Saturday, June 30, 2012

President’s FY 2013 Budget Would Repeal LIFO Accounting, Conforming to IFRS

President Obama’s proposed FY 2013 Budget would repeal the last-in, first-out (LIFO) inventory accounting method under which it is assumed that the last items entered into the inventory are the first items sold. Unlike U.S. GAAP, IFRS reporting standards do not treat LIFO as a permitted method of accounting. The SEC has indicated its support for global accounting standards and it continues to work toward making a determination as to whether, when, and how to further incorporate IFRS into the U.S. financial reporting system. The Joint Senate-House Committee on Taxation has noted that the potential shift from GAAP to IFRS raises the issue of whether companies will be able to continue using LIFO for tax purposes in light of the conformity requirement.


Friday, June 29, 2012

Chairman Schapiro Testifies JOBS Act Title II Rules Near But May be Late


The Jumpstart Our Business Startups (JOBS) Act, which became law April 5, 2012, requires the Commission to engage in several rulemakings. In the near term, the SEC must adopt rules to implement Title II within 90 days after enactment. The Commission has not yet proposed any JOBS Act rules, but the Title II rules are due on or about July 4, 2012.

In testimony on June 28, 2012 before the U.S. House Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs, SEC Chairman Mary L. Schapiro stated:

"The rulemakings to revise Rule 506 and Rule 144A are both required to be completed within 90 days of enactment of the JOBS Act. As I stated to Congress prior to the passage of the Act, time limits imposed by the JOBS Act are not achievable. Here, the 90 day deadline does not provide a realistic timeframe for the drafting of the new rule, the preparation of an accompanying economic analysis, the proper review by the Commission, and an opportunity for public input. Although we will not meet this deadline, the staff has made significant progress on a recommendation and economic analysis, and it is my belief that the Commission will be in a position to act on a staff proposal in the very near future."

Title II directs the Commission to remove the ban on general solicitation or general advertising stated in Securities Act Rule 502(c) of Regulation D for offers and sales of securities made under Rule 506 of Regulation D. Amended Rule 506 must require all purchasers of these securities to be accredited investors. The rules also must require an issuer to take reasonable steps to verify the accredited investor status of any purchasers, using methods to be determined by the Commission. Rule 506 must continue to be treated as issued under Securities Act Section 4(2).

Title II also requires the Commission to amend Securities Act Rule 144A(d)(1) to provide that securities sold under the revised exemption may be offered (including by general solicitation or advertising) to persons who are not qualified institutional buyers (QIBs), but these securities may be sold only to persons the seller (or any person acting on the seller’s behalf) reasonably believes are QIBs.

President Issues Veto Message on House SEC Funding Legislation


President Obama said that he would veto House legislation funding the SEC  $245 million below his FY 2013 Budget request, including a provision preventing obligation of funds from the Commission's non-appropriated Reserve Fund. 

More generally, said the President, HR 6020 would severely undermine key investments in financial oversight and implementation of Wall Street reform to protect American consumers, as well as needed tax enforcement and taxpayer services. Taken together with onerous mandated increases in information technology in excess of requested amounts, said the Statement of Administration Policy, The Financial Services and General Government Appropriations Act, HR 3060, would require the SEC to reduce staff that polices the US securities markets and enforces the federal securities laws, thereby threatening the stability of the financial markets. Similar to its position on SEC funding, the Administration strongly opposes the bill's reduction in funding from the FY 2013 Budget request for the IRS. HR 2060 has been approved by the House Appropriations Committee. 

The Statement of Policy noted that Sections 501 and 502 of the Act would terminate Federal Reserve transfers to fund CFPB and subject the agency to the annual appropriations process beginning in FY 2014.  The provision would shred the necessary independence of CFPB set in statute, in the President’s view, and would increase the likelihood of underfunding the Bureau, reducing consumer protection in the financial services marketplace. 

In addition, Sections 120, 203, and 503 place additional reporting requirements on the Office of Financial Research, OMB, and CFPB, respectively, that are duplicative of existing reporting requirements and costly to produce.

Under Section 503, the CFPB must submit a report to Congress detailing the obligations made during the previous quarter by object class, office and activity and the estimated obligations made during the previous quarter by object, class and activity. Similarly, Section 120 requires the Office of Financial Stability and the Office of Financial Research to submit quarterly reports to Congress on the obligations made during the previous quarter by object class, office and activity and the estimated obligations made during the previous quarter by object, class and activity. Section 203 requires the OMB to report to Congress on the cost of implementing the Dodd-Frank Act.

Thursday, June 28, 2012

Chamber of Commerce Urges CFTC to Conduct Formal Rulemaking on Cross-Border Application of Dodd-Frank Swaps Dealer Provisions


In a letter to CFTC Chair Gary Gensler, the US Chamber of Commerce expressed concern about reports that the Commission intends to address the extraterritorial application of the swaps dealer provisions of the Dodd-Frank Act through interpretative guidance rather than in a release that the Commission denominates a substantive rule and promulgates according to the procedures required for such rules. The Chamber noted suggestions that the Commission is considering proceeding in this manner to avoid the requirements of Section 15(a) of the Commodity Exchange Act, which directs the Commission to evaluate the costs and benefits of its actions in light of their effects on efficiency, competitiveness, and price discovery.

The Chamber urged the CFTC to conduct a full rulemaking, taking and considering public comments on the proposal in accordance with the Administrative Procedure Act and giving full consideration to the economic consequences of its action. In the Chamber’s view, setting an appropriate scope for Dodd-Frank’s extraterritorial application is crucial for achieving effective cross-border swaps regulation.

The letter went on to express the Chamber’s agreement with the position of European Commissioner for the Internal Market Michel Barnier that where the rules of a foreign country are comparable and consistent with the objectives of U.S. law, it is reasonable to expect U.S. authorities to rely on those rules and recognize activities regulated under them as compliant  with U.S. regulations. The Chamber cautioned that an overly-broad extraterritorial application of new derivatives regulations could create competitive disadvantages for U.S. firms. Foreign branches of U.S. firms could have to comply with U.S. regulations in foreign markets, the letter said, whereas foreign firms in foreign markets would have to comply with host country regulations. More costly regulations would drive up expenses for U.S. firms and could reduce the number of counterparties available to U.S. end-users.

Corp Fin to Implement EDGAR Procedure for JOBS Act Submissions

The SEC’s Division of Corporation Finance has announced that it will implement an EDGAR-based system for receiving confidential draft registrations from emerging growth companies (EGCs) under JOBS Act Section 106. The EDGAR system also will receive submissions from certain foreign private issuers. Currently, both EGCs and foreign private issuers can make submissions via a secure email system. Some aspects of the new EDGAR procedure will be detailed in the next EDGAR update (Release 12.1) as early as July 2, 2012. However, Corp Fin has instructed companies to continue using the secure email system until further notice. Once the EDGAR procedure is operational, Corp Fin will issue instructions explaining how eligible companies may make submissions via EDGAR.

