Friday, January 21, 2022

ESMA report details guidance rules for inside information under Market Abuse Regulation

By Mark S. Nelson, J.D.

The European Securities and Markets Authority (ESMA) published a final report detailing guidance on when issuers may delay the disclosure of inside information possessed by them. The report specifically contains an amended version of the Market Abuse Regulation (MAR) Guidelines with emphasis on the MAR transparency obligations and inside information and the prudential supervisory framework.

“The Guidelines are aimed at providing clarity, enhancing legal certainty and fostering supervisory convergence and should assist issuers in conducting their assessment as to whether they meet the conditions to delay inside information in accordance with MAR,” said a press release announcing the revised guidelines.

According to the report, the MAR requires that issuers generally should publicly disclose inside information directly concerning them as soon as possible. But, if certain conditions are met, an issuer may delay the disclosure of inside information, such as where disclosure of the inside information could prejudice an issuer’s legitimate interest, delayed disclosure is unlikely to mislead the public, the issuer ensures the confidentiality of the inside information.

Revised Guideline 1 specifies two additional circumstances where immediate disclosure of inside information is likely to prejudice an issuers’ legitimate interests. One such circumstances concerns redemptions and repurchases. The other circumstance concerns the receipt of a draft Supervisory Review and Evaluation Process (SREP).

New Guidelines 3 and 4 address the question of whether a draft/final Pillar 2 Capital Requirements (P2R) or Capital Guidance (P2G) constitute inside information. In both instances, an issuer should verify that the P2R/P2G is: (1) non-public; (2) directly related to the institution that received it; and (3) is of a precise nature. In both instances the issuer also should assess the price sensitivity of the P2R or P2G. In the case of a P2R, the P2R is generally considered inside information and is highly likely to be price sensitive. With respect to a P2G, however, the revised guidelines suggest that the P2G is inside information and then provide two examples of when a P2G is expected to be price sensitive: (1) there is a non-minor change and the institution likely will act (e.g., to increase capital); and (2) the P2G does not align with market expectations (i.e., a price impact is expected).

Under the revised guidelines, competent authorities to which the guidelines apply must notify ESMA within two months of the date of publication if they are in compliance with the guidelines, are not incompliance but intend to comply, or are not in compliance and do not intend to comply.

Thursday, January 20, 2022

IOSCO seeks feedback on digitalization risks, publishes best practices for global cooperation

By Anne Sherry, J.D.

IOSCO is requesting feedback on a consultation report that addresses growth in digitalization and the use of social media to market and distribute financial services and products. The report analyzes these developments and proposes tools relating to firm-level rules, responsibilities, surveillance and supervision, staff qualification, compliance, and clarity around internet domains. Comments are due March 17. Additionally, IOSCO published a set of good practices related to the use of global supervisory colleges in securities markets.

Consultation report. According to the consultation report, digitalization and cross-border offerings, while providing new opportunities for both firms and investors, also carry risks for investors and challenges for regulators. In retail over-the-counter leveraged products, firms have used social media, online marketing, and internet-based trading platforms to reach customers. But while improving investors’ access, digitalization can enable bad actors to hide their identities, target potential victims, and exploit jurisdictional differences. IOSCO is also concerned about the use of gamification to influence investors’ trading behavior.

To help member regulators address these concerns, the report includes two “toolkits.” The proposed policy toolkits encourage members to institute firm-level rules for online marketing and distribution, along with rules for online onboarding. Members should require, subject to applicable laws and regulations, that management assume responsibility for the accuracy of information provided to potential investors on behalf of the firm. IOSCO members themselves should consider whether they have the capacity to surveil and supervise online activities, including on social media. Finally, members should consider requiring firms to assess qualifications for digital marketing staff; do due diligence into third-country regulations in the case of cross-border activity; and adopt policies and procedures for disclosure of the underlying entity offering the product.

The proposed enforcement toolkit includes recommendations on proactive, technology-based detection and investigatory techniques for illegal digital conduct. IOSCO members could consider seeking additional powers to curb online misconduct and increasing cooperation with international counterparts and with criminal authorities. Finally, the toolkit suggests initiatives to foster collaboration with the electronic intermediaries themselves, as well as to address supervisory and regulatory arbitrage.

Good practices. IOSCO also published a set of good practices generated from its report Lessons Learned from the Use of Global Supervisory Colleges. The good practices encourage the use of supervisory colleges to share information and solutions during a crisis. They cover matters such as general purpose, membership, governance, multilateral confidentiality arrangements and the cross-border operations of supervisory colleges.

The report also calls for the use of “core-extended” structures that would allow all relevant authorities, including in emerging jurisdictions, to exchange information about a supervised entity. It highlights market sectors where the use of supervisory colleges could be expanded, taking into account interconnectedness across jurisdictions and emerging areas where supervisory knowledge is not yet fully developed. IOSCO members have suggested using supervisory colleges for market intermediaries, financial benchmarks administrators, crypto-asset platforms, and asset management.

Wednesday, January 19, 2022

Blackrock’s Fink seeks to explain stakeholder capitalism

By Mark S. Nelson, J.D.

In his annual letter to shareholders, Blackrock’s Chairman and CEO Larry Fink sought to dispel the notion that stakeholder capitalism is “woke” or an “ideological agenda.” Fink has previously used his annual letter to speak about ESG investing and, in particular, about climate change, a topic he once again addressed in his latest letter. But this time, Fink sought to provide some additional context around the larger concept of stakeholder capitalism by beginning with an explanation of what he says stakeholder capitalism is and is not.

Said Fink: “Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘woke.’ It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism” (emphasis in original).

According to Fink, stakeholder capitalism is more about a company having a clear purpose, consistent values, and engaging with and delivering for its key stakeholders. Fink added that the circumstance of the COVID-19 pandemic had brought about a more generalized reconsideration of the corporation and how people will work going forward. Specifically, Fink cited the “accelerating [of] how technology is reshaping life and business,” a trend also mirrored in an unrelated report on the legal profession published by Wolters Kluwer Incorporated titled “The 2021 Wolters Kluwer Future Ready Lawyer: Moving Beyond the Pandemic” (Securities Regulation Daily is a Wolters Kluwer Legal & Regulatory U.S. publication).

Fink also noted the twin trends of increasing political polarization and distrust of traditional institutions. “This polarization presents a host of new challenges for CEOs. Political activists, or the media, may politicize things your company does. They may hijack your brand to advance their own agendas,” said Fink. “In this environment, facts themselves are frequently in dispute, but businesses have an opportunity to lead.” According to Fink, this environment may cause employees to increasingly look to their employer for trustworthy information rather than to governments, media outlets, or nongovernmental organizations.

To further advance the public’s understanding of stakeholder capitalism, Fink announced that Blackrock would create the Center for Stakeholder Capitalism. Fink said the center would be “a forum for research, dialogue, and debate” that would allow for “explor[ing] the relationships between companies and their stakeholders and between stakeholder engagement and shareholder value.”

The case against “woke” corporations. Lawmakers at the federal level have introduced dozens of bills focused on environmental, social, and governance (ESG) investing during the last several sessions of Congress. Most of these bills would impose new securities disclosure requirements around climate change, diversity and inclusion, and other topics within the rubric of ESG investing.

But there also is a counter movement among lawmakers that seeks to limit the role of corporations with respect to ESG investing. For example, the Mind Your Own Business Act (S. 2829), sponsored by Sen. Marco Rubio (R-Fla), would potentially make it easier for shareholders to sue company boards for breach of fiduciary duty regarding a company’s adoption of “woke” social policies.

Upon introducing the bill, Senator Rubio said via press release: “Patriotic Americans who love their country and the opportunity it provides should be able to fight back against the growing tyranny of the woke elites running corporate America. These are often nationless corporations that amass fortunes divorced from the fate of our great country while pushing socially destructive, far left policies like boycotts and cancel crusades at home.”

Political stunts? Even among lawmakers and corporate leaders who may favor a more socially active corporation, there is some skepticism about whether companies will follow through with actual results regarding ESG initiatives and stakeholders. Following the January 6, 2021 U.S. Capitol insurrection and the adoption by some states of restrictive voting laws, many companies sought to pause or cease political donations to certain elected officials or candidates for public office. Within weeks an IBM executive had also proposed legislative reforms to curb corporate political influence. Companies that took a stand against voting rights limits faced pushback from some elected officials.

Former Delaware Supreme Court Chief Justice Leo Strine has described a statement published by the Business Roundtable on stakeholders as a “marker” while Sen. Elizabeth Warren has criticized the BRT statement as a publicity stunt. The BRT statement had suggested a broader opportunity for companies to address their numerous stakeholders. Senator Warren has previously introduced legislation that would require large companies to abide by a public benefit company-like federal charter.

Tuesday, January 18, 2022

Commenters differ on SEC’s securities lending proposals

By Jay Fishman, J.D.

The Better Markets organization and SIFMA stand out among the many persons commenting on the SEC’s rule proposals to increase transparency in securities lending, with Better Markets supporting the rulemaking pretty much as written while SIFMA requests some significant modifications. The proposals would implement Dodd Frank Act Section 984(b), by mandating that lenders of securities report certain terms of their transactions to a registered national securities association (RNSA), and further requiring the RNSA to make some of that information publicly available to investors.

