Friday, February 27, 2009

Volcker Calls for International Coordination of Financial Regulatory Reform

Fearing regulatory arbitrage, former Federal Reserve Board Chair Paul Volcker told Congress that it is absolutely essential that some part of the coming reform of financial regulation be internationally agreed upon and applied in a globally consistent way. Specifically, he listed accounting standards, capital and liquidity standards, and registration and reporting mandates as areas that demand international consistency. He singled out fair value accounting standards as having been inconsistently applied and contributing to downward spiraling valuations in illiquid markets.

In testimony before the Joint Economic Committee, Mr. Volcker, a top Obama Administration adviser, said that international standards will minimize regulatory arbitrage and combat a tendency by some jurisdictions to seek competitive advantage by tolerating laxity in oversight.

The former Fed Chair also asked Congress to impose capital, leveraging and liquidity requirements on large complex financial institutions that pose systemic risks to the markets. Those institutions should also be subjected to particularly high international standards directed towards maintaining their safety and soundness. Mr. Volcker defined systemic risk as a situation where the functioning of the financial system as a whole could be jeopardized in the event of a sudden and disorderly failure.

To help assure the stability of financial institutions, Mr. Volcker urged Congress to impose strong enforceable restrictions on risk-prone capital market activities conducted by hedge funds and proprietary trading firms. This is part of an emerging view, which was endorsed by the earlier Volcker G-30 report and the European Union High Level Group, that there should be regulation of hedge funds and other vehicles whose activities may pose a systemic risk to the markets even if the funds have no direct links to the public at large.

At the same time, Mr. Volcker said that trading and transaction-oriented financial institutions operating primarily in capital markets could be less intensively regulated, although stronger registration and reporting requirements would be appropriate.

Noting that the crisis revealed a massive failure of risk management, the official called for more disciplined financial management and the sound and effective management of risk. He also criticized highly aggressive compensation practices that encouraged risk taking in the face
of misunderstood and sometimes almost incomprehensible debt instruments. He recommended a complete review and reform of incentive compensation practices and other executive compensation practices.

This dovetails with a growing consensus that compensation was misaligned and promoted risk taking. Recently, European Commissioner for the Internal Market Charlie McCreevy said that perverse incentive compensation schemes led to excessive risk taking at many companies and financial institutions and that policy makers should establish clear guidelines to refocus executive compensation on long-term, firm-wide profitability.

Thursday, February 26, 2009

President Obama Sets Forth Principles to Guide Reform of Financial Regulation

President Obama has outlined seven broad key principles involving transparency, systemic risk management, and investor protection that will guide Congress in passing legislation to reform the financial and securities markets. In an earlier address to a joint session of Congress, the President called for quick action on legislation to reform the nation’s outdated financial regulatory regime.

The first and second principles center on systemic risk. The first is to enforce the strict oversight of financial institutions that pose systemic risks to the markets. The second and related principle is to strengthen markets so they can withstand both system-wide stress and the failure of one or more large institutions. These principles dovetail with recommendations of the recent Volcker G-30 report and High Level Group report to the European Commission for a systemic risk regulator, a concept also endorsed by House Financial Services Chair Barney Frank.

It is crucial that a systemic risk regulator be created so that there is in place an effective early warning mechanism as soon as signs of weaknesses are detected in the financial system. And a graduated risk warning framework for ensuring that, in the future, the identification of risks translates into appropriate action.

A third principle is to encourage transparency in the financial system. This is a goal of a number of blueprints for reform. In conjunction with systemic reform, a fourth principle seeks to regulate financial products based on actual data on how actual people make financial decisions. This principle appears to dovetail with a congressional desire to create a Financial Products Safety Commission similar to the Consumer Products Safety Commission.

A fifth principle that must guide financial regulation reform is accountability, starting at the top. This principle incorporates tone at the top and the need to create a culture of compliance, effective risk management, and sound corporate governance. A sixth broad principle is to overhaul regulations so they are comprehensive and free of gaps. This principle appears to portend the regulation of hedge funds and other entities that currently create a gap in regulation.

There is a growing consensus to regulate hedge funds and other entities that may affect systemic market risk. Finally, the regulatory overhaul must be informed by the recognition that the financial markets are global. This will mean cooperating and coordinating with financial regulators in the European Union and elsewhere.
NASAA Opens Registration for 24th Annual Public Policy Conference

The North American Securities Administrators Association (NASAA) has now opened registration for its 24th Annual Public Policy Conference. This year’s conference, which brings together securities regulators, financial service industry representatives, consumer groups and policy makers, will be held at the Washington Court Hotel in Washington, D.C. on Tuesday, April 28, 2009.

The conference begins with a luncheon and keynote address. The luncheon will be followed by two panel discussions, a featured speaker, and an ombudsman meeting. The panels will explore various proposals for restructuring the nation’s financial regulatory system and restoring investor confidence. A tentative agenda follows:

- Registration (11:00 a.m. – 12:00 p.m.)

- Luncheon with Keynote Address (12:00 p.m. – 1:15 p.m.)

- General Session (1:30 p.m. – 4:15 p.m.)

- Ombudsman Meeting (4:15 p.m. – 5:15 p.m.)

Registration forms may be downloaded from the NASAA website. All payments must be received by NASAA no later than March 27, 2009. Participants desiring hotel accommodations may contact the Washington Court Hotel at (202) 628-2100. Participants must book their reservations by March 27 and identify themselves as “NASAA Spring Conference” attendees in order to receive the special single occupancy rate of $299.00 plus tax per night.
White Paper on Executive Compensation and Corporate Governance Provisions of the Stimulus Legislation Is Available

The corporate governnace and executive compensation provisions of the American Recovery and Reinvestment Act are significant. They were inserted into the legislation by Senate Banking Committee Chair Christopher Dodd. In addition, Senator Dodd wrote a letter to the SEC explaining these provisions and asking that the SEC promulgate guidance. The SEC quickly responded to Senator Dodd with guidance on the say on pay provisions of the Act. Please click here for for a white papar discussing these events and issues
Indiana Proposes Securities Rule Changes to Coordinate with Adopted New Act

The Indiana Securities Division proposed rule amendments, new rules and proposals to eliminate outdated rules, to coordinate the rules with the July 1, 2008 adoption of the new Indiana Uniform Securities Act modeled after the Uniform Securities Act of 2002. Most of the proposals preserve the existing rule text and, instead, update rule references to reflect the section numbers of the new Act and replace legalese with plain English. Some of the substantive changes, however, add a federal covered securities rule for 18(b)(4)(D) [Rule 506] offerings and adopt by reference for registered offerings certain policy statements of the North American Securities Administrators Association (NASAA). A secondary market exemption and a notice of nonpublic sales provision would be among the existing rules eliminated.

The contact person at the Indiana Securities Division for the rule proposals is Jeff Bush, Enforcement Attorney. His phone number is (317) 232-6686 and here is his email address.

The Indiana Securities Division website can be found here.

Wednesday, February 25, 2009

Kentucky Issues Stop Order Against Rule 506 Offering

The Kentucky Department of Financial Institutions (DFI) has issued a stop order against a Rule 506 offering based on inaccurate and inconsistent information contained in the issuer's notice filing with the state. A Kentucky corporation had filed a copy of federal Form D and the offering's private placement memorandum (PPM) with the DFI in order to claim an exemption from state registration for the sale of joint venture interests in a well completion project. The DFI suspended the offer and sale of the securities in the public interest, concluding that the action was necessary to protect investors who might be induced to invest based on the false or misleading information contained in the offering documents.

Among its several administrative findings and conclusions of law, the DFI determined that the PPM contained material misstatements or omissions because it failed to disclose to investors an administrative action brought against the corporation and its president by the Pennsylvania Securities Commission. Additionally, the PPM did not disclose the amounts to be paid as salaries or administrative and management costs, even though the Form D disclosed that $100,000 had been earmarked for this purpose; failed to disclose relevant production history or revenue for wells in the project; and did not provide any background information related to the corporation's officers or management. The DFI also concluded that the corporation falsely represented in Form D that no commissions were to be paid in connection with the offering. The agency found that the corporation had represented elsewhere in Form D that commissions would be paid to certain individuals, several of whom were seeking registration as the corporation's agents and whose applications themselves were either misleading or incomplete.

In re Energy Exploration, Inc. (Ky. Order 2009).

