Thursday, July 29, 2021

Gensler: SEC action on climate disclosure by end of 2021

By Matthew Garza, J.D.

Citing investor demand and the need to keep up with the times, SEC Chair Gary Gensler made a call for SEC action to propose standardized climate change disclosures by the end of this year. "When it comes to climate risk disclosures, investors are raising their hands and asking regulators for more," he said. The remarks were made in an event sponsored by institutional investor group Principles for Responsible Investment. The SEC gathered 550 unique comments on climate change disclosures through July 21 after then Acting Chair Allison Herren Lee issued a public statement on the issue in March. Three out of four of these comments supported mandatory climate disclosure rules, Gensler said. Thousands more comments came in on standardized letters.

New disclosures are nothing new. The chair cited the SEC’s history of adding new disclosures that are now considered essential information for investors. Initially disclosures were about financial performance, followed by investor demand for information on who runs a company, then information about how they were compensated. He said in 1964 the SEC started to offer guidance about risk factors and in 1980 they added the MD&A section to Form 10-K. These disclosures came with opposition but they have become "integral to our regime," he said. "Investors are looking for consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs."

Chair Gensler referenced one report that found two-thirds of companies in the Russell 1000, and 90 percent of the 500 largest, published sustainability reports in 2019 that used various third-party reporting standards. But comparability is lacking. Using Olympic gymnastics as an example, Gensler noted how fans want to compare the performance of the competitors quantitatively and qualitatively, as well as across countries and generations. "Investors today are asking for that ability to compare companies with each other. Generally, I believe it’s with mandatory disclosures that investors can benefit from that consistency and comparability. When disclosures remain voluntary, it can lead to a wide range of inconsistent disclosures."

Form 10-K is being considered as the vehicle for these disclosures, he said, which should contain sufficient detail to be "decision-useful." Qualitative and quantitative answers to questions like how company leaders are managing climate risks and opportunities and adjusting strategy, as well as metrics on greenhouse gas emissions, the financial impact of climate change, and progress toward climate goals, could meet investor demand for more information.

Hinting at the potential complexity of specific new disclosures, the chair used the example of "Scope 3" greenhouse gas emissions. Scope 1 and 2 emissions are related to a company’s operations and use of electricity and resources. Scope 3 emissions are a measure of the greenhouse gas emissions of companies in an issuer’s value chain. He has asked staff to make recommendations about how Scope 1 and 2 emissions can be disclosed, and whether Scope 3 emissions should be disclosed.

SEC staff is considering the question of whether companies should provide "scenario analyses" on how a business might adapt to the physical, legal, market, and economic changes related to climate change. That could entail disclosure of "transition risks" associated with an issuer’s stated commitments or compliance requirements from certain jurisdictions.

The chair also referred to "net zero" commitments and other announcements from companies about their intentions to reduce greenhouse gas emissions by certain dates. Companies can make those claims without providing any information to stand behind it, he said. "For example, do they mean net zero with respect to Scope 1, Scope 2, or Scope 3 emissions?"

The requirements of jurisdictions companies operate in, such as those countries signed on to the Paris Agreement, could mean regulatory or economic changes in those countries. The staff is looking for useful data that companies might use to inform investors about how they are meeting those requirements. The chair said many commenters to Commissioner Lee’s public statement referred to the Task Force on Climate-related Financial Disclosures framework recently endorsed by the Group of Seven. "I’ve asked staff to learn from and be inspired by these external standard-setters. I believe, though, we should move forward to write rules and establish the appropriate climate risk disclosure regime for our markets, as we have in prior generations for other disclosure regimes."

Fund names rule. The SEC requested comment on fund names in March of 2020, and "truth in advertising" in fund names is also on the Commission’s radar in the context of climate change. Investors need objective figures to judge funds calling themselves "green," "sustainable," "low-carbon," and the like, said Gensler. "I think investors should be able to drill down to see what’s under the hood of these funds."

Wednesday, July 28, 2021

SEC charges 27 firms with failing to file and deliver Forms CRS

By Anne Sherry, J.D.

The SEC announced an enforcement sweep resulting in 27 settlements with advisers and broker-dealers for failing to file and deliver Form CRS. Under SEC rules that went into effect a year ago, SEC-registered financial firms with retail clients must file a Form CRS with the SEC, deliver the form to clients, and post it on their website. None of the 27 investment advisers or brokers filed, delivered, or posted their Form CRS until having been reminded, sometimes twice, by the Division of Examinations or FINRA, respectively.

The settlements range from $10,000 to $97,523, with the median at $25,000. Together, the penalties total more than $900,000. The SEC also censured the firms and ordered them to cease and desist from further violations.

Under the Exchange Act and Advisers Act, SEC-registered brokers and advisers who have retail clients must deliver a relationship summary that discloses certain information about the firm, including the services it provides, the fees retail investors will pay and the conflicts of interest they create, and the disciplinary history of the firm’s representatives. Firms were required to deliver the Form CRS to prospective and new retail investors by June 30, 2020, and to existing retail clients by July 30, 2020.

In each case, the SEC or FINRA contacted the firms after they failed to meet the deadline for filing the Form CRS. In the case of the investment advisers, the Division of Examinations again contacted the firms to announce an examination relating to the failure to file, and only then did the advisers file and deliver the relationship summary.

Gurbir S. Grewal, Director of the SEC’s Enforcement Division, said that the actions "reinforce the importance of meeting [filing and disclosure] obligations and providing retail investors with information that is intended to help them understand their relationships with their securities industry professionals." Adam S. Aderton, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, said, "these firms deprived their clients and customers of the benefits" of the information required by Form CRS, which helps inform their investment choices.

Tuesday, July 27, 2021

SEC staff issue risk alerts on cross trades, wrap fee programs

By Anne Sherry, J.D.

In a pair of risk alerts, the SEC’s Division of Examinations cautioned investment advisers about compliance issues that it observed in connection with fixed-income principal and cross trades and wrap-fee programs. The documents highlight deficiencies and other staff recommendations, particularly with regard to compliance programs, disclosures, and conflicts of interests, that advisers may wish to address in their policies and procedures.

Fixed-income principal and cross trades. The Division published the risk alert on fixed-income principal and cross trades as a follow-up to its September 2019 alert on this topic. The update follows an examination initiative focusing on SEC-registered investment advisers that engaged in cross trades or principal trades (or both) involving fixed-income securities. The alert defines a principal trade as involving a security sold to or bought from the adviser’s own account, an agency cross trade when the adviser arranges a trade between a client and a non-client, and a cross trade when the adviser effects a trade between multiple clients’ accounts.

As part of its FIX Initiative, Division staff conducted over 20 examinations of advisers that collectively managed $2 trillion in assets for over two million client accounts. Nearly two-thirds of the advisers received deficiency letters as a result, the vast majority of which related to compliance programs, conflicts of interest, and disclosures.

The staff found that policies and procedures were inconsistent with the advisers’ practices, disclosures, and/or regulatory requirements and sometimes lacked certain considerations or guidance. Many advisers did not effectively test the implementation of their written policies and procedures, so that even firms that prohibited principal and cross trades were unaware that such trades had occurred. Division staff also uncovered conflicts of interest that were not identified, mitigated, disclosed, or otherwise addressed by the advisers. Examined advisers omitted relevant information about cross-trading activities and failed to disclose conflicts.

The risk alert also identifies some of the practices that appeared to be effective in improving compliance. This includes policies and procedures that incorporate all applicable legal and regulatory requirements, define covered activities, set standards, provide for supervision, and establish controls. With regard to the disclosure deficiencies, the report suggests that advisers provide full and fair disclosure of all material facts and do so in multiple documents (Forms ADV, Part 2A; advisory agreements; separate written communications; and/or private fund offering documents).

Wrap fee programs. In a separate alert, the Division focused on wrap fee programs due to the growth of assets in these programs and the conflicts and disclosure issues staff discovered in over 100 examinations. The exams included both advisers that served as portfolio managers in, or sponsors of, wrap fee programs and those that advised client accounts through third-party programs. Division staff found room for improvement in many of the advisers’ compliance programs, particularly with respect to compliance, oversight, and disclosures.

In particular, Division staff cited issues with advisers’ recommendations that clients participate in wrap fee programs. The most common duty-of-care issue was a failure to monitor for "trading away" and the associated costs; due to fees, some clients would have been better off in non-wrap-fee accounts. In other cases, advisers did not have a reasonable basis to believe the programs were in clients’ best interests.

Advisers also had inconsistent disclosures across various documents, such as advisory agreements indicating that clients would pay brokerage commissions while the wrap-fee program brochures expressly stated clients would not pay such fees. Staff found that advisers omitted disclosing or inadequately described conflicts of interest.

The staff also observed that advisers omitted compliance policies and procedures entirely or their policies and procedures were inadequate. Where policies and procedures were in place, some advisers did not implement or enforce them consistently, while some did not perform adequate annual reviews (if any).

Best practices for wrap-fee programs involve both initial and periodic reviews to assess whether the programs are in clients’ best interest, using information directly obtained from clients, the risk alert states. Advisers should periodically remind clients to report any changes to their situations and objectives, and should otherwise communicate with clients to prepare and educate them when recommending wrap fee accounts.

The risk alert also recommends clear disclosures regarding conflicts of interests and spelling out what additional services and expenses are not included in the wrap fee. Compliance programs should include written policies and procedures and should be monitored for best execution.

Monday, July 26, 2021

Commissioner Pierce considers the cause of under-participation in U.S. markets

By Joanne Cursinella, J.D.

