Saturday, September 29, 2012

Federal Judge Vacates and Remands CFTC’s Dodd-Frank Position Limits Rule on Derivatives

Section 4a(a)(1) of the Commodity Exchange Act, as amended by the Dodd-Frank Act, clearly and unambiguously requires the CFTC to make a finding of necessity prior to imposing position limits, said a federal judge (DC of DC). The plain text of the statute requires that position limits be set as the Commission finds are necessary to diminish, eliminate, or prevent excessive speculation. The court found that the CFTC did not promulgate its Position Limits Rule on derivatives based on a correct and permissible interpretation of the statute at issue. The text does not state that the CFTC may do away with or ignore the necessity requirement in its discretion. Thus, the court concluded that Sec. 4a(a)(1) unambiguously requires that, prior to imposing position limits, the Commission find that position limits are necessary to “diminish, eliminate, or prevent” the burden described in Section 4a(a)(1). ISDA v. CFTC, DC of DC, Civil Action No. 11-cv-2146.

There is nothing in the plain language of the statute that supports the Commission’s argument that the discretion in Section 4a(a)(1) was somehow “converted” by Dodd-Frank. If anything, noted the court, the Dodd-Frank amendments are subject to the preexisting standards of Section 4a(a)(1), not the other way around. In these circumstances, the court vacated and remanded the position limits rule to the agency so that it can fill in the gaps and resolve the ambiguities. The Position Limits Rule, which according to both parties is a significant and unprecedented change in the operation of the commodity derivatives market, has not yet gone into effect. The court reasoned vacating the rule was proper since it would be disruptive to the markets if the Position Limits Rule were allowed to go into effect while on remand. The Court found that vacatur of the rule now would merely maintain the status quo and cause far less disruption than vacating the regime after it has gone into effect.

Friday, September 28, 2012

Martin Wheatley Urges UK Government Regulation of LIBOR

Martin Wheatley, UK Financial Services Authority Managing Director, recommends three specific regulatory changes to restore credibility to LIBOR. First, the submission and administration of LIBOR should become regulated by the Financial Services Authority. Second, the key individuals in these processes should be FSA approved persons; and, third, he government should amend the Financial Services and Markets Act to allow the FSA to prosecute manipulation or attempted manipulation of LIBOR.

In his view, bringing the submission and administration of LIBOR under the FSA’s regulatory umbrella will enhance the FSA’s ability to put in place rules that set out requirements on firms to ensure the integrity of the submission process and allow the FSA to supervise the conduct of firms and individuals involved in the process. Importantly, it will also enable the FSA to take regulatory action against firms and approved persons in relation to misconduct, including public censure and financial penalties. Many of the problems we have seen are down to the behaviour of individuals, said Mr. Whaetley, and these powers will allow the FSA to approve key individuals for these roles, ensuring that they are fit and proper to perform the job, something which is clearly lacking in the present system.

As part of this process, the recommendation is to amend the Financial Services and Markets Act to include, as an offense, the making of a false or misleading statement in order to manipulate LIBOR. This would enable the FSA to use criminal powers for the worst cases of attempted manipulation. These powers to take action against wrongdoers will be in addition to the powers under the new European market abuse regime. The European Commission has acted quickly to amend this new regime so that it will apply to manipulation of benchmarks. The senior FSA official urged the UK government to continue to assist in finalizing the new Market Abuse Regulation, which will apply across Europe, and bring another level of protection against manipulation.

Secretary Geithner Urges FSOC to Act Quickly on Money Market Fund Reform

Treasury Secretary Tim Geithner has urged the Financial Stability Oversight Council to use its authority under section 120 of the Dodd-Frank Act to recommend that the SEC proceed with money market fund reform.  To do so, he said in a letter to FSOC, the Council should issue for public comment a set of options for reform to support the recommendations in its annual reports.  The Council would consider the comments and provide a final recommendation to the SEC, which, pursuant to the Dodd-Frank Act, would be required to adopt the recommended standards or explain in writing to the Council why it had failed to act.  The Secretary has asked staff to begin drafting a formal recommendation immediately and is hopeful that the Council will consider that recommendation at its November meeting.
The proposed recommendation should include the two reform alternatives put forward by Chairman Schapiro, request comment on a third option, and seek input on other alternatives that might be as effective in addressing structural vulnerabilities. 
Option one would entail floating the net asset values (NAVs) of the funds by removing the special exemption that allows them to utilize amortized-cost accounting and rounding to maintain stable NAVs.  Instead, they would be required to use mark-to-market valuation to set share prices, like other mutual funds.  This would allow the value of investors’ shares to track more closely the values of the underlying instruments held by money market funds and eliminate the significance of share price variation in the future.
Option two would require them to hold a capital buffer of adequate size (likely less than 1 percent) to absorb fluctuations in the value of their holdings that are currently addressed by rounding of the NAV.  The buffer could be coupled with a “minimum balance at risk” requirement, whereby each shareholder would have a minimum account balance of at least 3 percent of that shareholder’s maximum balance over the previous 30 days.  Redemptions of the minimum balance would be delayed for 30 days, and amounts held back would be the first to absorb any losses by the fund in excess of its capital buffer.  This would complement the capital buffer by adding loss-absorption capacity and directly counteract the first-mover advantage that exacerbates the current structure’s vulnerability to runs.
Option three would entail imposing capital and enhanced liquidity standards, coupled with liquidity fees or temporary gates on redemptions. 

Thursday, September 27, 2012

Supreme Court Will Review Case Involving SEC Enforcement Action for Market Timing and Statute of Limitations

The US Supreme Court has agreed to review a case involving the application of a limitations period to an SEC enforcement action on the market timing of mutual funds. The Court will review a Second Circuit ruling that the five-year limitations period in 28 USC 2462 did not begin to run until the SEC discovered, or reasonably could have discovered, the alleged fraudulent scheme. The SEC has urged rthe Court to uphold the Second Circuit. Gabelli v. SEC, Dkt. No. 11-1274.

Section 2462 provides that an action for the enforcement of any civil penalty must not be entertained unless begun within five years from the date when the claim first accrued. The appeals court rejected the petitioners’ argument that the SEC claims against them for civil penalties first accrued when they engaged in the fraud at issue regardless of the time at which the SEC discovered or reasonably could have discovered the scheme.

The SEC’s brief notes that the Supreme Court has repeatedly recognized that, unless Congress specifies a different rule, the limitations period in an action for fraud does not begin to run until the plaintiff discovers, or in the exercise of reasonable diligence could have discovered, the facts underlying the claim. That rule, said the SEC, derives from the equitable maxim that a party should not be permitted to benefit from its own misconduct. The Court has long held as a matter of equity that defendants cannot use their own conduct as a defense, including by unfairly relying on a statute of limitations.