Connecticut Proposes Tougher Hedge Fund Laws

Connecticut, a state with a large volume of hedge funds, has proposed tougher oversight for the hedge fund industry following the Madoff scandals and market losses. State legislators recently introduced three bills that would bring changes to the state's longstanding hands-off approach, according to a letter the Connecticut Hedge Fund Association sent to its members on Tuesday.

Hearings on the bills are scheduled for February 27 at the Connecticut state capitol in Hartford.

The bills would require hedge funds to obtain a state license, provide an independent annual financial audit, disclose fees and report significant changes in their management or investment strategy.

For additional information, see here.
SEC Responds to Dodd with Guidance on Say on Pay Provisions of Stimulus Legislation

In a letter to SEC Chair Mary Schapiro, Senate Banking Committee Chair Christopher Dodd explained the shareholder advisory vote provisions for TARP recipients in the American Recovery and Reinvestment Act of 2009. He also discussed the requirement that chief executive and financial officers provide a certification of compliance with the new corporate governance standards contained in the Act. Moreover, although the Act gives the SEC up to one year to adopt regulations implementing say on pay, Senator Dodd urged the Commission to provide such guidance as soon as possible. He said that firms required to comply with the new executive compensation and corporate standards would benefit from prompt and clear guidance from the SEC staff on how to comply with the Act’s requirements. It was the Dodd Amendment to the stimulus legislation that inserted the provisions in the Act.

The SEC’s Division of Corporation Finance quickly responded to Senator Dodd’s request. The legislation provides that any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP recipient must permit a separate shareholder vote on executive compensation. According to the SEC, a separate shareholder vote on executive compensation is not required for any meeting other than the annual meeting of shareholders for which proxies will be solicited for the election of directors or a special meeting in lieu of such annual meeting.

The Act refers to the compensation of executives as disclosed pursuant to the compensation disclosure rules of the Commission, which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material. The staff noted that smaller reporting companies are not required to provide compensation discussion and analysis under Item 402 of Regulation S-K. Thus, in the SEC’s view, a smaller reporting company that becomes subject to the Act's say-on-pay provision will not have to provide compensation discussion and analysis disclosure.

In addition, the SEC staff said that a company that determines to comply with the Act’s say-on-pay provisions by including its own proposal to have shareholders approve executive compensation will be required to file a preliminary proxy statement pursuant to Exchange Act Rule 14a-6(a). Moreover, if the company faces special circumstances and would like to request acceleration of Rule 14a-6(a)'s ten-day review period, the company should contact the Assistant Director of the SEC office that reviews the company's filings to discuss the special circumstances the company faces and how the ten-day review period could be accelerated.
Kansas Proposes to Increase Investment Company Filing Fees

The notice fee for filing Form NF, Uniform Investment Company Notice Filing, to make an offering of investment company securities would increase to $750, from $500. Similarly, the notice fee to file Form NF to make an offering of unit investment trust securities would increase to $500, from $200. Also proposed are rules prohibiting securities industry persons from using senior-specific professional designations or certifications to offer or sell securities, or provide advice about them, to senior citizens unless prescribed conditions are met.

The time-period for submitting written comments about the rule proposals ends on April 20, 2009; a public hearing will be held April 22. Send written comments to the Office of the Securities Commissioner, 618 S. Kansas Ave., First Floor, Topeka, Kansas 66603-3804. For further information, please see http://www.securities.state.ks.us/

Monday, February 23, 2009

Dodd Letter to SEC Details Effective Dates of Say on Pay and Compliance Certification

In a letter to SEC Chair Mary Schapiro, Senate Banking Committee Chair Christopher Dodd explained the shareholder advisory vote provisions for TARP recipients in the American Recovery and Reinvestment Act of 2009. He also discussed the requirement that chief executive and financial officers provide a certification of compliance with the new corporate governance standards contained in the Act. Moreover, although the Act gives the SEC up to one year to adopt regulations implementing say on pay, Senator Dodd urged the Commission to provide such guidance as soon as possible. He said that firms required to comply with the new executive compensation and corporate standards would benefit from prompt and clear guidance from the SEC staff on how to comply with the Act’s requirements. It was the Dodd Amendment to the stimulus legislation that inserted the provisions in the Act.

The Act provides that, during the period in which any obligation arising from TARP assistance remains outstanding, any proxy for an annual or other meeting of the shareholders of any TARP company must permit a separate non-binding shareholder vote to approve the compensation of executives, as disclosed pursuant to SEC rules, which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material.

In his letter to the Commission, Senator Dodd said that this provision of the law became effective on February 17, 2009. In his view, the say on pay provision would not apply to preliminary, or the related definitive proxy statement even if filed after February 17, or definitive proxy statements filed with the SEC on or before February 17, but would apply to proxies filed after that date.

The law is intended to require a yearly vote by shareholders, reiterated the chair, and such vote can be held either at the annual shareholder meeting at which directors are elected or at a special or other meeting which is held in lieu of the annual meeting. He also emphasized that nothing in the shareholder advisory vote provisions of the Act changes the substantive executive compensation disclosure requirements under SEC rules. Further, although the SEC will determine if it will need to amend its rules to address the provisions of the Act, any such determination will not affect the effective date of the provision.

The Act also provides that the TARP company CEO and CFO must provide a written certification of compliance by the company with the mandated executive compensation and corporate governance standards. These standards include restrictions on bonuses, independent compensation committees, and prohibitions on golden parachutes. In the case of a TARP company whose securities are publicly traded, the certification must be provided to the SEC, together with annual filings required under the securities laws. For nonpublic companies, the certification must be filed with the Treasury.

Senator Dodd said that, since the certification requirement relates to compliance with executive compensation and corporate governance standards that are yet to be set by Treasury, this requirement is not yet effective. Thus, CEOs and CFOs will not be required to certify as to their company’s compliance with such standards until they have been established.
SEC Says Canadian Company and Finance Officers Misled Outside Auditors in Options Backdating Scheme

An SEC enforcement action charges a Canadian company and four of its senior officers with misleading the company’s independent auditors about a stock option backdating scheme. The SEC said that undisclosed, in-the-money options were illegally granted to company executives and employees by backdating millions of stock options over an eight-year period. The complaint alleges that the defendants made false and misleading disclosures about how the company priced and accounted for options, and that the illicit backdating provided the executives and other employees with millions of dollars in undisclosed compensation. The officers charged included the CFO and the Vice President of Finance, both of whom had previously worked as auditors for a Big Four accounting firm. (SEC v. Research in Motion Limited, et al., DC DofC, AAER No. 2937).

The SEC alleged that the executives backdated documents reflecting grants, such as option agreements and offer letters, which concealed the fact that the options were granted in-the-money. The two finance officers took steps to hide the backdating from the company’s independent auditor, outside counsel, and U.S. and Canadian regulators. The CFO also misled investors at the annual shareholder meeting by denying that the company was backdating. The SEC alleged that the two finance officers violated the antifraud provisions of the Exchange Act, as well as provisions prohibiting misrepresentations to auditors.

When the company became an SEC reporting company, the outside auditor provided the finance officers with a description of the U.S. GAAP requirements for stock option accounting, which description became part of the annual reports on Form 40-F that the company filed with the Commission. Further, the finance officers received numerous additional documents from the outside auditor and outside counsel explaining that the company was required to record compensation expenses for in­-the-money options.

The SEC said that the CFO misrepresented in management representation letters to the independent auditor that he had no knowledge of any fraud or illegal acts and that the company’s internal controls were adequate to permit the preparation of accurate financial statements. He also told the auditor that the financial statements were fairly presented in conformity with U.S. GAAP.

In addition, the SEC alleged that the two finance officers were aware that inaccurate stock option grant dates from the books and records, including backdated option agreements and information generated from the electronic database the company used for tracking options, were provided to the auditor. And, the senior officers understood that the auditor relied on those documents in conducting its audits and reviews. They also did not provide to the auditor e-mails revealing backdating.

Sunday, February 22, 2009

McCreevy Vets Counterparty Clearing Facility for Credit Default Swaps

Heeding the urgent call of European Commissioner for the Internal Market Charlie McCreevy, the derivatives industry has committed to implement the clearing of credit default swaps on a European central counterparty (CCP), pending a more complete review of the whole derivatives area. The commissioner considers that clearing of credit default swaps on a CCP in the EU essential for financial stability and oversight. The International Swaps and Derivatives Association and the European Banking Federation agreed to immediately engage in a dialogue to resolve all their outstanding technical issues.

