Thursday, October 27, 2011

SEC Officials Discuss Int’l Securities Regulation Issues at ABA-Hosted Seminar

At a forum hosted by the American Bar Association, senior SEC officials discussed a number of issues around international securities regulation, including regulatory arbitrage, the Dodd-Frank conflict minerals provisions, the Supreme Court’s Morrison ruling and the SEC study on the extraterritorial reach of the federal securities laws mandated by Dodd-Frank.

Elizabeth Jacobs, Deputy Director, Office of International Affairs, said that a major issue in the international context is trying to avoid an outbreak of regulatory arbitrage. While there is no perfect antidote, said the official, there are a number of tools regulators can use to avoid or limit regulatory arbitrage. One such tool is transparency on a number of levels, including the provision of information to investors so they can make better investment decisions and the exchange of information among regulators, as well as a process by which regulators can obtain useful information to assist them with rulemaking.

Another tool to avoid regulatory arbitrage is cross-border bi-lateral meetings between regulators to engage in the informal exchange of views. As an example, Ms. Jacobs mentioned the recent meeting between the SEC and the UK Financial Services Authority. MOUs and colleges of supervisors are also useful cooperative mechanism tools. Indeed, the Deputy Director sees a consensus of cooperation among regulators as they try to build frameworks for the discussion of issues such as confidentiality. She also noted that the Financial Stability Board has a key role to play in ensuring consistent cross-border financial regulation. She emphasized that Congress is watching these issues very carefully.

On cross-border derivatives regulation, Deputy Director Jacobs noted that the G-20 leaders, in a communiqué issued at the end of the 2009 Pittsburgh Summit, emphasized that all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012 at the latest. Also, OTC derivative contracts should be reported to trade repositories and non-centrally cleared contracts should be subject to higher capital requirements.

The SEC official stressed that national authorities must engage with each other in the area of derivatives regulation. She also mentioned that toward the end of 2011, the SEC and CFTC will deal holistically with derivatives regulation.

Lona Nallengara, Deputy Director, Division of Corporation Finance, spoke about SEC regulations implementing the conflict minerals provisions of Dodd-Frank, noting that final regulations in this area should be adopted by the end of the year. Section 1502 requires companies to disclose the origin of minerals purchased from the Democratic Republic of Congo and establish transparency and accountability in the mineral supply chain to help ensure that conflict minerals are not purchased by companies in the United States or abroad.
The Commission official noted that the recent SEC Roundtable on conflict minerals provided very valuable input that will inform the rulemaking as the staff works to complete the regulations. In particular, the staff received valuable information on tracking the supply chain, reporting and due diligence.

Paul Dudek, Chief of Office of International Corporate Finance, said that this year over 200 foreign private issuers will use IFRS and that this number will double next year as Canadian companies come under an IFRS regime. He also mentioned the guidance issued by the Corporation Finance staff on reverse mergers, noting that this guidance could also be applied to shell companies.

In the area of cyber security, the senior SEC official asked issuers to think about how to discuss cyber incidents under federal securities law disclosure duties. Issues that should be considered for disclosure in SEC filings would include remediation, protection costs, and/or reputational damage. In addition, any discussion of risk factors should be more than boilerplate.

Eric Pan, an Academic Fellow in the Office of International Affairs, discussed the US Supreme Court’s Morrison opinion and the SEC study mandated by the Dodd-Frank Act on the extraterritorial reach of US securities laws, particularly the antifraud rule. The classic conduct and effects test was used by the lower federal courts in the Morrison case, he noted, but the Supreme Court took a different approach and ruled that Exchange Act antifraud provisions do not apply to transactions outside the US. The Supreme Court effectively replaced the conduct and effects test with a transactional test and imposed a bright line rule on the cross-border availability of Rule 10b-5.

In Morrison v. National Australia Bank, Ltd, the Supreme Court ruled that Rule 10b-5 does not provide a cause of action to foreign plaintiffs suing foreign and US defendants for misconduct in connection with securities traded on foreign exchanges since the antifraud rule reaches the use of a manipulative or deceptive device only in connection with the purchase or sale of a security listed on a US exchange, and the purchase or sale of any other security in the US.

Professor Pan noted that there have been approximately 37 post-Morrison federal court opinions interpreting the new test. In most of these cases, he noted, the defendants won, leading to the conclusion that the transactional test has made it more difficult to bring extraterritorial Rule 10b5 claims. In general, the SEC has not gotten involved in these cases by, for example, filing an amicus brief.

Section 929Y of the Dodd-Frank Act directed the SEC to conduct a study and make recommendations on the extent to which private rights of action under the antifraud provisions of the Exchange Act should be extended to cover transnational securities fraud. The SEC has received 64 comment letters on the study, noted the SEC Fellow, and has been hosting visits from groups to discuss their views.

He said that it is unlikely that the SEC staff will make a single recommendation in this area. Rather, the staff study will lay out a number of options for Congress to consider. The study will include an analysis of recent case law and set forth policy questions for Congress to consider. More broadly, the study will pose the question of whether the Supreme Court’s transactional test is good for the US capital markets.

The study will also examine international comity issues with full awareness of the international concerns over the impact of extraterritorial extension of Rule 10b-5. Even more broadly, the study will examine the issue of what is the value add of private rights of action as a supplement to SEC enforcement actions.