The Second Circuit correctly applied the discovery rule in this case, argued the SEC, noting that the agency’s claims under the Investment Advisers Act were based on fraud. Thus, the discovery rule should define when the claim accrues. The appeals court correctly reasoned that for claims sounding in fraud a discovery rule is read into the relevant statute of limitation.

It does matter that the SEC is the plaintiff in the action, said the brief. The Court has previously stated that there is no good reason why the rule that statutes of limitations upon suits to set aside fraudulent transactions must not begin to run until the discovery of the fraud should not apply in favor of the Government as well as a private individual.

Finally, the SEC said that the petitioners’ reliance on the Court’s recent decision on Credit Suisse Securities v. Simmonds was misplaced. In Simmonds, the Court considered the limitations period for filing suits against a corporate insider to recover short-swing profits under Exchange Act Section 16(b). The Court divided 4-4 on whether that two-year period could be tolled at all. The Court held that, assuming some form of tolling did apply, it was preferential that form which Congress was aware of rather than a more expansive tolling rule. The Court concluded that allowing tolling to continue beyond the point at which a 16(b) plaintiff is aware or should have been aware of the facts underlying the claim would be inequitable and inconsistent with the general purposes of limitations periods.

The plaintiff’s claim for recovery of short-swing profits did not sound in fraud, noted the SEC, and thus the Court had no occasion to address the application of the discovery rule to cases where the underlying violation is based on fraud. Also, in the SEC’s view, the Court’s reason for rejecting the expansive tolling rule was inapposite here. In Simmonds, the plaintiff’s proposed approach was novel because it divorced equitable tolling principles from the reason equity would delay the limitations period, which would be the plaintiff’s reasonable lack of awareness of the facts underlying the claim. By contrast, in the instant action, the appeals court applied the discovery rule in its traditional form and held that the limitations period would begin to run when the SEC knew or with reasonable diligence could have known of the fraudulent scheme.

Federal Court Broadly Interprets Dodd-Frank Whistleblower Provision

A company human resources officer and member of the pension plan committee alleged sufficient facts about the underfunding of the pension plan to support a Dodd-Frank Act whistleblower claim based on his intra-corporate communications and external communications to the SEC, ruled a federal judge. The employee alleged sufficient facts to infer that he possessed a reasonable belief that he was reporting a possible securities law violation. In a letter to the SEC, the employee informed the Commission that the company had failed to submit its 2009 amendment to the pension plan to its board of directors for approval and had failed to file its amendment with the SEC. (Kramer v. Trans-Lux Corp, DC Conn., No. 3:11cv1424 (SRU), Sept 25, 2012).

Although the company argued that it actually filed a Form 10-K/A with the SEC on the date of the 2009 amendment to the plan and thus there had been no violation, the court noted that in order to qualify for whistleblower protection the employee need not demonstrate that there has been a violation, but only that he reasonably believed there had been such a violation. The court found that the language of the employee’s internal communication to the audit committee, and in the letter to the SEC, raising his concerns demonstrated that he may have reasonably believed the company to be committing violations of SEC rules or regulations.

In Section 922, the Dodd-Frank Act defines a "whistleblower" as any individual who provides information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission. In order to have provided information in the manner provided by the SEC, an individual would have either had to submit the information online, through the Commission's website, or by mailing or faxing a Form TCR. Mailing a regular letter is insufficient.

Thus, the company argued that the employee is not be entitled to sue under the retaliation provision of the Dodd-Frank whistleblower statute because he has not provided information to the SEC in the manner required by the SEC, and is therefore not a whistleblower. The court rejected this reading as inconsistent with the goal of the Dodd-Frank Act, which was to improve the accountability and transparency of the financial system, and create new incentives and protections for whistleblowers. The court did not believe that it is unambiguously clear that the Dodd-Frank Act's whistleblower retaliation provision only applies to those individuals who have provided information relating to a securities violation to the Commission, and have done so in a manner established by the Commission. In the court’s view, the company’s interpretation would dramatically narrow the available protections available to potential whistleblowers.

The court also rejected the company’s claim that the employee’s disclosures were not required by Sarbanes-Oxley, and thus not entitled to whistleblower protection Section 922 protects disclosures that are required or protected under the Sarbanes-Oxley Act, the Securities Exchange Act, and other rules or regulations that fall under the SEC's jurisdiction. The language of this section indicates that disclosures that are protected under Sarbanes-Oxley's whistleblower provision are also protected under the Section 922, the Dodd-Frank Act's whistleblower provision.

Sarbanes-Oxley protects persons who disclose information they reasonably believe constitutes a violation of SEC rules or regulations, when the information is provided to, among others, a person with supervisory authority over the employer or such other person working for the employer who has the authority to investigate, discover, or terminate misconduct. The employee alleged that he internally provided information to a person with supervisory authority over him, and to the audit committee, which may have had the authority to investigate, discover, or terminate misconduct. Sarbanes-Oxley's whistleblower protections also extend to persons who disclose information to a federal regulatory agency.

Wednesday, September 26, 2012

CFTC Chair Gensler Tells European Parliament that LIBOR Should Rely on Observable Transactions

As UK FSA authorities preprare a plan to either reform or replace the LIBOR benchmark, CFTC Chair Gary Gensler told a committee of the European Parliament that benchmark rates should rely upon observable transactions. A rate that relies upon observable transactions is anchored by the reality of that price discovery, said Chairman Gensler, and has a well lit path to credibility. A rate that relies upon observable transactions is also less vulnerable to misconduct.

In remarks to the Economic and Monetary Affairs Committee, he also urged international regulators and market participants to work together collaboratively to improve LIBOR’s governance, manage the conflicts of interest and enhance the integrity of LIBOR reporting. Nevertheless, even if we address the issues of governance and conflicts of interest, we will still need to address the fundamental issue – that the underlying market for unsecured interbank borrowing has largely diminished. So much so that there may not be enough observable transactions in the unsecured interbank marketplace for people acting in good faith to accurately, estimate a rate for submission. If the market were to move to a replacement benchmark rather than just mending LIBOR, noted Chairman Gensler, it is crucial that the international process address an appropriate transition for people borrowing, lending or hedging based on LIBOR.

Broad market input would be necessary to establish protocols and market mechanisms for such a transition. Moreoverin his view, any such transition should ensure that homeowners, commercial enterprises, and others with contracts indexed to LIBOR have an ability to smoothly migrate in a way over time so as to be least affected by a possible change.

Since the attempted manipulation of the London Inter-Bank Offered Rate (Libor) has cast a shadow over the financial industry at large and the governance of the benchmark, the UK has begun a review of the benchmark with an eye towards reforming it or replacing it with an alternative benchmark. Retaining Libor in its current state is not a viable option given its identified weaknesses and the loss of credibility it has suffered. The review is under the direction of Martin Wheatley, Financial Services Authority Managing Director. Mr. Wheatley is also the Chief Executive-designate of the new Financial Conduct Authority.

