Tuesday, October 31, 2017

Commissioner Piwowar addresses SEC’s ‘new path’ at market structure conference

By Joanne Cursinella, J.D.

The SEC is proceeding down a new path, and the current direction is such a complete change from the past few years that it can be called “SEC 180,” SEC Commissioner Michael S. Piwowar commented in his keynote address at the Unity Market Structure conference sponsored by FINRA and Columbia University. Market structure is not merely a subject we take up in response to a market event, a congressional inquiry, or a non-fiction book on high-frequency trading, he said. Rather, it sits at the core of the Commission’s mission, he claimed.

Current market strategy. From July 2010 through December 2016, the Commission’s policy agenda was determined by what Piwowar called “the Dodd-Frank Death March.” The mandates the Act placed on the SEC used up “an incredible amount of the agency’s resources and ultimately prevented the agency from working on important discretionary policy initiatives,” while simultaneously the SEC “also sunk a large portion of its scarce enforcement resources into a so-called ‘broken windows’ approach.”

But now, instead of mechanically plodding through implementation of the Dodd-Frank Act, the SEC is taking a fresh look at how the agency can better facilitate capital formation, the oft-forgotten third part of the SEC’s mission, Piwowar said. Issues surrounding market structure will be an integral part of new discussions. Comparing market structure to “the gears that turn the clock of the capital markets,” he said the details of market structure matter because they ensure the smooth operation of our complex financial markets.

In addition, market structure issues will take priority in the broader discussions around the financial markets, as evidenced by the Department of the Treasury’s recent report on capital markets, Piwowar claimed. That report contained an impressive level of focus and detail on market structure issues and provides strong support for the Commission’s ongoing efforts, he said.

Recent developments. The Commission’s Equity Market Structure Advisory Committee (EMSAC) has submitted practical recommendations to the SEC for consideration on issues such as market quality, execution quality and order handling disclosures, and an access fee pilot. Piwowar has been pleased both by the level of engagement of EMSAC members and by their thoughtful recommendations.

In addition to EMSAC’s work, Piwowar pointed to other positive advances in the equity market structure space. For example, the Commission approved a pilot to study the impact of wider tick sizes for small cap stocks. That pilot began in October 2016 and continues to collect data to help the Commission, academics, and market participants analyze the impact of these changes, Piwowar said. .Another recent market structure change worth noting, he said, is the shortening of the settlement cycle from T+3 to T+2, a change that was a long time coming. Piwowar commend the industry for their work to prepare for this change and drive it to completion.

Next phase. Piwowar is optimistic that the next phase of the Commission’s oversight of the securities markets will be known for its positive impact on market structure. First, there must be a review of market structure which must begin by exploring how the markets have evolved and become what they are today, he said. It must ask how competitive forces and regulation have combined to create our existing market structure and whether that result was intended or even desirable. The review should also try to uncover the incentives that drive the decisions of market participants. Only once the incentives at play have been identified can we make choices about which alternatives may best facilitate competition on choice, pricing, and innovation, Piwowar claimed.

The Commission must not conduct market structure work in a vacuum, though. It is vital that we receive the views and observations of the public to inform the market structure debate, Piwowar said. EMSAC has been a major driver of public dialogue on these issues, and we must continue to allow our review of market structure to benefit from vigorous public discourse, he added.

In addition to the EMSAC, Chairman Jay Clayton has announced his intention to form a new Fixed Income Market Structure Advisory Committee (FIMSAC), Piwowar noted. He fully expects the FIMSAC members to engage in difficult conversations, tackle challenging issues, and generate constructive recommendations for the Commission to consider. Of particular importance to Piwowar in the fixed income market structure space are areas like pre-trade transparency and the appropriate role of regulators vis-à-vis market-based solutions in providing that transparency. He hopes that the FIMSAC will provide insights into such issues.

Monday, October 30, 2017

SEC Enforcement co-director touts new retail investor, cybersecurity initiatives

By Amanda Maine, J.D.

Stephanie Avakian, co-director of the SEC’s Division of Enforcement, outlined the Division’s recent initiatives on protecting retail investors and strengthening the SEC’s cybersecurity efforts. Avakian’s remarks were delivered at a keynote speech at the Securities Docket’s annual enforcement forum in Washington, D.C.

Priorities identified. Avakian stressed that although the SEC, under the direction of new Chairman Jay Clayton, has made retail investors and cybersecurity priorities for the Division, the SEC’s broad mission of protecting investors has not changed. Avakian emphatically rejected the notion that the prioritization of these issues would direct resources away from other Commission enforcement activities, such as combatting financial fraud and policing Wall Street.

Retail investors. Chairman Clayton has emphasized the importance of the “Main Street investor.” In particular, the Commission should always take into account the long-term interests of “Mr. and Mrs. 401(k).” The SEC’s priorities under Clayton reflect this belief with the Enforcement Division establishing a Retail Strategy Task Force. The task force will employ the use of data analytics and technology to help detect widespread misconduct, Avakian said. While the task force does not have dedicated staff to conduct investigations themselves, it will refer possible targets for investigation across the Division, according to Avakian.

Avakian gave some examples about what kind of conduct would be targeted under the prioritization of misconduct against retail investors. The SEC will look at firms that charge undisclosed fees to investors, as well as practices such as “churning” that generate large commissions to advisers at the expense of investors. The SEC will also scrutinize incidents where financial industry professionals recommend risky investment vehicles to investors, such as those saving for retirement, for whom such investments are unsuitable.

She also stressed that enforcement alone is not enough to protect retail investors. The task force will be engaged in investor outreach as well, Avakian said.

Cybersecurity. Chairman Clayton issued a statement on cybersecurity last month emphasizing the importance of evaluating cyber risks. The cybersecurity issue hit closer to home with the Commission’s revelation of a cybersecurity breach of its EDGAR system last year. In the wake of cybersecurity incidents, Avakian outlined three main issues that the Division hopes to tackle with respect to cybersecurity. The first is targeting those engaging in activity such as hacking to gain an unlawful market advantage. As an example, she cited individuals who, through illegal hacking, obtain material, nonpublic information such as an upcoming merger and trade on that information prior to a public announcement of the transaction.

The Division will also focus on registered entities’ failures to take appropriate steps to ensure system integrity, Avakian said. The SEC has in recent years adopted several regulations aimed at the protection of systems that are risk-based and flexible. The Enforcement Division also coordinates with the Office of Compliance Inspections and Examinations (OCIE) regarding cyber concerns. OCIE has issued a Risk Alert detailing observations gained from inspections of SEC-registered broker-dealers, investment advisers, and investment companies about their cybersecurity preparedness.

A third issue regarding cybersecurity, according to Avakian, involves cyber-related disclosure failure. While the SEC has not yet brought a case on this issue, Avakian indicated that the increased scrutiny on cybersecurity could result in actions against companies that do not disclose cyber-related issues. She pointed to the Division of Corporation Finance’s guidance from 2011 about “meaningful and timely disclosures” about cybersecurity concerns. However, she assured that the Division has no intention of second-guessing decisions regarding cybersecurity disclosures if they are reasonable and well-informed.

Technology issues will be a priority for the Division, Akavian said. These include blockchain technology and initial coin offerings (ICOs). The SEC issued a statement in July indicating that ICOs can be treated like securities under the federal securities laws. Blockchain technology and ICOs have gained attention recently, and it makes sense to consolidate enforcement efforts to evaluate them, Avakian said.

Friday, October 27, 2017

Adviser’s fiduciary duty applies to annuity switches, NASAA contends

By John M. Jascob, J.D., LL.M.

NASAA has urged the Illinois Supreme Court to reverse a lower court’s ruling and hold that heightened fiduciary duties applied to an investment adviser’s conduct in switching clients between indexed annuities. NASAA contends that the antifraud provisions of the Illinois Securities Law apply to the entire scope of an adviser’s relationship with his clients. Carving out an exception to those fiduciary obligations and holding advisers to a lower suitability standard when selling indexed annuities would erode important investor protections, according to NASAA (Van Dyke v. White, October 25, 2017).