The two proposals. The first proposal would create a new Exchange Act Rule 10c-1 to provide investors and other market participants with timely access to pricing and other material information about all securities lending transactions made by all lenders including banks, insurance companies, and pension plans. Additionally, lenders would need to report the following material terms (and any modifications of those terms) to an RNSA within 15 minutes of a transaction, which would then be made public no later than the next business day:
  • Ticker symbol of these securities;
  • Time and date of the loan;
  • Name of the platform or venue, if one is used;
  • Amount of securities loaned;
  • Rates, fees, charges and rebate for the loan as applicable;
  • Type of collateral provided for the loan and the percentage of the collateral provided to the value of the loaned securities;
  • Termination date of the loan if applicable; and
  • Borrower type, e.g., broker, dealer, bank, customer, clearing agency, custodian.
The second proposal would amend Exchange Act Rules 17a-4 and 18a-6 on recordkeeping requirements for broker-dealers, security-based swap dealers, and major security-based swap participants, to provide an audit trail alternative to the WORM requirement for newly-created records. Basically, a broker-dealer of a security-based swap entity would need to produce electronic records in a reasonably usable electronic format, thereby enabling securities regulators to search the information in records that registrants must preserve for particular time periods.

The commenters. Better Markets. Better Markets implored the SEC to “finalize this long-overdue, mandatory rulemaking without delay or dilution” after implementing Better Markets small suggested changes. Better Markets stated, moreover, that the proposal “represents the bare minimum to ensure that the proposal meets the statutory requirement to increase the transparency of information available to brokers, dealers, and investors.”

Better Markets’ four suggestions asked the Commission to consider: (a) requiring reporting on the use of collateral; (b) reevaluating the proposal’s timing deadlines; (c) closing any potential loophole that would permit evasion by characterizing securities lending transactions as repurchase agreements; and (d) deem the proposals merely a first step in addressing short-selling issues.

Better Markets considers securities lenders reporting their collateral use in lending transactions as crucial to prevent unseen, dangerous risk to the financial system. Better Markets believes the 15 minute and next day reporting time-frames are weak (and should be further minimized) in light of high frequency traders’ ability to manipulate the system in seconds. As for the potential risks caused by mischaracterizing securities loans as repurchase agreements, Better Markets recommends the “securities lending” definition include transactions that could fairly be described as “securities loans” rather than excluding from that definition transactions which could fairly be described as repurchase agreements. Lastly, Better Markets advocates for a further proposal specifically addressing short-selling activities (because these proposals are insufficient on short-selling).

SIFMA. The following SIFMA-requested modifications, more significant than Better Markets,’ were hastily sent to the Commission because SIFMA found the comment period too short for appropriate fleshed-out remarks:
  1. Define what it means to “loan a security” to focus exclusively on securities lending transactions; more specifically, exclude transactions like short-selling from the definition because it does not constitute securities lending;
  2. Clarify extraterritorial issues to address U.S. lenders of U.S. listed securities; stipulate that extraterritorial activity solely comprises securities loans where the issuing country and primary trading market are in the U.S. and that the beneficial owner-lender or lending agent are U.S. persons;
  3. Narrow the scope of the reported data to the RNSA, as well as the scope of the data that becomes publicly available; in both instances, narrow the scope of the data to aggregated securities lending data, including volume-weighted average borrowing fee aggregated across all firms, for each security loaned.
  4. Replace the 15-minute reporting period with required reporting by the end of the next business day, or at least no more frequently than by the end of each business day; this is to achieve accurate reporting of contract terms for settled loans;
  5. Clarify the requirement to report securities “available to lend” and securities “on loan” in order to avoid providing the market with misleading information; and
  6. Implement a phased-in reporting regime to eliminate the significant cost of implementation and allow regulators sufficient time to analyze collected data to inform the merit for more than detailed reporting, and provide an implementation period that matches the compliance obligations; specifically an 18-month build-out period following RNSA’s finalization of the technical specifications for reporting, to enable lenders to comply.

Monday, January 17, 2022

Keeping the Dream Alive

[In commemoration of Martin Luther King, Jr. Day, we republish a post by the late Jim Hamilton from August 28, 2010, celebrating the anniversary of Dr. King's "I Have a Dream" speech in 1963.]

By Jim Hamilton, J.D., LL.M.

I once heard Alabama federal district judge (later named to the 11th Circuit Court of Appeals) Frank Johnson Jr. caution people not to think that federal judges decide momentous civil rights cases every day. Most of the work of federal judges, he said, consists of interpreting arcane federal regulations and US code provisions. Frank Johnson Jr. was the federal judge in the Rosa Parks case, which changed the history of the South and the entire US. So, every once in a while, I have to leave the arcane world of securities regulation to mention something more momentous.

Today is the anniversary of Dr. Martin Luther King Jr.’s "I have a dream speech." It envisions a world and a South where, in Dr. King’s words, ``one day on the red hills of Georgia the sons of former slaves and the sons of former slave owners will be able to sit down together at the table of brotherhood.’’ There is a New South today, and there are many to thank for it, President Jimmy Carter, Senator Claude Pepper of Florida, and dare I mention Governor and later Senator Terry Sanford of North Carolina, yes I do dare because he was a great man also.

But if the New South has a father, it has to be Dr. King. When I drive past the new gleaming auto plants and Seimens plants in South Carolina and Georgia and see the sign announcing a new $1 billion VW plant in Tennessee, I think how Dr. King made it all possible. Yes, he did. Because no global company, not Nissan not BMW not Seimens, would ever have come and built large new plants in a segregated South. That would never have happened, and that is the God’s truth. So, on the anniversary of ``I have a dream’’ let us pause to honor Dr. King. Tomorrow, we return to the arcane world of securities regulation.

Friday, January 14, 2022

Adviser to pay $1.2M for failing to disclose 12b-1 fee conflicts

By Rodney F. Tonkovic, J.D.

An investment adviser has settled SEC charges of breach of fiduciary duty arising from its selection of investments that provided it with compensation. The Commission found that the adviser advised its clients to buy mutual fund share classes via its parent company which received fees under Rule 12b-1 or through revenue sharing payments. The adviser provided no disclosure or inadequate disclosure of the conflicts of interest arising from the parent company's receipt of the fees or revenue sharing. To settle the charges brought under the Investment Advisers Act, the firm agreed to pay disgorgement of $866,257, prejudgment interest of $162,396, and a civil penalty of $210,000 (In the Matter of O.N. Investment Management Company, Release No. IA-5944, January 11, 2022).

O.N. Investment Management Company is a registered investment adviser, and its affiliated broker-dealer and parent company is O.N. Equity Sales Company. O.N. Equity acted as an introducing broker-dealer for O.N. Investment's advisory clients.

NTF revenue. The Commission found that O.N. Investment advised clients bought or held mutual fund share classes that charged 12b-1 fees when lower-cost share classes of those same funds were available. Since at least 2014, an unaffiliated clearing broker offered access to certain mutual funds with no transaction fees (the "NTF program"). When O.N. Investment's clients invested in funds on the NTF platform, the clearing broker shared some of the revenue with O.N. Equity. The clearing broker no longer pays revenue sharing to O.N. Equity, and since 2017, O.N. Investment has been rebating these 12b-1 fees to its clients.

Cash sweep. During the same period, O.N. Investment recommended that clients choose sweep account options to hold uninvested cash. Again, the same clearing broker shared with O.N. Equity a portion of the revenue it received in connection with money market funds offered to sweep accounts. A conflict of interest arose because the funds from which O.N. Equity received revenue sharing charged higher fees or at times returned lower investment yields, and these were the funds the O.N. Investment predominantly recommended and invested its clients’ uninvested cash in. These sweep account options have since been transferred to money market funds that do not pay revenue sharing.

Disclosure failures. As a result of this conduct, since 2014, O.N. Investment failed to adequately disclose on its Form ADV the conflicts of interest that arose when it invested clients in share classes that would generate fees or revenue sharing for O.N. Equity. While eligible to do so, O.N. Investment did not self-report O.N. Equity's receipt of 12b-1 fees to the Commission pursuant to the Share Class Selection Disclosure Initiative. In addition, by causing clients to invest in mutual fund share classes when more favorable terms were available to the clients, O.N. Investment violated its duty to seek best execution for these transactions. Finally, during the period at issue, O.N. Investment lacked written policies and procedures that would have prevented violations of the securities laws in connection with disclosure of conflicts of interest.

Sanctions. The Commission found that O.N. Investment violated Investment Advisers Act Sections 206(2) and 206(4) and Rule 206(4)-7. In addition to a cease-and-desist order and censure, the firm will pay disgorgement of $866,257, prejudgment interest of $162,396, and a civil penalty of $210,000. O.N. Investment also agreed to comply with a series of undertakings, including moving clients to a lower-cost mutual fund share class that does not result in O.N. Equity receiving revenue.

The release is No. IA-5944.

Thursday, January 13, 2022

2022 Congressional preview: China, insiders, and stablecoins remain likely topics

By Mark S. Nelson, J.D.