Wednesday, June 27, 2012

Senators Request Data from Securities Industry on Political Intelligence as Sen. Grassley Vows to Seek another Legislative Vehicle


Senator Charles Grassley (R-Iowa) and Senator Mark Udall (D-Colo) sought information from the financial services industry to attempt to understand the industry’s contention that the registration and disclosure requirement for political intelligence agents that Senator Grassley advanced earlier this year in the STOCK Act was overly broad. In a letter to SIFMA, the Senators noted that, because political intelligence activities are not disclosed, there is little information available on the scope of political intelligence and how it is actively prepared, marketed and sold to Wall Street.

The Senators asked SIFMA to respond by July 25, 2012 to a series of questions designed to give Congress information about the unique public policy implications of the growing political intelligence industry. They ask if SIFMA supports some kind of registration requirement for political intelligence agents and, if so, how should it be structured and, if not, why not. They asked for a list of all SIFMA members who have retained political intelligence firms from 2007 to the present, along with the names of the firms, and the amount of money spent on contracts with the firms.

Congress is inviting the financial services industry to explain its position on registration, Sen. Grassley said, and trying to understand the size and scope of political intelligence gathering.  If the previous disclosure provision was too broad, he indicated, the industry is welcome to propose a solution that would accomplish the same goals of transparency and accountability.

It is essential to increase disclosure and transparency requirements for political intelligence’ activities, Sen. Udall said, adding that political intelligence firms use information normal taxpayers and investors do not have to benefit their clients on Wall Street. When it comes to betting on government policy, Wall Street should not be able to secretly buy insider information.

In February, the Senate gave 60 votes to a Grassley Amendment to the Stock Act requiring the registration and disclosure of political intelligence agents.  The Amendment would have imposed the same registration requirements on political intelligence agents that have applied to lobbyists for decades.  However, the Grassley Amendment was dropped from the final legislation. Senator Grassley plans to revisit the provision in future legislative vehicles.

House Oversight Hearings Reveal that SEC Implementing Regulations Will Be Crucial to the Efficacy of JOBS Act Crowdfunding Title


House hearings focused on the implementation of the recently-enacted JOBS Act demonstrated a consensus that the SEC regulations implementing the Title III crowdfunding provisions will be critical in determining the efficacy of crowdfunding as a capital-raising mechanism.  The hearings were held before the Financial Services Subcommittee of the House Oversight Committee, chaired by Rep. Patrick McHenry (R-NC), who authored the House version of Title III, which was replaced by a Senate version in the enacted JOBS Act. Chairman McHenry said that the Senate version of Title III contains imperfect language. He said that the Senate inserted provisions complicated crowdfunding and made sections of the Act ambiguous and inconsistent.

On the day the House concurred with the Senate Amendment to the JOBS Act, Chairman McHenry said that the Senate changes to Title III were ill-conceived and burdensome and misguided in seeing crowdfunding as simply unregulated activity. He pledged to work in a bi-partisan way to fix the legislation. (Cong. Rec., Mar 27, 2012, p. H1590).

At the hearing, Chairman McHenry noted that the SEC holds a great deal of discretion over the Title III implementing regulations and questioned whether this discretion could place at risk the viability of using crowdfunding. He spoke about using light-touch regulation in the area of crowdfunding.

Professor C. Steven Bradford, University of Nebraska Law School, said that there is a potential that regulatory cost could make crowdfunding not feasible to use. The professor urged that the SEC regulations implementing Title III be as light-handed and unobtrusive as possible. Chairman McHenry said that, while the disclosure piece is important, there is concern over the cost of compliance.

Ranking Member Mike Quigley (D-IL) said that Title III is a welcome step forward. He also noted that the regulatory restrictions rolled back by the JOBS Act were put in place for a reason. He acknowledged a fear of fraud. While Congress correctly judged that there were too many hurdles to raising capital, he observed, the SEC has to protect investors. The Ranking Member also emphasized that the regulations implementing the JOBS Act should not be placed before regulations implementing the Dodd-Frank Act.

Professor Bradford said that crowdfunding has the potential to spark a revolution in small business financing. Whether that happens will depend a great deal on the regulatory burden in that the SEC implementing regulations will determine the future usefulness of crowdfunding under Title III. Professor Bradford believes that regulations should be imposed on the crowdfunding intermediaries and not the entrepreneurs raising the funds. Brokers and funding portals can spread regulatory costs over a large number of offerings, he reasoned, and they will be more heavily capitalized than almost all of the entrepreneurs using the crowdfunding sites. By contrast, the small companies and entrepreneurs most likely to engage in crowdfunding are poorly capitalized and legally unsophisticated.

Professor Bradford also urged the SEC to adopt a substantial compliance rule to protect those who inadvertently violate a regulation so that a minor technical violation will not cause the loss of the exemption. Given the complexity of the exemption’s requirements, he noted, inadvertent violations are likely and the consequence of even a minor violation is drastic. He added that other Securities Act exemptions include substantial compliance rules that protect issuers if they fail to comply with the exemption in certain insignificant ways.

While acknowledging that nothing in the JOBS Act itself specifically authorizes the SEC to enact a substantial compliance rule, Professor Bradford noted that Section 302(c) of the JOBS Act gives the SEC blanket authority to issue such rules as the Commission determines may be necessary or appropriate for the protection of investors to carry out Sections 4(6) and 4A of the Securities Act.

He observed that the SEC has even broader authority in both the Securities Act and the Securities Exchange Act to exempt any person, security, or transaction from any provision of the statutes if the Commission determines that such exemption is necessary or appropriate in the public interest and is consistent with the protection of investors. Professor Bradford said that the Commission could use this authority to specify that an issuer that reasonably believed it met the requirements of Section 4(6) or that substantially complied with Section 4(6) would still be entitled to the exemption, in spite of the noncompliance.

Former SEC General Counsel Brian Cartright noted that the JOBS Act calls for SEC rulemaking to address 15 separate matters, in addition to necessary FINRA rulemaking. How all the rulemaking is crafted, noted the former GC, will help determine whether Title III assists capital formation for small ventures or becomes a dead letter. The former SEC official urged the Commission to rigorously analyze the anticipated compliance costs for relying on Title III.

In evaluating the costs, advised the former General Counsel, the SEC should include such items as the costs an intermediary will incur to build and maintain a compliance infrastructure sufficient to survive SEC and FINRA inspections, as well as any costs to address the heightened risks arising from the higher standard of liability Title III carries compared to other private offerings. The SEC should then determine the estimated fraction of the proceeds that would be consumed by those costs at varying offering sizes allowed by Title III. If, after a rigorous cost analysis, the SEC decides that those costs could render impractical the use of Title III, it should state this in order to alert Congress so that legislators can consider if additional legislation is needed.

Federal Court Rules Financial Company Had No Duty to Disclose Receipt of SEC Wells Notice


A federal judge ruled that a securities fraud action could not be based on a financial company’s  failure to disclose receipt of a Wells Notice from the SEC. At best, said the court, a Wells Notice indicates not litigation but only the desire of the SEC Enforcement staff to move forward, which it has no power to effectuate.  This contingency need not be disclosed. While the investors claimed to want to know about the Wells Notice, a corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. (Richman v. Goldman Sachs Group, Inc., SD NY, 10 Civ. 3461, June 21, 2012.)