Libor is a benchmark used to gauge the cost of unsecured borrowing in the London interbank market and sets the price for hundreds of trillions of dollars worth of derivatives and other financial contracts worldwide. In recent remarks, Mr. Wheatley noted that Libor is an integral part of the modern financial system, referenced in a huge number and variety of financial contracts. Although Libor is calculated in London, it is based on daily submissions from a number of international banks and is used as a global benchmark. A consultation was published August 10, 2012 under a very tight time frame. Director Wheatley will make recommendations very soon to the UK Government, which will then make a decision and implement any changes in the Financial Services Bill or the Banking Reform Bill.

SEC to Receive Draft JOBS Act Registrations on EDGAR

The SEC’s Division of Corporation Finance has announced that draft, confidential emerging growth companies’ (EGCs) JOBS Act registration statements may soon be submitted through EDGAR. Earlier this year, the SEC devised a secure email system to receive EGC draft registrations as well as certain filings of foreign private issuers. Modifications to EDGAR for these submissions are expected to be available by Monday, October 1, 2012. According to CorpFin, firms will be able to choose the secure email system or EDGAR to submit draft registrations. Submissions via EDGAR will be mandatory when the EDGAR Filer Manual for the version 12.2 EDGAR release is effective. CorpFin also published guidance for making JOBS Act submissions on EDGAR.

Monday, September 24, 2012

SEC Must Advance Financial Literacy for Underserved Communities Says Comm. Aquilar

According to SEC Commissioner Luis Aguilar, one way to bridge the gap of financial education in the unbanked and underwerved is to improve financial literacy for all investors, but especially for Latinos, African-Americans, and other underserved communities. In remarks to the DC Hispanic Bar Association, he announced strong support for financial education and believes that the SEC has an important role to play in this area. Clearly the need exists,  he added.

Last month, the SEC staff published a study on financial literacy that found broad weaknesses in the ability of U.S. retail investors to make basic investment decisions and protect themselves from fraud. In addition, the study found that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population.” This is unacceptable, declared the Commissioner, who believes that the SEC should, do more to advance basic investor education, especially for underserved groups.

Saturday, September 22, 2012

IASB Chair Says Concept of Prudence Permeates IFRS Despite Removal of Definition in Bow to Convergence with USGAAP

The concept of Prudence is alive and well in IFRS even though the definition has been removed in a bow to convergence with US GAAP, said Hans Hoogervorst in remarks to the European Federation of Accountants. Prudence was defined as the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Prudence is designed to prevent earnings management. 

But the concept of Prudence, which essentially means if in doubt, be cautious, is still very much engrained in IFRS, said the Chair. For example, while fair values are often seen to be synonymous with exuberance, IFRS actually requires risk adjustments when fair values are measured using mark-to-model techniques. IFRS require liabilities to be recorded for guarantees or warranties even when they have not yet been called in.  Also, inventory is typically carried at lower of cost or net realisable value; noted the IASB Chair, again a prime example of exercising caution.  Impairment tests are required to ensure that the carrying amount in the statement of financial position is not greater than the recoverable amount of the asset.

IFRS also have very strict rules governing the balance sheet presentation, giving little room for off-balance sheet financing.  IFRS are also quite restrictive in terms of the netting of derivatives. The difference with entities reporting under US GAAP can be as big as 30 or 40% of the balance sheet. The IASB believes that derivatives are too important , and their net positions too volatile, to be relegated to the notes.  

Move Towards EU Regulations Away from Directives Will Reduce Regulatory Arbitrage Says ESMA Chair

The move away from EU Directives to EU Regulations and ESMA standards and guidance will  contribtute to consistent and congruent  financial and derivatives regulation actoss the EU and increased investor protection and a stable financial architecture, in the view of Steven Maijoor, Chair of the European Securities and Markets Authority. This is so because EU Regulations, unlike Directives, aplly equally and the same to all EU member states and cannot be changed by national legislation. ESMA coordinates the implementation of consistent regulations throughout the member states as part of its remit.  ESMA guidelines not only help investor protection and stability, but also achieving consistent supervisory practices across the EU. 

ESMA also closely cooperate and communicate with national authorities in order to avoid and mitigate cross-border differences which would generate regulatory arbitrage and the fragmentation of financial markets.  Thus, said the Chair, ESMA helps to sustain the market depth of the European Single Financial Market as well as the related economies of scale and risk absorption capacities. 

The Chair noted ESMA’s soon to be completed standards on derivatives central counterparties to facilitate the stability and efficiency of derivative markets. They will provide the basis for effective regulation and supervision of these very important market infrastructures.  ESMA’s guidelines on high frequency trading support a smooth market process and minimize trading distortions.  Also, ETF guidelines support the stability of these investment funds by having requirements for the quality of collateral, securities lending and the use of repo transactions. The Chair's remarks came at a meeting of the EU financial markets association.

Mass. Securities Chief Urges SEC to Establish Accredited Investor Methods under JOBS Act Reg. D Measure

In a letter to the SEC, the Massachusetts Securities Commissioner and Secretary of the Commonwealth William Galvin said that in the proposed regulations implementing the JOBS Act elimination on the ban on general solicitation under Regulation D the Commission has failed to meet its obligations under Section 201 of the JOBS Act to establish methods for issuers to use to verify that investors are accredited. In his view, this failure will put the interests of retail investors and savers at risk in unprecedented ways. This failure will also place unnecessary burdens on issuers, who could benefit from the Commission's guidance on this important obligation. Also, the SEC's failure to adopt meaningful requirements for the Rule 506( c) exemption will impede state and federal enforcement in virtually all cases involving unregistered offerings. There is also a serious risk that courts will draw the inference from the Commission's failure to issue meaningful rules that few or no standards are applicable to the Rule 506( c) exemption. This is likely to result in conflicting court decisions on issues relating to Title II, and to decisions that are contrary to the policies embodied in the Securities Acts. 

The requirement that investors must be accredited is the sole protective mechanism built into the new exemption under Rule 506. The exemption does not carry any mandatory disclosure requirements in sales to accredited investors, and such offerings are not subject to review at the state level. For these reasons, it is vitally important that the Commission's regulations protect investors even as the rules for the offer and sale of unregistered offerings are liberalized. The verification requirement was added to Title II specifically to protect unsophisticated and unqualified investors by means of methods to be specified by the Commission.  

Friday, September 21, 2012

Parliament Considers UK Draft Legislation Implementing Ring-Fencing of Retail from Investment Banking in Britain's Answer to Volcker Rule

A joint UK Parliamentary Committee has begun hearing evidence on draft legislation implementing the Vickers Commission recommendations that would ring-fence banks taking retail deposits from investment banks in the same banking group as Britain's answer to the Volcker Rule. The legisaltion would ring-fence vital banking services on which households and small and medium-sized busonesses  depend, keeping them separate from wholesale and investment banking activities. This would more effectively insulate them from problems elsewhere in the global financial system and make banks easier to resolve without taxpayer support. It would also curtail implicit government guarantees, reducing the risk to the public finances and making it less likely that banks will run excessive risks in the first place. Improving resolvability of banks through structural reform is in keeping with international initiatives to make it easier to deal with failing banks. Structural complexity has been identified by the Financial Stability Board as one of the most important barriers to successful bank resolution.