Annuity switches. The appellee, Richard Van Dyke, had effected 33 indexed annuity transactions for 21 advisory clients, for which he earned approximately $183,000 in commissions. The transactions, which Van Dyke had solicited, involved the liquidation of the clients’ previous indexed annuity contracts and the purchase of new annuities with higher fees.

The Illinois Secretary of State then commenced an administrative enforcement action against Van Dyke, finding that his conduct in “switching” the annuity contracts breached his fiduciary duty to his clients under provisions of the Illinois Securities Law. The Secretary of State revoked Van Dyke’s adviser registration, permanently prohibited Van Dyke from offering or selling securities in Illinois, and imposed a fine of approximately $330,000. The Illinois Court of Appeals, however, reversed the administrative order, concluding that the annuities at issue were not "securities" under Illinois law and that the adviser’s conduct was not fraudulent.

Avoiding regulatory arbitrage and perverse incentives. NASAA urged the Illinois Supreme Court to look to federal precedent for guidance when interpreting Section 12(J) of the Illinois Securities Law, which makes it a violation for investment advisers to engage in fraudulent conduct. NASAA urged the state high court to join other state supreme courts in following the U.S. Supreme Court’s decision in SEC v. Capital Gains Research Bureau (U.S. 1963). These state court decisions have held that advisers (whether registered or not) owe their clients fiduciary duties under state securities laws.

NASAA acknowledged that the law is unclear concerning the applicable standard of care when a conflict exists between a dually-registered adviser’s competing duties under Illinois’ insurance and securities laws. NASAA believes, however, that the court should apply the higher standard—in this case the fiduciary duty standard. The investment adviser designation holds special meaning to investors apart from any other license the adviser may hold, NASAA stated. Accordingly, this special meaning requires that those who have earned the right to call themselves investment advisers are held to a higher standard in dealing with their clients.

A regulatory regime that holds advisers to the higher fiduciary duty standard when selling securities, but a lower suitability standard when selling annuities incentivizes investment advisers to skew their recommendations towards insurance products such as annuities, thereby facilitating a system of regulatory arbitrage, NASAA argued. If the lower court’s decision were allowed to stand, NASAA believes that investment advisers in Illinois will play off of the bifurcated system created by the ruling in an attempt to avoid breach of fiduciary claims when those claims are related to the purchase or sale of an insurance product.

The case is No. 121452.

Thursday, October 26, 2017

FinTech opportunities and challenges mapped out at FIA Expo in Chicago

By Brad Rosen, J.D.

In his address before the 33rd FIA Futures & Options Expo held in Chicago, Illinois, CFTC Chief Innovation Officer, Daniel Gorfine, provided updates for LabCFTC initiative launched earlier in the year, surveyed the fintech landscape including significant areas of innovation, and identified related opportunities and challenges, as well as the evolving role of the CFTC.

After his prepared remarks, Gorfine led a related panel discussion on the boom in FinTech startups which was comprised of a cross-section of industry experts representing incubators, venture capital investors and public sector entities. The session, titled "The Geography of Innovation: Which City Is Best Positioned to Support Capital Markets Fintech? A Transatlantic Debate," explored the relative merits of some the world’s leading innovation hubs.

LabCFTC. Established in May 2017, LabCFTC is the cornerstone of the commission’s FinTech efforts and initiatives. Its mission is to cultivate a forward thinking regulatory culture, lead the agency to become more accessible to emerging technology innovators, discover ways to harness and benefit from FinTech innovation; and become more responsive to rapidly changing markets.

At time of the launch of LabCFTC, Chairman J. Christopher Giancarlo noted, “the CFTC can no longer be an analog regulator in an increasingly digital world. LabCFTC is intended to help us bridge the gap from where we are today to where we need to be—Twenty-First century regulation for 21st century digital markets.” Gorfine also serves as the director of Lab CFTC.

Gorfine noted that since the LabCFTC was launched, staff has met with innovators in New York City and Washington, D.C., and plans on further meetings in Chicago. Silicon Valley, Austin, and Boston in the near future. In total, Gorfine’s group has met with over 100 entities ranging from startup to established financial institutions to leading technology companies.

LabCFTC has also released its first primer titled A CFTC Primer on Virtual Currencies, a publication which seeks to provide an overview of the cryptocurrency markets, identify the CFTC’s role educate the public regarding an potential risks associated with these instruments. Gorfine noted other primers are in the offing.

FinTech landscape. As a definitional matter Gorfine observed that, “FinTech innovation today covers broad swaths of financial activity—ranging from efforts to disrupt components of retail banking and wealth management to aspects of capital markets, trading, and market infrastructure.” On the retail-facing side, he noted these activities include payments, lending, crowdfunding, virtual currencies, and robo-advisory. On the capital markets side, Gorfine has witnessed significant activity involving distributed ledger and blockchain technologies, smart contracts; artificial intelligence and machine learning; algorithmic trading; cloud computing, and digital identity.

Gorfine is optimistic regarding the future stating “[t]here is little doubt that FinTech innovation has the potential to—and already is—benefitting the American public. Whether through increased efficiency, lower transaction costs, or improved access, our society stands to improve based on such innovation.” Nonetheless, at the same time he remains cautious, observing “[t]hese innovations are not without their risks, however. The disintermediation of traditional actors or their functions will strain rules written for a different, analog era. Proper recognition of new actors in markets will necessitate regulatory consideration, though always with the careful balance of not prematurely stemming innovation.”

Wednesday, October 25, 2017

Commission approves PCAOB’s revised audit report standards, CAMs

By Mark S. Nelson, J.D.

The Commission approved a set of changes proposed by the Public Company Accounting Oversight Board to make the auditor’s report more accessible to investors and other consumers of firms’ financial statements. The amended PCAOB standards replace some existing provisions and create new ones, while also explaining their application to emerging growth companies. Portions of the new standards unrelated to critical audit matters (CAMs) would be effective for companies with fiscal years ending December 15, 2017. Implementation of provisions dealing with CAMs would be phased: large accelerated filers with fiscal years ending June 30, 2019; all other companies with fiscal years ending December 15, 2020.

CAMs. Under the new standards, the auditor’s report would have to either communicate any CAMs in the current period audit or state that there were no CAMs. An item is a CAM if it arose from an audit of a company’s financials and was communicated (or was required to be communicated) to the company’s audit committee and the item is material and involves subject matter that is “especially challenging” to document. Auditors would use their judgement about CAMs, but in conjunction with other factors which require an auditor to explain “why” and “how” something became a CAM.

The revised standards also require disclosure of the year in which an auditor began consecutively working for a company. Auditors must include a statement that they are subject to the requirements about independence. The audit report also must be addressed to a company’s shareholders and directors.

SEC Chairman Jay Clayton said he “strongly support[s]” the goals of the PCAOB’s new standards, but he also warned of the potential for boilerplate communications and litigation. “I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships—with Main Street investors ending up in a worse position than they were before,” said Clayton.

Commissioner Kara Stein emphasized the benefits to investors. “The new auditor’s report should provide investors with more meaningful information about the audit, including significant estimates and judgments, significant unusual transactions, and other areas of risk at a company,” said Stein. Commissioner Michael Piwowar praised the SEC staff for its work in completing the approval, but also observed that “[i]t is of the utmost importance that such communications be well tailored and effective.”

Tuesday, October 24, 2017

Industry, academics weigh in on ethics, diversity, future of Dodd-Frank

By Amy Leisinger, J.D.

Social responsibility, board diversity, and ethical issues facing boards have become increasing pressing issues in corporate governance, according to panelists at a conference hosted by Loyola University School of Law’s Institute for Investor Protection. Shareholders expect more from companies than just growth and dividends, but increased focus on these issues and general corporate behavior could serve to achieve both social and financial goals simultaneously, they explained. Many related Dodd-Frank requirements remain up the air as the Trump Administration and Congress explore potential changes, but the panelists agreed that federal and state regulators will continue to step up efforts to support investor protection and boards can play an important role in the process.

Social responsibility. Loyola’s own Seth Green noted that business are spending billions of dollars on corporate social responsibility activities, increasing participation in sustainable investments, and enhancing environmental, social, and governance criteria. According to Green, companies are embracing social good and going beyond compliance and typical corporate governance standards to meet societal expectations and employees’ desires to make an impact and create social value throughout their careers. By intertwining social responsibility with actual business activities and making long-term investments in addressing social and environmental concerns, corporations can create value and increase growth, particularly in light of increasing consumer interest in sustainability, he said.