The SEC provides a target of an investigation with a Wells Notice whenever the Enforcement Division staff decides, even preliminarily, to recommend charges. The party at risk of an enforcement action is then entitled, under SEC rules, to make a Wells submission to the SEC, presenting arguments why the Commissioners should reject the staff’s recommendation for enforcement.

In the court’s view, a party’s entitlement to make a Wells submission is obviously based on recognition that staff advice is not authoritative. Indeed, continued the court, the Wells process was implemented so that the Commission would have the opportunity to hear a defendant’s arguments before deciding whether to go forward with enforcement proceedings. Thus, receipt of a Wells Notice does not necessarily indicate that charges will be filed.

Item 103 of Regulation S-K requires a company to describe any material pending legal proceedings known to be contemplated by governmental authorities. Exchange Act Rule 12b-20 supplements Regulation S–K by requiring a person who has provided such information in a statement or report to add such further material information as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.

A Wells Notice may be considered an indication that the staff of a government agency is considering making a recommendation, noted the court, but that is well short of litigation that would have to be disclosed. Moreover, the investors did not show that the company’s nondisclosure of the receipt of Wells Notice made prior disclosures about ongoing governmental investigations materially misleading; or that it breached a duty to be accurate and complete in making
disclosures.  

The court rejected the argument that the company had an affirmative legal obligation to disclose receipt of the Wells Notice under Regulation S-K, Item 103. There is nothing in Item 103 which mandates disclosure of Wells Notices, emphasized the court. Item 103 does not explicitly require disclosure of a Wells Notices, and no court has ever held that this regulation creates an implicit duty to disclose receipt of a Wells Notice.  When the regulatory investigation matures to the point where litigation is apparent and substantially certain to occur, said the court, then Section 10(b) disclosure is mandated. Until then, disclosure is not required. 

FINRA Rule 2010, and NASD Conduct Rule 3010 explicitly require financial firms to report an employee’s receipt of a Wells Notice to FINRA within 30 days. There is no dispute that the firm was bound by and violated these regulations by failing to disclose receipt of the Wells Notice within 30 days.

However, federal courts have cautioned against allowing securities fraud claims to be predicated solely on violations of NASD rules because such rules do not confer private rights of action. The court reasoned that these historic precedents are applicable to FINRA rules, since FINRA is the NASD’s successor.


Tuesday, June 26, 2012

French Legislation Taxing Non-Resident Investment Funds While Exempting Domestic Funds Violated EU Law on Free Movement of Capital


French legislation taxing dividends paid to non-resident collective investment funds at 25 percent, while exempting domestic funds from the tax, violated EU law prohibiting restrictions on the movement of capital between Member States and between Member States and the US, ruled the European Court of Justice. A difference in the tax treatment of dividends according to an investment fund’s place of residence may discourage non-resident funds from investing in French companies and also discourage French investors from buying shares in non-resident funds. In addition, the court said that there was no overriding public interest that justified the difference in tax treatment of resident and non-resident  undertakings for collective investments in transferable securities funds (UCITS).  The case was brought by collective investment funds from the United States and three EU Member States that had invested in shares in French companies and received dividends from those shares subject to the withholding tax. Santander Asset Management SGIIC SA, et al. v. Ministre du Budget, des Comptes publics, de la Fonction publique et de la Réforme de l’État, European Court of Justice, May 10, 2012, Cases C-338/11 to C-347/11.
The difference in treatment introduced by the legislation could not be justified by the need to preserve the coherence of the French tax system in the absence of any direct link between the exemption from withholding tax on nationally sourced dividends received by a resident UCITS and the taxation of those dividends as income received by the shareholders. Similarly, the French Government failed to put forward any evidence to substantiate its claim that taxation affecting solely and specifically non-resident UCITS is justified by the need for effective fiscal supervision. 

The Court also rejected the argument that bilateral conventions on the avoidance of double taxation concluded between the French Republic and the Member State or non-Member State concerned ensure that shareholders in resident and non-resident UCITS receive similar tax treatment. That argument, said the Court, is based on the incorrect premise that shareholders in resident UCITS are themselves resident for tax purposes in France, whereas the shareholders in US and other non-resident collective funds are resident for tax purposes in the US or other State in which the UCITS concerned is established.

In fact, said the Court, it is not unusual for a shareholder in a UCITS which is not resident in France to be resident for tax purposes in France or for a shareholder in a UCITS resident in France to be resident for tax purposes in the US or another EU country. Under the contested legislation, nationally-sourced dividends paid to a resident distributing UCITS are exempt from tax even in cases in which the French Republic does not exercise its tax jurisdiction over the dividends redistributed by such a UCITS, in particular when they are paid to shareholders who are resident for tax purposes in the US or another Member State.  

At the same time, nationally-sourced dividends paid to non-resident distributing UCITS are taxed at a rate of 25 percent irrespective of the tax situation of their shareholders. The Court concluded that the criterion for determining the tax treatment established by the legislation at issue is not the tax situation of the shareholder but solely the resident status of the collective investment fund.

Texas Proposes Changes to Accredited Investor, Finder and Successor Registration

Amendments to the exemption for individual accredited investor sales, and to the application procedures for finders and successor entity securities dealers and investment advisers were proposed by the Texas State Securities Board.

The statement required for limited use advertisements in connection with individual accredited investor sales would exclude the value of the person's primary residence from that person's net worth calculation.

Finders would be no longer register using the procedures for securities dealers but instead follow application procedures proposed specifically for them.

The types of structural changes initiating successor registration for securities dealers or investment advisers would be separately identified to allow dealers or advisers whose structural changes are less comprehensive to file an amendment rather than a new application.

IASB Chair Says Board Will Examine Goodwill and Other Comprehensive Income Standards under Principles


In remarks at an Amsterdam accounting seminar, IASB Chair Hans Hoogervorst described pragmatism as practiced by the Board to be looking very carefully at any possible undesirable use of IFRS. Whenever the Board is confronted with a high degree of uncertainty, he averred, it will act with great caution. For example, if the standards were to provide too much room for recognition of intangible assets, the potential for mistakes or abuse would be immense. In such circumstances, he believes that it is better for the accounting standards to require more qualitative reporting than pseudo-exact quantitative reporting. The Chair said that it is nonsense to advise that accounting standards should not be set from an anti-abuse perspective.  If the IASB sees ample scope for abuse in a standard, he pledged, the Board will do something about it, adding that there are sufficient temptations and incentives for creative accounting as it is.

While the P&L is the traditional performance indicator on which many remuneration and dividend schemes are based, the meaning of other comprehensive income is unclear. It started as a vehicle to keep certain effects of foreign currency translation outside net income and gradually developed into a parking space for unwanted fluctuations in the balance sheet. There is a vague notion that other comprehensive income serves for recording unrealized gains or losses, but a clear definition of its purpose and meaning is lacking.

But that does not make it meaningless, said the Chair, especially for financial institutions with large balance sheets. Other comprehensive income can contain very important information. It can give indications of the quality of the balance sheet. It is very important for investors to know what gains or losses are sitting in the balance sheet, even if they have not been realized.

In the future, other comprehensive income will most certainly be an important source of information about insurance contracts. Recently, both the FASB and the IASB proposed that changes in the insurance liability due to fluctuations in the discount rate would be reported in other comprehensive income. Many of the Boards’ constituents requested them to do so.