Before a FINRA audience, Commissioner Hester Peirce contemplated the practical realities of securities law and the role it plays in our rapidly changing markets at the FINRA Certified Regulatory and Compliance Professional Program at Georgetown University. In recent prepared remarks, she said that current SEC private market regulation may be a factor in the under-participation of retail investors in U.S. financial markets. She also noted that legal barriers to employment in the financial industry do not necessarily protect investors and advocated that these be reevaluated for effectiveness in promoting such protection.

Cause of under-participation. Whileour financial markets are among the greatest wealth-generating machines ever developed by any society, only about half of American households own equities directly and only about half of Americans own mutual funds or exchange-traded funds, Peirce reported. This may be a by-product of poor investor education in part, she said, but in 2021 many retail investors have now been getting hands-on financial education. In addition, while the regulator’s first reaction is concern over potential investor losses, recent advances in technology can enable people of limited means to access cheap, convenient, high-quality financial services.

But these "newly minted retail investors" soon discover that a "huge swath" of the market is off limits to them, Peirce claimed. Private markets, not subject to the disclosure mandates applicable to the public markets, are the "gated domain of wealthy individuals and institutional investors," she said. Under the Commission’s accredited investor definition, an individual investor who wants to invest in companies making a private offering generally needs more than a million dollars in net worth, excluding her house, or an annual income above $200,000 (or above $300,000 for a couple), Peirce added.

The Commission’s view has been that wealthy individuals are likely to be more sophisticated about financial matters and are better able to bear the risk of loss from these investments. But the problem with this standard is pretty obvious, according to Peirce, since wealth or income is not always linked to financial sophistication or investing prowess.

Barriers remain. The Commission recently "tweaked" the rules to enable investors to qualify as accredited investors based on defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth, but, to date, these changes have been limited to a few select financial professionals, Peirce said. And the SEC has announced plans to explore updating the financial thresholds in the accredited investor definition so that presumably even fewer Americans will qualify, she reported. But the accredited investor rules are not the only barriers to the private markets for non-wealthy Americans, however. The Qualified Client and Qualified Purchaser rules under the Investment Advisers Act and Investment Company Act, respectively, play a similar gating role, Peirce claimed.

Solution? As a remedy, some have suggested regulating private markets more heavily to reduce the incentive to stay private or eliminating the ability to be private above a certain size, but this approach is the technocrat’s solution, Peirce said. A simpler approach would be to unlock the existing gates to the private markets so that retail investors can get exposure to them, she added.

Effects of the status quo. The private market gating rules’ pernicious effects go far beyond the individual, Peirce said. For example, a start-up in the Bay Area or in Manhattan may not find it particularly difficult to line up a significant pool of wealthy investors, but a start-up in Cleveland or Biloxi (where incomes are considerably lower) may not be able to locate investors who meet those same standards, which are uniformly applicable across different regions of the country with vastly different income and wealth levels.

"Those thresholds, however, effectively shut out the brilliant, young woman from a low-income background who had to go straight into the workforce to support a family but has a side hustle that could turn into something big if only she could solicit investments in her local community where her industriousness and talent are on display, but where few accredited investors live," Peirce added.

For decades there has been a call for the SEC to create a tailored regulatory framework in which people could act as "finders" to match investors with small businesses, Peirce said. The Commission proposed such a framework last fall and received comments on it, but no action has been taken. Peirce hopes that, whether by exemptive order as proposed or by rule, a way is found to enable finders engaged in helping small entrepreneurs seeking to raise early dollars without a network of wealthy friends to operate without the full weight of broker-dealer regulation.

Financial industry employment barriers. Barriers are also present with respect to employment in the financial industry, Peirce said. Everyone whether in regulatory bodies or in regulated firms, may have an interest in ensuring that the doors to employment and advancement in the financial industry are open to as many people as possible from every background and "We need to ask anew whether these barriers are well tailored to advance those goals while minimizing the significant costs of keeping individuals who pose little or no risk to investors out of the industry we regulate," she said.

Overly punitive? The list of things that will keep an individual or a firm out of the securities industry is long, Peirce claimed. A closer look at some SEC regulation, though, and it becomes clear that even some apparently reasonable bases for disqualification, in practice, may create unreasonable barriers to employment opportunities while doing little or nothing to protect investors. For example, she said, barring felons from working in the industry seems like an easy investor protection win—after all, a felony conviction is a pretty good indicator of moral turpitude or even moral depravity, right? But in fact, in America today committing a felony is remarkably easy So easy, in fact, that a felony conviction may tell us very little about a person’s moral character, Peirce claimed.

She cited research that there is a "dramatic rise" in the percentage of Americans who have felony convictions, from approximately 3 percent of the population in 1980 to over 8 percent of the population today. The same research suggests that a majority of those with felony conviction have served no time in prison.

Further, it is not the government’s place to deprive individuals of the opportunity to show an employer that they deserve a second-chance at a career in financial services and it may be time to begin rethinking whether the law strikes the right balance, Peirce said. While changing the definition of statutory disqualification would require an act of Congress, the Commission could consider the appropriateness of using its broad exemptive authority to limit the scope of the bar to something that is better tailored to the investor protection concerns the requirement was intended to address, she added.

Some of the barriers to employment in the industry come from good-faith attempts to gather information that may be relevant to the investor protection objectives that the statutory disqualification definition is intended to advance, according to Peirce. For example, she cited FINRA’s Form U4 and the Commission’s Form AD, which play central roles in the registration of individuals who seek to associate with broker-dealers or of investment advisers.

While much of the information required in these forms s unquestionably relevant to determining whether an individual should be interacting with customers and handling their money, some questions about criminal history, however, go beyond what the Exchange Act requires and may impose unjustifiable burdens on applicants, according to Peirce. For example, she said, both in the Criminal Disclosure section of Form U4 and in Item 11 of Form ADV, the applicant is required to report past felony or relevant misdemeanor convictions; in addition, the applicant must report if he has been charged with either type of offense. The relevance of these questions from a regulatory perspective is doubtful, Peirce claimed.

Peirce noted that in a recent regulatory notice, FINRA sought public comment in connection with barriers to participation in the broker-dealer industry, including with respect to the possible effects of "collection and publication of registered representative background data." The SEC should engage in similar review, Peirce said.

Compliance officers. Adifferent barrier to entry into the financial industry is legal liability for compliance officers, Peirce claimed. Compliance officers play a key role in helping financial firms apply a very complex set of rules to the unique intricacies of their own firms’ business lines. If, as has sometimes happened in the SEC’s, FINRA’s, and other regulators’ enforcement actions, when a firm violates the law, the regulatory consequences fall in whole or part on the compliance officer, Peirce noted. The Commission and other regulators could help to alleviate concerns about facing liability for someone else’s violations by establishing a compliance officer liability framework similar to what the New York City Bar Association recently proposed.

Friday, July 23, 2021

Future Ready Lawyer webinar explores technological innovation in corporate legal departments after a year of pandemic

By Brad Rosen, J.D.

Wolters Kluwer Legal & Regulatory U.S. recently hosted a webinar with Corporate Counsel Business Journal (CCBJ) focusing on the findings of the 2021 Wolters Kluwer Future Ready Lawyer Survey: Moving Beyond the Pandemic. Ken Crutchfield, a Vice President in the company’s Legal Markets group led a lively discussion about tops trends impacting corporate legal departments, approaches to innovation, client-law firm relationships, as well as lessons learned in the wake of the COVID-19 pandemic.

Crutchfield was joined by an all-star panel of some of the nation’s top thought leaders in the legal technology and innovation space, including Mark Brennan, Partner & Tech and Telecoms Sector Group Leader at Hogan Lovells; Chris Johnson, Senior Legal Counsel, Americas at Avery Dennison; Tommie-Ann Ferreira, Director, Contracts Management & Legal Operations at Rakuten; Marlene Gebauer, Director of Knowledge Management at Locke Lord and Co-host of The Geek in Review Podcast; and Terra Potter, General Counsel - EMEA/AP and Industrial at Hexcel Corporation.

You can read more about the Future Ready Lawyer webinar here.

Thursday, July 22, 2021

SEC’s Gensler cautions crypto, signals potential rules on swaps that brought down Archegos

By Lene Powell, J.D.

In keynote remarks at the ABA Virtual Derivatives and Futures Law Committee Mid-Year Program, SEC Chairman Gensler discussed potential rulemaking for increased reporting of security-based swaps that were implicated in the startling meltdown of Archegos Capital in March, which caused serious fallout for several banks. Gensler also discussed other topics including security-based swaps rules set to take effect in November, alignment of SEC and CFTC rules, and diversity and human capital disclosures.

But in Q&A following the speech, Gensler was peppered with questions about cryptocurrency ETFs and protection of retail investors investing in crypto assets.

Burning questions about crypto. The first crypto question related to Bitcoin ETFs. Kathryn Trkla, the panel’s interlocutor and a partner at Foley & Lardner, noted that former CFTC Chair Tim Massad and SEC Commissioner Hester Peirce have called on the SEC to approve Bitcoin ETFs, and asked what else must happen for the SEC to move forward with approval.

Gensler said that while the SEC is technology neutral, it is not neutral regarding the need for investor protection. Approval of products depends on whether a market is prone to fraud and manipulation. That is a challenge in many underlying crypto token markets, said Gensler, because crypto platforms are not subject to a federal regulatory regime. Gensler said he’ll continue to work with anyone, including the CFTC and Congress, to try to bring greater investor protections to the market.

Trkla’s next question was about protections for crypto investors. Gensler cut in.

"You’re not going to ask me anything on derivatives, I’m guessing, Katie," Gensler said with a smile.