The associations and nine of the leading dealer firms in credit default swaps have signed letters to Commissioner McCreevy confirming their engagement to use EU-based central clearing for eligible EU contracts by July 31, 2009. Signatories will work closely with infrastructure providers, regulators and European authorities including the European Central Bank in resolving outstanding technical, regulatory, legal and practical issues. These efforts mirror the engagement the industry has made in other jurisdictions in the interests of a globally cohesive regulatory framework.

While he is aware of the many reasons why more of these derivatives are not exchange traded, Commissioner McCreevy has always believed that more derivatives could be standardized. At the same time, there is a far more pressing need to have a central clearing counterparty for these derivatives. This was underlined by the collapse of Lehman. which was a major counter party in the derivatives area. In addition there was also considerable speculation on Lehman's default through the use of credit default swaps, which again increase the counter party risk in regard to these instruments

The commissioner’s remarks come against the backdrop of a growing global consensus favoring a central counterparty for credit default swaps. Recently, Elizabeth King, SEC Associate Director for Trading and Markets, said that a well-regulated and prudently managed central counterparty for credit default swaps has the potential to significantly reduce counterparty credit risks to market participants. In remarks at the Security Traders Association mid-winter meeting, the SEC official emphasized that a CCP can also reduce systemic risks by preventing the failure of a single market participant from having a disproportionate effect on the overall market.

A central counterparty can also facilitate greater market transparency and encourage a more competitive trading environment, she explained, which could decrease transaction costs, improve price transparency, and contribute to an increase in market liquidity.

A global CCP is becoming more likely as a consensus builds that this is an important aspect of market reform. Recently, French central bank chief Christian Noyer endorsed the initiative to create a central counterparty for credit default swaps, calling the initiative crucial to financial stability. Similarly, the European Central Bank welcomes the initiatives to create central counterparties for credit default swaps and expects to see concrete results. Former NY Fed President Gerald Corrigan recently told the House Agriculture Committee that there should be a single dedicated global CCP for credit default swaps.

Late last year the Fed, SEC and CFTC entered into a Memorandum of Understanding regarding central counterparties for credit default swaps, thereby providing something of an anchor for such focus as it applies to credit default swaps and OTC derivatives more generally. Further, as pointed out by Ms. King, in recognition of the need to strengthen the oversight and the infrastructure of the OTC derivatives market, in November the President's Working Group on Financial Markets announced a series of initiatives. One of these initiatives is the development of one or more central counterparties for credit default swaps, for which recent events have underscored the need.

In essence, the CDS is a deceptively simple financial instrument in which counterparty A (the seller of credit protection) receives a fee from counterparty B (the buyer of credit protection) in exchange for protecting counterparty B against a decline in credit worthiness of a loan or an asset-backed security. If the creditworthiness of the security declines the buyer of protection gains and the seller of protection loses. Needless to say, in a volatile financial market environment in which credit quality is falling and the risk of default is rising, the counterparty risk management process becomes challenging.

Friday, February 20, 2009

NASAA Seeks Comments on Multi-State Review Proposal

The Coordinated Interpretations Project Group of the North American Securities Administrators Association (NASAA) has requested public comments on the adoption of a new Statement of Policy Regarding Multi-State Review of Requests for Interpretative Opinions and No-Action Letters.

As noted by the Project Group in its release today, many state securities regulators have the authority to issue “no-action letters” in which staff confirms that a transaction carried out under a set of assumed facts will not result in a recommendation for enforcement action. Additionally, some states issue “interpretive opinions” in which staff provides guidance by indicating how a provision of law applies to a situation presented. These types of no-action letters and interpretive opinions are authorized by provisions of both the Uniform Securities Act of 1956, as amended, and the Uniform Securities Act (2002). Moreover, both the 1956 Act and the 2002 Act authorize the states to cooperate with each other in the development of no-action letters and interpretive opinions in order to encourage uniform interpretation of laws and maximize the effectiveness of regulation. Accordingly, NASAA has proposed this Statement of Policy.

Among it elements, Section II of the proposed Statement of Policy contains definitions, including the terms “interpretive opinion" and “no-action letter. " Section III establishes the criteria for eligibility, prohibiting the review of hypothetical situations, past transactions, or issues that are currently subject to or in preparation for litigation.

Sections IV and V set forth the rules governing the content of the request letter and the application process. Request letters and fees are to be accompanied by the submission of a new uniform form, Form MS-ONA (Application for Multi-State Review of Request for Interpretive Opinion or No-Action Letter). The review process itself is described in Section VI, which calls for conference calls and an electronic list-serve to facilitate communication between states. Each selected jurisdiction must use best efforts to generate a response within 60 days. Section VII contains optional disclaimers for the states to consider using.

The text of the proposed Statement of Policy may be downloaded from the NASAA website.

The comment period begins February 20, 2009 and will remain open for 30 days. All comments should be submitted on or before March 22, 2009, and should be directed to:

Rick A. Fleming
General Counsel
Office of the Securities Commissioner
618 S. Kansas Avenue
Topeka, Kansas 66603
rick.fleming@ksc.ks.gov

Rex Staples
General Counsel
NASAA
750 First Street, NE, Suite 1140
Washington, DC 20002-4251
rs@nasaa.org
UK FSA Seeks Input on Proposed Short Selling Disclosure Requirement

The below post is compliments of my esteemed colleague John Filar Atwood

The U.K. Financial Services Authority has proposed a general short selling disclosure requirement in a discussion paper that asks market participants for their input on the international debate on short sales. The FSA stopped short of providing a detailed blueprint for a disclosure regime because it believes a global consensus on the issue must be developed. The regulator simply wants to contribute to the work already being done by IOSCO, CESR and others on short selling.

The FSA stated in no uncertain terms that it believes that short selling is still a legitimate trading activity that tends to enhance price efficiency and liquidity. It also believes that there should be no direct restrictions on short selling. However, the regulator does see advantages in having enhanced transparency of short selling, and so proposed that disclosure requirements for significant short positions should be introduced for all U.K. listed stocks.

The FSA acknowledged that the different disclosure measures on short selling taken by various regulators around the world have raised issues for those firms that operate cross-border. It hopes that any enhanced transparency requirements for short selling would be applied on as wide a basis as possible to avoid market participants having to cope with a multiplicity of regimes.

Short selling can be used to commit market abuse and can contribute to disorderly markets, the FSA noted, and it understands that short selling is viewed as a controversial technique by many, particularly in times of falling markets. There is a widespread conceptual problem with market participants being able to sell something they do not own, according to the FSA, but economic theory and empirical studies support the view that short selling normally contributes to the efficient functioning of the market.

The FSA said that the case for improving transparency of short selling is two-fold: it would provide additional valuable information to the market, and applying new disclosure obligations could mitigate some of the problems associated with short selling.

A disclosure obligation enhances transparency by disclosing to the market the size of significant short positions and the identity of significant short sellers in the relevant stocks. This provides insight into short sellers’ price movement expectations and can improve pricing efficiency if the information is correctly interpreted, the FSA said. More information about the opinions that investors hold on a particular stock would be available to all investors.

A requirement to disclose short positions held also would help in detecting short selling that is being used to commit market abuse, in the FSA’s opinion. Greater transparency through disclosure also could help identify when investors are over-reacting to abrupt price changes, and give the regulator more advance warning of conditions in which it might have to consider regulatory intervention.

In the discussion paper, the FSA also outlined the potential costs of adding new disclosure obligations. If any new transparency obligations have the effect of significantly reducing the overall level of short selling, this could have an impact on price formation and liquidity in general. In addition, if short sellers adjust their behavior to stay under any disclosure limits, this would reduce the overall informational benefits.

The FSA noted that depending on how disclosures are made, another indirect cost could be the possible herding effect of other short sellers following a big-name short seller. This has the potential to turn a downward price spiral into a self-fulfilling prophecy, according to the FSA. This may also occur with the publication of information about the level of aggregate short interest in a particular stock.

There are also the direct costs to firms that conduct short selling—staff hours spent on compliance, funds needed to set up and maintain disclosure systems—in implementing and operating the systems in order to comply with new obligations. The FSA noted that these would be magnified if firms were faced with different obligations in different jurisdictions.

Even with these costs, the FSA said that because markets operate normally for the vast majority of time, it is firmly of the view that the positive benefits of short selling outweigh the negative impacts. This is why the regulator did not propose a permanent blanket ban.