Both preparers and users wanted to prevent underwriting results being snowed under by balance sheet fluctuations. As a result, other comprehensive income will become bigger and will contain meaningful information, such as indications of duration mismatches between assets and liabilities.

This decision for the use of other comprehensive income was not easy to make. Board member Stephen Cooper showed in what the Chair called  a ``razor-sharp analysis’’ that in this presentation, both net income and other comprehensive income, if seen in isolation, might give confusing information.

The IASB Chair said that the Board will try to tackle some of these problems with presentational improvements, but added that a full picture of an insurer’s performance can only be gained by considering all components of total comprehensive income. The Board will point this out explicitly in the Basis for Conclusions of the new standard.


More fundamentally, the Board will look at the distinction between net income and other comprehensive income during the upcoming revision of the Conceptual Framework. Board constituents have asked the IASB to provide a firm theoretical underpinning for the meaning of other comprehensive income and the Board will try to do so. For now, while it may not always be clear how important other comprehensive income exactly is, net income is not a very precise performance indicator either. Both need to be used with judgment, especially in the financial industry.

Finally, the Chair said that the Board will take another look at goodwill in the context of the post-implementation review of IFRS 3 Business Combinations. Although the accounting standards do not permit the recognition of internally generated goodwill, he noted, the standards do require companies to record the premium they pay in a business acquisition as goodwill. This goodwill is a mix of many things, including the internally generated goodwill of the acquired company and the synergy that is expected from the business combination.

Most elements of goodwill are highly uncertain and subjective, observed the Chair, and they often turn out to be illusory. The acquired goodwill is subsequently subject to an annual impairment test. In his view, these impairment tests are not always done with sufficient rigor. Often, share prices reflect the impairment before the company records it on the balance sheet, he cautioned, which means that the impairment test comes too late.


Monday, June 25, 2012

Hong Kong SFC Enforcement Director Outlines Special Remedies to Combat and Rectify Fraudulent Securities Market Misconduct


Fraudulent securities market misconduct is a special kind of fraud causing diffused damage across a wide spectrum of interests and persons and thus demands remedies beyond general deterrence, said Hong Kong Securities and Futures Enforcement Director Mark Steward. In remarks at an Asia Pacific Summit on fraud and corruption, he said that the prescription for tackling securities fraud on the market requires broad civil and criminal remedies to identify wrongdoers, chase down assets and proceeds, identify the nature and quantify the extent of damage or loss, identify victims, and secure remedial outcomes as well as ensure that those who perpetrate and assist in fraud and misconduct, including those who help to hide it from detection, are made to pay for the costs of rectification.

Criminal prosecution of perpetrators, where appropriate, is by no means last but it ought not to be the only measure. The need for civil remedies is also necessary because criminal sanctions are not always available especially if perpetrators are not in the jurisdiction or cannot be brought into the jurisdiction.  This is a real issue in a market as international as Hong Kong’s, he noted.

General deterrence alone is not enough, he explained, because, unlike the theft of valuable property, the damage caused by market misconduct fraud may not even be detectable.  Or if there is loss, its cause in fraud is unlikely to be discernible.  And damage may well continue to impair the investment. That is why identifying the nature and extent of damage caused by fraud is a necessary component of any anti-fraud strategy. 

According to the Director, there are at three distinct components to market fraud. First, market misconduct is perpetrated almost anonymously by market participants whose identities are shielded from other market participants by the automated matching systems of the exchanges. A second related distinction is the anonymity of the victims, which makes the problem of fraud in the markets an acute one. A third distinction is the way market fraud undermines the market’s singular function as a  place where reliable prices are set, a storehouse of value for savings and investments and a place upholding high standards of fairness.   Market misconduct fraud prejudices these functions and impairs the confidence needed to support them, he observed, and may also give rise to tangible losses to innocent investors.

Given the nature of market misconduct, the Commission is deeply engaged in not only sending deterrent messages, he emphasized, but also in remedying the consequences of securities market fraud and misconduct on the well-being of the market’s important functions and to protecting the interests of all market participants. 

This means that, in tandem with traditional deterrent remedies, the SFC is actively pursuing civil sanctions to tackle, not only the wrongdoer, but also the consequences of the wrongdoing so that the reputation of the market as a safe and fair place and a reliable guide to price and value can be restored.

Turning to specific actions, the Director noted that the Hong Kong Court of Appeal recently ruled that the Court of First Instance, in the exercise of its civil jurisdiction, can determine whether a person has contravened a market misconduct provision and that the function of making these types of findings is not the sole preserve of a criminal court or the Market Misconduct Tribunal.  The defendant in that case, a New York based hedge fund, is appealing this decision to the Court of Final Appeal.  The Commission is confident the Court of Appeal decision will be upheld. 

Another action recently reached what the Director called ``a milestone conclusion.’’ The action was to freeze the IPO proceeds of a Cayman Islands entity with a Mainland business, listed in late 2009 raising approximately $1 billion in capital from both institutional and retail investors.  It had no Hong Kong resident directors, said the Director, and is controlled by Taiwanese interests. The SFC was concerned that a number of statements made in its IPO prospectus were not true.

The initial action led to orders freezing approximately $832 million which derived from subscriptions to the IPO prospectus. The Commission then alleged the IPO prospectus included false statements and that the company’s turnover, profitability and cash and cash equivalent balances were grossly overstated in the IPO prospectus. The SFC initiated action to recover the balance and to obtain orders requiring the company to repurchase shares issued or bought by the public shareholders.

After the trial started, the company conceded that its prospectus contained materially false or misleading statements and acknowledged that it contravened section 298 of the Securities and Futures Ordinance, which prohibits the disclosure of information likely to induce a person to subscribe for or purchase shares if the information is materially false and the person knows or is reckless as to whether the information is false.  It is a market misconduct provision, noted the Director.

The company has also agreed to pay the sum of approximately $197 million into court so that, together with the $832 million, there is a total of a little over $1 billion to fund a full repurchase offer to all public shareholders, approximately 7,700 investors, at the suspension price.

This outcome, once executed and accepted by the shareholders, said the Director, will effectively repair the damage caused to those shareholders who were in no position to be able to detect the false information in the prospectus for themselves and who were victims. Under Commission remedial measures, the company will be obliged to return all of the paid up capital it received from its public shareholders as a consequence of the false statements contained in its prospectus at its last traded price. 

North Dakota Proposes to Incorporate NASAA Policy Statements

Statements of policy of the North American Securities Administrators Association (NASAA) would be applied to registered and exempt securities offerings in North Dakota as appropriate, as proposed by the North Dakota Securities Department.

The following policy statements would be incorporated: Asset-Backed Securities, Cattle-Feeding, Church Bonds, Church Extension Funds, Commodity Pool Programs, Corporate Securities Definitions, Debt Securities, Equipment Programs, Health Care Facility Offerings, Impoundment of Proceeds, Loans and Other Material Affiliated Transactions, Mortgage Programs, Oil and Gas Programs, Direct Participation Programs—Omnibus Guidelines, Options and Warrants, Preferred Stocks, Promoter’s Equity Investment, Promotional Shares, Real Estate Investment Trusts, Real Estate Programs, Risk Disclosure Guidelines, Specificity in Use of Proceeds, Underwriting Expenses and Underwriter’s Warrants, Unequal Voting Rights, Uniform Disclosure Guidelines for Cover Legends and Unsound Financial Condition.