Trkla defended the question, pointing out that crypto-asset issues cross over into the derivatives space. She noted that the ABA derivatives committee has a subcommittee on crypto assets with 80 members.

Gensler suggested thinking of the "duck test." If it quacks like a duck and waddles like a duck, it’s a duck. The Howey test for whether an instrument is a security was established by the Supreme Court and affirmed multiple times. And the SEC has spoken to it," said Gensler.

"And so if your client is asking you to kind of get over the line, bring them back from over the line," said Gensler. "There are a lot of projects asking for your client’s advice, whether it’s, you know, can we get away with this or get away with that. Bring ‘em back to the right side of the line. So investors are protected."

Gensler added that attorneys should keep in mind when advising clients that whether a product is called a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities, products are implicated by the securities laws and must work within the securities regime. This also holds whether crypto markets are called platforms, decentralized finance, or something else.

"If these products are securities-based swaps, the other rules I've mentioned earlier, such as trade reporting, will apply. Then any offer sale to retail participants, of course, must also comply with our securities laws and register and be on-exchange if exchanges are affected by those rules as well," said Gensler.

Archegos collapse and family office rules. Gensler observed that the collapse of Archegos Capital, a family office, highlighted the lack of transparency in single-name and narrow based equity swaps markets, also sometimes called total return swaps. While the SEC does not yet have reliable information on the size of these markets, they have played an important role in capital markets, said Gensler.

Gensler explained that Archegos used total return swaps based on underlying stocks that had significant exposures, and their prime brokers were on the other side of the family office. The limited transparency in this market, combined with potential shortcomings in market participants’ risk management, contributed to the firm's taking overly large positions and assess subsequent system wide tremors when firms started to unwind those positions.

Moreover, Archegos wasn’t the first time these markets have seen a significant meltdown. Gensler pointed out that Long Term Capital Management, a firm that had about $1.3 trillion in derivatives and collapsed in 1998, had a significant total return swap portfolio as well.

Gensler observed that swaps reporting rules scheduled to come online in November and next February will provide greater transparency in these markets. But Gensler said the SEC also has authorities under Section 10B of the Exchange Act to mandate certain disclosures and position limits for security-based swaps. The Archegos collapse has indicated that position reporting, including provisions regarding position aggregation, may be an important reform to consider, said Gensler. This would be carried out through a notice and comment rule proposal.

Gensler also noted that the SEC has not yet finalized rules for security-based swap execution facilities (SBSEFs). He has asked staff to recommend how to best harmonize with the CFTC’s regime for swap execution facilities (SEFs), which has been up and running for nine years. He envisions that the SEC will put out another notice and comment rulemaking to get further comments from the public and try to best harmonize.

In response to Trkla’s question whether further regulation may be needed for family offices, Gensler somewhat sidestepped a direct answer, instead emphasizing that entities must comply with anti-fraud and manipulation provisions of the securities laws, and that counterparties must have appropriate risk management.

CFTC Commissioner Dan Berkovitz has called for more stringent regulation of family offices. In contrast, CFTC Commissioner Brian Quintenz and SEC Commissioner Peirce believe that current regulations are enough.

The Archegos collapse caused several banks severe losses when they were caught unaware by the amount of Archegos’ swap exposure and did not have risk management measures in place sufficient to respond to the crisis. This has led to at least one securities class action, with a Credit Suisse investor alleging that the bank’s operational weaknesses led to billions of dollars in losses.

Human capital and diversity. Finally, Trkla noted that Rep. Maxine Waters, as chair of the House Committee on Financial Services, has held a hearing about diversity in financial services and brought surveys of large banks the nation's 31 largest investment firms for data on their diversity and inclusion. She asked if the SEC is considering disclosure requirements to shed light on or provide transparency around corporate board and senior executive diversity.

Gensler responded that yes, he has asked staff to offer a rule proposal to the Commission about many issues including diversity of the staff. He thinks investors are looking for more information about human capital and diversity at companies, and the SEC has received comments earlier in the year containing strong recommendations about such disclosures, both in terms of the entire workforce and at the board level.

Wednesday, July 21, 2021

Chamber of Commerce urges SEC to reconsider non-enforcement of proxy advisor rule

By Rodney F. Tonkovic, J.D.

The U.S. Chamber of Commerce's Center for Capital Markets Competitiveness has written to the SEC to express its concerns over the agency's plans to review the proxy advisor rule adopted in July 2020. The letter contrasts the abrupt cessation of enforcement with the decade-long examination of the role of proxy advisory firms underlying the rulemaking process. Ideally, the Chamber says, the SEC should let the rule go into effect and then assess what needs improvement. Given that Commission staff have decided not to enforce the rule, the Chamber formally suggests that the SEC revisit key provisions of the rule proposal and consider further strengthening the proxy advisor rule in the future.

The new proxy rule. In July 2020, the Commission adopted regulations requiring greater transparency from proxy advisors about their conflicts of interest and greater access by registrants and clients to registrant comments on proxy voting advice. Earlier, in August 2019, the SEC approved an interpretation regarding proxy voting advisers, stating that proxy voting advice provided by proxy advisory firms generally constitutes a "solicitation" under the federal proxy rules and providing related guidance about the application of the proxy antifraud rule to proxy voting advice.

Enforcement pause. The rules became effective in November 2020, but there was a transitional period during which compliance with some portions of the regulation was not immediately required. Controversial since the proposal stage, the new regulations met with strong opposition, including, for example, a lawsuit filed against the SEC by proxy advisory firm ISS, seeking relief in response to its proxy guidance and calling it "unlawful." Finally, in June 2021, the Division of Corporation Finance announced that its staff was considering revisiting the amendments and that it would not recommend enforcement action. This decision was met with a mix of praise and skepticism.

The Chamber is wary. The Center's letter, written on behalf of the Chamber, contrasts the lengthy regulatory process leading up to the adoption of the proxy advisor rule with the "abrupt" decision to suspend its enforcement. While the rulemaking was the product of a decade-long examination of the role of proxy advisory firms, the decision to suspend enforcement, the letter says, is void of evidence or arguments for why non-enforcement is in the best interest of investors. Plus, the Chamber is concerned about the precedent set by the decision to effectively ignore a recent rule, stating that this action "raises serious concerns about the Commission’s deliberative process, and harms the SEC’s reputation as an independent regulator that is free from political agendas."

The letter first notes that the proxy advisor rule is grounded in years of evidence and data regarding flaws in the proxy advisory system that harm investors and competition, and that the SEC should prioritize effective oversight and enforcement of the rule. Under the leadership of both parties, the Commission has been grappling with addressing problems with proxy advisors for over a decade. In addition, the letter observes that there were significant changes between the proposal and the final rule that incorporated concerns raised by proxy advisors. In contrast, there was no underlying rationale or transparency behind the announcement that the rule would not be enforced. This approach, the Chamber says, substitutes the judgment of SEC staff for that of the commissioners and undermines the thorough rulemaking process.

Next, the Chamber believes that the Commission should preserve its longstanding view that proxy advice constitutes a "solicitation" under the Federal proxy rules. It is unclear to the Chamber why it is necessary to review this matter when the Commission has defined proxy advice as a solicitation for years and without controversy. The Chamber urges the SEC to reject proxy advisors' efforts to change this longstanding position, characterizing their efforts as an open attempt to avoid oversight and accountability.

Finally, the Chamber recommends that as the SEC considers further regulatory action, it should revisit unfinalized provisions from the November 2019 proposed rule. The letters remarks that the "thoughtful" approach would be to let the rule go into full effect in order to gather data and experience associated with the application of the rule. That said, the Chamber formally suggests that the SEC revisit key provisions of the 2019 rule proposal and consider further strengthening the Proxy Advisor Rule in the coming years. For example, the proposal included provisions to address "robovoting" and would also have imposed explicit requirements to disclose conflicts of interest.

In sum, the Chamber says that the Commission must justify its sudden reversal of the "carefully considered evolution of proxy advisor regulation over the past decade." The letter states that the Chamber hopes this reversal is not an effort to appease "the proxy advisor oligopoly and a minority of activists that wish to preserve the status quo." The effectiveness of the proxy advisor reforms was dependent on the SEC enforcing its own rules, and this outcome can no longer be taken for granted, the letter observes.

Tuesday, July 20, 2021

Better Markets doubles down on the need for ESG disclosure regulation

By Amanda Maine, J.D.

In a new white paper, advocacy group Better Markets outlined the importance of environmental, social, and governance (ESG) issues and how the SEC can improve its approach to ESG. Better Markets has been active in voicing its desire for increased ESG regulation, including in a comment letter in response to then-Acting SEC Chair Allison Herren Lee’s call for input on the SEC’s approach to a new disclosure framework for climate-related disclosures.

Why ESG matters. The white paper points out that investors held over $37 trillion in ESG assets at the end of 2020, which could grow to $53 trillion by 2025. The number of exchange-traded funds (ETFs) and other financial products that are designed to track ESG criteria offered by brokerage companies and mutual funds have also increased, Better Markets advised.

According to Better Markets, the ESG movement matters for a number of reasons, including that it better equips investors to allocate their capital in accordance with their personal values. The movement towards ESG investing can also induce positive changes in society that increase sustainability, fairness, and quality of life by equipping policymakers with more granular information relating to ESG issues, Better Markets stated. "To the extent profit-seeking companies see value in taking steps to prevent the ongoing degradation of the environment, address racism and sexism, reduce income inequality, and prevent fraud and other corporate malfeasance, all at the insistence of profit-seeking investors, the results will be market-based solutions, or at least mitigants, of some of our societies’ most vexing problems," the white paper proclaimed.