Despite the media emphasis on pandemic-driven stimulus bills and lawmakers’ wrangling over the Biden Administration’s signature Build Back Better Act, a small number of potent bills were enacted in 2021 that spotlighted alleged human rights abuses in China, supported the CFTC’s whistleblower program, and provided for the reporting of cryptocurrency transactions to the IRS. While it remains unclear if 2022, a mid-term election year, will produce significant securities-themed legislation, it is a good bet that Congress will remain focused on bills that would further curb China’s influence in U.S. markets, may address insider trading by federal judges and Fed officials, and could set the stage for government regulation of stablecoins.

Congressional interest in digital assets is perhaps exemplified by yesterday’s announcement that the Democrat and Republican leaders of the Senate and House Agriculture Committees have jointly written to CFTC Chair Rostin Behnam seeking more information on digital asset markets and the CFTC’s authorities (or lack of authorities) to regulate these markets. Previously, SEC Chair Gary Gensler has spoken of the need to close regulatory gaps in digital asset markets: “In my view, the legislative priority should center on crypto trading, lending, and DeFi platforms. Regulators would benefit from additional plenary authority to write rules for and attach guardrails to crypto trading and lending.”

As has become an informal tradition for Securities Regulation Daily, our editors review the year just ended and preview the year ahead on a number of topics, including Congressional activity. This year’s trio of securities law white papers emphasized Congressional activity and the growing field of environmental, social, and governance (ESG) investing and the emergence of special purpose acquisition companies (SPACs) as an alternative to the traditional IPO.

Our Congressional review, the third and final installment in our 2021 year-end reviews, emphasizes human rights, insiders, CFTC nominations and reauthorization prospects, competing frameworks for regulating stablecoins, and corporate tax provisions within the Build Back Better Act. In 2022, these and other topics are likely to remain prominent as the second session of the 117th Congress unfolds. However, an equally prominent trend may be the extent to which the SEC preempts Congressional action on some topics, as the agency may succeed in doing regarding its recently proposed reforms to the rules for Exchange Act Rule 10b5-1 trading plans. For those looking for a wrap-up of Congressional action on ESG investing and SPACs, see the links below to our white papers focused on those topics.

Lastly, those of us at Wolters Kluwer Legal & Regulatory U.S. take this moment not only to reflect on the year’s legal developments in securities law, ESG investing, SPACs, and Congress, but also to soberly remember the awful human toll that COVID-19 has exacted around the world, including upon those in our shared legal profession. We remember those who have been lost to the virus and think of those who have lost loved ones to the virus, as well as those who have been unable to visit loved ones because of renewed COVID-19 visitor restrictions at long-term care and other facilities. The wide availability of COVID-19 vaccines that were in short supply only a year ago now give hope that the months and years ahead may be brighter. From all of us, to all of you, we once again wish you and yours a safer, healthier, and happier New Year.

Please click the following link to read our most recent legislative analysis, Mark S. Nelson, J.D., 2022 Congressional preview: China, insiders, and stablecoins remain likely topics.

For more focused discussions of legislation regarding ESG investing and SPACs, see our other year-end white papers:

Wednesday, January 12, 2022

McHenry, Toomey raise concerns with SEC Chair Gensler for short comment periods

By Elena Eyber, J.D.

The top Republican on the House Financial Services Committee, Patrick McHenry (R-NC), and the top Republican on the Senate Banking Committee, Pat Toomey (R-PA), sent a letter to SEC Chair Gary Gensler raising concerns with Gensler’s decision to limit outside input on rulemakings by providing unreasonably short public comment periods. McHenry and Toomey urged Gensler to extend the comment periods of all proposed rulemakings.

McHenry and Toomey stressed that public comments are critical to effective SEC rulemaking and properly scrutinizing a proposed rulemaking often requires a significant investment of time and resources, especially when a proposal consists of several hundred pages. Short comment periods pose particular difficulties when overlapping with holidays, year-end operational or regulatory obligations, or other times when commenters are expected to manage other deadlines.

McHenry and Toomey pointed out that the majority of SEC proposals put forward under Gensler’s chairmanship have allowed less than 60 days for public comment with two proposals providing 60-day comment periods, three proposals providing 45-day comment periods, and six proposals providing 30-day comment periods. McHenry and Toomey urged Gensler to immediately extend all comment periods for the SEC’s proposed rules of significance to at least 60 days, including reopening the comment filing for those rulemakings with shorter comment periods that have closed prematurely. They also requested that Gensler extend the comment period on the money market fund rule revisions to at least a 90-day comment period, consistent with the process for the most recent prior significant substantive revisions to the money market fund rule.

Tuesday, January 11, 2022

SPAC could not restrict CEO’s shares of acquired company

By Lene Powell, J.D.

A CEO’s shares in a company acquired by a special purpose acquisition company (SPAC) were not subject to a lockup restriction, the Delaware Court of Chancery held. The provision defined lockup shares as shares held “immediately” following the de-SPAC transaction, but under the logistics of the share transfer, the CEO was not actually issued shares until over 100 days later (Brown v. Matterport, Inc., January 10, 2022, Will, L.).

Disputed share restrictions. William J. Brown was the CEO of Matterport Operating, LLC (Legacy Matterport), a privately held spatial data company, from November 2013 to December 2018. Brown received equity compensation in the form of stock options granting him the right to purchase 1,350,000 shares of Legacy Matterport. He also purchased 37,000 restricted shares in 2014. Brown exercised all his options on October 6, 2020.

In February 2021, Legacy Matterport agreed to a business combination with Gores Holding VI, Inc., a SPAC. In the proposed de-SPAC merger, Gores would be the surviving entity and would be renamed Matterport, and Legacy Matterport would become a wholly owned subsidiary of Matterport. In July 2021, Gores adopted bylaws in anticipation of the business combination, which imposed transfer restrictions on certain shares of Matterport Class A common stock, referred to as “Lockup Shares.” The transaction was completed and the bylaws became effective.

Brown filed a complaint contending that the share trading restrictions were adopted without his consent in violation of Section 202(b) of the Delaware General Corporation Law. He sought a declaration that the lockup shares provision was unenforceable as to his shares and that he could freely transfer his shares and/or conduct derivative trading without restriction. Brown also brought fiduciary claims against Legacy Matterport’s former directors. The court bifurcated the claims and held an expedited trial on the limited issue of whether Brown was bound by the transfer restrictions.

CEO not bound by transfer restrictions. The court held that Brown’s shares were not Lockup Shares subject to the transfer restrictions in the bylaws. The ruling turned on the logistics of share transfer. In the bylaws, Lockup Shares were defined as “the shares of Class A common stock held by the Lock-up Holders immediately following the Business Combination Transaction.”

Significantly, in the de-SPAC transaction, Legacy Matterport stockholders did not automatically become Matterport stockholders. Instead, Matterport’s transfer agent would issue Matterport Class A common shares to Legacy Matterport stockholders upon receipt of a letter of transmittal surrendering their Legacy Matterport shares.

Brown argued that he held no Matterport shares “immediately following” the July 22, 2021 de-SPAC transaction’s closing. Instead, at that time he held only the right to receive Matterport Class A common shares. He was not actually issued Matterport shares until November 5 at the earliest, after he sent executed letters of transmittal to Matterport’s transfer agent. The court agreed, finding that obtaining shares over 100 days after closing was not “immediately” for purposes of the Lockup Shares provision.

The court rejected the defendants’ argument that Brown’s reading of the provision would “nullify” the transfer restrictions because no Legacy Matterport stockholder received Matterport shares” instantly after the transaction closed. The evidence demonstrated that some Legacy Matterport stockholders would have received their Matterport shares within a few days of closing. That timing could be viewed as consistent with a plain reading of the bylaw, said the court. As a result, Brown’s reading of the bylaws did not nullify the transfer restrictions.

Accordingly, the court found that Brown’s Matterport shares were not Lockup Shares under the bylaws and he was therefore permitted to freely trade his Matterport shares and enter into derivative transactions with respect to those shares, without restriction. The court reserved all other issues for the second phase of the litigation.

The case is No. 2021-0595-LWW.

Monday, January 10, 2022

SEC’s suit over Morningstar CMBS ratings clears first hurdle

By Anne Sherry, J.D.

The SEC may move forward on several claims involving Morningstar’s disclosure of, and internal controls concerning, its methodologies for determining credit ratings for commercial mortgage-backed securities (CMBS). The Commission sued the credit rating agency last February alleging that it violated several provisions of the Credit Rating Agency Reform Act. While the Southern District of New York dismissed the claim that Morningstar failed to identify what version of its methodology it used, the SEC can proceed on claims that it failed to provide a general description of its methodology and that it lacked effective internal controls (SEC v. Morningstar Credit Ratings, LLC, January 5, 2022, Abrams, R.).

Adjustments to ratings. Morningstar published two documents describing its rating methodology: a short overview and a more detailed description of the model. The SEC alleged that the longer document, while purporting to contain all the “primary features” of the rating methodology, failed to disclose that analysts had discretion to adjust the key stresses in the model. According to the complaint, analysts made these adjustments “overwhelmingly” in the direction of reducing the stress applied in the model, thereby lowering the credit enhancement required for many of the ratings awarded. Morningstar could thereby assign higher credit ratings, which benefitted its issuer-clients. The complaint also alleges a failure of internal controls governing the adjustments in at least 31 transactions in commercial mortgage-backed securities.