Virginia Adopts Private Fund Adviser Exemption

Private fund advisers are exempt from investment adviser registration requirements in Virginia if neither the advisers nor their advisory affiliates are subject to “bad boy” disqualification provisions under Rule 262 of federal Regulation A, and the advisers electronically file through the IARD the SEC-filed reports and amendments required for exempt reporting advisers by Rule 204-4 of the Investment Advisers Act of 1940, as well as a $250 fee. The exemption takes  effect when the reports and fee are filed and accepted by the IARD on the State’s behalf, assuming the exemption’s other conditions are met. NOTES: (1) Investment adviser representatives employed by or associated with exemption-eligible investment advisers are, themselves, exempt from investment adviser representative registration if they do not otherwise act as investment adviser representatives; (2) Investment advisers that become ineligible for the private fund adviser exemption must, within 90 days following their ineligibility, register or notice file as investment advisers (as applicable) in Virginia; and (3) Federal covered investment advisers, i.e., private fund advisers registered with the SEC, are ineligible for the exemption and, therefore, must comply with Virginia notice filing requirements.

UK Sharman Panel Breaks New Ground on Auditor Going Concern Opinions


In a seminal report on auditors and going concern, the UK Sharman Panel recommended a process to produce a going concern opinion that envisions a key role for company directors, audit committees and auditors. The panel would also require the going concern assessment process to focus on solvency risks and liquidity risks, as well as identifying risks to the entity’s business model or capital adequacy that could threaten its survival. The Sharman Panel wants to move away from a model where the company only highlights going concern risks when there are significant doubts about its survival, to one which integrates the going concern reporting with the directorial discussion of strategy and principal risks.

Lord Sharman said that the aim of the directors’ assessment and reporting of going concern risks is not primarily to inform outsiders of distress. Rather, it is to ensure that the company is managed to avoid such distress, while still taking well-judged risks. That judgment must rest with the directors, emphasized Lord Sharman, and regulators and policy makers must encourage them to discharge their duties in that regard with skill and in good faith. Therefore, in reaching its recommendations, the Panel’s primary purpose has been to reinforce responsible behavior in the management of going concern risks for companies.

Essentially the Sharman Panel recommends a model for auditor reporting on going concern in which there is an explicit statement in the auditor’s report that the auditors are satisfied that, having considered the assessment process, they have nothing to add to the disclosures made by the directors about the robustness of the process and its outcome. The Panel’s final recommendation in relation to the auditor’s role is therefore an enhanced one in which, in addition to addressing the basis of accounting and material uncertainty disclosures, the auditor also considers the directors’ going concern assessment process and narrative disclosures about the going concern status of the entity and includes a statement in the auditor’s report as to whether the auditor has anything to add to or emphasize in relation to the disclosures made by the directors about the robustness of the process and its outcome.

The Panel found strong support for regular and more nuanced disclosure in narrative reporting, compared to the current more binary approach to reporting on going concern in the financial statements. The moment when a company moves from being a going concern to a gone concern is dependent on a variety of interrelated factors, noted the Panel, and it is therefore important to articulate the assumptions, caveats and sensitivities associated with the going concern status of the entity well before significant doubts about its ability to continue as a going concern emerge.

The report recommended that the Financial Reporting Council consider moving UK auditing standards towards inclusion of an explicit statement in the auditor’s report as to whether the auditor has anything to add to the disclosures made by the directors about the robustness of the process and its outcome, having considered the directors’ going concern assessment process. The Sharman group also urged the FRC to encourage the IAASB to accommodate this approach to the international auditing standards.

Similarly, the Panel recommended that the FRC engage with the IASB and the IAASB to agree on a common international understanding of the purposes of the going concern assessment and financial statement disclosures about going concern, and of the related thresholds and descriptions of a going concern.


The Panel also recommended that the audit committee report illustrate the effectiveness of the process undertaken by the directors to evaluate going concern by confirming that a robust risk assessment has been made, providing an explanation of the material risks to going concern considered and how they have been addressed.

The report noted that the success of audit committees in tightening up corporate governance in the past means that they are seen as the most appropriate type of body to implement these improvements. The Sharman panel noted that reporting by audit committees and auditors on the directors’ assessment of going concern should engender greater confidence in the process that is undertaken.

The Panel recommends that the going concern assessment reflect the right focus on solvency risks, not only on liquidity risks, including identifying risks to the entity’s business model or capital adequacy that could threaten its survival, over a period that has regard to the likely evolution of those risks given the current position in the economic cycle and the dynamics of its own business cycles. Also, the going concern assessment should be more qualitative and longer term in outlook in relation to solvency risk than in relation to liquidity risk; and include stress tests both in relation to solvency and liquidity risks that are undertaken with an appropriately prudent mindset. Special consideration should be given to the impact of risks that could cause significant damage to the community and environment.

In its preliminary report, the Panel posited that an expectation gap exists between what stakeholders expect and what directors and auditors actually deliver. This expectation gap may result from an expectation that the absence of disclosure by directors, and the absence of a modified audit opinion in respect of the going concern status of the company, can be taken as a guarantee that the company will not collapse or fail. The Panel concluded from the comments received that there is a risk that there is not a sufficiently common understanding, in relation to going concern assessments, about the going concern threshold  or the degree of conviction with which a going concern statement is required to be made or about the purpose for which the assessment is made.

The Sharman report was initiated by the Financial Reporting Council, the UK counterpart to the PCAOB. Lord Sharman, Chairman of the Panel, said that, while the work of the Panel emanates from the financial crisis, companies in all sectors can do more to improve their management and disclosure of risks relating to going concern, liquidity and solvency. There should also be early identification and attention to economic and financial distress, he noted. Lord Sharman was the Liberal Democrat Spokesperson for Trade and Industry/Business and Regulatory Reform from 2001 to 2010. Before that, he held numerous senior UK and international positions with KPMG. The other two members of the Panel are Roger Marshall, Interim Chair of the FRC’s Accounting Standards Board, and David Pitt-Watson, Chair of Hermes Focus Funds, and former Finance Director of the Labor Party.

SEC Division of Risk, Strategy, and Financial Innovation Issues Staff Guidance on Economic Analysis in Rulemaking


High-quality economic analysis is an essential part of SEC rulemaking, said the Division of Risk, Strategy, and Financial Innovation and the Office of the General Counsel in recently published guidance designed to ensure that decisions to propose and adopt regulations are informed by the best available information about a the economic consequences, and allows the Commission to meaningfully compare the proposed action with reasonable alternatives. The staff noted that the SEC has long recognized that a rule’s potential benefits and costs should be considered in making a reasoned determination that adopting it is in the public interest

The staff emphasized that every economic analysis in SEC rulemakings should include the following four elements: (1) a statement of the need for the proposed action; (2) the definition of a baseline against which to measure the likely economic consequences of the proposed regulation; (3) the identification of alternative regulatory approaches; and (4) an evaluation of the benefits and costs, both quantitative and qualitative, of the proposed action and the main alternatives identified by the analysis.