Beyond addressing the social ills of society, Better Markets remarked that focusing on ESG issues will help investors reap higher investment returns. While many investors seek out ESG investments because of their personal values, it has also been shown that companies that take ESG factors seriously offer better financial returns. For example, companies that are better prepared to deal with the impact of climate change will likely be a safer investment than companies that ignore the threat of climate change, Better Markets advised. The white paper also noted that companies that focus on diversity tend to do better than those that lag on diversity factors. Focusing on ESG is not a "fringe concern" for the SEC but should be central to its core mission of protecting investors, ensuring market integrity, and promoting capital formation, according to Better Markets.

Breaking down the E, the S, and the G. Tackling the environmental, social, and governance issues one by one, Better Markets praised the SEC for its recent activity in this space, including its request for public input on climate change disclosures, the creation of an SEC enforcement task force related to climate and other ESG issues, and a Risk Alert detailing observations from examinations of investment advisers that offer and manage ESG options. Proclaiming that the SEC "is on the threshold of a new ‘ESG era,’" Better Markets urged the agency to follow through with its intention to propose, finalize, and defend a robust climate-related disclosure regime for public companies and expand disclosure-related climate rules to private companies as well.

Regarding issues that fall under the "social" category of ESG, Better Markets said that the SEC still has a great deal of ground to cover through the securities regulation framework, including issues that involve racial justice. When the financial industry engages in predatory behavior, minorities suffer disproportionately, and more effective and focused initiatives are necessary from all of the financial regulators, Better Markets implored.

The white paper observed that the SEC’s Asset Management Advisory Committee recently met to consider a recommendation from its Subcommittee on Diversity and Inclusion. Among the "sobering" data reported by the subcommittee was the fact that less than 1 percent of assets under management in the $70 trillion global market are managed by minority-owned or women-owned firms, Better Markets reported. The white paper did note that the Commission intends to consider in October proposed rule amendments that would enhance registrant disclosures about the diversity of board members and nominees.

On governance issues, Better Markets called out the SEC for its recent rules relating to proxy advisory firms and shareholder proposals, stating that they severely limit the ability of shareholders to hold management accountable and to have a say on important corporate policies. However, the organization praised Chair Gary Gensler for announcing that the SEC would revisit the proxy advisor rule. It also heralded the SEC for reviving its 2016 proposal on a universal proxy rule. Better Markets also urged the SEC to finalize rulemakings on Dodd-Frank compensation rules regarding risky compensation incentives, clawbacks, and pay-versus-performance disclosures.

Monday, July 19, 2021

Fiduciary claim over derivative arbitration award can continue

By Mark S. Nelson, J.D.

The Chancery Court concluded that a company may pursue its breach of fiduciary duty and unjust enrichment claims against a group of former company directors who, in their capacity as derivative plaintiffs acting on behalf of their former company, had obtained a $6.8 million arbitral award which they allegedly withheld from the company due to their animosity towards certain shareholders involved with a prior attempt to remove the company’s CEO from the company’s board. As a result, the court rejected arguments that such claims are not recognized by Delaware while also declining to disturb the arbitrator’s award of attorney’s fees to counsel for the derivative plaintiffs/defendants. The court, however, cautioned that the company’s claims will need to be tested via further discovery (OptimisCorp v. Atkins, July 15, 2021, Zurn, M.).

Palace intrigue. Optimis sued a group of its former directors who, following an arbitration, won an award in a matter in which they asserted that the company’s former outside counsel engaged in legal malpractice and breached fiduciary duties owed to the company. The follow-on suit by Optimis alleged that the derivative plaintiffs (here defendants) breached their own fiduciary duty to Optimis by withholding payment of the arbitral award to Optimis out of animus for the company’s CEO and because they now worked for a company that directly competes with a key Optimis unit. Optimis further alleged the derivative plaintiffs had been unjustly enriched and sought a levy against Optimis at a time when Optimis was depending on the arbitral award to help smooth its financial prospects.

Derivative action benefits company. A key theme of the Chancery Court’s opinion is that derivative lawsuits are intended to benefit the company on whose behalf they are brought. The derivative plaintiffs/defendants in this case, however, sought to prevent selected Optimis shareholder/adversaries from benefitting from Optimis’s arbitration victory.

The Chancery Court, in part one of the bifurcated proceedings, granted partial judgment on the pleadings to Optimis regarding the question of whether its claim for payment of the arbitral award was derivative—the court said it was. That left for the court to address questions of whether the derivative plaintiffs/defendants breached fiduciary duties and were thus unjustly enriched.

Optimis argued that the derivative plaintiffs/defendants had a fiduciary duty to deliver the arbitral award to Optimis. The derivative plaintiffs/defendants, however, countered that: (1) whatever duties they owed were owed to fellow shareholders and not to Optimis; (2) in the derivative suit context, Delaware imposes no duty beyond the maintenance of the derivative suit; and (3) Delaware does not recognize a claim for money damages for a derivative suit plaintiff’s breach of fiduciary duty.

The Chancery Court rejected the derivative plaintiffs/defendants’ arguments because Delaware imposes fiduciary duties on those who bring suit on behalf of a corporation regarding corporate assets (i.e., the derivative claim). The court concluded that the derivative plaintiffs/defendants breached this duty and went on to explain why holding the derivative plaintiffs/defendants accountable would make sense.

Said the court: "While Defendants contend that allowing this action to go forward would ‘disincentivize stockholder representatives from pursuing this kind of derivative litigation,’ I disagree. Instead, it would disincentivize the kind of misconduct alleged here: the improper withholding of a derivative award for personal reasons and without regard for the authority of corporate decisionmakers" (footnote omitted).

As a result, Optimis had pleaded a claim for breach of fiduciary duty.

Unjust enrichment. The court next concluded that, for purposes of a motion to dismiss, Optimis had pleaded a claim for unjust enrichment. Such claims require a plaintiff to allege: (1) an enrichment; (2) an impoverishment; (3) a relation between the enrichment and the impoverishment; (4) that there is no justification; and (5) that there is no legal remedy.

The court reasoned that because of the withholding of the arbitral award, a subsequent levy, and competition by the former directors who are the derivative plaintiffs/defendants that Optimis had pleaded an enrichment. Optimis likewise pleaded an impoverishment arising from the timing of the withholding of the arbitral award at a time when Optimis was relying on the award to remain adequately capitalized. Optimis also pleaded there was no justification because the derivative plaintiffs/defendants’ animus (ostensibly to protect innocent shareholders but also based on reliance on an interpretation of the arbitral award) nevertheless resulted in a breach of fiduciary duty by them. As for the last element, the derivative plaintiffs/defendants had argued that the unjust enrichment claim was duplicative of Optimis’s breach of fiduciary duty claim, but the court concluded that these claims were separate claims.

As a result, at least at the pleading stage of the case, Optimis had pleaded a claim for unjust enrichment. However, the court noted that still more discovery was needed to prove the claim.

No additional attorney’s fees. The derivative plaintiffs/defendants also sought judgment on the pleadings regarding their counterclaim that their counsel during the underlying arbitration should receive additional attorney’s fees beyond the attorney’s fees awarded by the arbitrator, who had applied the lodestar method to calculate the amount of attorney’s fees. The basis for the ongoing dispute was the fact that the amount of attorney’s fees awarded by the arbitrator was roughly half the 30 percent contingency fees contemplated by the engagement agreement with the law firm.

The Chancery Court reiterated that arbitrators are entitled to deference and that the court lacks jurisdiction to review disputes that parties have opted to subject to arbitration. As a result, the request for additional attorney’s fees was denied.

The case is No. 2020-0183-MTZ.

Friday, July 16, 2021

Charles Liu, Supreme Court petitioner, to disgorge over $20 million

By Rodney F. Tonkovic, J.D.

Charles C. Liu, whose case went before the Supreme Court in 2020, has been ordered to disgorge the net profits of his alleged conduct. Liu was ordered to disgorge $27 million in profits in 2018 for his role in an EB-5 investors scam. He then petitioned the Supreme Court to rule on the SEC's authority to seek disgorgement, and the Court answered in the affirmative, with some caveats, in 2020. Pursuant to the district court's final judgment order, Liu and his wife are now jointly and severally liable for disgorgement of nearly $21 million (SEC v. Liu, July 14, 2021, Carney, C.).

The case against Liu. In May 2016, the SEC charged Charles Liu and his wife Xin "Lisa" Wang with fraudulently inducing investors out of $27 million. Liu raised the money from 50 China-based investors through the EB-5 immigrant investor program, purportedly to build a cancer treatment center. There was no construction, and Liu instead transferred $11 million to three firms in China and diverted another $7 million to his and his wife's personal accounts.

In 2018, the district court ordered Liu, Wang, and three other defendant entities to disgorge nearly $27 million. The Ninth Circuit, in an unpublished decision, affirmed, explaining that the Supreme Court's Kokesh decision had left the question of the federal courts' authority to award disgorgement for another day, and concluded that the proper amount of disgorgement is "the entire amount raised less the money paid back to the investors."

Liu then asked the Supreme Court to take up the question of whether the SEC may seek and obtain disgorgement from a court as "equitable relief" for a securities law violation. Liu argued. Certiorari was granted in November 2019, and the Court issued its opinion in June 2020, affirming the SEC's ability to seek disgorgement in civil proceedings as a form of equitable relief, so long as the award is limited to the net profits of the wrongdoer and funds go to victims. The judgment was vacated and the matter remanded to the Ninth Circuit.