The fence should be flexible in location, said the Government, but of sufficient height to ensure effective legal, operational and economic separation between entities. Under the legislation, there be a set of mandated services within ring-fenced banks consisting of retail and SME deposits and overdrafts and a set of wholesale and investment banking services should be prohibited from the ring-fenced bank in order to meet the objectives of the policy. The ring-fenced bank should be allowed to conduct ancillary activities to support the provision of its core functions; and should be legally and operationally independent from the rest of its corporate group. Also, economically, the ring-fenced bank should not be dependent for its liquidity and solvency on the financial health of the rest of its group.

Thursday, September 20, 2012

Joint House-Senate Hearings Examine Hedge Fund Carried Interest as Part of Federal Tax Reform

A joint House Ways and Means and Senate Finance Committee hearings on tax reform discussed the treatment of capital gains and carried interest in the current federal tax code. Professor Leonard Burman, of Syracuse Business School, testified that, in 2012, the biggest tax shelter may arise from the fact that certain forms of compensation are taxed as capital gain.  For example, managers of private equity funds and hedge funds hold a carried interest, a right to receive a share (typically 20 percent) of the profits produced by an investment fund over and above any share corresponding to their actual cash investment.  As a result, a significant portion of their compensation is ultimately taxed as capital gain, rather than ordinary income.  Private equity managers also receive fees that are taxed as ordinary income, but if the investments are successful, that is a small portion of their compensation.   

Besides for the obvious inequity of people with multi-million dollar earnings being taxed at lower rates than middle-income workers, a disparity that at least in part motivated the Buffett Rule, he noted, this is also economically inefficient.  While there probably would be a role for private equity funds even in the absence of the capital gains tax break, he reasoned, it is surely true that more people and capital are drawn to such firms by the tax breaks.  

Data compiled by the Internal Revenue Service suggest a marked shift in the kinds of assets that generate capital gains over time. In 1997, more than half of capital gains came from corporate stock, either held directly or indirectly through mutual funds. Only 30 percent was generated by so-called pass-through entities: S-corporations, partnerships, trusts and estates.

Ten years later, corporate stock was less than 40 percent of all long-term gains while pass-through entities comprised more than 44 percent.  Over that same period, there was also a very large increase in the dollar amount of pass-through gains, 296 percent, compared with a 91 percent increase for stocks and mutual funds.  In the Professor's view, the growth of private equity firms, which are typically organized as partnerships, and other investment partnerships might be a significant factor in this shift.   

David Verrill, Chairman of the Angel Capital Associaiton, distinguished between angels, venture capitalists and private equity.  Angels invest their own money in management teams and technologies they like, typically where they live.  So angels are on Main Street of every state in the US.  Venture capitalists typically invest institutional capital from endowments, corporations and family offices. Private equity, much like VCs, invest institutional money but their focus is on mature companies. 

He cautioned Congress that raising the capital gains tax rate significantly will force many angels to broadly turn away from an asset class in which they are the most experienced, recognized experts and dominant players.  At a time when crowdfunding and general solicitation by issuers are about to come into play under the JOBS Act, he reasoned, the wisdom of angels is going to be needed more than ever to maintain discipline and order in this market. 

Rep. King Will Introduce Bill Guaranteeing Int'l Comparability of Volcker Rule

Rep. Peter King, (R-NY), a senior member of the Financial Services Committee, will introduce legislation, the U.S. Financial Services Global Viability Act. mandating that enforcement of the Volcker Rule be suspended until the US Treasury can certify that other international jurisdictions have adopted and are abiding by similar statutory rules on proprietary trading and sponsoring hedge funds by financial institutions. The bill targets nine specific jurisdictions, UK, Germany, France, Japan, China, Canada, Mexico, Brazil and Switzerland. The certification by Treasury must be determined after interested parties are given an opportunity for a hearing. The parties are also entitled to judicial review in the DC Circuit. 

European Parliament Committee Approves Legislation Mandating Extractive Industry Disclosure

Large extractive companies dealing with oil, gas and minerals would be obliged to disclose full information on their payments to national governments, on a country-by-country and project-by-project basis, according to legislation approved by the Committee on Legal Affairs. The committee approved a package of proposals imposing on large companies extracting oil, gas and minerals and loggers of primary forests a new obligation to provide full details on their payments to national governments. Arlene McCarthy (UK), the MP responsible this piece of legislation, was pleased that the committee overwhelmingly backed her compromises for a strong law on transparency and disclosure for the extractive industries.  

Ms. McCarthy is the rapporteur (lead legislator) for this legislation. She called the vote a clear rejection of the 27 member states' weak proposals for disclosure of country-by-country payments and reporting in the extractive industries. The legislation proposed by the committee, to be agreed with the 27 national governments, would delete from the European Commission proposal an article exempting companies from respecting information requirements forbidden in the host country. Information disclosure would be on a country-by-country basis and indicate the financial resources allocated to each project. Project-level disclosure is the only way in which local communities in resource-rich countries are able to expose corruption and hold their governments accountable for using revenues towards development, MP McCarthy added.

Wednesday, September 19, 2012

House Passes Legislation Clarifying Scope of Dodd-Frank Municipal Advisor SEC Registration

The House  of Representatives has passed by voice vote bi-partisan legislation clarifying that Section 975 of the Dodd-Frank Act requiring municipal advisors to register with the SEC does not include dealers, banks, investment advisers and members of municipal governing bodies, and others who were either already regulated before the enactment of Dodd-Frank or are appointed, volunteer public servants. According to Ranking Member Barney Frank (D-MA), the SEC supports the bill as approved by the full Committee.

According to the sponsor of HR 2827, Rep. Robert Dold (R-IL), the intent of Congress in enacting Section 975 was not to impose a regulatory structure on previously unregulated entities that are active in the financial markets. The full Committee Chair, Rep. Spencer Bachus (R-ALA), earlier expressed concern over the scope of Section 975. While he supports efforts to police this segment of the municipal market, Chairman Bachus believes that Section 975 and the SEC proposed regulations implementing the statute are overly broad and would require appointed, non-ex-officio municipal board members and officials to register with the SEC. In an earlier letter to the SEC, he said that the broad definition of municipal financial products combined with the failure to define ``advice’’ would also result in thousands of bank employees conducting routine business with municipal entities having to register with the SEC.