On the first element, the release must clearly identify the justification for the proposed regulation. In some circumstances, there will be more than one justification for a particular rulemaking. Frequently, the proposed rule will be a response to a market failure that market participants cannot solve because of collective action problems. Other justifications for rulemaking can include, among others, improving government processes, interpreting provisions in statutes the Commission administers, and providing exemptive relief from statutory prohibitions where the Commission concludes that doing so is in the public interest.

Additionally, OMB’s Circular A-4, implementing Executive Order 12866, recognizes that Congressional direction to adopt a regulation is, itself, an independent justification for rulemaking. The SEC staff has considered the recommendation in the Commission’s Inspector General Report No. 499 that even where Congress directs the Commission to engage in rulemaking, the Commission should identify a market failure or other compelling need for rulemaking apart from the Congressional directive, and concluded that this is unnecessary. 

Instead, the staff believes the better approach is set forth in Executive Order 12866, which states that agencies should promulgate only such regulations as are required by law or are made necessary by compelling public need, such as material failures of private markets to protect or improve the health and safety of the public, the environment, or the well-being of the American people. In the staff’s view, the Executive Order clarifies that a statutory mandate and a market failure are alternative possible justifications for a rule.

Although having concluded that the SEC is not obligated to identify a justification for rulemaking beyond a Congressional mandate, the staff acknowledged that there may be circumstances in which it could be useful to do so. For example, where Congress has itself stated that the mandate to engage in rulemaking is premised on a market failure or other compelling social need, the rulemaking release may identify that justification and attribute it to Congress in its description of the statutory mandate and explain how the rule, including any discretionary choices the Commission is making in the rulemaking, responds to the market failure or other compelling need that Congress identified.  

On the second element of a baseline, the economic consequences of proposed rules, potential costs and benefits including effects on efficiency, competition, and capital formation, should be measured against a baseline, said the SEC staff, which is the best assessment of how the world would look in the absence of the proposed action. The baseline serves as a primary point of comparison for an analysis of the proposed regulation. An economic analysis of a proposed regulatory action compares the current state of the world, including the problem that the rule is designed to address, to the expected state of the world with the proposed regulation or regulatory alternatives in effect.

On the third element, the release should identify and discuss reasonable potential alternatives to the approach in the proposed rule. Reasonable alternatives include only those that are available to the SEC and not those that the SEC lacks the authority to implement.

On the fourth element, said the guidance, rulewriting staff should work with the SEC staff economists to identify and describe the most likely economic benefits and costs of the proposed rule and alternatives; quantify those expected benefits and costs to the extent possible; and, for those elements of benefits and costs that are quantified, identify the source or method of quantification and discuss any uncertainties.

To achieve this objective, rulewriting staff should engage with staff economists at the earliest stages of rulemaking to determine whether there are areas in which monetization or other quantification can reasonably be undertaken and, if so, whether the Division of Risk, Strategy and Financial Innovation has the available resources necessary to develop such data. Before issuing a proposing release, staff should identify any specific data that would be necessary for or that would assist in quantification, and should consider various mechanisms by which to seek such data. The proposing release should also include a request for such data.

When particular benefits or costs cannot be monetized, advised Division staff, the release should present any available quantitative information: for example, quantification of the size of the market affected, or the number and size of market participants subject to the rule. Even without hard data, quantification may be possible by making and explaining certain assumptions. For example, if proposed rules would enable the operation of a new trading system, it may be reasonable to assume the system will attract a percentage of all market volume. With that assumption, reasoned staff, the cost-benefit analysis could then estimate a distributional effect of a certain magnitude. It is important to make assumptions and the rationales for them explicit and, where alternative assumptions are plausible, to include analysis based on each.

Division staff noted that court decisions addressing the economic analysis in SEC regulations have likewise stressed the need to attempt to quantify anticipated costs and benefits, even where the available data is imperfect and where doing so may require using estimates and extrapolating from analogous situations.

When monetization or other quantification is possible, said the Division staff, the proposing release should include those numbers and solicit comment on them, and the adopting release should address any comments on those numbers, including any data submitted to challenge them. When quantifying costs and benefits, staff should describe the measurement approach used, include references to statistical and stakeholder data if available, and specify the timeframe analyzed.


Sunday, June 24, 2012

Ranking House Members Urge SEC to Implement Dodd-Frank Conflict Minerals and Resource Extraction Regulations by July 1


In a letter to SEC Chairman Mary Schapiro, 58 members of the House of Representatives, including many Ranking Members, asked that the SEC schedule a vote on the final regulations implementing Sections 1502 and 1504 of the Dodd-Frank Act by July 1, 2012. If a vote cannot be scheduled by this date, the Members request that Chairman Schapiro respond to the letter by June 29, 2012 with an explanation regarding the extended delay in adopting the implementing regulations and provide a definitive date for a vote on these two sets of regulations.

The signatories to the letter included Rep. Ed Markey (D-MA), Ranking Member of the Natural Resources Committee;  Rep. Barney Frank (D-MA), Ranking Member of the Financial Services Committee,  Rep. Howard Berman (D-CA), Ranking Member of the Foreign Affairs Committee, Rep. Jim McDermott (D-WA),  Ranking Member on the Ways and Means Committee's Subcommittee on Trade; and Rep. Maxine Waters (D-CA), Ranking Member of the House Financial Services Committee's Subcommittee on Capital Markets.

Under the resource extraction regulations implementing Section 1504 of Dodd-Frank, companies engaged in the commercial development of oil, natural gas, or minerals would have to disclose in their annual SEC reports all payments made to either the United States or a foreign government, at the project-level. Under the conflict minerals regulations implementing Section 1502 of Dodd-Frank, companies using minerals such as tin and gold would have to disclose what measure they are taking to avoid making payments to rebel groups or military units in the Democratic Republic of the Congo or an adjoining country. This would help consumers and investors make more informed decisions about the products that they purchase and the companies in which they invest. Section 1502 requires SEC-reporting companies to disclose the measures they use to certify that their products do not contain conflict minerals.

The SEC published proposed regulations to implement these provisions of Dodd-Frank in December 2010, noted the members, adding that unfortunately the SEC has not yet finalized the process by releasing final, enforceable versions of the sets of regulations, both of which had a statutory deadline of April 17, 2011. 

There is no clear reason for the delay, said the Members. The comment period for both sets of regulations closed over a year ago. The SEC has had more than enough time to consider and respond to all of the substantive comments from industry, investors and others, said the Members. The issues involved are too serious to allow further delay, posited the Members, adding that if the regulations are not soon adopted some companies will not have to file their first reports until the summer of 2014, four years after the enactment of Dodd-Frank. The letter emphasized that the regulations move the issues of secret payments and the use of conflict minerals out of the shadows and into the open to help fight corruption and increase government accountability. The regulations will also provide material information to investors to reduce risk and increase choices for ethical investments. 