Most recently, in March 2021, the Ninth Circuit let stand an asset freeze and preliminary injunction against Liu. On remand from the appellate court, the district court renewed a freeze on all of Liu's assets pending a decision on the proper amount of net profits to disgorge. The Ninth Circuit reviewed the district court's preliminary injunction for abuse of discretion and found none.

The order. The court enjoined Liu and the other defendants from violating Section 17(a) of the Securities Act and from offering investments in a "commercial enterprise" under the EB-5 program. Liu and Wang were then ordered to pay $20,871,758.81, "representing net profits gained as a result of the conduct alleged in the complaint," plus $70,713.06 in prejudgment interest. Liu will also pay a $6,714,560 civil penalty, and Wang will pay $1,538,000. In addition, J.P. Morgan Chase Bank, N.A. Citibank, N.A., Wells Fargo Bank, N.A., and East West Bank were ordered to transfer the entire balance of 13 accounts held by Liu, Wang, Proton, and other entities to the Commission; the accounts had been previously frozen pursuant to a court order.

The case is No. 8:16-cv-00974.

Thursday, July 15, 2021

CFTC steps up LIBOR transition pressure with advisory committee adoption of SOFR First; Behnam signals rulemaking on clearing

By Lene Powell, J.D.

Accelerating momentum to get market participants to switch from the LIBOR benchmark rate to an alternative reference rate, the CFTC Market Risk Advisory Committee (MRAC) adopted the "SOFR First" initiative as a market best practice. SOFR First lays out a phased framework to switch trading conventions from LIBOR to the Secured Overnight Financing Rate (SOFR) for various U.S. Dollar (USD) derivatives instruments.

The committee’s SOFR First recommendation, along with earlier committee recommendations on plain English disclosures for new derivatives contracts referencing LIBOR and a CCP discounting transition tabletop exercise, will be submitted to the Commission for consideration.

Acting Chair Rostin Behnam issued a statement in support of SOFR First, saying he plans to have staff present the Commission with a rule proposal addressing mandatory clearing of SOFR swaps, with the expectation of finalization in 2022.

CFTC staff issued a statement that although the committee’s SOFR First adoption is not Commission nor Division action, the Divisions "strongly encourage" market participants and SEFs to consider following SOFR First.

SOFR First. The phased initiative was developed by the Interest Rate Benchmark Reform Subcommittee to help market participants decrease reliance on USD LIBOR in an orderly manner. The Financial Stability Board and the International Organization of Securities Commissions on LIBOR transition have backed U.S. banking regulator guidance that banks need to stop entering new contracts that reference USD LIBOR as of December 31, 2021.

SOFR First has four phases:
  • Phase 1: Starting July 26, 2021, interdealer brokers would replace trading of LIBOR linear swaps with trading of SOFR linear swaps. SOFR First recommends keeping interdealer brokers’ screens for LIBOR linear swaps available for informational purposes, but not trading activity, until October 22, 2021. After that, the screens should be turned off altogether.
  • Phase 2: Starting September 21, 2021, SOFR First recommends switching cross-currency swaps.
  • Phase 3: At a date to be determined by the committee, SOFR First recommends switching swaptions, caps, floors, and other non-linear products.
  • Phase 4: At a date to be determined by the committee, certain futures contracts and other exchange-traded products would be encompassed in the phase-in, giving due consideration to supervisory guidance and USD LIBOR’s cessation date.
Acting Chair Behnam and staff support. Acting Chair Behnam supported the SOFR First recommendation, reiterating earlier remarks that "it would be indefensible to stand by and allow market participants to mechanically continue down LIBOR’s road to obsolescence when a sustainable path is clearly in sight."

Behnam stated that he plans to have staff present the Commission with a rule proposal addressing mandatory clearing of SOFR swaps, with the expectation of finalization in 2022.

Behnam also stated that for purposes of the Commission rule prohibiting post-trade name give up (PTNGU) on swap execution facilities (SEFs), which is now applicable to swaps that are mandatorily cleared or intended to be cleared, Commission staff expects that SEF’s will treat SOFR swaps as intended to be cleared or as mandatorily cleared swaps for purposes of Commission Rule 37.9(d).

CFTC staff noted that the timelines for the end of all LIBOR panels are now clear. Given risks to market stability and integrity as well as many risks for market participants, the cessation of and transition away from LIBOR remains one of the Divisions’ significant regulatory priorities.

Accordingly, staff stated that the use of LIBOR rates in new contracts should, with very limited exceptions be ceased as soon as practicable and no later than December 31, 2021. Further, staff recommends that market participants should accelerate their conversion of legacy LIBOR contracts and SEFs should continue to focus on efforts to build liquidity in alternative reference rates in their markets.

Regarding SOFR First, although it is not binding, staff "strongly" encouraged market participants and SEFs to consider following SOFR First as a market best practice. Staff also urged market participants and SEFs to monitor the transition away from other IBOR rates relevant to their businesses.

Commissioner Stump’s concerns. Commissioner Dawn Stump said that while she "wholeheartedly" supports mandatory clearing as an important element of the post-financial crisis reforms, as the use of LIBOR ceases, all of the CFTC’s clearing mandates for interest rate swaps need to be revisited.

Stump noted that the CFTC implemented its Dodd-Frank clearing mandates and requisite clearing infrastructure updates ahead of other jurisdictions. As a result, these regulations were always meant to be a "temporary state" that would need to be revisited as other jurisdictions adopted their own measures.

"[C]ontinuing to mandate clearing of any specific product, while at the same time disallowing access to a robustly regulated, non-U.S. clearinghouse providing the type of liquidity U.S. clients seek to most effectively comply with the mandate to clear that product, is a critical issue that can no longer go unaddressed," said Stump.

Wednesday, July 14, 2021

Appeals court upholds Coscia spoofing conviction despite attorney conflict

By Anne Sherry, J.D.

The Seventh Circuit declined to order a new trial or vacate the conviction of Michael Coscia, who in 2014 became the first person charged in a federal criminal "spoofing" prosecution. Coscia failed to convince the court that data discovered post-trial would have made a difference in the outcome or that subsequent prosecutions of other traders belied the government’s arguments that Coscia’s conduct was unique. The court did find "cause for concern" in the fact that Coscia’s counsel represented one of the government’s witnesses, but concluded that this conflict did not prejudice Coscia or affect his attorney’s performance at trial (U.S. v. Coscia, July 12, 2021, Ripple, K.).

As added by the Dodd-Frank Act, Commodity Exchange Act Section 4c(a)(5)(C) prohibits the disruptive trading practice of spoofing, defined as conduct "of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution)." In the first criminal prosecution of the statute, Coscia was convicted by a jury in 2015 of six counts each of spoofing and commodities fraud and was sentenced to three years in prison. Coscia, as the manager of Panther Energy Trading, had designed two computer programs to implement a spoofing strategy and had a computer programmer create the software.

Coscia moved in the district court for judgment of acquittal and for a new trial, both of which the district court denied. The Seventh Circuit affirmed on direct appeal, and the Supreme Court denied certiorari. The instant ruling concerns Coscia’s appeal of the district court’s denial of a second motion for a new trial and a motion to vacate his conviction. Coscia argued that a new trial is warranted because of new evidence demonstrating errors in trading data presented to the jury and because subsequent indictments against other traders undercut prosecutors’ characterization of Coscia’s conduct as unique or an outlier. His argument for vacating his conviction is that his trial counsel, Sullivan & Cromwell, provided ineffective assistance of counsel due to an undisclosed conflict of interest with several government witnesses.

New evidence. In requesting a new trial, Coscia pointed to data that the exchanges on which he traded, ICE and CME, disclosed after the trial. According to Coscia, the data contradicted charts presented to the jury to demonstrate the rates at which Coscia filled and canceled orders. The court, however, found that Coscia already had the data underlying most of the charts and that the errors that were revealed in the new data were de minimis. Even assuming the new evidence could not have been discovered sooner, Coscia failed to carry his burden of proving the materiality of the evidence by demonstrating that it seriously called into question the jury verdict. The evidence would only have served to impeach some of the government’s witnesses, which does not warrant a new trial given the strength of the remaining evidence.

Coscia also argued that subsequent spoofing prosecutions rendered false the government’s characterization of him as "unique" and an "outlier." The district court had rejected this argument, stating, "That others may have employed illegal trading strategies does not constitute a defense to a criminal indictment based on the employment of illegal trading strategies." The appeals court agreed and found from a review of the record that the case against Coscia was not built exclusively around the uniqueness of his trading strategy.

Assistance of counsel. Coscia’s effort to vacate his conviction on the basis of ineffective assistance of counsel fared no better than his motion for a new trial. He noted that Sullivan & Cromwell represented ICE in various transactions, including a $5.2 billion acquisition finalized on the first day of Coscia’s trial. Lead counsel had personally represented ICE in prior matters. According to Coscia, these undisclosed conflicts meant that the firm chose not to ascertain the accuracy of the government’s summary charts and failed to effectively cross-examine the representative of ICE who testified as a witness for the government.

An actual conflict under the Sixth Amendment means a conflict that adversely affects counsel’s performance, the appeals court explained. While lead counsel’s "prior direct involvement and his firm’s simultaneous involvement in the representation of ICE in other matters at the time of Mr. Coscia’s trial, and the failure to disclose such conflict, is cause for concern that loyalties may have been divided," Coscia failed to demonstrate a reasonable possibility that his representation was adversely affected. Significantly, Coscia’s defense strategy at trial was to argue that his trading activity, while unique, was above board. The evidence recovered post-trial had only mild relevance and probative value to this defense.