According to Rep. Gwen Moore (D-WI), a cosponsor of the bill, HR 2827 eliminates confusion around the SEC proposed regulations implementing Section 975. The definition of municipal advisor is the heart of HR 2827. It is an exclusionary definition that creates certainty for market participants. HR 2827 also creates a federal fiduciary standard for municipal advisors with no blanket exemptions. The bill specifies that municipal advisors have a fiduciary duty to their municipal entity clients and specifies when such duties begin and end in relation to municipal advisory activities. The legislation also provides that municipal advisers can engage in principal transactions with the clients, subject to MSRB regulation.  

An amendment offered by Rep. Dold was approved in Committee providing that persons associated with municipal advisory firms did not have to separately register with the SEC. An amendment offered by the Ranking Member Barney Frank was approved in Committee deleting the phrase ``in writing'' from the definition of municipal advisor as one that is engaged, in writing, and for compensation by a municipal entity to provide advice. Rep. Frank described the amendment as anti-evasion, forcing a look at the reality of the transaction whether or not it was in writing.

In Letter to Chairman Bachus, Int'l Banking Group Urges Volcker Rule Comity Review

The Institute of International Bankers has urged Congress to undertake a comprehensive review and assessment of the statutory Volcker Rule, Section 619 of the Dodd-Frank Act based on the principles of comity, the need for international cooperation and the observation of appropriate territorial limits on U.S. regulation. In a letter to House Financial Services Committee Spencer Bachus (R-AL), The Institute said there is no justification for the Volcker Rule to limit transactions by international banks that do not put U.S. financial stability, the safety and soundness of U.S. banks or U.S. taxpayer dollars at risk. They warned that inappropriately imposing U.S. limitations outside the United States would have significant adverse and unintended consequences for international banks, as well as the U.S. economy and U.S. investors.  The flow of capital from foreign investors to U.S. companies would be restricted, and liquidity in U.S. markets would be reduced, without any corresponding benefit to U.S. financial stability, U.S. taxpayers or the safety and soundness of U.S. banks. The Institute represents represents internationally headquartered financial institutions from over 35 countries doing business in the United States.  The IIB’s members consist principally of international banks that operate branches and agencies, bank subsidiaries and broker-dealer subsidiaries in the United States.

While the U.S. operations of international banks are subject to the Volcker Rule to the same degree as U.S.-headquartered banks, said the Institute, Congress has already properly sought to limit the extra-territorial impact of the Volcker Rule by providing exemptions for 
certain activities conducted “solely outside of the United States” (the so called SOTUS exemptions). However, the proposed implementing rules issued by U.S. regulators interpret those exemptions and certain other provisions of the statute in a manner that would significantly and unjustifiably interfere with activities conducted by international banks outside of the United States, without any corresponding benefit for the safety and soundness of U.S. banking, U.S. financial stability or U.S. taxpayers.

Congress provided an exemption for trading and funds activities outside of the United States focused on the actions of banks as principal, which appropriately focuses on where the risk of the activity is taken. By providing this exemption, reasoned the Institute, Congress recognized that if it were to do otherwise and regulate the trading practices of international banks and their non-U.S. affiliates, it would create unwarranted conflicts with foreign regulation and needlessly divert scarce U.S. regulatory resources to matters that do not implicate U.S. financial stability, the safety and soundness of U.S. banks or U.S. taxpayers.

However, the Institute pointed out that the proposed rules layer on additional limitations that make the exemptions too 
narrow, cutting off trade with U.S. investors and on U.S. exchanges without any corresponding benefit for U.S. financial stability.  For example, under the proposed rules, a trade between a German bank in Frankfurt and a UK bank in London would apparently not qualify for the SOTUS exemption if it were executed on a U.S. exchange.  Similarly, a trade between a French bank and a U.S. manufacturing firm over a European trading platform would apparently subject the French bank to the full panoply of regulations under the proposed 
rules by virtue of having traded as principal with a single U.S. person. 

While the Volcker Rule quite appropriately recognizes that U.S. publicly-traded mutual funds should not be subject to the Volcker Rule’s funds prohibition, said the Institute, no similar recognition is given to comparable foreign investment companies, including funds that engage in public offerings outside of the U.S.  For example, regulated investment funds in Canada could not be offered or sold by Canadian banks to Canadian residents while traveling on business or pleasure in the U.S. 

In Letter to Chairman Bachus, Securities Industry Sees Basel III as More Effective Than Volcker Rule

In a letter to Representative Spencer Bachus (R-AL), chairman of the House Financial Services Committee, in response to his request for public comments on legislative alternatives to the Volcker Rule. SIFMA and the Financial Services Roundtable said that the many problems with the Volcker Rule identified by a wide variety of stakeholders demonstrate the need for a substantive re-evaluation by Congress, and they strongly support the Chairman’s initiative to do so. In its letter to Chairman Bachus, SIFMA urged Congress to explore one wholesale alternative to Volcker that relies on already proposed capital regulations that are under consideration and being implemented as a result of Basel III and other initiatives, rather than activities restrictions. A risk-based framework with an effective supervisory overlay, under which higher capital charges would apply to riskier activities as determined by the regulators, would be a more targeted and effective means of addressing the concerns underlying the Volcker Rule.  
While SIFMA supports a comprehensive re-evaluation of the Volcker Rule, including the risk-based approach, should Congress determine to retain the Volcker Rule framework as enacted, SIFMA believes that several modifications to the existing statute are necessary to achieve its goals without harming the ability of banking entities to continue to provide client-oriented financial services.  Those modifications include reconsidering the structural approach of the Volcker Rule’s approach to proprietary trading and reversing the presumption that all short-term principal trading with the intent to profit from changes in short-term price movements, wherever located within a banking organization, is impermissible.  As an alternative, the structure of the statute should define proprietary trading to capture only the types of trading activities that Congress intended to restrict, that is, those that are not related to client-oriented financial services and that are intended to generate profit from short-term price movements for the banking entity.  
    SIFMA also believes that Congress should revisit certain of the statute’s exemptions for permitted activities to ensure that they adequately preserve a banking entity’s ability to engage in socially and economically useful client-oriented activities, such as market making. The “near-term” limitation injects uncertainty as to the legality of an activity that Congress intended to permit, and at worst the limitation may effectively prohibit banking entities from making markets in a wide variety of markets altogether.  SIFMA recommends that Congress remove the “near-term” limitation or explicitly provide that market makers may build appropriate inventory based on their experience and the exigencies of a particular market. 
    SIFMA said that Congress should amend the hedging exemption to provide a clearer safe harbor for hedging activity.  For example, the hedging exemption could be revised to omit the requirement that the activity be designed to reduce “the specific risks” to the banking entity and instead refer generally to activity that is designed to reduce risks to the banking entity.  SIFMA also asks that Congress clarify that the hedging exemption is equally applicable to banking entities’ interests in hedge funds and private equity funds. 
    SIFMA believes the statute defines “hedge fund” and “private equity fund” extraordinarily broadly as any entity that relies on two exemptions in the Investment Company Act of 1940. SIFMA believes the funds portion of the Volcker Rule should be limited to hedge funds that engage in the same type of proprietary trading that is deemed to be too risky for banking entities to engage in directly. SIFMA also believes that congress should address the overbreadth of the definition of those terms to capture only those entities that have the characteristics of a genuine hedge fund or private equity fund as commonly understood. 