Ultimately, companies exist for benefit shareholders, and boards may not want to incidentally benefit shareholders primarily to help others, he explained. However, the industry is seeing an increasing competitive advantage to “doing good,” and, arguably, long-term benefits accruing to shareholders far in the future can be justified under the business judgment rule, Green said. To support the feasibility of socially responsible business, some states have adopted Low-Profit Limited Liability Corporation (L3C) structures, a new kind of organization that combines the financial and liability advantages of a traditional LLC with the social benefits of a non-profit. These entities require a primary purpose to further charitable, educational, or social goals with financial gains as a secondary consideration, he explained.

Ethics and board diversity. Many take issue with the increasing corporate focus on social and ethical concerns by arguing that the companies must be run for the benefit of shareholders, but Loyola Professor Steven Ramirez noted that management profits the most from corporate operations, not shareholders. Shareholders do not benefit from corporate misconduct, and, during the financial crisis, the industry saw a breakdown in accountability, according to Ramirez. Ethical outcomes are material to shareholders, and corporations should disclose what the firm is doing, he said. Holding management accountable and requiring disclosure of ethical structures while acclimating to shareholder demands for socially and ethically sound activities would lead to market-based ethicality and enhanced performance, he opined.

Monday, October 23, 2017

Washington insiders say tax reform likely to pass, see ‘rebalancing’ of derivatives regulation

By Lene Powell, J.D.

Despite a chaotic legislative environment, tax reform has a good chance of passing, said a panel of government affairs experts at a derivatives industry conference sponsored by FIA. Regarding derivatives in particular, the panelists see a “rosy picture” in revisiting regulation, including possible revisions to the Supplemental Leverage Ratio in bank capital requirements and CFTC proposed rules on position limits and automated trading.

“Destruction and despair.” Looking at the Washington picture overall, John Feehery, partner at EFB Advocacy, sees “six D’s” at work:
  • Disruption. Donald Trump is the “most disruptive President in our history, more so than Andrew Jackson,” said Feehery. Trump had no political or military experience and came to the White House in an unconventional way, and has said things and done things that no President has said or done before.
  • Distraction. Trump is a “master of distraction.” Some is intentional, some is unintentional, and we never know which, said Feehery.
  • Dismantle. Apart from the Treasury Department, Trump has an “obvious agenda” to dismantle the regulatory state. In Feehery’s view, this is the best thing Trump has done.
  • Destroy. Trump wants to systematically destroy Obama’s legacy, in particular to undo previous executive orders. 
  • Despair. This has all led to a sense of despair in the Washington political establishment—on both sides of the aisle, Feehery observed. 
  • Dystopia. “There’s a sense that Washington is collapsing, that the world is going to end, that we’re going to have either a fascist democracy installed or it’s going to be some sort of keystone cops. And none of that is true,” said Feehery. “There are systematic efforts to make Washington work better after eight years of the Obama administration.”
Tax cuts. “I think the President is putting all his marbles into tax reform,” said Feehery. Although the President and the White House are “sending confusing messages,” Feehery doesn’t see any chance of broad-based support. Senate Majority Leader Mitch McConnell (R-Ky) has said it’s going to be a tax cut. Feehery thinks Republicans will get 50 or 51 votes, with Vice President Pence voting for it. Ultimately, when that becomes obvious, five to seven Democrats who live in red states will vote for it in the end.

“Republicans and President Trump are kind of like Thelma and Louise. If they don’t get tax reform done, they’re going to fly right off the cliff together,” said Feehery. “I think this is going to be a good Christmas present for the American people and for the taxpayers.”

Friday, October 20, 2017

Stock purchase scheme almost ensnares transfer agent

By R. Jason Howard, J.D.

The Massachusetts District Court has granted VStock Transfer, LLC’s motion to dismiss after it determined that the plaintiff, B2 Opportunity Fund, LLC, failed to plead scienter in connection with a questionable transfer of shares in February, 2016 (B2 Opportunity Fund, LLC v. Trabelsi, October 18, 2017, Stearns, R.).

Scheme. VStock, a California LLC based in New York, was hired as a transfer agent by Mazzal Holding Corp., a Massachusetts-based company. In early 2016, Mazzal’s CEO entered into a stock purchase agreement (SPA) in which he agreed to sell 45.8 million restricted shares of Mazzal to B2. The SPA also promised that another individual would sell 9.5 million “free-trading” shares of Znergy-Mazzal stock to B2.

The SPA was signed in February 2016 and specified that B2’s payment for the shares was to be held in escrow until the promised shares were either delivered or the escrow agent was informed by VStock that the shares had been returned to VStock for transfer to B2 or its designee.

The escrow agent emailed a VStock employee asking if a package of documents contained all the necessary information to complete the share transfers and the VStock employee replied that it appeared they had all the paperwork necessary and, relying on that, the escrow agent released the funds to the CEO.

The CEO, however, had not provided all the required paperwork and VStock recorded a transfer of 9.5 million restricted shares of Znergy-Mazzal to B2’s designee. The issue was the promise for the “free-trading” shares and the receipt by B2 of restricted shares.

Claims. B2 asserted claims for securities fraud, common-law fraud, conversion, breach of fiduciary duty, gross negligence and wrongful registration.

The court, in addressing the securities fraud claim, noted that VStock asserted that B2 had failed to adequately plead both scienter and loss causation. B2 alleged that VStock’s representative must have known the terms of the SPA and therefore he could not have believed that he had received all the required forms but the court explained that the allegation was made on information and belief and did not demonstrate that level of knowledge on the part of the VStock representative.

B2’s second argument was that the representative should have known that the documents received did not match the items the CEO claimed to have sent based on emailed instructions sent from the CEO to the representative that explained the documents sent to VStock. From this, B2 argued that it could be inferred that the representative had examined the documents and if he had compared them to the email he would have recognized they did not match. The court said that inference could be drawn but that the more plausible inference was that VStock was simply negligent.

The court continued, explaining that other aspects of the transaction “make the inference of negligence the more cogent and compelling explanation.” For instance, VStock only gained a nominal fee of at most $200 for the transaction. B2 also argued that since the CEO chose VStock as Mazzal’s transfer agent, discovery could well “show additional motivations and connections behind that choice that are not currently known.” The court replied, “maybe so,” but it noted that under the heightened pleading standards of the PSLRA, B2 had failed to sufficiently plead scienter.

The court concluded by noting that any torts that VStock committed occurred outside Massachusetts and had no relation to VStock’s forum contacts and thus, the court was without jurisdiction over any remaining state-law claims. Motion to dismiss granted.

The case is No. 17-10043-RGS.

Thursday, October 19, 2017

Staff clarifies non-GAAP C&DIs on business combinations

By Mark S. Nelson, J.D.

The SEC’s Division of Corporation Finance issued a new Compliance & Disclosure Interpretation explaining the application of rules for non-GAAP financial measures to forecasts used in business combination transactions. The staff further renumbered two existing C&DIs and modifed one of them, also within the topic of business combinations.

The new C&DI (Question 101.01) regarding forecasts asked whether certain financials provided to advisers in the context of business combination transactions would be treated as non-GAAP financial measures. The staff said “No.” Generally, the staff explained, forecasts of this type would not fall within the definition of non-GAAP financial measures, which excludes items that must be disclosed under GAAP or under Commission rules.

But the staff also said the forecasts would have to satisfy some criteria. First, the forecasts must be provided to a financial adviser for purposes of obtaining an opinion materially related to the transaction. Second, the forecasts would be disclosed in compliance with Item 1015 of Regulation M-A or other law (including case law).

In addition to renumbering two of the existing C&DIs in this area, the staff also significantly altered one of these C&DIs by deleting a paragraph from Question 101.02 (previously Question 101.01). That question had asked whether exemptions from Regulation G or Item 10(e) of Regulation S-K for non-GAAP financials disclosed in business combination transactions apply in other contexts, such as registration, proxy, or tender offer “statements” (formerly “materials”). The staff answered “No” and provided a more detailed explanation. The revised C&DI, however, eliminated the following paragraph:
In addition, there is an exemption from Regulation G and Item 10(e) of Regulation S-K for non-GAAP financial measures disclosed pursuant to Item 1015 of Regulation M-A, which applies even if such non-GAAP financial measures are included in Securities Act registration statements, proxy statements and tender offer statements.
Nevertheless, part of the subject matter addressed in the deleted paragraph appears in new Question 101.01.

