Tuesday, October 29, 2013

House Panel Holds Hearings on Bills to Reduce Impediments to Capital Formation; Possible JOBS Act II

The House Capital Markets Subcommittee held a hearing to examine seven pieces of legislation designed to eliminate impediments to capital formation. H.R. 1800, the Small Business Credit Availability Act, would amend Section 60 of the Investment Company Act to allow business development companies (BDCs) to purchase, acquire, and hold securities of or other interests in an investment advisers or advisors to investment companies and allow BDCs to issue more than one class of senior security which is a stock. H.R. 1800 would also amend Section 61(a) of the Investment Company Act to reduce the ratio of assets to debt from 200% to 150%. Finally, H.R. 1800 would direct the SEC to revise its rules and forms to allow business development companies to use the streamlined securities offering provisions available to other registrants under the Securities Acts. Among these revisions, H.R. 1800 directs the SEC to revise Rules 418 and 14a-101 under the Securities Acts, and Rule 103 under Regulation FD, which are not explicitly included in H.R. 31, the Next Steps for Credit Availability Act, introduced by Rep. Nydia Velazquez (D-NY), is substantially similar to H.R. 1800 except that it does not direct the SEC to revise Rules 418 and 14a-101 and Regulation FD Rule 103.

Introduced by Rep. Mick Mulvaney (R-SC), H.R. 1973, the Business Development Company Modernization Act would amend Section 2(a)(46)(B) and Section 60 of the Investment Company Act to allow BDCs to purchase, acquire, or hold securities or other interests in the business of registered investment advisers, advisors to investment companies, and other “eligible portfolio companies” as defined in the Investment Company Act, including certain financial services companies. On June 12, 2013, Joseph Ferraro of Prospect Capital testified that by eliminating outdated limitations, H.R. 1973 would bring small- to medium-sized financial services businesses into the family of “eligible assets,” thus removing an obstacle to their growth and increasing the flow of BDC dollars into these new and expanding U.S. businesses.

Gary Wunderlich, CEO of Wunderlich Securities, testifying        on behalf of the Securities Industry and Financial Markets Association said supports efforts to modernize regulation of Business Development Companies as contemplated in the three bills under discussion. Since their creation, BDCs have been subject to regulation under the Investment Company Act subjecting them to certain statutory safeguards covering such areas as diversification, leverage, compliance and valuation. The BDC structure was created to promote public vehicles as a means to bring capital to small and medium sized businesses and by regulation, noted Mr. Wunderlich, adding that 70% of BDCs investments must be in private or small cap companies.

The JOBs Act provided for an onramp for Emerging Growth Companies to access the IPO market and has also created a framework for crowdfunding to bring capital to early stage entrepreneurs in much smaller increments. But SIFMA believes that more can be done to promote the flow of capital to private companies that are big enough to need larger amounts of capital to reach the next stage of their development but are still
years away from an IPO. BDCs offer one such critical source of capital to eligible companies, said SIFMA.. BDC's have been active issuers in the last few years as they see opportunity to bring funds to attractive companies that are struggling to find capital at a reasonable cost from other sources.

SIFMA also believes that some incremental flexibility in the asset coverage ratio should be provided to BDCs to allow them to better fulfill their mission while at the same time maintaining sufficient safeguards to protect investors such as enhanced disclosure requirements, capital structure limitations, corporate governance and compliance requirements, affiliate transaction limitations and restrictions on leverage, all of which are applicable to BDCs by virtue of their being subject to compliance with the 1940 Act and which are incremental to the safeguards applicable to other public companies.

Introduced by Rep. Bill Huizenga (R-MI), H.R. 2274, the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, would amend Section 15(b) of the Securities Exchange Act to create a simplified SEC registration system for M&A brokers. Specifically, H.R. 2274 would allow M&A brokers to register with the SEC by filing an electronic notice which would be made publicly available on the SEC’s website. A properly completed electronic notice of registration would become effective immediately upon receipt by the SEC, except that SEC approval of such notice would be required if the M&A broker, or a person associated with the M&A broker, is subject to suspension or revocation of registration, a statutory disqualification, or a disqualification under SEC rules pursuant to the Dodd-Frank Act. H.R. 2274 would also require M&A brokers to make certain disclosures to clients as may be required by the SEC including, but not limited to, a description of the M&A broker and its affiliates, associated persons, fees, and any conflicts of interest.

In addition, H.R. 2274 would direct the SEC to tailor its rules governing M&A brokers by taking into account the nature of the transactions in which M&A brokers are involved, the involvement of the parties to such transactions, and the limited scope of the activities of M&A brokers. Under H.R. 2274, an M&A broker would be prohibited from receiving, holding, transferring, or having custody of client funds or securities in connection with the transfer of an eligible privately held company and would not to be able to engage on behalf of an issuer in a public securities offering. H.R. 2274 would require the SEC to work with the states to establish uniform and consistent standards of training, experience, competence, and other qualifications for M&A brokers, as well as to develop the form and content of the electronic notice of registration.

Arkansas Securities Commissioner Heath Abshure, speaking for the NASAA, said that state securities administrators generally support the targeted, well-balanced provisions of H.R. 2274, the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act.  This legislation would establish a simplified and streamlined registration process for broker-dealers engaged solely in the business of effecting the transfer or sale of privately held companies. NASAA is optimistic that this legislation will encourage registration and regulatory compliance by M&A brokers. The M&A industry has worked with NASAA in developing the proposal that is contained in H.R. 2274. The group welcomes its introduction and look forward to supporting the legislation in the 113th Congress.

Tom Quaadman, testifying for the Center for Capital Markets Competitiveness described H.R. 2274 as a common sense reform that should help entrepreneurs avail themselves of expert assistance in selling their business and realizing the full value of their enterprise, thereby providing further incentives for aspiring entrepreneurs to push forward with their ideas. By facilitating M&A activity, it would provide another source of capital for smaller companies.

Rep. Sean Duffy (R-WI) has circulated a discussion draft of legislation to amend Section 11A(c)(6) of the Exchange Act to provide for an optional pilot program administered by the SEC allowing certain Emerging Growth Companies (EGCs), a category of issuers recently established in Title I of the Jumpstart Our Business Startups (JOBS) Act with a stock price above $1.00 to increase the tick size at which their stocks are quoted and traded from $.01 to $.05, or, if the EGC’s board of directors so elects, $.10. The discussion draft would allow covered EGCs to change the tick size of their stock from $.05 to $.10 or from $.10 to $.05 one time during the pilot program, as it would also allow EGCs to opt out of the program.

The Capital Markets Center believes that the draft legislation proposed by Representative Duffy would help ensure a market structure that supports capital formation for all public companies. However, the Center asked that a provision be added to the bill providing safe harbor to insulate management and directors from liability in exercising the option to choose a tick size. Without such a safe harbor, reasoned the Center, companies may not avail themselves of the opportunity to participate in the pilot program and an opening to help smaller public companies may be lost.

 Rep. Robert Hurt (R-VA) has circulated a discussion draft to provide an optional exemption for EGCs and non-accelerated filers from SEC rules requiring registrants to file their financial statements in an interactive data format known as eXtensible Business Reporting Language (XBRL). The discussion draft would direct the SEC to revise its rules in accordance with the XBRL exemption.

Rep. Stephen Fincher (R-TN) has circulated a discussion draft of legislation to change registration requirements for EGCs. The discussion draft reduces from 21 to five the number of days that an EGC must have a confidential registration statement on file with the SEC before the EGC may conduct a road show. The discussion draft also clarifies that an issuer that had been an EGC when it filed its confidential registration statement but ceased to be an EGC before its initial public offering will be treated as an EGC through the date of its IPO. The discussion draft requires the SEC to revise its general instructions on Form S-1 to indicate that a registration statement filed (or submitted for confidential review) by an issuer before its IPO may omit financial information for historical periods otherwise required by regulation S–X. Finally, the discussion draft allows EGCs to submit a confidential draft registration statement to the SEC for any follow-on securities offerings after its IPO.

