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.

Friday, January 27, 2017

Piwowar designated acting chairman

According to the SEC’s website, President Trump has designated Michael Piwowar Acting Chairman of the SEC. Piwowar joined the Commission in August 2013 after having served as chief economist to the Republican leadership on the Senate Banking Committee. Piwowar’s updated SEC biography indicates the designation occurred on January 23, 2017.

Piwowar, who is not a lawyer, once remarked in a speech that he believed he was just the third Ph.D. economist to serve as a member of the Commission. After completing his undergraduate work in foreign relations, Piwowar earned an M.B.A. from Georgetown University and a doctorate in Finance from Pennsylvania State University. Piwowar will temporarily lead an agency whose staff often has been led by attorneys.

Even with Piwowar’s designation, the Commission still has a total of three vacancies. Previously, then President-Elect Trump said he planned to nominate deal lawyer Jay Clayton to be SEC Chairman. An announcement last Friday from now President Trump indicated that Clayton’s nomination to be a member of the Commission had been sent to the Senate.

Thursday, January 26, 2017

FIA calls for comprehensive review of financial reform regulation

By Lene Powell, J.D.

In an open letter to President Trump and key congressional and regulatory leaders, FIA president and CEO Walt Lukken urged a “wholesale review” of all financial reform regulation and the Dodd-Frank Act. In particular, the derivatives association head urged that although the Dodd-Frank derivatives provisions and subsequent regulation have led to some improvements to the swaps and futures markets, there are also significant challenges. A comprehensive look at the cumulative regulatory burden is needed to determine where reform or repeal is appropriate, he said.

The letter was sent to President Trump, SEC and CFTC commissioners, and leaders of the House and Senate Agriculture, Senate Banking, and House Financial Services committees.

Wholesale review of regulation. Lukken first pointed to some benefits of Dodd-Frank derivatives reform, including increased safety, soundness, and transparency due to efforts by exchanges, clearinghouses and their members, and customers to implement central clearing and regulated trade execution in swaps markets. Seventy-five percent of interest rate and credit default swap transactions are now cleared, compared to only 15 percent before the financial crisis, Lukken said.

However, the FIA is concerned that the cumulative burden of regulation appears to be harming competition, reducing market liquidity, and stifling innovation and growth. Volume and growth are stagnating and industry members are consolidating, with the result that risk is now more concentrated. Lukken asked why commercial enterprises that had nothing to do with the crisis are being saddled with dozens of new rules.

Smart regulation and enforcement. In conducting a comprehensive regulatory review, policymakers should tailor rules to risk posed, taking into account public input and conducting thoughtful cost-benefit analysis, said Lukken. Regulators should focus enforcement efforts on unlawful acts that harm investors and markets, not technical violations caused by regulatory complexity.

Globally accessible markets. Lukken said regulators must create a regime that allows for cross-border access without overly burdensome and duplicative regulations. He urged that the U.S. should follow the example of the European Union, which is currently reviewing its financial reform legislation,

Focus on innovation and competition. To promote responsible innovation and fair competition for market participants, regulators should craft rules to not only protect the marketplace but also incentivize innovation and healthy market behavior, said Lukken. Policies that promote technological innovation make markets more efficient and accessible and can also lead to public benefits through improved tools for oversight and infrastructure security, he observed.

Lukken emphasized that it is essential to ensure that risk management tools provided by derivatives markets remain available, affordable, and accessible for businesses. He said he looks forward to working with policymakers to consider how to best reform Dodd-Frank in a coordinated manner that benefits the markets and their users.

Wednesday, January 25, 2017

Divided appellate panel: nondisclosure of bank fees claim preempted by SLUSA

By Amanda Maine, J.D.

A divided panel of the Seventh Circuit Court of Appeals sided with the lower court and Bank of America in holding that certain banking fees charged but not disclosed amounted to an omission of material fact, and therefore the plaintiff’s state law claims of breach of contract and fiduciary duty were preempted by SLUSA and must be brought in federal court (Goldberg v. Bank of America, N.A., January 17, 2017, per curiam).