Although the FSA currently does not think that any direct constraints on short selling are justified, it acknowledged that extreme market conditions could re-emerge where the risks posed by short selling would warrant some form of emergency intervention, most likely in the form of a prohibition. The regulator promised to continue to monitor the markets and reintroduce a prohibition should it be warranted.
FINRA Proposes New Registration Category for Investment Banking Professionals

The Financial Industry Regulatory Authority filed with the SEC a proposed rule change to create a Rule 1032(i) to add a new category for limited representative registration for investment banking professionals. Similarly, the proposal would adopt registration requirements for principals who supervise investment banking activities.

The proposed registration category would not cover individuals whose investment banking work is limited to public (municipal) finance offerings, direct participation program offerings, or private securities offerings.

The rule change will not be effective until it is published for comment and approved by the Securities and Exchange Commission.

For proposed rule text, please see here.

To submit electronic comments, use the SEC's Internet comment form or send an email that includes File Number SR-FINRA-2009-006 on the subject line.

Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F. Street, NE, Washington, DC 20549-1090.

Thursday, February 19, 2009


FASB to Review Fair Value Accounting; American Bankers Assoc. Urges Use of IASB Formula

Keying on a seminal SEC report and its own internal evaluation, FASB will conduct an intensive review of fair value accounting as part of an effort to improve the guidance used to determine fair values and the disclosure of fair value estimates. The initiative is in response to recommendations contained in the recent SEC report on mark-to-market accounting, as well as on input provided by FASB’s Valuation Resource Group.

The SEC expressed continued support for fair value accounting in its study, but recommended improvements in the guidance on the application of fair value principles. FASB Chair Robert Herz said that the Board agrees with the SEC that more application guidance is needed to determine fair values in current market conditions. Moreover, investors have asked for more disclosure about fair value estimates. FASB intends to ultimately provide guidance that will improve disclosures in financial reports.

The initiative is two-pronged. The project on application guidance will address determining when a market for an asset or a liability is active or inactive; determining when a transaction is distressed, and applying fair value to interests in alternative investments, such as hedge funds and private equity funds. The project on improving disclosures about fair value measurements will consider requiring additional disclosures on such matters as sensitivities of measurements to key inputs and transfers of items between the fair value measurement levels. The FASB anticipates completing the project on application guidance by the end of the second quarter of 2009, and the project on improving disclosures in time for year-end financial reporting.

While praising FASB’s initiative, the American Bankers Association is concerned that critical problems regarding the issue of other than temporary impairment are being overlooked. The ABA is disappointed that FASB has ignored the need to directly repair the problems regarding other than temporary impairment in the planned projects. The ABA noted that the recent SEC study recommended that FASB re-examine such impairment expeditiously.

In the ABA’s view, the international model for other than temporary impairment used by the IASB, which is based on credit impairment rather than fair value, represents a superior approach to US GAAP. As a result, U.S. companies are needlessly required to report higher paper losses than their international competitors. The trigger for determining such impairment in the U.S should be based on actual credit impairment, said the ABA, and the accompanying mark down should be made for the amount of that credit impairment as opposed to marking it to market. Recoveries of impairment should be reversed through earnings, as they are for international accounting.

The FASB and the IASB have simultaneously proposed changes to their standards for disclosure of fair value of financial instruments. The IASB proposed amendments to IFRS 7 that would require an entity to state in tabular form the fair value, amortized cost and amount at which the investments are actually carried in the financial statements. The amendments would also require an entity to disclose the effect on profit or loss and equity if all debt instruments had been accounted for at fair value or at amortized cost.

IASB Chair David Tweedie praised the joint effort as a swift reaction to the accounting issues that have arisen as a result of the financial crisis. Enhanced disclosures for investments in debt instruments will provide greater transparency and help to regain investor confidence in the financial markets, he said. The fact that FASB also issued similar proposals shows a commitment to seek global solutions to a global crisis.

For its part, FASB proposed changes to FAS 107, Disclosures about Fair Value of Financial Instruments, to increase the comparability of information about financial assets that have related economic characteristics but have different measurement attributes. The proposed staff position, 107-a, would apply to debt securities classified as held-to-maturity and available-for-sale and loans and long-term receivables that are not measured at fair value with changes in the fair value recognized through earnings.

The disclosures would be required include a comparison of common measurement attributes for financial assets and the pro forma income from continuing operations (before taxes) under the different measurement scenarios. These disclosures were developed jointly with the IASB, which, as noted above, issued an exposure draft proposing a similar set of disclosures.
SEC Corporate Finance Division Provides Guidance for Form D Filers

The SEC's Corporate Finance Division provides the following guidance to new filers and Form D filers.

Until March 15, 2009, Form D filers may submit their filings in either paper or electronic form. Beginning March 16, 2009, Form D filers must:

* Make all Form D filings electronically on EDGAR; and

* Amend their Form D filings if they are conducting continuing
offerings of securities and they have not made a Form D filing within the previous year.

Because the new annual amendment and electronic filing requirements will affect many filers that have not filed using EDGAR in the past, we expect requests for EDGAR access codes to increase. To avoid a delay in receiving EDGAR access codes, new EDGAR filers may wish to request EDGAR access codes well in advance of a filing deadline.

Filers with an annual amendment requirement may submit paper or electronic Form D filings before the March 16 deadline, and may wish to do so to avoid potential delays around that date. After March 16, the amendment must be electronic.

We strive to respond promptly to requests for EDGAR access codes. Given the potential filing volume during March, requests for EDGAR access codes may take longer than usual. To avoid unnecessary delays, we suggest that filers secure EDGAR access codes well in advance of their electronic filing deadline. Filers who have submitted only paper filings should use the "Convert Paper Only Filer to Electronic Filer" process outlined in the EDGAR Filer Manual.

Link

Tuesday, February 17, 2009

House Bill Would Tax Securities Transactions to Pay for TARP

A House bill would impose a securities transfer tax to pay for the cost of the troubled asset relief program (TARP). The Let Wall Street Pay for Wall Street's Bailout Act of 2009 (HR 1068) would add a new Section 4475 to the Internal Revenue Code to impose a tax on each covered securities transaction in an amount equal to the applicable percentage of the value of the security involved in the transaction. The tax would be paid by the trading facility on which the transaction occurs. The transfer tax would be broadly applied to the sale and purchase of financial instruments such as stock, options, and futures. Treasury must implement the tax in consultation with the SEC and CFTC.

The tax on each covered securities transaction would be an amount equal to the applicable percentage of the value of the security involved in such transaction. The bill defines applicable percentage to mean the lesser of the specified percentage or 0.25 percent. In turn, specified percentage is defined to mean the percentage that Treasury estimates would result in the aggregate revenue equal to the net cost of carrying out the TARP.

Monday, February 16, 2009

House Agriculture Committee Reports Out Derivatives Oversight Bill

The House Agriculture Committee has approved legislation to increase the transparency of and strengthen the oversight of futures, options and over-the-counter (OTC) markets. By voice vote, the Committee approved the Derivatives Markets Transparency and Accountability Act of 2009 as amended, a bill sponsored by Committee Chair Collin Peterson. The bill was referred to the House Financial Services Committee. There is a companion bill in the Senate introduced by Senator Tom Harkin, Chair of the Agriculture Committee. The Harkin bill, S 272, would bring all OTC financial transactions and credit default swaps currently traded without federal oversight onto regulated exchanges.

The House legislation, H.R. 977, will bring greater transparency and oversight to futures and OTC derivatives markets. It toughens position limits on futures contracts for physically-deliverable commodities as a way to prevent potential price distortions caused by excessive speculative trading. An innovative provision authorizes the CFTC to initiate and conduct criminal litigation for violations of the Act if the US Attorney General has declined to bring criminal proceedings. This is a power the SEC does not have.

From October through December 2008, this Committee held a widely publicized series of hearings on the role unregulated OTC financial derivatives have played in causing the present economic meltdown The draft legislation is designed to apply time-tested tools of market regulation to the OTC energy and financial derivatives markets.

The overwhelming message of the testimony presented to the Committee established a consensus that the previously unregulated OTC markets have caused severe systemic shocks because of a lack of transparency to the financial regulators of these private bilateral agreements, and because of inadequate capital reserves set aside by OTC derivative counterparties to underpin the trillions of dollars of financial commitments they made through the OTC transactions in question.

The bill requires all prospective over-the-counter transactions to be settled and cleared through a CFTC-regulated designated clearing organization, unless exempted by the CFTC in accordance with specified criteria. In some cases, the clearing requirement can met through an SEC regulated clearing agency or a properly regulated foreign clearinghouse. The measure gives the CFTC the authority, with the President’s consent, to suspend naked credit default swap trading whenever an SEC short selling suspension order is in effect.