Describing as laudable Congressman Fincher’s discussion draft which would modify existing regulation of EGCs, Gary Wunderlich, CEO of Wunderlich Securities, testifying on behalf of the Securities Industry and Financial Markets Association said SIFMA supports of  each of the four provisions in the draft. Section 1 amends the Securities Act to reduce the quiet period requirements from 21 days to 5 days for public filing prior to public offerings by EGC’s. Currently, an EGC must file its registration statement publicly and must refrain from marketing the securities through its underwriters or otherwise for 21 days. SIFMA supports a significant reduction in the quiet period as contemplated in the bill
Sections 2 and 3 of the Discussion Draft add clarity and efficiency to two areas of securities regulation without impairing investor protection, testified SIFMA.  Section 2 provides a grace period for a change in status of an EGC by allowing an issuer that qualifies as an EGC at the time of the filing of its confidential registration statement for review to continue to be treated as an EGC through the date on which it consummates its initial public offering. Section 3 is designed to simplify the financial statement disclosure requirements for EGC’s. Currently an EGC must include the previous two years of audited financials when it files its registration statement for review. The last provision in the Fincher bill extends the ability for EGC’s to file a confidential registration statement not only for their initial public offering but also for a follow-on offering.

Thursday, October 24, 2013

European Court of Justice Rejects European Commission Action against Germany over Volkswagen Anti-Takeover Law

The European Court of Justice dismissed the European Commission’s action against the Federal Republic of Germany to impose penalties for failure to fully comply with the Court's earlier ruling on the anti-takeover Volkswagen law. In its opinion, the German federal legislation enacted after the Court’s ruling fully complied with that ruling. (European Commission v. Federal Republic of Germany, No. C-95-12, Oct. 22, 2013)

The Volkswagen law was hammered out in 1960 with the participation of workers and trade unions that, in return for relinquishing their claim of ownership rights in the company, secured protection against any large shareholder gaining control. The legislation allows the federal government and Lower Saxony to each appoint two members of the supervisory board and gave them each a 20 percent stake.

In 2007, the Court of Justice ruled that Germany’s Volkswagen Law restricted the free cross-border movement of capital through the intervention of the public sector. The Court found that capping the voting rights of every shareholder at 20 percent regardless of their shareholding violated the requirement that there be a correlation between shareholding and voting rights. The Court also held that provisions in the law conferring two seats each on the company’s supervisory board (equivalent to the board of directors in the US) for the German Federal Republic and the State of Lower Saxony, regardless of their shareholding, also constituted a restriction on the cross-border movement of capital. (European Commission v. Federal Republic of Germany, No. C-112/05).

Subsequent to the Court’s opinion, Germany enacted legislation abolishing the provisions providing for the representation of public authorities on the board and the 20 percent voting cap. But the Commission contends that the legislation did not modify the provision establishing a 20 percent blocking minority in favor of Lower Saxony. Further, no changes were foreseen to the VW Articles of Association, which contain majority voting requirements mirroring the VW law and which were considered as a State measure by the Court.

According to the Court, it is apparent from both the operative part of the 2007 judgment, which contains the decision of the Court, and the grounds for that decision that the Court did not establish that there had been a failure to fulfill; obligations resulting from the provision relating to the lower blocking minority, considered in isolation, but established that there had been such a failure solely as regards the combination of that provision with the provision relating to the cap on voting rights.

Consequently, by repealing both the provision of the Volkswagen Law relating to the appointment, by the Federal Republic of Germany and the State of Lower Saxony, of members to the supervisory board and the provision relating to the cap on voting rights, thereby putting an end to the combination between that latter provision and the provision relating to the lower blocking minority, Germany did fulfill, within the period prescribed, the obligations that follow from the 2007 judgment.

Moreover, the Court rejected as inadmissible the Commission’s complaint that Germany should also have amended Volkswagen’s Articles of Association, which still contain a clause relating to the lower blocking minority, which is essentially analogous to that in the Volkswagen Law, on the ground that the 2007 judgment related exclusively to the compatibility of certain provisions of the Volkswagen Law with E.U. law and did not relate to that company’s Articles of Association.

IASB Oversight Chair Warns that Tweaks to IFRS Begins Slippery Slope Back to Fragmented Accounting Standards, Frustrating G20

The Chair of the IASB oversight body cautioned that changes to IFRS by national standard setters threaten to undo the goal of uniform international accounting standards. In remarks in Frankfurt, Michael Prada, Chair of the IFRS Foundation, warned that a tweak here of IFRS and a revision there of IFRS by a national standard setter and the E.U., for example, begins to slide back into fragmented accounting standards. The IASB and securities regulators must be vigilant to ensure that Europe continues to be a champion in global financial reporting for the stability of the E.U. and the global financial system.

Securities regulators have a major role to play together with standard setters, said the Chair. The IASB is part of the global financial architecture and is a member of the Financial Stability Board. While it is imperative that the IASB ensures that its standards are capable of being applied and enforced on a globally consistent basis, securities regulators are best placed to monitor the use and promote the consistent application of those standards.

With regard to the U.S. and IFRS, the Chair said that the IASB has moved from a period of bilateral convergence with FASB to a more inclusive, multilateral approach to standard-setting. This involves much tighter integration with a range of national and regional standard-setting bodies, including FASB. This is best illustrated by the formation of the IASB’s new Accounting Standards Advisory Forum. In only six months, this group has become one of the most important forums for dialogue with the standard-setting community, observed the Chair, which shows how the manner of standard-setting has continued to evolve.

The IFRS Foundation supports the upcoming review of international accounting standards by the European Commission; and indeed welcomes it. The Foundation recognizes the need to work in close cooperation with the European Parliament, the Commission, the Council, and the European Securities and Markets Authority ( ESMA), and many others.

Chairman Prada emphasized that the G20 Leaders have repeatedly requested that the IASB deliver a single set of global accounting standards. The G20 wants a single way to describe the financial performance and the situation of a company, the same throughout the world.

The IFRS Chair acknowledged that the uniformity that comes with globalization is often controversial. It can trample over established and familiar practices that have evolved over many decades, he noted, and cultural nuances can be challenged. The way that a German company is managed can be very different from that of an American company. Yet, he reminded, the G20, which includes Germany and the U.S., has asked the IASB to come up with a single set of metrics to compare these companies on a like-for-like basis.

This is controversial, difficult and time-consuming work, he added, but the IASB continues to make excellent process in signing up more countries and addressing issues in practice. The IASB has earned its legitimacy as a standard setter, he averred, because the transparency of its process has shown that the IASB has weighed all of the options, considered the costs and benefits of its standards, and given proper consideration to the feedback that it has received.

The Chair challenged those who become frustrated with the slow progress of standard-setting or the endless rounds of consultation to ask themselves what aspect of the IASB’s transparency and due process they are prepared to sacrifice. He warned that any alterations could lead to unintended consequences with regard to the independence of the standard setting process.

UK High Court Dismisses Liquidator’s Claims against Directors of Madoff Securities International

A U.K. High Court judge dismissed claims against directors of Madoff Securities International Ltd., the London business of Bernard Madoff, brought by the liquidator. Justice Popplewell said that Madoff Securities International Ltd. was not part of the Ponzi scheme. It was conducting its own legitimate business in London. The London directors had no reason to suspect Bernard Madoff's fraud, said the court, and none for a moment did so. In common with the rest of the financial world, they believed Bernard Madoff to be a man of unquestioned probity whose high reputation and status was justified by his apparently formidable history of financial trading and investment.

Among other things, the court held that the directors were reasonably entitled to believe, and did believe, that KPMG in its capacity as auditor and tax adviser were at all times fully aware of the nature of business activity of Madoff Securities International, Ltd. That directorial understanding about KPMG's knowledge and approval was a reasonable one is supported by a number of documents which suggest that the auditor was aware that the fees receivable were in part a subsidy, that the auditror approved the description of them as fees for services, and that the auditor knew that the value to be put on such "services" was a subjective one. Madoff Securities International (in liquidation) v. Raven, High Court of Justice, Queen’s Bench Division (Commercial), EWHC 3147, Oct. 18, 2013.

Discussing a director’s duty to act in good faith in the interests of the company, the Justice noted that a director owes a duty to the company to act in what he or she honestly considers to be the interests of the company. This may be regarded as the core duty of a director. It is a fiduciary duty because it is a duty of loyalty, said the court. The predominant interests to which the directors of a solvent company must have regard are the interests of the shareholders as a whole, present and future.