Lawsuit. The plaintiff, a trust representing the customer, maintained an account at LaSalle bank, which was later acquired by Bank of America. LaSalle invested (“swept”) cash balances at the end of the day into a mutual fund the plaintiff had selected from a list provided by LaSalle. Eventually, the plaintiff learned that LaSalle had been accepting reinvestment (“sweep”) fees from the mutual funds based on the average daily invested balance LaSalle had “swept” from his custodian account. After the Bank of America acquisition, the plaintiff was notified that the fee was going to be eliminated. The plaintiff had been unaware of the fee and sued LaSalle and Bank of America (“the Bank”) for breach of contract and breach of fiduciary duty. The complaint alleged that some mutual funds paid the bank a fee based on the balances it transferred without notifying customers that it was retaining them, the economic equivalent of a secret fee.

The Bank removed the suit to federal court under the Securities Litigation Uniform Standards Act (SLUSA), which seeks to prevent plaintiffs from avoiding the Private Securities Litigation Reform Act’s stringent pleading standards by bringing federal securities law claims as state law claims. According to the Bank, the plaintiff’s claim depends on the omission of a material fact; i.e., the secret fee. As such, SLUSA requires removal from state court to federal court, the Bank argued. The district court sided with the Bank, and the plaintiff appealed.

Appellate decision. According to the per curiam decision of the Seventh Circuit, the complaint alleged an omission of a material fact in connection with the purchase or sale of a covered security. It rejected the plaintiff’s argument that SLUSA did not apply because the Bank’s omission does not involve the “price, quality, or suitability” of a security. The opinion stated that omissions in connection with securities transactions are forbidden by the Exchange Act, regardless of whether that omission concerns the security’s price, quality, or suitability. The court affirmed the lower court’s decision.

Concurrence. Judge Flaum penned a concurring opinion in which he outlined different approaches taken by the Sixth, Third, and Ninth Circuit regarding dismissing complaints under SLUSA. He concluded that under the Sixth Circuit’s “literalist” approach, the plaintiff’s fiduciary claim triggers SLUSA preemption because the bank failed to disclose a fee that, if disclosed, would “give pause” to potential investors. Pointing to language in the original complaint, which alleged that the Bank “steered” clients’ money to mutual funds that agreed to pay the fees, SLUSA preemption is also triggered under the Third Circuit’s “looser” approach.

Regarding the Ninth Circuit’s approach, Judge Flaum noted that the Seventh Circuit has expressed concern with it because a plaintiff may simply reassert SLUSA-triggering language later upon returning to state court, again highlighting the “steered” language in the plaintiff’s original complaint.

However, the concurrence said that the question of whether SLUSA preempts the plaintiff’s entire complaint or just the individual claim has not been decided at this juncture. The plaintiff’s breach of contract claim includes an alleged material omission, and thus triggers SLUSA preemption, according to Judge Flaum.

Dissent. In a lengthy dissent, Judge Hamilton outlined his disagreements with his colleagues. According to Judge Hamilton, the plaintiff’s claim alleged a breach of contract because the Bank spelled out the fees it would charge, and the Bank breached that contract by charging additional fees. This claim can be proved without having to show any misrepresentation of material fact. He described the majority’s characterization of a breach of contract claim as one of omission of material fact as “reverse alchemy” that “turns gold into lead.”

Judge Hamilton noted that the question of how a court should apply SLUSA to state law claims for breaches of contract and fiduciary duty has produced a three- or four-way split in the federal circuit courts. In his opinion, the Second and the Ninth Circuit, which have held that a class action claim is barred by SLUSA only if the claim requires proof of a misrepresentation or omission of material fact, take the correct approach. He opined that the standard adopted by his colleagues is a new standard where virtually any breach of contract claim can be preempted.

The case is No. 11-2989.

Tuesday, January 24, 2017

Panelists discuss new accounting standards at PLI’s European securities regulation program

By Jacquelyn Lumb

SEC Chief Accountant Wesley Bricker was among the panelists at the Practising Law Institute’s conference on securities regulation in Europe, which addressed new accounting standards, international financial reporting standards, non-GAAP measures, audit committees, and internal control over financial reporting. John White, a partner at Cravath, Swaine & Moore, moderated the panel, which also included PricewaterhouseCoopers managing partner Michael Gallagher and IASB member Mary Tokar.

New standards on the horizon. Bricker said the new standards on revenue recognition, leasing, and financial instruments should be at the top of the agenda for executive teams, auditors, and others. The revenue recognition standard can be applied this year but is required for 2018. This standard affects the top line of nearly every company, he advised. The leasing standard will bring leases onto the balance sheet for most companies, making them part of the primary financial statements. The standard on financial instruments will affect strategic equity investment instruments, impairment for receivables, and lending activities, among other things. All of these standards will have a significant impact on the content of companies’ disclosures.