Coscia also argued that Sullivan & Cromwell represented two other entities whose representatives testified for the government, putting the firm in the position of having to cross-examine its former clients. But this did not establish that a conflict of interest existed at all in the absence of a showing that the representation of the former clients was related to the firm’s later representation of Coscia, or that the attorneys learned confidential information from the earlier representations that was relevant to Coscia’s case.

Finally, the court rejected Coscia’s other arguments of ineffective assistance of counsel. Here again, the defense strategy of acknowledging the unusual nature of the trades but maintaining their legality constituted a good-faith defense. Certain alleged failures to impeach or cross-examine witnesses did not overcome the strong presumption that counsel provided reasonable professional assistance. And even assuming that trial counsel’s performance was deficient, Coscia failed to demonstrate prejudice in light of the strong evidence of his intent.

The case is Nos. 19-2010 and 20-1032.

Tuesday, July 13, 2021

Advisory committee recommends that SEC require investment advisory firms to make diversity disclosures

By Amanda Maine, J.D.

The SEC Asset Management Advisory Committee (AMAC) unanimously approved a recommendation of its Subcommittee on Diversity and Inclusion (D&I) aimed at increasing the participation of women- and minority-owned investment advisers within the asset management industry. In addition to recommending that registered investment advisers be required to provide transparency on gender and racial diversity, the committee also recommended that SEC staff develop guidance for fiduciaries for selecting asset managers, engage in a study of how "pay to play" rules impact the selection of advisory firms, and establish uniform practices for parties who contact the SEC about discriminatory practices.

Recommendation guided by studies and testimony. According to the recommendation, which contained several pages of footnotes and links, the AMAC spent many months studying data and hearing from experts on diversity and inclusion in the asset management industry. One "startling" statistic is that of the $70 trillion in global financial assets under management (AUM) in the investment universe, less than 1 percent are managed by minority-owned or women-owned firms. The subcommittee also found that widespread gender and racial bias exists in the decisions made by those making asset decisions regarding who manages money for governments, universities, charities, foundations, and the institutional market in general. Artificial barriers are being used by asset allocators under the guise of fiduciary considerations, the subcommittee advised.

In addition, performance myths regarding diverse asset managers have been dispelled because their investment performance is equal to or greater than the investment performance of firms that lack diversity in ownership and senior leadership, according to the subcommittee. Finally, the subcommittee stated that there is a direct link between the SEC’s mission and investor calls for more transparency on diversity and inclusion in the asset management industry, advising that the concepts of "public interest" and "materiality" have evolved, making this area a worthy one for Commission action.

With these concepts in mind, the subcommittee developed four recommendations, which the full AMAC adopted:
  1. Transparency: The SEC should require enhanced disclosure in SEC by registered investment advisers (such as on Form ADV) to provide transparency on issues of gender and racial diversity not only in the workforce, officer ranks, and ownership ranks, but also fund board and fund adviser diversity and for business practices of consultants who recommend investment advisers and their diversity policies.
  2. Guidance: Citing earlier background that diverse managers tend to be filtered out by an inappropriately-limited diligence checklist of fiduciary considerations, the Commission or the staff should develop guidance that clarifies that a wide variety of factors should be considered by fiduciaries in their selection of asset management firms.
  3. Pay-to-play study: The SEC should study whether current pay-to-play rules unfairly impact diverse firms because market participants with large PACs and extensive lobbying budgets are allowed to influence firms, while a small campaign contribution by the owner of a small and/or diverse firm would subject that firm to certain exclusions.
  4. Reports on discriminatory practices: Noting that the differences between government procurement and private contracting processes and where to report discrimination can be confusing, the SEC should establish centralized and uniform practices for directing reporting parties to an office at a government agency designed for investigating complaints.
Discussion. Presenting the D&I subcommittee’s findings and recommendations to the full AMAC, Subcommittee Chair Gilbert Garcia of Garcia Hamilton & Associates said that while talking about diversity can be difficult because it involves categorizing people, he implored how difficult it is to live with when minorities and women are reminded of it all the time, usually in a negative context. He also urged the SEC to look at D&I as not only an "item" but as a core value that should permeate the SEC inside and out.

D&I subcommittee member Scot Draeger of R.M. Davis Inc. noted that a conscious decision was made in crafting the recommendation not to mandate business decisions or practices on SEC registrants, but instead make the focus on disclosure and transparency.

SEC Chair Gary Gensler said he has asked the SEC staff to consider ways that the Commission can enhance transparency of D&I in the asset management industry. According to Gensler, this could include requiring disclosure of aggregated demographic information about an adviser’s employees and owners or information about an adviser’s diversity and inclusion practices in its selection of other advisers. Commissioner Caroline Crenshaw also stated her appreciation for the AMAC’s proposed enhancements to the SEC’s disclosure regime that could promote greater diversity and inclusion in the industry.

Commissioner Hester Peirce voiced concerns about the recommendations, however, which she sees as potentially creating government-mandated diversity classifications for the asset management industry. "What if, for example, an African-American woman who owns an asset management firm prefers to be identified by her Wharton finance degree and her deep knowledge of fixed-income markets rather than her ethnicity or gender?" Peirce pondered. She asked the AMAC to work through practical issues that might arise if the recommendations are adopted, including how "diversity" should be defined (such as how an American with Chinese, Ethiopian, Finnish, Irish, and Mexican roots would be categorized), what an asset manager should do if an employee does not wish to identify their ethnicity or gender, and what are the potential consequences if the firm’s statements regarding its diversity end up being incorrect.

Monday, July 12, 2021

Chancery extinguishes case against FedEx board for illegal cigarette shipments

By Anne Sherry, J.D.

The Delaware Court of Chancery dismissed, with prejudice, a would-be derivative complaint brought on behalf of FedEx against its board of directors. The plaintiff alleged that demand on the board would have been futile because the directors abdicated their Caremark duties to detect and remediate illegal cigarette shipments, resulting in fines and settlements with regulators. But the complaint’s own allegations demonstrated that the board kept apprised of the issues with cigarette shipments and implemented measures to remedy the problems (Pettry v. Smith, June 28, 2021, Slights, J.).

FedEx is subject to several federal and state laws restricting the shipment of cigarettes. In 2004, the New York Attorney General opened an investigation into the company’s shipment of cigarettes to individual consumers and residence. FedEx settled the investigation in 2006 by entering into an Assurance of Compliance (AOC) agreement under which it agreed to comply going forward or pay $1,000 for each violation. Despite this, customers continued to ship unstamped cigarettes using FedEx, and further regulatory lawsuits followed in 2013 and 2017. In 2018, FedEx settled all pending enforcement actions for $35.3 million and agreed to implement training and employ an independent consultant.

According to the complaint, in 2012 the company’s general counsel updated the board on the status of the enforcement actions, including the report that FedEx’s outside counsel issued after an internal investigation. In 2014 the FedEx board created a committee to consider a stockholder’s demand that the company bring claims against directors and officers regarding the unlawful cigarette shipping practices. The committee released a report in 2019 detailing its findings and conclusion that it was not in FedEx’s best interests to bring the lawsuit.

Caremark allegations. The plaintiff obtained books and records from FedEx and filed a complaint in 2019 asserting one derivative claim for breach of the duty of loyalty. The complaint alleged that the board was alerted to illegal cigarette shipments in 2012 but did nothing to remediate the shipments, which continued to occur until 2016, when FedEx ceased delivering cigarettes nearly entirely. The plaintiff declined to make a litigation demand on the board, instead arguing that the board was incapable of investigating and prosecuting the breach-of-duty claims because a majority of the board faced a substantial likelihood of personal liability.

To demonstrate demand futility, the plaintiff was required to allege particularized facts under one of the two prongs of Caremark: either the directors utterly failed to implement any reporting or information system or controls—the plaintiff conceded that this was not the case—or consciously failed to monitor such a system or oversee its operations. The court determined that the plaintiff’s conclusory allegation that the board failed to take action to address the unlawful cigarette shipping practices ignored other facts acknowledged in the complaint.

Board responded to red flags. The complaint noted that the board was updated as to the cigarette shipment issues on 11 occasions during 2014 and 2015, while the audit committee was apprised of the status of the litigation against FedEx at least six times. The board also formed the committee in 2014 to consider the litigation demand it had received, and a report from its outside counsel found that the company should not bring the requested litigation. The existence of this report alone refutes a reasonable inference that the board sat by ignoring red flags, the court wrote.

Furthermore, several company personnel were reprimanded for the way they handled the account of one of the cigarette vendors, as well as other issues, contradicting the assertions of a "do nothing" environment. And importantly, the complaint acknowledged that FedEx eventually banned nearly all tobacco shipments, introduced numerous training programs, and implemented measures to increase the detection of illegal cigarette shipments. The decision to stop shipping cigarettes predated any litigation filed by the New York state prosecutor concerning post-2012 conduct. The reasonable inference to be drawn from contemporaneous board minutes is that the board was engaged on the issue but allowed the New York litigation to play out before making decisions about remediation of the underlying conduct.

The case is No. 2019-0795-JRS.

Friday, July 09, 2021

Securities Regulation Daily’s top 10 developments for June 2021

By John Filar Atwood

In case you missed the in-depth coverage in the June issues of Securities Regulation Daily, we have provided a recap of the most notable stories.

June was a busy month for the SEC, as Chairman Gensler continued to roll out his plans for the agency under his leadership. His intention to clean house at the PCAOB came into sharp focus as he removed then-Chair William Duhnke III from his position and replaced him with Acting Chair Duane Desparte. In making the change, Gensler also indicated his intention to seek candidates to replace all five PCAOB Members.