The duty is now codified in Section 172 (1) of the Companies Act in that a director of a company must act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to the likely consequences of any decision in the long term, the interests of the company's employees, the need to foster the company's business relationships with suppliers, customers and others, the impact of the company's operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of the company.

As expressed in the classic formulation by Lord Greene MR in Re Smith & Fawcett Ltd [1942], the duty is to act in what the director believes, not what the court believes, to be the interests of the company. The test is a subjective one.

A director has a duty by virtue of his office to exercise reasonable care skill and diligence. The duty is now codified in Section 174 of the Companies Act in that a director of a company must exercise reasonable care, skill and diligence, which means the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company and the general knowledge, skill and experience that the director has.

In these circumstances, the court concluded that the directors were not in breach of a duty to act in what they considered in good faith to be the interests of the company. The court found that the director Defendants were not in actionable breach of duty, and thus the remaining issues of remedy and causation did not arise.

Tuesday, October 22, 2013

Big Four Line Up Behind Position That Floating NAV for Money Market Funds Would Not Imperil Their US GAAP Cash Equivalent Status

In comments to the SEC, the Big Four accounting firms have lined up behind the position that in normal circumstances the existence of a floating NAV for money market funds as proposed by the Commission would not imperil the cash equivalent status of a money market fund investment. U.S. GAAP defines cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and that are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates; and includes a money market fund as an example of a cash equivalent.

In its proposed Release on money market fund reform, the SEC is considering two alternatives that could be adopted alone or in combination: 1) Floating NAV—Prime institutional money market funds would be required to transact at a floating NAV, while government and retail money market funds would be allowed to continue using stable NAV. 2) Liquidity fees and redemption gates---Non-government money market funds would be permitted to use liquidity fees and redemption gates to reduce run risks in times of stress.

GAAP and cash equivalents. In its letter to the SEC, PricewaterhouseCoopers said that it would be appropriate for a registrant to classify an investment in a money market fund that invests in assets in accordance with Rule 2a-7 as a cash equivalent in normal economic conditions, even if the money market fund does not maintain a perfectly stable value at all times. PwC went on to note that it may be prudent, however, to reiterate that independent of any rules adopted under the SEC proposal, registrants would typically re-evaluate this classification if either the underlying investments deviate from the requirements in Rule 2a-7 or other factors indicate that classification as a cash equivalent is no longer appropriate.

Under current practice, registrants generally consider open-end money market funds that maintain $1.00 per share to be cash equivalents, and would re-evaluate that conclusion if the fund's NAV falls below a rounded $1.00 per share. Under the proposal, registrants would be required to exercise judgment to assess at which point a meaningful decrease below $1.00 per share should trigger a change in the classification, in the rare instance this may occur. PwC urged the SEC to provide guidance on how to evaluate the magnitude of changes in the NAV in assessing whether the investment in the fund continues to qualify as a cash equivalent

The floating NAV could also have certain financial reporting implications, said PwC. Thus, if enacted, the Commission should address the transition in the financial highlights from amortized cost in prior periods to a floating net asset value in both a fund's financial statements, and its Form N-1A filing. As the change in methodology could also affect comparability with prior periods for certain disclosures such as advertisements and SEC yield, the firm similarly recommended that the Commission provide transition guidance in these areas.

In its comment letter, KPMG said that under normal market conditions U.S. GAAP would not preclude a money market fund with a floating NAV from being classified as a cash equivalent. Similarly, the ability to impose liquidity fees and gates combined with a floating NAV would not preclude such fund from being classified as a cash equivalent under U.S. GAAP. Consistent with the current reporting requirements for the classification of investments in money market funds under U.S. GAAP, continued KPMG, there may be circumstances, such as instability in the financial markets and defaults on underlying securities, where the money market fund may not be highly liquid and may not meet the criteria to be classified as a cash equivalent. KPMG reminded that the classification of any financial instrument as a cash equivalent requires judgment and is based on a variety of facts and circumstances present as of the date of the financial statements.

Echoing these views in its comment letter, Deloitte said that a money market fund would still qualify, under normal market conditions, as a cash equivalent in an investor’s financial statements if its NAV floats and it has the ability, as determined by the board of directors of the fund, to impose liquidity fees and gates.

In an earlier letter, Ernst & Young agreed that investments in money market funds with both a floating NAV and fees and gates under the proposed amendments would continue to meet the definition of a cash equivalent. The potential suspension of redemptions for up to 30 days in contingent circumstances would not violate the requirement that a cash equivalent be “readily convertible to known amounts of cash.” Moreover, the potential imposition of a liquidity fee of up to 2 percent in contingent circumstances would not violate the requirement that a cash equivalent present “insignificant risk of changes in value.”

Advocate General Advises Court of Justice to Reject European Commission Action against Germany over Volkswagen Anti-Takeover Law

The Advocate General of the E.U. Court of Justice issued an opinion urging the Court to dismiss the European Commission’s action against the Federal Republic of Germany to impose penalties for failure to fully comply with the Court's earlier ruling on the amti-takeover Volkswagen law. In his opinion, Nils Wahl found that German federal legislation enacted after the Court’s ruling fully complied  with that ruling. The Advocate General’s Opinion, while persuasive, is not binding on the Court of Justice. It is the role of the Advocates General to propose to the Court, in complete independence, a legal solution to the cases for which they are responsible. The Judges of the Court are now beginning their deliberations in this case. Judgment will be given at a later date.

The Volkswagen law was hammered out in 1960 with the participation of workers and trade unions that, in return for relinquishing their claim of ownership rights in the company, secured protection against any large shareholder gaining control. The legislation allows the federal government and Lower Saxony to each appoint two members of the supervisory board and gave them each a 20 percent stake.

In 2007, the Court of Justice ruled that Germany’s Volkswagen Law restricted the free cross-border movement of capital through the intervention of the public sector. The Court found that capping the voting rights of every shareholder at 20 percent regardless of their shareholding violated the requirement that there be a correlation between shareholding and voting rights. The Court also held that provisions in the law conferring two seats each on the company’s supervisory board (equivalent to the board of directors in the US) for the German Federal Republic and the State of Lower Saxony, regardless of their shareholding, also constituted a restriction on the cross-border movement of capital. (European Commission v. Federal Republic of Germany, No. C-112/05).

Subsequent to the Court’s opinion, Germany enacted legislation abolishing the provisions providing for the representation of public authorities on the board and the 20 percent voting cap. But the Commission contends that the legislation did not modify the provision establishing a 20 percent blocking minority in favor of Lower Saxony. Further, no changes were foreseen to the VW Articles of Association, which contain majority voting requirements mirroring the VW law and which were considered as a State measure by the Court.

The Advocate General shares the German government’s reading of the 2007 judgment that the Court found two infringements: the first in relation to the provision on the appointing rights and the second in relation to the provisions on the capping of voting rights and on the blocking minority combined. Therefore, reasoned the Advocate General, by repealing the provision constituting the first infringement and by repealing one of the two provisions constituting the second infringement, Germany has complied fully with the 2007 judgment.
In the Advocate General’s view, the use of the expression in conjunction with in the operative part of the 2007 judgment excludes, on its own, the interpretation proposed by the Commission. In addition, he found that the grounds of the 2007 judgment also fail to confirm the view taken by the Commission. In this respect, he emphasized that the Court, taking into account notably that the Land of Lower Saxony retained an interest in the capital of Volkswagen of approximately 20 %, considered it appropriate to analyze the provisions on the capping of voting rights and the blocking minority together and explicitly referred to the cumulative adverse effects of the two provisions on investors’ interest in acquiring stakes in Volkswagen.

The Advocate General further pointed out that the purpose of the present proceedings is not to determine whether the provision on the blocking minority, considered on its own, infringes EU law, but only whether Germany has complied with the 2007 judgment. With respect to additional complaints put forward by the Commission in the present action, namely that also the Articles of the Association of Volkswagen should have been amended, the Advocate General urged the Court to reject those complaints as inadmissible, because the Articles of Association were not scrutinized by the Court in the 2007 judgment.