Importantly, the measure would close the so-called London Loophole by requiring foreign boards of trade to share trading data and adopt speculative position limits on contracts that trade U.S. commodities similar to U.S.-regulated exchanges The bill also imposes a clearing requirement on OTC derivatives contracts and empowers the CFTC to suspend trading in naked credit default swaps under certain circumstances. The bill broadens and improves on last year’s bipartisan derivatives legislation that passed the House by a wide margin.

The measure will also limit eligibility for hedge exemptions to bona-fide hedgers and improve transparency by requiring the CFTC to disaggregate and separately report the trading activity of index funds and swap dealers in agriculture and energy markets. It also calls for new, full-time CFTC employees to enforce manipulation and prevent fraud.

The bill also authorizes the CFTC to take corrective action if it finds disruption in over-the-counter markets for energy and gas. A manager’s amendment by Chairman Peterson, by voice vote, contains technical and clarifying corrections, and changes regarding position limits and CFTC authority to suspend credit default swaps trading.

Section 4 of the bill requires the CFTC to issue a proposed rule defining and classifying index traders and swap dealers for data reporting requirements and setting reporting requirements for transactions in designated contracts markets, derivatives transaction execution facilities, foreign boards of trade, and electronic trading facilities with respect to significant price discovery contracts. The statute also requires the CFTC to disaggregate and publicly provide the number and total value of positions of index funds, and other passive, long-only and short-only investors in all regulated markets, and data speculative positions relative to their bona fide physical hedgers.

The bill also authorizes the CFTC to suspend trading in credit default swaps, with the concurrence of the President. The measure provides that credit default swaps traded or cleared by registered entities will not be considered a federal security except as necessary for enforcing insider trading prohibitions of the Securities Exchange Act.

The Act defines credit default swap to mean a contract which insures a party to the contract against the risk that an entity may experience a loss of value as a result of an event specified in the contract, such as a default or credit downgrade.

The bill essentially bans naked credit default swaps, which are those swaps that are merely a wager on the viability of an institution or financial instrument without requiring the corresponding underlying risk from the failure of those institutions or instruments. Former SEC Chair Christopher Cox repeatedly criticized these instruments as naked shorts on public corporations that evade the requirements for shorting stocks in the regulated equity markets.

The draft legislation provides for tailored and limited exemptions that may be granted by the CFTC from the mandatory clearing requirements for individually negotiated derivatives. The precise standards assure that the exemption will only be granted when systemic risks will not be posed. The draft legislation is a reasonable compromise that accommodates individually negotiated contracts that cannot be cleared. By contrast, Senator Harkin’s legislation flatly bans exceptions from this requirement that all OTC contracts be exchange traded, not merely cleared.

Sunday, February 15, 2009

Congress Passes Stimulus Act with Stringent Executive Compensation Rules and Strong Corporate Governance Mandates

Congress has passed and cleared for the President the American Recovery and Reinvestment Act of 2009, imposing stringent executive compensation limits on companies participating in the troubled assets relief program (TARP) and setting up a conflict between legislative mandates and less restrictive Treasury regulations. The provisions also require each TARP recipient to include in its annual proxy statement a nonbinding shareholder advisory vote on the company’s executive cash compensation program, thereby providing the first ever federal mandate on say on pay. The Act further prohibits golden parachutes to senior executives and severely restricts bonuses under a complicated regime based on the amount a TARP company receives.

The Act also imposes strong corporate governance mandates on TARP companies, including a requirement to have an independent compensation committee. In addition, it rescinds a controversial IRS ruling on acquisitions by financial institutions.

The provisions fall under a title of the bill added by Senate Banking Committee Chair Christopher Dodd. The Dodd Amendment applies strong executive compensation restrictions to all recipients of TARP funds, regardless of whether they receive a capital injection or sell troubled assets at auction.

The Act also prohibits any compensation plan that creates incentives for employees to manipulate reported earnings or take unnecessary and excessive risks that threaten the company’s value. The board must also adopt a company-wide policy on luxury expenditures.

The TARP company CEO and CFO must provide a written certification of compliance by the company with the executive compensation and corporate governance requirements. In the case of a TARP company whose securities are publicly traded, the certification must be provided to the SEC, together with annual filings required under the securities laws. For nonpublic companies, the certification must be filed with the Treasury.

The Act also requires TARP recipients to establish a compensation committee of the board of directors composed entirely of independent directors for the purpose of reviewing compensation plans. The Act directs the compensation committee of each TARP recipient to meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans.

Another required corporate governance standard for TARP recipients is that they are prohibited from paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any such prohibition must not apply to the payment of long-term restricted stock by such TARP recipient, provided that such long term restricted stock does not fully vest during the period in which any obligation arising from financial assistance provided to the TARP recipient remains outstanding and has a value that is not greater than one-third of the total amount of annual compensation of the employee receiving the stock; and also is subject to any other conditions Treasury may impose in the public interest.

The prohibition on the paying of bonuses by TARP companies will apply in the following way: For financial institutions that received TARP financial assistance of $25,000,000, or less the prohibition will apply only to the most highly compensated employee of the financial institution. For financial institutions that received TARP financial assistance of between $25,000,000 and $250,000,000 the prohibition on bonuses must apply to the five most highly-compensated employees, or such higher number as determined by Treasury as being in the public interest. For financial institutions that received TARP assistance of between $250,000,000 and $500,000,000 the prohibition on bonuses must apply to the senior executive officers and at least the next ten most highly compensated employees or a higher number determined by Treasury as in the public interest. For any financial institution receiving TARP assistance of $500,000,000 or more the bonus prohibition will apply to the senior executive officers and at least the 20 next most highly compensated employees or such higher number as Treasury may determine as in the public interest.

Friday, February 13, 2009

House Passes Stimulus Bill with Say on Pay

The American Recovery and Reinvestment Act of 2009 has passed the House and is in the verge of Senate passage. The Actimposes various executive compensation limits on companies participating in the troubled assets relief program (TARP). The provisions also require each TARP recipient to include in its annual proxy statement a nonbinding shareholder advisory vote on the company’s executive cash compensation program. This is the first ever federal say on pay mandate.

During the period in which any obligation arising from TARP assistance remains outstanding, any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP company must permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to SEC rules (which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material). Within one year of enactment, the SEC must issue final rules and regulations required by this section.

The shareholder vote will be nonbinding. Moreover, the Act provides that the vote may not be construed as overruling a decision by the company’s board or as creating any additional fiduciary duty of the board. Similarly, the advisory vote cannot be construed to restrict shareholders from making proposals for inclusion in proxy materials related to executive compensation.
Tide Shifts in Federal Preemption of State Securities Cases Involving Rule 506 Transactions

The National Securities Markets Improvement Act of 1996 (NSMIA) was designed, among other things, to curtail over-regulation of securities at the state level and, hence, increase capital formation, by preempting the states from regulating securities in transactions considered to belong exclusively to federal regulators such as the SEC. One of the most key and popular transactions among Blue Sky practitioners and their issuer-clients that was affected by NSMIA turned out to be the Rule 506 offering transaction. NSMIA preserved to the states the right to require a notice on SEC Form D and collect a fee for the filing but eliminated the states' right to regulate the merits of the offering. The thinking at the time was that NSMIA retained the states' right to prosecute the issuer for fraud, as well as the defrauded investors' right to have the deal rescinded, and thereby justified eliminating the duplicate efforts of the SEC by the states to regulate a transaction that came out of a federal Act and rule. Still, it seemed for the longest time, from the mid to late 1990s and into the 2000s, that the states' hands were tied where Rule 506 transactions were concerned...at least at the legislative level.

Then a curious thing began to emerge in the early 2000s, but at the judicial level: the rights of the states to regulate Rule 506 offerings by striking them down in transactions considered to be invalid started to show up in federal court. The first two cases now considered the minority view, Temple v. Gorman from 2002 and Lillard v. Stockton from 2003, held against the states and investors by siding with the defendant issuers' claims that the states were preempted from regulating the Rule 506 transactions by NSMIA. The states argued that the particular transactions violated the substantive requirements of federal Rule 506 but the South District Court of Florida in Temple v. Gorman and the Northern District Court of Oklahoma in Lillard v. Stockton held that the mere fact that the defendants brought forth the claim that Rule 506 transactions were preempted from state regulation under NSMIA was all that was necessary to rule in their favor.