Wednesday, October 18, 2017

TICs are securities under North Carolina law, NASAA argues

By John M. Jascob, J.D., LL.M.

NASAA has urged the North Carolina Court of Appeals to uphold a trial court’s ruling that tenancy in common (TIC) interests were securities under North Carolina law. Although disclaiming any interest in the outcome of the claims underlying the dispute, NASAA filed a joint amicus brief with the North Carolina Secretary of State, arguing that the case’s foundational jurisdiction issues directly implicate the Secretary of State’s ability to enforce the North Carolina Securities Act (NNN Durham Office Portfolio 1, LLC v. Grubb & Ellis Co., October 16, 2017).

TICs are securities. The trial court had held that the exercise of control over the enterprise by the tenants-in-common after the collapse of the defendants’ business plan did not prevent the investment from qualifying as a securities transaction. Although agreeing with this conclusion, the amici urged the North Carolina Court of Appeals to go further and reach the ultimate question left open by the trial court, namely, whether the TICs at issue fell within the definition of a security under North Carolina law.

The amici observed that the Secretary of State has adopted by rule a definition of the term "investment contract" that closely parallels the U.S. Supreme Court’s widely-followed Howey test. The TICs offered by the defendants were securities, the amici argued, because they constituted an investment in a common real estate enterprise with an expectation of profit to be derived from the defendants’ management of that enterprise. Other courts considering this question have also agreed that TICs are securities, and construing the North Carolina Securities Act in a similar fashion would promote uniformity with other jurisdictions and advance the legislature’s policy goals of protecting investors and the state’s capital markets, the amici stated.

Standing under the North Carolina Securities Act. The amici also urged the appeals court to reverse the trial court’s ruling that only those plaintiffs who actually received or accepted an offer in North Carolina could bring claims under the North Carolina Securities Act. The amici noted that North Carolina is one of 33 states that have adopted language from the Uniform Securities Act of 1956 providing for territorial jurisdiction when an offer to sell securities "originates from" the state. Although few courts have construed the "originates from" language, three precedents have been established:
  1. the Newsome test, which holds that an out-of-state offer "originates from" the state if "any portion of the selling process" occurred in-state (Newsome v. Diamond Oil Producers, Okla. Dist. 1983);
  2. the Lintz test, which holds that an out-of-state offer originates from a state if there is a "territorial nexus" between the extraterritorial offer or sale and the originating state (Lintz v. Carey Manor Ltd., W.D. Va. 1985); and
  3. the Lundberg test recently adopted by the Kansas Court of Appeals, which unifies these two approaches (State v. Lundberg, Kan. App. 2017).
The amici contend that the trial court erred by failing to consider any of these relevant precedents. The amici posited that the hybrid Lundberg test provides the appropriate test to apply when assessing territorial jurisdiction because this standard will keep North Carolina law uniform with the law of all other jurisdictions that have considered this question. If the trial court’s ruling were to stand on this point, the amici fear, the legislature’s intent of safeguarding the integrity of North Carolina’s securities markets would be subverted and the enforcement efforts of the Secretary of State and other state securities regulators could be impeded.

The case is No. COA17-607.

Tuesday, October 17, 2017

Justices asked to reject government petition in ALJ case

By Mark S. Nelson, J.D.

David Bandimere filed an opposition to the government’s bid to persuade the Supreme Court to decide the question of whether the SEC’s administrative law judges are appointed consistent with the U.S. Constitution’s Appointments Clause. A divided Tenth Circuit had granted Bandimere’s petition for review of a Commission decision upholding sanctions against him for securities law violations. According to Bandimere’s lawyers, the government’s certiorari petition should either be denied or granted, but not held pending the outcome of a similar case the justices have been asked to hear. Bandimere also said that if the Court declines to order an “outright” denial of certiorari, he would not disagree with a grant of certiorari in his case (SEC v. Bandimere, October 10, 2017).

The government had made a semi-cryptic argument in its petition for certiorari in Bandimere in favor of the justices instead taking a case from the D.C. Circuit that raises the same question, in which the government said it would soon provide a more fulsome reply (currently due October 25). But the government also hedged its position by asking the Court to hold Bandimere’s petition if it granted certiorari in the D.C. Circuit case, while alternatively urging the court to deny certiorari in Bandimere’s case if it were to decline certiorari in the D.C. Circuit case. Still, it is plausible that the justices may be waiting for a case from the Fifth Circuit regarding the Federal Deposit Insurance Corporation, or yet another case challenging the SEC’s ALJs, as the vehicle to address the Appointments Clause.

Bandimere and Lucia. Bandimere’s lawyers told the justices that Lucia may not be the better case to deal with the Appointments Clause question, as the government had previously suggested, because Lucia has limited precedential value. The Lucia petition for certiorari arrived at the Supreme Court after the three-judge panel’s opinion upholding the SEC’s ALJs had been vacated pending en banc review. An equally divided full D.C. Circuit later issued a brief order denying the petition for review in Lucia. According to Bandimere, Lucia is laden with vehicle issues that do not exist in his case.

The Lucia (rehearing denied) and Bandimere (rehearing denied) cases both arose from SEC administrative proceedings that were then appealed under the securities laws to federal courts of appeal. The D.C. circuit in Lucia upheld the SEC’s ALJs on the ground that they do not issue final opinions. That decision depended on circuit precedent (Landry v. FDIC) that had reached the same conclusion regarding the FDIC ‘s ALJs.

By contrast, the Tenth Circuit held that the SEC’s ALJs were not appointed in a manner consistent with the U.S. Constitution’s Appointments Clause and, in so holding, rejected the D.C. Circuit’s Landry opinion as unpersuasive. Although the Landry court was unanimous regarding the outcome in that case, one judge concurred to emphasize that the Supreme Court’s prior foray into the Appointments Clause arena (Freytag) could be read to find that government officials are inferior officers, rather than employees, even if they do not issue final orders. The Landry concurrence and many respondents in SEC proceedings have emphasized the “significant authority” touchstone in the Supreme Court’s precedents for deciding if a government official is an inferior officer as compared to an employee (See, e.g., Buckley v. Valeo).

Monday, October 16, 2017

CFTC chairman, EC VP agree to common approach on trading venue, margin requirement equivalence

By Brad Rosen, J.D.

In a significant development towards cross border harmonization with the European Commission, CFTC Chairman J. Christopher Giancarlo announced that the CFTC has agreed to a common approach with the European Commission regarding equivalence and comparability for derivatives trading platforms as well as a margin framework for uncleared derivatives. The chairman made the announcement at a joint press conferencein Washington, D.C. with his counterpart, EC Vice President Valdis Dombrovskis.

Under the contemplated derivatives platform equivalence arrangement, both European and U.S. firms will have assurances that they can trade on each other’s registered derivatives platforms. Additionally, the European Commission has adopted an equivalence decision for the CFTC’s margin framework for uncleared derivatives. At the same time, the CFTC has issued a decision today concluding that the EU margin rules are comparable to the CFTC rules. As a result, EU firms may rely on substituted compliance with EU margin rules to meet CFTC requirements.

In his remarks about these collaborative achievements, Chairman Giancarlo noted, "[t]oday marks a significant milestone in cross-border harmonization between the European Commission and the CFTC…These cross-border measures will provide certainty to market participants and also ensure that our global markets are not stifled by fragmentation, inefficiencies, and higher costs. Indeed these measures are critical to maintaining the integrity of our swaps markets," he added.

Common approach regarding derivatives trading venues. Under the common approach, Vice President Dombrovskis intends to propose that the EC adopt an equivalence decision covering CFTC-authorized SEFs and DCMs that are notified to it by the CFTC, provided that the requirements of the Markets in Financial Instruments Regulation (MiFIR), the Markets in Financial Instruments Directive (MiFID II), and the Market Abuse Regulation (MAR) are met.

