Wisconsin Emergency Adopts Prohibition Against Using Senior Certifications or Designations

Persons in the securities industry such as broker-dealers, agents, investment advisers or investment adviser representatives are prohibited from using certain professional designations that state or imply specialized knowledge of the financial needs of senior citizen investors. The use of these "senior designations" by industry persons is a dishonest, unethical practice under the Wisconsin Uniform Securities Law. Only those professional designations attained through prescribed training offered by a nationally accredited institution are approved professional designations by the Wisconsin Securities Division.

The rule-making procedures under Chapter 227 of the Wisconsin Statutes are being implemented to adopt permanent rules to be in effect upon expiration of identical emergency rules on the subject issued by the Division on September 11, 2008 (identical except for revised numbering of applicable rules and statutes referenced therein to reflect the January 1, 2009 effectiveness of the repealed and re-created Wisconsin Securities Law resulting from 2007 Wisconsin Act 196, together with revised administrative rules thereunder). The emergency rules became effective September 15, 2008 upon publication in the official state newspaper and compliance with other emergency rule-making requirements.

See http://www.wdfi.org/fi/securities for more information.

Bank of America, RBC Settle Auction Rate Securities Claims

The SEC announced preliminary settlements in principle with Banc of America Securities LLC and Banc of America Investment Services, Inc., and with RBC Capital Markets Corp. The agreements will allow investors to sell back auction rate securities they purchased before the ARS market collapsed in February 2008.

The proposed settlements would include charges alleging that the firms made misrepresentations to thousands of its customers when it told them that ARS were safe and highly liquid cash and money market alternative investments. The liquidity of these securities, however, was premised on the firms providing support bids for auctions when there was not enough customer demand, and this was not adequately disclosed this support to customers. The SEC claimed that the firms continued to market ARS as cash and money market alternatives despite being aware of escalating liquidity risks.

The firms may also face the prospect of financial penalties. Determinations as to the penalty amount, if any, will take into account, among other things, an assessment of whether the firms satisfactorily completed their obligations under the settlements, the costs incurred by the firms in meeting those obligations, including penalties imposed by other regulators and the cost of remediation, and the extent of cooperation with the Commission's investigation.

Links to the RBC and BoA releases.

3rd Circuit Changes Course, Finds Reclassification Exempt from Section 16(b)

Revisiting a case that prompted the SEC to amend its short-swing trading rules, a 3rd Circuit panel found that a reclassification of preferred stock to common shares was not a Section 16 purchase (Levy v.Sterling Holding Co.) under Exchange Act Rule 16b-3. In a previous ruling, the court held in 2002 that the transaction was not exempt under Rules 16b-3 and 16b-7. With regard to Rule 16b-3, the court limited the exemption to transactions with a compensatory purpose, and found also that Rule 16b-7 did not apply to all reclassifications.

In response, the SEC adopted amendments to the rules in 2005 to clarify that the exemptions applied to the kind of transactions at issue in the first Levy case. The question before the 3rd Circuit was the impact of their amendments on their previous ruling and to the transactions involved.
The plaintiff claimed that the earlier decision should stand because 1) the doctrine of stare decisis, 2) the amendments exceeded the SEC's authority and 3) applying the 2005 rules to the 1999 reclassification would have an impermissible retroactive effect. With regard to stare decisis, the court found that a previous holding by the court did not foreclose consideration of a subsequent agency interpretation.

On the question of SEC authority, the court found that the SEC rationale, that the purchase of securities from, or sale of securities to, the issuer by a director or officer did not present the same opportunity for speculative abuse targeted by Congress as transactions with unrelated parties. Because the SEC's rulemaking rationale was reasonable, the court concluded that new Rule 16b-3 was a valid exercise of the SEC’s congressionally delegated authority.

Finally, the court found that the case did not present retroactivity concerns. The rule changes, stated the court, were clarifications rather than new substantive provisions.