Monday, October 21, 2013

Former SEC Chair and Commissioners Urge Supreme Court to Reject Broad Reading of SOX Whistleblower Provision

Former SEC Chair Chris Cox and Commissioners Joseph Grundfest, Paul Atkins and Charles Cox have filed an amicus brief urging the Supreme Court to not adopt a strained and overly broad reading of the whistleblower provision of the Sarbanes-Oxley Act when Congress has already acted in the Dodd-Frank Act to extend whistleblower protections to private company employees. The former SEC officials asked the Court to affirm the decision of a First Circuit panel holding that only the employees of defined public companies are covered by the whistleblower provisions. Citing principles of statutory construction, the appeals panel concluded that Section 806 of Sarbanes-Oxley limits its whistleblower protections to employees of public companies. If Congress intended a broader meaning, said the panel, it could amend the statute. The Court granted certiorari on May 20, 2013, to review the First Circuit panel ruling. Oral argument in the case is set for November 12, 2013. (Lawson v. FMR, LLC, Dkt. No. 12-3).

In an earlier joint amicus brief, the SEC and Department of Labor urged the Supreme Court to rule that employees of contractors and subcontractors of public companies are protected from retaliation under the whistleblower provisions of the Sarbanes-Oxley Act when they report fraud or a violation of SEC rules.

But former SEC Chairman Cox and the SEC Commissioners argued that the whistleblower provision of Section 922 of the Dodd-Frank Act, and the SEC’s implementing regulations, alleviate the concern raised by the Petitioners that the First Circuit’s decision creates a gap in whistleblower protections. Although Congress plainly intended that violations be reported to the federal agency with primary expertise, noted the brief, Section 922 does not deter employees who opt to report violations internally at their companies.

To the contrary, Dodd-Frank allows potential whistleblowers to utilize an employer’s internal audit and reporting structures, if any, prior to providing information about securities law violations to the SEC. Acting pursuant to the authority delegated to it by Congress, the SEC has adopted rules permitting employees to first report alleged violations internally without waiving their eligibility for Dodd-Frank’s whistleblower reward program. In fact, continued the former officials, the SEC has recognized that a whistleblower’s attempt to report violations internally, prior to reporting to the SEC, may support the enhancement of a subsequent whistleblower award. Further, the enhanced protections in Section 922 include potential damages in the form of double back pay, direct access to federal courts following an alleged retaliatory act, and a longer statute of limitations.

Congress has thus already significantly expanded the federal anti-retaliation protections for employees reporting securities law violations, argued amici, thereby rendering unnecessary the expansive extra-textual reading of Section 806 being urged by the Petitioners. Congress purposely designed Dodd-Frank Section 922’s whistleblower reward program and its anti-retaliation protections so that reports of potential securities law violations would be channeled to the SEC, contended the former officials, the regulatory agency best positioned to investigate potential violations of the securities laws.

Thus, the brief concluded that the policy argument of Petitioners advocates a reading of Sarbanes-Oxley Section 806 that is inconsistent with its plain language by arguing that private company employees will otherwise be unprotected from retaliation for reporting alleged violations of the securities laws. This policy argument is moot because with the passage of Dodd-Frank, Congres expanded federal anti-retaliation coverage to private company employees.

Friday, October 18, 2013

Briefing Paper Analyzes Municipal Advisor Registration Rules

The SEC has finalized regulations implementing Section 975 of the Dodd-Frank Act, which created a new regime of municipal advisor regulation. Jim Hamilton has written a special report reviewing the new rules, which significantly dial back the scope of the registration requirement compared to the SEC’s original proposal. Jim's briefing paper discusses the many comments that informed the final regulations and provides an executive summary of the entities and individuals that are, and are not, subject to the regulation.

Jim also analyzes pending bipartisan legislation clarifying Section 975 and discusses the industry’s reaction to the new developments. The briefing paper, “SEC Implements Dodd-Frank Municipal Advisor Regulatory Regime Against Backdrop of Pending Legislation,” is available for download here.

Wednesday, October 16, 2013

PwC Survey Indicates Varied Preparation to Comply with SEC Conflict Mineral Regulations Implementing Section 1502 of the Dodd-Frank Act

In the spring of 2013, PricewaterhouseCoopers surveyed companies to determine their level of understanding of the conflict minerals regulations adopted by the SEC, as well as their progress towards compliance. The report summarizes the responses of nearly 900 individual respondents and sheds light on some of the more significant hurdles companies are, or are expecting, to encounter, as well as which industries seem to be furthest ahead with their compliance efforts.

Section 1502 of Dodd-Frank directs the Commission to issue rules requiring companies to disclose their use of conflict minerals if those minerals are necessary to the functionality or production of a product manufactured by those companies. Under the Act, those minerals include tantalum, tin, gold or tungsten. Under the final SEC regulations, a company that uses any of the designated minerals would be required to conduct a reasonable good faith country of origin inquiry reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources.

If the inquiry determines that the company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources or the company has no reason to believe that the minerals may have originated in the covered countries and may not be from scrap or recycled sources, then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry on new Form SD filed with the Commission.

Approximately 44 percent of companies surveyed by PwC expect to file a Form SD, meaning that they believe they are within the scope of the rule because they manufacture products containing conflict minerals. But only 8.4 percent said they would definitely expect to file a Conflict Minerals Report along with the Form SD. Early SEC estimates suggested that more than 50 percent of registrants would likely need to file a Conflict Minerals Report.
Companies filing a Form SD must designate one executive to sign the form. Ideally, said PwC, companies should determine which executive will sign the form early in the compliance process so that individuals will be involved in the many judgment calls that are necessary when complying with the rule. Of those companies anticipating the filing of a Form SD, 30 percent have already decided which corporate officer will be signing the form, with the CFO as the most popular choice followed by the General Counsel. The corporate officer signing the Form SD can be different from the signatory of other SEC filings.

About a quarter of the companies expect that they will not be able to determine the conflict status of their products in the first year and thus will be underminable and not required to obtain an audit of their Conflict Minerals Report. Another 14 percent plan to obtain an independent audit in their first year of compliance, either because they believe it will be required of them or because they want to obtain one on a voluntary basis.

Almost half of the companies in the PwC survey are still in the initial stages of their compliance efforts on the SEC conflict minerals regulations, with 16 percent not having started gathering information. Not surprisingly, the single most challenging task for most companies is obtaining accurate information from their suppliers. More than half of the companies view their conflict minerals regulation compliance efforts as a compliance exercise, while only six percent intend to use the regulations as an opportunity to make supply chain changes.

Around 42 percent of companies surveyed have agreed upon or are deliberating conflict minerals policies. With the SEC rules in effect and the first compliance deadline less than a year away, noted PwC, formulating a conflict minerals policy is a good first step to take as it helps provide the near and long-term goals for the program.

Many companies are incorporating OECD-due diligence guidance in developing their policies. But only two percent of companies have completed their reasonable country of origin inquiry and started due diligence. Conducting RCOI and due diligence on the origin of the conflict minerals used in products will be a detailed and time-consuming part of the compliance effort due to the breadth and depth of most company supply chains. More than a quarter of the companies surveyed saikd that their supply chain contains over 1,000 suppliers.

Securities Industry Urges U.S. Supreme Court to Confine Sarbanes-Oxley Whistleblower Protections to Public Companies

In an amicus brief filed with the U.S. Supreme Court in a Sarbanes-Oxley Act whistleblower case, the securities industry strongly argued that Section 806’s protections against retaliation against whistleblowers extend only to the employees of public companies, and do not reach the employees of their contractors, subcontractors, or agents. SIFMA contended that Congress deliberately placed the burdens attendant to Section 806 litigation on the shoulders of public companies and purposely stopped short of imposing the same burdens on private companies.

The Court granted certiorari on May 20, 2013, to review a First Circuit panel holding that only the employees of defined public companies are covered by the whistleblower provisions. Citing principles of statutory construction, the appeals panel concluded that Section 806 of Sarbanes-Oxley limits its whistleblower protections to employees of public companies. If Congress intended a broader meaning, said the panel, it could amend the statute. Oral argument in the case is set for November 12, 2013. (Lawson v. FMR, LLC, Dkt. No. 12-3).           

In an earlier joint amicus brief, the SEC and Department of Labor urged the Supreme Court to rule that employees of contractors and subcontractors of public companies are protected from retaliation under the whistleblower provisions of the Sarbanes-Oxley Act when they report fraud or a violation of SEC rules.