Gensler did not stop there, as he also directed the Division of Corporation Finance to consider revisiting its 2019 interpretive guidance and 2020 rule amendments on proxy advisory firms. The rule amendments have been criticized by proxy advisory firms and shareholder advocates, but largely welcomed by public companies. Then, in separate speeches given in June, Gensler said that he is looking to Commission staff to make recommendations on equity market structure that could lead to rules changes on a range of issues, and to prepare recommendations on shoring up Rule 10b5-1 for trading plans by insiders. In Gensler’s view, Rule 10b5-1 has led to problems in the insider trading regime.

In the area of enforcement, it was FINRA and not the SEC that grabbed the headlines in June. On the last day of the month, it levied $70 million in sanctions on Robinhood Financial, the largest financial penalty ever imposed by FINRA. The penalties stemmed from FINRA’s determination that Robinhood violated FINRA Rules 2010, 2210, and 2220 by negligently communicating a wide array of false and misleading information to its customers during certain periods since September 2016.

June saw the Supreme Court issue its opinion in Goldman Sachs v. Arkansas Teacher Retirement System, in which it held that the generic nature of an alleged misrepresentation is important evidence of price impact. At issue was whether the Second Circuit properly considered the nature of Goldman Sachs's statements, and the Supreme Court vacated the judgment and remanded it for the Second Circuit to consider all record evidence relevant to price impact.

Lawmakers in the House also had a productive month, moving forward some securities-related proposals. Among them was an expanded environmental. social, and governance (ESG) disclosure bill that would require new disclosures regarding ESG metrics, climate change, political spending, executive pay, tax havens, workforce data, workplace harassment, cybersecurity, diversity and inclusion, and the conduct of businesses operating in China regarding alleged abuses by the Chinese government of the Uyghur minority. Also advancing was the CFTC whistleblower bill, which would give the agency the right to devote up to $10 million to fund the operation of parts of its whistleblower program related to customer education and non-awards expenses. Lawmakers hope the legislation will shore up the program in the event that awards paid to eligible whistleblowers deplete funds for related educational and administrative expenses.

1. ENFORCEMENT

Robinhood hit with $70M in sanctions in largest-ever FINRA penalty


FINRA has fined Robinhood Financial LLC $57 million and ordered the broker-dealer to pay almost $13 million in restitution for distributing false and misleading information to customers and failing to supervise critical technology, among other FINRA rule violations. In levying the largest financial penalty ever imposed by the SRO, FINRA stated that the sanctions reflect the scope and seriousness of Robinhood’s violations, which affected millions of customers. In executing a Letter of Acceptance, Waiver, and Consent, Robinhood neither admitted nor denied the charges but consented to the entry of FINRA’s findings. See our full coverage.

2. ACCOUNTING AND AUDITING

SEC to replace all five members of PCAOB


Following a call from Sens. Elizabeth Warren (D-Mass) and Bernie Sanders (I-Vt) to replace the five-member Public Company Accounting Oversight Board, SEC Chair Gary Gensler has begun this process by removing William Duhnke from the Board and designating current Board member Duane DesParte as Acting Chairperson. The SEC also announced that it intends to seek candidates to fill all five board positions. While Gensler said this will begin to set the PCAOB "on a path to better protect investors," Commissioners Hester Peirce and Elad Roisman called the decision "hasty and truncated." See our full coverage.

3. PROXIES

SEC to reexamine Clayton-era rules on proxy advisory firms


The SEC’s Division of Corporation Finance issued a statement advising that the staff, at the direction of Chair Gary Gensler, is considering revisiting its 2019 interpretive guidance and 2020 rule amendments on proxy advisory firms. The rule amendments, which codified the Commission’s view that proxy voting advice generally constitutes a "solicitation" and adopted new conditions to exemptions from the proxy rules’ information and filing requirements on proxy voting advice, have been criticized by proxy advisory firms and shareholder advocates but welcomed by issuers and the more market-friendly commissioners on the SEC. See our full coverage.

4. EXCHANGES AND MARKET REGULATION

Gensler presents case for review of equity markets regulations


In his second substantive remarks in four days, SEC Chair Gary Gensler turned to a topic with which he has lots of experience—market structure. As Chair of the CFTC, Gensler stood up for the agency’s derivatives and swaps reforms under the Dodd-Frank Act. Now, as SEC chair, Gensler said in a speech to the Global Exchange and FinTech Conference that he is looking to Commission staff to make recommendations on equity market structure that could lead to rules changes on a range of issues, including the competitiveness of equity markets, payment for order flow (PFOF), and the formulation of the national best bid and offer (NBBO). See our full coverage.

5. SEC NEWS AND SPEECHES

Gensler eyes new limits on Rule 10b5-1 trading plans


At the CFO Network Summit, SEC Chair Gary Gensler announced that the staff will be preparing recommendations on shoring up Rule 10b5-1 for trading plans by insiders. Gensler specified four aspects of the rules for such trading plans that may undermine investor confidence or allow a "loophole" for bad actors. He also stressed that even under the current rules, amending or canceling a plan may call into question whether it was entered into in good faith and thus provides a safe harbor. Gensler said that Rule 10b5-1, which provides an affirmative defense for corporate insiders who trade stock under plans entered into in good faith and before learning of material information, have "led to real cracks in our insider trading regime." See our full coverage.

6. SEC NEWS AND SPEECHES

SEC, CFTC publish Spring 2021 rulemaking agendas


The SEC and CFTC have released their Spring 2021 agendas, providing insight into the agencies’ rulemaking priorities in the months to come. "To meet our mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation, the SEC has a lot of regulatory work ahead of us," said SEC Chair Gary Gensler. "I look forward collaborating with my fellow commissioners and the dedicated staff to propose and finalize rules that will strengthen our markets, increase transparency, and safeguard investors." See our full coverage.

7. SUPREME COURT DOCKET

Issue of generic nature of statements at class certification sent back to Second Circuit


The Supreme Court has issued an opinion in the Goldman Sachs case confirming that the generic nature of an alleged misrepresentation is important evidence of price impact. At issue was the rebuttal of the Basic presumption in class actions premised on the inflation-maintenance theory. Since the parties no longer disputed whether the generic nature of the alleged misrepresentations was relevant to price impact, the only disagreement was whether the Second Circuit properly considered the nature of Goldman Sachs's statements. It was unclear to the court whether the Second Circuit did so; as a result, the court vacated the judgment and remanded it for the Second Circuit to consider all record evidence relevant to price impact. Justice Barrett delivered the opinion, in which Justices Roberts, Breyer, Kagan and Kavanaugh joined in full. See our full coverage.

8.EXCHANGES AND MARKET REGULATION

Exchanges incur another setback in crusade against SEC’s market data plan


A panel of the Court of Appeals for the District of Columbia rejected arguments made by several national securities exchanges that the SEC’s equity data plans for the exchanges were actually "rules" and not "orders" as designated by the Commission. The exchanges had filed a challenge to the plans 65 days after the Commission’s action, falling outside of the Exchange Act’s deadline of 60 days for challenging Commission orders. The panel was unconvinced by the assertions made by the exchanges that the "order" was instead a "rule," which would be subject to different deadlines for filing challenges. In addition to giving weight to the SEC’s own designation that its actions did constitute an order, the panel disagreed with the exchanges’ protestations that the court should consider the substance of the Commission’s actions. See our full coverage.

9. PUBLIC COMPANY REPORTING AND DISCLOSURE

House passes expanded ESG bill with no room to spare


The narrow margin of victory in the House for Democrats pushing the most extensive ESG disclosure package yet proposed may signal big trouble in the Senate where the bill is almost surely to die, but individual pieces of the legislative package could remain viable, especially a component that would address diversity in the boardroom and the C-suite, which previously garnered bipartisan support in Congress and in the private sector. The final legislative package would require new public company disclosures regarding ESG metrics, climate change, political spending, executive pay, tax havens, workforce data, workplace harassment, cybersecurity, diversity and inclusion, and the conduct of businesses operating in China regarding alleged abuses by the Chinese government of the Uyghur minority. The final, amended legislative package contained in the retitled Corporate Governance Improvement and Investor Protection Act (H.R. 1187) passed by a vote of 215-214. See our full coverage.

10. WHISTLEBLOWER NEWS

House passes CFTC whistleblower bill, next stop the president’s desk


The House passed a bill that would allow the CFTC to devote up to $10 million to fund the operation of parts of its whistleblower program related to customer education and non-awards expenses. Lawmakers said the legislation was needed to shore up the CFTC’s whistleblower program in the event that awards paid to eligible whistleblowers deplete funds for related educational and administrative expenses. The bill (S. 409), sponsored by Sen. Chuck Grassley (R-Iowa), previously passed the Senate by unanimous consent in late May. The House passed the bill as part of a package of bills considered en bloc by a vote of 325-103 (due to the en bloc nature of the vote, the final vote tally may or may not represent the full support in the House for S. 409). The bill next heads to the president’s desk for his signature. See our full coverage.

Thursday, July 08, 2021

Commissioner Peirce criticizes IFRS proposal to create new International Sustainability Standards Board

By Lene Powell, J.D.

SEC Commissioner Hester Peirce has weighed in on an IFRS proposal to create a new International Sustainability Standards Board (ISSB), finding deep flaws with the idea of a new board to oversee globally aligned sustainability reporting standards. In a comment letter to IFRS, Peirce said that although the ISSB would be separate from the International Accounting Standards Board (IASB), also overseen by IFRS, the new board would raise serious governance concerns and potentially undermine IFRS’ important investor-centered work.

Imprecise and subjective purpose and scope. In Peirce’s view, the creation of the ISSB would risk misleading investors. The purpose of financial reporting—to paint an accurate financial picture of a company for investors—lends itself to objective, auditable, quantifiable, and comparable metrics.