The revenue recognition disclosure under GAAP and IFRS is substantially the same and will make financial information more comparable across companies. Bricker suggested that the information provided by the transition resource group should be used as a resource. Many large accounting firms participated in the group. Tokar reported that the group included 50 individuals and suggested that registrants consider the wisdom in this collective effort in drafting their disclosure.

Registrants are required to disclose the impact of the new accounting standards. Bricker advised that if the quantitative effect is not known, registrants should provide qualitative information. The staff will expect more specific disclosure as the adoption date nears. Gallagher recommended that issuers engage with their securities counsel on the required disclosure given that the consequences of getting it wrong can be pretty severe. White recommended a publication by the Center for Audit Quality on preparing for the revenue recognition standard, which he said is helpful for lawyers.

IFRS. On the topic of international financial reporting standards, Bricker referred to a statement issued by Chair Mary Jo White on January 5, 2017 about the role and relevance of GAAP and IFRS. She said that GAAP will remain in force for domestic issuers for the foreseeable future but also emphasized the continuing importance of IFRS given that investors invest in foreign companies, U.S. companies enter into transactions in reliance on IFRS information, and some multinational companies may have to comply with IFRS with respect to their foreign subsidiaries. Bricker added that approximately 525 foreign private issuers use IFRS in their SEC filings.

Frequent areas of comment. The panel talked about recurring themes in comment letters. Not long ago, a majority of the comment letters involved revenue recognition and MD&A, but now non-GAAP measures have risen to the top. Gallagher said the SEC is interested in things that require judgment, are complex, and are material, in addition to issues that are reported in the newspapers. The staff is also interested in the lack of an early warning about a large loss contingency or impairment, so a registrant will often get a comment asking why there was no earlier warning before reporting these losses.

White said a cautionary tale lies with the SEC’s actions against RPM International, which failed to disclose a Department of Justice investigation and a contingency that it may have to repay overcharges to the government. The SEC charged the company and its general counsel in the matter (LR-23639, September 9, 2016).

Non-GAAP measures. The SEC’s renewed focus on non-GAAP measures is the result of certain practices that undercut the credibility of the information that was being reported, according to Bricker. The staff has issued compliance and disclosure interpretations to remind registrants of the importance of not giving more prominence to non-GAAP numbers than GAAP and provides examples of how a non-GAAP measure may be materially misleading. A company cannot cherry pick good news while omitting bad news, he said. White said both lawyers and accountants should be a part of the disclosure process when it comes to non-GAAP measures.

Gallagher added that non-GAAP measures tend to have a significant impact and, accordingly, should be subject to rigorous internal controls. If the information is important enough to disclose to the public and move markets, it should be subject to internal controls, he said.

Takeaways. The panelists were asked for their takeaways at the conclusion of the program. Bricker advised registrants to focus on the tone at the top and to incorporate it into the reporting process. Gallagher said that the new GAAP (new accounting standards) and non-GAAP are at the forefront of financial reporting and should be a key focus area. Tokar said change is coming, and it is not a small piece of the reporting process. She urged registrants to get ready, report on their progress, and embrace the new disclosure.

Monday, January 23, 2017

Shareholder suit focuses on Time Warner’s Non-GAAP merger metrics

By Mark S. Nelson, J.D.

Shareholders of Time Warner, Inc. allege the company’s board misled them by filing a materially deficient proxy that left out information about how the company calculated certain non-GAAP financial measures related to its proposed acquisition by AT&T Inc. The suit, filed in the federal district court in Manhattan, seeks to stop the upcoming shareholders’ vote scheduled for February 15 (Collura v. Time Warner, Inc., January 19, 2017).

According to the complaint, Time Warner’s definitive proxy lacked line items for some calculations and did not contain a reconciliation to GAAP. The complaint noted the recent focus by then-SEC Chair Mary Jo White and several of the agency’s accounting officials pressing companies to provide more detailed non-GAAP disclosures. Last May, the SEC staff published new and revised Compliance and Disclosure Interpretations on non-GAAP financial measures.

The complaint explained that Time Warner has a sizeable portfolio of video, television, and film assets in three divisions, which have become even more focused on video following recent spin-off transactions. The merger with AT&T is valued at more than $108 billion and would pay Time Warner’s shareholders $107.50 per share, with that amount split equally between cash and AT&T shares.

The case is No. 17-cv-00399.