SIFMA argued that the construction of Section 806 advocated by the petitioners and the Government before this Court would dramatically expand Section 806 liability far beyond the outer boundaries established by Congress. Even the most conscientious public and private companies would suddenly be exposed to a new and unjustified wave of civil litigation that does nothing to advance the shareholder protection goals underlying Sarbanes-Oxley. Due to their many variegated and unique relationships with public companies, said SIFMA, the consequences for SIFMA’s members would be particularly severe.

Section 806 of Sarbanes-Oxley provides that no public company or any officer, employee, contractor, subcontractor, or agent of such public company may retaliate against an employee of such public company for engaging in protected whistleblowing activity. The language is clear, emphasized SIFMA, Section 806’s protections against retaliation extend only to the employees of those public companies, and do not reach the employees of their contractors, subcontractors, or agents.

Thus, continued SIFMA, Congress did not act willy-nilly in creating this new and entirely unprecedented whistleblower program. Rather, it fashioned a discrete remedy carefully tailored to a particular problem. A vast expansive construction of Section 806 would overturn the delicate balance struck by Congress more than a decade earlier while doing nothing to advance the shareholder protection goals animating the Act.

E.U. Parliamentary Panel Approves Legislation on Gender Equality of Non-Executive Directors

Acting on a proposal from the European Commission, the European Parliament Committees on Women’s Rights and Gender Equality and Legal Affairs voted 40-9 to approve legislation providing that large listed companies should aim to ensure that by 2020 at least 40 percent of their non-executive directors are women. For companies operating under a two-tier board system, such as Germany and the Netherlands, that would mean 40 percent of the supervisory board should be women, while for companies operating under a one-tier board, such as the U.K., it would essentially mean that 40 percent of their independent directors would be women. The committee’s approval means that the Parliament can begin negotiations with the E.U. Council to produce a final piece of legislation.

The legislation is on a type of modified comply or explain since it would require companies to aide with the new regulations or explain to national authorities why they failed to abide by them and describe the measures that they have taken and plans to comply in the future. Penalties, such as fines, could be imposed for a company’s failure to follow transparent appointment procedures, rather than for failing to achieve the 40 percent target. The draft also added an exclusion from public calls for tenders as a mandatory penalty. The Commission proposal would not have made such penalty mandatory. In 2012, only 15% of non-executive board members at the EU's largest companies were women.

According to the draft legislation, the rules approved by the Committee would not apply to small and medium-sized enterprises. However MEPs encouraged member states to support SMEs and give them incentives to improve gender balance on their boards also. MEPs also called for a transparent, open and meritocratic recruitment procedure in which gender balance is borne in mind throughout. Where candidates are equally well qualified, priority should go to the candidate of under-represented sex. MEPs also stressed that qualifications and merit must remain the key criteria.

MEP Rodi Kratsa-Tsagaropoulou (CD Greece), and co-rapporteur, said that the EU legislation to step up women's membership of and participation in boards of listed companies. What is currently a reality in some EU member states will soon be extended to the single market as a whole It is important that the directive should be broad in scope and that many listed companies are required to use the open and transparent procedure when selecting their non-executive directors, emphasized co-rapporteur, and Vice Chair of the Legal Affairs Committee, Evelyn Regner (S&D, Austria), who added that the draft does not have provide an exemption for family enterprises or specific sectors. The draft did strengthen the penalties that member states should apply when companies do not fulfill the directive's requirements, said MEP Regner. This is not a quota for women in the classical sense, noted the Vice Chair. The core of the proposed Directive is to mandate an objective and transparent selection process, she emphasized, which should generally improve the work of supervisory boards.

Friday, October 11, 2013

U.S. Supreme Court Hears Oral Arguments on SLUSA Preclusive Effect on Stanford Ponzi Scheme Cases

The U.S. Supreme Court heard oral argument in a case reviewing an interpretation by the Fifth Circuit Court of Appeals of the scope of the preclusive effect of the federal Securities Litigation Uniform Standards Act, which precludes most state-law class actions in which the plaintiffs allege misrepresentations in connection with the purchase or sale of a covered security. Chadbourne & Parke, LLP v. Troice; Willis of Colorado Inc. v. Troice; Proskauer Rose LLP v. Troice,. Dkt. Nos. 12-79, 12-86 and 12-88.

The case arose from a multi-billion-dollar Ponzi scheme run by Allen Stanford and various entities that he controlled, including a bank which issued fixed-return certificates of deposit (CDs) that the bank falsely claimed were backed by safe, liquid investments.  In fact, the claimed investments did not exist, and the bank had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs.

After the fraud was discovered, two groups of Louisiana investors filed suits in state court against a number of Stanford companies and employees claiming violations of Louisiana law. The defendants removed the Louisiana cases to federal court, and all of the actions were ultimately transferred to the Northern District of Texas, which dismissed the complaints as precluded under SLUSA.  The district court held that, while the CDs themselves were not “covered securities,” the plaintiffs had nevertheless alleged misrepresentations made in connection with transactions in covered securities since the bank said that it invested its assets in highly marketable securities issued by stable governments and strong multinational companies. The district court found that the bank led the plaintiffs to believe that the CDs were backed, at least in part, by investments in SLUSA-covered securities.

The Fifth Circuit reversed, deeming the references to the bank portfolio being backed by covered securities to be merely tangentially related to the heart the defendants’ fraud.  Misrepresentations about the investments were only one of a host of misrepresentations, reasoned the appeals court, which also observed that, because the CDs promised a fixed rate of return, they were not tied to the success of any of the bank’s purported investments in covered securities within the meaning of SLUSA.

Justice Elena Kagan noted that somebody, not necessarily the victim of the fraud, but somebody has to have had some transaction in the market. It is the kind of misrepresentation that would affect someone in making transactions in the covered market. How would this do that, she asked Paul Clement, who was arguing on behalf of the petitioners.

Mr. Clement said that the whole point of this fraud was to take a non-covered security and to imbue it with some of the positive qualities of a covered security, the most important of which being liquidity. And if you look at sort of the underlying brochures here that were used to market this, he continued, that is really what this fraud was all about. These CDs were offered as being better than normal CDs because we can get you your money whenever you need it.

Justice Samuel Alito queried whether it mattered that there apparently is not an allegation that there actually were any purchases or sales of covered securities. The statute says "in connection with the purchase or sale of a covered security." He did not see an allegation that they actually were purchased or sold. Does that matter, he asked.

Mr. Clement said that it did not matter because you don't want to draw a line that basically says if you buy different securities than you were supposed to or you sell fewer than you were supposed to, that's covered, but if you're a Madoff and you go all the way and simply lie about the whole thing and there never were any securities purchases at all, that that's somehow better. You cannot somehow have a better fraud that's immune from the SEC just because you completely made the whole thing up and there were no transactions at all, he contended.

Justice Antonin Scalia said that he had assumed that the purpose of the securities laws was to protect the purchasers and sellers of the covered securities. There is no purchaser or seller of a covered security involved here, he noted, adding that it is a purchaser of not-covered securities who is being defrauded, if anyone. Why would the federal securities law protect that person, he asked, somewhat rhetorically,

Mr. Clement noted that the federal securities laws apply to non-covered securities as well as covered securities. So the real question here is going to be SLUSA's coverage because, Rule 10b-5 applies to non-covered securities. The Court is well over the bridge about not requiring that it be the plaintiff's own purchases or sales that are what the inquiry focuses on.

Justice Scalia replied that, while it doesn't have to be the plaintiff's, but it has to be somebody's. Chief Justice Roberts remarked that the fraud did not go to the purchase and sales of the covered securities; it went to the CDs.

Responding to Justice Kennedy’s question on what would be the simplest formulation of the test if the Court were to reverse the Fifth Circuit, Mr. Clement said that the simplest, narrowest way to decide this case is to say that when there is a misrepresentation and a false promise to purchase covered securities for the benefit of the plaintiffs, then the "in connection with" standard is required.

Elaine Goldenberg, Assistant to the Solicitor General, as amicus curiae, supporting the petitioners, said the Government agreed with the narrow formulation that Mr. Clement had given, that the issue in this case is a false promise to purchase covered securities using the fraud victims' money in a way that they are told is going to benefit them, and that that is a classic securities fraud.