In contrast, sustainability standard-setting is an inherently more subjective, less precise, less focused, more open-ended activity, said Peirce. Not only is the term "sustainability" imprecise, but the objective of sustainability standard-setting and sustainability reporting is not universally agreed upon and is not consistent over time.

Peirce outlined several issues with sustainability standards:
  • Sustainability standards are "intentionally laden" with judgments about where capital should flow, a concept foreign to financial reporting standards;
  • Sustainability standards are "unlikely" to foster the same degree of accuracy, comparability, objectivity, and reliability across the reporting of a wide range of issuers that financial reporting standards do;
  • IFRS acknowledges that the ISSB’s focus will shift over time from investors to the larger set of stakeholders, which could lead to mission creep;
  • Weaving sustainability standards and financial reporting standards together is less likely to create synergies than to make it more difficult for investors to analyze financial reports.
Distraction from IFRS’ important work. Peirce is concerned that creation of the ISSB will divert resources from IFRS’ focus on develop a single set of high-quality, understandable, enforceable and globally accepted accounting standards—IFRS Standards—and promoting and facilitating adoption of the standards.

Specifically, Peirce stated the following concerns:
  • Adding another board under the Foundation’s umbrella will cost the Foundation time, resources, and attention;
  • Expertise in financial accounting and expertise in sustainability are two distinct skill sets, and bringing sustainability experts on as trustees or advisory council members could dilute attention from accounting standards and financial reporting expertise;
  • The trustees will be required to consult with both the IASB and ISSB in appointing the Foundation’s executive director, which will dilute the Foundation’s and the executive director’s attention on accounting standard-setting;
  • Technical staff will be accountable to the chairs of both the IASB and the ISSB, which will result in a weakening of the technical staff’s single-minded focus on technical accounting issues;
  • Full-throated support of the ISSB will be a requirement for all trustees, which means that people who do not equally value sustainability reporting and financial reporting will be ineligible to serve on the Foundation, [23] thus limiting the perspective diversity the Foundation values.
In a lighthearted post on Twitter, Peirce illustrated the concerns about distraction by sharing the "jealous girlfriend" meme, in which IFRS’ appreciative gaze is drawn to ISSB, while IASB looks on in angry disbelief.

Governance concerns. Peirce also found fault with decisions about governance of the new board. She noted that IFRS has acknowledged that the constitutional provisions applicable to the ISSB will not be identical to those applicable to the IASB, and has explained that lower standards are appropriate "to allow for the new board to reach an appropriate level of maturity in its standard-setting and develop its technical expertise within the confines of the Trustees’ strategic direction."

Peirce sees the following as potentially problematic:
  • The proposal would permit the ISSB to have a higher number of part-time members than the IASB—up to 6 of 14 compared to only 3 of 14 for the IASB. This heightens conflict of interest concerns as outside employment may impair part-time members’ objectivity;
  • ISSB’s standards would require approval by only a simple majority of members, compared to the IASB’s standards which require approval by a supermajority of members. Because the chair would be allowed to cast an additional vote in the case of a tie, only seven members of the board would have to vote in favor of a sustainability standard for it to be approved;
  • A provision that requires the ISSB "to establish and maintain liaison with relevant stakeholders with an interest in sustainability reporting standard-setting" raises independence concerns;
  • The geographic composition of the ISSB would give one less guaranteed member to each region (other than Africa, which only has one board seat on the IASB) in favor of more at-large members. This could erode the ISSB’s independence and objectivity. Peirce recommends giving more representation for the Americas and perhaps another seat for developing nations.
  • IFRS’ hurried approach to starting the ISSB raises the likelihood of design flaws in the board and the standards it ultimately produces.
  • Questions around ISSB’s funding also raise concerns, as it is not specified where funds will come from and even IASB’s funding structure presents independence challenges.
Peirce noted that we do not have perfectly converged global financial reporting standards, and a single set of sustainability standards is an even more difficult task. Further, centrally determined, universally applicable, inflexible standards could impede the global economy’s ability to effectively address climate change and the other critical issues on which the ISSB will likely focus.

Popularity of ISSB proposal. Peirce’s criticisms may be sailing against the wind, however. IOSCO has stated it sees "strong support" for the proposal. In two roundtables, stakeholders were united in their support for globally aligned sustainability reporting standards. Some participants worried that voluntary disclosure would not be enough and expressed support for mandatory reporting requirements aligned across jurisdictions, along with frameworks for audit and assurance.

Participants also urged that discussions noted that the design of ISSB standards should allow for interoperability, not only with jurisdiction-specific requirements that go beyond enterprise value creation, but also for the expansion of scope to other sustainability topics beyond climate and ongoing standards evolution to accommodate the dynamic materiality of sustainability topics over time.

Wednesday, July 07, 2021

Sen. Warren sees potential CEA liability for Google’s advertising exchange

By Mark S. Nelson, J.D.

Senator Elizabeth Warren (D-Mass) recently sent a letter to Acting CFTC Chair Rostin Behnam in an effort to focus the CFTC’s enforcement powers on certain activities by Alphabet, Inc.’s Google unit in the online advertising space. According to Sen. Warren, Google’s AdX advertising exchange trades "[d]isplay advertising impressions" in a manner that may violate both antitrust laws and the Commodity Exchange Act (CEA). The senator’s letter suggested that the CFTC could pursue manipulation charges against Google for the way it facilitates the trading of online advertising on its own advertising exchange, which she said confers upon Google a dominant market position.

Project Bernanke. Senator Warren explained that Google’s AdX sits at a critical juncture between advertisers and publishers and that Google has significant control over the software that advertising buyers and sellers use to find each other in the market for display advertising impressions. The senator points specifically to a purported secret Google project code-named "Project Bernanke" (presumably a reference to former Fed Chair Ben Bernanke, although the exact reference appears to be unknown publicly) which, if implemented, would allow Google to use bid data that it collects via AdX to promote its own advertising software (DV360 and Google Ads) to buyers and sellers of advertising to the disadvantage of tools available from competitors.

According to Sen. Warren, Google holds a nearly 86 percent share of the market for online display advertising in the U.S. She also noted that federal and state investigators have already begun examining Google’s online advertising business for potential antitrust violations.

Although not mentioned directly in the senator’s letter, antitrust regulators could examine whether an advertising exchange hindered the exchange of information in advertising markets because "[a]greements restricting advertising are a form of output restriction in the production of information useful to consumers" that can result in the inability of some firms being able to communicate effectively with consumers who might buy their services; advertising restrictions also may increase "consumer search costs" (See, Phillip E. Areeda (late) & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application, at 2023b. (footnotes omitted), a Wolters Kluwer Legal & Regulatory U.S. publication).

Senator Warren explained Google’s behavior thus: "The allegations around Project Bernanke, if true, would constitute deeply troublesome market manipulation by Google. To ensure that it maintains its dominant position, Google appears to be using its control over the exchanges to prevent other ad-buying tools from gaining market share against it. Google is not hiding this fact. In its court filings in Texas, Google acknowledges that Project Bernanke used customer bid data submitted in the past to make it more likely that Google Ads would win ad auctions ‘that would otherwise be won by other buying tools’" (footnotes omitted).

Is almost everything a commodity? The CEA defines "commodity" quite broadly by both explicitly labeling certain items as commodities (with the exception of onions and motion picture box office receipts) and by providing more general language that can bring additional items within the definition of commodity. As Sen. Warren’s letter notes, "commodity" is a term that can evolve over time to include items not previously contemplated to be commodities, most recently, for example, virtual currencies.

Senator Warren’s letter, however, is somewhat vague as to how "display advertising impressions" would fit within the definition of commodity, other that to cite in a footnote the more general language of the CEA, which applies to: "all other goods and articles and all services, rights, and interests... in which contracts for future delivery are presently or in the future dealt in" (See CEA Section 1a(9)). The senator also refers to the trading of "display advertising impressions" on advertising exchanges, although it is unclear if that form of trading involves futures trading.

The treatise Derivatives Regulation, by Philip McBride Johnson, et. al., and published by Wolters Kluwer Legal & Regulatory U.S., explains how an item becomes a commodity through futures trading. Two passages from the treatise state:
  • "A fair reading of the amended and expanded definition suggests that, as for "all goods and articles … and all services, rights and interests," their status as statutory commodities does not emerge until they become the subject of futures trading. Although this method of converting something into a commodity may seem curious, it illustrates an important principle of commodities regulation: its interest is in a form of economic activity, rather than in the attributes or character of the underlying subject. The economic activity in question is futures and commodity options trading; the nature of the commodity does not affect the regulatory result."
  • "Because an item or interest does not become a commodity until futures trading in it is initiated, it is unlikely that jurisdiction under the Act arises for cash or spot transactions in these newer subjects unless and until they become traded for future delivery. This result is consistent with the concept that the CFTC's interest in normal commercial transactions is related primarily to their interaction with a parallel market in futures contracts or similar instruments."
(See, Thomas Lee Hazen, Susan C. Ervin, Charles R. Mills & Kathryn M. Trkla, Derivatives Regulation, §1.02[1] (footnotes omitted).

Senator Warren’s commodities theory regarding Google’s AdX could, if the advertising traded on AdX meets the definition of "commodity," result in potential liability for Google on a theory of manipulation. The senator posited that the CFTC would not be constrained by its exclusive jurisdiction over futures but could instead assert its general jurisdiction as authority to investigate Google. The senator further posited that a CFTC investigation of Google would not preempt or hinder investigations now underway or being contemplated by other government regulators.