[Note: The court ruled on the basis of Rule 16b-3 and did not fully reach the Rule 16b-7 question.]

9th Circuit: Bar Orders in Settled Case Were Too Broad

A 9th Circuit panel found that bar orders issued in a settled class action did not extinguish state claims brought by a non-settling defendant against other defendants named in the class action. As a result, an employee of a firm that was the underwriter in an allegedly fraudulent municipal bond issue could pursue state tort claims against certain co-defendants, including his employers and the creators and operators of the bond offerings.

After approving the settlement of the class action, the district court issued several orders that barred non-settling defendants from bringing any future claims “arising out of or related to...any of the transactions or occurrences alleged" against their co-defendants. The 9th Circuit panel agreed with the employee's challenges to the scope of the bar orders, and held that under the PSLRA and California law that the orders should have been limited to claims for contribution and indemnity or disguised claims for such relief. According to the appellate court, "such bar orders may only bar claims for contribution and indemnity and claims where the injury is the non-settling defendant’s liability to the plaintiff." The question of "whether the allegedly independent claims arise from the same facts as the settled ones is not determinative of whether a particular claim is a disguised claim for contribution or indemnity," concluded the panel.

In re Heritage Bond Litigation

Bailout Bill Gives SEC Oversight Role; Uses SEC Executive Compensation Rules

The Emergency Economic Stabilization Act empowers the Secretary of the Treasury to purchase illiquid mortgage-backed securities under strong oversight by a board composed of the SEC and Fed Chairs, as well as the HUD Secretary. The Financial Stability Oversight Board will oversee the broad and still extraordinary powers granted to the Secretary even after the modifications to the the Treasury's original proposal. The Secretary will set the terms and conditions of the bailout program, adopt rules and guidance, name some financial institutions federal agents to assist in the program, and execute contracts. Unlike the original proposal, the Act provides for judicial review of the Secretary's abuse of discretion, and arbitrary and capricious acts, albeit on an expedited basis.

The Act also restricts executive compensation and golden parachutes to the top five executive officers of the financial institution selling illiquid asset-backed securities to the federal government under the plan adopted by the Secretary. The Act specifically provides that the five executive officers are to be the five executive officers that must report their compensation under the SEC's new executive compensation disclosure regime. This means that the chief executive officer, the chief financial officer, and the three highest paid officers are the five covered by the Act.

Bailout Bill Allows SEC to Suspend FAS 157 Mark-to-Market Accounting

The Emergency Economic Stabilization Act passed by Congress permits the SEC to suspend the application of FASB Standard No. 157 on fair value accounting, or mark-to-market accounting, for any issuer, including financial institutions, or for any transaction. In addition to this broad power,
the Act mandates that the SEC conduct a study of FAS 157 and report back to Congress in 90 days. Among other things, the study will examine how FASB adopts standards.

House Passes Rescue Bill Despite Some Misgivings

By Katalina M. Bianco, Law Analyst, Wolters Kluwer Banking and Finance Group

In its second vote of the week, the House of Representatives passed the Emergency Economic Stabilization Act on October 30. The crucial vote was 263-171. Most Democrats voted in favor (172 in favor to 63 against), while a slighter majority of Republicans voted against, with 91 voting for the measure and108 voting against it. Every member of the House voted.

The incentives added to the measure since its defeat on September 29, as well as a marked sense of urgency, turned the House around despite the mixed feelings of its members. The measure that the House passed included tax provisions that offer taxpayers more than $100 billion in relief, exempting millions from the Alternative Minimum Tax and providing tax breaks for specific businesses.

The raise in the FDIC deposit insurance limit for depositors in banks and credit unions from $100,000 to $250,000 also helped to convince reluctant House members to pass the revised version of the bill.
However, even as the House approved the $700-billion rescue and more than $100-billion in tax relief attached to it, some lawmakers voiced their continuing reluctance about the measure, calling it a “necessary evil” to address the credit crisis.