Alleged violations. The SEC alleged that Morningstar violated the requirement that NRSROs make available to the public a “general description” of procedures and methodologies for determining credit ratings that allows users of credit ratings to understand the process for determining those ratings. The complaint also alleged that Morningstar failed to identify the version of the methodology used to determine individual credit ratings. Finally, it alleged that Morningstar failed to establish, maintain, and enforce an effective internal control structure over its rating methodologies. While the court granted Morningstar’s motion to dismiss on the second allegation, it found that the SEC stated a claim as to the first and third.

Motion to dismiss. As a matter of apparent first impression, the court analyzed the plain text of the statutes, regulations, and form instructions at issue. The SEC plausibly alleged that Morningstar’s descriptions of its rating methodology failed to provide users with an understanding of that methodology. While Morningstar keyed in on the phrase “general description” in the introduction to the relevant instruction to the form, that term had to be interpreted in context with the additional requirement that an NRSRO furnish enough information that a user be able to understand the process by which it determines ratings. Taking inferences in the SEC’s favor, the disclosures did not discuss the stress adjustments that Morningstar elsewhere called a “central feature” of its methodology, and thus failed to give users enough information to glean how ratings were determined.

The court would not, however, allow the SEC to leverage those same allegations into a separate violation. Specifically, the SEC contended that because Morningstar’s disclosures failed to accurately describe its methodology, it necessarily failed to accurately identify the version of its methodology used to determine the credit ratings at issue. Here, the court read that statutory requirement as requiring nothing more than an identification, and it is possible to identify an item or procedure while failing to accurately or fully describe that item or procedure. The requirements to describe and to identify are “two different regulations, and the SEC does not explain why they should be read to impose the same requirements, much less do so persuasively.”

Finally, the court addressed the SEC’s claim that Morningstar’s internal control structure contained material weaknesses that allowed loan-level adjustments to run afoul of Morningstar’s policies and methodologies. Morningstar countered that the requirement is only that an NRSRO maintain an internal control structure and not that the controls themselves be effective as to each component of a rating methodology. The court was unpersuaded: “If a buyer discovers that her new car’s engine is dead, or that its brakes are shot, she will not be appeased by a response that the car itself is not defective because the engine and brakes are merely components of the car. A control structure governing adherence to a methodology cannot be said to exist or be effective if the controls that govern adherence to the components of that methodology are themselves nonexistent or ineffective—after all, what is a control structure made of if not one or more individual controls?”

The case is No. 21-cv-1359.

Friday, January 07, 2022

Lawmakers renew call for Senate’s passage of Build Back Better bill, acknowledge political realities at play

By Brad Rosen, J.D.

In the wake of the destruction of over 1,000 homes by unprecedented December wildfires around Boulder, Colorado in the final days of 2021, and a year that saw one in three Americans experience some form of extreme weather fueled by the climate crisis, environmentally oriented lawmakers gathered to discuss the urgency surrounding the climate provisions of the Build Back Better Act and the need for Senate passage. The House has already passed a version of the legislation.

In a press briefing hosted by the advocacy groups Climate Power and the League of Conservation Voters, Chair of the Select Committee on the Climate Crisis Kathy Castor (D-Fla), Sen. Brian Schatz (D-Hawaii), Sen. Martin Heinrich (D-NM), Sen. Tina Smith (D-Minn), Sen. John Hickenlooper (D-Colo), and Rep. Donald McEachin (D-Va) engaged in a vigorous discussion which focused on the need for enacting the Build Back Better Act, the underlying political dynamics at play, as well as the imperative of making transformational climate progress.

The gravity of the climate crisis and the moment at hand. The press briefing began with the lawmakers making short opening statements sharing their own insights and concerns with regard to the changing climate and its impacts on the nation and planet.
  • Sen. Brian Schatz observed that the planet will not stop its warming process while we sort out our politics, argue, fuss, and fight. He further noted that this has to be a generational fight, and the first step is to pass the Build Back Better Act. He concluded, “We have no other choice but to stay determined.”
  • Sen. Martin Heinrich stated that we don’t get to argue with the laws of physics or to choose our own facts, which he observed is sometimes the tendency in D.C. He added that what we just saw in Colorado is the new reality of the world that we are passing on to our kids and grandkids. In New Mexico, he pointed to the costs of inaction in terms of dying cottonwoods and extreme heat.
  • Sen. Tina Smith pointed to how climate change is presently posing a catastrophic stress to our communities noting that there were 22 weather disasters last year that resulted in $1 billion or more in destruction. She also pointed to massive droughts and wildfires in her home state of Minnesota. In Smith’s view, the Build Back Better legislation will also create a host of economic opportunities, lead to lower energy prices and better jobs as well. She sees Build Back Better as a call to action.
  • Sen. John Hickenlooper referred to the recent Marshall fires in Colorado, noting that we are facing these events again and again throughout the nation, and observed it is ridiculous that we are willing to avoid what is a scientific truth when it comes to climate change. He further observed the horrible agony that we are subjecting our towns and communities to through inaction. Hickenlooper stated, “Now is the time to act.”
  • Chair Kathy Castor stated that people across the country are demanding that Congress acts and pointed to recent climate-related catastrophes in Colorado, unprecedented heatwaves in the northwest sending thousands to the hospital, the bizarre catastrophic cold front that swept through Texas last winter, as well as Hurricane Ida, the second most destructive storm, after Katrina, in U.S. history. In her view, the new year provides an opportunity to get back to work and do the ambitious policy that must be done.
  • Rep. Donald McEachin asserted that we are at an inflection point, noting that the climate crisis is the greatest threat out there, and that we must take decisive steps to curb its impact. McEachin demanded action on the Build Back Better Act, proclaiming too much is at stake, the clock is ticking, and that we cannot afford to let this opportunity pass us by.
The Build Back Better Act’s climate provisions. The House-passed Build Back Better Act constitutes the largest climate investment in history, with $550 billion in clean energy, resilience, and climate solutions as noted in a release from the House Select Committee on the Climate Crisis. These investments would build on the already enacted Infrastructure Investment and Jobs Act (IIJA) by reducing energy costs and expanding the reach of cleaner energy sources like wind and solar, which are already cheaper than coal and natural gas. According to the release, the Build Back Better Act could save the average American household $500 a year on energy costs, and families who switch to electric vehicles will save an additional $700 a year on fuel and maintenance costs.

Notably, the Build Back Better Act would also invest directly in clean energy grants and loans for rural communities, and it would direct 40 percent of investments to environmental justice communities, including communities of color and Tribes. A detailed summary of the Build Back Better Act’s climate provisions, as developed by various House of committees, can be viewed here.

Realpolitik at play and path forward to passage in the Senate. When pressed by reporters whether Senate Democrats would consider a slimmed down version of the Build Back Better Act or lift out the climate provisions as part of a separate bill, Sen. Schatz pointedly responded that they were not going to negotiate through the media, though indicated all options were on the table. Sen. Heinrich added that the"friction points" with their more challenging colleagues did not center around the bill’s climate or energy provisions.

Schatz refused to address specific queries about Sen. Joe Manchin (D-WVa), the key Democratic holdout on the legislation, and his position on the bill’s union made electric vehicle tax credit, clean energy tax, and methane fee, stating flatly, “we’re not there yet”. Schatz went on to describe the hundreds of hours of committee and staff negotiations and noted that they were starting to arrive at a package that could achieve 50 plus 1 votes.”

Some successes to note. While the lack of visible progress around the Build Back Better legislation has been a source of consternation and frustration to climate advocates, Chair Castor reminded attendees of some of significant progress and accomplishments that have been on the climate front made in the past year and a half in her remarks. Specifically,377 of the 715 recommendations in the Climate Crisis Action Plan, which was issued June 2020, have already passed the House of Representatives; and 201 of those 715 recommendations have been signed into law.

Castor underscored that the next step is getting Build Back Better Act to President Biden’s desk for signing. She concluded, “We are in a code red moment for climate” adding, “we have to use this once in a generation opportunity to start solving this climate crisis. This is our moment to deliver. We cannot let it pass us by.”

Thursday, January 06, 2022

Proposed rescission of pieces of proxy voting advice rules divides industry stakeholders

By John Filar Atwood

The SEC’s proposal to rescind recently adopted rules addressing proxy voting advice businesses has divided industry stakeholders who have outlined their opposing positions in recent comment letters to the Commission. Proponents feel that the adopted rules unfairly favor the viewpoints of company management and impose unnecessary burdens on voting advice businesses, while opponents believe the rules support transparency and accuracy in the proxy voting process.

In July 2020, the Commission adopted amendments to the exemptions from the proxy rules for proxy voting advice businesses (PVABs). Among other things, the final rules codified the Commission’s interpretation that proxy voting advice generally constitutes a “solicitation” subject to the proxy rules.