But the tide has since shifted away from this view, and the majority view in more recent decisions starting with Buist v. Time Domain Corp., and proceeding to Private Equity Fund v. Miresco Investment Services, Pinnacle Communications International Inc. v. American Family Mortgage Corp., Hamby v. Clearwater Consulting Concepts, Grubka v. WebAccess International Inc., in re Blue Flame Energy Corp., and Brown v. Earthboard Sports USA, Inc. holds that if the transaction violates the substantive requirements of Rule 506 by allowing, for example, general solicitation and advertising, then federal preemption does not apply and the states may invalidate the transaction before the offering goes forth in their respective jurisdictions.

History is being made as the preemptive effect of the NSMIA Act continues to be tested in court through the currently most popular securities transaction at the state level, the Rule 506 offering.

The above summary is attributed to Jeffrey D. Chadwick who wrote a Comment "Proving Preemption by Proving Exemption: The Quadary of the National Securities Markets Improvement Act," 43 U. Rich. L. Rev. 764 (2009).
Stimulus Bill Imposes Corporate Governance Standards and Say on Pay

The American Recovey and Reinvestment Act of 2009 (H.R. 1), as reported out of the conference committee and cleared for passagwe imposes various executive compensation limits on companies participating in the troubled assets relief program (TARP). The provisions also require each TARP recipient to include in its annual proxy statement a nonbinding shareholder advisory vote on the company’s executive cash compensation program. The Act further prohibits golden parachutes to senior executives. The Act imposes strong corporate governance mandates on TARP companies, including a requirement to have an independent compensation committee. In addition, it rescinds a controversial IRS ruling on acquisitions by financial institutions.

The provisions fall under a title of the bill added by Senate Banking Committee Chair Christopher Dodd. The Dodd Amendment applies strong executive compensation restrictions to all recipients of TARP funds, regardless of whether they receive a capital injection or sell troubled assets at auction.

The Act also prohibits any compensation plan that creates incentives for employees to manipulate reported earnings or take unnecessary and excessive risks that threaten the company’s value. The board must also adopt a company-wide policy on luxury expenditures. The Dodd Amendment bans bonuses for many highly-paid executives of TARP-recipient firms under a sliding scale regime based on the amount of financial assistance the TARP recipient received.

The Act defines “senior executive officer” to mean an individual who is one of the top five most highly-paid executives of a public company and whose compensation must be disclosed pursuant to SEC executive compensation rules. Under SEC rules, these are the principal executive officer, the principal financial officer, and the company’s other three most highly-compensated executives.

The Act defines a TARP recipient to mean any entity that has received or will receive financial assistance provided under the TARP. The Act’s restrictions apply during the period when the TARP recipient has outstanding obligations arising from financial assistance provided under TARP. The Act states that the period in which any obligation arising from financial assistance provided under the TARP remains outstanding does not include any period during which the federal government only holds warrants to purchase common stock of the TARP recipient.

Say on Pay

During the period in which any obligation arising from TARP assistance remains outstanding, any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP company must permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to SEC rules (which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material). Within one year of enactment, the SEC must issue final rules and regulations required by this section. The shareholder vote will be nonbinding. Moreover, the Act provides that the vote may not be construed as overruling a decision by the company’s board or as creating any additional fiduciary duty of the board. Similarly, the advisory vote cannot be construed to restrict shareholders from making proposals for inclusion in proxy materials related to executive compensation.

Compensation Committee

As a matter of sound governance, the Act requires each TARP company have a compensation committee composed entirely of independent directors. The compensation committee must discuss and evaluate, at least semiannually, the employee compensation plans and their potential risk to the company’s financial health.

In the case of any TARP recipient, the common or preferred stock of which is not registered pursuant to the Securities Exchange Act of 1934, and that has received $25,000,000 or less of TARP assistance, the duties of the compensation committee under must be carried out by the board of directors.

Retroactive Compensation Review

The Act also requires a retroactive review of bonuses, retention awards, and other compensation already paid out by companies that received TARP funds. Under this provision, Treasury must review bonus and retention awards and other compensation paid to executives of TARP recipients to determine whether any payments were inconsistent with the Emergency Economic Stabilization Act or the TARP or otherwise contrary to public interest. If they are, Treasury must negotiate with the recipient and the subject employee for appropriate reimbursement of the compensation or bonuses to the federal government.

Repayment of TARP Funds and Loan Modifications

The Act provides that, after consulting with the appropriate federal banking agency, Treasury must permit a TARP recipient to repay any assistance previously provided under the TARP without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, Treasury must liquidate warrants associated with such assistance at the current market price. Treasury is ordered to adopt regulations implementing the repayment program.

The Act also provides that Treasury must not be required to apply these executive compensation restrictions, or to receive warrants or debt instruments, solely in connection with any loan modification under the Emergency Economic Stabilization Act.

Treasury Standards

During the period in which any obligation arising from financial assistance provided under TARP remains outstanding, each TARP recipient will be subject to the corporate governance and executive compensation standards established by Treasury under the Act and the provisions of Internal Revenue Code Section 162(m)(5).

Tracking SEC executive compensation disclosure rules, the five executive officers covered by Section 162(m)(5) are the chief executive officer, the chief financial officer, and the three highest-compensated officers other than the CEO or CFO. For the purpose of determining the three officers, “compensation” is defined as it is in the SEC rules to mean total compensation, whether or not it is includible in the officer’s gross income. However, unlike the SEC rules that determine the highest three officers by reference to total compensation for the last completed fiscal year, the measurement period under 162(m)(5) for purposes of determining the three officers for an applicable taxable year is that taxable year.

For purposes of Section 162(m)(5), including the determination of whether the aggregate amount of assets acquired from an employer exceeds $300 million, two or more persons who are treated as a single employer under Section 414(b) (employees of a controlled group of corporations) and Section 414(c) (employees of partnerships, proprietorships, etc., that are under common control) are treated as a single employer.An applicable employer for purposes of Section 162(m)(5) is not limited to a publicly traded corporation or even to the corporate business form. Thus, an entity, whether or not publicly traded, is an applicable employer if it sells troubled assets pursuant to the Treasury’s program. Also, unlike the general 162(m) calculation of employee remuneration subject to the deductible limit, 162(m)(5) remuneration includes commissions and performance-based compensation.

Under the Act, Treasury must require each TARP recipient to meet detailed, appropriate standards for executive compensation and corporate governance. These standards must include limits on compensation that exclude incentives for senior executive officers to take unnecessary and excessive risks that threaten the value of the company during the period that any obligation arising from TARP assistance is outstanding. The standards must also include a clawback provision for the recovery of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP company based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.

Further, the corporate governance standards must include a prohibition of any golden parachute payment to a senior executive officer or any of the next five most highly-compensated employees during the period that any obligation arising from TARP assistance is outstanding. The Act defines ``golden parachute’’ to mean any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued.

There must also be a prohibition of any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees.
The Act also requires TARP recipients to establish a compensation committee of the board of directors composed entirely of independent directors for the purpose of reviewing compensation plans. The Act directs the compensation committee of each TARP recipient to meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans.

Another required corporate governance standard for TARP recipients is that they are prohibited from paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any such prohibition must not apply to the payment of long-term restricted stock by such TARP recipient, provided that such long term restricted stock does not fully vest during the period in which any obligation arising from financial assistance provided to the TARP recipient remains outstanding and has a value that is not greater than one-third of the total amount of annual compensation of the employee receiving the stock; and also is subject to any other conditions Treasury may impose in the public interest.

The prohibition on the paying of bonuses by TARP companies will apply in the following way:

For financial institutions that received TARP financial assistance of $25,000,000, or less the prohibition will apply only to the most highly compensated employee of the financial institution.

For financial institutions that received TARP financial assistance of between $25,000,000 and $250,000,000 the prohibition on bonuses must apply to the five most highly-compensated employees, or such higher number as determined by Treasury as being in the public interest.

For financial institutions that received TARP assistance of between $250,000,000 and $500,000,000 the prohibition on bonuses must apply to the senior executive officers and at least the next ten most highly compensated employees or a higher number determined by Treasury as in the public interest.

For any financial institution receiving TARP assistance of $500,000,000 or more the bonus prohibition will apply to the senior executive officers and at least the 20 next most highly compensated employees or such higher number as Treasury may determine as in the public interest.