Tuesday, September 18, 2012

No Turning Back on Volcker Rule and Dodd-Frank Implementation Says Treasury Senior Official

Federal regulators are committed to the implementation of the Dodd-Frank Act, said Treasury Under Secretary for Domestic Finance Mary Miller in remarks to the American Banker Regulatory Symposium. The Volcker regulations are important, emphasized the official, but also complex because reality is complicated.  The intent of the Volcker Rule is clear: prevent banks from making speculative bets that put customer deposits at risk and potentially expose taxpayers to losses. But then, five regulators proposed a joint rule and 18,000 comment letters arrived addressing all kinds of issues and concerns. As it turns out, noted the official, the devil is in the details.

It is hard to write a very detailed rule that would address every concern that federal regulators are hearing, she said, but it is even harder to write a simple rule that is conceptually clear to handle the nuances of a complex financial system. She promised that regulators would strive for simplicity with Volcker and the other reforms they are implementing.  At the same time, regulators are mindful of the need to have smart rules that are responsive to the unique needs of the financial system and promote economic growth. 
At the same time, Dodd-Frank also provides that large financial institutions must hold more and higher-quality capital and maintain larger liquidity buffers. We want these firms to be less likely to fail and help them withstand financial stress.  These higher standards will force large institutions to operate within a framework that reduces systemic risk and will result in an effective governor on size. Community banks, which do not pose the same type of risks to the system, will not be subject to the same obligations. The Dodd-Frank Act provides regulators the tools needed to wind down, break apart, and liquidate large financial companies. With these new tools, said the official, culpable management will be replaced, creditors will suffer losses, and shareholders will be wiped out.  And large financial institutions, not smaller banks or taxpayers, will rightfully pay any costs associated with the wind down.

Stock Transfer Association Shares JOBS Act Concerns with the SEC

In a letter to the SEC, the Stock Transfer Association said that the JOBS Act, which significantly expands the number of investors that may hold shares in any company before it must become registered under Section 12, could significantly increases the possibility that the persons responsible for maintaining records of each individual’s investment or assuring that their funds are properly safeguarded will not be subject to regulatory oversight.   In addition, the STA is concerned that these persons, whether issuers or other intermediaries, will also not have the necessary experience, recordkeeping systems or controls to perform the 
function appropriately.

The STA questions, for example, whether many small issuers seeking to rely on an exemption under the JOBS Act will have the internal resources and sophistication to properly execute even the routine functions that registered transfer agents provide. Among other things, this would include procedures to record and balance registered shareowner positions; follow shareholder instructions (and retain records of the instructions) to change an address or transfer their interests as a result of death, divorce, or sale; escheat unclaimed assets under state laws; or address lost or stolen certificates.  Issuers, or their transfer agents, whether or not registered, also must comply with UCC requirements, state and Federal privacy laws, as well as IRS regulations relating to, among other things, transferee and cost basis reporting.  

Moreover, in STA.s view, it is equally unlikely that the many small investors that potentially would participate in offerings conducted in reliance on the JOBS Act would have the
sophistication to inquire about these operational safeguards.  Thus, even apart from any deliberate fraud, STA foresees the very likely possibility of innumerable investor complaints attributable to inaccurate recordkeeping or the failure to follow instructions in a timely manner. 
As an investor protection safeguard, the STA urged the SEC to condition an issuer’s ability to raise funds pursuant to the exemptions afforded by the JOBS Act on the use of a registered transfer agent to maintain records of share ownership and transfers.  This would afford investors the protection of rules that the SEC has developed over many years to protect their interests.  In addition,  reasoned STA, the SEC and Federal and state banking regulators would more easily be able to conduct routine
inspections and examinations of issuer records held at the transfer agent.   Equally as important, they would have a jurisdictional basis to address investor complaints and to conduct cause examinations in instances in which they may suspect fraud or negligent recordkeeping.

Monday, September 17, 2012

PCAOB Member Finds that Serious Deficiencies Continue in Outside Audits of Company Financial Statements

As the PCAOB continues its 2012 inspection season, and has completed a substantial number of the inspections, the Board continue to see a  high level of serious inspection findings, said Board Member Jeanette Franzel in recent remarks. The findings are serious, and represent deficiencies that are of such significance that it appeared that many firms, at the time they issued their audit reports, had failed to obtain sufficient, appropriate audit evidence to support their audit opinions on the financial statements and/or the opinions on internal control over financial reporting. These findings are reported in the public version of the report, which is referred to as "Part I."

According to Member Franzel, such deficiencies include cases where auditors issue unqualified opinions even though the audit work was incomplete or not properly conducted; financial statement information was contradicted by other available evidence; or audit conclusions on material issues were based on management's views without independent verification. She noted that these findings do not necessarily mean that the financial statements are misstated, but that they represent areas of risk where the audit work was not sufficient under the standards to support the audit opinion.

Also, PCAOB inspections are risk-based, and often focused on key areas in particular audits that pose risk to investors. Therefore, the results cannot be generalized to all audits.

Common areas where the Board found audit deficiencies include revenue recognition, fair value of financial instruments, management estimates, testing and evaluating internal controls, related party transactions, and the auditor's assessment and response to fraud risk, among others. An area that is frequently problematic for smaller issuers is the audit work related to the issuer's use of equity financing instruments to compensate employees, vendors, and others. Many of these agreements and instruments contain complex terms and conditions that impact the manner in which the instruments should be recorded and accounted for by the issuer.

Sunday, September 16, 2012

US and UK Sign First FATCA Inter-Goverenmental Implementation Reciprocal Agreement

The UK Government and the US treasury haved signed an agreement to implement the Foreign Account Tax Compliance Act (FATCA) establishing a reciprocal approach to FATCA implementation. This is the first agreement of its kind, benefiting UK financial institutions by addressing their legal concerns with complying with FATCA and reducing the burdens imposed on them. It also boosts the  UK's ability to obtain information from the US to help in tackling UK tax evasion.

The UK-US agreement follows the Joint Statement made in July 2012 by the governments of France, Germany, Italy, Spain, the United Kingdom and the United States, announcing the publication of the Model Intergovernmental Agreement to Improve Tax Compliance and to Implement FATCA. The signing of the agreement follows the conclusion of negotiations on the UK-specific Annex II. This sets out UK institutions and products which are seen as presenting a low risk of being used to evade US tax and are therefore effectively exempt from FATCA requirements.

The UK-US agreement is closely based on the Model Agreement, and addresses legal barriers to financial institutions complying with FATCA. It also ensures that withholding tax will not be imposed on income received by UK financial institutions or on payments they make and that the burdens imposed on financial institutions are proportionate to the goal of combating tax evasion.