The measure also lifts the ceiling on the accumulated national debt, which now exceeds $10 trillion, from $10.6 trillion to $11.3 trillion, a problem for most of the more reluctant House members. Yet still, some chafed at the tax breaks sprinkled into the measure to make it more palatable, including breaks for auto racing and Puerto Rican rum importers.

President Bush, who pressed the Congress to enact a plan first crafted by his Treasury Secretary, Henry M. Paulson Jr., and went on national television and radio to campaign for it, is primed to sign the result of the package that Paulson first rolled out in a three-page outline for the bailout. The original three pages grew to more than 100 in the House and more than 400 in the final Senate package that the House approved.

House Passes Bailout Bill

Despite "no" votes from a majority of Republican representatives, the financial services bailout bill passed the House by a 263-171 vote.

2nd Circuit: Basic Presumption Could be Available in Suit Against Research Analysts

A 2nd Circuit panel held that the fraud on the market reliance presumption established by the Supreme Court in Basic Inc. v. Levinson is not limited to statements by issuers, and could be available in an action against research analysts. "The reason is simple," stated Judge Pooler, as "the premise of Basic is that, in an efficient market, share prices reflect `all publicly available information, and, hence, any material misrepresentations'. It thus does not matter, for purposes of establishing entitlement to the presumption, whether the misinformation was transmitted by an issuer, an analyst, or anyone else."

The court also held that in order to fall within the Basic presumption, it was not necessary for the plaintiffs to show that the alleged misrepresentations had a measurable effect on the stock price. Judge Pooler wrote the point of Basic is that an effect on market price is presumed based on the materiality of the information and a well-developed market’s ability to readily incorporate that information into the price of securities.

It is important to note that the holding concerning the impact on the stock price was limited only to the question of the availability of the reliance presumption with regard to class certification. Under the Supreme Court's Dura Pharmaceuticals Inc. v. Broudo holding, the plaintiffs would still be required to show a causal connection between the alleged misrepresentations and a decline in the stock price to establish a Rule 10b-5 violation.

In re Salomon Analyst Metromedia Litigation

SEC to Hold Roundtable on 21st Century Disclosure Initiative

The SEC has announced that it will hold a roundtable on modernizing securities regulation under the auspices of its 21st Century Disclosure Initiative, which is an initiative to completely rethink the federal regulation of securities. Given the events of recent weeks, this initiative takes on added importance. And it also highlights that the SEC is a disclosure agency, which some people may have forgotten in the market turmoil. As former SEC Chair and US Supreme Court Justice William O. Douglas said, the truth of the matter being told, the decision is left to the investor, which means that once full and accurate disclosure about a security has been made, the investor makes the choice without any recommendation from the SEC. Thus, given full and candid disclosure, the SEC does not protect investors from unwise investment decisions.

Commission Extends Temporary Orders

The SEC announced that it was extending several of the emergency provisions ordered in response to the market crisis. The temporary prohibition of short selling in financial companies will now expire on the later of either 1) the third business day after enactment of the anticipated bailout legislation or 2) October 17, 2008.

The temporary requirement that institutional money managers report their new short sales will also be extended to October 17, 2008. The SEC stated, however, that the order will likely continue in effect beyond that date without interruption in the form of an interim final rule. The same is true of the naked short selling order with its closeout provisions and broker conduct requirements.

Other measures extended to October 17, 2008, include the issuer repurchase order relaxing Rule 10b-18, the short sale antifraud rule, Rule 10b-21, and the repeal of exception for options market makers from the short selling close-out provisions in Regulation SHO.

Bailout Bill in Senate Retains House Securities Law Provisions

The Senate version of the bailout bill leaves the securities law provisions of the original House measure described in the posts below basically untouched. New Section 403 in the tax provisions changes the Internal Revenue Code section concerning broker reporting of customer basis in specified securities transactions, however.