But the Act also provides that the bonus prohibitions will not be applied to prohibit any bonus payment required to be paid pursuant to a written employment contract entered into on or before February 11, 2009 as such valid employment contracts are determined by Treasury.

The TARP company CEO and CFO must provide a written certification of compliance by the company with the executive compensation and corporate governance requirements. In the case of a TARP company whose securities are publicly traded, the certification must be provided to the SEC, together with annual filings required under the securities laws. For nonpublic companies, the certification must be filed with the Treasury.

Luxury Expenditures

The board of directors of any TARP recipient must implement a company-wide policy regarding excessive or luxury expenditures, as identified by Treasury. These may include excessive expenditures on:

Entertainment or events;
Office and facility renovations;
Aviation or other transportation services; or
Other activities or events that are not reasonable expenditures for conferences, staff development, reasonable performance incentives, or other similar measures conducted in the normal course of business operations.

Wednesday, February 11, 2009

Stimulus Bill Rescinds IRS Notice 2008-83

The American Recovery and Reinvestment Act will soon be reported out of conference and become law. As of this writing, both House and Senate versions of the bill rescind IRS Notice 2008-83.

The Act prospectively repeals IRS Notice 2008-83 that interprets Section 382 of the Internal Revenue Code to allow banks and other financial institutions pursuing acquisitions to write-off acquired losses stemming from takeovers of other banks to offset future income. Notice 2008-83 came under intense criticism by many in Congress.

Section 382 was enacted by Congress to prevent tax-motivated acquisitions of loss corporations. On September 30, 2008, Notice 2008-83 effectively removed the limit on how much taxable income a purchasing bank, thrift, industrial loan company, and trust company could deduct post-acquisition. The Notice was designed to help the struggling banking sector recover by allowing acquiring banks the ability to deduct the built-in tax losses of any banks they acquire that possesses a portfolio of loans that have deteriorated in value.

The Act states that Congress finds that the delegation of authority to the Treasury under section 382(m) does not authorize the Secretary to provide exemptions or special rules that are restricted to particular industries or classes of taxpayers. Also, the statute says that IRS Notice 2008-83 is inconsistent with the congressional intent in enacting such 382(m); and that the legal authority to prescribe 2008-83 is doubtful.

With two exceptions, the provision states that Notice 2008-83 will not have any effect for any ownership changes after January 16, 2009. One exception is for ownership changes pursuant to a binding contract entered in to on or before such date, The second exception is for changes pursuant to an agreement entered into on or before such date and such agreement was described in a public announcement or in a filing with the SEC.
Whistleblower Claim Fails, 1st Circuit Finds Fraud Belief Not Reasonable

A former employee seeking Sarbanes-Oxley Act whistleblower protection acted in good faith, concluded a 1st Circuit panel, but under an objective analysis, his belief that the company was engaged in fraud was not reasonable (Day v. Staples, Inc.).

The employee complained that the company improperly handled regularly customer returns. In some instances, as claimed, the company would issue credit without proper documentation, while credits due would be denied in other cases. The company claimed that the employee was terminated for performance reasons not connected to his statements concerning improper conduct.

The Department of Labor administrative law judge dismissed the SOX complaint, as did the federal district court. The district court concluded that the belief that Staples was engaged in accounting fraud was not reasonable.

On appeal, the 1st Circuit stated that "the complaining employee's theory of such fraud must at least approximate the basic elements of a claim of securities fraud." Day's complaint failed to approach this level. Disagreements with management about internal tracking systems and other elements of corporate efficiency were not protected under the whistleblower statute, held the court.

Tuesday, February 10, 2009

Geithner Announces Transparent Regime to Remove Toxic Securities from Bank Balance Sheets

US Treasury Secretary Tim Geithner unveiled a Financial Stability Plan based on transparency and accountability and risk management. With many financial institutions burdened with illiquid asset-backed securities, the Financial Stability Plan will respond to the uncertainty about the real value of these illiquid instruments through increased transparency and disclosure. Treasury will work with bank regulators and the SEC and accounting standard setters in their efforts to improve public disclosure by banks. This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, the SEC and others recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.

Similarly, all relevant financial regulators will work together in a coordinated way to bring more consistent, realistic and forward looking assessment of exposures on the balance sheet of financial institutions.

A key component of the Capital Assistance Program is a requirement that major financial institutions undergo a comprehensive stress test assessing whether they have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected. All financial institutions with assets in excess of $100 billion will be required to participate in the coordinated supervisory review process and comprehensive stress test.

While banks will be encouraged to access private markets to raise any additional capital needed to establish a buffer, a financial institution that has undergone a comprehensive stress test will have access to a Treasury provided capital buffer to help absorb losses and serve as a bridge to receiving increased private capital. While most banks have strong capital positions, a Financial Stability Trust will provide a capital buffer that will operate as a form of contingent equity to ensure firms the capital strength to preserve or increase lending in a worse than expected economic downturn.

Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009. Financial institutions with consolidated assets below $100 billion will also be eligible to obtain capital from the CAP after a supervisory review.


Any capital investments made by Treasury under the CAP will be placed in a separate entity, the Financial Stability Trust, set up to manage the government’s investments in US financial institutions.

In order to cleanse the balance sheets of financial institutions of toxic asset-backed securities, the Financial Stability Plan institutes a public-private investment fund and expands the Fed’s asset-backed securities loan facility. The public-private capital program is designed with a public-private financing component, which could involve putting public or private capital side-by-side and using public financing to leverage private capital on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion. Because the new program is designed to bring private sector equity contributions to make large-scale asset purchases, it not only minimizes public capital and maximizes private capital: it allows private sector buyers to determine the price for current troubled and previously illiquid securities.

The initiative will also expand the initial reach of the Term Asset-Backed Securities Loan Facility to include commercial mortgage-backed securities. In addition, Treasury will continue to consult with the Federal Reserve regarding possible further expansion of the TALF program to include other asset classes, such as non-Agency residential mortgage-backed securities and assets collateralized by corporate debt.

Going forward, the Financial Stability Plan will call for greater transparency, accountability and conditionality with tougher standards for firms receiving exceptional assistance. These will be the new standards going forward and are not retroactive.

All recipients of assistance must submit a plan for how they intend to use that capital to preserve and strengthen their lending capacity. This plan will be submitted during the application process, and Treasury will make these reports public upon completion of the capital investment in the firm.

Firms must detail in monthly reports submitted to the Treasury their lending broken out by category, showing how many new loans they provided to businesses and consumers and how many asset-backed and mortgage-backed securities they purchased, accompanied by a description of the lending environment in the communities and markets they serve. This report will also include a comparison to their most rigorous estimate of what their lending would have been in the absence of government support.

For public companies, similar reports will be filed with the SEC on Form 8-K simultaneous with the filing of the companies’ 10-Q or 10-K reports.

Additionally, Treasury will publish and regularly update key metrics showing the impact of the Financial Stability Plan on credit markets. These reports will be put on the Treasury FinancialStability.gov website so that they can be subject to scrutiny by outside and independent experts.

Firms will also be required to comply with the recently announced senior executive compensation restrictions, including those pertaining to a $500,000 in total annual compensation cap plus restricted stock payable when the government is getting paid back, shareholder advisory votes on executive compensation, and new disclosure and accountability requirements applicable to luxury purchases.
Virgin Islands Decides Its First Securities Case

The U.S. Virgin Islands, the latest jurisdiction to begin regulating securities by adopting the Model Uniform Securities Act in 2005 and some coordinating administrative orders in 2005 and 2006, has just decided its first securities case at trial court level. A V.I. Superior Court Jury on February 8, 2009 found a St. Thomas man guilty of impersonating an investment adviser and running a $500,000 scam. The jury found 21-year old Vinny Gagliani guilty of multiple counts of general fraud, embezzlement by fiduciaries, violating V.I. investment adviser registration requirements, engaging in prohibited conduct by providing investment advice, and delivering a worthless check. The crimes were committed in 2006 and 2007.

For the complete story, please click here.
Utah Amends 506 Exemption Rule to Accommodate Electronic Form D

A 506 exemption rule was amended by the Utah Securities Division to accommodate electronic Form D that issuers have the option of filing electronically through March 15, 2009 but will be required to file electronically with EDGAR starting March 16, 2009.