The agreement has been laid before the Houses of Parliament and will undergo a 21 sitting day scrutiny period as part of the ratification process. Financial institutions and other interested parties will now be consulted on the implementation of the Agreement in the UK and draft legislation will be published later in 2012.

FATCA, which is part of the Hiring Incentives to Restore Employment Act of 2010, aims to combat tax evasion by US tax residents using foreign accounts.  It includes certain provisions on withholding taxes and on the reporting of information by foreign financial institutions for US tax compliance purposes. These give rise to certain legal difficulties and administrative burdens for financial institutions

House Leader Urges SEC to Quickly Implement JOBS Act Provision Ending Reg. D Ban on General Solicitation

Rep. Scott Garrett (R-NJ), Chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, said he was dismayed to learn that the SEC, after missing its initial 60 day requirement for the implementation of the JOBS Act elimination of the ban on general solicitation in Regulation D had again delayed implementation by proposing rehulations after the staff had proposed moving forward with an interim final rule. This type of delay on what is a very simple and straightforward requirement from Congress is completely unacceptable, he emphasized in an opening statement today at a joint Capital Markets Subcommittee and the Subcommittee on TARP, Financial Services Bailouts of Public and Private Programs hearing on the implementation of the JOBS Act:

This rulemaking process under the JOBS Act is not setting up a regulatory framework for the multi-trillion derivatives market, he noted, rather it on a topic that has been around for a long time and is well known by the SEC and market participants. Chairman Garrett expects the SEC to move forward with finalizing this rule in the near future.

Earlier this year, Congress passed the Jumpstart Our Business Startups (JOBS) Act. Specifically, the JOBS Act would ease the burden of capital formation on entrepreneurial growth companies that have traditionally served as the U.S. economy's primary job creators. In addition, said the Chair, this legislation would provide a larger pool of investors with access to information and investment options on these companies that do not currently exist.

In the Chairman's view, the implementation of the JOBS Act will provide start-up companies with a cost effective means to access capital and keep this country at the forefront of medical, scientific, and technological breakthroughs. Thus, he emphasized that the bipartisan JOBS Act implementation must become a higher priority at the SEC and be completed in the very near future.


Saturday, September 15, 2012

Hedge Fund Group Asks for Safe Harbor in Proposed SEC Rule Implementing JOBS Act

The Hedge Fund Association asked the SEC to adopt a more definitive safe harbor standard within the proposed regulations implementing Dodd-Frank provisions ending the ban on genereal solicitation in Regulaiton D offerings. In a letter to the SEC, the group said that a safe harbor would help private issuers manage the process of verifying an investor’s accreditation. Adding such a safe harbor to the proposed rule would be more in line with the original intent of the JOBS Act, said the group, which was to help increase jobs in the U.S. by simplifying the process for private companies to raise money from investors. Leaving the rule open without any such safe harbor may, in fact, serve to hinder the original intent of the law by creating administrative burdens and uncertainties for private issuers who intend to comply with the new rule but are not positive whether they have done so due to the lack of a definitive safe harbor. 
The Hedge Fund Association suggested the following safe harbor language to the SEC.
"If an issuer (or its investor relations administrator) receives a signed subscription/investment agreement (whether received physically or electronically) from an investor, where the investor unequivocally affirms that he is an accredited investor (with a detailed description of the reason why included in the same document), this fact pattern alone will serve to meet a "safe harbor" whereby the Commission would agree that the issuer has met its initial burden of taking "reasonable steps" to verify whether an investor is accredited under this rule."


Banking Industry Finds Legislation Exempting Banks from SEC Municipal Advisor Registration too Narrow

While praising the House Financial Services unanimous approval of HR 2827 to clarify the scope of the Dodd-Frank SEC municipal advisory registration mandate, the banking industry said that the well-intentioned substitute legislation would not adequately cover the range of products and services that banks provide to municipalities. In a memo, the American Bankers Association also said that HR 2827 may not provide an exemption for the negotiations that banks regularly undertake with municipalities when booking loan products such as tax anticipation notes and revenue anticipation notes.

The legislation exempts banks providing “traditional banking products” from the SEC’s proposed rule implementing the Section 975. The ABA said that the bill’s narrow “traditional banking products” definition covers deposits, bankers acceptances, letters of credits, loans, certain loan participations and swap agreements. The legislation also exempts banks for trust services that are subject to a state or federal fiduciary duty, and extends to them the existing exemption for registered investment advisers.

The committee approved an amendment to H.R. 2827 eliminating the need for individuals employed by municipal advisory firms to separately register with the SEC. It also adopted panel ranking member Barney Frank’s (D-MA) amendment deleting the bill’s provision requiring municipal adviser registration only where the adviser had a written contract to provide advice for separate compensation.

Friday, September 14, 2012

Senator Corker Sees Common Ground at SEC on Money Market Reform

 In a letter to the SEC, Senator Bob Corker (R-Tenn)., a member of the Senate Banking Committee, urged the Commission to continue pursuit of money market fund reform to protect taxpayers from a potential bailout, building on the common ground established with an initial proposal from Chairman Mary Schapiro. Despite making progress, the SEC set aside further consideration of a proposed money market rule last month due to a lack of consensus among Commissioners.

In the event of a disruption in our financial system, said Senator Corker, Congress could be faced with a difficult choice of allowing individual investors to bear significant personal losses while institutional investors, who likely watch the commercial paper markets closely and would quickly recognize market distress, flee, or providing another bailout for a fund or the fund industry. Based his read of Chairman Schapiro’s initial draft proposal and the dissenting comments of some of the Commissioners, the Senator believes that the SEC may be honing in on a solution that might work. Both proposals point out the benefits of some form of a redemption restriction. Some industry observers suggest a 3-5 percent withdrawal holdback for 30 days with a de minimis exception for small retail investors. Dissenting Commissioners appear to advocate a gating approach allowing some redemption restrictions managed by a fund’s board.
In the Senator’s view, there is common ground here around a set of rules that could stem a run and the potential need for government intervention. In the end, an optimal solution will be found if the SEC Commissioners and industry work together to find an appropriate structure that minimizes the risk of a wholesale run. Whatever that solution, he reasoned, reforms now are better than a taxpayer bailout down the road. Inaction is not an option, Senator Corker emphasized.  He urged the SEC to find an acceptable solution and move forward with a reform proposal along the lines indicated. 

SIFMA-FSR Publish Letter to Chairman Bachus on Planned Volcker Rule Hearing Before House Financial Services Committee

The Securities Industry and Financial Markets Association (SIFMA) and the Financial Services Roundtable (FSR) published a letter in reply to an August 7, 2012 request for comments on Dodd-Frank Act Section 619, commonly known as the Volcker Rule, made by Representative Spencer Bachus, Chairman of the House Financial Services Committee. Chairman Bachus’ letter noted the House will have its first opportunity to consider Volcker Rule alternatives at a hearing to be scheduled this fall. The SIFMA-FSR letter, published September 7, 2012, calls for Congressional reconsideration of the Volcker Rule and advocates an alternative risk-based approach to proprietary trading regulations.