The rules also added new conditions to two exemptions that PVABs generally rely on to avoid the proxy rules’ information and filing requirements, including that registrants have proxy voting advice made available to them at or prior to the time such advice is disseminated to the PVAB’s clients. A PVAB also must provide its clients with a mechanism by which they can become aware of any written statements regarding its proxy voting advice in a timely manner before the shareholder meeting (together, the Rule 14a-2(b)(9)(ii) conditions. The Commission also amended the note to Rule 14a-9, which prohibits false or misleading statements, to include specific examples of material misstatements or omissions related to proxy voting advice.

Since the adoption of the final rules, institutional investors and other PVAB clients have voiced concerns about the rules’ impact on their ability to receive independent proxy voting advice in a timely manner. In addition, the Commission has seen PVABs develop industry-wide best practices and improve their own business practices to address the concerns that were the impetus for the 2020 rules. Accordingly, in November the Commission proposed to amend Rule 14a-2(b)(9) to remove the Rule 14a-2(b)(9)(ii) conditions, and to amend Rule 14a-9 to remove Note (e) to that rule, which sets forth specific examples of material misstatements or omissions related to proxy voting advice.

Unfairly favors management. The North American Securities Administrators Ass’n. (NASAA) supports the proposals, and expressed its view that the Rule 14a-2(b)(9)(ii) conditions burden PVABs and shareholders unnecessarily, and unfairly privilege the views of company management. In its comment letter, NASAA said that it is unnecessary to require PVABs to disseminate the views of company management because they have ample opportunities to make their positions known, and responsive proxy materials are publicly available on the EDGAR database.

The kinds of investors who use the services of PVABs, NASAA continued, are sophisticated enough to know where to find a company’s written statements if they are interested. The current requirements tilt the playing field in favor of company management and create unequal access to the proxy solicitation process, In NASAA’s opinion. The existing rule does not require a PVAB to afford these opportunities to any other stakeholders, even shareholder proponents with respect to their own proposals, which can further marginalize their voices, NASAA said.

NASAA supports the proposed deletion of Note (e) from Rule 14a-9, which appears to have created the perception that issuers may use the threat of litigation to pressure PVABs to change their proxy advice, methodologies, analyses, and sources of information. Regardless of whether any such suits are , NASAA is concerned that the risk perceived by PVABs could create a dynamic that impairs the independence and objectivity of their proxy voting advice.

Full rescission. The Council of Institutional Investors (CII) also favors the rescission of the Rule 14a-2(b)(9)(ii) conditions, as well as the related Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers. CII believes that neither the 14a-2(b)(9)(ii) conditions nor the guidance were intended to benefit investors. Rescinding the conditions and the guidance would give proxy advisers and investors more flexibility to select mechanisms that best serve the needs of investors and adapt to evolving market practices, according to CII.

With respect to the removal of Note (e) of Rule 14a-9, CII agreed with the SEC’s view that subjecting proxy advisers to Rule 14a-9 liability creates uncertainties that unnecessarily increase the litigation risk to proxy advisers and potentially increase the cost and impair the independence of the proxy voting advice. We believe removing Note (e) in combination with amending Rule 14a-9 to include an express statement about the application of Rule 14a-9 to proxy adviser recommendations and determinations would substantially reduce those uncertainties.

CII went a step further than NASAA and suggested that the Commission rescind the 2020 final rules in their entirety. The group noted that the final rules are built on the SEC’s determination that proxy voting advice delivered to an investor requesting that advice constitutes a “solicitation” under 1934 Act Section 14(a). In CII’s view, the breadth of the Commission’s definition of a solicitation will likely continue to be a source of questions and confusion, and it is unclear that when challenged the definition will survive judicial scrutiny.

Opposition. The Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) opposes the November amendments, saying that changes to the final rules before they have fully taken effect raise concerns about the Commission’s deliberative process and harm the SEC’s reputation as an independent regulator that is free from political agendas.

The CCMC believes that if the SEC is serious about proceeding with proposed amendments in an open fashion, it should rescind the November proposals and issue an advanced notice of proposed rulemaking. In this way, all interested parties would be permitted to provide input and inform the Commission’s deliberations on whether to reopen the 2020 final rules, the CCMC said.

The CMC argued that if the Commission will not rescind the proposals, it should extend the comment period for another 60 days. The group said that 30 days is inadequate for meaningful feedback on amendments to a rule grounded in over a decade of careful deliberations spanning the tenure of multiple SEC Chairs.

According to the CCMC, the 30-day comment period does not permit adequate time to collect and assess relevant data from the most recent proxy season. This reinforces the perception that the comment period is a “check-the-box exercise,” the CCMC stated, rather than an effort to obtain meaningful feedback to inform the Commission’s actions.

Nasdaq’s views. In its comment letter, Nasdaq noted that the 2020 final rules were overwhelmingly supported by public companies because it provided a review-and-comment mechanism that would result in better informed voting decisions by investment advisers. In comparing the final rules with the November proposals, Nasdaq said, it must conclude that the proposals reverse many of the transparency gains in the final rules, which it believes contained common sense solutions to enhance the dialogue between proxy advisers and companies.

Nasdaq cited surveys that found that more than 80 percent of companies and retail investors supported the final rules. The final rules reflect the culmination of the SEC’s careful consideration of public comments submitted in response to a proposed rule, comments on an earlier concept release, and several public roundtables, Nasdaq said.

Nasdaq noted that it has long supported proxy advisory reforms on the principle that transparency forms the bedrock of securities laws disclosures, and should equally apply to proxy advisory firms because institutional investors increasingly rely on them to inform their voting decisions. In Nasdaq’s opinion, the 2020 final rules benefitted proxy advisory firms by enhancing investor confidence that their voting advice is based on factually correct, reliable information.

Nasdaq argued that the proposals undermine the transparency provided by the final rules by repealing carefully tailored mechanisms that balanced the need for accurate information with the demand for timely and objective voting advice.

Wednesday, January 05, 2022

CFTC revises no-action relief on LIBOR transition, provides new reporting relief

By Lene Powell, J.D.

In a new series of staff letters, the CFTC revised previous no-action relief to reflect guidance by the U.K. Financial Conduct Authority (FCA) regarding LIBOR transition timing. The revisions provide a longer transition period for certain swaps and market participants. The CFTC also provided no-action relief regarding certain Part 43 and Part 45 swap reporting obligations for swaps transitioning under the ISDA LIBOR fallback provisions.

Revised relief. The CFTC previously issued three staff letters in August 2020 relating to the LIBOR transition. The 2020 letters (20-23, 20-24, and 20-25) outlined conditions under which counterparties would qualify for relief in connection with amending swaps to update provisions referencing LIBOR or other IBORs. The letters also provided relief for additional types of amendments, and refined relief previously provided based on feedback from market participants.

In March 2021, the FCA confirmed that all LIBOR settings will either cease to be provided by any administrator or will no longer be representative according to the below timeline:
  • For all GBP, EUR, CHF and JPY LIBOR settings, and the 1-week and 2-month USD LIBOR settings, immediately after December 31, 2021; and
  • For all other USD LIBOR settings (the 2023 USD LIBOR Settings), immediately after June 30, 2023.
As a result of the 2021 FCA guidance, some market participants may now transition their swaps referencing the 2023 USD LIBOR settings after December 31, 2021 but before June 30, 2023.

The CFTC’s newly revised relief, issued December 22, 2021, supersedes its 2020 letters to align with the FCA guidance. The CFTC Division of Market Oversight and Division of Clearing and Risk issued revised letters 21-26, 21-27, and 21-28. The new relief is effective until June 30, 2023 for swaps otherwise covered by such letters, to the extent such swaps reference one of the 2023 USD LIBOR Settings.

The relief further provides that eligible end users should use their best efforts to work toward amending the reference rate provisions in certain documentation.

Swaps reporting. Separately, the CFTC’s Division of Data (DOD) issued a no-action letter relating to swaps reporting. Under the relief in Letter No. 21-30, DOD will not recommend enforcement against an entity for failure to timely report under Part 45 the change in a swap’s floating rate. The action relates to floating rate changes made under the ISDA LIBOR fallback provisions from any tenor of Swiss Franc, Euro, British Pound Sterling, or Japanese Yen LIBOR to the applicable risk-free rate (RFR).

The relief is conditioned on the entity using its best efforts to report the change by the applicable deadline in Part 45 and in no case reports the required information later than 5 business days from, but excluding, December 31, 2021.

In addition, DOD will not recommend that the CFTC take an enforcement action against an entity for failure to report under Part 43 the change in the floating rate for a swap modified after execution to incorporate the ISDA LIBOR fallback provisions to transition from referencing any tenor of Swiss Franc, Euro, British Pound Sterling, and Japanese Yen LIBOR to referencing an RFR.

This is CFTC Letters No. 21-26, 21-27, 21-28, and 21-30.

Tuesday, January 04, 2022

First Circuit gives shareholders a second bite at Carbonite

By Rodney F. Tonkovic, J.D.

A First Circuit panel has reversed and remanded the dismissal of a fraud complaint against Carbonite, Inc. In this case, company executives spoke highly of a new backup product while allegedly knowing that it did not work; the product was withdrawn from the market after less than one year. The district court found that the complaint failed to plead scienter, but the panel disagreed, reversing the dismissal after finding that the complaint showed that Carbonite's CEO and CFO made material misrepresentations with scienter (Construction Industry and Laborers Joint Pension Trust v. Carbonite, Inc., December 22, 2021, Kayatta, W.).