Division of Trading and Market Offers Guidance on Sale of Loaned but Recalled Securities

If a person who has loaned a security to another person sells that security, and a bona fide recall is initiated within two business days, the sale should be treated as "long" for purposes of the SEC's recent emergency orders. According to the Division of Trading and Market Offers, the person who loaned the security would be deemed to own it for purposes of Rule 200(g)(1) and Rule 200(b) of Regulation SHO.

The sale would not be treated as a short sale for purposes of 1) new Form SH; 2) the orders halting short selling in financial stocks; or 3) Rule 204T concerning naked short-selling. Under the energency orders, a broker-dealer may mark such orders "long" and the close-out requirement for long sales under Rule 204T would apply to sales of such securities.

The guidance is available here.

Members of Congress Urge Suspension of Mark-to-Market Accounting

More than 60 U.S. lawmakers urged the SEC to immediately suspend mark-to-market accounting. In a letter to SEC Chairman Cox, the legislators wrote that the rule, "while well-intended, has the unintended consequence of exacerbating economic downturns by hamstringing the ability of banks to make loans to consumers and businesses."

The group, from both parties and including two senators as well as members of the House, called on the Commission to expedite new guidance on a mark-to-value mechanism. In the interim, the letter urged the use of estimated fair value using the "best available information" of the instrument's value.

House Voices Concerns After Defeat of Financial Rescue Bill

By Katalina M. Bianco, Law Analyst, Wolters Kluwer Banking and Finance Group

The House of Representatives defeated the Emergency Economic Stabilization Act of 2008, popularly known as the “bailout plan,” by a vote of 228-205 on Monday, Sept. 29, 2008. The Senate expected to take action on Wednesday, October 1, 2008.

The rescue plan has been controversial since its inception, with critics citing lack of oversight, the steep cost of the plan, executive compensation and inadequate protection for taxpayers as drawbacks to the proposal. Congressional leaders responded to some of these criticisms by adding oversight boards to monitor and supervise the spending of the $700 billion, limiting compensation for executives of troubled institutions and providing taxpayers a stake in the troubled institutions in the form of warrants to buy stock from institutions seeking to sell distressed debt, however, resistance to the plan and strong doubts about its viability of the plan remained.

After the measure failed in the House, some legislators spoke of their concerns about the bill. Some Republicans cited ideological objections to the idea of government intervention, while more liberal Democrats voiced their reluctance to provide aid to “Wall Street tycoons.” Critics also noted that the haste in assembling the measure was troubling.

A number of legislators voted for the measure despite their concerns, taking a “better than nothing” position to the bill. Rep. Jim Marshall, D-Ga., who voted for the measure, said that he would prefer to see a bill that focuses less on acquiring mortgage-backed securities and more on minimizing foreclosures and home vacancies, two factors in the lowering of property values in communities. Marshall indicated that he would give bankruptcy courts the power to modify mortgage payments. He also would like to limit the pay of traders as well as top executives.

Lawmakers on both sides pointed to the flood of opposition coming from angry constituents just five weeks before every seat in the House is up for election as a fundamental reason that the measure was defeated. Rep. Roy Blunt, R-Mo., the Republican whip, said that before the vote on Monday, he had tallied 75 votes in his conference in favor of the bill. By the time the measure was put to a vote, only 65 of those votes were delivered.

Senate to Consider Financial Bill Tonight, DeFazio Proposes Alternative

It is likely that the U.S. Senate will take up a version of a financial bailout bill this evening. Sens. Obama, McCain and Biden are expected to attend.

Rep. Peter DeFazio (D-Oregon) has also proposed an alternative to the earlier House bill, which he called the "No BAILOUT" Act (Bringing Accounting, Increased Liquidity, Oversight and Upholding Taxpayer Security). The measure includes five key points.

1) The bill would require the SEC to suspend the application of fair value accounting standards to financial institutions without regard to conditions of the market.

2) Naked short selling would be prohibited by SEC rule.

3) The short sale "tick test" would be re-instituted.