The letter addresses three key areas. First, SIFMA and FSR note the attenuated legislative history of the Volcker Rule, which was accorded two Senate hearings and no hearing in the House. As a result, these organizations suggest the enacted version of the Volcker Rule may produce unintended consequences that can be tempered by an alternative approach or through revisions to the enacted rule.

The letter also observed that regulatory implementation of the Volcker Rule has been slow, despite the issuance of proposed rules in October 2011 and the submission of many thousands of public comments. Said the letter: “We believe that the fact that the agencies have been unable to agree on final rules nearly a year after the statutory deadline for final regulations should lead Congress to investigate whether implementation of the current statutory text is even possible.” In a footnote, SIFMA and FSR suggested that the conformance period, already started without final rules, should be extended to give financial firms more time to meet new regulatory requirements regardless of Congressional re-evaluation of the Volcker Rule.

Second, SIFMA and FSR proposed an alternative approach to managing the risks associated with activities barred by the Volcker Rule. Specifically, these organizations would prefer a regulatory framework grounded in enhanced capital requirements, more akin to the Basel III reforms. These rules could be augmented by a ban on stand-alone proprietary trading.

According to the letter, these risk-based standards would be more effective than the enacted Volcker Rule because similar rules already have global reach, a risk-based approach would place less emphasis on firms’ intentions than does the existing Volcker Rule, the alternative would focus on institutions’ financial soundness and systemic risk, and regulators could verify compliance through horizontal reviews.
Lastly, SIFMA and FSR proposed numerous amendments to the Volcker Rule that they would have Congress consider if the enacted Volcker Rule is retained. A key recommendation is to reverse the presumption against all short-term principal trading. "Proprietary trading" also should be defined in a more targeted fashion with appropriate safe harbors. These and other recommendations are contained in an extensive Part III of the letter and in an appendix.

Thursday, September 13, 2012

SEC Staff Questions EGC Status in Merger with Blank Check Company

Upon reviewing the Form S-4 filed by Tile Shop Holdings, Inc. (Tile Shop), the SEC staff inquired about the firm’s consideration of guidance issued by the Division of Corporation Finance on the Jumpstart Our Business Startups (JOBS) Act. Pursuant to a contribution and merger agreement, The Tile Shop, LLC was to merge with JWCAC, a blank check company, to form a new holding company named TS Holdings. Tile Shop had indicated in its original Form S-4 that the resulting company, TS Holdings, may qualify as an emerging growth company (EGC) under JOBS Act Title I. The staff asked why TS Holdings would be an EGC in light of the guidance provided in Question 24 of Generally Applicable Questions on Title I of the JOBS Act (FAQ 24).

FAQ 24 asked whether, in the context of a transaction that results in an issuer becoming the successor to its predecessor’s Exchange Act obligations under Rules 12g-3 and 15d-5, the successor issuer can be an EGC if the predecessor was ineligible for EGC status because it first sold common equity securities under an effective registration statement on or before December 8, 2011. FAQ 24 answered this question in the negative. In other words, if the predecessor was ineligible for EGC status because its first sale of common equity securities occurred outside of the time frame specified in the JOBS Act, then the successor also is ineligible for EGC status.

Tile Shop replied that it had considered FAQ 24 and determined that TS Holdings would not be a successor under Exchange Act Rule 12g-3(a). The company stated that Exchange Act Rule 12b-2 defines “succession” to “include only the direct acquisition of the assets comprising a going business.” Tile Shop further noted that JWCAC is a blank check company with no material operations except for the goal of identifying target businesses. As a result, the contemplated merger would not result in the direct acquisition of a going business. Title Shop also said that TS Holdings otherwise qualified as an EGC.

In a follow-up comment, the staff reiterated its position that TS Holdings is ineligible for EGC status because it is a successor under Exchange Act Rule 12g-3. The staff thus instructed Tile Shop to either remove a risk factor and other references suggesting TS Holdings’ EGC status or to provide its analysis of why TS Holdings is not a successor. The staff also observed that Exchange Act Rule 12b-2 defines “succession” to include “the acquisition of control of a shell company.” The staff noted that the blank check company JWCAC is a shell company.

Tile Shop replied that it had removed the risk factor and other references to EGC status from its Form S-4. As a result, Tile Shop said it would treat TS Holdings as a successor issuer to JWCAC.

The relevant staff comments and issuer replies were published on EDGAR on August 30, 2012.

Wednesday, September 12, 2012

Full Financial Services Committee Approves Legislation Clarifying Scope of Dodd-Frank Municipal Advisor Registration

The full House  Financial Services Committee has approved bi-partisan legislation clarifying that Section 975 of the Dodd-Frank Act requiring municipal advisors to register with the SEC does not include dealers, banks, investment advisers and members of municipal governing bodies, and others who were either already regulated before the enactment of Dodd-Frank or are appointed, volunteer public servants. The vote was 60-0. The bill was an amendment in the nature of a substitute. According to Ranking Member Barney Frank (D-MA), the SEC supports the bill as approved by the full Committee.

According to the sponsor of HR 2827, Rep. Robert Dold (R-IL), the intent of Congress in enacting Section 975 was not to impose a regulatory structure on previously unregulated entities that are active in the financial markets. The full Committee Chair, Rep. Spencer Bachus (R-ALA), earlier expressed concern over the scope of Section 975. While he supports efforts to police this segment of the municipal market, Chairman Bachus believes that Section 975 and the SEC proposed regulations implementing the statute are overly broad and would require appointed, non-ex-officio municipal board members and officials to register with the SEC. In an earlier letter to the SEC, he said that the broad definition of municipal financial products combined with the failure to define ``advice’’ would also result in thousands of bank employees conducting routine business with municipal entities having to register with the SEC.

According to Rep. Gwen Moore (D-WI), a cosponsor of the bill, HR 2827 eliminates confusion around the SEC proposed regulations implementing Section 975. The definition of municipal advisor is the heart of HR 2827. It is an exclusionary definition that creates certainty for market participants. HR 2827 also creates a federal fiduciary standard for municipal advisors with no blanket exemptions. The bill specifies that municipal advisors have a fiduciary duty to their municipal entity clients and specifies when such duties begin and end in relation to municipal advisory activities. The legislation also provides that municipal advisers can engage in principal transactions with the clients, subject to MSRB regulation.  

An amendment offered by Rep. Dold was approved providing that persons associated with municipal advisory firms did not have to separately register with the SEC. An amendment offered by the Ranking Member was approved deleting the phrase ``in writing'' from the definition of municipal advisor as one that is engaged, in writing, and for compensation by a municipal entity to provide advice. Rep. Frank described the amendment as anti-evasion, forcing a look at the reality of the transaction whether or not it was in writing.