At the same time, CFTC staff intends to propose an exemption from SEF registration requirements for trading venues that have been authorized in accordance with MiFID II/MiFIR requirements and that have been identified to the CFTC by the EC, as long as they satisfy the standard set forth in Commodity Exchange Act (CEA) Section 5h(g). Chairman Giancarlo indicated he will support this exemption.

Margin comparability and equivalence determinations. CFTC commissioners have unanimously approved a comparability determination finding the margin requirements for uncleared swaps under the laws and regulations of the EU comparable in outcome to those under the CEA and CFTC regulations. This determination is effective immediately.

Pursuant to this comparability determination, a swap dealer or major swap participant that is subject to the both CFTC and EC margin rules with respect to an uncleared swap may rely on substituted compliance wherever available under the CFTC’s margin rules. Any such swap dealer or major swap participant that complies with the EU’s margin rules would be deemed to be in compliance with the CFTC’s margin rules, but would remain subject to the CFTC’s examination and enforcement authority.

Likewise, the EC has recently announced its own equivalence decision which similarly finds that the CFTC’s uncleared swap margin rules are comparable in outcome to the EU’s corresponding margin requirements for uncleared OTC derivatives.

Commissioner comments. Commissioner Rostin Behnam observed, "[a]s important financial reforms are phased in across the globe, effective cross-border harmonization must be a top priority for all regulators." According to Behnam, "[t]oday's substituted compliance determination is a step towards harmonization." His fellow commissioner Brian Quintenz added, "this is a significant accomplishment that will help prevent fragmentation of the global derivatives market."

Chairman Giancarlo took a realistic but optimistic view in his closing comments at the press conference, observing, "I think what we've achieved today speaks very well for what we'll be able to achieve in the future. Invariably there will be additional issues come up. There are issues today, there will be issues in the future. What's important, though, is that we have a path to resolution of them. We have a methodology, we have staff-to-staff relationships all the way down the chain, and I think that bodes very well for the other issues that invariably will be ahead of us. But I think we have a path to success, and we've shown that today."

Friday, October 13, 2017

SEC committee considers promises and pitfalls of distributed ledger technologies

By Anne Sherry, J.D.

A morning session of the SEC’s Investor Advisory Committee tackled cryptocurrencies and distributed ledger technology (DLT) and the implications of these emerging technologies on the securities markets. A group of industry professionals and academics converged around the concept of these emerging technologies as tools that industry participants and regulators can use to shape or refine the way markets operate. But not all committee members were satisfied with the lack of a clear answer as to where they fit in the legal landscape.

An ex-regulator’s perspective. Jeff Bandman (Bandman Advisors) discussed the challenges regulators face and the potential that DLT offers. Bandman, a former FinTech Advisor at the CFTC, observed that regulators do not regulate technologies themselves, but rather their application. Regulators must remain neutral, not just between competing companies, but also competing technologies. He added that blockchain tends to be developed in the open, so it is more visible to regulators than some other technologies. It offers the potential to see events as they unfold—through the windshield—rather than through the rear-view mirror a day or two later.

Bandman also lamented well-intentioned rules that have unintended consequences for regulators. Procurement and ethics rules can stand in the way of progress, he said, giving the example of innovators offering nascent technology at below fair market value, which could constitute a gift that government officials are unable to accept. Officials may also be unable to become members in technology groups: if they get in free, it’s a gift; if they pay, it’s a procurement. CFTC Commissioner Quintenz has responded by promoting technology prizes and hackathons, but this is a workaround, not a solution, Bandman emphasized. Just as innovators have sandboxes in which to develop new technologies, Congress should give regulators a sandbox for applying them.

The SEC’s July report concluding that DAO tokens were securities is the agency’s digital Marbury v. Madison, Bandman concluded. Just like that seminal Supreme Court case, the report is a landmark declaration of the agency’s jurisdiction in the digital space. He praised the report for putting the market on notice that these tokens can be securities while avoiding a blanket, one-size-fits-all approach.

Four years of exploration at Nasdaq. Fredrik Voss (Nasdaq) described some of the half-dozen or so DLT implementations that Nasdaq has publicized since it started its blockchain initiative in 2013. Nasdaq focuses its work on the securities markets, the relationship between the issuer and investor, and enhancing societal awareness of what is happening in the capital markets. With one project, Nasdaq leveraged Chain’s blockchain protocol to enable peer-to-peer transfers. The firm also worked on a voting application whereby a company can digitize votes and submit tokens to investors on a blockchain network. This allows tracing, which is good not just for investors, but also intermediaries because they can indisputably prove they followed voting instructions, he said.

Cryptocurrencies distinguished. Chain’s cofounder and CEO, Adam Ludwin, offered an overview of the technology itself. Ludwin said that it is important to define the terms involved and avoid conflating distinct concepts. In particular, he emphasized that cryptocurrency like bitcoin is an asset class in service of something broader, just as securities are in service of the corporate form of organization. In a decentralized system, he explained, you need to create an incentive for entities to contribute resources to make the service possible. Bitcoin as an asset class (he believes “currency” is a misnomer) is a secondary market, he said. Its primary function is to compensate the computers and entities processing transactions on the market, also known as miners.

On virtually every dimension, Ludwin said, centralized services are superior to decentralized ones. They are faster, lower cost, more scalable, secure, and have a better user experience with less drama. The one advantage of decentralized services is their resistance to censorship. There are two groups for whom this advantage outweighs the disadvantages: people who are off the grid, such as in developing countries—and people who want to be off the grid.

Committee responses. The panel’s sometime reluctance to delve into the technology’s implications for the securities markets frustrated committee member Damon Silvers (AFL-CIO), who tried to pin panelists down as to whether the purchase of cryptocurrency is a contract and, if so, who is answerable if anything goes wrong. Silvers referred to Ludwin’s description of coin mining and said that cryptocurrency looks a lot like the definition of an investment contract—investing money with the expectation of earning profits from the efforts of third parties. Nancy Liao (Yale Law School) allowed that an investor may be able to sue the creator of the code, if that person can be found. Ludwin extended the mining hypothetical, asking, if you mine gold, “Do you have a contract with the Earth?” “I’m interested in the law,” Silvers retorted, “and you haven’t said a single thing that is legally relevant.”

The SEC’s Investor Advocate, Rick Fleming, asked specifically how the securities markets would change under distributed ledger technology. He posited that street name would go away, as would proxy overvoting and failures to deliver on short sales. Instead of a T+2 settlement, the market would be headed to T+0. He asked the panelists if they agreed with this list and whether they would add anything to it. Voss remarked that these questions are answered by the people who organize the markets; the underlying technology is just a tool. He also pointed out that T+0 is already supported today and is in use in some markets in the Middle East. Bodson concurred, adding that DTCC sometimes settles orders on a same-day basis, it just is not the market convention for the bulk of transactions.

Thursday, October 12, 2017

IOSCO provides insight into non-traditional products offered by credit rating agencies

By John Filar Atwood

The International Organization of Securities Commissions (IOSCO) has published a report on the non-traditional products offered by credit rating agencies (CRAs) that was begun after a 2015 inquiry into possible revisions to the CRA code of conduct. During that consultation, IOSCO received numerous questions about CRA products and was convinced that it should prepare a report to provide a better understanding of other CRA services.

The report covers non-traditional products such as private ratings, confidential ratings, expected ratings, indicative ratings, provisional ratings, preliminary ratings, one-time ratings, regional ratings, national ratings, and point-in-time ratings. It also covers scoring, credit default swap spreads, bond indexes, portfolio assessment tools, credit assessments, fund ratings, data feeds, and research, IOSCO said in a news release.

IOSCO noted that although other CRA products (OCPs) and services are distinct from commonly identified issuer-paid or subscriber-paid traditional credit ratings, they may be used by market participants to make investment and other credit-related decisions. They can also be used by issuers and obligors to make decisions about whether to obtain a traditional credit rating from a particular CRA.

The report describes six groups of OCPs and their current status, as well as business practices and trends within the CRA industry. IOSCO concludes that OCPs should be responsive to the spirit of the four high-level objectives set forth in the Principles Regarding the Activities of Credit Rating Agencies. The principles relate to the quality and integrity of the rating process, independence and conflicts of interest, transparency and timeliness of ratings disclosure, and confidential information.