Justice Kagan asked if the Government could satisfy the test that this the kind of representation that could affect somebody. It doesn't have to be the victim of the fraud, it can be somebody else, but that could affect somebody's decision to buy or sell or hold covered securities. Ms. Goldenberg said yes, adding that here there is a major effect on investor confidence, specifically with respect to covered securities in several different ways. If people see that lies of the kind here where someone is telling someone else I am going to buy covered securities and it is going to benefit you are being made, then people are less likely to go to their broker and say here is some money, go out on the market and buy me some securities

It is a lie that goes to the mechanism by which the securities markets operate, which is the purchases and sales, she emphasized, and it makes it less likely for people to be willing to believe that when they engage in purchases and sales, that something's really is going to happen, and the person is going to respond.

Chief Justice Roberts pointed out that nobody is suggesting that the SEC can't take action with respect to the non-covered securities. So, to the extent there's diminished confidence in the securities markets, the SEC has all the tools available to address that. The question is the different one under SLUSA.

Justice Scalia returned to the problem of  the text of the statute,  There has been no purchase or sale here.

Thomas Goldstein, for the respondents,  asked the Court to write an opinion affirming and adopting the following rule: that a false promise to purchase securities for one's self in which no other person will have an interest is not a material misrepresentation in connection with the purchase or sale of covered securities. The other side has asked you to adopt a rule that has never been advocated by the SEC in any other proceeding; noted counsel for the respondents, and it has never been adopted by any Court. And  there are good reasons for that, he added.. Their theory is that what happened here is that there was a promise to buy covered securities that would be for the benefit of someone else. The plaintiffs here bought something that Congress specifically excluded from preclusion under SLUSA, argued Mr. Goldstein..

Justice Anthony Kennedy asked what if a broker says, "Give me $100,000 and I will buy covered securities," and then he just pockets it and and flees. The Justice did not see how this case  is that much different. They say that we were going to invest in CDs and the CDs will be backed by purchase of the securities that we will purchase for you.

Mr. Goldstein said that the critical difference is in the definition of "purchase."     The reason that the broker example is securities fraud is the definition of a purchase includes pledging the stocks. That is really important. And it tracks with the Court's holding that "in connection with" reaches as far as frauds that would have an effect on the regulated market.

Justice Sonia Sotomayor noted that if someone tells me, sell your securities, give me the money, I will buy securities for myself and give you a fixed rate of return later, I think that is in connection with the purchase and sale of securities even though it's not legally purchased for my benefit, reasoned the Justice..

Mr. Goldstein argued that the key feature is that you can understand why it is that the market cannot function if your stockbroker is making promises about buying and selling securities. This is a bank in the instant case, he said, a bank that does not issue covered securities in any way because it is a foreign bank. It issues only the non-covered securities that Congress specifically excluded.

Mr. Goldstein concluded that this was not material to any purchase or sale. We have this idea from the National Securities Markets Improvements Act that the States regulate non-covered securities, he contended, and so we are going to say that the preclusive effect of SLUSA does not reach these things like the CDs that we leave to regulation by the State. So this case clearly falls very easily within the text of SLUSA as being not precluded.

Thursday, October 10, 2013

Wolters Kluwer Prepares Briefing on Partial Government Shutdown

The partial government shutdown is now nearing the end of its second week with no sign of resolution. Wolters Kluwer Law & Business senior analysts have prepared a special briefing that details which government functions are ongoing and which have been suspended during this lapse in funding. The briefing includes links to government websites to make it easier to check on the day-to-day status of a given department or agency.

Wednesday, October 09, 2013

Senator McCain Asks DOJ if Settlement with JP Morgan Will Preclude Enforcement Actions against Individual Officers and Directors

In a letter to U.S. Attorney General Eric Holder, Senator John McCain (R-AZ) expressed concern with reports indicating that the AG personally met with JPMorgan CEO Jamie Dimon in the course of settlement talks between JPMorgan Chase and the Department of Justice (DOJ). The meeting reportedly centered on multiple investigations into JPMorgan's issuance of mortgage-backed securities in the lead-up to the financial crisis. These discussions are taking place while DOJ is also investigating the bank's actions related to the $6 billion "London Whale" trading losses, noted Senator McCain, which the Senate Permanent Subcommittee on Investigations independently investigated.

The Senator described the personal meeting with the CEO of the corporate target of a major criminal investigation, at the request of the CEO, while negotiations on a global settlement agreement are pending, as highly unusual and, under the circumstances that the meeting occurred, giving rise to concern. It is noteworthy that at the same time the bank is facing a litany of regulatory woes that carry hefty fines and potential liability in private civil suits, added Senator McCain, individuals within JPMorgan and other similarly culpable financial institutions have escaped accountability.

JPMorgan's misconduct seriously harmed investors, said the Senator, and any government response relating to these events must hold the proper institutions and individuals accountable. In matters involving major corporate malfeasance, individual accountability is vital to deterring similarly severe misconduct by financial institutions and their officers, directors, or key employees in the future. He emphasized to the DOJ that Government enforcement actions must no longer be viewed by institutions and their management teams as simply the cost of doing business.

With this in mind, Senator McCain asked for a timely responses to a number of specific questions when the settlement agreement is announced. He wants to know if the DOJ is considering requiring admissions of wrongdoing on the part of any individuals within the bank as part of the settlement negotiations and, if not, why not. Also, he asks if the settlement agreement with the company will preclude either civil or criminal enforcement action against individuals at JPMorgan. Relatedly, DOJ is asked if it will seek to hold any top officer, director or key employees within JPMorgan personally accountable for the wrongdoing.

The Senator also asked DOJ to describe how each of the following will be determined and structured in any potential settlement: penalties; fines; disgorgement; compensatory damages and/or restitution; and admissions of wrongdoing. Importantly, how will the DOJ ensure that the settlement provides the proper relief for consumers, queried Senator McCain.

Finally, DOJ must relate if any settlement reached will specify whether JPMorgan is permitted to receive a tax deduction or favorable tax treatment for any resulting restitution, fines or penalties, or will such a determination be left to the IRS. Also, DOJ should relate how will this decision be reached. If deductions are permitted, DOJ should specify which aspects of the proposed settlement will be given favorable tax treatment.

U.K. Government Endorses Continued Relevance of True and Fair Principle under GAAP and IFRS

The U.K. Government has endorsed the view of U.K regulators emphasizing and reaffirming that the requirement that audited financial statements give a true and fair account of a company’s operations remains of fundamental importance under both GAAP and IFRS. The Accounting Standards Board and the Auditing Practices Board have both confirmed that fair presentation under IFRS is equivalent to a true and fair view. In a statement, the Department for Business, Innovation & Skills said that, in preparing financial statements, achieving a true and fair view is and remains the overriding objective and legal requirement. In the vast majority of cases, compliance with accounting standards will result in a true and fair view. Under Secretary of State Jo Swinson said that the Department has given serious consideration to concerns raised by some stakeholders that accounts prepared over the past years, in accordance with U.K. or IFRS, have not been properly prepared under U.K. and E.U. law. However, where compliance with an accounting standard may not achieve the objective of true and fair, noted the Minister, accounting standards expressly provide that that standard may be overridden. This is also the opinion of the Boards.

The Department is entirely satisfied that the concerns expressed are misconceived and that the existing legal framework, including IFRS, is binding under European law.

The Boards had earlier said that they expect preparers and auditors of financial statements to always stand back and ensure that the financial accounts as a whole give a true and fair view. They must also ensure that the consideration they give to these matters is evident in their deliberations and documentation. In the U.S., the analogous principle is that financial statements must fairly present the company’s financial picture.

The introduction of IFRS in the U.K. did not change the fundamental requirement for financial accounts to give a true and fair view. The true and fair concept has been a part of English law and central to accounting and auditing practice in the U.K. for many decades. There has been no statutory definition of true and fair. The most authoritative statements as to the meaning of true and fair have been legal opinions written by Lord Hoffmann and Dame Mary Arden in 1983 and 1984 and by Dame Mary Arden in 1993. Since those Opinions were written, there have been some significant changes in accounting standards and company law which have led some to question whether the views expressed in those Opinions remain applicable.

In these circumstances, the Boards concluded that it would be helpful to its preparers, auditors and users of financial statements if it commissioned a further legal opinion to ascertain whether the approach to true and fair taken in the Hoffmann-Arden Opinions needs to be revised. They instructed Martin Moore QC and his Opinion is now published on the FRC website.

