. In its request for no-action relief, Pfizer pointed to a number of previously issued no-action letters where the Division has permitted the exclusion of shareholder proposals which relate to the manner in which a company advertises its products as pertaining to the company’s ordinary business operations under Rule 14a-8(i)(7). Pfizer also disagreed with NCPPR’s characterization of the purchase of advertising with particular media organizations as indirect political spending. The NCPPR proposal is just a “thinly veiled attempt” to influence the company’s choice of news media organizations from which it purchases advertising space and time; such decisions, Pfizer advised, are part of Pfizer’s ordinary business operations.

NCPPR response. In its response letter to Pfizer’s request, NCPPR cited a previous no-action letter relating to a proposal by a shareholder of PNC in which the Division did not allow the exclusion of a shareholder proposal on greenhouse gases. Like the PNC letter, NCPPR’s proposal involves an “assessment of a significant policy issue that is intricately tied to the business operation of a company,” according to NCPPR. It also reiterated its argument that purchasing advertising from certain news organizations contributes to the “political activities” of those organizations, citing several stories resulting from WikiLeaks that allegedly exposed “high-level collusion” between political operatives and national news employees.

Pfizer response. Pfizer’s response letter disagreed with NCPPR’s assessment that the PNC letter involved a substantially similar proposal. Several recipients of PNC’s lending business were coal producers where financing provided by PNC could contribute to greenhouse gas emissions. This business activity directly implicated a non-ordinary business matter—the significant policy issue of climate change. Pfizer’s advertising decisions are business activities involving marketing Pfizer’s products—an ordinary business matter—and not a way to finance the political opinions of those organizations, according to Pfizer.

Relief granted. The Division sided with Pfizer, and determined that the company could exclude the proposal because it relates to its ordinary business operations.

Monday, January 30, 2017

Open-end funds may invest in closed-end funds regardless of relationship

By Amy Leisinger, J.D.

The SEC’s Division of Investment Management agreed with Dechert’s position that a registered open­-end investment company or a registered unit investment trust may rely on Investment Company Act Rule 12d1­-2 to invest in a closed­-end fund regardless of whether the two companies hold themselves out to investors as related organizations. Specifically, the staff noted, for the purposes of the rule, the definition of “group of investment companies” in Section 12(d)(1)(G) of the Act, does not include closed-­end investment companies.

Funds of funds. Section 12(d)(1)(A) prohibits a fund from acquiring securities issued by another investment company if, immediately after the acquisition, the fund: (1) owns more than three percent of the outstanding voting stock of the acquired fund; (2) has more than five percent of its total assets invested in the acquired fund; or (3) has more than ten percent of its total assets invested in the acquired fund and all other investment companies.

Section 12(d)(1)(G) provides an exemption for fund of funds arrangements for open-end funds to invest in other open-end funds that are part of the same “group of investment companies,” defined as two or more funds that hold themselves out to investors as related companies for purposes of investment and investor services.

In 2006, the Commission adopted Rule 12d1-2, which allows open-end funds relying on this exemption also to invest in securities issued by a registered investment company “other than securities issued by another registered investment company that is in the same group of investment companies,” subject to certain limitations.

Relief requested and granted. In its request for relief, Dechert noted that the rule permits investments in closed-end funds within these limits but that the absence of clarifying language suggests a possibility that closed-end funds deemed part of the investing fund’s “group of investment companies” may not qualify as permitted investments. There is no indication that the Commission intended to prevent an open-end fund from investing in closed-end funds that could be deemed to be within the same group, Dechert opined, and no policy reason would justify exclusion.

The staff agreed that the definition of “group of investment companies” refers solely, for the purposes of Rule 12d1-2, to open-end funds that hold themselves out as related companies. As such, the staff would not object to an open-end fund relying on the provisions investing in a closed-end fund regardless of whether the two funds belong to the same group, subject to the limitations set forth in the rule.