The report observes that some OCPs share similar processes and features as traditional credit ratings. CRAs develop a number of OCP using the same credit rating analysts who determine traditional credit ratings, and CRAs may also apply methodologies and follow similar rating processes to determine OCPs.

OCPs may be subject to similar regulatory- and compliance-driven policies and procedures as traditional credit ratings, the report notes, and may be expressed by CRAs and identified by the market using similar symbols, scales, and definitions as traditional credit ratings. The OCPs may or may not be described by CRAs as a type of credit rating, and CRAs whose activities are subject to the oversight of regulatory or other government authorities may not treat them as credit ratings subject to the same regulatory oversight as traditional credit ratings.

The report also concludes that CRAs tend to create separate structures or business line organizations. Some CRAs have organized themselves according to a bifurcated legal and/or corporate structure, while others separate all the activities that are subject to regulation, including traditional credit ratings, into regulated entities or business units. The report states that the legal and/or corporate organizational structures chosen by CRAs to engage in an activity or offer a service or product are not indicative of whether they are subject to the code of conduct.

The report notes that common features can be identified among OCPs, which can be categorized into six primary groups. Like traditional credit ratings, OCPs may be used by market participants as part of the process of assessing the creditworthiness of an entity or obligation, while some OCPs may be used by market participants as part of their internal risk assessment analysis.

However, some OCPs differ from traditional credit ratings, according to the report, in that they may emphasize only one aspect of a traditional credit rating. For example, OCPs may focus only on quantitative analysis or qualitative considerations, as compared with a traditional credit rating, which is typically understood to reflect both quantitative and qualitative analysis.

Wednesday, October 11, 2017

REIT merger challenge dismissed again for lack of presuit demand

By Anne Sherry, J.D.

For the second time, the Delaware chancery court has dismissed a lawsuit alleging that a REIT overpaid for assets. The New Residential Corp. stockholder failed to establish that demand on the board was futile, either by casting doubt on the directors’ disinterestedness or independence or by challenging their exercise of business judgment in approving the merger (Chester County Employees’ Retirement Fund v. New Residential Investment Corp., October 6, 2017, Montgomery-Reeves, T.).

The New Residential Corp. stockholder alleged that the board, along with other entities, caused the REIT to overpay for the assets of Home Loan Servicing Solutions, Ltd., in order to advantage commonly owned real estate assets and maximize fees. Last October, the chancery court dismissed the original complaint with leave to amend, reasoning that the dual-natured derivative and direct action should be treated as derivative for purposes of the demand requirement. While the plaintiff did plead that at least half of the New Residential directors were beholden to the REIT’s controller, Fortress, it did not establish that Fortress had a material interest in the challenged transactions. The complaint also failed to adequately allege how the New Residential directors were incentivized to overpay for the assets.

Aronson analysis. After the court denied the plaintiff’s motion for reargument, the plaintiff filed the second amended complaint, again without first making demand on the board. The court again concluded that demand was not excused. Under Aronson v. Lewis, demand is futile if the plaintiff alleges particularized facts to raise a reasonable doubt either that the directors are disinterested and independent or that the challenged transaction was otherwise the product of a valid exercise of business judgment. Demand was not excused under the first prong because the plaintiff failed to create a reasonable doubt as to the independence of four of the seven New Residential directors.

For example, a director’s receipt of indemnification and exculpation rights did not cast doubt on his independence and disinterestedness; Delaware law holds as much because indemnification has become commonplace in corporate affairs and does not increase a director’s wealth. The plaintiff alleged that another director had “several years of social connections” with two individuals with key positions at Fortress, but failed to plead particularized facts from which the court could infer the director and Fortress officials had a close personal friendship. Finally, the court would not rule that another director’s board compensation was material simply because he was retired; this would amount to a blanket determination that all retired board members lack independence.

Demand was also not excused under Aronson’s second prong. Demand is not futile even if Fortress is a controlling stockholder of New Residential and was interested in the challenged transactions. Although entire fairness would potentially apply if that were the case, the argument that demand is thus futile is inconsistent with Delaware case law. The focus of the demand futility analysis is whether the plaintiff’s allegations raise a reasonable doubt as to the impartiality of a majority of the board. Nor could the plaintiff rest demand futility on its “Monday morning quarterbacking” of the board’s business decision. This was not one of the rare cases in which a transaction is so egregious on its face that board approval cannot meet the test of business judgment.

The case is No. 11058-VCMR.

Tuesday, October 10, 2017

Virginia proposes federal regulation crowdfunding, agent fee increases

By Jay Fishman, J.D.

The Virginia Division of Securities and Retail Franchising has proposed adding a federal regulation crowdfunding rule; a fee increase for broker-dealer agents, issuer-agents, and investment adviser representatives; an adoption of certain policy statements of the North American Securities Administrators Association (NASAA); and the repeal of a rule under federal Regulation D’s Rule 505.

Interested persons may comment or request a hearing on the proposed rules by writing to Joel H. Peck, Clerk, State Corporation Commission, c/o Document Control Center, P.O. Box 2118, Richmond, Virginia 23218. All correspondence must reference Case No. SEC-2017-00034.

Federal regulation crowdfunding. A rule exemption would apply to offerings made under federal Regulation Crowdfunding 17 C.F.R. Section 227 and Securities Act Sections 4(a)(6) and 18(b)(4)(C).

Initial filing. Issuers with either a Virginia principal place of business or issuers that sell at least 50 percent of the aggregate offering amount to Virginia residents may claim the federal regulation crowdfunding exemption by sending the Virginia Corporation Commission: (1) a complete Uniform Notice of Federal Crowdfunding Offering Form or copies of all SEC-filed documents; and (2) a Form U-2, Uniform Consent to Service of Process (if the consent is not filed on the Uniform Notice of Federal Crowdfunding Offering Form).

The initial filing would be submitted to the Commission when the issuer makes its initial Form C filing for the SEC offering if the issuer’s principal place of business is located in Virginia. If the issuer’s principal place of business is located outside Virginia but Virginia residents have purchased at least 50 percent of the aggregate offering amount, the filing must be submitted to the Commission when the issuer becomes aware that the purchases have met this threshold, but in no event later than 30 days from the offering’s completion date.

Effectiveness and annual renewal. The notice would take effect for 12 months from the date it is filed with the Commission. To renew the same offering for an additional 12 months, an issuer would file a complete Uniform Notice of Federal Crowdfunding Offering Form marked “renewal” and/or a cover letter or other document requesting renewal on or before the date the current notice expires.

Amendment. To increase the amount of securities offered in Virginia, an issuer would submit either a complete Uniform Notice of Federal Crowdfunding Offering Form marked “amendment” or another document describing the transaction.

Fee increase for agents and investment adviser representatives. The initial and renewal registration fee for broker-dealer agents (including Canadian broker-dealer agents), issuer-agents, and investment adviser representatives would increase from $30 to $40.

NASAA statements of policy. The following four NASAA statements of policy would be adopted by reference: (1) Promotional Shares; (2) Loans and Other Material Transactions; (3) Impoundment of Proceeds; and (4) Electronic Offering Documents and Electronic Signatures.

Rule 505 repealed. Virginia’s Regulation D, Rule 505 rule would be repealed in light of the SEC’s repeal of this exemption.

Monday, October 09, 2017

SEC roasts reggae coffee company schemer for $58 million

By Rodney F. Tonkovic, J.D.

An SEC enforcement action against Marley Coffee has ground to a halt with a $58 million final judgment. Wayne Weaver was pressed for participating in multimillion-dollar international pump-and-dump scheme involving the stock of Jammin' Java Corp., a company using the trademarks of reggae artist Bob Marley for licensed coffee products. Weaver, of the U.K. and Canada, is the last defendant in this action against whom a judgment has been obtained (SEC v. Jammin' Java Corp., October 3, 2017).