In his Opinion, Mr. Moore endorsed the analysis in the Opinions of Lord Hoffmann and Dame Arden and confirmed the centrality of the true and fair requirement to the preparation of financial statements in the U.K., whether they are prepared in accordance with international or U.K. accounting standards. The true and fair concept remains paramount in the presentation of U.K. company financial statements, even though the routes by which that requirement is embedded may differ slightly.

In his Opinion, Mr. Moore notes that, in relation to the gradual shift over time to more detailed accounting standards, that it does not follow that the preparation of financial statements can now be reduced to a mechanistic process of following the relevant standards without the application of objective professional judgment applied to ensure that those statements give a true and fair view, or achieve a fair presentation.

Directors must consider whether, taken as a whole, the financial statements that they approve are appropriate. Similarly, auditors are required to exercise professional judgment before expressing an audit opinion. As a result, the Moore Opinion confirms that it will not be sufficient for either directors or auditors to reach such conclusions solely because the financial statements were prepared in accordance with applicable accounting standards.

The Moore Opinion also states that the true and fair view is of an overarching nature. The concept is dynamic, evolving and subject to continuous rebirth. The preparation of financial statements is not a mechanical process where compliance with GAAP or IFRS will automatically ensure that those statements show a true and fair view or a fair presentation of the financial statements. Such compliance may be highly likely to produce such an outcome, but does not guarantee it. Any decision or judgment made by the preparer of financial statements is not made in a vacuum but is made against the requirement to give a true and fair view.

The earlier Lord Hoffmann-Dame Arden Opinions noted that true and fair is a legal concept and the question of whether a company’s financial statements comply with it can be authoritatively decided only by a court. The law uses these types of concepts, another example of which is reasonable care, and they are seldom difficult to understand, noted the Opinion, but generate controversy in their application to specific factual situations. There will always be a penumbral area where views may reasonably differ, said Lord Hoffman and Dame Arden.

In his opinion in Her Majesty's Revenue & Customs v William Grant & Sons Distillers Limited, Lord Hoffmann said that, although the requirement that the initial computation must give a true and fair view involves the application of a legal standard, the courts are guided as to its content by the expert opinions of accountants as to what the best current accounting practice requires. The experts will in turn be guided by authoritative statements of accounting practice issued or adopted by the Accounting Standards Board.

Tuesday, October 08, 2013

ESMA Issues Guidance on Hedge Fund Reporting Obligations under AIFMD

The European Securities and Markets Authority (ESMA) issued final guidelines clarifying the reporting obligations for hedge fund managers and other alternative investment fund managers under the Alternative Investment Fund Managers Directive. ESMA’s guidelines will require hedge fund managers and private equity fund managers to regularly report certain information to national regulators. The guidelines clarify provisions of the Directive on required information, which will help to have a more comprehensive and consistent oversight of the activities of hedge fund managers.

ESMA has also issued an opinion that proposes introducing additional periodic reporting including such information as Value-at-Risk of hedge funds or the number of transactions carried out using high frequency algorithmic trading techniques.

ESMA Chair Steven Maijoor said that one of the key objectives of the AIFMD is bringing the alternative fund world under supervision thus providing more transparency to investors and regulators. As the AIFMD came into force in July, both AIFMs and national supervisors have begun to prepare for their regulatory filings. Chairman Maijoor said that it is these reports that will enable regulators to monitor the systemic risks of alternative investment funds. In order to achieve this objective, he advised national regulators to receive all the necessary information in order to ensure an appropriate overview of the sector.

The guidelines and opinion are designed to standardize the reporting across the European Union. It will also facilitate the exchange of information between national regulators, ESMA and the European Systemic Risk Board.

Hedge fund managers and other alternative fund managers need to report investment strategies, exposure and portfolio concentration According to the ESMA guidelines, the key elements that hedge funds and private equity funds will have to report to national regulators include information on, the breakdown of investment strategies of funds, the principal markets and instruments in which the fund trades; the total value of assets under management of each fund managed; turnover of the funds; and the principal exposures and most important portfolio concentration of the funds.

ESMA also issued detailed IT guidance for the filing of the XML and the XSD schema that will facilitate the reporting by hedge fund and private equity fund managers to regulators.

E.U. Consults on Crowdfunding as SEC Set to Implement JOBS Act Crowdfunding Mandate

With the SEC poised to implement the JOBS Act crowdfunding title, the European Commission has begun a consultation on the potential benefits and risks of this new and exciting form of capital-raising in a quest for the optimal policy framework to untap the potential this broad form of financing. The consultation covers all forms of crowdfunding, ranging from donations and rewards to financial investments.

Commissioner for Internal Market and Services Michel Barnier said that crowdfunding is an increasingly important alternative form of fundraising that is collective, participatory and interactive. It has the potential to bridge the financing gap many start-ups face and to stimulate entrepreneurship. Considering the development of crowdfunding and the diversity of regulatory, supervisory, fiscal and social frameworks for it across the EU, noted Commissioner Barnier, there is a compelling need for a single European framework to support both those who develop crowdfunding platforms and to reduce the risks to those who make use of such platforms to finance projects.

Crowdfunding is an emerging alternative form of financing that connects directly those who can give, lend or invest money with those who need financing for a specific project. It usually refers to open calls through the Internet to the wider public to finance specific projects. Promoters of an initiative can collect funds directly, said the Commission, but often a web-based intermediary, a so-called crowdfunding platform, will often assist in publishing campaigns and collecting funds.

While calls for funds to the public are not new, added the Commission, the phenomenon of using the Internet to directly connect with funders has emerged recently. Crowdfunding can take many forms, ranging from simple donations or rewards-based schemes through to pre-sales, peer-to-peer lending and investments in equity.

To be sure the Commission recognizes that crowdfunding has risks. For example, and perhaps most problematic, there is the risk of fraud when the money collected is not used for stated purposes. The Commission cautioned that Internet-based communication easily lends itself to fraudulent representation and false statements.

Relatedly, there is the risk that advertising and advice by promoters or platforms may be misleading. Another risk involves how crowdfunding platforms treat payments, such as whether reclaimable contributions are returned.

Financial forms of crowdfunding fall under sector-specific EU legislation on financial services. Due to the complexity and risks inherent in financial services, access to markets is tied to higher requirements, mainly to ensure investor protection. But this legal framework contains exemptions for transactions below a certain threshold. Since crowdfunding campaigns typically have relatively low target amounts, noted the Commission, they often fall out of the scope of EU legislation.

While targeted measures have been introduced in a number of Member States to regulate financial forms of crowdfunding ranging from minimum limits on individual contributions to various duties on platforms to safeguard investors' interests, it must be remembered that Commissioner Barnier has emphasized that a single E.U. crowdfunding framework is becoming a compelling necessity.

With regard to crowdfunding platforms that host securities campaigns, the Commission pointed out that the Markets in Directive (MiFID) requires entities performing financial intermediation to be registered and comply with MiFID investor protection rules. These entities benefit from a passport to other EU Member States. At the same time, Member States have the option to apply an exemption pursuant to Article 3 of MiFID for certain well defined entities advising or receiving orders from investors and transmitting them to platforms. The consultation will examine the question of whether MiFID offers the optimal legal environment to allow the growth of crowdfunding at the European level, while ensuring adequate investor protection.

Former Fed Chair Volcker Says Too Many Federal Financial Regulators Led to Incomplete Dodd-Frank Implementation

Pointing to the fact that three years after the enactment of Dodd-Frank important unresolved issues arising from the Act remain unresolved, including derivatives and proprietary trading, former Federal Reserve Board Chair Paul Volcker said that the U.S. does not need six federal financial regulatory agencies, which he called a recipe for indecision, neglect, and stalemate, adding up to ineffectiveness. In remarks at the Economic Club of New York, he noted that, while Dodd-Frank did create the Financial Stability Oversight Council as a mechanism to coordinate regulation, the regulatory landscape was essentially left intact by the reform legislation.

The result is that the U.S. is left with six very distinct federal financial regulators, he said, each with their own mandate, their own institutional loyalties and Congressional support networks, along with a cadre of lobbyists equipped with the capacity to provide for campaign financing.

Even beyond the Dodd-Frank Act, he continued, a consensus for action among the SEC and treasury on the reform of money market mutual funds has not been found, even though new legislation is needed to effect such a reform. Similarly, progress towards international accounting standards is stalled and any meaningful reform of the credit rating agencies regulatory regime has not been forthcoming.