Saturday, June 23, 2012

SEC Adopts Regulations Implementing Dodd-Frank Compensation Committee and Advisers Provisions


Implementing Section 952 of the Dodd-Frank Act, the SEC adopted regulations directing the exchanges to establish listing standards requiring each member of a company’s compensation committee to be an independent member of the board of directors. The regulations do not require that exchanges establish a uniform definition of independence.  Given the wide variety of issuers that are listed on exchanges, said the SEC, exchanges were given the flexibility to develop independence requirements appropriate for the issuers listed on each exchange. Although this provides the exchanges with flexibility to develop the appropriate independence requirements, the Commission reminded that the independence requirements developed by the exchanges will be subject to review and final SEC approval pursuant to Section 19(b) of the Exchange Act. 

In addition, when developing their own definitions of independence applicable to compensation committee members, the exchanges must consider relevant factors, including a director’s source of compensation, including any consulting, advisory or compensatory fee paid by the issuer; and whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.

The regulations also direct the exchanges to adopt listing standards providing that the compensation committee may, in its sole discretion, retain or obtain the advice of a compensation adviser. The compensation committee will be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser retained by the committee. Further, each listed issuer must provide for appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any compensation adviser retained by the committee. According to the SEC, the regulations may not be construed to require the compensation committee to implement or act consistently with the advice or recommendations of any adviser to the compensation committee or to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of its duties.

Moreover, SEC regulations do not require compensation committees to retain or obtain advice only from independent advisers.  The committee may receive advice from non-independent counsel, such as in-house counsel or outside counsel retained by management, or from a non-independent compensation consultant or other adviser, including those engaged by management. Nor do the regulations require a compensation committee to be directly responsible for the appointment, compensation or oversight of compensation advisers that are not retained by the compensation committee, such as compensation consultants or legal counsel retained by management.

Section 10C(b) of the Exchange Act, added by Dodd-Frank,  provides that the compensation committee of a listed issuer may select a compensation adviser only after taking into consideration the five independence factors specified in the statute as well as any other factors identified by the Commission.  In accordance with Section 10C(b), these factors would apply to the selection of compensation consultants, legal counsel and other advisers to the committee.  The statute does not require a compensation adviser to be independent, only that the compensation committee of a listed issuer consider the enumerated independence factors before selecting a compensation adviser. 

The SEC regulations require a compensation committee to take into account the five factors enumerated in Section 10C(b)(2), as well as one added by the Commission, which is any business or personal relationships between the executive officers of the issuer and the compensation adviser  or the person employing the adviser.  This would include, for example, situations where the chief executive officer of an issuer and the compensation adviser have a familial relationship or where he chief executive officer and the compensation adviser (or the adviser’s employer) are business partners.  The SEC agreed with commentators who stated that business and personal relationships between an executive officer and a compensation adviser or a person employing the compensation adviser may potentially pose a significant conflict of interest that should be considered by the compensation committee before selecting a compensation adviser.

The five statutory factors are the provision of other services to the issuer by the person that employs the compensation adviser; the amount of fees received from the issuer by the person that employs the compensation adviser, as a percentage of the total revenue of that person; the policies of the person that employs the compensation adviser that are designed to prevent conflicts of interest; any business or personal relationship of the compensation adviser with a member of the compensation committee; and any stock of the issuer owned by the compensation adviser.

The SEC believes that these six factors, when taken together, are competitively neutral, as they will require compensation committees to consider a variety of factors that may bear upon the likelihood that a compensation adviser can provide independent advice to the compensation committee, but will not prohibit committees from choosing any particular adviser or type of  adviser. The factors should be considered in their totality, said the SEC, and no one factor should be viewed as a determinative factor of independence

Neither Dodd-Frank nor the implementing regulations require a compensation adviser to be independent, only that the compensation committee consider the enumerated independence factors before selecting a compensation adviser.  Compensation committees may select any compensation adviser they prefer, including ones that are not independent, after considering the six independence factors.

Changes to Item 407(e)(3) of Regulation S-K will require issuers to disclose in their proxy statements whether the work of any compensation consultant that has played any role in determining or recommending the amount or form of executive and director compensation has raised a conflict of interest, and if it had, disclose the nature of the conflict and how it is being addressed. 


Constitutionality of CFPB and FSOC Established by Dodd-Frank Challenged in Federal Court Action

A Texas bank has challenged the constitutionality of the Dodd-Frank Act in federal court, focusing on Title X, which created the Consumer Financial Protection Bureau and Title I, which established the Financial Stability Oversight Council. The main contention is that the sweeping and essentially unlimited and judicially unreviewable powers the Act bestows on the Bureau and the FSOC violates the Constitution’s separation of powers doctrine. State National Bank of Big Spring, et al. v. Geithner, et al., US District Court for the District of Columbia

Thecomplaint states that the Dodd-Frank Act effectively delegates unlimited power to the CFPB to regulate practices that the Bureau deems to be unfair, deceptive, or abusive, thereby granting the Bureau vast authority over consumer financial product and service firms, such as the plaintiff bank.  The Act does not define unfair or deceptive acts or practices, leaving those terms to the CFPB to interpret and enforce either through ad hoc litigation or through regulation. The Act does not provide meaningful limits on what the CFPB can deem an abusive act or practice. While the Act allows the CFPB to define and enforce these standards through rulemaking, noted the complaint, Director Richard Cordray has already announced that the Bureau will define and enforce them primarily through ad hoc ex post facto enforcement. 


The bank contends that Dodd-Frank eliminates the constitutional checks and balances that would ordinarily limit the CFPB’s exercise of these broad and undefined powers, thereby violating the separation of powers doctrine. For example, Congress has no power of the purse over the CFPB, which the Act allows to essentially fund itself by unilaterally claiming funds from the Federal Reserve Board. The Director, who cannot be removed at the pleasure of the President, determines the amount of funding the Bureau receives from the central bank and then the Fed must transfer those funds to the Bureau. In addition to allowing the CFPB to fund itself, alleged the bank, the Act prohibits Congress from even attempting to review the Bureau’s budget.

Judicial oversight is limited by Dodd-Frank provisions requiring the courts to grant the same deference to the CFPB’s interpretation of federal consumer financial laws that they would if the Bureau were the only agency authorized to apply and interpret or administer the provisions of federal consumer financial law. The CFPB’s regulatory authority is further insulated from accountability to the very agency in which it is housed by provisions stating that no regulation adopted by the CFPB can be subject to review of or approval of the Fed.

Similarly, the FSOC is given sweeping power and unbridled discretion to pick which non-bank financial firms are systemically important, thereby subjecting the firm to enhanced federal regulation. The FSOC determination is not subject to meaningful judicial review. While a firm designated by FSOC as systemically important may appeal to a federal district court, noted the complaint, the appeal is limited to the question of whether that determination was arbitrary and capricious. Section 113 of Dodd-Frank forbids the courts to review whether FSOC’s action was in accordance with law.

The bank argues that Title I’s open-ended grant of power and discretion to FSOC, combined with the elimination of judicial review of FSOC’s judgments, and the inclusion of members neither appointed by the President nor confirmed by the Senate, gives FSOC the unfettered discretion to determine which non-bank financial firms are systemically important, violates the separation of powers and is unconstitutional.


Friday, June 22, 2012

Treasury Pursues Frameworks with Japan and Switzerland for Effective FATCA Compliance


The Department of the Treasury has jointly issued statements with Japan and Switzerland expressing mutual intent to pursue a framework for intergovernmental cooperation to facilitate the implementation of the Foreign Account Tax Compliance Act (FATCA) and improve international tax compliance based on the existing bilateral tax treaties between the U.S. and Japan and Switzerland.