The scheme brews up. According to the complaint, the scheme began to percolate in 2008, when former CEO Shane Whittle orchestrated a reverse merger to form the company and through which he secretly gained control of millions of Jammin' shares that had been issued to foreign nominees. In 2010, Whittle spread a portion of his stock through a complex network of offshore entities controlled by Weaver, among others. Weaver and the other offshore defendants then orchestrated a sham financing arrangement designed to create the false appearance of legitimate third-party interest and investment in Jammin'. The public announcement of this arrangement in December 2010 caused Jammin's share price to soar.

In early 2011, entities under the defendants' control or coordination took advantage of the elevated prices and sold over 45 million shares in unregistered transactions, generating at least $78 million in profits. Weaver also took part in funneling a portion of the profits back to Jammin' under the guise of the sham financing arrangement. In May 2011, however, the share price collapsed after Jammin' disclosed that it had learned of various unauthorized internet stock promotions. The price dropped even more after Jammin' released disappointing results in a Form 10-K.

Roasted. The final judgment permanently enjoins Weaver from violations of the registration, antifraud, and beneficial ownership disclosure provisions of the securities laws. Weaver is permanently barred from participating in penny stock offerings and was ordered to disgorgement of $26,371,585, prejudgment interest of $5,221,809, and a civil penalty of $26,371,585. He has filed a notice of appeal.

The last drop. The Commission has previously obtained consent judgments against all of the other defendants named in the action. These judgments have ordered the payment of over $8 million in disgorgement, interest, and penalties.

The case is No. 15-cv-08921.

Friday, October 06, 2017

International FCPA coordination is spiking, but so are potential pitfalls, PLI panelists report

By Lene Powell, J.D.

International coordination in anti-corruption cases just keeps getting better and better, and settlements are getting bigger and bigger, said panelists in a PLI program on FCPA enforcement. But cutting against that trend, strong privacy and labor protections can impede investigations, particularly in Europe, where enhanced privacy restrictions will take effect in May 2018. These cross-currents create complexity for multinational companies trying to comply with conflicting demands.

The panel, “FCPA Investigations and Enforcement: Developments and Updates,” was part of PLI’s White Collar Crime 2017 program and was moderated by F. Joseph Warin, chair of the litigation department of Gibson Dunn’s Washington, D.C. office.

Authorities are working together. Increasing international coordination between enforcement authorities has been a big-picture trend over the past few years, said Charles Cain, acting chief of the SEC FCPA unit. Calling it “the wave of the future,” he expects to see this trend to continue and to result in more coordinated resolutions. The SEC participates in many international efforts, including the Working Group on Bribery, which is part of the Organisation for Economic Co-operation and Development (OECD). Belonging to this group, which includes representatives from the Department of Justice, Department of Commerce, and State Department, allows members to strengthen peer-to-peer relationships and facilitate cross-border coordination, Cain said.

One recent big multinational success is In the Matter of Telia Company AB, a $965 million settlement announced in late September that was one of the largest criminal corporate bribery and corruption resolutions in U.S. history. The case involved a Swedish company’s payment of bribes government to officials in Uzbekistan, as well as money laundering. Cain observed that the structure of the settlement was a little unusual because the SEC, DOJ, and Dutch authorities reached a resolution that allowed for the possibility of a Swedish resolution, and the next day, Swedish authorities filed charges against three individuals. In all, over a dozen different jurisdictions assisted in the investigation. Cain pointed out that even though the company delisted, this does not extinguish jurisdiction.

Process can vary. How multinational investigations and prosecutions begin is very case-specific, said Alixandra Smith, of the U.S. Attorney’s Office for the Eastern District of New York. Sometimes the foreign country has already begun an investigation, and the question is how far along the investigation is and what resources can each country bring. Sometimes the U.S. starts first, and in the course of assisting, the other jurisdiction will decide to bring its own investigation, or the U.S. can actively encourage this.

As the case proceeds, the U.S. can obtain records and service of process via Mutual Legal Assistance Treaties (MLATs), which the U.S. has with most countries, said Smith. For example, to serve a subpoena for records in the U.K., a package is put together and submitted to the DOJ’s Office of International Affairs, which sends the request to and receives the records back from the U.K. authorities. The process is certified, so the records can be used in court in the U.S. Smith explained that although this is the formal process, obtaining records through informal law enforcement contacts can sometimes move more quickly.

According to Matthew Cohen, director of global anti-corruption at Hewlett Packard Enterprise, over the last five years the number of outgoing requests through the OIA has increased 75 percent over the last five years, and incoming requests have increased 150 percent.

Thursday, October 05, 2017

Commissioner Quintenz supports tech innovation, but critical of prior administration’s regulatory initiatives

By Brad Rosen, J.D.

CFTC Commissioner Brian Quintenz, in delivering his first major address since being sworn in to the commission in August of this year, announced his strong support to advance and promote innovation in financial marketplaces, but also offered harsh criticism for certain regulatory initiatives set in motion under the prior administration.

Reg AT. In remarks before the Symphony Innovate 2017 conference held in New York City, Quintenz railed against Reg AT (Regulation Automated Trading) noting, “[t]he agency’s process on this rule development was so confused, the regulation is titled Regulation Automated Trading but the entities it would require to register were classified as Algorithmic Trading Persons.” He further described Reg AT as a “lame-duck re-proposal” that reflects “poorly-crafted and flawed public policy.” Additionally, Quintenz described the controversial “source code repository” component of Reg AT as “massively over-reaching and highly concerning” and declared that “proposal is D-E-A-D.”

Role with Technology Advisory Committee. Quintenz will likely play a key role in connection with the commission’s embrace of technological innovation. He has been named as sponsor to the commission’s Technology Advisory Committee which is composed of outside professionals and structured to provide the CFTC with formal guidance on existing or emerging technological advances and associated potential regulatory issues.

Quintenz sees the financial markets and services sectors as now being primed to benefit from advancements made possible by the internet, as well as the exponential growth of computing power. He noted that new types of companies are now expanding into financial services, motivated by confidence in proprietary technological advancements. In order to realize the potential benefits offered by new technologies, Quintenz views two key elements that need to be in place. First, the commission requires leadership which prioritizes a consistent and engaging dialogue with the FinTech community, and secondly, it must fully utilize existing avenues and create new structures to empower those conversations.

LabCFTC. Quintenz noted that the CFTC’s LabCFTC initiative, which was launched in May of this year, as a pathway through which the CFTC can develop and foster dialogue with the FinTech community. LabCFTC is designed to make the CFTC more accessible to FinTech innovators, and serves as a platform to inform the Commission's understanding of emerging technologies and how they square with current rules. Additionally, LabCFTC is an information source for the Commission and the CFTC staff on market-enhancing innovation that may influence policy development. LabCFTC will enable the CFTC to be proactive as FinTech applications continue to develop, and to help identify related regulatory opportunities, challenges, and risks.

Bitcoin. Quintenz noted that prior to his arrival to the CFTC, through successive enforcement cases, determined that Bitcoin is a commodity and that trading in the cryptocurrencies represents trading in a commodity interest. As a result, the commission will be presented with many challenging issues surrounding features unique to cryptocurrencies will need to provide “regulatory consistency with other commodities….as well as regulatory certainty within which a more constructive trading environment may develop.”

Cybersecurity. Quintenz sees Cyberspace as the 21st century battlefield for those wanting to harm our country and threaten our way of life. He believes that recent public and private sector attacks have shown we also need to focus on mitigation and recovery. Moreover, he noted, “[w]e owe it to our registrants, who send us highly sensitive and proprietary information, to make a realistic assessment of our vulnerabilities and ensure that all data submitted is rationalized and completely necessary.”

In his concluding remarks, Quintenz noted that “innovation won’t wait for us,” adding, “[t]he world is changing, and we as regulators must now change. A 21st century economy demands 21st century regulation.” Time will tell what precise form 21st century regulation will take.

Wednesday, October 04, 2017

Rulemaking petition on human capital management disclosure gains support

By Jacquelyn Lumb

A rulemaking petition submitted to the SEC by the Human Capital Management Coalition, which seeks better disclosure about human capital management policies, practices, and performance, has received about a dozen letters of support, including one last month by the AFL-CIO. The AFL-CIO noted that it has submitted comments in the past about the importance of clear, consistent, and comprehensive disclosures to investors and the markets. Human capital management is a key driver of corporate performance and an essential indicator of value creation strategy and long-term viability, according to the AFL-CIO, and it urged the SEC to begin the rulemaking process immediately.