Buggy back up. In October 2018, Carbonite launched a new data-backup product called "Server VM Edition" ("VME"). For several months after the launch, Carbonite executives, including its CEO and CFO, publicly promoted VME as a strong product that would make Carbonite competitive in the market for backing up virtual environments. According to the complaint, however, VME simply never worked: there were no successful backups during prerelease testing and there were no successful backups of customer data. Following the launch, the complaint avers, Carbonite set up an internal team focused on fixing VME, and a large patch and "hundreds" of bug fixes were released. By the summer of 2019, Carbonite had internally decided to stop selling VME.

On July 25, 2019, Carbonite announced that VME was being withdrawn from the market. At the same time, Carbonite announced its results and projections, and also disclosed that the CEO had resigned, effective immediately. A stock price drop followed, and this suit was filed soon after, seeking recovery under the antifraud provisions of the Exchange Act. The district court dismissed the complaint with prejudice, finding that the complaint never successfully alleged that, at the time they made their statements, the CEO and CFO did not reasonably believe that VME's problems could be fixed.

Reversed and remanded. On appeal, the shareholders argued that 12 statements made by the CEO and CFO were materially false and misleading, and the panel agreed. The appeal focused most prominently on statements made on November 1 and 15 by the CEO and CFO, respectively, stating that VME was a strong and competitive backup product. The court first explained that the CEO's statement implied that VME offered better performance for backing up virtual environments and could thus be taken as a statement of fact—one that was false in light of the claim that VME could not back up virtual environments at the time. The CFO's statement, on the other hand, was presented as a belief: "we think" VME is competitive and a strong product. The court said that this statement still conveyed the facts that the CFO believed that VME was "strong" and "competitive," which was at odds with the actual state of the product. The court added that these statements were material because VME was, as the officers themselves said, an important product for Carbonite.

The panel also disagreed with the district court's finding that the complaint failed to plead a strong inference of scienter. The crux of the shareholder's argument was that Carbonite must have known that VME did not work because of its importance to the company. The panel pointed out that Carbonite thought VME was important enough to warrant specific plugs from top management, creating a "very strong" inference that the executives would have been paying close attention to the product's status. And, the complaint showed that the CEO and CFO could not have been in the dark about VME's status since employees had reported internally that the product was far from ready for the market.

The court accordingly found that the complaint sufficiently alleged that the statements of the CEO and CFO were material misrepresentations made with scienter. The judgment of the district court granting the motion to dismiss was reversed and remanded for further proceedings.

The case is No. 20-2110.

Thursday, December 23, 2021

SEC proposes rules to curb insider trading, hasten disclosure of stock buybacks

By Anne Sherry, J.D.

At its final open meeting of 2021, the SEC issued a suite of rule proposals addressing stock trading plans, stock buybacks, money market funds, and security-based swaps. The Commission also approved the PCAOB’s 2022 budget request reflecting an 8 percent increase over the current year. While the group showed rare unanimity on the 10b5-1 trading plans proposal, Commissioners Peirce and Roisman dissented from the other three proposals on grounds including regulatory overreach and shorter-than-usual comment periods.

Rule 10b5-1 plans. In June, SEC Chair Gary Gensler announced that his staff was preparing recommendations to close some gaps in Rule 10b5-1, which provides an affirmative defense to insider trading for officers and directors who trade stock under plans entered into in good faith and before learning of material information. Gensler said then that there has been broad bipartisan support for the idea, telegraphing the result of today’s vote, which saw all five commissioners agree to propose rules requiring a cooling-off period and limiting overlapping and one-off plans. While joining their Democratic colleagues, Peirce and Roisman nevertheless expressed reservations about some aspects of the proposal.

Under current rules, traders can adopt a trading plan and then execute a trade the same day, leading to concerns that insiders can capitalize on material nonpublic information. The amendments to Rule 10b5-1 would impose cooling-off periods delaying transactions under the trading plan for 120 days (for officers and directors) and 30 days (for issuers structuring a share repurchase plan under the rule). The 120-day period for individuals was designed to span an entire quarter, so that no trading could occur under a plan until the financial results associated with that quarter are public.

The amendments would also prohibit overlapping trading plans and limit single-trade plans to one in any consecutive 12-month period. Officers and directors entering into a 12b5-1 plan would also have to certify to the issuer that they are not aware of any material nonpublic information and are adopting the plan in good faith.

Finally, the proposed amendments would require new disclosures. A new table would report any options granted within 14 days of the release of material nonpublic information and the market price of the underlying securities the day before and after that disclosure. Forms 4 and 5 would include checkboxes about the applicability of a 10b5-1 or other plan, and gifts of securities previously reported on Form 5 would be required under Form 4.

Peirce said that she had been prepared to dissent from the proposal but that the staff ultimately won her over. She said the cooling-off periods and restrictions on overlapping plans are reasonable and that the once-a-year allowance for one-off plans is narrowly tailored. However, she expressed concerns about the certification requirement and the condition that the plan be “operated” in good faith, as well as what she called the “indirect regulation of corporate activity through our disclosure rules.”

Like Peirce, Roisman also had mixed feelings about the proposal. While he believes in the cooling-off period, there is little evidence of an actual problem that the other requirements are designed to solve. Roisman also raised concerns about the interrelationship of the trading plan amendments and the proposal on stock buybacks that the Commission also took up at the meeting. In his view, these should have been a single proposal to allow the SEC and the public to better understand the impact and how the rules will work together. Finally, Roisman highlighted that the comment period for most of the proposals taken up at the public meeting is only 45 days, with one at 60 days. This does not allow time for substantive feedback especially when the comment periods straddle several major holidays and overlap comment periods for other rules, he said.

Commissioners Lee and Crenshaw, however, expressed broad support for the rule proposal. While the Commission can go after insider trading through its enforcement power, prophylactic measures are vital, Lee said. And in contrast to Peirce and Roisman’s concerns about overregulation, Crenshaw suggested that the rule may not go far enough, saying that empirical evidence will reveal whether more work is needed. Among other things, Gensler lauded the rule for highlighting the little-discussed fact that charitable giving too is subject to the insider trading laws.

Stock buybacks. In a more controversial measure, the Commission voted 3-2 to propose a new Form SR to report stock buybacks within one business day. Currently, issuers typically disclose the repurchase plans themselves when the board authorizes them, but not the dates on which they will buy back shares under the plan. As a result, the public generally learns of the actual buybacks in the issuer’s periodic reports long after the trades are executed. The new Form SR would require issuers to identify the class of securities purchased, the total amount purchased, the average price paid, and the aggregate amount purchased on the open market in reliance on the safe harbor of Exchange Act Rule 10b-18 or under a 10b5-1 trading plan.

The amendments would also require an issuer to disclose the objective or rationale for the buybacks and any policies and procedures relating to insiders’ purchases and sales during a repurchase program. Finally, the issuer would have to check a box if any officer or director subject to Section 16(a) reporting requirements bought or sold shares within 10 business days before or after the buyback announcement.

Lee emphasized that the proposal does not prescribe how or why companies buy back their stock, but rather requires disclosures to let investors evaluate how, why, and to what effect companies are engaging in buybacks. Peirce disagreed, however, again calling the disclosure “indirect regulation of corporate activity” and objecting that concerns about informational asymmetries could be addressed through more tailored means. She and Roisman both highlighted an SEC study, mentioned in a footnote to the proposal, concluding that the firms that repurchased the most stock generally did not have compensation targets linked to earnings per share or considered the impact of repurchases when setting the targets or determining if targets were met. Roisman said that a better approach would be for companies to disclose in their Form 8-K that they intend to repurchase shares, and file a new 8-K if their plans change. This would communicate information without the daily reporting burden or the risk of discouraging buybacks, he said.

While Crenshaw supported the proposal, she agreed with Roisman’s point that the buyback rules should be read in conjunction with the proposal on insider trading plans. Gensler also took up this point and said he is glad that the Commission is proposing the two sets of amendments on the same day, giving the public a sense of the agency’s thinking and enabling them to comment within a similar time frame.

Money market funds. The day’s third proposal would impose money market reforms designed to address the liquidity crisis of March 2020. In response to the COVID-19 pandemic, investors seeking liquidity withdrew from prime and tax-exempt money market funds and fled to government funds. Some of the commissioners posited that this reaction could have been an unintended consequence of the 2010 and 2014 money market reforms, particularly the use of liquidity fees and redemption gates. This may have created a “first mover” advantage where there was a rush to redeem holdings before other market participants. Gensler likened this to being chased by a bear at a campsite: you don’t have to outrun the bear (or financial stress, in this analogy), you just have to outrun your fellow campers.

The proposed rules would increase the liquidity requirements for money market funds: the daily asset threshold would go from the current 10 percent to 25 percent, and weekly asset thresholds from 30 percent to 50 percent. The amendments would also remove the current rule’s allowance of liquidity fees and redemption gates. Institutional prime and tax-exempt money market funds would be required to implement swing pricing policies that would shift liquidity costs onto redeeming investors in certain circumstances. Finally, the proposal would amend certain reporting requirements.