4) The bill would require FDIC to implement a "net worth certificate program." The FDIC would determine banks with short-term capital needs and the ability to financially recover in the foreseeable future. For those entities that qualify, the FDIC would purchase net worth certificates in these institutions. In exchange, these institutions would issue promissory notes to repay the FDIC, counting the amount “borrowed” as capital on their balance sheets and

5) Increasing the FDIC insurance limit from $100,000 to $250,000.

Both presidential candidates have also called for this change in FDIC insurance.

Inactive Markets, "Disorderly" Transactions Subject of SEC Advice

In the guidance on mark-to-market accounting mentioned below, the SEC advised on the use of broker quotes and valuation involving "disorderly" transactions. The SEC advised that in a liquid market, a broker quote should reflect market information from actual transactions. In less active markets, however, broker quotes may be based more on models with information available only to the broker. Less reliance may be placed on quotes that do not reflect the result of market transactions.

With regard to "disorderly" transactions, the Commission advised that these results "are not determinative when measuring fair value." A key component here is the Commission's assertion that an orderly transaction "allows for adequate exposure to the market." While such transactions may not be disregarded, the SEC advised that the use of judgment is appropriate in valuing distressed or forced deals. A privately negotiated sale not adequately exposed to the market would not necessarily be determinative of fair value.

Transactions in an inactive market may affect fair value measurements, advised the SEC. Quoted prices in an active market for the identical asset are representative of fair value and generally must be used, in most cases without adjustment. Transactions in inactive markets may be inputs, advided the SEC, "but would likely not be determinative." The spread between the ask and bid price should be considered, along with the number of bidding parties. According to the SEC, "the determination of whether a market is active or not requires judgment."

The SEC guidance may be found here.

SEC and FASB Guide on Fair Value Accounting under FAS 157

As the market crisis continues, the SEC and FASB have issued joint guidance on the fair valuation of illiquid securities under FAS 157. Some commenters have said that the mark to market accounting demanded by FAS 157 contributed to the crisis. Many of the illiquid mortgage-backed securities that are to be purchased by the federal government are FAS 157 level three securities with no active markets.

The SEC and FASB sat that managers may use internal assumptions, such as expected cash flow, to measure fair value when an active market for a security does not exist. Managers can use estimates that incorporate current market participant expectations of future cash flows and appropriate risk premiums.

Bailout Bill Mandates Report to Congress on Reforming Financial Regulation

One of the more forward looking and possibly mementous provisions in the Emergency Economic Stabilization Act is one mandating a report to Congress on modernizing financial regulation. The report is be delivered by the Treasury Secretary, who earlier this year published a comprehensive blueprint for reform. The report must be submitted by April 30, 2009, after the Secretary conducts an exhaustive review of the financial markets and the regulation of them.

The Secretary is specifically ordered to analysis the over the counter swaps market and the government sponsored enterprises. In addition, the Secretary must recommend whether any currently unregulated market participants, such as hedge funds, should become subject to federal regulation. The Secretary must also submit recommendations on how to enhance the clearing and settlement of over-the-counter swaps.

Bailout Bill Gives SEC Oversight Role Amidst Extraordinary Power for Treasury

The Emergency Economic Stabilization Act that failed to pass the House today, but which I expect to pass Congress by the end of the week, gives the SEC a crucial role in overseeing the Secretary of the Treasury as that cabinet member exercises extraordinary, but judicially reviewable power in purchasing illiquid mortgage-backed securities from financial institutions. The bill sets up an oversight body called the Financial Stability Oversight Board composed of the chairs of the SEC and the Fed, the HUD Secretary and the Director of the Federal Home Finance Agency and the Secretary of the Treasury. The Board will select its own chair, but it cannot be the Secretary. So, the new SEC Chair could be the Board chair.

The Board will meet two weeks after the Secretary's first purchase of distressed assets and monthly thereafter. The Board must report to Congress semiannually. It may also set up a credit review committee to review how the purchase of troubled assets program is being conducted.