The lack of agreement on key regulations is unacceptable, emphasized chairman Volcker, who added that the current regulatory overlaps and loopholes play into the hands of industry lobbyists who resist change, In turn, this undercuts the need of the financial markets for clarity The time has come for change, he concluded.

Thursday, October 03, 2013

OIRA Chief Shelanski tells House Panel that Retrospective Review of Regulations is Informed by Executive Orders

In an atmosphere of increased congressional scrutiny of the cost and benefits of federal regulations, Howard Shelanski, the new Administrator of the Office of Information and Regulatory Affairs (OIRA), told the House Judiciary Committee regulatory reform subcommittee that the retrospective review of regulations is a crucial way to ensure that the regulatory system is modern, streamlined, and does not impose unnecessary burdens on the public. Even regulations that were well crafted when first promulgated, testified Mr. Shelanski, can become unnecessary or excessively burdensome over time and with changing conditions. The retrospective review of regulations on the books helps to ensure that those regulations are continuing to help promote safety, health, welfare, and well-without imposing unnecessary costs. Agencies filed their most recent retrospective review plans with OIRA in July.

OIRA completed its review of those plans a few weeks later and agencies have posted them on their websites. The OIRA retrospective review efforts to that point had already produced significant results, bringing near-term cost savings of more than $10 billion to the US economy. As agencies move forward with their current plans, he related, OIRA will work with them to achieve even greater gains. Many of the retrospective review efforts particularly benefit small businesses, he noted.

Mr. Shelanski importantly related that the largest area of OIRA’s work is the review of regulations promulgated by Executive Branch departments and agencies. Indeed, the OIRA Administrator said that his priorities are directly rooted in the relevant Executive Orders.

A set of Executive Orders establishes the principles and procedures for OIRA’s regulatory reviews. Most significantly, E.O. 12866 and E.O. 13563 delineate processes for regulatory review and establish standards and analytic requirements for rulemaking by departments and agencies. Other important Executive Orders focus on the reduction of regulatory burdens through the retrospective review of existing rules (EO 13563 and 13610), and on international regulatory cooperation (EO 13609).

President Obama has been a strong champion of reform of the fed eral regulatory process. This was evidenced by two Executive Orders issued during his first term: Executive Order No. 13563, 76 Fed. Reg. 3,821 (Jan. 21, 2011) and Executive Order No. 13579, 76 Fed. Reg. 41,587 (July 14, 2011).

EO No. 13563 set out general requirements directed to executive agencies concerning public participation, integration and innovation, flexible approaches, and science. It also reaffirmed that executive agencies should conduct a cost-benefit analysis of regulations.

EO No. 13579 states that independent regulatory agencies should follow EO No. 13563. To facilitate the periodic review of existing significant regulations, EO No. 13579 said that independent regulatory agencies should consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned.

Mr. Shelanski was previously the Director of the Bureau of Economics at the Federal Trade Commission. Before that, he served as Chief Economist of the Federal Communications Commission from 1999 to 2000 and as Senior Economist for the President’s Council of Economic Advisers from 1998 to 1999.

Wednesday, October 02, 2013

Senate Legislation Would Create Commission to Identify Outdated Regulations

Senators Angus King (I-ME) and Roy Blunt (R-MO) have introduced legislation creating a Regulatory Improvement Commission to review outdated regulations with the goal of modifying, consolidating, or repealing regulations in order to reduce compliance costs, encourage growth and innovation, and improve competitiveness. The Regulatory Improvement Act of 2013 liberates the regulatory reform debate from traditional political and ideological frameworks by employing a balanced approach to evaluating existing regulations, one that involves identifying regulations that are not essential to protecting broad priorities, like the environment, public health, and safety, but instead are outdated, duplicative, or inefficient

The goal of the Commission is to complement existing processes and to create a mechanism that acts expeditiously and incorporates wide stakeholder input. The goal of the Commission is not to circumvent congressional, executive, or agency authority, assured the Senators, but instead to complement existing processes and to create a mechanism that acts expeditiously and incorporates wide stakeholder input.

While regulatory self-review processes have been utilized for years with varying degrees of success, they noted, retrospective reviews often fall short in two ways: 1) internal pressures, from limited staff to extensive bureaucracy, limit the ability of individual agencies to effectively trim their regulations, and 2) the existing retrospective review processes tend to look at individual regulations in isolation, rather than considering the cumulative impact of regulations both within and across agencies.

The Commission will operate for a designated period of time and require congressional reauthorization each time a retrospective regulatory review is desired. Members of the bipartisan Commission will be appointed by congressional leadership and the President. The Commission will be tasked with first identifying a single sector or area of regulations for consideration. Upon an extensive review process, involving broad input from the general public and stakeholders, the Commission will submit to Congress a report containing regulations in need of streamlining, consolidation, or repeal.

The public and interested stakeholders will have several opportunities throughout the process to comment, including an initial public comment period directing the Commission’s area of focus as well as during a period of feedback on a preliminary draft of the Commission’s report to Congress.

Both houses of Congress will consider the Commission’s report under expedited legislative procedures, which allow relevant congressional committees to review the Commission’s report but not amend the recommendations. Within 30 days, each committee will be discharged of its consideration of the Commission’s report and the report (in legislative language) will be placed on the calendar of each house. Similar to the model for military base closing recommendations, the Commission’s report will be subject to an up-or-down vote without amendment.

Senators Urge SEC to Take a Different Approach in Monitoring General Solicitations in Regulation D Offerings

In a comment letter to SEC Chair Mary Jo White, Senators Jerry Moran (R-KN) and Mark Warner (D-VA) expressed concern with the proposed rules regarding Regulation D, Form D and Rule 156, which threaten to slow down or stop the usage of general solicitation offerings by startup entrepreneurs, thereby conflicting with the intentions of the JOBS Act. For example, under the proposals issuers must file a Form D fifteen days before they begin advertising their offering, delaying their fundraising and adding costs and heavy regulatory burdens, particularly for smaller and newer businesses. Instead of the 15-day filing period, suggested the senators, both members of the Banking Committee, the Commission could tie the Form D requirement to the term sheet for the offering or another appropriate milestone.

It is also proposed that entrepreneurs must submit their advertising materials to the SEC on the same day they are used, an enormous requirement for small young companies with few resources for compliance. Advertisements must also include a long set of standard disclosures, noted the senators, which may increase the costs of advertising space for startups and which is difficult to accommodate when utilizing new technologies, such as Twitter. Here, they suggested that the Commission could create an abbreviated set of disclosures or a process that recognizes the challenges posed by character limit requirements. Alternatively, the Commission could require issuers to include standard disclosures on term sheets instead of on the advertisements.

While the proposed rules allow an issuer a one-time 30-day period to correct a missed deadline in filing reports or submitting materials, the penalty for the issuer if they miss another deadline is quite severe in that they are automatically prohibited from using Rule 506 for an offering for one year. The senators urged the Commission to consider alternatives that are proportional to the severity of the infraction.

In the aggregate, said the senators, these proposed requirements and penalties seem burdensome to issuers, investors, and startups. They suggested that a better approach may be to ask several advisory bodies and working groups that the SEC has in the small business and investor protection area to form a working group or committee whose purpose is the monitoring of the form and content of Regulation D generally solicited and advertised materials and report back to the Commission on a regular basis, with anonymized examples. Such a process may better enable the Commission to address challenges such as the collection of solicitation materials given the iterative nature of advertising and offerings, including the use of social media and discussion forums that are updated frequently.
Regarding the lifting of the ban on general solicitations that the SEC has already implemented, the senators believe that investors and the public would benefit by the addition of more methods as reasonable steps to verify accredited investor status in the Commission' s principle-based approach to verification methodology. The four non-mandatory "safe harbors" included in the final rule present challenges for both startups and the early-stage investors who support them. Providing documentation of income or wealth to issuers and even to third-party certifiers is difficult, they noted, adding that, according to the Angel Capital Association, a number of its member angel groups are considering halting their activities if members must furnish private financial information to an entrepreneur or to a verifying agent. The senators are concerned that this requirement will lead to a drop in this very important type of investment, causing substantial harm to startups and the economy.