While voting against the proposal, both Peirce and Roisman paid it some compliments, and Peirce said she is open to revising her position based on what she learns through the comment process. Roisman again objected to the comment period, in this case 60 days compared to the other proposals’ 45, but still coinciding with two major holidays and multiple outstanding proposals raising hundreds of questions for comment. Lee called her support for the proposal preliminary and said she was especially interested in hearing comments on whether swing pricing will mitigate the first mover advantage and how it might impact investor choice. Similarly, Crenshaw invited comment on how to implement swing pricing, particularly on guarding against excessive variability and on the degree of discretion funds should have when establishing swing factors.

Security-based swaps disclosure. The last rulemaking item of the day was a reproposal designed to address fraud in security-based-swaps transactions. A new Rule 9j-1 would prohibit fraudulent, deceptive, or manipulative conduct in security-based swaps, including in connection with the exercise of rights and performance of obligations under a security-based swap. A new Rule 15Fh-4(c) would prohibit personnel from coercing, misleading, or otherwise interfering with the SBS entity’s chief compliance officer. Finally, a proposed new Rule 10B-1 would require any owner of a security-based-swap position that exceeds a threshold amount to file a position report on Schedule 10B.

Crenshaw said that while the proposal may seem somewhat obscure, the security-based-swaps market was at the heart of the financial crisis and remains a multi-trillion-dollar behemoth that can have far-reaching effects, as seen with the Archegos family office collapse. Gensler posited that the proposal would not only improve transparency, but also market integrity. But Peirce is less confident about that and objected that the proposal is disproportionate to the concerns it is designed to address. She believes the rules risk disrupting the norms developed by sophisticated participants to meet their hedging needs. Furthermore, Peirce said it is premature to impose more disclosure before seeing the effect of SBS reporting, which began only last month.

While Roisman said that the securities antifraud provisions have been time-tested and that this parallel approach is confusing to market participants, Lee countered that “it is vital to have antifraud rules that are tailored to the specific structure and trading patterns of the security-based swap market.”

PCAOB budget. Finally, the SEC unanimously approved the PCAOB’s 2022 budget request of $310.3 million, representing an 8 percent increase over 2021. The increase reflects an expectation that travel will increase, as well as IT costs and personnel. Lee praised the board for its intention to hire more staff in a number of offices, increase the number of advisers to the board, and engage more consultants. The SEC also approved an accounting support fee of $297.9 million, to be allocated $267.2 million to issuers and $30.7 million to registered broker-dealers.

Although Peirce supported the budget request, she spoke against the SEC’s action earlier in the year to dismiss William Duhnke as chairman and require the remaining four board members to reapply for their positions. Peirce said the action politicized what should be an independent board and left the PCAOB in a “credibility deficit.” She also urged the board not to “recast itself as an environmental, social, and governance regulator despite the allure of such issues in Washington these days.” Roisman had similar criticism of the SEC’s overhaul of the board, while Crenshaw and Gensler focused their comments on their support of the budget and the incoming members, including former SEC Commissioner Kara Stein.

The proposals are Release No. 33-11013 (Rule 10b5-1 plans); Release No. 34-93783 (buybacks); Release No. 34-93784 (security-based swaps); and Release No. IC-34441 (money market funds).

Wednesday, December 22, 2021

Revised disgorgement amount stands as reasonable approximation of profits

By Rodney F. Tonkovic, J.D.

A Second Circuit panel affirmed a district court judgement ordering disgorgement and imposing a civil penalty. The case against an individual charged with taking part in a pump and dump scheme had been vacated and remanded in light of Liu v. SEC. On appeal, the defendant argued that the district court failed to account for her personal net profits when ordering a revised disgorgement amount. The panel affirmed, finding that the defendant failed to overcome the SEC's showing that investor funds were misappropriated and used for personal expenses. The panel also found that the civil penalty imposed by the court reflected the defendant's gross pecuniary gain, and did not need to be disturbed (SEC v. de Maison, December 16, 2021, per curiam).

De Maison. Angelique de Maison was part of a ring of individuals charged with taking part in a pump-and-dump scheme involving a microcap company. The action commenced in 2014, and de Maison settled in late 2015. Under the consent agreement, de Maison was ordered to disgorge $4,240,049.30, plus pre-judgment interest, and pay a civil penalty of $4,240,049.30. The Second Circuit affirmed, and de Maison took her case to the Supreme Court. While her petition for certiorari was pending, the Court decided Liu v. SEC, and de Maison's petition was granted, vacated and remanded for further lower court proceedings consistent with Liu.

In light of Liu's holding that disgorgement may not exceed a defendant's net profits from wrongdoing, the SEC revised its disgorgement request to $524,885. The district court found that this amount represented a reasonable approximation of the profits causally connected to the violation. De Maison took issue with the civil penalty, asserting that the penalty amount should equal the disgorgement amount, but the court declined to revise the penalty, which was based on de Maison's "egregious and recurrent conduct."

Second circuit affirms. On appeal, de Maison contended that the $524,885 disgorgement amount exceeded her true net profits of $184,652. According to de Maison, around $340,000 of the funds at issue were transferred to their intended destination and were used for the benefit of investors. The panel agreed with the lower court's conclusion that this argument ignores that money is fungible and that de Maison did not overcome the SEC's showing that investor funds were transferred to de Maison's personal accounts and were used for personal expenses. Liu, the panel said, did not disturb the principle that specific tracing is unnecessary in ordering disgorgement. In all, the SEC fulfilled its obligation of establishing a reasonable approximation of the profits causally related to the fraud.

De Maison also challenged the district court's reimposition of the civil penalty, arguing that the amount was disproportionate in light of the reduced disgorgement sum. The panel concluded that the district court acted within its wide discretion in devising civil penalties. Nothing in Liu disturbs a court's power to order civil penalties, the panel said, and the Second Circuit has never held that a civil penalty needs to be proportional to the disgorgement amount. The penalty continued to represent de Maison's gross amount of pecuniary gain.

The case is No. 18-2564.

Tuesday, December 21, 2021

Uyghur human rights bill headed to president’s desk

By Mark S. Nelson, J.D.

The Senate passed a compromise version of the Uyghur Forced Labor Prevention Act (H.R. 6256) (See, Congressional Record, December 14, 2021, at H7804-H7806), which places the onus on U.S. companies to establish that their goods originating in the Xinjiang Uyghur Autonomous Region (XUAR) in China, where it is alleged that Uyghurs, Kazakhs, Kyrgyz, and members of other Muslim minority groups are subjected to human rights abuses by the Chinese government, are not the result of such forced labor. The compromise version, however, dropped a securities disclosure requirement that appeared in the original House version of the bill and resets the effective date for the rebuttable presumption that is at the heart of the legislation to a time frame between the original House and Senate versions of the bill. Even without the securities disclosure provision, the bill emphasizes the social component of environmental, social, and governance (ESG) investing, and public companies may still need to make disclosures if they otherwise would be material to their business. The House passed the bill by voice vote ahead of the Senate’s action and the bill now goes to the president’s desk.

Rebuttable presumption. The most recent version of the Uyghur Forced Labor Prevention Act imposes a rebuttable presumption that certain goods produced in the XUAR are banned from U.S. markets. The presumption, however, could be overcome if the Commissioner of U.S. Customs and Border Protection determines: (1) that the importer of record fully complied with applicable guidance and regulations and has completely and substantively responded to all inquiries for information submitted by the commissioner to ascertain whether the goods were mined, produced, or manufactured with forced labor; and (2) by clear and convincing evidence, that the good, ware, article, or merchandise was not mined, produced, or manufactured wholly or in part by forced labor. Upon determining to lift the ban, the commissioner must submit a report to Congress identifying the good and the evidence considered.

The compromise version largely tracks the original Senate version of the bill (S. 65) that was sponsored by Sen. Marco Rubio (R-Fla). The earlier House version (H.R. 1155), sponsored by Rep. Jim McGovern (D-Mass), provided for a rebuttable presumption but under slightly different terms. With respect to the timing of the implementation of the ban, the original House version of the bill provided for an effective date 120 days after enactment, while the Senate version provided for an effective date 300 days after enactment. The compromise version of the bill provides for an effective date 180 days after enactment.

The Uyghur Forced Labor Prevention Act’s rebuttable presumption would, like other bills addressing human rights issues (e.g., conflict minerals disclosures under securities regulations), provide for a sunset date. The compromise version of the bill provides for termination of the rebuttable presumption and of other provisions in the bill on the earlier of eight years after enactment or the date the President of the U.S. submits to Congress a determination that the Chinese government has ended mass internment, forced labor, and any other gross violations of human rights experienced by Uyghurs, Kazakhs, Kyrgyz, Tibetans, and members of other persecuted groups in the XUAR. By comparison, the conflict minerals provision contained in Dodd-Frank Act Section 1502 strips the president of such discretion for an initial period of five years (i.e., “on the date on which the President determines and certifies to the appropriate congressional committees, but in no case earlier than the date that is one day after the end of the five-year period beginning on the date of the enactment” (emphasis added)).