Public Citizen. Public Citizen noted that the petition builds on a robust body of research that shows the importance of human capital management in determining the value of a firm. Firms with superior human capital management enhance company performance and share value, according to Public Citizen. The group cited a number of studies that found a correlation with superior investment outcomes, but noted that the SEC’s Regulation S-K only requires disclosure of the number of persons employed. The disclosure is “woefully inadequate,” in Public Citizen’s view, especially given that firms often state that their employees are their most valuable asset.

Public Citizen expressed support for the nine subjects that the Coalition enumerated in its petition that should be disclosed, which include workforce demographics; stability; composition; skills; culture; health and safety; productivity; and compensation and incentives. Public Citizen said the disclosure also should include information about violations, fines, and work stoppages, and added that it supports a petition signed by 1.2 million investors calling for political spending disclosure. The SEC’s leadership seems to lean more toward reducing disclosure than providing the information that investors want, the organization said.

Jon Lukomnik. Jon Lukomnik, the executive director of Investor Responsibility Research Center, wrote in his personal capacity of his fear that financial reporting is facing what he called a slow-moving, but existential crisis. Today’s markets increasingly depend on information that is not required by GAAP, he explained, and the non-GAAP information should be improved in terms of quality and consistency. He encouraged the SEC to begin considering how its disclosure regime can evolve to provide the information that investors need while balancing the cost to issuers, and suggested that the chairman make this issue a hallmark of his tenure since it would improve both investor protection and capital formation.

ValueEdge Advisors. ValueEdge Advisors, a consulting firm that specializes in corporate governance matters, noted that GAAP was developed in an era when companies’ primary worth was based on real property, equipment, and their inventories of tangible products. Today, many companies’ primary assets and liabilities are human capital—the abilities, knowledge, and relationships of their employees. ValueEdge strongly endorsed the Coalition’s rulemaking petition and said the disclosure it seeks is achievable at a low cost while providing tremendous value to investors, analysts, and issuers. The firm urged the SEC to schedule hearings in pursuit of what it sees as an essential area for agency action.

Walden Asset Management. Walden Asset Management wrote that it tries to strengthen environmental, social, and governance policies of its portfolio companies through shareholder engagement and public policy advocacy. Walden agrees with the Coalition that the current disclosure requirements related to human capital management are unsatisfactory. More robust disclosures would support investors’ long-term objectives, stabilize markets, and encourage employers to invest in their employees, Walden advised.

British Columbia’s Municipal Pension Board of Trustees. British Columbia’s Municipal Pension Board of Trustees also wrote in support of further discussion about the importance of human capital metrics and disclosures. As long-term investors, the board said it understands the importance of measuring and reporting non-financial information, and said human capital management metrics are “a critical and missing piece of the puzzle for investors.” The board called for further research, discussion, and consideration of the importance of human capital management metrics.

Tuesday, October 03, 2017

High Court drops two SLUSA cases, but will hear another this term

By Rodney F. Tonkovic, J.D.

The Supreme Court has issued its first order list for the October Term 2017. In this list, the Court has denied certiorari for two securities-related cases asking the court to consider the application of the Securities Litigation Uniform Standards Act to state law contract and breach of fiduciary duty claims. Looking ahead to the first full term with Justice Gorsuch, the court will hear three securities cases involving Regulation S-K disclosures, Dodd-Frank's whistleblower provisions, and the SLUSA.

Cert denied. On September 25, 2017, the court held its first conference after its summer recess. In a voluminous order list, the court denied certiorari in two securities-related cases from the Seventh Circuit: Holtz v. JPMorgan Chase Bank, N.A. and Goldberg v. Bank of America N.A.

In Holtz (16-1536), the petitioner asked the court to address when a party is properly held to be "alleging" a "misrepresentation or omission of a material fact" within the meaning of 15 U.S.C. § 78bb(f)(1)(A). In this case, investors claimed that they were led to believe that a bank was acting in their best interests, but it failed to disclose a bias toward recommending its own funds. Seeking to avoid invoking federal law, the investors framed their claims under state contract and fiduciary principles. The district court threw the case out under the SLUSA, concluding that the class action claims rested on the "omission of a material fact." A Seventh Circuit panel agreed.

The petition argued that the issue of whether a party has alleged a misrepresentation or omission under the SLUSA has led to at least a three-way circuit split. The majority approach, as applied in the Second, Third, and Ninth Circuits, asks whether plaintiffs can prevail without proving that the defendants engaged in deceptive misrepresentations or omissions. In contrast, the petition asserts, the Seventh Circuit stands alone in holding that a suit is barred whenever an omission is even implicitly alleged and when it is likely that a fraud issue will arise in the course of the litigation. This position effectively eliminates most contract and fiduciary duty claims, "regardless of what the complaint actually alleges."

In Goldberg (16-1541), decided on the same day as Holtz, a divided Seventh Circuit panel sided with the lower court and Bank of America in holding that certain banking fees charged, but not disclosed, amounted to an omission of material fact. As a consequence, Goldberg's state law claims for breach of contract and fiduciary duty were preempted by the SLUSA and must be brought in federal court. Here, the Seventh Circuit affirmed the district court's dismissal, concluding that the complaint depended on the omission of a material fact in connection with a covered security.

The petition asked the court to address whether the SLUSA requires dismissing with prejudice a class action complaint for breach of contract and breach of fiduciary duty under state law when the plaintiff's claims are not predicated on a misrepresentation or omission of material fact. According to the petition, the Seventh Circuit's interpretation of the SLUSA places serious restrictions on the enforcement of state laws governing contractual and fiduciary relationships, effectively nullifying Illinois contract law in situations in which a federal fraud claim "could be imagined." As in Holtz, the decision conflicts with holdings of the Second, Third, and Ninth Circuits focusing on whether a plaintiff's claim is predicated on a misrepresentation or omission.

Monday, October 02, 2017

Government says Justice Gorsuch is one reason to prefer D.C. Circuit case to mull SEC’s law judges

By Mark S. Nelson, J.D.

The government filed its long-awaited petition for certiorari in a case originating in the Tenth Circuit that challenges the constitutionality of the SEC’s administrative law judges. A divided Tenth Circuit had granted SEC respondent David Bandimere’s petition for review and held that the mode of appointing the ALJ in Bandimere’s in-house proceeding violated the U.S. Constitution’s Appointments Clause. The government’s petition urged the Supreme Court to eventually consider the question presented by Bandimere’s case but instead to select a case from the D.C. Circuit that presents fewer vehicle issues (Bandimere v. SEC, September 29, 2017)

Among the reasons the government cited for waiting was the presence of Justice Gorsuch as a circuit judge on the Tenth Circuit at the time of the government’s request that that court review Bandimere’s case en banc. The Tenth Circuit denied the government’s request for the full court to rehear the case, although several judges dissented from the denial of a rehearing.

Both the Tenth Circuit (rehearing denied) case and the D.C. Circuit case (Lucia v. SEC; petition for review denied by equally divided court) turned on interpretations of the Supreme Court’s Freytag opinion, which held that Tax Court special trial judges are inferior officers. Previously, the D.C. Circuit in Landry upheld the FDIC’s ALJs because it found their decisions were not final. One judge concurred in Landry to emphasize his view that Freytag did not turn on finality and that ALJs exercising less than final powers could fall within the meaning of inferior officer because of the significance of those duties. The Tenth Circuit majority substantially adopted the concurring view in Landry.

The government’s Bandimere petition summed up its view: “We therefore respectfully request that the Court hold this petition pending its consideration of the petition in Lucia. If the Court grants the petition in Lucia, the government suggests that the Court hold the petition in this case pending the final disposition of Lucia. If the Court denies the petition in Lucia, it should deny the petition in this case as well.”

The government also promised a more fulsome explanation of why the court should decide the ALJ question when it replies to the Lucia petition in late October. The question of whether ALJs are inferior officers was a remnant of the Supreme Court’s Free Enterprise opinion regarding the PCAOB, in which the court said in a footnote that it was not yet ready to consider the issue while noting that the D.C. Circuit’s Landry opinion was disputed.

The case is No. 17-475.