The statements offer a framework for cooperation to facilitate FATCA implementation by supplementing direct reporting under FATCA by Japanese and Swiss financial institutions with exchange of information on request pursuant to the bilateral income tax treaty with Japan and Switzerland

FATCA was enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act.  FATCA requires foreign financial institutions to report to the IRS information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. In order to avoid withholding under FATCA, a participating FFI will have to enter into an agreement with the IRS to identify U.S. accounts, report certain information to the IRS regarding U.S. accounts, and withhold a 30 percent tax on certain U.S.-connected payments to non-participating FFIs and account holders who are unwilling to provide the required information.  Registration will take place through an online system that will become available by Jan. 1, 2013. Foreign financial institutions that do not register and enter into an agreement with the IRS will be subject to withholding on certain types of payments relating to U.S. investments.

FATCA is an important part of the U.S. government’s effort to improve tax compliance. The intergovernmental framework announced provides a second model for implementing FATCA in a way that addresses domestic legal impediments and reduces burdens on financial institutions, said Acting Assistant Secretary for Tax Policy Emily S. McMahon.

The framework contemplated in the joint statements represents a second model for an intergovernmental approach to improving tax compliance and implementing FATCA (Model II).   Model II establishes a framework of direct reporting by foreign financial institutions to the Internal Revenue Service , supplemented by information exchanged between the Japanese and Swiss governments and the United States government upon request.

Previously, the Treasury Department jointly issued a statement with France, Germany, Italy, Spain and the United Kingdom expressing mutual intent to pursue a government-to-government framework for implementing FATCA.  The model contemplated in the prior joint statement (Model I)  differs from the model just announced in that it contemplates reporting by foreign financial institutions (FFIs) to  their respective governments, followed by the automatic exchange of this information with the United States.  Treasury, in consultation with the jurisdictions participating in the joint statement issued in February, has been developing a model agreement that will serve as the basis for bilateral agreements with countries interested in adopting the intergovernmental framework contemplated in Model I and aims to publish this model soon.

Both intergovernmental models for implementing FATCA represent an important step toward addressing legal impediments to financial institutions’ ability to comply with the regulations. The frameworks contemplated in the joint statements will serve as alternative models for the United States’ work with other countries, as Treasury officials continue to engage in discussions with foreign governments about the effective and efficient implementation of FATCA by their financial institutions. 

Thursday, June 21, 2012

In letter to SEC Chair, and In Light of Facebook IPO, House Leader Wants Dialogue on Fundamental Reform of the IPO Process


In light of the substantial flaws in the IPO process revealed by the Facebook IPO, Chairman Darrell Issa (R-CA) of the House Oversight Committee wants to begin a dialogue with the SEC to fundamentally transform the regulation of the IPO process. In a letter to SEC Chair Mary Schapiro, Chairman Issa emphasized that Congress must revisit the Securities Act of 1933, which has given investment banks almost 60 years to enjoy what is essentially flawed legislation fraught with conflicts of interest and incentives to misprice shares. Among other things, he asked the SEC to take advantage of the vast technological improvements to protect investors while unleashing capital formation. More broadly, given the fierce global competition for capital, he noted, the continued protection, over-regulation and coddling of US financial firms will lead to a weakening of US financial markets.

The oversight chair then posed a series of specific questions that he wants Chairman Schapiro to answer by July 3, 2012. The Committee on Oversight and Government Reform is the principal oversight committee of the House with broad authority to investigate any matter at any time under House Rule X.

Chairman Issa asks if the exercise of substantial initial pricing discretion provided to underwriters and issues in the 1933 Act can lead to pricing errors and conflicts of interest. Specifically, he asks if the pricing discretion exercised in the Facebook IPO harmed retail investors. Regarding underpricing and allocations, he asked the SEC to provide a summary of internal or external research the Commission has relied on with regard to IPO overpricing and underpricing throughout the past 20 years. The oversight chair also wants to know if the vast majority of shares go to institutional investors and wants to see summary data on the allocation of IPO shares over the past 20 years to institutional investors.


The House leader also had a number of questions regarding barriers to communicating with investors. He noted that the Securities Act enables underwriters to determine the price of the issuance while they develop support from select potential investors under protection from public debate on the issuers’ valuation. The protection from public debate arises out of the restrictions to communicate outside of the prospectus. These communications restrictions generally fall within the quiet period. Separately Securities Act Rule 175, in the view of Chairman Issa, fails to properly carve out analyst research reports made by on or behalf of an issuer from Rule 10b-5 liability. As a result of Rule 175, he averred, analyst research is withheld from retail investors.

It seemed to him that the liability construct provided under Securities Act Rule 175 needlessly prevents ordinary investors from receiving valuable information on IPOs. Chairman Issa asked the SEC if it recognizes that the quiet period rules and liability under Rule 175 provide institutional investors an informational advantage over ordinary investors. Similarly, he asked the Commission if the quiet period is more and more difficult to enforce given the advances in information technology. Specifically, he requested SEC comment on the costs and benefits of enforcing restrictions on communication in light of current technology. More broadly, he wants to know if the restrictions on communication in the Securities Act inhibit price discovery in the IPO process.

Chairman Issa also asks the SEC to explain how restricting the access of ordinary investors to marketing materials from an issuer protects them. He queries if the quiet period is intended to protect ordinary investors from themselves. 

He also questioned if analysts working in the research departments of brokerage firms suffer potential liability under Rule 175(a) if their analysis fails to accurately predict the performance of an IPO issuer. He asked if the SEC believes that it is reasonable to expect that analyst estimates are accurate ex-post and that any liability should be associated with something as unrealistic as predicting the future. Further, he wonders if subjective requirements for a reasonable basis and good faith open the door to needless and excessive litigation and prevent ordinary investors from receiving valuable information.

He asks the SEC if it believes that, under the Section 27A safe harbor for forward-looking information, these same analysts can provide earnings estimates for public companies without being subject to liability if their earnings fail to meet the estimates. The SEC should explain the substantive basis for treating analysts of an IPO issuer differently than the analysis of a public company. Finally on this theme, Chairman Issa asks the SEC if it would, consistent with Section 27A, consider amending Rule 175 to provide a broad safe harbor for forward-looking information about the issuer.

On the issue of market price and fair market value, Chairman Issa asks for an explanation on why the SEC considers market price to be the best determinant of market value and contrast this approach with the non-market approach applied to traditional IPOs. He asks if the common post-IPO pop in share price reflects artificial underpricing and whether the pop reflects positively or negatively on securities market efficiency. He queries if the SEC has the authority to impose a market-based IPO price determination process without legislation.

Further, the SEC should address whether a market-based auction model would eliminate the pricing discretion exercised by the underwriter and the issuer. More particularly, would the SEC ask Congress for the complete abandonment of the non-market based approach provided by the 1933 Act in favor of a market-based approach, such as a Dutch auction that the issuer opens to all market participants. The SEC is requested to provide the Committee with information on whether allowing short selling within the Dutch auction could act to eliminate concerns over puffing by opening up the IPO to a broader set of initial investors.