Other general provisions in the Uyghur Forced Labor Prevention Act would provide for: (1) the development of an enforcement strategy; (2) the development of a related diplomatic strategy, and (3) for the imposition of sanctions. However, the compromise version of the bill and the original Senate bill do not include the original House provision requiring a determination by the Secretary of State on whether Chinese actions in the XUAR constitute crimes against humanity or genocide.

Getting the bill passed. Senate action on the Uyghur Forced Labor Prevention Act was briefly delayed when Democrats threatened to object to allowing votes on the bill unless the Senate voted on three high level Biden Administration nominees who are perceived to be key to implementing the bill. Specifically, Sen. Chris Murphy (D-Conn) asked Sen. Rubio to agree to proceed with the nominations of R. Nicholas Burns to be Ambassador to China, Ramin Toloui to be an Assistant Secretary of State (Economic and Business Affairs), and Rashad Hussain to be Ambassador at Large for International Religious Freedom. Senator Rubio did not object to the request and all three nominees were later confirmed by the Senate by significant margins on December 16, 2021 (Burns; Toloui; Hussain).

But proceedings had been further delayed when, shortly after Sen. Rubio agreed to Sen. Murphy’s request, Sen. Ron Wyden (D-Ore) objected to bringing the bill up for a vote until the Senate acts to extend the soon-to-expire child tax credit. A day later however, the Senate was able to move forward and pass the Uyghur Forced Labor Prevention Act.

In anticipation of passage, Sen. Rubio appeared to dispel concerns that companies would be caught off-guard by the ban on the importation of certain goods from the XUAR. “Many companies have already taken steps to clean up their supply chains, and, frankly, they should have no concerns about this law. Yet for those that have not done that, they will no longer be able to continue to make Americans—every one of us, frankly—unwitting accomplices in the atrocities and genocide that are being committed by the Chinese Communist Party.”

When the bill was debated in the Senate earlier in the week, Senator Rubio remarked on the supply chain aspect of the problem of slave labor as detailed by a New York Times report. Said Sen. Rubio: “I think it is also appalling that it reveals the level of dependence this country has and the need we have to rebuild our industrial base in this country and in allied nations. It is appalling because it is a fact that we are so dependent on China in our supply chain, that many have asked us to look the other way, to not complain about this, to not pass a bill about this because it would disrupt supply chains, when what they really mean is it would disrupt the bottom line, their profits.”

Likewise, Sen. Jeff Merkley (D-Ore) reached a similar conclusion: “Behind those fancy performances in the opening ceremonies [referring to the upcoming Olympic Winter Games to be held in China and for which the Biden administration has issued a diplomatic boycott], there is a very, very ugly truth. That ugly truth is that the Chinese Government is committing genocide against the Uighur population. More than a million Uighurs are enslaved, and they are enslaved to produce products for the world for the profit of China.” Senator Merkley then explained the purpose of the legislation. “And I don’t think anyone in America wants us to be complicit in genocide by buying these products. That is what this bill is all about,” said Sen. Merkley.

Earlier version had SEC disclosure provision. The original House version of the Uyghur Forced Labor Prevention Act contained a securities disclosure provision that resembled the existing Iran sanctions notice disclosure provision contained in Exchange Act Section 13(r). Specifically, the bill would have required a company subject to SEC reporting requirements to disclose in an annual or quarterly report certain information if it knowingly engaged in an activity with an entity or the entity’s affiliate that, in turn, had engaged in specified activities, including the provision of technical assistance for mass population surveillance in the XUAR or the building and running of detention facilities in the XUAR. A company that engaged with such entities would then have had to disclose a detailed description of: (1) the nature and extent of the activity; (2) gross revenues and net profits attributable to the activity; and (3) whether the company intended to continue the activity. Exceptions to the disclosure requirement existed for the importation of certain manufactured goods that originated in the XUAR (i.e., electronics, food products, textiles, shoes, and teas) and for manufactured goods that contain materials originated or sourced in the XUAR.

A company that made the required disclosure report also would have had to separately file a notice with the SEC that the disclosure had been made, similar to the Iran notice companies already file on EDGAR. The SEC then would have transmitted the report to the president and Congress and make the information in the disclosure and notice publicly available on the SEC’s website. The president would then have had to determine if an investigation for possible imposition of sanctions is appropriate or whether a criminal investigation is warranted.

A policy statement in the House version of the bill provided that it is U.S. policy to protect American investors regarding the presence in U.S. markets of Chinese and other companies that are complicit in gross violations of human rights. A findings section in the House bill stated that, since 2017, China has arbitrarily detained up to 1.8 million Uyghurs, Kazakhs, Kyrgyz, and members of other Muslim minority groups in internment camps where these persons are subjected to forced labor and other human rights abuses.

Monday, December 20, 2021

ESG picks up steam heading into 2022

By Matthew Garza, J.D., Mark S. Nelson, J.D., Lene Powell, J.D., and Brad Rosen, J.D.

This year has been a steady build up to what promises to be an active period of rulemaking, enforcement, and maybe even lawmaking on the environmental, social, and governance (ESG) front in 2022. In this article our analysts offer a comprehensive review of ESG activity of 2021 at the SEC, CFTC, and Congress, and highlight key issues to watch next year. We start with social and governance, where the SEC has already adopted rules and is now proposing modifications, then look at the SEC’s ESG enforcement activity and the CFTC’s ESG efforts. We summarize myriad ESG bills floating around the 117th Congress, take a deep dive into the formation of sustainability reporting standards, and provide a chronological list of other relevant activity from the SEC. Click here to read our analysts’ take on 2021 and the year ahead.

Friday, December 17, 2021

Behnam confirmed as CFTC Chair; White House nominates two for CFTC Commissioner

By Lene Powell, J.D.

At long last, Rostin Behnam has been confirmed by the Senate as the permanent chairman of the CFTC. Behnam has served as CFTC Acting Chair for almost a year. His confirmation was welcomed by Senate Agriculture Committee leadership and industry organizations.

Behnam has served as a CFTC commissioner for the past four years and as Acting Chair since January 22, having been elected to the latter position upon the administrative turnover in January. He was nominated for chair and a second term earlier this year.

On the same day, the Biden Administration announced its intent to nominate Summer Mersinger and Caroline Pham for CFTC commissioner. They join previously announced nominees Kristin Johnson and Christy Goldsmith Romero. If confirmed, together the four nominees will fill current vacancies and the pending departure of Commissioner Stump to constitute a full five-member Commission.

Bipartisan support for Chair Behnam. The new chair received strong bipartisan support in a statement from leaders of the Senate Agriculture Committee, which oversees the CFTC.

“Russ’ expertise and experience have proven that he prioritizes the interests of customers and our agricultural industry. He has been a leading voice on the financial risks of the climate crisis, and will be tough on those who break the law,” said Sen. Debbie Stabenow (D-Mich.), committee chairwoman. “I am glad my colleagues and I came together on a bipartisan basis to confirm this outstanding nominee.”

“Rostin Behnam can now finally shake the ‘acting’ title and officially take the helm at the CFTC. He has proven himself more than ready for the role while overseeing the agency pre-confirmation. I believe his understanding of agriculture will be a huge asset as chairman, and expect him to continue to bring a measured approach to regulating, which is critical for proper management of the wide range of financial products under the CFTC’s jurisdiction,” said Sen. John Boozman (R-Ark.), committee ranking member.

Industry Reaction. Behnam received support from key trade associations.

“FIA congratulates Russ Behnam on his confirmation to chair the CFTC. Chairman Behnam brings a depth of experience to the office that will serve the public well. He has been a principled advocate for safe, open and transparent markets, and FIA looks forward to working with Chairman Behnam and the Commission on the important issues facing our industry,” said Walt Lukken, president and CEO of FIA, the leading global trade organization for the futures, options and centrally cleared derivatives markets.

“We congratulate Rostin Behnam on his confirmation as Chairman of the CFTC. We look forward to working with Mr. Behnam on issues that enhance and maintain the integrity of our capital markets and wish him success in this role,” said Kenneth E. Bentsen, Jr., SIFMA president and CEO.

New nominations for Commissioner. The White House announced its intent to nominate two candidates for CFTC Commissioner.
  • Summer Mersinger has served as chief of staff to CFTC Commissioner Dawn D. Stump and as the director of Legislative and Intergovernmental Affairs. Previously, she spent 15 years on staff in the U.S. House of Representatives and Senate for Congressman and then Senator, John Thune from South Dakota. Mersinger received her undergraduate degree in political science from the University of Minnesota-Twin Cities and her law degree in 2007 from Catholic University’s Columbus School of Law in Washington, D.C.
  • Caroline Pham is currently a managing director at Citi, where she is head of market structure for strategic initiatives in Citi’s Institutional Clients Group. Pham represents Citi on the Executive Committee of the Chamber of Digital Commerce and has advised on prudential regulation and systemic risk, financial markets including currencies and commodities, fintech and digital assets, and environmental, social and governance (ESG). She has also led initiatives for Dodd-Frank Act implementation and other global financial regulatory reform. Pham previously served as special counsel and policy advisor to former CFTC Commissioner Scott O’Malia. She has a B.A. from UCLA and a J.D. from the George Washington University Law School.