Initial notice. Issuers must file during this six-month transition period that began September 15, 2008 an initial notice consisting of either a Temporary Form D (that remains effective through March 15, 2009) or a copy of the notice of sales on Form D filed electronically with the SEC through EDGAR. Issuers need to include a manual signature on either version of Form D, along with a statement indicating the date of first sale in Utah or that sales have yet to occur in the State, and a $60 fee. NOTE: Issuers filing Temporary Form D are required to include a manually signed Form U-2, Uniform Consent to Service of Process, but persons having previously filed a Form U-2 would not need to file another. The notice must be filed within 15 days after the first sale of securities in Utah.

Amendments. Issuers need to file amendments to correct material mistakes of fact or errors on a previously filed Form D as soon as practicable after discovering the mistake or error. Issuers filing an amendment to a previously filed notice must respond to all Form D requirements regardless of why the amendment is filed.

For further information, please click here.

Monday, February 09, 2009

Senate Stimulus Bill Contains Corporate Governance and Executive Compensation Title

The Senate version of the American Recovery and Reinvestment Act contains restrictions on various forms of executive compensation for companies participating in the troubled assets relief program (TARP). The provisions also require each TARP recipient to include in its annual proxy statement a non-binding shareholder advisory vote on the company’s executive cash compensation program. The bill also prohibits golden parachutes to senior executives.

The provisions are in Title VI of the bill, which was added by Senate Banking Committee Chair Christopher Dodd. The Dodd Amendment would apply strong executive compensation requirements consistently to all recipients of TARP funds, regardless of whether they receive a capital injection, sell troubled assets at auction or have other types of transactions.

The bill also prohibits a compensation plan that has incentives for employees to take unnecessary and excessive risks that threaten the value of the company. The board must also adopt company-wide policy on luxury expenditures. It further prohibits compensation plans that would encourage manipulation of reported earnings.

The Dodd Amendment bans bonuses for most highly paid executives of TARP-recipient firms and prohibits TARP recipients from paying a bonus, retention award, or other similar incentive compensation to the 25 most highly-paid employees or such higher number as Treasury may determine is in the public interest with respect to any TARP recipient.

The bill defines senior executive officer to mean an individual who is one of the top five most highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the SEC executive compensation rules. Under SEC rules, these are the CEO and CFO, and the next three most highly compensated executives.

Say on Pay

During the period in which any obligation arising from TARP assistance remains outstanding, any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP company must permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the SEC compensation disclosure rules, which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material. Within one year of enactment, the SEC must issue final rules and regulations required by this section.

The shareholder vote will be non-binding. Moreover, the bill provides that the vote may not be construed as overruling a decision by the TARP company’s board, nor create any additional fiduciary duty by the board. Similarly, the advisory vote cannot be construed to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.

Compensation Committee

As a matter of sound governance, the bill requires the compensation committee of each TARP recipient to be composed entirely of independent directors. The compensation committee is required to evaluate compensation plans and their potential risk to the financial health of the company. The Act mandates that the compensation committee of each TARP recipient must meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans

Retroactive Compensation Review

The bill also requires a retroactive review of TARP bonuses already paid out. Under this provision, Treasury must review bonus awards paid to executives of TARP recipients to determine whether any payments were excessive, inconsistent with the purposes of the Act or the TARP or otherwise contrary to public interest. If they are, Treasury must negotiate with the recipient and the subject employee for appropriate reimbursement to the federal government.

The measure also allows for the government to claw back any bonus or incentive compensation paid to an executive based on reported earnings or other criteria later found to be materially inaccurate.

Cap Executive Pay

Title VI of the Act also contains the Cap Executive Pay Act, which provides that no TARP company officer, director, executive, or other employee may receive annual compensation in excess of the amount of compensation paid to the President of the United States. This compensation limitation must be a condition of the receipt of assistance under the TARP, and of any modification to such assistance that was received on or before the date of enactment of the recovery act and must remain in effect with respect to each financial institution or other entity that receives such assistance or modification for the duration of the assistance or obligation provided under the TARP.

The Act broadly defines compensation to include wages, salary, deferred compensation, retirement contributions, options, bonuses, property, and any other form of compensation or bonus that Treasury determines is appropriate. Also, the Treasury is ordered to expeditiously issue such rules as are necessary to carry out this act, including with respect to reimbursement of compensation amounts.

This pay act, introduced by Senator Claire McCaskill effectively says that every TARP company executive going forward could not make more than $400,000 a year, and they have to limit that executive compensation for everyone in their company until they pay back every dime to the taxpayers. (See remarks of Sen. Claire McCaskill, CR, pS1127, Jan 30, 2009).

Executive Compensation and Corporate Governance

During the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, each TARP recipient will be subject to the standards established by Treasury under the Act and the provisions of section 162(m)(5) of the Internal Revenue Code.
Under the bill, Treasury must require each TARP recipient to meet detailed and appropriate standards for executive compensation and corporate governance. These standards must include limits on compensation that exclude incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of the company during the period that any obligation arising from TARP assistance is outstanding. The standards must also include a provision for the recovery by TARP recipients of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP recipient based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.

Further, the corporate governance standards must include a prohibition on a TARP recipient making any golden parachute payment to a senior executive officer or any of the next five most highly-compensated employees of the TARP recipient during the period that any obligation arising from TARP assistance is outstanding. Another required standard is a prohibition on TARP recipients paying or accruing any bonus, retention award, or incentive compensation during the period that the obligation is outstanding to at least the 25 most highly-compensated employees, or such higher number as Treasury may determine is in the public interest with respect to any TARP recipient.

There must also be a prohibition on any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees.

The TARP company CEO and CFO must provide a written certification of compliance by the company with the executive compensation and corporate governance requirements. In the case of a TARP company whose securities are publicly traded, the certification must be provided to the SEC, together with annual filings required under the securities laws. For non-public companies, the certification must be filed with the Treasury.

Excessive Bonuses

If before enactment, the preferred stock of a financial institution was purchased by the government using TASP funds, then the financial institution must redeem an amount of such preferred stock equal to the aggregate amount of all excessive bonuses paid or payable to all covered individuals. Financial institution must comply with this mandate within 120 days after the date of enactment, with respect to excessive bonuses paid before the date of enactment and not later than the day before an excessive bonus is paid, with respect to any excessive bonus paid on or after the date of enactment.

The Act defines excessive bonus to mean the portion of the applicable bonus payments made to a covered individual in excess of $100,000. The Act defines applicable bonus payment to mean any bonus payment to a covered individual that is paid by reason of services performed by such individual in a taxable year of the financial institution ending in 2008, and the amount of which was first communicated to such individual during the period beginning on January 1, 2008, and ending January 31, 2009, or was based on a resolution of the board that was adopted before the end of such taxable year.

In determining whether there was an applicable bonus payment paid by reason of services performed in the taxable year ending in 2008, a bonus payment that relating to services performed in any taxable year before the 2008 taxable year, and that is contingent on the performance of services in the taxable year, must be disregarded. Similarly, any condition on a bonus payment for services performed in the 2008 taxable year that the employee performs services in taxable years after the taxable year must be disregarded.

The Act defines bonus payment to mean any payment that is a discretionary payment to a covered individual for services rendered in addition to any amount payable to such individual for services performed at a regular hourly, daily, weekly, monthly, or similar periodic rate, and that is paid in cash or other property other than stock in the TARP company or an interest in a troubled asset held directly or indirectly by the TARP recipient. Bonus payment does not include a payment to an employee as a commissions, fringe benefits, or expense reimbursements.

The term covered individual means, with respect to any financial institution, any director or officer or other employee of such financial institution or of any member of a controlled group of corporations (within the meaning of section 52(a) of the Internal Revenue Code of 1986) that includes such financial institution.

The bill amends the Internal Revenue Code to impose an excise tax on TARP companies that fail to redeem securities from the United States. The bill adds a new section to Chapter 46 of the Internal Revenue Code. New Section 4999A imposes a tax on any financial institution which is required to redeem an amount of its preferred stock from the United States pursuant to section 1903(a) of the American Recovery and Reinvestment Tax Act of 2009, and fails to redeem all or any portion of such amount within the period prescribed for such redemption. The amount of the tax imposed by must be equal to 35 percent of the amount which the financial institution failed to redeem within the time prescribed under 1903(b) of the American Recovery and Reinvestment Tax Act of 2009.

Luxury Expenditures

The board of directors of any TARP recipient must implement a company-wide policy regarding excessive or luxury expenditures, as identified by Treasury, which may include excessive expenditures on entertainment or events; office and facility renovations; aviation or other transportation services; or other activities or events that are not reasonable expenditures for conferences, staff development, reasonable performance incentives, or other similar measures conducted in the normal course of business operations.